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Strategic Planning Module 6 - Part 2 Internal Analysis of the Company Instructor: Moataz Darwish, MBA
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Contents 6.1 Opportunity Cost 6/3 6.2 Fixed Costs, Variable Costs and Sunk Costs 6/4 6.3 Marginal Analysis 6/5 6.4 Diminishing Marginal Product 6/8 6.5 Profit Maximisation 6/10 6.6 Estimating Production Costs 6/10 6.7 Accounting Techniques: Break Even, Payback and Sensitivity 6/13 6.8 Accounting Ratios 6/17 6.9 Benchmarking 6/22 6.10 Research and Development 6/23 6.11 Human Resource Management 6/29 6.12 The Scope of the Company 6/31 6.13 The Value Chain 6/40 6.14 Competence 6/43 6.15 Strategic Architecture 6/49 6.16 Strategic Advantage Profile 6/54 EBS MBA / AUC 2
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Resource Management • Management of resources has a direct bearing on the competitive position of the company; • How can the company rationalize resource planning and allocation? Identify the company’s approach to resource planning. • REACTIVE – look one period ahead and hires and fires accordingly • PROACTIVE – product life cycles – product launch periods – selecting a planning horizon (beyond which so little is known) – developing a resource plan (incl inventories, learning curves..) – the implications for marketing strategy EBS MBA / AUC 4
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Human Resource Management • Effective human resource management is important for strategy for two reasons: 1. people in a company are a resource like any other and how effectively that resource operates can be affected by strategic change. 2. strategic changes are introduced and implemented by people, and resistance to change can exert a powerful constraint Adaptability and the ability to cope with strategic change is a majoron success. objective of human resource management. EBS MBA / AUC 5
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Human Resource Management • One of the main characteristics of an organization is its culture. – Culture is the set of beliefs, values and managerial approaches; – Reflected in its structures, systems and approach to the development of strategy. – Derived from the company’s past history, type of leadership, the people involved, its use of technology and resources. – Culture of each company is likely to be unique. EBS MBA / AUC 6
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Human Resource Management Four broad types of culture – classification helps in understanding how the workforce is likely to react to strategic change: 1. Power Culture - revolve around one individual (or small group),who dominates decision making, usually to new or small co. (newspaper industry). 2. Role Culture - relies on committees, structures, analysis and the application of logic. While a small group of senior managers make final decisions, they rely on procedures and systems and clearly defined rules of communication. This bureaucratic type of structure works well when the environment is stable. (civil service and the old style retail banks). 3. Task Culture - in organizations which are geared to tackle specific tasks which tend to be of limited duration. Uses the team approach (advertising agencies and consultancies). 4. Personal Culture - individual pays little attention to the organization and is most concerned with self gratification. (Voluntary Workers) What might appear to be a cultural problem may in fact be due to the more general principal agent problem, ex. the incentive system. EBS MBA / AUC 7
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The scope of the company Reduction in unit costReduction in unit cost due todue to Economies ofEconomies of Experience CurveExperience Curve Economies of ScaleEconomies of Scale Scope Scope (Economies of Learning)(Economies of Learning) High scale of ops close to synergy Output to-date “no. of units produced” “no. of products” Entry Barrier Reputation, shared I/P, R&D spillover… EBS MBA / AUC 8
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Economies of Scale and the Experience Curve • Economies of Scale - important as an entry barrier; • Average cost of production in relation to the productive capacity of a company. • In some industries it is significant, and in others it hardly exists. • It is not merely the increase in productive capacity which is relevant, but whether the higher productive capacity is based on a more efficient combination of labor and capital. – It may be that some larger companies have not selected the optimum combination of inputs. – Difficulties of managerial coordination beyond some company size make it impossible to benefit from potential scale economies. • In 1995 two very large Japanese banks, no job losses as a result of the merger. • Economies of scale tend to be confused with the experience curve. EBS MBA / AUC 9
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Economies of Scale and the Experience Curve • Experience Curve, relates to the reduction in average costs resulting from the total volume of output to date. – ex. degree to which employees learn to do their job more efficiently over time. – effect of experience varies among companies and industries; – Empirical evidence: doubling of output has the potential to lead to a 20% reduction in average cost. – Not linear: i.e. it takes successive doubling of output to achieve the same proportional cost reduction. The advantage conferred by experience is continually being eroded. EBS MBA / AUC 10
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Economies of Scale and the Experience Curve • Strategic Implication: – A company which feels it has a cost advantage over rivals should attempt to identify where the advantage is derived. • If it is from experience effects, the advantage can be expected to decline over time; • If it is from economies of scale the advantage will be retained so long as competing companies do not increase in size. EBS MBA / AUC 11
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Economies of Scope • Economies of scope: reduction in unit cost as the number of products is increased rather than the number of units produced. • Resemblance to synergy, • Why it may be cheaper to produce two goods than for two firms to do so: – possibility of sharing inputs among several outputs: Sainsbury’s sells about 30 000 items – because below some critical number customers do not find it worthwhile to come in. – benefits of good reputation: Rolls Royce cars carries over to its aero- engines. – R&D spillover effects – enhanced ability to compete in a range of related industries with a coordinated strategy – though diseconomies of scope may result as scarce management skills are spread ever more thinly especially in unrelated markets. EBS MBA / AUC 12
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Diversification • Firms need to confront the issue of the optimal degree of diversification. • Porter tracked the performance of 32 firms which were involved in acquisitions, and concluded that there had been virtually no benefit in any of the cases. • Four main incentives to diversify: – Minimize risk - Management risk not Shareholder risk! – Capture economies of scope – might lead to value destruction, spreading scarce top management skills across apparently unrelated business areas through the application of their dominant management logic (dangerous) – Add value through the parenting function – Benefit from synergy • Richard Branson’s business empire ex: dominant management logic of Branson, brand stretching; (long term value is difficult to imagine). EBS MBA / AUC 13
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Synergy • The notion differs from economies of scale and experience in that it is independent of the size of the company, or of the total output to date. • Synergy should lead to the situation where a corporation is valued at more than the sum of the value of its individual parts if they could be separated. 2 + 2 = 5 effect; • While the idea of synergy has an intuitive appeal it turns out to be a difficult principle to pin down in practice. • two problems: 1. identify where the benefits of synergy are likely to be generated. 2. little empirical evidence (wishful thinking?) EBS MBA / AUC 14
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Synergy • The Components of Synergy – Corporate management – Economies of scale – Vertical integration – Capacity utilization – Joint production – Innovative stimulus From the strategy viewpoint, managers should confront claims that benefits will accrue from synergy with questions about: •where the effects are likely to come from, •what evidence exists that they will be significant in this instance. EBS MBA / AUC 15
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Vertical Integration • Every product has a supply chain which starts from the extraction of raw materials and involves manufacture, distribution and sales to the final customer;Upstream Midstream Downstream Raw Material Distribution Retail and Customers Manufacture EBS MBA / AUC 16
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Vertical Integration • Vertical integration relates to the part of the supply chain which is controlled by a company. Every company is to some extent vertically integrated. • Forward integration occurs when a farmer becomes involved in the marketing of wool to garment manufacturers; • Backward integration occurs when manufacturers purchase farms, perhaps with the intention of ensuring the supply of certain types of wool. • The degree of vertical integration is closely bound up with the business definition of the company as discussed at 3.2. EBS MBA / AUC 17
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Vertical Integration • what is the rationale for vertical integration? – Company should make something itself or buy it from the Market? – Benefits and Costs of using the market rather than producing internally: Benefits of using market forms: Costs of using market forms: Market firms can achieve Coordination of production economies of scale. flows may be compromised. Market firms are subject to the Private information may be discipline of the market leaked to competitors. (efficiency and control). Transaction costs may be incurred. EBS MBA / AUC 18
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Vertical Integration – Three incorrect arguments used to justify making rather than buying: 1. Avoid paying the costs necessary to make the product – costs have to be borne by someone. 2. Avoid paying a profit margin to other firms – relative profitability is the key. 3. Avoid paying high prices during periods of peak demand or scarce supply - relative profitability is the key. 1. Impossible to cover all eventualities into account – bounded rationality 2. Severe difficulties involved in specifying and measuring performance with any accuracy; 3. Neither party is willing to reveal all information. – On the other hand, a complete contract with a market supplier cannot be achieved in the way that an internal contract can. There are at least three reasons for this. EBS MBA / AUC 19
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Vertical Integration • ‘Holdup’ problem: a party in a contractual relationship may be able to exploit the other party’s vulnerability once the contract has been agreed. • There are a number of ways by which internal organization can better resolve the holdup problem than arm’s length market contracting: – vertical integration gives access to more powerful governance structures - disputes can be settled by internal administrative mechanisms – internal relationship - more incentive to get things right. – cooperation - bound together in a common purpose. • one point of view is that the balancing of incentives for competitive and cooperative behaviors among autonomous units within a firm is the single most important task of top management. EBS MBA / AUC 20
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