1. 5/14/20151 Business Strategy & Policy PSU MGMT #562 Dave Garten daveoutside@alum.mit.edu Week # 5 Blue Ocean, Risk & Flexibility

2. 5/14/2015Dave Garten- Business Strategy2 Apple Case – Key Learnings 1. Company culture has bred inconsistent success 1. Highly innovative & creative w/strong niche 2. Very insular -- stumbled on industry dynamics 2. Product advantage is not competitive advantage 3. As differentiation narrows (wintel vs. mac), substitution & economies of scale dominate 4. Windows of opportunity can be a significant factor in success (despite the “best” strategy)

3. 5/14/2015Dave Garten- Business Strategy3 Apple

4. 5/14/2015Dave Garten - Business Strategy4 Strategy Formulation Derived from Blue Ocean Strategy by W. Chan Kim and Renee Mauborgne, HBS, 2004 Red OceanBlue Ocean Known boundariesUncontested market space Increasing competition for existing demand Redefine the value proposition (“leap in value for the buyer”) Globalization reducing niche/protected opportunities… Competition becomes “irrelevant” Bloody …Pull in a whole new group of customers Examples: Model T, Southwest, Cirque de Soliel, eBay

5. 5/14/2015Dave Garten - Business Strategy5 Strategy Formulation Study of business launches in 108 companies… “Blue Ocean” “Red Ocean”

6. 5/14/2015Dave Garten - Business Strategy6 Strategy Formulation Reshaping boundaries  value innovation 1. Look across alternative industries 2. Look across chain of buyers 3. Look across complementary products & services 4. Look across functional or emotional appeal of buyers 5. Look across time

7. 5/14/2015Dave Garten - Business Strategy7 Look across:Examples Alternative industries Chain of buyers Complementary products & services Functional/emotional appeal of buyers Time Strategy Formulation Netjets Home Depot Insulin Bloomberg Movies & babysitting Swatch Starbucks Cisco

8. 5/14/2015Dave Garten - Business Strategy8 Strategy Formulation Lower Cost Increase Value What can be eliminated? What can be reduced below industry levels? What can be created? What can be raised above industry levels?

9. 5/14/2015Dave Garten - Business Strategy9 Strategy Formulation Redefine target toward new market space Simultaneously pursue differentiation & low cost to achieve a leap in value (utility) Challenge deep reliance on: Existing customers Finer and finer segmentation Focus on non-customers Edge of market Unexplored non-customers Derived from Blue Ocean Strategy by W. Chan Kim and Renee Mauborgne, HBS, 2004 Buyer value Costs Value Innovation

10. 5/14/2015Dave Garten - Business Strategy10 Strategy Formulation: Mapping High Low Car SWA Major Airline

11. 5/14/2015Dave Garten - Business Strategy11 Principles of Uncertainty Decisions need to be made in an uncertain environment NPV (traditional managerial finance) does not handle contingent or adaptive decision making The creation of an option (to take action) is tangible and positive Manages levels of commitment as certainty unfolds… Flexibility: an option to manage uncertainty Highest value under uncertainty and risk

12. 5/14/2015Dave Garten - Business Strategy12 Sources of Uncertainty Unpredictable environmental events (e.g. disruptive technologies) Customer or stakeholder demands Competitor’s moves Actions of suppliers and buyers Managerial actions Employee actions Government behavior (or lack there of)

13. 5/14/2015Dave Garten - Business Strategy13 Uncertainty & Strategic Response L1 Pretty clear future L2 Future alternatives L3 Range of future alternatives L4 True ambiguity Level of Uncertainty ShaperAdapterReserving the right to Play Response: Strategic intent Big BetNo regretsOption Response: Tactics Source: Strategy Under Uncertainty by Hugh Courtney, Jane Kirkland and Partick Viguerie HBR 1997

14. 5/14/2015Dave Garten - Business Strategy14 Hedge Against Strategic Uncertainty Strategic RiskCountermoveExample Industry margin squeeze Shift to more collaboration Semiconductors -> fabless model Pharmaceuticals-> ally with biotech Technology shiftMultiple betsSony: Betamax, Blueray MS Brand erosionRedefine scope of brandAmEx Dominant competitor Redesign business (“avoidance”) Target vs. Walmart Family Dollar vs. Walmart Customer priority shift Conduct market experiments Capital One Market stagnation Expand value proposition, segment Intel Centrino

15. 5/14/2015Dave Garten - Business Strategy15 Flexibility in Uncertainty Cost of Change Low High Low High Uncertainty Create/preserve options Selective flexibility Isolate volatility Move Up

16. 5/14/2015Dave Garten - Business Strategy16 Some Option data Data 4/16/11 Stock PriceBetaCall Option Jan 2012 Call Option Jan 2013 Walmart540.37@60 strike $0.63/share @55 stri $3.65/share Qualcom531.06@60 strike $2.50/share @60 strike $5.20/share

17. 5/14/2015Dave Garten - Business Strategy17 Option Pricing: Black-Scholes C = cost (price) of the option S = the base value of the investment E = the option exercise price t = time until a decision (expiration)  = the level of uncertainty (beta, std. dev)

18. 5/14/2015Dave Garten - Business Strategy18 Scenario Analysis Contingency planning – generally one uncertainty Modeling Scenario analysis – multiple uncertainties driven by subjective interpretation Helps to breaks down bias, risk-aversion, disruption Develop scenario descriptions, driven by key uncertainties Model the scenarios Develop indicators to track how the future unfolds. Develop plans and (contingencies) for each scenario Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006

19. Scenario Analysis 5/14/2015Dave Garten - Business Strategy19 Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006

20. Scenario Example 5/14/2015Dave Garten - Business Strategy20 Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006

21. Scenario Example 5/14/2015Dave Garten - Business Strategy21 Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006

22. 5/14/2015Dave Garten - Business Strategy22 Uncertainty & Flexibility Summarized Flexibility/options are tools to manage uncertainty Use flexibility in areas of high uncertainty Isolate volatile elements – architect boundaries Value of options changes with time Volatility drops (less uncertainty) Revisiting project valuation/options Scenario analysis - a helpful tool to instill structure In the real world… build an intuition Framework to evaluate strategic options

23. 5/14/2015Dave Garten - Business Strategy23 Backup

24. 5/14/2015Dave Garten- Business Strategy24 Apple Case Source: UBS, 2006

25. 5/14/2015Dave Garten- Business Strategy25 Apple Case

26. 5/14/2015Dave Garten- Business Strategy26 Jan 2010 July 2000Feb 1996 May 2008 Feb 2006 Feb 2004 Jan 2011

27. 5/14/2015Dave Garten- Business Strategy27 Apple Case

28. 5/14/2015Dave Garten - Business Strategy28 Option Scenarios 1.0 NPVq = value/cost  sqrt(t) lower higher 1.“Now” 1.“Now”Act 2. “Maybe Now” Manage Risk and Act 3.“Probably Later” Learn before Acting 4.“Maybe Later” Explore Possibilities Before Acting 5. “Probably Never” 6. “Never” 6. “Never” Source: Strategy as a Portfolio of Options by Timothy A. Luehrman, HBR 1998

29. 5/14/2015Dave Garten - Business Strategy29 Flexibility in Practice Derived from: IT Outsourcing: Maximizing Flexibility & Control Selective 20-80% (20-3-8) None < 20% (5-5-5) Full > 80% (2-3-9) IT outsourcing: Cost containment vs. core competency

30. 5/14/2015Dave Garten- Business Strategy30 Strategy Evaluation Tools SWOT & Strategy Development Opportunities (O) Threats (T) Strengths (S)Weaknesses (W) SO Strategies ST Strategies WO Strategies WT Strategies Use strengths to take advantage of opportunities Use strengths to avoid threats Overcome weaknesses by taking advantage of opportunities Minimize weaknesses and avoid threats 1. 2.. 1. 2.. 1. 2.. 1. 2.. Source: Strategic management by Fred R. David