Introduction to Strategy

AGENDA

Agenda

What is Strategy?
Corporate Strategy
Business Strategy
Summary

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WHAT IS STRATEGY?

There are numerous definitions of strategy, but essentially is an integrated set of

choices, explicitly stating Where and How to Win

Strategy Definitions

Various Definitions Our Preferred Definition

Strategy is a plan to differentiate a business from its

An integrated set of choices, explicitly stating:
competitors profitably and sustainably (Bain & Co,
1994)
Strategy is a plan to create value by inducing your
competitors not to invest where you intend to invest
the most (Bruce Henderson, 1970)
Competitive strategy is a plan to establish a
profitable and sustainable position against the forces
that determine industry competition. Two central
questions underline the choice of strategy. The first
is the attractiveness of industries for long term
profitability. The second is the determinants of
relative competitive position within an industry
(Michael Porter)
A winning strategy seeks advantage over
competitors, but it also seeks ways to gain
advantage over other players in the industry chain
(McKinsey Staff Papers 1991)
Where to Win
- Which geographies will we target?
- What products would we consider?
- Which customer segments do we serve?
- Which channels do we use?
- Where in the value chain do we play?
How to Win
- What is our unique value proposition?
- What is our completive advantage?
What will we need do it?
What capabilities do we have today?
What capability gaps do we need to fill?
How do we structure ourselves?

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WHAT IS STRATEGY?

Corporate strategy has different concerns to business strategy

Corporate Strategy vs Business Unit

The What, Where, When The How

Corporate Strategy Business Strategy

Where to compete what industries to How to compete within a given industry

select how to manage diversification how to build sustained cost and
across domains value advantages in that domain

Corporate strategy is about Business strategy is about building a

managing diversification (who is the sustained competitive advantage
natural owner?)

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AGENDA

Agenda

What is Strategy?
Corporate Strategy
Business Strategy
Summary

5
CORPORATE STRATEGY

Corporate strategy typically centres around what businesses a company should be

in. This diversification can be horizontally or vertically related, or unrelated

Different Modes of
Diversification
1. Vertical Diversification
e.g. bauxite mining, alumina
refining, aluminium
Upstream smelting, extruding/ rolling
Business

2. Horizontal Diversification
e.g. PCs, printers

Current Related
Business Business

3. Unrelated Diversification
e.g. batteries, rubber gloves,
food
Downstream Unrelated
Business Business

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CORPORATE STRATEGY

Corporate strategy does not add value by eliminating volatility of returns for
investors they can do that themselves

Financial Diversification
Standard Deviation
of Portfolio Returns

An investor can
diversify away
Business unique or business
specific or
specific risks by
unique risk
assembling their
own portfolio
they dont need a
corporate to do this
for them

Market or Systematic Risk

0 5 10 15
Number of Stocks in Portfolio

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CORPORATE STRATEGY

rather, it is about how to optimise value

Depends on the value

extracting capabilities of
the parent
Only worth diversifying
into this business if the
Value due to synergies with existing parent can extract
NPV businesses in portfolio extra cash flow
Can a different parent
extract more cash than
we can?

NPV of
Business in
Portfolio

Depends on industry
attractiveness and relative
competitive position

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CORPORATE STRATEGY
The range of different frameworks used to consider corporate strategy broadly fit into
two categories financial or comprehensive
Financial Frameworks
Explicitly measure the value of each business unit
in the portfolio
Portfolio selection based on a comparison of the
value created by each business unit (i.e.):
Invest in high value markets
Improve performance of / or divest business
units that are destroying value
Financial frameworks measure the difference
between:
ROE and Cost of Equity or
ROCE and Cost of Capital
Neither framework identifies how the value of a
business unit can be increased
Comprehensive Frameworks
Use variants of the market attractiveness /
competitive position matrix to analyse the relative
value of each business unit in the portfolio
Earlier frameworks use single variables
More developed frameworks:
incorporate other dimensions in the analysis
(eg risk, extent to which the companys
strengths match the critical success factors in
the market)
weight and rate a list of criteria
Each framework recommends certain strategies
depending on the position of the business unit in the
matrix:
Invest to grow
Divest
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CORPORATE STRATEGY - FINANCIAL FRAMEWORK

The methodology for financial framework looks at performance measurement and

comparison

Financial Framework Example - ABC Company

ABC Companys approach asserts that firms cannot create value unless they invest in projects /
product lines that generate rates of return in excess of their cost of capital
Their approach values business units on the spread between current ROE and Cost of Capital, not
just on ROE
Investment in businesses with positive spreads is advisable, while business units with negative
spreads should be turned around to increase profitability, or divested
Methodology Input Application Output
Net profit after interest and Calculate Cost of Capital by business ROE by business unit
Performance
Measurement
tax by business unit unit Cost of capital by business unit
Equity Calculate ROE by business unit Spread between ROE and
Cost of equity Calculate difference between ROE COC for each business unit
Financial structure by and COC for each business unit
business unit

Spread between ROE and Compare spreads across business Portfolio options
Performance
Comparison cost of capital by business units
unit Identify portfolio options :
Invest in growth of positive - spread
business units
Units with negative - spreads
should be turned around to
generate higher profitability or
divested

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CORPORATE STRATEGY - COMPREHENSIVE FRAMEWORK

The BCG matrix is a well known example of a comprehensive corporate

framework

Comprehensive Framework Example (1) BCG Matrix

The original BCG framework for strategic High

Stars Question Marks
portfolio analysis was developed in 1967 Businesses have large Businesses with low share
Market attractiveness is measured by the share of high growth in high growth market

Future Market Growth Rate (%)

market
future growth rate and competitive position by Although stars are
the relative market share(1) profitable, they usually
consume considerable
The approach recommends four broad cash to continue growth
strategies:
Build market share
Hold market share Cash Cows
Harvest Businesses have high
share of low growth
Divest market
Often highly profitable and
Initially widely used, but has been outdated established leaders
due to its simplicity Usually have excess cash
which can be utilised in
star and question mark
business units
Low
Potential to grow and
become market leaders /
stars
May need to eventually be
divested if they cannot
grow without significant
financial investment
Dogs
Business units with low
share in low growth
market
Often marginal
businesses that incur
small profits or losses

High Low
Relative Market Share

Note: (1) Relative market share is the business units market share relative to that of the largest competitor in the market.

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CORPORATE STRATEGY - FINANCIAL FRAMEWORK

The Directional Policy Matrix assess profitability and competitive positioning

Comprehensive Framework Example (2) DPM (McKinsey similar)

The Directional Policy Matrix (DPM), originally developed by Shell, is comprehensive, but has a
manufacturing bias due to the nature of Shells business
It uses similar drivers to Porters analysis, considering the factors that influence long term profitability in the
market and long term competitive position of the business unit
Criteria are
Prospective forweighted, ranked
Market Sector Divestment
and combined to quantify
Profitability recommended
market due to
attractiveness weakness
and in market
competitive potential and
position
competitive position.
Unattractive Average Attractive
Weak

Divest Phased Double or

Competitive Position

withdrawal quit Businesses are typically cash generators, so maintain market

position and aim to harvest as much cash as possible. Proceed
with Care businesses have better growth opportunities.
Average

Phased Proceed Try harder

withdrawal with care

Growth strategies are recommended for these cells :

Strong

Phased Growth Leader Investment should be greatest in Leader and Growth markets
generator
Leaders should be supported, but Growth businesses should aim
for balanced cash flow
Invest for growth in Double or Quit markets with best long term
potential, but divest from businesses expected to fail

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CORPORATE STRATEGY

The common theme underpinning these corporate strategy frameworks is their

assessment of market/ industry attractiveness and competitive position

Porters Five Forces

Potential
Potential
Entrants
Entrants
Threat of New
Entrants

Industry Bargaining Power Bargaining

Attractiveness Industry
Industry
of Suppliers Competitors Power of Buyers
Competitors
Suppliers
Suppliers Buyers
Buyers
Rivalry
Rivalry among
among
existing
existing firms
firms
Threat of Substitute
Products or
Competitive Position
Services

Substitutes
Substitutes

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CORPORATE STRATEGY

Assessment of industry attractiveness and competitive position can be quantitatively

derived

Quantitative Scoring

Competitive Structure Competitive Position

Power
Power balance
balance between
between suppliers
suppliers
Linked to Demand Level
Level of
of customer
customer control
control
and customers
and customers

Barriers
Barriers to
to entry
entry Access
Access to
to market
market
Linked to Supply
Competitive
Competitive pressure
pressure Market
Market share
share

Level
Level of
of price
price differentiation
differentiation Position
Position on
on price
price
Linked to Economics
Level
Level of
of cost
cost differentiation
differentiation Position
Position on
on cost
cost

Overall Assessment X n x1 x2 x3 ...xn Y n y1 y2 y3 ... yn

xi = competitive structure criteria i yi = competitive position criteria i

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AGENDA

Agenda

What is Strategy?
Corporate Strategy
Business Strategy
Summary

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BUSINESS STRATEGY

Business unit strategy is fundamentally based on addressing two key areas

Key Components

Key Questions Key Considerations

1. Are returns satisfactory? Growth rate

1. Industry
Industry Attractiveness
Attractiveness
Which segments are most profitable?
What games should we play to win?
Relates to product lifecycle
Pricing, cost leadership
Impact of scale
Barriers to entry/ exit
Degree of rivalry between players
Availability of substitutes
Bargaining power of buyers

Can we develop a competitive Cost position

2.
2. Competitive
Competitive Position
Position position? Market Share
Is this position obtainable given our Product value proposition versus
current skills and capabilities? competitors (premium, brand, )
Is this position sustainable? Control over value chain
Buying power

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BUSINESS STRATEGY

The key considerations in answering these questions can be considered in terms of

a strategic balance sheet

Strategic Balance Sheet

Assets Liabilities

Customers
The current and potential value of
the customer base and the
vulnerability of high value
segments
Capabilities
The potential contribution of
capabilities (skills, processes,
organisation, culture); the ability to
mobilise these capabilities and
realise the full potential longer
term
Costs
Operating costs and potential long-
term cost position
Competitors
Competitor strengths, the impact
of competitor tactics and the effect
on longer term competitive
dynamics

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BUSINESS STRATEGY

Michael Porters generic business level framework demonstrates there are only a
handful of generic strategy choices

Business Strategy Framework Example How to win

Porters Generic Business Level of Competitive

Source of
Source Advantage
Competitive Advantage
Strategies
Cost
Cost Uniqueness
Uniqueness

Broad
Broad Cost
Cost
Target
Target Differentiation
Differentiation
Leadership
Leadership
Market
Market
Where to Win

Source
Source of
of
Competitive
Competitive
Advantage
Advantage

Narrow
Narrow Focused
Focused Low
Low Focused
Focused
Target
Target Cost
Cost Differentiation
Differentiation
Market
Market

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AGENDA

Agenda

What is Strategy?
Corporate Strategy
Business Strategy
Summary

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SUMMARY

Both Business Unit and Corporate strategy have the same common building blocks
around industry and company performance

Strategy Building Blocks Summary

Corporate
Corporate Business
Business Unit
Unit
Strategy
Strategy Strategy
Strategy

Where to invest? Same as for Business

How to maximise + Unit Strategy (for
Vs.
Industry Attraction
multiple businesses)
synergies? +
When to divest (who Corporate Position (for a single
is natural owner)? business or DBA)

Both based on considerations around common

themes of Demand, Supply, Economics

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SUMMARY

Why are Strategic Frameworks Useful?

Project / Process Perspective

Focuses the work on the most relevant issues that can be explored in
appropriate depth
Minimize yield loss due to excessive analysis of potentially irrelevant issues
Increase odds of identifying creative, full potential strategies, e.g.,
A ROS/RMS strategy in a high road industry might:
- Provide acceptable results but
- Ignore the upside that could be achieved through investing in brand
equity or differential pricing
Better connect with clients / management who expect a multifaceted approach

Outputs Perspective
Provides a clear and easily understandable way of describing the key drivers of
industry / company performance
Ensures that reasonable strategies will be identified in all cases, regardless of
time for analysis

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