Basic Questions

Answers to Basic Questions Will Provide Foundation for Remainder of Course How Do Companies Create Shareholder Value? How Do Companies Make Money (Profits)? What Are the Components of a Strategy? How Do We Craft a Strategy?

Shareholder Value is Created by Earning Returns in Excess of Your Cost of Capital Time WACC CAP Competitive Forces Drive Returns Down to the Cost of Capital Shareholder Value

Competitive Forces Drive Down Returns 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 10 20 30 40 ROI (%) Average Rate of Return for Top and Bottom 50% of Companies in PIMS Database Source: “Commitment: The Dynamic of Strategy” by Pankaj Ghemawat

Higher Returns and an Extended CAP Add Value Time WACC CAP Incremental Value Incremental Value Shareholder Value

Current Valuations Imply Long Period of High Returns Source: MarketGuide, 12Feb00 31x Revenue; ½ Value CAP Returns WACC Shareholder Value

Economic Value is Strongly Correlated to Shareholder Value Economic Profit = Operating Profit - Capital Charge Single-Period Measure (Historical) NOPLAT - (Capital Invested x WACC) = Five Ways to Increase Economic Profit (Value Drivers) Increase Returns on Existing Capital Increase Revenues Reduce Operating Costs Increase Returns on New Capital Reduce Existing Capital Reduce Cost of Capital

Dell’s Business Model Leverages Each Value Driver Increase Revenues Built-to-Order Equipment Increases Demand Reduce Operating Costs Mail Order and Web-Based Channels Reduce Costs Increase Returns on New Capital Economies of Scale in Production Reduce Unit Costs Reduce Existing Capital Financing Model Reduces Working Capital Reduce Cost of Capital Timing of Cash Flows Reduce Default Risk

The Strength of Dell’s Business Model is Evident Half the Revenue Twice the Value Source: Marketguide.com, 16Feb00

High-Value Companies Design Their Businesses to Focus on Profit The Four Dimensions of Business Design Customer Selection Which customers derive real value from our product & service offerings? Which customers will allow us to make a profit? Which customers do we not want to serve? Value Capture How do we capture, as profit, a portion of the value we create for customers? What is our profit model (direct & indirect)? Strategic Control How do we protect our profit stream? Strength of Strategic Control is a Critical Design Element Scope What products and services do we sell? Which business activities do we perform? Adapted from The Profit Zone, by Adrian Slywotzky

There are Many Sources of Profit... Return: High CAP: Short Profit Margin Time New Product Profit Margin Complementary Product Base Installed Buyers Business Sellers Switchboard Just as product designs become technologically obsolete, business designs become economically obsolete. To maintain its profitability, a company must continually change its business design. Profit/Transaction Transaction Size Transaction Scale Base Business Other Components Market Leverage Profit Time Customer-Focused Solutions Return: High CAP: High de Facto Standard Operating Profit Absolute Market Share …But Each Has a Different Return/CAP Characteristic Adapted from The Profit Zone, by Adrian Slywotzky

Traditional Definition of Strategy is Too Limited Five Ps of Strategy Strategy is a Plan (Intended) A Course of Action to Achieve a Desired Outcome Strategy is a Pattern (Realized) Consistency in Behavior Over Time Perfect realization implies brilliant foresight, not to mention an unwillingness to adapt to unexpected events. No realization suggests a certain mindlessness. Real world strategies inevitably involve some thinking ahead and some adaptation en route. Traditional Definition of Strategy Top Management’s Plans to Attain Outcomes Consistent with the Organization’s Mission and Goals. Strategy is a Position (Market Focus) Conscious Selection of Markets and Activities Strategy is a Perspective (Internal Focus) Organization’s Fundamental Way of Doing Things As position, strategy looks down, to the X that marks the spot where the product meets the customer. It also looks out, to the marketplace. As perspective, strategy looks in, inside the organization, but it also looks up—to the grand vision of the enterprise. Strategy is a Ploy (Competitive Focus) Specific Maneuver Intended to Outwit a Competitor Adapted from Strategy Safari, by Henry Mintzberg

Existing Strategic Frameworks Are Not Appropriate for High-Tech Markets Five Forces Generic Strategy Matrix Core Competence Strategic Intent Value Disciplines Value Migration

The Business of John Rockefeller... Early 20th Century Industry: Raw Materials-Based Scarce Resources Destructive Consumption Decreasing Returns Routine Work Management Focus: Prediction & Control Management Goal: Optimization & Scale

...is Not the Business of Bill Gates. Late 20th Century Industry: Knowledge-Based Unlimited Resources Constructive Consumption Increasing Returns Non-Routine Work Management Focus: Uncertainty Management Goal: Adaptation & Domination

New Science Provides the Raw Material for Our New Lenses Lenses for Examining Complex Systems Must Have Three Characteristics Must Examine the Whole System Must Be Dynamic Must Account for Non-Linearity Course Will Present & Apply New Frameworks that are Especially Useful for Crafting Strategies for High-Tech Markets