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1.1Getting Started

Before discussing strategy itself, let us begin by discussing the context of strategy. How does strategy fit within the general field of business? How does it compare to the other disciplines of business?

Many experts would argue (depending on the industry) that marketing, finance, and/or human resources are most important to the success of the company.  How can a business survive, they argue, without adequate human capital, a solid marketing campaign and money for daily operations? However, business strategy is somewhat different from these disciplines because strategy is more holistic than other areas of business. Business strategy touches every other area of business and a business can use any company resource to further its overall strategy. Strategy is at least as important as other areas of business because it encompasses and integrates with the other business disciplines.

In other words, effective strategists will use the organization's accounting system, operations, information systems, human capital, marketing, and any other available tool as part of its strategy. Used appropriately, strategy will use every discipline within the organization to accomplish its organizational goals.

1.2What is Strategy?

Strategy is the method that an organization uses to reach its goals. According to this definition, strategy is fundamentally a broad term. In the right context, almost any plan of action can be considered an organization’s strategy. Most academic papers on strategy, as well as this book, focus on competitive strategy. Competitive strategy is the way that an organization is going to compete in its industry. However, the tools and techniques of competitive strategy can be adapted to an organization’s quest for other goals.

Since competitive strategy (by definition) is focused on competition, competitive strategy is often expressed in terms of sports, war, history, survival, and board games. This terminology is transferred to the field of strategy as a whole. For example, when a manager states, "What is our game plan?" the manager is asking for clarification about the organization's strategy. When an organization ‘crafts' or builds its strategy, it is specifically choosing the actions it will take in the marketplace, including how it is going to compete with and outperform other organizations.

Stakeholders can often observe an organization's chosen strategy by evaluating what the firm does in the marketplace and asking questions such as the following:

· What industry does the firm operate in?

· What products and/or services does the firm market and sell? Does the firm take an offensive or defensive position?

· What is the firm's target market?

· Does the firm invest in research and development? Why or why not?

· What product or services does the firm offer that are different from competitors?

· What makes the firm successful or unsuccessful?

· Where does the majority of the firm's money come from?

· What type of employees does the firm invest in?

· How does the firm choose to market its products?

· Why type of manufacturing does the firm use?

Stakeholders can also come to understand an organization's strategy by evaluating statements made by upper management. Often, these statements can be found in mission statements, newsletters, press conferences, employee meetings, and even a company's annual report to shareholders. For example, consider Microsoft's 2012 annual report by its CEO Steven A. Ballmer:

Excerpt from Microsoft's 2012 Annual Report

"As we enter this new era, there are several distinct areas of technology that we (Microsoft) are focused on driving forward – all of which start to show up in the devices and services launched this year. Leading the industry in these areas over the long term will translate to sustained growth well into the future. These focus areas include: 

· Developing new form factors that have increasingly natural ways to use including touch, gestures, and speech. 

· Making technology more intuitive and able to act on our behalf, instead of at our command, with machine learning.

· Building and running cloud services in ways that unleash incredible new experiences and opportunities for businesses and individuals.

· Firmly establishing one platform, Windows, across the PC, tablet, phone, server and cloud to drive a thriving ecosystem of developers, unify the cross-devise user experience, and increase agility when bringing new advancement to market.

· Delivering new scenarios with life-changing improvements in how people learn, work, play and interact with one another."

It is clear that Microsoft Corporation's strategy over the coming decade will be to capitalize on an emerging market that focuses on intuitive machine learning, touch and speech technology, cloud services, and life-changing improvements in how people learn, work, play and interact one with another.

In essence, Microsoft is experiencing a shift in its strategy - going from a producer of operating systems - to an industry leader in cloud, interface and life-changing technologies. As part of its strategy, Microsoft is trying to develop products and services that will create a competitive advantagethat will benefit Microsoft in the marketplace. When an organization has a competitive advantage, it has an ‘advantage' or ‘unique capability' that sets it apart from all other players in the market. A central part of any strategy is the organization's ability to create a sustained competitive advantage.

1.3The Future of the Firm

Since strategy touches so many different aspects of a company, it can be difficult to know where to begin. In order to create a starting point and build a foundation for strategy, a firm should continually ask itself the following three questions:

1. Where are we currently? 

2. What are our goals? 

3. How will we reach our goals? 

Where are we currently?

Before managers can refine a company's strategy and decide on any future course of action, they must first understand the organization's current status. Unfortunately, understanding the status of a firm can be a challenging and difficult process that many organizations overlook. In deciding where the firm is currently at, it is helpful to get feedback from shareholders, customers, partners, and employees. Frank and honest feedback from stakeholders can help the firm improve processes, improve customer service, lower cost, and improve overall productivity.

Organizations can also use strategic financial numbers to help the organization understand its current profitability, revenue, market share and sustainability. Later in the course, we will discuss and examine financial statements in an effort to better understand the financial health of organizations. We will also learn about and discuss common financial ratios and how to compare financial ratios with other firms to help understand the competitiveness of the firm. 

What Are Our Goals?

Determining the future path of the organization is one of the most important decisions that any organization can make. When done correctly, deciding the goals and objectives of the organization can bring alignment and purpose to the firm. Furthermore, when organizations both define and communicate a common purpose for shareholders, it allows employees, partners, vendors and others to work together and influence one another towards organizational goals.

Organizations can choose from a variety of paths and directions. Obviously, some of these paths will result in sustainability, profitability, and success. Some paths will lead to decreased market share, lower profitability, and possibly closure. In choosing a path, firms must decide which product or service to sell, which industry to pursue, and which markets to enter.

How Will We Reach Our Goals?

After management has decided where they want to take the organization, they must then identify and implement the steps and actions that will help the organization to achieve both it's long-term and short-term goals. While most organizations want to increase market share, lower cost, and increase profitability, organizations must understand how best to do so. While most business goals are worthy endeavors, many organizations fall short in identifying and understanding the steps required to reach their objectives. And, even in situations where management is able to accurately identify necessary steps, firms often fail to reach their desired goals because of lack of understanding of the goals and resistance by employees. Furthermore, leadership within the organization may not put forth the required work, time, money and other resources needed to reach the goals.

Because of the fast-paced global environment of business today, even if management does gain companywide acceptance of goals and invests the necessary resources required to reach those goals, factors in the external environment – such as an increase in competition, economic risk, disruptive technologies and political disruptions – may still prevent the firm from reaching where it wants to go. In order to respond to the challenges of today, organizations must be flexible, adaptive and responsive to both the internal and external environment.

1.4The Internal and External Environments

The internal environment and external environment are foundational concepts for understanding strategy. At first, the distinctions between these environments seem trivial - one is about factors outside the firm, the other about the factors within. Yet many of the most influential tools in business strategy are rooted in this distinction. A clear understanding of and distinction between the internal and external environment will guide strategic actions because the organization can focus on what it can control, instead of becoming frustrated with external factors. Throughout this book, many of the tools and ideas will build upon this foundation. 

Strategic fit is one such idea. It would be difficult to understand strategic fit without an understanding of the internal and external environments. Strategic fit is the degree to which an organization can match its internal resources and capabilities with opportunities in the external environment.

Influencer spotlight: Michael Porter

Michael Porter

Michael Porter is one of the most influential figures in business strategy. His ideas have not only shaped the academic field of business strategy but are widely used by successful businesses around the world.

What made Porter's work so influential? Part of its influence came from his training in economics - he brought concepts and ideas from economics into business strategy, changing the way businessmen talk and think about strategy. This focus on economics, combined with his expertise on competition, gave him a unique ability to advise countries on their economic strategy.1

Porter's ideas and tools are discussed throughout this book, including Porter's Five Forces, Porter's Four Corners Analysis, Strategic Fit, and CSR.

Education

· Undergraduate - Aerospace and Mechanical Engineering - Princeton

· M.B.A. - Harvard Business School

· Ph.D. - Business Economics - Harvard Department of Economics

Career Progression

Upon finishing his Ph.D., Dr. Porter's work focused on corporate strategy and industry competition. During this time, he published widely influential articles and books - How Competitive Forces Shape Strategy (1979), Competitive Strategy(1980), and Competitive Advantage (1985). 2

During the 1990s, Porter's research centered around how regions and nations could use microeconomic principles to improve their competitiveness. In particular, he looked at the idea of clusters - regions where companies of a particular industry were clustered close together in a way that is mutually beneficial.3

Starting in the 2000s, Dr. Porter began analyzing the economics of health care. This work included measuring patient outcomes, reimbursement models, and health systems with multiple, integrated locations. 4

The External Environment

There are, obviously, many events and circumstances outside of a given organization. The external environment focuses on a subset of these events and circumstances - the factors that will impact the organization. Some difficulty arises in considering a broad enough range of factors that impact the organization without considering unnecessary factors. Some strategic tools, such as the STEEPLE Analysis, help broaden the manager's perspective on what impacts the firm. Other tools, such as the Weighted Comparative Strengths assessment, narrow the manager's view to focus on certain important factors. Organizations cannot directly change the external environment. However, they can respond to changes in the external environment. An incorrect response could spell disaster for the company, while a spectacularly good response could create a temporary comparative advantage.

Factors in the External Environment

· Legal oversight and regulation

· Macroeconomic trends

· Interest Rates

· Labor market constraints

· Industry growth or decline

· Competition

· New Market Entrants

· Relative strength of competitors

· Political Factors

Tools to Analyze the External Environment

· Porter's 5 Forces - provides a broad perspective on competition. 

· STEEPLE Analysis - a comprehensive analysis of the external environment. 

· SWOT Analysis - an integrated top-level analysis of both the internal an external environments. 

Questions to analyze the External Environment

Organizations that can respond well to the external environment reach new customers, provide innovative products and services, and integrate technology before their competitors do. The following questions can help you understand the external environment: 

1. From an economic perspective, what are the dominant features of the industry? 

2. Given the current information available, what is the future of the industry? 

3. What are the dominant forces that competitors must overcome in this industry? 

4. How impactful are the dominant forces within the industry? 

5. What market position does each competitor occupy? 

6. What moves are competitors likely to make? 

7. Which products/services will make this industry succeed? 

8. Are there players currently not in the market, which could easily compete within it? 

9. Are there disruptive technologies that could change the landscape of the industry? 

10. Are there economic and/or political changes that could re-define the industry?

Questions like these can highlight which factors in the external environment are most important to the organization. 

The Internal Environment

The internal environment refers to the conditions, events, entities, and factors that occur within (or internal to) the organization. As companies define their internal environment, they can align their resources to compete most effectively. An effective internal environment can provide a firm with the competitive advantage it needs to succeed in its industry. 

Factors in the Internal Environment

· Employee skills and experience

· Technology

· Organizational structure

· Trademarks, patents, and trade secrets

· Management

· Production capabilities

· Team cohesion

Tools to Analyze the Internal Environment

· SWOT Analysis - - an integrated top-level analysis of both the internal an external environments.

· Pareto Analysis - an analysis based on the 80 - 20 rule. 

· Organizational Resources - the resources available to an organization

· Measuring Productivity

1.5Strategic Management

One of the most important responsibilities of top management teams is to develop and execute plans to align the internal environment with the external environment in a way that will provide a competitive advantage. In order to achieve this objective, managers follow a process of developing and implementing a competitive strategy. The strategic management process consists of the following:

· Crafting the principal mission of the organization.

· Evaluating the internal strengths and weaknesses of the organization.

· Analyzing the opportunities and threats in the external environment.

· Developing the plans that the organization should implement that will enable it to best compete in the changing environment.

· Executing an action plan that will achieve organizational goals.

Figure 2-1:

1.6Choosing Strategy and Goals

Based on the strengths and weaknesses of the firm and the opportunities and threats that prevail in the environment, managers must formulate a strategy and goals. There are many levels of strategy and goals that build on one another and ultimately should be consistent with the overall mission of the organization. The grand strategy is the overarching plan for the firm. Under that grand strategy umbrella there may be corporate level strategies and business level strategies. Furthermore, those strategies can consist of more specific strategic goals, tactical goals, and operational goals.

Grand strategy is high level strategy for the organization that provides basic direction and long-term goals.1 Grand strategies typically consist of the objective to grow the business, seek to maintain current revenue and profit levels, or reduce the size of the business to restructure for the future. Facebook is an example of a company that is seeking high growth. Many owners of lifestyle ventures—small businesses that provide income for the owners—have the grand strategy of maintaining a stable size from year to year. General Motors recently enacted a retrenchment strategy as they cut brands like Oldsmobile and Saturn, and downsized the company to seek greater competitiveness.

The corporate level strategy determines the types of business in which the firm will compete. For example, Coca-Cola is in the business of making soft drinks and other beverages. Coca-cola is focused on making and distributing beverages. On the other hand, PepsiCo competes in the same business as Coca-Cola but PepsiCo's management team has also determined to be a major player in snacks (Frito-Lay) and other related foods (Quaker Oats). At the corporate level, executives must determine the right business mix to create a competitive advantage for the corporation. PepsiCo executives feel that there are significant synergies between snack foods and beverages insomuch that they are able to leverage those synergies to grow both business segments in a way that they would not be able to accomplish if they were independent businesses.13 Therefore, they have sought more diversification in their businesses than Coca-Cola has.

Diversification is seeking to expand into related or unrelated industries. PepsiCo's diversification strategy sought related businesses that might benefit from shared distribution and marketing efforts. In contrast, General Electric has broadly diversified the company into many unrelated industries. GE competes in kitchen appliances, commercial finance, medical technologies, and jet engines, among others.

Executives may also choose to diversify through vertical integration. Vertical integration is defined as the integration of new businesses that expand the range of value chain activities for the company. For example, PepsiCo could choose backward integration by moving into supplier businesses. They could purchase agriculture businesses to grow their own oranges for orange juice or sugar for soft drinks. Or they could choose forward integration by entering the retail market. PepsiCo could begin to compete in the restaurant industry (which they have done in the past) or convenience store industry in order to emphasize the sale of the beverages and snack foods that they manufacture and distribute.

Managers may consider a number of strategic options to accomplish the desired business mix. Mergers, acquisitions, and strategic alliances are frequently used strategic tools. A merger happens when two or more organizations combine to become one. In 1965, Pepsi-Cola merged with Frito-Lay to create PepsiCo.14 Mergers often result in a company with a new name, but that is not a necessity. In 2001, PepsiCo participated in another merger, this time with the Quaker Oats Company, but retained the name of PepsiCo.15 Such mergers allowed PepsiCo to diversify their overall business mix with related but separate product lines.

An acquisition differs from a merger in details of ownership control and ongoing management control. Strictly speaking, in an acquisition, one company purchases and assimilates another company. From a strategic viewpoint, mergers and acquisitions are very similar as the net result is a combination of the resources and capabilities of the two companies. PepsiCo acquired Tropicana in 1998 and the juice beverages were integrated into the PepsiCo beverage business unit.

If a firm has a deficiency in resources or capabilities but does not want to pursue a merger or acquisition, it may seek a strategic alliance with another firm. A strategic alliance is an agreement between two or more distinct companies in which they choose to share strategic resources or capabilities. Strategic alliances are commonly used in product development when one or both companies lack the needed expertise or resource to develop, manufacture, or sell a new product offering. At times, allying with a partner may be more timely and cost effective than trying to develop that particular expertise in house. In 2012, Ocean Spray Cranberries entered a strategic alliance with PepsiCo in Latin America. PepsiCo will have the exclusive rights to manufacture and distribute some of Ocean Spray's juice products in the Latin America market.16 Ocean Spray does not have the manufacturing and distribution resources that PepsiCo has in Latin America. PepsiCo does not have the brand recognition or expertise in cranberry based drinks that Ocean Spray has. The strategic alliance allows both companies to benefit from sharing important resources and capabilities.

The business level strategy is concerned with how the business unit competes within the industry. Business level strategy focuses on developing the right product line within the chosen business, effectively marketing and selling the products or services, efficiently managing the operations, and so forth. Business level strategy is best accomplished by setting clear goals for the business.

A goal is a desired future result that the organization strives to achieve. Goals provide direction and motivation to organizational members. Effective goals are specific, measurable, relevant, challenging but achievable, and linked to appropriate time periods and rewards. Goals act as a guide to action and can be used to provide direction for future decisions. Goals also help to motivate employees to work towards a common purpose.2 They provide a standard of performance that can be used to measure the organizations performance.

In order to achieve higher level strategic goals, managers may set specific tactical and operational goals. Each of the lower level goals should be directly tied to the accomplishment of a higher level goal. For example, a strategic goal may include "we will achieve 40% market share in the U.S. market by the end of 2013." Tactical goals related to marketing, e.g. launch a new online product promotion, might be set to help improve market share during the next quarter. Furthermore, the web based marketing team may set an operational goal to increase the page views of the new promotion by 25% during the next 30 days. Such goals will direct and encourage employees to develop and execute plans to achieve the stated objectives.

1.7Implementing Strategy

The final step in the strategic management process is the implementation of the strategy. No matter how brilliant the strategy, it can all fall short of expectations if it is not effectively implemented. Strategy falls primarily under the planning function of management. Implementation incorporates the organizing, leading, and controlling functions of management which will be covered in detail in the remaining chapters of the textbook.

1.8References

1 Kawasaki, G. 2004. The art of the start, New York: Portfolio.

2 Bartkus B, Glassman M, McAfee B. Mission Statement Quality and Financial Performance. European Management Journal, 24(1), 86-94.

3http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/9024539/Kodak-130-years-of-history.html

4 http://www.informationweek.com/news/global-cio/interviews/232400270

5 http://www.reuters.com/article/2012/01/19/us-kodak-bankruptcy-idUSTRE80I1N020120119

6 http://www.reuters.com/article/2012/01/19/us-kodak-idUSTRE80I08G20120119

7 Barney, J, & Hesterly, W. Strategic Management and Competitive Advantage. (New Jersey: Pearson, 2010)

8 Porter, M. Competitive Advantage (New York: Free Press, 1985)

9 Kim & Maugborgne (2000), Knowing a Winning Business Idea When You See One. Harvard Business Review, 2000 Sep-Oct;78(5):129-38, 200.

10 Porter, M. Competitive Advantage (New York: Free Press, 1985)

11 http://www.usatoday.com/money/industries/technology/story/2012-06-26/google-io-tablet/55844912/1

12 Pearce, J. "Selecting Among Alternative Grand Strategies," California Management Review. Spring 1982: 23-31.

13 http://www.pepsico.com/Investors/Corporate-Profile.html

14 http://www.pepsico.com/Investors/Corporate-Profile.html

15 Ibid.

16 http://www.pepsico.com/PressRelease/PepsiCo-and-Ocean-Spray-Announce-Strategic-Alliance-in-Latin-America01172012.html

17 Locke, E. & Latham, G. "Building a practically useful theory of goal setting and task motivation: A 35-year odyssey." American Psychologist. Vol 57(9), Sep 2002, 705-717.

Chapter 2:

2.1Introduction to Strategic Analysis

Learning Objectives

1. Explain the importance of matching strategy to a specific business.

2. Differentiate Between Planning, Craftng, and Emergent Strategies

3. Use SWOT and PESTLE Analyses to evaluate companies. 

4. Explain how mission and vision statements can improve an organization. 

5. Define Points of Parity and Points of Differentiation.

6. Describe various organizational resources that impact a company's strategy. 

7. Describe the components of a Balanced Scorecard and Product Revenue Analysis. 

8. Evaluate the competitive advantage of a company using the VRIO Framework.

9. Explain how Internal and External Evaluation Matrices are used. 

10. Use the McKinsey 7S Model to describe how various parts of a business are interrelated.

2.2Setting/Choosing a Strategy

How do you craft a business strategy that is a great fit for your business? This is certainly not an easy question, but this book is designed to help. By exposing you to a wide variety of strategies and strategic tools, we hope to give you the perspective and frame of reference to better create and implement a strategy for your business.

Why do you need a strategy?

Why does your business even need a strategy? Why can’t you just do business? Using a specific strategy helps your company to gain a competitive advantage, use resources efficiently, and narrow your focus. Inevitably, all good companies implement some sort of strategy that fuels their success. However, many failed companies also had a strategy. Thus, the task becomes choosing the right strategy.

Benefits of Great Strategy

A great strategy is one that effectively drives growth, solves problems in your company, and is easily turned into actions that employees can put into practice. This is obvious, but identifying which strategy will actually accomplish those things is rather difficult. For that reason, we have provided strategy tools throughout this book. These are ways of looking closely at your business and the competitors to figure out an effective strategy. Examples include the SWOT analysis, the PESTLE analysis, the Pareto analysis, and a variety of other analyses and assessments. These allow you to identify where your company is at, what drives its growth, what it is good at, and where it is struggling.

Match Your Strategy to Your Business

It is important that your strategy matches your business. Perhaps too often, people will look at a successful company like Apple and copy its strategy. Fundamentally, Apple is at a different point than your company is, and is probably positioned much differently than yours. Look at your company: are you the low cost leader, the premium brand, or a middle-priced competitor? Do customers buy because your product has nice features, or because it is the only product that fulfills a need? Do you service the high-end of the market, or some other section? Unless you offer a premium product and have fierce customer loyalty that allows you some exclusivity, you can’t realistically copy Apple’s current strategy. Instead, look for strategies that match your company. This will help your company have great strategic fit in future decisions. 

Look at where your business operates. Do you focus on a certain region of the country? Who are your customers? Do you focus on private label or on wholesale? Your location and distribution strategy will likely play a role in which strategy is right for you. It is practically impossible to have a strategy that doesn’t align with your distribution model. If your business is mainly focused on distributing through some local retail stores, you cannot have a low-margin, high-volume strategy and hope to succeed.

Set Yourself Apart

How does your company differentiate itself from the competition? This is a fundamental question when choosing a strategy. If you can’t set yourself apart from the competition, you will likely fail. If your strategy doesn’t focus your time and effort on the things that set you apart, your company is misusing its resources. Find what you do well and set up the business so the profits follow your expertise. 

As you go through this book, you will likely notice that many of the strategies overlap, and some of them seem very similar to each other. This simply lets you craft more precisely what you want in your business’s strategy. We invite you to modify and adapt any of the ideas and frameworks explained in this book to match your business’s specific needs.

2.3Planning, Crafting, and Emergent Strategies

Planning Strategy

Imagine that you are a professional basketball player and are playing in the national championship game. Before the game, the coaching staff likely created a plan – or strategy – to win the game. The strategy will likely be based on hours of film and careful evaluation of the other team. As the strategy is developed and planned, the coaching staff will have evaluated both the strengths and weaknesses of the opponent and compared those to your own team’s strengths and weaknesses. The purpose of the strategy is to exploit the opposing team’s weaknesses and emphasize your team's strengths in order to win the game.

Notice that the entire process of designing the strategy takes place before the game even starts. For most coaches, careful study, analysis, and benchmarking before the game is key to success. Similarly, in the business world, most senior managers and executives plan their strategies long before they are implemented. In fact, when most people think of strategy they often imagine a group of high-level executives sitting in a boardroom, using various analyses to better understand the organization and the direction it should go. In fact, many of the tools throughout this book are designed to be used in strategic planning. Such board meetings often include an analysis of the industry and a thorough evaluation of rivals. As such, most managers would agree that strategy is a plan, or course of action, that the firm should follow. This approach to strategy is often referred to as planning strategy. Planning strategy involves a careful analysis of rivals and markets to plan specific objectives, goals, and courses of action.

Crafting Strategy

While planning strategy is both important to organizational success and frequently used, there are other methods for creating strategy. Henry Mintzberg, a professor at McGill University and one of the pioneers in strategic management, challenged the traditional approach of planning strategy. He claimed that many important strategies are not planned before they are implemented but are crafted during the process of implementation. These strategies come about on their own in response to situations that arise.  In the basketball example, imagine that halfway through the championship game your team is behind by 20 points and struggling to maintain possession of the ball. Obviously, the predetermined – or planned – strategy was not actually a good course of action (or the opposing team’s strategy was simply better than yours). It was impossible to know before the game that your team’s planned strategy would be ineffective during the game. In this case, should your team change its predetermined strategy or stay true to the plan? Are there adjustments that your team should make to the defense and offense? Suppose that your team deviated from the planned strategy for a few plays and scored several points. Should you change your strategy mid-game so that your team will have a chance of winning? Henry Mintzberg refers to the process of learning, adapting and changing while engaged in business as the process of crafting strategy. In other words, crafting strategy is the process of developing strategy through action, learning, trial-and-error, self-analysis, and experience. Mintzberg suggests that crafting strategy, instead of planning strategy, is more likely to result in a successful strategy.1

One simple way to craft a strategy is to use your own products. By experiencing what it is like to be the consumer, you will likely discover how to craft your strategy.

Emergent Strategy

When an unplanned strategy emerges, it is often referred to as an emergent strategy. In other words, an emergent strategy is a strategy the simply comes about on its own that was not expressly intended.

According to Mitzenberg, emergent strategy is like weeds that pop up uninvited. The company either doesn’t have a clear set of goals or the emergent strategy doesn’t align with the original, outlined strategy. The clearest examples are companies that started out in one line of work, failed, and changed to pursue a different direction. 3M was originally founded as a mining company but transitioned into Scotch Tape, Post-It Notes, and Scotch-Brite cleaning products. Another example is Groupon. Originally, it was founded as The Point, a website which allowed users with a common cause to unite into a more powerful group. They had essentially no success. However, when a group got together with the cause of “saving money,” they enlightened the company leadership on a much better business plan—to offer an incredibly good deal every day to a local business, based on enough people signing up for it. Business could bring in a windfall of new customers or could unload extra inventory. The business became so popular that they hired 10,000 people in less than two years. No one in the original company planned on creating Groupon. Instead, their winning strategy emerged out of the market.

2.4SWOT Analysis

Strengths, Weaknesses, Opportunities, and Threats

One of the most frequently used analyses in business strategy is the SWOT analysis. A SWOT analysis looks at the favorable and unfavorable aspects of both the internal and external environment of a company. SWOT is a relatively powerful analysis because it can be used to both mitigate risks and potential competitive advantages. To begin, ask yourself the following four questions:

1. What are the company’s internal strengths?

2. What are our internal weaknesses?

3. What external opportunities do we have?

4. What external threats stand in our way?

Elements of a SWOT Analysis

Strengths

A strength is a resource or capability that provides the organization with an advantage relative to its competitors. Strengths may include the ability to develop new technologies, a reputation for exceptional customer service, superior efficiency in production, or accuracy in predicting customer needs. Organizations may have a unique strength in marketing, operations, design, or other specialties that leads to a competitive advantage.

Weaknesses

A weakness is a shortcoming or vulnerability in an organization's capability compared to competitors. Weaknesses generally stem from a lack of resources or competencies. For example, an organization may lack the financial resources to build a larger factory, resulting in missed profits and a decline in market share. A firm may not have the needed technical or design talent required to effectively compete. Sometimes, it can be a weakness to be slow-moving in industries that are rapidly changing.

Opportunities

An opportunity is a condition in the external environment that represents a prospect to improve the organization's competitive position in the market. Changes in technology, a growing middle class in international markets, or new sociocultural trends may provide fresh opportunities for businesses in the general environment. Stakeholders may also present opportunities such as improving relationships with key suppliers, finding a new segment of customers that had not previously been targeted, or partnering with a social cause to build goodwill.

Threats

A threat is a condition in the external environment that is unfavorable to the competitive potential of the firm. Examples of threats from the general environment might include a poor economy, changing sociocultural trends, or new laws and policies implemented by governments. Threats may also come from stakeholders in the external environment such as new competitors entering the market, poor relations with strategic partners, or special interest groups criticizing the organization.

Examples - SWOT Analyses at Different Levels

Personal SWOT Analysis

Let’s personalize this idea by performing a SWOT analysis on you. We will begin with the internal environment, which corresponds to your individual personality traits and characteristics. What are your strengths? As a student, you’re most likely young, bright, and educated (or becoming educated). Maybe you have specific talents that make you especially likable or brilliant in a certain subject. What are your weaknesses? Are you sometimes lazy, prone to lose your temper, or spend too much time on social media? What aspects of your personality prevent you from living a more meaningful life?

The external environment (your surroundings) also influences your state of being. What opportunities do you currently have? You have the opportunity to educate yourself, prepare for future employment, and choose what you want to make of your life. In fact, you have countless opportunities. Finally, what are your current threats? What could knock you off your feet if not addressed correctly? Is there a threat of not doing as well in this class as you’d like? Are you afraid you may not be accepted into your preferred grad school or maybe struggle to find a job? Performing a SWOT analysis allows for full understanding of what is most important to an individual, project, business, or even industry. It provides a way to understand a situation, analyze it, and then take the necessary steps towards improvement.

Industry SWOT Analysis

While a SWOT analysis is generally used to analyze a company, it can also be used to analyze an industry. Consider, for example, the online industry of goods and services (companies like Amazon and eBay operate in this industry). Strengths of such an industry could be its accessibility, convenience, and popularity. Weaknesses may include stiff competition, laws that make it difficult to operate, and security issues. An opportunity has developed in the online goods and service industry as the world has turned towards the internet as a replacement for old business practices. Threats to the industry involve heavy competition, compromised security, and lost or stolen devices and ideas.

Company SWOT Analysis

Now consider ramengobblers.com, a small online business that specializes in university student goods and services. Ramen Gobblers allows students to post housing contracts, textbooks, and merchandise they are willing to sell to other students at their university. 

Strengths

· Low startup costs - the company is very asset-light 

· Easy maintenance (low variable costs)

· Well-identified target market and clear ability to market specifically to customers (college campuses gather students together)

Weaknesses

· Low brand recognition (the company is relatively unknown)

· Limited capital 

Opportunities

· Potential partnerships with college - can gain quick access to lots of students if the app is approved by the college's administration for an exclusive partnership 

Threats

· Low barriers to entry invite competition

· Revenue model relies on advertising - requires a large consumer base to be profitable

· Potential for hacking 

As the CEO of Ramen Gobblers, how would you address your concerns and utilize the company's strengths and opportunities? You could minimize your threats by getting the site up and running quicker than other rising competition. You could instigate a marketing plan to promote the app and make sure that proper security measures are taken. To take advantage of its strengths and opportunities, Ramen Gobblers should stress its niche in the college market and try to capture the market quickly.

2.5Mission and Vision Statements

Definitions for mission and vision statements vary widely, nearly as much as opinion does on how to use them. Some believe vision and mission statements are exactly the same. Others say the vision statement explains the “what” and the mission statement explains the “how”. Others think it’s the other way around. In the end, your organization’s vision and mission statement can be whatever you want it to be. Almost all organizations come up with a flowery phrase they like, tie a bow on it and call it either the mission or vision statement. The goal of this section is to show how vision and mission statements can actually be useful to your organization and drive your business strategy forward.

Vision Statement

For our purposes, a firm’s vision statement is the overall dream that a firm hopes to accomplish. It is a snapshot of the future the firm hopes to create in the world; a timeless phrase that outlives changing market strategies and fluctuations within the company and can be as flowery or concise as necessary, so long as it accomplishes its purpose. The vision statement expresses the organization’s reason to exist which is useful in providing the organization a flagship to follow; something to always look to for direction. For example, a local food bank might have the following as their vision statement: “To bring an end to hunger in our community”. The vision statement explains quickly and distinctly the overarching goal of the organization and may be what motivates the firm. The vision statement however, does not provide the direction to take in order to achieve that goal. It gives the what without the how.

Mission Statement

An organization’s mission statement takes the vision statement to the next level by providing insight on how the organization will achieve its overarching goal. Using the example of a local food bank, an appropriate mission statement might be the following: “To alleviate hunger within our community through efficient collection and distribution of food products that effectively reach those in need”. As you can see, the mission statement repeats the vision statement but then takes the next step to express how to achieve the vision. However, it’s still vague. Our example for the food bank could be just as applicable to any other food bank in the world. AGCO, a fortune 500 company, has the following mission statement: “profitable growth through superior customer service, innovation, quality, and commitment”.1 That statement could be applied to any other business in the world. It is clear that some mission statements are better than others. What really makes the difference is the strategy behind the statement.

Sample Mission Statements

Organization	Mission Statement
AXA	Help customers live their lives with more peace of mind
The Church of Jesus Christ of Latter-day Saints	Invite all people to come unto Christ, and be perfected in him
Coca Cola	To refresh the world ... To inspire moments of optimism and hapiness ... To create value and make a difference.
FIFA	Develop the game, touch the world, build a better future.
Google	Organize the world's information and make it universally accessible and useful.
General Motors	Design, build, and sell the world's best vehicles.
London Business School	To advance knowledge and nuture talent in a multicultural learning environment for positive impact on the way the world does business.
McDonalds	To be our customers' favorite place and way to eat.
Petrobras	Operate in a safe and profitable manner in Brzil and abroad, with social and environmental responsibility, providing roducts and services that meet clients' needs and that contribute to the development of Brazil and the countries in which it operates.
Samsung	We will devote our human resources and technology to create superior products and services, thereby contributing to a better global society.
United Way	Improve lives by mobilizing the caring power of communities.

Connecting Mission Statements to Strategy

No mission statement is complete if it’s not based on your strategy. Taking the example from the food bank, “To alleviate hunger within our community through efficient collection and distribution of food products that reach those in need”, we can break it down as such:

· Goal: Alleviate hunger

· Method: efficient collection and efficient distribution that reaches those in need

Now we can complete the utility of the mission statement by applying strategy to our methods. This involves taking each method and strategizing what the company will do to accomplish each. For example, using the food bank’s method of efficient collection of food, an appropriate strategy may involve teaming up with local volunteers to collect food, advertising through pamphlets or signs, or heading up food drives at local schools. 

The most important thing to remember is that vision and mission statements are meant to be useful. If they don’t actually help an organization accomplish anything, there is no use in having them. The utility of the vision and mission statements is best found through creating a culture oriented around them and strategy which define how to accomplish them. Plan on spending much more time on the implementation of the statements than on the creation of the statements.

2.6Points of Parity and Points of Differentiation

Points of Differentiation

Companies care obsessively about how they compare to their competition, and continuously look for ways to get a competitive advantage. These measures fall into the category of points of differentiation, or things that a company does differently from its competitors.

Points of Parity

It’s also important to look at the points of parity in your industry. These are things which are done by all competitors in an industry because they can’t realistically win over consumers without them. What are the points of parity in your market? What things does your company have to offer in order to even begin competing? 

Example - Smartphones

For instance, let’s look at the smartphone market. In order to compete, all companies must offer a phone with certain points of parity. The phone has to be able to text, use wifi, connect to bluetooth, call people, and download apps in order to even be considered by a consumer.

However, you don’t buy a phone because it has wifi capabilities. You buy it because it has the points of parity AND you like the points of differentiation it offers. For smartphones, points of differentiation could be flexible screens, edge display, increased memory, faster operating systems, or a better camera. Apple seeks to differentiate itself by having a sleek operating system that connects seamlessly with your other apple devices and can even link with other iPhones.

Advertise Points of Differentiation

In strategy, you need to assure that you are doing well on the points of parity, but you market your points of differentiation. If you advertise that “customer satisfaction is our most important goal,” you probably are advertising something that all companies in your industry practice. This won’t set you apart. This won’t sell more product. This simply says, “We’re good enough to be in the same market with everyone else.” Instead, focus on what makes your product more attractive to a segment of the consumer base.

A few exceptions to this rule exist, but hopefully you can avoid them. If your company has historically failed to provide a point of parity feature, you may have to advertise that feature in order to restore customer confidence in your brand. For instance, Nature Valley granola bars were historically so hard and crunchy that they were practically impossible to chew. When they finally fixed the problem, they ran an ad campaign making fun of their previous granola bars and showing customers that the new granola bars were soft on their molars. Essentially, advertising points of parity is only a good idea if you are an extremely weak competitor that needs to convince people that you are good enough to be in the market or if you have historically failed to provide a point of parity necessary to your industry.

2.7PESTLE Analysis

Changes in a business environment bring both opportunities and threats to a firm. To help a firm understand the opportunities and threats they face, a PESTLE Analysis can be performed to see the broader picture and situation of the firm.

Elements of a PESTLE Analysis

Elements of a PESTLE Analysis

· Political (political environment, unrest, balance of power, public ideology, etc.)

· Economic (state of the economy, inflation, interest rates, etc.)

· Social (customer culture, demographics, consumer attitude, etc.)

· Technological (new technologies, technology research and spending, internet, etc.)

· Legal (business regulation, government laws, ordinances, tax laws, trade laws, etc.)

· Environmental (climate, weather patterns, temperatures, seasons, fault lines, etc.)

By analyzing each of the above factors and changes which affect each factor, a firm is better able to identify market opportunities and threats. The PESTLE analysis is carried out by considering each factor and identifying changes within each. In regards to these changes, opportunities which arise are determined, followed by possible threats also incurred. When possible opportunities and threats are accounted for, an action plan is created which takes advantage of opportunities and defends against threats. The final step in PESTLE analysis is initiating the action plan.

When is PESTLE most helpful?

PESTLE analysis can be particularly helpful for international companies that deal with global politics, economies, cultures, advancements, laws, and environments. The PESTLE framework helps these types of companies make sound decisions on where to expand and how to do it or to decide not to altogether. 

Sample Analysis: Point - Pest Control

Consider the following. As the cofounder of Point, a recently founded pest control company, you would like to better understand the market you’re involved in, its opportunities and threats. To better understand Point’s position, let’s perform a PESTLE analysis on the company.

Political Factors

First we analyze the political situation and political changes. Point does not operate outside of the US, but you have plans to take the company across the US. Luckily, there doesn’t exist any terrible national political feelings which may limit the existence of Point. However, depending on the state Point decides to perform its business within, different feelings do exist on a more local and state level. After searching through the state governments websites it’s easy to determine which states are pushing for policies in favor of or against your business.

Economic Factors

Second, we analyze the local and national economy. Since Point operates nationally, areas in which the economy has improved immensely will likely create the greatest opportunities. The general improvement in the economy is already an advantage to Point however. 

Social Factors

Third we analyze our customer culture, demographics, and consumer attitude. Many American residents have negative opinions of door to door salespeople. Areas which have already experienced an oversaturation of such sales strategies are less likely to have a positive response to Point’s sales approach. Areas of the country in which pests are a major problem, however, are far more likely to react well to Point. 

Technological Factors

Now we analyze technological changes. Door to door sales have evolved with the recent application of technology. The use of iPads and tablets has allowed for enhanced product presentation as well as the ability to transact sales on the spot. Point sees great opportunity in the development and use of a new customer app which will increase feedback as well as improve customer relations. 

Legal Factors

Next we take into account the legal aspects. At this part of our analysis we consider national and state regulations, laws and tax codes. As it turns out, depending on the state, laws have been created which specify the types of pesticides which can legally be used. Other regulations by both the EPA and OSHA limit pest control practices to a certain extent. Knowing these laws affects the operation and sales location of Point. In addition to state laws, many cities have laws which require door to door salespeople to have specific licenses and city permission. Depending on where Point can obtain licenses will also determine business operation. In areas which are more strict, less competition is likely to exist, which provides Point with an opportunity to monopolize certain areas. Tax code, which fluctuates by state, may also play a role in Point’s business strategy.

Environmental Factors

Finally we consider the environmental aspects to Point. The environment plays a huge role in Point’s business operations as it is the climate which determines if pests are even a problem. Point can easily determine states with year round warmer weather will be better candidates than states with freezing temperatures as warmer states will naturally have greater problems with pests than others. Other environmental aspects such as locations in danger of environmental catastrophes only have to be considered when deciding where to place Point’s headquarters.

Action Plan

Based on the threats and opportunities determined up to this point (no pun intended), we now determine an action plan that best allows Point to defend against these threats and take advantage of these opportunities. The PESTLE framework becomes a key decision making tool for determining this plan. The action plan, which will not be detailed in this paper, would consist of exactly which states Point would target, products Point would sell, the integration of Point’s customer app, and the specifics of employee training activities.

The final step to PESTLE analysis involves integrating the action plan by picking a place to start and beginning.

On an international level, companies have a lot to consider when performing a PESTLE Analysis due to the extreme differences in the cultures and countries around the world. The PESTLE Framework can guide companies to make sound decisions and appropriate strategies.

2.8Organizational Resources

Resources

Human capital, physical capital, financial capital, information capital and raw material all make up the resources available to organizations. Rightly named, these assets combined are known as a firm’s organizational resources. These play a vital role in shaping a company’s strategy. 

Human Capital

Human capital consists of everything to do with the employees of an organization. It consists of all the experience, knowledge, education, creativity, and abilities of the individuals within a firm. Human capital carries incredible value as a firm’s premier source of innovation and profitability. Without credible human capital, all other capital is useless and unprofitable.

Physical Capital

Physical capital includes everything a firm uses for the creation of a product apart from raw materials. Physical capital may include all production equipment, computers, vehicles, and buildings a firm owns and uses for operation. 

Financial Capital

Financial capital is the money a firm uses to purchase assets necessary for business operation. Access to financial capital can determine how quickly an organization can expand and how much interest it has to pay on loans.

Information Capital

Information capital includes information technology – databases, networks, and software – and business intelligence. These form the backbone of the business and its operation. For many companies, information is as valuable as any other resource a firm may have.

Natural Resources

Natural resources are raw material and substances used in production. Materials such as minerals, lumber, water, livestock, land, and crops are classified as natural resources. Manufacturing firms are most likely to be concerned with natural resources since the price of raw materials heavily impacts their profits.

Realizing a firm’s organizational resources is the start to strategic organizational thinking. Finding where a firm’s strengths and weaknesses are is critical. For example, firms lacking in human capital may consider finding new employees. Those with remarkable human capital should initiate programs which boost employee autonomy and creativity in order to best fit the value of their resources. Google, for example, recognizing the incredible human capital within their firm, gives their employees one day of work time a week to work on whatever projects they want. Such a loose and unorthodox program has been the birthplace to key services such as Gmail. 

Strengths and Weaknesses

What are the strengths and weaknesses in your company’s organizational resources? How can you craft your strategy to get the most value of your company’s strengths and fix any debilitating weaknesses?

When to Focus on Weaknesses

If your company has some weaknesses that really hold you back from realizing profits, your strategy should focus on fixing these. For instance, if your company is weak in information capital because all the computer systems are outdated, you might focus on fixing this by investing both in new systems and in employee training so they can use the new computers. 

When to Focus on Strengths

However, if your firm doesn’t have any weaknesses that significantly hamper the company, you should consider focusing on a strength. If your company has lots of cash available, you could take advantage of your financial capital to grow the company. You could invest in higher quality machinery, recruit some higher-quality employees, or even acquire another company. By focusing on your strengths, you exploit your competitive advantage. 

If you find that your strengths all center around one aspect of your company, you could consider outsourcing the other business processes to other companies. If they can perform the operations for less than you can, perhaps you should focus on the part of the chain where you add the most value to the final product. 

In the end, it works both ways. Your strategy needs to align with the organizational resources that you excel at, and your organizational resources must align with your strategy. Make sure that either your strategy fits the organizational resources that you posses or that you acquire the organizational resources needed to carry out your strategy.

2.9Balanced Scorecard

Businesses put a lot of effort into developing effective long term strategy. Such strategies and the processes used to create them can be complicated and illusive. The Balanced Scorecard, which was developed in 1992 by Robert Kaplan and David Norton, identifies four key perspectives which ultimately determine long term strategy.

· Financial Perspective - Includes shareholder value, economic value, net income, etc.

· Customer Perspective - Includes customer loyalty, customer satisfaction, and market share

· Business Process/Internal Perspective - Includes quality and delivery of product or service, output, production, etc.

· Learning and Growth Perspective - Includes elements of continual growth and value creation, employee skills, training, satisfaction and retention.

The Balanced Scorecard can be represented by the four legged diagram below. 

To use the balanced scorecard to its full potential, goals and the actions taken to reach those goals are determined for each perspective. Creating goals and a plan of action for each of the four aspects of long term success can become the backbone of long term strategy and thus determine long term success.

2.10Product Revenue Analysis

Most businesses with inventory sell more than one product. These products vary in their prices, their costs of production, their turnover rate, and how much of each product is sold. Product Revenue Analysis is a tool developed specifically to evaluate these product variations and help a firm make strategic decisions in regards to their products. Such decisions might involve deciding which products to focus on, how or if to change prices, which product lines to consider or cut, etc.

Sample Product Revenue Analysis

Imagine a startup that specializes in selling shovels, garden hoes and hatchets. The company is doing well but isn’t growing, and management isn’t sure how to extend their product line. They know what it costs to produce each of their products, they know how much each product sells for, and they know how much of each product is sold. On the other hand, the company doesn’t know how this information is helpful to making business decisions to developing company growth. As a college student intern who the company has hired to work in the warehouse, you see the company’s lack of strategic thinking as an opportunity to show your true value as an employee by performing a product revenue analysis. 

You begin by compiling a spreadsheet that shows each of the company’s products, the revenue brought in by each, the costs associated with the production of the products, and subsequently the income (sales-costs) of each. Your spreadsheet looks like the following.

Table 2.1

Products	Revenue	Cost	Income from Product
Shovels	$605,000.00	$395,000.00	$210,000.00
Garden Hoes	$50,000.00	$9,000.00	$41,000.00
Hatchets	$30,000.00	$18,600.00	$11,400.00
Total:	$685,000.00	$422,600.00	$262,400.00

The next step you take is to determine the profit margin, percentage of sales, and percentage of income of each product. Profit margin is determined simply by dividing the income of each product by the revenue brought in by the product. Percentage of sales is calculated by dividing the revenue of each product by the total revenue of all product sales. Percentage of income is found by dividing the income from each product by the total income of all products. At this point, your spreadsheet looks like the following.

Table 2.2

Products	Revenue	Cost	Income from Product	Profit Margin	Percentage of Sales	Percentage of Income
Shovels	$605,000.00	$395,000.00	$210,000.00	34.7%	88.3%	80.0%
Garden Hoes	$50,000.00	$9,000.00	$41,000.00	82.0%	7.3%	15.6%
Hatchets	$30,000.00	$18,600.00	$11,400.00	38.0%	4.4%	4.3%
Total:	$685,000.00	$422,600.00	$262,400.00

This is when you astonish management by pointing out simple figures that they’re ashamed to have overlooked. First, you point to the profit margin and indicate how much larger the profit margin of garden hoes is compared to shovels and hatchets. You note that the profitability of a product is affected greatly by its profit margin. 82%, compared to 38% and 34.7%, is a pretty stark difference. Next you point to the relationship between percentage of sales and percentage of income. Having a higher percentage of sales than percentage of income indicates that the product isn’t as profitable as it should be compared to other products. Having a percentage of income higher than percentage of sales, on the other hand, indicates that a product has a higher profitability in relation to other products. Knowing this you are able to point out that the percentage of sales and income of shovels indicate that focusing on selling more shovels would not be as profitable as focusing on selling more garden hoes, which have an incredible difference in percentage of income and sales. 

With a simple product revenue analysis you are able to impress the management of the company who subsequently promotes you from a warehouse worker to head of business strategy. Congratulations!

2.11The VRIO Framework

Comparative Advantage

VRIO is a framework designed to aid in determining the comparative advantage of a product, resource, idea, or service. Knowing the comparative advantage of what a firm has to offer before the implementation aids in the decision making process and helps the firm or individual succeed. In order to determine the comparative advantage, the questions of value, rarity, imitability, and organization are taken into account. 

Value

Starting with value: Does the product in question provide value to your company? If not, why is the firm even considering it? Putting out a product with no value will only be disadvantageous to the firm. 

Rarity

Moving on to the question of rarity: Is the product we are offering new to the market or already existing in one form or another? If we are offering a simple but different product, are the changes we’ve made significant enough to consider it rare? If not, there’s no expectation of a competitive advantage.

Imitability

Now considering imitability: Imitability brings to question the ease of copying or imitating the product being offered. Is the product you are offering difficult or easy to duplicate? Is it expensive or inexpensive to develop? If another firm is willing and able to replicate the product and undertake associated costs, our firm can only expect to hold a competitive advantage for a limited time (the time it takes our competition to develop their similar product). 

Organization

Finally considering organization: When our product demonstrates value, rarity, and difficult imitability, the final and possibly most important element to consider is organization. Is our firm organized and operate in such a manner that we can capture as much profit from our product as possible? What changes need to be made to promote innovation within the firm, create a more dedicated culture, and support a more effective management strategy? If our firm leaves unclaimed value in the market for another firm to take advantage of, our competitive advantage won’t last but when our organization can capture all available value, as well as pass the questions of value, rarity, and imitability, we expect a lasting sustainable competitive advantage. 

Sample VRIO Analysis - The iPhone

Here’s a VRIO framework of the iPhone to better explain this concept. The each step of the process and determine the strength of the iPhone’s competitive advantage.

· Value: There is value in the iPhone because of its ease of use, popularity, quality in hardware and software, and brand name. 

· Rarity: Although there are many smart phones which are in competition with Apple’s iPhone, the iPhone is rare in its unique software, hardware, and brand.

· Imitability: Many phones do the same functions just as well as iPhones but what can’t be imitated is Apple’s brand and software.

· Organization: Somehow Apple has captured a large portion of the smartphone market simply on brand name. They have amassed an army of iPhone diehards that refuse to support any other brand. The main aspect of the iPhone that passes all steps of the VRIO framework is Apple’s brand name

2.12Internal and External Factor Evaluation Matrices

One issue with many business analyses, especially those which involve examination of a firm or market, is how subjective they can be. One way to remove some of the subjectivity of internal assessment and external analyzation is to quantify the results with some sort of weight or rating. An Internal Factor Evaluation Matrix (IFE) and an External Factor Evaluation Matrix (EFE) have both a weight and a rating. An IFE Matrix is an auditing tool a firm can use to assess its own internal strengths and weaknesses and an EFE Matrix is an analyzation tool a firm can use to assess the market and external elements of the business.

Example: Johan's Furniture Store

Johan owns and operates a growing furniture store with several employees. Business is going well but he wants to better analyze the internal and external factors of his business to understand his business’ strengths and what should improve as well as the opportunities and threats of the local market. He can use an Internal Factor Evaluation Matrix to better understand his own business and an External Factor Evaluation Matrix to better understand the market. 

We’ll start by demonstrating how Johan would perform an IFE Matrix.

Internal Factor Evaluation Matrix

First, Johan identifies the main internal factors of his business. Such factors may include customer service, quality of product, his company location, storage capacity, etc. He lists these factors and categorizes them as either strengths or weaknesses.

Second, Johan gives weight to each factor depending on the importance of each. The weights must be made so that they total exactly 1. Elements of his business such as reputation and market share are naturally his highest weighted strengths and his limited storage capacity weighs in as his most detrimental weakness.

Once appropriate weights are determined, Johan gives each factor a rating. If the factor is a vitally important strength it is given a rating of 4, valuable but not vital strengths are given 3 as a rating, weaknesses which can be treated lightly are rated 2, and important weaknesses that need to be addressed are rated 1.

Table 2.3

Internal Factor Evaluation Matrix

	Key Internal Factors	Weight	Rating	Weighted Score
	Strengths
1.	Largest Market Share	0.12	4	0.48
2.	High Quality Product	0.1	4	0.4
3.	High Quality Service	0.08	3	0.24
4.	High Product Variety	0.08	3	0.24
5.	Good Location	0.09	3	0.27
6.	Great Reputation	0.14	4	0.56
	Weaknesses
1.	Limited Storage	0.11	1	0.11
2.	Low number of suppliers	0.09	2	0.18
3.	Unreliable software	0.1	1	0.1
4.	Untrained employees	0.09	2	0.18
	Total	1		2.76

The weighted score of each factor is determined by multiplying each factor’s rating by it’s weight. The total weighted score is calculated simply by the sum of every factor’s weighted score. An average total weighted score for a company is 2.5. A score lower than 2.5 indicates an internal situation that is weak but a score higher than 2.5 indicates an internal situation that is stronger than average. In Johan’s IFE Matrix , Johan determined that his business had a score above average of 2.76.

External Factor Evaluation Matrix

An External Factor Evaluation Matrix is performed similarly as follows.

First, Johan identifies the main factors of his market and categorizes each factor as either an opportunity or threat. Such factors might include whether the market is growing or shrinking, the state of Johan’s competition, or economic conditions.

Second, Johan gives weight as to the importance of each factor, as seen previously in the IFE Matrix.

Just as Johan did when performing the IFE Matrix, Johan’s third step is to his EFE Matrix is to rate each factor from 1 to 4. When performing an EFE Matrix however, each rating is a representation of how responsive the firm can be to each factor. A rating of 1 infers a very poor ability to respond to the factor and a rating of 4 shows a phenomenal ability to respond to the factor. 

The weighted scores and the average total weighted score are determined exactly how they were in the IFE Matrix example, as we can see in Johan’s EFE Matrix. An average score is still 2.5, below average is below 2.5, and above average is above 2.5.

Table 2.4

External Factor Evaluation Matrix

	Key External Factors	Weight	Rating	Weighted Score
	Opportunities
1.	New Homes Under Construction	0.2	4	0.8
2.	Declining # of Competitors	0.19	3	0.57
3.	New Suppliers	0.15	3	0.45
4.	New Custom Furniture Market	0.1	2	0.2
	Threats
1.	RC Wiley store in Construction	0.23	2	0.46
2.	Poor State of the Economy	0.13	1	0.13
	Total	1		2.61

2.13McKinsey 7S Model

It is rare that a single element of your business will either drive success or prevent it completely. Instead, different parts of the business overlap and interact to create success or failure. The McKinsey 7S model is a simplified way of looking at your organization and each element which may affect the company’s success or failure. 

In order for your business to be successful, you need to do well in each of these areas. As all elements are interconnected in the framework, each influences how well your organization does in the other areas.

Elements of the McKinsey 7S Model

The framework divides the factors into two groups - Hard S areas and Soft S areas. The top three, Strategy, Structure, and Systems, are hard areas. This means that these areas are easier to identify, manage, and work with. They are very tangible. The rest - Staff, Style, Skills, and Shared Values - are soft areas, meaning that they are harder to manage because they are difficult to define, alter, and control.

Hard areas:

1. Strategy

2. Structure

3. Systems

Soft areas:

1. Staff

2. Style

3. Skills

4. Shared Values

Strategy

Strategy is a company’s plan for how to be successful - how to stay ahead of competitors, how to grow, and how to improve on all these areas. Do your employees act in accordance with your strategy? Does your strategy drive growth? Does your strategy create long-term results?

Structure

Structure refers to the organization (structure) of your business - the organization of different departments and teams, as well as the leadership hierarchy. Can employees communicate problems to managers? Do you lose a lot of efficiency waiting for approval or other bureaucratic processes? Are your employees engaged and dedicated to the success of the company?

Systems

Systems are the business processes that make up your company. Do you have smaller profit margins than many companies in your industry? Do your manufacturing processes frequently cause delays in the orders you are sending out? Is your workplace a safe environment? 

Skills

Skills are the things your employees are good at doing. Do you have productive employees who surprise you with how much they accomplish? Are there technical issues that you frequently have to hire outside help to solve? Could you get one very skilled employee instead of two lesser skilled employees? Do you have a competitive advantage thanks to your employee skills?

Staff

Staff deals with who you hire, how many of each type of job you need, and other Human Resource functions. These include recruitment, training, motivation, and compensation. Do you have enough people to keep up with the tasks at hand? Are employees frequently idle? Do you have the greatest number of people in the departments which drive the most growth in your company? 

Style

Style means leadership style, or how the top-level managers lead the company and interact with each other and employees. Are your employees motivated by what your leaders say and do? Do you have lots of workplace conflict? High turnover? Perhaps solving issues in leadership will solve many issues throughout the company. 

Shared Values

Shared Values means that each of the elements of the model are interconnected around the standards and culture that guide both how employees act and what the company chooses to do. These are the foundation of your organization. Do you have strong mission and vision statements? Are you an ethical corporation? Do you accomplish good in the world? 

The McKinsey Model takes these categories and looks closely at each to see if it is working or not and how well each supports or diminishes others. You must balance the different areas of the company, addressing the elements which are either significantly better or significantly worse than the others. For instance, if your business has a fantastic strategy and great skills, it would seem that your company will be successful, however, if your systems are inefficient (maybe your computer systems are ancient and crash often), it is possible that your strengths will be undermined. Great strengths within the company may be utilized to improve those areas in which the company is lacking. A careful analysis of these 7 items will show your company’s balance and give a fairly accurate forecast into the future success of the firm.

2.14Strategic Fit

Strategic fit is a very broad term with several loose definitions. It can be used as a way of looking at many aspects of your business, all under the broad label of strategic fit. 

For instance, you can determine if a particular project is a good strategic fit for your company. Does this specific project align with the overall corporate strategy? Does it align with the resources you have available? Does it align with the opportunity that is present in the market?

Strategic fit can refer to how the activities a business undertakes fit together with the strategy of the company to match a need in the market, producing a competitive advantage for the company. For instance, if your company offers lower-cost software to small businesses because your small size allows you to create customized solutions for your clients, you have achieved strategic fit for a specific segment of the market. 

Mergers and Acquisitions

Many people will talk about strategic fit in terms of mergers and acquisitions. If the merger or acquisition doesn’t further your strategic aims, then don’t do it. The strategic value of the firm must fit your company strategy, the culture must fit your culture, and their employees must be a good strategic fit for your company. It is difficult to achieve strategic fit with mergers and acquisitions. 

Determine Overall Objectives and Market Needs

In order to determine strategic fit, it is necessary to establish the organization’s overall objectives, and identify the need in the market. All projects, mergers, acquisitions, and processes should align both with the company strategy and with the market need. 

Company and Strategy Alignment

Match your company to your strategy and match your strategy to your company. Fundamentally, your strategy and your company should align almost perfectly. If you have decided that a certain strategy is the best way for your business to move forward, you may have to adapt how you do business to fit that strategy. On the other hand, when creating a strategy, it is often wise to build the strategy around the business and success that you already have. 

Example - Premium Watches

For instance, let’s pretend that you sell classy watches. Your strategy is to offer a premium product to high-class customers. 

Supply Chain

Your supply chain needs to have strategic fit. You must get quality materials in order to build premium watches, so you need to find both adequate suppliers and high-quality manufacturing companies to create the watches. 

Distribution

Your choice of distribution should also match your strategy. You’ve decided that you are going to pursue an exclusivity strategy, in which you only sell your watches from certain, sophisticated stores. Selling your fancy watch in a gas station or in a big-box store works against your strategy. 

Price, Branding, and Advertising

Along with location, your price and your branding should fit with your strategy. You have to charge a high price to cover your costs, but you will probably increase this price even further to give the impression of majestic quality. Everything a customer sees about your product should speak of its quality and prestige. Strategic advertising will promote your brand and create a clear picture in the mind of your consumer as to what your company is. 

Human Resource Management

Your decisions in human resource management should also align with your strategy. If you want to sell classy watches, your sales reps need to be class, well-dressed individuals. You are unlikely to hire cheap employees who want a quick, temporary job. 

Organizational Resources

Organizational resources play a big role in whether or not you can achieve strategic fit with a given strategy. Making those premium watches may require hiring experts in the watch industry to continually develop better watches and inspire confidence from the customers. Research and Development or Technology may have to be improved to achieve strategic fit within your organization.

Leadership and Customer Support

Other support functions also need to work with your company strategy. Your business leadership has to make strategic sense, and your customer support must work together with the rest of your branding to give the correct impression to customers. 

Potentially, you could look at every aspect of your business and determine whether it fits strategically with the rest of your company or not. In general, you should focus your efforts to achieve strategic fit on the most impactful areas (these will change depending on your strategy) which are most important to your company.

2.15Summary

Starting Out: Analyzing Your Company

Setting/Choosing a Strategy

A brief introduction to the basic process of choosing a strategy, as well as how to use the book. Ask various questions to help the reader think about what his/her business really excels at and will be successful at.

Planning, Crafting, and Emergent Strategies

Planning strategy is essentially when a person sits down, creates a plan for the business, and puts it into action.

A Crafting strategy is one where business leaders adapt the strategy as they learn more about the market and the business. It is molded and shaped over time. 

An Emergent strategy is a strategy that comes about without structured plans or delineated changes but comes from the needs of the market. This kind of strategy could be thought of as a pivot from the planned or crafted strategy.

SWOT Analysis

A SWOT analysis looks at the Strengths, Weaknesses, Opportunities, and Threats that face your business. This is a very common analysis to perform when assessing a company for potential strategies. 

Mission and Vision Statements

Mission and Vision Statements focus on the big picture of a company - the reason it exists, its overall dream, and how it will achieve its goals. These help a company see its core focus and desires.

Points of Parity and Points of Differentiation

Points of parity are the features and services that all companies in your market must provide in order to compete. Points of differentiation are the features or services that set your company apart.

PESTLE Analysis

A PESTLE analysis looks in greater depth at the opportunities and threats a firm is confronted with. PESTLE stands for Political, Economic, Social, Technological, Legal, and Environmental factors facing a firm.

Organizational Resources

Organizational Resources are the different forms of capital (human, physical, financial, informational, etc.) that are available to an organization. An effective strategy must be backed by the correct organizational resources.

Balanced Scorecard

The balanced scorecard looks at your business from four different perspectives: a financial perspective, a customer perspective, a business process/internal perspective, and a learning/growth perspective.

Product Revenue Analysis

The Product Revenue Analysis looks at which products bring in the greatest percentage of your revenue, allowing you to determine what to focus your company efforts on.

The VRIO Framework

The VRIO Framework looks at the comparative advantage that a company offers to consumers. It looks at the value, rarity, imitability, and organization of the product, service, resource, or idea that it offers to customers.

Internal and External Factor Evaluation Matrices

The Internal and External Factor Evaluation Matrices seek to take some of the subjectivity out of assessments by giving each relevant business factor a weighted score. This allows for more objective evaluations of both your company and your competitors.

McKinsey 7S Model

The McKinsey 7S Model looks at the Strategy, Structure, Systems, Shared Values, Staff, Style, and Skills of your business. It helps you balance your company, seeing which areas you excel in and which areas are weaknesses.

Strategic Fit

Strategic fit looks at how well various aspects of your business mesh with your strategy. This can be seeing if your strategy fits your market, looking at whether a particular project fits with your strategy, or determining if you have the organizational resources to accomplish your strategy.

Chapter 3:

3.1Introduction to Competition

Learning Objectives

1. Describe Porter's 5 Forces.

2. Differentiate between Red Ocean and Blue Ocean Industries.

3. Explain the Product and Industry Life Cycles.

4. Define Disruptive Technologies.

5. Define Benchmarking and its use.

6. Describe a Weighted Competitive Strength Assessment.

7. Explain how to develop Core Competencies.

8. Perform a Four Corners Analysis.

9. Describe Incumbency Advantage, Diversification, and Diffusion of Innovations.

3.2Porter's 5 Forces

The 5 Forces

Introduced by Dr. Michael Porter, Porter’s five forces are a tool used to determine the level of competition and analyze the opportunity of an industry, individual, project, or firm. According to Porter, managers often look at competition too narrowly, focusing exclusively on the fight between the companies within an industry.1 Instead, he argues, the five forces shape how competition occurs. Without looking at all five forces, a manager cannot have a broad enough view to adequately create a business strategy. The five forces are the following:

· Supplier Power

· Buyer Power

· Threat of Substitution

· Threat of New Entrants

· Competition

Supplier Power

Supplier power refers to the ability suppliers have to drive up prices for the firm. An example would be copper suppliers selling to microchip companies or sugar producers selling to Coca Cola. Supplier power is often determined by the number of suppliers, their market share in the industry, and the difficulty for a firm to switch to a different supplier. Given that suppliers value firms the value of a firm decreases in the eyes of the supplier with each additional firm supplied, suppliers are most powerful when they hold a large market share and supply many firms.

Buyer Power

Buyer Power refers to the ability customers have to drive down prices offered by a firm. Consider for example how much influence Apple’s customers have over the price of iPhones or how much customers control the price of Colgate toothpaste. Neither of these companies would be impacted by one customer switching to competitors but both would face difficulty if there was a mass exodus of thousands or millions of customers to competitors. 

Threat of Substitution

Threat of substitution points to the possibility of customers switching from the products or services of one firm for those of another. The threat of substitution increases as product quality and value decrease, prices increase, or with the ebb of product uniqueness. Such substitutions can even completely disrupt the market for any given product. The computer substituted the typewriter. Digital cameras substituted film. Cloud storage is replacing hard storage. When considering this threat, a firm tries to innovate and stay ahead not only in the product market but in the industry as a whole.

Threat of New Entrants

Threat of new entrants brings to question the possibility and likelihood of new firms entering the market to compete. This threat is determined by ease of entry, the profit opportunity within the market, and the protection of existing firm’s system ideas and technology. Compare opening a lemonade stand with starting a new hotel chain. Out of the two, obviously opening a lemonade stand is far less expensive, easy to replicate, and incomparably easier to manage, therefore we can assume there is a higher risk of new entrants. 

Competition

Competition or rivalry refers to the existing market in which a firm is located. The competition is determined by how many other firms exist in the firm, the differences between those firms and their products, price differences, how much of the market share a firm holds, and the loyalty of customers. If we consider the beverage industry from the perspective of Coca-Cola it’s safe to say their biggest competitors are Pepsi and Dr. Pepper. Because of competitive rivalry, all three beverage companies are forced to keep their prices low and rely heavily on brand promotion to increase customer loyalty. They all hold a large enough market share that competition remains high as the three firms innovate and offer new products.

Dynamic forces, not static forces

It is important to remember that the five forces are dynamic, not static. Over time, any or all of the forces may change dramatically. These changes in the competitive environment necessitate changes in your company's strategy. Do not make the mistake of only looking at the five forces once and using the same strategy after the forces shift and realign.

3.3Blue Ocean vs. Red Ocean Strategy

Blue and Red Ocean Strategies are two different market competition strategies. Red Ocean Strategy involves competing companies working to outperform rivals and capture a greater portion of share in the same market where Blue Ocean Strategy focuses on the creation of new uncontested markets where no competition exists.

Different Types of Industries

Red Ocean

So what do these oceans represent? Red Oceans represent industries and markets which have existed long enough to become saturated by competition. The car industry, paper industry, oil industry, and paint industry are all examples of highly saturated markets which have existed for decades, if not centuries. These industries are few of the thousands which are Red Oceans.

Blue Ocean

Blue Oceans are new industries, new technology, and new product markets that have never existed before. Examples of Blue Oceans include future software concepts, ideas that have yet to be released, and some very recent new product industries (which will likely become Red Oceans in time) including smart glasses, virtual reality sets, self-driving cars, and new medical procedures and vaccines.

Characteristics

Red Ocean - Stiff Competition

Red Ocean Strategy is characterized by a cut-throat approach which entails competition to death. The ocean is dyed red as firms engage in a bloody fight for larger market share and niche markets. This strategy can be successful for firms that keep becoming more efficient and effective at attracting customers but if the market is teeming with competition, both profit and growth become challenging.

Blue Ocean - New Rules, New Boundaries, and New Vision

Blue Ocean Strategy is manifest when a firm innovates to create its own market with no competitors. They create new demand and capture what they create. When other firms follow suit they are too late to compete with the blue ocean firm. Blue Ocean Strategy challenges the existing market and allows a firm to define new rules, new boundaries and a new vision. 

Examples of Blue Oceans

Ford made a blue ocean move when they introduced the Model T, which was the first time the automobile was available to the general public. In a similar move, Canon offered the first personal printer to be used in customers’ homes. With Apple’s introduction of iTunes, a new blue ocean market of digital music was born.

Application

Think of how your company can enter blue markets. What innovations are not currently on the market? Are you significantly ahead in a certain sector of software development or other area? Look specifically for areas that you can enter but would be difficult to replicate or enter once the original has been released. If it is too easy for other companies to enter the market, the blue ocean will quickly turn red. This doesn’t mean that your company shouldn’t enter the blue ocean, it just means the blue ocean won’t protect you from competition. The incumbency advantage may be great enough to carry you through, or the temporary surge in sales may be worth the effort. If you choose to implement a blue ocean strategy, you must be prepared to invest enough in research and development to stay ahead of the competitors.

3.4Product and Industry Life Cycle

Industry life cycle is a concept of different stages an industry will undergo from first introduction to eventual decline. Product life cycle is similar in principle, only it refers to the stages a product undergoes from introduction to decline rather than an entire industry. Although the life cycle of an industry is generally much longer than those of its products, both life cycles follow the same four phases from beginning to end starting with introduction, followed by growth, then maturity and finally terminating with Decline.

Phases of the Product and Industry Life Cycle

First Phase - Introduction

The first phase of the cycle is the introduction of the product or industry. This phase is heavily characterized by endorsement and advertisement to promote and attract early buyers and participants. Let’s consider a new candy bar created by Mars Inc. called the Snickers Crisper. At stage one, the Snickers Crisper was advertised on major television in order to promote the product.

Second Phase - Growth

The second phase, growth, is characterized by product innovation and expansion. During this phase firms seek to expand their market share by making their product attractive and accessible to everyone. It will be during this phase that we can expect the Snickers Crisper to come out in king size, mini, and family sized portions and be wrapped in holiday specific packaging.

Third Phase - Maturity

The third phase of the cycle is maturity. At this phase, a firm hopes to see great results from the previous two phases and the efforts that went into their product. There may be some continued innovation and product alteration but only moderately. During this phase, Mars Inc. expects large profit from the Snickers Crisper as its popularity and availability will likely reach its peak.

Fourth Phase - Decline

The fourth phase of the life cycle is the product’s or industry’s decline. Most products reach a point where they are less and less interesting to consumers. They become less popular than they once were, but this is not to say such products are no longer profitable to a firm. They still may bring a firm considerable profit even if sales decline. For Mars, the Snickers Crisper will eventually be on its decline and Mars will decide how long to continue its production. As long as profit made is greater than expenses incurred, the Snickers Crisper is likely to remain in production.

Innovation is Key

Innovation is the key to beating the product and industry life cycle. If a company can successfully innovate and develop their industry and products to continually fulfill consumer demand, they can avoid decline. An innovative company is one that continually seeks to improve by investing enough time, talent and money into its next generation products. Innovative companies keep their eyes on their competitors and watch for advancements not only in their own industry but in others as well. They seek to create disruptive technologies.

3.5Disruptive Technologies

What are Disruptive Technologies?

Every once and awhile a new idea or technology comes along that seemingly changes everything. These new technologies change the status quo, they alter markets, reshape businesses, and modify our livelihoods. In an article published in 1995, Clayton M. Christensen classified such innovations as disruptive technologies.

For a new innovation or technology to be considered disruptive it must drastically alter a current market, much like the invention of the wheel changed transportation thousands of years ago and the mass production of the affordable Ford Model T altered the same market more recently. The invention of steel as a replacement for iron completely altered the construction market. The internet has completely disrupted multiple markets including communication by mail, retail, information, and socializing. Thousands of other technologies have disrupted our way of life including personal computers, printers, smartphones, word processing software, cameras, LED lights, advanced robotics, 3D printing, and cloud storage.

Adapting and Creating Disruptive Technologies

Recognizing disruptive technologies is fine, but ultimately we want to adapt to and create disruptive technologies. Firms who fail to adapt to disruptive technologies will be destroyed by them, and firms who create disruptive technologies will become extremely successful. 

Watching Competitors and Other Industries

Two ways a firm can be best prepared to take advantage of disruptive technology is to watch their competition closely and to watch other industries. If a firm keeps a close enough eye on all of their competition they can likely catch on to shifts in the market and be one of the first to benefit from the disruptive technology. Watching other industries is equally important because modern business ideas and technology transfer effortlessly across industries. If your firm is the first to notice a disruptive technology in another industry you might become a pioneer in applying it to your own industry. 

No Secret Recipe

There is no secret recipe to creating a disruptive technology, but in order for a firm to be at least in a position where they could create their market’s next disruption, the firm must be awake, watching, listening, and keeping up with their customers. They need to be aware of advances in society, technology, and production capacity as well as aware of changing customer needs and wants.

3.6Benchmarking

When benchmarking, a company compares their business processes/performance to the best practices of other similar companies.

Common Benchmarks

Although quality, time, and cost are three of the most common areas to benchmark in essentially all industries, benchmarking can be used to evaluate any quantitative measure of performance. The following list includes some of the most basic benchmarking areas:

1. Cost to produce a single unit

2. Productivity per unit

3. Cycle time per unit

4. Defects per unit

Benchmarking Example

Let’s pretend that I want to benchmark my beer company, Chad’s Blue Collar Beer. First, I’ll identify which companies in the beer industry have the best quality, time, and cost. Generally speaking, the industry leaders are very good at all of these. Perhaps I’d benchmark Chad’s Blue Collar Beer against Anheuser-Busch InBev (maker of Budweiser), MillerCoors, Heineken, and Pabst. These companies are among 11 brewers that make more than 90% of all beer in the United States, which shows their high industry performance. 

First, how much does it cost to produce a single bottle of beer? Perhaps Chad’s BCB spends $0.75 on each bottle. If Heineken spends $0.25 per bottle, MillerCoors spends $0.28, and Pabst spends $0.26 per bottle, it is easy to see that Chad’s BCB should look into decreasing costs as it grows. Obviously, the benchmark companies will be cheaper because of the volume they are producing, but the sizable gap in cost highlights an area to investigate.

We then perform the same comparison to benchmark Chad’s BCB productivity per bottle of beer, the cycle time per bottle of beer, and the number of defects we average.

Hypothetically, I may find that my company does proportionally much worse in the cost per bottle of beer and has a very long cycle time compared to the other beer companies. However, I may actually have fewer defects per 1,000 bottles than any of the other companies.

This opens up several possibilities. Perhaps Chad’s BCB should decrease the amount of time for a bottle to be made and filled (cycle time) even if it means that the number of defects increases to the industry average. This will allow us to produce a greater volume while the factory is open, decreasing the operating costs even if some money is lost on defects.

Or perhaps I will choose to work on decreasing my cycle time while still maintaining the relatively low rate of defects, attempting to gain a competitive edge on other companies.

Internal Benchmarking

Benchmarking can also occur within a company. If my beer company has 4 factories and each has several different bottling lines, I can measure the results of each line within the factory and make a comparison. Then a comparison can be drawn between the different factories, analyzing each of the measures listed above. 

Benchmarking from other Industries

Benchmarking can also be used from other industries. For example, Bill Smith and Mikel Harry introduced the statistical process control system called six sigma while making cell phones and other products for Motorola. Other industries recognized that six sigma control was preventing most costs from defects at Motorola (roughly 3.4 defective features per million opportunities), so many manufacturing companies began using six sigma within their respective industries.

3.7Weighted Competitive Strength Assessment

Weighted Competitive Strength Assessment is a tool used to quantify competition and simplify firm comparison and analyzation. When followed correctly, the process allows a firm to understand and see clearly its own strengths and weaknesses, as well as those of its competitors which help the firm make sound business decisions. Follow these steps to perform a Weighted Competitive Strength Assessment:

1. List key factors that determine industry success

2. Rate the firm you are analyzing and its competitors on each industry factor from above.

3. Give a weight to each element based on the value each factor has in the market (the total sum of all weights are 1.00). 

4. Determine the competitive score for each firm by multiplying each rating by each weight and then summing totals for each firm.

5. Analyze the firm in question, comparing each success factor to its competitors. 

Sample Weighted Competitive Strength Assessment

Johan owns and operates a growing furniture store with several employees. Business is going well, but he’s not really sure where he stands in regards to his competitors. He decides to perform a weighted competitive strength assessment to help him decide how to improve his business. Here is an example of what that weighted competitive strength assessment might look like.

Strength / Measure	Weight	Johan	Competitor 1	Competitor 2
		Rating	Score	Rating	Score	Rating	Score
Quality of Product	.18	9	1.62	6	1.08	9	1.62
Price of Product	.17	7	1.19	9	1.53	7	1.19
Service	.21	9	1.89	3	.63	9	1.89
Size of Inventory	.1	6	.6	9	.9	4	.4
Variety of Product	.1	7	.7	8	.8	3	.3
Reputation / Image	.24	9	2.16	6	1.44	8	1.92
Overall Strength Rating		8.16	6.38	7.32

Rating Scale: 1-weak, 5-average, 10-strong

3.8Core Competency

Many markets are saturated with similar firms offering similar products for similar prices. Every once and awhile, however, a firm manages to set itself apart by offering something more than the standard product. This differentiation could be due to the firm’s unprecedented manufacturing process or possibly their phenomenal customer service. Perhaps the firm has a particular marketing strategy that gives them a market advantage. Whatever it may be that differentiates the business, this skill, or combination of skills and capacities that a firm has over its competition compose the organization's core competency. A core competency is a deeply developed aptitude which empowers an organization to offer greater value to its consumers.

A core competency must be something difficult to emulate by competition and as such, provide somewhat of a sustainable advantage within the market. Because many of the skills and advantages emulated by a firm are fully transferable and applicable in multiple markets, having strong core competencies increases a firm’s ability to enter new markets and succeed.

Developing Core Competencies

C. K. Prahalad and Gary Hamel developed and presented the idea of core competencies in a 1990 Harvard Review. They cited three things to do in order to develop core competencies.

1. Invest in Needed Technologies

First, invest in needed technologies. Imagine the advantage had by the first dairy farmer who used automated milking machines. While his neighbors still milked 12 or so cows by hand the farmer with the new technology had a milking capacity that dwarfed those of his competition.

2. Distribute Resources

Second, distribute resources throughout business units to create variation. Google is an example of a company which has its hands in a bit of everything. Yamaha has also created a wide variety of products from their core competencies. Companies which effectively do this gain recognition, brand name, image, loyalty and improved distribution channels.

3. Strategic Alliances

Third, forge strategic alliances. An alliance between Starbucks and Barnes and Nobles bookstores was created to put to use core competencies through the instigation of in-house coffee shops. The alliance between Spotify and Uber allows customers paying for a hired vehicle to be welcomed by their favorite music playlist.

Developing core competencies which continue to develop and evolve to stay on top of the market determines the success and competitive advantage of a firm. According to Prahalad and Hamel, the key is to clarify core competencies, build core competencies, and cultivate a core competency mind-set.

3.9Four Corners Analysis

Guessing at your competitor's next move is difficult. There’s no way of knowing exactly what they are going to do. However, Michael Porter’s Four Corners Analysis provides insight on how to gain insight on your competitor’s future strategy. The analysis is built up of a systematic process that helps you look through the eyes of your competitors and think as they do. This allows you to identify areas where you can have an advantage; for instance, you may find that they are completely focused on selling their current product and aren’t innovating. By focusing on innovation, you can bring a new product to the market, rendering their current product obsolete. Your strategy can be influenced by what they will likely do.

Elements of a Four Corners Analysis

In the four corners analysis, you will look at each of the following. Try to imagine how your competitors would think about each of the following:

Drivers

What things motivate your competitor? Your competitor’s drivers consist of the things which motivate them, including their financial and performance goals, corporate mission statement, leadership backgrounds, and organizational structure and culture.

Current Strategy

What are they currently striving to do? We often think that corporate strategies are kept secret (unless they are published), but it’s not very hard to figure out what a given company’s strategy is. Look at what your competitor is doing for it’s customers, where they are investing their time, money, and effort, and what relationships they are developing.

Management Assumptions

How does your company see the world? Do they see themselves as the underdog? The hero? The revolutionary? Look at how they view their own strengths and weaknesses. Then look at how they view the market. Are they holding on to a product that is quickly becoming outdated? Are they missing any key market insights? Do they understand the market better than you? What changes do they anticipate occurring in the market? When looking at how they view the market, it can be difficult to separate your own perceptions from theirs. Finally, how do they view their competitors (including you)? Are they focused on fighting you, or is there a bigger competitor to worry about? Are they only competing in the same markets as you are, or do they have other industries with competitors to worry about. Your competitor’s management has perceptions of themselves, the market and their competition (including you). Determining what those perceptions are is understanding their management assumptions.

Capabilities

What are the strengths of your competitor? These are their capabilities. Such elements of their business as their financial strength, quality of their product, marketing, customer service, skills of their employees and qualities of their leadership determine their capabilities. These show how well the company can react to external factors and adjust to the market.

Understanding each corner of the four corners analysis allows you to think like your competitor and determine their future strategy as much as possible. The diagram shows the relationship of all four corners.

3.10Incumbency Advantage

Incumbency Advantage in Politics

What’s the easiest way to win an election? It’s really quite simple; run for an office or position that you already hold and get reelected. The incumbent, or person currently holding a political office, generally has a huge advantage over a challenger. This is referred to as incumbency advantage.

Why does this happen? Incumbents often have structural advantages that play in their favor. In most cases, incumbents have more name-recognition than their competitors, simply because voters already know who they are from previous elections and from their time in office. In areas where there is not a set schedule for elections, the incumbent can choose an election time that is favorable to them. Additionally, incumbents have huge advantages in fundraising. Financial backers are more likely to support an incumbent, and lobbyists logically see giving money to incumbents as a safer investment-there is a lower risk of losing the election and squandering the funds. For instance, in the 2016 Senate elections, incumbents raised an average of about 10 times as much as challengers ($7,900,000 per Senator vs. $756,000).

Incumbency Advantage in Business

The incumbency advantages is also very prevalent in business, and it parallels that of the political sector. Just as in elections, name recognition is a huge advantage in attracting potential customers and investors. Consumers trust the brands they already know. A new company can spend millions of dollars trying to get their name out into the market, whereas established companies don’t have to spend a penny for the name recognition they already have. Beyond name-recognition, incumbent companies also have customer loyalty, obviously a powerful factor. Even when Apple Maps proved to be a fiasco, customers held onto their religious-like devotion to Apple products.

Barriers to Entry

Invaders face problems from barriers to entry. Primarily, economies of scale prevent usurpation of incumbent companies. Initial costs can completely exclude many competitors from entering a market. After the initial costs, incumbent companies still are at an advantage. The sheer volume of customers allows them to keep costs low and quality high. Available money from investors also allows them to raise funds almost instantly, allowing for growth and innovation. Incumbents are likely to capture a large share of the market.

Market Share

With this market share, incumbents can attract more innovative employees, recruiting the best of the best. Both the better pay and the history of success brings in brilliance. For example, many of the best computer programmers dream of working for Google because it is one of the most successful companies ever created.

The list of incumbent advantages could stretch on forever, from better consumer research to established supply chains and distribution channels. In the end, companies new to a market have to overcome the incumbency advantage if they want to flourish in a market or find something new to which they themselves can benefit as the incumbent.

Disadvantages to Being an Incumbent

There are several possible disadvantages to being the first company into a certain market or being the established incumbent. Initially, it is difficult to sell a product that has never been sold before. Essentially, you must first teach customers what the product is, and then why they need it. You may have to do all of the original research into a product to prove that it will work, whereas other companies can simply copy what you’ve already done. Companies who follow you into the market may learn from your mistakes, and may find ways to offer better features. This can cause your customers to switch from your brand after their first few experiences. Incumbents tend to follow the same path that they originally started on, which may lead to the eventual demise of the company when market changes occur. It is easier for small, new entrants to a market to pivot and adapt to changing customer demands. Followers also have less risk because the concept has already been proven in the past. First movers may also launch a new product before a market is ready, causing the company to stumble.

3.11Diversification

What is Diversification?

Many companies specialize in one product and stay focused solely on the production, marketing and distribution of that product. For some this is an effective strategy. For other companies, however, their chosen strategy involves creating varied products or acquiring other companies with different products. This strategy is called Diversification.

Parallels in the Stock Market

Diversifying a business is like diversifying an investment portfolio. In a portfolio you can put all your eggs in one basket by investing in one stock, you can purchase a plethora of stocks related to one market which adds some diversification, or you can invest in stocks and bonds across boundaries in different and unrelated markets, diversifying your portfolio as much as possible. Diversification decreases risk because, while a single company or a single industry could potentially crash, broad market crashes affecting unrelated industries are rare. In the stock market, there is generally a trade-off between the potential to earn a large return and the risk associated with an investment portfolio.

Diversification of a Business

Businesses have the same decision to make in regards to where they decide to invest their time and money. If a business focuses on selling a single product, it could make a lot of money by perfecting their production of that product. However, if that product fails, goes out of style, or otherwise suffers, the company could soon be out of business. On the other hand, a diversified portfolio prevents the risk of the business going under after a single failed product.

How to Diversify

Businesses also have the decision of how to diversify. If they decide to diversify they can either expand within the market in which they already operate or they can diversify into new markets they haven’t yet explored. Procter and Gamble started in 1837 as a candle and soap manufacturer now owns brands in the food industry, consumer goods, and pharmaceuticals. Samsung, which we know as an electronics company also owns businesses in the financial industry, healthcare, and construction. Google and Apple, on the other hand, have both largely stayed focused on diversifying within the tech industry. Both own so many companies within the tech industry it seems every corner of software, hardware, and next-generation tech has Apple and Google involved.

3.12Diffusion of Innovations

Diffusion of Innovations explains the process by which ideas, products, and technologies are adopted by customers and accepted into the market. Adoption is diffusion from the perspective of customers and can be graphed in a normal distribution. 

As shown in the graph, innovators represent the first 2.5% of consumers who adopt the new product being offered. Early adopters generally embrace the new technology due to the positive response from innovators and represent the next 13.5%. Consumers who have aversion to risk and rely on the experience of other consumers fall into the early majority and represent the following 34% of consumers. The ensuing 34% who fall into the late majority consist of consumers who are generally skeptical or apathetic towards a product and adopt only after the product has become commonplace. Laggards, as the name suggest represent the last 16.5% of consumers who resist the new product and may not even accept it until conventional substitutes are no longer accessible.

Price Sensitivity

Innovators and Early Adopters

The different categories of consumers have very different levels of price sensitivity. Innovators are generally willing to pay a much higher price for a product, particularly if it seems particularly novel. They may be unusually interested in the particular market, causing them to apportion a greater percentage of their disposable income towards products in that market. Early Adopters will pay premium prices, assuming the innovators had a positive experience with the product.

Early Majority

As a product transitions into the early majority, price begins to become more of an issue. The early majority are moderately price sensitive, and may shy away from the prices which were acceptable in the earlier stages of the diffusion of innovations. However, they are not so price sensitive that your product risks being destroyed by excessively low margins.

Late Majority

The late majority are very price sensitive. Small differences in the price can make a huge difference to the conservative, late majority. They have watched most people around them adopt a product without buying it, so they are fine with waiting a bit longer if they can enjoy a lower price. If you want to attract the late majority, make the product cheaper, in addition to easier to use and more convenient.

Laggards

Laggards are at least as price sensitive as the late majority. However, a decrease in price won’t necessarily attract them to a product. They will stick with the way they did things before either until their previous product becomes so outdated that it is no longer a good option to keep using or until their previous product is no longer offered.

3.13GE-McKinsey Matrix

Originating from The Boston Consulting Group Matrix, McKinsey and Company developed the GE-McKinsey Matrix to help General Electric strategize which projects to undertake. The GE-McKinsey Matrix was designed to overcome the shortcomings of the Boston Consulting Group Matrix. 

The matrix is made up of two axes, Business Competitive Strength and Industry Attractiveness. Both are analyzed for a specific project and given a rating of either high, medium, or low. The diagram below shows a GE-McKinsey Matrix.

Industry Attractiveness

The rating for Industry Attractiveness is determined based on a number of industry elements:

· Market size

· Barriers to Entry

· Competition (Porter’s Five Forces)

· Political, economic, sociocultural and technological factors (PESTLE analysis) 

Business Competitive Strength

The rating for Business Competitive Strength is determined by:

· Market share of the company

· Core Competencies of the company

· Customer loyalty and brand strength

· Financial strength

· Management strength

After rating the industry attractiveness and business competitive strength for projects a firm is considering, the firm will be better able to choose those projects which are most likely to succeed.

3.14Summary

Here is a brief summary of each of the strategic tools discussed in this topic. 

Porter's Five Forces

Porter’s Five Forces are one of the fundamental ways of evaluating the competition in a market. The Five Forces are supplier power, buyer power, threat of substitution, threat of new entrants, and competition.

Blue Ocean vs. Red Ocean Strategy

All companies compete in either a Red Ocean or a Blue Ocean. A Red Ocean is a market saturated with competition, and companies battle between themselves over the available customers. Blue Oceans are new industries or products which are not saturated with competition. 

Product and Industry Life cycle

Products generally go through the 4 major stages of the Product Life Cycle: Introduction, Growth, Maturity, and Decline. Each of these stages is characterized by different pricing and promotional strategies.

Disruptive Technologies

Sometimes, a technology will completely change the nature of a market, rendering products obsolete or changing the way people live day to day. These disruptive technologies are both difficult to achieve and tricky to plan for, but can provide some of the best possible growth for a company.

Benchmarking

Benchmarking is when a company compares itself to different businesses in their industry. This gives a telling look into possible explanations for their success in the market, which can be put in place by your business.

Weighted Competitive Strength Assessment

The Weighted Competitive Strength Assessment gives a weight and a rating to the most important factors in an industry, and then compares them between different companies. This provides a more objective representation of the comparative strength of different companies.

Core Competency

A company’s core competency is a specific feature or service that distinguishes a firm from its competitors. Strategies should seek to make the most of this competitive advantage. 

Four Corners Analysis

The Four Corners Analysis is a way to potentially predict your competitor's future strategy. It looks at the Drivers, Current Strategy, Management Assumptions, and Capabilities of the competitor.

Incumbency Advantage

Companies that have operated for a period of time in a market do enjoy many advantages because of their past success. These incumbency advantages include name recognition, lack of barriers to entry, and economies of scale and scope.

Diversification

While some companies focus on a single product or service, other companies diversify their product lines. This Diversification decreases the risk of any one product failing and ruining the company.

Diffusion of Innovations

As new products are offered on the market, there are different categories of consumers that adopt the products. These are, in chronological order: Innovators, early adopters, early majority, late majority, and laggards. Your business strategy should match the categories your product currently appeals to within this Diffusion of Innovations.

GE-McKinsey Matrix

The GE-McKinsey Matrix helps companies decide which projects it will undertake. It looks at the business’s competitive strength and the industry attractiveness to determine whether the project is a high, medium, or low rating.

Chapter 4:

4.1Introduction to Creating and Handling Growth

Learning Objectives

1. Differentiate between Organic and Inorganic Growth.

2. Explain the strategic value of divestment and outsourcing.

3. Describe Growth Hacking Strategies.

4. Describe Horizontal and Vertical Integration.

5. Describe the elements of the BCG Growth-Share Matrix.

6. Explain international issues in strategy facing international businesses.

4.2Organic Growth

Companies want to grow. This is at the basis of all strategy efforts - “how can we grow?” 

Many companies experience a trend where they start out with strong, even aggressive growth. As time goes on, the growth flattens out and they find themselves in the “low growth” category, a situation that isn’t nearly as attractive to investors.

Ways to Create Growth

There are many different ways to remedy this situation. Mergers and acquisitions allow the company to grow very quickly and expand into new markets. Strategic alliances can also push growth as companies combine strengths without becoming one entity.

However, these options often cause stagnated companies to forget organic growth. Growth can be promoted the way the company was originally built, by increasing sales and decreasing costs over time. If the size of the business is a limiting factor, new buildings can be built and additional employees can be hired as cash becomes available for reinvestment.

What is Organic Growth?

Organic growth simply means expanding your business through normal everyday business operations. It is often compared to inorganic growth, which is growth from mergers, acquisitions, and alliances. 

Advantages of Organic Growth

Internal expansion can lead to several advantages:

· Low up-front cost: Mergers and acquisitions initially cost huge sums of money to perform. Organic growth usually does not require the same quantity of capital. In the event that it will take an equivalent amount of capital, the investment is usually spread out over some period of time.

· Maintaining control: Unlike a merger, no control is transferred to another company. All control is maintained by you or your executives. Even an alliance can result in some loss of decision-making ability

· Lowered risk: Many mergers and acquisitions fail. They simply do not generate the expected amount of revenue, and the majority of them actually lead to less growth than the companies would have experienced separately. Organic growth allows you freedom to adjust and adapt as you go along. If the direction proves to be disastrous, less capital was invested originally, so less is lost.

· Greater flexibility: As you grow your business organically, you can choose from a wider range of options. You can control how fast you grow. You can pivot to quickly capitalize on new markets. You know your business inside and out, and can adapt very quickly to change.

· Less risk of culture-clash: Often, mergers and acquisitions suffer from differing cultures clashing when the companies are combined. Growing organically allows HR to be more selective about employees, finding the best fit for the culture.

4.3Inorganic Growth

Pepsi vs. Coke

We all know that Pepsi and Coke have been battling it out in carbonated beverages for over 100 years. In 2005, PepsiCo passed The Coca-Cola Company in valuation for the first time in 112 years. This was due, at least in part, to the inorganic growth strategy that PepsiCo undertook.

What is Inorganic Growth?

Inorganic growth is when a company uses either a merger, an acquisition, or an alliance to grow their business instead of growing through internal expansion. Although PepsiCo has also divested several entities in order to focus on their core business and raise capital it is the inorganic growth through mergers and acquisitions that we will discuss below.

Mergers

A merger is when two companies combine into a single entity. For example, the Frito Company and the H.W. Lay Company combined to create Frito-Lay in 1961. Four years later (1965), Frito-Lay merged with Pepsi-Cola to form PepsiCo Inc. By merging together, these companies formed a much larger company, and thus switched to having the available capital, marketing power, and market presence.

Acquisitions

As PepsiCo grew, it began acquiring companies. It bought both Pizza Hut Inc. and Taco bell in the 1970s. It later acquired Tropicana Products, Kentucky Fried Chicken, and Mug Root Beer, among others.

Strategic Alliances

In 1994, PepsiCo and Starbucks formed an alliance called the North American Coffee Partnership to make ready-to-drink coffee beverages.

Deciding to Merge, Acquire, or Form an Alliance

Now, how do we decide whether to merge, acquire, or form an alliance, or to do none of them? Not an easy question. PepsiCo successfully used all three, and it can often seem the inorganic growth strategies are always great. After all, if Google, Apple, Pepsi, Coke, and Facebook are doing it, should we always pursue inorganic growth?

Not necessarily. Different studies estimate the failure rate of mergers between 50 and 85 percent. This is judged based on whether the merged company has a stockholder valuation of more than the two companies did separately. It’s important to determine whether a merger, acquisition, or alliance fits in with your company’s overall strategy. 

PepsiCo learned some lessons in this. Originally, they purchased Pizza Hut and Taco Bell, probably because both were very successful. Over time, PepsiCo determined that their strategy was to focus on the snack food and beverage items. While Pizza Hut and Taco Bell were good companies, they didn’t align with PepsiCo’s strategy, and so they were sold, along with the California Pizza Kitchen, KFC, and others. 

Key lesson: Only merge, acquire, or form an alliance if it aligns with your corporate strategy.

Choosing Between Mergers, Acquisitions, and Strategic Alliances

Now, which one to choose? Again, it depends on your company’s strategy and the specific situation. For instance, Microsoft historically embraced a strategy of buying out competitors, killing the competition. In a red-ocean strategy like this, acquisitions are obviously the choice. Acquisitions allow the company to do whatever they want with their acquisition, whereas merged companies both retain some control. 

Mergers are beneficial when both companies are doing pretty well and would do better when combined, but don’t have the money to acquire each other outright. In general, mergers and alliances tend to happen between companies of similar size, while acquisitions tend to be a larger company buying out a successful startup. Mergers should create additional value beyond what the two companies are valued at separately. Many people overestimate the synergistic value between two companies and assume that together they will be much better than either one currently is. If the companies don’t each bring something to the table that the other one doesn’t have or doesn’t excel at, will they really be better together?

When to acquire:

· When your large company wants to combine with a small one

· When you want to buy their employee talent

· When you want to gain control of a supplier (vertical integration), decreasing cost of supplies

· For example, PepsiCo acquired its two largest anchor bottlers in 2010, consolidating these suppliers under the PepsiCo company. 

· When you want to kill off competitors

· If you believe that you can sell the company later at a much higher price (more risky)

· When you want to get the assets of the company and the price makes it worth buying the whole company (less common)

· When you want to enter new markets

When to merge:

· When both companies are of similar size

· When buying the other company is unrealistic

· When you want to combine both corporate structures

· When the value of the combined company exceeds the value of the individual companies added together (synergy)

· When previously underutilized personal can work effectively for both companies

When to form an alliance

· When you only want to work together for a limited time

· When you only want to have one (or a few) products in common

· When neither company wants to give up its autonomy

· When the cultures between the two companies would clash if combined

· For a specific promotion

While these are general guidelines, they won’t apply to every situation. Again, make sure that inorganic growth aligns with your overall strategy and that you’ve done adequate research to assure that the combined company will be more valuable than they were separately.

4.4Divestment

Divestment essentially means selling part of a business. Where an acquisition infers the growth of a company by acquiring or investing in new subsidiaries, a divestment infers the downsizing of a company by selling subsidiaries or other assets. Also known as disinvestment and divestiture, divestment is the opposite of investment, meaning that rather than buying an asset, a company is selling an asset to other companies.

Reasons for Divestment

Reasons for divestment vary widely from financial, governmental, ethical, or simply logical. As a general rule, companies make divestment decisions based on whether or not a project, asset, subsidiary, or branch aligns with company goals and direction. For example, in 2012 Google divested a profitable 3D modeling software subsidiary called SketchUp. SketchUp was a profitable business with millions of users and was likely to grow, so it didn’t make sense from an outsider's perspective for Google to divest it. Looking at the divestiture closer however, we can see that Google bought SketchUp for the sole purpose of using it for the 3D modeling of buildings in Google Earth. Once the modeling project was done, Google no longer had interest in keeping the company as it was no longer needed to accomplish an organizational goal.

How Divestments Usually Occur

Divestments are generally done through a direct sale of the subsidiary, spin-offs, or asset liquidation. Often companies will sell the divestment directly to another company through a mess of debated contracts and traded patents, much like Google selling Motorola to Lenovo in 2014. In spin-offs a parent company issues new stock to existing shareholders and creates a new entity out of a subsidiary. Equity carve outs involve selling a percentage of a subsidiary to stockholders in the form of stock. Liquidation of assets is a fairly straight forward divestment practice. When the assets of a subsidiary have higher value than the subsidiary itself, the parent company will likely liquidate the assets to optimize profit. Spin-offs and equity carve outs are tax sheltered but both the direct sale of a subsidiary and asset liquidation, on the other hand, are taxable.

4.5Growth Hacking Strategies

New companies have an up-hill battle to fight against established companies. In order to effectively fight this battle, new companies will sometimes implement “growth hacking” strategies. Growth hacking means using tactics to create explosive growth in the early stages of a company. These strategies are often to get your name out there and to build customer recognition. 

In 2010, Sean Ellis came up with the term Growth Hacking when writing a job description. He worked as a consultant for startups, and wanted to find a stellar replacement who would continue the aggressive growth when he moved on to a new company. Beyond just someone who could market or someone with a marketing degree, he wanted someone who could create massive growth very quickly. 

Creating Explosive Growth

Word of Mouth

Word of mouth is a key part of growth hacking. If you want your small company to grow aggressively, you have to get people talking about your company. Creating buzz about your product can be great for going viral and growing quickly. 

Marketing and Scalability

Growth hacking is inseparably connected with marketing, and often is best achieved in tech companies or similar industries where growth is easily scalable. For instance, once Snapchat was developed as an app, it could be downloaded hundreds of times or thousands of times without changing very much. Snapchat is easily scalable. Producing a tennis shoe is not as easily scalable. Every time someone orders another tennis shoe, production has to go up. The difference between producing 50 shoes and 10,000 shoes is vast. If demand for shoes jumped up this drastically, it would cause a major crisis, meaning that growth hacking is simply not as effective.

Sample Growth Hacking Strategies

There are many different growth hacking strategies. They all share similarities, which are best seen by looking at a few examples.

Invite a friend

This works by having built-in incentives for people to share the product with their friends. For instance, Dropbox offers you free storage space for every friend whom you invite to open an account and actually does. Similarly, Cotopaxi will refund your money from the Questival if you get 5 additional people to sign up. 

This creates very impactful marketing because it is done between friends and connections. If I see an ad for a new program, I am very unlikely to sign up. If a friend tells me to do it, I almost assuredly will consider it.

Free content

A popular growth hacking strategy employeed by many modern companies is to offer a free version first, with the option to upgrade later. This is great if your business model requires thousands upon thousands of people using your product in order to work. Think of Spotify - the usefulness of Spotify grows with the number of people using it, so they generate value through volume by offering it for free. Revenue comes both from advertising to people on the free version and from monthly subscriptions.

Currently, many business offer their product for free - YouTube, Twitter, Facebook, and a million others. They make money by having everyone use their product often, creating huge advertising and leveraging opportunities. 

Embedding/Pairing

This is actually part of the reason that YouTube is the second-biggest search engine - long ago when MySpace was popular, YouTube offered the ability to embed their videos easily with MySpace. This quickly grew the number of users, and YouTube gained plenty of stability to survive the eventual demise of MySpace.

By linking your product to existing products, you can quickly access a huge number of people that are currently using a successful product. The method of accomplishing this will change vastly depending on the industry.

Growth Hacking is by no means a strictly defined strategy that includes only a few ways of achieving explosive growth. Instead, any tactic that can lead to your company becoming huge extremely quickly could be considered a growth hack. If it’s in the best interest of your company, be creative and think of innovative ways that could spark massive amounts of growth over a short period of time.

4.6Outsourcing

What is Outsourcing?

Outsourcing is when a company pays another company to do part of their work rather than doing it internally. 

Benefits of Outsourcing

There are many benefits of outsourcing, including the following:

· Outsourcing allows the company to focus on its core competencies, while allowing other companies to do the same.

· Outsourcing often benefits from inexpensive labor in foreign markets, lowering costs

· Outsourcing reduces the need for specialized staff required in the processes which they are outsourcing

· Outsourcing allows the business to operate on a smaller scale, with less capital and lower operating expenses

· Outsourcing sometimes improves overall quality, as each company focuses solely on what they do best

· Companies generally reduce spending by about 15% by effective outsourcing

As Peter Drucker said, “Do what you do best and outsource the rest.”

Costs of Outsourcing

There are some costs of outsourcing that are not immediately apparent. Outsourcing requires additional inspection and quality control on all products that are being brought in from an outside firm. There are often costs associated with travel and close communication with the company being outsourced to. An increased lead time from waiting for products to ship may decrease a company’s agility. Time and energy must be spent to draft, negotiate, and sign contracts. 

The main issue with outsourcing is communicating effectively to the outsourcing firm about exactly what is wanted. 

Many entrepreneurial students releasing a new product plan on outsourcing almost immediately. They see the lower cost of making it in China and envision tons of money pouring in. However, it is often wise to start domestically and eventually outsource. This is because overseas manufacturers almost always have a minimum order quantity (MOQ). This ensures that the manufacturing companies will produce enough volume to justify the costs of making molds and setting up the assembly line. MOQs are fine, as long as the product will be successful. With a very new product, it is a good strategy to make the product locally in small quantities, and test the market by selling the first 100 or so. Even if these first products are sold at a loss, the money spent prevents huge losses by ordering thousands of products from China and then discovering that the market isn’t willing to actually buy them. 

Ultimately, companies must simply do adequate research on the costs and benefits of outsourcing and determine if it will be a strategically beneficial decision.

4.7Horizontal and Vertical Integration

Horizontal Integration

In 2009, Pilot Corporation, a company which specialized in truck stops and convenience stores, merged with Flying J’s truck stop division. The two companies were previously two of the largest truck stop location providers in the western US. After the merger, the resulting Pilot Flying J chain dominated the US market as the largest truck stop location provider in the US.

This business strategy—expanding business operations to grow within one specific market—is known as horizontal integration. Horizontal integration is when a company grows within the same market with the hope of gaining as much market share and control as possible. When Heinz and Kraft Foods merged in 2015 they were similarly following a strategy based on horizontal integration.

Vertical Integration

Vertical Integration, on the contrary, involves growing a business to either the preceding or succeeding market in the path a product follows. For example, a retail business that expands into the production of their products would be integrating vertical integration. Pilot Flying J is not only involved with truck stops but also owns the fuel pumps which supply the trucks with fuel. The company also owns the oil refineries which produce the fuel, the trucks which ship the fuel, the convenience stores at their truck stop locations, and the restaurants the truck drivers eat at. This strategy is a great example of vertical integration.

Companies may use both horizontal and vertical integration, such as Pilot Flying J, in efforts to find success or focus on one strategy as needed. The goal of vertical integration is to cut down on costs because there aren’t companies taking a profit out at every stage of the process. Horizontal integration allows the company to have economies of scale and/or dominate a particular market. Consider what ways your company can use these strategies to expand your business.

4.8Boston Consulting Group (BCG) Growth-Share

First developed in the 1970’s, the BCG Growth-Share Matrix was created to help large business organizations apportion their resources throughout the different entities of the business. The matrix is created by looking at the market share and market growth rate of different aspects of the business. It looks at how you use cash, what generates cash for you, and what determines overall success.

The BCG Growth-Share Matrix is represented by the following table:

Figure 4.1: 

Elements of BCG Growth-Share Matrix

Cash Cows

Business entities which have large market share in mature industries or industries with slow growth are characterized by cash cows. Cash cows require little by whey (pun intended) of investment but cash generation is high due to their market share.

Dogs

Entities with small market share in slow growing or mature industries are referred to as dogs. Dogs require little cash to run but also have low cash generation. Such entities often best serve the company as divestitures as the money tied up in the entity may be put to better use elsewhere.

Stars

Entities that have a large relative market share within a fast growing industry are the stars of an organization. Stars may be profitable given their large market share but they require investment to maintain. Stars can develop into cash cows as the market growth rate decreases.

Question Marks

Entities characterized with small market share in a fast growing industry are referred to as question marks. These entities will require resources to grow in market share but whether they successfully develop into stars or not is questionable. The goal of a company is to develop question marks into stars, and stars into cash cows. Doing so requires a strategic disbursement of resources.

Some criticize the BCG Growth-Share Matrix for being too simple and failing to take into account other aspects which affect the profitability of a market besides market share and growth. The GE-McKinsey Matrix tries to better address elements of the market not covered by the BCG Growth-Share Matrix.

4.9International Issues in Strategy

Expanding internationally is obviously a huge advantage for many companies, as they gain access to a much larger market, different suppliers, and new partners. However, there are many things to take into consideration, both when deciding if you will begin international expansion and in deciding how to handle continued international operations. 

Currency Exchange

Currency exchange rates can have a huge impact on an international business. For starters, these rates fluctuate continuously, making it necessary to monitor rates to prevent losing thousands of dollars by transferring money on the wrong day. Exchange rates add a layer of uncertainty to doing business as a changing exchange rate may vastly decrease the margin on a given product at a given price. 

The strength of a currency will even influence your company through supply and demand. If you source many of your materials through a particular country, the cost of supplies may rise dramatically if the currency of that country gains in strength, compared to the dollar. This potentially could make your supply chain ineffective, or erase the margins on some of your products.

Demand in foreign countries for international goods depends heavily on the buying power of their currency. The economic strength of a nation will determine, in large measure, how much the people of that country will spend on consumer goods.

Be sure that you factor in currency exchange rates in your thought process when designing an international strategy. You may need to compensate for the fluctuations with a higher price, changing your demand calculations.

Tariffs, shipping, imports, and exports

Tariffs

Tariffs are a tax on a certain product when it is imported to a country. Effectively, they add an additional cost to the products that you want to sell in a foreign country, decreasing the likelihood that it will be profitable to sell that item in that country. Tariffs are put in place for many reasons - raising money for a government, protecting infant industries, increasing domestic employment, as a national defense measure, and to protect consumers from certain goods. Before expanding internationally, look at the tariffs that are already in place for the target country, as well as the probability that a tariff could be put in place on your products.

Shipping Costs

Shipping costs are an added cost, quite similar to a tariff. The profitability of shipping a product will depend in large measure on the weight of what you are shipping. If you are shipping a rather sizable product, it may be worth reengineering it to weigh less. In addition to the cost of shipping goods internationally, there is also a delay in time for any goods that have to be shipped. This increased lead time will make it more difficult to adapt order quantities and product specifications in response to the market.

Other Issues with Imports and Exports

There are many issues in imports and exports that affect businesses. Every country has its own rules and regulations on what can be imported, as well as constraints on how items can be imported and exported. Products can be lost or damaged in transit, and shipping companies don’t always cover the loss. Theft, accidents, and natural disasters all increase the risk of importing and exporting. 

Your company may need to buy export credit insurance, either through the private sector or through the government to prevent against non-payment issues. If you send a shipment of product to a client and the client is unable to pay for the imported goods, you face a substantial loss in bringing the product back to where you shipped it from. 

In some cases building a foreign manufacturing plant may be more cost effective than producing goods domestically and shipping them abroad. 

International Taxes and Repatriation

When a company makes money overseas, it does not have to pay taxes on the money until it brings the funds back into the United States. This “repatriation” tax is at around 35% (this rate varies depending on the taxes the company has paid in the foreign company) and gives companies a huge incentive to keep money in foreign countries. This practice is allowed by law, even though some question it on ethical grounds. 

Sometimes, these funds are used to pay for manufacturing or other expenses in foreign countries. As the money is both made and spent abroad, it wouldn’t make sense to bring it into the United States and lose more than a third of it.

In other cases, companies use creative accounting practices to seemingly shift profits to tax havens, or places such as Bermuda and the Cayman islands (both have extremely low tax rates). The money is kept there until the company needs to use it for something, in which case it can be shifted around.

Over 2 trillion is held overseas by U.S. companies, including companies like Apple (~$180 billion), General Electric (~$119 billion) and Microsoft (~$108 billion). It is particularly easy for computing, IT, and pharmaceutical companies to report their profits in foreign countries and keep their money outside of the country.

Bribery and Corruption

Bribery

Corruption and bribery also play a role in international business. Many people who work for US companies pride themselves on working for an ethical company, and are thus very surprised to find that their company pays bribes when operating in foreign markets. Some argue that these bribes are essentially required to operate in certain countries and thus are justified. Others disagree, saying that US companies should maintain a higher standard of ethics, even if it means refusing to enter certain foreign markets. 

Foreign Corrupt Practices Act of 1977

Whatever your business’s position on the matter, one item of consideration is the Foreign Corrupt Practices Act of 1977. This Act makes it illegal for many companies to bribe foreign government officials in order to obtain or retain business. Compliance with this act is necessary, and the Act should be reviewed before entering foreign markets. As this Act also includes provisions on how accounting practices should be handled in order to prevent bribery and corruption, all companies should assure that they comply. Even if a certain bribe isn’t illegal under the Act, it is still a costly measure and should be avoided, if possible. 

Corruption

Corruption is very costly to companies. Working with corrupt businesses, dealing with corrupt employees, and performing internal corruption checks all cost far more than many people realize. Unfortunately, corruption is widespread across the world.

When entering a new country, consider the relative corruption of the country you are entering. The more widespread the corruption is, the more likely it will be costly to operate in that country. In order to prevent internal corruption and white-collar crime within your own company, invest additional resources in hiring quality employees and vetting them for corruption. Perform frequent internal checks to assure that money isn’t leaking out of your company.

4.10Summary

Creating and Handling Growth

Organic Growth

Organic growth is the traditional method of growing a company - by expanding your operations, cutting costs, hiring additional employees, and doing the necessary work. This is the alternative to inorganic growth.

Inorganic Growth

Inorganic growth is when a company grows by merging with another company, acquiring another company, or forming a strategic alliance with another company. Inorganic growth tends to be a strategy used by larger companies.

Divestment

Divestment is when a business decides to sell part of itself to other companies. This can mean selling off a department, subsidiary, acquisition, or other asset and can be a useful strategy for focusing on the most profitable part of your business.

Growth Hacking Strategies

Growth Hacking Strategies are effective ways for a small company to have explosive growth in the early stages of business creation. 

Outsourcing

Outsourcing allows a company to strategically focus on the parts of their business that add the most value to the final product, leaving other companies to do the rest.

Horizontal and Vertical Integration

Horizontal Integration is when a business buys out or merges with competitors to gain a larger share of the market. Vertical Integration is when a company will either grow to control its own suppliers or grow to own the distribution channels that it generally has sold the product to.

Boston Consulting Group Growth-Share Matrix

The BCG Growth-Share Matrix focuses your business strategy on the most profitable products which you offer. It involves identifying your products or services as cash cows, dogs, stars, or question marks. 

International Issues in Strategy

Expanding internationally is a tricky process. This essay explains several issues to consider when undergoing international expansion.

Chapter 5:

5.1Introduction to Dealing with Change

Learning Objectives

1. Explain the importance of Change Management.

2. List several ways a company can reduce complexity.

3. Perform a scenario and stakeholder analysis. 

4. Describe Scenario and Contingency Planning.

5. Discuss how war gaming is used in an organization.

6. Define business process reengineering and restructuring.

7. Explain the benefit of performing early warning scans.

8. Identify the roles assigned in the decision-rights tool.

5.2Change Management

Change management is the process of managing organizational change. Seems simple right? Sometimes, all an organization must do to make a necessary change is tweak a few processes or implement a simple safety rule. However, in many cases, organizational change and change management is a huge undertaking. Change management is the tool used to drive such change.

Change is Part of Life

Change is a fundamental part of our lives. The world changes, markets change, people change, technology and understanding change. Everything around us develops and adopts alterations. Organizations which don’t realize this—those who don’t adapt to stay on top of change—will die.

Identify Needed Changes through Business Analysis

Organizations identify necessary changes through a variety of business analysis. Any of the business analysis explained in this book could be used to identify necessary change, such as SWOT analysis, Scenario Analysis, Value Chain Analysis, Market Segmentation, Porter’s five forces, etc. Once the crucial changes have been identified, change management comes into play.

Change management styles, steps, and theories differ in use and subjectivity according to situations, processes and problems faced by the organization. However different the situations may be, there are a few general change management principles that apply to most situations.

Principles of Change Management

Change Includes Top Management

First, change must include the leaders of the organization. Organizations won’t change until top management can change themselves and prove the change worthwhile.

Give People Roles

Second, Change is facilitated when as many people as possible are given roles within the change process. Letting people within the organization feel part of the change will boost their morale and desire to initiate change.

Small Victories

Third, small victories will give your change momentum to drive it throughout the organization from start to finish. Take the process of change one baby step at a time. When you accomplish small goals let everyone in the organization celebrate the success together and then move forward towards the next victory.

Communication

Fourth, communication is key. Effectively communicating the change over and over again to every individual and team in the organization and helping them see the need for change will move mountains during the change process.

Keep in mind that change is about people. The main challenge faced in change management is getting people to alter the things they have done for years. Getting people to support organizational change and changing their habits is not an easy task. However, when done effectively, it will make the difference between temporary and lasting change.

5.3Complexity Reduction

Successful businesses usually expand and keep expanding until they reach some sort of limiting factor. The complexity of doing business created by this expansion can sometimes become that limiting factor unless such complexity is effectively managed and reduced.

Complexity Reduction Example - FLIP

Imagine a small flip flops company called Footwear Lounging Instant Provider (FLIP). Initially, the concept and process are simple; FLIP makes extra comfortable flip flops for stylish teenagers. As their business takes off, they increase their product line from 3 different styles of shoe to 7 different styles in 4 distinct sizes. As business continues, they begin outsourcing most of their process, creating a more complex supply chain. FLIP continues to grow and begins to distribute across the country, necessitating sales reps and customer service support. A board of directors is created, as well as a marketing and HR department. Upper management determines that FLIP could vastly increase shareholder value if they expand to global markets. This requires design teams familiar with international fashion experience, as well as a massive network of distributors. Now FLIP offers a total of 25 different products, each in 5 sizes, in 15 different countries.

Complexity Creates High Fixed Costs

It is obvious that operating FLIP has become incredibly complex, and this complexity creates problems. The main problem is in high fixed costs—no matter how much sales volume FLIP has in the next month, it still has to pay for its massive organization, with all of its employees, computer systems, and manufacturing facilities. So FLIP starts looking for ways to reduce its complexity.

Looking for Ways to Reduce Complexity

First, FLIP should look at the most complex parts of their business and determine if each is necessary. Suppose that the smallest size of shoe is very difficult, and thus costly, to manufacture and is subject to lots of government regulations because it is for small children. This size makes up 8% of sales, and the largest size makes up 3% of sales. FLIP probably should discontinue both of these sizes - they create too much complexity without sufficient return.

Then FLIP realizes they are using 8 different computer systems across its many global offices. Files transferred between offices have to be re-formatted to work on other systems anytime important documents are sent. Consolidating to 1 or 2 systems will be expensive, but will reduce a huge amount of complexity.

Some other possible areas that FLIP could reduce in complexity:

· Materials - one style of flip flop is made using a particular type of foam that is difficult to source. Cut that style.

· Markets - Essentially the same styles are common in the United States, Western Europe, Canada, and Mexico. By limiting themselves to these markets, FLIP can avoid making multiple styles for foreign markets.

· Production plants - Instead of having 6 different plants making flip flops in different parts of the world, FLIP can consolidate down to the 2 largest manufacturing plants by investing in some additional technology to speed up their production.

There are many ways to reduce complexity, which vary depending on the market and the business model. According to The Global Simplicity Index, the largest companies in the world are each losing $1 billion+ from complexity that could be reduced.

Complexity Reduction can be a useful strategy for most companies. In some companies, reducing complexity can be the overall strategy until the complexity is significantly reduced. In most companies, it will help them in other strategies and in achieving company goals.

5.4Scenario Analysis

What is a Scenario Analysis?

Scenario Analysis is the process taken by a firm to project into the future and analyze possible different circumstances and events. Such projections include considering the future economy, future opportunities, competition, and threats. The analysis can go as far as attributing a probability as to the likelihood of each event occurring. Once future scenarios have been developed, strategy for each possibility is crafted so as to be ready for implementation in the occurrence of any future scenario.

The idea of scenario analysis is fairly simple, but the actual execution of the analysis is far more complicated. Without a magic crystal ball, it can be very challenging to project what the future holds. It is also difficult to provide an accurate probability of each scenario. As a firm matures and management becomes more practiced, scenario analysis, in theory, develops an accuracy that prepares the firm for future possibilities and makes employees ready to react quickly and resolutely in a way that best benefits the organization.

Example - Sunrise Cyclery

Consider Sunrise Cyclery, a local bicycle shop in business since 1981. The cyclery has never grown bigger than a small town repair shop and distributor but they have stayed in business now for 35 years. Let’s perform a scenario analysis on their business by projecting 1 year, 5 years, and 10 years into the future. First we create a chart that takes into account possible scenarios that could occur in the future of Sunrise. Using market and business trends, history and projections, a probability is then attributed to each scenario.

Projection Period	Increase in Demand	Decrease in Demand	Increase in Competition	Decrease in Competition	Economic Prosperity	Economic Stagnation	Economic Digression
1 Year	0.6	0.4	0.5	0.5	0.3	0.5	0.02
5 Years	0.8	0.2	0.7	0.3	0.4	0.5	0.1
10 Years	0.9	0.1	0.9	0.1	0.5	0.45	0.05

After the general analysis is finished, appropriate strategies must be planned out for each scenario.

In one year from now it has been determined there is a 60% chance there will be an increase in demand. To ensure customer loyalty and attract as many new customers, our short term strategy will be to run a promotional campaign just as mountain biking season is starting in order to take advantage of this increase in demand. Given the 40% chance that demand will decrease, we will focus on keeping the customers we currently have by offering discounted repairs to those who originally bought the products from us.

As probabilities for increased or decreased competition are equal, our overall competition strategy in the first year will involve exploiting our years of business experience and advertising ourselves as a historical, local, and family friendly small business that truly cares for its customers.

Different strategies will be initiated depending also on the overall prosperity, stagnation or digression of the economy. If the overall economy is in economic prosperity we can expect more users of our products. Offering a wide variety of product would help take advantage of such prosperity. If the economy is stagnant it will be vital to our company to keep the current customers we already have by making customer service our number one priority. If the economy is digressing we can expect demand for our products to also decrease. The most effective way for our firm to react to this circumstance is by tightening up our budget, offering only our popular products, and doing everything necessary to create a loyal base of customers.

Similar analysis with some time-dependent changes are done for the other projection periods as well.

5.5Scenario and Contingency Planning

The future is always uncertain, and that uncertainty can be vital in the world of business. Scenario Planning involves anticipating possible future events and opening the mind to basically any feasible situation. Such is not as easy as it sounds, as humans have the habit of incorrectly assuming the future will be similar to the present.

Scenario Planning

Scenario planning is performed by anticipating possible directions of the market and plausible changes to its current situation. Based on the anticipated directions of the market, opportunities and risks can be identified for each scenario and an appropriate action plan can be created. Effective scenario planning can create an organization based on creative thinking and strategy; prepared for nearly any possible change.

For instance, you may be experiencing wonderful growth and near total market domination. A scenario plan could include the hypothetical that a new competitor enters the market and begins to snatch up your original, loyal customers. If you have a loyalty rewards program in mind, you could quickly create additional incentives for your loyal customers to stay with you. Or perhaps you can lower prices quickly and use your economies of scale to sell product at a price new entrants to the market cannot match.

Contingency Planning

Contingency Planning, much like Scenario Planning, involves imagining what the future holds and planning accordingly. Rather than thinking of any possible scenario, however, contingency planning focuses solely on cataclysmic and disastrous possibilities. Such catastrophic scenarios may include what a company might do if their building caught fire and burned down or if their employees were all killed in a plane accident. Such events are incredibly unlikely but they do occur. Being prepared for such events can make the difference between the survival of a company or its demise.

Cantor Fitzgerald, a financial services company, successfully instigated their contingency plan after losing 658 of its 960 employees to the 9/11 terrorist attacks. The company was well enough prepared that it only took them one week before resuming business. Fitzgerald had very strong strategic partnerships, which helped them through this process. They focused heavily on their core business practices so the company was at least functional as quickly as possible. Even though they were back online within a week, it took 5 years of operation to fully recover what they had lost.

5.6Stakeholder Analysis

Imagine that you are Tony Stark and you are contemplating if you should convert your empire, Stark Industries, from a weapons company into an energy company. Assuming that you don’t have an overriding social cause to accomplish, you might want to conduct a stakeholder analysis before making such a monumental shift. This is essentially an analysis of the effects a given action will have on stakeholders. Stakeholders are people or groups that are either affected by the company or have some sway to influence the company. Thus, Tony will want to consider what effects this decision will have on his customers, his staff, the board of directors, shareholders of Stark Industries, and the federal government. By ranking both the amount of power and the level of influence each group holds, he can use the following chart to determine how much sway each constituency holds in the decision. The chart shows what actions you should do towards each category of stakeholders.

Stakeholders

Powerful but Uninterested

If someone has lots of power over your company, but is not interested in a specific decision, you should avoid aggravating them. For instance, Tony should avoid aggravating Pepper Pots, his PA, because she has a lot of power to influence him, but isn’t very concerned with how he runs his company.

Interested but Powerless

If someone is very interested in a decision, but has no real power, they should be given status updates. This keeps them happy, but does not base the decision on their ideas. Think of your nosy friend who takes an incredible amount of interest in your dating life, even though you aren’t very close. You can keep this friend informed about what’s going on, but they shouldn’t determine how your relationships go.

Uninvolved

People with little interest and little power are generally not even considered in decision making. They don’t care about this decision, and they couldn’t do much about it even if they do care. Don’t spend time or effort on them.

Key Individuals

The focus is obviously on the key people. They can sway decisions quite heavily, and they care a lot about this specific decision. For Mr. Stark, these people are his board of directors and his consumers. They have a huge vested interest in how he decides to run his company, and will ultimately determine the success of the company.

Given that consumers decide whether the company continues to be profitable or if it fails financially from lack of income, they should rank among the key stakeholders to consider. 

Timing

Timing is also very important to stakeholder analysis. If the analysis is made after the finalization of plans, it doesn’t serve any strategic purpose. If made before a course of action is adequately planned, it may be difficult to determine stakeholders’ position on the matter at hand, and it is likely that the plan will change and force an additional analysis, which may be costly and time consuming. 

Stakeholder analysis is a useful way to evaluate a corporate decision. This style of analysis prevents loud spoken groups without any power in the organization from unduly influencing the decision. It also forces the decision makers to adequately consider the effect the decision will have on the people that have the most real effect on an organization.

5.7War Gaming

What is War Gaming?

War gaming in business is a method of simulating future situations and determining how your organization would react to each one. Essentially, an outside organization comes in and sets up a game that mimics real-life business situations. The goal is to provide insights about how the future will unfold and to create plans accordingly.

Included Groups

Generally, the game will include groups representing 1) the market or consumer 2) a set of competitors and 3) uncontrollable factors or entities, as well as the team of executives from your company. Multiple rounds are undertaken in which all groups are given the same information and each determines how they will react.

Benefits of War Gaming

If performed correctly, war gaming can provide several benefits. These can include:

· Providing leadership with a specific plan of action

· Highlighting potential problems that may arise and determine how to respond to them

· Building confidence in a proposed plan

· Streamlining execution of the plan

For example, let’s pretend I own a shipping company and China’s economy just suffered a major downturn. In order to understand how to deal with it, I hire a team to help us through some extensive war gaming. They likely will run many scenarios and see how well our business model and strategic plans hold up under each.

For instance, if shipping to and from China was to be cut by 50%, how would our company react? Do we have enough other customers? Would competitors start a price war to maintain their current volume? Can we stay in business if we are forced to lay off 45% of our employees?

Or what if shipping simply shifted from China to South America. Do we have the relationships with strategic partners to enter markets there? Do we have the necessary set-up to engage those markets? How long would it take us to conform to health and safety regulations in the new countries?

Obviously, this example is rather dramatic, but it shows at least on a small scale how war gaming would work.

When is War gaming Useful?

War gaming can be useful in a variety of situations. When considering mergers, acquisitions, and corporate splits, war gaming can help determine what each affected group will do. Introduction of new products or large changes in price may necessitate war gaming to determine how consumers and competitors are likely to respond. Large shifts in corporate strategy or organization may also call for some insights on how to company will be affected.

Usually, war gaming is performed by an outside firm who charges a certain fee in order to perform the evaluation. As the fee is generally substantial, companies should assure that the game is actually needed and will impact the bottom line. There should exist a moderate level of uncertainty. Too much uncertainty means that the game can’t predict what will happen with any degree of accuracy. Too little uncertainty means that the game is not really needed.

5.8Business Process Reengineering

When a certain process or department of a business is underperforming, business process reengineering (BPR) may be the best solution. BPR is a complete overhaul of a business entity, redesigning it to improve its success. Such change can be motivated by financial goals to improve, customer satisfaction, employee well-being, or by a social cause.

Example - Nestle's Safety Program

A Nestle ice cream manufacturer in Santiago Chile used business process reengineering to restructure their safety program. With an increase in occurring accidents, the Nestle plant decided to take action to protect both their employees and their reputation as a well managed organization.

Discovering the Causes of Accidents

Nestle started their Business Process Reengineering by analyzing the reasons for the increase in accidents, which involved getting feedback from 1300 employees. They discovered that their intense focus on employee productivity was largely the reason for the increase in accidents. Stressing the importance of efficiency and the need to run the production line at full capacity caused many employees to take shortcuts in their work, often reaching their hands into machines to quickly solve a jammed part or remove an obstruction. Safety rules that had been previously observed were ignored in order to keep up with production goals.

The next step Nestle took was to strategize a plan to revamp their production safety process. They determined safety improvement methods from team training meetings, company conferences and bring your family to work events.

Shifting Focus from Productiviy to Safety

Nestle then initiated their plan by changing their focus from productivity to safety and launching their business process reengineering plan. Each team training and company conference was focused on safety improvements for a period of several months. They held employee events which involved each employee in the safety improvement process and Nestle even invited the families of each employee to get involved in the process. The effects were nearly immediate and as a result of Nestle’s plan, there was a 76% decrease in accidents.

Can you reengineer your business process to significantly improve the process? This process may be expensive, but often has very high returns if a significant change is made. What are the biggest problems in your company? What things seem to resist all efforts to fix them? The solution may be in business process reengineering.

5.9Restructuring

What do you do if your business used to be successful, but now it is struggling? Much like Business Process Reengineering, which involved overhauling a particular business process or entity, Restructuring is a complete overhaul of the entire business; each entity, process, and in many cases even the mission of the organization. Thus the term restructure means to structure again, or basically re-create your business.

Purpose/Goal of Restructuring

The general purpose behind restructuring is to improve the operation of a business. Other reasons for restructuring may be in response to a crisis, an acquisition, a change in law, or bankruptcy.

The overall goal of a restructure is to increase a business’s efficiency, cut down on costs, deal with problems, and create new value. Put simply, the goal of a restructure is to improve the profitability of a company. 

If a company’s restructure is more than an emergency, the company should ensure that some things are in order before attempting to restructure. Before a restructure is attempted, a company needs to forecast what the effects of the change will be. They then must assure that the company has enough cash to float through several months of perhaps decreased revenue. Every aspect of the restructure should be planned out before the change occurs in order to assure efficient time usage. A clear line of communication between line management, top management and shareholders, must be established before and maintained during the restructure.

Increase in Profitability

A restructure is successful if the business runs better and has an increase in profitability after the change. If the restructure was done in response to a crisis, success may be based on the survival of the company. If the restructure was in response to bankruptcy, success may be based on the company’s new ability to pay its creditors. If the restructure was done as part of an acquisition, success may be based on the company's increase in resale value.

5.10Early Warning Scans

Businesses generally have trouble keeping up with the pace of the modern world. External Factors change so quickly and unexpectedly, it is difficult to keep up. No one can perfectly predict the future. Forecasting is based on historical data and projects of that data into the future, so big changes in the market can make forecasts become completely inaccurate.

So what do you do? How can your company be ready to deal with the uncertainty of the future? How can you adapt quicker than your competitors will?

How to Perform an Early Warning Scan

Constantly Search for Irregularities

One way of doing this is through early warning scans. Some companies choose to perform early warning scans internally by looking at the market, while others invest in computer systems to scan for them. The first step in scanning for early warning signs is to constantly search for irregularities, or things that could indicate a fundamental shift in the market or in your business. Many of these will seem minor, caused by normal fluctuations in demand and in market conditions. 

Analyze Trends

Next, you look closely at each of the irregularities. What are the possible explanations for this? If this evolved into a trend, how could your company strategically change to deal with it? Are there other irregularities that also support this trend? What are the possible implications of this trend? Try to think of creative solutions to these theoretical trends. As you analyse them, focus your resources on the trends and issues that seem most likely and most relevant to your business.

Monitor and React to Important Trends

As time continues, pay attention to the trends that you spent the most time analysing (those deemed to be most important). If future data aligns with the trend, look out! It may very well be developing into a game-changing trend. Have a strategy prepared to deal with these trends. You may not end up using it, but if you do, you might save your company. 

For instance, let’s imagine that I run a small firm that produces material for deaf-blind children and their parents. We are heavily subsidized by state and federal governments, which gives us the needed margins to stay in business. One year, our subsidies were cut by 5%. We are efficient enough to deal with this without any problems, so the temptation is to ignore the cut and blame it on a tougher budget year for the government. 

However, because we have been performing early warning scans, we noticed that last year, the government increased the funding to cochlear implants (devices that allow hearing impaired children to hear sound like everyone else). If this trend continues and the government continues to support cochlear implants more heavily, our business will certainly go under. As this year’s budget cuts align with this theoretical trend, we begin making plans to deal with a complete transition away from material for the hearing impaired. 

Problems with Early Warning Scans

There are some problems to confront when using early warning scans to shape action plans and corporate strategy. 

· Potential for inaccuracy The future is impossible to predict with perfect accuracy, so there is a chance that the early warning scans will put you on a false path that eventually leads to the company’s downfall.

· Resistance to change People often drag their feet when they are asked to change how they do things, especially when their current actions are still bringing in profit for the company. 

· Wasted resources It takes time, human capital, and other resources to perform early warning scans. In most companies and most industries, these resources are worth the decreased risk. However, in extremely stable industries, it may not be worth the cost the perform these scans. 

Despite these problems, it is generally valuable to do early warning scans and create hypothetical plans to deal with them. It could be the difference between going out of business and becoming vastly successful.

5.11Strategic Planning

In strategic planning, a company determines what its strategy will be and makes plans to carry the strategy out. Generally, this involves using several different tools to analyse the business and determine what its goals are, as well as the things preventing it from getting there. During the 1960s, companies began strategic planning to a much greater extent than they had previously. 

Plum Incorporated

Let’s imagine that I own a small software company called Plum Incorporated. Given that Plum is rather small, there isn’t a budget to hire a strategist, so I decide to do the strategic planning myself. 

Analyzing Current Position

I start by reviewing our mission and vision statements, followed with a SWOT analysis of my company. As competition seems to be a weakness of our firm, I look at each of Porter’s Five Forces. On top of that, I benchmark my company against similar organizations in my industry. From these tools, I can see that Plum is extremely innovative and can charge premium prices for their software, but is very susceptible to new companies coming in and stealing customers. Despite the premium prices, Plum loses much of its revenue due to high costs, giving surprisingly low margins on all products produced. 

Previously, our strategic plan at Plum had a lot of meaningless buzzwords and phrases, like “Leverage our robust business plan to achieve greater synergy” and “Optimize performance through outside-the-box paradigm shifts.” These strategic plans are not specific or applicable enough to help the company, so I will throw them out and make a strategic plan that we can actually implement. 

What will make the biggest difference at Plum?

That’s the big question. In the short term, we have to decrease our costs. We simply cannot have low profit margins on premium priced items. Eventually, cutting costs won’t be an effective strategy - you can only cut costs for so long until the decreasing marginal returns are so low as to render the strategy completely ineffective. To deal with this, our strategy will have three stages. 

Stage One

In stage one, we will focus on complexity reduction, outsourcing, and total quality management in order to help decrease our costs. Once our overall margins are to 53% of the total price, we will shift to stage two. 

Stage Two

In stage two, we will focus on segmenting the market and dominating our core customers, driving home our advantage in creating customizable programs for mid-sized corporations. 

Stage Three

In the third stage, we will plan for a crafting strategy and a blue ocean strategy. We want to adapt as we go forward to continually enter markets with products that espouse blue ocean opportunities.

Am I scared about this strategy? Of course. I’m betting the company on our predictions of the future. By choosing a set of activities to focus on, I am inevitably not focusing on other activities. I’m cutting out the business practices that I don’t think will have the most value long-term, even if some of these are good practices. By focusing on the strategies listed above, I am inevitably not focusing as much time and energy on employee engagement, customer relationship management, or mergers and acquisitions.

Ultimately, that’s the catch; you can’t focus heavily on everything. In fact, Plum is probably focusing on too many different strategies in the above example. As I debate my proposed strategy with advisors, board members, and employees, we are likely to cut out several of the parts of the strategy in order to focus more heavily on the parts that really matter.

As you do strategic planning, focus on creating a meaningful strategy that can guide future actions. You can’t be good at everything right now, so be good at whatever presently matters most to your company.

5.12Decision-Rights Tool

Making decisions is often very difficult. For many organizations, a systematic approach to decision making is optimal to ensure the quality of the decision. This systematic approach is called the Decision-Rights Tool. Within the decision-rights tool, specific roles are assigned for each step of the process to maximize the quality of each element of decision making. 

Essentially, you choose some subject-matter experts to provide input, after which different members of your team make a recommendation, evaluate the recommendation, and finally make the decision. By forcing your team to work through all of these steps and by giving individuals specific tasks to concentrate on, you hopefully will arrive at a better decision.

Roles in the Decision-Rights Tool

Input

The first role assigned is that of input. Those given the role of input are the professionals of the field; those with experience and background in the subject in question. The inputters provide relevant information, facts, and figures to be organized and analyzed by a recommender.

Recommenders

The second role assigned is to the recommender who, after receiving information and input related to the decision at hand, assesses the input and analyzes possible options. After a thorough dissection of information and directions the decision can take, the recommender presents an educated and fact-based recommendation.

Agreers

Agreers are involved in the next step of the process. The Agreers listen to the recommender and seek to better understand the facts involved. It becomes the role of the agreers to either approve a recommendation, disapprove a recommendation, or initialize delay if more information is necessary.

Decider

Ultimately, the decision comes down to one individual who holds the role of the decider. When a recommendation makes it through the agreement process it becomes the responsibility of the decider to either finalize and initialize the decision, veto it or send it back down the process line for further consideration and fact finding.

Performers

The last people involved in the decision-rights tool are the performers; those who perform the job of implementing the decision once it is made.

The decision-rights tool can be very effective at obtaining an incredibly well studied and backed up decision, but at times the steps can be cumbersome. In time sensitive decisions it may be most effective to skip the role of agreers and going straight to the decision maker. The goal of the decision-rights tool is not to make decision making harder it is to help assure the quality of the decision. The tool is to be used when effective.

5.13Summary

Dealing Effectively with Change

Change Management

A general introduction to managing change within an organization.

Complexity Reduction

As businesses grow, they inevitably encounter increasing amounts of complexity, which threatens to increase the cost of operating. Reducing complexity results in a more agile, profitable business.

Scenario Analysis

Scenario analysis is when a company looks at the most likely situations that will arise in the next projected time period and estimates how likely each of them is to occur. This allows your business to plan for strategies to deal with the most likely scenarios.

Scenario and Contingency Planning

Scenario planning is the process in which companies look at possible changes in the market and create plausible plans to deal with these changes. Contingency planning is much like scenario planning, except that it is focused on cataclysmic and disastrous possibilities.

Stakeholder Analysis

If your company is planning on undergoing a major change, it may be beneficial to perform a stakeholder analysis. This is a process of evaluating the different groups who are involved in a decision and planning on how to interact with them.

War Gaming

War gaming is a simulation of future events, with people assigned to represent customers, competitors, your executive team, and other factors. Various situations are presented, and each group reacts as the group they are representing would.

Business Process Reengineering

Instead of making minor changes to a department or process within your business, you can completely overhaul the entity to improve its success. This is called business process reengineering.

Restructuring

Restructuring is the process of overhauling your entire business, redesigning it to have success when it has been failing in the past.

Early Warning Scans

After something disastrous happens in a business, it’s easy to wonder how you didn’t see it coming. Early warning scans are a method to help you see disastrous or fantastic events earlier along the way, allowing you to start creating plans earlier on.

Strategic Planning

If you want to create an effective strategy, you need to do effective strategic planning. This is the process of creating a strategy that you can put into practice.

Decision-Rights Tool

The Decision-rights tool is a systematic process of making decisions within an organization where members of the team are assigned differing roles and accomplish specified tasks.

Chapter 7:

7.1Introduction to Decreasing Costs and Creating Efficiency

Learning Objectives

1. Explain the basics of Total Quality Management and Six Sigma Process Control.

2. Describe how to perform a Pareto analysis.

3. Discuss the pros and cons of zero-based budgeting.

4. Discuss ways to improve organizational time management and ways to measure productivity in the workplace.

5. Differentiate between Economies of Scale and Economies of Scope.

6. Describe the principles of the Shingo Model of Excellence.

7. Explain the importance of employee engagement, business location, and effective forecasting.

8. Describe basic concepts in forecasting including accurate vs. effective forecasting, strategic forecasting, and principles of effective forecasting.

7.2Total Quality Management

Total Quality Management is the effort to continuously improve an organization’s processes to create better products in a more efficient manner. Defects and errors are prevented and removed as time goes on. The goal of TQM is to make the customer happy by controlling every single step in the business process.

Dr. William Deming in Japan

Dr. William E. Deming played a major role in the development of TQM when he introduced statistical process control to Japan. Originally, he had attempted to implement his ideas in the United States, but he was rejected. He taught his ideas on creating better manufacturing lines through statistical control to Japan, and helped fuel the strong Japanese economy between 1950 and 1960.

TQM Spreads to Many Industries

Even though Total Quality Management started in the manufacturing sector, it is used in many types of organizations, including medicine, finance, manufacturing, and banking. The concept is broad and is consequently applicable and adaptable to each individual kind of business. In large businesses where there are multiple sizable departments, it is important to coordinate efforts between the various departments. For instance, if manufacturing discovers a new method which prevents many defects but marketing and HR are unaware of this method, new employees won’t be trained to implement the procedure and marketing will not advertise the improvements to customers.

Elements of TQM

Continuous Feedback

A major part of Total Quality Management is continuous feedback. As improvements are made to a system, the problems and areas of concern from top management become outdated. New problems arise, and areas that previously were considered good enough become areas of improvement.

Plan, Implement, Monitor, Plan

Essentially, the organization plans the change they want to implement. After the plan is created, it is carried out and checks are performed to monitor progress. Finally, in the acting phase, results are documented and insights are gathered to fuel the next round of planning, doing, etc. 

Customer-Defined Quality

Total Quality Management focuses on customer-defined quality. This means that the goal is to improve the product in the areas that the customer actually cares about. For instance, a manufacturer of potato chip bags could spend tons of time and money creating a biodegradable bag, only to discover that the consumer doesn’t care about that at all. Instead, they want a bag that is easier to open and doesn’t make as much noise.

7.3Six Sigma

Defects are Costly

Every time you manufacture a defective part, you are losing money. In early stages of a company, defects often don’t seem to be a significant problem. They only occur every once in awhile, and the net loss in profit is quite low.

However, as your company expands and starts producing millions or billions of parts, defects start really adding up. Even if only 1 part is defective in every thousand, it still is taking away a sizable chunk of time, money, and energy to catch the defects, remove them, recycle or dispose of them, and make a replacement.

Six Sigma

In order to deal with this problem, many manufacturing companies use a Six Sigma methodology.

Statistical Process Control

Six Sigma is a method of statistical process control designed to reduce the number of defects. When manufacturing, there is variation in the accuracy of making a given dimension on a part. Most dimensions have a tolerance, or an acceptable range above and below the specified size which is still acceptable (the product will still work the same). The variation follows a normal distribution. Depending on the precision of the process, a certain amount of that distribution will be within the acceptable range, or tolerance. Generally, most people think that three sigma, or three standard deviations above/below the mean is enough accuracy. After all, 99.73% of all parts will be within the given tolerance.

However, 99.73% still means that in a million parts, 2,700 of the parts will be defective. If you are making a million parts a week and you lose $1 on each part, that’s $2,700 wasted every week. Depending on your industry, a defective part can cost much more than a dollar, and in some industries you may be producing far more than a million parts in a week. Whatever the case, you are effectively pouring money down the drain.

Three Sigma is Not Accurate Enough

Thus, three sigma isn’t accurate enough for mass production. Six Sigma is far more accurate. 99.99966% of the opportunities for defects will not result in a defect when using Six Sigma process control. This means that there will be 3.4 defective features per million.

Shifts from the Mean

Six Sigma also allows for a shift away from the mean without creating huge numbers of defects. Suppose that you have a machine that is supposed to make a part that is 1 inch long. Instead, it is calibrated to have the mean length of the part as 1.001. Six Sigma can effectively deal with a 1.5 standard deviation shift from the mean without causing a large proportion of the parts to be defective.

Both General Electric and Motorola, two of the early adopters of Six Sigma, have estimated their savings due to Six Sigma to be over 10 billion dollars.

Using Six Sigma

How can you increase your accuracy to Six Sigma? Well, it is difficult and depends on the process. Workers can be trained and certified in Six Sigma. Better machinery can be bought, which is more accurate and easier to calibrate. Jigs and fixtures can be designed to hold parts while they are being made. Becoming very familiar with the points where defects are created or hiring someone who is experienced in Six Sigma quality control are generally the most effective ways of implementing Six Sigma.

7.4Pareto Analysis

The Pareto Principle

Where do most of your problems come from? It’s likely that a few key issues cause the majority of the problems in your life which is the same in business. Usually roughly 80% of the problems result from only 20% of the causes. This principle, often known as the 80/20 rule, was named after an Italian economist who recognized that 80% of Italian income was allocated to 20% of the population. In Business, the Pareto Principle can be applied in many instances such as the following examples.

· 80% of company revenue results from 20% of products. 

· 80% of the work is accomplished by 20% of the team

· 80% of customer complaints come from 20% of customers

· 80% of new ideas come from 20% of employees

Performing a Pareto Analysis

Identifying Problems

A Pareto Analysis uses the Pareto Principle to evaluate a problem and identify which 20% of causes result in 80% of the problem. Based on statistical evidence, a Pareto Diagram can be created and analyzed. To better understand Pareto Analysis and creating a Pareto Diagram, we will use an example of a university that has had problems with computers crashing over the past year.

Example - University Computer Crashes

To perform a Pareto Analysis, the team assigned to tackle the computer problem first identifies all of the reasons for which the computers have crashed over the past year, and how many computers have been affected. They identify 10 reasons for which 260 computers have crashed. The frequency of each reason is then calculated which allows the team to order each cause in descending order. The next step the team takes is to determine the cumulative percentage in descending order, which is calculated by adding each frequency by the frequency of the preceding causes and dividing by the total number of frequencies. Once all totals have been found, the diagram can be plotted. The reasons for the computer crashes are placed on the x-axis with the frequency of each occurring on the y-axis. A second y-axis is given to show the cumulative percentage which can be plotted on the same graph. The following is the example of the diagram developed by the team.

Using the diagram, the team is able to identify the key issues (the 20%) which are causing most of the computer crashes (the 80%). The team now knows exactly which problems to focus their energy on to solve most of the computer crashing problems.

In this example, there was easy-to-analyze data that allowed for a Pareto Analysis. Suppose instead you wanted to figure out which 20% of individuals on your team accomplish 80% of the work. Without some way to measure productivity, the analysis would likely be biased based on personal perceptions and stereotypes. In the next section, we discuss ways of measuring productivity that can help make such an analysis less subjective.

7.5Measuring Productivity

How do we measure productivity?

Your company makes money based on selling its products. If you want to sell more product you need to produce more (as long as there is demand). Other sections of this book focus on increasing the firm's productivity, but in this section, we focus on the best way to measure productivity - specifically, the productivity of employees.

Hours Worked

Measuring productivity by the number of hours worked is pretty much useless in today’s society. If an employee works 8 hours but spends 2 hours on Facebook, 1 hour surfing the web, and 1 hour texting, that employee clearly wasn’t productive. Despite this, many companies still pay their employees by the hour, incentivizing them to work for more time rather than to get more done. Paying by the hour is still an acceptable practice as long as other incentives are given to motivate an increase in production.

Output

Logically, the best way to measure employee productivity is to measure how much they produce, and reward them for their individual output. In some industries, this works fabulously. In a manufacturing plant, the worker who can assemble more parts in an hour is more valuable than a worker who assembles fewer parts. However, in more complicated business, it is more difficult to measure a single employee’s contribution. For instance, in a large journalism firm, you can’t simply measure the number of articles or words written in a given period of time. This overlooks the quality of the article and makes for a potentially disastrous situation. This can become even more complex if multiple individuals helped research and write the article - it is practically impossible to separate individual contributions.

Equation for Productivity

The basic equation for productivity is this: Productivity = Output / Input

Issues with Measuring Output

However, this equation may be deceptive if your measurement of output doesn’t reflect the reality of your business. If you are an artist and you measure your productivity by the number of paintings you produce, the best way to improve your productivity is to spend far less time on each painting. This style of measurement doesn’t include a way to measure the quality of production and doesn’t work well for knowledge jobs.

Ways to Measure Productivity

Here are several ways to measure productivity, as well as the instances when they are most effective:

Items produced per unit of time

This is a method of measuring employee productivity that works particularly well in manufacturing environments. Simply take the number of items produced and divide it by how long it took for that employee to produce them. For instance, you may find that Jennifer can thread 50 shoelaces per hour at your shoe factory.

Sales

This obviously is an effective way of measuring the productivity of any employee who is primarily responsible for selling your product directly to a consumer. Any effective way to incentivize employees whose productivity is measured by volume of sales is through commission - the more she sells, the more money she gets. For instance, Brian make 30% commission on every Pest control sale he successfully makes, and will receive a bonus if he sells more than 50 contracts in a given month. 

360 - degree feedback

This method provides a very in-depth assessment of an employee by having co-workers, managers, and other employees of the company evaluate how well an individual is doing. This is an excellent method for small firms where everyone interacts frequently, as well as for individual departments within a larger organization.

Accomplishing objectives

Setting goals and then measuring how well employees accomplish those goals is a very customizable method that can apply to business across industries, including those that are more difficult to measure using other methods. Knowledge workers can still be given goals, which can include a quality component. For instance, instead of giving Janet a goal to write 500 lines of code this week, we could give her the goal to create a program that works without any major flaws and is user-friendly within the next 2 weeks. This method also works well for companies that rely heavily on teams. For instance, Bill sets a goal for his marketing team to increase gross sales by 2% and it takes them 49 days to do it.

7.6Zero-Based Budgeting

Reviewing Every Budget Item

Generally, budgeting is done by taking the previous year’s budget and then justifying any changes for the upcoming year. In zero-based budgeting, every item of the budget is reviewed every time the budget is approved. Instead of basing the budget on the past, it is based on zero costs. This process forces executives to look at every single expense of the organization and analyze whether it is still relevant and worth the cost.

Culture Shift and Cutting Costs

Effective zero-based budgeting embodies a culture shift to being more cost-conscious. It is also often ambitious, seeking to look from end-to-end of the business process and figure out exactly where the company is adding value and where the greatest costs are incurred.

Often, companies use this budgeting technique when they want to cut costs to the bare minimum. However, executives can decide how aggressively they will cut costs and base approvals on that decision. Perhaps a very growth-oriented company could use this tool to identify areas of waste, but plan on approving almost all Research and Development expenses. 

This process is useful in several ways. It almost always brings costs down, as wasteful operations are eliminated. It also prevents costs that were needed in the previous year but are no longer necessary from being added onto the new budget.

Shaping Strategy through Zero-based Budgeting

Zero-based budgeting can help shape a company’s future strategy. If management discovers that one particular aspect of the business has abnormally high expenses, then they might consider outsourcing it, or acquiring a small company that specializes in that area in order to reduce costs.

Zero-based budgeting can be used in certain departments without applying it to the entire organization. For instance, if Google wanted to use zero-based budgeting, it would be practically impossible. There would simply be too much paperwork, time spent accomplishing it, and personnel required to create the budget and gather enough data to make informed decisions. However, they could create a zero-based budget for an individual department or section of the company. 

Issues with Zero-Based Budgeting

There are some issues with zero-based budgeting. It takes forever—or at least a really long time. Being so meticulous about what is approved for company spending means that every detail of the business must be analyzed and scrutinized. Zero-based budgeting also tends to favor areas that directly lead to revenue or create production because these sectors produce an immediate return on the money spent. Other areas, like research and development, may be hurt because its benefits are long-term and may not translate as readily into profit. 

Organizations need to be careful about what items are cut in Zero-based budgeting. Being overly zealous in cutting items or misimplementing a Zero-based budget can limit a business and prevent it from functioning to its potential. 

Steps to Zero-Based Budgeting

1. Identify and Rank Core Business Activities

What drives your business? What activities add the most value to the product? Which things do consumers value most?

2. Determine the Cost of Each Activity that the Business Does

You can decide how in-depth this will be, but generally it works best if it is far-reaching and includes very detailed costs of each aspect of the business

3. Are the costs worth it?

Look at each listed cost. Is it worth it? Are you spending the most money on your most important business activities? Are there expenses that seem unnaturally high?

Cut each activity that doesn’t seem to be worth it. Align this process of cost-cutting with how aggressively you want to cut costs and with your overall business strategy.

4. Establish guidelines

Set up guidelines to keep your company within the budget you have established, specifying which costs are no longer needed and what things are most important to the organization.

7.7Economies of Scale

Cutting costs is great, as it naturally increases both your margins and your overall profit. One way of cutting the cost to produce each item is through economies of scale.

Economies of Scale

Benefits

Economies of scale are the advantages a company gets by producing large quantities of their product. These include decreased cost of materials, the ability to spread costs such as research and development over a wider base, and increased specialization of labor. Economies of scale can be divided into both internal and external economies of scale.

External Economies of Scale

External economies of scale happen in an industry. The industry, for whatever reason, has decreased costs as it grows. This could happen because suppliers have specialized to deal with the number of companies in the industry, decreasing the cost of supplies. Or perhaps there is an increase of infrastructure created to deal with the number of entrants to the market, decreasing the cost for each of the companies in the industry. The development of more efficient technology could also be a factor.

Internal Economies of Scale

Internal economies of scale are when a company decreases their costs and expands their production. Generally, when you think of the advantages of mass production, you are thinking of internal economies of scale. Buying supplies in bulk usually decreases the cost per unit of the supplies. The cost of marketing is spread out over a greater number of products. Research and Development costs are also spread across more products. Internal economies of scale decreases both fixed and variable costs.

Beyond spreading costs of certain departments across a greater number of products and advantages in buying supplies, economies of scale also allow for greater specialization of labor. In small businesses, a few individuals do almost everything - they market the product, handle the finances, order supplies, and perform quality control. They may be decently good at each of those aspects, but it is very unlikely that they are expert in each fields. As the business becomes large enough, it can hire an accountant to do the accounting, a quality control expert to do quality control, and a marketing specialist to handle marketing. The more a company grows, the more specialized the labor can become.

Usually, we focus on internal economies of scale in business strategy. External economies of scale are nice for our company, but give us no competitive advantage over our competitors.

Diseconomies of Scale

Be careful of diseconomies of scale. This occurs when increasing the production of a certain product no longer provides an economic benefit, and may actually hurt the company. For instance, if a company produces far above the market demand, they can expect lower costs per unit, but they will be unable to sell enough quantity to actually receive any benefit. Increased complexity also causes diseconomies of scale. As a company expands, the complexity of doing business increases. Overseas suppliers are found, various distributors are used, and the sheer number of employees grows. At a certain point, the complexity becomes so great that the cost of the complexity outweighs the economies of scale from increased production.

7.8Economies of Scope

As your business grows, what are ways to decrease the cost of producing each item? Through economies of scale, we can decrease the cost per item by mass producing them. Another way to decrease the cost per item is through economies of scope. 

Economies of Scope

Economies of scope means that if you produce multiple different products from the same fixed costs, profit will increase dramatically with a small increase in cost. It can also refer to other advantages obtained by producing multiple different products. 

Example

For instance, take the Marriott Hotel in Cache Valley. The fixed costs on a hotel are very high - no matter how many people stay in the hotel, they still have to pay for the building and most of the staff. If they just offer hotel services, they only make money on the people who stay in the rooms. However, let’s say that the Marriott starts hosting events - weddings, business conferences, high school dances, and public speaking events. Now, many of the costs stay the same (costs for the building, electricity, front-desk staff, cleaning and maintenance, etc.) but these costs are spread over two different sections of the business - hotel services and events. The revenue from each pays for itself, and thus the impact of fixed costs is much less, increasing the profit on the bottom line. 

Diseconomies of Scope

Sometimes, instead of economies of scope, businesses can experience diseconomies of scope. This is when companies think that expanding to a new product will decrease the per-unit cost, but instead it actually increases their per-unit cost. This can be caused by a need for additional factories or other buildings, decreases in efficiency, lack of demand for the new product, higher-than-expected costs for raw materials or specialized personnel, or a host of other reasons. 

Opportunities

What are opportunities for you to use economies of scope? 

1. Look for excess capacity. Do you have machines that are idle for much of the day? Specialized workers that have extra time? Departments that are under utilized?

2. Is it easy for your machines to switch between tasks?

3. Are your fixed costs a very large portion of your overall costs? If so, look for a way to spread these fixed costs across multiple lines of revenue.

4. Do you have assets that aren’t used very often? What else could they be used for? 

5. Can technology create economies of scope in your business? Historically, many of the problems preventing economies of scope were caused by issues in manufacturing. It took a long time to set machines up for different tasks, workers were much more efficient when they only manufactured one item, etc. Now, computer-aided manufacturing overcomes much of that. The computer can switch between different parts instantaneously, has no learning curve, and can create very precise parts.

7.9Shingo Model of Excellence

Twenty years before the Shingo Model of Excellence was established, Utah State University created the Shingo Prize for Excellence in Manufacturing in honor of a Japanese industrial engineer named Shigeo Shingo. The prize was originally focused on the presence of lean principles in manufacturing companies but was eventually expanded to encompass principles of effective organization within companies of many industries. With this shift came the renaming of the Prize to the Shingo Prize for Operational Excellence.

In 2008, the Shingo Model of Excellence was created to better show companies what the Shingo Prize was looking for in applicants, and to teach what they considered to be the best practices in business and manufacturing. The model is as follows: 

Principles of the Shingo Model

The following principles are the core of the Shingo Model. As the chart displays, these principles interact and shape the culture, systems, results, and tools of an organization. 

Respect Every Individual

Respect is valued highly by essentially all individuals in an organization; everyone wants to be respected. This respect can help employees be dedicated to the success of the company, rather than merely worried about the next paycheck. Look closely at your company. Do you help your employees progress, following a development plan with appropriate goals? Are your employees involved in improving the work around them? Do your employees have access to coaching to help them through difficult problems? 

Lead with Humility

How do your leaders interact with everyone else? Often, companies will end up creating huge inefficiencies when executives are unwilling to listen to anyone below them in the corporate hierarchy. Strive for a corporate culture where leaders seek input for improvement and are constantly learning better ways to do business. As leaders listen to and follow their subordinates, all employees will feel more invested and engaged at work, giving them a sense of empowerment. Instead of punishing mistakes, focus on fixing the process. 

Seek Perfection

Complacency is a sure way to halt improvement. Are there problems where you’ve effectively said, “That’s just the way it is, we have to live with it,”? If so, you will have to live with it. Constantly seeking perfection will allow you to overcome the major problems that hold back your organization. Perhaps they won’t all be resolved right now, but as long as everyone is looking for ways to fix problems instead of accepting them, they will eventually be fixed. This creates a culture of continuous improvement, which is a much healthier mindset for an organization. What are the problems that hold your business back? What are you doing to fix them? Are you simplifying work? Do you generally implement long-term or short-term solutions? 

Embrace Scientific Thinking

Scientific thinking involves repeating experiments, taking direct observations, and learning from the past. This process is powerful, and has driven the progression of the human race. Explore new ideas. Find ways to test out ideas on a small-scale to see if they work. When experiments fail, re-design them and try again. Relentless pursuit of scientific thinking will drive innovation and improvement. Do you have some sort of structure to your problem-solving method? Does your organization have an overriding fear of failure? Do you accept the suggestions of the engineers or scientists who you have employed? 

Focus on Process

Who’s to blame, the person or the process? Generally, the problem is with the process. Even the best employees will fail if the business process is deficient. When something goes wrong, put off the natural tendency to blame people. Instead, look at the process. How could the process be improved? Why did the error occur? Can you establish a process that would prevent that error from ever occurring again?

Assure Quality at the Source

Do things right the first time. If they aren’t done right the first time, track down the source and correct it at the point of creation. This often means stopping work and waiting until the errors are resolved before continuing.

Flow and Pull Value

If a company produces more, it makes more money - right? Not always. Value comes from customer demand, and everything your company does should be to satisfy customer demand. Demand is often distorted, which creates waste in the organization. Structure things so that customer demand will pull product through your business, and match the value offered to the value demanded. Don’t overproduce and stockpile, and respond quickly to customer demand.

Think Systemically

Does your system allow ideas, materials, info, decisions, and suggestions to flow from one group to another? Do you have strong relationships built on clear communication? If your system of passing ideas, materials, etc. is effective, it will prevent a lot of inefficiency and frustration. Communicate goals to the people that need to know them, and be inclusive.

Create Constancy of Purpose

Why does your business exist? Every person within the organization should be able to explain why the business exists, the direction it is heading in, and how the progress is going. This allows individual actions to align with the overall purpose, empowering employees and improving output. Individual goals should align with organizational goals.

Create Value for the Customer

Value is what the customer wants and will pay for. At the end, this is what your company must provide. Failure to achieve this spells doom for your company. Gather data on your customers. Ask them for feedback. Look for the things that the customers care most about. These will drive the success of your business.

These principles, along with your business systems, tools, and final results, are tied to and shape your company culture. In order to have the most success in your company, you need to optimize all of these areas.

7.10Organizational Time Management

It is obvious that every organization wants to have its employees working diligently all the time. It is also clear how easy it is to get distracted—think of how many times you’ve gotten on social media when you should have been doing your homework! In an organization, the question is far broader than whether employees waste time. It applies to how they spend their time, what they focus on, and who is assigned to a given task. Time management has become such a prevalent problem that many organizations are creating various programs to help their employees better manage their time.

It’s often said, “Work smarter, not harder!” What does that actually mean? How do you make your time more impactful? How can you help your organization better manage time? There isn’t one magic key designed to solve this problem. However, here are some ideas that you can try when designing an organizational time management program.

Ideas to Improve Organizational Time Management

First—spending time on organizational time management is an investment. It is far too easy to say, “We don’t have time to spend on time management.” This is a great attitude to stay perpetually busy and never have enough time to catch-up or get ahead at work. There will always be more things to do than time to do them, so take some time to work on becoming more productive.

Establish clear priorities

It is incredibly important to communicate to employees what matters most to the organization. Otherwise, they will inevitably put too much time into projects that don’t really help the organization or don’t impact the bottom line. Explain to employees what their number one task is, and then explain what other tasks are still important.

Don’t try to do everything

Train your employees to stop trying to accomplish every possible task that comes their way. Instead, teach them to prioritize and focus on the most important tasks. This will keep employees more motivated and productive at work. Have them focus on the 20% of tasks that determine 80% of the results (see Pareto Analysis). 

Streamline the process

Do you need so much paperwork? Do you need to mandate approval from so many people? Trust your employees to do a good job and cut out some of the organizational bureaucracy. This empowers your employees to shine, and if they don’t, fire them. It’s worth it to have great employees and trust them.

Delegate correctly

Delegation is a key part of almost every organization. Take time to make sure that you delegate the right tasks to the right people. It’s obviously a problem if your productive employees are given tons of projects to do simply because they are productive. This is essentially an incentive to not be productive. Additionally, if an extremely important project comes up, what are you going to do if all your best talent is bogged down on other projects? As logical as this seems, it is very common in organizations. It is equally ineffective to pass the best tasks up to the most senior employees and the worst to the newest employees. You will have high turnover rates and low motivation among new employees. Instead, look objectively at which people can best accomplish which tasks. Assign people to projects that they enjoy and will be motivated to put in their best effort at.

Put limits in place

Can you limit the amount of wasted time? Better yet, can you limit the amount of “good” activities that happen and focus on the “best” activities? For instance, collaboration is important. Yet it can often go too far, leading to people constantly barging into each other’s offices, wrecking their train of thought and distracting them from the project at hand. Maybe limit the amount of time when employees are available to their co-workers. Limit the number of reports given to managers. If people need some isolation or insulation from each other, create a system that can accomplish this. This has to be adapted to the style of workplace you are in. Some places require collaboration on everything, many will not.

Work on your workplace

Are employees continually looking for tools? Files? Documents? Collaborators? If creating an organizational structure for these things would help save people time, do it. Outline the wrench so it always gets put back on the same rack. Have all employees on the same project put their documents in a shared file. Simple annoyances like these become major frustrations when deadlines or executives put lots of pressure on employees.

If organizational time management is a main focus in your company’s strategy, you should seriously consider paying an outside consulting agency to come in and train your workforce. As professionals, they have a lot of tools at their disposal, as well as experience in helping other organizations. It may also be useful to track employees’ time, looking closely at how the typical employee in your firm spends his/her time. Software programs or employee planners may also be worth the investment. Look at Google Calendar, Microsoft Outlook, Google Keep, iCal, Dropbox, Focus booster, Trello, and others. Effective employees almost always mean a successful company.

7.11Employee Engagement

When do you work hardest at a job? While there are lots of factors influencing this, you probably only work your very hardest at jobs you care about. If you’re working in a call center and aren’t passionate about calling random strangers, it is unlikely that you will exert your best effort every day at work. However, if you absolutely love skiing and work in a ski design and development shop, you’re much more likely to put forth extra effort to do a good job. The more engaged you are, the harder you will work.

Increasing Employee Motivation

Employee engagement is a measure of employees commitment to and passion for their role within an organization. Because employee engagement measures the extent to which employees are motivated to accomplish organizational goals, much of the organization is dependent on an effective employee engagement strategy. Everything from revenue, customer satisfaction, product or service quality, and innovation is driven by employee engagement. Modern companies realize the importance of keeping employees dedicated and put time and effort into creating an organization that cultivates employee engagement.

Employee Engagement Surveys

Companies with successful employee engagement strategies generally have effective employee engagement surveys. Employee engagement surveys consist of question series distributed at least annually to every employee within an organization. The survey examines each employee’s understanding of and commitment to the organization's goals and mission, their dedication to their coworkers and teams, and motivation to accomplish projects. A well prepared and distributed survey can give management a good idea of the level of employee engagement within an organization.

Ideas to Boost Employee Engagement

Different sources cite different strategies for boosting employee engagement, but the success of these strategies likely varies depending on the nature of the organization. The following are a few ideas which are likely to boost any organization’s employee engagement.

Improve the Employee Engagement Survey

Prove your employee engagement survey and tweak it to perfection. A poor employee engagement survey will provide poor results. A survey which can successfully measure employee engagement will provide an organization with key information needed to take engagement to the next level.

Be genuine and transparent

Genuineness and transparency are magic attributes which allow subordinates to trust a leader and want to follow them. They also allow leaders to offer constructive criticism employees are willing to listen to. When genuineness and transparency are present in an organization, devotion to that organization increases.

Understand the importance of communication

Employees cannot be dedicated to an organization’s mission or goals unless the organization clearly communicates those ideas to its subordinates. Employees also need to feel listened to and asked to communicate ideas and give input to management.

Incentivize the right employee traits

In order to create a positive attitude towards the organization and organizational goals, it’s a good idea to promote employees who show extreme dedication to their role within the organization.

Realize employee engagement is contagious

Create an organization that allows employees infected with a high level of engagement to spread it to others like a weird desirable disease. Cultivate engagement within management and team leaders and drive them them to do the same to those they lead.

Do more than just work with your employees

Involving your employees with volunteer opportunities, recreation, and social and cultural events will help build relationships which facilitate employee engagement. Create an atmosphere which can provide for employees’ social and recreational needs as well as their financial needs.

7.12Location

How do we choose the location of our business?

When constructing a manufacturing facility, putting up a restaurant, opening a bike shop, or creating any other kind of business, location matters. It is tempting to simply find the cheapest piece of land and build or jump into a contract with either the cheapest or best located (and likely most expensive) rental space, but this approach misses several crucial factors.

Markets

Where are you going to sell your product? Obviously, a retail store needs to be in an advantageous location to effectively reach your target consumers. For instance, stores targeting tourists in downtown Verona pay huge premiums to be on the same street as Juliet’s balcony because they are guaranteed to have millions of potential customers see their store every year. However, identifying the end market is also useful in deciding where to place a manufacturing plant. If your product is made closer to where the end customers are, you will save money on shipping costs.

Shipping materials

Look carefully at how you will ship supplies. Not all locations are equally connected to interstate roads, ports, or railways. If you are constantly shipping product in or out of your factory, it may be worth paying more for a certain location in order save on shipping costs. Know your supply chain by heart, and find the best spot to make it efficient.

Labor

Another factor to consider is the supply of labor. Placing your business near a major city can give you a better supply of labor, particularly if there is a high turnover rate in your industry. A large labor supply also allows you to be more selective about who you hire, focusing on employees who fit your company culture and who are productive.

Other issues

Taxes also vary by state, which may determine where it will be most profitable to build a manufacturing plant or place your headquarters. For instance, Utah attracts some businesses with its favorable tax policies towards businesses. Also, some states and cities regulate pollution and other environmental issues more heavily than others, and may even charge a tax on pollution (for instance, Boulder Colorado has a carbon tax on electricity generation). If your company is likely to be affected by these concerns, do your research before you pick a location.

Buying property vs. Leasing

A difficult question is whether your business should lease or buy property. When starting out as a small business, buying property outright is expensive and a down payment will likely use up much of your startup money. As you grow, the question to buy or lease becomes increasingly difficult.

Leasing

Leasing has the advantage of freeing up capital for other uses. Instead of using money for a down payment, that money can be used to grow the business. If your business is successful, it should grow faster than real estate can appreciate or than the cost of leasing.

Buying

Buying can have many advantages as well. In general, banks are more willing to finance loans that are backed by real estate because real estate tends to hold its value very well. Additionally, once the loan has been paid off on the property, your overall expenses will go down significantly.

How long is your business likely to stay in the same place? If your company is likely to use the same building for the next decade or longer, buying the property will save you money in the long run. However, if your vision for the company involves expanding and will require more space relatively soon, perhaps leasing is a better option.

7.13Effective Forecasting

Forecasting professionals are the first to tell you that forecasting is always wrong. This means that forecasts are always inaccurate in some way because no matter what you do in the present, the future is out of your control, and unforeseeable surprises are always waiting on the horizon. No one can tell you how to make a perfect forecast because it’s impossible. So why even bother? If no one can forecast with 100% accuracy, why do companies use forecasting?

Forecasting Improves Planning

Even though forecasting is never 100% accurate, it is still very useful. It is useful because even when the forecast isn’t perfectly accurate, it still can allow us to plan for the future in a manner that maximizes profit and minimizes wasteful expenses by giving a better idea of how the future will be. It is particularly useful when it comes to projecting future sales, expenses, inventory, accounts receivable, taxes and salaries—those elements of a business that largely determine success. Forecasting the critical elements of a business as accurately as possible gives you a general idea of what to expect in the future, allowing you to align your current actions with these future expectations. If a firm expects future earnings to decrease in the following year, they can start looking for ways to minimize expenses now. On the contrary, if a business predicts a rise in sales on the horizon, it allows the firm to start looking for profitable avenues to invest their profits in now.

Accurate vs. Effective Forecasting

At first glance, we would assume that we want our forecasts to be both accurate and effective. However, this isn’t necessarily true. Accurate forecasting is either impossible or extremely difficult to achieve. However, an effective forecast is a forecast which allows you to shape the strategy of your company in a way that gives you an advantage, even if the forecast is inaccurate in some way. If your forecast is effective, it doesn’t need to be any more accurate.

Forecasting takes more common sense than it does science, mathematics, or an advanced degree. It takes critical thinking to identify possible market shifts, and then the courage to make educated guesses about how these shifts will affect the company’s future. Traditional forecasting simply involves looking at financial trends in a company’s own statements—looking at your own past to predict your future.

Strategic Forecasting

However, this book focuses on strategic forecasting, which takes traditional forecasting a step further. Strategic forecasting involves understanding competitors and the unique industry and allowing your company's differentiation strategy to influence your forecast. Knowing what the competition is doing and how their actions impact our firm gives you a powerful glimpse into our company’s future.

It may be silly to give specific steps to performing an “accurate as possible” forecast, but to provide you with some idea of how to perform such a forecast, here are some valuable steps to take, no matter the business element you are analyzing - sales, expenses, taxes, inventory turnover, or general growth.

Basic forecasting

There are many different ways to create a forecast, and they can vary in effectiveness depending on the sector of your business that you are dealing with. Here are a few types of forecasting, with examples based on forecasting quantity of products demanded. Note that forecasts can be made for sales, revenue, expenses, inventory, accounts receivable, salaries, taxes, financial ratios, and other aspects of your business. We are merely focusing on demand to make the methods easier to understand.

Naïve approach

This is the cheapest and easiest way to forecast. Simply take the demand from last year and forecast that you will have the same demand this year. 

Forecasted demand = Demand from last year

Time Series Methods

This is a collection of methods which rely on historical demand data to predict future demand. The Naive method is one of the time series methods. Another is the simple mean, which takes the mean of all available demand data and projects that for next year.

Exponential smoothing is perhaps the most frequently used time series method because it doesn’t require a lot of data and it is easy to use. The equation is

Forecast of this year = Alpha * Actual value of last year + (1-Alpha) * Forecast of last year or

FT+1 = 𝞪 AT + ( 1 - 𝞪 ) FT

Alpha 𝞪 is a smoothing coefficient between 0 and 1.0 which determines how much you rely on last period’s data. 

Time series methods are valuable because they don’t require consulting outside individuals and they are based on data that is generally easy to get. However, these methods are inaccurate for any strong shifts in the market and are most accurate for stable, slow-growth industries.

Delphi Method

This method involves asking many experts in the field what they think will happen to future market demand and aggregating these opinions into a predictive forecast. In a series of rounds, the experts are told the opinions of the other experts and are given the chance to revise their predictions. Supposedly, the opinions will eventually converge to a single prediction of the future. This method is time consuming and rather difficult, but can give insights into long-term developments in the market that other methods are simply not effective in predicting.

Other Methods

Other methods include the drift method, seasonal naïve approach, moving average, weighted moving average, Kalman filtering, causal/econometric, regression analysis, and artificial intelligence methods. If forecasting is a fundamental part of your business, be sure to seek out the best method for your company to use. Whatever the case, keep the following principles in mind:

Principles of Effective Forecasting

Focus on strategy

The first step to effective forecasting is to focus on your company’s strategy. Mentioned earlier was the concept that when you perform a strategic forecast, you consider how your company is differentiating from the competition. Just as a firm alters the rest of its operations to align with its strategy, it only makes sense to do the same with forecasting.

Determine levels of uncertainty

In each forecast there is only one thing that is certain and that’s uncertainty (see what I did there?) The next step in forecasting is to determine the levels of uncertainty you’re dealing with. If you happen to be be brainstorming on a giant whiteboard, you might consider drawing a giant horizontal line from one side to the other. Towards one end of the line, write the word certain and towards the other end of the line write the word uncertain. Then, write down all the elements of whatever it is you are dealing with and place them in their appropriate location on the uncertainty line. If you were projecting sales revenue for the following year, you might place elements involving secured customers or customers under contract closer to certainty than you would place sales that, although might be scheduled, haven’t yet closed. Doing this exercise allows you to get a better feel for the factors affecting the forecast and see how much you are relying on certain elements. If you feel a pit in your stomach because you realize everything that will bring certain success actually lie far on the uncertain side of the line, you may have some strategic changes to make. 

Embrace what doesn’t fit, but challenge it

Creative ideas and concepts should be embraced when creating a strategy and forecasting on that strategy. Considering everything from the most basic to the most outlandish of ideas allows a firm to consider possibilities they never have. Often when a crazy idea is even entertained, the idea can morph into something alarmingly doable. Having such a good idea come from such a surprising source will be shocking, but it will happen. The roots to this step go back all the way to strategy. As much as a firm should push for creative, out of the box ideas, they should also challenge that idea. Just because an idea seems original and packed with potential doesn’t mean it’s going to fly, and certainly doesn’t necessarily mean it’s going to attract as many customers as expected. When forecasting, challenge projected sales volume, challenge projected expenses and collection on accounts receivable. Question on what merits you have projected numbers to be what they are. Have you tested anything in the market on a smaller scale? Are your out of the box ideas actually answering a customer concern and need? Pepsi failed at this step when they introduced Pepsi Crystal, the new pepsi version of Sprite. They projected the idea would be wildly successful and failed to adequately challenge it. In the end, Pepsi Crystal didn’t answer a customer need that wasn’t already being met, and thus the idea failed. 

Be willing to let go of your babies

Along the same lines as challenging ideas is being willing to let them go. Especially the ones you feel emotionally attached to—that is—your babies. To be too emotionally attached to a specific outcome is likely to affect the outlook of your forecast. Effective forecasts are based on objective facts, figures and expectations but they are analyzed and constructed subjectively by people with feelings and opinions that may or may not be based on real facts. Some helpful practices to avoid human error is to have multiple people or teams perform forecasts on the same projections, pay an outside firm to perform your company’s forecast, and keep individuals with high emotional involvement as uninvolved as possible.

Look forwards, backwards, left, and right

The goal of forecasting is to look into the future with an “as accurate as possible” idea of what’s coming. That is called looking forward. Commonly understood in forecasting is the need to also look backwards—that is—to use past financial statements, company history, and trends to identify patterns that will carry forward from the past. Less understood in forecasting is the need to not only look backwards but look left and right as well. What does that mean? When we say strategic forecasting requires looking left and right we mean it requires analyzing current market situations and watching our competitors closely. When analyzing the market consider the following questions. Are there new technologies or disruptive practices being introduced in the field or in related fields? What new researches have come out or are currently being performed? What does popular consumer opinion support? Just as much as we’d like our company to succeed so do all of our competitors. When analyzing the competition ask yourself the following questions. What are the assumptions we’ve made about our competitors in the past? Are those assumptions still accurate or are they now invalid? Is there a company in the industry that has done poorly historically but is now making major changes? What effects will those changes have? Realizing the effect the past and current market has over the future as well as the effect competition in the market and your own company’s past might have is imperative to strategic forecasting.

Stick to your guns, within reason

When forecasting is done right, there comes a point when you are satisfied with your predictions. You might still be concerned about accuracy, but you can at least be assured that your projections are as realistic as possible and involve a comprehensive analysis of the important factors. You can be satisfied with how well your projections reflect both reality and your company’s strategy. When you’re sure your forecast is as good as it will ever be, it’s now time to stick to your guns...to a certain point. Why to a certain point? When a forecast is made, the next step is ultimately to watch the future unfold and do what is in the company’s control to assure that it unfolds according to design. Naturally there will be elements of the future outside of your control, and that is where the phrase “within reason” comes in play. Stick to your guns until changes need to be made to maximize the company’s success. When appropriate changes are made and a course correction is put in place, stick to your guns again—that is—within reason.

7.14Summary

Decreasing Costs and Creating Efficiency

Total Quality Management

TQM is when a company continuously works on improving their business processes to create better products in a more efficient manner.

Six Sigma

Six Sigma is a process of statistical process control to reduce the amount of defects that are produced by your business.

Pareto Analysis (80/20 rule)

A Pareto Analysis looks at both the problems and the solutions that have the biggest impact in your business. In general, 80% of problems come from 20% of the causes, and 80% the work is accomplished by 20% of the people. By looking at what drives growth and what holds your company back, you can better craft your strategy to focus on the highest impact ideas.

Measuring productivity

Productivity will determine, in large measure, the success of your firm. The question is, how do we measure productivity?

Zero-based budgeting

Zero-based budgeting is done by taking every single item of the budget and reviewing its value whenever the budget is approved. This helps identify wasteful spending and eliminate expenses from previous operations that are no longer necessary.

Economies of Scale

As you produce more volume of a given product, your cost to produce each unit go down. This is referred to as economies of scale.

Economies of Scope

Sometimes, you can reduce your cost per unit on one item by also producing another item that shares materials, machines, or processes. Essentially, by diversifying your product line, you decrease your costs. This is referred to as Economies of Scope.

Shingo Model of Excellence

This model is a way of looking at the people, processes, purpose, and stakeholders involved with your business and finding the best way to structure each of these areas. The Shingo Model relies on 10 core principles that should guide business decisions.

Organizational Time Management

Organizational time management involves looking at all the aspects of our business that decrease employee productivity and finding ways to remove or lessen the inefficiencies.

Employee Engagement

If you help your employees become engaged in your business and invested in the success of your business, they are likely to be more productive and work harder at the job.

Location

The location where you decide to build retail stores, manufacturing plants, and company headquarters can help decreases many costs of your company.

Effective Forecasting

Forecasting future sales, expenses, demand, and other critical elements of your business will help your company align its present actions with future expectations.

8.1Introduction to Financial Statements

Learning Objectives

1. Describe what a balance sheet is used for.

2. Explain what assets, liabilities, and shareholders' equity mean on a balance sheet.

3. Explain what an income statement indicates about a company.

4. Describe what a cash flow statement is used for.

5. Evaluate a company based on its balance sheet, income statement, and cash flow statement.

8.2Balance Sheet

The financial statement which shows the balance of a company’s assets, liabilities and owners’ equity at a certain moment in time is appropriately named the Balance Sheet. In accounting, you learned an equation: assets equals liabilities plus owners’/shareholders’ equity. The balanced sheet is based on this equation:

Assets = liabilities + owners'/shareholders' equity

The following is an example of what the balance sheet might look like for Parts Manufacture Co., a parts firm which sells and machines custom mechanical parts.

Balance Sheet for Parts Manufacture Co. 

Assets
Current Assets
Cash	$ 85,000.00
Petty Cash	$ 1,000.00
Accounts Receivable	$ 23,000.00
Inventory	$ 198,000.00
Supplies	$ 12,000.00
Total Current Assets	$ 319,000.00
Property, Plant, and Equipment
Land	$ 78,000.00
Buildings	$ 75,000.00
Equipment	$ 65,000.00
Less: Accumulated Depreciation	$ (6,000.00)
Net Property, Plants, and Equipment	$ 212,000.00
Total Assets	$ 531,000.00
Liabilities
Current Liabilities
Notes Payable	$ 3,000.00
Accounts Payable	$ 17,000.00
Wages Payable	$ 23,000.00
Interest Payable	$ 212,000.00
Taxes Payable	$ 53,000.00
Warranty Liability	$ 27,000.00
Unearned Revenue	$ 15,000.00
Total Current Liabilities	$ 146,000.00
Long-term Liabilities
Bank Loan	$16,000.00
Total Long-Term Liabilities	$ -
Total Liabilities	$ 146,000.00
Total Owners' Equity	$ 385,000.00
Total Liabilities and Owners' Equity	$ 531,000.00

As we can see from the example above, there are three distinctive sections to the balance sheet - assets, liabilities, and stockholders’ equity.

Assets, Liabilities, and Stockholders' Equity

Assets

Assets are the resources of economic value that a firm owns. Assets are bought and traded with the intent to increase value. A retail store trades inventory for cash which creates value both for the store and the customer. On a balance sheet there are both current assets (those which are more liquid) and assets categorized as property, plant or equipment (those which are less liquid). Current assets include cash, accounts receivable, inventory and supplies. The section entitled “Property, plant and equipment” includes land, buildings, and equipment such as large machinery or vehicles. Assets can be further broken down into either financial assets, such as investments, or intangible assets, such as patents, trademarks or copyrights.

Liabilities

Financial debts or obligations to pay a creditor are called liabilities. Liabilities which will be paid within a year are considered current liabilities and liabilities which will last longer than a year are considered long-term liabilities. Current liabilities might include notes payable, accounts payable, wages payable, interest payable, taxes payable, warranty liabilities, and revenue for which you’ve been paid but haven’t done the work. Long-term liabilities would include such things as mortgage loans, outstanding bonds, and other bank loans.

Shareholders' Equity

Owners equity, also known as Shareholders equity in a publicly traded company, is made up of two elements, stock and retained earnings. Stock or common stock in the case of our example, represents the initial investment it took to get the business started. Further issue of stock or expansion of ownership of the company can be made by the business owner or other investors by taking on more investment in the form of stock. Retained earnings is a cumulative amount which shows how much net income a company retains minus dividends if dividends are paid to shareholders.

The sum of a company’s liabilities and its owners’ equity must equal the sum of the company’s assets according to the accounting equation. If the two do not equal each other, an accounting error has occurred and needs to be corrected.

Besides showing everything that a company owns and owes and how much the company is worth, the balance sheet is an invaluable tool when performing ratio analysis to determine a company’s health. The quick ratio, current ratio, other solvency ratios, turnover ratios, and capital structure ratios are all based on the numbers provided by the balance sheet. As an investor, owner or shareholder in a company understanding these ratios (many of which are explained in this book) and what they mean is inestimable.

8.3Income Statement

The financial statement used by a business to show the business’s revenues and expenses over a financial period is known as the income statement. The income statement categorizes revenues and expenses into both operational income, or income from the normal day to day operations of the business, and non-operational income, or income from exceptional activities. 

The following statement is a fair example of what an income statement might look for Parts Manufacture Co., a parts firm which sells and machines custom mechanical parts.

Income Statement for Parts Manufacture Co. 

Revenue
Sales			$876,000.00
Less: Sales Discounts		$14,000.00
Less: Sales returns and allowances		$12,000.00	$26,000.00
Net Sales			$850,000.00
Cost of Goods Sold
Opening Inventory		$180,000.00
Add: Purchases		$250,000.00
Add: Freight-in		$23,000.00
Less: Purchase Discounts	$5,000.00
Less: Ending Inventory	$86,000.00
Total Cost of Goods Sold		$362,000.00
Gross Profit			$488,000.00
Operating Expenses
Advertising Expense		$15,000.00
Salaries Expense		$234,000.00
Utilities Expense		$24,000.00
Rent Expense		$32,000.00
Supplies Expense		$4,000.00
Total Operating Expenses			$309,000.00
Operating Income			$179,000.00
Nonoperating Items
Interest Expense	$8,000
Depreciation Expense	$14,000.00
Gain from Sale of Equipment		$24,000.00
Total Nonoperating Items		$2,000.00
Income Before Tax			$181,000.00
Tax Expense			$53,840.00
Net Income			$127,160.00

Income Statement

Operational Revenues and Expenses

The first major part of the income statement is made up of operational revenues and expenses. In the case of this business, revenue is earned by the sale of inventory (mechanical parts). Net sales is determined by subtracting sale returns and discounts from total sales.

Cost of Goods Sold

Cost of goods sold (COGS), an operational expense, shows how much the inventory or “goods” sold cost the business to supply. The expense takes into account the purchase of the goods sold, the cost of freight, any possible discounts and damaged goods. You’ll notice the difference between beginning and ending inventory is used to determine the amount of goods which were sold. Gross profit is determined by subtracting cost of goods sold from net sales.

Determining Operating Income

Following COGS, the other operational expenses are taken into account and subtracted from gross profit to determine the business’ operating income.

Non-Operating Items

The rest of the income statement takes into account non-operating items. In this case interest on funds from either bondholders or lenders (such as a bank) are accounted as the interest expense. The gain from the sale of equipment is accounting for the profit the business had from the sale of one of their assets, in this case, an expensive piece of equipment.

Income Before Taxes and Net Income

Income before taxes is determined by accounting for all expenses and revenues besides taxes which is the last expense accounted for. Net income is finally determined when the tax expense is subtracted from income before taxes. 

Revenue and Expenses

The revenue and expenses shown on the income statement are later transferred to the balance sheet to affect the company’s retained earnings.

Understanding the income statement and the significance of each term takes time and practice. As a stakeholder of a company, however, developing this understanding is critical. Ratios discussed later in this book such as return on stockholders’ equity, earnings per share, operating margin and price-earnings ratio will help you see the implication of the income statement.

8.4Cash Flow Statement

Cash Flow

A company’s cash account is purely liquid. Cash is what makes a company operate from day to day and gives a company financing as well as investing capabilities. Since cash is vital to a company and to the company’s stakeholders, a cash flow statement is used to show the inflow, outflow, and retention of cash. A cash flow statement is divided into three components which show the flow of cash: cash flow from normal operating activities, cash flow from investment activities, and cash flow from financing activities. All activities which affect a company’s cash account fall into one of these three activities.

Operating Activities

Operating activities are the everyday transactions of a business such as sales, purchasing of inventory, accounting for depreciation, paying off accounts payable and receiving payment on accounts receivable. Expenses paid are shown as an outflow of cash from operating activities and income received are shown as an inflow of cash from operating activities.

Investing Activities

Investing activities are transactions made for the purchase of new equipment, land, or tradable securities. When such assets are purchased (with cash) the cash flow statement shows an outflow of cash from investing activities and when those assets are sold (for cash) the cash flow statement shows the inflow accordingly.

Financing Activities

Financing activities involve the cash flow affected by the issue of bonds, payment of dividends, or acquiring loans. When capital is raised, the cash flow statement reflects an inflow of cash and as debts are paid, it shows an outflow of cash.

Cash Flow for Parts Manufacture Co. 

Cash Flow from Operating Activities
Sales	$267,000.00
Payment on Accounts Receivable	$45,000.00
Purchase of Supplies	$ (2,300.00)
Depreciation	$ (34,000.00)
General Operating Expenses	$ (175,000.00)
Sales Tax	$ (20,000.00)
Net Cash Flow from Operating Activities	$80,700.00
Cash Flow from Investing Activities
Sale of Land	$58,000.00
Purchase of Equipment	$ (15,000.00)
Net Cash Flow from Investing Activities	$43,000.00
Cash Flow from Financing Activities
Equipment Loan	$12,000.00
Notes Payable	$(5,500.00)
Dividend	$ (7,000.00)
Net Cash Flow from Financing Activities	$ (500.00)
Net Increase in Cash	$123,200.00
Cash at Beginning of Period	$57,000.00
Cash at End of Period	$ 180,200.00

The cash flow statement is particularly useful to stakeholders interested in seeing where a company is acquiring its cash and how that cash is being spent. If you as an investor are interested in knowing how responsibly a company is with its liquid funds, the cash flow statement is your premier source of knowledge. An example of what a cash flow statement might look like for a small retail store is found above.

8.5Vertical and Horizontal Analysis

Vertical and horizontal analysis are forms of financial statement inquiry that are fundamental for managerial accounting. The analyses involve using a firm’s financial statements (the income statement and balance sheet) and giving a percent value to each line item to see the ratio of each. This percent is whatever the line item is divided by sales. Here is an example of a vertical analysis performed on a firm’s income statement.

Vertical Analysis

Revenue				Percent
Sales	$456,000.00			100.00%
Cost of Goods Sold	$(213,000.00)			46.71%
Gross Margin		$243,000.00		53.29%
Operating Expenses
Advertising Expense	$(30,000.00)			6.58%
Salaries Expense	$(112,000.00)			24.56%
Utilities Expense	$(3,600.00)			0.79%
Rent Expense	$(6,000.00)			1.32%
Shipment Expense	$(59,000.00)			12.94%
Supplies Expense	$(1,800.00)			0.39%
Total Operating Expenses		$(212,400.00)		46.58%
Income before Tax			$30,600.00	6.71%
Tax Expense (5%)			$(1,530.00)	0.34%
Net Income			$29,070.00	6.38%

As observed, total sales represent 100% of revenue and the other ratios are computed by dividing each line item value by total sales. Performing a vertical analysis allows a firm to find possible inefficiencies and understand which line items have greatest ratio. Remember such analysis is also commonly performed using the balance sheet. 

Horizontal Analysis unlike Vertical, involves comparing line value percentages over time. Consider the following example.

Horizontal Analysis

Revenue	2012	2013	2014
Sales	$ 456,000.00	100.00%	$ 498,000.00	100.00%	$ 536,000.00	100.00%
Cost of Goods Sold	$ (213,000.00)	46.71%	$ (229,000.00)	45.98%	$ (250,000.00)	46.64%
Gross Margin	$ 243,000.00	53.29%	$ 269,000.00	54.02%	$ 286,000.00	53.36%
Operating Expenses
Advertising Expense	$ (30,000.00)	6.58%	$ (32,000.00)	6.43%	$ (39,000.00)	7.28%
Salaries Expense	$ (112,000.00)	24.56%	$ (124,000.00)	24.90%	$ (145,000.00)	27.05%
Utilities Expense	$ (3,600.00)	0.79%	$ (3,600.00)	0.72%	$ (3,600.00)	0.67%
Rent Expense	$ (6,000.00)	1.32%	$ (6,000.00)	1.20%	$ (12,000.00)	2.24%
Shipment Expense	$ (59,000.00)	12.94%	$ (65,000.00)	13.05%	$ (75,000.00)	13.99%
Supplies Expense	$ (1,800.00)	0.39%	$ (1,900.00)	0.38%	$ (1,900.00)	0.35%
Total Operating Expenses	$ (212,400.00)	46.58%	$ (232,500.00)	46.69%	$ (276,500.00)	51.59%
Income before Tax	$ 30,600.00	6.71%	$ 36,500.00	7.33%	$ 9,500.00	1.77%
Tax Expense (5%)	$ (1,530.00)	0.34%	$ (1,825.00)	0.37%	$ (475.00)	0.09%
Net Income	$ 29,070.00	6.38%	$ 34,675.00	6.96%	$ 9,025.00	1.68%

In this example vertical analysis is performed on three years of the firm’s operation and a horizontal analysis is performed comparing those three years, side by side. The firm can see how each line value ratios differ but perhaps not in the way the firm would like. The following example shows a more common form of horizontal analysis.

Common Horizontal Analysis

Revenue	2012	2013	% Change	2014	% Change
Sales	$ 456,000.00	$ 498,000.00	9.21%	$ 536,000.00	7.63%
Cost of Goods Sold	$ (213,000.00)	$ (229,000.00)	7.51%	$ (250,000.00)	9.17%
Gross Margin	$ 243,000.00	$ 269,000.00	10.70%	$ 286,000.00	6.32%
Operating Expenses
Advertising Expense	$ (30,000.00)	$ (32,000.00)	6.67%	$ (39,000.00)	21.88%
Salaries Expense	$ (112,000.00)	$ (124,000.00)	10.71%	$ (145,000.00)	16.94%
Utilities Expense	$ (3,600.00)	$ (3,600.00)	0.00%	$ (3,600.00)	0.00%
Rent Expense	$ (6,000.00)	$ (6,000.00)	0.00%	$ (12,000.00)	100.00%
Shipment Expense	$ (59,000.00)	$ (65,000.00)	10.17%	$ (75,000.00)	15.38%
Supplies Expense	$ (1,800.00)	$ (1,900.00)	5.56%	$ (1,900.00)	0.00%
Total Operating Expenses	$ (212,400.00)	$ (232,500.00)	9.46%	$ (276,500.00)	18.92%
Income before Tax	$ 30,600.00	$ 36,500.00	19.28%	$ 9,500.00	-73.97%
Tax Expense (5%)	$ (1,530.00)	$ (1,825.00)	19.28%	$ (475.00)	-73.97%
Net Income	$ 29,070.00	$ 34,675.00	19.28%	$ 9,025.00	-73.97%

As shown, this horizontal analysis, unlike the previous, shows line value ratios as a percent change from year to year. This type of analysis is particularly useful in determining which line items have or have not been consistent. Performing this type of horizontal analysis facilitates the firm’s ability to spot irregularities and determine which line items to focus on.

Both vertical and horizontal analysis are used to compare trends and industry averages. A firm uses these analyses to understand its own ratio distributions but in comparing those results with the average results of other similar firms, a firm understands more clearly necessary areas to improve and line items comparatively doing well.

Net revenue is a valuable number to compare various other parts of your income statement to. Net revenue is synonymous with net sales. These comparisons are very similar to a Vertical and Horizontal analysis, except that instead of using gross sales, it uses net sales. This gives a more realistic evaluation of how much revenue your company has, allowing for more meaningful comparisons.

Income Statement for Parts Manufacture Co. 

Revenue
Sales			$876,000.00
Less: Sales Discounts		$14,000.00
Less: Sales returns and allowances		$12,000.00	$26,000.00
Net Sales			$850,000.00
Cost of Goods Sold
Opening Inventory		$180,000.00
Add: Purchases		$250,000.00
Add: Freight-in		$23,000.00
Less: Purchase Discounts	$5,000.00
Less: Ending Inventory	$86,000.00
Total Cost of Goods Sold		$362,000.00
Gross Profit			$488,000.00
Operating Expenses
Advertising Expense		$15,000.00
Salaries Expense		$234,000.00
Utilities Expense		$24,000.00
Rent Expense		$32,000.00
Supplies Expense		$4,000.00
Total Operating Expenses			$309,000.00
Operating Income			$179,000.00
Nonoperating Items
Interest Expense	$8,000
Depreciation Expense	$14,000.00
Gain from Sale of Equipment		$24,000.00
Total Nonoperating Items		$2,000.00
Income Before Tax			$181,000.00
Tax Expense			$53,840.00
Net Income			$127,160.00

Price of inventory compared to net revenue

The price of inventory compared to net revenue looks at what percentage of the money you made from sales was put into buying inventory previously.

In the income statement above, price of inventory is $453,000 (Opening inventory $180,000 + Purchases $250,000 + Freight-in $23,000). Net sales are $850,000, so 453,000 / 850,000 = 53.29% . 

This means that it costs you roughly half of your net sales to pay for inventory. Both investors and employees care immensely about the level of inventory which you have and the amount of revenue you bring in. If this ratio gets higher, it can mean several things. It could mean that you aren’t selling as much of the inventory you purchase. It could mean that the price of inventory has gone up. It could even mean that your company is no longer adding as much value to the product.

Cost of goods sold compared to net revenue

By looking at the cost of goods sold, we can see how much capital it took to bring in our revenue. The cost of sales is found by taking the opening inventory, adding in purchases/freight-in costs, and then subtracting purchase discounts and our ending inventory. Essentially, this tells us how much money we spent on the inventory we sold during the month/year.

If we then make it a ratio of COGS / Net Revenue, it is easier to compare and understand. 362,000 / 850,000 = 42.6% .

This means that a little more than 40% of our revenue goes towards buying the goods that we sold in the last year. Ideally, this percentage should be low, indicating that it you generate a lot more revenue than it costs you to buy your product. 

This is more telling than the comparison between the price of inventory and net revenue because it takes into account the fact that your ending inventory can still be sold and generate revenue in the future.

8.6Debt Financing vs. Equity Financing

Your company needs financing, and you are faced with two options. You can either finance through debt, or you can sell some of the equity of your company in the form of stock. How do you decide which option is best for you?

Equity Financing

In selling stock options neither you or your company has any obligation to pay back the money raised. Selling equity increases the value of the company without increasing liabilities and helps you gain financing without any interest.

However, equity financing dilutes ownership of the company. Not only do you forfeit some ownership of the company but in financing through equity, you also give the right to that percentage of the company’s profits and possibly some of your decision making power.

Debt Financing

Financing through debt allows you retain ownership and all decision making power. The rights to the company’s profits will also stay with your ownership. One of the most attractive reasons for debt financing is that debt financing decreases your taxable income. Loans and bonds require some form of interest payment and on the income statement that payment is known as an interest expense. It’s the last expense to be subtracted from operating income before taxes are determined and subsequently subtracted. 

Debt financing does require payment which essentially means in order to make a profit your business must not only cover normal operating expenses but must also generate enough cash to cover a non-operating interest expense. This is a tall order for some companies. In some cases debt financing might just not be an option if investors or creditors don’t feel your business is worth the risk or if you consider the risk of taking on more liabilities too great.

Leverage

Leverage is the term used to describe how much a company relies on debt financing vs. equity financing. Leverage is determined by dividing total liabilities by total equity so a higher leverage suggests higher debt financing. Chances are there won’t be a magic answer to whether you should pursue debt or equity financing. Eventually using a mix of both options to optimize the value of your firm, your firm’s leverage within your industry, and the financial health of the entity, is likely the strategy you’ll need to take.

8.7Dividends

To Dividend or Not to Dividend, That is the Question

Paying dividends to shareholders is an important issue to a company because that decision can affect everything, from how happy the company’s shareholders are to how much disposable cash the company has. Here are some reasons a company might want to consider paying a dividend and reasons why a company might choose not to. 

Reasons to dividend

· Many investors really like dividends (keep them happy)

· Paying dividend is a sign of a company’s strength

· Paying dividends shows company management expects good earnings for the company

· Paying dividends can increase the value of a company’s stock

Reasons not to dividend

· Paying dividends might hurt a new company trying to grow

· Paying dividends may make it difficult to acquire new assets or companies

· Not paying dividends saves on taxes

· Keeping all retained earnings avoids risk of needing to issue more stock

· Paying dividends once will give the expectation that dividends will be paid in the future

Whether a company pays a dividend or not certainly does not determine whether or not a company is successful. Apple is known for paying out dividends and Amazon is not, yet both are very successful companies. Whether a company pays dividends or not, however, does affect the way the company is viewed by investors and talked about in media. Some theories argue that companies which pay dividends are viewed more favorably by investors than those which don’t pay dividends. Other theories argue that paying dividends overall has no effect. In the end, the questions to consider are the reasons given above. There are reasons a firm may decide to pay dividends and other reasons a firm may decide not to.

8.8Stock Repurchase

Right now (August 8, 2016 at 9:06 am) Apple stock is selling for $107.72. Now let’s pretend it was actually selling for $85.53, but Apple knew it could be selling for $107.72. What could Apple do to get the stock price back up? How could they signal to the market that their stock was undervalued?

Increase Value of Shares

If you know what they could do, A+ for you (or congratulations for reading the title), but to those of you who aren’t sure, consider this. If Apple were to repurchase a portion of their outstanding stock so it was no longer traded on the open market and then retire that stock, the stock that remained would increase in value because the value of the company would be represented by a smaller amount of shares. The market would also value Apple stock higher because the company repurchase would suggest that Apple thinks their stock is not being sold for what it’s actually worth. So the most simplistic solution to Apple’s problem is to repurchase some outstanding shares.

Does this actually work, or is it just hypothetical? Well, since we’re using Apple as an example, let’s look at Apple’s history. On August 9, 2013 Apple stock was valued at $64.92 and as stated earlier, today, three years later the stock is valued at $107.72. That’s a difference of $42.8. Are you curious to know if there’s a difference in how many shares Apple had outstanding in 2013 vs. today? Well, there is! In August of 2013 Apple had 6.359 billion shares outstanding, and today they only have 5.388 billion—a repurchase of nearly one billion shares! It would therefore appear that repurchasing shares really can send a message to the market that the current price of the stock is undervalued.

Other Advantages

Other huge advantages that give companies incentive to repurchase stock include increasing earnings per share (EPS) as well as boosting the company’s return on equity (ROE).

Earnings per Share

Earnings per share is perhaps the investor’s premier indication of a company’s profitability. Earnings per share is calculated by simply dividing a company’s net income by the number of shares they have outstanding so when the earnings per share starts dropping below an acceptable level, decreasing the amount of shares outstanding through a repurchase is the easiest way to increase the EPS to an acceptable level.

Return on Equity

Return on equity is calculated similarly to EPS, only rather than using the number of shares outstanding as the denominator, the dollar amount of shareholder’s equity is used instead. A stock repurchase affects ROE with the exact same positive correlation as with EPS.

8.9Summary

Financial Statements

Balance Sheet

A balance sheet shows a company’s assets, liabilities, and owners’ equity. Useful in calculating various financial ratios. 

Income Statement

An income statement shows a business’s revenues and expenses over a period of time. Useful in calculating various financial ratios.

Cash Flow Statements

A cash flow statement shows the inflow, outflow, and retention of cash in a company. Useful in calculating various financial ratios.

Vertical and Horizontal Analysis

A vertical analysis looks at what percentage of your revenue goes to different expenses on your income statement. A horizontal analysis compares these percentages over time. This is a very valuable tool in determining areas of the business that are improving, getting worse, or need attention.

Financial decisions

Debt financing vs. Equity financing

Debt and equity financing are ways to raise capital for your company. Your company’s situation will determine which one is ideal. 

Dividends

Determining whether to pay out dividends is a vital part of shareholder relations. 

Stock Repurchase

Repurchasing stock signals the market that the stock is undervalued, potentially attracting more investors. A stock repurchase will boost the earnings per share and the return on equity for your company.

Chapter 9:

9.1Introduction to Financial Ratios

Learning Objectives

1. Calculate a company's earnings per share, price/earnings ratio, and interest coverage ratio and explain what these ratios indicate about the company.

2. Calculate a company's current ratio, quick ratio, and return on equity.

3. Perform a DuPont Analysis.

4. Calculate a company's debt to assets ratio, net profit margin, and operating margin.

5. Explain what inventory turnover and days in inventory ratios indicate about a company.

9.2Earnings per Share

Investors are fixated on how much a company earns. Successful companies generally earn more money than other comparable companies. Earnings per Share is a tool used to determine the profitability of a firm. Essentially, Earnings per Share (EPS) tells you how much of a firm’s income is attributable to each share of outstanding common stock within a firm. EPS is determined by subtracting preferred stock yearly dividends from the firm’s yearly net income and dividing the difference by the weighted average number of common stock shares. The formula is represented as follows:

Calculating Earnings per Share

Dauntless Inc. is a hypothetical manufacturing company which specializes in tight black leather clothing, grappling hook guns, tattoos, zip lines and mind control pills. Last year, the firm had a net income of $2,350,000, and paid $132,000 in preferred stock dividends. For the first 7 months of the year the firm had 200,000 common stock shares outstanding but after issuing more stock the company had 240,000 common stock shares outstanding.

Using the information from above, we can calculate the EPS of Dauntless Inc. Since the amount of shares outstanding was not the same for the entire year, instead of using either 240,000 or 200,000 in our calculation, we will compute the weighted average of the two. The computation is as follows:

The chart above is not necessary to understand and compute the weighted average number of common stock shares outstanding but was used simply to clearly show the necessary steps. The number of shares for each portion of the year are multiplied by the total percentage of the year that each was present. There were, for example, 200,000 shares for 7 of the 12 months so we multiply 200,000 by 7/12. Once the weight of each period is found, weights are totaled and the calculation is complete.

The rest of the calculation is fairly straightforward. Subtracting the preferred stock dividends from the firm’s net income we are then able to divide the difference by the weighted average of outstanding shares and compute Earnings per Share. The equation is as follows. The common stock is valued at $10.24 per share.

9.3Price/Earnings Ratio

Earnings are Important

Earnings are perhaps the single most important item to shareholders. Any publically traded company has to be aware of their earnings because it determines, in large part, how favorably investors will view the company. One of the most common ways to look at earnings is with a Price Earnings Ratio.

The Price Earnings Ratio is the market price of one share in a company divided by the earnings per share of the company. For example, pretend that a company is currently trading at $100 per share. It’s earnings over the last 12 months were $2.50 per share. It’s P/E ratio would be $100 divided by $2.5 which equals 40.00. In essence, if a stock is trading at a P/E of 40, an investor can expect to pay $40 for every $1 of current earnings.

The formula is written as follows:

As you see in the above equation, it’s necessary to know EPS before figuring out Earnings per Share. The EPS formula is given below.

The cool kids on Wall Street talk often about the PE ratio, and sometimes refer to it as a company’s multiple (“Amazon has a multiple of 705! I’ve never seen it that high!”). PE is both easy to understand and very logical to use in evaluations, so many investors religiously follow the PE. Given the importance of the ratio, companies will sometimes strive for a lower ratio as part of their strategy if they want to attract more investors.

There are many ways to lower the ratio, some more controversial than others. Obviously, most companies drive themselves towards higher earnings. This will naturally bring in investors. Creative accounting decisions like boosting the balance sheet, overvaluing assets, inventory manipulation, shifting depreciation, and other examples of “cooking the books” are sometimes possible but are frowned upon and ethically questionable. The Generally Accepted Accounting Principles are rules designed to help prevent these practices.

A more strategy-based question is whether a company should focus on short-term or long-term earnings. If your company focuses exclusively on short-term earnings, you can boost your PE ratio and attract investors who see the rising PE ratio as evidence of a company’s profitability. However, this type of focus often sacrifices adequate investment in research and development. You can kill your company by focusing too heavily on the short-term earnings and not on the activities that drive long-term growth. 

Another way of improving your ratio is taking on corporate debt. In a Price Earnings ratio, the amount of debt on a company’s balance sheet is not accounted for.

Types of PE Ratios

There are different kinds of PE Ratios.

· A trailing PE means that the ratio is based on the last 12 months

· A forward PE means that the ratio is based on projected earnings for the next 12 months

Average PE Raio

An average PE Ratio has historically been between 15 and 25. In general, a higher PE suggests that investors expect higher earnings in the future, and are, therefore, willing to pay more per share of stock. These are considered expensive stocks. Sometimes, high P/E ratios can identify a more “risky” investment, as the future expectations for the stock exceed the current performance. A low PE can indicate if a company is currently undervalued. Generally, a higher P/E suggests a higher value firm, but PE should simply be one tool is an analyst’s arsenal. Often, companies are either overvalued or undervalued, and P/E is only one piece of the puzzle for someone trying to determine whether to purchase a particular stock.

Limitations to the PE Ratio

The PE ratio is helpful in comparing companies, but there are limitations to this. PE can differ widely between different industries because of differing company structure. For instance, large margins and high growth rates for technology companies can lead to a high PE valuation, whereas the fast food market has low profit margins that may result in a lower ratio.

9.4Interest Coverage Ratio

Most companies have outstanding debt. Whether that debt be from a bank loan, from creditors, or even from money loaned by a friend or family member, chances are the company is paying interest on that debt. You can use the Interest Coverage Ratio to figure out how easily a company can pay the interest on its outstanding debt. The calculation for the ratio involves dividing the company’s earnings before interest and taxes (EBIT) by the company’s Interest Expense for the same time period. The formula is shown below.

Let’s say our company has an EBIT of $700,000 for the year and interest payments of $35,000 for each quarter of the year. To determine the interest coverage ratio we first multiply $35,000 by 4 (for each quarter of the year) and then divide $700,000 (EBIT) by the resulting 140,000. Our results show an interest coverage ratio of 5, meaning that before interest and taxes, the company could cover its interest payments 5 times over.

Higher Interest Coverage Ratio = Healthier Company

A higher interest coverage ratio indicates a healthier company. Ratios are normally acceptable until they drop below 2.5, at which time a company may need take action to assure it does not decrease any farther. A ratio of 1.5 is the bare minimum at which a company may not have serious problems, but a ratio of less than 1 indicates clearly that the company does not even earn enough to cover the interest on its debts.

9.5Current and Quick Ratios

Current and Quick Ratios are liquidity ratios used to determine the ability a firm has to pay its creditors; a critical aspect to a firm’s strength. Both ratios contrast assets against liabilities with slight differences in calculation.

Current Ratio

The Current Ratio is the broader of the two comparisons, and is determined by adding the value of all current assets and dividing the total by the sum of all current liabilities as shown in the following formula:

Quick Ratio

By definition, a liability that is due next month and a liability due in 12 months could both be considered current liabilities. That being said, a liability due in 12 months is not near as much of a concern as one due next month so the Quick Ratio is used to show how well a firm can cover its liabilities with only the most liquid of assets. The Quick Ratio is calculated nearly identically to the Current Ratio except for inventory and prepaid expenses are not accounted for when summing total current assets. The formula is shown as follows: 

Because both inventory and prepaid expenses are not easily liquidated, the Quick Ratio excludes them in order to better show a company’s ability to pay off it’s debt in the short term.

Both the Current and Quick Ratio are fairly elementary and don’t necessarily prove or disprove the health of a company. Generally speaking, a ratio below 1 for both ratios indicates a firm may have trouble paying its outstanding debts, and represents a financial risk to investors. A usually acceptable current ratio is higher than 1.5 and an acceptable quick ratio is higher than 1. These rules are not to be used blindly as ratio averages vary from industry to industry and may not accurately indicate the long term financial strength of a company. It’s important to look at a firm as a whole and analyze it from multiple angles.

9.6Return on Equity (ROE)

Return on Equity is a percentage calculated to show the amount of profit created by a company for each dollar of investors money. It is calculated by dividing a company’s net income (after dividends paid to preferred stock but before dividends paid to common stock) divided by the total shareholder’s equity. The formula is shown as follows:

Assume company Z had a net income of 3 million dollars over the last fiscal year and the company’s shareholder’s equity totaled 5 million. By dividing 3 million by 5 million we can determine the company’s ROE of 60%. This means that the company made a profit of $0.60 for each $1.00 of investor’s money.

When shareholder’s equity fluctuates throughout the year, either from issuing shares or purchasing shares outstanding, the average shareholder’s equity will need to be used in the calculation. Average shareholder’s equity is determined by adding the beginning and ending shareholder’s equity and dividing the sum by two.

Efficiency

Besides expressing the profitability of a company, ROE especially shows the efficiency of a company. Comparing the ROEs of companies within the same industry allows you to determine which companies can turn investors dollars into the most profit. The higher the ROE, the more efficient the company but their can be a catch.

Limits of ROE

ROE does have it’s limits. Unfortunately, companies can artificially boost the ROE rather easily through repurchasing shares outstanding or through debt financing. ROE should also only be compared between companies within the same industry, as industry averages vary widely depending on the nature of the industry. ROE fluctuation over years of business is a good indication of long term profitability, efficiency, and consistency.

9.7DuPont Analysis

The equation commonly used to determine a firm’s Return on Equity (ROE) is as follows:

Return on Equity is particularly useful for investors and shareholders as the ROE calculation shows how much income a firm generates for every dollar of invested equity. It is a simple way of understanding profit per investment dollar within the firm.

DuPont Analysis takes Return on Equity to the next level by breaking the equation up into the three calculations which affect ROE, profit margin (net income/total sales), total asset turnover (total sales/total assets), and the equity multiplier (total assets/total equity). The formula is as follows:

As you can see, by canceling out total sales and total assets as follows, both equations are the same; DuPont is simply an expansion to better understand each factor affecting ROE.

In dividing ROE into profit margin, total asset turnover, and the equity multiplier, it is easier to pinpoint exactly what is affecting ROE. If ROE is increasing, DuPont analysis helps a firm see where they are having success. If ROE is decreasing, DuPont analysis helps a firm find the problem.

9.8Debt to Assets Ratio

Company Health

How do you assess the health of a company? It seems easy to just look and see if the business is making a profit, but that doesn’t paint a complete picture of the company. There are countless factors which affect a company’s health. One obvious key determinant of a company’s financial situation is it’s debt to asset ratio.

Calculating the Debt to Assets Ratio

The debt to asset ratio is simply a ratio calculated by dividing total debt (long term and short term) by total assets (current and fixed). This ratio represents how levered a company is. Leverage is the amount of debt a company has in respect to its assets. Therefore, the higher the debt to asset ratio, the higher the leverage. The higher the leverage, the greater the obligations a company has to pay back its debt. The higher its obligations, the higher the financial risk of investing in that company.

Additionally, the debt to assets ratio shows how much of the company's assets are financed through debt. A company with a higher debt ratio than another is funding a greater percentage of its assets through debt. Companies with higher debt ratios than the industry average may represent companies which are less likely to succeed during a recession. They are equally less likely to qualify for additional loans if they are already in debt.

Take Other Factors into Consideration

This is not to say that any company with a high debt to assets ratio is doomed to crash and burn. Other elements come into play when considering the health of a company, not to mention that the debt to assets ratio doesn’t take into account what kind of assets and what kind of debt a company has. If a company had to stretch out and risk a high debt to assets ratio in order to be in a position that dominates its competitors, the risk is likely to pay off and the ratio will likely stabilize as the company pays off its debts. Knowing what a company’s debt to assets ratio doesn’t truly serve a purpose unless you also know reasons why.

9.9Inventory Turnover and Days in Inventory Ratios

Making a profit through the sale of inventory is the goal of every retail store. How quickly and how much inventory a company manages to sell shows a lot about the profitability and strength of the company, and is a closely measured ratio. This ratio, known as Inventory Turnover, shows the number of times a company’s inventory is sold over a period of time (usually a year). 

Inventory Turnover

Inventory turnover is determined by either dividing net sales by average inventory or dividing cost of goods sold by average inventory. Since using cost of goods sold proves more accurate, our example will show the formula as follows:

The average inventory is used in this calculation to account for fluctuations in inventory due to changes in growth and is determined as follows:

Let’s assume our company’s COGS was $300,000, we had a beginning inventory of $25,000 and an ending inventory of $35,000. To determine the inventory turnover, we would first determine the average inventory by adding $25,000 and $35,000 and dividing the total by 2 which equals $30,000. We then divide $300,000 by $30,000 to get an inventory turnover of 10 meaning inventory is sold and replaced 10 times throughout the year.

Days in Inventory

To find the Days in Inventory ratio we simply divide 365 (the number of days in a year) by 10 (the number of times inventory turned within that year) and find our inventory is on hand for 36.5 days. This tells us about how long it takes for inventory to move.

9.10Net Profit Margin

Net Profit Margin is a ratio given as a percentage that shows how much of each dollar earned by a company transfer into profits. The formula for the ratio is given as follows:

Within this formula, Net Profit is calculated by subtracting cost of goods sold, operating expenses, interest and taxes from total revenue.

Net Profit Margin can vary greatly between industries and from company to company. Some companies manage to be incredibly successful on small margins. One example is Amazon, which has a profit margin of a mere 1.76%. Other companies, particularly in the tech industries survive on much higher margins, such as Microsoft’s margin of 15.14% or Oracle’s margin of 26.56%.

Companies often benchmark Net Profit Margin against other companies in the same industry. Doing so gives both investors and companies an idea of how their profitability compares across the board. Knowing the profit margin of your competitors also allows you to approximate their COGS, operating expenses, interest and taxes.

9.11Operating Margin

The Operating Margin of a company is a percentage ratio which tells how much of every dollar of a company’s sales are profit. In other words, how much revenue is left over after operating expenses are accounted for? The formula is shown as follows:

In this formula, operating profit (operating income) is determined by subtracting operating expenses and depreciation from total revenue. Net sales is calculated by accounting for the values of returned, damaged, and missing goods, and discount sales and subtracting each from total sales.

Let’s assume there’s a company with the following figures:

Total sales:	$435,000
Cost of Goods sold:	$200,000
Operating expenses:	$85,000
Depreciation expense:	$15,000
Damaged or missing goods:	$6,000
Discounts:	$7,000

To determine the operating profit, we subtract depreciation and operating expenses from our total revenue.

Total Sales − ( Damaged/missing goods + discounts ) = Net Sales

$435,000 − ( $6,000 - $7,000) = $422,000

Net Sales − ( operating expenses + depreciation) = Operating Profit

$435,000 − ( $85,000 + $15,000 ) = $335,000

Operating Profit / Net Sales = Operating Margin

$335,000 / $422,000 = .794

What does this actually tell us? The operating margin essentially shows how much of your sales are going to operating expenses. The higher the ratio is, the more profitable your company is. Obviously, it is unrealistic for companies to have an operating margin of 1.0, but you should strive to improve your operating margin by decreasing costs on products or by raising prices. Analysts often look at operating margins and operating leverage together to get a better picture of the profitability of the company. Operating margins are useful for comparing companies across industries.

9.12Summary

Financial Ratios

Earnings Per Share

Net income minus dividends on preferred stock divided by the weighted average number of common stock shares outstanding gives us the earnings per share. Earnings per Share is a great way to judge the profitability of a company. 

Price/Earning Ratio

Price per share divided by earnings per share. The Price/Earnings ratio is heavily used by investors when evaluating a firm. 

Interest Coverage Ratio

Dividing the earnings before interest and taxes (EBIT) by the company’s interest expense gives us the interest coverage ratio. This ratio tells us how health a company is with regard to debt.

Current and Quick Ratios

The current ratio is found by dividing your current assets by your current liabilities. A quick ratio is equal to current assets minus both inventory and prepaid expenses, and then divided by current liabilities. These ratios are liquidity ratios which show how easily a company can pay its creditors. 

Return on Equity

Net income divided by shareholder’s equity. Return on Equity shows how much money a business can make with a dollar of investor’s money. 

DuPont Analysis

DuPont Analysis takes Return on Equity to the next level by looking at the profit margin, total asset turnover, and the equity multiplier that make up ROE. Very useful for seeing where a company is having success. 

Debt to Assets Ratio

Total Debt divided by Total Assets. The Debt to Assets Ratio shows how leveraged a company is, which can indicate how much risk there is in investing in the company. 

Inventory turnover and Days in Inventory Ratio

Inventory turnover is the cost of goods sold divided by the average inventory. Days in inventory is number of days in a year divided by the inventory turnover. These ratios help show how much inventory you generally have and how long it takes to move inventory out the door. 

Net Profit Margin

Net Profit divided by Total Revenue. Net Profit Margin shows how much of each dollar earned transfers into profits. 

Operating Margin

Operating Profit divided by Net Sales. The Operating Margin gives insight into how much of your revenue is lost through your operating expenses.

Chapter 10:

10.1Introduction to Customer Relations

Learning Objectives

1. Explain the importance of Customer Relationship Management and the Voice of the Consumer.

2. Differentiate between geographic, demographic, behavioral, and psychographic market segmentation.

3. Explain basic concepts in branding and marketing, including the 4 Ps of Marketing and push vs. pull marketing.

4. Describe the impact of price on business strategy, including the use of Price Optimization Models. 

5. Explain why companies engage in Corporate Social Responsibility and use a Triple Bottom Line.

6. Perform a Value Chain Analysis of a company

7. Use the Value Equation to conceptualize strategic decisions

10.2Customer Relationship Management

Customer Relationship Management (CRM) is essentially the manner in which a company interacts with its customers. These interactions include corporate guidelines, standards, and practices which guide interactions with customers. Increasingly, companies are turning to software and big data analytics to improve the quality of their Customer Relationship Management.

Benefits of CRM

By tracking customers and their interactions with a company, the company can improve sales, marketing, and customer support. Usually, a company will invest in a type of software that allows them to track all of the interactions between a customer and the company, including website, telephone, chat, social media, and email interactions. By combining these points of contact with a history of past marketing efforts to the target audience, a company can better plan future marketing and customer relation efforts.

Target Predictions

Perhaps the most famous example of this was when Target predicted a teenage girl’s pregnancy before her parents were aware that she was pregnant. Target had developed a “pregnancy prediction” score, based on the previous purchases of the individual. Not only could the database predict with a surprising degree of accuracy if the girl was pregnant, it could also predict the delivery date within a narrow window.

This allowed Target to target girls in their second trimester, a clear advantage because most other stores began targeting new mothers as soon as the baby was born. Target was able to sell many necessary products long before the baby arrived.

While this example is rather extreme and somewhat freaky, Customer Relationship Management is very useful and generally much less intrusive. Companies can either gather their own data, or purchase data on demographics from independent organizations.

Customer Insights

Collecting the data isn’t necessarily the difficult part of this process. Once the data has been collected, analysts must determine what meaningful changes can be made to marketing and customer service plans. CRM software helps provide some analytics, but in order to gain a comparative advantage in Customer Relationship Management, analysts need to provide insights.

Ultimately, the goal of Customer Relationship Management is to keep customers coming back. If a company does a good job of managing their relationship with a customer, that customer is likely to become increasingly loyal to the organization. If a company does a poor job, they will lose their customers.

10.3Market Segmentation

Market segmentation is a strategy used by firms in which they analyze a market and subcategorize the elements of the market into more precise and understandable parts. Markets are commonly segmented into geographic, demographic, behavioral and psychographic elements and then analyzed as market subcategories. Much of market segmentation is straightforward logic; nevertheless, following this systematic approach to determine what strategy a firm applies in each subcategory of the market is a catalyst for success.

Types of Segmentaion

Geographic Segmentation

Geographic segmentation involves segmenting the market based on region, climate and weather patterns, population, and urban development. Examples of firms which utilize geographic segmentation include a local grocery store that caters to a single neighborhood or a commercial grocery store which caters to a large city; both have different strategies to succeed in their chosen market. A sporting goods store located in Utah’s Rocky Mountains will cater to its customers through geographic segmentation by providing goods such as mountain bikes and rock climbing gear. In contrast, a sporting goods store located near the Californian coast will provide its customers with surfboards and beach equipment.

Demographic Segmentation

Demographic segmentation involves segmenting the market based on elements such as race, age, religion, gender, income, and family. For gender a simple example would be a clothing chain who markets ties to men and dresses to women. Many companies have products which are specialized to fit people of different demographics. Baby products, video games, and even family sized food products all have specific demographics as a focus.

Behavioral Segmentation

Behavioral segmentation suggests segmenting the market based on the behavior of customers towards a product or service. It takes into account occasions in which customers buy a product, benefits sought by customers, loyalty to which customers feel to the firm, and the customer usage of a specific product or service. Examples may include umbrella vendors that use a rainstorm as an occasion to boost sales or toothpaste companies which provide teeth whitening as a benefit to their products. A hotel chain may attract the loyalty of a customer by providing incredible customer service and reward cards and an internet provider may take advantage of customer usage by providing internet at 10 Mbps for $25 and internet at 35 Mbps for $40. This gives incentive for many to opt for the higher-speed internet given the price becomes cheaper per Mbps with the faster internet.

Psychographic Segmentation

Psychographic segmentation involves segmenting the market based on customer lifestyle, preference, personality traits, values, and attitudes. Because people prefer different products and styles of the same product, firms use psychographic segmentation to appeal to as many different customers as possible. Vehicle manufacturers offer luxury vehicles, sports cars, electric cars, off-road vehicles, and heavy-duty work vehicles to entice customers with all different tastes and lifestyles. Ski manufacturers market thousands of different types of skis to appeal to those who prefer groomed ski runs, park rails, jumps, deep powder, moguls, or backcountry skiing.

The goal of market segmentation is to design strategies to target a specific segment, gaining a competitive advantage because you offer more precisely what the consumer is looking for.

10.4Voice of the Consumer

In today’s world, information travels fast. At any given second of the day you can pull out your phone and read headlines from Turkey, you can see posts from your friends hundreds or thousands of miles away, and you yourself can post to the world what you’re doing in that very moment. There are 60 hours of video uploaded to YouTube each minute alone! Just imagine how much information is uploaded to Facebook, Instagram, and Twitter! According to some sources, in 2015 there were 2.4 million emails sent throughout the world every second which adds up to about 74 trillion emails for the whole year! These informational advances, as you very well know, have changed the face of business in many ways. One of the major changes has come through an increase in communication between businesses and their customers.

What is the Voice of the Consumer?

Customer’s opinions, expectations, apprehensions, and preferences of a business and it’s products and services are defined by a single term; Voice of the Consumer. Because of information advancement, the voice of the consumer has become louder and louder. Now more than ever, businesses can hear the voice of their consumers and make sound business decisions based on that voice. 

Vital to Successful Business

Successful businesses are those which successfully answer to the voice of the consumer. In order to answer to respond to it, they must first hear it. Online ratings and reviews often stem from consumers who give their voice without being solicited and can be useful sources to many businesses. Most consumers, however, only give their voice if prompted. Data collection companies like qualtrics and survey call centers have boomed in recent years simply by providing businesses with the voice of their consumers. Online data mining solicit consumer voice through online surveys and questionnaires. Call centers do the same through phone calls which target specific consumers. These companies can reach thousands and thousands of people and provide businesses with invaluable information on the voice of their consumers. 

Once a business hears the voice of the consumer they can perform a simple analysis to better understand the wants, needs, expectations, preferences and apprehensions of their consumers. This knowledge helps businesses craft their services and products to better suit the desires of their customers. Data driven companies, companies which hear the voice of the consumer, analyze the data, and make appropriate alterations and developments to their products are the companies of the future.

10.5Branding

Let’s pretend you have the best strategy in the world, but you are failing at branding. The impact your strategy can have is now limited. Yes, you can have efficient operations, happy employees, and great plans for continued growth, but if your branding is terrible your customers will think that your company is terrible.

Your Brand is the Face of Your Business

Your company’s brand is how you present your company to the consumer. It includes the logo, marketing, and advertisements, as well as the things that you can’t measure - like how your customers feel about your brand. 

Companies with fantastic branding come easily to mind - Nike, Apple, Coca-Cola, and Disney. In fact, wildly successful companies almost always have brilliant branding strategies. 

Match Your Brand to Your Strategy

Make sure your brand strategy matches what you actually offer as a company. Nike never could have positioned itself as a premier sports apparel brand if it didn’t provide high-quality clothing and equipment. Your brand and your product need to support each other completely. 

Target Customers

Determine who your target customers are. What appeals to them? What are they looking for from your type of product? How can you create an emotional connection with them?

Emotional Reaction

Your brand should strive to create an emotional reaction with your customers. This emotional connection to the brand explains why people are willing to pay so much more for a similar product when it is made by their favorite company. 

A Promise to the Consumer

Your brand makes a promise to the consumer, and you have to live by that promise. If you brand yourself as a fast-moving tech company that works on the cutting edge, you have to deliver. Every time your company interacts with the consumer, they need to receive a message consistent with your brand and your strategy.

Remain Flexible

As a company however, you need to remain flexible. Ideally, your brand will be broad enough to allow for some shift in consumer preference. As you gather consumer data and discover customer insights, you likely will have to make adjustments to what you offer and how you advertise it. You may even have to change your brand strategy to match what consumers want. That’s ok. Powerful brands build upon the impressions that they make and it’s impossible to make an impression if your strategy does not match the wants of your consumers.

10.6The Four Ps of Marketing

Someone could have the most brilliant idea for a product or service, but unless she knows how to get people to notice it, accept the price it’s offered at, and find it through the right distribution, the idea will fail. In other words, without proper marketing, the business stands no chance. A marketing mix is the specific way a company or individual brings a product or service to market. Defined in 1960 by E J McCarthy, the four P’s of Marketing is the most widely accepted and used marketing mix strategy.

The four P’s are as follows (in no specific order):

· Product

· Price

· Place

· Promotion

Product

The product is simply the good or service you’re offering to the consumer. To effectively plan the product part of a marketing mix, whatever you offer to your customer must answer some sort of unmet need. Your product must bring value to your customers, hopefully in a new and improved way that differs from the products of your competition. Otherwise, no one will want to buy it.

Price

Price plays a huge role in the marketing of a product. How do your prices compare with those of your competitor? Is your product good enough to sell at a higher price? Will a higher price actually give your product the impression of being higher quality? These are just a few of the questions you need to consider when determining price.

Place

In regards to a marketing mix, place refers to where your product will be sold and how it will be distributed. Distribution location depends greatly on who you are trying to market your product to. This seems obvious, but perhaps there are distribution channels perfect for your product that you hadn’t considered. For example, the first person to sell their car chargers at gas stations probably made some pretty good money.

Promotion

Promotion is where true marketing magic comes into play. The promotion must take into account who the product is being sold to, what distribution channel is being used, and what needs to happen for the product to be more popular than that of the competition. An appropriate median and appropriate content for the promotion will have to be chosen based on the answers to those considerations.

Creating a marketing mix that takes into account the Four Ps, not only at it’s debut, but throughout the implementation and continuation of a market strategy is the most effective way to keep a marketing mix from going out of date or losing impactfulness. You should continuously ask yourself if your products, prices, places, and promotions, are optimized and diligently make the necessary changes to keep your marketing mix effective.

10.7Pricing Strategy

Price is Important

At the end of the day, one of the most important parts of your business is the price you charge for your products. If you charge a price that consumers won’t pay, you inevitably will fail.

Align Price with Strategy

However, beyond just charging a fair price, your price should align with your company strategy. Do you offer such a high-quality product that you can charge premium prices? Are you trying to be the low-cost leader in the market? 

Different Pricing Strategies

There are a million different pricing strategies—loss-leading pricing, discount pricing, dynamic pricing, keystone pricing, psychological pricing, anchor pricing, and others. These provide a framework for pricing effectively, and can be useful if your business does not have an effective pricing model. Below are a few brief explanations of some of these pricing strategies.

· Margin Based pricing - simply adding a markup to the cost of the product

· Bundle pricing - combining products to increase price

· Psychological pricing - pricing using odd numbers that make a price seem more attractive $199 seems like a much better price than $200

· Price skimming - setting a high price and then lowering it with time

· Penetration pricing - setting a low price and then raising it with time

· Decoy pricing - pricing multiple different brands of the same product to influence consumers to purchase a particular one.

Internet Pricing

The internet has created some difficulty in pricing effectively. Customers can compare prices between different sources in an instant, and they often do so while they are in a store. Be careful to maintain positive retailer relationships. Generally, retailers get a 40% increase in the price of a product. If you don’t include a similar mark-up on your online price, your internet distribution system will compete with your brick-and-mortar retailers. One way of dealing with this challenge is by using the MSRP as the online price.

MSRP

MSRP is the Manufacturer's Suggested Retail Price. Stores use MSRP both to standardize prices across stores and as a way of promoting a product by showing how much less they are charging than the MSRP. One major advantage of the MSRP is that, even if you discount the price to drive sales (perhaps as a promotion), you don’t necessarily create the expectation of that lower price in future sales. By displaying the MSRP price, you communicate to the customer where the price generally will be, even though it is temporarily lower.

10.8Price Optimization Models

How much should you charge for your product? Price matters, both to your potential consumer and to your business strategy. Some companies try to create such a great product that they can charge a premium price. Others try to undersell the competition, stealing market share and making up for lower margins with higher volume.

What are Price Optimization Models?

Price Optimization Models are a way for companies to determine the best price for their product. Essentially, these models show how demand will fluctuate based on a change in price.

Airline Industry

The airline industry was one of the first to embrace price optimization models, which they began doing in the 90s. Instead of using them just to determine a single price point, airlines use them to deal with changes in demand. Most customers on the same flight paid a different price because of price optimization. For instance, if there is an extremely high demand for the December 20th flight to Hawaii, airlines will charge a premium price and likely increase the number of flights offered. If a flight has very little demand however, prices are slashed in an attempt to still fill up enough of the airplane, either breaking even or turning a profit.

Retail

Retail is different because there isn’t such a strictly limited supply, as there is on an airplane, but the same principles apply. Price optimization models tell the company where to put their price to earn the most profit.

Obviously, there is some difficulty in accurately predicting the future. However, given the immense complexity of markets with thousands of different products offered at different prices, Price Optimization Models are very helpful in providing insights as to what the price should be.

Creating Price Optimization Models

Generally, Price Optimization Models are created by mathematics-based computer programs provided by consulting firms. First, the company executives or managers determine which Price Optimization model will be used and what firm will be providing it. Then they input historical product volumes, prices, past promotions’ effects on volume and price, as well as fixed/variable cost info, economic trends and conditions, and seasonal fluctuations in volume. 

Market Segmentation

In order to effectively optimize price, customers within the market are often divided into segments (see market segmentation) and tested to find the optimal price. This way, the price will reflect the business’s strategy in pursuing the target audience. When a firm manages to meet the demand of each market segment, the firm can maximize profit. 

Factors Influencing Price Optimization

A few factors influencing Price Optimization

· Price elasticity

Some products are very price sensitive, while others are not. For instance, the sales of grocery store products can vary as much as 10% with a 1 cent change in price

· Seasonal items/constraints

The optimal price can change depending on the time of year for some products.

· Product life cycle

Innovative new products can have a much higher price, as early adopters are less price sensitive.

Later on in the product life cycle, more competitors enter the space and drive down the price. Late adopters are much more price sensitive.

Making Price Optimization Models Useful

Price Optimization Models are most useful in the right set of circumstances. If a company is determining its initial price of the product, Price Optimization will be most accurate if the products are commodity items or are very common in the market. POMs can also be used very effectively to predict the effect of a particular promotion or change in price of an existing product with historical sales and volume data.

In other situations, price optimization models can still be helpful, but with less accuracy. Nonetheless, it is essential that businesses look closely at their price and determine if it is optimal and if it aligns with their business strategy.

10.9Corporate Social Responsibility

Companies, particularly large companies, have an incredible amount of power. They can hire or fire thousands of people, boost or drag down economies, and destroy or preserve environments. Sometimes, companies choose to use this power to accomplish a noble cause, putting their money and influence to bring about good. This is called corporate social responsibility (CSR).

Examples of corporate social responsibility range widely, including companies advancing education, protecting the environment, offering healthier food options, fighting poverty, creating fuel-efficient vehicles, and seeking cures to diseases among others.

Controversy Over CSR

Proponents of CSR

There is a rich debate surrounding corporate social responsibility. Proponents of corporate social responsibility claim many advantages. One is that socially conscious consumers will buy from socially conscious companies. Another is that governments often offer advantages to companies who engage in corporate social responsibility. Recruitment is positively impacted, as some talented employees want to work for socially responsible companies. This is particularly true of Millennials, who tend to seek CSR much more than past generations have. Michael Porter argues that CSR can be a source of both innovation and competitive advantage. Of course, a huge benefit is the opportunity to actually make a difference for good in the world.

Opponents of CSR

Opponents of corporate social responsibility argue that companies have no obligation to improve society, and that a company’s only responsibility is to generate money for shareholders. Some even go as far as to argue that funds allocated to CSR are being stolen from shareholders, the rightful owners of that money. When companies strive to limit their pollution or environmental impact beyond what is required by law, opponents ask why the company is regulating itself beyond what the government already does. Others argue that CSR is just a way to get positive public relations (PR) and doesn’t really serve other purposes.

Is Corporate Social Responsibility Right for You?

Rather than choose one of these sides, we are going to look at some things to consider when deciding if corporate social responsibility is a good strategy for your company.

Company Size

How large is your company? Realistically, there are many kinds of CSR that small firms cannot perform. Building a school in an impoverished community, donating large sums of money to a charity, or investing in research to cure cancer are among hundreds of CSR activities beyond the reach of a small company. If you are small, consider things that contribute more directly to the bottom-line of the company. Waste reduction is a great start - if you can reduce the amount of waste in production, you benefit the environment and save money.

Industry

Are you in an industry that values CSR highly? Some industries are more socially-conscious than others. For instance, the Outdoor Recreation Industry cares immensely about the environment because damage to the environment destroy recreational opportunities in the outdoors. Patagonia and others have embraced CSR for years, and consumers in the industry expect companies to be socially conscious. This explains, at least in part, why new entrants to the Outdoor Product industry generally are founded with CSR as a fundamental part of their strategy. Cotopaxi is an example of this.

Financial Benefit

Are you likely to benefit financially from CSR? Corporate Social Responsibility is much easier to justify if it will attract more customers, distinguish you from your competitors, or allow you to charge premium prices.

Public Relations

Do you need positive PR? While some question the ethics of using CSR to create good PR, it certainly works. If your company image has been damaged in some way, CSR can help repair this image.

Even if you didn’t answer yes to the questions, you can still have CSR as part of your company’s strategy. It may just be more difficult to justify. Some companies, like TOMs shoes, are created with CSR as a founding principle of the organization. Others choose CSR for its intrinsic value, rather than the benefits that come from it. Whatever the motivation or the setup of Corporate Social Responsibility in your company, you should carefully consider all of the options and benefits so you can maximize both the good you do in the world and the benefit you do for your own company and its shareholders.

10.10Triple Bottom Line

What should your company work towards? Some would argue that companies are created for the sole purpose of making money - the bottom line. In 1994, John Elkington introduced a different idea. He argued that companies should be pursuing three different bottom lines - profit, people, and planet.

Three Bottom Lines

Profit

The first, profit, is what companies have been doing for centuries. This is the traditional bottom line. Unless a company makes a profit, they cannot stay in business and will fail.

People

The second bottom line is “people”. This measures the impact the business has on all of the people who interact with the company. Companies who focus on this bottom line offer a safe place to work, encourage employee health, and help employees progress. Improving the social impact of your supply chain is another way to focus on the people aspect, by not using child labor and offering reasonable wages even in countries where people will work for barely enough to survive.

Planet

The third bottom line is planet, which encompasses the environmental impact that the company has. Some companies focus solely on trying to decrease the damage they do to the environment. Others strive to go beyond that, benefiting the environment instead of just preventing additional harm from being done.

The triple bottom line is a framework for looking at Corporate Social Responsibility. The same advice and suggestions that are included in CSR are applicable to the triple bottom line.

Difficult to Measure

One of the greatest difficulties in implementing a triple bottom line strategy is an inability to measure and compare the three bottom lines. Profit can be measured in dollars, but the other two cannot. How do you measure the positive impact you’ve had on people who work with your company? How do you measure the effect you’ve had on the environment? This difficulty in measuring results causes difficulty in balancing how many resources you dedicate to each of the bottom lines. If you focus too heavily on one of the bottom lines, you can deprive the others of the resources they need to keep going. To help with this, the federal government has sponsored a website to help companies effectively implement the triple bottom line.

Look carefully at each of the three bottom lines can be implemented at your company. Which one needs the most improvement at your company? Which one are you doing best at? What measures can be taken in each area that align best with your company’s culture and resources?

10.11Push vs. Pull Strategy

Push vs. Pull Marketing

Push Marketing Strategy

Push marketing involves simply bringing products to customers and convincing them to buy it. Conversely, pull marketing is designed have consumer seek out the product themselves. If a company is attempting to use a push strategy, they want to place the product in front of a consumer as often and in every way possible. If you are using a push strategy, you will actively work with channels of distribution, pushing the product onto retailers, middlemen, and selling it directly to your consumer. Imagine this strategy like a door-to-door salesperson; he/she attempts to explain to you all of the product features, the benefits of buying, and why now is the right time. Some examples of push marketing include trade shows, cold-calling, and direct selling. 

Push marketing is often characterized by direct sales. The company will attempt to take the merchandise to the customer and present the product to them. Company showrooms or tradeshows can help place the product into the hands of potential users. Pushing a specific product can originate with manufacturers, who make lots of the product and then push it onto wholesalers, possibly at a discounted price. The wholesalers then try to sway retailers to stock the product in their stores. Once the product is stocked, retailers are forced to push the product to customers.

Pull Marketing Strategy

Pull strategy is designed to bring customers to the business and focuses on customers who will actively seek the product. For instance, Rossignol has built its reputation as a manufacturer of quality skis over the last 100 years. Instead of finding skiers, explaining the product to them, and trying to “push” them to buy the skis, Rossignol lets the customers seek out reviews, specs, and features of each new ski. Consumers go to Rossignol, so the Rossignol marketing department focuses on making sure stores and websites adequately explain the product.

Pull marketing uses traditional advertising, referrals, promotions, discounts, and today, social media to bring in customers. Often, it is characterized by a solid advertising campaign, intended to generate a large demand amongst consumers. If customers are demanding a certain product and are drawn into stores in order to find it, retailers typically find a supply chain and will do what is necessary to make the product available in their store.

Example - The Grocery Store

A trip down to the grocery store highlights the difference between push and pull strategy. Perhaps you went into Lee’s because you know that they stock Lucky Charms, your favorite cereal. The Lucky Charms have “pulled” you into the store and you have planned on purchasing a box (or possibly several). After you arrive at the store, you see a point-of-purchase display case wonderfully showcasing Kit Kats. You didn’t plan to buy a Kit Kat, but now you see those red wrappers and pictures of beautiful people eating Kit Kats. Your mouth begins to water, before you know it you’ve placed several bars in your shopping basket.

Mixed Approach

Push and Pull strategies are not mutually exclusive. A company can both pull consumers into stores to buy the product and promote the product through “push” methods. In fact, many would recommend a mixed approach to marketing most products. The balance between pull and push must be determined by the market, the product type, and the company’s vision.

Often, pull strategies are more widely used for products that require a certain amount of forethought. Push strategies tend towards lower-cost items that people will buy without much planning. For instance, few people buy a car on complete impulse; hence, car dealers seek to pull interested customers into their dealership. Conversely, relatively few people make an entire trip to the store to buy a pack of gum. However, if gum is presented properly and at the right moment many people buy it impulsively.

10.12Value Chain Analysis

One mistake made by many firms is assuming that once they have a successful product or service that provides the company with a steady inflow of customers and profit that there’s nothing left to do but continue to sell. Companies which forget the importance of continual improvement are eventually highly disadvantaged. One process which helps firms continuously evaluate the value they offer customers and thus know how to improve is called the Value Chain Analysis. The Value Chain Analysis is a three step procedure used to improve the customer experience by adding value to your firm. Here are the steps to the process:

1. Determine the main services or activities involved in moving products from producers to consumers. (Operations, Marketing, Sales, inbound logistics, outbound logistics)

2. Identify what could be done to add the most value to the services and activities found in step one and optimize the customers’ experience.

3. Consider the ideas found in step two. Evaluate the practicality of each idea and decide whether or not to implement them. Make an organized plan of action to carry out the implementation of the decided improvements.

Example Value Chain Analysis

Kuru Design

To better understand this concept, we’ll apply a Value Chain Analysis to a small local firm called Kuru Design. Kuru specializes in the design and retail of travel-size hammocks.

Process from Producer to Consumer

First we need to determine the process Kuru’s hammocks take from producer to consumer. The process starts with purchasing and importing hammocks from a foreign manufacture. Once the supplies have arrived, a quality control is conducted on each hammock and the hammocks are packaged and readied for sale. Most of Kuru’s hammock sales are performed at public markets, fairs, festivals, and community events. They advertise and sell their products by setting up hammocks at the event and spending time talking to those walking by (much like other vendors in such locations). Customers select and purchase their hammocks on the spot, the transaction is made and inventory is tracked.

Identify Improvements

Now that we have a perception of the process Kuru products take, our next step is to identify improvements that could be made to optimize the customers’ experience. Small changes, such as allowing customers to sit in a hammock before deciding to purchase, might improve the buying experience for the customer. Other improvements could be made to make the products more pleasurable to Kuru’s customers, such as creating a unique Kuru hammock pillow, implement a speaker system for urban hammock users, or creating an innovative water-proof winter hammock for extreme hammock users. Other improvements could be made simply by varying hammock colors offered by Kuru, or even personalizing hammocks through stencils. There really are a lot of ideas for improvements that can be imagined in any industry. If we can think of a whole bunch within in the hammock industry, imagine what else exists out there!

Create an Action Plan

The final step to our Value Chain Analysis is to determine which ideas to implement from step two and create an action plan. After considering all of their options and conducting some market research, Kuru’s owners determined the most effective way to improve their customers experience would be to make improvements to their products. They decided to pursue speaker system implementation, winter hammock production, and have all of their hammocks available for customers to try out at sale locations. Their action plan consists of creating prototypes of their new products and conducting product testing.

10.13The Value Equation

The Value Equation as a Strategic Tool

The value equation is a simple way to picture what a firm offers to the customer. Ultimately, value is what the consumer bases their purchase decision on. For example, a meal purchased at McDonald's has a very different set of benefits and costs than a meal purchased at Ruth’s Chris Steak House does. Yet both serve the same utility; a meal. Likewise, BMW and Hyundai both make automobiles that serve the same utility; they get you from point A to point B. However, the features, benefits, and costs are very different between the two. Value is created, in different ways, for each of their respective purchasers (market segments).

The equation looks like this:

The equation can help a firm conceptualize strategic decisions. The greater the value the firm can offer the customer relative to its competitors, the more likely the firm is to create greater sales and thereby profits. From the diagram you can see two generic growth strategies; increase benefits and/or reduce costs. Also, the cost side of the equation includes the customer’s total costs to acquire, some elements of which the firm may have little or no control over. An example might be a trip to the store to make the purchase.

Understanding Customer Perceptions

The problem most firms run into is that they don’t understand the customer’s perceptions. They think they do, but they really don’t. Sometimes they understand what customers used to value, but no longer do (markets are dynamic and change often). Customer perception is what drives their view of Value, and ultimately their purchase decision. It is vitally important that firms understand what their customers actually value.

10.14Summary

Customer Relations

Customer Relationship Management

Customer Relationship Management is how a company interacts with its customers. It often involves tracking customers and how they interact with the company. 

Market Segmentation

By breaking your consumer group into different categories, you can better understand your consumers and more effectively market to different market segments. 

Voice of the Consumer

Technology has given the consumer an increasingly strong voice in specifying what is good and bad about a certain product. Beyond unsolicited reviews on the internet, companies can use call centers, data collection companies, and online data mining to better understand what the consumer wants. 

Branding

Your brand is how your company presents itself to consumers. Your brand should align with your strategy, and the two should work together to drive sales.

4 Ps of Marketing

Marketing is often categorized into price, product, place, and promotion. These are the fundamental areas that will determine the success of marketing efforts. 

Pricing Strategies

The price you set for a product says a lot to consumers about the product you are selling. It is essential to match your pricing strategy with your overall strategy. 

Price Optimization Models

Given the essential nature of setting the right price for your product, it can be helpful to use a price optimization models to determine what this ideal price is.

Corporate Social Responsibility

When companies seek to make the world a better place, they are engaging in corporate social responsibility. There is a rich debate over the value of CSR. 

Triple Bottom Line

The Triple Bottom Line states that companies should try to maximize what they do for their profit, people, and the planet. This is a further elaboration on corporate social responsibility. 

Push vs. Pull Strategy

Push strategy involves attempting to push your product through any and all channels of distribution to the consumer, throwing it in front of them and convincing them to buy it. On the other hand, pull strategy involves creating such high customer satisfaction and anticipation that they will seek out your product where they can find it, creating demand and pulling the product through retailers and middlemen. 

Value Chain Analysis

Three steps are outlined under the value chain analysis in order to continuously improve the value of the firm’s products or services.

The Value Equation

Value can be defined through one equation, benefits offered divided by the cost incurred. Companies try to create value by either increasing benefits, minimizing costs, or both.