Week 3 / Chapters 2, 11, 13 Flashcards
1
Q
Chapter 2: Analysis of the External
Environment: Opportunities
and Threats
A
Chapter 2: Analysis of the External
Environment: Opportunities
and Threats
2
Q
A firm’s external environment provides both
A
1) opportunities—ways of
taking advantage of conditions in the environment to become more profitable
2) threats— conditions in the competitive environment that endanger the profitability of the firm
3
Q
Competition for profits goes beyond established
industry competitors to include four other forces that shape industry attractiveness and profitability:
A
1) customers,
2) suppliers,
3) potential entrants,
4) and substitute products
4
Q
LO 1 Determining the Right Landscape: Defining a
Firm’s Industry
A
LO 1 Determining the Right Landscape: Defining a
Firm’s Industry
5
Q
The first strategic decision that most firms must make is to
A
select the industry, and markets,
in which it will compete (the sandbox)
6
Q
The firm’s landscape is typically defined by:
A
(1) the industry (or industries)
in which a firm competes, and
(2) the product and geographic markets within that
industry that the firm targets
7
Q
How the US Government Defines Industries
A
- North American Industry Classification System (NAICS)
- vary from two to seven digits, becoming more narrow with increasing numbers of digits
- Used to be SIC codes
8
Q
LO 2 Five Forces that Shape Average Profitability
Within Industries
A
LO 2 Five Forces that Shape Average Profitability
Within Industries
9
Q
Michael Porter’s 5 Forces
A
1) Rivalry
2) Buyer power
3) Supplier power
4) Threat of new entrants
5) Threat of substitutes products
10
Q
There are three basic steps involved in using the five forces analysis tool:
A
Step 1: Identify the specific factors relevant to each of the five major forces. We describe
the factors that contribute to each of the five forces in the next five sections of this chapter.
• Step 2: Analyze the strength of each force. To what extent is it shaping the industry’s
attractiveness? The appendix at the end of the book lists several sources where you might
find the data you need to analyze each of the five forces.
• Step 3: Estimate the overall strength of the combined five forces to determine the general
attractiveness of the industry, the profit potential for an average firm in the industry.
11
Q
Rivalry
A
Competition among firms within an industry. Typically this involves firms putting pressure on each other and limiting each other’s profit potential by attempting to gain profits and/or market share.
12
Q
Substitute
A
A product that is
fundamentally different yet serves
the same function or purpose as
another product.
13
Q
Threats
A
Conditions in the
competitive environment that
endanger the profitability
of a firm.
14
Q
Opportunities
A
Ways of taking
advantage of conditions in the
environment to become more
profitable.
15
Q
Attractiveness of an industry
A
The degree to which an average
firm in the industry can earn
good profits.
16
Q
The following seven factors are critical to understanding the intensity of rivalry in
an industry:
A
- The number and size of competitors
- Standardization of products
- Costs to buyers of switching to another product
- Growth in demand for products
- Levels of unused production capacity
- High fixed costs and highly perishable products
- The difficulty for firms of leaving the industry
17
Q
Competitor rivalry as per Figure 2.2
A
In the middle is Competitor Rivalry, around it is:
Buyer power, New entrants, Supplier Power, Substitutes
18
Q
The Number and Relative Size of Competitors
A
The more competitors there
are in an industry, the more likely that one or more of them will take action to gain profits at the
expense of others.
19
Q
Fragmented Industry
A
What Economists call an industry with a lot of competitors
-it is difficult to keep track of the pricing and competitive moves of multiple players. The large number of firms responding to one another tend to create intense
rivalry
20
Q
Concentrated Industry
A
-have far fewer competitors
and tend to be dominated by a few large firms
-rivalry is typically much less
intense
21
Q
Relatively Standardized Products
A
Differentiated products, ones that boast different
features or better quality, tend to engender loyalty in customers because they meet customer needs in unique ways.
22
Q
When products are standardized, or commodity-like
A
buyers are
less loyal to a particular brand and it is easier to convince them to switch brands
23
Q
Standardized products
A
manufactured products or materials that are interchangeable regardless of who makes them, like bolts and nuts, rubber, plastics, or commodities such as coal, crude oil, salt, or sugar
24
Q
Switching costs
A
Barriers that help keep buyers using the same
supplier by imposing extra costs
for switching suppliers.
25
Low Switching Costs for Buyers
The lower the switching costs, the easier it is for competitors to poach customers,
thereby increasing industry rivalry
Buying a different type of gum vs going from Windows to MacOS
26
Switching costs are a fundamental part of not just rivalry but also the other four forces:
1. Buyer power: If customers, or buyers, can easily switch firms, then buyers have increased
power.
2. Supplier power: If firms can’t switch suppliers easily, then suppliers have increased power.
3. New entrants: If buyers can easily switch to new companies attempting to enter the industry, there is a greater threat of new entrants.
4. Substitutes: If buyers can switch to substitute products without much difficulty, firms face
an increased threat from those substitutes.
27
Slow Growth in Demand for Products or Services
-When demand is increasing
rapidly, most firms can grow without taking existing customers from competitors
-When sales decline competitors may try to increase their sales volume by attracting customers from their competitors through sales promotions, price discounts, or other tactics
Examples: TV prices dropping by 25% in 2010 as sales dropped tremendously
28
High Levels of Unused Production Capacity
Firms typically try to produce at or near their full production capacity so that they can spread the fixed cost of factories, machinery, and other means of production across more units
However, when more is produced than is demanded in the market, firms often have to drop their price or risk having unsold product
Examples: Automobile industry when economic downturns hit and they have too many cars
29
High Fixed Costs, Highly Perishable Products, High Storage Costs
Industries that produce or serve products in these three categories sometimes find themselves with
a supply of products that they have to sell quickly or take large losses on
Example: Airline seats that don't sell, produce in a grocery store that is approaching its expiration date, manufacturing firms that produce too much and need to pay for storage
30
High Exit Barriers
In some industries, companies don’t exit even when they aren’t making a lot of money. Most often, they stay because they have made investments in specialized
equipment that can’t be used in any other industry
Example: Steel blast furnaces
31
Buyer Power: Bargaining Power and Price Sensitivity
When buyers have sufficient power, they can demand either lower prices or better products
from their suppliers, thereby hurting average profitability of firms in the supplier industry
32
The two primary situations in which buyers have high power are when
1) Buyers hold a stronger bargaining
position than sellers
2) When buyers are price-sensitive
33
Buyer Bargaining Power
-Four key factors influence the degree to which buyers have bargaining power over their suppliers
34
Four key factors of Buyer Bargaining Power
1 + 2) Buyers switching costs and demand
3) Number, or concentration, and size of buyers:
4) Credible threat of backward integration:
35
Supplier
A firm that provides products that are inputs to
| another firm’s production process.
36
Number, or concentration, and size of buyers:
Buyer concentration reflects the law of supply
| and demand
37
If there are few buyers but many sellers,
hen the sellers must compete
more strongly for buyer business.
Sellers in this situation are likely to give concessions to
make the sale
38
If there are lots of buyers but few sellers,
many buyers
The more likely sellers are to increase the level of competition in order to gain buyers’ business
39
Credible threat of backward integration:
In some cases, a buyer can exert pressure over
suppliers by threatening them with backward integration, meaning they will make the
product themselves.
40
Backward integration
A firm purchases one or more of its
| suppliers in order to make a product itself rather than buying it from another firm.
41
Buyer Price Sensitivity
In general, when buyers are more price-sensitive, they are more likely to exert pressure on suppliers to keep prices low.
Buyers exert pressure not just through price negotiation but also through more comparison shopping and a greater willingness to switch suppliers
42
Buyer price sensitivity tends to increase in the following situations:
Buyers are struggling financially
Product is significant proportion of buyer’s costs
Buyers purchase in large volumes
Product doesn’t affect buyers’ performance very much
Product doesn’t save buyers money
43
Supplier Bargaining Power
The factors that increase the bargaining power of suppliers are very similar to those that
increase the bargaining power of buyers.
When supplier industries have strong bargaining power, they can charge higher prices, which tends to decrease average profitability in a buyer’s industry
44
Number, or Concentration, and Size of Suppliers
As with buyer concentration,
supplier concentration also follows the law of supply and demand.
If there are few sellers but lots of buyers in an industry, then the buyers have to compete to get the products that they want, often paying higher prices to get sufficient supply
45
Credible Threat of Forward Integration
In some cases, a supplier can exert
pressure over its buyers by threatening them with forward integration, doing what its buyers
do, if the buyers don’t offer price concessions
46
Forward integration
A firm goes into the business of its former
| buyers, rather than continuing to sell to them.
47
Barriers to entry
The way organizations make it more difficult for potential entrants to get a foothold in the industry.
48
Incumbent firms might have cost
advantages relative to new entrants for a variety of reasons besides economies of scale. These
include the following:
1. Patents or proprietary technology, such as those that exist in the pharmaceutical industry
2. Better locations, a deterrent to firms wishing to enter markets where Starbucks is dominant,
for example
3. Economies of scope, less expensive costs per unit created by bundling different types of
products.
4. Preferential access to critical resources, such as raw materials or access to distribution networks.
49
Capital Requirements
Not only do potential entrants often need capital to build a factory or store, but they may also have to invest in R&D to generate viable products, build inventory, undertake sufficient advertising and marketing to take market share from incumbent firms, and have sufficient cash on hand to cover customer
credit.
50
Network Effects
Growth in demand for a firm’s product that results from a growth in the number of existing customers.
51
Government Policy Restrictions
Finally, government policies may make it more
difficult to enter a market or even restrict a market completely to new entrants
Example: governments often raise the costs of entry by requiring bonding, licenses, insurance, or environmental studies before a firm can enter an industry
52
Threat of Substitute Products
A substitute is a product that is fundamentally different yet serves the same basic function
or purpose as another product.
Example: Coffee vs Energy Drink, e-mail instead of text, phone calls, fax
53
Difference between a rival and a substitute
If the product has the same basic characteristics
and is made using the same general set of inputs, it would be considered part of rivalry, rather than a substitute.
For instance, competitor brands serving the same basic need, such as Apple’s iPhones and Samsung’s smartphones running Google’s Android operating system, are rivals, not substitutes
54
Awareness and Availability
Sometimes customers aren’t readily aware that substitutes exist.
The threat increases when substitute products are well known
Likewise, if the substitute product is just as easy for customers to obtain as the industry’s products are, it is more of a threat. If the substitute is difficult to find or acquire, the threat is diminished.
55
Price and Performance
The price of the substitute itself also factors into customers’ decisions. If substitutes are cheaper than
products from another industry, the threat is higher.
Likewise, if the performance of substitutes
is similar or better, the threat is higher. The closer the substitute is in performance, the less flexible a seller can be with price
56
LO 2.3 Overall Industry Attractiveness
LO 2.3 Overall Industry Attractiveness`
57
Attractive (profitable) industries
Are those where firms have created power over buyers and suppliers, created barriers to entry to reduce the threat of new entrants, and minimized the threat of substitutes while keeping rivalry to a minimum.
58
Unattractive industries
Firms in these industries are consistently
pressured by buyers and suppliers alike. They face high rivalry, easy entrance for new competitors,
and many well-positioned substitute products
59
Do industries often show up at unattractive or attractive after doing the Porter's test?
A significant threat from just one or two of the five forces is often sufficient to destroy the attractiveness of
an industry
60
LO 2.4 Where Should We Compete? New Thinking
| About the Five Forces and Industry Attractiveness
LO 2.4 Where Should We Compete? New Thinking
| About the Five Forces and Industry Attractiveness
61
Popular idiom for this assessment tool
“Beauty is in the eye of the beholder.”
Or, in other words, unattractive markets according to traditional industry analysis may be quite attractive to the right kind of entrant.
62
Should you enter an attractive market or an unattractive market to make money?
On average, new entrants into highly profitable (attractive) markets were 30 percent less profitable than new entrants into unattractive markets (i.e., in general, it is easier for new entrants to make money in unattractive industries than attractive ones)
The reason? Barriers to entry made it difficult for the new entrant to establish itself. So, on average, an attractive market (from a five-forces perspective)
is actually the least attractive market for a new entrant
63
LO 2.5 How the General Environment Shapes Firm
| and Industry Profitability
LO 2.5 How the General Environment Shapes Firm
| and Industry Profitability
64
A simple way to think about the general environment is to break it down into eight categories.
* Complementary products or services
* Technological change
* General economic conditions
* Population demographics
* Ecological/natural environment
* Global competitive forces
* Political, legal, and regulatory forces
* Social/cultural forces
65
Complementary Products or Services
AKA Ecosystems
Products or services that
can be used in tandem with those
from another industry.
Examples: Burgers and buns, Gas stations and roads are complements to automobiles, piping is a complementary product to natural gas
For example, video gaming hardware and software, or smartphone operating systems and Apps, are complementary sets of products
66
For many industries, changes in complementary products are one of the most important trends to keep an eye on. Some consider them significant enough that they even refer to them as a ______ force among the five industry forces
sixth
6th
67
Technological Change
can include new products, such
as smartphones; new processes, such as hydraulic fracturing (fracking), which has dramatically
increased the output of the natural gas industry; or new materials, such as lithium batteries,
which make electric automobiles possible
68
General Economic Conditions
Economic growth
Interest Rates
Currency exchange rates
Inflation
69
Analyzing the economic environment typically involves
Measuring the economic growth rate, interest rates, currency exchange rates, and the rate of inflation or
deflation
70
Economic Growth
How quickly, or slowly, an economy is growing has a direct impact on most firms’ bottom line.
Economic expansion tends to improve customer balance sheets, lower price sensitivity, and increase the growth rate in an industry, as customers purchase more, easing rivalry.
Example: Africa now having more money so people can buy cars and automobiles
71
Interest Rates
Interest rates particularly affect rivalry by increasing or decreasing the demand for an industry’s products.
This is particularly true for expensive items like housing, cars, and even education, which often require customers to take out loans to purchase
72
Currency Exchange Rates
Currency exchange rates reflect the value of one country’s currency in relation to the currency from another country.
Exchange rates can have a large
impact on the prices that customers pay for products from firms in other countries, directly
affecting profitability for those firms
73
Inflation
significant, consistent rise in prices, known as inflation, can create many problems for firms.
Inflation, or the opposite, deflation, means that the value of the dollar doesn’t stay constant. Today, a product may cost $1.
If inflation is at 2 percent a year (low inflation), then next year that product will cost $1.02.
74
Demographic Forces
Involve changes in the basic characteristics of a population, including changes in the overall number of people, the average age, the number of each gender or ethnicity, or the income distribution of the population
75
Ecological/Natural Environment
The natural environment can also be a source of change for many industries. In some cases,
this involves changes to the physical environment such as increasing shortages of key inputs
like rare earth metals or fluctuations in the amount and cost of energy (i.e., oil and gas).
Current trends in the natural environment involve changes in the public’s perception
of how business affects the environment
76
Global Forces
Another factor
77
Political, Legal, and Regulatory Forces
Those that arise from the use of government
When new laws are passed, they may alter the shape of an industry and influence the strategic
actions that firms might take
78
Social/Cultural Forces
refer to society’s cultural values and norms, or attitudes
Values and attitudes are
so fundamental that they often affect the other six general environmental forces, shaping the
overall landscape in which firms compete
79
Chapter 11: Competitive Strategy and
| Sustainability
Chapter 11: Competitive Strategy and
| Sustainability
80
In order to effectively compete, a company must first ________ and then it must
launch strategies to ____________
know the competition
win against the competition
81
LO 11.1 Understanding the Competitive Landscape
LO 11.1 Understanding the Competitive Landscape
82
Strategic group
A set of companies that compete in similar
ways with similar business models
pursuing similar sets of customers.
83
Strategic group maps
aka strategic group analysis
are constructed by identifying the main differences in the ways in which firms in an industry compete to deliver value.
These differences typically relate to value
chain activities such as relative price, geographic placement, product line breadth, extent of
vertical integration, niche or full-service offerings, and so forth
To Create:
1. Identify the main differences (variables) in the ways firms in the industry compete, and choose 2 variables to create a grid for comparing firms
e.g. price (low-cost vs. high-end/niche)
e.g. brand position / geographic coverage / range of products / size
2. “Score” industry players relative to each other, and plot them on the grid
3. Draw circle(s) around “clusters” of industry players on the grid (look for any outliers are those who do not fit in a group)
84
Barrier to mobility
Any factor that limits the ability of a company
| to move between strategic groups.
85
A strategic group map provides a basis for making competitive assessments not only
because it defines who a company’s competitors are but also because it can help to analyze
potential ______________________________
changes in the landscape
86
Strategy Canvas
Figure 11.2 Strategy Canvas of the Short-Haul Airline Industry
a way to assess relative competitive strengths and weaknesses against specific purchase criteria
By rating firms on various criteria that customers use to make purchase decisions, the analyst is able to quickly
grasp similarities and differences in how companies attempt to offer unique value to customers
relative to competitors.
Big difference between this a strategic group map is that there are multiple factors to consider on a Strategy Canvas
87
LO 11.2 Evaluating the Competition
LO 11.2 Evaluating the Competition
88
Competitor response profile
A profile of a competitor that identifies its objectives and assumptions, its strategy, and its resources and capabilities in order to anticipate how the competitor
might respond to rival actions.
Description: box in the middle with words and arrows pointing into it
89
What Drives the Competitor?
Within this category, objectives and
assumptions are identified
What assumptions reinforce these objectives?
These kinds of assumptions often point the way to potential rival moves.
90
What Is the Competitor Doing or Capable of Doing?
Here is where a competitor’s
| strategy and its resources and capabilities are identified
91
How Will a Competitor Respond to Specific Moves?
After these four factors—objectives, assumptions, strategy, and resources/capabilities—are laid out for a specific competitor, a company such as Southwest can anticipate how the competitor might respond to specific moves.
92
Using Game Theory to Evaluate Specific Moves
The word game in game theory refers to strategic interaction among competitors
and the word theory refers to a set of predictions about how competitors play games.
93
Game theory
A structured approach to analysis of
competitor interaction that yields predictions about which strategic actions are most likely to be
chosen by rivals.
The word game in game theory refers to strategic interaction among competitors
The word theory refers to a set of predictions about how competitors play games
94
Pay-off (Jargon in game theory)
rivals are expected to make moves that deliver the greatest profit
95
Simultaneous Move Games
Assume the players make their moves simultaneously
and they play the game only once.
This set up is called a simultaneous move, one-shot game
Example: Prisoner's Dilemma
96
Nash equilibrium
A set of moves in a game that simultaneously maximize each firm’s payoff, given the choices of rivals, and from which no player has an incentive to defect.
The first component of the definition reflects that
players are striving to achieve their best possible outcome while the second ensures that the outcome is stable (i.e., the players have no incentive to change their action).
97
Dominant strategy
In game theory, a set of actions that is
| always played no matter what a rival chooses to do.
98
In game theory, a strategy
is a set of best responses to every possible
| rival action
99
Infinitely Repeated Games
In the real world, most companies are in competition with rivals each and every day, month, or year with no certain end date
Even though the games are not literally played forever,
they are treated this way since the competitors repeatedly interact and the ending period is
not known.
100
Tit-for-tat strategy
A strategy that responds in kind to the moves
of rivals.
Companies watch each other closely and choose actions that mimic what their rivals are doing
101
LO 11.3 Principles of Competitive Strategy
LO 11.3 Principles of Competitive Strategy
102
Four general principles of competitive strategy:
These principles, when applied, strengthen a company’s ability to compete:
1. Know your strengths and weaknesses
2. Bring strength against weakness
3. Protect and neutralize vulnerabilities
4. Develop strategies that cannot be easily imitated or copied (go where the competitor is not)
103
1. Know Your Strengths and Weaknesses
A company’s strengths are the resources and capabilities that deliver unique value. A company must work to develop these strengths through focus, investment, and effort
A company’s weaknesses are the resources and capabilities that are subject to rapid obsolescence,
easy imitation, or high cost not recouped by value
104
2. Bring strength against weakness
After a company’s key strengths are identified, they
should be targeted to competitor weaknesses
Bringing strength against weakness can have
devastating effects on the competition
105
3. Protect and neutralize vulnerabilities
A company’s own weaknesses, once identified,
must either be strengthened or truly neutralized; that is, made irrelevant so that they don’t become targets of competitors
106
4. Develop strategies that cannot be easily imitated or copied
This seems obvious, but often companies are so busy copying competitors’ moves that they fail to see how they could do something altogether different.
The principle might be best captured in the idea of going to where the competitor is not.
107
Market structure
The way rivals in a market interact and bargain
| for advantage. In its simplest terms, it’s the number of rivals in a particular market.
108
Market structures typically fall into one of three categories:
1) monopoly,
2) oligopoly,
3) or perfect competition
109
Competition Under Monopoly
market of one firm or one highly dominant firm, such as Sirius XM in satellite radio or Microsoft in word-processing software for personal computers
110
The basic strategic objective of a monopolist is to reinforce its monopoly and it does so in 4 ways:
(1) raising entry barriers,
(2) limiting competitive access to scarce resources,
(3) innovating and patenting, and
(4) introducing new products frequently
111
Barrier to entry
Any factor that increases the costs, lowers the
profit margins, or limits the market share of entrants to a market.
For example, a monopolist may choose to practice limit pricing, which means to set the market price of a product just low enough so that a new entrant cannot pay the cost of entry to come into a market and be profitable.
112
Types of barrier to entry to deploy:
1) Raise Entry Barriers
2) Limit Competitive Access to Scarce Resources
3) Innovate and Patent
4) Introduce New Products Frequently
113
Competition Under Oligopoly
markets of a few firms, typically two to five, though in some cases the number could be as high as 10
Because the firms in oligopolies are locked in tight competition with only a few other firms, they must make their moves carefully, knowing that rivals will detect their actions and respond accordingly.
oligopolists monitor and mimic rival behavior, particularly in price and product features,
and they employ tit-for-tat strategies
114
Monitor and Mimic Rival Behavior
In this process, norms emerge in competition around particular approaches to the market. For example, pricing norms are very common.
Companies know that they could dramatically cut their price and possibly pick up market share in the short run, but they realize that this move would be quickly detected and matched, leading to lower profits for all firms in the market
115
Employ Tit-for-Tat Strategies
Tit-for-tat strategies are those
that respond in kind to the moves of rivals, including the meting out of punishments for behavior
that violates norms (e.g., price wars, lawsuits, etc.).
116
“Perfect” Competition
“Competitive” markets are markets with many firms
Firms are price takers rather than price setters because attempts to use price strategically, as is done in
monopolies or oligopolies, are not effective and wind up hurting the firm that tries
117
This leads to very specific set of competitive strategies that “Perfect” Competition are likely to take to be successful
The list includes
(1) consolidate markets,
(2) pursue low cost, or
(3) pursue differentiation strategies.
118
Merge or Consolidate Markets
Firms in competitive markets often suffer from the
superior bargaining power of buyers or suppliers
Because many firms in the market are selling a homogeneous product, bargaining power is difficult to obtain. This feature of the market also creates intense rivalry among firms.
One strategic remedy to this problem is for firms in the market to merge.
119
Pursue a Low-Cost Strategy
Since companies in competitive markets are price
takers, they have little control over price. Therefore, in order to realize profit, they must drive
down their costs.
120
Pursue a Differentiation Strategy
To separate themselves from the pack, they can
add product features, store locations, bundled services, or other variations to create unique
value for customers
121
What companies must do in these environments is reconfigure their processes and capabilities
to emphasize both _______________________
innovation and speed
122
Five specific sustainability tactics and mechanisms
1) Create or Preempt Rare Resources
2) Secure Government-Sanctioned Barriers
3) Create Buyer Switching Costs
4) Leverage Network Effects
5) Leverage Rare Intangible Assets
123
1) Create or Preempt Rare Resources
The first tactic for sustaining advantage is to
first possess and then preempt others from acquiring scarce resources. These could be raw
materials, land, locations, or any other resource in limited supply
Companies that are the first to secure scarce resources are often described as benefiting from
“first mover advantages.”
124
2) Secure Government-Sanctioned Barriers
The second tactic is to secure
government sanctioned barriers to imitation in the form of patents, regulations, tariffs, etc
Government tariffs and other regulations can also protect certain companies. For example, US tariffs on imported steel help protect U.S. steel producers.
125
3) Create Buyer Switching Costs
A third way to prevent imitation is to create buyer
| switching costs. One source of switching cost is investment or learning on the part of a buyer
126
4) Leverage Network Effects
A fourth way to prevent imitation is to offer a product or
service that benefits from “network effects.” A network effect is a phenomenon whereby a product
or service gains additional value as more people use it
Example: The more people on Facebook the more valuable it is
Markets characterized by network effects are sometimes called “winner take all” markets because the first mover to ignite the network effect often dominates the market.
127
5) Leverage Rare Intangible Assets
Fifth, companies can prevent imitation through
valuable intangible assets such as branding, loyalty, and customer habit
Cumulative Advantage, a reservoir of goodwill among
customers that predisposes them to purchase new versions of Tide and not even look at competing
brands
128
Chapter 13: Corporate Governance and Ethics
Chapter 13: Corporate Governance and Ethics
129
Corporate governance definition
The processes and structures that
provide the ultimate decision making
authority for the firm.
130
Corporation definition
A legal structure for organizing where the organization
| is a distinct and separate entity from its owners, also known as shareholders.
131
Individual proprietorship
A legal structure for organizing where
the same person owns and runs
the business.
132
Partnerships
```
A legal structure for
organizing where the owners of
a business share ownership. The
partnership is not separate from
its owners.
```
133
In terms of corporate
| governance, this question is often worded in one of two ways:
What is the purpose of the
corporation?
Or, who is the corporation run for?
134
Shareholder primacy model
The belief that a corporation should be run, primarily or exclusively, for the benefit of its shareholders.
Professor Adolf Berle
135
Stakeholder model
aka stakeholder theory
The belief that a corporation should
be run for the benefit of its entire stakeholder set, with
no group enjoying primacy in decision making.
Professor Merrick Dodd,
136
Nexus of contracts
A model of the corporation suggesting that the firm is the sum total of its contracts with different stakeholders.
Examples: Suppliers contract with the firm to provide
needed inputs, employees contract to provide labor, and even distributors and many customers
purchase goods from the corporation through a sales contract
137
Property rights
The rights of owners to:
(1) claim the residual
earnings of the corporation, or the
profits after all other stakeholders
have been paid, and/or
(2) monitor
the management team to make
sure that the team works in their
best interests.
138
Proponents of the shareholder primacy model usually cite three reasons for their support.
First, the shareholders are the legal owners of the corporation’s assets
Second, proponents of the shareholder
model claim that financial capital is the most important input into making a business
successful
Finally, advocates of the shareholder model point
to other societies and business arrangements in which business firms try to maximize the
welfare of some other stakeholder group—such as employees or the local community
139
Critics of the shareholder primacy school
First, they note that shareholders don’t really own the corporation, since shareholders own stock that they can easily trade
Second, shareholders have different objectives for investing in a firm. Some investors, such as Warren Buffett or pension funds such as CalPERS (the
California Pension and Retirement System), put their money in a company’s stock as a long-term
investment and want to see the corporation managed to earn the greatest long-term return.
Finally, opponents of the shareholder primacy model point to failures
such as Enron, Long-Term Capital Management, BP and the Deepwater Horizon oil spill,
the collapse of Lehman Brothers, the behavior of firms during the financial crisis of 2008, and
the recent activities of Wells Fargo as evidence that managing for shareholder value creates
negative consequences for firms, investors, and society at large
140
Stakeholder
Any person or group
that can affect or is affected by the
activities of the corporation.
141
The primary stakeholder
| groups for most organizations are
```
shareholders, customers, suppliers, employees, and
local communities (including governments)
```
142
Secondary stakeholders include
competitors, national or global communities, and many special-interest groups, such as those working to
protect the natural environment. We are all stakeholders of many organizations
143
Those who advocate stakeholder models do so from two grounds.
They point to what executives and managers actually do, which is spend most of their time interacting with
and managing the demands and needs of different stakeholder groups. This includes working to better understand and meet customer needs, negotiating wages, dealing with working conditions for employees, responding to government regulations, and reacting to
the demands of special interest and advocacy groups
Second, many people believe that stakeholder groups have the right to be considered in decisions that will have an impact on them. This is known as the intrinsic
stakeholder model
144
Criticisms of the The stakeholder model
Making shareholder value
the final decision criteria gives managers a clear direction for the tough tradeoffs they must
make in the course of formulating and implementing strategy. With no way to decide whose
claims have priority, managers have no way to efficiently and effectively run their firms
Other critics note that stakeholder management has a dark side: stakeholders may make, and try to
enforce, unreasonable and narrow-minded claims on the firm
145
Agency problem
A consequence of the separation of ownership
(shareholders/principals) and control (managers/agents) in the corporation. Agency problems occur when the goals of principals differ from those of agents.
146
Principals
The owners of a resource or piece of property. In
| the corporation, shareholders are considered principals.
147
Agents
Individuals or groups hired to administer the property
or resources of principals. The managers of a corporation are considered to be agents of the
shareholders.
148
Corporate raiders or takeover artists
These are investor groups who believe they can manage the corporation’s assets better than
the current management team
They use a method known as Tender offer
149
Tender offer
An offer by those hoping to control the corporation
to purchase shares of dissatisfied investors.
Purchase shares of dissatisfied investors, usually at a 10 percent to 30 percent premium above the current stock price but below what they believe the company is really worth. If these takeover artists convince enough other investors to sell their shares, then they take control of
the company and begin to implement their own strategy.
150
Proxy fight
An attempt by dissatisfied investors or
| stakeholders to gain seats on the board of directors, or to influence corporate policy.
151
Agency problems destroy value in two particular situations:
First, when the principal’s
investments are sunk and difficult to recover, and
Second, when their ability to monitor and
supervise the actions and decisions of the agents, the managers of the corporation, is limited
152
To protect themselves against the second condition, principals employ
two tools to monitor their manager-agents:
monitoring through the board of directors,
and reducing the agency problem through compensation and incentives
153
The Board of Directors
A group of individuals who monitor the
executive team of the corporation and ensure that those executives are acting in the best interests of
the shareholders.
154
Fiduciary duty
The legal obligation of an agent, a fiduciary,
to act in the best interests of the principal, or owner.
```
Fiduciary duties include the duty of loyalty,
to work for the optimal good of
the owner, and the duty of care,
to not take undue risk that would
jeopardize the principal.
```
155
Inside directors
Executives or managers working inside the
company who also hold seats on
the board of directors.
156
Outside directors
Members of the board of directors not
employed by the corporation in
any other role.
157
Other constituency laws
```
Laws that allow the board of directors
to freely consider the needs
of stakeholders other than
shareholders when making critical
strategic decisions for the firm.
```
158
Pay for performance
```
Variable
or contingent compensation
that focuses managers on key
variables, designed to align their
interests with the shareholders
```
159
Bonuses
```
Additional
compensation paid to executives,
managers, and employees when
they meet certain performance
objectives
```
160
Stock-based compensation
Payment to organizational
members in the form of shares
in the corporation.
161
Stock option
The right to
buy a certain number of the
corporation’s shares at a specified
future date for a specified price.
162
Stock grants
gift, or grant,
of stock given to organizational
members, primarily executives.
163
Ethical values
Values that define for an individual, group,
or society things that are morally
right or wrong.
164
Philosophers have debated what constitutes ethical behavior for centuries. Participants in these debates employ one of four arguments in making
their case:
Philosophers have debated what constitutes ethical behavior for centuries. Debates
about ethics are debates about what is right and wrong, but also which behaviors lead to the
good or just society. Participants in these debates employ one of four arguments in making
their case:
1. A good society creates the greatest good for the greatest number of people
2. The good society ensures a basic set of rights for its citizens
3. The good society creates the most freedom for people to act as they please
4. In a good society, individuals care for each other, exhibit empathy with others, and focus
on meaningful relationships
165
1. A good society creates the greatest good for the greatest number of people
Goodness is measured as utility, or the presence of pleasure and the absence of pain
Utilitarianism, the name for this position, suggests that we can calculate what’s right by looking at the
benefits created by the action and then subtracting out the costs
166
2. The good society ensures a basic set of rights for its citizens
While utility is good, people
have fundamental rights that cannot be violated or traded away and duties they cannot
ignore.
This ethical tradition views people as ends in themselves and argues that it is
immoral to use people in any way as merely a means to an end
167
3. The good society creates the most freedom for people to act as they please
This moral philosophy is closely aligned with Libertarian political philosophies that advocate very
limited government and efficient markets.
Ethical behavior is that which promotes
human freedom of expression and development
168
4. In a good society, individuals care for each other, exhibit empathy with others, and focus
on meaningful relationships
Known as the ethic of care this position believes concerns for utility, rights, duties, and human freedom are all worthy aims, but in pursuit of these goals we need to be concerned about other people, empathetic to their plight, and mindful of the impact of exclusion
169
Caring for and Avoiding Harm to Individuals
Many people include animals and
the natural environment. Companies in the mining and oil extraction industries spend substantial
resources making sure they avoid undue harm to the environment.
170
Concern About Fairness and the Condemnation of Cheating
Fairness for some groups means equality, while for others it means equity or merit. Employees and
managers of financial services companies work in an environment ripe for insider trading, a
form of cheating
171
Recognition of Things as Sacred or Degraded
As companies enter markets where religious values and laws are strong, such as Islamic countries governed by Sharia law, they must ensure that their products and services conform to those
religious norms
172
Praise of Liberty and Condemnation of Oppression
Products, services,
or policies that promote human development, flourishing, freedom, and growth are praiseworthy,
while those that oppress people or cultures face condemnation
173
Culture
A pattern of behaviors
and beliefs that are considered
appropriate and correct for
organizational members.
174
Mission statement
A formal
declaration of a company’s core
values, business objectives, and
ethical aspirations.
A good mission
statement clarifies who the company’s stakeholders are and how they should be treated
175
7 S's (only two covered lol)
Shared Values
| Style
176
3 C's
Concise Statement
Competitive Advantage
Clearly defined scope
177
Indirect Assault
Successful entrants use strategies that allow them to stay under the radar screen of powerful incumbents and avoid incumbent retaliation
In general, the more indirect the assault, the more successful it is
178
How to Launch an Indirect Assault
To create successful Indirect Assaults, Profitable entrants to top markets combine at least two out of three approaches...
1. Leverage existing assets
•Companies leverage excess capacity in existing assets, often supplementing their resources with a partner’s, to overcome costly entry barriers at minimal cost
2. Reconfigure the value chain
•Entrants change the activities or the sequence of activities they perform to deliver value to customers.
3. Exploit a niche
•Entrants develop offerings that appeal only to some customers, particularly those that are over- or under-served by existing incumbent offerings
179
Looking for Entry Opportunities
1. Can We Reconfigure the Value Chain?
Examples: Can we use new technologies or perform activities in this industry in ways that weren’t possible
until recently?
2. Can We Find a Niche?
Example Q's: In this market, do customers care about a large number of features?
Do customers vary significantly in their preferences?
Are there distinctive groups of customers who are not well served by current offerings?
3. Can We Leverage our Assets and Resources?
Example: Do we have excess capacity in existing resource's related to either to Customers, Distribution Channels, Inputs, Processes, Technologies
180
Close the Door Behind You
Create barriers to entry by securing scarce inputs or
locations, investing preemptively in capacity, generating network effects, or developing cost advantages by racing down the experience curve (e.g., Jet Blue acquiring LiveTV; purchasing all of Embraer capacity).
181
Barriers to Mobility
Switching strategic groups is difficult because it is
hard and slow to reconfigure activities or activity
systems
•This inability to jump between groups is known as a barrier to mobility
182
Strategic Responses in Dynamic Environments
“Reconfigure processes and capabilities to emphasize
| innovation and speed”
183
Week 3, Slide deck 2, slide 23
Compares monopoly, oligopoly, and perfect competition
184
The English word govern traces its
| root back to in the ancient Latin word gubernare, which meant to_______________
steer or pilot a ship
185
Strategy in Practice: Mapping Stakeholder Influence
A great table showing all the possible stakeholder groups and a list of tools for listening and responding to them
186
Which correctly lists Porter's five forces
```
Rivalry
Buyer Power
Supplier Power
Entrants
Substitutes
```
187
Generally, how does the number of buyers affect buyer bargaining power?
When there are fewer buyers, buyer bargaining power is high
188
If there are lots of buyers, but few sellers, buyer bargaining power tends to be
Low
189
An industry is less attractive the lower number of substitutes there are
False
190
Direct competitors are companies that are in your industry but not in your strategic group
False
191
How do companies in different strategic groups differ from each other?
They employ different business and go after customers with different value propositions
192
If something is legal, it must be ethical
False
193
The word governance originally meant
Steering or piloting a ship
194
Which of the following is NOT important for members of the Board of Directors to have
Friendship and rapport with top manager
195
Ethical values are those values that distinguish what is legally right and wrong
False
196
Which of the following is NOT important for members of the Board of Directors to have?
Independence from corporate executives
