1. MBA795 Strategy Formulation
Steven E. Phelan 1

2. Introduction
Course Objectives
Course Assessment
Group Formation

3. Registration Codes www.bsg-online.com Intro to simulation next week!
Registration required for passing grade
Company   Registration Code
Company A   9099-SPN-A
Company B   9099-SPN-B
Company C   9099-SPN-C
Company D   9099-SPN-D
Company E   9099-SPN-E
Company F   9099-SPN-F
Company G   9099-SPN-G
Company H   9099-SPN-H

4. The Concept of Strategy
OUTLINE
The role of strategy in success
A framework for strategy analysis
The evolution of strategic management
Corporate strategy and business strategy
Strategy making: Design or process?
The role of strategy 2

5. GIAP & NORTH VIETNAMESE
Components of Success
MADONNA
GIAP & NORTH VIETNAMESE
LANCE ARMSTRONG
GOALS
Single-minded quest for stardom.
Reunification of Vietnam under Communist rule.
Winning the Tour de France
UNDER-STANDING THE ENVIRONMENT
Identified emerging trends in popular culture. Understood key success factors in showbiz
Intimate knowledge of terrain
Understanding of U.S. political system.
Diagnosis of the physical, psychological and strategic determinants of individual and team performance
RESOURCE APPRAISAL
Recognized limited raw talent. Exploited strengths in self-promotion, product development & relationship management
Recognized economic and military weaknesses and core political strengths
Systematic development of individual stamina and team capabilities
IMPLEMENT- ATION
Commitment and discipline. Charismatic leadership. Team building. Attention to detail.
Tight control. Long-term commitment. Effective propaganda. Inspirational leadership.
Clear delineation of individual roles. Alignment of incentives with team goals. Nurturing esprit de corp 3

6. What Makes a Successful Strategy?
EFFECTIVE IMPLEMENTATION
Long-term, simple and agreed objectives
Profound understanding of the competitive environment
Objective appraisal of resources 4

7. What is Strategy? Distinguishing strategy from tactics:
Strategy is the overall plan for deploying resources to establish a favorable position.
Tactic is a scheme for a specific maneuver.
(Plan versus strategy?)
Characteristics of strategic decisions:
Important.
Involve a significant commitment of resources.
Not easily reversible.
(Long term) 6

8. The Evolution of Strategic Management
1950s 1960s-early 70s Mid-70s-mid-80s Late 80s –1990s s
Budgetary Corporate Positioning Competitive Strategic
planning & planning advantage innovation
control
Financial Planning Selecting Focusing on Reconciling
control growth &- sectors/markets. sources of size with
diversification Positioning for competitive flexibility &
leadership advantage agility
Capital Forecasting. Industry analysis Resources & Cooperative
budgeting. Corporate Segmentation capabilities. strategy.
Financial planning. Experience curve Shareholder Complexity.
planning Synergy Portfolio analysis value. Owning
E-commerce. standards.
— Knowledge Management—
Coordination Corporate Diversification. Restructuring. Alliances &
& control by planning depts. Global strategies. Reengineering. networks
Budgeting created. Rise of Matrix structures Refocusing. Self -organiz
systems corporate Outsourcing. ation & virtual
planning organization
DOMINANT
THEME
MAIN
ISSUES
KEY CONCEPTS&
TOOLS
MANAGE-MENT
IMPLIC-
ATIONS 7

9. The Smith Family Case

10. The Basic Framework Strategy: the Link between the Firm and its Environment
• Goals &
Values
• Resources &
Capabilities
• Structure &
Systems
THE
INDUSTRY
ENVIRONMENT
• Competitors
• Customers
• Suppliers
STRATEGY
STRATEGY
SWOT or WOTS-Up
Analysis 5

11. Sources of Superior Profitability
INDUSTRY
ATTRACTIVENESS
Which businesses should we be in?
CORPORATE STRATEGY
RATE OF PROFIT ABOVE THE COMPETITIVE LEVEL
How do we make money?
COMPETITIVE ADVANTAGE
How should we compete?
BUSINESS STRATEGY 16

12. Strategy Making : Design or Process?
Strategy as Design
Strategy as Process
Planning and
rational choice
Many decision makers
responding to multitude of
external and internal forces
INTENDED
STRATEGY
EMERGENT
STRATEGY
REALIZED STRATEGY
Mintzberg’s Critique of Formal Strategic Planning:
The fallacy of prediction – the future is unknown
The fallacy of detachment -- impossible to divorce formulation from
implementation
The fallacy of formalization --inhibits flexibility, spontaneity,
intuition and learning. 10

13. Strategy Making Processes within the Company: Multiple Roles of Strategy
Strategy as Decision
Support
Improves the quality
of decision making
(Real-Time Strategic Thinking rather than Strategic Planning)
Strategy as Coordination
and Communication
Creates consistency
and unity
(Focuses Resource Allocation and Rationale)
Improves perform-
ance by setting
high aspirations
Strategy as Target

14. The Role of Analysis
Strategy analysis improves decision processes, but doesn’t give answers.
Strategy analysis assists us to identify and understand the main issues.
Strategy analysis helps us to manage complexity (tells us what to focus on).
Strategy analysis can enhance flexibility and innovation by supporting learning. 11

15. Goals, Values and Performance
OUTLINE
Strategy as a quest for value
What is profit?
The shareholder value approach
The shareholder value and strategy formulation
Mission and values

16. Strategy as a Quest for Profit
The stakeholder approach : The firm is a coalition of interest groups—it seeks to balance their different objectives
INDUCEMENT v. CONTRIBUTION
The shareholder approach : The firm exists to maximize the wealth of
its owners (= max. present value of profits over the life of the firm)
For the purposes of strategy analysis we assume that the primary goal of the firm is profit maximization.
Rationale:
Boards of directors legally obliged to pursue shareholder interest
To replace assets firm must earn return on capital > cost of capital
(difficult when competition strong).
Firms that do not max. stock-market value will be acquired
Hence: Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm 13

17. From Profit Maximization to Value Maximization
Profit maximization is an ambiguous goal
Total profit vs. Rate of profit
Over what time period?
What measure of profit?
Accounting profit versus economic profit (e.g. Economic Value Added: Post-tax operating profit less cost of capital)
Maximizing the value of the firm:
Max. net present value of free cash flows: max. V = St Ct
(1 + r)t
Where: V market value of the firm.
Ct free cash flow in time t
r weighted average cost of capital

18. The World’s Most Valuable Companies:
Performance Under Different Profitability Measures
COMPANY
MARKET CAP. ($BN.)
NET INCOME ($BN)
RETURN ON SALES (%)
RETURN ON EQUITY (%)
RETURN ON ASSETS (%)
RETURN TO SHARE-HOLDERS (%)
Exxon Mobil
372
36.1
19.9
34.9
17.8
11.7
General Electric
363
16.4
10.7
22.2
14.7
(1.5)
Microsoft
281
12.3
40.3
30.0
18.8
(0.9)
Citigroup
239
24.6
22.0
21.9
1.5
4.6 BP
233
22.3
9.9
27.9
10.2
Bank of America
212
16.5
27.0
14.1
1.2
2.4
Royal Dutch Shell
211
25.3
26.7
11.6
11.8
Wal-Mart
197
11.2
5.5
21.4
8.1
(10.3)
Toyota Motor
12.1
13.0
4.8
(22.1)
Gazprom
196
7.3
28.1
9.8
7.1
n.a.
HSBC
190
15.9
23.0
16.3
1.0
(11.8)
Procter & Gamble
8.7
17.3
13.7
6.4
7.2

19. Shareholder Value Maximization and Strategy Choice
The Value Maximizing Approach to Strategy Formulation:
Identify strategy alternatives
Estimate cash flows associated with each strategy
Estimate cost of capital for each strategy
Select the strategy which generates the highest NPV
Problems:
Estimating cash flows beyond 2-3 years is difficult
Value of firm depends on option value as well as DCF value
Implications for strategy analysis:
Some simple financial guidelines for value maximization
On existing assets—maximize after-tax rate of return
On new investment—seek rate of return > cost of capital
Utilize qualitative strategy analysis to evaluate future profit potential

20. Valuing Companies and Business Units
If net cash flow growing at constant rate (g) V = C1 ( r - g ) With varying cash flows which can be forecasted for 4 years: V = C0 + C1 + C2 + C3 + VH (1 + r ) (1 + r )2 (1 + r )3 (1 + r )3 where: VH is the horizon value of the firm after 4 years

21. Real Options The right but not the obligation to buy an asset
Black Scholes Formula used to value financial options
There is hidden value in real (or strategic) options
Flexibility to speed up or slow down projects
Flexibility to abandon a project
Flexibility to shutdown a project
Flexibility to extend a project into new products or markets
Flexibility to switch designs or plants
In general, more uncertainty and more time before committing to a decision increases the value of an option
Hence, strategists should seek explore options given time and uncertainty

22. ROCE Performance Diagnosis: Disaggregating Return on Capital Employed
Past performance analysis
(see Ford v. Toyota)
COGS/Sales
Margin
(Return on
Sales)
Depreciation/Sales
SGA expense/Sales
ROCE
Fixed asset turnover
(Sales/PPE)
Inventory Turnover
(Sales/Inventories)
Asset
productivity
(Sales/Capital
Employed)
Creditor Turnover
(Sales/Receivables)
Turnover of other items
of working capital

23. Corporate/Divisional
Linking Value Drivers to Performance Targets
Order Size
Customer Mix
Sales
Targets
Sales/Account
Customer Churn
Rate
Margin
cogs/
sales
Deficit Rates
Cost per Delivery
Development
Cost/Sales
Maintenance cost
Shareholder
value
creation
ROCE
New product
development time
Indirect/Direct
Labor
Inventory
Turnover
Customer
Complaints
Economic
Profit
Capital
Turnover
Downtime
Capacity
Utilization
Accounts Payable
Time
Cash
Turnover
Accounts
Receivable Time
CEO
Corporate/Divisional
Functional
Departments & Teams

24. Balanced Scorecard
An attempt to link long-term (intangible) value drivers to financial measures
An attempt to combat a tendency to short-termism by CEOs
Four areas:
Financial
Customer
Internal
Learning & growth

25. Balanced Scorecard for Mobil N. American Marketing & Refining
Strategic Objectives
Strategic Measures F I N A C L
F1 Return on Capital Employed
F2 Cash Flow
F3 Profitability
F4 Lowest Cost
F5 Profitable Growth
F6 Manage risk
* ROCE
* Cash Flow
* Net Margin
* Full cost per gallon delivered to customer
* Volume growth rate Vs. industry
* Risk index
Financially
Strong
C O
U M
S E
T R -
C1 Continually delight the targeted consumer
C2 Improve dealer/distributor profitability
* Share of segment in key markets
* Mystery shopper rating
* Dealer/distributor margin on gasoline
* Dealer/distributor survey
Delight the Consumer
Win-Win Relationship I N T E R A L
I1 Marketing
1. Innovative products and services
2. Dealer/distributor quality
I2 Manufacturing
1. Lower manufacturing costs
2. Improve hardware and performance
I3 Supply, Trading, Logistics
1. Reducing delivered cost
2. Trading organization
3. Inventory management
I4 Improve health, safety, and environmental performance
I5 Quality
* Non-gasoline revenue and margin per square foot
* Dealer/distributor acceptance rate of new programs
* Dealer/distributor quality ratings
* ROCE on refinery
* Total expenses (per gallon) Vs. competition
* Profitability index
* Yield index
Delivered cost per gallon .Vs. competitors
* Trading margin
* Inventory level compared to plan & to output rate
* Number of incidents
* Days away from work
* Quality index
Safe and Reliable
Competitive Supplier
Good Neighbor
On Spec
On time L
E &
A G
R R
N O
I W
N T
G H
L1 Organization Involvement
L2 Core competencies and skills
L3 Access to strategic information
* Employee survey
* Strategic competing (?) availability
* Strategic information availability
Motivated and Prepared

26. A Comprehensive Value Metrics Framework
Shareholder
Value
Measures:
Market value of the
firm
Market value added
(MVA)
Return to
shareholders
Intrinsic
Value
Measures:
Discounted cash
flows
Real option values
Financial
Indicators
Measures:
Return on Capital
Growth (of
revenues & operating
profits)
Economic profit (EVA)
Value
Drivers
Sources:
Market share
Scale economies
Innovation
Brands

27. (Issue of Corporate Social Responsibility)
The Paradox of Value
The companies that are most successful in creating
long term shareholder value are typically those that:
Have a mission—They give precedence to goals
other than profitability and shareholder return;
Have strong, consistent, ethical values.
Examples:
“Visionary” companies studied by Collins & Porras,
e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP
Boeing — Focus pre-1996: “to build great planes,” weak
financial controls—yet high profitability
— Focus : “creating shareholder
value”—Outcome: loss of market leadership,
declining profitability
(Issue of Corporate Social Responsibility)