Modern Competitive Strategy 3 rd Edition Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reservedMcGraw-Hill/Irwin

Chapter 2 Strategic Planning and Decision Making 2-2

What Is Strategic Planning? Strategic planning should: Be a line management, not staff, activity. Require evaluation of the contribution of investments to financial goals—in the context of industry trends and competitor behavior. Extend top management leadership and power Neutralize decision-making biases. Overcome organizational drift. Identify what the organization needs to do to improve its performance. 2-3

What is Strategic Planning? (cont’d) Strategic planning should: Be distinct from strategy execution. Act as a tool for management decision-making. Communicate the organization’s strategy without jargon and in a conceptually coherent format. Generate commitment from employees. Motivate the organization’s systems of financial and operating control. Be reviewed regularly and in response to unexpected and significant market changes. 2-4

Decision Making Biases Myopia Weighting short term over long term outcomes, controlling for a discount rate Sunk costs Continuing to invest in failing projects in hope of getting back the original investment Bias based on whether a decision is framed in terms of gains or losses Tending to be risk seeking in terms of losses and risk adverse to gains, as described by Prospect theory 2-5

Decision Making Biases (cont’d) Information availability Valuing and using information simply because it is favored, most recent, or readily at hand. Information anchoring Overweighting information that appears first in the information flow. 2-6

Planning in a Single Business Strategic planning elements: Mission statement Include a vision if desired Analysis of industry and firm’s market position Financial and operating goals Strategic initiatives Program planning within each initiative 2-7

Mission Statement Describes the scope of the business in terms of its product line and markets served May include a statement of the strategic intent of the business Should be no longer than several sentences Should be in a clear and unambiguous language Should convey the purpose and direction for the firm 2-8

Industry Analysis Is necessary for an effective strategic plan Identifies how much firm performance is due to macroeconomic and industry factors Provides a baseline for goal setting Should include a detailed estimate of the direct and indirect competitors’ strategies May be improved by scenario planning 2-9

What are the key macroeconomic variables that affect profits in the industry? What are the current macroeconomic trends? What are the critical regulatory factors that influence performance in the industry? What are the key industry forces (e.g., powerful buyers, strong substitutes, ease of entry) affecting firm profitability? What are the trends in these forces? What are the entry and exit rates in the industry? What are the trends in these rates? Elements of Industry Analysis 2-10

Has the industry passed through a shakeout? Has the industry experienced significant disruption? If so, how have entrants competed against incumbents? If not, are there identifiable forces or products that could be disruptive to the industry? What are the key value and cost drivers in the industry? How is the industry structured into strategic groups based on these value and cost drivers? Elements of Industry Analysis (cont’d) 2-11

What is the trend in industry revenue? Which competitors are growing faster in revenue than the industry trend? Why? What are the key competitors the firm faces in its major markets? What are their strategies and performance levels? What is the trend in industry profitability? Which competitors are growing faster in profitability than the industry trend? Why? Elements of Industry Analysis (cont’d) 2-12

What new strategic initiatives and programs have key competitors developed, if any? How likely is it that these initiatives will improve the market positions of these competitors? How aggressive are these firms in growing their market positions? How aggressively do these firms defend their positions? Where is the firm located in this competitive landscape in terms of its value and cost drivers? How are the resources and capabilities underlying the value and cost drivers protected from imitation? Elements of Competitor Analysis (cont’d) 2-13

Financial Goals Setting goals focuses management attention and pushes the planning team to articulate which investments are strategically important Goals force management to be explicit about its expectations and assumptions Three key questions in setting financial goals: What is the planning period? What are the key financial metrics? What should the goals be? 2-14

Planning Period Depends on the volatility of strategic situation Extended planning period forces management to articulate its view on how firm’s performance can be improved as competition and other industry’s forces evolve With an increase in rate of market change, length of planning period must shorten Managerial resistance to long-term goals makes firms vulnerable to decline 2-15

Financial and Operating Metrics Common performance metrics for single business planning: Revenues Net profits Return on Investment Metrics and goals should be centrally related to the firm’s economic performance in its product market over time Interplay of financial and operating metrics is critical for setting robust objectives Operating metrics Reflect the value and cost drivers that determine the firm’s market position. Measure the source of revenue growth 2-16

Measures of Business Performance Accounting measures of performance Widely accepted, but criticized for: Managerial control over accounting policies Poor valuation of intangible assets Measures of economic performance Use capital market variables Firm’s market value Tobin’s q Cost of capital Capital asset pricing model 2-17

Setting Goals Managers rely upon: Firm’s historical performance Performance of competitors When firm’s trend is below industry average, it is vulnerable in the long-term When firm’s trend tracks industry average, it is highly subject to industry forces When firm’s trend is above industry average, it needs to focus on staying ahead 2-18

Setting Goals (cont’d) Stretch goals: Push management to exceed expected performance targets based on firm or industry trends Stimulate a level of innovation beyond what management has already imagined. 2-19

Strategic Initiatives Strategic initiatives are the essence of the strategic plan, acting as an organizing framework for activities throughout the firm Initiatives are categorized as projects that: Improve the firm’s value drivers Improve the firm’s cost drivers Raise customer retention rates Invest in growth Terminate or turnaround underperforming activities of the firm Focus on risk management and compliance 2-20

Programs Are created to achieve specific strategic initiatives Are the basic units through which the plan is executed May be ongoing Should have: An accountable manager and documented schedule A means of being valued financially (e.g., NPV, real options models) 2-21

Program Valuation Discounted cash flow analysis DCF includes the identification of the net present value of a project Higher the NPV, the greater the project’s value Real options analysis Extension of the financial options models Useful for projects that are uncertain and irreversible 2-22

Table 12.2a Sample Program Template: Strategic Initiative 2-23

Table 12.2b Sample Program Template: Strategic Initiative (cont’d) 2-24

Planning in a Multibusiness Firm Allocate financial resources to the business units through the internal capital market Manage the portfolio of businesses to improve corporate profitability Manage relationships among the units Centralize activities Develop top down initiatives Build an effective corporate infrastructure 2-25

Resource Allocation Goal of resource allocation is to invest in and support those businesses within the portfolio whose projects produce the highest economic return for the firm One tool is the Marakon profitability matrix: 2-26

Centralization and Transfers Interbusiness relationships The plan outlines how transfer policies are aligned with the business units’ value and cost drivers. Centralization of activities The plan articulates how shared or centralized activities contribute to business unit performance. 2-27

Top-down Initiatives and Corporate Infrastructure Top-down initiatives The plan provides management with a vehicle to state its intended initiatives, to develop programs to assess their impact, and to identify where new initiatives are warranted Corporate infrastructure The plan offers an overview of how elements of the corporate infrastructure (e.g., legal, IT, HR) contribute to business unit performance or effective compliance 2-28