1. Strategic Management/ Business Policy
Power Point Set #2
EMBA 544

2. The First Rule of Strategy:
A Good Strategy Is “Coherent.”
Functional pieces of strategy support the whole (Michael Porter)
Oper.
Strategy
Finance
Acctg.
H.R.
Mktg.

3. Strategic Coherence The Logic of How The Business Fits Together:
Southwest Airlines
Low Price
Short Routes
No Frills
Point-to-Point
One Aircraft - Boeing 737
High # of Aircraft per Route
No Meals
Flexible/ Lower Staffing
American Airlines
Premium Priced
Short, Long, & Int’l
Variety
Hub & Spoke
Multiple Aircraft
Low # of Aircraft per Route
Meals & Service
Higher Staffing

5. A Basic Analytical Framework SWOT Analysis
Strengths, Weaknesses, Opportunities, & Threats
Strengths & Weaknesses
Opportunities & Threats
Values Of
Management
Values Of Stakeholders
Strategy
Internal Factors
External Factors
Drivers
Objectives

6. How Do We Measure Performance?
So, a good strategy will be coherent and will:
Neutralize any threats we face
Utilize available opportunities
Capitalize on our strengths
Avoid or improve upon current weaknesses
But, how do we measure our success in accomplishing those objectives? That is, how do we measure performance?

7. How Do We Measure Performance?
“The strategic aim of a business is to earn a return on capital, and if in any particular case the return in the long run is not satisfactory, then the deficiency should be corrected or the activity abandoned for a more favorable one.”
Alfred P. Sloan My Years with General Motors

9. Sustainable Competitive Advantage and the Measurement of Performance
While we have said that the objective of strategy is to “create competitive advantage,” specifically we have the goal to maximize economic return.
Static Measures of Performance
Economic Profits
ROA, ROE, ROC
Dynamic Measures of Performance
NPV Methods
Capital Market Measures of Performance
Market Value of the Firm
MVA and EVA
Tobin’s Q (James Tobin, Yale)

14. Problems With Shareholder Wealth Maximization
Under what conditions does “maximizing shareholder wealth” not make sense? When do we need to pay attention to other “stakeholders?”
What are the social responsibilities of business to:
Employees?
Communities?
Customers?
The Issue: What are the “externalities,” and who bears the costs?

15. Economic Profits and Competitive Advantage
Driving a wedge between revenues and costs is how competitive advantage is created.
In strategy, we need to think simultaneously about:
the value we create for our customer
how we appropriate some of that value in the form of higher prices
the costs we incur in creating that value
Conceptual Traps Managers Fall Into
Accounting Costs versus Opportunity Costs
Market Share is not competitive advantage

16. Dynamic Measures of Performance: NPV or DCF Analysis
Competitive Advantage doesn’t happen over night; it evolves over time - So Profits may not be the best way to measure performance
Finance vs. Strategy

17. Dynamic Measures of Performance NPV or DCF Analysis:
The principle of discounted cash flow (DCF) analysis that firms apply to their individual projects can also be applied to the firm as a whole.
Maximizing the net present value of the firm’s cash flow (“sustainable competitive advantage”) corresponds to maximization of its stock market valuation and hence maximizes the wealth of its shareholders.

18. Net Cash Flow EBT - t (EBT) EBT (1-t) = NET INCOME
EBT (1-t) + depreciation - capital expenditures = NET CASH FLOW
(note we are assuming no change in accounts receivable, no change in net working capital, no change in inventory)
Equivalent concepts:
Maximize NPV
DCF Approach
Maximize Economic Profits (EVA)
Sustainable Competitive Advantage (SCA)

19. Limitations of Present Value Measures
Projections are only as good as the ability of managers to measure accurately the financial consequences of actions.
An implicit assumption of value-based strategy was that business units and all investment proposals were self-contained. It was usually expected that divesting a business or curtailing an investment project would have no financial repercussions elsewhere in the corporation (e.g., ignores knowledge transfers).

20. Limitations of Present Value Measures
Strict financial measurement of many long-term investments, particularly in intangible assets, is virtually impossible.
Investments in R&D typically do not offer direct returns; their value is an option to invest in new products and processes that may arise from R&D. Narrowly- defined DCF does not accurately value investments where there is significant options value.
(Note: Merck has been at the forefront of applying options theory to analyze investments in R&D).

21. Capital Market Approaches To Measuring Performance
Market Value Added (MVA)
Market Value less Total Investment
Economic Value Added (EVA)
Operating Profit (after tax) less annual capital costs; basically, this is economic profit
Tobin’s q (Market Value/Book Value)
a firm’s market value divided by its “replacement” cost
The Market Value of the Firm -
Current Value of all securities issued by the firm

22. Economic Value Added (EVA)
Anheuser-Busch
Operating profit $1,756 million - taxes $617 million = $1,139 million
WACC : 67% equity at 14.3%
33% debt at 5.2%
11.3% WACC

23. Economic Value Added (EVA)
WACC = 11.3%
Capital of $8 billion
11.3% * $8billion = $904 million
$1,139 - $904 = $235 million is the EVA

24. Economic Value Added (EVA)
Former CEO Roberto Goizueto introduced EVA to Coca-Cola in Its impact has been to encourage:
Divestment (e.g., pasta, wine, instant tea) where returns failed to cover the cost of capital
Increased efficiency (e.g., inefficient plants shut down)

25. The Context Of Strategy Formulation
Continuous Monitoring Of Strategic Situation
Decisive Moments In The Company’s History
Boeing and the 747
Nucor and the Continuous Strip Mill

26. Key Characteristics Of Strategic Decisions
Important
Not Easily Reversible
Significant Commitment Of Resources
Involves Alternatives, Consequences, and Choice
Some Level of Uncertainty Typically Involved