Week 2

Question 1

PESTEL-model

Answer 1

This model looks at the political, economic, sociocultural, technological, environmental and legal issues surrounding the industry.

Question 2

Five big trends that have a big influence on most of the industries

Answer 2

1. The ageing population
2. Urbanization
3. Climate change
4. Al (Artificial Intelligence)
5. Globalization (the fact that our world is closely connected)

Question 3

Determine the attractiveness of an industry through Porter’s five forces

Answer 3

1. threat of new entrants,
2. Power of buyers,
3. Power of suppliers,
4. Threat of substitutes and
5. Industry rivalry

Question 4

External environment

Answer 4

All factors that can affect a company’s potential to gain and maintain competitive advantage.

Strategic leaders should analyse the external environment, since it can help mitigate threats and leverage opportunities.

Question 5

General environment

Answer 5

Encompasses all factors that the manager has little direct influence over, such as macroeconomic factors (e.g. exchange rates).

The task environment is all factors managers do have influence over, for example, the structure of the industry.

Question 6

Political –> PESTEL

Answer 6

Political factors relate to the process and actions by government bodies that can influence a company’s decisions and behaviour.

Although political factors are in the firm’s general environment, and, therefore, companies should have little impact on them, companies are increasingly trying to have influence through non-market strategies.

Non-market strategies include lobbying, public relations, contributions, and litigations that are favourable to the firm.

Question 7

Economic –> PESTEL

Answer 7

Macroeconomic factors affect economy-wide phenomena. Five economic factors that managers should consider are:

a. Growth Rates: An overall measure of the change in the amount of goods and services produced by a country’s economy;
b. Levels of employment: In boom times, unemployment is usually low. This could make human capital expensive and hard to find;

C. Interest Rates: The amount creditors earn and debtors pay for use of money, adjusted for inflation;

d. Price Stability: A lack of change in the price levels of services and goods. This rarely occurs, so it is more common that firms have deal with changing price levels;
e. Currency Exchange Rates: How much you have to pay for one unit of foreign currency.

Question 8

Sociocultural –> PESTEL

Answer 8

A society’s norms, values and cultures.

Question 9

Technological –> PESTEL

Answer 9

Applying knowledge to develop new processes and products.

Question 10

Ecological –> PESTEL

Answer 10

Broad environmental issues.

Question 11

Legal –> PESTEL

Answer 11

Official outcomes of political processes manifested in mandates, laws, and regulations.

Question 12

Industry effects

Answer 12

Industry’s underlying economic structure. Here, firm performance is attributed to the industry it operates in.

This can involve aspects such as entry barriers, types of products offered, and the size and number of companies.

Question 13

Firm effects

Answer 13

Attribute firm performance to actions taken by managers. According to research, about 20% of firm performance can be explained by industry effects, 25% by other effects (e.g. business cycles), and up to 55% by firm effects.

This means that managers can have a signifiant influence on firm performance.

Question 14

Industry analysis

Answer 14

Allows us to determine the industry’s profit potential and what strategic position a company should take. For industry analysis we use Porter’s 5 forces.

Question 15

Porter’s 5 forces

Answer 15

Porter suggests that firms must not only create economic value, they must also be able to capture it or else suppliers, buyers or competitors will take it - managers must not only worry about direct competition.

Economic value is the value created by a company’s product or service, minus the costs it took to produce it.

According to Porter, the stronger the 5 forces, the lower the industry’s profit potential, making it less attractive.

This means that existing companies competing in an industry should position themselves in a way that leverages weak forces, while relaxing the constraints of strong forces. As a result, this model can help firms to better understand their industry, shaping firm strategy.

Question 16

Threat of Entry

Answer 16

Risk that potential competitors will enter the industry and depress industry profit. New entrants can reduce profits by (1) encouraging existing firms to lower their prices to reduce the attractiveness of entry, or (2) by forcing established companies to spend more to satisfy customers. This increases cost, reducing the profitability of the industry.

Barriers to entry on the other hand, prevent new entrants. These include:

a. Economies of scale: Cost advantages for firms with large outputs;
b. Network effects: The positive effect that one user of good or service has on the value of that same product for other users. For example, Facebook would have no use if no one else used it;

C. Customer switching costs: If firms are buying from one supplier, switching suppliers might mean retraining employees or changing business processes which is expensive and, therefore, discourages switching;

d. Capital requirement: Describes how much capital is needed to compete in an industry. Large investments are harder to find funding for. The threat of entry is high when capital requirements are low compared to expected returns;
e. Advantages independent of size: includes things such as brand loyalty, new technology, preferential access to raw materials, distribution channels, and learning effects;
f. Government policy. Policies can either restrict new entrants, or can encourage new entrants through deregulation;
g. Credible threat of retaliation: if an established firm will react to new entrants for example through price cuts, then new entrants will be deterred.

Question 17

The Power of Suppliers

Answer 17

Reduces the firm’s ability to achieve superior performance for two reasons. Firstly, powerful suppliers can raise costs of production by demanding higher prices or lowering quality.
Secondly suppliers can reduce industry profit by capturing part of the economic value created.

Bargaining power of suppliers is high when:

a. The supplier’s industry is more concentrated than the one it sells to;
b. The suppliers do not depend heavily on the industry for revenue;
c. Firms face significant switching costs when they change suppliers;
d. Suppliers provide products that are differentiated;
e. There are no readily available substitutes for the products the suppliers offer;
f. Suppliers can threaten to forward integrate; for example a supplier will begin producing the same product your company does, instead of just selling materials for producing that product.

Question 18

The Power of Buyers

Answer 18

The pressure industry customers can put on margins by demanding lower prices or higher product quality. Higher product quality typically means higher costs, leaving less profit for the company.

Bargaining power of buyers is high when:

a. There are a few buyers and each buyer purchases large amounts;
b. The industry provides standardised products/commodities;

C. Buyers have low switching costs;

d. Buyers can threaten backward integration; for example a company can begin to produce components it needs in its production instead of buying them from another company.

Question 19

The Threat of Substitutes

Answer 19

Substitutes are products that meet the same basic customer needs, but in a different way.

Products outside of the industry can threaten the profit of the industry and limit the price that industry producers can charge.

The threat of substitutes is high when the substitute offers attractive performance-price payoff or when the buyer’s switching costs to substitute are low.

Question 20

Rivalry among existing competitors

Answer 20

The intensity with which companies fight over market share and profitability. The stronger the four other forces, the stronger the rivalry in the industry.

Rivals can compete in two ways: price and non-price competition. Price competition involves lowering prices. Non-price competition involves creating more value with after sales service, design, higher quality, or advertising.

Question 21

Perfect Competition

Answer 21

The industry has many small firms that cannot set prices. They offer a commodity product.

There are no entry barriers and industry profitability is low since consumers make purchasing decisions solely based on price.`

Question 22

Monopolistic Competition

Answer 22

The industry has many differentiated firms with some price setting ability, and some barriers to entry.

Question 23

Oligopoly

Answer 23

The industry has a few large firms with differentiated products. There are high barriers to entry.

The most important characteristic of an oligopoly is that firms are interdependent, so every firm has to consider the actions of its competition.

Question 24

Monopoly

Answer 24

The industry has one large firm that may or may not offer a unique product. The monopolist has a lot of pricing power, and barriers to entry tend to be very high.

Natural monopolies occur when Governments grant only one company the right to supply a good that would normally not be profitable to supply if there were more firms in the market.

An example is electricity because it is so expensive to create all the power lines, no company would do this unless they were the only ones who could do so.

Near monopolies are firms that have a lot of market power due to valuable patents or technology. An example could be certain pharmaceutical companies.

Question 25

Four factors affecting the intensity of rivalry among competitors:

Answer 25

1. The competitive industry;
2. Industry growth; higher growth means lower rivalry, because rivals capture the parts of the market that are growing, instead of taking parts of the market away from each other;
3. Strategic commitments; these are actions that are costly, difficult to reverse and long-term. If firms make strategic commitments to compete in an industry, rivalry among competitors is more likely to be intense;
4. Exit barriers; these are obstacles, both economic and social, that determine how easily a firm can leave an industry. An example is fixed costs that need to be paid regardless of operation. An industry with low exit barriers is more attractive because firms can exit more easily. These exits reduce competitive pressure, and therefore rivalry, for the remaining firms.

Question 26

The Strategic Role of Complements

Answer 26

Complements are products, services, competencies that add value to the original product.

Complements increase demand for the primary product, enhancing the profitability of industry.

A complementer is a company that makes your customers value your product more because they can combine it with theirs. Co-opetition is when competitors cooperate to achieve a shared strategic objective.

Question 27

Strategic group

Answer 27

Set of companies that pursue a similar strategy within a specific industry.

Question 28

Strategic group model

Answer 28

This is a framework that clusters firms into groups based on strategic dimensions, to explain differences in firm performance in the same industry.

Question 29

Mobility barriers

Answer 29

Industry-specific factors that separate one strategic group from another. Therefore, a strategic group is defined by mobility barriers.

Furthermore, mobility barriers are strategic commitments which are costly and not easily reversed.

Question 30

Method to measure and assess competitive advantage: 1. Accounting profitability

Answer 30

Calculating financial ratios and collecting data from publicly available sources, such as the income statement and balance sheet. It allows for an accurate assessment of firm performance, benchmarked against other competitors.

Firms are also legally required to make these statements that are stringently regulated, making them reliable.

Some ratios that assess profitability and allow direct comparisons to competitors include the ROIC (Return On Invested Capital), the ROE (Return On Equity), the ROA (Return On Assets), and the ROR (Return On Revenue).

ROIC is favoured because it is a good proxy for profitability, measuring how effectively a firm uses its total invested capital. If the ROIC exceeds the cost of capital, a firm generates value.

Accounting profitability, therefore, allows us to assess firm performance, relative to competitors and previous time periods. It provides a good starting point for determining competitive advantage.

Question 31

Disadvantages of Accounting profitability

Answer 31

1. All accounting data is historical and backward-looking;
2. Accounting data does not consider off-balance sheet items (e.g. pension obligations);
3. Accounting data focuses mostly on tangible assets, which are no longer the most important (e.g. customer experience is not included).

Question 32

Method to measure and assess competitive advantage: 2. Shareholder value creation

Answer 32

A second method to measure and assess competitive advantage is shareholder value creation. Shareholders own shares in a public company and are the legal owners.

Shareholders own shares in a public company and are the legal owners. As a result, they see return on their risk capital as the most important measure.

Question 33

Method to measure and assess competitive advantage: 3. Risk capital

Answer 33

Investment they give in return for their equity share. In case of bankruptcy, this cannot be recovered. Investors mainly focus on the total return to shareholders.

This involves stock price appreciation and dividends. Looking at stock market valuations over the long term allows us to assess competitive advantage.

Question 34

Advantages of using the shareholder value creation

Answer 34

1. Is external and forward-looking;
2. According to the efficient-market hypothesis, all the available information about a company’s past, present, and future performance is embedded in its stock price. From this perspective, the share price is an objective indicator of performance;
3. Market capitalization captures the current total market value of a firm’s total outstanding shares and is a useful point of comparison in the long term.

Question 35

Limitations of using the shareholder value creation

Answer 35

1. Stock prices can be highly volatile, making it hard to assess firm performance, especially in the short term;
2. Overall macroeconomic factors, such as economic growth, also all have a direct bearing on stock prices;
3. Stock prices often reflect the psychological mood of investors, which can sometimes be irrational.

Question 36

Economic value creation

Answer 36

This means a firm has a competitive advantage when it creates more economic value than rival firms.

Economic value created is the difference between buyers’ willingness to pay for a product or service and the firm’s total cost to produce or provide it.

Question 37

Reservation Price

Answer 37

When looking at the willingness of buyers to purchase something we look at their reservation price; the absolute maximum a buyer is willing to pay for something, based on the total perceived consumer benefit.

Question 38

3 elements to consider for economic value creation

Answer 38

1. Value: the dollar amount the consumer attaches to good or service and hence the maximum amount they are willing to pay. This is also referred to as the reservation price;
2. Profit/Producer Surplus: the difference between the price charged and cost to produce;
3. Consumer Surplus: the difference between value and price charged.

Question 39

3 types of costs included in economic value

Answer 39

1. Fixed costs
2. Variable costs
3. Opportunity costs

Question 40

Balanced scorecard

Answer 40

This perspective claims managers should rely on many different internal and external metrics to accurately assess company performance. There are 4 key questions to assess at a firm’s current state:

1. How do customers view us?
2. How do we create value?
3. What core competencies do we need?
4. How do shareholders view us?

Question 41

Advantages of using the balanced scorecard approach

Answer 41

1. It uses both internal and external views of the firm;
2. It uses long-term and short-term data;
3. It allows both identification and improvement from past data, so that the company can position itself for future growth;
4. It also allows managers to link the strategic vision to responsible parties within the organisation, and translate the vision into measurable operational goals.

Question 42

Disadvantages of using the balanced scorecard approach

Answer 42

The scorecard is a tool for strategy implementation, not formulation.

It provides only limited guidance on metrics to use, and failure to achieve competitive advantage is due to strategic failure, not a failure of the framework, meaning the framework is only as good as the manager using it.

Question 43

Triple Bottom Line

Answer 43

The Triple Bottom Line focuses on a firm’s economic, social, and ecological performance. This is also referred to as the 3 Ps: Profits, People, and Planet.

A positive result in all three areas creates a sustainable strategy. A sustainable strategy is one that can be followed over time without detrimental effects on profits, people, or the planet.

The triple bottom line takes a more integrative and holistic view in assessing a company’s performance.

Question 44

Types of business models

Answer 44

• Razor-razor-blades; where the initial product is sold at a loss or even for free to drive demand, but the firm makes money on the replacement parts needed.
• Subscription; where users pay for access to a product whether they use it during the payment period or not;
• Pay-as-you-go; where users pay only for the services they consume;
• Freemium; provides basic features of a product free of charge, but charges for premium services, such as advanced features;
• Wholesale; where product providers sell to retailers at a fixed price, and retailers can set their own price to earning a profit as well;
• Agency; where the producer relies on an agent to sell the product at a predetermined percentage commission;
• Bundling; where products for which demand is negatively correlated are sold at a discount. A negative correlation between products means you value one product more than the other.

Question 45

5 different ways in which business models can change

Answer 45

1. Firstly, business models can be combined. An example includes combining the razor-razor-blade model and the subscription model;
2. Models can also evolve. For example, freemium can be seen as an evolution of the razor-razor-blade model;
3. Disruption can also occur. For example, certain companies can come in and use radically different business models to disrupt industries;
4. Firms can also change business models as a response to disruption. To counterattack, other firms might adopt different business models as well;
5. Lastly, legal conflicts cause business models to change. For example, fast development of business models can lead producers to breach existing commercial laws. An example of this could be Uber.