1.2 WHAT IS BUSINESS STRATEGY?

Business strategy allows a firm to outperform in a line of business which is a subset of the
firm that competes in a given industry.
An industry is a set of competitors that offer closely substitutable products and services to
address similar client needs. Some company specialize in one business online. E.g Raynair
only competes in airplane and therefore it should only specialize in one business line. Danone
instead has different business line in which needs to create different business strategies.
Its purpose it to discover how a company can create a competitive advantage in order to

How is competitive advantage is created?

Developing a competitive advantage requires consistency between functional policies
such as:
- Marketing
- R&D
- Manufacturing
- Finance
- HR
Business strategy must therefore ensure that decisions made in each of these areas are
consistent with each other.
E.g.: Ford
model, low cost, low prices) and Rolls-Royce consistency (personalized models, high cost, high
prices).
E.g.: Ryanair case:
- One type of airplane only
- Secondary airports
- No free meals
- Minimal leg room
- No free luggage
- Multi-tasking underpaid staff
Business Strategy should also define which competitive advantage each company should
follow. E.g.: Ford offers reliable and affordable cars whereas Rolls Royce offers the best
money can buy.
Business Strategy:
- Is always measured against competition within a given industry and is only as good
as the progress that competitors can make to outcompete the firm implementing it
> It should be assessed in relative terms
- Is inevitably transient
There is no best strategy, it should constantly be reinvented.

4
1.3 BUSINESS STRATEGY FRAMEWORK
A competitive advantage must inevitably result in the firm being able to charge a higher price
or incur lower costs or both than its competitors. The competitive advantage is the gap a firm
creates between the total costs incurred and the willingness to pay it can elicit in its customers.
A competitive advantage is specific to a given industry or business.
E.g.:
- Designer shoes: style, fashion, prestige, snob appeal are critical components of
any successful strategy.
- Coal mining: extraction costs and transportation are the key to success.
To create a competitive advantage is necessary to understand the impact of industry features
on competitive advantage. Business Strategy Framework has three pillars:
1. Analysing the structure of the industry: because industry structure is similar to all

competitors, competitive advantage must arise from the specific choices of the
company within the general Industry context that all competitors are facing.
2. All these choices together create what we call Strategy Business Model which is the
second pil
have the same strategy. E.G Firms with significant financial resources will be able to
make choice that are out of reach for smaller companies. Because of this it is necessary
to do and,
its sources and compatibility is a very critical component. Another critical question is
why if a firm can adopt a successful strategy, competitors cannot choose the same
strategy as well? Indeed, easily imitation of strategy by competitors will provide the
firm with a short- term competitive advantage or leave the firm in a worst position.
3. Analysis of the competitive dynamics
understand and anticipate the actions of our competitors and more generally to
understand which decisions come in our business.
This three are the main pillars in which the firm can create a sustainable competitive advantage
in a particular line of business.

5
 1.4 SWOT FRAMEWORK

Objective
strategy.
The main advantage is how simple it is, and it forces us to distinguish between:
- Opportunities and Threats
(which was later developed in the 5 forces model)
-Internal factors feature present in the firm itself: Strengths and Weaknesses (Later developed
in the resource-based view of the firm)
E.g., HEC Paris
Limitations:
- Very little structure and guidelines as to how external factors should be classified
as either opportunities or threats or as to how internal factors should be seen as
either strengths or weaknesses.
- Relevance of factors to be assessed by analyst
- Casual relationships to be explicated
- It should be applied to the business or corporate level?
- Not very adequate for highly diversified companies
However, SWOT framework is useful to sit through, classify and organise the relevant
information on a company strategy and performance. At the same time, it has to be
complemented by other framework and tools.
1.5 STRATEGY TIMELINE

o No strategy courses.
o Some overall courses related to business policies.

o Corporate Strategy by Igor Ansoff: tools and concepts to make good decisions.
Coined the term strategy and created strategy as a different subject.
o Professors Learned, Christensen, Andrews and Guth (LCAG model) emphasized
the difference between the assessment of external environment and Internal
capabilities.
o Strategy and Structure by Alfred D Chandler Jr commented on the divisional
strategy, distinguishing corporate strategy from business strategy and focused on

6
 strategy implementation as opposed to strategy formulation. Organizational
structure as a critical element.

o BCG Experience Curve: formalized and rigorous approach to strategy

formulation. - BCG Business portfolio matrix
o These approaches were somewhat mechanistic and deterministic.

o Michael Porter: he believed that business strategy should be formulated in response

to particular industry features. He developed the 5 Forces which allowed the
industry to be analysed in its specificities.
o BCG - Industry Types Framework which classifies all industries in 4 categories,
each one require the implementation of a proper strategies. In general all of these
decisions have to be taken into account considering the industry. Implicitly all
firms competing in the same industry are similar, almost interchangeable.
o Firm resources (Wernerfelt, Rumelt, Barney): what makes a firm different from
the others? the set of assets, skills, capabilities and more generally resources that it
can deploy to pursue its objectives - Resource-based view of the firm What
drives the main difference between industry is their Corporate Culture (Peters &
Waterman): In search of Excellence.

o Built to last (Collins, Porras) Reaction than emphasized implementation over

formulation
o The quest for value: how does strategy foster value creation?

o Focus on innovation: a, Blue Ocean Strategy

1.6 A STRATEGY TIMELINE 2
eterministic view, Michael Porter proposed that business strategy should
be developed considering certain industry features, creating the 5 FORCES MODEL which
allows to analyse industry structures and apply appropriate business strategy.
Later, BCG responded with the Industry-Types-framework, which classifies all industries in 4
categories (fragmented, volume driven, differentiated, stalemate), with each category requiring
1 strategy.

7
All these discussions are focused on the external environment (industry). Implicitly, all firms
competing in an industry are similar -BASED view of
the firm What makes a Co unique is its OWN set of resources, assets, capabilities.
Environmental differences have a smaller influence compared to its peculiarities.

Several different views on the business strategy were making stuff confusing.

important).

finance and strategy closer.

.

2 INDUSTRY ANALYSIS

2.1 WHY DOES INDUSTRY MATTER?

Why do some firms outperform others?
Business or industry in which the firm has chosen to compete. This is often
underestimate!
Choices the firm makes and its strategy influence in its performance
Why do we underestimate it?

allocate between industries until all of them are equally profitable on average. This continuous
adjustments in the industry should make the industry profit like what it is its cost of capital. In
other words, economic profit would tend to 0 and no industry would destroy or create much
value, but that is not the case in the real world. Some industries show much higher and sustained
profitability (cosmetics, pharmaceuticals, soft drinks) than others (airlines, steel). Industries
are not equally profitable.
It is critical for any given company when formulating its strategy to analyse the features of the
industry in which it operates, especially those that drive profit. For example, a company should
for its industry:
Anticipate how tough competition will be in the industry and how is or difficult it would
be to make a profit
Design a strategy that considers the essential features of the industry that effects its overall
profitability
The drivers of profitability
Businesses with products involving:

8
 o Subsequent spare parts.
o Subsequent services.
o Complementary products.
o E.g.: Razor blade industry (Gillete, Wilkinson): the profit resides in the blades. -
E.g., Printers: the profit resides in the ink cartridges.
o E.g., Elevator manufacturers: the profit resides in the maintenance contracts
This example demonstrate how firms can implement strategies to leverage the
favourable features of their business to minimize its negative attributes. Products that
require subsequent spare parts, service, or complementary products then to be much
more profitable with all the other things equal. This business is called Razor blade
businesses.
Price as driver of competition: less profitable industries. The more customers focus only
on price when choosing a product, it will be more difficult to create it.
Average price level: usually industries with low-price products (soft drinks) tend to be
more profitable than those with high-price products (airlines). Because people pay much
more attention when they are buying an airplane tickets instead of a soft strong.
Bargaining powers of suppliers and buyers: e.g., packaged food manufacturers vs. big
distributors. Supermarket chain are able to squeeze their supplier margin and increase
their own profit.
Anticipating industry profitability requires understanding industry structure.
Any firm should be prepared for any changes in the industry that might deteriorate the
profitability of the business. When things are going well often managers tend to say that it is
because of its strategy, meanwhile when things are going worst then they blame it.
Frameworks used to analyse the structure of the industry:
Pestel Framework predicts industry trends and profitability
5 forces model: systematically analyse the structure of the industry
The 4 industry types by BCG: understand industry structure for anticipating industry
profitability
2.2 THE FIVE FORCE MODEL
Antitrust agencies identify factors that stifle competition and make some industry abnormally
profitable. Porter flipped the logic around by relying on the same factors to help managers to
better understand which are the factors that give a negative impact on the profitability of the
business.

9
 The 5F model must be adapted and extended to map the specific features of any given industry.
CLASSIC EXAMPLE: The Book-publishing industry
Not one, but two businesses:
Concentrate producers: very high profitability
Bottlers: normal profitability
1. This industry is actually profitable, the book-publishing industry is divided in three
businesses, printing, publishing and wholesaling (which is the most profitable).
2. Suppliers: Authors sells the books for royalties, and also with printing the bargaining
power of suppliers is quite low.
3. Buyers: Bookstores store a huge number of books, instead of buying directly to authors,
they rely on wholesalers, so their bargaining power v. wholesalers is low.
4. Substitutes
eBooks remain relatively expensive, because of the agreement between the industry and
the regulations from the government.
5. New entrants: Entry barriers are quite low; however, the problem is the need of
wholesalers, which are usually linked to publishers.
The model should only use to explain how the industry works, and not to develop a
strategy.
2.3 INTENSITY OF COMPETITION
Intensity of competition is influenced by:
1. Distribution of market shares Fragmented markets show more intense competition (due
to the ongoing struggle for leadership) while businesses in which there is a clear competitor
hierarchy show little aggressive behaviour.
2. Slow industry growth: Competitors want to gain market share, and therefore end up having
lower profitability, which is not something happening with quick growing industries.
3. High fixed costs or storage costs: the lower the level of variable costs, the more firms can
engage in aggressive price cutting. In industries with high fixed costs, the pursuit of greater
volumes leads to more aggressive price wars.
4. Limited differentiation: when products are similar, there is a competition for price and
profitability is not really high. Higher differentiation tends also to deliver more customer
loyalty.
5. Low Switching costs: when there are high costs of customer switching costs, customers
are less sensitive to price, and so the profitability can be higher.

10
 6. Capacity augmented in large increments
7. Diverse competitors
8. High strategic stakes
9. High barriers to exit
All these factors interact to determine the level of competition in the industry.
2.4 NEW ENTRANTS & SUBTITUTES

dramatically (i.e., Flight ticket vs high speed trains). There are 6 main barriers that make entry
into the industry more difficult, but if these are low then entry is easier:
Limited economies of scale: new entrants do not suffer disadvantages with respect to
enter,
Lack of product differentiation: if products are highly differentiated, it is hard for new

easy substitutes,
Capital requirements: if low needs, many tempted to enter,
Low switching costs: will push new competitors to enter the industry,
Easy access to distribution channels: one of the toughest to overcome (i.e., Internet
channels have made it easier to reach customers),
Limited impact of experience: entry is difficult if experience is much important
2.5 SUPLIERS AND BUYERS
Buyers
When the buyers have significant bargaining power, they can drive prices down and limit
profitability. 7 main factors drive greater bargaining power:

discounts

is small, then the supplier can be more profitable (i.e., Buyer has lower bargaining power,
since it will not have the time to bargain with suppliers that account for a smaller part of
its total costs)
Standardization: very standardized products lead buyers to have more power,
Impact of the quality of the indust
buyer has more power (These last two relate to Switching costs: Airline industry by
assigning miles-
then less sensitive to prices, and this made the industry overall more profitable)
The buyer industry earns low profits: The buyer group earns low profits, is strapped for
cash, or is otherwise under pressure to trim its purchasing costs. Highly profitable or cash-
rich customers, in contrast, are generally less price sensitive (that is, of course, if the item
does not represent a large fraction of their costs)
The buyer industry can credibly threaten to backward integrate: Buyers can credibly

are too profitable. Producers of soft drinks and beer have long controlled the power of

11
 packaging manufacturers by threatening to make, and at times making, packaging
materials themselves.
.
Suppliers

1. The supplier industry is dominated by a few firms and is more concentrated than the focal
industry.
2. The industry is only a marginal customer of the supplier industry.
3.
4. highly differentiated.
5. The suppliers can credibly threaten to forward integrate.

2.6 THE INDUSTRY TYPES FRAMEWORK (BCG)

Differentiation of products (i.e., Steel, differentiation is very limited)

Size and extent of competitive advantage firms can create in some industries it is long
lasting.
Based on these 2 features, BCG identified 4 types of industries:
Stalemate industries: competition is primarily based on price, while similar costs for all
competitors. Profitability is very hard to meet (i.e., Oil refineries)
Volume driven industries: the advantage comes from costs, through economies of scale. Few
competitors have managed to capture a large market share. (i.e., Amazon)
Differentiated industries: large differentiation that leads to large competitive advantage.
Multiple specialized competitors can enjoy large profits in their own niche! (i.e., Wine
businesses, tech businesses, healthcare).
Fragmented industries: large differentiation, but it is easily imitated, and it will not reap infinite
profits. Competitors need to keep flexible and re-invent themselves continuously.
Understanding your type of industry is critical to identify a successful strategy.

12
I.e., If you try to scale-up volume to compete on costs and prices in a fragmented industry
fail products are changing quickly and new products are easily imitated.

2.7 PESTLE
All firms are embedded in an environment, which impacts their performance. For example, an
aging population limits growth in some businesses while fosters others. Or rules and
regulations also impact some businesses.
To make sense of this broad environment and analyse its influence on performance, we can use
t
Political environment: tax and fiscal policies in the country in which firm operates
Economic environment: inflation, growth, interest rates, consumption patterns, and
saving rates
Social environment: demographics, social level, attitudes towards equality
Technological environment: intellectual property rights, patent laws, existence of top
universities in the country with ties to the industry (MIT).
PEST was expanded into PEST + LE to include:
Legal environment: antitrust laws, accounting norms, financial regulations
Environmental environment: concern for natural environment
Both frameworks provide checklists of issues to consider when making strategic moves.
However, not specifies which factors are more important: up to us to understand which are.
Also, not clearly categorizes some categories and some issues may belong to more than one of
the domains. Finally, the list is not exhaustive.
It serves as a reminder that external factors impact the performance of the industry and thus of
the firms! PESTLE factors do influence supply and demand in the industry, cost of capital for
the firm. Focusing on changes in these domains can help to identify needed adaptations to the

13
 3 COMPETITIVE ADVANTAGE

3.1 DIFFERENTIATION
Consists in building an offer that cannot be compared directly
To achieve it, a firm must build a product with unique attributes,
increasing so the WTP of customers for such product and to decrease competition and then charge
a premium price. -
lasting competitive advantage (CA).
For CA to be sustainable, the unique attributes must meet 3 critical conditions:
1. Clearly perceived and highly valued by many customers: for example
understand the attributes of headphones costing 500 compared to 50. In contrast, the brand
Even when an object
has value, customers need to value the attribute enough to be willing to pay for it.
2. Be proprietary and hard to imitate: If competitors can easily copy, the firm initially
introducing it will not be able to reap the benefits. Ex, Apple was the first to introduce the
touchscreens, but now this feature is common to everybody. Now, Apple primarily
differentiates its products through brand and operating system. These two attributes are much
more difficult to copy than an entire product. Differentiation based on technology is more
difficult to sustain over time, instead of other type based on brandings or design.
3. Economically viable: differentiation leads to a premium price, which restricts the market
potential of the offer when compared with more standard offers, thus it limits the chance of
exploiting economies of scale. The premium prices must therefore cover not only the
additional cost incurred in setting up the unique feature, but also this is more limited for
economies of scale. Ex, Apple Operating System costs 1 or 2 bn, and on a per-computer basis
OS. So, enough people must be willing to pay
for it to offset the extra costs of OS. If Apple market share fell, Apple would need to raise price
and so sell probably even less and so exploit even less economies of scale.
Managers need to be aware that not all industries offer same opportunities for differentiation.
Commodities industries do not offer much, but luxury business does for example.
3.2 Cost Leadership
These strategies build on the idea that a firm with lower costs than its competitors will generate
greater profits if it sells at the market price. It can also choose to undercut their competitors (by
reducing their price), gain market share and eventually dominate the market, while being
profitable.
Cost leadership strategies can be adopted when customers are price sensitive and not sensitive to
differentiation. Thus, these strategies are particularly well suited to commodity type industries.
They usually build on economies of scale (and thus require a considerable market share) and
strong experience effects.

14
In these industries, implementing a cost leadership strategy will result in lower costs, making it
possible to charge lower prices, gain market share and volume and thus benefiting from even
greater scale economies.
As a result of these dynamics, cost leadership strategies are generally implemented by the
dominant competitors in the industry.
But beware: low costs do not necessarily result from economies of scale, high volumes,
and large market shares. It might be more effective to be selective with your offerings. E.g.
Ryanair, Southwest Airlines.
3.3 THE EXPERIENCE CURVE
One of the most famous field in strategy, introduced by Bruce Henderson (founder of BCG) in
late 1960s. It builds on the learning curve that was built by department of defence of US in 1930s,
when monitoring the cost incurred by military equipment suppliers. They realized that the time to
produce one aircraft fell dramatically the more aircrafts were produced.

The experienced curve also adds the spreading of fixed costs over a larger volume of units, and
process innovation. It shows that in most industries, the total unit costs of products decrease by a
constant % (10-30%) each time the cumulated output of that product doubles. The experience is
industry specific, and it is higher in electronics and aircraft manufacturing, but limited in services
industry like banking or airlines.
It is a curve when drawn on a decimal scale but becomes a straight line when drawn on a
logarithmic scale.

In this ex

15
 The formula (It links levels of cumulated output to total unit cost):

Strategy implication of the experience curve:

If costs decline rapidly as cumulated output and experience increase, firm will grow rapidly and
gain market share, reducing further costs firms will reduce prices and grow further market
ompetitors will come to dominate
the industry).
Why not anymore, a popular guide?
1. If firms use a similar experience-curve driven strategy, they will end up in a price war that
drives down profits.
2. Refrain from innovating and introducing new products to exploit on their cumulated
experience.
3. Experience is copied also by similar industries through imitation, so it is hard to benefit from
the cost advantage derived from greater cumulative volumes. Smaller competitors can have
smaller costs, since have fewer bureaucracies.
Finally, managers should pay attention to costs, thus the experience curve can help understand
how costs change over time as we grow.
3.4 WHAT IS COMPETITIVE ADVANTAGE? COST AND WTP
The essential purpose of Business Strategy is to create a sustainable CA, which is what allows
firms to capture more values in the industry. How to do that? Spend more on marketing, R&D,
quality, innovate, etc.
All ideas are aimed at either reduce costs or increase value of our product. Customer value is what
drives customers to purchase our product, a higher one resolves in higher WTP we can increase
our prices. Firms have 2 ways to increase its profitability: decrease costs or increase prices.
However, in
acquire supplies) buyers talk and trade with several suppliers before taking a decision. Usually
prices come from lengthy negotiations, ending up within such frame: cost of supplier and the WTP
of the airline for the supply. The lower limit is given by the costs the the company incurred, under

16
which it would result a decrease in cost, meanwhile the upper limit is the WTP. This is driven by
the value that such supply will create in the airline business.
Clients only buy products from which they derive value: price must be lower than benefit derived.
When comparing products, will choose the one leaving them with highest value.
Highly differentiated product (Tesla) can allow sellers to charge larger prices because higher value
perceived. However, no matter the price, customers will have greater WTP for the firm offering

be seen in the wedge between the WTP consumers and the total costs it may incur in running the
business. A higher wedge makes possible for a firm to lure clients with better deal and retain
greater profits.
If such wedge is kept in the long term sustainable CA
More ads, R&D, innovation will only enhance your CA only if the resulting increase in costs is
lower than the increase in WTP. So, to increase WTP more proportionally with respect to the
increase in costs, a firm must understand where it is most capable of maximizing that gap. The
greater the gap, the greater the CA. The harder to imitate such gap, the more sustainable the CA
is.
This view is very simple and comprises 3 elements: Competition, Costs, WTP.
Reality is more complex: whenever firm wants to increase WTP of consumers it will most likely
WTP for
its product. (ie. If restaurants want to increase prices, will need to hire better chef or buy more
expensive raw materials).
If possible, to reduce costs without touching WTP should do so. Ex, Apple can generate high
WTP, so it can stand high costs too and still generate profits. This of course has to do with the
different capabilities that the different firms have bought over time.
In a nutshell business strategy seeks to maximize the gap between WTP and costs and the
more difficult to imitate such moves, the more there is this competitive advantage.
3.5 TYPES OF COMPETITIVE ADVANTAGES
Common belief is that to have CA firms must either be differentiated (and charge > prices) or
have larger volumes (and thus < costs) to cut prices. The dichotomy between Volume & Cost
strategy and Differentiation. Firms trying to combine them end up stuck in the middle with low
performance.
But reality is different: strategy is not about maximizing WTP or minimizing costs, but the most
profitable companies can be in the middle. They are those who create large enough gap between
costs and WTP. (Firms do not need to have highest WTP and lowest costs though). What is critical
is not to have simultaneously higher costs and lower WTP when compared to its competitors.
Ex: Toyota is less differentiated than Mercedes; has higher price than some brands; and sells
lower volumes than others . Clients perceive Toyota as higher
quality and reliability for its clients, thus increasing WTP. Also, it can optimize its costs.
Meanwhile Toyota system is efficient and therefore it can produce at lower cost. So, it reached

17
8% operating profitability, compared to 4% for Volkswagen. Managers should always obsess
on what are the results of decisions on costs and WTP.
Three ways to achieve a larger gap than competitors and thus have CA:
1. Differentiation: a differentiated competitor incurs higher costs, but also higher WTP in its
target clients. So, it can charge higher prices and cover its greater costs. Such strategy is
sustainable only if costs < price. Of course, while prices can increase and be higher than
competition, they must stay at reasonable level.
2. Low costs: firm strips down its offerings to keep down its prices, while keeping a sufficient
WTP in its customers. Strategy succeeds only if prices are low enough to attract customers,
but high enough to generate profits. Ex: Low-cost airlines like Ryanair.
3. Dual advantage: combines higher WTP with lower costs, which immediately increases the
gap. Ex: social networks like Facebook/Instagram leverage network effects by which people
can enjoy differentiation and large communities: they offer greater opportunities to interact
and generates a snowball effect. As most digital businesses, they incur high FC, but scale
drives down unit costs dramatically : the dominant platform can end up in
an almost monopolist position.
These 3 types of CA correspond to 3 different combinations of costs and WTP. In each pattern,
the firm must focus on widening the gap between the two, instead of focusing on differentiation
at the expense of cost or cost and volume at the expense of differentiation.
Ex: Rolls Royce went bankrupt in 2003. Its volumes dropped too much, leading to too
excessive high unit costs.
Ex: Tata nano car failed in India, because of customers low willingness to pay. They
a Nano! They chose either
to move to motorcycles or used cars.
The right balance between costs and WTP is crucial for CA.
3.6 COST DRIVERS
CA is the gap the firm can create between the WTP in its customers and the costs incurred. So,
managing costs is essential. A firm overall cost position results from the aggregation of so many
costs, from labour, raw materials, services, depreciation. Understanding how they all add up
requires that we co
down into cost components corresponding to discrete activities, such as R&D, marketing, raw
materials, etc., rather than broad cost categories (labour, depreciation, etc.)
Ex: Smartphone costs can be broken down into a P&L accounts, or elementary activities needed
to produce a phone. The various costs do not increase/decrease for the same reasons: fixed and
variable costs. They do not have the same cost drivers:
Volume: variable costs increase as the firm increases its output, while the share of fc in total
unit costs decreases.
Exogenous factors: the cost of raw materials tends to fluctuate depending on global supply
and demand, politics, natural resources, etc. A firm has little or no control over it.

18
 Long-term trends: the cost of electronics has dropped significantly since years, while cost
of labour has increased significantly. More generally the cost of manufacture goods when
down, on the other hand the cost of labour has risen almost continuously.

change, but also the relative weights of each component in the total unit cost can change
dramatically.
Ex:
manufacturers because hardware is mainly a VC: it is what makes up each smartphone;
Software instead are developed once and only so it is a fixed cost. So, volumes have become
more critical, making more difficult for smaller competitors to survive.
Ex: Rising cost of labour: those firms that chose to automate some operations are now more
advantaged. Fuel costs and transportation costs increased: de-localising manufacturing in
other countries has therefore not been a great choice!
It is critical to develop understa
When making trade-off between costs and WTP, it is very important to understand when to
sacrifice WTP in order to gain a significant cost advantage, or vice versa.
3.7 VALUE PROPOSITION
Business model comprises 3 components Value proposition, value architecture, profit
equation.
Value proposition describes what the firm is offering and who is selling to. It focuses on the
products and services offered, on the customer needs and problems that they solve. It identifies
the target customers, which can be several. For ex, pharmaceutical Coms have several clients:
individual patients, physicians, chemists, public insurance companies.
VP generates greater WTP
product, but rather on the image that the product conveys to the owner. The WTP is given to much
more than its practicality. Oppositely, Flix Bus targets customers with low WTP. Such customers
will compare these prices with trains, etc.
A useful tool to compare different VP is the Value Curve. It helps in analysing how a customer
chooses between different options in the market.
Ex: BlaBla car trip:
Value attributes (x-axis): the criteria clients use to select an offer. For ex, when choosing
customer will compare speed, comfort, etc. relative to price.
Perceived value (y-axis): measures how much each attribute is associated with each
alternative offering. The higher the level on the attribute, the more it contributes to
For example, on speed and safety train travel outperform car.
It clearly depicts the trade-off made by customers.
If several types of customers, several value curves must be drawn, in fact, the values attributed
by a patient are not the same of those of by a physician. The value curve is very used, in fact,
it is directly derived from value analysis/engineering, an approach used by engineers in 1950s.

19
 General Electric used it in WW2, when raw materials and components were scarce, so
engineers had to find substitutes. These substitutes could reduce costs, improve product
performance or both they turned to value analysis: analysing product performance with
respect to costs. They could identify remove unnecessary features not valued for the customers,

Building a value curve is a good intention to describe in detail the value proposition associated
with a business model. Main problem is to identify the main attributes to assess the relative
Is recommended
to develop a deep understanding of customers through panel or focus groups.
3.8 VALUE ARCHITECTURE
It describes how the company puts together all the behind-the-scenes activities that contribute to
delivering its Value Proposition. It includes the set of activities (value chain), the resources used,
the activities outsourced to key partners.
The value chain framework was described first by Michael Porter, who described the primary
activities, all the steps needed, and the support activities like procurement and HR management.
So, the Value Architecture is broader: includes the internal value chain and the external value
network with external partners.
WTP. As
CA is measured as the gap, VA is a strong driver.
Ex: All pc manufacturers need to put together microprocessors, memory; run it with the
operating system (OS); and then distribute the final product to customers through brick and
mortar or online. A firm that would only focus on microprocessor or on the plastic case of pc

Of course, the firm may decide to outsource, but then all inputs must be put together/reintegrate
into a final product and the firm then sell the product. These choices must cohere into a
consistent VA.

several different
In the pc industry, m
Mac OS. Apple so chose a very different VA in the pc business. Also, spent much time into
designing. Therefore, Apple has reinforced the unique VP of Apple computers. Also, in

its choices in VA, as we see its choices above, we can outline already a strategy.
Analysing
focusing on which activities you must focus on. Usually, those that account for significant costs
or that are critical for CA. In the same way, should focus those activities determine the value in
the VP and drive the WTP.
VA can also help to anticipate which activities will become more significant for the future,

activities are carried out in other firms. Any difference in CA or performance arises from different
ways of carrying out activities.

20
anticipate evolutions and to predict winning strategies.
3.9 PROFIT EQUATION
Last component of the Business Model. PE adopts a financial perspective to re-examine the first
two components, to assess whether and to what extent they can make the Co profitable.
If clients perceive VP very attractive high WTP (In financial terms, it will feed the Revenues
line).
VA describes how the company carries out its activities to deliver VP to customers. In financial
terms, it will feed the Operational Costs and the amount of Capital Deployed to carry out business:
Operational Costs: all the costs incurred by the company to perform its activities such as
salaries, energy, depreciation, ...
Capital Employed (reflected in Capex): buildings, machineries, ...
The PE reflects all the choices made in the VA. For example, if firm decides to close factory
and outsource manufacturing, the level of Capex would fall. Indeed, a plant and all the
associated machine requires a lot of capital.
The profitability can be measure by the:
ROCE = NOPAT/Capital Employed where NOPAT= Revenues-operational costs
Or written as ROCE= (NOPAT/Sales) *(Sales/CE):
NOPAT/Sales = Return on sales measures the operating margin of the company. But it
is not enough to measure profitability as we need to count in also capital employed/used to
invest in the business.
Sales/CE = Asset turnover measures how much revenues it generates for a given amount
of CE. The higher, the greater its efficiency.
Ex: BlaBla Car capital employed needed: very low. Zip Car owns the cars, so much greater
CE. Similar value proposition (a car) can have very different CE. And to have a similar
profitability, therefore, Zip Car will need a much higher Return on Sales.
Overall, by examining the Business Model, we can say that VP and VA must be aligned for the
firm to generate good performance.
3.10 BUSINESS MODEL AND COMPETITIVE ADVANTAGE

understand where the firm stands. Indeed, the VP helps to understand the willingness to pay,
meanwhile the value architecture determines the costs incurred by the company; the company
equation make it possible to measure the competitive advantage of the company. The business
model framework
usiness Model.
For ex, a VC analyst can use the BM to understand what a start-up wants to do, but not to see
if it can be successful.
A good BM leading to CA must be:

21
 1. Unique
similar. Departing f

providing ideas for improvement to your BM.

Most successful companies have a unique BM. Even small differences in each component
can lead to big changes in your performance and BM:
For example:
Patagonia: differentiates in that it protects environment and, in the quality, and
technicality of its products. Also, it donates part of profits to environmental companies.
These increased value of brand and products. Its CA lies in a niche differentiation
strategy by targeting customers that wants products particularly technical and it
generates HWTP.
Ryanair: wants to succeed on consumers with low WTP. It keeps costs limited by having
a limited training costs, maintenance costs. All these features make up a unique BM
that traditional airlines have struggled to replicate.
2. Consistent: both VP and VA must be aligned to generate CA. Profitable companies
deviate, they will not serve
those customers that would undermine the consistency of their BM. So, sometimes,
they must forego some growth opportunities. Also, some companies have not to do list
to maintain their BM (like Stef that decided of not transporting pharmaceutical if
products despite those regulations requires the same sanitary requirements. However,
the law requires that it is necessary to use two different type of trucks). Giving up some
opportunities sometimes it is necessary to safeguard your business model. Indeed,
strategy is all about what we choose to do and what we choose not to do.
3. Difficult to imitate: a CA must rely on a sequence of complex elements in the BM.
logical and market features,
leveraging on a strong brand. Some competitors have tried to compare an Apple store
but WTP.
Sometimes, imitating is not even worth it for competitors: imagine an Airline Co trying to imitate
Ryanair. It would lose its market positioning and incur huge costs for restructuring the company.
3.11 INTRODUCTION TO BUSINESS MODELS
In a given industry, incumbent firms face the same business environment. If external factors were
the only ones to influence, then all firms would have same profits. However, there are major
performance differences among individual firms in several industries: Airlines like Ryanair have
achieved higher profitability than legacy airlines such as Lufthansa. How? The BM framework
can help us, by analysing the specificity of a given firm.
BM term arose in the e-business boom in 1990s to explain investors their potential of their start-
ups. BM explains nowadays the main choices made by a Co, explaining its level of profitability.

to understand which choices you need to examine in order to explain the profitability of a
company.

22
 , what the company is offering?
And who the company is trying to sell to?
VA refers to how Co creates and delivers VA to the clients so as to deliver VP, the major
activities that the firm carries out in order to offer the value proposition to its customers.
PE explains how the firm can make a profit from its business, it explains the financial
implications of VP and VA. They must be aligned so as to create viable profits. A good
value proposition will be able to create revenue, meanwhile the cost structures derive from
the value architecture.
BM, basically, help us to analyse the 3 sources of CA.

4 Disruptive strategy/ Competitive Dynamics

4.1 COMPETITIVE DYNAMICS: BASIC PRINCIPLES OF GAME THEORY

Trying to anticipate actions and reactions of competitors is a critical aspect of business strategy,
if a company reduces its costs, they will increase their market share, but if all the companies do
the same it will be a disaster, since they will remain the same with just less profit.
Strategic Moves: Introducing a new product, entering a new market, or investing in additional
production capacity are examples of strategy as a game.
The prisoner dilemma: There are two prisoners, if none of them confess they will let free, if just
one confesses and blames the other he will be sentenced lightly while the other heavily, and finally
if both confess, they will both be sentenced not as heavily.
The same logic can be applied to firms, they can choose to advertise heavily, moderate or light,
the optimal thing is to both advertise moderately, but if they advertise heavily, they will not take
the optimal solution.
Interesting insights:
1. Suggests that
2. Forces us to identify all the possible competitors that will be affected by our strategy.
3. Helps us take a long-term view on how strategy will unfold.
4. Represent competitor interactions as a decision tree. To unfold the best strategy to
follow.
Overall, game theory is more interesting as to see the relations and reactions between competitors
than to apply as theory to decide a strategy.
4.2 HOW TO USE GAME THEORY: DECISION TREE AND PAYOFF MATRIX
The typical use of game theory is to investigate the likely behaviour of competitors, suppliers,
buyers, new entrants, and substitutes. Because the success of a firm is highly dependent on the
interactions with the other firms.
The model strategy as a game, you need to identify:
1. The actors/players

23
 2. The information the players have
3. The payoffs
3.1. Zero-sum games: like poker, money just changes hands.
3.2. Non-zero-sum games: the overall gain can be positive.
The decision tree considers all the different scenarios that can happen when entering into a
situation of business. Then, with the payoff matrix, you can see the different outcomes of each
situation, which allows us to see beforehand the different profits and analyse which is the best
option overall.
4.3 COMPETITIVE DYNAMICS: FIRST MOVER ADVANTAGE
Managers tend to think that a firm that enters a market or a business before their competition can
gain advantage towards other firms with a later entrance. But is not always like this, for example,
success, and the strong movers ended up
dominating the market.
Usually, the first mover takes risks and has a costly proposition as needs a lot of research and
development, with a lot of trial-and-error processes. On the other hand, the strong movers, already

For the first movers to materialize, they need:

1. Capture resources that will no longer be available for later entrants, like strategic locations
for example. Ex: McDonalds. A patented innovation, taking advantage for a long period
of time since the customer base will be loyal for a longer time.
2. Possess, acquire, or gain access to essential complementary resources, for example, with
ations, they will lose part of their business.
4.4 COMPETITOR INTELLIGENCE

profiles:
1. What are their goals?
2. What is its business model and strategic plan?
3. What are its resources and capabilities?
4. What assumptions is it making about the business?
To be able to learn about this, you can:
1.
2. Reverse engineers their products.
3. rs as well.
4. Consult the purchasing managers.
5. Ask the distributors about customers.
6. Consult industry experts, bankers, consultants, and patents.
7. Hiring senior managers, or technical experts, away from competitors.
8. Alliances provide a window into our

24
 4.5 RESOURCES AND CAPABILITIES
What makes a competitive advantage sustainable?
RBV = Resource-Based View Are valuable resources that a company can use for creating
unique capabilities to create a competitive advantage.
Ex: for the iPhone, all the resources that they need to produce it, are part of the Value
Architecture. These resources can be tangible, intangible, and human resources. But this is not
enough, as another firm with the same resources but with another brand, the capabilities that
apple has are special. Their culture, processes, routines, organization, and experience are the
tools to put everything together to make it a brilliant product.
4.6 STRATEGIC RESOURCES: VRIST
Not all resources are available to all the companies as some of them are more strategic, while
others are perfectly available to everyone. To form the basis of a competitive advantage, resources
must:
1. Valuable: must contribute to lowering costs or to enhance the costumers WTP.
2. Rare: to be strategic if
3. Inimitable: must be difficult to imitate
4. non-Substitutable: must be hard to substitute
5. non-Tradable: must be non-tradable or hard to trade, as then the value will be part of the
resource and not just in the firm.
VRIST (Capitals of the 5 points above)
4.7 FEATURES OF STRATEGIC RESOURCES
To have value inseparable from the firm there are 3 root causes:
1. History dependent: resources are developed over a long period of time. For example, a
strong brand is impossible to build over a short period of time despite their marketing or
advertising expenses.
2. Causally ambiguous: only the full combination of the firm
creating a valuable product. For example, in a football team despite having a great player,
you need also a good team to be successful.
3. Organizationally embedded: all the resources need to be used in a specific way to make it
work, again, like a football team and the players positions.

5 Platform Strategy

5.1 WHAT ARE PLATFORM BUSINESSES AND TWO-SIDED MARKETS?

Multi-sided platforms business
Counts of Champagne:

Allowed the fairs to be held in their cities.

25
 Guarantied safety and property rights of merchants.
Ensured that contracts signed during a fair would be enforced.
The counts collected a fee during all fairs. These fairs, where platforms, they operated with
-
users and advertisers.
A platform-firm brings together distinct groups of users that are attracted to each other and
transact with the help of a third party. Also, provides the infrastructure and sets the rules that
govern transactions.

There are numerous platforms, in the different markets:

In the last years, there has been an exponential rise in the number of Internet platforms, these
types of companies have existed for a lot of years, but the new technology has helped develop
the company to make it more safe, easy, and fun.
must establish a critical structure
of the business, altogether with the intellectual property, the rules of the business and the

26
obligations for example, to be able to establish trust in all the users, for them to feel safe in
any of the sides of the market.
Platform businesses require a different approach to strategy analysis and formulation, so
competitive advantage needs to be developed in a different way, so most approaches like
Porter, or other frameworks and tools are ill adapted.
5.2 CHARATCERISTICS OF MULTI_SIDED PLATFORMS PART 1: NETWORK
EFFECTS
Network effects
Network effects arise when the value a customer assigns to a product or service is altered by
the fact that some other customer has purchased the same product or service. For instance,
with our Facebook account, the value of the platform, resides in the number of users they have,
so for the users, there is a Same Side Network effects, as the more users and friends use the
platform the better for us. On the other hand, for advertisers, the more users there is, the better
for the advertiser, which is called Cross Side Effects.

These effects can be positive or negative, as the more advertisers there is, the less value the
users see in the platform.

The network effect, have an impact on the revenue stream and the costs of the platform:

Impact on revenue: Is like the chicken and egg situation, for instance, like in the
videogames industry, the value of the platform depends on the number of users on the
other side of the platform, the more players the better for game developers, and same
happens on the opposite situation. Due to this, these platforms need to develop both
sides simultaneously value propositions.
Impact on the costs: Platforms tend to be more sensitive to economies of scale and
volume. Platform firms essentially incur fixed costs: the more users on the platform,
the lower the cost per user.

5.3 CHARATCERISTICS OF MULTI SIDED PLATFORMS PART 2: PRICING,

Platform firms create value by connecting different types of users, and by charging fees for
access to the platform. So, the question is to who and how much should they charge the users

27
for accessing the platform. So, the important part, is to decide the relation between the subsidy
side and the money side.

Another business strategy is the Freemium models, which is very used in the gaming industry.

recruiters and advertisers.

Regarding the platform business resources, the most important resource for the platform is the
community of the users attracted to each other. Information technology has made possible to
cheaply connect various communities and organize transactions between them. Platform firms
can achieve high performance without owning significant assets.

Since most costs they have are fixed, they can improve the WTP while lowering costs. As the
community grows, cost per users decreases and the more valuable it becomes.

This types of competition between pla

outcome when:
High network effects
High multihoming costs
Monetary investment, time, and effort a user needs to join a specific platform. Once you join
and are used to a platform, is very difficult to change, for instance, when you own a Windows
computer is very unlikely to change easily to Mac OS.

6 Vertical Scope

6.1 INTRODUCTION TO INNOVATION STRATEGIES

Innovation is an important driver of firm performance. also
it is often
extent of change, from incremental to radical innovations, from one to the other is a
continuum.
This distinction is very limited, so there is a second way to understand innovation, from the
strategic point of view. Some innovations are sustaining, maintaining the same business
model, and others are disruptive innovations, with new business models, which can also be
called strategic innovation.

always mean new business models.

Sustaining innovation: can increase willingness to pay or reduce costs.
Disruptive innovation: can result in the creation of new competitive advantage, changing
radically the value proposition, the value architecture, and the profit equation.

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6.2 APPROACHES TO STIMULATE CREATIVITY
Three approaches, the Blue Ocean Strategy, the Business Model Canvas, and the Odyssey
3.14. All three approaches have the same goal, to stimulate the creativity of managers and
increase the Competitive Advantage as the difference between WTP and cost.
The common characteristics from the three approaches are:
1. Design Thinking
The Blue Ocean Strategy: based on the value curve, explains how the
customer choses the products in the market and the perceived value of all

2.
3. Look across industries
4. Search for complementary products or services
5. Question the revenue generation model
The Business Model Canvas: Freemium model
Odyssey 3.14: based on performance-based revenue generation, being paid
on the savings that their customers make.

6.3 OUTCOMES OF THE BUSINESS MODEL INNOVATION

Business model innovation can create a stronger competitive advantage for the firm and thus,

Red Ocean v. Blue Ocean:

Existing industries are known as red oceans, with rules and limits clear, rivals try to capture
share of the market, as the market gets crowded, the more difficult it is to capture, and
competition gets bloodier.
On the other hand, blue ocean refers to yet to exist industries. Demand is created instead
of being captured. Creating new value propositions and new niches in the market. The goal
is to enhance the value created for customers while eliminating features that are of less
value to the current or future customers.

29
6.4 CHALLENGES OF BUSINESS MODEL INNOVATION
The performance of any offer tends to increase naturally overtime through incremental
innovation products or services. The level of performance achieved often exceeds the actual
expectations of most customers both now and at the high end of the market.
When this happens, industry is ripe for disruption at first disruptive technologies or business
models often offer much lower performance levels than the existing offer in the market,
however this level of performance is usually sufficient for a specific type of customers who
cannot afford the existing offer.
A disruptive innovation is an innovation that creates a new market, addressing new consumer
needs. This innovation will eventually disrupt the existing market and replace an existing
product or service. This implies that companies must pay attention understand and respond to
disruption. To do so existing firms should always question how their existing offer addresses
the need of the customer. Focusing on the need of the customer is the best way to challenge
existing products and business models.
This approach also explains why incumbent firms which may be good at identifying new and
disruptive technologies fail at framing a new business model that is based on them this is also
known as the contact syndrome.
Innovative business models are a significant challenge for companies as it requires that they
questioned the models that had made them successful in the past. This is exactly what is
currently threatening many companies.
6.5 WHAT IS CORPORATE STRATEGY
Growing the company while remaining in the same business and market space is part of
Business Strategy rather than Corporate Strategy.
In Corporate Strategy we will address why a firm chooses to compete simultaneously in more
than one business or more than one market. It deals with the scope and the boundaries of the

Corporate Strategy boils down to decide on which activities should the company own and
operate, and which should not.
Scope: activities that the firm owns
Boundaries: separate activities located within the firm from that outside of the
company.
6.6 DIRECTIONS OF GROWTH
So far, we have seen Business Strategy, or how to increase business growth within the current
business. But a business can also expand its scope by taking three directions for growth:
Vertical integration
o
content)
o e.g., Ford and Hertz, Apple
distribution).

30
 Business diversification
o Technology based diversification
o Unrelated diversification (conglomerates)
o Market Based Diversification
Geographic/International expansion. Main issue: extent to which companies that are
successful in one country can extend their competitive advantage to other countries and
what adaptation moves should they make.
6.7 MODES OF GROWTH
Organic/internal growth: firms will buy or create all the elementary resources and
assets they need to operate in a new business or market. (e.g.: Microsoft in the game
console industry with Xbox)
External growth: M&A.
Collaborative growth: Alliances and joint ventures. Many foreign companies create
JV with local companies to enter other countries.

6.8 VALUE CREATION

What is the ultimate purpose of Strategy? Ensure superior performance of the firm.
How do we measure this performance? Depends on our ideology, beliefs, cultural background.
But, in any case, any company needs to raise capital. For doing so, their equity should be an
interesting investment for potential investors. Firms will only raise capital if their shares offer
adequate returns for the risk they entail. This is precisely what is generally called Value
Creation.
Value Creation needs to be measured through the return that accrues to investors
investment.

Employed, which depends on the Operating Profit and the Capital Employed Turnover.

31
Firms should maximize the gap between costs and willingness to pay to increase their return
on sales, but their strategy should also aim at maximizing the sales they generate with the
investment they invest or minimize the investment needed to obtain a level of sales.
These notions are crucial for Corporate Strategy. Any capital the firm employs to increase its
scope needs to generate an adequate level of return.
6.9 AGENCY PROBLEMS AND GOVERNANCE
are not always perfectly aligned. This is an agency
problem. The owners are the principals while the managers are agents of the owners.
Diversification is the strategy move for which agency problems are more particularly salient.
Owners, driven by efficiency, tend to favour focus on one business. Managers, driven by
security, tend to favour diversification. Diversification also increases the level of information
asymmetry between managers and outsiders (esp. shareholders).
Owners seek efficiency, want to be nondependent on managers and seek high profits. Managers
seek security, want to be indispensable and seek high volumes.
Many companies have set up governance mechanisms intended to align the interests of
managers with those of shareholders. Bonuses, rewards, monitoring mechanisms.
Shift in Corporate Strategy: diversification was extremely popular from the mid-forties to the
mid-sixties, but now refocusing has become a powerful trend in North America and Europe.
6.10 VERTICAL INTEGRATION
Vertical Integration occurs when a firm chooses to run operations in two successive stages in
the value chain. (e.g., Ford owning its own steel factory, Pepsi acquiring fast food chains).
Two main kinds:
Upstream or Backward Integration (raw materials, components, manufacturing)
Downstream or Forward Integration (distribution, sales, service)

If a firm is not vertically integrated, it must buy all the inputs it needs from independent
suppliers and sell their output to buyers that will use it in their processes or resell them. The
non-integrated firm relies therefore on market transactions. It will require certain features in
the inputs they acquire and will guarantee other features in the products they sell. At the same
time, it will try to obtain the lowest possible price for the suitable inputs and achieve the highest
possible price for the products it offers.
Because of incentives created by competition, a market usually offers the best option for getting
the best inputs at the lowest possible price. When the nature of the inputs a company is buying
or of the products that the company is selling creates efficient market conditions, vertical
integration will almost inevitably prove more costly and be less effective than market
mechanisms.
In such circumstances the firm should avoid vertical integration. Yet, under circumstances,
market may not work effectively, and vertical integration could be a suitable option.

32
The choice between integration or non-integration is the choice between market and
hierarchies. This choice entails a trade-off between administrative costs and transaction costs.
6.11 MYTHS ON VERTICAL INTEGRATION
Wrong reasons for vertical integration:
More control: actually, being able to choose from different suppliers usually grants
more control over features and price of supplied inputs than trying to convince
colleagues and employees of making a good job at a low cost. Companies can more
easily move between suppliers than efficiently managing employees. When market
offers sufficient choice and changing from one supplier to another is easy, vertical
integration is rarely a sound choice.
Skills and know-how can be transferred upstream or downstream. Unfortunately,
skills, know-how and competitive advantage do not transfer easily from one stage in
the value chain to another.
Cost reduction: completely flawed. Capital employed determines the need for profit.
The best of both worlds (units within the company would continue to operate as if
they were independent from one another): this almost never happens. When units are
in trouble, the rest of the units are forced to buy from or sell to them to buy them out.
Combining the benefits of vertical integration and market mechanisms is a myth.
The end vertical integration is only justified when markets are flawed. If the company
decides to vertically integrate, it should go the whole way and radically change the nature of
the relationship between the upstream and downstream links in the value chain.
6.12 WHAT ARE TRANSACTION COSTS
Using the market is not free, it can usually be costly due to transaction costs, which vary
depending on the features of the products being traded. In some cases, transaction costs can be
so high that it is best to avoid the market altogether.
What are transaction costs?
Cost of scanning the environment and finding an adequate trading partner
Cost of negotiating and bargaining
Cost of contracting
Costs of controlling and monitoring
Contract enforcement costs
-
powerful suppliers/buyers
Vertical integration should be considered if the transaction has three attributes:
Being central and frequent
High level of uncertainty: especially if loopholes can be used by opportunistic
suppliers/buyers, like R&D.
When a supply of a particular input requires investments specific to a particular buyer,
-
Incentive to make generic investments.

33
The more the firm requires unique inputs or produces outputs specific to each customer the
more vertical integration may be a desirable option.
option and long term
contracts may provide attractive alternatives.
6.13 DISADVANTAGES OF VERTICAL INTEGRATION AND OUTSOURCING
Main disadvantage of vertical integration:
Increases asset base and capital invested: forces the company to generate higher
revenues to maintain a good ROCE.
Reduces flexibility.
Limits the size and scale of the input business. Limitation of economies of scale.
Converts variable costs into fixed costs. Increases vulnerability to fluctuations in
demand.
Makes it difficult to have a precise knowledge of the various costs of the different
operations and inputs that get combined into
Main disadvantages of outsourcing:

Deprives the firm of valuable knowledge

Limits the extent of differentiation
6.14 ORGANIC GROWTH AS THE BASELINE OPTION
Consists of putting together all the elementary resources needed to operate in the new market
or business. Organic growth is typical of how entrepreneurial new ventures get started.
Advantages:
Learning-by-doing
Trial-and-error
Accumulating experience
Step-by-step basis
Specific configuration
Consistency with original business and existing corporate culture (e.g.: Microsoft
creating Xbox)
Disadvantages:
Slow
Lack of knowledge of local context
Challenge of getting access to elementary resources
Ill adapted to mature markets

34
7 DIVERSIFICATION

7.1 What is diversification?

Most companies offer more than one product or service. Diversification is the strategic
move a company makes when it chooses to enter a new industry, a new business, or a
new product category.
Conversely, refocusing takes place when a company chooses to move out of an industry,
a business, or a product category it was previously operating in. By t
refocusing has been the norm in the west.
The terms industry and business both refer to a consistent set of products or services,
offered on the same market to the same broad category of customers. An industry or
business is the universe within which inter-firm competition takes place.
Industries are usually defined in an institutional way. Official codes. Based on
administrative grounds. Very stable over time. These may not be well adapted to fast
is an attempt to better stick to the
competitive reality.
A business is defined by:
The combination of a consistent family of products or services offered to a
homogeneous group of customers.
A consistent set of key success factors.
A value chain, combining the same set of activities.
A group of competing firms.

Diversification is the strategy that a firm implements when it enters a new business or
industry, in which it was not previously present.
7.2 RATIONALE FOR DIVERSIFICATION
Some typical reasons given (all are flawed from the shareholder value perspective,
except synergies):
Spread risk among various businesses: debatable, it depends on the view we
have of the role of companies in society. If we consider shareholder value, this
logic is fallacious. It is less costly for investors to diversify their investments
than to invest in diversified businesses.
Utilizing excess available resources: investments should only be made if
companies create value with them. Companies will probably be better off
investing in known, familiar businesses than in unfamiliar ones.
Achieving growth in new businesses: the shareholder value perspective would
argue that as the core business matures or declines, firms should adjust, shrink,
and eventually disappear as the business they were founded on becomes no
longer viable.
Benefiting from size-related advantages: most size-related advantages accrue
at the business level when they increase the economies of scale. Bunching

35
 together several businesses that have nothing to do with each other will not
enhance economies of scale in any of these businesses. The only size-related
advantages that might appear in the context of a diversified firm have to do with
its overall borrowing capacity, and its bargaining power with public authorities
and other institutional actors. When bargaining with suppliers, in contrast, each
business will likely continue to negotiate on its own.
Leveraging synergies. Synergies exist when it is less costly or more effective
to do two things simultaneously than to do them separately. This is the only
conceptually sound reason for diversification.
7.3 DOWNSIDES OF DIVERSIFICATION
Diversification carries with it several downsides that need to be considered.
Defocuses management expertise.
Complicates standard procedures and processes
Requires an entirely new level of corporate management. Coordination costs.
Encourages complacency. Failing businesses can be bailed out by other divisions
Scatters resources and weakens focus
A diversified company is less attractive to investors than a single business firm,
all other things being equal. Conglomerates generally trade at a discount (10%-
15% in US and Western Europe)
However, diversification usually tends to benefit employees and managers. In
inefficient financial markets, diversification may not only benefit employees and
managers, but also create value for its shareholders. Small undiversified businesses
might not be able to raise capital, and capital may flow into big conglomerates.
7.4 SYNERGIES
Value creating diversification = Related diversification
Economies of scope: the broader scope of activities of the firm results in greater
efficiency and lower unit costs across product categories (e.g: Amazon expanding its
retail activities to various categories entailed befits of synergies in data processing,
logistics and warehousing; Apple using the same single operating system across
products).
Synergies arise from:
A common input utilized across multiple businesses
Products acquiring greater value when sold jointly than when sold separately
Common input synergies can arise at any stage of the value chain:
Technology
Production facilities
Distribution networks
Common set of skills and capabilities
Brand
Synergies are hard to achieve:
They are often built on illusion (e.g.: Kodak stating their business was anything
that had

36
 Their potential is often overestimated (e.g.: airlines getting into the hotel
business).
Their implementation difficulties are underestimated.
7.5 BUSINESS PORTFOLIO MODELS
BCG Matrix
Matrix with two dimensions:

share of the strongest competitor. If greater than 1, the firm is a leader. If less
than 1, the firm is dominated by one or several stronger competitors

average growth of the economy, weak if less.

Depending on these two dimensions, there are four quadrants:
1. Cash cows. Market leader & slow growth: high margins, limited investments.
High cash Flows.
2. Question Mark/ Dilemmas. Follower & rapid growth: large investments.
Need for cash.
3. Dogs. Follower & Slow Growth: Low margins, limited investments. No need
for cash.
4. Stars. Market Leader & Rapid Growth: High margins, large investments.
Self-funding.
Other consulting firms have developed their own diversification models, but most
changes are
industry attractiveness
diversity of activities of the firm.
All the business portfolio models are based on two assumptions:
The firm should remain financially independent with the various businesses
cross funding each other
Decisions for each business can be made independently and there are no
synergies between businesses.
In recent years, financial markets have become more efficient and raising capital when
needed is not an issue. In turn, investors now pressure companies to return excess cash
to them before they consider reinvesting it. Consequently, synergies have become the
only acceptable justification for diversification. Therefore, business portfolio models
have become less relevant.
Additional limitations:
Highly dependent on the way overall activity is segmented into individual
businesses.
Business segmentation entails subjectivity.
However, it is interesting to note that the two main dimensions of these models refer to
the two main components of competitive strategy we have already discussed when
explaining business strategy:
Market growth/industry attractiveness Structure of the industry
Relative market share/competitive position Competitive advantage Business

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 portfolio models remain useful to assess:
The diversity of a firm business portfolio
Their respective competitive environment
And think of possible refocusing or diversification moves.
7.6 MERGERS AND ACQUISITIONS
7.6.1 INTRODUCTION
M&A are another mode of growth available to firms seeking to expand into a new area
of business or a new market. Rather than putting together all the elementary resources
needed to operate in that new market or business, as is the case with organic growth, the
firm can choose instead to acquire the entire bundle of resources required to operate
successfully in the new context.

Such a bundle of resources is an existing company operating in the target market or

business. Acquiring or merging with such an existing company is a second way to
expand into the target market or business.

Legally, an acquisition is said to have taken place when an acquiring company buys out
a majority, or all the shares, of a target company. The target company then becomes a
wholly owned subsidiary of the acquiring company. Its strategy is now completely
dictated by the acquiring company, with some restrictions when minor shareholders
remain in the acquired company.

From a legal standpoint, a merger is said to have taken place, when all the assets
belonging to two preexisting companies are placed within a newly created company.
The shareholders of the two merging companies receive shares of the newly formed
corporation in exchange for their shares in the preexisting companies.

The distinction between mergers and acquisitions is more a tax and legal issue than a
management issue. It has little to do with whether the shareholders of one company
supported or rejected the move.
M&A tend to occur in waves, that affect specific industries and the economy.

The peaks in M&A activities have been explained by:

Excess liquidity of prospective acquirers
Upward trend in stock prices
Relaxed antitrust policies
Technology and industry changes
Trend towards greater globalization
Bandwagon effect: particularly visible at the industry level. Chain reaction by
which one M&A in the industry cause other firms to fear they are lagging and
be more prone to M&A.
E.g.: firms from developing countries acquiring firms from the developed world: Jaguar

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and Land Rover being acquired by Tata.
7.6.2 ASSESSING THE PERFORMANCE OF M&A
It is very tempting for managers to carry out M&A. They are strategic moves for which
it is very difficult to be held accountable. It usually takes years to assess if a move was
correct, and so many things will have happened by then that it will be complicated to
evaluate the move fairly.

However, sometimes we can say an acquisition was a failure if the acquiring company
sells the acquired company after a few years for less money than what it costed them.

One factor that significantly drives the way in which a merger or acquisition is viewed
is the price that the acquiring firm ultimately agrees to pay for the target. The same
acquisition might be viewed as a success if the price paid for the target is a bargain or
as a disaster if the acquirer is seen as having overpaid the target. Because of this, hostile
takeovers are usually riskier that mutually agreed upon acquisitions or mergers. In these
cases, the management opposes the acquisition leading the acquirer
to increase its bid sometimes considerably to make the deal go through.

In so called friendly M&A no such escalation of commitment takes place, generally

resulting in a price that is more in line with the real value of each involved company.
7.6.3 THE BENEFITS OF M&A
The benefits of M&A are:
Fast, especially when compared to organic growth.
Full control over all the assets and resources of the preexisting entities.
Acquisition of a full bundle of new resources and competitive advantages.
No need for additional capacity that might increase too much competition in the
industry.
7.6.4 THE DOWNSIDES OF M&A
Acquiring companies usually pay a premium when acquiring the target
company.
o Current shareholders of the target company will only sell their shares if
the price
cashflows.
o

o Information asymmetry.
Implementation issues may prevent the expected synergies from materializing.
o Leveraging synergies takes time. Reorganization of assets and
procedures.
o Convergence of management systems is needed.
o Clash of cultures
o Loss of business focus

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7.6.5 CREATING VALUE THROUGH MERGERS AND ACQUISITIONS
M&A is a tool for growth, international expansion, vertical integration of diversification:
Mergers in the same industry: the objectives are usually to increase volumes
and achieve greater economies of scale or to decrease competition and enhance
profitability. Firms are consolidating or concentrating the industry.
o Reorganization of plants and facilities must be carried out:
o Eliminate redundancies
o Centralize purchasing
o Coordinate pricing
Vertical integration
o Control supply/distribution
o Procurement is internalized
(Unrelated) Diversification (goal of balancing cash flows between businesses
and reducing risks)
o Little change.
o Control of cash management and investments
(Related) Diversification (goal of developing synergies)
o Common assets and inputs
o Sharing of knowledge
International expansion
o Build on assets of local firms
o Transfer sources of competitive advantage
o Emphasize collaboration between different country divisions
In the end:
Value created (destroyed) = Value added as result of acquisition cost of
acquisition Where
Value added because of the acquisition = Value of combined entity Sum of
individual values of each pre-existing companies.
Cost of acquisition = Transaction costs + Acquisition premium +
Implementation costs

8 GLOBALIZATION

8.1 GLOBALIZATION
public
awoke to the fact that business needed to be carried out on a global scale, due to the following
factors:
Diminishing barriers to international trade and foreign direct investment. Creation of
NAFTA and WTO.
Collapse of communist system with new markets becoming more accessible.
Decrease in costs of transportation and communications.

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 Greater exposure to foreign cultures and more homogeneity in demand.
Accelerating pace of technological change and increase in R&D.
Business has globalized dramatically during the last 30 years and will very likely continue to
do so.
What is globalization?
Expanding international trade?
Growth
Increasingly homogeneous products across countries?
Production becoming more concentrated in a limited number of countries.
ng an irrelevant notion?
8.1.1 MULTIDOMESTIC VS. GLOBAL INDUSTRIES

-offs between
these two characters, the global and the local one. Firms cannot be global and local at the same
time. We will have to look at those industry features that affect how companies compete in an
international setting.

At a broad level we can distinguish between two main types of industries:

Multi-domestic industries: the industry is present in many countries, but competition

occurs on a country-by-country level. It is a collection of essentially domestic
industries. E.g.: daily local newspaper, beer industry, retail banks. In these industries,
competitive advantages are specific to each geography and cannot therefore be easily
transmitted from one place to another.
Global industries: competition takes place on a worldwide scale. Competitive
advantages cut across countries. E.g.: aircraft manufacturing, pc industry, telecom
devices. Firms must implement the same strategy everywhere in the world and integrate
activities on a worldwide basis.

Most industries are somewhere between these two types. In addition, industries change over
time and can move in the spectrum.

8.1.2 WHAT DRIVES GLOBALIZATION

Factors impeding globalization - CAGE framework:
Cultural factors:
o Tastes
o Preferences
o Language
o Habits
o E.g.: food, press, TV, consulting
Administrative factors
o Rules and regulations

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 o Depends on the industry: much more important in strategic industries than in
consumer electronics
Geographic factors
o Influence of transportation costs, which depends on the ratio of value/weight
Economic factors
o Levels of economic development influence on purchasing power, infrastructure
Factor favouring globalization:
Economies of scale.
Cost arbitrage opportunities: when various production factors have very different
costs in different regions of the world, firms operating on an international basis can
exploit arbitrage to their advantage.
Opportunities for learning: having a presence in multiple markets makes it possible
to develop new capabilities that will strengthen competitive position in other regions of
the world.
The balance between factors favouring globalization or impeding it will determine where in
the spectrum multidomestic global a specific industry lay.

8.2 INTERNATIONAL STRATEGY

8.2.1 FOREIGNESS LIABILITY
The liability of foreignness can be defined as all the disadvantages companies operating
abroad suffer from, when compared to their local competitors.
These disadvantages may include:
Xenophobia
Lack of local connections
Poor understanding of local conditions
Strategy by analogy
Import duties, regulations
Some of the disadvantages associated with the liability of foreignness are due to the foreign
firms themselves. They tend to underestimate the differences between their home market and
foreign markets. They replicate their strategies abroad without realizing that these strategies
are contingent upon specific local factors that may no longer be present in a foreign market.

companies may overcome these obstacles.

Subsidiaries must be integrated with the foreign company and draw from it valuable resources.
If not, they will suffer from the liability of foreignness without benefiting from the broader
international corporation.

Because of the liability of foreignness, firms seeking to internationalize must pay close
attention to the way in which they are going to exploit their sources of advantage on an
international level.

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8.2.2 ADAPTATION AND CONFIGURATION
There are two defining choices in international strategy formulation:
Adaptation vs. Standardization
Local adaptation implies:
Greater local market acceptability
Less economies of scale
Therefore, whenever a firm seeks to maximize economies of scale, it must refrain from
adapting locally.
In businesses with important CAGE differences, multi-domestic industries, firms should
prioritize adaptation. In businesses with existing opportunities of economies of scale,
global industries, firms should prioritize standardization.
In practice, firms need to adapt to some extent while still achieving economies of scale.
Adaptation should be applied to those product/service attributes that have a differential
value on a geographic basis and which are not very scale intensive, and vice versa for
standardization.
Configuration of activities:
Concentration of activities in one country and then export
o Advantages:
Simpler operations
Better communication and coordination
Greater economies of scale
o Disadvantages
Subject to transportation costs
Poor responsiveness to local specificities
Dispersion of activities and facilities around the world to get closer to the markets they
want to serve. Two kinds: decentralized dispersion and coordinated dispersion.
o Advantages
Closer to local markets
Reduced distances
Reduced liabilities of foreignness
Decentralized dispersion
o Advantages:
Easier to manage
Autonomy of subsidiaries
Fast response to local market
o Disadvantages
Loss of potential economies of scale
Limited benefits from corporate
Exposure to liability of foreignness
Coordinated dispersion: facilities in one country do not just serve consumers in that
market, but also in other markets. Specialized production. Heavily relies on intrafirm
trading: subsidiaries in one country buy and sell from subsidiaries in other countries.
o Advantages:
Local market intimacy

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 Greater economies of scale
o Disadvantages:
High levels of coordination
Bureaucratic rigidity

8.2.3 BUSINESS FREATURES AND INTERNATIONAL STRATEGY

There are only 2 means through which activities can be internationalized:
Export: associated with concentrated configuration.
Foreign direct investment: associated with dispersed configuration.
Exporting is impossible if the service requires the presence of the customer (e.g:
restaurant services). Exporting is necessary when the product can only be made in a
specific location (e.g.: local wines).
8.3 ALLIANCES AND JOINT VENTURES
Intermediary option between organic growth and M&A.
Alliance: a project, activity or business carried out in cooperation by two or more firms.
Joint venture: a jointly owned legal entity that carries out some or all the tasks resulting
from the alliance.
Alliances have two main objectives:
Jointly achieve economies of scale (e.g: coach sharing agreements in the airline
industry).
Build on partners complementarities in terms of assets, resources, capabilities
(e.g.: Amazon and ).
Scale alliances achieve economies of scale based on the accumulated size of partners
involved. (e.g.: alliance between Peugeot, Renault, and Volvo to build V-6 engines. By
pooling their requirements, all three manufacturers were able to achieve acceptable
levels of efficiency in an otherwise narrow market.):

Primarily defensive to resist competition

Scale alliances challenges:
Relatively weak integration between partners
Conflicting objectives
A joint venture could be helpful in addressing these challenges
Complementary alliances seek to leverage complementary skills, resources, and assets
of partner firms.
Broader in scope
Offensive in nature
Complementary alliances challenges:
Shifting complementarities between firms.
8.3.1 THE TROJAN HORSE
Alliances are based on the mutual dependence of partner firms and depend on the
evolution of such a dependence over time. The dependence issue is critical in the case
of complementary alliances since the skills and capabilities of one partner can be learned
or acquired by the other.

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