STRATEGIC MANAGEMENT

Strategic Management

BUSINESS the art of making irrevocable decisions based on insufficient knowledge

STRATEGY Insight into how to create value Insight into how to create value

STRATEGIC MANAGEMENT managerial decisions and actions that determine the long-run performance of a corporation Emphasizes monitoring and evaluating environment (external) (external)

HISTORICAL PHASES OF STRATEGIC PLANNING n Basic Financial Planning n Forecast-Based Planning n Externally-Oriented Planning (Strategic Planning) n Strategic Management

STRATEGIC MANAGEMENT MODEL Environmental Scanning Strategy Formulation Strategy Implementation Evaluation and Control

We will not be doing much in this area in this course. What you have been doing in most other courses.

STRATEGIC DECISION MAKING PROCESS

STRATEGY Insight into how to create value Insight into how to create value

Corporate Governance

Separation of Ownership and Managerial Control n Basis of the modern corporation – shareholders reduce risk by holding diversified portfolios – shareholders purchase stock, becoming residual claimants – professional managers are contracted to provide decision-making n Modern public corporation form leads to efficient specialization of tasks – risk bearing by shareholders – strategy development and decision-making by managers

Corporate Governance Refers to the relationship among the board of directors, top management, and shareholders in determining the direction and performance of the corporation.

Corporate Governance

Own company Elect Board of Directors Received residual profits Shareholders

Corporate Governance Setting corporate strategy, overall direction, mission or vision Hiring and firing the CEO and top management Controlling, monitoring, or supervising top management Reviewing and approving the use of resources Caring for shareholder interests Board of Directors

Corporate Governance Manage Organization Planning Leading Organizing Controlling CEO

Organization of the Board n Size – Determined by charter and bylaws – Average for publicly-held, large firm is 11 directors – Average for small/medium private firms is 7 to 8 directors Board of Directors

Nominations & Elections Traditional Approach: – CEO invites members to serve – Shareholders approve in annual proxy statement – All nominees are usually elected

(Survey, 1999) n 75% of boards have at least 1 female director n 25% of boards have two female directors n 60% of boards have at least one minority member Board of Directors

Members: Inside directors – “Management directors” – Officers or executives employed by corporation Outside directors – “Non-management directors” – May be executives of other firms but not employed by board’s corporation Board of Directors

“Outsider” overly simplistic term -- Some outsiders are not truly objective and could be considered insiders. Examples: n Affiliated Directors n Retired Directors n Family Directors

Board of Directors Continuum Phantom Rubber Stamp Minimal Review Nominal Participation Active ParticipationCatalyst Never knows what to do, if anything; no degree of involvement. Permits officers to make all decisions. It votes as the officers recom- mend on action issues. Formally reviews selected issues that officers bring to its Involved to a limited degree in the perform- ance or review of selected key decisions, indicators, or programs of management. Takes the leading role in establishing and modifying the mission, objectives, strategy, and policies. It has a very active strategy committee. Low (Passive) High (Active) Approves, questions, and makes final de- cisions on mis- sion, strategy, policies, and objectives. Has active board committees. Performs fiscal and manage- ment audits. DEGREE OF INVOLVEMENT IN STRATEGIC MANAGEMENT

Firm ownersFirm owners Agency Relationship: Owners and Managers Shareholders(Principals)

Decision makersDecision makers Agency Relationship: Owners and Managers Managers(Agents) Shareholders(Principals) Firm ownersFirm owners

Risk bearing specialist (principal) pays compensation toRisk bearing specialist (principal) pays compensation to A managerial decision-making specialist (agent)A managerial decision-making specialist (agent) Agency Relationship: Owners and Managers An Agency Relationships Managers(Agents) Shareholders(Principals) Decision makersDecision makers Firm ownersFirm owners

Agency Theory Problem n The agency problem occurs when: – the desires or goals of the principal and agent conflict and it is difficult or expensive for the principal to verify that the agent has behaved appropriately n Solution: – principals engage in incentive-based performance contracts – monitoring mechanisms such as the board of directors – enforcement mechanisms such as the managerial labor market to mitigate the agency problem

Agency Theory Conflicts n Principals may engage in monitoring behavior to assess the activities and decisions of managers However, dispersed shareholding makes it difficult and inefficient to monitor management’s behavior n Boards of Directors have a fiduciary duty to shareholders to monitor management However, Boards of Directors are often accused of being lax in performing this function

Agency Theory Problems arise in corporations because the agents (top management) are not willing to bear responsibility for their decisions unless they own a substantial amount of stock in the corporation.

Stewardship Theory Executives tend to be more motivated to act in the best interest of the corporation than their own self-interests. Theory argues that over time, senior executives tend to view the corporation as an extension of themselves.

Codetermination – The inclusion of a corporation’s workers on its board of directors. Board of Directors

Interlocking Directorates Direct Interlocking Directorate – – When two firms share a director or when an executive of one firm sits on the board of a second firm. Board of Directors Indirect Interlocking Directorate – – When two corporations have directors who also serve on the board of a third firm.

Board of Directors  No consistent link between board membership, leadership, structure, and financial performance of firm  Investors pay more for a firm’s stock when positive toward good corporate governance— Belief that Good governance leads to better performance over time Reduces risk of company finding itself in trouble Governance is a major strategic issue

Governance MechanismsOwnershipConcentration Large block shareholders have a strong incentive to monitor management closely Their large stakes make it worth their while to spend time, effort and expense to monitor closely They may also obtain Board seats which enhances their ability to monitor effectively (although financial institutions are legally forbidden from directly holding board seats)

OwnershipConcentration Boards of Directors Recommendations for more effective Board Governance: Increase diversity of board members’ backgrounds Strengthen internal management and accounting control systems Establish formal processes for evaluation of the board’s performance Governance Mechanisms

OwnershipConcentration Boards of Directors ExecutiveCompensation Salary, bonuses, long term incentive compensation Executive decisions are complex and non-routine Many factors intervene making it difficult to establish how managerial decisions are directly responsible for outcomes Governance Mechanisms

OwnershipConcentration Boards of Directors ExecutiveCompensation Stock ownership (long-term incentive compensation) makes managers more susceptible to market changes which are partially beyond their control Incentive systems do not guarantee that managers make the “right” decisions, but do increase the likelihood that managers will do the things for which they are rewarded Governance Mechanisms

OwnershipConcentration Boards of Directors ExecutiveCompensation Market for Corporate Control Firms face the risk of takeover when they are operated inefficiently Many firms begin to operate more efficiently as a result of the “threat” of takeover, even though the actual incidence of hostile takeovers is relatively small Changes in regulations have made hostile takeovers difficult Acts as an important source of discipline over managerial incompetence and waste Governance Mechanisms

Board of Directors Trends in Corporate Governance n Boards more involved in reviewing, evaluating, and shaping strategy n Institutional investors active on boards; pressure on CEO for firm performance n Shareholders demand directors own more than token amounts of the firm’s stock n Non-affiliated outside directors increasing

Board of Directors Trends in Corporate Governance n Boards becoming smaller n Boards taking more control of board functions n Corporations becoming more global; international experience needed n Societal expectations that boards balance profitability and social responsibility n Diversity of board members

Board of Directors Nominations & Elections Staggered Board Approach: Corporations whose directors serve terms of more than one year, divide the board into classes, and stagger elections so that only a portion of the board stands for election each year.

Board of Directors Nominations & Elections Criteria for Selection Board of Director Membership Wiling to challenge management Special expertise Availability for advice and meetings Expertise on global issues Understands key technologies External contacts valuable to the firm Detailed knowledge of industry High visibility in field Accomplished in representing firm to stakeholders

Styles of Corporate Governance Entrepreneurship management Partnership management Chaos management Marionette management Degree of Involvement By Top Management Degree of Involvement By Board of Directors High Low High

Corporate Governance Role of the Board in strategic management – Monitor n Developments inside and outside the corporation – Evaluate & Influence n Review proposals, advise, provide suggestions and alternatives – Initiate & Determine n Delineate corporation’s mission and specify strategic options

Responsibilities of Top Management: Provide executive leadership and a strategic vision Manage the strategic planning process Corporate Governance

Top Management Executive Leadership – – The directing of activities toward the accomplishment of corporate objectives. Sets the tone for the entire corporation. Strategic Vision – – A description of what the company is capable of becoming. Often communicated in the mission statement.

Top Management CEO and Clear Strategic Vision Common Characteristics : n CEO articulates a strategic vision n CEO presents a role for others n CEO communicates high performance standards and shows confidence in followers

Strategic Management Process Strategic Planning Staff -- – Supports top management and business units in the strategic planning process.

Strategic Management Process Strategic Planning Staff Responsibilities: n Identify and analyze company-wide strategic issues, suggest corporate strategic alternatives n Work as facilitators with business units to guide them through the strategic planning process

International Corporate Governance: n Owner and manager are often the same in private firms n Public firms often have a dominant shareholder, frequently a bank n Frequently there is less emphasis on shareholder value than in U.S. firms, although this may be changing Germany

n Medium to large firms have a two-tiered board – vorstand monitors and controls managerial decisions – aufsichtsrat selects the Vorstand – employees, union members and shareholders appoint members to the Aufsichtsrat International Corporate Governance:Germany

n Obligation, “family” and consensus are important factors n Banks (especially “main bank”) are highly influential with firm’s managers n Keiretsus are strongly interrelated groups of firms tied together by cross-shareholdings International Corporate Governance:Japan

n Other characteristics: – powerful government intervention – close relationships between firms and government sectors – passive and stable shareholders who exert little control – virtual absence of external market for corporate control International Corporate Governance:Japan

STRATEGY Insight into how to create value Insight into how to create value

Strategic Management

STRATEGIC MANAGEMENT MODEL Environmental Scanning Strategy Formulation Strategy Implementation Evaluation and Control

STRATEGIC MANAGEMENT MODEL Environmental Scanning Strategy Formulation Strategy Implementation Evaluation and Control

STRATEGIC DECISION MAKING PROCESS

External Societal Environmental General Forces Task Environment Industry Analysis Internal Structure Chain of Command Culture Beliefs, Expectations, Values Resources Assets, Skills, Competencies, Knowledge Environmental Scanning

External Societal Environmental General Forces Task Environment Industry Analysis Internal Structure Chain of Command Culture Beliefs, Expectations, Values Resources Assets, Skills, Competencies, Knowledge Environmental Scanning

The layer of the external environment that affects the organization indirectly. The layer of the external environment that directly influences the organization’s operations and performance.

ENVIRONMENTAL SCANNING Societal Sociocultural Political-Legal Economic Technological Internal Structure Culture Resources Task Shareholders Suppliers Customers Competitors Others - gov., unions creditors

SWOT Analysis

SWOT ANALYSIS S TRENGTHS W EAKNESSES are within the organization itself and not usually within the short run control of management

SWOT ANALYSIS S TRENGTHS W EAKNESSES O PPROTUNITIES T HREATS are within the organization itself and not usually within the short run control of management are outside the organization, general factors and trends in the societal environmental and specific factors in the task/industry environment

SWOT ANALYSIS S TRENGTHS W EAKNESSES O PPROTUNITIES T HREATS are within the organization itself and not usually within the short run control of management are outside the organization, general factors and trends in the societal environmental and specific factors in the task/industry environment 4-6 of each Internal External

ENVIORNMENTAL ANALYSIS

POTENTIAL ENTRANTS Economies of scale Product differentiation Capital requirements Switching costs Access to distribution channels Cost independent of size Government policy RIVALRY Number of competitors Rate of industry growth Product characteristics Amount of fixed costs Capacity Height of exit barriers Diversity of rivals SUBSTITUTESBUYERS STAKEHOLDERSSUPPLIERS TASK/INDUSTRY ANALYSIS

ENVIORNMENTAL ANALYSIS

STRATEGIC MANAGEMENT MODEL Environmental Scanning Strategy Formulation Strategy Implementation Evaluation and Control

STRATEGIC MANAGEMENT MODEL Environmental Scanning Strategy Formulation Strategy Implementation Evaluation and Control

STRATEGIC MANAGEMENT MODEL Strategy Formulation Mission Objectives Strategies Policies

Prentice Hall, 2000Chapter 180 Levels of Strategy Corporate Corporation’s overall direction and the management of its businesses Business Emphasizes improving the competitive position of a corporation’s products or units What business should we be in? How will we compete?

Formulating Corporate Strategy What Business Should We Be IN?

GENERIC CORPORATE STRATEGIES GROWTH STABILITY RETRENCHMENT

GENERIC CORPORATE STRATEGIES GROWTH (p. 134) Vertical Integration Horizontal Integration Related Diversification (Concentric) Unrelated Diversification (Conglomerate) Up & down the value chain Backward - Forward Increasing Geographic locations Range of products Unrelated Related industries

GENERIC CORPORATE STRATEGIES STABILITY (p.143) Pause/ Proceed with Caution No Change RETRENCHMENT (p ) Turnaround Divestment Liquidation

X X

Formulating Business Strategy How Will We Compete?

Porter's Competitive Strategies n Differentiation n Cost Leadership n Focus Unique/different Components of value chain Competitive/market segment

STRATEGIC MANAGEMENT MODEL p. 8 Environmental Scanning Strategy Formulation Strategy Implementation Evaluation and Control

STRATEGIC MANAGEMENT MODEL Strategy Implementation Programs Budgets Procedures Evaluation and Control Performance How will we know it is working?

STRATEGIC DECISION MAKING PROCESS

GENERIC CORPORATE STRATEGIES GROWTH STABILITY RETRENCHMENT

STRATEGY Insight into how to create value

Think Strategically how to create value