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					                ESM 210
Strategic Management of Business

    Corporate Strategy Value
    Chain and Diversification
             Week 6 May 9, 2002

             Magali Delmas
   Bren School of Environmental Science and
 Sources of Competitive Advantage

                         Cost advantage


        Controlling the Cost Drivers

•   Independent of firm size, scope, or cumulative
    –   input prices, location, economies of density, process
        efficiency, technological change, government policies
•   Related to firm size or scope
    –   economies of scale, economies of scope, capacity utilization
•   Related to cumulative experience
    –   learning curve
•   Relative to the value chain and organization
    Company Value Chain
Primary Activities and Costs

Inbound                   Outbound    Sales and              Profit
             Operations                           Service
Logistics                 Logistics   Marketing              Margin

Product R&D, Technology, Systems Development

            Human Resources Management                      Support
                General Administration                      and Costs
Costs drivers in the automobile industry
             The Value Chain for the environment

                Research  Pollution Energy       Waste
Technology                                                    Recycling
                and       control   conservation minimization

Stages in
product         Product              Manufacturing, Product
                          Raw materials                       Final
life-cycle      design               sales          use
                          sourcing                            disposal

 Differentiation Strategies

• A product / service with unique and appealing
  attributes allows a firm to
      Command a premium price and/or
      Increase unit sales and/or
      Build brand loyalty
       = Competitive Advantage

     Classification of benefit drivers

• Physical characteristics of the product
   – performance, quality, features, aesthetics, durability…
• Quantity and characteristics of the services or complementary
  goods the firm or its dealers offer for sale
   – training, consulting services, warranties…
• Characteristics associated with the sale or delivery of the good
   – timeless of delivery, availability of credit, location of seller…
• Characteristics that shape consumer’s perception of product
   – product reputation, perceived financial stability of firm
• Subjective image of the product
   – advertising messages, packaging, labeling...
 Differentiation opportunities in
 the value chain


Best choices for gaining a longer-lasting, more
profitable competitive edge:
   New product innovation
   Technical superiority
   Product quality and reliability
   Comprehensive customer service                                          10
Environmental Product
Differentiation: requirements

• Forest Reinhardt 1998
  – Find willingness among customers to pay
    for environmental quality
  – Establish credible information about the
    environmental attributes of its products
  – Innovation must be defensible against
    imitation by competitors

Organic food willingness to

• Environmental sensitive practices:
  public good
• Quality of product: private benefit
  – Taste
  – Impact on health (GMOs, mad cow etc…)
• Link between organic food and high
  quality food

Organic food

• Food market share 1999
  – Austria 10% ; Switzerland 7%; Sweden 7%;
    Finland 7%; Australia 1-2%
• The organic share of the food market is
  projected to reach 30% in Europe by 2010
• The world market for organic produce
  – US$17b/an in 1999,
  – is expected to reach US$100b by 2006 (25%/an
    growth rate).
• The US market is estimated at US$3b in the
  US, growing at ~25%/an.                          13
Organic food credible

• How much information about product
  – is necessary?
  – is manageable, tolerable?
• How to differentiate between labels?

   Organic certification programs
• State organic certification programs
   – Colorado Dept. of Agriculture; Idaho Dept. of Agriculture; Kentucky Dept. of
     Agriculture+ Louisiana Dept. of Agriculture and Forestry; Maryland Dept. of
     Agriculture; New Hampshire Dept. of Agriculture ; New Mexico Organic
     Commodity Commission ; Oklahoma Dept. of Agriculture; Rhode Island Dept. of
     Environmental Management ; Texas Dept. of Agriculture; Virginia Dept. of
     Agriculture & Consumer Services; Washington State Department of Agriculture
• Private organic certification programs
   –   California Certified Organic Farmers; Carolina Farm Stewardship Assn; Demeter Assn; Farm
       Verified Organic, Inc. Florida Certified Organic Growers & Consumers Georgia Organic Growers
       Assn. Hawaii Bio-Organic Growers Assn. Hawaii Kauai Organic Growers Assn. Hawaii Organic
       Farmers Assn. Indiana Certified Organic Maine Organic Farmers & Gardeners Assn. Mountain
       State Organic Growers & Buyers Assn. Northeast Organic Farmers Assn.-Connecticut Northeast
       Organic Farmers Assn.-MA Northeast Organic Farmers Assn.-NJ ; Northeast Organic Farmers
       Assn.-NY ; Northeast Organic Farmers Assn.-Vermont ; Ohio Ecological Food & Farming Assn;
       Oregon Tilth; Organic Crop Improvement Assn; Organic Growers & Buyers Assn; Organic
       Growers Of Michigan; Organic Verification Organization of North America; Pennsylvania
       Certified Organic ; Quality Assurance International; Scientific Certification Systems (Nutriclean) ;
       Tennessee Land Stewardship Assn; Vermont Maple Sugarmaker's Assn

Organic wine: an exception?

• Willingness to pay?
• Survey of California wine consumers most
  important factors in wine purchasing
     »   1. Previous tasting
     »   2. Grape variety
     »   3. Winery environmental sensitivity
     »   4. Price
     »   5. Brand name etc…
• Negative image associated with Organic wine


• Green power: willingness to pay?
• Credible information?
• Barrier to imitation?

Willingness to pay?

  – provides "Customer Credits" to consumer who
    purchase eligible renewable electricity from
    electric service providers that are registered with
    the California Energy Commission.
  – Through this program, consumer choosing
    renewable or "green power" can automatically be
    credited with up o 1.0 cents per kilowatt-hour

Credible information Green e

• Green e
  – 50% or more of the electricity supply comes from
    one or more of these eligible renewable
    resources: solar electric, wind, geothermal,
    biomass, and small or certified low-impact hydro
  – if a portion of the electricity is non-renewable, the
    air emissions are equal to or lower than those
    produced by conventional electricity,
  – there are no specific purchases of nuclear power
• Green-e is administered by the Center for
  Resource Solutions, a non-profit organization19
  based in San Francisco, California
Green Mountain Energy 1997

• Provides electricity from wind, solar, water,
  geothermal, biomass, and natural gas
• Ex in California, consumers have the choice of three
  different blends of electricity:
      » 100% Renewable Power (1% new renewables and 99%
        old renewables),
      » Solar for the Future (5% new renewables and 95% old
      » and Wind for the Future (25% new renewables and 75%
        old renewables).
• About a half a million customers in
   – California, Connecticut, New Jersey, Ohio, Pennsylvania and
Green Mountain
Connecticut Price


• Sept. 20 2001 -- Green Mountain Energy
  Company is extremely disappointed
  that the California Public Utilities
  Commission today voted to suspend
  the rights of Californians to choose their
  energy provider


Company                Product                Annual    % Fuel      % Fuel      Gree-e     Stat
                                              Premiu    Mix from    mix from    certifie   e
                                              m         renewable   newly       d
Go-Green. Com          Eco-Save               $46.69    100
                                                        s           5
                                                                    created     Yes        CA
Common wealth Energy   Green Smart            -18.00    100         renewable
                                                                    5           Yes        CA
Green     100%Renewable          59.40     100         1           No         CA
Green     Solar for the future   83.40     100         5           Yes        CA
Green     Wind for the future    263.40    100         25          Yes        CA
PG&E                   Clean Choice           20.40     100         5           No         CA
PG&E                   Clean choice 50        130.80    100         12          Yes        CA
PG&E                   Clean choice 100       210.00    100         25          Yes        CA            Green Planet           -72.00    100         5           Yes        CA
CY Energy Coop         EcoWatt                150.00    100         0           Yes        CT
Energy Atlantic        PureGreen Energy       120.00    100         0           No         ME
Connectiv              Nature’s Power 50      94.80     100         0           Yes        NJ
Connectiv              Nature’s Power 100     94.80     100         0           Yes        NJ
Green     EcoSmart               41.40     10          1           No         NJ
Green     Enviroblend            149.90    50          5           Yes        NJ
Electric AmericA       100%Hydro              -102.00   100         0           No         PA
Energy Coop of PA      Eco Choice 100         5         100         5           Yes        PO
Green     Eco Smart              31.80     10          1           No         PA
Green     Enviro Blend           144.60    50          5           Yes        PA
Green     Nature’s Choice        220.20    100         5           Yes        PA
Mack Service Group     100% Renewable         -33.60    100         5           Yes        PA
Business and the Environment

• Firms will capture environmental value
  depending of fundamental economics of the
• Much of the demand for environmental
  quality stems from government regulation
  – (especially for industrial sectors)
• Environmental policies must be integrated
  with other aspects of strategy

   Level of Strategy and
   Organization structure

Corporate Strategy       Corporate Head Office

Business Strategy    Division A        Division B

                         R&D               R&D

                          HR                HR
   Strategies           Finance           Finance

                      Production        Production

                     Marketing/Sales   Marketing/Sales
Diversification and Corporate

•   A company is diversified when it is in two or
    more lines of business
•   Strategy-making in a diversified company
     –   A diversified company needs a multi-industry,
         multi-business strategy
     –   A strategic action plan must be developed for
         several different businesses competing in
         diverse industry environments

Economies of Scale and
Economies of scope

• Economies of Scale
  – MC < AC
    » MC= marginal cost
    » AC= Average cost
• Economies of Scope
          – Total cost to a single firm producing Qx units of
            good x and Qy of good Y

    Concept: Economies of Scope

•   Arise from ability to eliminate costs by
    operating two or more businesses under
    same corporate umbrella
     –   Relative to the total cost of producing a variety
         of goods together in one firm versus separately
         in two or more firms
•   Exist when it is less costly for two or more
    businesses to operate under centralized
    management than to function
    independently                             29
Sources of economies of scope

• Marketing economies
• R&D
• Purchasing economies

 Concept: Strategic Fit

• Exists among different businesses when their
  value chains are sufficiently similar to offer
• Offers competitive advantage potential of
   – Lower costs
   – Efficient transfer of
       » Key skills
       » Technological expertise
       » Managerial know-how
   – Use of a common brand name                  31
Types of Strategic Fit

• Technology fits

•Operating Fits

•Distribution and Customer Related fits

•Managerial fits

    Technology Fits

•   Potential for sharing common technology or
    transferring technological know-how
•   Potential benefits
    – Cost-savings in technology development
      and new product R&D
    – Shorter times in getting new product to market
    – Interdependence between
      resulting products leads to increased sales

    Operating Fits

•   Offer potential for activity sharing or skills transfer
     –   Procuring materials
     –   Improving production processes
     –   Manufacturing components
     –   Assembling finished goods
•   Example supply chain management or
    manufacturing expertise can benefit another
     –   Producing office furniture vs home furniture

    Distribution and
    Customer-Related Fits
•   Products are
     –   Used by same customers
     –   Distributed through common dealers and retailers
     –   Marketed or promoted in similar ways
     –   Sold under a common brand name

•   Benefits
     –   Single sales force for related products , Advertising
         related products together, Use of common brand name,
         Joint delivery and shipping, Combining after-sale
         service and repair work, Joint order processing and
         billing, Joint promotional tie-ins, Combining dealer
         networks                                            35
Managerial Fits

•   Emerge when different business units require
    comparable types of
    –   Entrepreneurial know-how
    –   Administrative know-how
    –   Operating know-how
•   Allow accumulated managerial know-how in
    one business to be useful in managing
    another business
   Examples of related business

• Gillette                             • Philip Morris
   – blades and razors                   – cigarettes (Marlboro,
   – toiletries (right guard, foamy,       Virginia Slims, Benson &
     dry idea)                             Hedges, Merit…)
   – Jafra skin care products            – Miller Brewing Company
   – writing instruments and               (Miller Genuine Draft,
     stationery products (paper            Miller Lite, Icehouse, Red
     mate pens, Parker pens,               Dog..)
     Waterman pens..)                    – Kraft General Foods
   – Braun shavers, coffeemakers,          (Maxwell House, Sanka,
     alarm clocks, mixers, hair            Jell-O, Thombstone pizza…)
     dryers, and electric                – Mission Viejo Realty
Firm boundaries and
transaction costs

• Why must business units be brought into the
  firm for economies to be realized?
• Where transaction costs are present this is an
  efficient model
• Transaction costs are more likely to appear
  when there are investments in specific assets
• Ex: trade secrets, specific know-how, capital
  investments, know-how etc…

Unrelated Diversification

•   Involves diversifying into businesses with
     –   No strategic fit
     –   No meaningful value chain
     –   No unifying strategic theme
•   Approach is to venture into “any business
    in which we think we can make a profit”
•   Firms pursuing unrelated diversification are
    often referred to as conglomerates             39
    Risks of a Single Business
•   Putting all the “eggs” in one industry basket
•   If market becomes unattractive, a firm’s prospects
    can quickly dim
•   Unforeseen changes can undermine a single
    business firm’s prospects
     –   Changing customer needs
     –   Technological innovation
     –   New substitutes
    Appeal of Unrelated
•   Business risk scattered over different industries
     –   Stability of profits -- Hard times in one industry may
         be offset by good times in another industry

•   Capital resources can be directed to those
    industries offering best profit prospects

•   If bargain-priced firms with big profit potential
    are bought, shareholder wealth can be enhanced

Drawbacks of Unrelated

•   Difficulties of competently managing many diverse
•   There are no strategic fits which can be leveraged
    into competitive advantage
     –   Consolidated performance of unrelated
         businesses tends to be no better than sum of
         individual businesses on their own (and it may
         be worse)
     –   Promise of greater sales-profit stability over
         business cycles seldom realized
  Unrelated Business portfolio

• Union Pacific               • American Standard
  Corporation                   – Air-conditioning
  – Railroad operations           products (Trane,
  – Oil and gas exploration       American Standard)
  – Microwave and fiber         – Plumbing products
    optic transportation          (American Standard,
                                  Ideal standard,
  – Hazardous waste
    management disposal
                                – Automotive Products
  – Trucking
                                  (commercial and utility
  – Oil refining                  vehicle braking and
  – Real estate                   control systems)    43
Diversification and
Shareholder Value


    –   A strategy-driven approach to creating
        shareholder value


    –   A finance-driven approach to creating
        shareholder value

Next week

• Mid-term:
  – bring blue book
  – Based on readings and lecture
• Technology Management
  – Prepare write-ups
• Arturo Keller
    First-Mover Advantages

• When to make a strategic move is often as crucial
  as What move to make
• First-mover advantages arise When
    – Pioneering helps build firm’s image and reputation
    – Early commitments to raw material suppliers, new
      technologies, & distribution channels can produce cost
    – Loyalty of first time buyers is high
    – Moving first can be a preemptive strike

    First-Mover Disadvantages

•   Moving early can be a disadvantage (or fail to
    produce an advantage) when
     – Costs of pioneering are sizable and loyalty of first
       time buyers is weak
     – Rapid technological change allows followers to
       leapfrog pioneers
     – Achievements of pioneers are easily and quickly
       imitated by late movers
     – It is relatively easy for latecomers to crack the

Sources of early mover

• Learning curve
   move further down on the curve
• Network externalities
   consumer benefit from purchasing the product is
     greater the more consumers currently use the
     product o
• Reputation and buyer uncertainty
quality that cannot be assessed before purchase
  (established reputation)
• Buyer switching costs

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