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Edinburgh Business School MBA AUC Academic Partner Strategic Planning Module 4 The Company and the Economy Instructor: Moataz Darwish, MBA
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Contents 4.1 The Company in the Economic Environment 4.2 Revenue and Costs: The Basic Model 4.3 The Workings of the Economy 4.3.1 Understanding and Using Economic Information 4.3.2 Supply and Demand in the Economy 4.3.3 Unemployment and Inflation 4.3.4 The International Economy 4.4 Forecasting: What Will Happen Next? 4.5 PEST Analysis 4.6 Environmental Scanning 4.7 Scenarios 4.8 The Economy and Profitability 4.8.1 Implications for Company Sales and Revenues 4.8.2 Competitive Reaction and the Economic Environment 4.8.3 Implications for Inputs and Company Costs Introduction – Moataz Darwish 2
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Lincoln quote during the civil war I don’t claim to have controlled events but confess plainly that events have controlled me. Introduction – Moataz Darwish 4
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The Company in the Economic Environment • Systematic view involves much more than general awareness. • Environmental Scanning provides information which can be used to construct (PEST) review of the environment and (ETOP). • In the face of this quantity of information: • identify important variables, • simplify them as far as possible, • and subject them to appropriate analyses. Introduction – Moataz Darwish 6
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Revenue and Costs: the Basic Model • Economy-wide changes can have significant effects on revenues and costs. • The model is constructed by identifying the variables which determine revenue and costs and determining the factors which affect these variables. Revenue = Total Market x Market Share x Price Outlay = Number of Workers x Wage Rate + Units of Capital x Price + Units of Material x Price A sensible interpretation of macroeconomic factors can prevent the company from undertaking strategic moves too early. Introduction – Moataz Darwish 7
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Revenue and Costs: the Basic Model • The factors affecting the variables are numerous: 1. Total Market: Population, Total Income, Preferences, Competing Products, Product Life Cycle 2. Market Share: Price, Marketing Expense and Strategies of self and competitors 3. Price: Demand Conditions, Segmentation, Competitive Reaction 4. Workforce: Labour market, Regional Supply, Wage Rate, Work Conditions 5. Wage rate: labour market conditions, unemployment rate. 6. Capital: Capacity of the Goods Sector 7. Capital Price: Capital Market Conditions 8. Materials: Capacity of Suppliers 9. Materials Price: Materials Market Conditions Introduction – Moataz Darwish 8
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Revenue and Costs: the Basic Model • Comprehensive picture of company performance. • Applied to those which it might produce in the future. • Dependent to some extent on the general state of economic activity. • Determines the behavior of the economy as a whole. Introduction – Moataz Darwish 9
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The Workings of the Economy • There are several reasons for analyzing and attempting to understand the economy. • Mangers, their attitudes and management styles can be greatly affected by general economic conditions. • The problem facing the manager is: • to decide which information is relevant, • interpret it in order to form a view on what is happening in the economy as a whole. Introduction – Moataz Darwish 10
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UK Economic History 50’s 60’s 70’s 80’s 90’s Stable prices , Growth No training Thatcher Bubble rates, Unemployment activities , Era, burst, rates and inflation rates. Managemen Privatization economic (World-wide Phenomenon) t ideas was and downturn, alien deregulatio Slow concept n progress ( Oil prices, recovery Collapse of Bretton Woods) Fiscal Approach Introduction – Moataz Darwish 11
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Understanding and Using Economic Information • An overall impression of the level of economic activity can be obtained from general economic indicators such as: • Unemployment rates, • Industrial output, • consumer spending. Introduction – Moataz Darwish 12
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Understanding and Using Economic Information • A consensus when the economy is in a boom or a slump. • Economic information must be interpreted in the context of current conditions. • ‘Boom’ economy had strategic implications for companies in depending on which markets they were operating in. • It is not necessary for managers to have a detailed understanding of how the statistics were arrived at in order to derive strategy implications. Introduction – Moataz Darwish 13
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Supply and Demand in the Economy • The total value of goods and services produced in one year is known as Gross National Product (GNP). • National Product (GNP).The total output which the economy could produce if labour is fully employed and there was no excess capacity is known as potential or full employment GNP. • Actual output is not necessarily equal to potential output. • Actual output exceeds potential when there is labour shortage and overtime – consumption is above what the economy is capable of producing. Introduction – Moataz Darwish 14
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Supply and Demand in the Economy • When potential output > actual • Unemployment is high • Inflation is low • When potential output < actual: • Unemployment is low • Inflation is high • Unemployment can increase while actual output increases – depending on the relative rate of growth of potential and actual output. This relationship between unemployment rate and the output gap is not exact because of changes in definition of unemployment. Introduction – Moataz Darwish 15
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Supply and Demand in the Economy • Unemployment is comprised of 3 elements: • Structural unemployment • Frictional unemployment • Demand related unemployment • This simplified approach to the behaviour of the economy using actual and potential output coupled with the different types of unemployment gives a basis to assess the likely impact of government policy measures. Introduction – Moataz Darwish 16
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Unemployment and Inflation • In market economies: near full employment, wage rates, capital costs and material prices increase. • On the other hand, when there is significant unemployment, wage rates should decline but rarely do. • When demand grows faster than supply, prices go up (inflation) - too much money chasing too few goods • A reasonable proposition is that: • the lower the unemployment rate, • the higher the wage inflation rate (Phillips curve). • Usually it is expressed as a relation between unemployment and inflation. Introduction – Moataz Darwish 17
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Unemployment and Inflation • Stagflation: • One explanation is that the curve moved due to expectations that current inflation would continue. Hence unemployment stayed high. • Policy was then to shift back Phillips curve – by eliminating the expectation of continuing inflation. How : • By maintaining growth of money supply constant This is the “monetarist” approach. • Increase unemployment rate and wait until inflation fell. • Monetarist approach advantage is to avoid high cost of unemployment. The implication is that inflation can only be countered with high unemployment – the effect of constant money supply takes longer. The lesson for managers is that once prices increase caused by excess demand, it will take time for wage inflation rate to fall. This can have important implications for the timing of the company’s strategy. Introduction – Moataz Darwish 18
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The International Economy • Companies are affected by the international factors – exporting, importing products or raw materials, competing in internal markets with importers …etc. • Relative Inflation Rates - which are not reflected in the exchange rates – affects costs and prices. • Export and FDI decisions may be impacted by these forces. • Exchange Rates Fluctuations – not determined by Balance of Trade but by international capital flows (80 times real trade flows !) • The factors affecting capital flows are – relative interest rates and expectations. • While difficult to plan accurately, scenario planning allows for contingencies. • Some companies argue they are not in the forex business - these will miss an opportunity to hedge some risks. • While it will not be possible to cover future exchange rates entirely, currency risks should be identified as any other risk and incorporated in the decision-making. Introduction – Moataz Darwish 19
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The International Economy – Diamond Model The Competitive Advantage of Nations 1. Domestic factor conditions 2. Related and supporting industries 3. Demand conditions 4. Strategy, structure and rivalry • Porter identified ways in which a nation can affect competitiveness of a company: • A firm’s home nation plays a critical role in shaping managers’ perceptions about the opportunities that can be exploited by supporting the accumulation of valuable resources and capabilities and creating pressures on the firm to innovate, invest and improve over time. • The impact of the history and environment of a country is often obvious. • Ex. Scotland vs. Singapore • can offer favorable factor conditions, in particular those that are highly specialized to the needs of particular industries. • can also offer favorable demand conditions in the form of sophisticated home consumers who continually force firms to produce the right things. • Dangers of protectionism is that local companies have little incentive to retain competitive advantage (ex India’s auto industry, Eastern Bloc economies) Introduction – Moataz Darwish 20
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