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Table of Contents Keith Parker’s Notes from USC
Volume 5 of 5
Senior Year, Second Semester Page Content BUAD-497: Strategic Management 1 Syllabus 11 Course Documents 25 Assignments 37 Class Notes 63 Group Project 89 Powerpoint Slides FBE-440: Trading and Exchanges 179 Syllabus 190 Course Documents 214 Assignments 228 Class Notes 243 Exam Things FBE-462: International Trade and Commercial
Trade 272 Syllabus 277 Course Documents 282 Handouts 286 Homework 300 Class Notes 315 Group Project 356 Powerpoint Slides MOR-492: Global Strategy 401 Syllabus 412 Discussion Help 413 Reading Notes 417 Class Notes 435 Projects 493 Powerpoint Slides
University of Southern California Marshall School of Business
BUAD 497: STRATEGIC MANAGEMENT
Spring 2007 Instructor: Peer C. Fiss, Ph.D. Office: Bridge Hall 303-B Phones: Office: 1-213-821-1471 Email: [email protected]: Section 15102R – T/TH 12-1:50pm ACC 201 Section 15107R – T/TH 2-3:50pm HOH 304 Section 15112R – T/TH 6-7:50pm ACC 201 Office Hours: Wed 2:00pm – 4:00pm and by Appointment Prerequisites: Successful completion of all core business requirements COURSE DESCRIPTION This course introduces the concepts, tools, and first principles of strategy formulation and competitive analysis. You will learn about why some firms survive and prosper while others do not, and develop the critical analysis and communication skills necessary to create and implement firm strategy. The course focuses on the information, analyses, organizational processes, and skills and business judgment managers must use to design strategies, position their businesses and assets, and define firm boundaries, to maximize long-term profits in the face of uncertainty and competition. Strategic Management (BUAD 497) is an integrative and interdisciplinary course in two important respects:
1. The course assumes a broad view of the environment that includes buyers/consumers, suppliers, technology, economics, capital markets, competitors, government, and global forces and it assumes that the external environment is dynamic and characterized by uncertain changes. In studying strategy, this course draws together and builds on all the ideas, concepts, and theories from your functional courses such as Accounting, Economics, Finance, Marketing, Organizational Behavior, and Statistics. However, it is much more than a mere integration of the functional specialties within a firm.
2. The course takes a general management perspective. It views the firm as a whole, and examines how
policies in each functional area are integrated into an overall competitive strategy. We designed this course to develop the “general management point of view” among participants. This point of view is the best vantage point for making decisions that lead to sustainable business performance. The key strategic business decisions of concern in this course involve determining and shaping organizational purpose to evolving opportunities, creating competitive advantages, choosing competitive strategies, securing and defending sustainable market positions, and allocating critical resources over long periods. Decisions such as these can only be made effectively by viewing a firm holistically, and over the long term.
This course is intended to help you develop skills for formulating strategy. These skills will help you in whatever job you take after graduation as well as in your personal investing and choice of employment. The strategy formulation process demands the mastery of a body of analytical tools and the ability to take an integrative point of view. You will develop these skills through:
• In-depth analysis of industries and competitors • Prediction of competitive behavior • Techniques for analyzing how firms can develop and sustain competitive advantages over time
NOTE: BUAD 497 is a core course taught by several instructors. Policies regarding assignments and grading may be different for each instructor. Be sure to refer ONLY to this syllabus.
BUAD-497: Syllabus
2
EDUCATIONAL OBJECTIVES Theory and Concepts. The central concept of this course is that of competitive strategy. Definitions abound, but they all share some sense of the allocation of critical resources over relatively long periods in pursuit of specific goals and objectives. Successful strategies exploit external conditions, entrepreneurial insights, and internal resources, seeking configurations of prices, preferences, technologies, and information that offer opportunities for sustainable competitive advantage. Strategy can be usefully thought of as the comprehensive alignment of an organization with its future environment. Success, however, depends not only on the soundness of the strategy, but also on its effective implementation through appropriate organizational and administrative choices. In the end, unforeseen external factors may cause a well-conceived and executed strategy to fail, in spite of its initial wisdom -- but a poor strategy badly executed increases the chances of failure. Opportunities to act strategically often do not come labeled as “strategic” and occur infrequently. If missed, or mismanaged, they can prove disastrous for any firm. Understanding the concept of competitive strategy formulation is a primary educational objective of this course. This will involve mastering an array of economic, strategic, and organizational concepts and theories, and acquiring an integrative general manager’s point of view. The course will cover theories for in-depth industry and competitor analysis, for anticipating and predicting future industry developments, and for examining the impact of change (in technologies, tastes, government regulations, global competition, and other important environmental forces) on competition and industry evolution. The course will also examine the economic underpinnings of competitive advantages, and the fundamental conditions that allow firms to conceive, develop, and sustain, advantageous strategic positions. While our primary focus will be on mastering strategy formulation at the business unit or competitive level, the course will also examine corporate and global strategy issues such as diversification, vertical integration, economies of scope across related businesses, the transfer of technology and core competencies, and international expansion and growth. Analytical Skills. Theoretical concepts are a great aid to understanding, but by themselves, they do not help resolve real business problems or challenges. Also needed are analytical skills and techniques that can be applied to the data to "fill in" the facts and premises assumed in the theories. A second educational objective is further to increase each student’s inventory of useful analytical skills and tools. Some of the tools are quantitative -- analyzing financial statements, computing comparative buyer costs, and calculating the effects of scale and learning on production costs, for example -- while others are qualitative. Learning how to apply these techniques, and, more importantly, when to apply them is a key objective of the course. In learning to size-up a business and its problems or opportunities, this course will require you to conduct "full blown" strategic analyses. That is, identifying firms’ strategies and testing them for consistency, recognizing potential entrepreneurial opportunities and strategic challenges/problems, selecting and establishing competitively protected market niches, identifying competitive advantages and shaping defenses to circumvent the advantages of rivals, formulating and implementing internally consistent business strategies, and designing efficient and effective organizations. Rhetorical Skills. The best analysis in the world will have little effect if it cannot be communicated to others. Managers must be able to articulate their views coherently and persuasively, and they must be skilled at understanding and analyzing other points of view. Management is a "verbal sport;" perhaps 90% of a typical manager's day is consumed by oral communication. Time is often scarce. You must learn to make convincing arguments and to make them quickly, or the merits of their ideas are likely to become simply irrelevant. This skill takes practice, and we will place a great deal of emphasis on it in class. Wisdom. Much of the knowledge that successful managers and consultants employ consists of "rules of thumb" about what issues are likely to be important in certain kinds of business situations. These rules of thumb, or heuristics, are often implicit in the thinking of people who have never bothered to articulate them explicitly. A fourth goal of this course is to help you build up your set of useful "stories" and heuristics for your future managerial careers. In this course, we are as much interested in developing an appreciation for the art of management as we are in understanding the science of management. Tools alone will not a strategist make. While the ability to master
BUAD-497: Syllabus
3
analytical models, frameworks, and tools is essential, ultimate success is more strongly predicated on prescient judgment, entrepreneurial insight, iconoclastic vision, and a willingness to act forcefully with conviction. COURSE FORMAT AND THE CASE DISCUSSION METHOD In order to achieve the objectives of the course, we will devote the majority of our class time to the analysis and discussion of selected management, competitive strategy, and business policy cases. I will use lectures to elaborate on key theoretical models and frameworks or to reinforce crucial concepts. These lectures, however, will be subordinate to the case analysis. Cases provide a natural "test-bed" for theory and provide vivid examples that aid memory of concepts. While nothing can surpass first hand personal industry and managerial experience as a basis for analysis and decision-making, case analysis is an indispensable proxy for the kind of knowledge that can only be gained through years of experience and research. I have selected a mix of old and new business cases on a range of companies from a variety of industry settings. Each case is intended to teach us something specific, yet each can teach many things. We will not attempt to exhaust each case of all its learning experiences, but rather build up a "tool kit" of analytical tools, skills and insights, progressively over all the selected cases. There are other reasons for employing the case discussion method of instruction. First, it allows you to develop skills at problem definition in addition to problem solving. Cases typically do not have an obvious set of tasks whose performance will lead to mastery. Rather, they force you to sift through a mass of information, some of it irrelevant or contradictory, in order to identify the important or strategic issues. Second, the case method gives you a chance to deal with ambiguity. Most cases do not have obvious "right" answers. Managers must be able to function in situations where the right answer is not known, without falling into the trap of assuming that any answer is as good as another. Some analyses and proposed strategies are clearly wrong, and some are clearly better than others are. A popular phrase in case analysis classes is "There are no right answers, but there are wrong answers." Case discussion techniques provide a chance to learn the meaning of analytical rigor in situations other than open-and-shut problems. These rationales are offered because the case method is unfamiliar to most of you and frequently causes initial confusion. There will be many times when I will not reveal my own opinions about a particular issue, and there will be many cases that do not end up neatly packaged with an "answer." You may discover that your preparation "misses" key points of a case, especially at first. This is a normal part of the learning experience. While we will direct class discussions, the quality of your learning experience will be directly determined by: (1) your degree of preparation, active listening, and participation, and (2) your classmates' preparation, listening, and participation. Some will not agree with you, and you may be asked to defend your argument or change your mind. So long as criticism is directed at arguments and not at individuals, is relevant to the issues at hand and coherently argued, it is very much welcomed. Case Preparation Because this course relies heavily on case material, extensive before class preparation and in class participation are required to ensure the class' success. (1) Preparation for a case discussion should begin with a rapid reading of the assigned case and other materials. (2) Then, it is worthwhile to review the discussion questions provided for clues as to what issues require special attention. (3) The next step is normally to re-read the case carefully, taking notes which sort information, facts, and observations under a number of relevant headings. Try to formulate theories or hypotheses about what is going on as you read ("the company loses money on small orders"), modifying or rejecting them as new information surfaces ("Table 2 shows that shipping costs per unit are higher for small orders, but only for long-distance shipments"). Push yourself to reach definitive conclusions before you come to class. (4) You should perform quantitative analyses, “crunching” whatever numbers are available. It is also very important to provide quantitative support wherever possible, particularly when exploring various hypotheses as to the nature and importance of certain phenomena. (If the requisite data are not available in the case, a precise description of what data are missing often triggers ideas for making creative use of the information that is available.) It is usually worthwhile to identify trends in the firm or industry, preferably with a quantitative measurement. Some of these trends, often very important ones, will not be flagged in the text of the case. (5) Finally, preparation will include notes that can be used to guide your interventions in class discussions. You will probably want to, and I strongly encourage you to form study groups that regularly meet to share insights and ideas about the assigned cases. While this is voluntary, experience shows that satisfactory performance in this course, and a good grade, depend on it.
BUAD-497: Syllabus
4
WARNING! There is a good chance that you will feel a bit confused or overwhelmed during the first module, or two, of the course. This is a byproduct of the peculiar structure of the strategy course that does not build up linearly by successively adding components of knowledge week by week. Rather, every case in a sense contains all the material in the entire course. Furthermore, the early theoretical concepts will gain in meaning to you once you have worked through a few cases. As a result, there is no logical way to begin except by immersion. So remember: SOME CONFUSION IS NORMAL AT FIRST. You will gain experience as we progress through the course. COURSE EVALUATION Course grades will be determined by individual and group activities: Course contribution and participation 15% Individual mini case analysis 10 Individual midterm exam 20 Group project presentation 10 Group project writeup 20 Individual final exam 25 100% In order to pass this course successfully, a passing grade (> 50%) must be achieved in the group and in the combined average of the individual components. Please note that if your individual performance in the course is unsatisfactory, it will not be brought up by a good group grade. The distribution of grades will closely follow the guidelines of the Marshall School of Business (an average class GPA of 3.0 for required courses). Course Contribution and Participation. Managers must often “sell” their ideas to others in order to get their acceptance and support. In this course, the classroom provides a laboratory in which you can test your ability to convince your peers of the appropriateness of your approach to complex management problems. Furthermore, it tests your ability to carefully listen to others’ perspectives and understand why they may reach a different conclusion. Before you can effectively sell your ideas to others, you must understand what is motivating them, what issues they feel are important, and what assumptions they are making that may be different from your own. When evaluating your contribution to the class discussion, then, I will consider how effectively you put forth your own arguments, as well as how well you listen to, understand, and build upon (or refute) the arguments of others. In all cases, I will look for high quality (which is frequently not the same as high quantity) arguments, analyses and questions that improve the class’ collective understanding of the case issues. While I encourage you to speak up at any time, keep in mind that comments that are redundant, tangential or seemingly irrelevant to the case discussion at hand or attempts to dominate class discussion will have a negative impact on your participation grade. I will use the following criteria when determining class contribution grades: • Has the student attended and made significant contributions to each class discussion? • Does the student show evidence of careful case analysis by using facts and evidence from the case? • Does the student draw valid conclusions from the facts presented in the case? • Does the student contribute interesting examples? Does the student make effective comparisons among
different cases situations, as well as between case situations and real life cases? • Do the ideas suggested by the student push us to consider an aspect of the case that is not necessarily obvious at
the outset? Do they go beyond the surface and get into core issues? • Is the student is an active listener? Do his/her comments fit in with the flow of the class discussion? Do his/her
comments demonstrate listening to and reflection on points suggested by others? Does the student interact with, challenge, question, and extend comments of other participants, or are all comments directed towards the instructor?
• Does the student engage in constructive debate that challenges the opinions expressed by others without diminishing the value of their contribution?
BUAD-497: Syllabus
5
I realize that some of you may be shy about speaking up in a large class like this. Therefore, I offer you the opportunity to somewhat compensate by participating in the class’s online discussion group. The same evaluation criteria apply here as for in-class discussion. However, keep in mind that this can never fully substitute for in-class discussion. Please remember that your classmates and I expect you to attend and be well prepared for each class, having read the required conceptual material and analyzed the assigned case study ahead of time. We also expect you to play an active role in class discussion. If all class members prepare for and actively participate in each class discussion, your experience will be all the better for it. I will ask you to speak even if you have not volunteered, so please be ready for discussion every class. Individual Mini Case Analysis. For this assignment, I will ask you to analyze a recent event in the business press using the tools we have discussed in class. The analysis should not exceed four (4) double-spaced pages with 1" margins and 12 point font. I will post more information on this assignment on the course website. This assignment will be due on Tuesday, February 6. Individual Midterm Exam. For this assignment, I will provide you with specific questions regarding a company case, and your answers should be confined primarily to the facts as presented in the case. You are expected to use both the concepts and the terminology presented in this course in your write-ups. For the mid-term analysis, the analysis should not exceed six (6) double-spaced typewritten pages, with 1" margins and 12 point font). Your analysis will be evaluated equally on the following criteria: • How well (i.e., thoroughly and concisely) do you describe the environmental context and internal factors that
are important to the problem? • Accurate and thorough use of course concepts • Integration of course concepts with information about the company and problem • How well do you integrate course concepts with information about the problem to illuminate the problem in a
way that leads to solutions? • Extent to which recommendations are consistent with analysis • Feasibility and specificity of recommendations • Quality of written analysis The individual midterm exam will be a take-home exam. It will be due on Tuesday, March 6, at the beginning of class. Please put your name and student number ON THE BACK OF YOUR EXAM ONLY, NOT ON THE FRONT. I don’t want to see your name while I grade these assignments. As always, you should not discuss the case itself with any other student. Group Project Presentation and Writeup. For this group project, you will self-select into groups of 4-6 members. It is your responsibility to form teams. All team members must be from the same section. The project requires you to examine strategic challenges or an issue of concern at real organizations. The purpose of the project is to give your team an opportunity to apply what has been learned in the course to strategic problems faced by real-world organizations. In terms of the topics for your analysis, groups can choose from a menu of topics including the organizational development of a firm over its entire history, an analysis of a firms’ responses to the internet, an analysis of the growth pattern of a successful and an unsuccessful firm, or a successful and unsuccessful radical repositioning of two companies. Your team should identify one or more public, private, or not-for-profit organizations to study. You may select an organization in which one or more of the team members has worked or been a member. I would suggest that you be selective in choosing an issue or problem to analyze, as a lack of background on the issue itself will not be an acceptable excuse for a lack of depth in the analysis. 1. an e-mail with the names an addresses of your group members, a team name, and a brief statement that
outlines your proposed project (see below)
BUAD-497: Syllabus
6
2. a written analysis and data appendix (20% of course grade) and 3. an oral presentation to the class (10% of course grade) 4. completing a peer evaluation form within 24 hours of the presentation You will conduct original research on your organization(s) and will supplement this information with data from the media, the organization(s)’ own literature, and other secondary sources. You should focus your analysis on applying concepts from the course. Although it is acceptable to incorporate several concepts from the course, please aim for depth rather than breadth regarding the use of course concepts. In my experience, papers that aim to apply a bunch of concepts end up being shallow in their analysis and don’t do well. The project proposal e-mail will be due by midnight on Wednesday, January 31. This e-mail should include: 1. The team name and names of all team members 2. A brief description (roughly 400 words) of your topic. The written analysis should not exceed fifteen (15) double-spaced typewritten pages, with 1" margins and 12 point font. I will only read the first 15 pages of text, so please stay within the page limit. The limit does not include appendices, which you can use to provide charts, figures, or other background material, but should be no longer than five (5) pages. Appendices which are not directly referenced in the text will not be read. The appendix is not a catch-all for anything that might be relevant, but is to be used carefully to support your points. Always include page numbers. Staple papers only, (no binding, folders, clips, or anything other than plain paper). This written document is due at noon on Friday, April 6 for all teams. Oral presentations will be given during the final 4 class sessions. Each presentation should be 25-30 minutes in length, and additional time will be set aside for questions from other teams after the presentation. Both the oral presentation and written document should cover all of the key elements of your analysis. For grading purposes, it will not be sufficient to orally present an aspect of your analysis that does not appear in the written document. The in-class presentation of your paper is worth 10% of the course grade. Half of these 10% will come from your peers, who will attend your presentation and afterwards score it, while the other half will come from my evaluation. It is therefore imperative that you both do well on these presentations and also attend the presentations of your peers, as you will have to post grades for them online. Also, I do not expect but welcome non-traditional forms of presentation. I expect that at this time of your USC career, you know how to give a professional presentation, so this may be a good opportunity to play around with the format. However, please remember that presentations that neglect content in favor of form are not likely to score well. Finally, each team is free to structure itself as it wishes. However, at the conclusion of the project, each member of the group will be asked to evaluate every other group member anonymously on the last day of class using a peer evaluation form that will be available on the course website. All team members must complete the form within 24 hours of their presentation. The goal of this evaluation is to discourage free-riding. If any students receives unsatisfactory ratings from their group, their grade will be marked down accordingly. Individual Final Exam. A final exam will be given during the exam time specified by the University. The exam will consist of questions on an exam case passed out to you one week prior to the exam. The format is similar to case presentations and discussions (e.g., you will be asked to diagnose the problem and make recommendations for action based on all the materials covered in this course). The anticipated times are listed in the course schedule attached at the back of the syllabus. However, you are responsible for confirming this date and time in the university schedule of classes. COURSE POLICIES Attendance. Attendance at all class sessions is expected. Because learning in this course occurs primarily through interactions with other participants during class, every effort should be made to attend each class. There is no substitute for being present, prepared, and participating in the class discussion. While I recognize that from time to time absences may be unavoidable, absences necessarily limit your class contribution (you can’t gain participation points if you are not there…) and hence can influence your grade. Please notify me by email at least a day in
BUAD-497: Syllabus
7
advance if you must miss a class. If you do miss class, it will be your responsibility to get notes, find out what was discussed, etc. from one of your classmates. Participation Cards. At the end of each case discussion, students who actively participated in the discussion should turn in a Participation Card. These cards should list your name, the date, the case discussed that day, and a synopsis of your contributions during that day’s discussion. The Participation Cards will be used in combination with my own daily evaluations to determine your participation grade for the day. For this purpose, please purchase a package of 3x5 index cards and bring them to each class. Please turn off all Communication and Entertainment Devices. Your classmates and I expect your full attention, so please keep your laptops closed unless we use them for an assignment. Also, please be sure your cell phones, pagers, Blueberries, phasers, tricorders, or other devices are turned off during class. Other Stuff: • Do not wait until the end of the semester to see me regarding problems with your performance. Your
performance in this class is important to me, so please see me early. • Written assignments must be submitted on time. As managers, you will not be afforded the luxury of missing
deadlines (think of deadlines as “windows of opportunity”). The discount rate for late assignments is steep. • If you can convey your thoughts more succinctly in your written assignments, please do so! Suggested paper
lengths are only upper limits. • Like managers executing actual strategies, we may find that the course syllabus must be amended slightly as the
semester progresses. Please be sure to check the course webpage before class for study questions and further information on the readings and cases!
COURSE MATERIAL Case Package: The assigned cases for this course are available from the University Book Store. When
necessary, I will place additional materials on the course website for you. Text: There is no required textbook for this course. However, if you would like to use a textbook to
extend your understanding, you are welcome to come by my office and browse my collection and pick my brain about them (i.e. which ones to buy, which ones to avoid…)
3x5 Cards: Please bring a deck of 3x5 cards to every class to record your participation (see above
description). COURSE COMMUNICATION: BLACKBOARD SYSTEM I have posted the course syllabus to the 497 folder for your section in Blackboard. I will also post additional course lecture notes/materials, further details on assignments, and general course announcements to this folder throughout the semester. You should develop the habit of checking the course folder on a daily basis. You can access Blackboard either by going to http://totale.usc.edu/webapps/portal/frameset.jsp or by going through the “My Marshall” portal http://mymarshall.usc.edu. You will need your UNIX password for either site. IMPORTANT: (1) Since e-mails sent to the class originate from the Blackboard system, it is your responsibility to make sure your e-mail is set up to forward your messages to your preferred internet provider (IP) account such as EarthLink, AOL, Hotlink, etc. (2) Be certain that you include a recent digital color photograph of yourself within the personal information section, as I will use these to learn your names (important for your participation grade). ACADEMIC INTEGRITY
The following information on academic integrity, dishonesty, and the grading standard are placed here at the recommendation of the School of Business Administration Faculty and are taken from the Faculty Handbook.
BUAD-497: Syllabus
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Additional statements about academic integrity may be found in SCampus handbook available at the Topping Student Center and online at http://www.usc.edu/go/scampus. Further information may be obtained from the Office of Student Judicial Affairs and Community Standards at http://www.usc.edu/student-affairs/SJACS/index. “The University, as an instrument of learning, is predicated on the existence of an environment of integrity. As members of the academic community, faculty, students, and administrative officials share the responsibility for maintaining this environment. Faculty has the primary responsibility for establishing and maintaining an atmosphere and attitude of academic integrity such that the enterprise may flourish in an open and honest way. Students share this responsibility for maintaining standards of academic performance and classroom behavior conducive to the learning process. Administrative officials are responsible for the establishment and maintenance of procedures to support and enforce those academic standards. Thus, the entire University community bears the responsibility for maintaining an environment of integrity and for taking appropriate action to sanction individuals involved in any violation. When there is a clear indication that such individuals are unwilling or unable to support these standards, they should not be allowed to remain in the University.” (Faculty Handbook, 1994: 20) Academic dishonesty includes: (Faculty Handbook, 1994: 21-22) 1. Examination behavior - any use of external assistance during an examination shall be considered academically
dishonest unless expressly permitted by the teacher. 2. Fabrication - any intentional falsification or invention of data or citation in an academic exercise will be
considered a violation of academic integrity. 3. Plagiarism - the appropriation and subsequent passing off another’s ideas or words as one’s own. If the words
or ideas of another are used, acknowledgment of the original source must be made through recognized referencing practices.
4. Other Types of Academic Dishonesty - submitting a paper written by or obtained from another, using a paper or essay in more than one class without the teacher’s express permission, obtaining a copy of an examination in advance without the knowledge and consent of the teacher, changing academic records outside of normal procedures and/or petitions, using another person to complete homework assignments or take-home exams without the knowledge or consent of the teacher.
The use of unauthorized material, communication with fellow students during an examination, attempting to benefit from the work of another student, and similar behavior that defeats the intent of an examination or other class work is unacceptable to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior resulting from the nervous tensions accompanying examinations. Where a clear violation has occurred, however, the instructor may disqualify the student’s work as unacceptable and assign a failing mark on the paper. STUDENTS WITH DISABILITIES
Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained from DSP. Please be sure the letter is delivered to me as early in the semester as possible. DSP is located in STU 301 and is open 8:30 a.m. – 5:00 p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.
BUAD-497: Syllabus
CO
UR
SE S
CH
EDU
LE
Tu
– T
h Sc
hedu
le fo
r Fa
ll, 2
006
Dat
es
Day
s of
th
e W
eek
Ses
sion
Topi
c
In
trod
uctio
n 1/
09
Tues
day
1
Intro
duct
ion
1/11
Th
ursd
ay
2
Pre
view
Cas
e: In
tel C
orpo
ratio
n
In
dust
ry a
nd F
irm A
naly
sis
1/16
Tu
esda
y 3
In
dust
ry A
naly
sis
I
1/18
Th
ursd
ay
4
Indu
stry
Ana
lysi
s II:
CF
Mot
orfre
ight
1/
23
Tues
day
5
Indu
stry
Ana
lysi
s III
: App
le In
c.: i
Pod
s an
d iT
unes
1/25
Th
ursd
ay
6
Firm
Com
pete
ncie
s I
1/30
Tu
esda
y 7
Fi
rm C
ompe
tenc
ies
II: P
epsi
co R
esta
uran
ts
Team
pro
ject
pro
posa
l e-m
ail d
ue b
y m
idni
ght o
n W
edne
sday
, Jan
uary
31
2/01
Th
ursd
ay
8
Firm
Com
pete
ncie
s III
: Wal
Mar
t 2/
06
Tues
day
9
Com
plem
enta
ritie
s an
d Fi
t
In
divi
dual
min
i cas
e an
alys
is d
ue a
t the
beg
inni
ng o
f cla
ss
2/08
Th
ursd
ay
10
Fi
t App
lied
I: P
rogr
essi
ve C
orpo
ratio
n 2/
13
Tues
day
11
Fi
t App
lied
II: A
irbor
ne E
xpre
ss
C
ompe
titiv
e D
ynam
ics
and
Posi
tioni
ng
2/15
Th
ursd
ay
12
C
ompe
titor
Ana
lysi
s 2/
20
Tues
day
13
C
ompe
titor
Ana
lysi
s A
pplie
d: R
yana
ir
2/22
Th
ursd
ay
14
C
ompe
titor
Ana
lysi
s A
pplie
d: L
eade
rshi
p O
nlin
e (A
): B
arne
s an
d N
oble
ver
sus
Am
azon
.com
2/
27
Tues
day
15
C
reat
ing
Com
petit
ive
Adv
anta
ge: H
arni
schf
eger
Indu
strie
s
3/01
Th
ursd
ay
16
S
usta
inin
g C
ompe
titiv
e A
dvan
tage
: Sat
urn
9
BUAD-497: Syllabus
3/06
Tu
esda
y 17
Sta
ndar
ds a
nd N
etw
ork
Ext
erna
litie
s I
Indi
vidu
al m
idte
rm e
xam
due
at t
he b
egin
ning
of c
lass
3/08
Th
ursd
ay
18
S
tand
ards
and
Net
wor
k E
xter
nalit
ies
II: T
he B
row
ser W
ars
3/13
Tu
esda
y --
Spr
ing
Bre
ak
3/15
Th
ursd
ay
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BUAD-497: Syllabus
Porter’s 5-force framework: • Assesses competitive position of a firm within an industry • 5 variables measure competitive advantage • Assumes continuous downward pressure of competition • Points to interdependencies between factors (i.e. interaction, substitution)
Competition… Threat of entry: ease of ability to enter new markets
Impacted by: absolute cost advantages, government policy, economies of scale, and brand identity (minimum efficient scale) Patents, tariffs, quotas, licensing, geographical locations, language/cultural
Buyer power: size and concentration of customers Impacted by: concentration, switching costs, backwards integration Powerful…large and concentrated, backwards integration Weak…fragmented, producer’s supply critical parts Supplier power: differentiation and switching costs Impacted by: # of suppliers, switching costs and presence of substitute inputs Powerful…concentrated and significant switching costs Weak…standard product and concentrated purchasers Rivalry: intense rivalry reduces average profitability
Impacted by: growth, differentiation, # of competitors, diversity and exit barriers Concentration ratio, Herfindahl Index (monopoly, perfect competition)
Threat of substitutes: price/performance ratios, switching costs and sub. improvement Impacted by: products in other industries ability to constrain the raising of prices
*Great framework for industry dynamics…but complimentors and government influence missing!
PEST: Political: tax policy, employment laws, environmental regulations, trade restrictions, tariffs and political stability. Economic: growth, interest rates, exchange rates and inflation. Socio-cultural: health consciousness, population growth rate, age distribution, career attitudes and safety. Technological: barriers to entry, MES and outsourcing decisions (R&D, automation). *Useful for understanding market growth/decline, business positions, potential direction for operations. Overview of various macroenvironmental factors in firm’s particular environment. These factors = external opportunities and threats in SWOT !!!
SWOT: Strengths: internal asset Weaknesses: internal liability Opportunities: external asset Threats: external liability *Unfortunately, most strengths have corresponding weaknesses and all future events are both opportunities and threats…thus, SWOT = introspective analysis of company, not the industry or competitive environment
Porter’s Generic Strategies: Strategy: unique position for a firm
not doing the same activities better, rather doing them differently or doing different activities. Strategy involves trade-offs
Due to incompatible product features, inconsistencies in image, limits of coordination, motivation, management, etc.
Strategy = achieving high degree of fit between internal activities and external environ. Operational effectiveness is not strategy
*Strategy key tension…control and flexibility!!!
BUAD-497: Course Documents
Hambrick and Fredrickson: Strategy: central, integrated, externally oriented concept of how to achieve objectives. Arenas: where will we be active? (geographically, industry, markets, segments/positions) Vehicles: how will we get there? (joint ventures, subsidiaries, LLP, corporations) Differentiators: how will we compete? (quality, quantity, cost, service, efficiency, safety) Staging: what speed and sequence of moves? (monthly, quarterly, annually, saturate markets, slow introduction, across entire continents, select countries) Economic Logic: where will profits come from? (premium prices, superior product, etc.)
*does strategy…fit environment? Exploit key resources? Sustain differentiators? Internally consistent? Enough resources to pursue in long term? *Elements of firm must reinforce strategy!!!
Boston Consulting Group Matrix: Stars: (high Market share, high Growth) Aggressive investment to support continued growth and consolidate competitive position of firm Question Marks: (low Market Share, high Growth) Selective investments: divestitures for weak firms or those with uncertain prospect for strategic fit.
Cash Cows: (high Market Share, low Growth) Investments sufficient to maintain competitive position: excess cash used to nurture stars and select question marks. Dogs: (low Market Share, low Growth) Divestiture, harvesting or liquidation and exit. *Measures market share against growth
McKinsey Matrix: Industry Attractiveness (comp. position-good, medium, poor): Low: profit producer, loser, loser Medium: winner, average business, loser High: winner, winner, question mark
Core Competencies: Core competencies combine resources and capabilities to create a competitive advantage.
Resources: tangible (factories, products) and intangible (reputation, loyalty) assets to firm in the form of: financial, physical, human, org. Capabilities: proficiencies enabling firm to take full advantage of resources (marketing and cooperative relationships).
Portfolio of Competencies: existing and new Existing: opportunity to improve existing position in markets by leveraging current core competencies…new products to be created from a different configuration of existing resources. New: new products required to protect and expand brand in current markets…the markets of the future.
Resource Based View (RBV) of Corporation: 2 critical assumptions: Resource Heterogeneity (differences in resources among existing firms) and Resource Immobility (costly for firms to acquire)…have something someone doesn’t and can’t get, then a sustainable competitive advantage is created. *Internal focus on idiosyncratic strategies (not external with identical)…resources not highly mobile, therefore possession directly correlated to competitive advantage.
VRIO: Value: resource enables firm to exploit opportunity (increase revenue) or neutralize threat (decrease costs). Rare: if not rare, perfect competition observed: no competitive advantage…must have scarcity among firms to enjoy rarity and competitive advantage. *Valuable and rare…competitive advantage *Valuable and not rare…competitive parity
BUAD-497: Course Documents
*not Valuable…competitive disadvantage Imitability: cost disadvantage in imitating valuable and rare resources = sustainable competitive advantage: intangible and bundles of resources more costly to imitate.
• Unique historical conditions: first mover advantage, path dependence • Casual ambiguity: bundling fogs actual casual links • Social complexity: unable to duplicate relationships exactly • Patents: periods of legal protection
Organization: align structure and control mechanisms to exploit resources and compliment other resources within firm (3M rewards innovation and risk taking). * Valuable, Rare, Imitate, Organized resources = sustainable competitive advantage.
Greiner’s model of Org. Growth: Phase 1: growth by creativity…crisis by style of management Phase 2: growth by tight management…crisis by autonomy Phase 3: growth by delegation…crisis by control Phase 4: growth by coordination…crisis by bureaucracy Phase 5: growth by team spirit…crisis by unknown factors *Firm grows as organization evolves…each new phase sparked by revolutionary infusion
Organizational Structures: Simple: low revenue base, simple product-market scope. Functional: increase in revenues, engage in vertical integration.
Cost Leadership: operations = main function. Process engineering > R&D. Large centralized staff, formal procedures, and highly structured job roles. Differentiation: marketing = main function. R&D, decentralization emphasized. Foster change and promote new ideas with organic, less structured job roles.
Divisional: expand into new/related product markets and/or geographic areas. More autonomy for divisions: corporate staff relegated to logistical and general strategic oversight. Divisions are solely responsible for functionality. *Decentralized structure (i.e. Nucor).
Matrix: expand internationally: extension of divisional concept to project level.
Mintzberg’s Organizational Theory: 5 Basic Elements Operating Core: employees perform basic work related to organization’s product. Strategic Apex: corporate executives responsible for running entire organization. Middle Line: managers transfer information between higher and lower levels of organizational hierarchy. Technostructure: organizational specialists responsible for standardizing various aspects of organization’s activities. Support Staff: individuals provide indirect support services to organization.
5 Organizational Structures: The Simple Structure: young, small; nonsophisticated technical system; simple, dynamic environment. (Key: strategic apex) Machine Bureaucracy: old, larger; regulating, nonautomated technical system; simple, stable envir. (Key: technostructure) The Divisionalized Form: diversified markets (esp. products & services); old, large. (Key: Market grouping, performance control, limited vertical decentralization) The Professional Bureaucracy: complex, stable envir. Nonregulating, nonsophisticated technical system: (Key: Operating Core). The Adhocracy: complex, dynamic envir.; sophisticated and often automated technical system (Key: Support Staff) *The Idea Organization: Value-based organizations, public/religious organizations…Jehovas Witnesses, Greenpeace, Al-Qaeda, IRA
Activity Systems:
BUAD-497: Course Documents
Configurations exhibit high degrees of internal fit. Interplay of complementarities and trade-offs across multiple activities is critical to success...equifinal (different, yet equally effective methods). Must extend and strengthen fit among activities according to strategic position.
What is strategy? Unique position, tailored activities, clear tradeoffs, continuity of position with consistent improvement and integrated system of activities with fit. What is not strategy? Best practices, learning, agility, flexibility, restructuring, mergers/consolidation, alliances or the Internet.
Game Theory:
1. Structure of games: • Players – any number of persons • Rules – determined by the number of options/alternatives in the play of the game. Structure of
play off matrix is a function of the rules of the game. • Payoff Structure
1. Zero sum: one side must get less if the other gets more 2. Non-zero sum: not an equal trade off of +/-
• Strategies 1. Minimax – to minimize the maximum loss; defensive strategy 2. Maximin – to maximize the minimum gain; offensive strategy 3. Tit-for-Tat – always respond in kind 4. Tat-for-Tit – always respond conflictually to cooperation and cooperatively towards
conflict
2. Moves to change the game played: • Players: can bring in customers, bring in suppliers, bring in complementors, or bring in
competitors. • Added Value: can limit the supply, raise amount of consumers are willing to pay, or lower
competitors’ value. • Rules of the Game: can change the rules to benefit you • Tactics employed: can make the game more transparent or opaque, depending on which
benefits you • Scope of the Game: you can link games to other games or de-couple the game from other
games.
3. Basic games: Prisoners’ Dilemma – The result of using a minimax strategy. It assumes no communication. Strategies can be altered if there is sufficient trust between the players. Both confess at the saddle point. Characterized by T > R > P > S
• Temptation: desire to double- cross other player • Reward: cooperate with the other player • Punishment: from playing it safe • Sucker’s pay off: for the player who is double-crossed
Chicken – there is no saddle point. No matter what one player choose, the other player can change for some advantage. It is unstable and the outcome cannot be predicted, but credible commitment can persuade the other player to back down
Dilemma of the Commons – the problem of the unregulated use of a public good. Someone takes advantage of a shared good and profits himself but reduces the overall capacity of the market, hurting the rest of the group.
Competitor profiling
BUAD-497: Course Documents
Complements game theory w/ competitor profiling to work around restrictive assumptions on which game theory is built
Behavioral perspective • Focus on competitors’ predispositions • What competitors really want given beliefs, blind spots, and historical gathering
Why Competitor Profiling Matters • Goals may not be fully rational
• Differences in an organizations’ charter (public, non-profit, family-owned) • Beliefs—see the world differently
• Mental models may differ (diff. in functional backgrounds) • Agency problems (top-management’s interests may be different) • Irrationality (pride, jealousy, fairness)
• Routines may constrain opportunities for action • inertia due to size/family/maturity/complexity/strong culture/bureaucratization
Integrating game theory and competitor profiling • Think Broadly about the set of strategic options
• Variables (organization, customers, pricing) • Asymmetric • Commitment postures • Information
• Augment your toolkit for dynamic Analysis • Scenario analysis (role-playing/devils advocate) • Market testing • Sequenced rollout
• Match analytics and industry/company context • Do general assumptions hold in the industry/company? • But: question industry logics/orthodoxies
Value chain analysis, including value creation, value division, value added, the value net
Value added chain analysis (Harnishfeger Case)
• Why Value Creation? • Before who gets what, determine what there is to get
• Assessing= • Who are the players? • Customers willing to pay? • Suppliers’ opportunity costs?
Value Chain • Production Flow
SUPPLIER resource or input BUSINESS product/output CUSTOMER
• Monetary flow ($) CUSTOMER BUSINESS SUPPLIER
Value Creation
SELLER (indifferent) Opportunity cost
BUAD-497: Course Documents
Cost (profit) Price Willingness to pay BUYERS
Value Created = buyer’s willingness to pay – supplier’s opportunity costs
• Price measures the division between business and the customer • Cost measures the division of value between business and supplier
Value Added = total value with you – total value w/o you • What you bring to others
| Cost | Price | (positive bargaining zone) | Willingness to pay
Size of the pie = willingness to pay – opportunity cost
Division of the pie = value added
Value net
Customers
/ | \
Competitors Company Complement
\ | /
Suppliers
Standards/network externalities and their role in strategy (open/closed, tactics etc..)
Standards matter whenever products depend on compatibility
Strategies • Hold back product launch • Adopt a simple, undifferentiated, standard design • Encourage imitation by other manufactures • Lower prices to maximize early sales
• Sony vs. JVC
BUAD-497: Course Documents
• Standards introduce network effects • Benefits that come from having a large installed base of users • Classic examples are literal networks
• Telephone • Fax • Internet
• Number of possible connections grow rapidly w/ number of users – “network externalities” • System w/ one user is of little users • System w/ all customers on is very valuable
• Windows vs. Mac
Wins and looses • Consumers
• Better off • Reduced uncertainty • More users, more value • Decrease in variety
• Complementars • Generally better off • Brokering role
Key Points • Understand the positions and interests of all pates involved in the standards competition • Strength of position – 7 key assets
1. Control over an installed based 2. Intellectual property rights 3. Ability to innovate 4. First-mover advantages 5. Manufacturing 6. Strength in complements 7. Reputation and brand name
• Preemption • New technologies require champions to invest early to build • Being first can back fire if there are better technologies arriving soon
Expectations Management • Engage in aggressive marketing, make early announcements of new products, assemble allies, make visible
commitments to your technology • Self-fulfilling prophecies can overrule technical advantage
• Leapfrogging
Open • No one firm controls • Specs are public – anyone can build compatible products • May require license fee • May not help firm that invented
Closed • One firm • Systems can be controlled, so benefits don’t flow to a competitor • Leapfrogging may occur •
BUAD-497: Course Documents
Dynamic industries and their effect on strategy
• Competitive advantages erode quickly • Established rules are broken • Industry boundaries are breached • Customer loyalty is fickle • Sustainable competitive advantages becomes a series of shorter unsustainable competitive advantages
• Internet Explorer vs. Netscape • Internet Explorer vs. Mozilla
Judo and Hardball strategies
Judo Strategy Target your opponents weakness and use it as leverage
Hardball Strategy Use “unfair” advantage
Design vs. Learning schools in strategy (fallacies, deliberate vs. emergent etc..)
Design School • Ex-ante analysis, thinking and reasoning • Assumes all relevant factors can be objectively analyzed • Assumes that this analysis precedes and dominates action – implementation follows as a separate stage • Separates thinking from doing and often implies a hierarchy – senior managements thinks – others implement • Option appraisal is conducted logically on the basis of analysis
Learning School • Strategy making takes place w/in an unpredictable world
• Creates the necessity for the flexible strategic approaches • Serendipity (accidental discoveries, luck, etc) is required for effective performance • Strategy is often made by lower-level managers – strategy evolves through autonomous action • Strategy has both intended and emergent components
Mintzberg’s 3 fallacies of strategic planning 1. fallacy of predetermination – future is unknown 2. fallacy of detachment – impossible to detach formulation from implementation 3. fallacy of formation – inhibits flexibility, spontaneity, intuition, and learning
= GRAND FALLACY – “because analysis is not synthesis, strategic planning is not strategy formulation”
Deliberate vs. Emergent Strategies Intended Strategy + unrealized strategy Deliberate realized strategy + emergent strategy = sustained superior strategy
Robust action
Allows a company to rapidly take advantage of opportunities as they occur Enables various levels and functions w/in the organization to contribute to the emerging strategies
BUAD-497: Course Documents
The public company and its strengths/weaknesses
The public company faces pressure from various angles including: Wall Street – investor expectations, earnings growth, and quarterly pressures Executive Compensation – increase in overall level, use of stock options Economic Cycles Cyclical Industry
The above pressures are offset by the following methods of control: Compliance Department Disclosure Governance Ethics and integrit of participants
Strengths/Weaknesses of the Public Company Strengths Ability to raise enourmous amounts of capital and spread risk
Transparency – financing acitivites are visible and information readily available. Poor performance results in lower share values Corporation are disciplined both by their internal governance systems and by competition in product and factor markets.
Weaknesses Separation of ownership and control results in an agency problem
Lack of powerful and informed monitors results when the shareholders are widely dispersed Entrenchment incentives – management may invest in protecting their jobs rather than creating value Excessive mandated information disclosure lowers value of proprietary product and strategic information.
Agency Theory
Risk bearking specialist (principal) pays compensation to a managerial decision-making specialist (agent)
“The essence of the Agency Theory is that the Principal has inferior information to the Agent.
Moral Hazzard: the principal and agent share the same information up to the point at which the agent takes an action, but thereafter the principal is only able to observe the outcomes. Adverse Selection: the principle does not know some information which is relevant to the action (such as the ability of the agent to perform the task), whereas the agent can make use of this information to his own advantage.
Example: any time someone hires an outside consultant or contractor to perform a service for which the principal has no real input/influence that can alter the outcome aside from the directions given to the Agent. Financial Advisor or contractor (construction),
Diversification and differences in risk preferences
…. The role of the board of directors (formally and actually)
The Board of Directors is responsible for hiring, firing, monitoring, and setting compensation of the firm’s managers. They have broad discretion to direct the company’s affairs and is supposed to ensure that the firm in managed in the best interest of shareholders.
BUAD-497: Course Documents
Shareholder votes are also required to approve corporate mergers, to authorize the sale of major assets, to amend the firm’s bylaws, and to authorize the issuance of new equity issues. Directors are frequently selected by management and are beholden to them for their jobs CEO’s are often on the Board which can create accountability problems. Boards too often have poor procedures of evaluation in place, both regarding management and their won performance. As a result, Board’s of Directors often exercise rather little control.
Disclosure and shareholder control (formally and actually)
Publicly-traded companies are required annually to disclose a great deal of information about corporate earnings, executive compensation, and the ownership of the company’s voting shares. Firms are also required to hold annual shareholders’ meetings that are open to all owners of common stock Prior to these meetings, corporations send out proxy statements to shareholders that describes: The meeting agenda Spells out precisely which issues are to be voted on by shareholders
Provides a form for shareholders to use either to vote personally at the meeting or to assign their right to vote to someone else.
How corporate control is really exercised… Most corporate elections are usually staid affairs where shareholders are asked to vote for or withhold their vote for single slate of company directors Proxy fights occur when a rival group of shareholders nominate a slate of alternative directors who do not support the current management team.
-This is relatively rare due to the expense to shareholders As a result, shareholders often have little opportunity or incentive to actively engage in corporate control.
Compensation and stock options (formal and actually)
In 2006, avg total compensation of chief executives of S&P 500 companies was $14.78 million. This represented a 9.4% increase in CEO pay over 2005 Performance and compensation have a cloudy connection when it comes to CEO’s Compensation on average was comprised of: Salary (cash): 20%
Short term incentive plans (bonus): 20%....usually tied to specific performance measures such as ROI or net profits
Long term incentive plans (stock options): 60% Other benefits (insurance, legal, pension…)
Underwater options and indexed options
Underwater option: an option in which the strike price (price you can purchase stock at) is higher than the current stock price. No reason to exercise option until this situation is reversed.
Indexed Options: Indexed options balance a company's relative stock market performance against its absolute gains. Because indexed stock options pay primarily for out performance, they are highly leveraged. This means they require more shares to deliver the same value as traditional stock options Indexed Options strip out market effects. They link an option's strike price to a benchmark such as the S&P 500 or an industry index. Executives are rewarded only for beating the benchmark
BUAD-497: Course Documents
The Market for Corporate Control and Takeover Defense • Board of directors is supposed to act in the interest of shareholders; they decide things such as the
hiring and firing of upper-level management. Shareholders must vote on things such as major sales of assets, mergers et cetera
• How the corporation controls this: Directors are selected by management, and owe them for their jobs; CEO are very often the head of the boards of directors, causing accountability problems
• Boards of directors therefore usually have very little power over companies • Stockholder meeting are usually set up by companies to be intimidating, hard for stockholders to ask
questions or make any comments • Voting for directors is usually ‘yes or no’ for a proposed slate of new directors • Shareholders are too fragmented to really put up any fight against current management • The market thus operates when firms face the risk of takeover when they are operated inefficiently.
Many firms begin to operate more efficiently as a result of the “threat” of takeover. Hence, the market allegedly acts as an important source of discipline over managerial incompetence and waste
• However, it’s an expensive last resort...and often doesn’t work!
Predictable Surprise • The learning school theory: remember that you can’t just depend on one core competency and ignore
changes in the environment, things change • Externalities will have many effects on business operations, predicting these surprises is an important
part of strategic thinking
Corporate Crime and Strategic Control Systems, Warning Signs, and how to control it (KPMG guidelines) • White collar crime is a very big problem, yet it is seldom investigated • Most companies aren’t doing very much about the threat of fraud in the business world • Managers often feel enormous pressure to meet financial expectations, and will do a lot to try to meet
these numbers, even if some of it is unethical • Company culture has a large effect on the amount of white-collar crime going on • Some warning signs: Kill the messenger attitude in the company; low confidence in accounting
statements; employees seldom refer to ethical conduct codes when making decisions; top management ethical statements seem to be just for the public; people who ignore ethics but produce good numbers are promoted
• How to control crime: find out what the risks are in your company, address these specifically; make views on fraud known; create a culture that looks down on corporate crime; ensure that internal controls are effective; develop a response plan when fraud comes up; be strict on fraud when it is found
• Good news: The majority of consumers will switch to brands/ stores when they are found to be ethical
BUAD 497 Final Study Guide- Scott Exner
I. 7-S Framework The 7-S framework is a management model used for internal analysis describing the 7 interconnected factors to:
• Organize a company in a holistic and effective way (create alignment among depts.) • Determine “doablility” of strategies • Examine the effects of change on the Org. • Examine functional/dysfunctional aspects of the Org.
• Strategy – a plan of action to maintain competitive advantage over the competition • Systems – measures and actions which accommodate the execution of daily activities • Structure – the way the organization is structured, who reports to whom • Style – how do you lead? Personal style? • Shared Values – company culture, work ethics etc
BUAD-497: Course Documents
• Staff – company employees and their capabilities • Skills – core competencies of the company as well as that of its staff
• Successful strategy implementation requires the alignment of all the seven S’s—fit is just as important inside as outside!
II. Beer’s formula for organizational change and…
Δ = f(D•M•P) – C
Δ is the effectiveness of change, a positive function of D (dissatisfaction), M (model, or vision), and P (change process) that need to be greater than C (cost of change).
III.…Leading organizational transformations
When implementing a new strategy, start with the hard part of operational improvement! Only then make the transition to improving the work environment.
IV.Five forces of management and strategy execution
I couldn’t find any info relevant to the graphic provided by Peaches in slides of online.
• Many excellent strategies fail because of poor execution • Good execution accepts the role of communication and politics • Good execution is flexible enough to roll with the punches and builds options into the process è
robust action
V. Small world effects, direct/indirect ties, strong/weak ties, and the strength of weak ties
• Small World Effects: People know neighbors, distant people, and people at random Small World of Connections (i.e. 6 degrees of Kevin Bacon). The first five random links reduce the path length of the network by half!--> Small World Networks should be everywhere!!!
• Can be seen in Al Qaeda, Marketing, Connections amongst industry leaders • We tend to use “weak ties” (Granovetter) and also friends-of-friends, because they are more
likely to have non-redundant information • Direct and indirect ties are positively related to innovation • Alliance Networks: Access to know-how, contacts, resources expands the size of radar screen
and make you detect technological discontinuities, emergent markets, new designs. The position of the firm in the alliance network also determines the propensity to collaborate.
VI.Network foundations of social capital Social capital is a “useful metaphor,” explaining “how people do better because they are somehow better connected with other people- What mechanisms form foundations of?
• When focused on a single person, the network is fragile! • As structural cohesion increases, fewer nodes are able to control resource flow within the
network. • Power, Information, Norms and Values, Informal Social Control is more uniform for better
foundation, less freeriding (Community Character)
BUAD-497: Course Documents
VII.Structural holes, brokerage and closure, strategic network expansion Structural Holes are contact disconnects- create social capital via brokerage opportunities. Structural holes provide important benefits.
• Brokers occupying structural holes earn bigger bonuses • Managers located in structural holes are promoted earlier in their careers • People located in structural holes often have “better ideas” than others
Combine Brokerage and Closure:
Strategic Network Expansion was just this lame graphic, basically means build contacts from contacts in different industries I think…
Takeaways: • It is the diversity of contacts that generates social capital—strength in weak ties • Network centrality and structural holes are important for determining power and knowledge flows—
both for firms and for your personal experience. Brokers do better! • Social capital and power come from bridges that person can build between others!
BUAD-497: Course Documents
BUAD 497: Strategic Management Informal Cheat Sheet for the Final Exam Spring 2007
Listed in chronological order: Porter’s 5-Force framework, PEST and SWOT frameworks Porter’s Generic Strategies Hambrick & Fredrickson framework (from “Are you sure you have a strategy?”) BCG and McKinsey matrices Core competency and resource-based view of the corporation VRIO framework Greiner’s model of org. growth and classic growth patterns of firms Organizational structures (simple, functional, divisional etc.) and their relation to strategy Mintzberg’s approach to org. structure Activity Systems and strategy as positioning/configuration/fit Complementarities, tradeoffs, equifinality, fit Game theory, the structure of games, moves to change the game played Basic games such as PD, Chicken, the Dilemma of the Commons Competitor profiling Value chain analysis, including value creation, value division, value added, the value net Standards/network externalities and their role in strategy (open/closed, tactics etc..) Dynamic industries and their effect on strategy Judo and Hardball strategies Design vs. Learning schools in strategy (fallacies, deliberate vs. emergent etc..) Robust action 7-S Framework Beer’s formula for organizational change and leading organizational transformations Five forces of management and strategy execution Small world effects, direct/indirect ties, strong/weak ties, and the strength of weak ties Network foundations of social capital Structural holes, brokerage and closure, strategic network expansion The public company and its strengths/weaknesses Agency theory, moral hazard, adverse selection (think of examples!) Diversification and differences in risk preferences The role of the board of directors (formally and actually) Disclosure and shareholder control (formally and actually) Compensation and stock options (formal actually) Underwater options and indexed options The market for corporate control and takeover defenses Predictable surprise Corporate crime and Strategic control systems Warning signs of deviant org. cultures KPMG’s recommendations on deterring employee fraud
BUAD-497: Course Documents
BUAD-497: Assignments
Professor Fiss Individual Mini Case Analysis
BUAD-497: Tuesday-Thursday 12-1:50 PM ID#6390.4899.77
BUAD-497: Assignments
BUAD-497: Assignments
1) The sales growth in McDonalds Coffee of thirty percent over the past year since the
introduction of McCafe has reinforced Sgro’s belief that a bold move into a more dedicated
retail coffee offering in McDonalds’ restaurants provides value. Nonetheless, this is not to say
that the current success of McCafe has completely solved the problem of McDonald’s
lackluster breakfast offering. First, to tackle the issues facing McDonald’s breakfast sales, one
must look at the value that these breakfast items bring to the quick-serve breakfast industry.
Clearly, McDonalds is an industry leader in providing good-quality products quickly at a low
price. The restaurant had continued to offer this value in their breakfast menu, but hadn’t
vigorously sought innovative new breakfast items or changes in the menu to match changes
occurring in the industry. As a result of this oversight in McDonald’s product management,
the fast-food leader was quickly losing ground in breakfast sales to its competitors, namely
Tim Hortons. As McCafe brings value to McDonald’s breakfast menu by turning McDonalds
into a one-stop-shop for breakfast and coffee, something valued in the industry as seen by the
melding of Wendy’s and Tim Hortons as well as others, McCafe does not solve the
McDonalds’ breakfast menu’s lack of dynamism.
2) If McCafe were to be introduced years before the case date, it may have been much
more rare than it actually was at its introduction. The ‘McCafe’ concept had become more of
an industry trend than an exception, with many major quick-service retailers offering similar
value to McDonald’s McCafe integration. At the time, Tim Hortons had already begun to
broaden its breakfast offerings, essentially offering similar value to that provided by a
McDonald’s with a McCafe. The advantage McDonalds would have over Tim Hortons in this
arena would have been its historically efficient operations; Tim Hortons, though, has
challenged this advantage after being purchased by Wendy’s, another quick-service chain that
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has brought its operating efficiency to Tim Hortons coffee houses. Furthermore, Tricon Global
Restaurants, which includes KFC, Pizza Hut, and Taco Bell, had already begun to offer menus
from these three restaurants in different combinations under one roof, the success of which has
further strengthened the idea that combination restaurants are appealing to consumers.
Concurrently, there is strong evidence that multiple offerings under one roof, such as
McDonalds and McCafe, are more attractive to consumers than a restaurant that serves only a
menu similar to McCafe’s. Nonetheless, McDonalds is not a first mover in implementing this
idea, as the industry has already been busy making a trend out of this concept.
3) McCafe is imitable, to an extent. For the most part, as mentioned in the above
paragraph, Tim Hortons in collaboration with Wendy’s has largely already implemented this
concept in their international operations. Other restaurants in the quick-serve industry cannot
imitate McDonald’s strategy in a very important way, though. McDonald’s brand image is
arguably stronger than any other restaurant, especially the “Mc” branding. Further, McCafe
has attempted to differentiate itself with its coffee delivery. While its competitors take a few
minutes to make each cup of specialty coffee, McCafe’s machines take only seconds to brew
up the same coffee. While this speedy delivery may prove to differentiate McCafe enough for
some gain in market share, its competitors are sure to react quickly to this strategy. Other
coffee and breakfast providers, such as Tim Hortons, are likely to either switch to these faster
machines or advertise that their coffee is made the ‘right’ or ‘original’ way, and that it is
somehow more genuine than the mass-produced McCafe coffee. Further, Wendy’s may
further promote the strategy they have been using largely in their international restaurants,
melding Tim Hortons and Wendy’s together in one restaurant, by bringing this strategy to the
Canadian market. While McDonalds’ McCafes may help the restaurant chain to regain some
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market share in the quick-serve breakfast market, competitors are likely to respond with similar
offerings or strong product differentiation.
4) The McCafe concept falls directly in line with McDonald’s organizational structure.
McDonalds has been organized to depend on low-cost largely unskilled labor, quick service, a
strong brand image, and overall low product cost to consumers. Further, McDonalds allows
consumers to enjoy their orders in a variety of ways: take-out, eat-in, and drive-through. The
new McCafes took advantage of these operating efficiencies by utilizing new coffee
technology that allows for unskilled workers to quickly brew premium coffee at a low cost to
the consumer as per McDonalds’ trademark efficiency. In tandem, customers can order their
premium coffee with take-out, drink-in, and drive through, all on the same receipt as their
McDonalds breakfast order. As McCafe so closely follows McDonalds organizational
structure, the restaurant will have the knowledge in operating efficiency to be a cost leader in
the premium coffee industry in Canada. While others, such as Tim Hortons and Wendys, may
have similar restaurant structures with menus similar to McDonalds and McCafe, they may not
be able to achieve the operating efficiency of McDonalds that allows for such low prices.
Therefore, McDonalds will be able to achieve a sustainable competitive advantage in the low-
cost quick-serve premium-coffee market that also serves a breakfast menu as a result of its
historically strong operating efficiency and strong brand image. Nonetheless, competitors may
be able to capture market share by differentiating themselves as more genuine premium coffee
servers that don’t use mass-produced machine-made coffee. Further, if Wendy’s were to
further integrate Tim Hortons into its operations, it may be able to achieve the operating
efficiency of McDonalds and McCafe, therefore diminishing the McCafe competitive
advantage.
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Professor Fiss Take-Home Midterm
BUAD-497: Tuesday-Thursday 12-1:50 PM ID#6390.4899.77
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2
1) An analysis of the steel industry based on Porter’s five forces model reveals that
rivalry is high, due not only to the basic five forces in the industry but also to powerful
changes in the global steel market. To begin, the threat of entrants into the steel industry
is low. The primary reason for this threat level is due to the high costs of entry. Steel
manufacturing mills are extremely expensive to build and maintain, leading to a low level
of new entrants into the market, especially given the state of the industry today. Namely,
the industry has been blanketed with over-capacity in the United States while it has been
experiencing little growth. Therefore, there is little incentive for new players to enter the
market, as providing more capacity in the industry would be of little value to buyers.
Buyer power, alternatively, is relatively high in some respects but low in others.
Overall, buyer power is rated to be medium. On one hand, there are few possibilities for
differentiation in the steel industry, lending buyers the power to bid competing steel
manufacturers against each other for the lowest possible price. Further, buyers arrive one
at a time for purchases, in a sense. In other words, when a buyer is interested in placing
an order for steel, steel manufacturers line up all at the same time to bid on supplying the
product to the buyer. Therefore, buyers can easily force these undifferentiated steel
manufacturers into a bidding war that drives margins down for manufacturers. As H.
Aycock, former Nucor chairman and CEO, said, “The key to making a profit when
selling a product with no aesthetic value, or a product that you really can’t differentiate
from your competitors, is cost.” On the other hand, some companies in the industry have
shown an ability to differentiate their steel product in some ways. Although this has been
limited, manufacturers such as Nucor have offered services along with their product such
as in-house engineering that provides the buyer with a product that is uniquely designed
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3
for their use of the product. Conversely, the high transportation costs of steel products
lowers buyers ability to bid manufacturers against each other, as the number of
manufacturers that can be bid against each other is limited to those within a reasonable
proximity of the buyer. Finally, the ability of buyers to backward integrate is limited due
to the high barriers to entry into the steel manufacturing industry mentioned earlier.
The threat of substitutes in this industry is relatively high. The largest threats are
lighter metals and stronger alloys as well as plastics and synthetics. As technology
develops, these types of products have been used more and more in applications typically
reserved solely for steel, such as the side paneling of new cars. Further, many other
consumer products, such as bicycles, are being made from these new materials. While
the steel industry clearly has a future with stable purchasers, such as the construction
industry, technology has allowed substitute products to become more of a threat to the
steel industry than what the industry has seen in past decades.
The power of suppliers, like buyers, is rated at a medium level. First, suppliers of
the minerals and scrap steel required for steel production aren’t able to demand a very
high margin on their products. While the steel itself makes up a significant portion of
costs in this industry (sixty percent in the case of Nucor), the mini-mill developed by
Nucor has allowed backward integration to eliminate suppliers in some cases and cause
low supplier margins in other cases due to the threat of backward integration. The
industry’s other primary supplier, employees, have high bargaining power. Many of
those employed in this industry are members of unions that demand high wages and
benefits, while others who aren’t unionized are paid high wages and given steep benefits
in order to compensate for harsh working conditions. The power of employees in this
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4
industry becomes clear after reviewing their incredibly high wages, which is usually
double the average wage in the manufacturing industry in the United States.
Rivalry among firms is very high. There are a variety of reasons for this. First,
foreign competition made a strong entrance onto the US steel-manufacturing scene and
had more of an impact on domestic competitors than it should have. It was found that
many of these new entrants were being unfairly subsidized by foreign governments or
were ‘dumping’ into the United States. Secondly, the industry has been burdened with
overcapacity, leading to intense rivalry among firms. Further compiling on top of this
overcapacity are barriers to exiting the industry. These barriers of exit keep firms in the
industry that are under bankruptcy protection or that aren’t making a profit on their goods
sold. Third, the industry growth rate has been slow in many of the developed nations of
the world that are home to competitive multi-national steel manufacturers, leading to
intense global competition. All of these factors contribute to the intense rivalry seen in
this industry. Overall, the industry is not very attractive in the state that it is currently in.
To compete in this type of industry, a firm will do best to challenge the tough
powers working against it. Namely, in order to combat supplier power a firm can
backwards integrate and automate the production process to reduce necessary manpower.
In order to combat threat of substitutes and buyer power, a firm might find a way to
differentiate its product by bundling other services with it. To combat intense rivalry, a
firm could take advantage of its excess capacity by expanding into developing markets
with a higher industry growth rate.
2) Central to Nucor’s activity system is low cost. As mentioned in the previous
pages, H. Aycock can be directly quoted in saying that cost leadership is essential to the
Nucor activity system. Leading to this low cost advantage first is Nucor’s lean
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5
organizational structure. Nucor puts a very strong emphasis on keeping executive
management limited, with a total corporate staff of less than twenty-five when 1999
began. This is achieved by having a decentralized management system, where very little
corporate oversight is present. Managers of individual mills and manufacturing plants
are given nearly full autonomy of operations, and operations such as engineering and
software development are operated independently in each facility. Further, executives
within the company don’t receive the traditional perks usually associated with their
position, such as private jets and plush corporate offices. This lends to employee loyalty,
lower costs, and a lean company culture.
Also important to Nucor’s activity system is their unique incentive-based
employee compensation system. With this system, employees are given bonuses based
on the amount of production that is reached in a week that is above a standardized
production rate. This system leads to increased employee loyalty, decreased employee
turnover rates, and more satisfied employees who don’t demand unionization. Although
they pay their employees more per hour than the industry average, Nucor’s incentive
system leads to a more productive employee base and a strong company culture. This
productivity leads to lower product costs, and their more self-reliant employees are able
to self-manage in Nucor’s decentralized management structure.
Further strengthening Nucor’s activity system, technological innovation adds
value to the entire organization. Nucor’s emphasis on technological innovation is
strengthened by in-house engineering in each individual facility that caters to the
different demands of customers in different regions and industries, which is supported by
the decentralized management structure explained earlier. Further, innovation in the firm
led to the development of he mini-mill system of manufacturing, which allowed for
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6
backwards integration and lower costs. Other technological innovations included the
placement of electric arc furnaces in their mini-mills to increase efficiency and, again,
lower costs.
In an industry where low costs and local innovations are key to success, Nucor’s
activity system has provided these values enough to become a major competitor in the
steel manufacturing industry. The four core elements of Nucor’s activity system, an
incentive-based employee structure, technological innovation, a lean organizational
structure, and low costs, lend to a product that provides a great value to buyers. (See
Appendix #1: Nucor Activity System)
3) One change in Nucor’s organizational structure involved the overcapacity of the
steel manufacturing industry in the United States. As capacity utilization was about
seventy-five percent, opening new plants and adding to this over-capacity would not be
beneficial. Although Nucor had traditionally opened Greenfield plants, this structure had
lost its effectiveness in the current state of the industry. Thus, the firm’s executives
decided that they would move towards mergers and acquisitions.
The other relevant move by the management of Nucor was the decision to add a
level of management to the corporate office staff: four new Executive Vice Presidents
and two specialist jobs in strategic and steel technology. The reasoning for this change,
as stated by Aycock, was to enable corporate headquarters to get back in touch with
independent facilities. Although this move appears to be a clear departure from the
companies tried-and-true activity system, it actually falls neatly into their strategy.
Specifically, as competition increased and Nucor grew in size, the small corporate office
staff began to lose touch with independent facilities. Thus, the entire organizational
structure was deteriorating, which led the organizational structure to be not lean but,
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7
more accurately, non-existent. In order to keep the ‘lean organizational structure’
element of their activity system intact, it was necessary for Nucor to keep communication
intact and expand the number of employees in corporate operations.
4) Nucor’s options for future strategies include the option of doing more of the same.
That is, keeping their newly altered organizational structure with a slightly larger
corporate staff. Further, mergers and acquisitions would lead their development in the
United States. Yet another option for Nucor would be to focus more on expansion
overseas, in markets where the steel industry is growing much quicker than in developed
markets. This option would allow for Nucor to utilize some of its excess capacity
without trying competing in the over-saturated US market. A third option would be to
focus on technological innovations that would lower costs and allow for a lower cost to
the buyer.
I would recommend a combination of two of these strategies. The best option for
Nucor is to continue with mergers and acquisitions of other steel-manufacturing firms in
the United States, but place more of an emphasis on technological development that
would reduce their costs of steel manufacturing. This is best because it allows Nucor to
sustain one of its primary and more important competitive advantages as a company: a
very productive self-reliant workforce that is able to manage itself. This advantage might
not travel internationally, thus Nucor must focus on the domestic market. In order to
compete in the domestic market, price must be lowered by technological innovation.
Further, in order to grow as a company, mergers and acquisitions must continue in order
to develop the company but not add to the over capacity of the US market.
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App
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1
1: Extremist Religious Ideology Al-Qaeda Defined
Al-Qaeda is a radical political group driven by an interpretive religious ideology.
Literally meaning “the base,” al-Qaeda is the core of an international network of Islamic
terrorist organizations. Its goals include eliminating foreign influence in the Muslim
world, especially American forces in Saudi Arabia, eradicating those deemed to be
infidels, recapturing Jerusalem, and establishing a new Islamic caliphate. Ultimately, it
hopes to create Islamic states and build a formidable army with nuclear capabilities to
wage war on the Western world.1 Led by Osama bin Laden and Ayman al-Zawahiri, the
evolution from a brick and mortar organization to a decentralized global network is
transforming terrorism. Appendix ‘A’ provides a timeline of al-Qaeda’s significant
events. Their popular ideology makes them a performance and networking leader.
Technology is the vehicle inspiring believers to become recruits, willing to sacrifice
everything because of a steadfast dedication to the message of al-Qaeda’s ideology.
Radical Influence
Al-Qaeda’s ideology is a Sunni Islamist movement using the mujahadeen to
pursue jihad against the influence of the West. Although the literal meaning of jihad is
not directly correlated with the popularized definition as a holy war, the influence of
radical religious factions removes all but this military context from the word. The six
rules of jihad and the Koran clearly state that deliberate killing of noncombatants is
forbidden unless they are conspirators.2 However, modern Islamists, including bin Laden
and al-Qaeda’s ideological leader, al-Zawahiri, extend the religious boundaries of
interpretation to generate support for their political agenda. They select elements of
tradition and modernity to create a unique religious perspective. Al-Qaeda’s leadership
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understands the significance of its ideology as the fundamental core of its global strategy.
Implementing a broad platform that appeals to the greater cause of martyrdom rather than
targeting specific rules is instrumental to understanding why al-Qaeda is the world’s
leader in terrorism.
It is important to note that al-Qaeda was conceptualized by Abdullah Azzam, not
bin Laden. Azzam was not a proponent of resorting to terrorist tactics because of the
grave implications on future negotiations and hopes of peace.3 After his assassination, an
act some believe to have been ordered by bin Laden himself, al-Qaeda was free to
broaden the appeal of their ideology to attract the widest possible support base. With al-
Zawahiri and other religious scholars at his side, bin Laden used Qutbism and takfir to
create an indiscriminate brand of Islam closely resembling the unifying philosophy of
Salafism.4 Strong anti-US and anti-Israeli rhetoric engenders a vast support structure
across all spectrums of radical Islam, including the second largest Islamist group
Hezbollah, a Shia organization. While many terrorist organizations have short life spans
due to their specific convictions and confinement to territorial campaigns, al-Qaeda’s
underlying goal to bridge the ethnic, cultural and secular divides between Shia and Sunni
Muslims for the greater good applies to every Islamist struggle.5 Uniting Muslims as one
coherent force fighting the tyranny of the West, al-Qaeda is instilling a locally rooted, yet
globally inspired attitude to develop its global influence.
Religious Justification Al-Qaeda engenders support from non-radical Muslims because it establishes
religious justification for its actions. Bin Laden constantly refers to the will of Allah in
both his writings and speeches, leading many to believe that he is carrying out His divine
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requests. As the loudest voice in many areas of the Muslim world, he maximizes
effectiveness through expansive awareness of al-Qaeda’s mission. Bin Laden released
two fatwa’s, one in 1996 and another in 1998 that clearly describe his disgust of
American occupation in several Muslim countries and their unilateral support of Israel.
More importantly, he provides religious authorization for the indiscriminate killing of
Americans and Jews everywhere. 6 Although bin Laden is not a religious scholar worthy
of issuing such official Islamic decrees, he rejects the authority of contemporary Islamic
leaders and assumes responsibility for directing the jihad against the West.
The strength of this ideology lies in its overwhelming acceptance by Muslims of
all social classes. Al-Qaeda is the best at reinforcing the glory of martyrdom because of
the time and effort spent on training and preparing its operators for the reward of
sacrifice. Believing that sacrifice is the ultimate act of allegiance, suicide operators view
death as an appealing opportunity to drive fear into the enemy.7 The robust capacity for
regeneration is directly attributable to the widespread sympathy and belief in their
ideology. However, the most compelling aspect of their religious legitimization is the
danger it poses to civilization at large. Widespread politicization of radical ideas allows
al-Qaeda to dramatically influence both non-radical Muslims and the West.
Spectrum of Islamist Groups
The Spectrum of Islamist Groups is a framework separating terrorist organizations
by their goals and methods. It highlights the role al-Qaeda’s ideology plays in making it
the most feared and powerful terror network in Islamism.8 Unlike other terrorist
organizations, al-Qaeda is evolving from segment to segment as it increases its global
capabilities and presence. While their core values are revolutionary and ideological, its
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progression from a utopian to an apocalyptic group following the attacks on 9/11 leaves it
the world’s foremost authority of terror. The only other group exhibiting such force is the
Armed Islamic Group of Algeria (GIA), an organization even bin Laden denounces for its
extreme methods. But al-Qaeda’s leveraging its ideology to validate the dramatic
escalation of violence opposed to the sheer terror the GIA is inflicting intentionally.9 Just
as Hezbollah politicized its popular national movement in Lebanon, al-Qaeda is doing so
on the global stage through its complex organization and operations. This carefully
crafted ideology threatens both Western and Islamic societies on a scale that reaches far
beyond that of traditional terrorism.
2: Decentralized Organizational Structure Vertical Leadership
Al-Qaeda’s decentralized organizational structure is guided by strong leadership,
the only vertically integrated segment. Bin Laden is al-Qaeda’s emir-general, or head of
operations. He provides spiritual council, financial governance and oversees all strategic
objectives. Next is the shura majlis who act as the organization’s board of directors. With
twenty to thirty members, including the chief lieutenant al-Zawahiri, they monitor
strategic, operational and religious issues.10 Al-Qaeda’s leadership are the lines of
authority responsible for coordination and guidance. Their insight keeps the organization
on a goal-oriented, big picture approach focusing on furthering their ideology.
Compartmentalized Operational Committees
Below the council are the four operational committees, each led by an emir who
reports directly to the shura majlis. These groups include: military, finance and business,
Islamic study and fatwa, and media and publicity. It is the duty of the committees and
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regional networks to oversee day-to-day operations and implement al-Qaeda’s specific
operations
Military The military committee trains, recruits and acquires military resources without
disrupting their decentralized structure. Current estimates indicate Al Qaeda camps have
trained more than 100,000 Islamist militants, with over 120 camps operating in
Afghanistan at the time of 9/11, although they retain only “a small number of militants
under direct orders.”11 Organizational success requires constant attention to internal and
external changes within an organization’s environment. As Al Qaeda grows, its
leadership has reconciled the challenges faced by expansion through self-sufficient and
independent terrorist cells. Al-Qaeda created precise training resources, namely the Al
Qaeda Field Manual, Encyclopedia of Afghanistan Jihad and the Declaration of Jihad
Against the Country Tyrant’s.12 These comprehensive training manuals cover everything
from doctrinal values, military principles, recruiting and the importance of teamwork.
Discussing issues ranging from assassinating enemy personnel to qualifications for
becoming members, these manuals lay out exact directions for how to live a life free from
conceptual problems and full of religious principle.
Finance/Business
Although al-Qaeda is popularly seen as an illegitimate organization, much of its
financing is quite legitimate. With many terrorist organizations resorting to illegal
activities, including kidnapping and drug trafficking, al-Qaeda focuses on genuine
businesses like diamond trading, import/export, construction, manufacturing, transport
and financial services. Nonetheless, some funding has been tracked to fraud, currency
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counterfeiting, document forging and wealthy individual supporters through infiltration
of various charities and non-governmental organizations (NGO’s). Al Qaeda's financial
network is valued at approximately three-hundred million dollars, with annual dispersion
between thirty and forty million a year. Organizing collection and distribution are
members of al-Qaeda’s finance committee. Professional bankers, accountants, and
financiers control the large and diverse supply of funding. An operational doctrine
teaches operatives frugal financial behavior, self-sustaining financial tools, deception and
denial.13 The entire financial network is built on a base of operationally strong terrorists
and networked financiers, allowing it to be extremely adaptive and flexible. Its means of
sourcing, hiding, and distributing funds are numerous and complex. Although the US has
had some success in freezing funds, the complexity of the organization minimizes the
pervasive effect on al-Qaeda as a whole. As of 2004, every Al Qaeda cell carrying out a
successful terrorist attack has received its funding from a different source.14
Al-Qaeda’s primary objective is to carry out financial activities that limit record
keeping and potential tracking. Focusing on discretion and decentralization, operatives
are trained to manage finances, forge documents, participate in credit card scams and
hack into accounts. Many cells are expected to be almost fully self-reliant in terms of
funding, a slight change in structure that followed the World Trade Center bombing of
1993.15 Al Qaeda cells were required to be too self-sufficient; the operative involved in
this attack didn't have sufficient funds for buying enough explosives to do substantial
damage to the trade center, nor did they have the funding needed to fly out of America
(leading one of the operatives to foolishly return to the dealership for a deposit refund on
the van carrying the explosives). Thereafter, a portion of funds raised by individual sects
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is pooled for redistribution to groups planning major attacks. As described in Al Qaeda's
military training manual Declaration of Jihad Against the Country's Tyrants, the
commander of each cell also divides remaining funds into those needed for operational
activity and those to be invested for financial return.
Through international banking, the Islamic banking system and the underground
hawala network, al-Qaeda easily hides funding sources and distribution channels.
International banking does not have heavy regulations or authorities to pursue potential
terrorist activity. The Islamic banking system suffers from even weaker oversight due to
the poor economic state of most developing countries using this construct. Finally, the
hawala network is widespread, even in the US, and has no records of transactions or
financial systems. The business environment in which Al Qaeda operates contributes
greatly to their ability to conceal their methods. 16 Through these frameworks, al-Qaeda
raises substantial amounts of funding and redistributes them across the globe, all under
the watchful eye of seemingly powerless anti-terrorist organizations and governments.
Islamic Law The Islamic Law committee serves as the lightning rod for growth and creating
cohesion between its decentralized units. Combining their intangible ideology with
various resources, especially human capital, has far reaching effects on expansion. The
many “loosely-organized and widely-disbursed movement or ideology comprised of
many small and localized "self-generating" terrorist cells and individuals”17 responsible
for the bulk of al-Qaeda activities are linked by religious foundations in Islamic Law. Al-
Qaeda roots its battle on the West in the Sharia, or Islamic Divine Law, illustrated by the
fatwas placed upon the West. Maintaining a low profile in its role in global terrorism
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without wavering its ideology allows al-Qaeda to maximize its effectiveness. 18
Legitimizing their actions as a struggle for social justice in combination with the power
of religious indoctrination is providing al-Qaeda with both rapid growth and continued
success.
Media and PR This committee molds al-Qaeda’s public image, aiming to garner support
throughout the Muslim world and further insight ill-will against the West. Their strategy
and methods are discussed in detail in Part 3: Strategic Use of Digital Technologies.
Expansive Global Network
The remainder of al-Qaeda exists in an intricate global network of independent
cells and affiliates. Al-Qaeda’s strong leadership provides financial, logistical, and
strategic guidance to an estimated six to seven million radical Muslims worldwide,
roughly 120,000 of them willing to resort to violence.19 The ability to draw on countless
independent operators at any time makes their options limitless. Using an arms-length
network with some strong ties, al-Qaeda’s decentralized structure acts like that of a
consulting firm or holding company facilitating communications with its subsidiaries.
Most members of al-Qaeda are actually associates without inside access to the
organization. Only a special few whose devotion is constantly tested make up the strong
ties within the network. Maintaining maximum security and integrity within the
organization is the driving force behind this specialized arms-length approach.
Much like the compartmentalized committees, cells are designed to be completely
self-sustaining and independent of one another. The “family” idea developed in their
training camps is the basic construct for members. Each family represents a separate
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nationality. From these families, cells ranging from two to twenty people are organized
for specific missions. Whether its surveillance, active reconnaissance or a suicide
bombing, these teams are well prepared and fully aware of their objectives. The level of
trust remains high even among members from different families because of their common
bond of being strict believers in the brotherhood of Islam above all else.20 With a
horizontally integrated global network, dissemination of information through different
groups is done only on a need to know basis, making it very difficult for intelligence
agencies to procure tangible amounts of reliable information. As globalization diversifies
the world, al-Qaeda understands the need for interconnectivity, but does so only when
necessary to maximize efficiency and effectiveness without sacrificing protection.
Appendix ‘B’ illustrates al-Qaeda’s organizational structure in a flow chart.
3: Strategic Use of Digital Technologies Technological Web of al-Qaeda
Al-Qaeda’s strategy is continuous reinforcement of their ideology while
remaining decentralized and anonymous. Utilizing advances in modern technology, al-
Qaeda delivers an unweaving devotion to a universal brand strategy: communicating a
single message to all myriad units. They are ahead of the curve in using digital media,
namely the internet and satellite broadcasting. Computer technologies and the internet
allow the jihadist networks to communicate, spread their ideology, and recruit new
members.21 “Terrorist websites have exploded in numbers from a dozen in 1998 to more
than 4,800 today. Modern terrorist organizations exploit the internet to raise funds, recruit
members, and execute attacks.”22 Because al-Qaeda is so decentralized with vast
networks, the use of the internet explains their superior functionality. They stay
connected in complicated webs of networks with minimal risk. Many encrypted internet
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sites facilitate communication and interaction with security and privacy, leaving little to
no paper trail.
As the internet and digital media are developing a 360º approach, making it
available everywhere, on every device, at anytime, it is becoming the cornerstone of
modern strategic implementation. Such versatile vehicles, al-Qaeda is constantly pushing
their ideology on users at every level. Only a computer with internet access is needed to
watch and listen to bin Laden himself. The ease and speed of communication is
remarkable, especially when considering they are able to raise funds, spread propaganda,
recruit members, and execute attacks online. Be it financing, active involvement or mere
sympathy, al-Qaeda’s militaristic strategy is deeply impeded in an ideology successfully
communicated through digital media. Adoption of these digital communication networks
and methods greatly enhance al-Qaeda’s capabilities. Trying to connect an organization’s
strategy and structure through a virtual system is an abstract concept. Al-Qaeda is
currently deeply rooted in social networking sites, portable programs, and Massively
Multiplayer Online Role-Playing Games (MMORPGs).
Social Networking
Social networking sites enable al-Qaeda to recruit through propaganda of their
ideology. Children growing up with computers and the internet are exposed to jihadist
sites dedicated to rearing them on violence and hatred towards the US. They also show
graphic images of war casualties, video executions, and leader statements. This
generation of internet users is more likely to believe in conspiracies and the ideologies of
al-Qaeda because of the psychosomatic interaction between the internet and the jihad
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ideology.23 Furthermore, user accessibility is increased through free communication
services on the internet like Skype and Voice-Over-Internet Protocol (VoIP).
Portable Programs
Al-Qaeda’s use of technology is nothing short of staggering, especially with the
recent discovery of Mujahadeen Secrets by iDefense/VeriSign. Mujahadeen Secrets is a
portable program utilizing USB and pen drive technology that does not require
installation of applications, allowing them to operate at internet or computer cafés. 24 It is
nearly impossible to trace usage of such programs beyond the café itself. The programs
are very popular because they are written in native languages, rather than English based
sites like YouTube.com. This language system increases user comfort, trust, and
understanding, ultimately allowing for easier acceptance of al-Qaeda’s ideology.
MMORPGs
Extensive research is developing the functionality of MMORPGs in business and
military arenas. MMORPGs are a virtual world where users can live in the game almost
as realistically as in real life: design their own characters, team with groups, purchase
land and other goods, and socialize through VoIPs. Popular MMORPGs are World of
War Craft and Second Life. Second Life is more “realistic” than the fantasy-warrior
planet of War Craft. “Second Life is a 3-D virtual world entirely built and owned by its
residents. Since opening to the public in 2003, it has grown explosively and today is
inhabited by a total of 5,231,598 people from around the globe.”25 The threat comes from
virtual terrorism. Extreme activists can connect online and implement 3D plans of
attacks, gather intelligence, recruit more members, and perform other aspects of
communication and networking. Essentially, Second Life allows for an entire world
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without law or prosecution. Extremist groups “activity has included attempts to infiltrate
[other] groups, use of virtual weapons, and mass protest rallies.”26 Al-Qaeda seeks to
gain the advantage of this technology’s massive global networking capabilities and
virtual scenario executions.
Al-Zawraa TV
On November 14, 2006, al-Zawraa, a 24-hour insurgent station began
broadcasting throughout the Middle East.27 This strategically important information
outlet is overloaded with propaganda, audio messages from leaders, violence against the
Iraq government, and military footage. It is broadcast on a satellite owned by Egypt as a
“purely commercial arrangement.”28 On January 26, the signal started broadcasting from
a satellite somewhere in Saudi-Arabia. With these types of satellite collaborations,
shutting down this station is highly unlikely making the jihad ideology difficult to tune
out. The stations long term effects have yet to be measured however its content is viewed
as highly credible.29 Importantly, this is another strong communication of al-Qaeda’s
ideology and unifying strategy.
Craigslist and Decentralization
An interesting parallel is the United States concentration on Craigslist as a model
for al-Qaeda. Craigslist is merely an online bulletin board that astonishingly receives over
five billion hits a month with only 24 employees.30 This is an exemplary model of a
decentralized agency whose unifying-internal-message statement has led to vast success.
Founder Craig Newmark states: “Decentralized organizations can be more effective and
resilient. People who are passionate and can work independently can get more done than
a centralized organization.” Key to al-Qaeda’s operations, the leadership does not require
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sub cells to report back, rather they are given a strong up front mission (ideology) and are
expected to perform independently. The combination of ideology and devotion is so
strong that each sub cell functions extraordinarily well. Bin Laden’s message to
followers: “I want to kill people and wreak havoc. Don’t check with me, or they will find
me. We’ll send money.” Not reporting back also ensures more secrecy and confidentiality
of the leaders.31 Like Craigslist, other user-generated sites provide interesting leverage
for communication between strangers. Groups sharing an ideology can develop wikis,
post videos, and join blogs. There is almost no limit to the ability of a small group to
communicate. With the extensive decentralization of Al-Qaeda, they have truly advanced
the art of military communication borrowed from innovative business models.
4: Countering al-Qaeda’s Strategy Western Response
Following 9/11, the West intensified efforts to capture and destroy al-Qaeda. The
invasion of Afghanistan left the Taliban and al-Qaeda’s infrastructure destroyed.
Although nearly two-thirds of al-Qaeda’s leadership has been neutralized, failure to
capture bin Laden or al-Zawahiri combined with al-Qaeda’s technological prowess leaves
them a major threat. The West’s inability to secure quality counterintelligence through
state-of-the-art technology underscores the need for a more inclusive strategy. A military
campaign alone will not destroy al-Qaeda. The use of satellite imagery, intercepting
communications and direct countermeasures to the digital media devices being employed
by al-Qaeda is inadequate because of their decentralization, popular ideology and
technical abilities. Focusing on these core elements rather than the peripherals of how
they spread their ideology is the only way to defeat them. A successful strategy must be a
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fluid and dynamic approach that challenges their ideology and attacks their financial
supporters directly.
Challenge the Ideology
Discrediting their ideology is the most essential element to destroying al-Qaeda.
Undercutting their religious legitimacy by revealing their political motivations and
hypocritical actions will tarnish their movement. Damaging their reputations as religious
figures fighting for Islam will weaken their massive global support structure and create
widespread dissension. By working with legitimate leaders of Islam to inform the Muslim
world of the true extent of al-Qaeda’s actions, the West will be able to use Islam against
them. Unable to undermine their technology, al-Qaeda’s ideology is becoming deeply
engrained into the Muslim world. Western forces must challenge this key differentiator in
the global arena in order to halt this rapid progression. Until their fundamental ideology
is attacked, their cause will always have believers carrying on the fight.
Attack Financial Supporters
Attacking those that sponsor terrorism through financing or protection is the next
phase of reducing al-Qaeda’s global strength. As Colonel Gadaffi told the American’s
post 9/11, “If you want to combat terrorism, bomb London and Riyadh.”32 With various
individuals donating over $1.6 million a day to Islamic causes via charities and
investments in Saudi Arabia, the time to go after those behind terrorism is now. London
is the home to many Islamist offices and anonymous financial contributors. Moreover,
support from the governments of Iran, Syria and the Sudan to name a few, must be
stopped in order to achieve substantial military success. Al-Qaeda must be destroyed
from within by attacking their core strengths. Challenging al-Qaeda’s ideology and
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eliminating their major financing and protection sponsors will erode their global network,
not to mention helping locate bin Laden and al-Zawahiri. With technology helping to
further their decentralization and spread their ideology, a cohesive strategy confronting
these crucial aspects simultaneously is the path leading to the ultimate destruction of al-
Qaeda in its entirety.
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Appendix ‘A’: Timeline of Significant Events ‘80s: Maktab al Khadamat (MAK), led by Abdullah Azzam and Osama bin Laden, is a
mujahadeen financing organization used during the anti-Soviet revolt in Afghanistan begins evolving into the organization al-Qaeda.
’88: al-Qaeda is officially formed under Azzam and bin Laden in response to an outcry
for expanding assistance to Islamist struggles throughout the world. ’89: Azzam is assassinated and al-Qaeda consolidates remaining MAK members that
share bin Laden’s point of view. ’90: bin Laden returns to Saudi Arabia to find the country’s wealthy oil fields
vulnerable to Saddam Hussein’s military, who recently invaded Kuwait. Bin Laden offers his mujahadeen army to protect these natural resources, but the Saudi royal family instead allows American forces to deploy from Saudi Arabia.
’91: bin Laden’s public outcry against the Saudi royal family for allowing them to
profane the sacred soil in the land of the two mosques forces him into exile to the Sudan.
’92: al-Qaeda builds a solid financial infrastructure through legitimate business
(construction firms, import/export companies, and farms) and through banking operations to facilitate unfettered growth for several years.
’93: World Trade Center (WTC) bombing kills six and injures over one thousand. ’96: bin Laden returns to Afghanistan amidst heavy foreign pressure on the Sudanese
government to extradite him. This is when al-Qaeda establishes alliance with Taliban, whose similar outlook on world relations and isolation from the Western world provides them safe haven for training recruits and solidifying the organization’s operations. Issues first fatwa denouncing the American occupation of Saudi Arabia and their support of Israel.
’98: bin Laden creates World Islamic Front Against the Jews and Crusaders to issue a
fatwa authorizing the indiscriminate killing of Americans and Jews across the globe. US embassy bombings in Tanzania and Kenya kill over three hundred.
’00: suicide attack on the USS Cole stationed in Yemen kills seventeen. ’01: suicide attack on WTC and the Pentagon on 9/11 kill three thousand people. US
led coalition enters Afghanistan and begins attacking Taliban and al-Qaeda. ’04: over two-thirds of al-Qaeda leadership has been either captured or killed and much
of their physical infrastructure is destroyed, but bin Laden and al-Zawahiri remain at large.
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Shura-Majlis Advisory Council
Finance and Business Committee
Fatwa and Islamic Study Committee
Military Committee Media and Publicity Committee
Training Subcommittee
Camp Administration Subcommittee
Osama bin Laden Emir-General/Senior
Operations Chief
Islamic Army (Affiliate Organizations)
Appendix ‘B’: Organizational Structure Flow Chart
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Appendix ‘C’: Glossary Terms: Caliphate: the only form of government fully approved by Islamic theology. It represents the political unity and leadership of the Muslim world. Emir-general: high title of nobility traditionally used in Islamic nations; literally meaning commander or general. Fatwa: a legal pronouncement made by a mufti, a scholar capable of making judgments on Islamic law. Usually made when fiqh (Islamic jurisprudence) is unclear. Families: each family denotes a different country. At the basic level, cells are organized by nationality. Recruitment is made through family, friends or trusted acquaintances. However, for specific operations, families sometimes merge or recruit outside their nationality (i.e. the 9/11 attacks predominantly used the Saudi family, but were led by Muhammad Atta of the Egyptian family). Hawala: informal value transfer system based on performance and honor of a huge network of money brokers. Via a network of hawaladars, or money brokers, customers transfer a sum of money to recipients is other cities under a promise to repay the debt at a later date. There is no legal interference (or protection) and no records of individual transactions. Infidel: one who denies Allah or the Islamic prophet Muhammad; literally meaning “unbeliever” or “one without faith.” Islamism: the idea that Islam is also a political system, as well as a religion. It also refers to groups violently opposed to Western encroachment on their way of life. Jihad: the exertion of one’s utmost effort in order to attain a goal or to repel something detestable in a variety of contexts, ranging from personal to military conflicts. Mujahadeen: term for Muslim fighting in a war or involved in any other struggle; literally meaning “struggler.”
Qutbism: radical strain of Islamic ideology and activism inspired by Sayyid Qubt, a leading Egyptian ideologue who believed only followers of his strain of Islam were true Muslims and that furthering the Middle East required the removal of Israel and the Jews. Salafism: a universalistic vision of classic Islam. Viewing Islam in totality, it has no bias against conflicting sects. Its goal is to return Islam to the sublime nature described in the Koran. Sharia: body of Islamic law, it’s the legal framework within the public and some private aspects of life are regulated for those living in a legal system based on Muslim principles of jurisprudence. Shura majlis: a term used by many Sunni terrorist organizations for their top leadership; literally meaning consultative council. Six rules of jihad:
1. jihad is for the sake of Allah, not for the sake of wealth, goods, fame, glory or power 2. obedience to the imam (Arabic for “leader”) 3. avoid misappropriating booty 4. respect pledges of protection 5. manifest endurance under attack 6. avoid corruption
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Spectrum of Islamist Groups: 4 segments of radical Islamic factions:
1. Revolutionary – seek to legitimize violence by advocating and practicing collective decision making, drawing selectively on the Qutbist ideology. (i.e. Egyptian Islamic Jihad, Hamas)
2. Ideological – have a coherent discourse of political violence. (i.e. Hezbollah) 3. Utopian – seek to destroy existing order. (i.e. Abu Sayyaf Group, Libyan Islamic Fighting Group) 4. Apocalyptic – use collective violence but are indiscriminate. (i.e. GIA)
Takfir: in Islamic law, the practice of declaring those previously known as Muslims as actual kafirs, or non-believers. People/Organizations: Abdullah Azzam: Palestinian by birth, he was a central figure in the global development of the Islamist militant movement. As a religious scholar, he created an ideology and paramilitary operation to further the cause of oppressed Muslims. His practical approach to recruitment and training combined with his ideology left a lasting impression of bin Laden and was instrumental in establishing al-Qaeda. Armed Islamic Group of Algeria (GIA): Islamic terrorist organization that seeks to replace the existing Algerian government with an Islamic state. Notorious for extreme violence, their methods during the ‘90s resulted in many fellow terrorist organizations, including the Libyan Islamic Fighting Group, Egyptian Islamic Jihad and bin Laden to denounce their overly aggressive actions. However, they stop short of denouncing their ambitions for an Islamic Algerian state. Ayman al-Zawahiri: Egyptian by birth, he is a poet, physician, author and former head of the militant group Egyptian Islamic Jihad. Fluent in English, French and Arabic, he merged his organization with al-Qaeda in ’98 and is a high ranking member of the shura council. It is believed he is the chief lieutenant to bin Laden and also his physician. Al-Zawahiri is credited with much of al-Qaeda’s ideological ideas and military operations. Colonel Gadaffi: although he holds no public office, he is the de facto leader of Libya. Government officials refer to him as the “Brother Leader and Guide to the Revolution.” Hezbollah: a Shia Islamic political and paramilitary group based in Lebanon. It shares similar goals with al-Qaeda, including the eradication of Western influence and the establishment of an Islamic government in Lebanon. As the second largest recognized terrorist organization, their expertise in bombing buildings has been tapped by al-Qaeda through their unique and truly rare tactical alliance. Osama bin Laden: Saudi Arabian by birth, he is the leader of al-Qaeda. As a member of the prestigious and wealthy bin Laden family, he inherited between $25-30 million following his father’s death. A careful financial planner and shrewd businessman, bin Laden’s skills have guided al-Qaeda to become a powerful multinational organization. His methods are revolutionary, changing the Islamist movement to pursue a global strategy against the West that is justified by two fatwa’s he issued in ’96 and in ’98. One of the FBI’s Ten Most Wanted, bin Laden remains the most renowned terrorist in the world.
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Notes 1 "Al Qaeda." wikipedia Encyclopedia. Jan 2007. 29 Mar 2007
<http://en.wikipedia.org/wiki/Al-Qaeda>. 2 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.120-122 3 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p. 134 4 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.124 5 Hayes , Laura. "Al Qaeda: Bin Laden's Network of Terror." infoPlease. 29 Mar 2007
<http://www.infoplease.com/spot/al-qaeda-terrorism.html>. 6 "fatwa." wikipedia Encyclopedia. Jan 2007. 29 Mar 2007
<http://en.wikipedia.org/wiki/fatwa>. 7 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.112-126 8 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.112-126 9 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.72 10 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.55 11 "Al Qaeda." wikipedia Encyclopedia. Jan 2007. 29 Mar 2007
<http://en.wikipedia.org/wiki/Al-Qaeda>. 12 Sympathy for al-Qaeda Soars in Pakistan, Frontier Star, January 23, 2006. Monday, 350 words 13 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press, 2002), p.60-69 14 Basile, Mark, ‘Going to the Source: Why Al Daeda’s Financial Network is Likely to Withstand the Current War on Terrorist Financing’, Studies in Conflict & Terrorism, 27:3, 169-185 15 Committee on Banking, Housing, and Urban Affairs, Subcommittee on International Trade and Finance, Hawala and Underground Terrorist Financiang Mechanisms: Hearing before the Subcommittee on International Trade and Finance. 107th Congress., 1st sess., 14 November 2001 16 Schramm, Matthias and Markus Taube, Evolution and institutional foundation of the hawala financial system, International Review of Finincial Analysis, Vol. 12 Issue 4, Pages 405-420 17 Signs Point To a Surviving Terror Network, The Washington Post, August 11, 2006 Friday, Final
Edition, A Section; A01, 1214 words, Karen DeYoung, Washington Post Staff Writer <LexisNexus>
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18 "Al Qaeda." wikipedia Encyclopedia. Jan 2007. 29 Mar 2007
<http://en.wikipedia.org/wiki/Al-Qaeda>. 19 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.13-14 20 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.21-71 21 Bernard, Jerome. "Weakened Military, al-Qaeda Fights On-line." Agence France Presse 19 Feb 2007 22 McKenna, Brian. "Sinister Links to a Deadly Network." Times Higher Education Supplement 06 Oct
2006: 25. 23 McKenna, Brian. "Sinister Links to a Deadly Network." Times Higher Education Supplement 06 Oct
2006: 25. 24 Cochran, Andrew. "Internet Security Company Cracks Special Jihadist Software." Internet Blog 26 Jan
2007 02 Apr 2007 <http://counterterrorismblog.org/mt/pings.cgi/3583>. 25 "What is Second Life?." Second Life. 2 Apr 2007 <http://secondlife.com/whatis/ >. 26 Cochran, Andrew. "Part II of ‘MetaTerror: The Potential Use of MMORPGs by Terrorists”." Internet
Blog 12 Mar 2007 02 Apr 2007 <http://counterterrorismblog.org/mt/pings.cgi/3583>. 27 Grace, Nick. "Al Qaeda TV." Daily Standard 03 Jan 2007: 28 Cochran, Andrew. "Arabsat Begins to Broadcast Insurgent Propaganda Station." Internet Blog 12 Mar
2007 02 Apr 2007 <http://counterterrorismblog.org/mt/pings.cgi/3754>. 29 Cochran, Andrew. "Arabsat Begins to Broadcast Insurgent Propaganda Station." Internet Blog 12 Mar
2007 02 Apr 2007 <http://counterterrorismblog.org/mt/pings.cgi/3754>. 30 Jones, Del. "Can Small Businesses Help Win the War?." USA Today - Final Edition 3 Jan 2007: 1B. 31 Jones, Del. "Can Small Businesses Help Win the War?." USA Today - Final Edition 3 Jan 2007: 1B. 32 Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press, 2002), p.192
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AL QAEDADecentralization and the Technological
Evolution of Global Terrorism
Scott Exner · Lizzy Friedman · Keith ParkerMark Kimbrough · Bryan Neff · Matt Zimmerman
5: PEACHES
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AGENDA
1: Extremist ReligiousIdeologyAl-Qaeda DefinedRadical InfluenceReligious JustificationSpectrum of Islamist Groups
2: DecentralizedOrganizational StructureVertical LeadershipExpansive Global NetworkCompartmentalizedOperational Committees
3: Strategic Use of DigitalTechnologiesTechnological Web of al-QaedaSocial NetworkingPortable ProgramsMMORPGsAl-Zawraa TVCraigslist andDecentralization
4: Countering al-Qaeda’sStrategy
1: EXTREMIST RELIGIOUS IDEOLOGY
Al-Qaeda: a radical political group driven by aninterpretive religious ideology.
Goals: eliminate foreign influence in the Muslim
world eradicate those deemed to be infidels establish a new Islamic caliphate
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1: EXTREMIST RELIGIOUS IDEOLOGY
Extremist Ideology: Sunni Islamist movementpursuing jihad against the West.
Core of Ideology Locally rooted…globally inspired Fundamental rhetoric Extend religious boundaries
1: EXTREMIST RELIGIOUS IDEOLOGY
Maximize effectiveness through expansiveawareness
Fatwas, video messages, etc.
Robust capacity for regeneration glory ofmartyrdom
Spectrum of Islamist Groups
2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Vertical Leadership Emir-General = Osama bin Laden Shura Majlis (20-30 members)
– Includes: Ayman al-Zawahiri– Oversees strategic, operational, and religious
issues
Lines of authority = goal-oriented
2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Compartmentalized Operational Committees Finance/Business Military Islamic Law Media and PR
2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Expansive Global Network Intricate global network of independent cells
and affiliates Arms-length network with some strong ties
– “family” construct
2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Finance and Business Sophisticated financial network
– Professional Finance Committee– Strict operational doctrine; self-reliant– Adaptive and flexible
Limit record keeping and potential tracking– Frugal financial behavior– Self-sustaining financial tools– Deception and denial– Limited upward communication/ financing– Difficulties with this structure
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2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Finance and Business Redistribution Channels
– International banking: fewer regulations &policing authorities
– Islamic banking system: weaker thaninternational banking
– Hawala network: no records! Purposefully make unnecessarily high number
of money transfers
2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Military Military Committee Trains, recruits and acquires military resources Decentralized management through Literature
and Ideology Self-sufficient and independent terrorist cells
2: DECENTRALIZED ORGANIZATIONALSTRUCTURE
Islamic Law Rooted in “Sharia”- Islamic Divine Law Lightning rod for growth Cohesion between decentralized units
Media and PR Molds public image of itself and the West Garner support in Muslim populations
STRATEGIC USE OF DIGITALTECHNOLOGIES
Technological Web of al-Qaeda
Unified BrandStrategy
AlignmentIdeology
NetworksAutonomy
SocialNetworking
Craigslist &Decentralization
MMORPG’sAl-Zawraa TV
PortablePrograms
SOCIAL NETWORKING
Propaganda of Ideology
Graphic images, videos, and leaderstatements
Skype &Voice-Over-Internet Protocol (VoIP)
Children target sites
PORTABLE PROGRAMS
“Mujahadeen Secrets”
Program on USB –No installation required
Impossible to trace
Native language
Internet cafés
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MMORPG’S
5,231,598+ global users
Virtual Terrorism
Scenario Executions
Recruiting
World without laws
AL-ZAWRAA TV
November 14, 2006, al-Zawraa, a24-hour insurgent station
Violence against the Iraqgovernment & military footage
January 26, 2007 – satellitesomewhere in Saudi-Arabia
Long term effects have yet to bemeasured however its content isviewed as highly credible
CRAIGSLIST &DECENTRALIZATION
Decentralized internet organizationwith a strong internal message
Online bulletin board - five billionhits a month with 24 Employees
User-generation: build wikis andblog
Autonomy – no reporting back
4: COUNTERING AL-QAEDA’SSTRATEGY
Western Response thus far Strategy for Future Success
– Challenge the Ideology– Attack Financial Supporters
QUESTIONS?
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BUAD 497: Strategic Management
Prof. Peer C. FissOffice: Bridge Hall 303-BTelephone: (213) 821-1471Email: [email protected] Hours: Wednesdays 2-4 pm, or by
appointment
Sections 15102, 15107, 15112
Class 1: Introduction to Strategy
Class Introductions Who am I
Why this class What will you learn How will we operate
What is Strategy?
My Own Background
German citizenWorked for a number of companies, including
Mannesmann and DPDPh.D. in Management and Sociology from Northwestern
University (Kellogg School of Management)Appointments at Queen’s University and USCPublished in a variety of top academic journalsTaught courses on strategy and corporate governance at
the undergraduate, MBA, and executive levelSome of my research interests
Corporate governance Executive compensation Strategic change
Where I grew up…
Why this class?
Strategic Management is intended to be achallenging and exciting capstone
The primary objective of this course is tointroduce you to the analysis and formulation ofstrategic problems and decisions facing managersand leaders.
The material in this course is designed to be as“real world,” relevant, and interesting as possible.
I hope this course will be one of the most usefulyou have ever had and that it will be instrumentalin helping to make you more successful in yourcareer
What will I teach?
This class will focus both on themaking and implementation ofbusiness strategy
How will we operate?
Mix of theory and casesCurrent events Performance evaluation
Contribution to class discussion (15 %) Individual mini case analysis (10%) Individual midterm case analysis (20 %) Group project presentation (10%) Group project writeup (20%) Individual final exam (25%)
Course packet available from Campus Bookstore– there is no textbook
Come prepared
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Other Administrative Stuff… What is Strategy…?
A preliminary definition:
A company‘s strategy is the ‚game plan‘management has for positioning thecompany in its chosen market arena,competing successfully, pleasingcustomers, and achieving good businessperformance. (Thompson/Strickland 1998)
Strategy-making efforts must aim atproducing a good fit between acompany‘s resource capability and itsexternal situation
Basics of Strategic Management
Four aspects that set strategicmanagement apart
Interdisciplinary capstone course
External focus Competition and the nature of the business landscape
Internal focus Firm competencies, strengths and weaknesses
Future direction Where are we going and how is the marketplace developing?
Why is strategic managementimportant?
Makes a difference in performance levels
Provides systematic approach touncertainties and business challenges
Coordinates and focuses employees
Who does strategy?
The Role of the Board of Directors Elected representatives of the company’s stockholders Legally obligated to represent and protect
stockholder’s
The Role of Top Management Responsible for decisions and action of every
employee Providing effective leadership
Other Organizational Employees Implement—put the strategies into action and
monitor performance Evaluate—do the actual evaluations and take
necessary actions
A Short History of Strategy
HBS requires a class in Business Policy in 1912Adam Smith’s “invisible hand” (the market) gives
way to Alfred Sloan (GM CEO from 1923-1946)concept of the “visible hand”—middle manager
Chester Bernard influential book “The Executive”argues that managers should pay attention to“strategic factors”
Ronald Coase’s 1937 article “why firms exist”(Nobel Prize in economics) and JosephSchumpter’s concept of “disruptive technologies”written in 1942 bring in organizational economics
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Historical Overview:From Planning to SM
Phase: Planning (1945-1960) Only budgeting. If you focus on financial
aspects and controlling, you will be able toplan and forecast.
Order optimization Operations research
Historical Overview:From Planning to SM
2. Phase: Long-Range Planning(1960-1973)
Operations researchers aim to integrate thefirm into one single model
But then…main external shock: Oil crisis of1973, increases demand for forecasts
Historical Overview:From Planning to SM
3. Phase: Strategic Planning (1973-1980) Before: Main focus on past and extrapolation
to the future. Now: What can we learn from the oil crisis? Do
we have to accept such external shocks? Arewe able to predict them?
Change of perspective: How can we analyzefuture chances and risks?
Oil shock was located outside the company,therefore main focus changed to theenvironment. What is the environment askingfor?
Are we able to handle and to meet theserequirements?
Important Research: Strategic IssueManagement, Strategic Surprise Management(Early Warning Systems by Krystek/Müller-Stewens / Weak Signals by Ansoff)
Historical Overview:From Planning to SM
4. Phase: Strategic Management (1980- aboutnow)
Globalization strengthens the customer‘sposition.
Interconnections between firm and environmentare getting more and more intensive. In manyindustries, there is a necessity for permanentchange and innovation.
Focus on social sciences and “human factor”: Acompany can only implement a strategy if it isaccepted by all members.
So called “soft factors” are more Important:personnel, organization, culture.
The organization has to be more open forcooperation and integration. Congruence modelbecomes dominant.
(1980: Strategic Management Journal and Journal of Business Strategy)
Historical Overview:From Planning to SM
5. Phase: New OrganizationalTypes…?
“Knowledge workers” “Complexity science” “Virtual organizations” “Network forms of organizing” “Adaptive teams” “Virtual markets” “Boundariless organizations”
Historical Overview:From Planning to SM
A Central Idea of Strategic Management: “Fit” between the elements of the system
(Intra-System-Fit), focus on structure, culture,and behavior.
Chandler (1962): Strategy and Structure >„Structure follows strategy“
Ansoff (1965): Corporate Strategy > “System-Environment-Fit“
Basic hypothesis: environment, externalstrategic behavior, and the internal ‚structure‘are interrelated
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Strategic Management Process
AnalyzingCurrentSituation
Decidingon
Strategies
PuttingStrategiesin Action
Evaluating andChangingStrategies
SituationAnalysis
StrategyFormulation
StrategyImplementation
StrategyEvaluation
Key Takeaways
Fast Paced Class…come prepared!Where strategy came fromWhat strategy isKnow the basic strategic management
process
Preview for Class 2
Preview Case of interaction between firmactions and industry landscape
Prepare the assigned readings (Porter, Intelcase; see syllabus and course website)
Fill out the personal information sheet onthe course website
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BUAD 497: Session 2
Preview Case
Agenda for today
• Administrative items• Case Discussion: Intel Corporation
Learning goals for this session
• Understand how the industry landscapeinfluences a firm’s opportunities for growth
• See how strategic choices at the firm levelmatter
• Examine the nature of the competitivelandscape and how it can be shaped
• Connect strategy and the creation of value forfirms
Intel Corporation: 1968-1997
• What was Intel’s strategy in DRAMs?
• What accounts for Intel’s dramatic decline inmarket share in DRAMs between 1974- 1984?
Intel Corporation: 1968-1997
• What strategy did Intel use to gain acompetitive advantage in microprocessors?
Up Through 286 386 and Later
IBM IntelIntel
Licensee
Licensee
Licensee
Licensee
PCManufacturer
PCManufacturer
PCManufacturer
PCManufacturer
PCManufacturer
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Intel Corporation: 1968-1997
• What threats has Intel faced in sustaining thiscompetitive advantage?
• How did Intel deal with each threat?
Intel Corporation: 1968-1997
• Why has Intel been able to sustain itsadvantage in microprocessors, but not inDRAMs?
Intel Corporation: 1968-1997
• Intel and Internet: New Challenges
Key Takeaways
• Industry landscape strongly influences a firm’sopportunities for profit—microprocessors are a morefertile landscape to achieve high profits
• Strategic choices at the firm level matter—Intelexploited that landscape to its benefit
• Firms can shape the landscape—Intel shows how firmscan affect the competitive landscape
• Strategy is about value appropriation as well as valuegeneration—you have to capture value or someoneelse will
• Capabilities as a source of sustainable competitiveadvantage
Next session: Industry Analysis I
• Prepare Porter “The structuralanalysis of industries”
• Prepare Hambrick and Fredrickson“Are you sure you have a strategy?”
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BUAD 497: Session3
Industry Analysis I
Industry Analysis: Issues andTools
Learning goals for this session Know how industry analysis fits into strategy formulation Know the general tools for industry analysis— be an informed consumer Know Porter’s model for industry analysis and be able to apply it on your own Understand Hambrick & Fredrickson’s model of strategy and be able to apply it on your own
Industry and competitive analysis
“When an industry with a reputationfor difficult economics meets amanager with a reputation for
excellence, it is usually the industrythat keeps its reputation intact.”
(Warren Buffet)
Profitability Differences AcrossSelected Industries (Ghemawat, Rivkin, 1999)
Profitability Differences Within thePharmaceutical Industry(Ghemawat & Rivkin, 1998)
Profitability Differences Within theAirline Industry(Ghemawat & Rivkin, 1998)
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A Three-Dimensional BusinessLandscape (Ghemawat, 2001)
What is causing the industry tochange? An Example
"An Update on Moore’s Law“
The observation made in 1965 byGordon Moore, co-founder of Intel,that the number of transistors persquare inch on integrated circuitshad doubled every year since theintegrated circuit was invented. Thisis the current definition of Moore'sLaw, which Moore himself hasblessed. Most experts, includingMoore himself, expect Moore's Lawto hold for at least another twodecades.
Moore’s Law Industry Importance: Empirical Evidence
Rumelt, R. (1991). How much does industrymatter? Strategic Management Journal, 12: 167-185.
"To the extent that accounting returns measure thepresence of economic rents, the results obtained hereimply that by far the most important sources of rents in… manufacturing businesses are due to resources ormarket positions that are specific to particular business-units rather than to corporate resources or tomembership in an industry. Put simply, business unitswithin industries differ from one another a great dealmore than industries differ from one another.”
How much does industry matter?Rumelt (1991)
46.4%Stable Business-Unit Effects
8.3%Stable Business Effects
0.8%Corporate Effects
% of VarianceExplained
Variable
Approximate Effects on Variance inReturn on Capital:
Industry Importance: EmpiricalEvidence
McGahan, A., Porter, M. (1997). How muchdoes industry matter, really? StrategicManagement Journal, v18, pp. 15-30.
“We also find that the importance of the effectsdiffer substantially across broad economic sectors.Industry effects account for a smaller portion ofprofit variance in manufacturing but a larger portionin lodging/ entertainment, services, wholesale/retailtrade, and transportation.”
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How much does industry matter?Porter & McGahan (1997)
32%Business Specific Effects
4%Corporate Parent
19%Industry
2%Year
% of Variance ExplainedVariable
Approximate Effects on Variance inReturn on Capital:
Industry Analysis: Basic Issues
What does this industry look like? What are the major competitive forces? What are the trends?
What does it take to do better than averagein this industry? What are the sources of sustainable competitive
advantage?
Michael E. Porter is the Bishop WilliamLawrence Professor Professor, basedat Harvard Business School where heleads the Institute for Strategy andCompetitiveness
(1980): Competitive Strategy, Free Press, NewYork
(1990): What is Strategy?, Harvard BusinessReview
Porter’s Five Forces
Framework used to assess the competitiveposition of a firm within an industry
Uses five forces or variables to measurecompetitive advantage
Assumes continuous downward pressure ofcompetition
Points to interdependencies between factors Interaction Substitution
Porter’s Five Forces Model
Rivalry
Threat of Substitutes
Threat of Entry
Buyer PowerSupplier Power
Industry Rivalry
Intense rivalry among firms in an industryreduces average profitability.
Rivalry is impacted by industry growth product differentiation number of competitors competitor diversity exit barriers
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What causes rivalry to be strongor weak?
Number and relative size ofcompetitors
Concentration ratio = % of total industry salesaccounted by the 4 largest firms
Logging = 18% Cigarettes = 85%
What causes rivalry to be strongor weak?
Herfindahl Index - a measure of thebalance in an industry
Example: 3 firms with market shares of 0.50, 0.25, 0.25
H = ((0.50)2+(0.25)2+(0.25)2) = 0.25 + 0.0625 + 0.0625 =0.375
H of 0 ➔ Perfectly Competitive H of 1 ➔ Monopoly H > 0.18 ➔ Relatively high concentration, i.e. industries with
reduced rivalry
2. Buyer Power
Size and concentration of customers
Buyer Power
The power of buyers is determined by factorssuch as buyer concentration, switching costs,and backward integration
Buyers are powerful if Buyers are large and concentrated (government
purchases from defense contractors) Credible threat of backward integration (large auto
manufacturers and small parts suppliers—classic Fisherauto body case)
Buyers are weak if Buyers are fragmented (most consumer products) Producers supply critical parts (Intel’s relationship w/
PC manufacturers)
3. Supplier Power
Differentiation Switching Costs
Supplier Power
Bargaining power is based on factors such asnumber of suppliers, switching costs, andpresence of substitute inputs
Suppliers are powerful if Suppliers are concentrated (drug industry’s relationship
with hospitals) Significant cost to switch suppliers (Microsoft’s
relationship with PC manufacturers) Suppliers are weak if
Standardized product with many competitive suppliers(tire industry’s relationship with auto manufacturers)
Concentrated purchasers (garment industry’srelationship to major department stores)
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4. Threat of Substitutes
Price to Performance Ratios Switching Costs
Threat of Substitutes
In Porter’s model, substitute products refer toproducts in other industries (Pepsi is not asubstitute for Coke!)
A close substitute constrains the ability of firmsto raise prices (e.g. aluminum can maker isconstrained by price of glass bottles, steel cans,and plastic containers)
Factors that affect substitutes: Price/Performance tradeoff Switching costs Substitute improvement
5. Threat of Entry Threat of New Entrants
Ability of new firms to enter market isdetermined by factors such as: absolute cost advantages government policy economies of scale brand identity
Minimum Efficient Scale
Volume
UnitCosts
MESEntryPoint
Entry Barriers
Patents - pharmaceuticals Licensing - physicians, lawyers physicians,
lawyers Laws - product standards, corporate crime Tariffs Geographic advantages - Panama or Suez
canal Language or culture - publishing in many
countries
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Rivalry
Threat of Substitutes
Threat of Entry
Buyer PowerSupplier Power
So, what’s missing from Porter’smodel…?
A Toolkit fir Industry Analysis(from Macro to Micro)
PEST (or STEP) Political/Economic/Socio-cultural/Technological
Porter’s Five ForcesSWOT Strengths/Weaknesses/Opportunities/Threats
Value Chain Analysis
SWOT
SWOT stands for Strengths,Weaknesses, Opportunities, and Threats
ThreatWeaknessLiabilities
OpportunityStrengthAssets
Future/ExternalNow/Internal
But how well does SWOT work?
Research has shown that managers viewopportunities and threats differently
But almost any future event can be framedas either an opportunity or a threat.
Likewise, most strengths entailcorresponding weaknesses, and vice versa.
Thus, SWOT mostly tells you aboutyourself, not your environment…
Hambrick & Fredrickson: Do youhave a strategy?
Strategy: “central, integrated, externallyoriented concept of how we will achieveour objectives”
Five elements: Where will we be active? (arenas)
How will we get there? (vehicles)
How will we compete? (distinctive properties)
What speed and sequence of moves? (staging)
Where will profits come from? (economic logic)
An Example: GE Transportation Systems --Locomotives
Arenas
Differentiators
Vehicles Staging EconomicLogic
Arenas
• Diesel• Emphasize long and heavy hauls (including industrial and mining)· Americas, Asia, Middle East, Africa· Limited defensive position in Europe
Vehicles
• Wholly-owned subs with extensive service sites• Selective JVs in Europe (including Eastern/Central)
Differentiators
• Service• Mileage/operating efficiency• Safety• Operator comfort/ergonomics
Economic Logic
• Premium prices for superior product and service• Lowest diesel manufacturing costs (Erie factory)
Staging
1: • New Model X by Year 2 • Push very aggressively in Latin America and Asia • Sign Eastern Europe JVs
2: • New Model XX by Year 4 • Push aggressively in Africa
Throughout: • 5% annual productivity gains • Wait-and-see in Western Europe
9
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Hambrick & Fredrickson: KeyEvaluation Criteria
1. Does your strategy fit with what’sgoing on in the environment?
2. Does your strategy exploit your keyresources?
3. Will your envisioned differentiatorsbe sustainable?
4. Are the elements of your strategyinternally consistent?
5. Do you have enough resources topursue this strategy?
Key takeaways – Industryanalysis
Industry matters; know your toolkit forunderstanding the constraints it poses uponyou
Porter’s model is useful for making sense ofindustry dynamics, but it has importantshortcomings; know the blind spots
Don’t take your industry for granted—thedefinition matters!
Make sure you have a strategy and that itselements reinforce each other
Next class
Prepare CF Motorfreight Case Be sure to have handed in the complete
personal information sheet (w/ yourpicture…)
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BUAD 497: Session 4
Industry Analysis II
Administrative Stuff
Group projects Other stuff…
Learning goals for this session
Apply the tools for industry analysisto a classic industry
Build a deeper understanding ofindustry dynamics
Connect this to strategy formulation
CF MotorFreight in 1992
Why is it so difficult to make money in theLTL trucking business?
CF MotorFreight in 1992
How well positioned is CFMF in the LTLbusiness? How should we evaluate theirstrategy for this industry?
CF MotorFreight in 1992
As Bob Lawrence and Don Moffitt, whatare your options for solving thesecompetitive problems?
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CF MotorFreight: Update
CF spun off its unionized trucking business andcalled it CFC
Performance continued to deteriorate CFC’s competitors such as Roadway Express,
Yellow, and Arkansas Best remained profitable The regional trucking units kept cannibalizing
CFC’s business In May 2002, the board replaced the CEO with a
turnaround specialist CFC filed for bankruptcy September 3, 2002
Price
Cost
Market Share
Market Size
Unit Margins
Unit Volumes
Net Income
AssetsManaged
Return On Investment
DividedBy
Times
What mattersmost…!
Product Innovation
Process Innovation
Functional Efficiency
Marketing Effort
Customer Value
New Products
Barriers to Entry
New Markets
More Useage
Integration
Marketing Effort
Product QualityPrice Strategies
Cost Strategies
Market Share Strategies
Market SizeStrategies
Margin
Volume
Net Income
Your Essential Choice of Strategies
Key Takeaways
Industry analysis is a powerful tool for analyzingstrategy; it can show what opportunities exist inthe environment
A deeper understanding of industry dynamicsprotects you from simplistic strategies that oftenget you into trouble
Next session: Industry Analysis III
Prepare Apple Inc.: iPods and iTunes case Begin planning for your group projects
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BUAD 497: Session 5
Industry Analysis III
Learning goals for this session
Use several tools for industry analysisin a dynamic industry
Examine factors that contribute todynamic industry change
Begin to think about strategyformulation under uncertainty
Apple Computer Inc: iPods and iTunes Apple Computer Inc: iPods and iTunes
How attractive was the music industrytraditionally for the recording companies?
Apple Computer Inc: iPods and iTunes
How has the attractiveness of the industrychanged with the entry of Napster?
Apple Computer Inc: iPods and iTunes
What was Napster’s strategy and how didit evolve over time?
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Apple Computer Inc: iPods and iTunes
What was Apple’s strategy as it relates tothe music industry?
Apple Computer Inc: iPods and iTunes
As Apple, what should be your strategygoing forward?
Entry into theRussian marketin 1992
Entry intoemergingmarkets suchas India
Entry intoderegulatedlocal phonemarket
Strategy againstentrant in themining industry
Examples
Analogies andpatternrecognition;Nonlineardynamic models
Latent-demandsearch;Scenarioplanning
Decisionanalysis; GameTheory; Optionvaluationmodels
Classic industryand strategyanalysis tools
AnalyticTools
No basis toforecast thefuture
A range ofpossibleoutcomes, butno naturalscenario
A few discretesolutions thatdefine thefuture
A single,forecast preciseenough forstrategy
What canbe known?
TrueAmbiguity
A Range ofFutures
AlternateFutures
Clear-EnoughFuture
Four Levels of Uncertainty in Strategic Planning
Source: Courtney et al, Strategy under Uncertainty, HBR 1997
Key Takeaways
Companies must look broadly at the economics andforces of the industry. Think about the powerconstellations and how they are likely to change
Good strategies are coherent, build on existingadvantages, and exploit industry landscape. That’swhat Apple did
There is a big difference between having a productadvantage and having a competitive advantage.Product advantages alone are difficult to sustain
Uncertainty is critical to strategy making, and thereare tools to deal with different levels of uncertainty
Next session: Firm Competencies I
Prepare Hill and Jones chapter “InternalAnalysis”
Go to the USC and Marshall homepagesand study the strategic framework forUSC and the Dean’s message for Marshall
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BUAD 497: Session 6
Firm Competencies I
Learning goals for this session
Examine the RBV and role of corecompetencies in building competitiveadvantage
Understand how a Resource-based View(RBV) of the firm works and how it differsfrom the IO view
Apply both frameworks to conduct astrategic analysis of USC and Marshall
A Comparison: GTE vs. NEC in1980
GTE Sales 9.98B Active in
telecommunications Positioned in
display technologies Net cash flow 1.73B
NEC Sales 3.8B No telecom
experience Comparable
technological base
And eight years later… GTE vs.NEC in 1988
GTE Sales – 16.46B Closed down semi-
conductors Divested much of
their display business Telephone operating
company Moved other areas
into joint ventures
NEC Sales – 21.89B World leader in semi-
conductors First tier player in
telecommunications Included lifestyle
products – mobilephones, fax,notebooks
GTE’s Strategy: A Portfolio ofBusinesses
No clear strategic intent or commitment Significant work to identify key
technologies, but little coordinationamong business units
Decentralization and outsourcing madeGTE increasingly dependent on outsidersfor critical skills
NEC’s view of changes in the1980s
NEC identified three interrelated streams oftechnological and market evolution Computing would evolve from Main Frame to
distributed processing Components from ICs to VLSI Communications from mechanical to digital
→ Semi-conductors would become the ‘Core Product’
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NEC’s Strategy: A Portfolio ofCompetencies
Exploit the convergence of computing andcommunications – C&C
Communicated its intent to the wholeorganization
Shifted resources between units to supportcomponents and processors
GTE vs. NEC
Portfolio of Businesses
Portfolio of Competencies
vs.
The BCG Portfolio Matrix The Strategic Implications of the BCGMatrix
Stars Aggressive investments to support continued growth and
consolidate competitive position of firms
Question marks Selective investments; divestiture for weak firms or those
with uncertain prospects and lack of strategic fit
Cash cows Investments sufficient to maintain competitive position.
Cash surpluses used in developing and nurturing stars andselected question mark firms
Dogs Divestiture, harvesting, or liquidation and industry exit
The McKinsey/GE Matrix The Corporation as a Portfolioof Core Competencies
Source: G. Hamel and C. K. Prahalad, Competing for theFuture (Cambridge, Mass.: Harvard Business School Press,1994), p. 227.
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Two Concepts of the Corporation
SBU is a potential reservoir ofcore competencies
Autonomy is central; the SBU“owns” all resources other thancash
Status of the business unit
Building strategic architectureand competencies to securethe future
Optimizing corporate returnsthrough capital allocation trade-offs among businesses
Value added of topmanagement
Businesses and competenciesare the unit of analysis; topmanagement allocates capitaland talent
Discrete businesses are theunit of analysis; capital isallocated business by business
Resource allocation
Portfolio of competencies, coreproducts and businesses
Portfolio of businesses relatedin product-market terms
Corporate structure
Interfirm competition to buildcompetencies
Product competition based ontoday’s products
Basis for competition
Portfolio of CompetenciesPortfolio of Businesses
Core Competencies and the RBV:What is the company good at?
Core competencies are a source of competitiveadvantage They make a company distinctive
Competencies = Resources and Capabilities Resources
tangible and intangible assets of a firm» tangible: factories, products intangible: reputation
four general categories: financial, physical, human, organization
Capabilities proficiencies that that enable a firm to take full advantage of
other resources » marketing skills, cooperative relationships
Examples:Distinctive Competencies
Toyota, Honda, Nissan Low-cost, high-quality manufacturing capability and
short design-to-market cycles
Intel Ability to design and manufacture ever more powerful
microprocessors for PCs
Motorola Defect-free manufacture (six-sigma quality) of cell
phones
Competencies At Marks & Spencer
Adapted from Exhibit 3.5 Marks & Spencer: How Resources and Capabilities Lead to Advantages, with permission of Harvard BusinessReview: Exhibit from “Competing on Resources: Strategy in the 1990’s” by D. J. Collis and C. Montgomery, 73, no. 4 (1995).
Marks &Spencer
The Resource Based View (RBV)
Two critical assumptions of RBV: Resource Heterogeneity
differences in resources among similar firms
Resource Immobility costly for firms to acquire
What do these assumptions mean? If one firm has resources that are valuable and
other firms don’t AND if other firms can’t imitatethese resources without incurring high costs, THENthe firm possessing the valuable resources will likelygain a sustained competitive advantage
IO vs. RBV
Firms have idiosyncratic,not identical strategicresourcesResources are notperfectly mobile andtherefore heterogeneous
Firms within an industry haveidentical strategic resources
Resources are highly mobile(easily bought and sold) andtherefore homogeneous
Assumptions:
Internal—describesfirm’s internalcharacteristics andperformance
External—describesenvironmental conditionsfavoring high levels of firmperformance
Focus:
Barney, WernerfeltPorter, RumeltSomeAuthors:
Resource Based View(RBV)
Industrial Organization (IO)
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The VRIO Framework
If a firm has resources that are…
• valuable,• rare, and
• costly to imitate, and…• the firm is organized to exploit these resources,
…then the firm can expect to enjoy a sustainedcompetitive advantage
Applying the VRIO Framework
The Question of Value
In theory: Does the resource enable the firmto exploit an external opportunity or neutralizean external threat?
The practical: Does the resource result in anincrease in revenues, a decrease in costs, orsome combination of the two?
Levi’s reputation allows it to charge a premium for its Docker’s pants
Applying the VRIO Framework
The Question of Rarity
A resource must be rare enough that perfect competition has not set in
If a resource is not rare, then perfect competitiondynamics are likely to be observed (i.e., nocompetitive advantage, no above normal profits)
Thus, there may be other firms that possess theresource, but still few enough that there is scarcity
Several pharmaceuticals sell cholesterol-lowering drugs, but the drugs are still scarce—look at prices
Applying the VRIO Framework
Valuable and Rare
If a firm’s resources are… …the firm can expect:
Not Valuable Competitive Disadvantage
Valuable, but Not Rare Competitive Parity
Valuable and Rare Competitive Advantage(at least temporarily)
Applying the VRIO Framework
The Question of Imitability The temporary competitive advantage of valuable
and rare resources can be sustained only ifcompetitors face a cost disadvantage in imitatingthe resource
intangible resources are usually more costly to imitate than tangible resources and bundles of resources are more costly than single resources
Harley-Davidson’s styles may be easily imitated,but its reputation cannot
Costs of Imitation
Unique Historical Conditions First mover advantages Path dependence
Causal Ambiguity Causal links between resources and competitive advantage may not
be understood Bundles of resources fog these causal links
Social Complexity The social relationships entailed in resources may be so complex that
managers cannot really manage or replicate them
Patents Offer a period of protection if the firms is able to defend its patent
rights Can be a two-edged sword as firms disclosure may decrease costs of
imitation by other firms
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Applying the VRIO Framework
The Question of Organization
A firm’s structure and control mechanismsmust be aligned so as to give people abilityand incentive to exploit the firm’s resources
Examples: formal and informal reporting structures,management controls, compensation policies,relationships, etc.
These structure and control mechanisms complementother firm resources—taken together, they can help a firm achieve sustained competitive advantage
3M Company – rewards innovation and risk-taking
The VRIO Framework
Valuable? Rare?Costly toImitate?
Exploited byOrganization?
CompetitiveImplications
No
Yes
Yes
Yes
Yes
Yes Yes Yes
No
No
No Disadvantage
Parity
TemporaryAdvantage
SustainedAdvantage
EconomicImplications
BelowNormal
Normal
AboveNormal
AboveNormal
Source; Adapted from J. Barney, “Firm Resources a Sustained Competitive Advantage, ‘ Journal ofManagement 17 (1991), pp. 99-120.
Competitive Dynamicsof Resource Imitation
Competitive Dynamics The strategic decisions and actions of firms in
response to the strategic decisions and actionsof other firms
Firm A(strategy decisionslead to competitive
advantage)
Firm B’s Possible Responses
No Response
Change Tactics
Change Strategy
Case Study: USC/Marshall
Key Takeaways
While traditional factors used to be important,knowledge-based core competencies are increasinglyimportant in the new business landscape
Internal strategic analysis aims to integrate the firm’sspecific strengths to maximize advantage
Know the VRIO framework for understanding how toachieve and sustain competitive advantage
Core competencies can become core rigidities
Next class: Firm Competencies II
Examine the role of corporateheadquarters in acquiring anddeveloping competencies
Prepare PepsiCo case
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BUAD 497: Session 7
Firm Competencies II
Learning goals for this case
Use the RBV to understand what PepsiCoshould do
Examine how we can achieve coordinationamong businesses to exploit competencies
Examine the relationship betweencorporate vs. business unit strategy andtrade-offs between autonomy andcoordination
PepsiCo’s Restaurants PepsiCo’s Restaurants
Should PepsiCo acquire CoC and CPK?
PepsiCo’s Restaurants
Given PepsiCo’s strategic goals, whereshould CoC and CPK be placed in thePepsiCo structure?
PepsiCo’s Restaurants
How could PepsiCo be re-structured toimprove coordination and synergy?
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PepsiCo Restaurants: Update
Pepscio made both acquisitions. They took a51% ownership with agreements to buy out therest over time, conditional on performance.
CPK and CoC were left as independentcompanies reporting to VP Strategic Planning(Ken Stevens) and one or two restaurantpresidents
CoC was reconceived as a design and marketingcompany, with production outsourced
CPK has rolled out more stores nationwide, usingthe funding from PepsiCo
PepsiCo Restaurants: Update (Cont’d)
However, 1994 operating profits from restaurants fell 6% Pepsico Vice-Chairman Roger Enrico’s goals are to return
to profitable growth by tying together business functionsacross the chains, including accounting, billing, andpurchasing to cut costs, and reducing the number ofcompany owned stores.
In 1997, PepsiCo spun off its restaurants as Tricon,renamed Yum! in 2002.
Yum! focused on generating concentrated efficienciesunder a single brand, sometimes placing two or threebrands into a single restaurant; sales have increasedconsiderably, though still less than at McDonalds
Growth has been impressive in China, with operatingprofits rising from $20m to $200m from 1998 to 2005
Key Takeaways
Be able to analyze what actions createcompetencies and how they affect corporatestrategy
PepsiCo: clear example of benefits of sharing andcoordination at the corporate level (you can’t getmuch more related than three fast foodrestaurants…!)
But even here: tradeoff between autonomy andgrowth!
You can create value through fairly independentdivisions—the question is, can coordinationcreate even more?
Next class: Firm Competencies III
Prepare Wal-Mart Case and skim the businesspress on current developments around Wal-Mart
Remember that group emails are due bymidnight on Wednesday, the 31st
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BUAD 497: Session 8
Firm Competencies III
Learning goals for this session
Continue analyzing the sources of a firm’scompetitive advantage and how they relateto competency
Examine the sustainability of thiscompetitive advantage
Analyze the transferability of competitiveadvantage and what factors matter whenmoving into different environments
Wal-Mart Stores Inc. Wal-Mart Stores Inc.
What are Wal-Mart’s sources ofcompetitive advantage?
Wal-Mart Stores Inc.
How sustainable is Wal-Mart’s position?
Wal-Mart Stores Inc.
What are the issues involved with Wal-Mart diversifying into foreign countries?
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Next class: Complementarities and Fit
Prepare readings Milgrom and Roberts, “Complementarities
and Design Decisions” Grant, “Alternative Structural Forms”
Mini case analysis due at beginning ofclass
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BUAD 497: Session 9
Fit and Complementarities
Learning Goals
Understand the importance of organizationalstructure and configurations for designing and inimplementing strategies
Understand the tension between differentiationand integration in organizing
Know the relative advantages and disadvantagesof the most common organizational structures(functional, divisional, matrix)
Examine different views of organizations, such asMintzberg’s approach and a view of firms asactivity systems
Why Understand OrganizationalConfigurations and Structure?
Internal fit of organizational configurations isessential for achieving sustainable competitiveadvantage
Understanding configurations and structures isimportant for your career. What activities arecore? Where do you fit in? What organization doyou want to be in? Formal vs. informal?Centralized vs. decentralized? Entrepreneurial vs.rule-guided?
Organizational Structure and Design
Organizational Structure The formal configuration between individuals
and groups with respect to the allocation oftasks, responsibilities, and authorities withinorganizations
Organizational Design The process of coordinating the structural
elements of an organization in the mostappropriate manner
Three approaches: Classical Organization Design Mintzberg’s Framework Activity Systems
Part I: The Classical Approach The history of a hostel that grewtoo fast…
Chef
WaiterCleaning aid
It-technician Dishwashers
Receptionist
Caretaker
Midlevel manager Midlevel manager Midlevel manager
Husband
WifeChildren
Guests
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Graphic Description
= Evolution = Revolution
Age of Organisation
Size
of O
rgan
isat
ion
Crisis by Style of Management
Phase 1
Growth by Creativity
Phase 2
Growth byTight Management
Phase 3
Growth by Delegation
Crisis by Autonomy
Crisis by Control
Crisis by Bureaucracy
Crisis by what?
Phase 4
Growth by Coordination
Phase 5Growth byTeam Spirit
Greiner’s Model of OrganizationalGrowth
”After the task has been divided into specialist subtasks, the problem isto integrate the subtasks around the completion of the global task. Thisis the problem of organisation design.”
Jay Galbraith (1974), Organization Design – An Information Processing View
Control Flexibility
The circularity of formalisation
The problem is how to find the right balance and not let the organisation drown in complexity
The Basic Problem of Organizing
Growth Patterns of Firms
Phase 1Strategy: Low revenue base; simple product-market scopeStructure: Simple
Phase 2Strategy: Increase in revenues; engage in vertical integrationStructure: Functional
Phase 3Strategy: Expand into new, related product-markets and/or
geographical areasStructure: Divisional
Phase 4Strategy: Expand into international marketsStructure: International Division, Geographic Area, Worldwide
Product Division, Worldwide Functional, orWorldwide Matrix
Functional Structure
Chief ExecutiveOfficer or President
ManagerProduction
ManagerEngineering
ManagerMarketing
ManagerR&D
ManagerPersonnel
ManagerAccounting
Lower-level managers, specialists, and operating personnel
Advantages Pooling of specialists
enhances coordinationand control
Centralized decisionmaking enhances anorganizational perspectiveacross functions
Efficient use of talent Career paths and
professional developmentin specialized areas arefacilitated
Disadvantages Differences in functional
orientations impedecommunication andcoordination
Tendency for specialiststo develop a short-termperspective and a narrowfunctional orientation
Functional area conflictsmay overburden top leveldecision makers
Difficult to establishuniform performancestandards
Functional Structure
Office of the President
Centralized Staff
Marketing Personnel
Engineering Operations Accounting
• Operations is main function• Process engineering is
emphasized over R&D• Large centralized staff• Formalized procedures• Structure is mechanical, job
roles highly structured
Structure for Cost LeadershipStrategy
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Operations HumanResources
President andLimited Staff
Marketing
New ProductR&D
• Marketing is the main function for tracking new product ideas• New product R&D is emphasized• Most functions are decentralized• Formalization is limited to foster change and promote new ideas• Overall structure is organic; job roles are less structured
R&D
FinanceMarketing
Structure for a Differentiation Strategy Divisional Structure
Chief ExecutiveOfficer orPresident
Corporate Staff
Division A
General Manager
Division B
General Manager
Division C
General Manager
ManagerProduction
ManagerEngineering
ManagerMarketing
ManagerR&D
ManagerPersonnel
ManagerAccounting
Organizedsimilarly toDivision 1
Organizedsimilarly toDivision 1
Lower-level managers, specialists, and operating personnel
Advantages Increases strategic and
operational control,permits executives toaddress strategic issues
Quick response toenvironmental changes
Increased focus onproducts and markets
Minimizes problemsassociated with sharingresources across functions
Facilitates development ofgeneral managers
Disadvantages Increased costs incurred
through duplication ofpersonnel, operations,and investment
Dysfunctionalcompetition amongdivisions may detractfrom corporateperformance
Difficulty in maintaininguniform corporate image
Overemphasis on short-term performance
Divisional Structure
A structure based on geographic lines usuallyimplies a multi-domestic international strategy
NorthAmerica Australi
aEurope Asia Latin
AmericaAfrica
Product A Product B Product C Product D
Chief Executive Officer
Corporate Office (Staff)
Multi-Divisional Structure (A)
Multi-Divisional Structure (B)
Product A Product B Product C Product D
A structure based on product lines usuallyimplies a global international strategy
Chief Executive Officer
Corporate Office (Staff)
Matrix Structure
Chief ExecutiveOfficer orPresident Corporate
Staff
ManagerAdministration
and HumanResources
ManagerProjects
ManagerManufacturing
ManagerEngineering
ManagerMarketing
Manager PublicRelations
Project A
Project B
Project C
Project D
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Advantages Increases market
responsiveness throughcollaboration andsynergies
Allows more efficientutilization of resources
Improves flexibility,coordination, andcommunication
Increases professionaldevelopment throughbroader responsibilities
Disadvantages Dual reporting relationships
can result in uncertaintyregarding accountability
Intense power strugglesmay lead to increasedlevels of conflict
Working relationships maybe more complicated andresources duplicated
Excessive reliance onteamwork may impedetimely decision making
Matrix Structure Restructuring Leo Burnett
Part II: Mintzberg’s Approach Henry Mintzberg: Five Basic Elements
Operating Core: Employees who perform thebasic work related to an organization’s product orservice.
Strategic Apex: Top-level executives responsiblefor running an entire organization.
Middle Line: Managers who transfer informationbetween higher and lower levels of theorganizational hierarchy.
Technostructure: Organizational specialistsresponsible for standardizing various aspects ofan organization’s activities.
Support Staff: Individuals who provide indirectsupport services to an organization.
Mintzberg’s Five Organizational Forms
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Five Organizational Forms (1)
The Simple Structure: young, small;nonsophisticated technical system;simple, dynamic environment.Key: strategic apex
Machine Bureaucracy: old, larger;regulating, nonautomated technicalsystem; simple, stable envir.Key: technostructure
The Divisionalized Form: diversifiedmarkets (esp. products & services); old,large.Key: Market grouping, performancecontrol, limited vertical decentralization
Five Organizational Forms (2)
The Professional Bureaucracy:complex, stable envir. Nonregulating,nonsophisticated technical system:Key: Operating Core.
The Adhocracy: complex, dynamicenvir.; sophisticated and often automatedtechnical systemKey: Support Staff
The Idea Organization: Value-basedorganizations, public/religiousorganizations…Jehovas Witnesses,Greenpeace, Al Quada, IRA
Summary of Mintzberg Part III: Organizations as ActivitySystems
The Underlying View: Strategy asPositioning (Porter, 1996)
Operational effectiveness is not strategy Operational effectiveness is a given
Strategy is a unique position for the firm Strategy is not doing the same activities better, rather
doing them differently or doing different activities
Strategy involves trade-offs Due to incompatible product features, inconsistencies
in image, limits of coordination, motivation,management, etc.
Strategy means achieving a high degree of fitbetween internal activities/resources and theexternal environment
A Different View:Firms as Activity Systems
Activity Systems form configurations thatneed to exhibit a high degree of internal fit
Interplay of complementarities and trade-offs across multiple activities is critical tosuccess
Different configurations can be equifinal,i.e. equally effective (“many best ways toorganize”)
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LimitedCustomer
Service
Self-selectionby Customers
ModularFurniture
Design
LowManufacturing
Cost
SuburbanLocation
With ampleparking
LimitedSales
staffing
IncreasedLikelihood of
Futurepurchase
In-houseDesign focused
On cost ofmanufacturing
ExplanatoryCatalogues,Informative
Displays andlabels
Ease ofTransport and
assembly
“ knock-down”Kit packaging
Wide varietyWith ease of
manufacturing
MoreImpulsebuying
MostItems in
inventory
Year-roundstocking
100%Sourcing from
Long-termsuppliers
Self-Transport by
customers
High-trafficStore layout
Self-assemblyBy customers
AmpleInventoryOn site
IKEA’s Activity System
Robert Mondavi Premium wine producer Long-term contracts with
outside growers, also ownsvineyards
Established relationships,extensive knowledge-sharing
Extensive use of hand-methods to ensure highestquality
Aging in small oak barrels Heavy use of tastings, PR,
wine tours
E.&J. Gallo Large-volume, low-price
producer Grapes purchased at arms-
length from outside growers,often also imported
Highly automated productionmethods
Aging in stainless steel tankfarms
Heavy use of advertising(leading advertiser amongCalifornia wineries)
Equifinal Activity Systems withInternal Fit: Wine Industry
Home Depot Huge stores with no-frills
design Widest selection of items High ceilings allow large
inventories on store shelves No warehouses or distribution
centres; direct deliveries fromlimited number of vendors
Goods delivered go directly onselling floor on palettes
Well-trained employees toadvise mostly DIYs and smallcontractors
Low prices
Lowe’s Slightly smaller, more
attractive stores Greater emphasis on
fashion, kitchen, decorating Lower ceilings with more
attractive shelving Regional distribution
centres with hub-and-spoke system
Contractors are served byseparate corporate divisions
Higher proportion ofunique and fashion itemsw/ higher prices
Equifinal Activity Systems withInternal Fit: Home ImprovementRetailing
Implications: Strategy and Fit
Taylor many activities to the strategicposition
Strengthen the fit among activities The strategic value of outsourcing depends
on fit Outsourcing tends to make activities generic Tailor suppliers to strategy
Improve the strategy (and counter yourrivals’ moves) in ways that extend andstrengthen fit
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What is a Strategy? Unique position Tailored activities Activities fit together in an
integrated system Clear tradeoffs Continuity of position but
consistent improvement
What is not a Strategy? Best practice improvement Learning Agility Flexibility Restructuring Mergers/Consolidation Alliances/Partnering The Internet
Summary: Strategy as Configuration Key Takeaways
Structure and configuration need to follow strategy There is a key tension in organizational structures
between control and flexibility; know which one ismore important for your situation
Organizations go through growth cycles; knowwhich one you are in and recognize the symptoms
Know the main organizational structures and theiradvantages and disadvantages
Formal structures are only half the story—knowhow a firm’s activity systems are configured andhow this supports/hinders the firm’s strategy
Next Session: Fit Applied
Prepare Progressive Case
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BUAD 497: Session 10
Fit Applied I
Learning Goals
Get experience applying the activitysystem framework
Examine trade-offs of strategic positions Understand the model of strategy that
underlies the configurations approach
Progressive Corporation Average Industry Ratios 1995-1998
Strategy as “OneBest Way”
One ideal competitive position inthe industry
Benchmarking of all activitiesand achieving best practices
Aggressive outsourcing andpartnering to gain efficiencies
Advantages rest on a few keysuccess factors, criticalresources, core competencies
Flexibility and rapid responses tocompetitive and market changes
Strategy as Fit
Unique competitive positionfor the company
Activities tailored to the firm’sstrategy
Clear trade-offs and choicesvis-à-vis competitors
Advantages arise from fitacross activities
Sustainability comes from theactivity system, not the parts
Alternative Views of Strategy Key Takeaways
Competitive advantage emerges out of the entiresystem of a firm’s activities
Fit among activities reduces cost or increasesdifferentiation
Relying on complex activity systems decreasesthe threat of imitation by competitors
The most viable strategic positions are thosewhose activity systems are incompatible becauseof tradeoffs
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Next Session: Fit Applied II
Continue with analysis of activitysystems
Prepare Airborne Express case
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BUAD 497: Session 10
Fit Applied II
Learning Goals
Compare different positions within anindustry and understand the strategiesthat go with them
Examine the effect of cost position onstrategy
Be able to identify priorities based ontotal and marginal relative costs
Airborne Express Airborne Freight Stock Price
Update
Airborne continued to prosper in 1997 and 1998(net income 1996: $28m, 1997: $120m, 1998:137m).
However, in 1999 Airborne began to falter. FedExmoved further into ground operations. BothFedEx and UPS exploited the online shoppingboom of the late 1990s, but Airborne struggled.
After 1999, Airborne’s profits were meager withlosses in some quarters
Update (cont’d)
In March 2003, DHL announced it would acquireAirborne for about $1.2 billion.
Since 2003, DHL has committed extensive fundsto catch up with FedEx and UPS in the US. DHL’sbrand has replaced Airborne’s and is trying toestablish itself as a “third force” in the expressmail industry
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Key Takeaways
Greater interactions between decisions tend tolead to internally consistent but mutuallyexclusive positions
Even a small firm can carve out a long-viableposition in an inhospitable environment byexploiting a distinct position
Successful strategies tailor a large number ofactivities in mutually reinforcing ways to createthis position
However, even the best fit is not invulnerable tocompetitive moves that take away positionaladvantages
Next Session: Fit Applied II
Continue with analysis of activitysystems
Prepare Airborne Express case
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BUAD 497: Session 12
Competitor Analysis
Learning Goals
Understand how game theory applies to businessand helps us to analyze strategic moves by ourcompetitors
Know the main elements of games and their basicforms
Examine how firms can change the rules of a gameto capture more value for themselves
See how competitor profiling can complement gametheory
What is Game Theory?
“No man is an island”
Analysis of rational behavior in interactive or interdependent situationsThe bad news…
…knowing game theory does not guaranteewinning
The good news……very useful framework for thinking about
strategic interaction
Games We Play
Group projects Free riding and reputationPoker CredibilityTraffic CongestionDating Information manipulationDining out Coordination
Decision Theory vs. Game Theory
Ten of you go to a restaurant
If each of you pays for your own meal……this is a decision problem
If you all agree to split the bill...…now, this is a game
Restaurant Decision-Making
A check splitting policy changes incentives:they depend now on the moves of other players…
May I recommend that with theBleu Cheese for ten dollars more?
Sure!
It is onlya dollarmore
for me!
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Games Businesses Play
Market entry CommitmentSupply chains AuctionsCorporate takeovers Winner’s curseFishing CongestionPatent races Game of chickenOPEC output Collusion & enforcement
Components of a Game
Games have the following characteristics:
Players Rules Payoffs Strategies
Games as Defined by the Numberof Players
1-person (or game against nature)2-personn-person (3-person & up)
Games as Defined by the Rules
Rules determine the number of options/alternativesin the play of the game.
The payoff matrix has a structure (independent ofvalue) that is a function of the rules of the game
Thus many games have a 2x2 structure due to 2alternatives for each player
Games as Defined by the PayoffStructure
Zero-sumClassic games: Chess, checkers, tennis, poker.Business games: Sales negotiations (often)
Non-zero sumClassic games: MonopolyBusiness games: Market entry, research investment
Generic Strategies
In simple games, it is natural to suppose that oneplayer will attempt to anticipate what the otherplayer will do
Minimax: to minimize the maximum loss; a defensivestrategy
Maximin: to maximize the minimum gain; anoffensive strategy
Games can also have sequential play, which leadsto more complex strategies
Tit-for-tat: always respond in kind Tat-for-tit: always respond conflictually to
cooperation and cooperatively towards conflict
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Game or Nash Equilibria
Games also often have solutions or equilibriumpoints
These games, owing to the selection of particularreasonable strategies, will result in a determinedoutcome
A Nash Equilibrium is that pointwhere it is not to either player’sadvantage to unilaterallychange his or her mind
John F. Nash (1928-)
(1) The Prisoner’s Dilemma
Two years
Two years
Ten years
Free
Confess
Free
Ten years
Six months
Six months
~ Confess
Prisoner B
Confess~ Confess
Prisoner A
Should youconfess?
What makes a Game a Prisoner’sDilemma?
We can characterize the set of choices in a PD as: Temptation (desire to double-cross other player)
Reward (cooperate with other player)
Punishment (play it safe)
Sucker’ pay off (for the player who is double-crossed)
A game is a Prisoner’s Dilemma whenever: T > R > P > S
Free > Six months > Two years > Ten years
What is the Outcome of a PD?
The saddle point is where both confessThis is the result of using a minimax strategy.Two aspects of the game can make a difference.
The game assumes no communication The strategies can be altered if there is sufficient
trust between the players
Examples in Business: two companies deciding onwhether to start an advertising campaign; Boeingvs. Airbus in VLAs; research investments, …
(2) The Game of Chicken
0
0
+1
-1
Swerve
-1
+1
-20
-20
~ Swerve
Driver B
Swerve~ Swerve
Driver A
Chicken is an Unstable game
There is no saddle point in the game.No matter what one player chooses, the other
player can unilaterally change for some advantageChicken is therefore unstableWe cannot predict the outcomeBUT: Credible commitment can persuade the other
player to back down
Examples in Business: Patent races, Microsoft vs.Linux, etc.
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(3) Tragedy of the Commons
Describes the problem of the unregulated use of apublic good
Take a village with 10 familiesEach family has 10 cows which just exactly provide
the food they needThe village commons
has a carrying capacityof 100 cows
Cow Carrying Capacity
Each cow produces 500 lbs of meat & dairy per yearup to or at carrying capacity of the pasture.
10 families X 10 Cows X 500 lbs = 50,000 lbs offood at carrying capacity
…and then Farmer Symthe’s wife has triplets…
One more cow…
So Farmer Smythe decides he really needsone more cow
And there is no one to tell him “No!” becausethe commons is an unregulated public good Some modern commons are forests, oceans,
public roadways, air quality, Internet (nospamming), markets with limited carryingcapacity, etc..
Reduced Capacity
With the overgrazing, each cow will now produceonly 490 lbs of food.
101 Cows X 490 lbs = 49,490 lbs of food at carryingcapacity
Each family gets 4900 lbs of meat & dairy, insteadof 5000
Except Farmer Smythe, who gets 5390 lbsEven with the reduced carrying capacity,
it is still to his advantage toadd the extra cow
Looks familiar…?
Look at the situation: N players Equilibrium solution is to ~cooperate Joint optimal outcome is to cooperate This is an n-person, collective Prisoner’s dilemma
Applying Game Theory toBusiness: Toys “R” Us
Competitive Landscape Toy & department stores
Do not compete with TRU on price (50% markups)
General discounters (Wal-Mart, Target) Cannot compete with TRU on selection (9% markups) Toys exhibit high product differentiation
Specialized discounters (only TRU) Enjoyed 20% market share nationally
Warehouse clubs (Costco, Pace) Introduced in the 1980s By 1989, about 200 items in competition
Cause of concern for Toys “R” Us!
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Toys “R” Us (continued)
Market research into the future of warehouseclubs Manufacturers estimated 3-5% annual growth rate Toys “R” Us conducted comprehensive but proprietary
study Manufacturers were aware of the study, but not its
results Toys “R” Us expected warehouse clubs to grow quite
fast…
Idea! Issue statement to manufacturers: “You may not sell to warehouse clubs without losing
Toys “R” Us as a customer.” Effectively, choose between a $5 billion market (TRU) and a
less than $500M market (warehouse clubs)
Toys “R” Us (continued)
Manufacturers agreed to TRU deal Really they had little choice given the uncertainty about
the future
Warehouse club toy sales decreased Pre-agreement growth of 51% per year Overall growth of clubs of over 10% per year
Toys “R” Us kept its market
The Toys “R” Us Example
Sequential timing Threat of Manufacturer’s decisions
How will my opponents react?
Simultaneous timing Manufacturer’s decisions
What is my opponent doing right now?
Information Future profitability of warehouse clubs
What can I infer from the actions of others?
Agreements Enforceability of contracts & agreements
What happens if someone breaks the agreement?
Changing the Game…
What game is being played?
Who are the key players? duopoly game; oligopoly game; etc…
What options are open to the players? pricing game; advertising game; etc.
What goals are the players pursuing market share? profits?..
Are goals complementary or conflicting? issues the players agree on, sources of conflict, etc..
What is the time structure of the game? one shot, repeated, simultaneous, sequential…
How can the game be changed?
The game can be changed by changing…
Players Added value Rules of the game Tactics employed Scope of the game
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Changing the players
Bring in customers Pay customers (esp. early adopters) to play (Samples, Netscape) Subsidize some customers, other full paying customers will follow
(Initial discount to lower risk)
Bring in suppliers Holland Sweetener Co./NutraSweet and Coca-Cola
Bring in complementors Do it yourself. Nintendo - both h/w & s/w Pay complementors to play (at least initially)
Bring in competitors Create a second source to encourage buyers to adopt technology
Limit your supply DeBeers and diamonds; Nintendo & video games Downside: Shrinks the pie today; leaves entry opportunity open
Raise amount consumers are willing to pay Policies that build loyalty (frequent flier miles) increase willingness
to pay - GM / Ford credit cards
Lower competitors’ value Softsoap - by cornering the supply of pumps
Change the added value
Changing tactics
Make the game more transparent or opaque depending on which benefits you
To establish credibility (clear the fog) Absorb uncertainty (e.g. accept a pay-for-performance contract) Offer guarantees or advertise Ask others to demonstrate their credibility to you
To establish uncertainty (preserve the fog) Create complexity (long distance calling rates) Bluff: Ask yourself whether you will be believed and under what
circumstances Ask what others stand to gain by preserving the fog, and what they
could be bluffing about
Changing the scope
What is the current scope of the game? Games are often linked across geographic and product
markets
Do you want to link the game to other games? Would a multi-market contract be beneficial to you?
Do you want to de-couple the game fromother games? Leave a market to stop competing head-on with
another firm
Beyond Game Theory:Competitor Profiling Why Competitor Profiling?
Game Theory takes an economic perspective Focus on incentives and interactions among moves Assumption of rationality; what competitors should do
if they behaved rationally
Competitor Profiling takes a behavioralperspective Focus on competitors’ predispositions What do competitors really want given their beliefs,
blind spots, and historical tendencies
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Why Competitor Profiling Matters
Goals may not be fully rational due to- Difference in an organizations’ charter (public, non-
profit, family-owned…)- Agency problems (top management’s interest may be
different)- Irrationality (pride, jealousy, fairness…)
Beliefs may lead them to see the world differently- Mental models may differ (e.g. due to differences in
functional backgrounds)
Routines may constrain opportunities for action- Inertia due to size/maturity/complexity/strong
culture/bureaucratization etc.
How to Integrate Both GameTheory and Competitor Profiling
Think broadly about the set of strategic options Variables (organization, customers, pricing…) Asymmetries Commitment postures Information
Augment you toolkit for dynamic analysis Scenario analysis (role-playing/devil’s advocate) Market testing Sequenced rollout
Match analytics and industry/company context Do general assumptions hold in this industry/company? But: question industry logics/orthodoxies
Key Takeaways
Game theory is a powerful tool for analyzingcompetitive moves—know the typical games andbe able to anticipate your rival’s response
Logics can often be changed so a new game isplayed—use this to your advantage
Never assume your opponent’s behavior is fixed!Predict their reaction to your behavior
Complement game theory with competitor profilingto work around the restrictive assumptions onwhich game theory is built
Next Session
Get experience applying gametheory and competitor analysis
Prepare Ryanair case
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BUAD 497: Session 13
Competitor AnalysisApplied I
Learning Objectives
Get experience applying competitoranalysis
Examine market entry and the threat ofretaliation
Ryanair Ryanair: What Happened…
Even before Ryanair initiated service in May1986, Air Lingus and BA reduced their lowest,restricted round-trip fare to £95!
Ryanair countered with an unrestricted fair of£94.99
By 1989, customers could find fares as low as £70 Ryanair’s initial performance was promising
almost 100% seats sold great PR for “taking on the big guys”
Ryanair: What Happened…(Con’d)
Ryanair soon grew to serve 27 routes (Dublin,Manchester, Liverpool, Glasgow etc.)
Passenger volume grew rapidly But…the company began to accumulate large
losses I£6 Million in 1988, I£4.5 Million in 1989
Expansion strained the firm’s management system January 1991, Ryanair was hours away from
bankruptcy…
Ryanair reborn!
The airline cut costs radically dropped all loss-making routes removed all in-flight amenities (coffee, snacks, etc.) promoted duty-free sales renegotiated labor contracts
Ryanair remodeled itself completely on SouthwestAirlines
2002-2003: 30% operating profit margin vs.British Airway’s 3.8%
2003: market capitalization of $5b – compared to$3b for BA and $2.7b for Air France
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Key Takeaways
Combining game theory analysis with competitorprofiling is essential; you need to examine bothsides of the story
Retaliation is extremely unattractive when theentrant is small, the incumbent large, and across-the-board price cuts necessary to retain customers
But: the ability to retaliate in a targeted waymakes retaliation more attractive and likely
Credible commitment is often difficult
Mini Case Analysis Notes andComments
Next Session
Continue with applying competitor analysis Case: Leadership Online—Barnes and
Nobles vs. Amazon
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BUAD 497: Session 14
Competitor AnalysisApplied II
Learning Objectives
Examine competitive moves in the neweconomy of online selling
Understand how positioning analysis—theanalysis of willingness to pay and ofcost—matters in the context of onlineselling
Explore the substitution threat tocompetitive advantages in this newbusiness landscape
Leadership Online
vs.
Cost Comparison of Online vs. OfflineBusiness Models
What B&N brings to the table…
The B&N annual report of 1996 read as follows:
“The competitive advantages we bring to thisbusiness are enormous, as is our ability toleverage pre-existing assets. They include [the]distribution center, [the] 2.5 million title database, special order processing, direct marketingexpertise, name recognition and franchise value,international reputation, excellent partnerships(Firefly, AOL, etc), [and] bookselling expertise.”
Amazon vs. Barnes & Noble
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Update on the Online Battle
Amazon in 2004: $588m net income on revenues of $6,921m about 70% of the online book market market cap of $18 billion
Barnes & Noble in 2004: $143m net income on revenues of $4,874 about 15% of the online book market market cap of $2.3 billion
By 2005, Amazon had become the world’s largest onlineretailer with 47 million accounts. It had moved frombooks into other media (CDs, DVDs…) and then intoelectronics and a dozen other categories
Amazon added operations in the UK (1998), Germany(1998), France (2000), Japan (2000), Canada (2000), andChina (2004)
Key Takeaways
Competitor analysis is valuable across variousbusiness landscapes and can show the differencesresulting from differing ability to digitize products
There is usually a continuum of competitiveresponses—consider all and select the one thatbest works with your capabilities and is hardest toimitate
The sustainability of competitive advantage isoften complicated in virtual contexts. Online andoffline competition can coexist and interact
The threat of imitation for online business modelsis frequently overblown, but such business likelyhave to deal with new threats to sustainability
Next Session
Focus on creating value and competitiveadvantage
Case: Harnischfeger Industries
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BUAD 497: Session 15
Creating CompetitiveAdvantage
Learning Objectives
Enhance our understanding of value creation,value appropriation, and value added
See how value creation and appropriationrelate to competitive moves
Apply these concepts to the Harnischfeger case
Why Care About Value Creation?
In any market, before consideringwho gets what it is important tounderstand what there is to get
What determines total value created?
Assessing Value Creation
Who are the players? What are customers willing to pay for
the good or service? What are suppliers’ opportunity costs
of providing the good or service?
The Value Chain Value Creation
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Value Creation
Value created =Buyer’s willingness-to-pay
minusSupplier’s opportunity cost
This is the value that can beappropriated
Value Division
Value Added
Price measures the division of valuebetween business and customer
Cost measures the division of valuebetween business and supplier
What determines these divisions ofvalue?
Added Value
Value Added - A Simple Game
Imagine there are 30 students in this class. A blackcard is passed out to each student.
Added Value - A Simple Game
Imagine the instructor holds 30 red cards.
Added Value - A Simple Game
The Dean has agreed to pay $100 for each pair (1black + 1 red) of cards.
$100
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Added Value - A Simple Game
How much would you be willing to accept for yourblack card? Imagine the instructor offered you$20. Would you accept this offer?
Added Value –A Slight Modification
Imagine the same game except now the instructoronly has 27 red cards. There are still 30 blackcards for 30 students. How much would youaccept for your black card?
Added Value in the card game =
When the instructor is in the game, the valueof the game is $3,000. When theinstructor is not in the game the value ofthe game is $0.
When there are 30 black and 30 red cards,each student has an added value of $100because without each student a matchcannot be made and $100 is lost.
Added Value in the card game =
When there are 30 black and 27 red cards,the instructor has an added value of$2,700 and an individual student has anadded value of $0. Since 3 students willend up without a match, no one student isessential to the game.
The total value of the game with 30 studentsis $2,700.
The total value of the game with 27 studentsis also $2,700.
What you get is based on youradded value
Added value =total value with you
minustotal value without you
It’s what you bring to others
(Brandenburger and Nalebuff, Coopetition, 1996)
What is your added value?
Ask yourself the following question:
If I enter this game, what do I add?
That is how much you can bargain for…
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Summary
The size of the pie Willingness-to-Pay minus Opportunity Cost
The division of the pie: Added Value
The next step: what happens if youcannot cooperate to maximize valuecreated?
Harnischfeger Industries
Update on Harnischfeger…
Bob Hale of Harnischfeger chose to do battle withKranco
In July 1992, Kranco filed for Chapter 11bankruptcy after its biggest lender cut off the funds
In January 1993, Kone announced that it hadacquired Kranco’s operating assets, including therights to designs and trade names, for $3.5 million
This was about the worst possible outcome fromHarnischfeger’s perspective
In January 1998, Harnischfeger sold its crane unitto an investment firm and left the market foroverhead cranes
The Value Net
Key Takeaways
Value creation and value division are bothimportant aspects of strategy
If you only consider the competitive battle,you may miss the larger opportunities thatcome from creating value!
Added value largely determines the divisionof the pie
Expanding the game by bringing in newplayers may frequently be your best bet atcapturing more value (i.e. more of the pie)
Next Session
Move from creating to sustainingcompetitive advantage
Case: Saturn—A Different Kind of CarCompany
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BUAD 497: Session 16
SustainingCompetitive Advantage
Learning Objectives
Examine how to create competitive advantageas a de novo entrant in a mature industry
Understand the challenges of sustainingcompetitive advantage
See how Saturn has used the configuration ofits value chain to secure its competitive position
Saturn: A Different Kind of Car Company Key Takeaways
As a de novo entrant in a mature industry, youcan only achieve competitive advantage bycreating value in a new way
The likely way of creating new value is throughreconfiguring the value chain to achieve novelproduct attributes
Sustaining competitive advantage may rest on anarrow set of interlinked activities
Taking actions to secure and protect competitiveadvantage can be a two-edged sword: it canprevent imitation but may also make knowledgetransfer to the corporate parent more difficult
Next Session
Strategy in a world of standards andnetwork externalities
Reading: Shapiro and Varian, “The Art ofStandard Wars”
Also: Check out the Blue-Ray/HD-DVDbattle going on right now
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BUAD 497: Session 17
Standards and NetworkExternalities I
Learning Goals
Understand the role of standards instrategy and implementation
Know the rules of standards strategy andthe politics of standard setting
Apply these concepts to a current real-life example
Winning with Standards
Standards are central to business strategy,yet are often not well understood
Standards matter wherever productsdepend on compatibility (software, CDs, videotapes, lamp batteries, razor blades, typewriter keyboards,ski bindings, credit card systems…)
Standards change the game and therequired different strategies
Standards Require DifferentStrategies
The elements of the generic “Porter Style”strategy:
get in the market early differentiate the product protect it from imitation charge premium prices
With standards, successful strategies oftenwork differently. It may be smarter to…
hold back the product launch adopt a simple, undifferentiated, standard design encourage imitation by other manufacturers lower prices to maximize early sales
An Example…
versus
Sony vs. JVC
Sony launches its Betamax videotape recording system in1974
Two years later, JVC introduces its Video Home System(VHS), an incompatible alternative to Betamax
By that time, more than 100,000 Betamax machines hadalready been sold
BUT: JVC adopts a more “open” policy for partners,sharing information about the technology…
By 1984, the JVC “family” has 40 companies, includingGrundig, Hitachi, Matsushita, Philips, RCA, and Sharp,some of the biggest manufacturers in Japan, Europe, andNorth America. The Betamax group has only about adozen members
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Sony vs. JVC: Number of Units Sold Sony vs. JVC: Share of VCR Market
Sony vs. JVC
Sources of JVC’s success: “Bandwagon” of supporting firms
Consumer confidence Faster pace of product improvement at moment of choice
Larger scale lowers costs Network externalities for consumers
The Result: by 1988, Sony conceded and beganproduction of VHS recorders; the war wasofficially over
Understanding Standards andNetwork Externalities
How Standards Change the Game
Standards introduce network effects “Demand side Economies of Scale”
Benefits that come from having a large installedbase of users
Classic examples are literal networks telephone network (“natural monopoly”) fax machines Internet
Number of possible connections grows rapidlywith number of users – “network externalities”
system with one user is of little use system with all customers on is very valuable
How Standards Change the Game
Positive feedback strengthens widely usedplatforms
Example: Windows vs. Mac Windows has more users, therefore
More retailers sell Windows PCs More software producers write for Windows Windows documents can easily be exchanged with
others More IT staff specialize in Windows
Therefore, still more people switch to Windows
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Microsoft products are not necessarily better Some quality benefits from huge sales, but not crucial “Popularity adds value”
Switching costs can be considerable Legacy systems can create path dependencies
Where no clear winner exists yet Customer expectations for future will decide winner Need to lure developers and users in early stages
(win “mindshare”)
Network effects are not based onefficient production The Evolution of a Standard War
Who Wins and Who Loses FromStandard Adoption?
Consumers Generally better off Reduced uncertainty; no need to wait More users, more value But variety may decrease
Complementors Generally better off May serve in a brokering role (DVD)
Incumbents May be a threat Strategies
Deny backward compatibility Introduce its own standard Ally itself with new standard
Open versus Closed Standards
Some technological standards are open (WiFi networks,Ethernet, TCP/IP)
no one firm controls them specifications are public, anyone can build compatible products may require license fee
Some standards are closed, controlled by one firm (e.g.most of Windows)
Important tradeoffs here: Openness helps technology become dominant But success of a technology may not help the firm that devised
it (e.g. IBM and desktops) Closed systems can be controlled, so benefits don’t flow to a
competitor But development may be stifled and leapfrogging may occur
Discontinuity(Many vendors)CD audio, 3.5” disks
PerformancePlay
Palm Pilot,Iomega Zip
Incompatible
Open Migration(Many vendors)Fax machines,
some modems
ControlledMigration
Windows 98,Pentium,Softwareupgrades
Compatible
OpenControl
Strategies for New Standards:Open vs. Closed
Part One: Tactics in FormalStandard Setting
Don’t automatically participate If you do you have to license
Keep up momentum Continue R&D while negotiating
Look for logrolling Trading technologies and votes
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Part One: Tactics in FormalStandard Setting
Be creative about deals Second sourcing, licensing, hybrids, etc.
Beware of vague promises Definition of “reasonable royalties”
Search carefully for blocking patents Also patents held by non-participants
Preemptively build an installed base
Part Two: Tactics in StandardWars
Standard wars emerge when twoincompatible technologies struggle tobecome a de facto standard
These wars usually end in truce (56 k modems) duopoly (video games) fight to death (VCRs)
Key Assets for Standard Wars
Control over an installed base Intellectual property rights Ability to innovate First-mover advantages Manufacturing Strength in complements Reputation and brand name
Two Basic Tactics forStandard Wars
Preemption New technologies require champions willing to invest
early to build an installed base Being first to market can backfire if superior technology
will soon arrive
Expectations management Engage in aggressive marketing, make early
announcements of new products, assemble allies,make visible commitments to your technology
Blu-ray vs. HD-DVD
vs.
Strategies after you win a war
Staying on your guard Offer your customers a migration path to fend off
challenges from upstarts
Leverage your installed base andcommoditize complementary products But enter adjacent markets only if integration adds
value for consumers
Competing with your own installed base You need improvements to drive upgrade sales
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Strategies after you win a war
Protecting your position Offer ongoing attractive terms to important
complementors
Stay ahead Develop proprietary extensions to improve your
technology
Strategies if you fall behind
Adapters and interconnection Target a market niche or interconnect with the larger
network (American Express with Visa)
Survival pricing It doesn’t work
Legal approaches If all else fails, sue!
Key Takeaways
Understand the positions and interests of allparties involved in a standards competition
The strength of your position in standardscompetitions depends on seven key assets
Preemption is a critical tactic, but there are waysaround it
Expectations management is critical; self-fulfillingprophecies can overrule technical advantage
Once you’ve won the war, don’t rest; beware ofleapfrogging
Next Class
Apply standard strategy to themarketplace
Prepare Browser Wars Case
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BUAD 497: Session 18
Standards and NetworkExternalities II
Learning goals for this session
Analyze fast-moving competition in anindustry with network externalities
Understand the dynamics of a small firmtaking on a much larger rival
Competition in Dynamic IndustryEnvironments
Competitive advantages erode quickly Established rules are broken Industry boundaries are breached Customer loyalty is fickle Sustainable competitive advantages
becomes a series of shorter unsustainablecompetitive advantages
New Rules of CompetitiveEngagement
Don’t cling to competitive advantages—createnew ones
Entry barriers are easily overcome Consistency and logical thinking make your firm
predictable, so think outside the box Long term planning only prepares you to sustain
and exploit existing advantages, so work to createnew competencies and advantages
Consistently attacking your competitor’s mainweakness forces them to become stronger, soattack a range of weaknesses
(D’Aveni--Hypercompetition)
The Browser Wars
vs.
Mike Homer—Netscape
Held Senior Positions atNetscape as well asother firms such asApple and AOL
Graduate of Universityof California at Berkeley
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Usage Share of Major WebBrowsers
Source: Wikipedia.org
The Next Challenger: Firefox
vs.
Current Market Share Key Takeaways
The winning strategy in the Browser War Get market share (give the product away) Innovate constantly Adopt open standards; but not too open
“Judo Strategy”: target your opponents weaknessand use it as leverage Netscape exploiting its competitors’ retail sales and
revenue streams Microsoft doing the same to Netscape
“Hardball Strategy”: use “unfair” advantage Microsoft exploiting its Windows advantage
End of the course’s first part
Move on to strategy implementation Prepare Honda (A) case
Have a great break!
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BUAD 497: Session 19
Strategy Formulation andImplementation I
Second Part of the Course
How do good strategies get implemented? What can managers do to foster good
strategies?
The Honda Case (A) Next Class
Prepare Honda (B) case Read Eccles and Nohria: “Strategy as a
Language Game”
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BUAD 497: Session 20
Strategy Formulation andImplementation II
Understanding Strategy
Honda (A) and (B): Two versions of a story that
emphasize the differences betweenplanned and emergent strategies
Where we left off…
Whatmotorcyclesused to beabout in the1950s…
July 21st, 1947 LifeMagazine Photo
Where we left off…
…and what Honda didwith it!
Changed marketperception of thedefinition of a motorcycle
Drove rapid increase inoverall U.S. market formotorcycles
Grew from ~ 0% in 1959to 43% of total market in1974
BCG’s View of Honda’s Entrance intothe US Motorcycle Market Honda (A)
Made strong investments in R&D Used extensive vertical integration Aggressive low price strategy for entry into USA. Market strategies expanded and redefined the market
segment – “You meet the Nicest People on a Honda”,through pricing, distribution and advertising.
Progressive expansion of market from region to region(West to East) over a six year period
Construction of plant with a capacity 10x demand Low cost producer with high volumes and high
productivity based on capital intensive automatedtechniques to exploit economies of scale; focus on long-term profitability & share
The Inside View of Honda’sEntrance Honda (B)
Soichiro Honda onthe assembly line(circa 1950s)
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Two Views of Strategy The Design School in Strategy
Ex-ante analysis, thinking and reasoning. Assumes all relevant factors can be objectively
analysed Assumes that this analysis precedes and
dominates action – implementation follows as aseparate stage.
Separates thinking from doing and often implies ahierarchy – senior management thinks – othersimplement.
Option appraisal is conducted logically on thebasis of analysis
The Classic Planning Process
IdentifyMission,Goals, &
Strategies
Analyze theEnvironment
AnalyzeResources
Opportunitiesand Threats
Strengths andWeaknesses
ReassessObjectives
FormulateStrategies
ImplementStrategies
EvaluateResults
The Learning School in Strategy
Strategy making takes place within anunpredictable worldCreates the necessity for flexible strategic approaches
Serendipity (accidental discoveries, luck, etc.) isrequired for effective performance
Strategy is often made by lower-level managersStrategy evolves through autonomous action
Strategy has both intended and emergentcomponentsRealized strategies are combinations of intended andemergent strategies
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Mintzberg’s Three Fallacies ofStrategic Planning
Fallacy of predeterminationThe future is unknown
Fallacy of detachmentImpossible to detach formulation from implementation
Fallacy of formalizationInhibits flexibility, spontaneity, intuition, and learning
All three contribute to the “Grand Fallacy”:"Because analysis is not synthesis, strategic
planning is not strategy formation"(Mintzberg 1994, “The Rise and Fall…”, p. 321)
Deliberate versus Emergent Strategies
IntendedStrategy
RealizedStrategyUnrealized
Strategy
Deliberate Strategy
Emergent Strategy
Adapted from: Mintzberg, H. “The Strategy Concept I: Five Ps for Strategy” California Management Review. Volume 30Number1, Fall 1987.
SustainedSuperior
Performance
Eccles and Nohria
Strategy as Robust Action
Robust Action is…
Acting without certitude Constantly preserving flexibility Being politically savvy Having a keen sense of timing Judging the situation at hand Using rhetoric effectively Working multiple agendas
Eccles & Nohria, Beyond the Hype
What, then, is the role ofstrategic planning?
1. Provide a structured mechanism for analysis andthinking about complex strategic problems
2. It involves people in strategy process giving themownership
3. Planning helps communicate the strategy4. Planning assists control by requiring regular
review of performance5. Assist in presentation of alternative and possible
radical ways of considering strategic issues–“thinking outside the box”
Key Takeaways
Effective strategies combine both deliberate andemergent elements; both are important
Strategic planning processes should really beviewed as strategic learning processesUse strategy language to build consensus on mission,objectives, and strategic alternatives
Plans and processes must be robust enough to… …allow a company to rapidly take advantage ofopportunities as they occur
…enable various levels and functions within theorganization to contribute to the emerging strategies
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Next Session
Continue with implementation andchange inside the firm
Prepare Lehman Brothers (A) case
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BUAD 497: Session 21
Implementationand Change I
Session Objectives
Examine strategy implementation upclose and personal
Understand the key ingredients insuccessful strategy implementation
Understand what it takes tosuccessfully manage change
Lehman Brothers (A) The Rise of Lehman Brothers’ EquityResearch Department, 1987-1990
The 7-S Framework The 7-S Framework
A tool for determining the “doability” of strategies
Used for internal analysis of a company
Analyze strategic characteristics of a company
Aims to create alignment among variousdepartments of an organization
Allows to examine the effect of change on acompany
Analyze the successful and dysfunctional aspectsof an organization
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The 7-S Framework: “Hard S”
Strategy – a plan of action to maintaincompetitive advantage over the competition
Systems – measures and actions whichaccommodate the execution of daily activities
Structure – the way the organization isstructured, who reports to whom
The 7-S Framework: “Soft S”
Style – how do you lead? Personal style?
Shared Values – company culture, work ethicsetc
Staff – company employees and their capabilities
Skills – core competencies of the company aswell as that of its staff
Beer’s Formula of OrganizationalChange
Δ = f(D•M•P) - C
Δ is the effectiveness of change, which is apositive function of D (dissatisfaction), M(model, or vision), and P (change process)that need to be greater than C (cost ofchange).
(Michael Beer, “Leading Change,” HBS Press, 1988)
Leading OrganizationalTransformation
Desired State
Existing State
Effective transformation path
Ineffective transformation path
Wor
k en
viro
nmen
t
Operational efficiency
The Five Forces of Management
Down
Up
Across OutSelf
Down
Key Takeaways
Successful strategy implementation requires the alignmentof all the seven S’s—fit is just as important inside asoutside!
Know Beer’s formula of organizational change: it’s afunction of Dissatisfaction, Model, and Process
When implementing a new strategy, start with the hardpart of operational improvement! Only then make thetransition to improving the work environment. But domake it!
Success in playing a game changes the game. Failure toappreciate the consequences of one’s success and tenacityin playing the old game are what tragedies are made of!
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Next Session
Continue with implementation andchange
Prepare Lehman Brothers (B) case
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BUAD 497: Session 22
Implementationand Change II
Session Objectives
Examine the factors that lead to thedecline of Lehman Brothers
Understand the challenges of strategyimplementation and staying on top
The role of leadership in strategyexecution
Lehman Brothers (B): The StoryContinues…
The Rise and Fall of Lehman Brothers’Equity Research Department, 1987-1995
The 7-S Framework: What’s notaligned now…?
Leading OrganizationalTransformation
Effective
IneffectiveGlo
bal C
oord
inat
ion
Local Autonomy
Ineffective
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“More than anything else,management cut the analysts’emotional ties by ejecting thenucleus of the department, Jackand Fred” (Dean Eberling, 1993)
How Much Do You Want to Rely onPeople?
What Happened Next…
Firm-wide change, 1997-2001: Employees up more than44% since 1997, as Lehman bulks up in banking, equityresearch, and sales & trading− 2001: 2/3 of Lehman’s revenues from trading and underwriting,
with the balance from bonds; in 1997, it was opposite− 2001: Lehman’s 150th anniversary; average tenure of upper
ranks: 22 years; “no splashy acquisitions, no managerial coups,no lay-offs; employees own 35% of the firm
“2001 was Lehman’s year…” Posted the best ROE of anysecurities firm; top tier of corporate debt underwriting;almost doubled its equity underwriting market “It wasn’t what happened in 2001. It takes years to create
change” (Fuld) No plans to downsize; “Now is the time to build market share”
(Fuld, 2002)
Back on top…but at what price?
How They Did It Again
In 1999, analyst Steve Hash is Lehman’s newequity research head
Hash gets senior leadership’s mandate to rebuildthe equity research department
He consults with Fraenkel and reintroducesseveral of Rivkin & Fraenkel’s processes to thedepartment Training sessions Weekly meetings
Hash later reflects that he had taken “all thatJack and Fred had done” and did it again—andthe formula had again succeeded
Back on top…but at what price?
An industry expert estimated it cost Lehman close to$100 million in additional expenses to get back to #1
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Why Many Strategies fail…theImportance of Execution
“We had a failure in communication and execution, not inplanning…” (Chris Pettit, August 1995)
Common mistakes in execution: The strategy is not made by those responsible for its execution Pursuing too many initiatives concurrently Failure to appreciate the weaknesses of the assumptions and
develop contingency plans Successful execution involves both communication and
politics. It entails… Jointly setting goals Following through and holding people accountable Learning from how reality deviates from the plan.
“Execution…it’s the leader’s most important job.” (Bossidyand Charan, 2002)
Effective leadership is key to execution
John Chambers and Jack WelchLeadership Styles
Seven Critical Aspects ofSuccessful Execution
1. Know your people and your businessCan you trust the information you get or has itbeen extensively filtered?
2. Insist on realismCan you clearly articulate the organization’sproblems and weaknesses?
3. Set clear goals and prioritiesAre the business priorities few in number andfocused in a constructive way?
4. Follow throughHow many meetings have you attended in whicha good idea surfaced, but never got done?
Seven Critical LeadershipAttributes
5. Reward the doersDo you have a process in place that rewards high-performers objectively, fairly, and openly?
6. Expand people’s capabilitiesDo you spend enough time directly coaching,providing feedback, and cultivating people?
7. Know yourselfCan you be honest with yourself, deal objectivelywith business and organization realities, and givepeople direct and forthright assessments?
Key Takeaways
Many excellent strategies fail because of poorexecution
Good execution keeps the 7 S’s aligned—fitrules!
Good execution accepts the role ofcommunication and politics
Good execution is flexible enough to roll withthe punches and builds options into the process robust action
Next Session
Managing with networks and power Burt, “Structural Holes: Introduction” Reading: Cross, Borgatti, and Parker,
“Making Invisible Work Visible”
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BUAD 497: Session 23
Managing withNetworks and Power I
Learning Goals
Understand how and why networks matter Know the different characteristics of
networks and network positions Know the basic concepts tools for analyzing
your firm’s and your own position in anetwork
What is “Six Degrees”?
“Six degrees of separation between us and everyone else on this planet”
John Guare (1990)
The Kevin Bacon Game
Invented by Albright Collegestudents in 1994
Goal: Connect any actor toKevin Bacon, by linking actorswho have acted in the samemovie.
Oracle of Bacon website usesInternet Movie Database(IMDB.com) to find shortestlink between any two actorshttp://oracleofbacon.org/
The Kevin Bacon Game:An Example
KevinBacon
TimRobbins
Om Puri
Amitabh Bachchan
Yuva (2004)
Mystic River (2003)
Code 46 (2003)
Rani MukherjeeBlack (2005)
Source: Kentaro Toyama, Microsoft Research India
Not Quite theKevin Bacon Game…
KevinBacon
TeriHatcher
Larry Shaw
Peer Fiss
Is the brother of…
The Big Picture (1989)
Desperate Housewives (2004)
Lynda ManssonIs the aunt-in-law of…
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Another Fun Example: The ErdősNumber
Number of links required toconnect scholars to Paul Erdős,via co-authorship of papers
Erdős wrote 1500+ papers with507 co-authors.
Jerry Grossman’s (Oakland Univ.)website allows mathematicians tocompute their Erdos numbers:
http://www.oakland.edu/enp/
Connecting path lengths, amongmathematicians only: average is 4.65 maximum is 13
Paul Erdős (1913-1996)
The Science Behind “Six Degrees”
The Small World Experiment (Milgram, 1967)
A single “target” (stock broker in Boston) Random ”senders” chosen in Nebraska Each sender asked to forward a packet to a
friend who was “closer” to the target All friends got the same instructions 64 packets reached the target via different
“chains” Typical length of chain?
Stanley Milgram (1933-1984)
Six…
Society as a Graph
People arerepresented asnodes
Society as a Graph
People arerepresented asnodesRelationships arerepresented asedges (lines)(Relationships may befriendship, colleagues,business contacts etc.)
Ring graphFully Connected graph
Random graph
Power Law Graph
The Small World EffectWatts and Strogatz (1998)
b = 0 b = 0.125 b = 1
People knowothers atrandom.
Not clustered,but “small world”
People knowtheir neighbors,
and a few distant people.
Clustered and“small world”
People know their neighbors.
Clustered, butnot a “small world”
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First five random links reducethe average path length of thenetwork by half, regardless ofN!
So what would it take for anyworld at all to be small?It turns out: not much…Some source of “order”The tiniest amount of randomness
So: Small World Networksshould be everywhere!
Clu
ster
ing
coef
ficie
nt /
Nor
mal
ized
pat
h le
ngth
Clustering coefficient (C) and average path length (L) plotted against b
The Small World EffectWatts and Strogatz (1998)
But Who Cares…?
Why do networks matter?
Why is Six Degrees interesting?
The 9/11 Hijackers and TheirAssociates
Nodes: investment pharma research labs public
biotechnology
Source: http://ecclectic.ss.uci.edu/~drwhite/Movie
Business ties in US Biotech-Industry: 1988
Links: financial R&D collab.
Source: http://ecclectic.ss.uci.edu/~drwhite/Movie
Business ties in US Biotech-Industry: 1991
Nodes: investment pharma research labs public
biotechnology
Links: financial R&D collab.
black: opinion leaderspurple: influencedgreen: uninfluencedgrey: undecided
Viral and Buzz Marketing
Source: http://www.orgnet.com
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Typical Small Interfirm ProductionNetwork in NYC Garment Industry
Source: Uzzi, ASQ 1997
Example 1: Finding a Job
Contrary to economic theory, many labormarkets rely on personal contacts
We ask family, friends, colleagues for help In particular, we tend to use “weak ties”
(Granovetter) and also friends-of-friends,because they are more likely to have non-redundant information
Hence, the “Strength of Weak Ties”
Example 2: Making BusinessContacts
PeterJane
Sarah
Ralph
Example 3: Mapping Email Flow to Find„Hidden“ Communities of Experts
colors refer todepartment affiliation
source: http://www.orgnet.com
Example 4: Alliance Networks
Access to know-how, contacts, resources expands thesize of radar screen and make you detecttechnological discontinuities, emergent markets, newdesigns
Direct and indirect ties are positively related toinnovation (Ahuja 2000)
Experience and centrality in the network are related tosuccess—the relevant knowledge is widely distributedoutside the firm (Powell et al. 1996)
The position of the firm in the alliance network alsodetermines the propensity to collaborate (Stuart 1998)
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Networks and Social Capital
Ron Burt argues that social capital is a “usefulmetaphor,” explaining “how people do betterbecause they are somehow better connectedwith other people,” and that we need to “cutbeneath the metaphor to reason from concretenetwork mechanisms responsible for socialcapital” (Burt 2005)
What are the “concrete network mechanisms” that create advantage for communities & organizations? How do individual membership patterns shape
community cohesion?LOW Cohesiveness
Network Foundations of Social Capital
A collectivity is structurally cohesive to the extent thatthe social relations of its members hold it together
Add more ties ….
Network Foundations of Social Capital
But when focused on a single person, the network is fragile!
Network Foundations of Social Capital
Remove that one person and the whole networkdisintegrates… Problem!
Network Foundations of Social Capital
Solution: Spreading relations around the structure makes it robust to node removal
Network Foundations of Social Capital
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As structural cohesion increases, fewer nodes are able tocontrol resource flow within the network
Power is more evenly distributed because nobodycontrols access to network resources
Information flows more uniformly across the network Norms & values tend to be more uniform Informal Social Control is uniform as there are fewer
opportunities to free ride
The collectivity should take on a community character
Network Foundations of Social Capital A Key Feature: Structural Holes(Burt 1992)
Structural Holes are disconnects between contacts thatcreate social capital via brokerage opportunities
Ego actor gains earlier access to flows of valuableinformation
Ego fills structural holes by forging new ties linking itsunconnected alters, extract “commission” or “fee” forproviding brokerage services
Information and control benefits mean better performance,which mean higher return on human capital
Ego maximizes its self-interests by controlling & exploitinginformation, playing one actor against another (“tertiusgaudens”)
A
YOU B
D
C
Structural Holes Filled by “You”
Redundant contact
Non-redundant contact
Structural Holes and the SocialStructure of Competition
?
How Network Position Matters
Structural holes provide important benefits.For example…
Brokers occupying structural holes earn biggerbonuses
Managers located in structural holes arepromoted earlier in their careers
People located in structural holes often have“better ideas” than others
(Burt 1992; 2003)
How Network Position Matters
You
Network A’
You
Network B’ Network C’
You
Strategic Network Expansion
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Combining Brokerage and Closure
© 2004 Ronald Burt. Brokerage and Closure, Cambridge University Press 2005.
Exercise: Assessing YOURNetwork
Ask yourself the following questions…
Academic matters Who are the people with whom you have discussed important
projects and assignments?
Job Search What people have been most helpful in your job search so far?
Friends Who are your closest friends?
Professional development during your time at USC What people have contributed most significantly to your professional
development during the last year?
Key Takeaways
Network centrality and structural holes areimportant for determining power and knowledgeflows—both for firms and for your personalexperience. Brokers do better!
Social capital and power come from the bridgesthat a person can build between others
It is the diversity of contacts that generates socialcapital—strength lies in weak ties
Network effectively; what does a new contactadd to your network? What do YOU contribute totheir network?
Next Session
Prepare case: Abelli and Savotti atBanca Commerciale Italiana (A)
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BUAD 497: Session 24
Managing withNetworks and Power II
Learning Objectives
Get experience applying tools of networkanalysis
Examine the role of power and influence ininterorganizational and interpersonalnetworks
Abelli & Saviotti at BCI Another Example: The GermanNetwork of Crossholdings
Italmobil iare
HdP
SAI
Burgo
Pirel l i
Banca Intesa
Banca d’Ital ia
Lazard
Unic reditoItal iano
Banca diRoma
Commerzbank
General i
Paribas
Compart
Banca Commerc iale Ital iana
Deutsche BankFIAT
Mediobanca
6%
3.2% 8.1%
2%
3.4%
1.2%
4.5%
0.6%4.9%
5.7%
21%
6.2%
13.2%
1%
3.3%0.4%
4.5%0.8%
9.2%
4.9%
1%
3.3%
0.7%
9.4%
2.9%
2%
3.1%
2%
12.5%
8.2%
4.7%
1.7%
7.6%
14.5%
2%
3%
2.2%
2%
4.5%
1.4% 2.2%
1.9%
13.1%3.1% 2%
2.1%
14.2%
0.4%
11.7%
2.7%
10%4.8%
5%5%
Cross-shareholdings—March 1999
12.5%
4.9%
Italmobil iare
HdP
SAI
Burgo
Pirel l i
Banca Intesa
Banca d’Ital ia
Lazard
Unic reditoItal iano
Banca diRoma
Commerzbank
General i
Paribas
Compart
Banca Commerc iale Ital iana
Deutsche BankFIAT
Mediobanca
6%
3.2% 8.1%
2%
3.4%
1.2%
4.5%
0.6%
5.7%
21%
6.2%
13.2%
1%
3.3%0.4%
4.5%0.8%
9.2%
4.9%
1%
3.3%
0.7%
9.4%
2.9%
2%
3.1%
2%
8.2%
4.7%
1.7%
7.6%
14.5%
2%
3%
2.2%
2%
4.5%
1.4% 2.2%
1.9%
13.1%3.1% 2%
2.1%
14.2%
0.4%
11.7%
2.7%
10%4.8%
5%5%
Cross-shareholdings—March 1999
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Italmobiliare
HdP
SAI
Burgo
Pirelli
Banca Intesa
Banca d’I talia
Lazard
UnicreditoItaliano
Banca diRoma
Commerzbank
Generali
Paribas
Compart
Banca Commerciale Italiana
Deutsche BankFIAT
Mediobanca
Sav iotti
Gutty
Lucchini
LucchiniGutty Desiata
Rondelli
v Ruedorf err
F.-PoncetRondelli
Gutty
Sozzani
Director Interlocks—March 1999
LucchiniGutty
Sav iotti
Influence Matrix for BCI Case
BCI: What Happened Next…
May 12, 1999: BCI chairman Luccini calls a generalshareholders meeting for June 21
May 15, 1999: Under pressure from the Mediobancacoalition, the BCI board rejects the Unicredito proposal
June 17, 1999: The BCI board convenes to asses BancaIntesa’s offer (70% stake, BCI to remain a separate entitywithin Banca’s group)
June 20, 1999: Abelli and Saviotti resign with the entireBCI board except for Luccini and one other board member
What Happened Next… (Cont’d)
• June 21, 1999: The general assembly the next dayappoints a new board that duly reflects Mediobanca’scontrol over BCI. Fausti is appointed honorary chairman
• June 23, 1999: The governor of Banca d’Italia (thecentral bank) publicly states his approval of the BancaIntesa deal
• End of June, 1999: BCI and Banca Intesa seal atakeover deal; by September, Banca Intesa has completecontrol of BCI
A Comparison of the BancaIntesa and Unicredito ItalianoOffers
Source: Morgan Stanley Dean Witter Researchestimates, MSDW Equity Research, 09/01/1999
What Happened Next… (Cont’d)
So Mediobanca seems to have prevailed…?
April 2000: Banca Intesa severs its ties withMediobanca! Moreover, the reorganization of IntesaBCIturns BCI into a direct competitor of Mediobanca
June 2000: Mediobanca Honorary Chairman, EnricoCuccia, dies
2001 and after: Mediobanca’s influence over Italy’scorporate world continues to decline. By 2003, itsshareholders agree to restrain the banks managementfrom using its holdings as a means of control overcorporate Italy
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(Some) Key Takeaways
Understanding power and influence in complexnetworks is an important advantage; as both A&Sand Cuccia found out, you have to know theterritory
There is a lot more to power than authority andcompetence; often power is best exercisedindirectly through intermediaries
There is considerable value in buildinginterdependent relationships with key playersover time that can be leveraged when needed inthe future
Next Week
Last topic relating to strategyimplementation: Performance andGovernance
Sharon Oster “Organizational Goals:Politics and Power in Organizations”
Prepare Monks and Minow on “ArthurAndersen”
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BUAD 497: Session 25
Performance andGovernance I
Goals for this Session
Examine challenges to implementingstrategy and the essential problem of thepublic company
Know the various mechanisms forexercising corporate governance
Examine problems at Arthur Anderson
Strategy, Performance, andIntegrity
A critical function of managers is to create strongcompetitive strategies that enable the company tomeet financial goals without compromisingintegrity
BUT: Today’s business environment isextraordinarily complex Less staff forces organizations to do more with less Expense reductions continue to be major way
companies increase EPS Earnings growth continues to be core focus Unrealistic performance goals can pressure those who
must make them work Reward and compensation systems can expose
employees to ethical compromises
Arthur Andersen’s HoustonBranch Office
“…perhaps nothing can bring a company down with suchamazing speed as misconduct.”
M. Ingebretsen, Why Companies Fail: The 10 Big Reasons Businesses Crumble, and How toKeep Yours Strong and Solid. (2003)
The Paradox of Operating as aPublic Company
Pressures
Wall Street Influence Investor expectations Earnings growth Quarterly pressures
Exec. Compensation Increase in overall level,
stock options
Economic Cycle Cyclical Industry
OffsettingControls
Compliance (Enron)
Disclosure (Worldcom)
Governance (Tyco)
Ethics and integrity ofparticipants (ArthurAndersen)
An Example: The “Walk-down toEarnings Game”
Analysts are “systematically optimistic” regarding earningsforecasts at the beginning of the fiscal reporting period
Aware of these tendencies, company financial officers give“guidance” to analysts (usually in the form of discretionaryinformation disclosures” suggesting the analysts lowertheir estimates)
As analysts lower their estimates towards the end of theperiod
The company releases its official reported earnings at alevel that “beats” the analyst estimates
The analysts issue “strong buy” recommendations If the game is played right, the company’s stock
will rise sharply on the day it announces its earnings
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The Public Company Conundrum
Strengths Ability to raise enormous amounts of capital and spread risk Transparency - financing activities are visible and information
readily available / Poor performance results in lower share values Corporations are disciplined both by their internal governance
systems and by competition in product and factor markets
Weaknesses Separation of ownership and control results in an agency problem Lack of powerful, informed monitors results when the
shareholdings are widely dispersed Entrenchment incentives - management may invest in protecting
their jobs rather than creating value Excessive mandated information disclosure lowers value of
proprietary product and strategic information
A historical example…
On a boat trip up China’s Yangtze River in the 19th
Century, a titled English woman complained to her hostof the cruelty to the oarsmen. One burly coolie stoodover the rowers with a whip, making sure there were nolaggards.
Her host explained that the boat wasjointly owned by the oarsmen, andthat they hired the man responsiblefor flogging!
Why would such an organizational arrangement arisevoluntarily?
Agency Relationship: Owners andManagers
• Risk bearing specialist(principal) pays compensation to
• A managerial decision-makingspecialist (agent)
An AgencyRelationships
Managers(Agents)
Shareholders(Principals)
• Decision makers
• Firm owners
Basic Problems of InformationAsymmetry
Moral Hazard: the principal and agent share thesame information up to the point at which the agenttakes an action, but thereafter the principal is only ableto observe the outcomes
Adverse Selection: the principal does not know someinformation which is relevant to the action (such as theability of the agent to perform the task), whereas theagent can make use of this information to his ownadvantage
The essence of the Agency Theory is that thePrincipal has inferior information to the Agent.
The Tradeoff Between Profitabilityand Revenue Growth Rates
Manager and Shareholder Risk andDiversification
Ris
k
Diversification
DominantBusiness
UnrelatedBusinesses
RelatedConstrained
RelatedLinked
Managerial(employment)
risk profile
B
Shareholder(business)risk profile
A
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How is Corporate ControlExercised
The Board of Directors The elected B of D is responsible for hiring, firing,
monitoring, and setting the compensation of the firm’smanagers
The B of D has broad discretion to direct the company’saffairs and is supposed to ensure that the firm is managedin the best interest of shareholders
Shareholder votes are also requiredto approve corporate mergers,to authorize the sale of majorassets, to amend the firm’s bylaws,and to authorize the issuanceof new equity issues
How is Corporate ControlExercised (really…)
Directors are frequently selected by managementand are beholden to them for their jobs
CEOs are all to often also the chairs of the boards,which creates all kinds of accountability problemsThis is the case in about 75% of S&P 500 firms in theUS (McKinsey & Company US Directors Survey,2002)
Boards too often have poor procedures ofevaluation in place, both regarding managementand their own performance
As a result, BoDs often exercise rather littlecontrol…
How is Corporate ControlExercised
Disclosure and Shareholder Meetings Publicly-traded companies are required to annually disclose
a great deal of information about corporate earnings,executive compensation, and the ownership of thecompany’s voting shares
Further, these firms are also required to hold annualshareholders’ meetings, which is open to all owners ofeven a single share of common stock
In announcing these meetings, corporations send everyshareholder a proxy statement that describes: the meeting agenda, spells out precisely which issues are to be voted on by shareholders, and provides a form for shareholders to use either to vote
personally at the meeting, via www, via telephone or to assign theright to vote the shares they own to someone else
How is Corporate ControlExercised (really…)
Most corporate elections are usually staid affairswhere shareholders are asked to vote for orwithhold their vote for single slate of companydirectors
“Proxy fights” occur when a rival group ofshareholders nominate a slate of alternativedirectors who do not support the currentmanagement team.
However, these are relatively rare due to expenseto shareholders
As a result, shareholders often have littleopportunity or incentive to actively engage incorporate control
Flow of Authority in CorporateGovernance
© 2006 The McGraw-Hill Companies
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How is Corporate ControlExercised
Compensation and Incentives In 2006, the average total compensation of chief
executives of S&P 500 corporations was $14.78 million,including salaries, bonuses, and incentive plans
That’s a 9.4% increase in CEO pay over 2005 The connection between superior performance and pay is
rather tenuous CEOs Henry McKinnell of Pfizer and Robert Nardelli of Home Depot
both received exit packages of more than $200 million. Both firmsunderperformed during their tenures
Compensation on average consisted of Salary (cash): ~20% Short term incentive plans (bonus): ~20%, usually tied so specific
measures (ROI, net profits…) Long term incentive plans (stock option plans etc): ~60% Other benefits (insurance, legal, pension etc.)
Compensation and CorporateEarnings (Bebchuck & Grinstein, 2006)
Source: Bebchuck & Grinstein, The Growth of Executive Compensation (2005)
Market Downturn and theDilemma with Stock Options
The problem of “underwater” options…
Why take action?
Why NOT take action?
An External Mechanism: TheMarket for Corporate Control
To the extent that managers do not act in the bestinterest of shareholders, the stock price of the firm will beless than what it would have been if the managersfocused on maximizing shareholder wealth.
The market thus operates when firms face the risk oftakeover when they are operated inefficiently. Many firmsbegin to operate more efficiently as a result of the“threat” of takeover.
Hence, the market allegedly acts as an important sourceof discipline over managerial incompetence and waste
However, it’s an expensive last resort…and oftendoesn’t work!
Impediments to the Market forCorporate Control
Entrenched insider groups frequently fight these bidsusing: Various court actions Staggered boards Poison pills Amendments to the corporate charter Greenmail Selling off “crown jewels” (aka “scorched earth”) Searching for white knights Any other strategy designed to discourage the bidder from
pursuing the target further
Firms frequently succeed in fending off takeover bids evenwhen they would yield the target firm shareholders verylarge share premiums
The Full Picture on CorporateControl…
Boards of Directors have a fiduciary duty toshareholders to monitor management, but…
Principals (i.e. shareholders) may engage inmonitoring behavior to assess the activities anddecisions of managers, but…
Executive Compensation can be used to alignthe incentives of managers and owners, but…
The Market for Corporate Control candiscipline ineffective management, but…
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Arthur Andersen Arthur Andersen Background Info
Arthur Andersen was an accounting andconsulting service that operated businessesthroughout the US & world.
The 89 year old company was part of the “Big 5”accounting firms.
Main headquarters in Chicago, Illinois andHouston, Texas.
Enron, the large energy corporation, was a clientof Andersen’s for 16 years up until Enron’s 2001bankruptcy.
Timeline of the Scandal
In the summer and fall of 2001, Arthur Andersenforesaw government litigations and investigationsagainst Andersen and Enron.
October 16th,2001- Enron issued a press releaseannouncing the company’s $618m net loss for the3rd quarter of 2001.
On the same day, Enron reduced shareholder’sequity in the stock and the stock priceplummeted.
Timeline (cont’d)
October, 2001- Enron informs Andersen todestroy all paper documents and emailsconcerning Enron.
Shortly after, the SEC starts an investigation ofthe two companies.
Lawyers defending Arthur Andersen argued thatshredding documents was a routine practice.
Eventually, Andersen was charged withobstruction of justice for destroying thedocuments before the collapse of the energygiant.
August 31, 2002- Arthur Andersen dissolves
Key Takeaways
Know (and be able to “speak”) Agency Theory;it is the most dominant theory today incorporate governance and likely to remain so inthe future
Also know the limits of Agency Theory; it haslittle to say about trust, dominant social,political, or organizational culture. Thesematter! (and may differ considerably…)
All the different mechanisms of internal andexternal governance as currently on the bookshave their weaknesses—know and avoid them!
Next Session
Prepare Bausch & Lomb Case
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BUAD 497: Session 26
Performance andGovernance II
Session Goals
Examine what factors contribute tounethical conduct in organizations
Understand what went wrong at Bausch& Lomb
Corporate or “White Collar” Crime
“…crime committed by a person of respectability and highsocial status in the course of his occupation” (Sutherland1939)
Encompasses a variety of non-violent crimes usuallycommitted in commercial situations for financial gain,including
antitrust violations, computer/internet fraud,credit card fraud, phone/telemarketing fraud,bankruptcy fraud, healthcare fraud, environmentallaw violations, insurance fraud, mail fraud,government fraud, tax evasion, financial fraud,securities fraud, insider trading, bribery,kickbacks, counterfeiting, public corruption,money laundering, embezzlement, economicespionage, trade secret theft etc…
Corporate or “White Collar” Crime
In the U.S., the cost of corporate crime such as price-fixing and unsafe or illegal practices is estimated at up to$200 billion annually
Employee theft is 10 times as big a problem as streettheft, white collar crime is 2-10 times as big a problem asemployee theft
White collar criminals are far less likely to be investigated,arrested or prosecuted than other types of offenders
White-collar crime is especiallydangerous because of opportunitiesfor large-scale thefts; large enoughto sink even a large company
Companies reporting fraud byindustry sector (Global)
Source: PWC Global Economic Crime Survey 2005
45% of companiesworldwide
reported beingvictims of
economic crime inthe last 2 years
Fraudster’s relation to thecompany
Source: PWC Global Economic Crime Survey 2005
Typical profilemale (80%), between 31 and
41 years (34%), educated withdegree or higher (48%)
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Source: PWC Global Economic Crime Survey 2005
Almost a quarter of actscommitted by senior
management
Reasons for committing fraud How are companies respondingto the threat of fraud…?
KPMG’s survey of large companies in 2002found that
10% admitted fraud is “something we have not reallythought about”
17% said fraud risk management is not adequatelyaddressed
55% said they needed to improve channels for reportingsuspicion of fraud
More than 80% said the person with overall responsibilityfor fraud prevention and detection is either the CEO or CFO
KPMG Fraud and Misconduct Diagnostic Survey 2002
Bausch & Lomb: Pressure to Perform Bausch & Lomb: Missing the Mark
Essential Elements of StrategicControl Systems
Boundaries
Culture Rewards
Between 1994 and 1995, the value of the company’sshares sank by about a third
Daniel Gill retired in late 1995 in response to increasinglyangry shareholders
A later SEC inquiry cleared Gill personally but stated that“Bausch & Lomb violated the anti-fraud, reporting andrecord keeping, and internal control provisions of theExchange Act.”
Bausch & Lomb struggled to develop a viable long-termstrategy, resulting in the restructuring of the company inlate 2001 and early 2002, which included the loss of some700 jobs.
Update: Bausch & Lomb
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In October, 2005, Bausch & Lomb disclosed that anaccounting fraud problem in its Brazilian subsidiary mayrequire the company to postpone filing its quarterlyfinancial report due to problems with its books and records
On March 17, 2006, B&L announced it would delay its2005 annual report by about 6 weeks to make adjustmentsfollowing internal investigations
Bausch & Lomb also said its ongoing investigation intoSouth Korean vision joint venture BL Korea has foundevidence of improper sales practices from 2002 to 2005.
On March 23, 2006, Moody's Investors Service announcedit considering lowering its "Baa3" rating on B&L’s $544million of unsecured debt (that’s just one notch above junk)
Bausch & Lomb is currently still working on its 2006financial statements and plans to file them by April 30
Update: Bausch & Lomb Again inTrouble (cont’d)
Managers often feel enormous pressure to do whatever ittakes to deliver good financial performance
Actions often taken by managersCut costs wherever savings show up immediatelySqueeze extra sales out of early deliveriesEngage in short-term maneuvers to make the numbersStretch the rules further and further, until
limits of ethical conduct are overlooked
Executives feel pressure to hit performance targets sincetheir compensation depends heavily on companyperformance
Fundamental problem with a “make the numbers”syndrome: The company does not serve its customers orshareholders well by placing top priority on the bottom line!
Bausch & Lomb: Not theException…
Warning Signs of a DeviantOrganizational Culture
1. There is a "kill the messenger" ethos in theorganisation -- justifies distortion andconcealment of information
2. There is a low degree of confidence in theaccuracy of internal reports
3. Despite claims to doing the right thing, in the lastanalysis, top management does the mostexpedient thing
4. Employees do not know ofor refer to written ethics policies
5. The operative value of the organisationis: if it's legal it's ethical
Warning Signs of a DeviantOrganizational Culture (con’d)
6. Top management's stated concern for ethicsappears to be mainly for public relations
7. Managers (while basically truthful) are willing todeceive in order to accomplish organizational orpersonal goals
8. Managers do not believe there is an obligation tobe candid where it could harm personal ororganizational goals
9. People who ignore ethicsbut produce bottom line resultsget promoted
KPMG: How to Deter EmployeeFraud
Know the risks in your business What areas are most at risk? Where do you need to concentrate
your efforts?
Make your views on fraud known Set the tone, establish clear guidelines, make clear your intention
to investigate vigorously. Nothing is a better deterrent than ahistory of investigation
Create a culture that frustrates fraud Lead by example and avoid gray areas in rules, including receiving
or giving gifts, entertainment, commissions, conflict of interest
Ensure that your internal controls areeffective Be alert for indicators of fraud. Develop a fraud response plan so
you know what to do. Set up an audit committee or expand therole of the BoD’s audit committee
KPMG: How to Deter EmployeeFraud
Make certain that personnel policies areeffective Check applicant’s information and references thoroughly,
particularly for risk areas. Establish an employee hotline forreporting fraud.
Review disciplinary policy Be tough on fraud; it can put your entire
business at risk and damage its reputationas well as yours. A firm response to fraud willbe your best protection against future fraud.
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But there’s also good news..!
76% of customers will switch to brands orstores based on ethics & societal issues(Cone/Roper, 1997)
88% of consumers are more likely to buyfrom a socially responsible firm (WalkerResearch, 1998)
Sales growth, profits, and ROI arecorrelated with corporate citizenship(Maignan, 1997)
Ethical strategy and business = profits!
Next Class
Next….YOUR Turn Presenting!
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Professor Larry Harris FBE 440 Marshall School of Business Courses 15355R (MW) & 15356R (TTh) University of Southern California Spring 2007
TRADING AND EXCHANGES Course Syllabus
Course Objectives This course will introduce you to the theory and practice of securities and contract trading at exchanges and in dealer networks. We will examine
• why and how people trade, • the principals of proprietary trading, • why market institutions are organized as they are, • how markets are changing in response to innovations in information technologies, • the origins of liquidity, volatility, price efficiency, and trading profits, and • the role of public policy in the markets.
To address these questions, we must understand why and how institutions, dealers, and individuals trade. Understanding trader behavior thus is a primary course objective.
At the end of this course, you should be able to
• solve various trading problems, • recognize various trading styles, • judge whether you would be a successful trader, • evaluate and motivate brokers, • design markets, and • effectively lobby policy-makers on market issues.
Target Audience I designed this course for anyone who wants to understand how markets work and how traders trade. The reading assignments and the class lectures are appropriate for students who have no market experience.
Experienced traders will also find this course to be valuable. Although you may already know much about market institutions, the economic perspectives that you will learn in this course will greatly improve your understanding of why some people make money while others lose money. Many brokers and dealers have greatly appreciated taking this course.
Students with substantial market experience have little advantage over other students other than initial familiarity with the jargon and institutions.
Prerequisites This course has no prerequisites. Familiarity with Investments, Microeconomics, Corporate Finance, Information Technologies, and Statistics is helpful but not necessary.
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You will not be lost if you have not yet studied these subjects, but you may have to work harder than students who are already familiar with their principle concepts.
Addresses and Telephone Numbers Professor Larry Harris (213) 740-6496 office Fred V. Keenan Chair in Finance (323) 933-0888 home USC Marshall School of Business (323) 244-1154 mobile Hoffman Hall 600G Los Angeles, CA 90089-1427 [email protected] LarryHarris.com
You may call me at home or on my cell, but not before 7:00 AM, after 9:30 PM, on Friday night, or on Saturday.
How to Reach Me 1. Drop in during office hours—no appointment is necessary. My office is in Hoffman
600G. My office hours this semester are:
Mondays 1:00-2:00 PM Thursdays 9:45-10:45 AM
2. Arrange to meet me by appointment.
3. Just drop in. I am in my office most days. It is best (but not necessary) to call ahead to make sure I am available and not occupied. I am obviously unavailable when I am teaching. I teach MW 10-12, TTh 8-10, and TTh 11-12:30.
4. Call me on the telephone. If you leave a message, please speak slowly and clearly when you give your phone number. You may call me at home or on my cell phone, but please not before 7:00 AM, after 9:30 PM, on Friday night, or on Saturday.
5. Arrange to dine with me before or after class. Consider inviting your classmates too.
6. Send me e-mail at [email protected]. While I am always happy to take questions about course topics, I prefer to respond orally rather than by e-mail. The opportunity to listen and respond generally produces more effective learning.
Electronic Notices I post assignments and information of interest to this class on Blackboard. The web address for BlackBoard is http://blackboard.usc.edu.
I may use a password to protect some documents. If so, the password will be TradeOn. The password is case sensitive.
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Grades and Examinations I will base the course grade on two midterm examinations, many small homework projects (see below) and on a final examination. Their relative weights in the course grade are as follows:
2 midterm examinations at 20 percent per midterm 40% Homework projects / class participation 25% Final examination 35%
Total 100%
The examinations are scheduled as follows:
MW Class TTh Class Midterm 1 Wednesday, February 14 Thursday, February 15 Midterm 2 Wednesday, April 4 Tuesday, April 3 Final Exam Monday, May 7, 8:00 - 10:00 AM Wednesday, May 9, 8:00 - 10:00 AM
The midterm and final examination dates will not change. Please check now to see that you do not have any conflicts.
The second midterm will cover primarily topics covered since the first midterm. Since you cannot fully understand some topics without understanding earlier topics, you may wish to review earlier topics before the second midterm.
The final examination will be a cumulative examination. Topics covered after the second midterm, however, may be somewhat over-represented.
When assigning grades, I compute the weighted sum of examination and homework numeric scores using the weights above. Since the in-class variance of scores typically varies across exams and homework, the influence of a given score may be different from the weights presented above. In the past, the greatest in-class variation has been in homework scores and in essay exam scores. These exercises therefore have had a greater influence on the final grade than the above weights would suggest.
Grading Standards The Marshall School uses (and I adhere to) the following standards for undergraduate grading:
A Excellent quality work B Good quality work C Fair quality work D Work of minimum passing quality F This grade is awarded to any undergraduate student failing to meet the
minimum standards for passing the course. The grade of F indicates that the student failed at the end of the semester or was doing failing work and stopped attending the course after the twelfth week of the semester.
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Plus/minus grading (A, A-, B+, B, B-, C+, C, C-, D+, D, D-, F) increases the basic five grades to a total of twelve possible levels of performance.
I interpret these standards as follows:
A Mastery of course concepts, tools, and techniques, plus a solid understanding of implications, applications, and interrelationships. Ability to apply and express that understanding with meaningful oral and written language.
B Solid understanding of course concepts, tools, and techniques, plus
knowledge of or awareness of implications, applications, and interrelationships. Capability to converse effectively in the terminology of the course.
C Knowledge of course fundamentals. Basic understanding or awareness of
finer points of course and discipline. Meets normal expectations of course input criteria.
D Barely grasps the essentials of the course with little or no understanding of
the finer points. F Unable to communicate an understanding of the basic concepts, tools, or
techniques of the course. A failure to measure up to the basic course output goals.
Class Participation and Homework Projects Class participation is an important part of the learning experience of this course. The richness of the learning experience depends upon the degree of preparation by all students before each class session. Your classmates and I expect you to prepare for all classes and to actively participate in class discussions. I may call upon you at any time during class discussions to summarize insights from readings and class discussions, to analyze problems, or to opine on the value of what you are learning.
Many concepts that we will discuss in the class sessions do not appear in the textbook. We also will discuss many topics more thoroughly and from different perspectives than does the textbook. Accordingly, class attendance also is an important component of the learning experience for this course.
I generally will assign a short homework project for you to do before each class session. The homework usually will challenge you to think deeply about topics of interest to this course. It often will provide a foundation for an in-class discussion.
The project will be due at the beginning of the class session. To encourage on-time attendance, I do not accept late projects. You must personally turn-in your homework projects. On days when no homework is due, I may pass an attendance signup sheet which will serve as a substitute for the homework.
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To encourage you to attend the entire class session, I may call upon you at anytime until I dismiss the class. If you do not respond when I call your name, you will not receive credit for the homework assignment, even if you turned it in.
I designed these homework collection procedures to encourage you to attend class. I have taught this course without these procedures and have observed that students who did not attend class typically learned much less than those who did. Since I adopted these procedures, I have observed that students come to class better prepared and that they learn more.
Take the homework assignments seriously. You may fail the course if you do not receive credit for enough assignments. Regrettably, I have failed students who did not obtain credit for enough homework assignments.
To ensure that these policies are not too burdensome to you, you may miss three homework assignments during the semester with no negative effect on your grade. For example, if I assign 25 homework projects during the course, you will have a perfect homework/participation score if I accept at least 22 adequately prepared assignments from you. Although I will not award extra credit if you complete all the assignments, I strongly encourage you to do so.
After you have missed three assignments, you may request permission to be absent. I will grant permission entirely at my discretion and only under the most severe circumstances. You should avoid missing homework assignments early in the semester because you may need to miss them later if you get sick or need to attend an interview or a funeral.
Since I expect that missing homework will be a rare occurrence, and since you will always know when you have missed an assignment or have left class early, I will not post my records of completed assignments. I will notify you if your work has not been acceptable.
To obtain complete credit for a homework project, • it must be turned in on time, as noted above, • you must be present if I call your name, as noted above, • your paper must represent your sincere effort to address the assignment, • the paper should be properly formatted, and • your name and social security number must be legibly written in the upper right hand
corner of the paper.
I will judge the sincerity of your effort by whether your written presentations are thoughtfully prepared and/or by your ability to discuss your work in class. If I have accepted your homework and I have not contacted you to tell you that your assignment was not adequately prepared, you may assume that you obtained full credit for the assignment.
Given the very large number of homework papers that I will receive, our time would be poorly spent returning your homework papers to you in class. I therefore will not return your homework papers to you unless I have specific comments to give you. You therefore may want to keep a copy for yourself.
Adequately completing the homework assignments will primarily require that you be disciplined and that you make an honest effort to complete the assignment. To trade
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effectively requires good personal discipline. In a course about trading, asking you to exercise personal discipline is very reasonable.
The Fine Print on Grades These rules protect you and me should unexpected events occur.
You generally will receive no credit for tests that you miss. If you secure prior permission from me to miss a test, or if you have a valid medical excuse, I will make a special arrangement for you. At my sole discretion, I will allow you take the test (or a similar test) at another time, or I will arrange to give more weight to your other test results.
To prove illness, you must submit your doctor’s note stating the nature of the illness and your doctor’s name, address, and telephone number. To prove that you were sent out of town on business, you must submit a copy of your airline and motel receipts, plus the name, address, and telephone number of your superior. I will not excuse you unless I receive all documentation listed above. I reserve the right to contact your doctor, superior, etc.
USC strongly discourages incomplete grades, except in dire circumstances. Consequently, I will not give a grade of “Incomplete.” I will only make an exception to this rule if you have taken the examinations when scheduled, but missed the final examination due to illness or to a required out-of-town business trip for which you give prior written notice. You cannot pass the course without taking the final examination. Students who do not complete all required work, and do not receive a grade of “incomplete” will fail.
To receive a final grade in the unlikely event of an “Incomplete,” you may either take the final exam that I administer to my next “Trading and Exchanges” class (which could be years from now) or take the final of another professor teaching an equivalent class (which is not likely as I have been the only professor teaching this class).
Register in this class only if you are willing to abide by these rules. Your registration will be your confirmation that you agree to abide by these rules.
Academic Integrity Academic integrity is an important component of the optimal learning environment that USC seeks to maintain. General principles of academic integrity include the concept of respect for the intellectual property of others, the expectation that individual work will be submitted unless otherwise allowed by an instructor, and the obligations both to protect one’s own academic work from misuse by others as well as to avoid using another’s work as one’s own. All students are expected to understand and abide by these principles. SCAMPUS, the Student Guidebook, contains the Student Conduct Code in Section 11.00; recommended sanctions appear in Appendix A. http://www.usc.edu/dept/publications/SCAMPUS/gov/
I do not expect academic dishonesty to be a problem in this course. However, should any suspicion of academic dishonesty arise, students will be referred to the Office of Student Judicial Affairs and Community Standards for further review. The review process appears at: http://www.usc.edu/student-affairs/SJACS/.
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Disability Services Any student requesting academic accommodations based on a disability must register with Disability Services and Programs (DSP) each semester. You can obtain a letter of verification for approved accommodations from DSP. Deliver the letter to me as early in the semester as possible. DSP is located in STU 301 and is open 8:30 AM - 5:00 PM, Monday through Friday. The phone number for DSP is (213) 740-0776.
Returned Papers To protect the confidentiality of your work, you must pick up your own graded paperwork. I will not give your papers to anyone else. Students who miss class sessions when paperwork is returned must arrange for an appointment to retrieve the material. I will discard graded paperwork unclaimed by a student after four weeks.
Disputes over graded material must be brought to my attention as soon as possible.
Technology Use in Class Sessions Communication devices such as cell phones, Blackberries, etc. capable of sending or receiving electronic communication and all entertainment devices such as iPods or other MP3 players must be turned off and kept off throughout the class session. Receiving or sending communication or entertainment during class disrupts the learning environment and is rude to those around you.
You may use laptops for taking notes, but I may revoke this privilege on an individual or global basis if I find that it is disruptive. You may use laptops for other purposes only with my expressed permission. In all events, you may not connect to the Internet unless I specifically permit it. You may not use laptops during examinations.
Your Responsibilities • Read assigned readings before coming to class and come prepared to discuss them.
If you are uncertain of the assignment, consult the course web pages at http://blackboard.usc.edu. The readings and our discussions are an integral part of the course.
• Read the financial press every day. Come to class prepared to discuss current events in the markets. At a minimum, read the front page of the Money & Investing section of The Wall Street Journal. You also should read the Los Angeles Times business section. The business sections of the New York Times, The Financial Times and Investor’s Daily are even better. Try reading the finance section of The Economist and any relevant special reports. Best of all, read Traders Magazine or Securities Week, if you can get a copy. Serious professionals follow current events in their industry. Be a securities industry professional, if only for the next seventeen weeks. Reading the news will help you get more out of this class.
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• Come to class on time. If you are late, enter quietly. If it is raining, remember that you will need more travel time. If you are habitually late, think about why you are not excited about coming to class. If I can improve things, please tell me. If you are simply not interested, drop the class for your sake—you must have better things to do than to attend a class that does not interest you.
• Help your classmates study and prepare for class. The best way to learn is to teach. Teach each other, and you will learn quickly and thoroughly. Also, your classmates may become your professional colleagues. Start forming your professional networks by getting to know them now.
• Express yourself. This is your class. Express your opinions, your problems, your reservations, your suggestions, and your interests. Make this class work for you. Help me improve the course. There are no dumb questions. If you do not understand something, many of your classmates also probably do not understand it either. Please ask the question.
• Initiate. Do not limit yourself only to the resources I assemble for the course. If you want to learn something we do not cover, find a source (I can help) and study.
Required Text Larry Harris, Trading and Exchanges: Market Microstructure for Practitioners, Oxford University Press, 2003.
I am offering a one-dollar bounty for each new error in the book that you bring to my attention. To earn this reward, you must be the first to identify the error. I am interested in typos, grammatical problems, factual inaccuracies, and any other objective issues that are the responsibility of the author. I will be the sole arbiter of what qualifies and I reserve the right to cancel this offer at anytime. An errata sheet appears at http://www.tradingandexchanges.com.
A Very Useful Book John Downes and Jordan Elliot Goodman, editors, Dictionary of Finance and Investment Terms, 7th Edition (New York: Barron’s Educational Series, 2006, ISBN 978-0764134166)
This inexpensive dictionary is very useful for quickly defining financial jargon and concepts.
A Strong Recommendation Edwin Lefèvre, Reminiscences of a Stock Operator, (New York: John Wiley and Sons, Inc., Reprinted 1993, ISBN 0-47105970-6, first published in 1923)
Reminiscences is a ghostwritten autobiography of Jesse Livermore. Livermore was a very successful stock and commodity speculator who traded in the late 19th and early 20th centuries. The author, Edwin Lefèvre, was a financial reporter who spent two months interviewing Livermore for this project. The result is presented as a first-person narrative by a character called Larry Livingston, who clearly represents Jesse Livermore. The book is full of market wisdom and human wisdom. It is easy to read, engaging, and covers many of the topics of this course.
FBE-440: Syllabus
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Rev: 1/4/07
FBE-440: Syllabus
Professor Larry Harris Trading and Exchanges USC Spring 2007
FBE 440 TTh Class Schedule
The examinations indicated on this schedule will take place as scheduled. Otherwise, this is a tentative schedule that I may modify in response to the needs and interests of the class. As the course evolves, I will post the topics to be covered in the next lecture (and associated reading assignments) on BlackBoard. The topics below correspond to chapters in the textbook. Please read them before coming to class.
I will not attend class on March 27 (Q Group Conference) and April 10 (Passover holiday). I hope to arrange for outside speakers on those days.
Date Topic
Jan 9 Tu 1 Introduction
Jan 10 Th 2 Trading Stories 3 The Trading Industry 4 Orders and Order Properties
Jan 16 Tu 5 Market Structures
Jan 18 Th 6 Order Driven Markets
Jan 23 Tu 6 Order Driven Markets (continued)
Jan 25 Th 7 Brokers
Jan 30 Tu 8 Why Do People Trade?
Feb 1 Th 9 Good Markets
Feb 6 Tu 10 Informed Traders and Market Efficiency
Feb 8 Th 11 Order Anticipators
Feb 13 Tu 12 Bluffing and Price Manipulation
Feb 15 Th Midterm Examination
Feb 20 Tu 13 Dealers
Feb 22 Th 14 Bid/Ask Spreads
Feb 27 Tu 15 Block Trading
Mar 1 Th 16 Value-motivated Traders
FBE-440: Syllabus
Professor Larry Harris Trading and Exchanges USC Spring 2007
2
Date Topic
Mar 6 Tu 17 Arbitrageurs
Mar 7 Th 18 Buy-side Traders
Mar 13 Tu Spring Recess Holiday
Mar 15 Th Spring Recess Holiday
Mar 20 Tu 19 Liquidity 20 Volatility
Mar 22 Th 21 Liquidity and Transaction Cost Measurement
Mar 27 Tu No Class
Mar 29 Th 22 Performance Evaluation and Prediction
Apr 3 Tu Midterm Examination
Apr 5 Th 23 Index and Portfolio Markets
Apr 10 Tu No Class
Apr 12 Th 24 Specialists
Apr 17 Tu 25 Internalization, Preferencing, and Crossing
Apr 19 Th 26 Competition within and among Markets
Apr 24 Tu 27 Bubbles, Crashes, and Circuit Breakers
Apr 26 Th 28 Floor versus Automated Trading Systems 29 Insider Trading
May 9 W Final Examination, 8:00 AM - 10:00 AM
May 11 F University Commencement
FBE-440: Syllabus
Professor Larry Harris Trading and Exchanges USC Spring 2007
Techniques for Learning Efficiently You will learn more in less time if you learn efficiently. You then will have more time for other activities. Consider the following suggestions to make your learning quicker and more effective.
The General Principle You learn most effectively when you force yourself to use what you must learn. You must put new information and concepts into your own words. Then you must organize, manipulate and use them.
Specific Suggestions When studying, imagine that you will have to teach others what you have learned. Think carefully about how you would do this. This objective is more real than you might imagine. When people hire you for what you know, they expect you to share your knowledge. You soon will be educating your supervisors, colleagues and employees.
Practice teaching the course material to your classmates in study sessions.
If you have a copy of a speaker’s lecture notes, do not use them when you attend the lecture. You will learn most effectively if you take notes yourself and then later compare your notes to the speaker’s notes. If no speaker’s notes are available, trade lecture notes with your classmates and discuss the differences among them. Do this even if the speaker’s notes are available.
Highlighting and underlining may help you identify what you need to learn, but they are not efficient learning techniques. At best, they help you understand what other people have written. To remember your studies, you must put them into your own words. People like to highlight and underline because these tangible activities make them feel productive. Do not mistake activity for productivity. If you ever catch yourself highlighting and underlining on autopilot, you know what I am talking about.
You learn most effectively by taking notes. If you do not feel like writing, consider dictating your notes into a tape recorder. Both methods work well. In either event, do it in your words. Do not copy what others have written. You learn more from composing your notes than from studying them. Spend more time composing.
Compose notes after you finish reading a section or a chapter. It is best to wait a few hours. Recompose your lecture notes after a lecture, preferably without looking at your original notes. To remember something, you have to practice remembering. If you know that you will later compose and recompose, you will remember more.
When you review your studies, start by trying to remember what you want to review. Then go back to your notes, see what you forgot, and study just that. It is inefficient to study what you already know. If necessary, return to the original sources.
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To prepare for tests, practice taking old tests if they are available. Take the tests before you read the answers. Being able to recognize a correct answer is not the same thing as being able to provide the correct answer. Practice providing, not recognizing.
If you cannot understand an important passage in your readings, go back and review. Good texts are organized so that you should not have to read forward to understand an earlier passage. You accomplish little by plowing through confusion. Unlike snow, confusion usually piles up in front instead of being pushed to the side. Not all texts are well written, however, and even the best texts may have some weak sections. Sometimes it is best to do a quick first pass over the material so you can see where it is going. Then go back and read it carefully.
If you are lost in a lecture, tell your instructor. Many others may be lost too. The true object of a lecture is to transmit knowledge, not to finish a set of topics. Instructors that finish their lectures without conveying information have wasted your time and their time. Come to class prepared to minimize the chance that you will get lost.
Everyone gets frustrated when they are confused about something that they believe they must know. Frustration is an emotion that makes learning less effective. It can cause you to overestimate the time necessary to accomplish your objectives and lead to feelings of failure that would become self-reinforcing if you quit. Managing frustration therefore is essential to effective learning.
You can prevent frustration by not allowing yourself to get confused. When you do not understand what you are reading, go back and review. When you do not understand a point made in lecture, ask the instructor to explain it again differently.
When you do become frustrated (everyone does at some point), deal with it immediately by taking action to control this emotion instead of letting it control you. If you are studying, stop and do something else for a while. If you are in a lecture or a meeting, ask a question. Do not waste time in an emotional state that is not productive. Instead, recognize your emotion and deal with it.
Do not eat a heavy meal before you attend class or plan to study. It is easier to learn when you do not have to fight the natural inclination of your body to doze on a full stomach.
Most peoples’ minds slow down in the early afternoon (if they keep normal sleeping hours). Try to avoid studying and taking classes when your mind is not active.
If you are too tired to learn effectively, get some sleep and return to your studies when you are more rested. Otherwise you will waste your time and be even more tired.
Study somewhere where you will have few distractions. You only have one CPU in your head. Multitasking is inefficient because keeping track of tasks and switching among them consumes energy and time. You can accomplish more in less time by devoting your full attention to one task at a time than if you try to do several at the same time.
If you review a little bit every now and then, you will learn more than if you spend the same amount of time cramming before an exam.
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A Final Note of Encouragement Although these suggestions may seem as though they are difficult, they will allow you to learn more in less time. Learning effectively will give you more time to do other things. Time is our most scarce resource. Use it wisely.
FBE-440: Course Documents
Name_____________________________ Last, First
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 MW Midterm 1 Write your name on the exam now. Each question can be answered with a short answer. Please use a pen and write legibly. If most fourth grade students could not read your cursive script, please write in block print. Take your time and do well. Please ask me if you have trouble with spelling or grammar.
Since knowing that you do not know something is a valuable form of knowledge, I give half credit for blank answers. A completely wrong answer, of course, will receive no credit.
Good luck!
Very Short Answers (five points each) 1. What kind of option does a buy limit order
represent? __________________________
2. What common order type has the greatest market impact? __________________________
3. What benefit do commodity hedgers expect to obtain from trading? __________________________
Simple One Sentence Answers (5 points each) 4. In what sense are exchanges and brokers the same?
5. What is the primary conflict of interest within an SRO?
FBE-440: Course Documents
6. What is the main advantage of a call market over a continuous trading market?
7. Why is price priority self-enforcing?
8. The pricing rule used in the bucket and bucketering shops that Jesse Livermore traded in is a derivative pricing rule. Why have I classified it as such?
Slightly Harder One Sentence Answers (10 points each) 9. Why do mutual fund management companies like soft dollars commissions?
FBE-440: Course Documents
Name_____________________________ Last, First
10. Of what benefit is orthogonality to a well-informed trader?
11. Consider a sealed bid auction in which the highest bidder wins and pays the average of the highest and second highest bid prices. Explain why bidders should or should not bid their reservation prices in this auction.
12. Provide one example of how informative prices in the secondary capital markets (trading of seasoned securities) help make production in our economy more efficient.
FBE-440: Course Documents
Computation Questions (10 points each) 13. Suppose that the following orders are submitted to a call market that conducts a single
price auction using price-time precedence rule at 10:15. What will be the market clearing price and the total volume of trade? (Please do not double-count the volume.)
Trader Arrival time Side Price Size
A 9:30 Buy 11 10 B 9:40 Sell 11 10 C 9:45 Buy 9 20 D 9:50 Sell 9 10 E 10:00 Buy 12 5
Price _____________ Volume _____________ 14. Mark submits a market order to sell 9 to a continuous market with the following order
book: Trader Bid Size Price Offer Size Ann 15 80.0 Jack 3 80.3 Steve 80.4 5 Beth 80.6 10 At what average price will Mark’s order be filled? __________________________
FBE-440: Course Documents
Name_____________________________ Last, First
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 TTH Midterm 1 Write your name on the exam now. Each question can be answered with a short answer. Please use a pen and write legibly. If most fourth grade students could not read your cursive script, please write in block print. Take your time and do well. Please ask me if you have trouble with spelling or grammar.
Since knowing that you do not know something is a valuable form of knowledge, I give half credit for blank answers. A completely wrong answer, of course, will receive no credit.
Good luck!
Very Short Answers (5 points each) 1. Price is currently at 50. What order should a trader
use if she wants to sell if the price falls to 30? __________________________
2. What limits the trading profits of informed traders? __________________________
Simple One Sentence Answers (5 points each) 3. Who or what is on the “buy-side?”
4. What is the difference between a broker and a dealer?
FBE-440: Course Documents
5. What benefit do members of an SRO obtain by subjecting themselves to its regulation?
6. Ignoring labor costs, what is the most important argument against opening the NYSE an hour earlier to accommodate European traders?
7. The pricing rule used in the bucket and bucketering shops that Jesse Livermore traded in is a derivative pricing rule. Why have I classified it as such?
8. Rational investors expect to lose on average to well-informed traders. Why are they still willing to trade?
FBE-440: Course Documents
Name_____________________________ Last, First
Slightly Harder One Sentence Answers (10 points each) 9. Consider a sealed bid auction in which the highest bidder wins and pays the average of
the highest and second highest bid prices. Explain why bidders should or should not bid their reservation prices in this auction.
10. Why is a large tick (minimum price variation) necessary to make secondary precedence rule such as time precedence economically meaningful?
11. How do informative prices in the primary (new issue) capital markets help make production in our economy more efficient?
12. How might gamblers in the financial markets benefit the economy as a whole?
FBE-440: Course Documents
Computation Questions (10 points each) 13. An ECN that organizes a continuous pure price-time auction opens with an empty limit
order book. It then receives the following orders: Trader Arrival time Side Pric
e Size
A 9:30 Buy 10 10 B 9:40 Sell 11 10 C 9:45 Buy 9 20 D 9:50 Sell 8 15 E 10:00 Buy 10 5
List the trades, if any, that the ECN arranges:
Trade # Time Buyer Seller Price Size
1
2
3
4
5
14. Consider the following order book for a single price auction:
Aggregate Bid Sizes
Price
Aggregate Offer Sizes
15 12.0 35 12.1 15 12.2 5
5 12.3 10 5 12.4
12.5 12.6 10 12.7 15 12.8 12.9 15 13.0 10
What will be the market clearing price and the total volume of trade? (Please do not double-count the volume.)
FBE-440: Course Documents
Name_____________________________ Last, First
Price _____________ Volume _____________
FBE-440: Course Documents
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 MW Midterm 1 Answers
Very Short Answers (five points each)
1. What kind of option does a buy limit order represent? A put option.
2. What common order type has the greatest market impact? Large market orders
3. What benefit do commodity hedgers expect to obtain from trading? Risk reduction
Simple One Sentence Answers (5 points each)
4. In what sense are exchanges and brokers the same? They both arrange trades for their clients.
5. What is the primary conflict of interest within an SRO? An SRO is managed by the members that it regulates. The SRO thus may place the members’ interests before the public’s interests.
6. What is the main advantage of a call market over a continuous trading market? The call market reduces search costs by concentrating liquidity at a single point in time and space.
7. Why is price priority self-enforcing? Traders always seek the best prices.
8. The pricing rule used in the bucket and bucketering shops that Jesse Livermore traded in is a derivative pricing rule. Why have I classified it as such?
Bucket and bucketering shops obtain (derive) their contract prices from prices printed at other venues.
Slightly Harder One Sentence Answers (10 points each)
9. Why do mutual fund management companies like soft dollars commissions? Soft dollar commissions allow fund management companies to pay for goods and services with their customers’ assets.
FBE-440: Course Documents
10. Of what benefit is orthogonality to a well-informed trader? Orthogonality increases the liquidity available to well-informed traders by decreasing the probability that they will compete with other informed traders for the same liquidity.
11. Consider a sealed bid auction in which the highest bidder wins and pays the average of the highest and second highest bid prices. Explain why bidders should or should not bid their reservation prices in this auction.
Bidders should bid slightly less than their reservation prices because their bids determine to some extent the prices that they will pay if they win.
12. Provide one example of how informative prices in the secondary capital markets (trading of seasoned securities) help make production in our economy more efficient.
Informative secondary prices help allocate managers to existing capital by pricing how well they use the resources available to them. Informative secondary prices also allow shareholder to motivate their managers with stock options.
FBE-440: Course Documents
Computation Questions (10 points each) 13. Suppose that the following orders are submitted to a call market that conducts a single
price auction using price-time precedence rule at 10:15. What will be the market clearing price and the total volume of trade? (Please do not double-count the volume.)
Trader Arrival time Side Price Size
A 9:30 Buy 11 10 B 9:40 Sell 11 10 C 9:45 Buy 9 20 D 9:50 Sell 9 10 E 10:00 Buy 12 5
The sorted order book is
Bid Size
Price Offer Size
20 9 10 10 11 10 5 12
The 5 to buy at 12 are matched with 5 of the 10 to sell at 9 leaving 5 to sell at 9. The remaining 5 to sell at 9 are matched with the 10 to buy at 11 leaving 5 to buy at 11. The remaining 5 to buy at 11 are matched with 5 of the 10 to sell at 11. No further trades can be arranged because the next best buyer is only willing to pay 9. The single price is 11 and the volume is 15. 14. Mark submits a market order to sell 9 to a continuous market with the following order
book: Trader Bid Size Price Offer Size Ann 15 80.0 Jack 3 80.3 Steve 80.4 5 Beth 80.6 10
At what average price will Mark’s order be filled? 3 trade at 80.3 and 6 trade at 80.0 so that the average price is 80.1.
FBE-440: Course Documents
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 TTH Midterm 1 Answers
Very Short Answers (5 points each)
1. Price is currently at 50. What order should a trader use if she wants to sell if the price falls to 30?
A stop order at 30.
2. What limits the trading profits of informed traders? Liquidity
Simple One Sentence Answers (5 points each)
3. Who or what is on the “buy-side?” Institutions and individuals that manage money.
4. What is the difference between a broker and a dealer? A dealer trades for his own account whereas a broker trades as agent for other accounts. A dealer fills orders from his own account whereas a broker fills orders by finding a trader to take the other side.
5. What benefit do members of an SRO obtain by subjecting themselves to its regulation? SROs regulate their members to decrease the costs that members may impose upon each other. The costs may result from bad business practices or from the loss of reputation suffered by all when some members cheat the public.
6. Ignoring labor costs, what is the most important argument against opening the NYSE an hour earlier to accommodate European traders?
It will dilute liquidity by further spreading it through time.
7. The pricing rule used in the bucket and bucketering shops that Jesse Livermore traded in is a derivative pricing rule. Why have I classified it as such?
Bucket and bucketering shops obtain (derive) their contract prices from prices printed at other venues.
8. Rational investors expect to lose on average to well-informed traders. Why are they still willing to trade?
They benefit by using the markets to move money from the present to the future.
FBE-440: Course Documents
Slightly Harder One Sentence Answers (10 points each)
9. Consider a sealed bid auction in which the highest bidder wins and pays the average of the highest and second highest bid prices. Explain why bidders should or should not bid their reservation prices in this auction.
Bidders should bid slightly less than their reservation prices because their bids determine to some extent the prices that they will pay if they win.
10. Why is a large tick (minimum price variation) necessary to make secondary precedence rules such as time precedence economically meaningful?
A small tick allows traders to cheaply obtain precedence through price priority.
11. How do informative prices in the primary (new issue) capital markets help make production in our economy more efficient?
They make it impossible or expensive for entrepreneurs to obtain capital for bad investment projects and make it easy for entrepreneurs to obtain capital for good projects.
12. How might gamblers in the financial markets benefit the economy as a whole? They make prices more efficient in the long run by making markets more liquid for informed traders.
Computation Questions (10 points each) 13. An ECN that organizes a continuous pure price-time auction opens with an empty limit
order book. It then receives the following orders: Trader Arrival time Side Price Size
A 9:30 Buy 10 10 B 9:40 Sell 11 10 C 9:45 Buy 9 20 D 9:50 Sell 8 15 E 10:00 Buy 10 5
List the trades, if any, that the ECN arranges:
Trade # Time Buyer Seller Price Size
1 9:50 A D 10 10 2 9:50 C D 9 5 3
4
5
FBE-440: Course Documents
14. Consider the following order book for a single price auction:
Aggregate Bid Sizes
Price
Aggregate Offer Sizes
15 12.0 35 12.1 15 12.2 5
5 12.3 10 5 12.4
12.5 12.6 10 12.7 15 12.8 12.9 15 13.0 10
What will be the market clearing price and the total volume of trade? (Please do not double-count the volume.) Match 5 bid at 12.4 with 5 offered at 12.2. Match the 5 bid at 12.3 with 5 of the 10 offered at 12.3. No more trades are possible. The only price that works for all is 12.3. The total volume is 10.
FBE-440: Course Documents
Professor Larry Harris Trading and Exchanges USC Spring 2007
Homework Assignment 7 - Answers Using the following orders, please complete the following tables taken from Chapter 6.
Table 6-1-New. Example Orders
Time Trader Order side Size Price
10:01 Bea Buy 3 30.0 10:05 Sam Sell 2 30.1 10:08 Ben Buy 4 30.2 10:09 Sol Sell 2 30.3 10:10 Stu Sell 5 30.3 10:15 Bif Buy 4 market 10:18 Bob Buy 3 30.2 10:20 Sue Sell 4 30.0 10.27 Sun Sell 3 30.2 10:29 Bud Buy 3 30.3
Assume that Bif’s true reservation price is 30.5.
Table 6-2. Example Order Book
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea Sue 4 30.0 Sam 2 30.1 Sun 3 30.2 30.2 3 Bob 30.2 4 Ben 30.3 3 Bud Sol 2 30.3 Stu 5 30.3 Market 4 Bif
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Please conduct a single price call market auction and present the results:
Table 6-3. Call Market Trades
Match Seller Buyer Quantity
1 Sue Bif 4 2 Sam Bud 2 3 Sun Bud 1 4 Sun Ben 2
Total: 9
What is the single uniform price? 30.2
Table 6-7. Trader Surpluses in the Single Price Auction Example
Trader Order Filled sales
Filled buys
Trade price
Assumed value Trader surpluses
Sue Sell 5 limit 30.0 4 30.2 30.0 (30.2 − 30.0) × 4 = 0.8 Sam Sell 2 limit 30.1 2 30.2 30.1 (30.2 − 30.1) × 2 = 0.2 Sun Sell 3 limit 30.2 3 30.2 30.2 (30.2 − 30.2) × 3 = 0.0 Bif Buy 4 at market 4 30.2 30.5 (30.5 − 30.2) × 4 = 1.2 Bud Buy 3 limit 30.3 3 30.2 30.3 (30.3 − 30.2) × 3 = 0.3 Ben Buy 4 limit 30.2 2 30.2 30.2 (30.2 − 30.2) × 2 = 0.0 Totals 9 9 2.6
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Please conduct a continuous market auction using the same orders from Table 6-1-New above and present the results:
Order Book after First Order Arrives
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea
The market is 30.0 bid for 3
Order Book after Two Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea Sam 2 30.1
The market is 30.0–30.1 3 x 2.
Order Book after Three Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea 30.2 2 Ben
The market is 30.2 bid for 2
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Order Book after Four Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea 30.2 2 Ben Sol 2 30.3
The market is 30.2–30.3 2 x 2.
Order Book after Five Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea 30.2 2 Ben Sol 2 30.3 Stu 5 30.3
The market is 30.2–30.3 2 x 7.
Order Book after Six Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea 30.2 2 Ben Stu 3 30.3
The market is 30.2–30.3 2 x 3.
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Order Book after Seven Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea 30.2 3 Bob 30.2 2 Ben Stu 3 30.3
The market is 30.2–30.3 5 x 3.
Order Book after Eight Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea 30.2 1 Bob Stu 3 30.3
The market is 30.2–30.3 1 x 3.
Order Book after Nine Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea Sun 2 30.2 Stu 3 30.3
The market is 30.0–30.2 3 x 5.
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Order Book after Ten Orders
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea Stu 2 30.3
The market is 30.0–30.3 3 x 2.
Table 6-8. Trades in the Continuous Auction Example
Time Seller Buyer Price Quantity
10:08 Sam Ben 30.1 2 10:15 Sol Bif 30.3 2 10:15 Stu Bif 30.3 2 10:20 Sue Ben 30.2 2 10:20 Sue Bob 30.2 2 10:27 Sun Bob 30.2 1 10:29 Sun Bud 30.2 2 10:29 Stu Bud 30.3 1 Total: 14
Table 6-9. Trader Surpluses in the Continuous Auction Example
Trader Order Filled sales
Filled buys
Average trade price
Assumed value Trader surplus
Sam Sell 2 limit 30.1 2 30.1 30.1 (30.1 − 30.1) × 2 = 0.0 Sol Sell 2 limit 30.3 2 30.3 30.3 (30.3 − 30.3) × 2 = 0.0 Sue Sell 4 limit 30.0 4 30.2 30.0 (30.2 − 30.0) × 4 = 0.8 Sun Sell 3 limit 30.2 3 30.2 30.2 (30.2 − 30.2) × 3 = 0.0 Stu Sell 5 limit 30.3 3 30.3 30.3 (30.3 − 30.3) × 3 = 0.0 Ben Buy 4 limit 30.2 4 30.15 30.2 (30.2 − 30.15) × 4 = 0.2 Bif Buy 4 at market 4 30.3 30.5 (30.5 − 30.3) × 4 = 0.8 Bob Buy 3 limit 30.2 3 30.2 30.2 (30.2 − 30.2) × 3 = 0.0 Bud Buy 3 limit 30.3 3 30.233 30.3 (30.3 − 30.233) × 3 = 0.2 Totals 14 14 2.0
FBE-440: Course Documents
Keith Parker ID#6390.4899.77 [email protected] WSJ Article Summary From Tuesday, January 9th, Print edition of the WSJ “Same Crowd Behind Oil Rise Now Sells Out” Many people expected investors to continue to put more money into crude oil and to
continue to buy futures in the commodities market. Many analysts don’t believe this to
be completely true, as returns have slowed and the costs of holding investments in this
market have increased significantly. If the large cost of holding onto an investment in the
crude oil market continues, investors may not be willing to buy. Further, oil futures have
fallen 27 percent since their peak in July of last year. This article is important to the class
largely because it demonstrates that an investment that provides a return may not be
attractive to investors if the cost of holding onto said investment is too high.
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] Discussion on SRO’s self-regulation and its implications For Thursday, January 18th While there are clearly ways in which for-profit stock exchanges that list
themselves on their own exchange could manipulate the regulations applicable to buying
and selling stock, I do not believe that this would happen in today’s market. The most
prominent reason for this is the industry’s focus on such a thing happening. Further,
because the idea that a for-profit organization regulating itself seems to many to be ill-
fated, there follows the idea that there will be intense scrutiny of discrepancies and
manipulations of self-imposed regulations that might be aimed at the increase of profits
for said exchange. As a result of this scrutiny that is likely to occur over these
organizations’ self-regulations, it would be too risky for such exchanges with long-
standing reputations (such as the NYSE or NASDAQ) to take part in self-regulation
manipulations for fear of being caught.
As far as regulatory problems that could occur go, there are a few possibilities.
First, an exchange such as the NYSE or NASDAQ could manipulate the time it takes for
their own stock to update in electronic trading systems to work in their advantage when
trading of their stock is taking place. Further, when buyers purchase their own stock at
low prices, these exchanges could artificially make it appear that prices are low for a
period of time; this would result in more stocks being sold than if the price were allowed
to rise, as regulations require.
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] WSJ Article Brief The Most Important Traders in the Stock Market For Tuesday, January 30th In the stock market the most important traders are speculators, particularly the
informed traders within this group. This is true because the price of stock for a certain
company in the stock market should represent as best it can the true value of that firm.
Informed traders act on information about the fundamental values of a firm, thus their
trades balance out to an equilibrium price that is the nearly true value of the firm,
according to what is known in the market. This ‘close-to-true’ value is based on trades
from value traders who extensively research the worth of the company, as well as news
traders who keep the stock price up-to-date by acting on the most recent news relevant to
the organization. Nonetheless, the price of a stock usually doesn’t represent the true
worth of a firm, as noise traders whose trade is based on factors outside of standard
information and news cause the price of a stock to vary widely from its real value.
Essentially, informed traders are important to the stock market because they act as a
counter-balance to the noise created by ‘noise traders’ (essentially all traders who are not
‘informed traders’).
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] What Is The Optimal eBay Bidding Strategy? For Thursday, January 25th In order to receive an item for the lowest possible price through the online bidding
site eBay, a user is best served by not bidding at all until as close to the auction end as
they can get, then entering their bid limit. EBay is essentially an English auction.
Further, the eBay system automatically enters a bid for one’s item at a set bidding
increment above the previous bidder’s bid limit, up to the price of one’s bid limit. As a
result of this, a user needs not constantly sit at his or her computer outbidding somebody
else up to their bid limit, they can merely enter their bid limit and let the eBay system do
the rest. Secondly, it is best to enter one’s bid limit as close to the end of the auction as
possible. The reason for this is as follows. If users enter their bid limits early in the
auction, the current bid price will rise and other users may reconsider their bid limit,
raising their limit to a higher amount than it would have previously been. This will result
in a higher cost of the item. The exception here is an item with many substitutes or listed
by many sellers. In this case, bidding early will raise the bid price enough to cause other
users to look elsewhere and not bid on the item at all.
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] WSJ Article Brief The Most Important Traders in the Stock Market For Tuesday, January 30th In the stock market the most important traders are speculators, particularly the
informed traders within this group. This is true because the price of stock for a certain
company in the stock market should represent as best it can the true value of that firm.
Informed traders act on information about the fundamental values of a firm, thus their
trades balance out to an equilibrium price that is the nearly true value of the firm,
according to what is known in the market. This ‘close-to-true’ value is based on trades
from value traders who extensively research the worth of the company, as well as news
traders who keep the stock price up-to-date by acting on the most recent news relevant to
the organization. Nonetheless, the price of a stock usually doesn’t represent the true
worth of a firm, as noise traders whose trade is based on factors outside of standard
information and news cause the price of a stock to vary widely from its real value.
Essentially, informed traders are important to the stock market because they act as a
counter-balance to the noise created by ‘noise traders’ (essentially all traders who are not
‘informed traders’).
FBE-440: Assignments
FBE-440: Assignments
FBE-440: Assignments
FBE-440: Assignments
FBE-440: Assignments
FBE-440: Assignments
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] New York Times Article Brief S.E.C. is Looking at Stock Trading For Thursday, February 8th The SEC has begun an investigation that will attempt to reveal which banks on
Wall Street, if any, have been engaging in front running. Front running is when a bank
tells valuable clients about a major trade before the trade actually happens. This allows
the client to make a risk-free trade on said stock. Some banks may have been allowing
front running a little differently than it has happened in the past; banks may be giving
their valuable clients information about trades in advance of large trades, after which
these clients would go to a different bank to make the trade. The SEC has demanded all
stock and option trading data for the last two weeks of September from Major Wall Street
Banks. Concerns have arisen from studies that show unusual amounts of trading
occurring before major deals are carried out. Further, the growing dominance of Hedge
funds on Wall Street, which now account for 30 to 50 percent of trading on most major
markets, has fed concerns of insider trading. The SEC has reported that any information
regarding insider trading will be immediately investigated as usual.
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] Bidding for CBOT For Thursday, March 23rd Although ICE may be offering a higher bid price for CBOT (over one billion
dollars higher), the shareholders will benefit more from the acceptance of the CME bid.
The underlying reason for this is compatibility. The nature of the futures trading markets,
that futures can only be traded within their exchanges (unlike stocks which can be moved
from exchange to exchange), it is important to build market share. Most importantly, a
merger between CBOT and CME will provide customers with more liquidity. CBOT
should accept the lower bid offer and through this provide a better service with more
liquidity, thus providing more value to their shareholders.
FBE-440: Assignments
Keith Parker ID#6390.4899.77 [email protected] Jim Cramer on Market Manipulation For Thursday, March 29th It seemed to me that Jim Cramer, when speaking of things that would manipulate
the market illegally, wasn’t as concerned as much about the legality of such moves as he
was whether or not such actions were commonplace and accepted as standard in the
market. His insights into the way in which markets could be manipulated were
interesting though. His comments in regards to short-selling companies such as Apple
and RIM (Research in Motion), then leaking rumors that the near futures of those
companies weren’t looking very good in order to lower stock price in order to make a
profit were also a clear indication that market manipulation and corruption were more
routine than many people might think. Some comments in the video, such as it ‘only’
costing 10 or 15 million dollars to manipulate the market in some ways, made it clear that
market manipulation is often a very expensive game to play.
FBE-440: Assignments
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
Keith Parker, University of Southern California
FBE-440: Class Notes
FBE-440 Review 2/9/07 2:13 PM
Traders often use whole numbers more often than fractions, et cetera Some questions will come from boxes in the book What are the benefits of a call market?
• Bring people together at the same place and time, creating and offering more liquidity
• What’s the role of time and place when we think about Call markets? Liquidity
How do order-driven markets arrange trades
• Market uses a set of rules, order precedence rules, to match buyers to sellers, and use pricing rules to determine price
Do brokers work for their clients or for themselves? Obviously, they work for themselves, though the nature of their work is that they are working for other people Of what value is a large entertainment budget to a broker?
• Brokers are most valuable when they have many clients Soft dollars, what are they? Soft dollars paid towards research from one account might benefit another account, this could be a problem here What agency regulates options trading? The SEC Find out what a deep-discount broker is Activities that may appear in the back office of a brokerage firm? Why is it important to have a poker face in a physically convened market? This is negotiating prices face-to-face Why do traders care about trustworthiness? Don’t ramble on when answering questions like these, just answer it very straightforward
FBE-440: Exam Things
Things from the book that weren’t in class? • Does it appear in the list of important points in the chapter? • Was it highlighted in some way in the book? • Was an example provided to make it more clear? • Were there questions on it at the end of the book?
Will get more credit for not writing something on the exam that you know you don’t know, rather than making something up What do brokers do?
• Help their clients arrange trades, provide more value when they have more clients
Figure out what payment for order flow is
• What is payment for order flow, why are regulators concerned about it, and what affect does it have on commissions?
What markets would you expect to see the greatest market efficiency? What makes prices informative? In what way is market structure like the rules of the game? It determines who has power, et cetera Lecture notes on blackboard represent at least one outline for going through the course; basically an abbreviated form of the book with the important stuff; often professor looks at lecture notes when writing exam A couple of questions might be on current events in the trading arena
FBE-440: Exam Things
Continuous AuctionTime Trader Order Side Size Price
10:01 Bea Buy 3 30Sam Sell 2 30.1Ben Buy 4 30.2Sol Sell 2 30.3Stu Sell 5 30.3Bif Buy 4 MarketBob Buy 3 30.2Sue Sell 4 30Sun Sell 3 30.2
10:29 Bud Buy 3 30.3
TradesBuyer Seller Price QuantityBen Sam 30.1 2Bip Sol 30.3 2Bif Stu 30.3 2Ben Sue 30.2 2Bob Sue 30.2 2Bob Sun 30.2 1Bud Sun 30.2 2Bud Stu 30.3 1
Order BookBuyer side Sellers sideBuyer Price Quantity Seller Price QuantityBen 30.2 2 Sam 30.1 2Bob 30.2 3 1 Sun 30.2 2Bea 30 3 Sol 30.3 2
Stu 30.3 5 3 2
Buyers' Surplus Seller SurplusSurplus Reservation Surplus Reservation(30.2-30.1)2 30.2 Ben (30.1-30.1)2 30.1 SueList goes on List goes on
When calculating suplus for Bud, who traded at two prices, you have to calculated his weighted average trading price
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2007
FBE 440 MW Midterm 1 Answers
Very Short Answers (five points each)
1. Suppose the market is 100 bid, offered at 101. What would be the limit price of a limit buy order if it were placed at the market?
100
2. The following orders are in a market: Order A: Buy 10 for 18 Order B: Buy 15 for 19 Order C: Buy 5 for 20 Order D: Sell 5 at 21 Order E: Sell 25 at 22 Order F: Sell 20 at 23 What is the best bid?
Order C: Buy 5 for 20 (The highest priced buy order.)
3. An order book in a continuous auction contains only one limit order. It is a buy order with a limit price of 5. A limit sell order with a limit price of 4 arrives. At what price will a trade be arranged, if any?
5
4. In the extreme, a market sell order is like what kind of limit order? A limit order with a zero price.
5. In what direction is price moving when a limit sell order placed at the market fails to execute?
Down
6. What do you expect will happen to bid/ask spreads if volatility increases? Spreads will increase.
7. Suppose a buyer buys 5 contracts for 40 using a limit order priced at 42. Given this information only, what is a reasonable lower bound for his trader’s surplus?
(42-40)*5=10
8. Who makes payments for order flow? Dealers
FBE-440: Exam Things
Simple One Sentence Answers (5 points each)
9. How can a buyer who does not have time-precedence at $25 acquire order precedence?
Raise her bid.
10. The market in a continuous trading auction is 100 bid, offered at 101. An IOC order to buy, limit 100.5 arrives. What happens?
Nothing. The order does not fill and it cancels automatically.
Simple One Sentence Answers (10 points each)
11. Why do traders only want to trade with creditworthy counterparts? They want to be sure that their counterparts are able to settle their trades.
12. Why would it be difficult to enforce the uniform pricing rule in a continuous trading market?
Traders will break their orders into pieces to price discriminate.
13. In this course, what is the difference between an investor and a speculator? An investor trades to move money from one point in time to another. A speculator trades to profit from unique information.
FBE-440: Exam Things
Computation Questions (10 points each)
14. Consider the following summary order book for a single price auction.
Aggregate Bid Sizes
Price
Aggregate Offer Sizes
Market Sell 2 15 12 20 12.1 2 15 12.2 10 12.3 7
7 12.4 4 5 12.5 4 1 12.6 10 1 12.7 15
12.8 30 12.9 15 13 10
4 Market Buy
At what price should the single price auction be conducted?
What total quantity will trade? The single price auction price will be 12.4. The market buy orders are matched with the market sell orders leaving 2 unmatched on the buy side. These are matched with the sell orders placed at 12.1. The sell orders placed at 12.3 are matched with the buy orders placed at 12.7, 12.6 and 12.5. The sell orders place at 12.4 are matched with 4 of the buy orders placed at 12.4, leaving 3 unfilled on the buy side. No further trade is possible. The clearing price of 12.4 maximizes the total volume. The volume, counted on the buy side is 4 + 1 + 1+ 5 + 4 = 15. Counted on the sell side it is 2 + 2 + 7 + 4 = 15.
15. Mark submits a market order to buy 9 to a continuous market with the following order book:
Trader Bid Size Price Offer Size Ann 15 80.0 Jack 3 80.3 Steve 80.4 6 Beth 80.7 10
FBE-440: Exam Things
At what average price will Mark’s order be filled? 6 trade at 80.4 and 3 trade at 80.7 so that the average price is 80.5.
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2007
FBE 440 TTH Midterm 1 Answers
Very Short Answers (5 points each)
1. In what direction is price moving when a limit buy order placed at the market fails to execute?
Up
2. Whose trading would a public order precedence rule restrict? The members of an exchange
3. The following orders are standing in a market: Order A: Buy 10 for 18 Order B: Buy 15 for 19 Order C: Buy 5 for 20 Order D: Sell 5 at 21 Order E: Sell 25 at 22 Order F: Sell 20 at 23 What is the best offer?
Order D: Sell 5 at 21 (The lowest priced sell order).
4. Suppose a seller sells 8 bonds for 95 using a limit order priced at 93. Given this information only, what is a good lower bound for her trader’s surplus?
(95-93)*8=16 or 1600 if you remember the bond pricing convention.
5. An order book in a continuous auction contains only one limit order. It is a buy order with a limit price of 5. A limit sell order with a limit price of 4 arrives. At what price will a trade be arranged, if any?
5
6. Which type of informed trader typically profits when values change but prices do not change?
News trader
Simple One Sentence Answers (5 points each)
7. The market at a continuous trading auction is 100 bid, offered at 101. A day order to buy, limit 100.5 arrives. What happens?
The order is placed into the book on the buy side at 100.5 to await execution.
FBE-440: Exam Things
8. What makes a market transparent? A transparent market publishes its quotes, orders and trades in a timely fashion.
Simple One Sentence Answers (10 points each)
9. Why is a large tick (minimum price variation) necessary to make secondary precedence rules such as time precedence economically meaningful?
A small tick allows traders to cheaply obtain precedence through price priority.
10. Why would it be difficult to enforce the uniform pricing rule in a continuous trading market?
Traders will break their orders into pieces to price discriminate.
11. What effect does liquidity have on price efficiency? Prices should be more efficient in liquid markets because informed traders need liquidity to profit.
12. Why are uninformed traders willing to lose to informed traders? Uninformed traders are willing to lose to informed traders because they obtain some other benefit from trading besides trading profits. These benefits may come from investing, hedging, gambling or asset exchanging.
FBE-440: Exam Things
Computation Questions (10 points each)
13. Suppose that the following orders are submitted to a call market that conducts a single price auction using price-time precedence rule at 11:00. What will be the market clearing price and the total volume of trade? (Please do not double-count the volume.)
Order Arrival Time Side Limit Price Size A 9:30 Sell 50 25 B 10:00 Buy Market 25 C 10:15 Buy 51 10 D 10:31 Sell 50 5 E 10:35 Buy 49 10 F 10:38 Sell 51 20
What is the market clearing price?
First sort the orders into an order book as follows: Order Arrival Time Side Limit Price Size A 9:30 Sell 50 25 D 10:31 Sell 50 5 F 10:38 Sell 51 20 B 10:00 Buy Market 25 C 10:15 Buy 51 10 E 10:35 Buy 49 10
In a single price auction, all of Order A (25) is first matched with Order B and both are completely filled. All of Order D is then matched with 5 of Order C. The remaining 5 of Order C are matched with part of Order F. No further trades are possible because Order E is only willing to pay 49 but Order F wants 51.
The uniform price for this auction is 51 since 51 is the only price at which a trade can be arranged between Order C and Order F.
What total quantity will trade? The total volume is 25 + 5 + 5 = 35.
FBE-440: Exam Things
14. Mark submits a market order to buy 9 to a continuous market with the following order book:
Trader Bid Size Price Offer Size Ann 15 80.0 Jack 3 80.3 Steve 80.4 6 Beth 80.7 10
At what average price will Mark’s order be filled? 6 trade at 80.4 and 3 trade at 80.7 so that the average price is 80.5.
FBE-440: Exam Things
Midterm #2 Review FBE-440 3/30/07 2:17 PM
Arbitragers provide liquidity – connects people who arrive in different places and time, provide an example of a speculative arbitrage Recognize pure and speculative arbitrages It is speculative for sure if you can image some factor that would cause the arbitrage spread to forever move apart All arbitragers are risky Discuss the risks of doing an arbitrage, implementation risks, risks of engaging in a speculative arbitrage Market manipulation
• Potential for bluffing imposes a discipline • The price impact per share, when your buying you typically raise
prices • If the price impact per share of buying is higher, than you could
just buy a bunch to push prices up and then sell them Understand that brokers end up staking their reputation on the quality of information that they produce Order anticipation chapter, if you go around telling everybody that you’re going to trade, people will front run you- control the exposure of your order Dark liquidity pool: a trading system where people can’t see who is willing to trade Explain why firms with crummy ideas have a hard time selling capital
• If you have a bad idea, you have to sell a lot of shares and this dilutes the values of the shares, which is just transferring the cost of the new venture to the shareholders, which isn’t good
Know a lot about adverse selection, and where it arises in trading markets
• Bid-Ask spreads, et cetera
FBE-440: Exam Things
What determines a bid-ask spread? Why is it unlikely that a liquid market would ever develop around somebody’s pizza parlor? There would be too much asymmetric information Two models of the bid-ask spread: the equilibrium spread model talked about in class should be known
• The implications of free entry and exit • People are deciding whether to, if you are selling, to take a bid or
make an offer, and, if you are buying, whether to take a bid or make an offer
Who is going to be doing the best with arbitrage? The arbitrage portfolio, the high frequency arbitrage is going to tend to be done with high something Fundamental volatility is due to changes in actual value; transitory volatility is the volatility due to everything else (effects of uninformed traders, et cetera) Transitory volatility has a strong link with transaction costs When is a value motivated trader able to trade?
• If price is below (or above) fundamental value o This can happen for two reasons: prices changed and values
didn’t (uninformed traders), or vice versa (news trader) o Value motivated trader is a supplier of liquidity
Winner’s curse • Why it arises (valuation errors) • When bidding in an auction, must be careful because, as a buyer,
the highest bidder is the one who wins. It is likely that the highest bidder is the guy who probably overvalued the thing being bid on
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 MW Midterm 2 Write your name on the exam now. Each question can be answered with a short answer. Please use a pen and write legibly. If most fourth grade students could not read your cursive script, please write in block print. Take your time and do well. Please ask me if you have trouble with spelling or grammar.
Since knowing that you do not know something is a valuable form of knowledge, I will give 40 percent credit for blank answers. A completely wrong answer, of course, will receive no credit.
Good luck!
Short Answers: These questions can be answered with one or two sentences. (10 points each)
1. Order anticipators, informed traders, and dealers all profit from other traders. Which of these traders are parasitic traders and why?
2. Why are momentum traders especially vulnerable to bluffers?
3. How do dealers learn about value from their order flow?
FBE-440: Exam Things
2
4. Under what conditions would you expect adverse selection spreads to be large?
5. Why do block brokers prefer to serve uninformed traders rather than informed traders?
6. How do we know that value traders are the ultimate suppliers of liquidity?
7. Arbitrageurs and dealers both match buyers to sellers. How do their methods differ?
FBE-440: Exam Things
Name_____________________________ Last, First
3
8. How do exchanges simplify bilateral searches?
9. What distinguishing characteristics of fundamental volatility and transitory volatility allow us to discriminate between them?
10. Suppose that transaction costs for a trader are evaluated relative to an opening price benchmark. The trader fills orders for a portfolio manager who trades on momentum. Will the trader’s estimated transaction costs be unbiased?
FBE-440: Exam Things
4
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 TTH Midterm 2 Write your name on the exam now. Each question can be answered with a short answer. Please use a pen and write legibly. If most fourth grade students could not read your cursive script, please write in block print. Take your time and do well. Please ask me if you have trouble with spelling or grammar.
Since knowing that you do not know something is a valuable form of knowledge, I will give 40 percent credit for blank answers. A completely wrong answer, of course, will receive no credit.
Good luck!
Short Answers: These questions can be answered with one or two sentences. (10 points each)
1. How do the strategies used to front-run a market order and a standing limit order differ? (Assume the orders are buy orders.)
2. Why do bluffers fear value traders?
3. Suppose that an uninformed trader trades only with dealers who only know about market values but nothing about fundamental values. Do the uninformed trader’s trading profits depend on the number of informed traders in the market? Why or why not?
FBE-440: Exam Things
2
4. If the value of all traders’ time increased, what would you expect would happen to bid/ask spreads? Why?
5. Why do large liquidity suppliers want to know whether the traders who seek to trade with them will want to trade more of the same security in the future?
6. You plan to bid in an auction for an item for which the value is uncertain. You set your bid assuming that there will only be ten bidders. Before submitting your bid, you learn that 100 people will bid on the item. Should you change your bid? Why?
7. Do arbitrageurs and dealers compete with each other for trading profits? Why or why not?
FBE-440: Exam Things
Name_____________________________ Last, First
3
8. What is liquidity?
9. How is transitory volatility related to transaction costs?
10. Suppose that transaction costs for a trader are evaluated relative to a closing price benchmark. The trader fills orders for a portfolio manager who tends to be well informed. Will the trader’s estimated transaction costs be unbiased?
FBE-440: Exam Things
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 MW Midterm 2 Answers
Short Answers (10 points each)
1. Order anticipators, informed traders, and dealers all profit from other traders. Which of these traders are parasitic traders and why?
The order anticipators are parasitic traders because their trading neither makes markets more liquid nor prices more informative.
2. Why are momentum traders especially vulnerable to bluffers? Since momentum traders follow trends, bluffers can cause them to trade unwisely by manipulating prices.
3. How do dealers learn about value from their order flow? A surplus of buy order volume over sell order volume suggests to them that informed traders may be present so that values are probably higher then current prices, and vice versa for a surplus of sell order volume.
4. Under what conditions would you expect adverse selection spreads to be large? When many informed traders are in the order flow or when the information that informed traders tend to have is highly material (i.e. price is very different from value).
5. Why do block brokers prefer to serve uninformed traders rather than informed traders? The clients with whom the block brokers match block initiators do not want to lose to informed traders. If they burn these clients, they won’t be able to do more business with them.
6. How do we know that value traders are the ultimate suppliers of liquidity? Value traders trade when price departs from value, which usually happens when uninformed traders are moving prices away from values. They thus supply liquidity in response to the demands from these uninformed traders.
FBE-440: Exam Things
2
7. Arbitrageurs and dealers both match buyers to sellers. How do their methods differ? Arbitrageurs use their hedge portfolios to match buyers to sellers at the same time but in different places. Dealers use their inventories to match buyers to sellers in the same market buy who arrive at different times.
8. How do exchanges simplify bilateral searches? They reduce the costs of searching by creating systems that allow buyers and sellers to quickly find the best trading opportunities.
9. What distinguishing characteristics of fundamental volatility and transitory volatility allow us to discriminate between them?
Price changes due to fundamental volatility are unpredictable whereas those due to transitory volatility tend to reverse (are mean-reverting).
10. Suppose that transaction costs for a trader are evaluated relative to an opening price benchmark. The trader fills orders for a portfolio manager who trades on momentum. Will the trader’s estimated transaction costs be unbiased?
The estimated transaction costs will be upward biased because momentum managers buy when prices are rising and sell when prices are following so that the trader will tend to buy when price is above the open and sell when price is below the open.
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 TTH Midterm 2 Answers
Short Answers (10 points each)
1. How do the strategies used to front-run a market order and a standing limit order differ? (Assume the orders are buy orders.)
To front run the market order, you buy first and then sell when the price impact of the market order moves prices up. To front run a standing limit order, you buy first. You then sell to the standing limit order if you believe that prices will fall.
2. Why do bluffers fear value traders? Value traders can stop a bluff by supplying all the liquidity that the bluffer is demanding when the bluffer is trying to move prices.
3. Suppose that an uninformed trader trades only with dealers who only know about market values but nothing about fundamental values. Do the uninformed trader’s trading profits depend on the number of informed traders in the market? Why or why not?
The uninformed trader’s profits are reduced by adverse selection spreads that the dealers must charge to recover from them what the dealers lose to the well informed traders.
4. If the value of all traders’ time increased, what would you expect would happen to bid/ask spreads? Why?
Bid/ask spreads would widen to compensate traders who offer liquidity for the additional value of their time committed to do so.
5. Why do large liquidity suppliers want to know whether the traders who seek to trade with them will want to trade more of the same security in the future?
They do not want to offer liquidity to price discriminators.
6. You plan to bid in an auction for an item for which the value is uncertain. You set your bid assuming that there will only be ten bidders. Before submitting your bid, you learn that 100 people will bid on the item. Should you change your bid? Why?
You should lower your bid because if you win the auction, you will learn that your estimate was higher than 100 people rather than just 10—you probably over estimated value.
FBE-440: Exam Things
2
7. Do arbitrageurs and dealers compete with each other for trading profits? Why or why not?
Arbitrageurs and dealers compete to match buyers to sellers. If either were not in the market, the other would be more profitable.
8. What is liquidity? 1. The ability to trade quickly when you want at low cost. 2. The successful outcome of a bilateral search in which buyers look for sellers and vice versa.
9. How is transitory volatility related to transaction costs? The price impacts of trades are both transaction costs and contributors to transitory volatility.
10. Suppose that transaction costs for a trader are evaluated relative to a closing price benchmark. The trader fills orders for a portfolio manager who tends to be well informed. Will the trader’s estimated transaction costs be unbiased?
The estimated transaction costs will tend to underestimate the actual transaction costs because the trader will tend to buy at a price below the close because his manager is well informed.
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2007
FBE 440 MW Midterm 2 Answers
Very Short Answers (five points each)
1. Which type of informed trader typically profits when prices change but values do not change? Value-motivated trader
2. When deliberately moving prices, bluffers hope that other traders will identify them as what kind of trader? Informed trader
3. When selling has more price impact than buying, should a bluffer buy first or sell first? Sell first.
4. Name an important way that dealers attract order flow. Quote aggressive prices Quote substantial sizes Purchase order flow Advertise
5. Dealer Jack quotes a market of 20 bid, 21 offered. Dealer Jill quotes 20.5 bid, 21 offered. Dealer Julia quotes 20 bid, 20.75 offered. What is the inside market quote? 20.5 bid, offered at 20.75
6. Name the two most important risks that concern traders who offer liquidity to large traders. Risk of trading with an informed trader (Adverse selection risk) Risk that the large trader will trade more size
7. Name an important risk that an arbitrager faces when he engages in a pure arbitrage. Poor implementation (poor trading) Model risk (winner’s curse)- Failure to properly understand the relative value relation.
8. Is the outside spread generally wider or narrower than a typical dealer’s spread? Wider
FBE-440: Exam Things
2
Very Short Essays (20 points each)
9. In what sense can we identify arbitrageurs as producers and recyclers of financial instruments? Many arbitrages involve trading of nearly identical risks that appear in different forms. When an arbitrageur buys one instrument and sells the others, he or she in effect transforms the risk from one from to another. The process can be viewed as producing or recycling financial instruments. For example, when an arbitrageur buys the 500 S&P 500 stocks and sells the S&P 500 futures contract, the arbitrageur effectively creates the futures contract. The arbitrageur would do this when the futures contract gets expensive relative to the cash index, which typically will happen when demand for the futures form of the S&P 500 equity risk rises relative to demand for the cash form of the risk.
10. What causes the winner’s curse and how do traders avoid it when bidding for an item? The winner’s curse arises because traders cannot perfectly value the instruments that they trade. When they overvalue them, they tend to bid too high and win the auctions at prices above values. Traders avoid the winner’s curse by considering what they learn when they are the highest bidder. In particular, if they are the highest bidder, they likely overvalued the item. They avoid the winner’s curse by lowering their bids to reflect the fact that, if they win, they will learn that everyone else likely had a lower valuation. The amount that they lower their bid increases with the number of other bidders and with the uncertainty in their estimates of value.
11. Describe how a sentiment-oriented technical trader might identify profitable trading strategies. A sentiment-oriented technical trader tries to anticipate the trades that uninformed traders will do. He or she would do this by considering why uninformed traders trade. If the reasons can be predicted, the technical trader can front-run the uninformed traders. For example, suppose that uninformed traders tend to buy whatever stocks are featured on CNBC. A sentiment-oriented technical trader would watch CNBC and immediately buy on the first indication that a stock will be featured on the show.
FBE-440: Exam Things
Professor Larry Harris Trading and Exchanges USC Spring 2007
FBE 440 TTH Midterm 2 Answers
Short Answers (10 points each)
1. When buying has more price impact per contract than selling, should a bluffer buy first or sell first? Buy first.
2. To which type of trader do bluffers most commonly lose? Value-motivated traders
3. Name an important way that dealers attract order flow. Quote aggressive prices Quote substantial size Purchase order flow Advertise
4. What do you expect would happen to bid/ask spreads if gamblers traded more often in the instruments in which dealers make markets? Spread would narrow because gamblers are uninformed traders.
5. How does large trade size affect the adverse selection spread component? It increases it because people fear that large traders are well informed.
6. Name the two most important risks that concern traders who offer liquidity to large traders. Risk of trading with an informed trader (Adverse selection risk) Risk that the large trader will trade more size
7. What trader type can ultimately supply the most liquidity to a market? Value-motivated traders
8. In a pure order-driven market, how would an increase in the value of all traders’ time affect bid/ask spreads? Bid/ask spreads would increase.
FBE-440: Exam Things
2
Very Short Essays (20 points each)
9. Why do we expect a liquid market to have more informative prices? The liquidity would make informed trading more profitable since the informed traders would have less impact on price when trading. They then would acquire more costly information and put it into the price.
10. A slow trader has issued a large standing buy limit order at the market. How could a clever fast trader profit from this situation? Place a buy order at a slightly better price and hope that it executes. If values subsequently rise, the clever trader profits without bound. If values fall, the clever trader will sell to the large buyer for a small loss. This strategy is profitable if the slow trader is not likely to cancel his order after the clever trader’s order is filled. This strategy effectively extracts the option value of the put that the buyer granted to the market.
11. How do arbitrageurs and dealers compete with each other? Dealers use their inventories to move liquidity through time by connecting a buyer who arrives at one point in time with a seller who arrives at a different point in time, both in the same market. Arbitrageurs use their hedge portfolios to move liquidity from one market to another by connecting a buyer who arrives at one market to a seller who arrives at a different market, both at the same time. Since dealers and arbitrageurs both can satisfy demands for liquidity, they are competitors.
FBE-440: Exam Things
Fall 2007 Professor Baizhu Chen 740-7558 HOH701C email: [email protected] http://www-rcf.usc.edu/~baizhu/ Office Hours: M 4:00 – 6:00pm
TTH 2:00 – 3:00pm or by appointment The post-war period has been a remarkable era of growth in trade. As a result economies in general have become more open. Countries are more interconnected through international trade. Firms are now more and more facing competitions from other countries. Many aspects of trade relations are now headline news - for example the bilateral trade conflict between U.S. and Japan; alleged unfair trading practices of Japan, Korea, Taiwan, and now increasingly China and others; the Super 301 provisions; restrictions on U.S. multinationals; newly negotiated voluntary restraint agreements; liberalization in Eastern Europe and other formal socialist countries; Human rights and trade; the Uruguay Round of GATT negations; NAFTA,WTO and so on. U.S. policy on these and other issues is of crucial importance to global prosperity in the 1990s. Firms' competitive strategies are increasingly influenced by the trade policies of U.S. and other countries. A firm without a global view will not be competitive in a global economy in which competitions come not only from domestic competitors but also from competitors located in different countries. COURSE OBJECTIVES: This course surveys the major topics in the theory of international trade. Like all branches of economics, this course is concerned with decision making with respect to the use of scarce resources to meet desired economic objectives. It is consequently concerned with how international transactions influence such things as social welfare, income distribution, employment, growth, and the possible ways public policy can affect the outcomes. We will focus on such questions as: (1). What determines the basis for trade? (2). What are the effects of trade? (3). What determines the value and the volume of trade? (4). What factors impede trade flows? (5). What is the impact of public policy that attempts to alter the pattern of trade? We will cover most basic trade theories and their policy implications. In this course, we will analyze various trade and industrial policies, for instance, tariff, quota, VER, anti-dumping, customs union. We will also discuss the U.S. trade law, institutional framework of WTO/GATT, the Uruguay Round negotiations, the Multi-Fiber Agreement, and NAFTA. This course is concerned mainly with the non-monetary aspect of international economics. The monetary and balance of payments issues are only marginally discussed. COURSE REQUIREMENTS:
International Trade and Commercial Trade
(FBE 462) Department of Finance
Marshall School of Business University of Southern California
Keith Parker, University of Southern California
FBE-462: Syllabus
Thomas A. Pugel, International Economics, 12th edition, Irwin McGraw-Hill, 2004 Reading Packet Wall Street Journal is required Lecture notes will be posted in the BLACKBOARD system under the course number for downloading. You should be able to access the BLACKBOARD by typing your userid and password of your UNIX account. For more information of the BLACKBOARD, please contact the Keck Center. COURSE EVALUATION: Requirements for the course include one project (25%), three examinations (45%), three homework assignments (each 5%) and class participation (15%). Class participation may alter your grade by as much as one level. The final grade is based on a “curve.” I adhere roughly to the school guidelines: An average grade of 3.30 out of 4.00 for undergraduate elective courses. This translates loosely into something like 30-35% A, 45-50% B, 15-20% C, and 0-10% D&E. I do not assign letter grades to individual exams and homework assignments. However, I will give you complete distributions for each grade and you can apply the scale indicated above. Project 25% Examinations 45% Homework 15% Class Participation 15% Examinations will consist of multiple choice questions, numerical problems, and in some cases short essays. All exams are closed-book, closed-notes. Each exam will cover the required readings from the text and all the material covered in class. Students should turn in their homework assignments before the due dates. Generally the homework assignment should be turned in at the beginning of the lecture on the due date. Should he or she for any reasons turn in the homework assignment after the due dates, his or her scores will be discounted 10% for every hour the homework is overdue up to a maximum of 50% discount. Violations of academic integrity standards will be treated seriously. "The use of unauthorized materials, communication with fellow students during an examination, attempting to benefit from the work of another student, and similar behavior that defeats the intent of an examination or other class work is unacceptable to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior resulting from the nervous tensions that accompany examinations. Where a clear violation has occurred, however, the instructor may disqualify the student's work as unacceptable and assign a failing mark on the paper." Make-up Exams: Current department policy to which I adhere is “No makeup midterm and final exams will be allowed.” If you have an extenuating circumstance that prevents you from taking the exams, discuss your reasons with me BEFORE the time of the exam. Current department policy is that a student may not be given a make-up exam unless he or she has obtained written permission from the course instructor in advance. In addition, you must be able to document your extenuating circumstance. Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained from DSP. Please be sure the letter is delivered to me (or my TA) as
Keith Parker, University of Southern California
FBE-462: Syllabus
early in the semester as possible. DSP is located in STU 301 and is open 8:30 a.m. - 5:00 p.m. Monday through Friday. The phone number for DSP is (213) 740-0776 Team Project: We will arrange a field trip to Maquiladoras of Mexico. The trip date is tentatively scheduled on March 1-4, 2005. We will leave in the evening of March 1, Thursday, and return on March 4, Sunday. We will visit several Maquiladoras in Tijuana and other places in Mexico. Students are asked to conduct preliminary research on these Maquiladoras before the trip. After the field trip, students are required to complete a team research paper, which is to be presented at the end of the semester. Disclaimer This syllabus is an invitation to you to engage in an exciting and interactive study international trade. It is my goal to provide a collaborative and supportive learning environment where students will learn from one another both inside and outside of the classroom. To that end, modifications to this syllabus may be warranted as I assess the learning needs of this particular class. This is a contract for this course between you and me. If you want a grade from this class, implicitly you have to follow this contract. COURSE OUTLINE: 1/9 Introduction 1/11 Global Trade Overview International Economics (TP), ch. 1, p1-11, p33 1/16 Is Trade A Zero-Sum Game? International Economics (TP), ch. 2, p15-28 1/16- Why Nations Trade (I)? International Economics (TP), ch. 3, p31-43 /18
“The Halo Effect”, The Economist, Sept. 30, 2004 “Trade Disputes,” The Economist, Sept. 16, 2004 Case Discussion: Free Trade vs. Protectionism: the Great Corn Laws Debate, HBR Case 9-701-080, Feb. 20, 2001
1/23 Why Nations Trade (II)? International Economics (TP), ch.3, p48-57, ch.4, p68-72 1/25 “A forbidden fruit in Europe: Latin bananas face hurdles”,
The New York Times, April 5, 1993 “Working Man’s Dread”, The Economist, October 1, 1994. “The Sucking Sound from the East”, the Economist, July 26, 2003
1/25 Why Nations Trade (III) ? International Economics (TP), 5 1/30 2/1 Growth and Trade International Economics (TP), ch.5 “Korea is overthrown as sneaker champ”,
Keith Parker, University of Southern California
FBE-462: Syllabus
the Wall Street Journal, October 7, 1993 2/6 Examination 1 2/8 Tariff International Economics (TP), ch. 7 2/13 Tariff Case Discussion: Can Florida Orange Growers Survive
Globalization?, HBR Case 9-904-415, March 8, 2004 2/15 Non-tariff Barriers International Economics (TP), ch. 8 “U.S. import rights: going once, going twice...”
Business Week, March 9, 1997 “China Trade Policy’s Ripple Effect,” the Washington Post, November 11, 2003
2/20- Protect or Not To Protect International Economics (TP), ch. 9 2/22 “Argument against free trade when market fails,” Notes (to be
provided in class) “How Countries Go High-tech,” the Economist, November 8, 2001 Case Discussion: Brazil on Wheel, HBR Case 9-804-080, May 25, 2004
2/27- Pushing Exports International Economics (TP), ch. 10
“How to beggar your neighbor” the Economist, February 3, 1996
3/1 No Class (Preparation for Mexico trip) 3/1-4 Trip to Mexico 3/6 Pushing Exports International Economics (TP), ch. 10
“How to beggar your neighbor” the Economist, February 3, 1996
3/8 Examination 2 3/12- No Classes (Spring Break) 3/16
Keith Parker, University of Southern California
FBE-462: Syllabus
3/20- Trade Blocs and Trade Blocks International Economics (TP), ch. 11 3/22
“Regionalism and trade, the right direction?” the Economist, September 16, 1995 “Building blocks or stumbling blocks”, the Economist, October 31, 1992 “Everybody’s Doing It,” the Economist, February 26, 2004
3/27- GATT/WTO, US Trade Laws Case Discussion: 3/29
Creating the International Trade Organization, HBS, Case, 9-798-057, Feb. 1998
David Moss and Nick Barlett, The World Trade
Organization, Sept. 2002, HBR Case, 9-703-015 4/3- Trade and Environment International Economics (TP), ch. 12 4/5 “Trading Hot Air”, the Economist, October 17, 2002 “Tax or Trade”, the Economist, February 14, 2002
Case Discussion: the Sweat Serpent of the South-East Asia, the Economist, Dec. 30, 2003
4/10 Trade in Factors International Economics (TP), ch. 14 4/12 Review/Catch up 4/17 No Class (Preparation for Project) 4/19 Project Due Project Presentation 4/24 Project Presentation 4/26 Examination 3
Keith Parker, University of Southern California
FBE-462: Syllabus
Spring 2007 Professor Baizhu Chen 740-7558 HOH701C II. Please answer each question in the space provided. Do not feel compelled to fill the entire space.
Complete but concise answers are appreciated. 1. (8 points) The following table shows the labor costs of producing cloth and wheat in England and Poland
Poland England Wheat 4 1 Cloth 2 1.5
Both countries use only labor to produce each product. Labor can move between the two industries. Each country is endowed with 100 units of labor.
a. Which country is more productive in producing wheat? What is its labor productivity in wheat? Which country is more productive in producing cloth? What is its labor productivity in cloth?
Answer: England more productive in both wheat (productivity: 1) and cloth (productivity: 2/3)
b. Write out the full employment condition for each nation. Draw it in the following diagram. What is the autarky relative price of cloth in Poland?
Midterm Examination International Trade and Commercial Policies
(FBE 462)
50 C
W W
Poland England
25
C
100
66.7
Keith Parker, University of Southern California
FBE-462: Course Documents
4W+2C=100 W+1.5C=100
c. Which country has a higher wage? Why? 1*WE = Pw 2*WP=Pc Pw = Pc => WE =2*WP
Keith Parker, University of Southern California
FBE-462: Course Documents
2. (5 points) The following table shows the factor endowments of several countries. 3. (4 points) In article "Working Man's Dread" published in The Economist, October 1, 1994, in the
reading packet, it says:
- Trade => price of skilled labor intensive goods goes up and price of unskilled labor intensive goods
goes down => unskilled labor wage goes down while skilled labor wage goes up => gap increases
- technological change => demand for skilled labor increases while demand for unskilled labor decrease
4. (11 points) In the great Corn-Laws debate, many arguments have been made to support or against the repeal of Corn Laws in Britain in the mid-19 century. These arguments are listed in the following table. In the column “Effect”, enter R if you believe that the argument is for repealing the Corn Laws. Enter N if the argument is not for repealing.
5. (4 points) BANANA question (a). Answer: these factors are possibly the reasons – weather, cheaper land and cheaper labor (b). Answer: benefiting American consumers
Keith Parker, University of Southern California
FBE-462: Course Documents
International Trade and Commercial Policies, FBE 462
Group Project
This group project is to be completed by a group of no more than 5 students. It is due on April 19, 2007. The project needs to be typed with double space. Total pages should not exceed 20, including tables, reference, footnotes, executive summary and title page. You will present your findings at the end of this term. Any report exceeding the page upper limit will be penalized. There is no minimum page requirement. Each group will choose one of the companies visited as your target company. One company can be selected by multiple groups. Discussions between different groups are not allowed. Your project write-up should contain an executive summary, a body of analysis, and a conclusion. You should also include references and footnotes, if necessary. You should collect as much data/evidence as possible to support your statements in your project. Ideally, you should utilize as much as possible in your report the knowledge, terms, models/frameworks, and techniques that you have learnt in this class. You should use your target company as a sample to study the industry. You should address the broad question if the industry in Mexico has a comparative advantage. The overall aim of your report is to develop a detailed industry report, focusing on the strategic challenges and opportunities in your industry in Mexico today and in the next five or so years. It should emphasize analyses instead of description. Descriptive information should be discussed to set the stage and context for the situation facing your industry but the analyses of the situation should receive much greater emphasis. Your team should think critically about the industry and should develop your own perspective on the situation facing the industry now and in the future.
The intended audience should be managers in the industry who are interested in Mexico, both local and foreign managers. Thus, it should read like a report prepared for an industry association or set of players in the industry. Any company in the industry, foreign or local, should be interested in the report as it should discuss the basic structural information of this industry.
In analyzing your industry, think back to frameworks, concepts, tools, theories, models, and other material learned in this class, as well as in other classes of your undergraduate curriculum. Use appropriate frameworks, concepts, tools, theories, and models you learned earlier in the undergraduate program for analyzing and drawing conclusions about your industry. A well developed industry analysis is interdisciplinary in nature, drawing upon strategic, marketing, operational, financial, economic, and management perspectives. Therefore, you should apply and integrate appropriate material from earlier courses in preparing your industry report. Issues to Address
1) Conclusions and recommendations about opportunities for foreign companies to compete in the industry in Mexico over the next five years
2) Conclusions and recommendations about opportunities for local Mexican companies to compete domestically and globally over the next five years
Keith Parker, University of Southern California
FBE-462: Course Documents
In analyzing your industry, the following are some possible areas you may wish to consider. However, the following list is NOT meant to be a template of areas that you must cover for the report. You should think about what kinds of analyses are appropriate to analyzing the situation facing your industry in your target country and include those relevant analyses in your report. You should define the areas of analyses that are relevant to your report.
1) Evolution of the industry over time – forecasts of growth, future trends, upcoming opportunities and challenges, etc.
2) Competitive analysis of local players in the industry in Mexico – strengths and weaknesses of domestic participants in the industry, the strategies pursued by various players, the relative levels of success and profitability of various players, the likelihood of new domestic entrants into the industry over the next five years, etc.
3) Competitive analysis of foreign players in the industry in Mexico – strengths and weaknesses of foreign participants in the industry, the strategies they are pursuing, the relative levels of success and profitability of these players, the likelihood of new foreign entrants into the industry over the next five years, the relative comparative advantages of foreign vs. local players in this industry, etc.
4) Strategic marketing analysis – assessment of the dynamics of customers, viable target segments, market potential in the target country, marketing opportunities and challenges, etc.
5) Cost structures of the industry – what are the major components of the cost? Is it mainly the labor cost, or capital cost? How does regulations affect the cost structure?
6) Strategic operational analysis – assessment of the challenges, opportunities, and critical success factors for carrying out effective operations in the country, advantages and disadvantages of local production, etc.
7) Environmental analysis of Mexico – assessment of the impact of the economic, political, cultural, and technological environment of Mexico on the industry, the implications of these environment factors for being successful in the industry, etc.
8) Policy analysis – assess the impact of various government policies on your industry. You may want to address how NAFTA or China’s entry of WTO influences the competitive structure of this industry.
9) Ethical issues confronting companies in your industry in Mexico – assessment of the ethical challenges faced by managers in your industry doing business in Mexico, the implications of these ethical challenges for competition and for being successful in the industry, etc.
10) Comparison of the characteristics and strategic challenges of the industry in Mexico with that of the industry in other countries, particularly the U.S. or China – assessment of the similarities and differences in your industry Mexico and other countries in areas such as competitive environment, customer environment, opportunities and challenges, key success factors, etc.
11) Strategic importance of the country in regard to global competition in the industry – importance of the country in the global context of the industry in terms of market opportunities, access to factors of production, access to new innovations, competitive positioning, as a base for exporting to other countries, etc.
12) Conclusions and recommendations about opportunities for foreign companies to compete in the industry in Mexico – motivations for foreign companies to participate in the industry in Mexico, likelihood of new foreign entry into the industry, etc.
13) Conclusions and recommendations about opportunities for local companies domestically and globally
Keith Parker, University of Southern California
FBE-462: Course Documents
Keith Parker, University of Southern California
FBE-462: Handouts
Keith Parker, University of Southern California
FBE-462: Handouts
Keith Parker, University of Southern California
FBE-462: Handouts
Keith Parker, University of Southern California
FBE-462: Handouts
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
Keith Parker, University of Southern California
FBE-462: Homework
FBE-462 1/11/07 10:12 AM
Globalization and global trade overview • People same • Communicate (transaction cost goes down) • Trade freer
o Goods and services o Capitals and labors
• Interdependence o Factors of production
• Technology • Conflict • Trade is more regional
o 49% of Asian exports go to Asia, if you add 20% to that (the amount that goes to North America), you see that over 70% of Asian trade is within Asia
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 1/16/07 10:01 AM
Basic mercantilist idea assumes that the more precious metals a country has, the wealthier it is
• This promotes exports, and dissuades from high imports • Agriculture was always the heavily protected industry protected
back then, during this period Is trade a zero-sum game?
• Barriers still exist in trade among countries • As long as there are barriers, there is arbitrage • Globalization process creates winners and losers, more social
stratification, some countries are becoming worse off than they were before
Wealth of a nation should be measured by the amount of goods and services that can be produced, not by the amount of gold
• This is less convenient than gold, but better • Today, we see gold as just another good, like anything else • Many people still think that export is better than import, without
any preconditions • Section 301 is a trade law that says that any foreign country that
has an excessive trade imbalance with the US, the US will enter into trade negotiations with that state to attempt to eliminate this imbalance
o This was targeted at Japan when it was first introduced • Consumer surplus • Utility curve for consumers, indifference curve, the shit learned last
semester in Econ for business – the more of a good one has, the less it is worth to them
• Marginal willingness to pay for a good or service • Consumer surplus is $2 if the consumer is willing to pay $8 for a
service, but only has to pay $6 • Selling Apples, market price is $10 but you are willing to sell them
for $8, producer surplus is thus $2 Autarky to open economy
• Supply equals demand
Keith Parker, University of Southern California
FBE-462: Class Notes
• What is the total wealth of this country? • Total welfare of a nation is consumer surplus plus producer surplus
(CS+PS=Total Welfare) • North Korea is a close example of this, China before 1978 • In the slide, the difference (e) is exports, when price is above the
market equilibrium of demand and supply • CS=c, PS=d • Total welfare in this case is c=d=e, so by engaging in trade, a small
country will benefit (the total welfare of that country is higher with trade)
• Consider two countries, one is the home country the other is foreign o One is importing the other is exporting o World market price is determined by the equilibrium of the
export supply and the import demand o The smaller the country is, the more relative gains you will
receive from trade from other countries o We see this, small countries have applied more free trade
policies because of the benefits that come to these countries from this free trade
o NAFTA set up an emergency fund to compensate those countries that will be negatively affected by the opening of trade
o In exporting country, consumers will suffer and producers will gain, while this is vise-versa in importing country
General Equilibrium Approach
• Production possibility frontier • There is a line tangent to the production frontier that shows world
relative price, this line meets consumer utility curve • Relative price of cloth, versus relative cost of wheat • Suppose in a world market, cloth is more expensive than wheat • The world market price line (in the slide) will be steeper • Price of exports divided by Price of imports = relative price of
exports or TOT (terms of trade) • When terms of trade increases, line gets steeper and country can
get more of relative product for each product being exported
Keith Parker, University of Southern California
FBE-462: Class Notes
• China, long history of China • Chinese have small bananas, while the US has very big bananas
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 1/18/07 10:06 AM
Why nations trade? Going over handout given in class “The halo Effect” article from the economist Benefits
• Change in relative prices will be good for developed countries Downsides
• Hurts developing countries who are competing with China in industries attractive to developing nations
For a developed country, TOT (terms of trade) will improve because of this effect in China, with 200 million unskilled workers “One man’s junk is another man’s treasure” article for today
• Scrap metals, papers • Trash is the number one export from the US to China • This is based on relative prices, exports of scrap metals, papers, et
cetera are cheaper as raw materials in China than getting these products in others ways from within China
Another example of how demand affects imports and exports
• Chicken breast exported to the US from China, more demand for it here than there
• Chicken slaughtering in China Case Analysis
• Corn law- protecting agriculture industry within the UK (not just corn, many other agricultural products as well)
• Case is about Britain thinking about appealing the corn law and opening free trade of agriculture
• Pros of this proposition o Price of agricultural goods in the UK will go down
Keith Parker, University of Southern California
FBE-462: Class Notes
o Trade relations with countries supplying these goods might be improved
o Better usage of land within the UK, instead of subsidized agriculture
o Shifting resources to other industries, reduce strain on government funds to subsidize farmers
o Solve certain food shortage problems o More varieties of goods available in the country
• Cons o Farmers’ wages will decrease o Increase dependence on other countries for agricultural
products o Other countries may not reciprocate o Will the economy be able to absorb the shock? o Losing political support from farmers o Loss of revenue and fairness
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 1/23/07 10:01 AM
Why Nations Trade? • What determines supply and what determines demand? • Substitutes, et cetera • Article brings up concerns of Southeast Asian countries of whether
or not they will have a competitive advantage over China in industries that might benefit these nations
• Ricardo’s Theory of Competitive Advantage Both productivity and wage are very important
• Outsourcing • Starting to outsource white-collar jobs has caused dispute
Ricardo model
• Requires a high degree of specialization • Competitive advantage
o If a country has a lower opportunity cost of producing good A, the country has a comparative advantage in that trade
• The line in the graph is usually not straight in the real world, it is curved
• Japan is smaller than the US in all respects
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 1/30/07 10:01 AM
Dogswell presentation Why nations trade Resource-based trade Labor-based trade Chile trade article
• Farming products, most notably fruits, made in Chile (their summer is our winter)
• Chilean wines are now becoming more competitive in other countries
• In their winter, we sell them fruits Brazilian article
• Covering the agriculture sector in Brazil o Oranges are very competitive, especially orange juice o Sugar, Coffee, Soy beans
Growth rate of soy bean exports in Brazil is very high • Why do they have a competitive advantage in growing?
o Good growing conditions, tropical weather o Vast amounts of land, it’s a land-abundant country
• Prices of these commodities have gone up (such as orange juice prices)
Who wins and who loses?
• Everybody doesn’t always win, creates larger income gaps • For simplicity, assume that production technologies are constant
Article “Working Man’s Dread”
• What happened to the real wage in America since 1973? o It has gone up at a slower rate than other wages
• Wage is price for labor • Demand is determined by labor productivity • Labor for tech jobs has increased, as demand for technology
increases
Keith Parker, University of Southern California
FBE-462: Class Notes
Article “The Sucking Sound From The East”
• Mexico • Low-skilled manufacturing demand has gone down in Mexico • They are less competitive, can’t compete with labor costs in China • Also, Mexico has high energy costs • Energy sector in Mexico is a monopoly, and has reduced the
competitiveness of their low-skilled work force • This work force isn’t as productive as China’s work force • Unions of labor forces in Mexico makes them less competitive
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 2/1/07 10:15 AM
Exam on Tuesday will be similar to class discussions and homework • There will be a couple of questions on the articles read for the class,
but these questions will be preceded by an excerpt from the article • Structure of exam will be similar to homework, but a bit longer and
with questions from cases and articles Who is most likely to benefit from free trade and who is most likely to be hurt from free trade?
Labor C W Price of cloth relative to wheat will go up
Land • Exporting cloth
o Labor will be better off and land owner will be worse off (as cloth is labor intensive, and price relative to wine will increase as the country exports cloth)
• US is capital abundant, US will export capital o Capital owners will likely vote for free trade, and will benefit
from it, labor will be worse off from free trade as labor prices relative to capital will go down
• Will the two groups always vote against each other on the issue of free trade?
o It depends on which industry one is in, those in industries who don’t have a competitive advantage will be protectionist, those in industries with an advantage will be pre-free trade
o Boeing all voted for a most-favored nation status for China Section 5: Economies of Scale and Trade
• Intra-Industry trade o US imports and exports cars o US sells soybeans, buys shoes from China
Economies of scale
• External economies of scale (EES) o Prices go down when the entire industry gets bigger
Keith Parker, University of Southern California
FBE-462: Class Notes
• Internal economies of scale (IES) o Prices go down as the size of operations within the firm
increases • C = F + a*X • AC = (C/X) = (F/X) + A • The more a firm produces, the less the fixed costs per unit are Perfect Competition Monopoly Monopolistic Competition Oligopoly • Companies often merge if the fixed costs factor is high enough, this
way Internal Economies of Scale come into effect o Examples here are car manufacturers and banks
• Monopolistic competition: Each firm is a monopoly in its own product, but competes with similar products
Scale economies and product differentiation
• Two countries that are exactly the same o Instead on each country making some expensive cars and
some cheap cars, these nations will benefit from economies of scale if one nation produces cheap cars only and the other country produces expensive cars only
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 2/13/07 10:19 AM
Dutch disease • Currency appreciation • Direct result of the resource-based trade model • Immiserizing growth: Even though there is a harvest of coffee,
because of price drops some coffee producers are worse off than if they had not increased production
o In a small country, growth is always good o Balanced growth for a large country is usually good o Growth biased towards export sector of a large country, may
be worse off- prices of export drop, country gets less of import product for each unit of export product
• Economic growth can also affect the TOT • When export growth occurs in a large country, world price may
decrease and effect TOT so much that the country is worse off (with a small country, world price may not be affected as much)
• ISI strategies (He calls is Import Substitution Strategy) Product cycle theory
• Dynamics of comparative advantage • Comparative advantage changes over time because of economic
growth o South Korea and the shoe-making market
• Countries will gain competitive advantage, and other will lose it, its all part of a cycle
• Difficult to figure out when a country will lose its competitive advantage, took about 20 years for South Korea to lose its competitive advantage in sneakers
Tariffs – Section 7
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 2/15/07 10:03 AM
Tariffs – Basics • NAFTA- trade should be duty free by 2015 • Preferential duties • GSP (Generalized System of Preferences) • Weighted average of tariff rates- weighted average based on dollar
amount of trade of each product/service Welfare of import duty
• Small nation: its TOT is given • Tariff has no effect on its TOT • Gain or loss? • For large countries, when tariff is imposed the world market price
drops and P-star (P*) declines, making the Tariff more than it would be for a small country
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 3/20/07 10:17 AM
Dumping and Anti-dumping • The product is sold in another country at lower than the fair market
value o How does one determine the fair market value? o Compare to other similar products or prices of same or similar
products in other countries o If you can’t do this, base it on the cost of production
• The case of China and shrimp dumping o There is a 112% import duty on shrimp from China o Even though price is lower in China, this can’t be used for
comparison in determining fair market price because Chinese are commies
o The US just makes excuses why it can’t use local price for comparing shrimp prices in the US (i.e., in Thailand they eat fresh shrimp so its OK that the price for shrimp there is lower than the price for Thai shrimp in the US)
• Conditions for dumping to occur o Imperfect markets o Segmented markets
• Types of dumping o Predatory dumping
Very difficult to do this, because after you raise prices back up, more competitors will enter
o Cyclical dumping Dumping Christmas trees at low prices after Christmas
is over o Persistent dumping
Export subsidy and countervailing duties
• China is the largest cotton producer, with US coming in second and India coming in third
• US cotton subsidy is $2 billion • Divide that out, you get $120,000 to produce cotton in the United
States
Keith Parker, University of Southern California
FBE-462: Class Notes
FBE-462 3/22/07 10:07 AM
Export subsidies • Consumers lose welfare • Producers gain welfare • Government must pay for subsidy • Results in a deadweight loss • Country will always lose if implementing a export subsidy, whether
the country is large or small • European agricultural industry
o Agriculture goods are more expensive in Europe o Land for farming is limited in Europe, makes it hard for them
to compete in the world market o World price is $10 for farm goods, EU set a price floor at $15,
at one point 75% of the EU budget was for buying Europe’s excess supply
o EU implemented an export subsidy of $5, so farmers had incentive to export their excess production to foreign countries (this way they wouldn’t have to spend so much buying and storing excess production)
o Many reasons for the original protection of the agriculture industry
Keith Parker, University of Southern California
FBE-462: Class Notes
Mexican Wine Industry Analysis
Prepared by: Eric Chen
Cyrus Chini Alex Daly
Shelley Goto Keith Parker
FBE 462 – International Trade and Commercial Policy
April 19, 2007
Keith Parker, University of Southern California
FBE-462: Group Project
Page 2 of 17
Executive Summary
This report on the Mexican wine industry is intended to serve as a resource for both domestic wineries and foreign wine companies considering Mexico as a potential investment opportunity. As a truly global industry, we had to center our analysis of Mexico’s wine industry within the context of this international market. What we found on a global level is a $90 billion industry undergoing a serious transition, with New World producers reinventing the way that wine is produced, distributed, and marketed, and challenging the traditional vintners of Europe worldwide. Scale economies and cost efficiency, consistent quality, and aggressive branding campaigns have replaced esteemed terroir as the success factors for wineries. Tariff barriers and regulations are falling, allowing almost any wine-producer to compete worldwide.
Turning to Mexico, we will examine the $230 million wine industry in terms of its factor endowment advantages and infrastructural and customer base shortcomings. There is very little foreign investment in the industry, and the largest domestic wineries have done little to break into export markets. An analysis of the environment facing Mexican wineries highlights the favorable political and economic policies in place but also the striking lack of experience with viticulture and interest in wine within the country.
Looking ahead to opportunities and challenges, wineries worldwide will continue to compete aggressively for the sole growth segments of premium and super-discount wines. Innovative branding and access to solid distribution channels will continue to be essential. In the end, we offer the following recommendations:
o Mexican wineries must place much more emphasis on these marketing concepts and strongly push the export of their premium and super-premium wines.
o Due to existing global oversupply and the many challenges impeding successful
operations in Mexico, we do not believe that any foreign wine companies should look to invest in the Mexican industry.
Keith Parker, University of Southern California
FBE-462: Group Project
Page 3 of 17
Mexican Wine Industry Analysis
A Global Overview
The global wine industry is currently undergoing a drastic transition. In the past 30 to 40 years,
this $90 billion industry has changed from a European agricultural product based on centuries of
tradition to a globally competitive, marketing-centric industry. New World producers in
Australia, the United States, and South America have turned the conventions of wine-making
upside down, utilizing huge plots of fertile land, implementing advanced agro-industrial
techniques, and aggressively pushing the exports of strongly branded wines.
Major Players
Though their hold over the market is declining, the largest wine exporters are still the traditional
countries of France, Italy and Spain, followed by the United States and Australia. However,
even though France and Italy produce far more wine than New World countries, the two largest
wine companies are from the U.S. and Australia. A 2003 merger between Constellation of the
U.S. and BRL hardy from Australia formed the world’s largest wine producer, just passing E&J
Gallo of California. These conglomerates have achieved economies of scale in both production
and distribution that far exceed any current competitors in Europe.
Consumption Patterns
Wine consumption is still concentrated in Europe, with France, Italy and Spain being the three
largest wine markets in the world, but per capita consumption is rapidly declining in these
traditional wine regions – from over 100 liters per capita in 1966 to under 60 liters today. At
the same time, wine consumption is steadily increasing in North America, Australia, and most
rapidly in totally new markets such as Asia and Africa. Across all markets, demand for higher
quality wine is actually still growing, leading to an emphasis on quality, not quantity. Trend-
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wise, red wines are on the upswing, and younger consumers especially look for new, more
exciting wines than the traditional Chardonnays of the 1980s. With their open acreage for
planting and more consistent production, New World wineries are much more capable of
adjusting to these changing trends than European competitors.
New World Innovations
Australian, American, and South American entrepreneurs have fully taken advantage of their
ability to carve a domestic industry out of nothing – to completely reinvent wine-making.
Utilizing resource factors such as abundant land, a warmer climate, and capital intensive
technology, New World producers are now challenging European wine makers in almost every
market and at every price segment. The use of irrigation, trellis growing systems, scientific
experimentation, stainless steel fermentation tanks has all but eliminated the annual quality
variations that affect the consistency of European wines. New marketing techniques such as half
gallon bottles, screw off tops, and boxed wines have also proven very attractive to consumers, in
addition to reducing shipping and storage costs.
The Rise of Australian Wines
“Australia is the driving force in the global wine industry.”1 This quote would have been
unheard of just 30 years, but since Australia is now the largest wine exporter to the United
Kingdom, it is probably fitting. Due to their relatively small domestic market, Australian
wineries had to combine their new production methods with an aggressive marketing campaign
to establish themselves on the international stage. Companies such as BRL Hardy and Southcorp
vastly improved the accessibility of wine by simplifying their denomination systems and
1 The Economist. “Blended.” http://economist.com 23 June 2003.
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FBE-462: Group Project
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establishing strong brand identities that could carry over from one varietal to the next. Their
methods have obviously worked, as Britain, long considered a key import market due to its lack
of domestic production, now sells more Australian wine than French wine. Showing how much
the industry has changed, a recent study shows that British consumers choose their wines based
on previous purchases, price, country and occasion, in that order – nothing to do with the region
or variety, which are two areas often focused on by traditional wine-makers. 2
South American Experiences
Of particular interest to the Mexican winemakers may be the successes of the wine industry in
Chile and Argentina. Argentina is the world’s fifth biggest wine producer, most of which is
consumed domestically, and Chile is one of the most competitive wine exporters. Argentina has
all the natural endowments necessary for wine production, and its exports have increased
dramatically during the past seven years of domestic stability – many of its signature varietals
are especially popular with American consumers.3 Chile, on the other hand, has followed
Australia’s model of strongly branding its wines and even promotes its exports through the use
of overseas wine trade groups. Chile has been further aided by its existing free trade agreements
with countries including the United States, Japan, and South Korea.
Cost Structure of the Industry
New World wine producers launched their immensely successful growth based on their
efficiency and ability to essentially mass produce what was once considered an artisan’s product.
While the quality of wine exported by countries such as Australia and Chile has greatly
2 Campbell, Gwyn and Nathalie Guibert. “Introduction.” The British Food Journal 108:4 233-39. 3 The Economist. “Vino’s Twin Peaks.” http://economist.com 15 Mar 2007.
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improved, a large part of their competitive advantage still stems from lower production costs, of
which there are four major components:
• Grape costs per case
• Crush and Capitol costs
• Barrel Costs (corks, labels, etc.)
• Dry goods costs per case
Grape Costs
Depending on the quality of wine produced, this cost sees the most variability. For Basic quality
wines, grape costs are usually around 8% the total cost of production. On the other end of the
spectrum, for Ultra-Premium quality wines, the cost of grapes range from around 65%-85% of
the total cost of production. Of greater importance, however, is the fact that the amount of
grapes needed for a 9L case of Ultra-Premium Australian wine can be produced for $45.45 as
opposed to $104.55 in France.
Crush and Capitol Costs
This category includes the cost of the machinery and labor used to produce the wine. These costs
are usually fixed and do not see much variability between the different qualities of wine nor
between the different wine-producing countries. Costs range from $13-20 for each 9L case
produced.
Barrel Costs
These costs are relatively 0% for lower quality wines and only reach up to about 2% of the total
cost of producing higher quality wines.
Keith Parker, University of Southern California
FBE-462: Group Project
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Dry Goods Costs
The costs remain less than 1% of the production per case regardless of the quality of the wine or
the country. But when all of the production costs are added together, New World wineries are
able to achieve significantly higher margins than European producers across every market
segment and most notably with their Super-Premium and Ultra-Premium wines. In these
segments, Australian winery margins of 17% and 50%, respectively, far outshine the 4% and
18% of their French counterparts. Further downstream profits are also available for companies
who have vertically integrated enough to own their own marketing and distribution channels.
Regulations
The historical status of wine production in Europe plays a major role in the cost structure of the
wine industry. Heavy fines may be imposed if guidelines are not properly met, and many
countries that produce wine, mostly in Europe, have restrictions placed on grape varieties in
particular regions. Other regulations may include the amount of sugar content in the wine, the
amount of time spent aging the wine, and the geographic origin of the oak used for barreling.
These sorts of limits hurt certain countries when there are shifts in demand. For example, if the
market demand shifts to a drier red wine, there may be restrictions holding back wineries in
certain German regions from producing what the market demands. With their non-traditional,
more market-based approach, New World producers are largely free from these constraints and
can quickly adapt to market preferences.
Tariffs
The tariffs applied to the imports of wine vary greatly from country to country. The United
States charged a tariff of $0.063 per liter of wine in 2002, which is one of the lowest in the
Keith Parker, University of Southern California
FBE-462: Group Project
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world.4 Other import tariffs range from $0.11 per liter in Europe, to 4% ad valorem in Mexico,
to 60% ad valorem in Hong Kong. A 2002 Mutual Acceptance Agreement (MAA) on
Oenological Practices signed by the U.S., Canada, Chile, Australia, and New Zealand sought to
promote the international wine trade and ease barriers.5
Strategic Market Analysis
Wineries have two main customers:
Wholesalers
Retailers such as grocery stores, liquor stores, etc. obtain the wine they sell from their
wholesalers or wine merchants, who have previously purchased cases from the wineries
themselves. Wine retailing has undergone a shift in recent years, as large, powerful grocery
chains or wholesale stores such as CostCo have exerted more influence on their distributors.
These chains are able to demand a large scale and scope from their distributors, meaning the
most successful wine producers will often be those who are able to provide their distributor (or
retailer if the winery owns their distribution) with enough variety to stock an entire grocery shelf.
And of course, the wine conglomerates of Australia, Chile and the United States are in a much
better position to do this than the independent vintners of Bordeaux.
End Consumers
Wine drinkers can also purchase their wine directly from the winery but this method is often
inconvenient, and largely relegated to small, local wineries that are unable to gain access to
broader distribution channels. End consumers are much more likely to purchase their wine at a
local retailer. To reach more consumers, producers strive to create a diverse product line to
4 Penn, Cyril. “Wine Gaining Ground in US Trade Outlook.” Wine Business Monthly 5 Penn.
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appeal to all palates. For example, German wineries do their best, with respect to regulations, to
respond to the market demand in sweeter wines by producing their own brand of dessert wine.
These shifts in ‘fashion’ are one of the biggest challenges wineries are faced with. Strict
regulations prohibit many Old World wineries from quickly meeting the new demands.
Competitive Analysis of Mexico’s Wine Industry
With this understanding of the global wine industry, we can now turn specifically to Mexico. In
2005 the Mexican wine industry generated revenues of $230.2 million, and growth is expected to
accelerate in the coming years, with the market reaching $313.6 million by 2010.6 The industry
centers around the city of Ensenada in Baja California, which accounts for 90% of the quality
wine produced in the country. Other major winegrowing regions include Guadalupe, Calafia,
San Vicente and Santo Tomas Valleys. Although Mexico is not a global leader in the wine
industry, one advantage it has over many other countries is its weather. Baja California lies
above the 30th parallel on the Pacific Coast and has the perfect climate of hot days and cool
nights needed for winegrowing, allowing grapes to develop their sugar without a corresponding
drop in acidity.
Challenges for the Industry
Even though Mexico has this ideal weather for producing high quality grapes, the Mexican wine
industry still faces many barriers, one of which is the relative shortage of wine drinkers.
Traditionally, wine is not the primary choice of alcoholic beverage for Mexican people, who tend
to prefer beer and tequila. Domestic consumption is further discouraged by the fact that the
Mexican government put a 40% tax on each bottle of wine, making it harder for wine to compete
with the more traditional Mexican beverages. A more complicated challenge for the Mexican 6 Datamonitor Industry Market Research. “Mexico – Wine.”
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wine industry is the water supply, specifically the management of water use in the winegrowing
areas. Controlled water stress has worked well for Mexican wineries in the past, but due to the
proliferation of new wineries, many Mexican vineyards that require irrigation are not getting
enough water supply. On top of that, the fact that the city of Ensenada is growing rapidly results
in even less water available for the vines, leading Josef Backhoff to argue that “if the region were
to have no problem with water, without a doubt we would be growing 10 times faster."
The Market Leader – L.A. Cetto
There is very little foreign involvement in the Mexican wine industry, but there are a few
domestic companies that have enjoyed some success both domestically and internationally. The
largest producer is L.A. Cetto. L.A. Cetto is a family owned company that has a large vineyard
in the Guadalupe Valley and Sonora and annual sales of 1.8 million liters. The winery divides its
wine into three different levels, commercial blends, the single varietal series, and the "Limited
Reserve". In addition to the more common wines, it also sells wines that acknowledge their
Italian heritage, such as Nebbiolo and Passito dessert wine, as well as the Californian specialties
of Zinfandel and Petite Syrah. Overall, L.A. Cetto enjoys a great deal of success; it has a large
market share of 9.9% within Mexico, and exports about 40% of its total wine production.
Other Mexican Wineries
The second biggest producer in Mexico is Bodegas de Santo Tomas, with an 8.8% market share
and sales of 1.6 million liters in 2005. Another winery that is doing fairly well is Monte Xanic.
Monte Xanic is smaller than L.A. Cetto, but it is a proud winner of numerous prizes, including
the bronze medal at the 2000 Challenge International Du Vin in Blaye-Bourg, France for the
1998 Monte Xanic Chardonnay. Strategically speaking, Monte Xanic chooses to differentiate
itself by concentrating on Bordeaux varietals and Chardonnay.
Keith Parker, University of Southern California
FBE-462: Group Project
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Environmental Analysis for Mexico’s Wine Industry
Economic Environment
Despite primary and secondary education being free and mandatory, 47% of the population live
below the poverty line.7 This provides an abundance of cheap, disposable labour, which is
especially useful in a seasonal, labor-intensive industry as is wine. Since the growing and
harvesting season only comprises about a third of the year, the ability to pick up seasonal
workers is very important to the industry, and Mexico can provide that. The relative abundance
of labor along with the shortage of available jobs for low-skilled employment allows the winery
to freely hire and fire as many workers as it needs, allowing them to keep wages down and profit
maximized.
The second important dimension of the economic environment is overall macroeconomic
stability. While the economic and financial crises that Mexico experienced in the 1980s and
1990s may seem to be distant memories, in terms of wine-growing this really is not that long at
all. To produce top quality wines, vintners must wait as long as 20 years to really see their
investment mature, which helps explain why wine production and exports in the more stable
Chile have grown so much more rapidly than in Argentina.
Cultural Environment
From our first-hand experiences in Mexico, it was apparent that Mexico has a very small
domestic market for wine. The alcohol sector is dominated by beer and tequila, because those
are the more traditional drinks. This means that if wineries and the industry want to expand, they
will have to export a good portion of their product.
7 Ed. Starr, Pamela K.. Challenges for a Postelection Mexico: Issues for US Policy. Council on Foreign Relations. Council special report no. 17, November 2006
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Political Environment
Mexico is very open to trade; they have free trade agreements with about 40 different countries.8
Also, as the NAFTA transition periods progress, and US-Mexico trade becomes more and more
open, whatever tariffs exist on liquors and wines will be dropped along with the rest of the agri-
business sector.9 This will give Mexican wineries a large market in the US that allows low
transportation costs, and a favorable market. This would give them a larger target market and
allow them to expand beyond the capacity of the domestic market.
Technological Environment
Mexico, unlike the more traditional wine-producing regions like France and other European
states, lacks the rules and regulations regarding the traditions in wine production. Therefore, it
can utilize technological advances like steel vats for brewing white wines, as we observed at L.A.
Cetto. This gives the Mexican wineries an advantage in the cheaper-grade or boxed wine
industries that can be produced en masse.
Policy Analysis
NAFTA’s effect on the industry
About 90% of all Mexican imports go to either the US or Canada, both of which have an
appreciation for imported wine and cheap wine.10 Also, the lower trade barriers allow for the
Mexican wineries to take advantage of lower transportation costs to the US and Canada as
opposed to overseas. Also, as the NAFTA countries continue to integrate, Mexico will have
8 Ed Starr. 9 Adams, John A., Jr.. Bordering the Future: The Impact of Mexico on the United States. Praeger Publishers: Westport, Connecticut. 2006 10 Starr.
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freer and freer access to the North American markets, allowing them to expand their wine
exports.
Border Control
Since there is a 1 liter limit on how much alcohol private citizens can bring across the border
from Mexico to the US, Mexican wineries can mark up the prices of wine they import based on
supply and demand. Since the US consumers can therefore really only get Mexican wines
domestically as opposed to buying in bulk while south of the border and bringing it back, the
wineries can up the price that they charge distributors in the states to reflect that exclusivity.
In addition to this, the increased security at the border is draining California wineries of their
supply of seasonal workers. The migrant workers that used to pick the wineries’ grapes during
the relatively short harvesting season can no longer go to the US from Mexico as easily. This
restriction on the international mobility of labor gives Mexico a comparative advantage over the
US wineries, since the labor is much cheaper and more readily available in Mexico.
China’s Effect on the Industry
Although China is the world’s sixth largest producer of wine, it consumes most of it domestically,
and does not rank among the top ten wine exporting countries.11 In the future, however, China
may become a threat to the Mexican wine industry, especially as the country becomes more open
to western cultures and consumables. Analytically speaking, China has the climate, the
resources and the land for wine production, it just hasn’t taken off because wine in the
conventional sense is not traditionally a part of Chinese culture. Right now, in the wine and beer
sectors, Mexico exports over 200 times as much as China does to the US.12 Mexico, as well as
11 FAOSTAT. Food and Agriculture Organisation of the United Nations. http://faostat.fao.org. 12 April 2007. 12 USDA Foreign Agricultural Service (FAS). United States Department of Agriculture: Foreign Agricultural Service. http://www.fas.usda.gov. 12 April 2007
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any other wine-producing country, will continue to benefit from China staying out of this export
market.
Competitive Environment
The domestic array of wine producing competitors in Mexico is very limited, due to its status as
a relatively under-developed market for wine production. Competition from imports poses a
very strong risk to any potential wineries in Mexico, though. Established foreign wine producing
markets have years of experience in making high quality wine in bulk at low prices, most notably
the California and Australian markets. Further, European wineries have long produced premium
wine brands and still hold a large portion of the world wine market, despite the problems they
have had in recent decades. In order to develop as an effective world wine-producing competitor,
Mexico would first have to develop its own domestic wine market. Currently, Mexico makes
up .7 percent of the wine market for the Americas.13 With such a small market, it would be
difficult to establish the image of desirability so needed in this competitive industry. Further,
wine making has been making a move from a labor-intensive business to a capital intensive
business, as evidenced by the emergence of very large mass-producing wine companies such as
E&J Gallo, who recently posted a US$4 Billion revenue intake. While California is known for
its abundance of Capital, Mexico is not.14 These conditions paint a clear picture of the
difficulties Mexico would face in emerging as a competitive force in the world wine industry.
13 “Wine Industry Overview.” Business and Company Resource Center, 11 April 2007 14 “Business: Blended; Wine Industry Mergers.” The Economist, 25 January 2003
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Customer Environment
When looking at consumer trends in the wine industry in Mexico, the picture is a little brighter.
While US wine sales growth has slowed from its record-breaking numbers in the 90s, Mexican
consumers’ demand has seen recent sharp increases. Wine sales in Mexico are expected to have
a compound annual growth rate of 6.2 percent, compared with similar markets such as Brazil
who have seen growth slide to 1.9 percent.15
Opportunities and Challenges
The vast majority of growth in the wine industry has been in the premium wines and super-
discount wines. The market for wines between these two extremes has seen very little growth,
and often market shrinkage. As the Mexican wine industry is fairly under-developed, wine
producers in this market have little opportunity to achieve the scale needed for the production of
super-discount wines, the opportunity in this market lies in premium brands. This actually
coincides nicely with the wine-growing conditions in Mexico, as the Mexican climate and soil
are said to be very conducive to premium grape growing. Also, when looking at the target
market for wine consumption in Mexico, the focus will quickly fall to the upper-middle to higher
income population. This segment, and specifically urban professionals with travel experience
and greater discretionary spending, will be the people most likely to venture away from the
traditional choices of beer and tequila. An opportunity for Super-Premium and Ultra-Premium
wines exists here as a status symbol.
Furthermore, as mentioned earlier, the lack of domestic competitiveness leads to a lack of
pressure for innovation and improvement in quality; conversely, the highly developed wine
producing regions around the world are constantly under pressure from competitors to improve 15 “Wine Industry Overview.” Business and Company Resource Center, 11 April 2007
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quality and to rapidly innovate. A major boost from foreign investors with agricultural,
technological, and most importantly marketing experience would probably be needed to really
raise the Mexican wine industry up to the standards of even Chile or Argentina, but the problem
lies in attracting these investors.
Conclusions and Recommendations
With this understanding of the global wine industry, the economics of wine production, the
history of the industry in Mexico, the overall business environment in Mexico, and the ongoing
development of the wine market in Mexico, it is possible to make some concluding
recommendations for both local wineries and foreign companies considering expanding to
Mexico.
Domestic Producers
For a domestic winery such as LA Cetto to be grow and be successful both domestically and
internationally, we strongly believe the emphasis must be placed on quality and branding, due to
the fact that the only segments that continue to grow in sales on a global basis are the premium
wines. The primary challenge in entering the market as a high quality brand is the development
of a strong brand image. In order to compete in the premium wine segment, a Mexican wine
producer would need to develop a brand image that could compete with well established and
respected brand name labels from Australia, California, France, Italy, and others. Given the fact
that Mexico has no history of wine-making, this could prove especially challenging. However,
since there have already been a few wineries such as Monte Xanic experiencing success
internationally, perhaps the Mexican government could consider export subsidies for the wine
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industry, or at least looking into MAA’s such as the one signed in 2002 to promote their
involvement in the international wine trade.
Foreign Companies
In the final evaluation, we do not believe that the Mexican wine industry is a desirable
investment opportunity for foreign wine companies looking to expand. As mentioned above, the
infrastructure in Mexico is still lacking, especially in regards to irrigation and water supply, but
also concerning financial and economic stability. The domestic market for wine is also very
small, meaning a new foreign producer would have to focus almost entirely back on their home
market, limiting the advantages to be gained from economies of scale. This need to focus almost
entirely on exports would cause problems of its own due to the fact that there is very little
recognition of Mexican wines worldwide. With no wine heritage, it would be very hard for a
new Mexican wine to compete with the established vintners of Europe, the US, Australia, or
even Chile. Furthermore, success in the wine industry is currently being driven by marketing
and quality, and while foreign investors could bring their branding experience to Mexico, they
would have a very difficult time establishing a competitive image for Mexican wines. Finally,
and perhaps most fundamentally, there is currently a huge global oversupply of grapes for every
type of wine except specialties such as champagne and port. In the face of declining global
consumption and falling prices for grape growers, there is simply no reason for a foreign firm to
make the huge investment necessary to jumpstart the Mexican wine industry.
Keith Parker, University of Southern California
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Comparison of markets
Competitive Environment
The domestic array of wine producing competitors in Mexico is very limited, due
to its status as a relatively under-developed market for wine production. Competition
from imports poses a very strong risk to any potential wineries in Mexico, though.
Established foreign wine producing markets have years of experience in making high
quality wine in bulk at low prices, most notably the California and Australian markets.
Further, European wineries have long produced premium wine brands and still hold a
large portion of the world wine market, despite the problems they have had in recent
decades. In order to develop as an effective world wine-producing competitor, Mexico
would first have to develop its own domestic wine market. Currently, Mexico makes up
.7 percent of the wine market for the Americas.1 With such a small market, it would be
difficult to establish the image of desirability so needed in this competitive industry.
Further, wine making has been making a move from a labor-intensive business to a
capital intensive business, as evidenced by the emergence of very large mass-producing
wine companies such as E&J Gallo, who recently posted a US$4 Billion revenue intake.
While California is known for its abundance of Capital, Mexico is not.2 These conditions
paint a clear picture of the difficulties Mexico would face in emerging as a competitive
force in the world wine industry.
Customer Environment
When looking at consumer trends in the wine industry in Mexico, the picture is a
little brighter. While US wine sales growth has slowed from its record-breaking numbers
1 “Wine Industry Overview.” Business and Company Resource Center, 11 April 2007 2 “Business: Blended; Wine Industry Mergers.” The Economist, 25 January 2003
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in the 90s, Mexican consumers’ demand has seen recent sharp increases. Wine sales in
Mexico are expected to have a compound annual growth rate of 6.2 percent, compared
with similar markets such as Brazil who have seen growth slide to 1.9 percent.3
Opportunities and Challenges
The far majority of growth in the wine industry has been in the premium wines
and super-discount wines. The market for wines between these two extremes has seen
very little growth, and often market shrinkage. As the Mexican wine industry is fairly
under-developed, wine producers in this market have little opportunity to achieve the
scale needed for the production of super-discount wines, the opportunity in this market
lies in premium brands. This actually coincides nicely with the wine-growing conditions
in Mexico, as the Mexican climate and soil are said to be very conducive to good grape
growing. The primary challenge in entering the market as a premium brand is the
development of a strong brand image. In order to compete in the premium wine segment,
a Mexican wine producer would need to develop a brand image that could compete with
well established and respected brand name labels from Australia, California, France,
Italy, and others. Further, as mentioned earlier, the lack of domestic competitiveness
lends to a lack of pressure for innovation and improvement in quality; conversely, the
highly developed wine producing regions of the world are constantly under pressure from
competitors to improve quality and to rapidly innovate.
3 “Wine Industry Overview.” Business and Company Resource Center, 11 April 2007
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1
Entering the MexicanWine Industry
Professor ChenFBE-462Yu Chen
Cyrus ChiniAlexander DalyShelley GotoKeith Parker
Agenda
• Global Wine Industry Overview• Industry Cost Structure• Overview of Mexican Wine Market• Analysis of market externalities• Opportunities and Challenges• Conclusion and Recommendations
Global Wine Industry Overview
• $90 billion industry in 2002• Largest national producers and exporters
– France, Italy, Spain, United States, Australia
• Key import markets– Germany, United Kingdom, United States, France
• Major wineries/conglomerates– Constellation, LVMH, E&J Gallo, Southcorp,
Seagram
The Reshaping of the CompetitiveEnvironment
• The decline in Europeandominance– Falling consumption rates– New World production methods and
innovation– Oversupply of grapes
• The rise of Australian exports• The South American experience
Cost Structure of the Industry
• Production– Grape Costs– Crush and Capitol Costs– Barrel Costs– Dry Goods Costs
• Non Production– Regulation Fines– Tariffs– Marketing, Shipping, and Distribution
Market Analysis
Winery Wholesaler Retailer End Consumer
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2
• Centered in Ensenada
• Guadalupe, Calafia, San Vicente andSanto Tomas Valleys
The Mexican Wine Industry Advantages and Disadvantages ofthe Mexican Wine Industry
Weather
Water Supply
Number of Wine Lovers
Main Wine Producersin Mexico
L.A. Cetto
Monte Xanic
Environmental Analysis
• Economic– Abundance of cheap, low-skilled labor– Favors the seasonal nature of the wine
industry– Possibility of macroeconomic instability
• Political– Free trade agreements– NAFTA
Environmental Analysis
• Cultural– Small domestic market– Expansion opportunities lie in exports– Marketing necessary to increase domestic
consumption• Technological
– Lacks traditional wine-making regulations– Cheap mass production possible
Policy Analysis
• Border Control: mobility of goods– Limited amounts may be brought across the
border– Can sell for a higher price to reflect exclusivity
• Border Control: mobility of labor– US lack of cheap seasonal labor– Give Mexican producers an advantage
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3
Policy Analysis
• NAFTA– Take advantage of US markets– Continuing integration promises less profit
loss to tariffs• China
– Large producer, but not exporter– Has the resources to take market share
away, but less cultural incentive
Competitive Analysis
• Domestic Wine Competition– Very Limited
• International Wine Competition– Very large and established– Have reached Economies of Scale and Scope– Competitors have established images
• Very hard to develop• Mexico currently doesn’t have the right image
Opportunities and Challenges
• Overall Industry Growth– On the extremes– Mexican entrants should focus on Premium
• Establishing a Premium Brand– Good Terroir in Mexico– Would compete with established name brands– Lack of significant domestic competition
• Less innovation• Less pressure for higher quality
Conclusions and Recommendations
• Domestic Firms– Focus on branding – creating a Mexican identity– Expand exports, especially within premium segments
• Foreign Companies – NOT attractive– Infrastructure not in place– Domestic market too small– Lack of a national wine heritage, limited branding
possibilities– Global oversupply
Thank You
Questions?
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Business & Company Resource Center
Datamonitor Industry Market Research, Nov 15, 2006 pNA
Mexico - Wine.
(L.A. Cett)(Industry overview)
Full Text: COPYRIGHT 2006 DatamonitorMarketDefinition
The wine market consists of fortified wine, sparkling wine and still wine. The market is valued according to retail selling price (RSP) and includes any applicable taxes. Any currency conversions used in the creation of this report have been calculated using constant 2005 annual average exchange rates.
For the purpose of this report, the Americas comprises the US, Canada, Brazil and Mexico.
ResearchHighlights
*The Mexican wine market generated total revenues of $230.2 million in 2005, this representing a compound annual growth rate (CAGR) of 5.6% for the five-year period spanning 2001-2005.
*Market consumption volumes increased with a CAGR of 2.5% between 2001-2005, to reach a total of 18.2 million liters in 2005.
*The performance of the market is forecast to accelerate, with an anticipated CAGR of 6.4% for the five-year period 2005-2010 expected to drive the market to a value of $313.6 million by the end of 2010.
MarketAnalysis
The Mexican wine market has posted steady rates of growth throughout 2001-2005 and is expected to grow at an even faster pace in the forthcoming five year period. Similarly to wine markets in Brazil and Canada, Mexico benefits primarily from the sale of still wines.
The Mexican wine market generated total revenues of $230.2 million in 2005, this representing a compound annual growth rate (CAGR) of 5.6% for the five-year period spanning 2001-2005. In comparison, the Canadian and Brazilian markets grew with CAGRs of 4.1% and 1.9% over the same period, to reach respective values of $4257.8 million and $2235.7 million in 2005.
Market consumption volumes increased with a CAGR of 2.5% between 2001-2005, to reach a total of 18.2 million liters in 2005. The market's volume is expected to rise to 19.4 million liters by the end of 2010, this
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representing a CAGR of 1.3% for the 2005-2010 period.
Still wines sales proved the most lucrative for the Mexican wine market in 2005, generating total revenues of $183.7 million, equivalent to 79.8% of the market's overall value. In comparison, sales of sparkling wines generated revenues of $33.4 million in 2005, equating to 14.5% of the market's aggregate revenues.
The performance of the market is forecast to accelerate, with an anticipated CAGR of 6.4% for the five-year period 2005-2010 expected to drive the market to a value of $313.6 million by the end of 2010. Comparatively, the Canadian and Brazilian markets will grow with CAGRs of 3.4% and 3.8% respectively over the same period, to reach respective values of $5026.1 million and $2,697.7 million in 2010.
Value
The Mexican wine market grew by 5.1% in 2005 to reach a value of $230.2 million.
The compound annual growth rate of the market in the period 2001-2005 was 5.6%.
Mexico Wine Market ValueUnit: USD Year Value Growth2001 1853000002002 197100000 6.4%2003 207200000 5.1%2004 219000000 5.7%2005 230200000 5.1%CAGR 2001-2005 5.6%
Volume
The Mexican wine market grew by 2.1% in 2005 to reach a volume of 18.2 million liters.
The compound annual growth rate of the market volume in the period 2001-2005 was 2.5%.
Mexico Wine Market VolumeUnit: Liters Year Volume Growth2001 165000002002 17000000 3.3%2003 17400000 2%2004 17800000 2.5%2005 18200000 2.1%CAGR 2001-2005 2.5%
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Segmentation
Sales of still wine accounts for 79.8% of the Mexican wine market's value.
In comparison, sparkling wine generates a further 14.5% of the market's revenues.
Mexico Wine Market SegmentationYear: 2005 Category PercentageStill wine 79.8%Sparkling wine 14.5%Fortified wine 5.7%
Segmentation
The Mexican wine market accounts for 0.7% of the Americas market value.
In comparison, Brazil generates 7.3% of the market's value.
Mexico Wine Market SegmentationYear: 2005 Geography PercentageUnited States 78.1%Canada 13.9%Brazil 7.3%Mexico 0.7%
Share
L.A. Cetto accounts for 9.9% of the Mexican wine market's volume.
In comparison, Bodegas de Santo Tomas generates a further 8.8%.
Mexico Wine Market ShareYear: 2005 Company PercentageL.A. Cetto 9.9%Bodegas de Santo Tomas 8.8%Pernod Ricard 1.1%Serena 0.5%Other 79.7%
CompetitiveLandscape
L.A. Cetto leads the Mexican wine market, with sales in 2005 amounting to 1.8 million liters, this accounting for 9.9% of the markets volume. Other significant players include: Bodegas de Santa Tomas, whose sales of 1.6 million liters comprise 8.8% of the markets volume, and Pernod Ricard, which has sales of 0.2 million liters and a volume share of 1.1% of the market.
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Supermarkets & hypermarkets form the most significant distribution channel for wine sales in Mexico, accounting for 35.7%. On-trade sales account for an additional 28% of the market.
This section contains brief overviews of the leading companies in the Mexican wine market.
Company
L.A. Cett
L.A. Cetto is based in Chapultepec, Mexico. It primarily produces Cava and exports to 27 countries.
No recent financial data is available.
Company
Pernod Ricard
Pernod Ricard is the second largest manufacturer of spirits and fourth largest manufacturer of wines globally. It manufactures and distributes wines and spirits under more than 65 brand names. The company operates in the Americas, Europe and the Asia Pacific. It is headquartered in Paris, France and employed about 12,250 people as of December 2003.
The company recorded revenues of $6.5 billion during the fiscal year ended December 2005, an increase of 46.9% over 2004. The operating profit of the company during fiscal 2005 was $1.3 billion. The net profit was $800.5 million during fiscal year 2004, an increase of 22% over 2004.
Supermarkets & hypermarkets are the most important distribution channel, with 35.7% of the market's volume distributed via this channel.
On-trade accounts for a further 28%.
Mexico Wine Market DistributionYear: 2005 Channel PercentageSupermarkets/hypermarkets 35.7%On-trade 28%Specialist Retailers 24.7%Other 11.6%
ForecastValue
In 2010, the Mexican wine market is forecast to have a value of $313.6 million, an increase of 7.3% since 2005.
The compound annual growth rate of the market in the period 2005-2010 is predicted to be 6.4%.
Mexico Wine Market Value Forecast
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Unit: USD Year Value Growth2005 230200000 5.1%2006 242100000 5.2%2007 255900000 5.7%2008 275500000 7.7%2009 292200000 6.1%2010 313600000 7.3%CAGR 2005-2010 6.4%
ForecastVolume
In 2010, the Mexican wine market is forecast to have a volume of 19.4 million liters, an increase of 6.6% since 2005.
The compound annual growth rate of the market volume in the period 2005-2010 is predicted to be 1.3%.
Mexico Wine Market Volume ForecastUnit: Liters Year Volume Growth2005 18200000 2.1%2006 18400000 1.3%2007 18600000 1.1%2008 18900000 1.4%2009 19200000 1.4%2010 19400000 1.3%CAGR 2005-2010 1.3%
MacroeconomicData
Population
Mexico Size of PopulationUnit: Population Year Value Growth2001 1012000002002 102500000 1.2%2003 103700000 1.2%2004 105000000 1.2%2005 106200000 1.2%
GDP
Mexico GDPUnit: Real GDP (1995=100) Year Value Growth2001 130.22002 131.5 1%
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2003 133.4 1.4%2004 137.7 3.2%2005 142.6 3.5%
Inflation
Mexico InflationUnit: Inflation Rate % Year Value2001 0.0442002 0.0572003 0.042004 0.042005 0.033Exchange RateUnit: Exchange Rate Year Value2001 0.0012002 0.0012003 0.0012004 0.0012005 0.001
Article A156814249
© 2007 by The Gale Group, Inc.
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Wines, Brandy, and Brandy SpiritsSIC Code(s) Covered
2084-Wines, Brandy & Brandy Spirits
NAICS Code(s) Covered
312130-Wineries
Industry Snapshot
Although the first commercial wine venture in the United States was in Pennsylvania in 1793, the majority of modern American wineries have been located in California, with Washington and New York coming in a distant second and third, respectively. California and its 1,300 wineries has accounted for more than 90 percent of all U.S. wine production and more than 70 percent of all wine sold in the United States. If viewed as a nation, California would rank fourth in worldwide wine production, following Italy, France, and Spain. In the mid-2000s Gallo was the dominant wine producer in the country, as well as the leading exporter.
In the mid-2000s Americans purchased 627 million gallons of wine, with a retail value of approximately $23 billion. Eighty-eight percent of the total was table wine, 7 percent was dessert wine, and 4 percent was sparkling wine or champagne. Table wine has been the most popular kind of wine sold in the United States. Varietals, table wines made predominately of one kind of grape, grew in popularity in the past decade. In 2004, 40.5 percent of wine sold in supermarkets was red, 40.4 percent was white, and 19.1 percent was blush.
Organization and Structure
All winemakers must sell their products through wholesalers and retailers to accommodate various federal, state, and local regulations regarding the sale of alcoholic beverages. The Federal Alcohol Administration Act (FAA) was established after the 13-year Prohibition Era ended in 1933. The Bureau of Alcohol, Tobacco, and Firearms (ATF) is responsible for administering and enforcing the FAA, including qualifying winemakers, collecting producer and wholesaler occupational taxes, and regulating trade practices, advertising, and labeling. Beyond the uniformity of the FAA, regulations vary greatly among the 50 states.
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States can sell wine in one of two ways, either in a controlled environment or using an open, licensed method. "Open" states have licensed retailers and wholesalers that handle the distribution and sale of alcoholic beverages. Thirty-two states and the District of Columbia are open states. The other 18 states operate under the control method, in which each state government buys and sells alcoholic beverages at the wholesale and retail levels. In addition to federal regulations, some states have set up their own independent agencies that are responsible for the administration, licensing, and enforcement of state laws and the collection of state revenues. Some state legislatures even have created their own alcoholic beverage control (ABC) agencies with rule-making power, and 32 states allow their citizens to vote for or against the sale of liquor on a city or county-wide basis.
Background and Development
California winemaking began in 1769 when Father Junipero Serra planted vines at Mission San Diego. In September 1772, the grapes were harvested and pressed, creating California's first vintage. These early wines were produced for sacramental purposes and personal consumption at the missions.
The commercial era of wine production began in 1830 with the efforts of Frenchman Jean Louis Vignes from Bordeaux, France. His vineyard was located in what is now downtown Los Angeles. The wine industry boomed as an ancillary result of the discovery of gold in California in 1848. A surge of Europeans came to the state seeking their fortune. Immigrants from Italy, France, and Germany who had no luck finding gold turned to a trade they already knew--winemaking.
Between 1860 and 1880, the industry grew rapidly as numerous wineries were established. By 1890, several of the state's famous wine regions already had taken shape and the industry was producing 25 million gallons of wine per year. After suffering losses from a vine pest called phylloxera, the industry virtually disappeared with the passage of Prohibition in 1919. The repeal of Prohibition in 1933, however, prompted the industry to rebuild. Growth was steady between 1949 and 1960, with annual output increasing from 117 million gallons to 129 million gallons. By the 1970s, the demand for California table wines had doubled.
As the industry evolved, so did consumer preferences. From 1933 to 1967, dessert wine was the most popular kind of wine in the United States. During the 1970s, generic table wines, like California Chablis and California Burgundy, dominated sales. By the late 1980s, varietal wines, those labeled with the name of the grape, had taken over.
After posting a 6.5 percent loss in 1993, wine sales in the United States continued to rise, while per capita consumption remained steady at 1.8 gallons. According to the San Francisco-based Wine Institute, consumer demand for premium varietal wines spurred a 5 percent increase in California table wine sales in 1994--the strongest performance in more than a decade.
While most of the largest wine producers reported record sales, and consumer tastes moved upscale to more expensive wines, 1994 was noted as the best year for the wine industry since the late 1980s. "The end of the drought, the waning of phylloxera root
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louse problems and increased consumer demand all have winemakers singing a new tune," reported Clifford Carlsen of The San Francisco Business Times.
Total U.S. production again rose in 1995, up 10.3 percent at 437 million gallons. According to wine industry analyst Jon Frederickson of San Francisco-based Gomberg, Fredrickson and Associates, wine sales increased 8 percent in 1995 to a record $4.4 billion. Increased consumer demand and a relatively strong supply of fruit contributed to the industry's continued strong growth.
Following record wine sales and all-time high prices for grapes in 1995, the industry experienced another banner year in 1996. In fact, many North Coast wineries, with sales increases of 30 to 40 percent, did not have enough wine to meet the staggering demand.
The improved economy and continuing news reports about the health benefits of moderate wine consumption fueled the continued growth of the industry. A 1991 broadcast of 60 Minutes reported a link between moderate wine consumption and a reduced risk of heart attack. Called the French Paradox, two scientists found that despite similar fat intake, France's heart attack rate was one-third that of the United States. A key factor they attributed to this was the French custom of drinking wine with meals. Red wine sales increased more than 75 percent after that 1991 report.
Champagne sales continued to drop despite increases of specific brands. From a peak of 18.2 million 9 liter cases of sparkling wine and champagne in the United States in 1986, consumption fell to 12.3 million 9 liter cases in 1995. Causes for the decline were high prices for champagne, high taxes, high cost of shipping, and lack of consistent, high-profile marketing programs.
Wine sales were expected to continue their increase as the federal government took an unprecedented step in advocating moderate consumption. When the U.S. government issued new dietary guidelines in 1996, it acknowledged, for the first time, the benefits of moderate wine consumption. Previously, the government had warned that even small amounts of alcohol had "no net health benefit."
"Writing that language into the dietary guidelines was an extraordinary statement of public policy change in the United States. It's a foundation we can build on into the next century," said John De Luca, president of the Wine Institute, the trade association for the wine industry. He added that the revised guidelines culminated five years of work to redefine the image of wine, "putting it back on the dining room table where it's been for 2,000 years."
Leading the pack in wine sales have been the varietals. Relatively new to the industry, a "fighting" varietal has been defined as a value-priced, cork-finished, 750 ml varietal wine. The leader in fighting varietals has been Glen Ellen, followed by Fetzer's Bel Arbors, Sebastiani's Country Wines and Swan Cellar label, Beringer's Napa Valley, and Robert Mondavi's Woodbridge. Tim Wallace, a Glen Ellen executive, told Beverage Dynamics that "fighting varietals are the foundation for the American wine industry in the future."
In the late 1990s, fruit-flavored varietal wines became popular. Canadaigua introduced Arbor Mist in 1998 in flavors such as peach and tropical fruits chardonnay and exotic fruits and sangria zinfandel. Other producers followed suit, including Sutter Home's Portico, Earnest & Julio Gallo's Wild Vines, and the Wine Group's Lyrica.
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The introduction of fruit-flavored varietals caused a minor uproar among wine purists in the industry. Because these wines contain less than 7 percent alcohol, they are regulated for the Federal Drug Administration (FDA), which does not issue designation requirements for varietals.
At the end of the twentieth century, U.S. producers of champagne and sparkling wine commanded a 70 percent share of the domestic market. Growth continued to be slow. In 1997, shipments of champagne rose 1 percent for the first time since the 1980s, but they fell by 3 percent the following year. These losses were attributed to consumers' abandonment of the less expensive charmat producers in favor of the higher-end method champenoise varieties.
The good news was that the quality of champagne, both domestic and imported, was rising. Those producing champagne began to make a product that was more suited to American tastes. Improvements in champagne production were forged mainly in Carneros, Mendocino County, California, as well as on the central coast. In return, these domestic producers saw consumers move to brands that offered high quality at affordable prices.
The sale of wine over the Internet stirred a heated debate between the U.S. Congress and the wine industry. Spurred by a rash of student-led violence in the nation's schools, legislators created a bill on youth crime and gun control. An amendment to the bill gave states the power to use federal courts to enforce local laws governing the interstate alcohol trade. Proponents said that the amendment's purpose was to prevent underage drinking. Many in the wine industry believed that it would restrict their business. A survey of 176 California vintners, conducted by the Wine Institute, found that nine out of ten shipped their products to out-of-state customers and 50 percent used Web sites to sell their products.
Production.
The making of wine begins with the grape harvest, which generally occurs from August through November, depending on the grape variety and the weather. The grapes are placed in a crusher that separates the stems from the fruit and breaks up the berries. The stems are then discarded, leaving a combination of juice, seeds, pulp, and skins, called "must." Juice from red or white wine grapes is colorless.
To make white wine, the skins and seeds usually are removed from the must after a few hours. The remaining juice is called "free-run." The discarded skins also are pressed to extract the "press juice." Both juices then are filtered, placed in storage, and given yeast to facilitate the fermentation process. White wine fermentation can last anywhere from three days to three weeks. Upon completion, the wine is filtered for solids or remaining yeast. The wine then is aged for a period of one week to a year in stainless steel, oak, or redwood containers. It also can be aged in the bottle. After aging, the wine can be blended with other wines to create a desired style or can be sent to be finished, a process that stabilizes and filters the wine before bottling.
Production of red wine is slightly different than the process of making white wine. Red wine is fermented at warmer temperatures than white wine. For red wine production, the skins are fermented with the crushed juice to give it color and flavor. The skins float to the top and are moistened regularly with juice to extract color and flavor. Red wine usually is fermented for five to ten days and then is filtered, clarified, and preserved with sulfites. Red wine commonly is aged in oak barrels for one to two years.
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Champagne is made in one of two ways: by method champenoise or the charmat process. In method champenoise, still wine is blended with a mixture (called triage) of still wine, yeast, and a sugar substance. This blend is resealed in bottles where it is fermented for a second time and aged. Carbon dioxide collects in the bottles, which is released in a rush of bubbles when the bottles are uncorked. In the charmat, or bulk, process, the still wine, yeast, and sugar are fermented in a pressurized tank rather than in bottles.
Types of Wines.
Wines sold in the United States generally are divided into the following categories: champagne, aperitif, dessert wine, table wine, and varietal wine. Also included in this discussion are brandy and other fortified wines. Wines can be named one of four ways: by variety, which tells the predominant type of grape; by a generic name describing the color, such as blush; by the region that originally inspired the wine, such as Chablis; or by a proprietary name, which is a label created by the winery.
Champagne and sparkling wines are names used interchangeably in the United States for wines with effervescence. These wines range from very dry (natural), to dry (brut), to slightly sweet (extra dry), to sweet (sec and demi-sec). Aperitifs are appetizer wines usually served prior to a meal and can include champagnes and sherries. Dessert wines are officially classified as those with an alcohol content of 17 percent to 21 percent. They can be sweet or dry and include sherries and ports.
Table wine is a term commonly used to describe all red, white, blush, and rose wines that contain 7 to 14 percent alcohol. These wines are still rather effervescent and are served mainly with meals. Table wines can be made from any grape or combination of grapes and in any style that the winemaker chooses. Varietal wines are table wines that are made from a minimum of 75 percent of a particular grape variety; they carry the name of the grape variety from which they are produced, such as Chardonnay or Merlot.
The red table wine category has been led by Cabernet Sauvignon, a full-bodied, rich, intense wine with noticeable tannins. A leading prestigious varietal, Cabernet Sauvignon has been one of the most widely available wines from California. Other red varietals include Merlot, Petite Sirah, and Zinfandel. Merlot is a medium- to full-bodied wine that originally was made for the sole purpose of blending with Cabernet Sauvignon. Petite Sirah is a wine with deep color, full body, and a fresh-berry taste. Zinfandel, known as the classic California wine, is known too for its versatility, range of style, and raspberry-spicy aroma and flavor.
White table wines have been dominated by Chardonnay, which is the most widely planted variety of grape in California, making up more than 56,000 acres. It is a dry wine that has a balance of fruit, acidity, and texture. Depending on what the winemaker uses for storage, Chardonnay can range from clean and crisp wines to rich, complex, oak-aged wines.
Other white varietals include French Columbard, Sauvignon Blanc, Johannisberg Reisling, Gewurztraminer, and Pinot Blanc. French Columbard is generally fresh and fruity, ranging from light to medium in body. Sauvignon Blanc has been one of the fastest growing varietals in California; sometimes called Fume Blanc, it is best known for its grassy, herbal flavors and is often consumed with fish and shellfish. Johannisberg Riesling, from the German Riesling grape, is aromatic, delicate, and slightly sweet. Late Harvest Rieslings are good accompaniments for dessert.
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Gewurztraminer offers spicy aromas and flavors and a slight wisp of residual sweetness. Often this wine goes well with Asian food. Pinot Blanc is a unique, dry white wine, with styles ranging from bold, oak-aged to crisp and medium-bodied.
Brandy is "burnt wine" or fruit wine that is boiled and aged in wood. Virtually any type of fruit can be used to make brandy, although grapes have been the most common. Brandy has been produced primarily in Spain, Italy, and France, and most recently in the United States. Cognac has been considered to be the best of all brandies. Cognac's discerning characteristic has been its blending, often created from a number of different cognacs coupled carefully to achieve an appropriate mixture.
Fortified wines were the creation of the Spanish and Portuguese and included port, sherry, and Madeira. Sherry is made by blending younger sherries with older sherries in oak casks. It varies in dryness levels and in hues. Harvey's Bristol Cream, imported by Hiram Walker & Sons, has been the top-selling sherry in the United States, with a nearly 41 percent market share. The best-seller is a blend of aged oloroso, a fortified full-bodied sherry, and Pedro Ximines grapes, which sweetens the mixture.
Port is red wine fortified with grape brandy. It was created unintentionally in the seventeenth century when Portugal tried to ship its table wine to England. In order to stabilize the wine during its voyage across the Atlantic, the wine needed the addition of grape brandy. England has remained the most popular market for port.
Madeira comes from a tropical island of the same name and is a raisiny, sweet wine. Madeira has been closely linked with the history of the United States, according to the New York Times Magazine. It was considered to be the wine of choice for American Revolutionary notables such as Thomas Jefferson, George Washington, and Ben Franklin. Unlike other wines that soured during the long, hot voyage across the Atlantic, Madeira was the only wine known to improve dramatically with the introduction of heat.
After a time of record growth throughout the 1990s, U.S. winemakers began seeing wine sales flatten in the early 2000s. With a shaky economy made all the more so by the attacks of September 11, 2001, the wine industry, like many U.S. industries, was affected by the decrease in consumer spending on travel and recreation, which is tied in to wine drinking. Another factor in the state of the wine industry from 2000 to 2003 was the overproduction of grapes and the ensuing drop in grape prices by as much as 75 percent in 2001 and 2002. Wine prices dropped during this time while sales flattened. Retail sales of wine in the United States were $19.8 billion in 2001, a 4 percent increase over 2000's sales of $19.0 billion. By 2002, sales of California wine dropped in all categories for the first time in more than a decade. Finally, the proliferation of high quality, inexpensive imported wine caused further woes for U.S. winemakers. Imports rose 17 percent in 2002, accounting for 25 percent of total wine sales in the United States.
White wine continued to be popular, owning 40 percent of the wine market in 2001, with red not far behind, growing from 17 percent in 1991 to a strong 37 percent of market share in 2001. The MKF Wine Trends Report noted that the leading California table wine varietals, Chardonnay, Cabernet Sauvignon, Merlot, and White Zinfandel/Blush, accounted for about 76 percent of all retail sales by value of California wine in 2001. Chardonnay continued its leading spot with a 29 percent dollar market share, followed by Cabernet with 19 percent, Merlot with 15 percent, and White Zinfandel/Blush holding 13 percent of the market by value. Secondary red varietals, including Syrah, Pinot Noir, and Red Zinfandel, all were up more than 30 percent in
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revenues for California wineries. There was a surge in popularity of Pinot Grigio, which the Wine Spectator reported had sales increasing faster that any other white wine in supermarkets. Wine coolers, once popular in the late 1990s, were less so as the new millennium dawned.
In a climate of more cautious consumer spending, wines priced at $50 and higher were selling far less than in the robust 1990s, noted Charles Krug Winery co-proprietor Peter Mondavi in a July 2002 interview with Beverage Industry. "The wines that are $35 or so are still going through the roof. So we're having great success in that category," he added. With prices falling to record lows, consumers were indeed enjoying bargains in the early 2000s. Indeed, California chain Trader Joe's seemed to be leading the bargain trend, offering the Charles Shaw line of Merlots, Cabernets, and Chardonnays for $1.99 in late 2002 and early 2003. In those six months, wine industry analysts Jon Fredrikson estimates the company sold about 1 million cases of the generally good quality wine that was dubbed, "Two-Buck Chuck."
Current Conditions
By the mid-2000s the U.S. wine industry was picking up. California wineries shipped a record amount of products, with approximately 428 million gallons shipped domestically, from a total 522 million gallons shipped worldwide. While so-called "extreme value" varieties continued to sell well, the expensive premium wines also were seeing increases, accounting for 64 percent of industry revenues. Following the trend across nearly all American retail industries, the middle variety sales were flat, with the majority of the industry growth occurring at either extreme end of the price spectrum. In 2004 sales of red outpaced white for the first time in years.
To ensure that California sustained its fertile winegrowing land, the Wine Institute and the California Association of Winegrape Growers launched the "Code of Sustainable Winegrowing Practices" in 2002, which in 2004 received a $475,000 USDA grant for support of sustainable winegrowing practices. The program for vintners and growers was a voluntary and helpful tool for conserving natural resources, protecting the environment, and enhancing relationships with neighbors, local communities, and employees.
A new trend in the mid-2000s was that of bringing winemaking to the masses with make-your-own wineries and classes springing up in Florida, New York, California, and Texas, to name just a few of the locations. While the majority of these operations, which were not affiliated with any particular winery, allowed customers to simply choose grapes, add yeast, and design labels, some of the larger operations, such as the Bacchus School of Wine, were truly teaching the winemaking process in less than a year, starting students from the very beginning.
Other relevant trends included more vintners moving to plastic corks. Although considered "tacky" by some, more and more winemakers worldwide were seeing the benefits to the move, as costlier, traditional corks were increasingly blamed for ruining bottles with sediment, mustiness, or leakage. This negative cork performance costs vineyards money, as they absorb the cost of returned bottles. Other winemakers made a move to organics, as Fetzer Vineyards announced that it intended to grow and use 100 percent organic grapes for all of its wine by the 2010 harvest.
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Industry Leaders
As dominant as the state of California is in the wine industry, so too are the wineries of California winemakers Ernest & Julio Gallo (E & J Gallo). Controlling nearly 40 percent of the U.S. wine market, E & J Gallo Wineries led every wine category in which it competed. According to the Wine Spectator, one out of every three bottles of wine made in America is a Gallo product. The world's largest winemaker, E & J Gallo Wineries had annual sales of more than $3 billion in 2004.
In 1933 the original Ernest and Julio Gallo brothers winery was founded in Modesto, California. Unable to obtain bank financing, the company bought crushing and fermenting equipment on 90-day terms and rented a warehouse to make its first commercial wine. Using pamphlets on winemaking from the local library and grapes bought on a promise to pay from eventual sales, the two brothers made their first batch of wine. By 1993 Gallo owned five separate vineyards totaling more than 2,000 acres. The company remained a private, family-owned business (two of Julio Gallo's great-grandchildren, Matt and Gina, are actively involved in the company's winemaking operations) and was one of the largest organic farms in the United States.
The company's success was due in part to the partnership of the Gallo brothers; Ernest marketed the wine that Julio made. Another part of Gallo's success was its quest for improving the quality of the wine it produced. To this end, Gallo replanted its vineyard in Livingston in 1946 using grape varieties that had not been previously grown in the area. Various viticultural techniques were experimented with, and in 1947 a formal research program was established to evaluate the results. Specific standards were developed for winemaking and were used thereafter.
In 1965 Julio Gallo established the first Growers Relations Department and shared research findings with area growers. In 1967 Gallo offered long-term contracts to selected growers, giving economic security and incentive to replant vineyards with the better grape varieties recommended by Gallo. During the 1970s, the winery shifted to producing premium varietal wines, and in 1991 it introduced its first ultra-premium wine, 1991 Sonoma Estate Chardonnay. Leading brands for E & J Gallo Wineries have been Gallo, Andre, Bartles & James, and Carlo Rossi.
Constellation Brands, the former Canadaigua Wine Company, became the number-two seller in the U.S. wine market in 1995 with the acquisition of the Almaden and Inglenook wine labels (in 1994) from Heublein for $130.5 million. Although the company name may not be well known, its products such as Almaden, Inglenook, Taylor California Wines, and Paul Masson Wines are household names. Constellation had sales of $3.6 billion in 2004.
The company is a father-and-son operation located in upstate New York, started in 1945 by Marvin Sands, who bought a sauerkraut factory and turned it into a winery for $60,000. For ten years, Canandaigua Industries sold fruit wines in bulk to local bottlers who then sold them under their own brand names. In 1954 Sands turned away from bulk wines and created a brand for himself--Richards Wild Irish Rose, a blended red dessert wine. During the 1960s Wild Irish Rose represented nearly all of the company's sales.
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Working from that base, Sands slowly expanded, acquiring 11 small wineries through 1984. Then the company entered the wine cooler market with its Country Wine Coolers. Although the company suffered an operating loss of $20 million in 1987 and 1988 due to expensive advertising, Sands realized the power of the company's distribution network and began looking for established brands.
In 1991 Canadaigua made its first major purchase with Cook's Champagne for $60 million. Then came additional purchases in 1993, 1994, 1998, and 1999. By the end of the twentieth century, Canadaigua was posting annual sales of $740 million. In 2004, the company had more than 200 brands of wine, beer, and spirits on the market.
Workforce
In 2003, the beverage manufacturing industry as a whole employed more than 169,000 workers. In total, as of the early 2000s, the winemaking industry employed more than 17,000 workers. The majority of wineries were family-owned, were located in California, and had a tremendous impact on that state's economy. Los Angeles-based Recon Research Corporation reported that the California wine industry contributed nearly $1.5 billion annually to the Sonoma County economy, employing more than 3,600 people and creating secondary industrial employment of an additional 2,500 jobs.
America and the World
U.S. wine companies' efforts to establish joint ventures in Europe were not as successful as they had hoped. Controlled by small producers and cooperatives, experiences there led U.S. companies, in the early 2000s, to the more successful, growing trend of teaming with Australian companies, who were more than willing to establish a greater foothold in the United States. However, overseas planting of premium varietals elsewhere had been growing at a fast pace and was expected to be a significant new source of wine for U.S. consumers. In fact, California wineries bought unprecedented amounts of overseas wine to meet consumer demand for low-priced everyday wine and to expand their existing line of products in the mid-1990s.
For example, in 1996 Robert Mondavi began importing a Chilean line of wines, the Caletara brand, priced in the $6 to $9 range. A second brand, Edwardo Chadwick, was introduced in the $12 to $15 range, followed by a brand in an even higher price range. In 1995 the winery also launched a line of Italian varietals.
Demand for Australian wine in the United States skyrocketed as American consumers enjoyed the Australian style of wine. Its worldwide trademark of generous flavors, soft tannins, and accessible fruit made this wine easier to like when young, a perfect style of wine for Americans. In 1990 the Australians shipped only 578,000 cases of wine to the United States. By the decade's end, the Australian Wine Bureau reported that more than 4 million cases of Australian wine would be shipped to the United States by 2001, and by 2026 shipments should total more than 10 million cases with an estimated value of
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$440 million. Chilean wine became popular in the late 1990s and early 2000s as well, with Chilean exports up 15.6 percent, but falling prices earned them only 1.4 percent more money. Exports of Chilean wine to the United States fell 1.8 percent in 2001. South African wines, meanwhile, grew faster than projected, growing by 29 percent and increasing 133 percent in value, based on 1999 sales figures.
In late 2001, the United States, Canada, Australia, Chile, and New Zealand signed the Mutual Acceptance Agreement on Oenological Practices. The wine trade agreement was a significant development in promoting international wine commerce and would loosen trade restrictions for U.S. wines. John De Luca, president and CEO of the Wine Institute in San Francisco exclaimed, "This agreement is a breakthrough for the world wine trade that recognizes the effectiveness of other country's regulatory and enforcement systems for assuring that producers comply with its country's standards." Argentina and South Africa had the option to sign the agreement prior to March 2002.
According to the Department of Commerce, U.S. wine exports totaled $541 million in 2001. The largest market was the United Kingdom, which grew by 32 percent in volume with values of exports rising 20 percent to $170 million in that market. Other leading markets included Canada, with $95 million; the Netherlands, with $69 million; Japan, with $57 million; Belgium, with $28 million; the Federal Republic of Germany, with $14 million; Ireland, with $14 million; France, with $7.1 million; Sweden, with $6.6 million; and Denmark, with $6.2 million. Champagne and sparkling wine exports totaled 25 million gallons valued at $31 million, down from a high of 37 million gallons in 1999 due to consumers stocking up for millennium celebrations. Dessert wine exports were $31 million, and grape must and other fermented beverage exports stood at $22 million in 2001. In total, the United Stats shipped 1 percent less wine in 2001 than the previous year. Mexico was expected to be an important market in the twenty-first century because, according to the North American Free Trade Agreement (NAFTA), the 16 percent tariff on American wine sales to that country would be lifted around the year 2004.
Further ReadingsBaker, Deborah J., ed. Ward's Business Directory of U.S. Private and Public Companies. Detroit: Thomson Gale, 2003.
"Bottled Perfection." Entrepreneur, February 2005.
"Business: Blended; Wine Industry Mergers." The Economist, 25 January 2003.
"California Vintners Getting Stomped After a Decade of Growth." The San Diego Union-Tribune, 7 January 2003.
Carlsen, Clifford. "Full-bodied Sales Make 1994 Vintage Year for Wineries." San Francisco Business Times, 4 August 1995.
------. "Robust Year of Sales Gives Wine Makers a Healthy Glow." San
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Francisco Business Times, 15 November 1996.
Ceausu, Joel. "US: Winegrowing Study Results Revealed." Entrepreneur,February 2005.
Cioletti, Jeff. "Three Markets in One." Beverage World, 15 February 2005.
"Crisp Pinot Grigio at Last Gets Chance to Sparkle as Chardonnay Alternative." Nation's Restaurant News, 10 February 2003.
"Fetzer Vineyards." Beverage Industry, 18 November 2002.
George, Jason. "An Italian Tradition Moves from the Cellar to the Classroom." The New York Times, 27 September 2004.
"GP Life: Drink." GP, 5 July 2004.
Hallett, Vicky. "Vintage Me, 2004." U.S. News & World Report, 27 September 2004.
"Hoover's Company Capsules." Hoover's Online, 2005. Available from http://www.hoovers.com.
Lazich, Robert S., ed. Market Share Reporter. Detroit: Thomson Gale, 2005.
"Plastic Corks Coming of Age; Low Cost Appeals to Vintners." South Florida Sun-Sentinel, 6 February 2003.
"Seeing Red: Changing Preferences Make U.S. Wineries Happy to be 'In the Red.'" Beverage Industry, July 2002.
"Too Many Bottles, Not Enough Buyers; Wine Industry Souring." Seattle Times,24 January 2003.
"Up Close with Peter Mondavi, Jr." Beverage Industry, July 2002.
U.S. Department of Labor. Industry-Specific Occupational Employment Statistics, 17 February 2005. Available from http://www.bls.gov.
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Whitley, Robert. "Big Cult Is Swallowing $1.99 Wine." The San Diego Union-Tribune, 25 February 2003.
Wine Institute. "California Vintners and Growers Introduce Code of Sustainable Winegrowing Guidelines," October 2001. Available from http://www.wineinstitute.org.
------. "California Wine Industry Statistical Highlights," December 2004. Available from http://www.wineinstitute.org.
------. "Despite Economic Conditions, September 11 and the Strong Dollar 2001 California Wine Shipments Up One Percent," April 2002. Available from http://www.wineinstitute.org.
------. "New Ground-Breaking Report Documents California Sustainable Winegrowing Practices," 6 October 2004. Available from http://www.wineinstitute.org.
------. "Strong Sales Growth in 2004 for California Wine as Shipments Reached New High," 5 April 2004. Available from http://www.wineinstitute.org.
------. "United States, Canada, Australia, Chile and New Zealand Sign Mutual Acceptance Agreement on Oenological Practices," December 2001. Available from http://www.wineinstitute.org.
------. "U.S. House and Senate Approve Limited Direct Wine Shipments for Winery Visitors," October 2002. Available from http://www.wineinstitute.org.
------. "U.S. Wine Exports Up Three Percent in Volume, Strong Dollar Contributes to One Percent Decrease in Revenues," May 2002. Available from http://www.wineinstitute.org.
Source Citation: "Wines, Brandy, and Brandy Spirits." Encyclopedia of American Industries. Online Edition. Thomson Gale, 2006. Reproduced in Business andCompany Resource Center. Farmington Hills, Mich.:Gale Group. 2007.http://galenet.galegroup.com/servlet/BCRC
Document Number: I2501400038
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© 2007 by The Gale Group, Inc.
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1
Section 1. Globalization &Global Trade Overview
Professor Baizhu ChenFBE462
Marshall School of Business
2
Overview Questions
Discussion of Globalization List some stylized facts about the world
trade What is Mercantilism?
3
1. Globalization
Product Market – Trade FlowWorld Merchandise export as % of GDP
0
1
2
3
4
5
6
7
8
9
1889 1913 1929 1950 1960 1970 1980 1990 20004
Globalization
International Interdependence, % import of GDP Export of G&S 1970 1998 United States 6% 12% United Kingdom 23 29 Japan 11 10 Netherlands 42 56 Germany 21 27 Singapore 102 170 China 3 22 Belgium 52 73 Korea 14 28
5
Globalization
6
Globalization
22.62.72.24.941.74.419.8World49.93.01.71.716.82.222.5Asia48.67.33.50.816.00.915.5Middle East17.71.510.20.648.42.518.9Africa
7.62.31.124.556.81.74.6C.E Europe/CIS
7.92.62.56.867.71.89.5Western Europe7.61.21.41.213.615.657.8Latin America
22.02.11.20.818.115.440.5North America
AsiaMiddleEast
AfricaCIS/CE Europe
WesternEurope
LatinAmerica
NorthAmerica
destinationorigin
Destination of Merchandise Export, 2003
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FBE-462: Powerpoints
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7
Globalization
8
Globalization
transaction costs are lower but still exist
Bald
win
& M
artin
NBE
R 69
04
9
Globalization
Bald
win
& M
artin
NBE
R 69
04
10
Pr
oduc
t Mar
ket –
LO
OP
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Globalization
10.6107.96.28.16.28.57.2US29.128.323.821.9151538.552.3UK6.54.76.93.31.91.29.90.8Japan14.411.19.29.75.31.10.811.1Germany13.6129.262.76.827.821.1France
19971995199019851980196019381914
Outward FDI Stock as a % of GDP
Factor Market – FDI
12
Globalization
World FDI Stock as a % of World Output
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FBE-462: Powerpoints
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13
Globalization
Correlation between domestic savingsand domestic investment
14
Globalization
Foreign securities held by Pension, % of total assets
US Japan UK
15
Globalization
1900 1920 1960 1980 200019400
5
10
15
20percentage
Share of U.S. Population That is Foreign-Born1900-2000
Source: Department of Commerce Historical Statistics of the US Colonial Times to 1970, USStatistical Abstract 2000
Factor M
arket – Labor
16
Overview of World Trade
17
Overview of World Trade
2003, leading merchandise exporters and importers
$7.7TTotal World$7.5TTotal World3.0Belgium3.4Belgium3.2Canada3.6Canada3.4Netherlands3.9Italy3.7Italy3.9Netherlands4.9Japan4.1UK5.0France5.2France5.0UK5.8China5.3China6.3Japan7.7Germany9.6US
16.8US10.0GermanyImport ShareCountryExport ShareCountry
18
Overview of World Trade
$1.8TWorld Total$1.8TWorld Total2.8Canada2.5HK, China2.8Ireland2.6China3.1China3.5Netherlands3.6Netherlands3.9Japan4.2Italy4.0Italy4.7France4.2Spain6.2Japan5.5France6.6UK6.4Germany9.6Germany8.0UK
12.8US16.0USImport ShareCountryExport ShareCountry
2003, leading service exporters and importers
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FBE-462: Powerpoints
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19
Overview of World Trade
8.59.76 Econom ies in E. A sia
1.10.8India
0.71.1B razil
5.96.5C hina
30%34.6%D eveloping N ations
1.41.2A ustralia/N ew Zealand
4.86.4Japan
44.845.3Europe
19.012.5U S & C anada
70%65.4%D eveloped N ations
进口占全球比例出口比例占全球Merchandise/2004
20
Overview of World TradeShare of China and other Asian countries in US merchandise imports, 1990-03 (%)
21
Overview of World Trade
Intra-regional trade of major RTAs, share in world exports
22
Overview of World Trade
Foods & Beverage 45
Industry Supplies 148
Capital Goods 300
Auto & Parts 69
Consumer Goods 83
Others 32
Total 676
Meat 7Soybeans 5
Corn 5Chemicals 26
plastic 13others 13
semiconductor 42Computer accessories 34Telecom equipment 26
Civilian aircraft 25
Pharmaceutical preparations 15Apparel, textiles7
US Export (Jan – Nov 2001, billion)
23
Overview of World Trade
Foods & Beverage 43
Industry Supplies 258
Capital Goods 276
Auto & Parts 174
Consumer Goods 262
Others 44
Total 1057
fish 9meat 6wine 4
Crude oil 70Chemical 18
Natural gas 16
Computer accessories 57Semiconductor 29
Telecom equipment 22Electronic apparatus 22
Apparel 64Pharmaceutical preparations 30
Toys 20
US Import (Jan – Nov 2001, billion)24
US Trade Deficits (Quarterly)
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FBE-462: Powerpoints
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25 26
2. Mercantilism
Assumption: the wealth of the nation ismeasured by the nation’s stock of preciousmetals export goods to other nations => receive
precious metals from other nations import goods from other nations => pay
precious metals to other nations
27
- Mercantilism
If a nation’s export exceeds its import =>its stock of precious metals increase => wealth increases
If a nation’s export exceeds its export =>its stock of precious metals decrease => wealth decreases
28
- Mercantilism
Policy implication based on Mercantilism: a nation’s wealth can be accumulated through
export rather than import trade is a zero-sum game trade policy should be used to promote export trade policy should be used to restrict import
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FBE-462: Powerpoints
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1
Section 2. Is Trade A Zero-Sum Game?
Professor Baizhu ChenFBE462
Marshall School of Business
2
1. Overview Questions
What is consumer’s surplus? What is producer’s surplus? Will a small nation gain from trade? Is trade a zero-sum game?
3
2. Demand
Consumer decision: max U(q1,q2) Budget constraint: F(q1,q2, p1, p2, I) = 0 Demand function: qi=qi(p1, p2, I)
p
q
4
- Demand
Consumer surplus: measures the amount a consumer gains from a
purchase by the difference between the pricehe actually pays and the price he would havebeen willing to pay
5
- Demand
In the diagram, the consumer surplus ofconsuming 10 units of apple is given by a
12
10
a
b
p
q
6
- Supply
Producer’s decision: max pq-c(q) the cost function c(q) depends on factor
prices and techniques of production (# offactors required to produce one unit output)
supply function: qs=qs(p, …)p
q
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FBE-462: Powerpoints
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7
- Supply
Producer surplus: measures the amount a producer gains from a
sale by the difference between the price heactually receives and the price he would havebeen willing to accept
8
- Supply
In the diagram, the producer surplus ofselling 10 units of apple is a
p
p
a
b
10
9
3. From Autarky To Open Economy
Autarky total welfare of this nation = ?
p
q
D
S
a
b
10
- From Autarky To Open Economy
Small country: price is taken as given welfare with trade = ? gains = ?
p* c
de
11
- From Autarky To Open Economy
Large country: price is endogenous Two countries: Home and Foreign
p c
de
Hp* c*
d*e*
F
F exportsupply
H importdemand
12
- From Autarky To Open Economy
world market price: determined by the worlddemand and supply
==> gains from trade In Home country, anyone worse off? Income distribution: across nations, within
the same nation
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FBE-462: Powerpoints
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4. General Equilibrium Approach
P
Cloth
Wheat
A
General equilibriumanalysis Two goods Autarky equilibrium – A Relative price of cloth - p
14
General Equilibrium Approach
General equilibriumanalysis World relative price – p* Production – B Consumption – C Country gains from trade Gains are not distributed
evenly Trade creates winners
and losers
Cloth
P
Wheat
A
B●
●
C
P*
15
Gains From Trade
Terms of trade (TOT) Relative price of
export to import When TOT improves,
the country is betteroff
P*
Wheat
A
B
●
●
C
D
Cloth
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 3. Why Nations Trade (I)?
Professor Baizhu ChenFBE462
Marshall School of Business
2
Overview Questions
Know the determinants of trade pattern What is comparative advantage? What is absolute advantage?
3
Determinants of Trade
Countries trade with each other becausethey are different Demands are different
(Dc/Dw)h
(Sc/Sw)h= (Sc/Sw)f
(Dc/Dw)f
C/W
Pc/Pw
(Pc/Pw)f
(Pc/Pw)h
4
Determinants of Trade
Supplies are different
(Sc/Sw)h
(Sc/Sw)f
(Dc/Dw)h= (Dc/Dw)f
Pc/Pw
C/W
(Pc/Pw)f
(Pc/Pw)h
5
Determinants of Trade
Demands are different because tastes differ it is hard to explain the difference in tastes
What cause the difference in supply? labor cost or labor productivity factor endowments
6
Ricardo’s Theory ofComparative Advantage
Consider a simple situation: two countries, two goods produced by labor, labor fully mobile domestically not
internationally, full employment no trade barrier, perfect competition
Will Mexico be able to export?
Labor cost to make In Mexico In the US1 bushel of Wheat 4 hours 1 hours1 yard of cloth 2 hours 1.5 hour
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FBE-462: Powerpoints
7
Ricardo’s Theory ofComparative Advantage
If no trade between them, the opportunitycost of producing cloth in Mexico: 0.5 bushel of wheat per yard in US: 1.5 bushel of wheat per per yard
Mexico USOne bushel of wheat
One yard of cloth
Save 0.5 bushelof wheat
Get 0.5 morebushel of wheat
8
Ricardo’s Theory ofComparative Advantage
Comparative Advantage: If a country has a lower opportunity cost of
producing good A, the country has acomparative advantage in producing A
A country will export the good in which ithas a comparative advantage In Ricardo’s Theory: opportunity cost of
production is determined by the relative laborcost
9
Ricardo’s Theory ofComparative Advantage
If each country has 100 labor hour still assume the free-trade relative price of
wheat is one per yard of cloth (terms of trade)
50
25
wheat
Cloth 66.7
100wheat
Cloth
Mexico US
C2015
20 30
76
16 20
80C*
S0
S*0
S1
S*1
50
10
Ricardo’s Theory ofComparative Advantage
Countries gain from trade if trade is basedon comparative advantage
Trade is a positive sum game Mercantilism: Trade is a zero sum game
Direct comparison of the absolute laborcost of production is irrelevant for trade
The country that has an absolute advantagein labor cost has a higher wage
11
Ricardo’s Theory ofComparative Advantage
Ricardian model implies extremely highdegree of specialization
Ricardian model implies that trade willbenefit everyone
12
Extension from Ricardo
wheat
Cloth
C
S1
wheat
Cloth
C
S1
S0
S0
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
Extension from Ricardo
wheat
Cloth
C
S1S0
Cloth
CS1
S0
Gains from trade with increasing cost ofproduction
wheat
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
1
Section 4. Why Nations Trade (II)
2
Module Objectives
To explain why countries with similartechnologies trade
Income distribution effect of trade
3
Factor Endowments
How to explain this trade pattern?
4
Factor Endowments
Consider a simple situation: Two factors of production: labor and capital factors can freely move domestically but not
internationally, full employment technologies of production are the same for all
countries (two countries) no trade barriers, perfect competition countries differ in their endowments
5
They Have the Same Technology
Japan endowments: Land=10, Labor=8 US endowments: Land=20, Labor=10
Wheat Cloth
Land
Labor
3
1
1
3
3W + C =10W + 3C = 8
3W + C = 20W + 3C = 10
US
Japan
6
Will A Less Resource Nation BeAble to Export?
US is said to be land abundant and Japan islabor abundant
Cloth is said to be labor intensive, andWheat is land intensive
Will Japan be able to find anything toexport?
Keith Parker, University of Southern California
FBE-462: Powerpoints
2
7
Production Possibility Frontier
10/3
W
C
10
20/3
20
10/3
10
W
C
8
8/3
3W + C = 10W + 3C = 8
Japan
3W + C = 20W + 3C = 10
US
8
Which Country RelativelySupply More?
More general, production possibilityfrontiers in these countries which country relatively supply cloth more at
any given relative price?
W
C
JapanW
C
US
9
Factor Endowments Determine
Countries export the products that use theirabundant factors intensively Heckscher-Ohlin Theory
To know your advantage: Which factors are abundant? Does your industry use the abundant factor
intensively?
10
Comparison of Factor Endowments
11
Who Wins and Who Loses?
For simplicity, assume that productiontechnologies are constant
W is land intensive, C is labor intensive capital-labor ratio:
W: 1/3 C: 3 W C
Land
labor
3
1
1
3
12
- Who Wins and Who Loses?
Assume the prices are: Wheat: Pw = $14 Cloth: Pc = $10
Perfect competitive conditions: MC of producing cloth = MR of selling cloth MC of producing wheat = MR of selling wheat
Keith Parker, University of Southern California
FBE-462: Powerpoints
3
13
- Who Wins and Who Loses?
3r + w = $14 r+ 3w = $10 ==> equilibrium factor prices
r = $4 w = $2 r
w
Pc
Pw14
- Who Wins and Who Loses?
Suppose Pc increases by 20% 3r + w = $14 r + 3w = $12
r = $3.75 w = $2.75
r
w
Pc
Pw
15
- Who Wins and Who Loses?
==> %Δr = -6.25% ==> %Δw = 37.5% %Δr < 0 = %ΔPw < %ΔPc =20% < %Δw those factors intensively used in sectors
with prices increase will be better off those factors not intensively used in sectors
with prices increase will be worse off Stolper-Samuelson Theorem
16
- Who Wins and Who Loses?
Application: Suppose U.S. has export andimport sectors. Assume export sector ishigh-skill labor intensive and import is low-skill labor intensive. U.S. is high-skill laborabundant
who will support freer trade in U.S.?
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
1
Section 5 Economies of Scaleand Trade
2
Module Objectives
To explain the scale economies To explain trade that is not based on the
standard assumptions
3
Patterns of Trade of US
4
Inter- versus Intra-Industry Trade
How to explain intra-industry trade? A country exports and imports goods of the same
industry Can difference in labor cost and factor
endowments explain intra-industry trade? Inter-industry trade
a country exports goods in some industries andimports goods in other industries.
5
Economies of Scale
External economies of scale (EES) average production cost of a firm is lower if
the whole industry at a particular location islarger but does not depend on the size of thefirm
Internal economies of scale (IES) average production cost of a firm is lower if
the firm size is larger
6
Economies of Scale
Examples of EES? What kinds of market structures are
consistent with EES? If EES is significant, history, luck,
coincidence, or government policy playimportant role in determining the pattern oftrade
Policy implications?
Keith Parker, University of Southern California
FBE-462: Powerpoints
2
7
Economies of Scale
What can lead to Internal Economies of Scale? What kinds of market structures are consistent
with IES?
8
Scale Economies andMonopolistic Competition
Consider differentiated product - products that are
seemingly the same good but that are perceived byconsumer to have real or imagined difference
consumers value varieties monopolistic competition - a producer has a
monopolistic power on his brand; but competewith other brands
scale economies - size of the firm increasesreduces the cost of production (two types of scaleeconomies)
9
Scale Economies and ProductDifferentiation
Two nations: US and UK, two types of car cheap car expensive car labor output labor output 10 5 20 5 15 10 25 10 20 15 30 15 25 20 35 20 30 25 40 25 35 30 45 30
10
Countries Are Identical
Assume U.S. and UK were identical, andeach has 35 labors
Assume in autarky, each produce 10 cheapcars and 5 expensive cars
11
Gains From Trade
If U.S. and UK can trade with each other,consider the following two situations: U.S. uses 35 labors produce cheap car and UK
uses 35 labors produce expensive car => howmany cheap and expensive cars total?
12
Gains From Trade, Again
U.S. uses 35 labors produce expensive car andUK uses 35 labors produce cheap car => howmany cheap and expensive cars total?
Keith Parker, University of Southern California
FBE-462: Powerpoints
3
13
Why Trade Benefits?
With economies of scale and productdifferentiation, nations with similarcharacteristics will still trade with eachother to explore the scale of the market to satisfy the diversified needs of consumer
14
Scale Economies andMonopolistic Competition
How to describe the pattern of trade? Japan - capital abundant Canada - land abundant Two goods: manufacturing (capital intensive)
and food (land intensive) differentiated products in manufacturing with
increasing returns to scale
15
Patterns of Trade
Canada
Japan
Food Manufacturingproducts
16
What If Market Sizes Differ?
If nations have different sizes of marketsand trade has to incur transportation costs,what kind of pattern of trade will it be? => country with a larger demand for a good
will likely to be the export of this good, if scaleeconomies are present
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 6. Growth and Trade
2
1. Overview Questions
What is the Rybczynski Theorem? What is the “Dutch Disease”? Under what circumstances the
immiserizing growth will more likelyoccur?
What is the product cycle theory?
3
2. Rybczynski Theorem
Two factors of production: labor and capital factors can freely move domestically but
not internationally all factors are fully employed technologies of production are the same for
all countries no natural and man-made trade barriers perfect competition
4
- Rybczynski Theorem
Consider only two goods: wheat and cloth
W C
L
K
5
- Rybczynski Theorem
For simplicity, first assume that productiontechnologies are constant
W is labor intensive, C is capital intensive capital-labor ratio:
W: 1/3 C: 3 W C
L
K
3
1
1
3
6
- Rybczynski Theorem
Home country endowments: Labor: 10 capital: 14
full employment condition: 3W + C = 10 W + 3C = 14 A: (W,C)=(2,4) 10/3
10
W
C
14
14/3
A
K
L
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
- Rybczynski Theorem
Suppose L increases by 20% A: (W,C) = (2.75, 3.25) W↑by 37.5%, C↓ by 18.75%
10/3
10
W
C
14
14/3
A
K
L
8
- Rybczynski Theorem
If one factor endowment increases, the industryuses the factor intensive will grow, the otherindustry will decline
“Dutch Disease” The deindustrialization of an economy as a result of the
discovery of a natural resource. So named because itoccurred in Holland after the discovery of North Sea gas; ithas also been applied to the UK since the discovery ofNorth Sea oil. The discovery of such a resource lifts thevalue of the country's currency, making manufacturedgoods less competitive; exports therefore decline andimports rise.
Ÿ Dictionary of Business, Oxford University Press
9
3. Immiserizing Growth
For a small country, growth is always good.
W
C10
- Immiserizing Growth
Balanced growth for a large country The country tends to be better off
W
C
11
- Immiserizing Growth
Growth biased toward to the import sectorfor a large country => better off
W
C12
- Immiserizing Growth
Growth biased toward to the export sectorfor a large country => maybe worse off
W
C
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FBE-462: Powerpoints
13
- Immiserizing Growth
Two effects when a large country grows growth effect => tends to make it better off TOT effect
if growth biased toward to import sector =>TOTimproves
if growth biased toward to export sector => TOTworsens
If TOT worsens so much that dominates thegrowth effects => growth is immiserizing
14
- Immiserizing Growth
Conditions that growth causes TOT worsenssuch that immiserizing growth occurs: growth strongly biased toward to the export sector world demand for the export good is very inelastic the country is heavily dependent on the export
sector (heavily involved in trade) before growth the country must be a large economy
15
4. Product Cycle Theory
Dynamics of Comparative Advantage comparative advantage changes overtime
because of economic growth
16
Product Cycle Theory
New Product Stage high income countries (US) produce and
consume new product firms need to familiarize the products and to detect
consumer response high R&D cost, high cost in advertising, sales
promotion, marketing, etc. demand is local almost no international trade
17
Product Cycle Theory
Maturing Product Stage standards begin to emerge and large-scale
production is adopted economies of scale begin to realize first high income countries (US) exports to medium
income nations (Spain) later medium income nations (Spain) export to high
income countries (US) foreign direct investment occurs, and MNCs emerge
18
Product Cycle Theory
Standardized Product Stage product is familiar to consumers production processes can be easily learnt
labor costs play an important role developed countries busy introducing other new
products production shifts to developing counties developed countries become the importer
Keith Parker, University of Southern California
FBE-462: Powerpoints
19
Product Cycle Theory
t0 t1 t2New productstage
Maturingproduct stage
Standardizedproduct stage
Production,consumption ofa product
U.S. Production
U.S.Consumption
exportsimports
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 7. Tariff
2
1. Overview Questions
What are different types of tariffs? What happens to terms of trade when a
small country imposes a tariff? a largecountry?
What is the effective rate of protection? What is the optimal tariff rate?
3
2. Basics of Tariff
tax on import or export ad valorem tariff: P = P* (1+t) specific tariff: P = P* + t
4
Basics of Tariff
Source: http://www.usitc.gov/tata/hts/bychapter/index.htm
5
Basics of Tariff
Tariff structures can be quite complicated wristwatches with case of precious metal or of
metal clad with precious metal: withmechanical display only, having no jewels oronly one jewel in the movementMFN: 51c each +6.25% on the case & strap, band
or bracelet +5.3% on the batteryNon-MFN: $2.25 each +45% on the case+80% on
strap, band or bracelet +35% on the battery
6
Basics of Tariff
Tariff Rates in China, 1995
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
- Basics of Tariff
Preferential duties tariff rates applied to an import according to its
geographical source; a country that is givenpreferential treatment pays a lower tariff
e.g., British Commonwealth, EU, NAFTA GSP (generalized system of preferences)
developed countries permit duty-free entry of aselected list of products if those products areimported from particular developing countries
8
- Basics of Tariff
Measurement of tariff rates unweighted average tariff rate
10% on Good A, 15% on good B, 20% on good C unweighted average tariff rate = 15% overstate the height of the country’s average tariff if the
country imports mostly good A
weighted average tariff rate value of A import $500, B $200, C$100 weighted average tariff rate = 12.5% What is the problem of using weighted average tariff rate as a
measure of degree of protection?
9
3. Welfare of Import Duty
small nation: its TOT is given tariff has no effect on its TOT gain or loss?
P
Q
DS
P*
P*+ t
a
b
fc d e
10
- Welfare of Import Duty
large nation: tariff affects its TOT gain or loss?
P
Q
DS
P*
P*+ t
P*
a
b
c
ed
fi
g h
11
- Welfare of Import Duty
Effects of tariff consumption effect production effect trade effect revenue effect redistribution effect terms of trade effect
12
- Welfare of Import Duty
tariff=consumption tax+production subsidy e.g. $10 shirt, 50% tariff => P = $15,
government collects $5 This is equivalent to a 50% consumption tax +
50% production subsidy
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
- Welfare of Import Duty
Optimal tariff the tariff rate that maximizes the welfare of the
tariff-imposing nation what is the optimal tariff of a small nation? what is the optimal tariff of a large nation? Why U.S. does not impose the optimal tariff?
14
- Welfare of Import Duty
A country has both tariffs on its car importsand auto engine imports. The countryproduces cars using imported auto engine.As the pressure of trade liberalization rises,the country pledges to move toward freertrade by eliminating the tariff on engineimports. Evaluate the country’s policy.
15
- Welfare of Import Duty
effective rate of tariff when there are different levels of production,
and at each level, there is a tariff imposed, howto measure the degree of protection?
16
4. Welfare of Export Duty
examples of export tax: cocoa (Ghana) coffee (Brazil and Colombia) jute (Pakistan) rice (Burma and Thailand) timber (Ivory Coast and Liberia) tea (Sri Lanka) tin (Malaysia)
17
- Welfare of Export Duty
small country: export duty $25
Pw=60
D
S
20
P=35a
bc
d
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 8. Non-tariff Barriers
2
1. Overview Questions
What are the effects of an export tariff? What are the differences and similarities of
a tariff, quota, and VER? Name some other non-tariff barriers
3
2. Quota and VER
Tariff, Quota and VER What if it is a large nation?
P
Q
10
12
q1 q2
a b c d
q3 q44
- Quota and VER
Quota versus Tariff With increasing foreign competition, quota
offers more protection to domestic industriesthan tariff
Quotas provide bureaucrats more power quotas are more likely to create a domestic
monopoly than tariff
5
- Quota and VER
MFA: multifiber arrangement (1974) iron and steel sugar (quota + tariff)
1989, US sugar price $0.2281/lb, World price$0.1445, equivalent tariff rate of 58%
Japanese car 1981, 1.68 million cars (VER) to U.S. 84-85, increased to 1.85 million cars
6
3. Other Barriers
Local content requirement technical, administrative and other
regulations health and technical regulations
Government procurement policies “Buy America” act
Fed government agencies must buy from home U.S.firms unless the price is 6% abover foreigners’
for Department of Defense, this figure is 12%
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
- Other Barriers
Reclassification Restrictions on services trade
restrictions on foreign insurance companies foreign ships not allowed from carrying cargo
between purely domestic ports (U.S., etc.) landing rights for foreign aircraft limited (open
space? Canada, EU versus US)
8
- Other Barriers
Foreign exchange controls exporters are required to sell their foreign
exchange earnings to the central bank, whichin term parcels out to importers selectively
Advance deposit requirement license to import is awarded only if the
importing firm deposits with the governmentspecific funds
9 10
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 9 Protect or Not to Protect
2
1. Overview Questions
What is market failure? What is the implication to trade when
market fails What is the Coase Theorem? What is the industrial policy?
3
2. For and Against Free Trade
Arguments for free trade efficiency scale economy transfer of technology reducing social cost (e.g. rent-seeking cost)
4
-For and Against Free Trade
Arguments against free trade optimal tariff theory Revenue Income Distribution/welfare policy Political and strategic objectives market failure
free trade no longer optimal=> policy need to beused to correct market failure
5 6
Keith Parker, University of Southern California
FBE-462: Powerpoints
7 8
9
3. What if market fails?
Market fails if there is monopoly, orincreasing returns to scale, or, …
When market fails, the price no longerreflects the opportunity cost of producingthis good
When market fails, producer’s surplus orconsumer surplus does not fully capture thebenefit of producing or consuming a good
10
- What if market fails?
If the market fails to compensate theproducer for the extra benefits generated
p
Q
Sso =MCso
Spr=MCpr
11
- What if market fails?
What is the first-best policy to correctmarket failure? - a positive externality
p
Q
Sso
Spr
pw=10
q1 q3 q4
12
q2
a b c de
12
- What if market fails?
What is the first-best policy to correctmarket failure? - a negative externality
p
Q
SprSso
pw=10
q1 q3 q4
8
q2
ab
cd e f
gh
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
- What if market fails?
The first-best policy is always the onewhich can directly correct the market failure
The second-best policy is the one which ismost closely targeted to the market failurethough cannot directly correct it.
A general rule: The closer a policy is targeted to the problem,
the better it is (requires to identify theproblem!)
14
- What if market fails?
An alternative to impose policies, specifythe property rights Coase Theorem
If costless negotion is possible, rights are well-specified, and redistribution does not affectmarginal values, thenŸ the allocation of resources will be identical whatever the
allocation of legal rights, andŸ the allocation will be efficient, so there is no problem of
externality, further moreŸ if additional policy (tax/subsidy) is imposed in such a
situation, efficiency will be lost.
15
- What if market fails?
Purse-seine fishing of tuna fish results indrowning of dolphin (similarly the seaturtles killed trapping in the nets withshrimp)
What is the source of problems? What are the policy options?
16
- What if market fails?
The African elephant population was cut inhalf within a span of 8 yrs in 1980s due topoaching
Public pressure from affluent countries tosave the elephants intensified in late 1980sand early 1990s
What is the source of problem? What are the policy options?
17
4. Industrial Policy
Government policy to channel resources toparticular industries, generally thoseindustries that government views asimportant to future economic growth
Instruments used to channel resources: tariff, direct production subsidy, government
procurement, free R&D, cheap credit, etc... Should or should not use industrial policy?
18
- Industrial Policy
Consider using industrial policy for thefollowings: industries with high value-added per worker upstream industries industries with future growth potential high-tech industries
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 10. Pushing Export
2
1. Overview Questions
What is dumping? What is countervailing duty? Explain the strategic trade policy
3
2. Dumping and Anti-dumping
The product is sold in another country at aprice less than fair value. less than the price of the like product in the
exporting country or (in the absence of such domestic price) less
than the highest comparable price of the likeproduct selling in any third country
or less than the cost of production in thecountry of origin
4
- Dumping and Anti-dumping
dumping if the good is selling below “fairmarket value”
how to calculate the “fair market value” Conditions for dumping to occur:
imperfect market segmented markets
5
- Dumping and Anti-dumping
types of dumping predatory dumping cyclical dumping persistent dumping
6
- Dumping and Anti-dumping
Persistent Dumping perfect competition in foreign market monopoly domestic
MC
Ddom
Dfor=MRfor
MRdom
P
Q
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
- Dumping and Anti-dumping
antidumping duty can be imposed if dumping occurred (selling at less than fair
value) ITA of Commerce Dept. determines if dumping
occurs
dumping causing material injury to plaintiff ITC determines if material injury occurs
8
- Dumping and Anti-dumping
Petition
ITA
Casedismissed
If not belowLTFV
ITC
Casedismissed
If no injury
ITA
Negotiatesettlement
Imposepenalty
9
- Dumping and Anti-dumping
Numbers of antidumping investigations inU.S. 1980 37 1985 63 1981 15 1986 71 1982 65 1987 15 1983 46 1988 42 1984 74 1989 23 Total 1980-1989: 451
10
- Dumping and Anti-dumping
Target industries of U.S. antidumpinginvestigations Chemicals 58 Food 16 Iron and Steel 201 Machinery 8 Textiles and apparel 15 others 153 Total 1980-1989: 451
11
- Dumping and Anti-dumping
Target countries of U.S. antidumpinginvestigations, 1980-1989 Japan 58 Brazil 24 Germany 29 France 22 Korea 27 UK 18 Italy 26 China 17 Canada 25
12
- Dumping and Anti-dumping
U.S. cases 1980 1982 1985 total(80-85)
duties 10(27%) 13(20%) 25(40%) 82(27%)
rejected 9(24%) 21(32%) 20(32%) 104(35%)
withdrawn 18(49%) 31(48%) 18(29%) 114(38%)
total cases 37 65 63 300
U.S. International Trade Commission Annual Report
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
3. Export Subsidy and Countervailing Duty
welfare cost of export subsidy what if it is a large nation?
P
a b c dPw
ps
14
- Export Subsidy and Countervailing Duty
European Common Agriculture Policy(CAP) EC members: Germany, France, Italy,
Belgium, Netherlands, Luxembourg, UK,Ireland, Denmark, Greece, Spain, Portugal.
15
- Export Subsidy and Countervailing Duty
Million T Million T
16
- Export Subsidy and Countervailing Duty
According to GATT/WTO, export subsidyis to be condemned (except farm subsidy)
Countervailing duty is permitted if export subsidy is found if the subsidized export cause or threaten to
cause material injury to domestic firms
17
- Export Subsidy and Countervailing Duty
Numbers of CVD investigations in U.S. 1980 69 1985 63 1981 17 1986 71 1982 116 1987 15 1983 8 1988 42 1984 26 1989 23 Total 1980-1989: 301
18
- Export Subsidy and Countervailing Duty
Target countries of U.S. CVDinvestigations, 1980-1989 Japan 17 Brazil 36 Germany 18 France 28 Korea 17 UK 18 Italy 24 China -- Canada 18
Keith Parker, University of Southern California
FBE-462: Powerpoints
19
4. Strategic Trade Policy
Government may encourage exporters toform cartel to extract rents from foreigncountries OPEC, MITI
An importing country facing a foreigncartel may tax the import to extract backpart of the monopoly rents.
20
- Strategic Trade Policy
Airbus v.s. Boeing If Boeing starts produce first
Boeing
AirbusP NP
P
NP
-5
-5
0
100
100
0
0
0
21
- Strategic Trade Policy
Airbus v.s. Boeing If Europe subsidizes Airbus $25
Boeing
AirbusP NP
P
NP
20
-5
0
100
125
0
0
022
- Strategic Trade Policy
Airbus v.s. Boeing If Europe and US both subsidy their firms
Boeing
AirbusP NP
P
NP
20
20
0
120
120
0
0
0
23
- Strategic Trade Policy
Suppose the payoff matrix is the following What if EC $25 subsidy
Boeing
AirbusP NP
P
NP
-20
5
0
125
100
0
0
024
- Strategic Trade Policy
What lessons we learn from these? strategic trade policy is a beggar-thy-neighbor
policy strategic trade policy could be used to increase
the welfare of the nation imposing the policy it is not clear that strategic trade policy will
always increase the welfare of the nation if foreign nation retaliates, all nations may be
worse off in this non-cooperative game
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 11. Trade Blocs andTrade Blocks
2
1. Trade Blocs
Free-trade-area countries abolish all import duties on their
mutual trade in all goods, but each country hasits own tariffs for the rest of the world
Andean GroupŸ Bolivia, Colombia, Ecuador, Peru, Venezuela
European Free Trade Association (EFTA)Ÿ Austria, Finland, Iceland, Liechtenstein, Norway,
Sweden and Switzerland
NAFTA transshipment and rules of origin
3
- Trade Blocs
Customs Union a free-trade-area with a common external tariff
toward the rest of the world Benelux (1947, later absorbed into EC in 1958)
Ÿ Belgium, Netherlands, and Luxembourg
ASEAN (loose association-moving towardcustoms union)Ÿ Brunei, Indonesia, Malaysia, Philippines, Singapore,
Thailand
no transshipment problem
4
- Trade Blocs
Common Market a customs union with mobility of factors of
production EC (European Community, 1958, Treaties of Rome) MERCOSUR (Southern Cone Common Market)
Ÿ Argentina, Brazil, Paraguay, Uruguay
Central American Common MarketŸ Costa Rica, El Salvador, Guatemala, Honduras,
Nicaragua
5
- Trade Blocs
Economic Union a common market with unified fiscal,
monetary and socioeconomic policies European Union
Ÿ Belgium, Denmark, France, Germany, Greece, Ireland,Italy, Luxembourg, Netherlands, Portugal, Spain and UK
6
- Trade Blocs
Is a FTA always welfare improving? tariff $4
10
12
1415
SK
SUS
SM
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
- Trade Blocs
If U.S. and Korea form a FTA, US betteroff?
If U.S. and Mexico form a FTA, U.S. betteroff?
10
12
1415
SK
SUS
SM
ab c
ed f
ihg j
15
A CB D 8
- Trade Blocs
FTA improves welfare if Trade Creationdominates Trade Diversion
What kind of FTA likely improves welfare? more trade originally (large trade partner) low tariffs among members before FTA
relative to external tariff member nations complement with each others more members and larger size of economies if transportation => closer geographically
9
- Trade Blocs
NAFTA Benefits of being in NAFTA for each of the
following nations? U.S., Mexico, and Canada
EC Difference between EC and NAFTA?
PAFTA? (Pacific-Asia Free Trade Area) APEC
10
- Discuss:When Can SanctionsSucceed
Give some successful examples ofeconomic sanction
Give some unsuccessful examples ofeconomic sanction
Under what conditions economic sanctionswill be more successful?
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 12. WTO
2
History of WTO
1944 Bretton Woods IMF, World Bank and ITO (GATT) GATT suppose to be temporary GATT function
lists code of conduct dispute settlement multilateral negotiation
3
Principles of WTO
non-discrimination (MFN, Article I) trade liberalization
reciprocity any new tariff or increase in tariff must be offset by
cuts in other tariffs no unilateral quotas on imports, except threaten
“market disruption”
no unfair encouragement for exports no export subsidy, except agricultural goods
transparency protect through tariff 4
GATT/WTO negotiations
yr nations $ Kennedy Round: 62-67 48 40b Tokyo Round: 73-79 99 155b Uruguay Round: 86-93 108 1,000b
5
US Tariff Rates
Smoot-Hawley (1930)
% of of dutiable
% of total import
Kennedy RoundTokyo Round
6
Exemptions
Exemptions from GATT/WTO rules antidumping and countervailing duties (VI) safeguard arrangements (XIX) BOP and Economic Development (XII, XVIII) free trade areas (XXIV) general exemptions (XX, XXI)
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
GATT problems
“gray area”: VER abuse antidumping and CVD exemptions traditional issues: agriculture, T&C new issues: service, & IPR free-trade-area weak GATT institution
8
US Tariff and Non-tariffBarriers
Tariff (% of dutiable)
Equivalent tariff rate of non-tariff barriers
9
- GATT negotiations
GATT Rounds resulted tariff reduction % of nations’ trade subject to nontariff
barriers 1966 1986 US 36% 45% EU 21% 54% Japan 31% 43% All DC 25% 48% Laird & Yeats, Weltwirtschaftliches Archiv, 1990, 126, 2:299-326
10
The Uruguay Round
Accomplishment of Uruguay Round 40% reduction in tariffs agreement of all nations to recognize IPR agreement among developed nations on starting to
convert nontariff to tariff barriers on Textile &Clothing (over 10 years) and then cut tariff rate
Subsidies in agriculture be cut over six years by 20%,non-tariff barriers be converted to tariffs and cut by36%
more formalized institution (WTO) to monitor tariffreductions and resolve disputes
No agreements on financial services andtelecommunications yet, but talks continue
11 12
Achievement of WTO
Dispute settlement mechanism is working 104 disputes submitted in less than 2 years (compare
with 196 cases to GATT in 50 years) Case of Kodak v.s. Fuji Case of Costa Rica lingerie case v.s. US
Telecommunications Agreements (Feb. 1997) 68 nations (account for 90% of the revenue) pledged US, EU, and Japan fully liberalized by Jan 1, 1998
Financial Service Agreement (Dec. 1997) 102 nations (over 95% market) pledged US, EU fully open to foreign banks, insurance and
securities with minor exceptions
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
Unresolved Issues
Substantial trade barriers remain in some sectors Financial, entertainment, and publishing
Environmental concerns Worker’s rights Foreign Direct Investment
Local content requirement, local ownership rules,outright prohibition
Abusive use of antidumping
14
Some U.S. Trade Policies
US Trade Laws
15
Case: China’s Entry of WTO
Agriculture average tariff reduced to 17%, duty on US
major agri-export to 14.5% grace period to 2004 accept USDA certification tariff once lowered, cannot be increased tariff-rate quota (TRQ)
low tariff rate if within quota (1-3%), but high tariff exceedingthe quotaŸ soybean oil: TRQ currently 1.7 million cubic ton, increases to
3.3 million cubic ton in 2005, TRQ to be abolished in 200616
Case: China’s Entry of WTO
17
Case: China’s Entry of WTO
18
Case: China’s Entry of WTO
Export from US to China
Keith Parker, University of Southern California
FBE-462: Powerpoints
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Case: China’s Entry of WTO
Industrial Products average duty lower from 24.6% to 9.44% after WTO,
key products to 7.1% high tech products duty lower from 13.3% to 0, no
requirement of technological transfer lowered duty cannot be adjusted 2/3 of products grace period to 2003, majority of others
to 2005 no quotas on major US products (fertilizer, fiber
optical cable, etc.), grace period 5 years if there is a quota, increase 15% per year car quota 6 million, abolish by 2005 20
Case: China’s Entry of WTO
Services permitting grandfathering the provincial
agreement abolish restrictions on domestic distribution
within 3-5 years restrictions on leasing, warehouse, advertising,
packaging, air shipping, inspections abolishedwithin 3-4 years
21
Case: China’s Entry of WTO
Telecommunication abolish geographical restriction
paging - within 4 years mobile - within 5 years
foreign investment after 4 years can be 49%(51% in paging)
adopt CDMA protocol
22
Case: China’s Entry of WTO
Insurance abolish geographical restriction with 5 years foreign insurance firms can do group
insurance, health insurance and pension life insurance firms can choose their own
domestic venture partner, can take 50% shareafter WTO and increase to 51% after one year
non-life firm can take 51% share after WTO,can be WOFE after 2 years.
23
Case: China’s Entry of WTO
Banking and Security retail banking will be opened for WOFE banks
by 2005 banking on RMB business allowed by 2005 only joint venture is allowed in security,
foreign firms can take up to 33% (???)
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 13. Environmental andLabor Standards
2
What are the differences?
Income(1999)
Numbers Population (b) Income Rangeper person ($)
AverageIncome perperson ($)
Low 58 2.4 100-754 410
Lowermiddle
49 2.1 755-2995 1200
Uppermiddle
27 0.6 2996-9265 4900
High 27 0.9 9266+ 25730
3
Income(1999)
Infant Deathsper 100,000birth
% childrenof 10-14yworks
CO2EmissionsMetric Tonsper person
Annual deforest.square kilom per100,000 person
Low 68 19 100-754 1.8
Lowermiddle
35 7 755-2995 1.2
Uppermiddle
26 6 2996-9265 7.2
High 6 <1 9266+ -1.3
What are the differences?
4
Setting Standards
Harmonization of standards Mutual recognition of standards Separate standards
5
Labor Standards
International Labor Organization (ILO) Prohibition of forced labor Freedom of association The right to organize and bargain collectively An end to the exploitation of child labor Nondiscrimination in employment
6
Child Labor
US Child Labor 300,000 – 800,000
40%
20%
18%
% of its children
Keith Parker, University of Southern California
FBE-462: Powerpoints
7
Trade and Environmental Issues
Non Transboundary Environmental Issues Difference in environmental standards Pollution havens
Transboundary Environmental Issues
8
How to attack externalities?
impose tax to force producer to pay extrasocial cost
Problems? second-best
P
80
400
A
B
C
D
Germany’s MB ofdumping waste
MC of wastedumping to Austria
9
- How to attack externalities?
Coase Theorem if costless negotiation is possible, property
rights are well-specified, and redistributiondoes not affect marginal values, then the allocation of resources will be identical,
whatever the allocation of legal rights the allocation will be efficient, so there is no
problem of externality if a tax is imposed in such a situation, efficiency
will be lost10
Cases
CFC’s and Ozone what is the policy used? is the policy working? why the policy is (or not) successful?
11
- Cases
Dolphins and Tuna what is the policy for U.S? Is the policy working? why the policy is (or not) successful?
12
- Cases
Elephants and Ivory what is the policy? Is the policy working? why the policy is (or not) successful?
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
- Cases
Brazilian Rain Forests what is the policy? Is the policy working? why the policy is (or not) successful?
Keith Parker, University of Southern California
FBE-462: Powerpoints
1
Section 14. Trade in Factors
Professor Baizhu ChenFBE462
Marshall School of Business
2
International Capital Flow
foreign portfolio investment Stocks and bonds No direct management and control
foreign direct investment Often involves control and management In the U.S., owns more than 10% shares to be
counted as FDI for accounting purpose.
3
Inbound FDI
4
FDI
Firm factors What unique advantage the firm has over local firms?
Local factors What factors in local are attractive? Is it cheaper labor
or land? Or is it the market? Or else? Policy factors
Is the local policy encouraging FDI? Legal structuresare favorable?
Competitive factors Scale economy? Competitors there already? Can we
keep our competitiveness?
5
FDI
6
FDI
Keith Parker, University of Southern California
FBE-462: Powerpoints
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FDI – China Case
8
FDI – China Case
9
FDI – China Case
0.144Zambia100.151Thailand090.165Singapore080.235Korea070.416Australia060.446Macau050.502U.S.040.533Virgin Is033.691Cayman Is0224.63HK01
Accumulated $BNation2003
10
FDI – China Case
55%
56%46% 74%
4% 57%
15% 26% 16% 2% 10% 1%
% of asset overseas
Source: UNCTAD
11
FDI – China Case
130BurgCIMC2006
18500*UnocalCNOOC20051275*MaytagHaier2005520Ssangyong MotorsSAIC20051750IBM PCLenovo2005
7000*NorandaMinmetals2004650Hynix TFT-LCD unitBOE20039.8Schneider Electronics AGTCL2002262Devon’s oil fieldPetrol China2002
275BP’s refinery assetsCNOOC2002
3205% interests Northwest Shelf VentureCNOOC2002394Oil fields AlgeriaSinoPec2002592Repsol-YPECNOOC20027Menghetti SpaHaier2001
US$ millionTargetCompany
12
FDI – Why Go Global?
Domestic competition Diversification v.s. globalization
Technology & know-how Global brand Protectionism Exchange Rate Government policies
Keith Parker, University of Southern California
FBE-462: Powerpoints
13
Immigration
14
Immigration
0R0S L1LE
MPLS
MPLR
DS DR
A
B
C
E
WS WS
WR WR
WE WE
a
b
c
d
F
15
Immigration
0R0S L1LE
MPLS
MPLR
DS
DR
A
B
C
E
WS WS
WR WR
WE WE
a
b
c
d
F
L2
W’RW’R
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If L1L2 in S country is unemployed
L
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Keith Parker, University of Southern California
FBE-462: Powerpoints
University of Southern California Marshall School of Business
MOR 492: GLOBAL STRATEGY Spring 2006
Professor: Carl W. Voigt, Ph.D. Office: Bridge Hall 303-E Phone: Direct: (213) 740-0764 Department of Management and Organization Office: (213) 740-0728 Email: [email protected] [Note: I do not check email sent to [email protected]!!!] Office Hours: MW 11:00-12:00 noon, 1:30-2:00 pm, immediately after class, and by appointment COURSE DESCRIPTION Business enterprise in today’s environment increasingly involves crossing national borders and, more generally, engaging in business activities in numerous countries that are often very different from each other. Changes in technology, transportation, communications, and political alliances have significantly internationalized business. Increasingly, firms are required to compete in multiple foreign markets at both the product and supply-chain levels. Understanding the management, marketing, financial, and operational challenges associated with global business activity, and developing skills in these areas, have become essential requirements for success. The Global Strategy course is designed to provide students with the skills, knowledge, and sensitivity required to create, maintain, and renew sustainable competitive advantage within a global environment. Global Strategy will explore international business issues from an integrated firm-level perspective. The course will adopt a strategic perspective and will highlight the following topics from this perspective: the analysis of industry and environmental forces, the competitive context in which companies operate in global industries, creating and sustaining global competitive advantage, the characteristics of global, multi-domestic and transnational strategies, international entry strategies, global strategic alliances, the role of global organizational structures, and the importance of global strategic control. Case studies used in this course will help you develop your analytical and decision-making skills and also highlight the reality of environmental uncertainties influencing decision making in the global context. Cases also seek to develop your capacity to identify issues, to reason carefully through various options and improve your ability to manage the organizational process by which decisions get formed and executed. In addition to case analyses we will also read and discuss additional articles on strategic issues relevant to operating in a global context. Thus, students will develop both, historical and current, and theoretical and practical, perspectives on operating in a global context. This course has two broad objectives and will be taught simultaneously at two levels. First, this course is designed to teach students “about” international business issues. That is, the course intends to help students understand how business practices vary widely across regions and countries. Secondly, this course is designed to teach students “how to” formulate and evaluate winning global strategies. In a very real sense, this course is designed for students who seek to work in, or with, firms that operate in many different countries, or which operate outside the US. By the end of the course, students should be able to: perform country, region, industry and firm analyses in an international setting, evaluate the effectiveness and sustainability of international and global corporate strategies, analyze the benefits and shortcomings of various multinational organizational structures, compare the relative merits of different modes of global market entry, and understand the underlying conditions of the international economy that influence global competitive behavior activity such as economic, legal, political and cultural differences, exchange rates, comparative national advantage, national economic policy, the role of international agreements and customs unions, and balance of trade and payments.
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
2
COURSE EVALUATION Course grades will be determined by students’ relative performance on the following course components: Course Contribution (participation and unannounced quizzes) 20% Individual Case Analysis (one) 10 Group Case Analysis (one) 10 Doing Business with Mexico Group Project and Presentation 25
First Mid-term Exam 15 Second Mid-term Exam 20 100% In order to successfully pass this course, a passing grade (> 50%) must be achieved in each individual course component. Missed mid-terms and/or assignments severely reduce a students grade. Plus and minus shades will be assigned to those immediately above or below grade cutoff points. The distribution of grades will closely follow the guidelines of the Marshall School of Business (an average class GPA of 3.3). ATTENDANCE POLICY Class attendance is absolutely essential. All missed classes will be noted. The policy on missed classes is to allow each student three (3) absences, no questions asked, no penalty. All further absences over the limit will reduce the student's participation grade, no questions asked, no excuses of any kind expected or accepted. Students with an excessive number of absences are at risk of failing the course. Only Official University engagements, such as scheduled debating events, sports events, are excepted from this policy. Job interviews, etc., are not excused, so choose your absences carefully. Habitual lateness (and leaving class early), for whatever reason, will be noted as evidence of low course commitment, and penalized. Simply put, you cannot learn for our class discussions, and your classmates cannot learn from you, if you are not present. COURSE CONTRIBUTION Since this course is principally a case and seminar class, your overall commitment and attitude toward this course, and your daily active verbal participation (speaking and listening) in classroom discussions, will be closely monitored. In grading class participation, we will look at both the quantity and quality of your class contributions/interventions. Class participation is obviously a function of preparation, skills, attitude, and a willingness to actively commit yourself in front of your instructor and colleagues. A classroom is a cost-free environment for experimenting and learning to "play the game." Make use of it. Shyness is no excuse. With regard to quality, the dimensions that we look for include: Relevance -- does the comment bear on the subject at hand? Comments that do not link up with what the discussion is focusing on can actually detract from the learning experience. Causal Linkage -- are the logical antecedents or consequences of a particular argument traced out? Comments that push the implications of a fact or idea as far as possible are generally superior. Responsiveness -- does the comment react in an important way to what someone else has said? Analysis -- is the reasoning employed consistent and logical? Evidence -- have data from the case, from personal experience, from general knowledge been employed to support the assertions made? Importance -- does the contribution further our understanding of the issues at hand? Is a connection made with other cases we have analyzed? Clarity -- is the comment succinct and understandable? Does it stick to the subject or does it wander? All students will be formally called on, at random, to take the lead in various aspects of class discussions at least once or twice during the semester. If the student called upon is not present, is late, or is not sufficiently prepared to make a substantial contribution to the class discussion, he/she will lose points for class contribution. If the student makes helpful comments, he/she will accumulate points for class contribution. Since it is unlikely that there will be
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
3
enough opportunities to call on each student more than once or twice, be warned that failure to be thoroughly prepared, on all occasions, can be devastating to your overall grade. Each student will receive a score for participation at the end of each lecture/discussion and case discussion session. No Credit Students, though present, who make no contributions, will receive no credit. A Little Credit The simple recitation of facts from the case will receive some credit toward the student’s class contribution score. More Credit Comments that do more than simply recite case facts will receive significantly greater credit towards a student’s class contribution score. For example, comments that provide synthesis or raise counterintuitive points, will add much more to a student’s class contribution score. Gold-Star Credit Students who substantially advance the learning of the whole class by providing non-intuitive analyses, profound insights, or “over the top” quantitative analyses, will receive maximum credit. Negative Credit Comments that contain factual misstatements, demonstrate lack of adequate preparation, or are distracting because they come too late in the discussion, will be penalized. Attempts to dominate class discussion rarely result in consistent and significant contributions. Participation Cards: At the end of each case discussion, students who actively participated in the discussion will be asked to turn in a “Participation Card”. These cards should list your name, the date, the case discussed that day, and a synopsis of your contributions during that day’s discussion. The Participation Cards will be used in combination with the instructor’s own daily evaluations to determine your participation grade for the day. For this purpose, please purchase a package of 3x5 index cards and bring them to each class. Group Article Presentations and Critiques: On days when additional articles have been assigned one group will be given the task of reviewing and critiquing each article. Groups should creatively think of ways to help the other students in class learn the assigned materials. These presentations will be evaluated and will factor into determining a students overall course contribution grade. Unannounced Quizzes: Short unannounced quizzes may be given at any time during the course to test the level of student preparation for lecture and case discussions. Multiple choice and short answer questions may be given at the beginning of classes where a case is assigned for class discussion. No make-up opportunities will be given to students who are absent or late. Student performance on these pop-quizzes will be used to determine a student’s participation grade. INDIVIDUAL CASE ANALYSIS Students must select a case and prepare a comprehensive external, competitive, and internal analysis, and provide appropriate strategic recommendations and implementation plans. The individual case analysis should include a “consulting format” report with a carefully prepared one page executive brief (attached to the front) containing the essence of the critical issues, analysis and strategic recommendations which have detailed in your report. A “consulting format” report should contain powerpoint slides which are essentially visual in appearance. Examples of reports will be presented in class. Please note carefully those cases which can be prepared as an individual analysis. They are designated by an “ica.” More detail will be given in class. The individual case analysis is 10 percent of the course grade. Students must be present in class to submit individual assignments, and they must be submitted at the beginning of class. Unfortunately, late individual assignments will not be accepted. Students may submit a second individual case assignment if they are not satisfied with the first grade received. The better of the two individual assignments will be used in determining your final course grade. GROUP CASE ANALYSIS I will assist all students in forming groups. I will attempt to ensure a proportional distribution of women and men in each group. In forming groups I will also ensure that no group has more than two non-native English speakers. Additionally, international students will be distributed across groups so as to ensure within-group diversity.
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
4
The group case analysis should include a carefully prepared report with a two-page executive brief. Your report should be in “consulting format”. Please note carefully those cases that can be prepared as a group case analysis. They are designated by a “gca” on the course schedule. More detail will be given in class. The group case analysis is 10 percent of the course grade. Note: Each group must submit a GCA, in Modules I or II, before the first Mid-term Exam which is scheduled for Wednesday, February 14th. Late group case analyses will not be accepted. Groups may submit a second group case assignment if they are not satisfied with the grade received on the first. The better of the two grades will be used in determining the final course grade for all group members. INTERNATIONAL FIELD TRIP TO MEXICO This course includes a MANDATORY field trip to Tijuana and Ensenada, Mexico. The dates and length of the international field trip are still to be determined but are likely to be March 1-3. We are planning a two-day trip (Friday and Saturday) where we will study local Mexican businesses, Maquiladoras (multinational companies with facilities in Mexico which benefit from free trade agreements), meet with local Mexican government officials, and study local culture and business practices. The cost of the trip will be subsidized by USC’s CIBER (Center for International Business Education and Research) and the USC Marshall Undergrad Program, but will require students to contribute to the cost of the trip. The trip will require students to make arrangements to miss classes, and/or work obligations on those days. You should ask your professors and employers for permission to be absent now. Participation on the field trip to Mexico is mandatory. You must have a valid passport for this trip. If you DO NOT have a passport, you must apply for one IMMEDIATELY. DOING BUSINESS WITH MEXICO GROUP REPORT AND PRESENTATION Assignment: If you were advising a global company not already present in Mexico (or another country such as China), would you advise them to enter the “x” business sector? Why or Why not? If yes, How? If not, what would change your decision? Your analysis should consider how you would enter and market products to the lowest tiers for the consumer sector. [Where “x” represents an industrial, retail, financial, or service sector of your choice. For example, automotive sector, textile sector, tourism sector, electronics, retail, etc.] Creativity in framing your project is encouraged. While the primary assignment is to take a U.S. business (not currently doing business in Mexico) to Mexico and enter all segments of the Mexican market, you may structure your assignment differently. You could consider bringing a Mexican company to the US. Or you could consider taking a U.S. company to another global market instead of Mexico. Or you could consider bringing a non-US business to Mexico. Any variation on the topic should be outlined in a short memo and be presented in advance of all deadline to me for feedback and acceptance. Assess the opportunity for an existing global corporation, typically a U.S. firm in the same sector but not already present in Mexico. Prepare your report as if you were going to present your findings to the top management executive team of the global company. Your report should examine the challenges of entering all segments of the Mexican market place. You must consider how to enter the fourth and “fifth” tiers of the consumer market place. If you choose to enter, why and how do you enter this sector, i.e., a recommended entry strategy for the global firm including an analysis of which segment of the sector you would enter, the mode of entry you would choose. If not, why not? Is this decision contingent on some factors, and what are these factors? Regardless of whether you chose to enter or not to enter, what would make you change your decision? What indicators do you look for to change your decision?
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
5
To support your recommendation, the following key dimensions should be addressed
(Whenever possible, you should collect data and use statistical analysis to support your arguments. These data should be presented clearly in tables and figures both in the report and the presentation):
1) Market Potential: For example: Importance of sector to economy in terms of absolute size and percentage of
the sector in the economy, employment and any other dimensions, growth rate of sector, profitability in then sector, foreign investment in sector, sources of foreign investment.
2) Competition in the Sector: For example: who are the players, their market shares, what types of strategies are they following, domestic players and multi-national players, countries of origin of key multi-national players, who are the major investors in the sector—domestic and multi-nationals, what are the primary ways in which they compete, sources of competitive advantage of key players, value chain configurations of key players.
3) Strategic Importance to Mexico of the Sector: For example: does Mexico have factor endowment advantages in this sector, is Mexico a lead market for trends and developments in the sector, are there related and supporting industries that support the development of this industry in the country, how important is Mexico in the global competitive battles among major international players in this sector, how important is this market as a platform for expansion into surrounding countries.
4) Profitability and Growth rates: For example: current profitability of the sector as a whole, differences in the profitability of different strategies of competitors, attractive competitive positions of incumbents, potentially attractive strategic positions for new entrants.
5) Key Institutional Forces / Institutional Voids (Economic, Political, Legal, Technological, and
Social Context) affecting Sector including any barriers to entry: For example: Economic policies, Political forces, Regulatory framework, Technological forces, Social changes; focus should be on laying out the current context and what is changing; focus should be on only the major issues not a laundry list; in particular, you should address key impediments or barriers to entry faced by foreign firms seeking to enter Mexico especially with respect to this particular sector.
6) Marketing Analysis: For example: what are the primary target markets, what are the needs and preferences
of the target markets regarding the sector, what are customer attitudes and perceptions of the sector, what are the key trends in customer demand and behavior impacting the sector, how satisfied are customers with the sector, what products and services are typically offered, and how are the products and services priced, promoted and positioned relative to the competition. How is the consumer market segmented? What are lowest tiers of the consumer market like?
7) Comparison of Key Characteristics of Sector with Same Sector in the U.S. Economy: For example: a comparison of the key characteristics and features of the sector with the same sector in the U.S.; in particular, you may compare the structure of the industry, key operating characteristics, cost and quality competitiveness of the sector or key players in the sector; value chain configurations and so on.
8) Sector Evolution: For example: How is the sector likely to evolve in the future and why so; what key
indicators of evolution should an analysis focus on to understand the changes in the industry; how is the structure of the sector likely to change?
9) Entry Strategy: For example: If you choose to enter the market, how does your entry strategy address the
entry barriers described in section 5 and the evolution of the sector described in section 8? If you chose not to enter the market, come up with a strategy that would reduce the risk of entry if a U.S. company decided to enter the market in spite of your recommendations.
Page Limit You should limit your report to 2 pages of executive summary, and up to 10-15 pages of appropriate “consulting format” presentation slides. Fewer pages would be better if you can more effectively present the data in
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
6
diagrams and tables (and Powerpoint slides). Make use of tables and charts to present as much information as parsimoniously as possible. You will not have enough time to be able to provide a full comprehensive treatment of the assignment, so focus on the most important issues in each area outlined above. Please note: Cases are not good models for your group project because they are intendedly descriptive, and, on purpose lack substantive analysis. Your project should be long on analysis and short on description. The report and presentation is 25 percent of the course grade. Late projects will be penalized 10 percent per day late, including weekends. The 25 percent report grade will be divided into 15 percent for the written report, which I will assign, and 10 percent for the class presentation. The class presentation grade will be determined by the class as a whole. Member of the class will be required to rank all the group presentations. Your average presentation ranking will determine your presentation grade. The top ranked group will receive an A, the bottom ranked group will received a B-. In preparing your Doing Business in Mexico presentation you should carefully consider your audience; your classmates. Be sure to prepare your verbal/oral presentation in a way that teaches them something new and interesting. It is difficult to educate without entertaining, although it is easier to entertain without educating. Be careful to get the education part right. Your written reports should necessarily be more comprehensive, including all appropriate detailed analyses. However, an oral presentation, to your classmates who have also prepared similar reports, will necessarily be different than your written report.
MID-TERM EXAMS Two mid-term exams have been scheduled for this course. These mid-terms will cover all the assigned readings, course lectures, and case studies in the modules preceding the mid-terms. The mid-term exams will consist of multiple choice questions, short answer and short essay questions on all assigned readings and cases. Students who miss mid-terms without prior arrangement will receive a grade of zero. See Course Schedule for the dates of the mid-term exams. COURSE MATERIAL A series of cases and readings have been assigned for this course. They are available through University Partners in the University Book Store. When necessary, your instructors may place additional materials in the bookstore for you to purchase. COURSE COMMUNICATION: BLACKBOARD An “Electronic Folder” has been created for this course in BLACKBOARD. You should begin the habit of checking the BLACKBOARD folder on a very regular basis. The course syllabus, case discussion and assignment information have been posted to the MOR 492 folder. Additional course lecture notes/materials, further details on assigned cases and the group projects, and general course announcements, will be posted to the folder throughout the semester. STUDENT REPRESENTATIVE You will be asked to elect a Section Representative during our first session. The selected student representative will act as a liaison between the section and the instructor to provide informal feedback and communication, particularly on issues that individual students may not wish to raise personally with the instructor. OFFICE HOURS AND APPOINTMENTS
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
7
I have set aside the hour before lunch on Monday and Wednesday for “open” office hours, and 30 minutes before the afternoon class, for those who would like/need to discuss specific issues related to the course. I will also make appointments for those who cannot meet me during the “open” office hours. ACADEMIC INTEGRITY
The following information on academic integrity, dishonesty, and the grading standard are placed here at the recommendation of the School of Business Administration Faculty and are taken from the Faculty Handbook. “The University, as an instrument of learning, is predicated on the existence of an environment of integrity. As members of the academic community, faculty, students, and administrative officials share the responsibility for maintaining this environment. Faculty have the primary responsibility for establishing and maintaining an atmosphere and attitude of academic integrity such that the enterprise may flourish in an open and honest way. Students share this responsibility for maintaining standards of academic performance and classroom behavior conducive to the learning process. Administrative officials are responsible for the establishment and maintenance of procedures to support and enforce those academic standards. Thus, the entire University community bears the responsibility for maintaining an environment of integrity and for taking appropriate action to sanction individuals involved in any violation. When there is a clear indication that such individuals are unwilling or unable to support these standards, they should not be allowed to remain in the University.” (Faculty Handbook, 1994: 20) Academic dishonesty includes: (Faculty Handbook, 1994: 21-22) 1. Examination behavior - any use of external assistance during an examination shall be considered academically
dishonest unless expressly permitted by the teacher. 2. Fabrication - any intentional falsification or invention of data or citation in an academic exercise will be
considered a violation of academic integrity. 3. Plagiarism - the appropriation and subsequent passing off of another’s ideas or words as one’s own. If the
words or ideas of another are used, acknowledgment of the original source must be made through recognized referencing practices.
4. Other Types of Academic Dishonesty - submitting a paper written by or obtained from another, using a paper or essay in more than one class without the teacher’s express permission, obtaining a copy of an examination in advance without the knowledge and consent of the teacher, changing academic records outside of normal procedures and/or petitions, using another person to complete homework assignments or take-home exams without the knowledge or consent of the teacher.
The use of unauthorized material, communication with fellow students for course assignments, or during a mid-term examination, attempting to benefit from work of another student, past or present, and similar behavior that defeats the intent of an assignment or mid-term examination is unacceptable to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior resulting from the nervous tensions accompanying examinations. Where a clear violation has occurred, however, the instructor may disqualify the student’s work as unacceptable and assign a failing mark on the paper. STUDENTS WITH DISABILITIES Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained from DSP. Please be sure the letter is delivered to me as early in the semester as possible. Your letter must be specific as to the nature of any accommodations granted. DSP is located in STU 301 and is open 8:30 am to 5:00 pm, Monday through Friday. The telephone number for DSP is (213) 740-0776.
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
8
RETURNED COURSEWORK Returned paperwork, unclaimed by a student, will be discarded after 4 weeks and hence, will not be available should a grade appeal be pursued following receipt of his/her grade. ABOUT YOUR PROFESSOR Carl Voigt is an Associate Professor of Strategy (Clinical) in the Management and Organization Department. He also received his Ph.D. from the Anderson School at UCLA in strategy and organization. He is a native New Zealander, although he completed his undergraduate work at Avondale College in New South Wales, Australia. Dr Voigt specializes in teaching competitive and global strategy, and management courses in both the undergraduate and MBA programs here at USC. His academic interests are in business, corporate and global strategy, and in particular in entrepreneurship. Dr. Voigt has consulted with firms and organizations in the entertainment, food processing, tourism, health care, engineering, telecommunications, defense, and not-for-profit sectors. He has also conducted numerous seminars for teams of managers in the areas of management and strategy. He is an academic consultant with the F.T.C. Line of Business program. Initially, Dr. Voigt began his career as a high school teacher. His first job was teaching high school business subjects on Guadalcanal in the Solomon Islands. During that time he also served as Chair of the Business Studies Curriculum Development Committee and a member of the National Secondary School Curriculum Committee for the Solomon Island government. Dr. Voigt has been awarded two Marshall’s Golden Apple teaching awards: one from the Marshall MBA students in 2001, and one from the Marshall undergrads in 2005. Dr. Voigt has previously been an Associate Dean of our Marshall Undergrad Program, MBA.PM and EMBA Programs, and Marshall MBA Program. He has also successfully coached several teams of Marshall undergraduates to world prominence in different case competitions. In April 2001 he helped coach four Marshall undergraduates to first place in McGill’s international case competition. In February 2000 he coached Marshall’s team to first place in the Marshall International Case Competition. And he also coached Marshall undergraduate teams to a second place finish in 1998, and a final four finish in 1999. In a “past” life, he was heavily involved in coaching basketball; having coached at the high school, college and international levels. While in the Solomon Islands he coached their national basketball team for 2 ½ years. Today, he is first and foremost a father. He spends most of his free time, now, organizing and coaching and refereeing in recreational programs for his children (He has three sons: 22, 17 and 13 years old, and a 12 year old daughter). Dr. Voigt’s wife, Diane, teaches grades 7-10. TENTATIVE COURSE SCHEDULE** ** Please note that this is a tentative course schedule. Changes may be necessary relative to coordinating our International Field Trip to Mexico. Additionally, some cases may be changed by the instructor. For those without a current valid passport, you must apply for a Passport. You will need
this for our field trip to Mexico in March. You must expedite your passport Session Date Case / Topic Course Deliverable
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
9
1 1/8 Course Introduction Lecture/Discussion: What is Globalization and the Global Marketplace, really? Read: Gupta and Govindarajan. “Managing Global Expansion: A Conceptual Framework” I. COMPETING IN THE GLOBAL MARKETPLACE 2 1/10 Review/Introduction: First Principles and Core Concepts of Strategy Photo and Bio Read: Siegel, Introduction to Global Strategy 1/15 M L K H O L I D A Y 3 1/18 Case: Jollibee Food Corporation: International Expansion Immigration Documents
4 1/22 Case: Global Wine Wars: New World Challenges Old (A) gca/ica 5 1/24 Case: BRL Hardy: Globalizing an Australian Wine Company gca/ica Read: Ghemawat, “Regional Strategies for Global Leadership” II. GLOBALIZATION IN CONTEXT 6 1/29 Lecture/Discussion: Global Environmental Analysis: Frameworks for Analyzing Global Regions, Countries, Industries and Markets Read: Ghemawat, “Distance Still Matters: The Hard Reality of Global Expansion Note on Political Risk Analysis 7 1/31 Case: Toys “R” Us Japan ica Read: Prahalad and Lieberthal, “The End of Corporate Imperialism” 8 2/5 Lecture/Discussion: Country Analysis: Analyzing Opportunities and Challenges Case: Mexico: Unfinished Business Read: “Country Analysis” Selection of economic sector and focal company for doing business in Mexico project due *** 9 2/7 Case: The Competitive Advantage of China Read: Porter, “The Competitive Advantage of Nations” 10 2/12 Case: AmorePacific: From Local to Global Beauty gca/ica 11 2/14 FIRST MID-TERM EXAM 2/19 P R E S I D E N T S’ D A Y H O L I D A Y III. CREATING GLOBAL COMPETITIVE ADVANTAGES 12 2/21 Lecture/Discussion: Global Strategy: Creating Global Advantages and Building Strategic Multinational Capabilities Read: Ghemawat, “The Forgotten Strategy” 13 2/26 Case: S.A. Chupa Cups ica
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
10
Read: Bartlett and Ghoshal, “Going Global: Lessons from Late Movers” 14 2/28 Case: The Globalization of CEMEX gca Read: MacMillan, van Putten, McGrath, “Global Gamesmanship” 3/1-3 I N T E R N A T I O N A L T R I P T O M E X I C O Mandatory 15 3/5 Case: Haier: Taking a Chinese Company Global ica IV. GLOBAL ENTRY STRATEGIES AND STRATEGIC ALLIANCES 16 3/7 Lecture/Discussion: Global Entry Strategies: Exporting, Foreign Direct Investments, Joint Ventures and Strategic Alliances Read: Hamel, Doz and Prahalad, “Collaborate with Your Competitors – and win” Working Outline, with designation of individual responsibilities, of “Doing Business in Mexico” course group project due. *** 3/10-18 S P R I N G B R E A K 17 3/19 No Class Work on your “Doing Business in Mexico Project” 18 3/21 Case: Louis Vuitton Moet Hennessy: Expanding Brand Dominance in Asia ica 19 3/26 Case: Hong Kong Disney (A): The Walt Disney Perspective ica 20 3/28 Case: Flextronics International, Ltd. gca V. MANAGING AND ORGANIZING MULTINATIONAL CORPORATIONS 21 4/2 Lecture/Discussion: Global Business Management: Designing and Managing Multinational Corporations Read: Bartlett and Ghoshal, “What is a Global Manager?” 22 4/4 Case: P&G Japan: The SK-II Globalization Project ica 23 4/9 Case: Timberland: Commerce & Justice 24 4/11 SECOND MID-TERM EXAM 25 4/16 No Class: Work on Doing Business in Mexico Group Assignment ** VI. DOING BUSINESS IN MEXICO PROJECT PRESENTATIONS 26 4/18 Final Presentations: Doing Business in Mexico Report Due 27 4/23 Final Presentations 28 4/25 Final Presentations FINAL EXAM PERIOD (see Spring Schedule of Classes for date)
Keith Parker, University of Southern California
MOR-492: Syllabus
MOR 492 Syllabus
MOR 492 GLOBAL STRATEGY Spring, 2006
11
Scheduled Feedback Sessions on Presentations and Report Please Note: Submitting Group Case Analyses All groups must submit a group case analysis (gca) before the first Mid-Term Exam. I will assist you with a within-group peer performance appraisal. You should plan on using this group peer evaluation intervention to give open, honesty, and constructive feedback to each other based on performance to this point in our class. It is better to deal with within-group issues earlier rather than later! Submitting Individual Case Analyses ica/gca: In modules I & II, you may submit an individual case analysis (ica), if your group choose not to prepare and submit a gca. Note, however, that you may not submit an ica at the same time your group submits a gca. Submit Photo and Bio by January 10 (Session 2) Please prepare a 5 x 7 inch card with a picture of yourself (depicted anyway you like so long as you are recognizable), with some brief information about yourself such as country of origin, languages you speak, your major, your short-term and long-term career goals, hobbies, eccentricities, and anything else that is interesting about yourself that you would like to share with me. Immigration Documents by January 18 (Session 3) You will need legal documents for our trip to Mexico in October. A current passport is required and/or alien resident card. As of January U.S. citizen must travel to and from Mexico with a valid passport. Please turn in a clear photocopy of your passport, alien resident card, or a copy of you application for a passport, on Wednesday, January 18th. Note: All cases and articles are in the Case Package available from the University Book Store.
Keith Parker, University of Southern California
MOR-492: Syllabus
Session 3: International Expansion: Global Strategy & Management Challenges Wednesday, 1/18 The Jollibee case traces the international expansion of Jollibee Foods Corporation, a Philipines based fast food company led by entrepreneur Tony Tan Caktiong (or TTC) that is expanding within Asia, and now beyond. The case begins with Noli Tingzon, the new general manager of the international division, facing three investment decisions. He has opportunities to expand into Papua New Guinea (PNG), Hong Kong, or the United States, and recognizes that his decision on which project to back will probably shape the broader strategic agenda and organizational model that the company’s international operations will follow. The Jollibee case will also give us practice at identifying a competitive strategy, drawing a business model, evaluating the sustainability of competitive advantages, and thinking critically about how far a company’s strategy can “travel” without modification. Read Gupta and Govindarajan. “Managing Global Expansion: A Conceptual Framework” Seigel “Introduction to Global Strategy” Case Jollibee Foods Corporation: International Expansion Discussion Questions 1. How was Jollibee able to build its dominant position in fast food in the Philippines? What sources
of competitive advantage was it able to develop against McDonald’s in its home market? 2. How would you evaluate Tony Kitchner’s effectiveness as the first head of Jollibee’s international
division? Does his broad strategic thrust make sense? How effectively did he develop the organization to implement his priorities?
3. As Noli Tingzon, how would you deal with the three options described at the end of the case?
How would you implement your decision? 4. Provide advice to the top management team at Jollibee. What should Tingzon do to ensure global
success? Which option should he select? What competitive advantages does he have to build on? What global competitive advantages can Tingzon exploit to improve its global position?
No formal turn-in assignment This is our first case and we will use it to get used to doing a case analysis. Reminder: Immigration Documents Please bring to class one of the following: (1) a clear photo copy of the information page from your passport (the copy of your photo should be recognizable), or (2) a copy of your birth certificate and one government issued photo ID. If you are an international student or an international exchange student (that is, a student on any type of visa), we need a copy of your visa, too.
Keith Parker, University of Southern California
MOR-492: Discussion Help
The Forgotten Strategy By Pankaj Ghemawat
• In many if not most cases, companies see globalization as a matter of taking a superior business model and extending it geographically, with necessary modifications, to maximize the firm’s economies of scale
• The key strategic challenge is simply to determine how much to adapt the business model – how much to standardize from country to country versus how much to localize to respond to local differences
• Many companies have moved toward more localization and less standardization • All companies that view global strategy in this way focus on similarities across countries, and the potential
for the scale economies that such commonalities unlock, as their primary source of added value • In their rush to exploit the similarities across borders, multinationals have discounted the original global
strategy: arbitrage, the strategy of difference • If they are to get their global strategies right in the long term, many companies will have to find ways to
combine the two approaches, despite the very real tensions between them The Strategy of Differences
• Arbitrage has been around for a very long time • Many of the industries in which arbitrage has historically been applied – farming, mining, and textiles – are
regarded as low-tech and mature • There is also the sense that well-run global enterprises have already reaped what competitive advantage
they can from arbitraging such generic factors of production as capital or labor, which, as one leading management guru has put it, can now be sourced efficiently with the click of a mouse
• The scope of arbitrage is as wide as the differences that remain among countries, which continue to be broad and deep
o Cultural Arbitrage Claims that the scope for cultural arbitrage is decreasing over time are clearly not true for
all countries and product categories Reduction in other dimensions of difference – tariffs or transport costs, for instance – can
also increase the viability of cultural arbitrage o Administrative Arbitrage
Legal, institutional, and political differences from country to country open up a host of strategic arbitrage opportunities
Tax differentials are an obvious example (NewsCorp) Few managers explicitly treat tax or other administrative arbitrages as a strategic tool,
despite their potential Executives are reluctant to draw attention to such arrangements for fear that they might
be outlawed In some cases, administrative arbitrageurs are actually breaking the law Many forms of administrative arbitrage involve working with or around given rules In some cases, companies can leverage political power to try and change the rules The potential for using government influence to create administrative arbitrage
opportunities remains high o Geographic Arbitrage
Transportation and communication costs have dropped sharply in the last few decades But the drop does not necessarily translate into a decrease in the scope of geographic
arbitrage strategies Although communication costs have dropped more sharply than transportation costs,
there are cases in the telecom sector where returns earned by focusing on residual distance have been higher than those gained by building or exploiting global connectivity
The geographic arbitrageurs that have lost some ground in recent decades are the great general trading companies of the past, which traditionally took advantage of large international variations in prices for a broad array of products by getting them from market A to market B
Keith Parker, University of Southern California
MOR-492: Reading Notes
o Economic Arbitrage Refers to the exploitation of specific economic factors that don’t derive directly from a
country’s culture, geography, or administrative context These factors include differences in the costs of labor and capital, as well as variations in
more industry-specific inputs such as knowledge or the availability of complementary products, technologies, and infrastructures
The best-known type of economic arbitrage is the exploitation of cheap labor, which is common in labor-intensive, capital-light industries like clothing
Labor arbitrage can be applied to R&D as well as to ongoing operations, as Emraer also demonstrates
One might argue that labor arbitrage is an unsustainable strategy in knowledge industries because labor costs quickly rise to match demand
Capital cost differentials would seem to offer slimmer pickings than labor cost differences; they are measured in single percentage points rather than multiples of ten or twenty
The subtlest forms of economic arbitrage involve the exploitation of knowledge differentials
Reconciling Difference and Similarity
• One would think that companies that try to exploit differences would not find it easy to exploit similarities as well
• Fundamental tensions between pursuing scale economies and playing the spreads exists • The data indicates that there is some merit to classifying companies according to the primary way they add
value through their international operations over long periods of time • For a start, it’s possible to apply different strategies to different elements of a business • The branded business grew to significant volumes but continued to generate losses because the competitive
environment was particularly tough for a late mover • The future of globalization process is by no means obvious • Markets may integrate further once economic conditions improve • Some argue that the process could actually shift into reverse, toward even greater economic isolation, if the
experience between the two World Wars is any precedent • The differences that make arbitrage valuable as well as the similarities that create scale economies will
remain with us for the foreseeable future
Keith Parker, University of Southern California
MOR-492: Reading Notes
Going Global: Lessons from Late Movers By Christopher A. Bartlett and Sumantra Ghoshal
• Companies from developing countries have entered the game too late • They don’t have the resources; they can’t hope to compete against giants • There is plenty of evidence that the above is not true • The writers studied 12 emerging multinationals in depth
o They operate in wide range of businesses, but they are all based in countries that have not produced many successful multinationals
• The evolution into more-profitable product segments can be clearly tracked on what we call the value curve o All industries can be seen as a collection of product market segments o The value curve is a tool used to differentiate the various segments o The more profitable the segment, the more sophisticated are the capabilities needed to compete in
it – in R&D, distribution, or marketing A Model of Success
• Indian pharmaceutical company Ranbaxy o Moving into large markets like China and Russsia – required building new customer relationships,
a strong brand image, and different distribution channels o U.S. and European markets – the company needed to meet much more stringent regulatory
requirements o Their immediate challenge was to break out of the mind-set that they couldn’t compete
successfully on the global stage o Once freed of that burden, they had to find strategies in which being a late moves was a source of
competitive advantage rather than a disadvantage o They had to also develop a culture of continual cross-border learning
Breaking Out of the Marginal Mind-Set
• Companies from peripheral countries can fall into several traps, which we call liabilities of origin • Some companies feel as though they are locked in a prison of local standards because of the gap between
technical requirements and design norms at home and world-class standards abroad • If demand at home is strong, managers then can reasonably postpone the investments needed to comply
with international standards • Sometimes, management is either unaware of the company’s global potential or too debilitated by self-
doubt to capitalize on it • There are a few companies for which the liability of origin derives from a limited exposure to global
competition, leaving them overconfident in their abilities or blind to potential dangers • Our emerging multinationals started to overcome them by creating a push from home and a pull from
abroad o Push from home
Management’s greatest challenge is to shock or challenge the company to push it from its nest
Samsung example Another way to create a push from home requires a leap of faith more than a shock of
recognition These leaps can be dramatic, and they are always risky, like performing on a trapeze
without a net Some CEO’s do this by investing far ahead of demand, even if doing so reduces the
company’s responsiveness to its successful home market o Pull from abroad
Organizations need an engaged trading post, not just a passive listening post
Keith Parker, University of Southern California
MOR-492: Reading Notes
Companies need offshore champions who can provide the young, overseas organization with credibility and confidence, both internally and externally
Singh from Ranbaxy created an organization in which managers from other parts of the world had a seat at the table on key corporate decisions
Devising Strategies for Late Movers
• The next major challenge is to choose a strategy to enter the global marketplace • Benchmark and sidestep
o Emerging multinationals can learn how to compete against the players in foreign markets simply by adapting and responding to those players as they enter the home market
o They benchmark the established global players and then maneuver around them, often by exploiting niches that the larger companies have overlooked
o Jollibee example • Confront and challenge
o When companies use their newcomer status to challenge the rules of the game, capitalizing on the inflexibilities in the existing players’ business models
o A more radical strategy is to introduce new business models that challenge the industry’s established rules of competition
o Though risky, this approach can be very effective in industries deeply embedded with tradition or comfortably divided among an established oligopoly
o The typical business model in these industries has become inflexible o BRL Hardy example
Learning How to Learn
• The global marketplace is information based and knowledge intensive • To survive in this environment you must learn how to learn: its is the central skill that allows a company to
move up the value curve • Protect the past
o Too many companies become so focused on where they are going that they forget where they are coming from
o With the Jollibee example, the new manager broke down the barriers between the international and domestic organizations and began building relationships that acknowledged his respect for their success and dependence on the home country’s expertise
• Build the future o Entering a new market requires considerably more than simply tweaking the home-market formula o Often companies lack the expertise needed to tailor the product or strategy to the new environment o So many emerging multinationals try to take a shortcut to learning by entering into a partnership
with a foreign company o In theory, companies can sidestep the disadvantages of partnering by buying the necessary
capabilities o After the false start, Hardy realized that in international business new capabilities cannot simply
be installed; they must be developed and internalized Having the Right Stuff
• Moving from the periphery into the mainstream of global competition is such a big leap that it was always led from the top
• The emerging multinationals always have leaders who drive them relentlessly up the value curve • Their commitment to global entrepreneurialism was rooted in an unshakable belief that their company
would succeed internationally • Their operation expanded, they all exhibited a remarkable openness to new ideas that would facilitate
internationalism – even when those ideas challenged established practice and core capabilities • These leaders are models for the heads of thousands of marginal companies in peripheral economies that
have the potential to become legitimate global players
Keith Parker, University of Southern California
MOR-492: Reading Notes
MOR-492 1/10/07 2:04 PM
General Strategy
• Managing the future
Risk premiums, sustainable/renewable above normal returns
• ROA: Return on Assets
• ROIC
• EVA: Economic Value added
• Government no risk
• More risks with businesses
Willingness to buy
• Marketing, placement of staples in grocery stores
• Willingness to pay: Hospitals, we don’t shop around for the
cheapest emergency room
• Harley Davidson tattoos, you can charge them whatever you want
Cost minimization
• Fixed costs stay the same, economies of scale doesn’t affect fixed
costs
• Economies of scope, sharing fixed costs, so one item carries less of
a burden
o Trucking, want to fill up lorries so there is less cost on each
product
Not often is it possible to have both high volume and high margins
• It’s not true at all that high market share equals high profit
• There are two winning strategies
• One emphasize low price and high volume
Business Models
• Very important to know the business model, for direction in
decisions
• Investment goes into uniqueness
o Usually, some exceptions (R&D to lower costs)
When you have a good thing in business, people will try to copy you
Keith Parker, University of Southern California
MOR-492: Class Notes
• Rivals
o Entrants
o Buyers
o Substitutes
o Supply
• If there are many of these in some market, it is not attractive
• To solve this
• Barrier to entry to block entrants
Targeting
• Low Cost – Broad market focus: Ivory, Dial et cetera
• Low Cost – Focused market focus: The stuff you get in a hotel
• Differentiated – Broad:
Drug industry can charge a lot, because insurance covers it
• Most Pharmaceuticals are patent protected
• Huge barrier to entry when getting into this industry
Shocks and trends can have enormous affects on industries
Attractive products
• Valuable
• Rare
• (non)Imitable
• Organization
Strategy is your idea for making money
• How to sustain it over time
• Competitive threats, how to build up a defensible market position
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Keith Parker, University of Southern California
MOR-492: Class Notes
Global Expansion
Nan WangWhitney Stambler
Keith ParkerKerry MacDonald
Gary LilardiChen Kang “CK” Hsu
Mark DavenportFebruary 12, 2007Group 5 “The Seven Samurai”
Decision Tree - Strategic Approach
Vision: To become a top 10company with $4 billion insales by increases overseassales from $100m to $1.2b.
Keith Parker, University of Southern California
MOR-492: Projects
Cosmetics – An Expanding Industry
Expected expansion ofcosmetics industry by 2009:
$180 Billion
• AmorePacific is involved in 49%of the potential cosmetics productscope (green shaded slices).
•Europe makes up the largestmarket followed by Asia with theUS closely behind in third.
Projected Performance
Threat ofNew Entrants
- High
Threat ofSubstitutes -
Low
Bargainingpower of
Suppliers -Low
Bargainingpower ofBuyers –
High/Medium
Rivalryamong
competitors -High
• Large selection of otherlabels• Low switching costs•Fragmented market• Some degree of customerloyalty
• Low barriers to entry•Low restrictive regulation(FDA)• Low capital requirements
• Many suppliers• Fragmented• Low switching costs
• Oral supplements• Tattooed make-up• Plastic/dermatology surgery• Spa treatments
• L’Oreal, The Procter & Gamble, UnileverPLC, Shiseido Co. Ltd., The Estee LauderCos. Inc., Avon Products, Beiersdorf AG,Johnson & Johnson, Alberto-Culver Co.,Kao Corp.•Similarity among brands•Increasing global concentration
From this analysis, AmorePacific is facing an overall medium competitive global cosmetic industry.
Porter’s 5 Forces
Keith Parker, University of Southern California
MOR-492: Projects
CAGE FrameworkDistance between Korea and other countries
Korea vs. China
Culture Distance
•Different languages
•Korean herbal medicine system was based on China’s
•Common Confucian tradition, colonial ties
Administrative Distance
•World Trade Organization
•China open to foreign investment and competition
Geographic Distance
•Land borders
•Northeast China is accessible from Korea, and shares
much history and culture
Economic Distance
•Korea is a developed country, China is a developing
country
Korea vs. U.S
Culture Distance
•Different languages
•Different religions and Value, Norms, and ethnicity
•Korean based business on personal contact
Administrative Distance
•World Trade Organization
•Korean government has heavy influence on economy
•Relatively unstable political climate due to North Korea
Geographic Distance
•Long Distance
•Korea has multiple American military bases
Economic Distance
•Rich-Rich: Replication
•Korea has complicated social and distribution network
Korea vs. FranceCulture Distance : - Different languages
- Different religions and Value, Norms, and ethnicity
- France has a relatively lax work environment
Administrative Distance - World Trade Organization
- France has strict socialist labor laws
- France has relatively unfriendly political environment for commerce
Geographic Distance - Long Distance
Economic Distance - Rich-Rich: Replication
Macro-Environment Analysis
P.E.S.T. AnalysisTechnological EnvironmentUnited States:• High cosmetics R&D• Rapidly expanding Internet based economy
China:•Evolving e-commerce
France:• Advanced cosmetic industry R&D infrastructure
Political EnvironmentUnited States:• Open trade• FDA approval required for most cosmetic products
China:•Law banning door-to-door sales in 1996•Shares much history and culture with Korea
France:• Labor Union activity can affect production costs
Economic EnvironmentUnited States:• Capitalist Economy
China:•1980s and 1990s became more open to foreigninvestment and competition• High GDP growth rate
France:•Strong currency (EU)
Social EnvironmentUnited States:•Mixed cultural environment
China:•Common Confucian tradition, colonial ties, and Koreanherbal medicine systems comes from China•Growing popularity on South Korean culture
France:•Prefer “Made in France” products•“the home of cosmetics”
AmorePacific wants to expand their product line internationally. Therefore, the company needs todetermine the right place to sell the maximum amount of their products to earn the highest profit. Eventhough there are cultural gaps between Korea the United States, China , and France, AmorePacificshould be able to make a profit in these different regions through thorough research of where to enter themarket in order to reach the widest consumer base.
Keith Parker, University of Southern California
MOR-492: Projects
Business Model
Loyal
Consumers
Premium
Prices
Increased
Margins
R&D
Brand
Marketing
Reputation Extra
Profits
Quality
As a cosmetics company, AmorePacific relies on Differentiation-based model to attract customers and build
consumer loyalty.
Door to Door
Personal Selling
Value Chain
R&D Raw Materials Manufacturing Distribution Marketing Retail
•Experience
•Knowledge
•Designated
national
research lab
by Korean
government
•Nano
structure
technologies
•Location
•botanicals
•chemicals
•location
•technology
•consolidation
•Differentiatio
n
•Brand
marketing
•Scope of
production line
•transportation
•Customer
relationship
•Changing of
consumer’s
taste
•Door to door
personalized
selling
•High-end
retail
distribution
AmorePacific serves a wide range of customers by offering products of different quality and levels of
innovation. Furthermore, AmorePacific’s unique culture of adaptability and unity has given more market
sensibility. Combined with their strong home base, high levels of innovation, successful marketing
strategy, expansive knowledge base, and a wide range of personalized products, AmorePacific is able to
obtain its current success.
Keith Parker, University of Southern California
MOR-492: Projects
ChinaFrance
USB
enefit
sC
ost
sR
isks
• Market Size and Growth
• Growth potential, unsaturated
• Joined the WTO
• Political stability
• Economic freedom lacking
• Unemployment levels high
• Access to majority ofpopulation is limited
• Door-to-door sales illegal
• World center for cosmeticproduct development
• Strong demand for cosmetics
• Reluctance to buy from newlydeveloped country
• Trouble reaching mid-pricedpharmacy channel
• Different cosmetic productpreferences
•Flagship product, a fragrance,has low loyalty levels
• Entry costs are high,especially in high profiletargeted locations
• Overcoming association with‘newly developed country’origins
• Brand confusion, with low-endproducts and high end offerings
• Reaching the non-immigrantmarket
• Highly regulated market
• Another world leader incosmetic product development
• Large number of Koreanimmigrants
• High discretionary income
Opportunities & Attractiveness
Well Equipped for High-End Market
DIFFERENTIATION
STRATEGY
Exclusive Ingredients
•Only available in Korean farms
•Hand picked rare ginsengaged precisely 6 years
•Unmatched perfectmicroclimate
•Green tea extract harvested byhand during 1st week of April
Unique Packaging
•Designed in multiple layers
•Protect products from light,heat, cold, and time
•Packaging is the “shape ofdevotion”
R&D Center
•Among the largest of anycosmetics company worldwide
•Exclusive “Nano DeliverySystem”, 1/1000th the size of a
skin cell
•Maximizes nurturing at thecellular level
•First in sector designated“National Research Lab”
New Products
•Quick launch of high-endbrands
•Innovative and research-basedproducts
Distribution
•Single brand booths
•High-tech door-to-door sales
•Hue Place
Keith Parker, University of Southern California
MOR-492: Projects
Success FactorsAmore Pacific’s success is the contribution of several factors that helped them establish their brand in
the Korean cosmetics market. Factors such as product quality, their market familiarity, and luck enables
them to become Korea’s leading producer of skin-care and cosmetic producs.
Market Familiarity Product Quality
Reputation
•Understand Korean
women and their
needs.
•AmorePacific is a
local Korean company
with majority of their
employees Korean.
Hence, they are able to
better understand their
market’s needs.
• High quality products
that works.
•Access to rare and
quality ingredients.
•Beauty professionals
to provide customer
service through spas,
department store
booths, etc.
Luck•AmorePacific is the first company to provide skin-care and cosmetic products to the
Korean market.
•Korean Economic crisis and depression creates a larger entry barrier for large
international competitior to enter Korea and enables AmorePacific to take advantage of their
market dominance.
Global StrategyIn order to understand AmorePacific’s strategy for going global, and what they wanted to achieve in their
global businesses, close attention should be paid to their levels of local responsiveness and global
coordination through this model.
Global
International
Glo
balC
oo
rdin
ati
on
Local Responsiveness
Transnational
Multi-Domestic
AmorePacific
(Tomorrow)
AmorePacific
(Now)
AmorePacific’s goal is tocompete with the bestinternational brands in the globalcosmetic market. To do this,they must appeal to the differentglobal consumer needs whilekeeping their costs at a minimum
One solution for this is to moveinto a Transnational-typecompany. This would mean highproduct differentiation for eachregional market (scope) whilekeeping high global coordinationto take advantage of economiesscale.
High
Low High
Keith Parker, University of Southern California
MOR-492: Projects
Initial Entry StrategyAmorePacific’s entry strategy for each of their global market were different to suit the heterogeneousity of
consumer preference. These differentiations included: Marketing strategy (target market and entry market),
Product lines, and Distribution/retail points.
Entry Market: High-MediumIncome
Products: Exclusive to Fragrances
Marketing Strategy:
•“M ade in France” Fragrances tocreate an exclusive image
•Different brand name to betterappeal to the local’s preference
Entry Market: Low-MediumIncome
Products: Skin-care and Cosmetics
Marketing Strategy:
•“Bottom-up” strategy
•Used Korean marketing strategybecause of similar marketenvironmet. (eg.Korean Models)
Entry Market: High-Medium Asianmarket
Products: Full line Skin-care andCosmetics
Marketing Strategy:
• Target the Asian market within theUS because they had more brandawareness
•High priced skin-care products topromote youthfulness
Recommendations
UnitedStates
France
China
• Strongest emphasis on the US market, largepotential for high investment returns.
•Top Down Approach.
•Focus on High-End department stores andretailers.
•Diversify marketing towards non-Asian andKorean consumers in US.
• Second strongest push for development in theFrench market, strategically necessary location forcosmetic companies.
•Retain separation from Corporate to allow localdecision making for the French market.
•Expand product line to build from the foothold offragrances. Bundle skincare products.
• Emerging market offers strong potential for high marketshare, but many barriers still exists low-end targetingcould influence global brand image
•Retain “Made in Korea” to ride the “Korean Wave.”
•Introduce higher-end products but retain accessibility toTier 3 consumers.
Keith Parker, University of Southern California
MOR-492: Projects
Implementation
France
•Exploit strong perfume market, but avoid cosmetics forthe near-term
•Sophisticated demand in perfume market can provideknowledge for introducing quality products for marketsin other countries
•Avoid “Made in Korea” concept
•Emphasize quality
United States
•Potential for highest returns because of profit premiums on high-end product lines with emphasis on research & technology
•Resources should be dedicated to securing premium distributionchannels for market introduction (i.e. Saks Fifth Avenue, Bergdorf-Goodman, Neiman Marcus, etc.)
•Penetrate top � down by catering to 1st & 2nd tier customers
All Global Markets
•Management should avoid reducing resourcecommitments because this will hinder goals toincrease worldwide market share. The strongfinancial position currently doesn’t necessitatereductions.
•Continue to pursue organic growth. Inorganicgrowth through acquisitions or joint ventures canlead to inconsistencies in operations anddamage AmorePacfic’s global image.
•Diverse entry strategies are necessary becauseof differences between cosmetic market maturityand consumer preferences by country.
China
•Continue bottom � up penetration
•Huge mass market opportunities in the lower tiersthrough low-end niches
•Emphasize “Made in Korea” to appeal toyoung popular culture
Conclusion• The United States would offer the highest returns on investments of
resources and managerial emphasis.
• France is strategically important in the global cosmetics market, as anindustry focal point.
• By moving from the multi-domestic to transnational approach, SuhKyung-Bae should be concerned with maintaining localresponsiveness and increasing global coordination.
• Joint ventures and acquisitions could be considered, but not at theexpense of losing control or sacrificing the company image.
Keith Parker, University of Southern California
MOR-492: Projects
Keith Parker, University of Southern California
MOR-492: Projects
Keith Parker, University of Southern California
MOR-492: Projects
4 N Q\ r UFu k» u D
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Tuesday, February 06, 2007 Tuesday, February 06 07 Tue, Feb 6 Tue, Feb 6, 2007
02/06/2007 06/02/2007 2007/02/06 02/2007 02-06-2007 06-02-2007 2007-02-06 02-2007 02/06/07 06/02/07 07/02/06 02/07 02-06-07 06-02-07 07-02-06 02-07
[MOR 492] White Board
Keith Parker, University of Southern California
MOR-492: Projects
P&G in Japan: The SK-II Globalization Project
Individual Case AnalysisKeith Parker
ID#6390.4899.77
Keith Parker, University of Southern California
MOR-492: Projects
In deciding upon which markets to enter, two factors are important to consider.
First, the individual country factors must be analyzed and compared with the core
competencies of the P & G organization. Second, and just as important, one must
understand the effects that entering either or both of these countries will have on the
newly created strategic organizational structure of P & G’s entire group.
In analyzing a potential move into the English market, it has become clear that
many of the core competencies that SK-II holds in Japan do not travel to the European
market. First, the four to six-step face washing program might be too intense for the
casual European woman. Further, service at the point of sale, one of AK-II’s strong
points, must be able to travel in order to ensure success. England, with its high minimum
wage, does not provide the most attractive market for such a sales model.
The consideration of entering the high-end Chinese market appears to be much
more appealing than the entry into the English market. While the overall Chinese market
may not be able to afford such expensive luxuries as the SK-II product line, the more
sophisticated inner-city markets with a high discretionary income appear to be a great
match for entry by SK-II. Olay has already done some of the work in testing the waters
by borrowing the service-based sales model and putting it into practice in China. This
model was highly successful, which lends to the idea that one of SK-II’s most important
core competencies will travel to the Chinese market.
Moving into the Chinese market seams to be a good move from most angles.
When taking into account the new organizational structure of P & G, which emphases the
firms’ ability to take successful products from separate GBUs and spread them across the
globe, a move into the English market seems to be a good test of this organizational
structure and may help newly appointed managers find their place in the organization.
Keith Parker, University of Southern California
MOR-492: Projects
Brin
gin
g S
K-II in
toB
ring
ing
SK
-II into
Eu
rop
eE
uro
pe
an
d C
hin
aa
nd
Ch
ina
Ke
ithP
ark
er
ID#
63
90
.48
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.77
Keith Parker, University of Southern California
MOR-492: Projects
Ove
rvie
wO
ve
rvie
w•
Th
e c
ore
co
mp
ete
ncie
s o
f SK
-II trave
l be
st to
the
Asia
nM
ark
et
•T
he
Eu
rop
ea
n m
ark
et h
as d
iffere
nt p
refe
ren
ce
s th
an
the
Asia
n m
ark
et a
nd
ve
ry d
iffere
nt c
om
pe
titive
co
nd
ition
s
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ark
et s
ha
re o
f SK
-II is s
till low
in A
sia
, an
d w
ith its
pro
mis
e o
f su
cce
ss a
s s
ho
wn
by la
rge
gro
wth
in J
ap
an
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ark
et in
Asia
tha
t mig
ht b
est b
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n fo
r be
ing
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ost s
op
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au
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me
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reg
ion
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on
eth
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ss, w
ith th
e n
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org
an
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tion
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tructu
re o
fP
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am
ble
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pp
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e w
ide
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ale
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G p
rod
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ry e
ntry
into
the
En
glis
hm
ark
et m
igh
t pro
vid
eclu
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s to
the
po
ten
tial fo
r furth
er
exp
an
sio
n in
to o
the
r we
ste
rn m
ark
ets
Keith Parker, University of Southern California
MOR-492: Projects
SK
-II So
urc
es o
f Su
cce
ss
SK
-II So
urc
es o
f Su
cce
ss
Re
se
arc
ha
nd
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ve
lop
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nt
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ve
rtisin
gM
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ufa
ctu
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tribu
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Se
rvic
ea
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nte
r
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cce
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thC
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aa
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e
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ely
trave
lto
Ch
ina
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he
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refe
ren
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sa
resim
ilar.
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gh
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t
Keith Parker, University of Southern California
MOR-492: Projects
Ind
ustry
An
aly
sis
Ind
ustry
An
aly
sis
Th
rea
t of E
ntry
•Mo
stly
am
ark
etin
g-b
ase
din
du
stry
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hic
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he
avy
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pita
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ga
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nific
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tm
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am
ou
nt
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arc
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nd
de
ve
lop
me
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utiq
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en
tran
tsm
ay
find
nic
he
ma
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bu
tin
ord
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tog
ain
asig
nific
an
tm
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et
sh
are
itis
imp
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tob
ee
sta
blis
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da
nd
ha
ve
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ca
pita
lb
ase
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bs
titute
s•D
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din
go
nth
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ark
et,
su
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ma
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or
rare
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me
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ste
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ple
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ap
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Ja
pa
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me
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ph
istic
atio
nle
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sto
the
ide
ath
at
the
reis
littlesu
bstitu
tion
for
be
au
typ
rod
ucts
Su
pp
lier
Po
we
r•S
up
plie
rsa
ree
mp
loye
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ou
nt
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rit
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er
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ve
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uch
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h
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ny
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the
be
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me
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cre
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alry
;th
isis
esp
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sa
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ted
ma
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ts
Bu
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r Po
we
r•B
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recu
sto
me
rsa
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me
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nt
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be
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typ
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ucts
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usu
ally
so
ldn
ea
rco
mp
etin
gb
ea
uty
pro
du
cts
so
itis
ea
sy
for
the
cu
sto
me
rto
wa
lka
wa
y
Keith Parker, University of Southern California
MOR-492: Projects
Po
ssib
le E
ntry
Co
nsid
era
tion
sP
ossib
le E
ntry
Co
nsid
era
tion
sL
oc
atio
n D
rive
rsC
os
t an
d V
olu
me
Driv
ers
By
exp
an
din
go
pe
ratio
ns,
mo
ve
me
nt
alo
ng
the
lea
rnin
gcu
rve
will
incre
ase
eco
no
mie
so
fre
plic
atio
nAs
initia
le
xp
an
sio
nin
toth
ese
ma
rke
tsw
illo
nly
inclu
de
on
ep
rod
uct
line
(SK
-II),o
pe
ratio
ns
will
no
tb
eb
en
efite
db
ye
co
no
mie
so
fsco
pe
As
with
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no
mie
so
fre
plic
atio
n,
an
din
cre
ase
into
tal
un
itsso
lda
fter
en
terin
ge
ithe
ro
fth
ese
ma
rke
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illle
ad
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en
efit
from
eco
no
mie
so
fsca
le
Na
tion
al
diffe
ren
ce
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elim
iting
inE
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pe
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ut
no
so
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ch
ine
nte
ring
Ch
ina
No
n-m
ark
et
stra
teg
ies
are
no
tsu
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ntia
lin
this
ca
se
Glo
ba
lle
arn
ing
will
be
se
en
mo
st
ine
nte
ring
Eu
rop
e,
an
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ea
nim
po
rtan
tte
st
of
the
ne
wo
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atio
na
lstru
ctu
reo
fP
&G
With
the
siz
eo
fP
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’so
pe
ratio
ns
ino
the
ra
nd
sim
ilar
ind
ustrie
s,
the
firmw
illb
ea
ble
top
rovid
eso
me
of
the
flexib
ilityn
ee
de
din
en
terin
gE
uro
pe
an
dC
hin
a
Keith Parker, University of Southern California
MOR-492: Projects
Re
gio
n a
na
lysis
Re
gio
n a
na
lysis
En
gla
nd
Ch
ina
Ja
pa
n
Cle
arly
,th
ere
are
larg
ecu
ltura
ld
iffere
nce
sb
etw
ee
nth
eA
sia
nb
ea
uty
ma
rke
ta
nd
the
Eu
rop
ea
nb
ea
uty
ma
rke
t.W
hile
Ja
pa
nm
ay
be
the
so
ph
istic
ate
dm
ark
et
of
Asia
,w
he
rela
rge
am
ou
nts
of
de
ve
lop
me
nt
with
inth
ein
du
stry
occu
r,F
ran
ce
isth
ee
qu
iva
len
to
fE
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pe
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itho
ut
be
ing
inF
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er
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rop
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ng
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-tier
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mo
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ilar
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ltho
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hth
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rod
ucts
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vid
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this
ha
sa
rise
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mO
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use
ofS
K-II’s
Ja
pa
ne
se
tactic
sin
Ch
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ino
rde
rto
justify
the
pric
ep
rem
ium
for
the
irp
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his
ha
sb
ee
nw
ildly
su
cce
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l.
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pa
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ma
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ph
istic
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nt
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nd
ha
sp
rove
nth
at
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-II,a
lon
gw
ithth
ese
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es
an
dm
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at
acco
mp
an
yth
ep
rod
uct,
ca
nsu
cce
ed
inm
ark
ets
sim
ilar
toth
is
Keith Parker, University of Southern California
MOR-492: Projects
En
terin
g E
ng
lan
dE
nte
ring
En
gla
nd
•A
lthough
Euro
pe
may
notbe
ideally
suite
das
apote
ntia
llo
catio
nfo
rexpansio
nofth
eS
K-II
line,entry
into
this
mark
etm
ay
pro
vid
estra
tegic
benefit
•A
sm
ostla
rge
beauty
pro
ductcom
panie
sare
glo
balin
scale
,S
K-II
can
reap
the
benefits
ofknow
ledge
transfe
r,econom
ies
ofscope,
etcete
ra
•If
SK
-IIis
tobecom
ea
glo
bally
com
petitiv
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mustte
stth
ew
ate
rsand
make
apre
sence
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este
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orld
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ngla
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ithits
concentra
ted
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entsto
rechannels
thatw
ould
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wlim
ited
hig
h-c
ostserv
ice
sta
ffbutsim
ilar
serv
ice
quality
,w
ould
be
agood
choic
e
•W
hile
losses
may
occur,
this
isnecessary
inord
er
togain
astra
tegic
positio
nin
the
world
mark
et
•F
urth
er,
alth
ough
SK
-II’sp
rem
ium
positio
nin
gd
oesn’t
fitw
ell
with
P&
G’s
volu
me-b
ased
stra
tegy,it
will
com
plim
entO
lay’s
low
er-c
ostvolu
me
stra
tegy
and
pro
vid
eeconom
ies
ofscope
as
well
as
stro
nger
barg
ain
ing
pow
er
with
Engla
nd’s
very
pow
erfu
lconcentra
ted
reta
ilers
•F
urth
er,
as
bra
nd
image
and
serv
ice
quality
are
essentia
lto
the
success
ofS
K-II
inth
eB
ritish
mark
et,
ow
ners
hip
ofth
ese
com
ponents
should
be
as
full
as
possib
le.
Apartn
er
inente
ring
this
mark
et
would
be
agood
idea
for
the
oth
er
com
ponents
ofbusin
ess
opera
tion,th
ough,so
as
tom
inim
ize
risk
and
pro
vid
efo
ra
sm
ooth
er
exit
stra
tegy
Keith Parker, University of Southern California
MOR-492: Projects
En
terin
g C
hin
aE
nte
ring
Ch
ina
•T
he
Ch
ine
se
ma
rke
t,th
ou
gh
on
ave
rag
eq
uite
ab
itd
iffere
nt
from
the
Ja
pa
ne
se
ma
rke
tin
term
so
fp
ers
on
alsp
en
din
gp
ow
er
an
dso
ph
istic
ate
dp
refe
ren
ce
s,
ca
nstill
pro
vid
eS
K-II
with
ala
rge
am
ou
nt
of
su
cce
ss
inth
eA
sia
nm
ark
et
•In
the
larg
est,
we
alth
ies
citie
so
fC
hin
are
sid
eth
ose
wh
oh
ave
pre
fere
nce
ssim
ilar
toth
eJa
pa
ne
se
an
dth
eb
uyin
gp
ow
er
top
urc
ha
se
item
sm
ark
ed
up
as
hig
ha
sS
K-II
•A
sse
rvic
eis
su
ch
ala
rge
pa
rto
fS
K-II’s
ove
rall
pro
du
ct
offe
ring
an
dstra
teg
y,
the
ab
ilityto
hire
se
rvic
ew
ork
ers
at
an
extre
me
lylo
wp
rice
inC
hin
aa
dd
sg
rea
ta
pp
ea
lto
en
terin
gth
em
ark
et
•O
lay
bo
rrow
ed
the
se
rvic
e-b
ase
did
ea
from
SK
-IIa
nd
pu
tit
tow
ork
inC
hin
a,
toh
ug
esu
cce
ss;
this
alo
ne
isp
roo
fth
at
on
eo
fS
K-II’s
stro
ng
est
co
reco
mp
ete
ncie
sw
illtra
ve
lin
toth
eC
hin
ese
ma
rke
ta
nd
me
et
su
cce
ss
•C
hin
a’s
po
ten
tialfo
rg
row
tha
nd
pro
fitis
stro
ng
en
ou
gh
for
on
eto
su
gg
est
tha
tP
&G
en
ter
into
the
ma
rke
tw
itho
ut
ap
artn
er
ino
rde
rto
ma
xim
ize
pro
fit(I.e
.C
hin
ais
no
ta
ve
ryris
ky
en
try)
Keith Parker, University of Southern California
MOR-492: Projects
Ho
w D
oe
s T
his
Fit In
to T
he
Ho
w D
oe
s T
his
Fit In
to T
he
Org
an
iza
tion
al S
tructu
re?
Org
an
iza
tion
al S
tructu
re?
•As th
is c
ase
an
aly
sis
ma
yh
ave
pro
vid
ed
mo
reco
ncre
tere
aso
ns to
NO
T e
nte
r En
gla
nd
tha
n v
ice
vers
a, w
hen ta
kin
g in
to a
ccount P
& G
’s n
ew
org
an
iza
tion
al s
tructu
re o
ne
find
s th
at th
is is
cle
arly
no
t the
ca
se
•On
e o
f the
co
re c
om
pe
ten
cie
s o
f the
ne
wo
rga
niz
atio
na
l stru
ctu
re o
f P &
G is
its a
bility
to ta
ke
a g
oo
d id
ea
from
on
e G
BU
an
d m
ass m
ark
et th
esa
me
tech
no
log
y in
diffe
ren
t wa
ys th
rou
gh
ou
t the
wo
rld; S
K-II is
the
pe
rfect p
rod
uct to
ch
alle
ng
e th
isn
ew
org
an
iza
tion
al s
tructu
re a
nd
allo
wa
ll of th
en
ew
ly a
pp
oin
ted
ma
na
ge
rs to
esta
blis
hth
eir ro
le in
the
org
an
iza
tion
Keith Parker, University of Southern California
MOR-492: Projects
Me
xic
an
Exp
an
sio
n
Pre
sente
dby
Mark
Davenport
,C.K
.H
su,
Gary
Lilard
i,Kerr
yM
acD
onald
,
Keith
Park
er,
Whitney
Sta
mble
r,N
an
Wang
Th
e W
ahah
a G
rou
p
Keith Parker, University of Southern California
MOR-492: Projects
Executive
Sum
mary
Wahaha’sCompanyBackground
Wahaha
isth
ele
adin
gbevera
ge
pro
ducer
inC
hin
a.
Founded
by
Zong
Qin
gou
in1989,
the
com
pany
has
gro
wn
into
abillion
dollar
industr
y.
Wahaha
has
begun
alim
ited
expansio
nabro
ad
by
ente
ring
the
United
Sta
tes
and
putt
ing
its
pro
ducts
on
shelv
es
inN
ew
York
and
Los
Angele
s.
Part
of
Wahaha’s
str
ate
gy
isto
find
mark
ets
with
hig
hgro
wth
opport
unitie
s.
Mexico’sAttractivenesstoWahaha
The
Mexic
an
soft
dri
nk
mark
et
isan
extr
em
ely
att
ractive
mark
et
for
Wahaha.
Curr
ently,
Mexic
ois
ranked
the
worl
d’s
second
larg
est
soft
dri
nk
mark
et.
Within
the
soft
dri
nk
industr
y,
carb
onate
dbevera
ge
cate
gory
dom
inate
sw
ith
huge
revenues
repre
senting
over
60%
of
the
mark
et.
Carb
onate
sare
part
icula
rly
popula
rin
Mexic
odue
toth
ehot
clim
ate
,com
patibility
with
Mexic
an
food,
and
the
wid
em
ark
et
penetr
ation.
Infa
ct,
carb
onate
ddri
nks
have
becom
epart
of
Mexic
an
culture
;“m
any
Mexic
ans
would
find
itdifficult
toim
agin
ea
gath
eri
ng
with
frie
nds
without
carb
onate
s.”
[1]
Over
the
next
few
years
,th
esoft
dri
nk
mark
et
isexpecte
dto
be
valu
ed
at
$20.3
billion,
an
incre
ase
of
27%
sin
ce
2005.
Meanw
hile,
sale
svolu
me
isexpecte
dto
incre
ase
by
28.6
%to
49.6
billion
lite
rs.
Wahaha
should
take
advanta
ge
of
the
opport
unity
toente
rin
this
gro
win
geconom
y.
Wahaha’s
targ
et
custo
mers
are
sim
ilar
tow
ho
the
com
pany
appeals
toin
Chin
a.
The
com
pany
willaim
at
the
low
er
tiers
of
the
mark
et
(tie
rs3
and
4)
where
consum
ers
are
more
pri
ce-s
ensitiv
e.
InM
exic
o,
this
targ
et
mark
et
repre
sents
ala
rge
perc
enta
ge
of
the
overa
llM
exic
an
mark
et
(appro
xim
ate
ly64%
).
HowtoEnterintoMexico
There
are
many
options
for
Wahaha
toconsid
er
befo
reente
ring
Mexic
o.
How
ever,
out
of
the
many
possib
lepath
sth
ebest
choic
eis
tojo
int
ventu
rew
ith
Gro
upe
Danone.
Wahaha
and
Danone
have
an
exis
ting
rela
tionship
that
was
form
ed
in1996.
Curr
ently,
Danone
ow
ns
51%
of
Wahaha.
With
Danone's
assis
tance,
Wahaha
was
able
toin
vest
inadvanced
pro
duction
lines,
impro
ve
eff
icie
ncy,
and
pro
duction
double
dfr
om
1996
to1997.
Danone
has
been
opera
ting
inM
exic
ofo
rover
30
years
.W
ith
Danone’s
experi
ence
inM
exic
o,
Wahaha
can
use
its
know
ledge
of
the
mark
et
tohave
agre
ate
rchance
at
success.
Wahaha
willneed
tobuild
abott
ling
pla
nt,
but
with
the
hig
hgro
wth
of
the
mark
et,
the
bre
akeven
should
occur
duri
ng
the
second
year.
Als
o,
Danone
alr
eady
has
aw
ide
dis
trib
ution
and
manufa
ctu
ring
netw
ork
that
can
be
used
todis
trib
ute
Wahaha
pro
ducts
.W
ahaha
willbe
able
toente
rM
exic
oand
know
that
they
have
atr
ustw
ort
hy
part
ner
with
them
.
When
ente
ring
into
this
new
mark
et,
Wahaha
should
imple
ment
its
old
busin
ess
model,
but
make
som
enecessary
sm
all
adapta
tions.
InC
hin
a,
Wahaha
targ
ets
the
low
er
tiers
inru
ralre
gio
ns,
but
inM
exic
o,
these
are
as
are
not
as
popula
ted
and
popula
tion
inru
ralare
as
continues
todecline
There
fore
Wahaha
willneed
Keith Parker, University of Southern California
MOR-492: Projects
Executive
Sum
mary
Continued
CompetitorsWahahaWillFace
Wahaha
faces
majo
rcom
petition
inM
exic
o.
The
larg
est
are
Coke
and
Pepsiw
ho
dom
inate
the
mark
et
with
63%
com
bin
ed
mark
et
share
.H
ow
ever,
Wahaha
willnot
be
dir
ectly
com
peting
with
these
two
com
panie
s.
Inste
ad,
Wahaha
willlo
ok
togra
bsom
eof
the
mark
et
that
the
sm
aller
bra
nds
reach.
Big
Cola
isone
of
the
sm
aller
bra
nds
that
Wahaha
willbe
com
peting
with
and
matc
hin
gth
epri
ce
they
put
on
its
pro
ducts
.M
ark
et
trends
indic
ate
that
much
of
the
incre
ase
inconsum
ption
volu
mes
inM
exic
ois
dri
ven
by
low
-pri
ce
carb
onate
sth
at
are
more
aff
ord
able
for
consum
ers
.In
this
sense,
Wahaha
willnot
bestealing
mark
et
share
from
com
petito
rsas
much,
butexpanding
the
mark
et.
BarrierstoWahaha’sSuccessinMexico
While
Mexic
ohold
sgre
at
pote
ntialfo
rW
ahaha,
there
are
facto
rsth
at
may
hin
der
the
success
of
the
com
pany.
There
are
rela
tively
hig
hpoliticalri
sks
and
corr
uption
within
Mexic
o.
There
are
als
ocultura
ldis
tances
because
of
the
diffe
rence
inla
nguage
and
Mexic
ans
do
not
favor
Asia
npro
ducts
.H
ow
ever,
by
join
tventu
ring
with
Danone,
Wahaha
can
mitig
ate
these
cultura
ldis
tances
by
learn
ing
from
Danone’s
experi
ence
and
respondin
gto
these
diffe
rences
inth
em
ark
et.
HowtoSucceedinMexico
Inord
er
tosucceed
inth
eM
exic
an
carb
onate
ddri
nks
industr
y,
Wahaha
needs
tobuild
its
glo
balcom
petitive
advanta
ge.
Inord
er
todo
this
,th
ecom
pany
can
take
advanta
ge
of
its
know
ledge
incre
ating
econom
ies
of
scale
and
scope
that
impro
ved
trem
endously
with
their
join
tventu
rew
ith
Danone.
Additio
nally,
the
way
that
Wahaha
advert
ises
willhelp
spre
ad
its
bra
nd
image.
Wahaha
willre
plicate
the
mark
eting
str
ate
gy
that
ituses
inC
hin
aand
use
com
merc
ials
,pri
nt
ads,
and
cele
bri
tyendors
em
ents
.D
anone’s
30-y
ear
experi
ence
inM
exic
ow
illals
ohelp
Wahaha
succeed
inth
isnew
mark
et
and
captu
rea
port
ion
of
the
soft
dri
nk
industr
y.
[1]
“Soft
Dri
nks
–M
exic
o.”
Euro
monit
or
Inte
rnati
onal.
August
20
06.
Keith Parker, University of Southern California
MOR-492: Projects
Com
pany
Info
rmation
Keith Parker, University of Southern California
MOR-492: Projects
Who
isW
ahaha?
�“W
ahaha”
inChin
ese
refe
rsto
the
sound
kid
sm
ake
when
they
are
happy
and
laughin
g
�Found
by
Zong
Qin
ghou
in1989
�Private
-ow
ned
com
pany
and
big
gest
bevera
ge
pro
ducer
inChin
a
�M
anufa
ctu
res
non-a
lcoholic
bevera
ges
and
non-b
evera
ge
goods
inclu
din
gclo
thes,
snacks,
etc
.
�Responsib
lefo
r15.6
%ofChin
a's
tota
lbevera
ge
pro
duction
�RM
B4.6
5billion
into
talassets
�JV
ow
ners
hip
:Zong
Qin
ghou
hold
s49%
and
Danone
hold
s51%
�Lookin
gfo
rgro
wth
opport
unitie
s
Keith Parker, University of Southern California
MOR-492: Projects
There
are
severa
lentr
ystr
ate
gy
opti
ons
available
for
Wahaha
for
their
move
into
Mexic
o.T
he
most
capit
alin
tensiv
ein
vestm
ent
would
be
aw
holly-ow
ned
subsid
iary
.A
lthough
this
would
giv
eth
ecom
pany
com
ple
tecontr
olover
their
opera
tions,th
ism
ode
ofentr
yis
not
advis
able
as
Wahaha
lacks
experi
ence
inexpandin
git
sbusin
ess
inte
rnati
onally.
Rath
er
than
buildin
gth
eir
opera
tions,W
ahaha
could
acquir
ea
Mexic
an
bra
nd
that
isa
dir
ect
com
peti
tor
toW
ahaha,but
this
com
es
wit
hth
eri
sk
offa
ilin
gto
inte
gra
teth
ecom
panie
sor
overp
ayin
gfo
rth
ecom
pany.
Wahaha
could
consid
er
astr
ate
gic
allia
nce
such
as
ajo
int
ventu
rew
ith
Danone
or
apart
ners
hip
wit
ha
localbott
ler/
dis
trib
uto
rsuch
as
AR
CA
.
All
ofth
ese
are
via
ble
entr
ystr
ate
gie
s.
How
ever,
Wahaha
needs
tocare
fully
weig
hth
epro
sand
cons
ofeach
opti
on
toensure
successfu
lentr
yin
toM
exic
o.
Me
xic
oJointVenturewith
existingfirmin
Mexico
(Danone)
Partnershipwith
localbottler
ordistributor
(ARCA)
Acquisitionofa
localbrand
Directinvestment
withoutany
strategicalliances
Aft
er
consid
eri
ng
all
ofth
eopti
ons,w
ere
com
mend
that
Wahaha
ente
rth
eM
exic
an
mark
et
thro
ugh
ajo
int
ventu
rew
ith
Danone.W
ahaha’s
exis
ting
rela
tionship
wit
hD
anone
mit
igate
sm
uch
ofth
eri
sk
ofa
part
ner
hold
ing
up
Wahaha
because
Danone
isfinancia
lly
tied
toW
ahaha’s
success.Furt
herm
ore
,W
ahaha
could
take
advanta
ge
ofD
anone’s
alr
eady
esta
blished
dis
trib
uti
on
channels
inM
exic
o.
Danone
firs
tente
red
Mexic
oin
the
70
’sas
aw
holly
ow
ned
inte
rnati
onalsubsid
iary
,and
now
has
an
exte
nsiv
enetw
ork
ofdis
trib
uto
rs,re
tailers
,and
support
ing
industr
ies
under
its
belt
.T
his
would
,in
effect,
make
Wahaha’s
dis
trib
uti
on
inlo
calsuperm
ark
ets
and
mom
and
pop
sto
res
much
easie
rth
an
ifth
ey
go
inM
exic
oby
them
selv
es.
Wit
hD
anone
ow
nin
g5
1%
ofW
ahaha
inC
hin
a,th
ecom
panie
s’clo
se
rela
tionship
would
pro
vid
eW
ahaha
an
easie
rand
more
effecti
ve
entr
ystr
ate
gy.It
allow
sth
em
tobe
com
peti
tive
wit
hlo
cal
bra
nds
that
are
com
peti
ng
inth
elo
w-cost,
hig
h-volu
me
soft
dri
nk
pro
duct.
How
Wahaha
Should
Ente
rM
exic
o
Keith Parker, University of Southern California
MOR-492: Projects
Quality
Extr
a
Pro
fits
Advert
isin
gIm
pro
ve
bra
nd
aw
are
ness
and
use
pull
mark
eting
to
incre
ase
WTP In
cre
ased
Marg
in
Low
Unit
Cost
Econom
ies
Of
scale
sR&
DIn
novation
and
cre
ativity
for
new
taste
sand
pro
ducts
Volu
me
Num
ber
of
vis
its
And
repeating
vis
its
Price
The
exhib
itbelo
wis
adepic
tion
of
Wahaha’s
busin
ess
model.
The
main
focus
of
Wahaha
isin
cre
asin
gsale
svolu
me
incre
ative
and
eff
ective
ways.
Success
inth
eir
modelis
driven
by
quality
,R
&D
,advert
isin
g,
and
econom
ies
of
scale
.
Wahaha’s
busin
ess
modelis
transfe
rable
but
sm
all
adapta
tions
are
necessary
.In
Chin
a,
Wahaha
targ
ets
the
lower
tiers
inru
ralare
as.
However,
inM
exic
o,
the
rura
lare
as
are
not
as
popula
ted
and
the
popula
tion
inth
ese
are
as
isdeclinin
g.
For
this
reason,
they
must
alter
their
str
ate
gy
tore
ach
the
lower
tiers
inurb
an
and
suburb
an
are
as
as
well.
Wahaha’s
Busin
ess
Model
Keith Parker, University of Southern California
MOR-492: Projects
Bra
nd
Image
Many
carb
onate
d
dri
nks
taste
sim
ilar.
Bra
nd
image
willdri
ve
incre
ased
sale
s
and
mark
et
share
inth
elo
ng
run.
Dis
trib
ution
Wahaha’s
targ
et
mark
et
inclu
des
people
livin
gin
tiers
3
&4,
and
these
custo
mers
oft
en
buy
soda
from
am
ong
the
many
mom
and
pop
sto
res
inM
exic
o.
Itis
impera
tive
that
Wahaha
finds
aw
ay
todis
trib
ute
eff
ectively
toth
ese
scatt
ere
d
locations.
Sale
sV
olu
me
There
are
many
dete
rmin
ants
for
the
success
ofa
com
pany.In
the
case
ofW
ahaha,th
em
ost
import
ant
facto
ris
sale
svolu
me
whic
his
essential
togenera
ting
incom
e.W
ith
volu
me
bein
gth
efo
cus,
there
are
oth
er
facto
rsth
at
are
supple
menta
ry.
Advert
isin
gcan
incre
ase
bra
nd
equity
and
consum
ers
’w
illingness-t
o-p
ay.G
ood
advert
isin
g
builds
astr
ong
bra
nd
image,w
hic
hdrives
volu
me.
The
channels
for
dis
trib
ution
are
als
oextr
em
ely
import
ant—
part
icula
rly
inM
exic
ow
here
itis
a
challenge
tore
ach
custo
mers
with
so
many
sm
all
Advert
isin
gW
hen
ente
ring
a
new
mark
et,
advert
isin
gis
essentialto
buildin
g
consum
er
aw
are
ness
about
the
pro
duct.
Incre
ased
aw
are
ness
can
als
o
lead
toan
incre
ased
willingness-t
o-p
ay
and
hig
her
pro
fit
marg
ins.
CriticalS
uccess
Facto
rs
Keith Parker, University of Southern California
MOR-492: Projects
Industr
yand
Countr
yAnaly
sis
Keith Parker, University of Southern California
MOR-492: Projects
•More
than
90%
oftr
ade
under
free
trade
agre
em
ents
•Mem
ber
ofW
TO
,th
ere
fore
subje
ctto
regula
tions
Eco
no
mie
so
f
Scale
Nati
on
al
Dif
fere
nces
No
n-M
ark
et
Str
ate
gy
Fle
xib
ilit
yL
earn
ing
Econom
ies
ofscale
are
cru
cia
lfo
rW
ahaha
as
costsavin
gs
from
scale
effectis
cri
ticalto
sta
ycom
petitive
inth
esoft
dri
nk
industr
y.B
ycom
peting
with
hig
hvolu
me
&lo
wm
arg
inpro
ducts
,W
ahaha
has
tohave
low
cost
ofpro
duction
tosupport
the
low
pri
ces
thatth
ey
charg
e
Inord
er
tobe
successfu
lin
Mexic
o,it
isim
pera
tive
thatW
ahaha
take
full
advanta
ge
ofeconom
ies
ofscale
.
We
recom
mend
that
Wahaha
lim
its
their
pro
duct
line
when
ente
ring
Mexic
o.
This
isbecause
one
ofth
ecri
ticalsuccess
facto
rsfo
rth
ein
dustr
yis
scale
advanta
ge
and
notscope.
There
fore
,once
they
have
esta
blished
the
scale
they
needed,th
en
they
should
sta
rtconsid
eri
ng
expansio
nto
cre
ate
scope.
Eco
no
mie
so
f
Rep
licati
on
•Location
Advanta
ges:H
igh
volu
me
oflo
w-m
iddle
incom
econsum
ers
who
are
very
pri
ce
sensitiv
e
•Language
barr
ier
thatm
ight
affectth
ebra
nd
nam
e
•Diffe
rentconsum
er
taste
and
pre
fere
nce
mig
htaffectsale
s.
•Very
little
flexib
ility
as
ente
ring
anew
mark
etin
this
industr
yre
quir
es
very
hig
hcapitalcosts
.
•Ris
ks
may
be
reduced
ifbottling
or
oth
er
opera
tions
can
be
outs
ourc
ed
toa
local
part
ner.
Wahaha’s
pro
ductta
kes
advanta
ge
ofeconom
ies
ofre
plication
as
soft
dri
nks
are
sta
ndard
ized
and
are
manufa
ctu
red
thro
ugh
afixed
pro
duction
pro
cess.
There
fore
,th
ey
requir
elittle
modific
ation
and
are
sim
ple
topro
duce.
Eco
no
mie
so
f
Sco
pe
•Learn
scru
cia
lin
form
ation
aboutth
eM
exic
an
mark
et
(consum
er
pre
fere
nce,
cultura
ldiffe
rences,
dis
trib
ution
channel
effectiveness,etc
.)
•Str
ate
gic
allia
nce
with
Danone
would
pro
vid
eth
em
with
abetter
unders
tandin
gof
their
mark
et
This
dia
gra
mof
Volu
me
and
Location
drivers
allows
for
an
in-depth
analy
sis
of
Wahaha’s
opera
tions
and
the
advanta
ges
/dis
advanta
ges
of
movin
gin
toanoth
er
location.
This
willle
ad
toa
bett
er
unders
tandin
gof
the
com
pany’s
com
para
tive
advanta
ge.
Com
petitive
Advanta
ge
&Location
Drivers
Keith Parker, University of Southern California
MOR-492: Projects
Mexic
o is t
he w
orld’s
2nd
larg
est
soft
drink m
ark
et
CompoundAnnualGrowthRate
GlobalSoftDrinkSales(InbillionsUS$)
•C
arb
onate
sale
spro
ved
tobe
the
most
lucra
tive
inM
exic
o,
genera
ting
revenues
of
US$9.7
billion,
or
60.6
%of
the
soft
drink
mark
et
•Bott
led
wate
rgenera
tes
anoth
er
27.4
%of
sale
sof
soft
drinks
inM
exic
o
•PepsiC
oand
Coca-C
ola
are
both
purs
uin
gaggre
ssiv
ecam
paig
ns
togain
mark
et
share
inM
exic
o,
recogniz
ing
the
hig
hvalu
eof
the
mark
et
•By
2010,
the
Mexic
an
soft
drink
mark
et
isexpecte
dto
be
valu
ed
at
$20.3
billion,
an
incre
ase
of
27%
sin
ce
2005
•In
this
sam
etim
eperiod,
sale
svolu
me
isexpecte
dto
incre
ase
by
28.6
%to
49.6
billion
lite
rs
•In
2002,
the
Mexic
an
govern
ment
appro
ved
a20
perc
ent
tax
on
soft
drink
manufa
ctu
rers
who
use
fructo
se
sweete
ners
,in
ord
er
tohelp
stim
ula
teth
edom
estic
sugar
industr
y
Why
Go
To
Mexic
o?
Keith Parker, University of Southern California
MOR-492: Projects
FirmStrategy,
Structure,Rivalry
•R
ivalry
from
localcola
s
(Big
Cola
)and
leadin
g
cola
bra
nds
(C
oke,
Pepsi)
.•Low
-cost,
Hig
hVolu
me
str
ate
gy.
•Targ
ets
mid
dle
-lo
w
incom
egro
ups
FactorConditions
•W
ahaha
has
the
experience
of
doin
g
busin
ess
ina
develo
pin
gcountr
y.
•M
exic
ois
suited
for
their
busin
ess
modelbecause
of
sim
ilar
mark
et.
DemandConditions
•G
row
ing
mark
et
for
soft
drink
industr
yin
Mexic
o
•D
em
and
for
low
cost
soft
drink
ishig
hdue
tolo
wer
purc
hasin
gpow
er
of
consum
er
Relatedand
SupportingIndustry
•D
anon
could
pro
vid
e
dis
trib
ution
channels
for
Wahaha
•Larg
esuperm
ark
et
chain
saro
und
the
com
pany
toact
as
pote
ntialdis
trib
uto
r
(C
alim
ax)
Go
vern
men
t
Ch
an
ce
Port
er’s
dia
mond
analy
sis
of
com
petitive
facto
rsallows
us
toanaly
ze
Wahaha’s
com
petitive
advanta
ges
when
the
com
pany
makes
the
move.
With
good
dem
and
conditio
ns
and
support
ing
industr
ies,
we
can
conclu
de
that
there
are
sig
nific
ant
facto
rsth
at
can
pote
ntially
allow
them
tosucceed
inM
exic
o.
The
Key
toS
uccessfu
lM
ark
etE
ntr
ance
Keith Parker, University of Southern California
MOR-492: Projects
ThreatofEntry-Low
•M
ostly
am
ark
eting-based
industr
y,
whic
hre
quires
heavy
use
of
capitalto
gain
asig
nific
ant
mark
et
share
•O
nly
inth
eenerg
ydrink
cate
gory
do
we
see
fragm
enta
tion
•Fairly
sim
ple
toente
ras
there
are
many
bott
lers
tocontr
act
with,
but
difficult
togain
mark
et
share
without
advert
isin
gcapital
BuyerPower-Low
•The
buyers
are
bott
ling
com
panie
sand/or
reta
ilers
•Thre
at
of
forw
ard
inte
gra
tion:
many
larg
ecom
panie
sare
buyin
gth
ebott
lers
they
used
tosell
to•Bott
lers
are
undiffe
rentiate
d,
can
easily
be
substitu
ted
with
anoth
er
bott
ler
inth
eare
a
Substitutes-High
•M
any
substitu
tes
for
soft
drinks:
Wate
r,ju
ices,
alc
ohol,
and
energ
ydrinks
•Private
labels
show
thre
at
within
the
soft
drink
mark
et
(i.e.
sto
re-bra
nd
labels
or
‘spin
-off
s’)
Supplier
Power–
Medium/Low
•Suppliers
for
sugar
and
oth
er
raw
mate
rials
are
mostly
undiffe
rentiate
dand
have
litt
lepower
•Em
plo
yee
are
backed
by
unio
ns
Rivalry-Medium-
High
•Advert
isin
gis
heavy
from
the
majo
rcom
petito
rs,
rivalry
for
mark
et
share
isvery
hig
hThe
mark
et
has
been
recogniz
ed
by
majo
rpla
yers
as
agro
win
gm
ark
et,
spurn
ing
heavy
investm
ent
tocaptu
regro
wth
•Pepsi,
Coke,
Big
Cola
Heavy
rivalry
and
ahig
hth
reat
of
substitu
tes
off
sets
the
low
ratings
for
the
oth
er
facto
rsfo
rnew
entr
ants
.Low
supplier
and
buyer
power
make
the
industr
yatt
ractive
for
esta
blished
com
petito
rsand
those
with
larg
ecapitalsourc
es.
How
Attra
ctive
isth
eIn
dustr
y?
Keith Parker, University of Southern California
MOR-492: Projects
So
ftD
rin
ks
Ma
rke
tS
ha
re
•There
are
about
43
soft
drink
com
panie
sin
Mexic
o,
though
70%
of
sale
scam
efr
om
the
top
8com
panie
s
•Pepsiand
Coke
his
torically
split
up
Mexic
oin
tore
gio
ns,
where
each
would
dom
inate
the
mark
et;
this
has
changed
inre
cent
years
,in
cre
asin
gcom
petition
•In
2004,
Coca-C
ola
em
plo
yed
86,0
00
people
inM
exic
o
•PepsiC
oconsid
ers
Mexic
oits
second
most
import
ant
mark
et
outs
ide
of
the
US;
inearly
2002,
PepsiC
oannounced
its
goalto
invest
more
than
US$1.2
billion
inM
exic
oby
2006
•Bott
lers
inM
exic
ohave
been
consolidating
opera
tions,
leadin
gto
apossib
lestr
ength
enin
gof
buyer
power
•In
the
past,
Coke
and
Pepsitr
ied
topre
vent
sm
aller
com
panie
sfr
om
ente
ring
the
mark
et,
but
this
behavio
ris
no
longer
bein
gto
lera
ted.
in2005,
the
Mexic
an
govern
ment
fined
15
Coke
bott
lers
and
dis
trib
uto
rs$15
million
for
anti-com
petitive
pra
ctices.
The
deale
rs“u
nfa
irly
pre
ssure
dm
om
-and-pop
reta
ilers
not
tocarr
yBig
Cola
by
thre
ate
nin
gto
sto
pC
oke
deliveries
and
yank
from
their
tiny
sto
res
While
Coke
and
Pepsidom
inate
the
mark
et,
Wahaha
willnot
be
directly
com
peting
with
them
.In
ste
ad,W
ahaha
willfo
cus
on
gra
bbin
gsom
eofth
em
ark
et
that
the
sm
aller
bra
nds
reach.
There
fore
,W
ahaha
willbe
priced
low
er
than
Coke
and
Pepsi.
Com
petition
inM
exic
o
Keith Parker, University of Southern California
MOR-492: Projects
BackgroundFacts
–Bott
led
and
mark
ete
dby
Aje
max,
asubsid
iary
of
Peru
via
nfirm
Kola
Real
–Ente
red
Mexic
an
mark
et
in2002
–Pre
sently
accounts
for
5%
of
the
Mexic
an
dri
nk
mark
et
–In
vestm
ent
sta
nds
at
$40
million
in2004
TargetMarket
–3
rd&
4th
tier
of
the
pyra
mid
,sim
ilar
toW
ahaha
–“T
aste
sgood
as
long
as
itis
cold
,”accord
ing
toa
consum
er
–Sold
for
$1.1
3,
som
etim
es
as
low
as
87
cents
–Forc
ed
PepsiC
oto
low
er
pri
ces
Distribution
–Consid
ere
da
“counte
r-bra
nd”
–O
nly
28
dis
trib
ution
cente
rsand
sells
tosm
all
gro
cery
sto
res
–Busin
ess
modelbased
on
econom
ics
alo
ng
valu
echain
–Savin
gs
passed
alo
ng
toconsum
ers
–U
ses
freela
nce
vendors
who
open
up
new
mark
ets
for
Big
Cola
Main
Com
petito
r:
Wa
ha
ha
wil
lb
ed
ire
ctl
yc
om
pe
tin
gw
ith
Big
Co
la,
aP
eru
via
ne
ntr
an
tin
toM
exic
o.
Bo
thsh
are
the
sam
eta
rge
tm
ark
et
an
dw
ill
be
co
mp
eti
ng
fie
rce
lyto
co
me
ou
tw
ith
the
low
est
pri
ce
sin
ord
er
toa
ttra
ct
the
pri
ce
-se
nsi
tive
co
nsu
me
rs
Keith Parker, University of Southern California
MOR-492: Projects
CountryFactorEndowments
•U
nsta
ble
political
envir
onm
ent
Soft
Infrastructure
•Logis
tical
inte
rmedia
ries
–
dis
trib
ution
channels
are
lim
ited
inru
ral
are
as
•Legalsyste
m
HardInfrastructure
•Poor
sanitation
•In
adequate
waste
dis
posalfa
cilitie
s
•Conta
min
ate
dw
ate
r
•55%
of
Mexic
an
household
sw
ith
access
topip
ed
wate
rre
ceiv
ed
serv
ices
on
an
inte
rmitte
nt
basis
Th
em
ost
imp
ort
an
tc
ha
lle
ng
es
for
Wa
ha
ha
wil
lb
ed
eve
lop
ing
ao
n-s
ite
wa
ter
pu
rifi
ca
tio
nsy
ste
ma
nd
wo
rkin
gw
ith
the
loc
al
go
ve
rnm
en
tto
en
sure
are
gu
lar
wa
ter
sup
ply
at
the
irb
ott
lin
gp
lan
t.M
ore
ove
r,W
ah
ah
aw
ill
ne
ed
tore
lyo
na
ne
sta
bli
she
dp
art
ne
rfo
ra
de
qu
ate
dis
trib
uti
on
.B
uil
din
gth
eir
ow
nd
istr
ibu
tio
nc
ha
nn
el
wil
lb
eto
oc
ost
lya
nd
tim
ec
on
sum
ing
.
Institu
tionalV
oid
sA
naly
sis
Keith Parker, University of Southern California
MOR-492: Projects
P.E
.S.T
.A
na
lys
is
PoliticalEnvironment
•Federa
lRepublic
•C
om
merc
ialand
financia
ldependence
on
the
US
•Part
ofW
TO
,subje
ct
tore
gula
tions
•Ranked
as
num
ber
63
for
index
ofeconom
ic
freedom
•M
ixtu
reofU
Sconstitu
tionalth
eory
and
civ
il
law
syste
m
•Blu
ecollar
work
forc
eis
up
toa
6-d
ay,48-
hour
work
week
•M
exic
an
Federa
lLabor
Law
pre
vents
unsafe
work
ing
conditio
ns
•Fore
igners
are
not
allow
ed
toow
nla
nd
inth
e
restr
icte
dzone
EconomicEnvironment
•Tourism
inM
exic
ois
ala
rge
industr
y,
ranked
third
inim
port
ance
•Fre
em
ark
et
econom
y
•13th
larg
est
econom
yin
the
world
•Esta
blished
as
an
upper
mid
dle
-incom
e
countr
y
•G
DP
-per
capita:
$10,6
00
•U
nem
plo
ym
ent
rate
:3.2
%•U
ndere
mplo
ym
ent
ofabout
25%
•Fore
ign
Debt:
$178.3
billion
•Low
labor
wages
•Sta
ble
inflation
rate
5.4
%
•G
row
thra
te1.1
6%
SocialEnvironment
•M
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Keith Parker, University of Southern California
MOR-492: Projects
Cultural
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onot
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ark
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iffe
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igh
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ahaha
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lyfo
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Keith Parker, University of Southern California
MOR-492: Projects
BENEFITS
•C
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ay
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Although
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isks
Keith Parker, University of Southern California
MOR-492: Projects
Entr
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ot
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Keith Parker, University of Southern California
MOR-492: Projects
�Low-cost
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ave
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ith
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ays
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Keith Parker, University of Southern California
MOR-492: Projects
•The
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arg
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hip
Keith Parker, University of Southern California
MOR-492: Projects
HistoryofCooperation
�W
ahaha
form
ed
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rein
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awith
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upe
Danone
SA
in1996
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advanced
pro
duction
lines
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duction
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din
just
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anone
curr
ently
owns
51%
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ance
in1976
“1st
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pany
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ide
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orp
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exic
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plicate
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ting
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ahaha
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ution
and
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ctu
ring
netw
ork
.In
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way,
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toente
rth
enew
mark
et
of
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oknowin
gth
at
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ble
and
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ort
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ark
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Keith Parker, University of Southern California
MOR-492: Projects
Export
ing
Wahaha
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their
entr
ystr
ate
gy
into
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oby
ship
pin
gth
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concentr
ate
toD
anone.
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leand
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trib
ute
the
pro
duct.
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ship
pin
gbott
led
soda
because
of
the
low
valu
e-to
-weig
ht
ratio
whic
hm
akes
itim
pra
ctical.
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hig
hpoliticaland
financia
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toente
ring
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mark
et
as
awholly-owned
subsid
iary
.There
fore
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mitig
ate
these
risks,
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.with
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isk
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onate
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et,
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late
rin
troduce
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oth
er
drinks
inclu
din
gju
ices,
tea,
and
sport
drinks.
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tion
&P
olit
icalR
isks
Dic
tate
Entr
y
Keith Parker, University of Southern California
MOR-492: Projects
Wahaha
willta
rget
tiers
3&
4w
hic
h
inclu
des
65.7
million
people
Tie
r5
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r4
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r3
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Me
xic
an
Po
pu
lati
on
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mil
lio
ns
)
Rath
er
than
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peting
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ead
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ola
and
Pepsi,
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willaim
for
the
low
er
tiers
ofth
em
ark
et
with
more
price
sensitiv
econsum
ers
.This
repre
sents
a
very
larg
eperc
enta
ge
ofth
eovera
llM
exic
an
mark
et.
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ever,
our
targ
et
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et
als
o
care
sabout
image,w
hic
his
why
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willuse
lim
ited
advert
isin
gto
build
abra
nd
and
diffe
rentiate
from
our
key
com
petito
r,Big
Cola
.
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etM
ark
et
Keith Parker, University of Southern California
MOR-492: Projects
SuccessfulMarketingStrategyinChina
-C
entr
alized
mark
eting
cam
paig
n
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igh
cash
investm
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et.
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aller,
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ste
dto
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rence
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betw
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two
countr
ies.
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eting
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paig
ncan
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hed
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event
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exic
o,
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ilar
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ero
llout
of
Wahaha’s
TV
advert
isem
ents
duri
ng
the
Worl
dC
up
of
2006.
Keith Parker, University of Southern California
MOR-492: Projects
Ma
nu
fac
ture
Co
nc
en
tra
te
Wa
ha
ha
Da
no
ne
Da
no
ne
Wa
ha
ha
Va
rio
us
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anufa
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reth
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pconcentr
ate
at
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ries
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hin
aand
export
it
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anone’s
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ling
pla
nt.
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en
bott
leand
dis
trib
ute
the
soda
usin
gth
eir
pre
-exis
ting
dis
trib
ution
netw
ork
.W
ahaha
willm
anage
mark
eting
effort
sw
ith
input
from
Danone’s
localm
anagem
ent.
Acom
bin
ation
push
and
pull
mark
eting
willbe
used
togain
shelf
space
at
reta
illo
cations.D
anone
willuse
its
clo
ut
and
levera
ge
to
negotiate
with
reta
ilers
and
Wahaha’s
cre
ative
advert
isin
gw
illcre
ate
adra
win
dem
and
by
custo
mers
.
Wahaha’s
Valu
eC
hain
Bo
ttlin
gD
istr
ibu
tio
nM
ark
eti
ng
Re
tail
Keith Parker, University of Southern California
MOR-492: Projects
2008E
2009E
2010E
Volu
me
(in
millions
of
lite
rs)
440.6
935.0
1488.0
Revenue
149.8 1
317.8
9505.9
2
CO
GS
77.9
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0263.0
8
Gro
ss
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in71.9
1152.5
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epre
cia
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nt)
20.0
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clu
din
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ark
eting)
65.0
020.0
020.0
0
Opera
ting
Incom
e(EBIT)
- 1 3 . 0 9112.5
9202.8
4
Taxes
0.0
033.7
860.8
5
Net
Incom
e
- 1 3 . 0 978.8
1141.9
9Tota
l NPV
NPV
(8%
dis
count
rate
)
- 1 2 . 1 267.5
7112.7
2168.1
6
NPV
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dis
count
rate
)
- 1 1 . 9 065.1
3106.6
8159.9
1
NPV
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dis
count
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)
- 1 1 . 6 962.8
3101.0
7152.2
0
Exp
ecte
dB
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MOR-492: Projects
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MOR-492: Projects
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Refe
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Keith Parker, University of Southern California
MOR-492: Projects
1
Mexican Expansion
Presented by
Mark Davenport, C.K. Hsu, Gary Lilardi, Kerry MacDonald,Keith Parker, Whitney Stambler, Nan Wang
The Wahaha Group
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
• Company Information
• Country & Industry Analysis
• Entry Strategy
• Financial Analysis
• Conclusion
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Company Information
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Who is Wahaha?• Private-owned company and biggest beverage producer (15.6% of totalproduction) in China
• Found by Mr. Zong Qinghou in 1989
• “Wahaha” in Chinese is the sound happy kids make when they arelaughing
• Non-alcoholic beverages and non-beverage goods
• $600M USD in total assets
• JV ownership with Danone
• Looking for growth opportunities
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Wahaha’s Business Model
Quality
Extra
Profits
AdvertisingImprove brand
awareness and use
pull marketing to
increase WTP
IncreasedMargin
Low UnitCost
Economies
Of scalesR&D
Innovation and
creativity for new
tastes and products
VolumeNumber of visits
And repeating
visits
Price
Advertising Brand ImageSales
VolumeDistribution
Critical Success Factors
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Country & Industry Analysis
Keith Parker, University of Southern California
MOR-492: Projects
2
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Why, or Why Not, Go to Mexico?• Why?
– Market Size
– Market Value– Market Growth
• Why Not?
– Aggressive Competitor Campaigns– Government Imposed Tax
• Competitors– Market Concentration
– Pepsi and Coca Cola– Recent Anti-competitive practices– Wahaha will compete more directly with more fragmented, smallercompetitors
Market Growth
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
How Attractive is the Industry?
Threat of Entry: Low
Buyer
Power:
Low
Substitutes: High
Supplier
Power:
Medium/
Low
Rivalry:
Medium/
High
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Wahaha’s Target Market
Wahaha willtarget tiers 3 & 4
which includes
65.7 million people
Tier 5
Tier 4
Tier 3
Tiers 1 & 2
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Main Competitor: Big ColaWahaha will be directly competing with Big Cola in the same target market
•Background Facts–Bottled and marketed by Ajemax, a subsidiary of Peruvian firm Kola Real
–Entered Mexican market in 2002
–Presently accounts for 5% of the Mexican drink market
•Target Market–3rd & 4th tier of the pyramid, similar to Wahaha
–Sold for $1.13, sometimes as low as 87 cents
–Forced PepsiCo to lower prices
•Distribution–Considered a “counter-brand”
–Business model based on economics along value chain
–Uses freelance vendors who open up new markets for Big Cola
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Wahaha’s Distance Barriers
Economic
•Ranked 9th mostimpoverished out of102 developingcountries
•17.6% of thepopulation is inextreme poverty
•Severeunderemployment formuch of the population
•Consumers are pricesensitive
Geographic
•Water contamination
•Distribution mobility islimited in rural areas
Administrative
•High corruption andpolitical risk
•Weak law enforcement
Cultural
•Do not favor Asianproducts
•Market dominatedproducts: Coke andPepsi
•Majority of stores aresmall scale (Mom &Pop)
•Different language
•Different tastes &preferences
Partnership with a company that has been in Mexico for a while can help Wahaha learnand respond as necessary to the differences in the Mexican market.
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Entry Strategy
Keith Parker, University of Southern California
MOR-492: Projects
3
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Entering Mexico – How?
Mexico
Joint Venture with
Existing firms in Mexico
(Danone)
Partnership with local
bottler/distribution
(ARCA)
Acquisition of a local
Brand
Direct investment
Without any
Strategic alliances
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Distribution Channels in Mexico
Goals for Distribution• Must establish a method to reach the Mom and Pop stores• Existing transportation infrastructure can pose challenges to overcome• Access to bottling facilities which are geographically disbursed
• Access to water
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Distribution Options
•Low-cost
•Utilize existing expertise
•Relationships with stores already established
•Distribution infrastructure will already be inplace
•Access to water rights is responsibility ofpartner
•Easy exit strategy
• Less financial risk
•Because have partial ownership ofWahaha, they are more aligned with theircore values
•Have a previously built relationship withdistributors
•Share shelf space in stores
•Lack of control over distribution
•Partner may not prioritize brand
•Must share shelf-space with the big brands.
•Their plants are only in the Northern regionof Mexico
•May not want to have a JV with Wahaha
•Less control over distribution
•Limited distribution to the rural areas
Ad
van
tag
es
Dis
ad
van
tag
es
Contracting with ARCA JV Partnership with Danone
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
: Utilizing an Existing Relationship
• History of Cooperation– Wahaha formed a Joint Venture in China with Groupe Danone SA in 1996
– Invested in advanced production lines and improved efficiency
– Production doubled in just one year
• 30 Years of Presence in Mexico– Market share leader in their industry (41.3% in 2006)
• Excellence in Execution– 33.5% share of shelf space in leading supermarket chains
– 10,000 POS to cater to rural areas by 12/2007
Danone’s Market Share Growth
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Adaptation & Political Risks Dictate Entry
Global
International
Local Responsiveness
Glo
bal
Coord
inatio
n
LoLo
Lo H
i
Hi Wahaha &
Danone JV
Political Risk
Eco
n.
Opport
unity
LoLo
Lo H
i
Hi
Manufacture
ConcentrateBottling Distribution Marketing Retail
Wahaha Danone Danone Wahaha Various
E
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Financial Analysis
Keith Parker, University of Southern California
MOR-492: Projects
4
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Financial Analysis
Expected Breakeven in 2ND Year!
$0.34Wahaha
$0.34Big Cola
$0.38Pepsi
$0.53Coca-cola
Retail Price Per LiterComparison (USD)
Capital Investments: $60M bottling plant, $60.5M advertising
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Exit Strategies & Conclusion
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Possible Exit Strategies
Sell off the bottling plant to Coca Cola, Pepsi,Big Cola, ARCA, or another company
Discount remaining inventory until all is sold off
Worst case scenario, liquidate all remainingassets in Mexico
Insure it, burn it, and move to New Zealand!
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Conclusion
•Enter Mexico
•JV with Danone
•Target tiers 3 & 4
•Start with carbonated products and
later add teas, juices, etc.
Thank you!Xie Xie
Questions?
AGENDA COMPANYINFORMATION
ANALYSIS FINANCIALANALYSIS
CONCLUSIONENTRYSTRATEGY
Financial Analysis
152.20101.0762.83-11.69NPV (12% discount rate)
159.91106.6865.13-11.90NPV (10% discount rate)
168.16112.7267.57-12.12NPV (8% discount rate)
Total NPV
141.9978.81-13.09Net Income
60.8533.780.00Taxes
202.84112.59-13.09Operating Income (EBIT)
20.0020.0065.00SG&A (including marketing)
20.0020.0020.00Depreciation (Bottling Plant)
242.84152.5971.91Gross Margin
263.08165.3077.90COGS
505.92317.89149.81Revenue
1488.0935.0440.6Volume (in millions of liters)
2010E2009E2008E
Expected Breakeven in 2ND Year!
Assumptions:•Retail price: $0.34/l i ter•Market share: 1% in 2008, 2% in 2009, 3% in 2010
•Market growth (in volume): 6.1% CAGR
•Tax rate: 30% (same as Coca-Cola FEMSA)•Deprec iation: $60M bottl ing plant straight-l ine
deprec iation over 3 years
•No interest expense (all-equity firm)
$0.34Wahaha
$0.34Big Cola
$0.38Pepsi
$0.53Coca-cola
Retail Price Per Liter Comparison (USD)
Pro Forma Income Statement (millions of USD)
Keith Parker, University of Southern California
MOR-492: Projects
Plantronics, Inc. (NYSE: PLT)
Headquarters
Address: 345 Encinal St.Santa Cruz, CA 95060 USA
Tel: 831-426-5858Toll Free: 800-544-4660Fax: 831-426-6098Web: http://www.plantronics.com
Mexico (dba Plamex, S.A. de C.V.)
Address: Avenida Produccion, #12Parque Industrial Internacional TijuanaMesa de OtayTijuana, Baja California 22390, Mexico
Tel: +52 664-682-2798Fax: +52 66-822796
Overview
Plantronics, Inc. engages in the design, manufacture, and marketing of lightweightcommunications headsets, telephone headset systems, and accessories for the business andconsumer markets under the Plantronics brand worldwide. It also manufactures and marketscomputer and home entertainment sound systems, portable audio products, and a line ofheadsets, headphones, and microphones for personal digital media under Altec Lansing brand.In addition, the company offers specialty telephone products, such as telephones for thehearing impaired, and other related products for people with special communication needsunder Clarity brand. Further, Plantronics provides audio enhancement solutions to consumers,audio professionals, and businesses under Volume Logic brand. It distributes its productsthrough a network of distributors, original equipment manufacturers, wireless carriers, retailers,and telephony service providers. (Yahoo Finance, 2007)
Finances (2006)
Sales: $750.4M1 yr sales growth: 34%Net Income: $81.2M
Miscellaneous
Founded: 1961Top competitors: GN Netcom, Logitech, MotorolaTotal employees: 7,300
PeopleChairman: Marvin TseuPresident, CEO, & Director: S. Kenneth KannappanSVP, Finance & Administration, CFO: Barbara SchererSVP, Chief Marketing Officer: Mark BreierSVP, Operations: Terry Walters
Operations in Mexico
Plantronics opened Plamex in Tijuana, Mexico, 35 years ago and since then the facility hasbeen recognized worldwide for its commitment to quality and progressive employeeprograms. Plamex has won nine international manufacturing awards over the past two years,and was recognized twice by Mexico president Vicente Fox Quesada for its technology andquality leadership. Plamex is also the only manufacturing facility in the world to win both theIbero American Quality Award and Asia-Pacific Quality Award for large manufacturingorganizations. PLAMEX's 3,600 associates contribute to Plantronics' worldwide success bymanufacturing more than 8,000 different models of headset products.
Keith Parker, University of Southern California
MOR-492: Projects
1
COMPETITIVESTRATEGY
A Primer
Overarching Goal
• Above Normal Returns
• Strategic Competitiveness
• Sustainable/Renewable
Sustainable/RenewableAbove Normal Returns &Strategic Competitiveness
Profits = Q (R-C) X Time
• Aggressive Competition (all 5 forces)• Uncertain turbulent future
Margin
Willingness to Buy
Q Quantity
•Fast food – Size of the ticket•Discount Stores – volume purchasing•Staples are at the back of the store• Impulse buys
•ADVERTISING!!!/POINT OF PURCHASE
Willingness to Pay
R Price/Revenue
•Premium prices•Branding•Monopoly situations – broken arm•Lifecycle costs of a product
•Customer loyalty – Harley Davidson tattoos
Cost Minimization
• Scales
• Scope
• Location
• Experience
• Design
• Productivity
• Capacity Utilization
• HR Productivity
C Costs
Keith Parker, University of Southern California
MOR-492: Powerpoints
2
Sustainability
TIME•Competitive imitation•Substitution
•Technological Obsolescence•Organizational Slack
Business Models: TheCore of a Strategy
• A firm’s choice of relationshipamong these variables is itsbusiness model
• Focus and tradeoffs amongvariables
• Two generic business models:• Cost-based
• Differentiation-based
Illustration of tradeoffs inQ*Margin
Volume
Margin
Hi
Hi
Lo
Lo
Made in Heaven
Market Share (Quantity)Low High
Prof
itabi
lity
Low
High
Differentiation-based Strategies
Low CostLeadershipStrategies
Stuck-in-the-Middle
Market Share-Profitability Relationship:“Porter’s Bucket”
Business Models
Volume
Economiesof Scale
Low UnitCost
IncreasedMargins
R&D Advertising
Price
ExtraProfits
Quality
Business Models
LoyalConsumers
PremiumPrices
IncreasedMargins
R&D BrandMktg
ReputationExtra
Profits
Quality
InvestmentsUniqueness
Keith Parker, University of Southern California
MOR-492: Powerpoints
3
Strategic AdvantageUniqueness Perceived
by the CustomerLow Cost Position
Industrywide
Stra
tegi
c Ta
rget
DIFFERENTIATIONOVERALL
COSTLEADERSHIP
FOCUSParticular Segment Only
Porter's Generic Strategies
Source: Porter (1980)
Firm A:
Firm B:
Firm C:
Firm B:
Price
Price
Price
Price
Total cost to buyer
Firm A has acost advantage
Firm C has adifferentiationadvantage
Producer’s cost Producer’s margin Buyer’s cost
Value Chains for Cost Advantageand Differentiation Advantage
Sourcesof AboveNormalReturn
GreatStrategies
GreatIndustries
0
10
20
30
40
50
60
70
80
90
100
2% 4% 6% 8% 10%
12%
14%
16%
18%
20%
22%
24%
26%
28%
30%
32%
Numberof
Industries
First QuartileAverage
22.2%
Fourth QuartileAverage
9.3%
Note: Return on Equity = Net Income / Year EndShareholders’ Equity; Analysis based on sample of 593industries
Average = 14.7%Median = 13.8%
11.7%
13.8%
16.5%
Return on Equity (Percent)
Average Return on Equity in US Industries, 1982-1993
Distribution of Industry Returns
Source: Jan W. Rivkin’s Analysis Based on Dun and Bradstreet Data
Source: Jan W. Rivkinbased on Compustat
Computer system design
Operating Income / Assets, 1988-95 (%)
0 5 10 15 20 25
Scheduled airlines
Motor vehicles
Cable TV service
Engineering services
Trucking except local
Race track operations
Petroleum / natural gas
Drug stores
Eating places
Dental equipment
Women's clothing stores
Semiconductors
Prepackaged software
Pharmaceuticals
Profitability Differences AcrossSelected Industries
WHY?
Superior Profitability
DELLCOMMODOREWANG
GATEWAYHP
LENOVO???
Keith Parker, University of Southern California
MOR-492: Powerpoints
4
Determinants of SuperiorPerformance
• Profits earned are determined by:• Willingness-to-Pay: the value of the product/service to
customers• Intensity of Competition• the relative Bargaining Power at different levels in the
production chain• Sources of profits above competitive level are
determined by:• Industry attractiveness• Strategic group attractiveness• Competitive position attractiveness
Threat of New Entry
Rivalry AmongExisting Competitors
Bargaining Powerof Customers
Threat of Substitutes
Bargaining Powerof Suppliers
• Economies of scale• Proprietary product
differences• Brand identity• Switching costs
• Capital requirements• Access to distribution• Absolute cost advantages• Government policy• Expected retaliation
• Relative price performance of substitutes• Switching costs• Buyer propensity to substitute
• Industry growth• Fixed costs / value
added• Overcapacity• Product differences• Brand identity
• Switching costs• Concentration and balance• Informational complexity• Diversity of competitors• Corporate stakes• Exit barriers
• Differentiation of inputs• Switching costs• Presence of substitute
inputs• Supplier concentration• Importance of volume to
supplier• Cost relative to total
purchases• Impact of inputs on cost
or differentiation• Threat of forward
integration
• Buyer concentration• Buyer volume• Buyer switching costs• Buyer information• Ability to integrate
backward• Substitute products• Price / total purchases• Product differences• Brand identity• Impact of quality /
performance• Buyer profits
Porter’s Five Forces Analysis
Source: Michael E. Porter, Competitive Advantage (New York: Free Press, 1985)
SUPPLIER POWERLOW
THREAT OF ENTRYLOW
•economies of scale•capital requirements
for R&D and clinicaltrials
•product differentiation•control of distribution
channels•patent protection
INDUSTRYCOMPETITIVENESSLOW
•high concentration•product differentiation•patent protection•steady demand growth•no cyclical fluctuations of demand
THREAT OFSUBSTITUTES
LOW
No substitutes.(Changing as managed care
encourages generics.)
BUYER POWER LOW
Physician as buyer: Not price sensitive No bargaining power.(Changing with managed care.)
DRUG INDUSTRY(ROE=28%)
30
SUPPLIER POWERHIGH
•strong labor unions•concentrated aircraft makers
THREAT OF ENTRYHIGH
•entrants have cost advantages
•low capital requirements•little product differentiation•deregulation of governmental barriers
INDUSTRYCOMPETITIVENESSHIGH•many companies•little product differentiation•excess capacity•high fixed/variable costs•cyclical fluctuations of demand
THREAT OFSUBSTITUTESMEDIUM
•autos for short distancetravel
BUYER POWERMEDIUM/HIGH
Buyers extremely price sensitiveGood access to informationLow switching costs
Airline Industry(ROE=-1%)
31
Neutralizing the Five CompetitiveForces
Force Entry
Rivalry
Substitutes
Buyers
Suppliers
Method for Neutralizing Force Erecting barriers (isolating
mechanisms) create exploit economies of scale,aggressive deterrence, design in switching costs, etc
Compete on nonprice dimensions:cost leadership, differentiation, cooperation, etc
Improve attractiveness compared tosubstitutes: better service, more features, etc
Reduce buyer uniqueness: forwardintegrate, differentiate product, new customers, etc
Reduce supplier uniqueness: backwardintegrate, obtain minority position, second source, etc
Issues with the Five-ForcesFramework
• Industry definition• Completeness (e.g., import competition)• Consistency (e.g., import strategic variety)• Duplication (e.g., switching costs)• Symmetry (e.g., buyer substitution vs. supplier
substitution, complements)• The role of informational conditions• The need for macroenvironmental analysis• Long-run focus vs. change
• shocks• cycles• trends
• Product rather than resource focus
Keith Parker, University of Southern California
MOR-492: Powerpoints
5
Customers
Firm
Suppliers
Competitors Complementors
A player is your complementorwith respect to customers ifcustomers value your product morewhen they have the other player’sproduct as well
A player is your competitor withrespect to customers if customersvalue your product less whenthey have the other player’sproduct as well
A player is your complementorwith respect to suppliers if it ismore attractive for a supplier toprovide resources to you when itis also supplying the other player
A player is your competitor withrespect to suppliers if it is lessattractive for a supplier toprovide resources to you when itis also supplying the other player
Coopetition and the Value
Net
Source: Adam Brandenburger and Barry Nalebuff, Co-operation (New York: Currency Doubleday, 1996)
Continually ChangingIndustry Conditions• Exogenous Changes
• Shocks and Trends
• TINAs
• Endogenous Changes• New innovations
• New business models
• New Supply chains
• Etc.
Shocks and Trends
Uncertainty &Market Ignorance
ConsumerTastes
TechnologyLaws,Tax Policy,Regulations
Relative Pricesof InputsGlobal Supply &
DemandConditions
Inventions &Discoveries
External “Triggers”
• “Triggering” shifts, shocks and trends, even in adjacentmarkets, may create uncertainties that allow/force firms tochange their strategies
• Shocks and Trends• changes in consumer tastes• changes in technology• changes in relative prices of inputs• changes in laws, regulations, and tax policy• inventions and discoveries• changes in global supply and demand conditions
• Uncertainty and market ignorance create/produce theopportunity for firms to reformulate their strategies
Examples of Intelligentand Threatening
Competitors
Aggregating Demand in NewWays
Keith Parker, University of Southern California
MOR-492: Powerpoints
6
New Product Concept &New Business Model
New Types of Arbritage
Narayana Hrudayalaya Heart Hospital, India
Closing the “GlobalDistance”
New Customer Segments
New Strategic GroupsComplementaryProducts/Services
Keith Parker, University of Southern California
MOR-492: Powerpoints
7
Strategic Group
AnalysisCompanies may take differentapproaches to competing in
the same industry
Strategic Map of the United States Airline Industry
International
National
Regional
NoFrills
Full ServiceQuality of Service
The Late 1970s
Braniff
TWA
EasternUnited
American
Delta
Western Republic Ozark
USAir Piedmont
Frontier AirCal
PSA
South-west
Texas Int’l
Continental
PanAm
Northwest
Laker
World
Geo
grap
hic
Scop
e
Strategic Map of the United States Airline IndustryThe Early 1980s
TWA
United
Eastern
American
Delta
Western Republic Ozark
USAir Piedmont
Frontier AirCal
PSA
South-west
Continental
PanAm
Northwest
NewEntrants
XX
International
National
Regional
Geo
grap
hic
Scop
e
Quality of ServiceNoFrills
Full Service
Strategic Map of the United States Airline IndustryThe Mid 1980s
Republic
Ozark
USAir Piedmont
Frontier
AirCal
PSA
South-west
Continental
TWA
Eastern
UnitedAmerican
Delta
Northwest
NewEntrants
International
National
Regional
Geo
grap
hic
Scop
e
Quality of ServiceNoFrills
Full Service
Strategic Map of the United States Airline IndustryThe Late 1980s
South-west
United
TWA
American
Delta
USAir
Continental
Northwest
AmericaWest
MGMGrand
International
National
Regional
Geo
grap
hic
Scop
e
Quality of ServiceNoFrills
Full Service
Strategic Map of the United States Airline IndustryThe Early 1990s
South-west
United
TWA
American
Delta
USAir
Continental
Northwest
AmericaWest
XReno
Kiwi
Others
International
National
Regional
Geo
grap
hic
Scop
e
Quality of ServiceNoFrills
FullService
Mobility Barriers
Keith Parker, University of Southern California
MOR-492: Powerpoints
8
Finding New ProfitPools within Industries
Profits earned in different partsof the industry production chain
can change over time0% 100%
Share of Industry Revenue
Ope
ratin
g M
argi
n
The U.S. Auto Industry’s Profit Pool
Source: Gadiesh & Gilbert, 1998
Competitive Advantages
GreatStrategies
ValuableResources&Capabilities
ProtectedCompetitivePositions
A Three-Dimensional BusinessLandscape: Great Positions!!!
CompetitiveAdvantages
(Sources of Rates of Profit inExcess of the Competitive Level)
AvoidCompetitors
(Position)
Be Better ThanCompetition(Capability)
Sources of Competitive Advantage
Better,Faster,Cheaper
Get in first,Keep others out
Attractive Industryprotected by Entry Barriers
Attractive Strategic Groups(within Industry) protectedby Mobility Barriers
Attractive CompetitivePositions (within Strategic Group)protected by IsolatingMechanisms
AND/OR
AND/OR
Sustainability of Superior Performance Based on Impediments to Imitation
Keith Parker, University of Southern California
MOR-492: Powerpoints
9
Isolating Mechanisms
• Information Impactedness• Response Lags• Economies of Scale and Scope• Producer Learning• Buyer Switching Costs• Reputation• Buyer Evaluation Costs• Advertising and Channel Crowding
Source: Richard Rumelt, 1987
COMPETENCIES & CAPABILITIES:
Outperforming Competitors
Building and RenewingDistinctive Competencies &Organizational Capabilities
Building Cost and DifferentiationStrategies
• Cheaper• Better• Faster
Differentiation
Cost Reduction
Total Quality Management
Just-In-Time
Time Management
Geographic Location
Business Re-engineering
Mass Customization
etc.
etc.
Cost Drivers
• Economies ofscale
• Economies ofscope
• Learning
• Pattern ofcapacity utilization
• Linkages
• Interrelationships
• Integration
• Timing
• Policies
• Location
• Institutionalfactors
Source: Michael E. Porter, Competitive Advantage (New York: Free Press, 1985)
TANGIBLEDIFFERENTIATION
Observable product characteristics:• size, color, materials, etc.• performance• packaging• complementary services
INTANGIBLEDIFFERENTIATIONUnobservable and subjectivecharacteristics relating toimage status, exclusively,identity.
TOTAL CUSTOMER RESPONSIVENESS: Differentiation not justabout the product, it embraces the whole relationship between thesupplier and the customer.
The Nature of Differentiation
“Differentiation means providing something unique that is valuableto the buyer beyond simply offering a low price.” (M. Porter) THE KEY IS CREATING VALUE FOR THE CUSTOMER
The Sources ofDifferentiation Advantage
• Observable Goods:– Buyer Learning– Buyer Switching Costs– Advertising Economies
• Experience Goods:– Reputation– Credibility
• Communication Goods:– Relative Base
Keith Parker, University of Southern California
MOR-492: Powerpoints
10
TECHNOLOGY PRODUCT DESIGN MANUFACTURING MARKETING DISTRIBUTION SERVICE
The McKinsey Business System
The Value Chain as a Frameworkfor Creating CompetitiveAdvantages
Inbound Logistics Operations Outbound
Logistics Service
Marketing Management Adv ertising
Sales Force
Administration
Sales Force
OperationsTechnical Literature Promotion
Source: Michael E. Porter, Competitive Advantage, 1985.
Firm Infrastructure
Human Resource Management
Procurement
Technology Development
The Porter Value Chain
Marketing& Sales
• Identify activities
• Assign costs, assets • Identify cost drivers • Competitive scope
• Cost position of competitors • Control drivers
Cost Advantage
• Change chain
Source: Susan Polk, 1991
Cost Analysis
ValueChain
Using The Value Chain ToAnalyze Costs
Stages In Value ChainAnalysis
• Disaggregate firm into separate activities• Establish relative importance of activities• Identify cost drivers• Identify linkages• Examine scope for reducing costs
Be Better Than Competitors
(2) In coordinating elements of value chain
(1) In individual elements of value chain
(3) In selecting elements of value chain (make vs. buy)
X XSource: Michael E. Porter “What is Strategy” Harvard Business Review, Nov-Dec 1966
Limitedpassengeramenities
Short-haul,point-to-pointroutes betweenmidsize cities
and secondaryairports
Highaircraft
utilization
Frequent,reliable
departures
Lean, highlyproductiveground andgate crews
Very lowticket prices
No meals
No seatassignments
No baggagetransfers
No connectionswith other
airlines
15-minutegate
turnarounds
Limited useof travelagents
Automaticticketingmachines
Standardizedfleet of 737
aircraft
Flexibleunion
contracts
High levelof employee
stockownership
“Southwest,the low-fare
airline”
Highcompensationof employees
Southwest Airlines’ ActivitySystem
Keith Parker, University of Southern California
MOR-492: Powerpoints
11
0
10
20
30
40
1 2 3 4 5 6 7 8 9 10
Year
RO
I%
Source: Pankaj Ghemawat, Commitment (New York: The Free Press, 1991)
Reversion to the Mean
AddedValue
AppropriatedValue
Imitation Substitution
Slack Holdup
Four Threats to Sustainability
AddedValue
AppropriatedValue
Responding to the Threats toSustainability
Responses toImitationBuilding Barriers• Economies of scale andscope• Learning/privateinformation• Contracts and relationships• Network externalities• Threats of retaliation• Time lags• Strategic complexity• Upgrading
Responses to Slack• Gathering information• Monitoring behavior• Offering performanceincentives• Shaping norms• Bonding resources• Changing governance• Mobilizing for change
Responses toSubstitution• Not responding• Fighting• Switching• Recombining• Straddling• Harvesting
Responses toHoldup• Contracting• Integrating• Building bargainingpower• Bargaining hard• Reducing asset-specificity• Building relationships• Developing trust
Strategic Renewal
The Strategic Task
HIGH
EXTENT OFADVANTAGE
LOW
TIMESource: Marvin Lieberman, 1997
The Strategic TaskKeep developing new sources of competitive advantage!
HIGH
EXTENT OFADVANTAGE
LOW
TIMESource: Marvin Lieberman, 1997
Keith Parker, University of Southern California
MOR-492: Powerpoints
12
Customer/ Market
Product/ Service
Assets /Resources
Business System/ Value Chain
Scale/Scope
The Hexagon of Competitive Advantage:Potential Sources for Creating Advantages
Competitor/ Partner
Interaction
Source: George Yip,1997
CompetitiveAdvantage
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Spring 2007
GSBA 582: GLOBE 1
GSBA 582: GLOBE
Country AnalysisAnalyzing the Attractiveness of
Regions, Economies, Industrial Sectors,and Markets for Global Business
MOR 492: Global Strategy
Country Analysis Framework
2
Session Agenda Analyzing the “Meet” Dimension Country Analysis Institutional Differences & “Voids”
Analysis Getting to Know the Data Workshop
MOR 492: Global Strategy
Country Analysis Framework
3
Analyzing the Global Market:What will the firm meet?
Regional Analysis
Country Analysis
Industry Analysis
Industrial Sector Competitiveness Analysis
Market Potential Analysis
Competitor Analysis
FeasibilityAnalysis
ProfitabilityAnalysis
Meet Question?
MOR 492: Global Strategy
Country Analysis Framework
4
Country Analysis Global Economics of Region
ASEAN, NAFTA, APEC, etc. Macroeconomic Policies
Political Agenda Fiscal & Monetary Policies Policies toward foreign investments & control
Political Risk Analysis Institutional Voids Analysis
Meet question?
MOR 492: Global Strategy
Country Analysis Framework
5
Firm Strategy, Structure, and
Rivalry
Factor Conditions
Demand Conditions
Related and Supporting Industries
Source: Porter (1990)
Government
Chance
Diamond of Global CompetitivenessMeet Question?
MOR 492: Global Strategy
Country Analysis Framework
6
Examining Relevant “Distances” CAGE Framework (Ghemawat)
Cultural Distance Administrative Distance Geographic Distance Economic Distance
• Global strategy must exploit/mitigate relative“distance” between the firm and the global market
• CAGE can be applied at the Country level, industrialsector, industry, and firm level
Meet Question?
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Spring 2007
GSBA 582: GLOBE 2
MOR 492: Global Strategy
Country Analysis Framework
7
Business “Context”
Land Political &Social Systems
CapitalMarketsLaborCountry Factor
Endowments
“Hard”Infrastructure
Roads, Rail& Ports
FunctioningIndependentLegal System
Banks & FinancialInstitutions, Regulators
Physical &Property
Rights Security
“Soft”Infrastructure
LogisticsIntermediaries
Spec ial izedConsultantsAccountants
& Legal System
Debt & EquityMarkets,
Venture Capital
Professions,CredentialingSearch Firms
Schools,Universities,
Training
Business Strategy& Operations
MOR 492: Global Strategy
Country Analysis Framework
8
Country AnalysisFramework
Comparing and ContrastingOpportunities and Differences
MOR 492: Global Strategy
Country Analysis Framework
9
Why Country Analysis? Countries continue to achieve remarkably
different rates of economic growth Countries differ in size, geographic location,
resource endowments, historical experiences,cultures and income levels, and thesedifference are important for global strategydecisions
The profit performance of similar industriesdiffers widely from one country to another
“Country effects” matter
MOR 492: Global Strategy
Country Analysis Framework
10
Country Effects Matter Nation States make the “rules” by which businesses
must abide Country “Institutions” (courts, laws, capital
markets, law & order enforcement, unions,governments, etc) create the context for businessand markets
Countries “do” compete with each other forresources
Countries do have “strategies” too Governments do play an active role Country borders (degree of openness) do matter
MOR 492: Global Strategy
Country Analysis Framework
11
Country Borders Matter Within countries, economic forces
work efficiently to bring convergence Across countries, global economic
forces are impeded by barriers totrade, capital flows and immigrationand convergence is mitigated
MOR 492: Global Strategy
Country Analysis Framework
12
Foreign Direct Investment Distribution
Theory suggests that capital should flow towhere the arbitrage opportunities aregreatest However, low wages may be offset by institutional
voids which raise overall costs In reality, most FDI is between “rich”
countries, and a select group of emergingeconomies (e.g. China, Brazil, Mexico,Singapore, Indonesia, Malaysia, SaudiArabia, Argentina)
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Spring 2007
GSBA 582: GLOBE 3
MOR 492: Global Strategy
Country Analysis Framework
13
Institutional Voids Institutional voids are the absence of intermediaries
between buyers and sellers Examples:
FinanceVenture Capital FirmsPrivate Equity ProvidersMutual FundsBanksAuditors
ManagementTalent
Business SchoolsCertification AgenciesHeadhunting FirmsRelocation Services
Products Certification AgenciesConsumer ReportsRegulatory AuthoritiesExtra-judicial dispute resolution
MOR 492: Global Strategy
Country Analysis Framework
14
Country Analysis Framework Identification
Strategy Context Performance
Evaluation Prediction
Context Strategy Performance
MOR 492: Global Strategy
Country Analysis Framework
15
Performance Formal economy, grey market, black market Economic Performance Measures
Output Prices Employment Savings Investment Productivity Wages increases Unit labor costs Utilization of capital Distribution of income
Net inflows vs outflows of capital, labor, etc.MOR 492: Global Strategy
Country Analysis Framework
16
Strategy Vision – guiding motivating values
Community solidarity vs. individual achievement Goals Policies – policy mix Foreign/Defense Policies Fiscal Policy
Spending priorities, types of taxes, balanced/ deficit/surplus budgets
MOR 492: Global Strategy
Country Analysis Framework
17
Strategy (continued)
Monetary Policy Income Policies
Redistribution of incomes Foreign Trade and Investment Policies
Import vs. Export Orientation Industrial Policy Social Policies
Education, Population, Health Care, Religion
MOR 492: Global Strategy
Country Analysis Framework
18
Context International Context
Trading Blocs Historical ties
Domestic Context Political – strong or weak governments, ability to
bring about reform Institutional Context – Government, legal, financial,
agricultural, transportation, energy, infrastructure.Other institutions like union, religions
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Spring 2007
GSBA 582: GLOBE 4
MOR 492: Global Strategy
Country Analysis Framework
19
Context (Continued)
Ideological Context Rights vs. Obligations Individual vs. Group (minority rights
protection) International Context
GATT, WTO, IMF
MOR 492: Global Strategy
Country Analysis Framework
20
Resources – The equipment andrecruiting system Human capital, physical capital, natural
resource wealth, and technological skills The Players in the Game
Firms, government actors, and non-government organizations
Context (Continued)
MOR 492: Global Strategy
Country Analysis Framework
21
The Rules of the Game Written and unwritten rules of conduct Formal
Laws, property-rights Informal
Business practices which come for culture heritage Rules define what is possible and what is not
International Dimension Role of multinational corporations International organizations like IMF, World Bank, WTO
Context (Continued)
MOR 492: Global Strategy
Country Analysis Framework
22
Treaties on Trade and Inv estment, InternationalMonetary Sy stem
Tarif f s, quotasInternational Organizations
Exchange ratesLocation
Balance of pay mentsInternational
International
- conventions, culture, religious beliefs, ideology
Political stability , political f reedom, etc.Inf ormal rules
Politicaleconomic (e.g. property rights, contract law), political ( e.g.federal system, separation of powers), treaties
Formal rules
Fertility , mortality , literacy , etc.Rules of the GameConstitutional ref orm
Income distributionIndustrial policies
Social Unions, employer associations, religious groups, politicalparties, etc.Sectoral policies
Non-state organizations:Trade and inv estment policies
Unemploy mentGov ernment actorsExchange rate policies
Inf lationFirmsFiscal & monetary policies
PricesPlayers in the GamesPolicies
National income accounts
GNPLabor, capital, natural resources, technology ,geography
Higher per-capita income lev el and growth,equality of income, stability , autonomy ,def ense, etc.
EconomicNational ResourcesGoals
PerformanceContextStrategyFRAMEWORK FOR COUNTRY ANALYSIS
GSBA 582: GLOBE
Examining the InstitutionalContext for Business in New
and Emerging Markets
Institutional Voids Analysis
MOR 492: Global Strategy
Country Analysis Framework
24
Framework for Analyzing the“Fitness” of Emerging Markets
The creation or replication of a global businessstrategy in a new market presupposes theexistence of supporting “infrastructure” andcomplementary “institutions” Physical infrastructure, specialized intermediaries, legal
support, contract-enforcing mechanisms, disputemediation, regulatory systems, etc.
Firms have three choices: Adapt to local “institutional voids” and market conditions Change the local markets and “fix” the institutional voids Stay out of the market altogether
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Spring 2007
GSBA 582: GLOBE 5
MOR 492: Global Strategy
Country Analysis Framework
25
Business “Context”
Land Political &Social Systems
CapitalMarketsLaborCountry Factor
Endowments
“Hard”Infrastructure
Roads, Rail& Ports
FunctioningIndependentLegal System
Banks & FinancialInstitutions, Regulators
Physical &Property
Rights Security
“Soft”Infrastructure
LogisticsIntermediaries
Spec ial izedConsultantsAccountants
& Legal System
Debt & EquityMarkets,
Venture Capital
Professions,CredentialingSearch Firms
Schools,Universities,
Training
Business Strategy& Operations
MOR 492: Global Strategy
Country Analysis Framework
26
Spotting Institutional Voids:Hard Infrastructure
Political and Social System Role of government in supporting/controlling business/market
activities Transparency in regulatory environment
Physical Infrastructure Quality of ports, roads, rail Energy, water, housing stock, etc.
Personal and Property Protection Personal safety – atmosphere of security, law & order Health care Legal protection of personal property, intellectual property, etc.
MOR 492: Global Strategy
Country Analysis Framework
27
Openness Role of media, non-government institutions, churches, social
groups, etc. Restrictions on foreign investment, repatriation of profits, etc. Restrictions on foreign intermediaries (e.g. auditing firms, ad
agencies, consulting firms, banks, insurance, etc. Free trade agreements (WTO compliant, FTAs, RTAs) Freedoms on business activities – restrictions on where and in
what sectors foreign businesses are allowed to invest Freedom of foreigners and locals to travel within, and into and
out of country
Spotting Institutional Voids:Hard Infrastructure
MOR 492: Global Strategy
Country Analysis Framework
28
Spotting Institutional Voids:“Soft” Infrastructure
Product Markets Existence of reliable data on consumer behavior Access to quality raw materials, local manufacturing of
components Quality of retail sector Consumer credit (credit cards, cheques, etc.) Regulation of quality standards, product content, etc. Environment and safety standards
Supply Chain Intermediaries Logistics and transportation specialists Distribution channels, wholesale markets, warehousing
MOR 492: Global Strategy
Country Analysis Framework
29
Spotting Institutional Voids:“Soft” Infrastructure
Labor Markets Quality of basic and specialized education
Technical and professional training Accreditation of education
Prevalence of “English” (Int’l language of Business) Free movement of employees Compensation practices (merit pay, seniority based, stock options) Enforcement of labor contracts Workers’ rights, Unions Regulations on layoffs, etc.
MOR 492: Global Strategy
Country Analysis Framework
30
Spotting Institutional Voids:“Soft” Infrastructure
Capital Markets Prevalence and effectiveness of banks, insurance companies,
savings & loan institutions Access to banking for consumers, businesses Transparency in Banking practices Debt & equity raising, venture capital Standards of financial reporting, protection for stockholders,
bankruptcy laws/protections Market for acquisitions/takeovers
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Mayer & Voigt, Term IV, 2001
GSBA 515 GLOBAL STRATEGY 1
MOR 492 Global Strategy
Geographic Scope
1
Geographic Scopeof Competition and
Strategy
MOR 492 Global Strategy
Geographic Scope
2
Geographic Scope of Competition Effective geographic
scope of competition Local Regional National International global
Geographic Scopeis influenced by: Economics Politics Corporate Strategy
MOR 492 Global Strategy
Geographic Scope
3
Geographic Scope of Competition Geographic scope of competition
tends to expand with: Increases in economies of scale, scope, and
learning Reductions in logistical constraints Reductions in the distinctiveness of local
markets – differences in consumers tastes Reductions in barriers to competition
MOR 492 Global Strategy
Geographic Scope
4
Drivers of Change in Scope Exogeneous drivers
Changes in government policies Reductions in trade barriers
Endogeneous drivers: New technologies Adoption of strategies requiring large fixed
investments Decisions to enter new markets
MOR 492 Global Strategy
Geographic Scope
5
Geographic Scope of Strategy Firms choose:
Overall geographic scope of firm’s strategy The markets to compete in The location of important activities The organization and coordination of these
activities
MOR 492 Global Strategy
Geographic Scope
6
Geographic Scope Choices Geographically-
focused Serving local markets Distinct products/services Localized marketing Satisfying local
regulatory requirements Local distribution
Advantage Strong local responsiveness Strong differentiated market
position Dangers
Scale, scope and learningadvantages of globalcompetitors may overtakelocal advantages
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Mayer & Voigt, Term IV, 2001
GSBA 515 GLOBAL STRATEGY 2
MOR 492 Global Strategy
Geographic Scope
7
Geographic Scope Choices Global Strategy
Serving universal needsacross borders
Same product everywhere Global customers Global product varieties –
slightly modified for localmarkets requirements
Global marketing approach
Advantage Exploit scale, scope, and
learning economies Capture global low-cost
leadership position
Dangers Inability to compete with
locally responsivedifferentiated firms
MOR 492 Global Strategy
Geographic Scope
8
Configuration and Coordinationof Firm Activities
Location of firm activities are influenced by: Market conditions Regulatory barriers Tax regimes Wages rates Locations of specific pockets of expertise
Firms can choose to locate activities insingle or disperse locations
MOR 492 Global Strategy
Geographic Scope
9
Configuration and Coordinationof Firm Activities
Two extremes Tight coordination
Important decisions centrally managed from homenation
Loose coordination Important decisions decentralized to many nations
The appropriate form of coordination willdepend on the relative importance ofpressures for global coordination andpressures for local responsiveness
MOR 492 Global Strategy
Geographic Scope
10
Competitive Interactionand Multi-market Competition
The scope of competition may expandglobally as firms match/mirror themoves of rivals
Firms feel compelled to match therivals to avoid cross-subsidization
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 1
MOR 492 Global Strategy
Strategic Alliances
1
THE COLLABORATIVE CHALLENGE:JOINT VENTURES AND STRATEGIC ALLIANCES
“Companies are just beginning to learn whatnations have always known -- in a complex,uncertain world filled with dangerousopponents, it is best not to go it alone.”
Kenichi Ohmae, McKinsey - Japan
MOR 492 Global Strategy
Strategic Alliances
2
STRATEGIC ALLIANCESSTRATEGIC CHALLENGEPre 1980s
Protect profits from erosion throughcompetition/bargaining
1980s and 1990sPursue multiple sources of competitive advantageSimultaneous reliance on competition and
collaboration [Coopetition]
MOR 492 Global Strategy
Strategic Alliances
3
STRATEGIC ALLIANCESQUESTIONSWhat types of arrangements are most
appropriate?
What can we learn from the experience ofothers?
How do we successfully manage thesealliances?
MOR 492 Global Strategy
Strategic Alliances
4
TYPES OF STRATEGIC ALLIANCES
JOINT VENTURESNew entity jointly owned by two or more firms
Shared or 50-50 venturesDominant ventures
INFORMALCooperation without any formal contractual
obligations
MOR 492 Global Strategy
Strategic Alliances
5
STRATEGIC ALLIANCES
TraditionalJoint Venture
Exchange of access
Alliances offeringaccess to marketsin return for technology
Joint developmentKnow how
Access tobusiness system
Know -how:Technology; concept
Access to business system:Customers; distribution; manufacturing
Local company offers
Foreign company offers
MOR 492 Global Strategy
Strategic Alliances
6
TYPES OF STRATEGIC ALLIANCES
MINORITY INVESTMENTSFirm buys stock in anotherOften access to resources for capitalStronger mutual commitment
TWO-WAY INVESTMENTSReciprocal equity stakes/cross-ownershipLess concern about dominance
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 2
MOR 492 Global Strategy
Strategic Alliances
7
WHY STRATEGIC ALLIANCES?TRADITIONAL REASONSSharing of resources and risksHost government requirementsOvercoming strong nationalistic sentimentsQuicker entryBenefit from partner’s local knowledge
MOR 492 Global Strategy
Strategic Alliances
8
EMERGING REASONS Learning from one another Attain global scale economies
Raw material/ Component supply Marketing and distribution
Rising R&D costs and technological interdependence Short product life cycles
Industry convergence
WHY STRATEGIC ALLIANCES?
MOR 492 Global Strategy
Strategic Alliances
9
Industry Globalization and Global CompetitionImproved market access
Stronger product line
Superior timing
Shaping competitive rivalry
Keeping key competitors at bay
Reduced transaction and other costs
WHY STRATEGIC ALLIANCES?
MOR 492 Global Strategy
Strategic Alliances
10
STRATEGIC ALLIANCES –POTENTIAL RISKS
Partner opportunism and loss of competitiveedge
Strategic and organizational complexity
Conflict of interest problems
Decreasing partner commitment
MOR 492 Global Strategy
Strategic Alliances
11
MAKING STRATEGIC ALLIANCES WORK
ASSESSING NEED Do you need a partner? How big is the payoff? How likely is success?PARTNER SELECTION Does the partner share your goals and objectives? Does strategic synergy exist? Is the partner compatible?
MOR 492 Global Strategy
Strategic Alliances
12
MAKING STRATEGIC ALLIANCES WORK
DEFINING GOALS AND OBJECTIVES Clarify and resolve separate interests Develop mutual trust and understandingDESIGNING AN ALLIANCE Define role of each partner Define venture boundaries Identifying champion(s) Trust versus legal considerations Allow for termination
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 3
MOR 492 Global Strategy
Strategic Alliances
13
MAKING STRATEGIC ALLIANCES WORK
MANAGING THE ALLIANCE
Achieving operating momentum
Recognize alliance needs Policies
Resources (inc. human resources)
Overcoming reluctance to give up autonomy
MOR 492 Global Strategy
Strategic Alliances
14
MAKING STRATEGIC ALLIANCES WORK
MANAGING THE ALLIANCE
Managing cultural differences
Flexibility
Assuring continued commitments
Increasing willingness to learn
Avoiding bottleneck dependence
MOR 492 Global Strategy
Strategic Alliances
15
STRUCTURING ALLIANCES TO REDUCEOPPORTUNISM
Probability ofOpportunism by Alliance PartnerReduced By
Walling off Critical technology
Establishingcontractualsafeguards
Agreeing to swap valuable skills andtechnologies
Seeking crediblecommitments
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 1
MOR 492 Global Strategy
Generic Global Strategies
1
Generic Global Strategies
Multidomestic strategy Global strategy Choice -- Global versus Multidomestic Transition -- Multidomestic to Global Transnational strategy
MOR 492 Global Strategy
Generic Global Strategies
2
FOUR BASIC STRATEGIES
Benefits from nationalresponsiveness
Efficiencybenefitsfrom globalintegration
GLOBAL
INTERNA-TIONAL
TRANS-NATIONAL
MULTI-DOMESTIC
MOR 492 Global Strategy
Generic Global Strategies
3
Location and Coordination IssuesLOCATION COORDINATION
Production facilities Product line, market
selection Location of service
organization Number and location
of R&D centers Location of
purchasing function
Networking ofinternational plants
Commonality of brandname, similarity ofchannels etc.
Similarity of servicestandards
Coordination of pricing Coordination of
suppliers
MOR 492 Global Strategy
Generic Global Strategies
4
PRESSURES: NATIONALRESPONSIVENESS
Differences in consumer preferences
Infra-structural differences Government demands New manufacturing technology Organizational limitations Managerial resistance
MOR 492 Global Strategy
Generic Global Strategies
5
MULTIDOMESTIC STRATEGY
Customized product
Countries -- selected on their stand-alone potential
Units independent
Low coordination; high dispersion
Few inter-subsidiary transfersMOR 492 Global Strategy
Generic Global Strategies
6
MULTIDOMESTIC STRATEGY
Unit 3
Unit 1
Unit 2
HQ
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 2
MOR 492 Global Strategy
Generic Global Strategies
7
MULTIDOMESTIC STRATEGYCompetitive advantage from Local responsiveness Goodwill -- local government,
customers Lower costs -- avoiding shipping costs
and tariffs Quick response to local market
situations MOR 492 Global Strategy
Generic Global Strategies
8
INDUSTRY GLOBALIZATION POTENTIAL
COST DRIVERS
MARKET DRIVERS
GOVERNMENT DRIVERS
COMPETITIVE DRIVERSIndustry
GlobalizationPotential
MOR 492 Global Strategy
Generic Global Strategies
9
PRESSURES: GLOBAL INTEGRATION COST DRIVERS
Economies of scale Economies of scope Decreased transportation costs Learning and experience Lower communication costs
GOVERNMENT DRIVERS Reduced tariffs, quotas Compatible technical standards
MOR 492 Global Strategy
Generic Global Strategies
10
MARKET DRIVERS Homogenization of product needs Global customers Improved product quality Reduced adaptation costs
COMPETITIVE DRIVERS Global competitors Increased formation of global alliances
PRESSURES: GLOBAL INTEGRATION
MOR 492 Global Strategy
Generic Global Strategies
11
GLOBAL STRATEGY Central control over country operations Central surveillance of resource allocation
and performance Standardized products Extensive transshipments Cross-subsidization Activities located in country(ies) providing
comparative advantageMOR 492 Global Strategy
Generic Global Strategies
12
GLOBAL STRATEGY
Unit 3
Unit 1
Unit 2
HQ
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 3
MOR 492 Global Strategy
Generic Global Strategies
13
GLOBAL STRATEGYCompetitive advantage from Lower cost structure
Economies of scale Less duplication of activities Lower inventories
Improved quality Increased competitive leverage Greater bargaining power Quick response -- R&D concentration
MOR 492 Global Strategy
Generic Global Strategies
14
TRANSITION: MULTIDOMESTIC TO GLOBAL
Determine where the benefits ofglobalization lie
Establish mandate for each subsidiary
Reduce strategic autonomy of subsidiaries Rotate country managers to help them
develop a global vision
Change reward and evaluation system to fitthe mandate
MOR 492 Global Strategy
Generic Global Strategies
15
MULTIDOMESTIC AND GLOBALSTRATEGIES
Strategic Arena
Business Strategy
Product-line strategy
Production Strategy
Sources of supply
Marketing
Organization
Most countries whichconstitute critical markets
Same basic strategyworldwide
Standardized products
Plants located on thebasis of competitiveadvantage
Attractive suppliers fromanywhere
Worldwide coordination;minor adaptation
Central control
Selected TargetCountries
Custom strategies;little coordination
Adapted to localneeds
Plants scatteredacross many hostcountries
Suppliers in hostcountry preferred
Adapted to localpractices and culture
Autonomy
MULTIDOMESTIC GLOBAL
MOR 492 Global Strategy
Generic Global Strategies
16
CONSUMER ELECTRONICS
Local Responsiveness
GlobalIntegration
Matsushita
Philips
General Electric
MOR 492 Global Strategy
Generic Global Strategies
17
“You want to be able to optimize abusiness globally -- to specializein the production of components,to drive economies of scale asfar as you can ....But you alsowant to have deep local rootseverywhere you operate ... If youbuild such an organization, youcreate a business advantagethat’s damn difficult to copy.”
Percy Barnevik, CEO, ABBMOR 492 Global Strategy
Generic Global Strategies
18
CONSUMER ELECTRONICS:TRANSITION TO TRANSNATIONALITY
Local Responsiveness
GlobalIntegration
Matsushita
Philips
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2000
MOR 492 GLOBAL STRATEGY 4
MOR 492 Global Strategy
Generic Global Strategies
19
TRANSNATIONAL STRATEGY Greater emphasis on differentiated products than in
“pure” global industries
Greater demand for global efficiency and lowercosts than in “pure” multidomestic industries
Greater sensitivity to governmental demands
Units coordinate activities with HQ and with oneanother
Units may adapt to special circumstances only theyface
MOR 492 Global Strategy
Generic Global Strategies
20
TRANSNATIONAL STRATEGY
Unit 3
Unit 1
Unit 2
HQ
MOR 492 Global Strategy
Generic Global Strategies
21
TRANSNATIONAL CORPORATION Each national unit is a source of ideas and
competencies that can be harnessed for thebenefit of the corporation
National units achieve global scale by makingthem the company’s world source for particularproduct, component or activity
New, highly-complex managing roles whichcoordinates relationships between units in aflexible way
MOR 492 Global Strategy
Generic Global Strategies
22
FOUR BASIC STRATEGIES
Benefits from nationalresponsiveness
Efficiencybenefitsfrom globalintegration
GLOBAL
INTERNA-TIONAL
TRANS-NATIONAL
MULTI-DOMESTIC
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2003
MOR 492 GLOBAL STRATEGY 1
MOR 492 Global Strategy
Global Competitive Advantage
1
Creating GlobalCompetitive Advantage
Building Multinational Competencies
MOR 492 Global Strategy
Global Competitive Advantage
2
Creating Competitive Advantage
Most markets have local, regional, andglobal aspects
ExampleGlobal IndustryCharacteristics
• Interdependent markets
• Extra-national scale
• Cross-market competition
National IndustryCharacteristics
• Differentiated markets
• National scale economies
• Local competition
MOR 492 Global Strategy
Global Competitive Advantage
3
Strategies for Globalization
Adaptation
Arbitrage
Aggregation
LocalCustomization
GlobalStandardization
Loca
lizat
ion
Glo
baliz
atio
n
Exploit differencesacross countries
Exploit similaritiesacross countries
MOR 492 Global Strategy
Global Competitive Advantage
4
Logic of Global Advantages Arbitrage Adaptation/Replication Aggregation Transformation(“ARAT” Model)
From Ghemawat, “ Global Advantage…”
MOR 492 Global Strategy
Global Competitive Advantage
5
Arbitrage Taking advantage of supply and demand
mismatches Taking advantage of national differences
Factor endowments Industry clusters, etc. Unique consumer demand
Consolidated and coordinated globaloperations
MOR 492 Global Strategy
Global Competitive Advantage
6
Three Kinds of Arbitrage
Classic Trading Arbitrage Relocation Arbitrage Production Integration Arbitrage
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2003
MOR 492 GLOBAL STRATEGY 2
MOR 492 Global Strategy
Global Competitive Advantage
7
Classic Trading Arbitrage
Taking advantage of supply and demandmismatches through trading
Taking advantage of national differences insupply and demand prices and qualities Factor endowments: Raw materials, Labor Unique consumer demand: US Surfboards in Japan, Unique production capability: Japanese textiles,
French and Belgian goldsmithing
MOR 492 Global Strategy
Global Competitive Advantage
8
Relocation Arbitrage
Taking advantage of differences in endowmentsthrough activity relocation
Activity location depends on countrydifferences: Cost and quality of inputs and processes Porter’s Diamond Factors Risks and Uncertainties Transport costs Tariffs
MOR 492 Global Strategy
Global Competitive Advantage
9
Production Integration asArbitrage
Economies of scale or scope acrosscountries/regions/globe
Where integrating and trading outperformsreplication
TENSION between scale/scope economies onthe one hand and commitment, tariffs, andtransport costs on the other
MOR 492 Global Strategy
Global Competitive Advantage
10
Integration and the Value Chain
REMEMBER:Integration can take place at anypoint in the value chain:
Local selling, global sourcingGlobal selling, local sourcingGlobal selling, global sourcing
MOR 492 Global Strategy
Global Competitive Advantage
11
Integration and ExtensibilityDeciding Tradeoffs in Activity Integration
National
Activity 3
Activity 2
Activity 1
GlobalRegionalLocal
MOR 492 Global Strategy
Global Competitive Advantage
12
Other Forms of Arbitrage Cultural arbitrage
Examples: French Culture, US Culture, Brazilianlifestyle
Administrative arbitrage Examples: tax differentials, smuggling
Geographic arbitrage Examples: international flower markets
Economic arbitrage Examples: lower cost labor, cheaper capital
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2003
MOR 492 GLOBAL STRATEGY 3
MOR 492 Global Strategy
Global Competitive Advantage
13
Replication (with Adaptation) Applying a successful model in multiple national
environments; “transfering DNA” Taking advantage of similarities among nations
Product Segment similarity Value Chain similarity Customization/Standardization tension
Replication will almost always require someadaptation to local market conditions
Multi-divisional organization in order to focus onnational organizations
MOR 492 Global Strategy
Global Competitive Advantage
14
Adaptation “Think Global, act local (and adjust)” Strategic action on both the global and
local levels
MOR 492 Global Strategy
Global Competitive Advantage
15
Forms of Adaptation Decentralization – moving decision-making from HQ to
the field Partitioning – separating choice elements Modularization – separating and designing standard
interfaces Recombination – melding elements of the parent
business model with new possibilities Innovation – deliberate local-for-local innovations Transformation of context – reduce the need for
adaptation by changing tastes Scope selection – reduce need for adaptation by
focusing on a narrow geographic area similar todomestic market
MOR 492 Global Strategy
Global Competitive Advantage
16
Transformation Trying to simultaneously take advantage
of differences and similarities amongnations Utilize arbitrage strategies where nations have
different and strategically significantcharacteristics (e.g., differences in productioncosts or natural resources)
Utilize replication strategies to capitalize onwhat has worked in other settings
MOR 492 Global Strategy
Global Competitive Advantage
17
Economic Implications ofArbitrage and Replication
Strategies
From Ghemawat, “ Global Advantage…”
Arbitrage ReplicationCost
Drivers
BenefitDrivers
Key Metrics
Risk Mgmt
International differences in absolute costs
Country-of-origineffects
International economiesof scale and/or scope
Nature, amount, & effectsof standardization
Spread/Margin Volume/Market Share
Hedging (e.g., Enron)Spreading risks across markets
MOR 492 Global Strategy
Global Competitive Advantage
18
Aggregation Finding scale and scope opportunities in
new markets/nations Aggregation mechanisms that operate at
levels intermediate to one country and thewhole world.
Like a transnational mentality Deals with the integration-responsiveness
trade-off
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2003
MOR 492 GLOBAL STRATEGY 4
MOR 492 Global Strategy
Global Competitive Advantage
19
Bases for Creating Global Advantage
NationalDifferences
Economiesof Scale
EconomiesofReplication
Economiesof Scope
GlobalLearning
GlobalFlexibility
Non-MarketStrategies
© Voigt, Mayer & Liebeskind, 2006
MOR 492 Global Strategy
Global Competitive Advantage
20
NationalDifferences
Location Drivers
© Voigt, Mayer & Liebeskind, 2006
GlobalLearning
GlobalFlexibility
Non-MarketStrategies
MOR 492 Global Strategy
Global Competitive Advantage
21
Cost and Volume Drivers
© Voigt, Mayer & Liebeskind, 2006
Economiesof Scale
Economies ofReplication
Economiesof Scope
MOR 492 Global Strategy
Global Competitive Advantage
22© Voigt, Mayer & Liebeskind, 2006
NationalDifferences
Economiesof Scale
EconomiesofReplication
Economiesof Scope
GlobalLearning
GlobalFlexibility
Non-MarketStrategies
MOR 492 Global Strategy
Global Competitive Advantage
23
National Differences Comparative advantage
Natural factor endowments and Societal endowments Scarce or abundant resources Cost differences in factors of production
Lower labor costs, lower cost of capital, tax advantages,availability of land, etc.
Differences in consumer demand “Relatively “ high willingness-to-pay
Location advantages Lower transportation costs, etc.
MOR 492 Global Strategy
Global Competitive Advantage
24
Economies of Scale Economies of scale
Expand output in order to achieve lower production costs Lowering costs by expanding in one area
Experience or learning effects Higher volume helps firms exploit benefits of accumulated
learning
Value-added Chain Selecting components of chain to specialize in, and exploiting
coordination benefits across activities
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2003
MOR 492 GLOBAL STRATEGY 5
MOR 492 Global Strategy
Global Competitive Advantage
25
Economies of ScopeEconomies of scope
Expand into different activities in order to maximizeutilization of resources and lower total costs
Lowering costs by expanding into different areasSharing investments and costs across the same or
different value chainsSources
Shared physical activitiesShared external relationsShared learning
MOR 492 Global Strategy
Global Competitive Advantage
26
Examples of Scope Economies
From Bartlett and Ghoshal, “ T ransnational Management”
Multi-ProductScope Advantages
Shared PhysicalAssets
SharedExternal
Relations
SharedLearning
A factory that can produceseveral different products or
product variations (e.g., Ford)
Using common distributionchannels for multiple products
(e.g., Matsushita)
Global brand name (Coca-Cola)
Servicing multinationalcustomers worldwide
(e.g., Citibank)
Shared R&D across multipleproducts (e.g., NEC computer
& communications LOBs)
Pooling knowledge developed in different
markets (e.g., P&G)
Multi-MarketScope Advantages
MOR 492 Global Strategy
Global Competitive Advantage
27
Economies of Replication Duplicating successful profit-making
activities in new locations May also involve learning advantages
– costing of replicating a business mayfall with cumulative experience
MOR 492 Global Strategy
Global Competitive Advantage
28
Global Learning & Innovation Transfer of learning & innovations across markets
From the center to the subsidiaries From the periphery to the center Throughout the network of locations
Organizational challenges Putting the right incentives and processes in place
Decentralize collection of knowledge Centralize processes for sharing knowledge across markets
and divisions Local loyalties, turf protections, NIH (not-invented here)
Intelligence gathering Identification of market opportunities
MOR 492 Global Strategy
Global Competitive Advantage
29
Creating Worldwide Innovations Capture external diversity
Worldwide stimuli as potential source ofcompetitive information advantage
Need to convert “delivery pipelines” into“sensory feelers”
Leverage internal variety Worldwide human resources and capabilities as
potential sources of competitive advantage Opportunity to leverage central and local innovations Create true global innovations by linking sensing,
response and implementation capabilitiesMOR 492 Global Strategy
Global Competitive Advantage
30
Global Flexibility and Adaptiveness Managing diversity and volatility across
markets – manage the risk/exploit the opportunities Portfolio of national and product markets Minimize impact of adverse conditions (political or
economic) in a single market Competitive actions
Cross-parrying, multi-market retaliation, etc. Cross-market subsidization (e.g. cross-market cash-flows)
Internal markets for resources Labor, capital, etc.
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2003
MOR 492 GLOBAL STRATEGY 6
MOR 492 Global Strategy
Global Competitive Advantage
31
Global Flexibility Macroeconomic Risks
Shocks and major trends in macro-environment Political Risks
Actions of national governments Competitive Risks
Uncertainties of competitors actions & reactions Resource Risks
Scarcity of strategic resources
MOR 492 Global Strategy
Global Competitive Advantage
32
Non-Market Strategies Taking advantage of government
protection, subsidies, tax holidays,interest-free loans, etc.
Taking advantage of government rule-making that creates barriers for newcompetitors
MOR 492 Global Strategy
Global Competitive Advantage
33
GlobalHighGlobalCoordination,Integration International
Low
Low NationalDifferentiation,
Responsiveness
Multi-Domestic
High
Trans-National
Global Strategy Perspectives
MOR 492 Global Strategy
Global Competitive Advantage
34
The Four Strategies and ART
MULTIDOMESTICProduct And Value ChainArbitrage through RDI
INTERNATIONALArbitrage throughexporting
TRANSNATIONALTransformation:Products and ValueChain
GLOBALProduct Replication;Value Chain Arbitragethrough integration
MOR 492 Global Strategy
Global Competitive Advantage
35
The Four Strategies:Replicating Versus Responding
Multidomestic StrategyInternational Strategy
Transnational StrategyGlobal Strategy
RESPONDREPLICATE
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 1
MOR 492 Global Strategy
Global Context
1
Globalizationin Context
MOR 492 Global Strategy
Global Context
2
Overview Analyzing the Global External
Environment Globalization and “Distance” National Competitiveness: Competitive
and Comparative Advantage of Nations Non-Market Strategy Political Risk
MOR 492 Global Strategy
Global Context
3
Country’s Overall Attractiveness
BENEFITS•Size of market•Growth rate•EconomicSystem
COSTS•Political factors•Economicunderdevelopment
•Legal system
RISKS•Political•Economic•Legal
ATTRACTIVENESS
GSBA 492 Global Strategy
Macro-environmentalAnalysis
Analyzing Similarities andDifferences
MOR 492 Global Strategy
Global Context
5
Global External EnvironmentFirst Cut Analysis
Macro-environmental (PEST) Analysis Political Environment Economic Environment Social Environment Technological Environment
Competitive and Competitor Analysis Similarities, Differences, and Rate/Velocity
of Change Shocks and Trends
MOR 492 Global Strategy
Global Context
6
Political Environment Type of Government
Stability Political goals/agenda Succession and transfer of power
Political Alliances Legal Infrastructure
Contract enforcement Nature and extent of Regulation
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 2
MOR 492 Global Strategy
Global Context
7
Political Environment Business-government relationships
Role of business in political agenda Role of Public Sector
Privatization Influence Activities
Lobbying Bribery/corruption
MOR 492 Global Strategy
Global Context
8
Legal Environment Property Rights Intellectual Property Rights - Patent,
trademark, copyright laws Contract Law – common law and civil law Tariffs, quotas and trade barriers Restrictive trade practices legislation Taxation Product liability, civil and criminal laws Labor laws Laws governing business practices
MOR 492 Global Strategy
Global Context
9
Political Systems
Political System – the system of government in a nation
Collectivism Individualism
• Socialism• Communism• Social Democracy
• Individual Freedom &Self-Expression
• Economic Self-interest (invisiblehand)
MOR 492 Global Strategy
Global Context
10
Political EnvironmentPOLITICAL SYSTEMS Democracy – representative democracy Totalitarianism
Communist Theocratic Tribal Right-wing
Others (e.g., Oligarchy)
MOR 492 Global Strategy
Global Context
11
Economic Environment Economic growth; stage of economic development GDP per capita (income) Financial Institutions – stock exchanges, banks, etc. Monitoring Institutions
SEC, Auditors, GAAP Money supply and monetary stability Balance of payments; foreign debt “Hard” currency reserves Exchange rate fluctuations Fiscal policies, interest rates, taxation Unemployment levels
MOR 492 Global Strategy
Global Context
12
Economic Systems Market Economy
Free interplay of demand and supply No restrictions on supply
Central Command Government moderates the activities of different economic systems –
quantity produced and prices charged set by government
Mixed Combination of market and command economies – both private
ownership and free markets and government planning
State-Directed Economy State plays a significant role in directing the investment activities of
private enterprise through “industrial policy” and other wise regulatingbusiness activity in accordance with national goals
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 3
MOR 492 Global Strategy
Global Context
13
Social/Cultural Environment
CULTURE
Norms, ValueSystems, Attitudes
and Beliefs Education
Work PlaceValues
Religion
Language
Social structure
MOR 492 Global Strategy
Global Context
14
Culture : Silent Language Time
Meaning of delays, deadlines, schedules
Space Size, conversation distance
Things Material possessions, language of money
Friendships Meanings of “friends”, expectations
Agreements “Verbal” versus “written” agreements
MOR 492 Global Strategy
Global Context
15
Demographic Environment
Population growth
Education and literacy
Age distribution and changes
Population shifts
GSBA 492 Global Strategy
CAGE FrameworkPankaj Ghemawat,
“Globalization and Distance”
MOR 492 Global Strategy
Global Context
17
Country Level Influences on Bilateral Trade Flows
Economic Size: GDP (1% increase) Income Level: GDP per capita Distance: 1% increase Geographic size Landlockedness Common Land Border Common Language Common Regional Trading Bloc Colony/Colonizer Common Colonizer Common Polity Common Currency
+0.8%+0.7%-1.1%-0.2%-50%+80%+200%+330%+900%+190%+300%+340%
MOR 492 Global Strategy
Global Context
18
CAGE Framework for Thinking aboutDistance(Closeness) at Country Level
Cultural Distance Cultural attributes of society that are sustained by general social
interaction Administrative Distance
Administrative attributes encompass laws, policies andinstitutions that emerge from the political process
Geographic Distance Geographic attributes include natural constraints and physical
differences Economic Distance
Economic Factors
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 4
MOR 492 Global Strategy
Global Context
19
Cultural Distance Common (Different) Languages
Example: Spanish companies invest more in South Americawhich is geographically further away than Asia
Common (Different) Ethnicity Lack of connective ethnic or social networks Immigrant populations can substitute for language-related links
Common (Different) Religions Common (Different) Values, Norms, and Dispositions
Examples: values (Confucian vs Western), norms (insiders vsoutsiders), average disposition (materialism, individualism, orrisk-taking)
Other: Insularity, traditionalism
MOR 492 Global Strategy
Global Context
20
Administrative Distance Common (Lack) Colonial Ties Shared Regional Trading Agreements
NAFTA, Mercosur, ASEAN, European Union Common Currencies Political Climate (hostility)
Examples: Pakistan vs. India, Pariah States Others:
restrictions on foreign trade & investment, discrimination against foreign companies, limits on currency convertibility/remittance, poor institutional quality – bribery/corruption poor contract enforcement
MOR 492 Global Strategy
Global Context
21
Geographic Distance Physical Distance Land Borders Differences in Climates/Disease Environments Others:
landlockness lack of internal navigability geographic size absolute remoteness
MOR 492 Global Strategy
Global Context
22
Economic Distance Rich/Poor Differences
80% of the trade/FDI of high-income countries isdirected at other high-income countries
Rich-Rich is “replication”, Rich-Poor is “arbitrage” Others:
factor endowments infrastructure advanced factors
GSBA 492 Global Strategy
NationalCompetitiveness
Comparative andCompetitive Advantages
MOR 492 Global Strategy
Global Context
24
Comparative Advantages:Factor Endowments
Natural Resources Land, climate, mineral resources, water,
demographics, location, etc. National Infrastructure
Ports, transportation system, energy,telecommunications, banking system, etc.
Labor Productivity Education levels, skill levels, labor costs, etc.
Advanced Factors Research facilities, technical know-how, court system
etc.
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 5
MOR 492 Global Strategy
Global Context
25
Competitive Advantage of Nations What explains:
Japan Inc., Taiwan Dragon, “The German Machine”etc.
Why Competitive Clusters? Silicon Valley, French Wines, Italian Ceramics, UK
Formula I Racing, etc. Why do some nations have such negative
inertia? India, Mexico, Russia, China, etc.
MOR 492 Global Strategy
Global Context
26
Firm Strategy, Structure, and
Rivalry
Factor Conditions
Demand Conditions
Related and Supporting Industries
Source: Porter (1990) Government
Chance
Determinants of National CompetitiveAdvantage of Nations: Porter’s Complete System
GSBA 492 Global Strategy
Non-MarketStrategy
Non-market Influences onGlobal Economic Activities
MOR 492 Global Strategy
Global Context
28
BUYERS
Threat ofnew entrants MARKET
COMPETITORS
Bargaining powerof customers
SUPPLIERS
SUBSTITUTES
Rivalry amongexisting firms
Bargaining powerof suppliers
Threat of substituteproducts or services
Source: Porter (1980)
Porter’s Five Forces Framework
POTENTIALENTRANTS
Governmentas Supplier
Governmentas Buyer
MOR 492 Global Strategy
Global Context
29
BUYERS
Threat ofnew entrants MARKET
COMPETITORS
Bargaining powerof customers
SUPPLIERS
SUBSTITUTES
Rivalry amongexisting firms
Bargaining powerof suppliers
Threat of substituteproducts or services
Source: Porter (1980)
Government as a Sixth Force
POTENTIALENTRANTS
Government:Player and/or
Rulemaker
MOR 492 Global Strategy
Global Context
30
Disaggregating Non-Market Influences
Government Roles Transactor (Government entities) vs. Rulemaker
National vs. Regional vs. Local Government Politicians vs. Bureaucrats Stakeholders
Regulators, partners, competitors, unions, media,consumers, communities, interest groups/activists
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 6
MOR 492 Global Strategy
Global Context
31
Government as a Rulemaker Taxes and subsidies Price/profit restrictions Disclosure requirements and other financial
regulations Product/process regulation Local content requirements Trade/industrial policy Governmental ownership by statute
MOR 492 Global Strategy
Global Context
32
Local ownership/partnership requirements Competition policy Restrictions on entry/expansion Patent law Intellectual property right recognition and
enforcement Technology transfer policies
Government as a Rulemaker
MOR 492 Global Strategy
Global Context
33
Non-market Strategy Responses Lobbying Political Contributions, bribery Advocacy advertising Public exposure Constituency influence Collegial persuasion Litigation Collective organizing Official testimony
GSBA 492 Global Strategy
Political RiskAnalysis
MOR 492 Global Strategy
Global Context
35
US Intelligence Sources (1985)estimated that 80 percent of
foreign contracts for large scalecapital projects were won by
firms paying bribes.
MOR 492 Global Strategy
Global Context
36
Political Risk Political Risk arises from the vagaries of
governmental action: Policy changes Leadership changes Nationalization of private property Expropriation of foreign holdings Civil strife Currency inconvertibility War Etc.
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 7
MOR 492 Global Strategy
Global Context
37
Political Risks -- Macro
Competingpoliticalphilosophies
Armed conflictsand rebellion
Social unrest anddisorders
New internationalalliances
Confiscation,nationalexpropriation
Damage toproperty, persons
Loss of transferfreedoms
Causes Form
MOR 492 Global Strategy
Global Context
38
Political Risks -- Micro
Changing socialvalues
Unstable economicconditions
Vested interests Quasi-political Local business
Latent hostilitytowards foreigners
High inflation,currency instability
Breach/revision ofcontracts
Discrimination
Operatingrestrictions
Causes Form
MOR 492 Global Strategy
Global Context
39
Political Risk -- Vulnerability
“Critical” industries Entirely foreign or entirely local
management Control over foreign firm’s access to
market, raw materials etc.
Globally, integrated firm High technology firm
HIGHER
LOWER
MOR 492 Global Strategy
Global Context
40
Political Risk -- Defensive Strategies Stay ahead -- technical and managerial
capabilities Multiple sourcing of products Raise political costs of intervention JVs with politically connected local
companies Maximize debt investment from local sources Significant exports “Good citizen” -- public services
MOR 492 Global Strategy
Global Context
41
Political Risk Forecasting Internal stability
Prospects of domestic violence Demonstrations, riots, strikes Terrorisms, assassinations
External political relations Prospects of border warfare Regional political alliances Trade disputes and economic warfare
MOR 492 Global Strategy
Global Context
42
Political Risk Rating Agencies
Business Environment Risk Intelligence:BERI Index
Bank of America World InformationServices: Country Risk Monitor Rankings
Economist Intelligence Unit (EIU): CountryRisk Ratings
Euromoney: Country Risk Ratings Institutional Investor: Country Credit Ratings
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt
MOR 492 GLOBAL STRATEGY 8
MOR 492 Global Strategy
Global Context
43
Example: The Economist Rankings Politics (50 points)
Being near a superpower or troublemaker Authoritarianism Longevity of regime Illegitimacy General in power War/armed insurrection
Economics (33 points) Falling GDP per capita High inflation Capital flight High and rising foreign debt as a proportion
of GDP Decline in food production per capita Raw material as a high percent of exports
Society (17 points) Pace of urbanization Islamic fundamentalism Corruption Ethnic tension
MOR 492 Global Strategy
Global Context
44
Example: Business Environment Risk Intelligence(BERI) Political Risk Index
Internal Causes of Political Risk Political fractionalization Ethnic fractionalization Coercive measures required for retaining power Mentality, including xenophobia, nationalism, corruption, nepotism Social conditions, including population density and wealth distribution Radical left
External Causes of Political Risk Importance of hostile major power Negative regional influences
Symptoms of Political Risk Societal conflict involving demonstrating, strikes, and street violence Instability as perceived by non-constitutional changes, assassinations, and
guerilla wars
MOR 492 Global Strategy
Global Context
45
Country’s Overall Attractiveness
BENEFITS•Size of market•Growth rate•EconomicSystem
COSTS•Political factors•Economicunderdevelopment
•Legal system
RISKS•Political•Economic•Legal
ATTRACTIVENESS
Keith Parker, University of Southern California
MOR-492: Powerpoints
1
COMPETITIVEADVANTAGE OF NATIONS
This is presentation is based onMichael E. Porter’s book:
The Competitive Advantage of Nations, Free Press, 1990
Source: The presentation slides were prepared by George Yip,UCLA
MOR 492 Porter on Global Strategy 2Voigt, 2002
Porter’sCompetitive Advantage of Nations
Extends and modifies traditional theory ofcomparative advantage to take into account thefollowing factors:
Competitive advantage is about companies -- theimportance of the national environment is providing ahome base for the company
Sustained competitive advantage depends upon dynamicfactors -- innovation and upgrading of firm’s resourcesand capabilities
The critical role of the national environment is itsinfluence upon the dynamics of innovation and upgrading
Keith Parker, University of Southern California
MOR-492: Powerpoints
2
MOR 492 Porter on Global Strategy 3Voigt, 2002
Firm Strategy, Structure, and
Rivalry
Factor Conditions
Demand Conditions
Related and Supporting Industries
Source: Porter (1990)
The Determinants ofNational Advantage
MOR 492 Porter on Global Strategy 4Voigt, 2002
Factor Conditions
Keith Parker, University of Southern California
MOR-492: Powerpoints
3
MOR 492 Porter on Global Strategy 5Voigt, 2002
Demand Conditions
MOR 492 Porter on Global Strategy 6Voigt, 2002
Leather Footwear
Leather Working
Machinery
Design Services
Processed Leather
Source: Porter (1990)
Parts of Footwear
Related and Supporting Industries
Keith Parker, University of Southern California
MOR-492: Powerpoints
4
MOR 492 Porter on Global Strategy 7Voigt, 2002
Internationally CompetitiveRelated Industries
MOR 492 Porter on Global Strategy 8Voigt, 2002
Firm Strategy, Structure and Rivalry
Keith Parker, University of Southern California
MOR-492: Powerpoints
5
MOR 492 Porter on Global Strategy 9Voigt, 2002
Estimated Number of Japanese Rivalsin Selected Industries, 1987
MOR 492 Porter on Global Strategy 10Voigt, 2002
Firm Strategy, Structure, and
Rivalry
Factor Conditions
Demand Conditions
Related and Supporting Industries
Source: Porter (1990)
Government
Chance
The Complete System
Keith Parker, University of Southern California
MOR-492: Powerpoints
6
MOR 492 Porter on Global Strategy 11Voigt, 2002
Company Strategy
MOR 492 Porter on Global Strategy 12Voigt, 2002
1. Competitive advantage grows fundamentally out of improvement, innovation, and change. 2. Competitive advantage involves the entire value system. 3. Competitive advantage is sustained only through relentless improvement. 4. Sustaining advantage demands that its sources be upgraded. 5. Sustaining advantage ultimately requires a global approach to strategy.
Competitive Advantage inInternational Competition
Keith Parker, University of Southern California
MOR-492: Powerpoints
7
MOR 492 Porter on Global Strategy 13Voigt, 2002
Pressures For Innovation
MOR 492 Porter on Global Strategy 14Voigt, 2002
Perceiving Industry Change
Keith Parker, University of Southern California
MOR-492: Powerpoints
8
MOR 492 Porter on Global Strategy 15Voigt, 2002
Predicting the Behavior of Foreign Rivals FirmStrategy, Structure and Rivalry
MOR 492 Porter on Global Strategy 16Voigt, 2002
FACTOR CONDITIONS What is the direction of industry-related researchin the nation and the types of training received bynew employees?
How will pressures from selective factordisadvantages modify strategies?
Predicting the Behavior ofForeign Rivals, cont.
Keith Parker, University of Southern California
MOR-492: Powerpoints
9
MOR 492 Porter on Global Strategy 17Voigt, 2002
DEMAND CONDITIONS Which industry segments are likely to beemphasized because of their importancedomestically?
What trends in domestic buyer needs willshape competitor perceptions of new productdirections?
Predicting the Behavior of ForeignRivals, cont.
MOR 492 Porter on Global Strategy 18Voigt, 2002
RELATED AND SUPPORTING INDUSTRIES How will developments in local supplier industriesskew the direction of technical development? How will entry from related industries redefine the natureof domestic rivalry or pressure firms to change?
Predicting the Behavior ofForeign Rivals, cont.
Keith Parker, University of Southern California
MOR-492: Powerpoints
10
MOR 492 Porter on Global Strategy 19Voigt, 2002
Choosing Industries and Segments For Whichthe Nation is a Favorable Home Base
MOR 492 Porter on Global Strategy 20Voigt, 2002
Choosing Industries and Segments For Whichthe Nation is a Favorable Home Base, cont.
Keith Parker, University of Southern California
MOR-492: Powerpoints
11
MOR 492 Porter on Global Strategy 21Voigt, 2002
Choosing Industries and Segments For Whichthe Nation is a Favorable Home Base, cont.
MOR 492 Porter on Global Strategy 22Voigt, 2002
Choosing Industries and Segments For Whichthe Nation is a Favorable Home Base, cont.
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2005
MOR 492 GLOBAL STRATEGY 1
MOR 492 Global Strategy
Introduction: What is Globalization?
1
What is Globalization andthe Global Marketplace,
really?
MOR 492 Global Strategy
Introduction: What is Globalization?
2
Outline What is Globalization? Drivers of Globalization The Changing Demographics of the
Global Economy The Globalization Debate: Prosperity
or Improverishment? Managing in the Global Marketplace
MOR 492 Global Strategy
Introduction: What is Globalization?
3
Definition of Globalization Globalization is the trend toward a
more integrated global economicsystem
Examples: telecommunications,automobiles, computers, credit cards,fast food, etc.
MOR 492 Global Strategy
Introduction: What is Globalization?
4
What is Globalization?The Globalization of Markets
The merging of historically distinct andseparate national markets into one huge globalmarket place
Convergence of consumer tastes andpreferences Citicorp credit cards, Coca-Cola, Levis, Sony Walkman,
Nintendo, McDonalds, etc.
MOR 492 Global Strategy
Introduction: What is Globalization?
5
Globalization of Markets (Continued)
The most global of markets are for industrialgoods and materials Markets for Commodities
aluminum, oil, wheat Markets for Industrial Products
microprocessors, DRAMs, commercial jet aircraft Markets for Financial Assets
T-bills, Eurobonds, futures
Same multinationals compete with each otherin multiple national markets
MOR 492 Global Strategy
Introduction: What is Globalization?
6
Globalization of Production The tendency of firms to source goods and
services from different locations around theglobe to take advantage of nationaldifferences in the cost and quality factors orproduction (such as labor, energy, land, andcapital)
Global web of suppliers Almost irrelevant to speak about American
products, Chinese products, Japaneseproducts, Italian products
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2005
MOR 492 GLOBAL STRATEGY 2
MOR 492 Global Strategy
Introduction: What is Globalization?
7
Semi-Globalization
Globalization vs Semi-Globalization Semi-Globalization is a state between
completely integrated markets andcompletely independent localizedmarkets
Regionalization – NAFTA, EU, Mercosur
MOR 492 Global Strategy
Introduction: What is Globalization?
8
Drivers of GlobalizationDeclining Trade (tariffs) and
Investment Barriers General Agreement on Tariffs and Trade (GATT) World Trade Organization (WTO)
The lowering of trade and investment barriershas allowed firms to locate productionoptimally almost anywhere in the world
“Home” markets are now under attack fromforeign competitors
MOR 492 Global Strategy
Introduction: What is Globalization?
9
The Role of Technological Change Microprocessors and Telecommunications
As costs of telecommunications fall, so do thecosts of coordinating and controlling globalorganizations
Internet and the World Wide Web Information backbone of the global economy Greatly increased across-border transaction Location, scale and time no longer become
major competitive advantages
MOR 492 Global Strategy
Introduction: What is Globalization?
10
The Role of Technological Change(continued)
Transportation Technology Development of commercial aircraft and
superfreighters Containerization (simplifying transshipments) Commercial jet travel (reducing time to travel)
MOR 492 Global Strategy
Introduction: What is Globalization?
11 MOR 492 Global Strategy
Introduction: What is Globalization?
12
Implications for the Globalization ofProduction Containerization
Development of commercial aircraft andsuperfreighters
Containerization (simplifying transshipments) Commercial jet travel (reducing time to travel)
Information Technology Real costs of info processing and
communication have fallen dramatically Ability to manage globally dispersed production
systems
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2005
MOR 492 GLOBAL STRATEGY 3
MOR 492 Global Strategy
Introduction: What is Globalization?
13
Implications for the Globalization ofMarkets Containerization and Low-cost Transportation
Economical to ship products around world Low-cost Global Communication
eCommerce Low-cost Jet Travel
mass movement of people between countries reduced cultural distance between countries creating a worldwide culture
Emergence of global markets for consumerproducts
MOR 492 Global Strategy
Introduction: What is Globalization?
14
Changing Demographics of theGlobal Economy
In the 1960s world stylized factscharacterized the demographics of theglobal economy:1. US dominance of the world economy and world trade2. US dominance of world foreign direct investment3. Dominance of international business by large US
multinational corporations4. Approximately half of the world was under the control
of centrally-planned communist economies which wereoff-limits to US businesses
MOR 492 Global Strategy
Introduction: What is Globalization?
15
Changing World Output and WorldTrade Patterns
Decline of US of world output (and othertraditionally dominant economies) relative toemerging economies such as Asia
Decline of US as leading exporter relative toJapan, Germany, South Korea, China, etc.
Emerging regions and economies such asthose of South America, Eastern Europe, andAsian Pacific have further eroded US position
MOR 492 Global Strategy
Introduction: What is Globalization?
16
The Changing Pattern of World Output and TradeCountry Share of World
Output, 1963Share of WorldOutput, 1997+
Share of WorldExports, 1998
United States 40.3% 20.8% 12.7%
Japan 5.5 8.3 7.26
Germany* 9.7 4.8 10
France 6.3 3.5 5.7
United Kingdom 6.5 3.2 5.1
Italy 3.4 3.2 4.5
Canada 3 1.7 4.0
China++ NA 11.3 3.4
South Korea NA 1.7 2.45*1963 figure for Germany refers to the former West Germany.+ Output is measured by gross national product. The 1997 estimates are based on purchasing power parity (PPP) statistics that adjust GNP for differences in prices (the cost ofliving) between countries.++ The Chinese figures are somewhat suspect. When calculated using unadjusted GNP data, China's share of world output shrinks to 3.1 percent. Thus, China's high share ofworld output on a PPP basis is partly due to the relatively low cost of living in China.Source: Export data from World Trade Organization, Annual Report, 1999 and Statistics, 1996 (Geneva: WTO, 1996). World output data from CIA factbook, 1999.
MOR 492 Global Strategy
Introduction: What is Globalization?
17
Changing Foreign Direct InvestmentPicture Relative decline to US foreign direct
investment Emergence of non-US firms investing across-
borders
MOR 492 Global Strategy
Introduction: What is Globalization?
18
Changing Nature of the MultinationalEnterprise Definition: A multinational corporation (MNC)
is any business that has productive activitiesin two or more countries
Two important trends: Emergence of non-US MNCs
Japanese and European MNCs Growth of mini-MNCs
Medium and small businesses with as few as 25employees
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2005
MOR 492 GLOBAL STRATEGY 4
MOR 492 Global Strategy
Introduction: What is Globalization?
19
The National Composition of theLargest Multinationals
Source: The 1973 figures from Hood and Young, The Economics of the Multinational Enterprise (NewYork: Longman, 1979). The 1997 figures from "The Global 500," Fortune, August 4, 1997, pp. 130-31.
Of the Top 260 in 1973 Of the Top 500 in 1997
United States 126 (48.5%) 162 (32.4%)
Japan 9 (3.5) 126 (25.2)
Britain 49 (18.8) 34 (6.8)
France 19 (7.3) 42 (8.4)
Germany 21 (8.1) 41 (8.2)
MOR 492 Global Strategy
Introduction: What is Globalization?
20
Changing World Order
Between 1989-1991 a series of democraticrevolutions swept the communist world Collapse of the Soviet Union Numerous European and Asian countries with
a commitment to free-markets createsinternational business opportunities
Quieter revolutions in China and LatinAmerica
MOR 492 Global Strategy
Introduction: What is Globalization?
21
The Global Economy of the 21st Century Barriers to the free flow of goods, services, and
capital have come down The volume of cross-border trade and
investment grew more than global output indicates national economies are becoming more
closely integrated into a single, interdependent,global economic system
More nations have joined the ranks of thedeveloped world e.g. Korea, Taiwan
MOR 492 Global Strategy
Introduction: What is Globalization?
22
The Global Economy of the 21stCentury (Continued)
Widespread adoption of liberal economicpolicies privatization of state-owned businesses deregulation removal tariffs and other barriers
New countries are expected to build powerfulmarket economies Czech Republic, Poland, Brazil, China, South
Africa
MOR 492 Global Strategy
Introduction: What is Globalization?
23
The Global Economy of the 21stCentury (Continued)
Russia appears to be backing away from amarket economy
Financial crises such as the Asian crisis of1998 spread very quickly across borders,driving economies to recession
Some South American countries seem to bereversing course
MOR 492 Global Strategy
Introduction: What is Globalization?
24
The Globalization Debate:Prosperity or Impoverishment
Pros: Lower prices for goods or services Economic growth resulting in increased
household incomes Job creation from international trade Countries that conduct a lot of trade together
usually don’t go to “war” with each other Promotes cross-cultural understanding
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2005
MOR 492 GLOBAL STRATEGY 5
MOR 492 Global Strategy
Introduction: What is Globalization?
25
The Globalization Debate:Prosperity or Impoverishment (Continued)
Cons: Destroys manufacturing jobs in developed
countries Wages rates of unskilled workers in
developed countries have declined Growing inequality between skilled and
unskilled workers wages
MOR 492 Global Strategy
Introduction: What is Globalization?
26
The Globalization Debate:Prosperity or Impoverishment (Continued)
Cons: Movement of manufacturing facilities of
advanced nations to developing countries exploitation of labor and environmental abuse
in developing countries “fleeing” to avoid perceived burdensome
regulations Economic power and sovereignty is being
challenged by supranational organizations WTO, EU, UN
MOR 492 Global Strategy
Introduction: What is Globalization?
27
Managing in the Global Marketplace International Business and MNCs
Definition of international business Any firm that engages in international trade or
investment Managerial Challenges
Profound and enduring differences incultures, political systems, economicsystems, legal systems,and levels ofeconomic development International business must vary practices
country by country MOR 492 Global Strategy
Introduction: What is Globalization?
28
Managing in the Global Marketplace Strategic Questions
Where in the world to produce to minimizecost and maximize added-value?
How to best coordinate and control theglobally dispersed production activities?
Which foreign to enter and which to avoid? What mode of entry?
Export? License? Joint Venture? Wholly-owned subsidiary?
MOR 492 Global Strategy
Introduction: What is Globalization?
29
Managing in the Global Marketplace Across-border financial transaction
challenges Government restrictions on international
trade and investment Foreign exchange rate movements Restrictions on the repatriation of profits
MOR 492 Global Strategy
Introduction: What is Globalization?
30
Managing in the Global Marketplace Differences between international
business and domestic business1. Countries are different2. The range of problems confronted by a manager in an
international business is wider and the problems aremore complex
3. An international business must find ways to work withinthe limits imposed by government intervention in theinternational trade and investment system
4. International transactions involve converting moneyinto different currencies
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2005
MOR 492 GLOBAL STRATEGY 6
MOR 492 Global Strategy
Introduction: What is Globalization?
31
Who is us?AND
Who is them?
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 1
GSBA 492 Global Strategy
Modes ofGlobal Market
Entry
GSBA 492 Global Strategy
Global Entry Mode
2
OVERVIEW: ENTRY STRATEGIES EXPORT ENTRY
Direct and indirect exporting
CONTRACTUAL ENTRY Licensing/franchising, technical agreements Contract manufacturing, turnkey projects
STRATEGIC ALLIANCES
INVESTMENT ENTRY Wholly owned subsidiaries
GSBA 492 Global Strategy
Global Entry Mode
3
Choice of International Entry ModeDIRECT INVESTMENTTRANSACTIONS
EXPORTING:Spot
Transactions
EXPORTING:with
Long-termcontracts
EXPORTING:with
foreigndistributor/ag
ent
LICENSINGTECHN-OLOGY
and
TRDAE-MARKS
FRANCH-ISING
JOINT VENTURE FULLY OWNEDSUBSIDIARY
Market-ing &Dist’nonly
Fullyinte-
grated
Market-ing &Dist’nonly
Fullyinte-grated
Key Issues:Is the firm’s competitive advantages based upon firm-specific or country-specificresources and capabilitiesIs the product tradable and what are the barriers to/costs of trade?Does the firm possess the full range of resources and capabilities needed toserve the overseas market?
GSBA 492 Global Strategy
EXPORTSTRATEGIES
GSBA 492 Global Strategy
Global Entry Mode
5
EXPORT - APPROACHESDIRECT Firm handles entire export operations itselfINDIRECT Exports using
Manufacturers' export agents
Export commission agents
Export merchants
GSBA 492 Global Strategy
Global Entry Mode
6
EXPORT - ADVANTAGES
Lower per unit cost Economies of scale Better capacity utilization
Overcome domestic market size limitations
Offset market cyclicality Low asset exposure to political risk
Flexibility of switching the geographicaldirection of products
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 2
GSBA 492 Global Strategy
Global Entry Mode
7
EXPORT -- DISADVANTAGES Costs associated with trade barriers Lower control over market Local government objections Transportation costs Costs associated with locating and
maintaining relationships with importer(s) Conflicts-- exporters’ and importers’ goals
GSBA 492 Global Strategy
Global Entry Mode
8
EXPORT -- QUESTIONS
Will there be sustainable competitiveadvantage in export markets? Why?
What exports markets and segments willvalue our products sufficiently?
Standard product with standard marketingmix or tailored products?
What trade barriers impede export? What are the appropriate channels for
distribution?
GSBA 492 Global Strategy
LICENSING
GSBA 492 Global Strategy
Global Entry Mode
10
LICENSING: ADVANTAGES
Extends product life cycle Allows penetration of small markets Helps build goodwill for MNC’s products Limited exposure to political risks Reduces loss due to “piracy” Requires limited resources Quick entry
GSBA 492 Global Strategy
Global Entry Mode
11
LICENSING: DISADVANTAGES Lost control over technology
Difficulty in maintaining quality standards
Government restrictions/ high taxes on royalties
Development of potential competitors
Opportunity costs
Post-agreement costs Protecting industrial property Backup services
GSBA 492 Global Strategy
Global Entry Mode
12
LICENSING PROCESS
Building aworkingpartnershipwithlicensee
Assessingpotentialin targetmarket
Findingsuitablelicensingcandidates
Negotiatinga licensingagreement
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 3
GSBA 492 Global Strategy
Global Entry Mode
13
WHEN IS LICENSING EMPLOYED?
Firm lacks capital, managerial resources orknowledge of foreign markets
Testing and developing a market that can belater exploited by direct investment
Technology involved is not central to thelicensor’s core business
Prospects of “technology feedback” are high Host-country government restricts imports or FDI Licensee unlikely to become a future competitor Pace of technological change is rapid Beamish (1994)
GSBA 492 Global Strategy
CONTRACTMANUFACTURING
GSBA 492 Global Strategy
Global Entry Mode
15
CONTRACT MANUFACTURINGADVANTAGES Limited commitment
of resources Quick entry Avoids ownership
problems Cost reduction Access to technology
DISADVANTAGES Time and effort required
to develop manufacturer Adverse sentiment
domestically Potential loss in
flexibility and control Expense -- negotiating,
maintaining andenforcing contracts
Creation of futurecompetitor
GSBA 492 Global Strategy
Global Entry Mode
16
GLOBAL SOURCING STRATEGY
OUTSOURCING
DOMESTICDomestic purchasing agreement
FOREIGNOffshore outsourcing
GSBA 492 Global Strategy
STRATEGICALLIANCES
GSBA 492 Global Strategy
Global Entry Mode
18
STRATEGIC ALLIANCES• Enable firms to shares risks and resources to expand
into international ventures• Most joint ventures (JVs) involve a foreign company
with a new product or technology and a hostcompany with access to distribution or knowledgeof local customs, norms or politics
• May experience difficulties in merging disparatecultures
• May not understand the strategic intent of partnersor experience divergent goals
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 4
GSBA 492 Global Strategy
Global Entry Mode
19
WHY STRATEGIC ALLIANCES?
TRADITIONAL REASONS Sharing of resources and risks Host government requirements Overcoming strong nationalistic sentiments Quicker entry Benefit from partner’s local knowledge
GSBA 492 Global Strategy
Global Entry Mode
20
WHY STRATEGIC ALLIANCES?EMERGING REASONS Learning from one another Attain global scale economies
Raw material/ Component supply Marketing and distribution
Rising R&D costs and technological interdependence Short product life cycles
Industry convergence
GSBA 492 Global Strategy
Global Entry Mode
21
WHY STRATEGIC ALLIANCES?
Industry Globalization and Global Competition Improved market access
Stronger product line
Superior timing
Shaping competitive rivalry
Keeping key competitors at bay
Reduced transaction and other costs
GSBA 492 Global Strategy
Global Entry Mode
22
RISKS OF STRATEGIC ALLIANCES
Partner opportunism and loss ofcompetitive edge
Strategic and organizational complexity
Conflict of interest problems
Decreasing partner commitment
GSBA 492 Global Strategy
Global Entry Mode
23
MAKING STRATEGIC ALLIANCES WORK
ASSESSING NEED Do you need a partner? How big is the payoff? How likely is success?PARTNER SELECTION Does the partner share your goals and
objectives? Does strategic synergy exist? Is the partner compatible?
GSBA 492 Global Strategy
Global Entry Mode
24
MAKING STRATEGIC ALLIANCES WORKDEFINING GOALS AND OBJECTIVES Clarify and resolve separate interests Develop mutual trust and understanding
DESIGNING AN ALLIANCE Define role of each partner Define venture boundaries Identifying champion(s) Trust versus legal considerations Allow for termination
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 5
GSBA 492 Global Strategy
Global Entry Mode
25
MAKING STRATEGIC ALLIANCES WORK
MANAGING THE ALLIANCE
Achieving operating momentum
Recognize alliance needs Policies
Resources (inc. human resources)
Overcoming reluctance to give up autonomy
GSBA 492 Global Strategy
Global Entry Mode
26
MAKING ALLIANCES WORKMANAGING THE ALLIANCE
Managing cultural differences
Flexibility
Assuring continued commitments
Increasing willingness to learn
Avoiding bottleneck dependence
GSBA 492 Global Strategy
Global Entry Mode
27
STRUCTURING ALLIANCES TOREDUCE OPPORTUNISM
Probability ofOpportunism by Alliance PartnerReduced By
Walling off Critical technology
Establishingcontractualsafeguards
Agreeing to swap valuable skills andtechnologies
Seeking crediblecommitments
GSBA 492 Global Strategy
DIRECTINVESTMENTSTRATEGIES
GSBA 492 Global Strategy
Global Entry Mode
29
FULLY-OWNED SUBSIDIARIES:GREENFIELD INVESTMENTS
ADVANTAGES Total control Lack of partner
commitment not aconcern
Greater learning aboutforeign markets
No loss of technology
DISADVANTAGES Host government objections Large investment required Labor union objections Vulnerability to political risk Time required to establish
competitive advantage
GSBA 492 Global Strategy
Global Entry Mode
30
FULLY-OWNED SUBSIDIARIES:ACQUISITIONS
ADVANTAGES Total control Quick entry
DISADVANTAGES Acquisitions difficult to
evaluate Post-acquisition assimilation
problems Vulnerability to political risk Can be considered as “anti-
social”
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 6
GSBA 492 Global Strategy
GLOBAL MARKETENTRY CHOICES
GSBA 492 Global Strategy
Global Entry Mode
32
ENTRY STRATEGIES
EXPORTING
LICENSING
STRATEGIC ALLIANCES
WHOLLY OWNED SUBSIDIARY
Ownership and control of foreign operations
Limited Medium High
Limited
Medium
High
Level ofInvestmentRisk
GSBA 492 Global Strategy
Global Entry Mode
33
ENTRY STRATEGY: CHOICEEXTERNAL FACTORS Target country environment
Government policies/regulations Economy Socio-cultural factors Institutional voids Political risk
Market factors Size/attractiveness of markets Competitive structure Marketing infrastructure
GSBA 492 Global Strategy
Global Entry Mode
34
RESPONSE TOGOVERNMENTAL BARRIERS
TRADE BARRIERS Tariffs and quotas Domestic content
restrictions Government
procurementrestrictions
BUSINESS RESPONSE Establish manufacturing
operations in country Acquire local firm Subcontract or purchase
locally Develop products jointly Shift to higher-priced
exports (for quotas)
GSBA 492 Global Strategy
Global Entry Mode
35
RESPONSE TOGOVERNMENTAL BARRIERS
INVESTMENT BARRIERS Limits on foreign
ownership Restrictions on
repatriation of earning Fear of expropriation Tax barriers
BUSINESS RESPONSE Enter into a JV Franchising/ licensing
agreements Set up affiliate
relationships with localfirms
Shift high value-addedactivities to low-taxnations
GSBA 492 Global Strategy
Global Entry Mode
36
ENTRY STRATEGY: CHOICEINTERNAL FACTORS Technology and product characteristics
Product factors Pre and post purchase services Technological intensity Minimum efficient scale
Resource and commitment factors Resource availability Willingness to take risks Corporate goals
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization Voigt, Fall, 2002
MOR 492 GLOBAL STRATEGY 7
GSBA 492 Global Strategy
Global Entry Mode
37
CHOICE OFENTRY
STRATEGY
Firm CapabilityFirm Size; Multinational Experience
Industry Factors Industry growth; Global industry
concentration; Technical intensity;Advertising intensity
Location-specific Factors Country risk; Cultural distance;
Market potential; Market Knowledge
Venture-specific Factors Contractual risk; Venture size; Tacit
nature of know-how
Strategic Factors Global strategic motivation; Global
synergy
ENTRY MODESAND DEGREEOF CONTROL
GSBA 492 Global Strategy
Global Entry Mode
38
ENTRY STRATEGY SELECTION• Joint Venture• Contract manufacturing• Exporting
• Joint Venture• Wholly owned subsidiaries
• Licensing• Contract manufacturing• Exporting
• Licensing• Exporting
POLITICAL RISK
Low High
ECONOMICOPPORTUNITY
Low
High
GSBA 492 Global Strategy
Global Entry Mode
39
ENTRY STRATEGY SELECTION
POLITICAL RISK
HighLow
RISK OF HOLD-UPBY TRADINGPARTNER
Low
High Wholly OwnedSubsidiary
MarketTransaction
ExportDelay EntryGet Creative
Joint Venture/Strategic Alliance
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 1
MOR 492 Global Strategy 1
The Global Organization andManagement Challenge:
Organizational Design,Coordination, and Control
MOR 492 Global Strategy 2
OVERVIEW
Control: Essence of Implementation
Global Managers
Organization Design
Organization Systems
Organization Culture
MOR 492 Global Strategy 3
Global Managers The Business Manager (Global scale & competitiveness)
Strategist+Architect+Coordinator The Country Manager (Local responsiveness & flexibility)
Sensor+Builder+Contributor The Functional Manager (Linking functions worldwide)
Scanner+Cross-Pollinator+Champion The Corporate Manager (Transnational mission)
Leader+Talent Scout+Developer
MOR 492 Global Strategy 4
Four Basic Global Strategies
Importance of Local Responsiveness
Efficiency,Global Scale,Low Cost,GlobalIntegration
GLOBAL
INTERNA-TIONAL
TRANS-NATIONAL
MULTI-DOMESTIC
High
High
LowLowEXPORT
-ING
MOR 492 Global Strategy 5
Four Basic Global Organizational Designs
Importance of Local Responsiveness
Efficiency,Global Scale,Low Cost,GlobalIntegration
CENTRALIZEDGLOBAL
BUSINESSUNITS
INTERNA-TIONAL
FUNCTIONAL
GLOBALNETWORKS
DECENTRAL-IZED
AREA-FOCUSED
High
High
LowLowEXPORT
-INGMOR 492 Global Strategy 6
Aligning Managers Responsibility and Decision-makingDiscretion with Organizational Arrangements
Importance of Local Responsiveness
Efficiency,Global Scale,Low Cost,GlobalIntegration
GBU ManagerDominant
InternationalFunctionalManagerDominant
NetworkedTeam
Country ManagerDominant
High
High
LowLowEXPORT
-ING
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 2
MOR 492 Global Strategy 7
Successful Multinational Execution Important but not sufficient – Formal Control
Mechanisms Incentives, compensation, monitoring systems, rewards &
punishments Due Process in Global Strategic Decision-making
Head office is familiar with subsidiaries local situation Two-way communication exists in the global strategy-making
process Head office is relatively consistent in making decisions across
subsidiaries Subsidiary units can legitimately challenge HQ views and
decisions Subsidiary units receive an explanation for final strategic
decisionsMOR 492 Global Strategy 8
Global Strategy Prescriptions Locate each value-added activity in the country that has
the least cost for the factor that activity uses mostintensely
Dexterously shift capital and resources across nationalmarkets, cross-subsidizing global units
Institutionalize fully standardized product offerings,marketing approaches, and commonly used distributionsystems worldwide to allow maximum global efficiencies
Consciously consolidate worldwide knowledge,technology, marketing and production skills to buildreservoirs of distinctive core competencies that can actas engines for continuous new business development,innovation and enhanced customer value
MOR 492 Global Strategy 9
How do you execute them? Increasing sacrifice of subsystem for system
priorities and considerations Swift actions in a globally coordinated manner Effective and efficient exchange relations
among the nodes of the multinational’s globalnetwork
Multinational enterprises need subsidiarymanagers with a sense of commitment, trustand social harmony
- compulsory vs. voluntary executionMOR 492 Global Strategy 10
CONTROLIMPEDIMENTS Historical evolution of headquarters-
subsidiary relationship HQ managers may lack understanding
of skills and limitations involved inoperating in dissimilar environments
Presence of JV partners Host governments like to influence
strategy at subsidiary level
MOR 492 Global Strategy 11
ORGANIZATION STRUCTURE
International
Worldwide Area
Global Product Division
Matrix
Network
NameTitle
NameTitle
NameTitle
NameTitle
NameTitle
NameTitle
MOR 492 Global Strategy 12
EXPORT ORGANIZATIONDisadvantages
Export manager may have insufficient clout
Export orders may receive low priority
Domestically oriented organization notsupportive of foreign market requirements
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 3
MOR 492 Global Strategy 13
TRADITIONAL SOLUTION:STRUCTURAL MERRY-GO-ROUND
InternationalDivision
AreaDivision
WorldwideProductDivision
FOREIGN PRODUCTDIVERSITY
FOREIGN SALES ASPERCENTAGE OF TOTAL SALES
GlobalMatrix
MOR 492 Global Strategy 14
INTERNATIONAL DIVISIONCEO/
PRESIDENT
DOMESTICDIVISION
B
DOMESTICDIVISION
A
DOMESTICDIVISION
C
INTERNATIONALDIVISION
Germany Japan Brazil
MOR 492 Global Strategy 15
INTERNATIONAL DIVISION
· Focus oninternationalopportunities· Greater “weight”
in hierarchy· Establishment of
formal controlprocedures
· International-domestic split· Domestic
divisions exertgreater power· Manager needs to
understandproduct marketstrategies of alldivisions
ADVANTAGES DISADVANTAGES
MOR 492 Global Strategy 16
WORLDWIDE AREACEO/
PRESIDENT
EuropeNorth
AmericaSouth
America Asia
CountryManager: U.S.
Canada
Germany
Spain
Brazil
Argentina
India
Japan
MOR 492 Global Strategy 17
WORLDWIDE AREA
· Local sensitivity· More efficient
use of resourceswithin country· Motivated
countrymanagers
· Countryconsiderationsdominate over global· Country managers
may not haveadequate knowledgeof all products· Duplication at HQ
ADVANTAGES DISADVANTAGES
MOR 492 Global Strategy 18
WORLDWIDE PRODUCT DIVISIONCEO/
PRESIDENT
Product Division B
Product Division A
Product Division C
Product Division D
Area ProductManager: U.S.
Area ProductManager: Japan
Area ProductManager: U.S.
Area ProductManager: Japan
Area ProductManager: U.S.
Area ProductManager: Japan
Area ProductManager: U.S.
Area ProductManager: Japan
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 4
MOR 492 Global Strategy 19
WORLDWIDE PRODUCT DIVISION
· Bettercoordinationwithin productgroups· Global view of
competition· Facilitates
technologytransfer acrosscountry border
· Duplication atcountry level· Coordination across
product groups· Less subsidiary
initiative
ADVANTAGES DISADVANTAGES
MOR 492 Global Strategy 20
PORTFOLIO- WORDWIDEBUSINESS MANAGER
WorldwideBusinessManager
Country 1
Country 2 Country
3
Country 4
Country 5
MOR 492 Global Strategy 21
PORTFOLIO- COUNTRYMANAGER
CountryManager
Business 1
Business 2 Business
3
Business4
Business 5
MOR 492 Global Strategy 22
GLOBAL MATRIXCEO/
PRESIDENT
Product Division A
ProductDivision B
Product Division C
Subs. Mgr.Japan
Subs. Mgr.Germany
Manager A Manager B Manager C
MOR 492 Global Strategy 23
GLOBAL MATRIX
· Combinespositives ofproduct andarea structures· May be
suitable fortransnationalstrategies
· Dual reporting cancause confusion· Slow decision
making· Requires high
horizontal andverticalcoordination
ADVANTAGES DISADVANTAGES
MOR 492 Global Strategy 24
ORGANIZATIONAL IMPLICATIONS:THE INTEGRATED NETWORK
DECENTRALIZEDFEDERATION
THE INTEGRATED NETWORK
COORDINATED FEDERATION
CENTRALIZEDHUB
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 5
MOR 492 Global Strategy 25
NETWORKBusinessmanager
Businessmanager
Businessmanager
CorporateManagement
Businessmanager
Businessmanager
Businessmanager
MOR 492 Global Strategy
TRANSNATIONAL MANAGEMENT
BUILDING AND MANAGING THETRANSNATIONAL
MOR 492 Global Strategy 27
STRATEGIC CAPABILITY OF THE TRANSNATIONAL:The New Multi-layered Game
Sensitivity, flexibility, and responsivenessto local needs
Global scale efficiency and competitiveresponse capability
Worldwide innovation skills and learningcapabilities
MOR 492 Global Strategy 28
Developing Transnational Organization
Building an organization - More than Installing a Structure
Requires an integrated approach - Building the Transnational Anatomy - Shaping the Transnational Physiology - Moulding the Transnational Psychology
MOR 492 Global Strategy 29
BUILDING AND MANAGING THE TRANSNATIONAL:A Biological Metaphor
A new structural anatomy* Redistributing assets and responsibilities
A new process physiology* Redefining information flows and relationships
A new cultural psychology* Readjusting mentalities and beliefs
MOR 492 Global Strategy 30
Building and Managing the Transnational
- Don’t manage like the United Nations: Differentiate roles and responsibilities
- Don’t let a single perspective dominate: Legitimize business, area and functional
management
- Don’t search for a standard coordination process: Develop and apply different tools to different tasks
- Focus beyond structure and systems: Build a matrix in managers’ minds
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 6
MOR 492 Global Strategy 31
The New Organizational Roles andResponsibilities
ConsumerElectronics
Production
Phillips
Matsushita
GE
Medical
Telecom
Lighting
ResearchPurchasing
Development
Marketing
SalesService
TaiwanSingapore
UK
France
Australia
Brazil
India
Company Business Function Geography
MOR 492 Global Strategy 32
Building and Maintaining Multiple Strategic CapabilitiesRequire Protecting the Legitimacy of Multiple Management Tasks
BUSINESS MANAGEMENT
AREAMANAGEMENT
FUNCTIONAL MANAGEMENT NATIONAL
RESPONSIVENESS
WORLDWIDEINNOVATION AND
LEARNIING
GLOBALEFFICIENCY
MOR 492 Global Strategy 33
Building and Balancing MultipleOrganizational Perspectives
- Build legitimacy and credibility of nondominant groups: Coopt specific individuals Provided required mandate- Provide access to information channels Modify existing channels Create new channels- Create influence in decision processes Use micro-structural tools Use both visible and invisible hands- Maintain balance over time Manage ambiguity and flux Develop fit and flexibility
MOR 492 Global Strategy 34
Transnational CoordinateMechanisms
- Intense cross-border flows - Goods: Materials, components, products - Resources: Financial, human - Knowledge: Technology, expertise, Intelligence
- Administrative heritage influences coordination - Centralization in Japanese centralized hubs - Formalization in American coordinated federations - Socialization in European decentralized federations
MOR 492 Global Strategy 35
Transnational Coordination MechanismsPortfolio of tools, selectively applied - Goods flows: Formalized coordination - Resource flows: Centralized coordination - Knowledge flows: Socialized coordination
With flexibility to match roles and tasks
- Leaders and black holes: Socialization dominates - Contributors: Centralization dominates - Implementers: Formalization dominates
MOR 492 Global Strategy 36
Traditional Solution: Structural Merry-Go-Round
Structure and systems- Blunt instrument of change
- Deny, oversimplify or compartmentalize complexity
- Reinforce parochial, hierarchical, adversarial mentality
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Fall, 2004
MOR 492 GLOBAL STRATEGY 7
MOR 492 Global Strategy 37
CHANGING ATTITUDES AND BEHAVIORS:The Foundation Stone of Change
Developing shared values and purpose * Clarity, Continuity, Consistency
Building multi-dimensional perspectives, capabilities * Expand career paths, assignments, education
Helping the organization embrace, not deny,complexity
* “Create a matrix in managers’ minds”
MOR 492 Global Strategy 38
INSTALLING THE TRANSNATIONALSTRUCTURE LIMITS OF TRADITIONAL
CHANGE MODELS
•Classic change process driven by structural reconfiguration
Assumptions of change model:
Change in formal structure/responsibilitiesreshapes
redefines
Organizational processes/relationships
Individuals attitude/mentalities
MOR 492 Global Strategy 39
BUILDING THE TRANSNATIONAL ORGANIZATION:The Alternative Approach
• Recognizes structures as a blunt instrument of change
* Simultaneous changes organization's anatomy, Physiology, psychology
Modify individual attitudes/mentalities (Psychology)
Develop new processes/relationships (Physiology)
Confirm with redefined structures/responsibilities (Anatomy)
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Term Iv, 2006
GSBA 519b Corporate & Global Strategy 1
MOR 492 Global Strategy
WBMH FrameworkAn Overview Framework for
Global Strategy Analysis
MOR 492 Global Strategy
WBMH Framework
2
The “Radio” Model Framework
W Why go global? What is the motivation,goals, intended end outcomes?
B What does the firm bring (and what will“travel”) to the global market opportunity?
H How should the firm enter the globalmarket? How should it organize itself?
M What will/should/can the firm expect tomeet when it goes global?
Source: WBMH is bui l t on idea from Porter
MOR 492 Global Strategy
WBMH Framework
3
Motivations/Imperativesfor “Becoming” Global
Growth Imperative: pursuing new sources ofvolume by finding “Q” in new global markets “Replication” of existing business model in new
locationEfficiency Imperative:
pursuing low cost raw materials, labor, etc. “Arbitrage” is using involved in some way
economies of scale and scope Minimum efficient scale may be bigger than any single
market reducing distribution costs, inventory costs, etc
Why?
MOR 492 Global Strategy
WBMH Framework
4
Motivations/Imperatives (Continued)
Knowledge Imperative: continuous learning markets change, consumer’s tastes and needs change, competitors innovate and adapt, technology “jumps”
Globalization of Customers: when customersstart to go global, firms must keep pace with themor lose overseas and domestic business to newrivals
Globalization of Competitors: Rivals may capture global first mover advantages Rival may be able to use multi-market presence to
cross-subsidize an attack on a firm’s home market
Why?
MOR 492 Global Strategy
WBMH Framework
5
Transferring Competitive Advantages, CoreCompetencies and Capabilities across Borders
What “travels” from a firm’s strategy(business model) to the new global market?
What can the firm “take” with it? What can the firm replicate in the local market? What can the firm adapt to the local market? What resources and skills will not travel?Asking and answering the “Taco Stand” question iscritical to determining what the firm can “bring” global
Bring?
MOR 492 Global Strategy
WBMH Framework
6
Global “Generic” Strategies Source of Global Strategies are in two
areas: Arbitrage Replication Transformation (third area which combines first two)
Bring?
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Term Iv, 2006
GSBA 519b Corporate & Global Strategy 2
MOR 492 Global Strategy
WBMH Framework
7
Bases for Global Advantage
NationalDifferences
Economiesof Scale
EconomiesofReplication
Economiesof Scope
GlobalLearning
GlobalFlexibility
Non-MarketStrategies
© Voigt, Mayer & Liebeskind, 2006
Bring?
MOR 492 Global Strategy
WBMH Framework
8
Analyzing the Global Market:What will the firm meet?
Regional Analysis
Country Analysis
Industry Analysis
Industrial Sector Competitiveness Analysis
Market Potential Analysis
Competitor Analysis
FeasibilityAnalysis
ProfitabilityAnalysis
Meet?
MOR 492 Global Strategy
WBMH Framework
9
Country Analysis Global Economics of Region Macroeconomic Policies
Political Agenda Fiscal & Monetary Policies Policies toward foreign investments & control
Political Risk Analysis Institutional Voids Analysis
Meet?
MOR 492 Global Strategy
WBMH Framework
10
Global Competitiveness Relative competitiveness of “Country” Relative competitiveness of “Industries” Use Porter’s Diamond of Global Competitive
Advantage
Also important to examine sources leading to“un”competitiveness of country or industry
Meet?
MOR 492 Global Strategy
WBMH Framework
11
Firm Strategy, Structure, and
Rivalry
Factor Conditions
Demand Conditions
Related and Supporting Industries
Source: Porter (1990)
Government
Chance
Diamond of Global CompetitivenessMeet?
MOR 492 Global Strategy
WBMH Framework
12
Examining Relevant “Distances”
CAGE Framework (Ghemawat) Cultural Distance Administrative Distance Geographic Distance Economic Distance
Global strategy must exploit/mitigate relative“distance” between the firm and the global market
Meet?
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Term Iv, 2006
GSBA 519b Corporate & Global Strategy 3
MOR 492 Global Strategy
WBMH Framework
13
“How” to Become Global? Choice of Global Strategy Choice of Entry Mode Choice of Organizational Structure
How?
MOR 492 Global Strategy
WBMH Framework
14
Four Basic Global Strategies
Importance of Local Responsiveness
Efficiency,Global Scale,Low Cost,GlobalIntegration
GLOBAL
INTERNA-TIONAL
TRANS-NATIONAL
MULTI-DOMESTIC
High
High
LowLowEXPORT
-ING
How?
MOR 492 Global Strategy
WBMH Framework
15
Choice of International Entry ModeDIRECT INVESTMENTTRANSACTIONS
EXPORTING:Spot
Transactions
EXPORTING:with
Long-termcontracts
EXPORTING:with
foreigndistributor/ag
ent
LICENSINGTECHN-OLOGY
and
TRDAE-MARKS
FRANCH-ISING
JOINT VENTURE FULLY OWNEDSUBSIDIARY
Market-ing &Dist’nonly
Fullyinte-
grated
Market-ing &Dist’nonly
Fullyinte-grated
Key Issues:Is the firm’s competitive advantages based upon firm-specific or country-specificresources and capabilitiesIs the product tradable and what are the barriers to/costs of trade?Does the firm possess the full range of resources and capabilities needed toserve the overseas market?
How?
MOR 492 Global Strategy
WBMH Framework
16
Traditional Solution:Structural “Merry-go-round”
InternationalDivision
AreaDivision
WorldwideProductDivision
FOREIGN PRODUCTDIVERSITY
FOREIGN SALES ASPERCENTAGE OF TOTAL SALES
GlobalMatrix
How?
MOR 492 Global Strategy
WBMH Framework
17
International DivisionCEO/
PRESIDENT
DOMESTICDIVISION
B
DOMESTICDIVISION
A
DOMESTICDIVISION
C
INTERNATIONALDIVISION
Germany Japan Brazil
How?
MOR 492 Global Strategy
WBMH Framework
18
Worldwide AreaCEO/
PRESIDENT
EuropeNorth
AmericaSouth
America Asia
CountryManager: U.S.
Canada
Germany
Spain
Brazil
Argentina
India
Japan
How?
Keith Parker, University of Southern California
MOR-492: Powerpoints
Marshall School of BusinessDepartment of Management and Organization
Voigt, Term Iv, 2006
GSBA 519b Corporate & Global Strategy 4
MOR 492 Global Strategy
WBMH Framework
19
Worldwide Product DivisionCEO/
PRESIDENT
Product Division B
Product Division A
Product Division C
Product Division D
Area ProductManager: U.S.
Area ProductManager: Japan
Area ProductManager: U.S.
Area ProductManager: Japan
Area ProductManager: U.S.
Area ProductManager: Japan
Area ProductManager: U.S.
Area ProductManager: Japan
How?
MOR 492 Global Strategy
WBMH Framework
20
Global MatrixCEO/
PRESIDENT
Product Division A
ProductDivision B
Product Division C
Subs. Mgr.Japan
Subs. Mgr.Germany
Manager A Manager B Manager C
How?
MOR 492 Global Strategy
WBMH Framework
21
NetworkBusinessmanager
Businessmanager
Businessmanager
CorporateManagement
Businessmanager
Businessmanager
Businessmanager
How?
MOR 492 Global Strategy
WBMH Framework
22
Organizational Implications:The Integrated Network
DECENTRALIZEDFEDERATION
THE INTEGRATED NETWORK
COORDINATED FEDERATION
CENTRALIZEDHUB
How?
Keith Parker, University of Southern California
MOR-492: Powerpoints