Strategic Management Concepts and Cases, 4th Edition Solution Manual

Strategic Management Concepts and Cases, 4th Edition BY Jeffrey H. Dyer

Chapter 1 – What is Business Strategy?

Class Exercise – Marketing Strategy at Delta

Teaching Note Source for this exercise is in the Chapter 1 PowerPoint deck and textbook. (Mini Case: Marketing Strategy at Delta. See slide notes for additional information.) Comments from the slide notes are adapted for small group discussion and large group debrief. The students are instructed to read the chapter before coming to class. An option is to give students advance notice of an upcoming in-class exercise. Students are given approximately 15 minutes to discuss the questions and document answers in small groups (Bloom Comprehension and Application). A debrief is then conducted with the entire class. The debrief takes approximately 20-25 minutes.

Strategies are more likely to be successful when the plan explicitly takes into account four factors: 1. The attractiveness of a market 2. How to offer unique value relative to the competition 3. What resources or capabilities are necessary 4. How to sustain a competitive advantage once it has been achieved (i.e. How to create barriers to imitation to prevent other companies from offering that same value.)

This exercise focuses on “barriers to imitation”, but could also include a discussion of how Delta addressed the other three factors: market, value proposition, resources & capabilities.

Mini Case In the mid-1980s, Delta’s market researchers found out that customers (particularly business customers) were strongly influenced to choose a particular airline by the airline’s frequent flyer program.

Consequently, to motivate customers to choose Delta, they teamed up with American Express (an exclusive arrangement) to offer a special program: customers could receive triple miles if they would fly on Delta and purchase the tickets using the American Express card.

How would you evaluate Delta’s strategy? (Good or Bad?) Consider the following questions: 1.

Average Load Factor (# passengers vs available seats) = 78%. Why is this relevant?

Unless demand (passenger #s) decreases significantly, the plane is flying whether it’s 70% or 100% full.

The marginal additional cost for more passengers is near zero. Same # of people to fly plane, fuel, etc., don’t have to hire more people to manage the additional business. 1 more passenger = all profit.

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2.

On what does this new strategy depend in order for it to succeed? AND….how does it help me get the additional 22% load factor?

Have to consider: • Will people use their Am Ex to fly w/ us?

• Will some people switch from another airline? (Don’t have to fly more – just need to get them to switch).

• What if they don’t switch? Are we just giving more perks to existing customers?

• How does this strategy help me get the additional 22% LF? Other aspects of the program: • Am Exp gives Delta lower card rate.

• They split promotional expenses for the marketing.

• Am Exp has large market share especially among business travelers (65-70%) but…… Delta doesn’t have 65-70% of air travelers….this is a Big Opportunity for Delta to gain more customers.

3.

If you were running other airlines, how would you respond to Delta’s strategy?

Team with another credit card company: • United Airlines – Visa • Northwest Airlines – MasterCard • Southwest Airlines – Visa.

Delta has AmEx – the dominant card used by business travelers – they typically pay higher fares, pay a yearly fee and fly during week. These are the target customers. What if you don’t match the triple miles? Will you lose customers?

4.

Do you think this strategy led to more customers for Delta? Explain.

Probably not once competition kicks in with their programs. Because you wouldn’t necessarily attract more customers as business people are the ones paying – they or their company pays the yearly fee for Am Ex. The casual traveler probably isn’t going to pay yearly fee to get triple miles.

So the program is attracting the same people who are already attracted to it: 1. Am Ex 2. Delta 3. Am Ex and fly other airlines.

Some people might go get the Am Ex and now they can get triple miles if they fly Delta.

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5. In the end – as a result of Delta’s strategy, who were the biggest winners?

The Customers. See Class Debrief Notes below.

What actually happened? (Class debrief) 1. Within a week every other major carrier announced they would offer triple miles AND they didn’t care how you paid.

2. Now all of a sudden the Am Ex requirement was a weakness. With that in mind, what is the big issue with Delta’s approach? There was NO BARRIER TO IMITATION. 3. When you take a strategic action, you have to ask, what’s the barrier to imitation? a. If there is none, it can be imitated the next day by dropping price and there goes any advantage you had. b. If it can be quickly imitated, then there is no Cost Advantage. c. That was the case with the “triple mileage” program. d. Since all airlines matched the triple miles strategy, who was the big winner?

CUSTOMERS! Conclusion: • This continued for about 2 years.

• The federal government stepped in and said: “you know what – this looks like a pretty big liability you are building up. You need to estimate and calculate the liability and put it on your balance sheet” • Airlines started to calculate the liability – it was big so they changed the frequent flyer programs: 1. Grandfathered you on your old miles.

2. Got rid of triple miles.

3. Increased # of miles needed to earn free trips.

• • • •

In the end, none of those companies were better off.

Airlines thought these were strategic moves they had to make but in the end it didn’t help any of them.

These partnerships / relationships led to the co-branded credit cards we see today.

You probably could argue that Delta was even a little worse off because they teamed up with Am Ex…and their fliers had to use Am Ex to get the triple miles. o And….could say that Delta did get some benefit of Am Ex who helped to fund the program…..so they did get some visibility.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 3

Chapter 2 – Analysis of External Environment: Opportunities and Threats Class Exercise – Porter’s Five Forces Teaching Note Source for this exercise is textbook Chapter 2. Two slides are included in the student handout for quick reference. Students will be analyzing companies later in the semester using Porter’s Five Forces. The purpose of this exercise is to enhance student knowledge and comprehension (Bloom’s Taxonomy) of each of the five forces and other aspects that influence the external environment. It also requires the students to actively engage with the textbook to find the answers.

Students are given approximately 30 minutes to research and document their responses during class in small groups. You may assign select topics to groups OR have all groups complete the entire exercise depending on available time. A large group debrief follows for the balance of class time. Where student responses are insufficient, the instructor can “fill in the blanks” or ask another group to complete the thought.

This exercise occurs early in the semester and it sets the stage for the type of engagement, dialog and contribution that is expected during this course.

Exercise Porter (2007) pointed out that “the arena in which competition takes place is the industry in which a company and its rivals vie for business. Each industry has a distinctive structure that shapes the nature of competitive interaction that unfolds there. Understanding the underlying structure of a company’s industry, now and in the future, is a core discipline in strategy formation” (Porter, p. 1-2).

Porter argues that “to understand industry competition and profitability, one must look beyond their differences and view industries at a deeper level. In any industry, there are five basic forces whose collective strength determines the long-run profit potential of the industry. Understanding competitive forces, and their causes, gives a strategist a way to size up any industry, regardless of whether it is a product or a service, emerging or mature, high tech or low tech. An analysis of industry structure reveals the roots of an industry’s profitability at any point in time while providing a framework for anticipating and influencing changes in industry competition (and profitability) over time. As you will see, defending against the competitive forces or shaping them in a company’s favor becomes an important component of strategy” (Porter, p.1-2).

The purpose of this exercise is to enhance your knowledge and comprehension of Porter’s Five Forces Model and other aspects that influence the external environment. Everyone is expected to contribute.

For this assignment please do the following: 1. Assign discussion leader, recorder (takes notes), reporter (role may be shared for large group debrief) and timekeeper (monitor time remaining, keep team informed) 2. Use textbook as your primary resource.

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3. Discuss as a group those concepts and ideas related to your assignment.

4. Fine tune the information you plan to share with the larger group. (You may use notes, but don’t read them to us when you report out.)

5. Use your time efficiently for good discussion, documentation and a report out practice, i.e. what will you say?

Groups Assignment 1&2 Buyer Power: (1) Explain the 2 situations when buyers have higher power.

(2) Provide at least 2 ways that a firm can neutralize buyer power.

Two situations when buyers have higher power are when buyers hold a stronger bargaining position than sellers and when buyers are price-sensitive.

1. Buyer bargaining power – 4 factors influence the degree to which buyers have bargaining power over their suppliers: Switching costs, demand, number or concentration and size of buyers, credible threat of backward integration (buyer can make the product itself).

2. Buyers are price-sensitive – if buyers are more price sensitive, they will exert pressure on suppliers to keep prices low. They will exert pressure through price negotiation and comparison shopping. Buyer price sensitivity tends to increase in the following situations: buyers are struggling financially, product is a significant proportion of buyer’s cost, buyers purchase in large volumes and expect price breaks, product doesn’t affect buyers’ performance very much, product doesn’t save buyers money.

Two ways that a firm can neutralize buyer power include: 1. Differentiate your offering so that it uniquely responds to only certain buyer needs.

Buyers have less power when something you offer is unique.)

2. Narrow the options of the buyer through market consolidation or exclusive alliances.

Buyers have less power when there are fewer choices.

Supplier Power: (1) Explain the 2 factors that give suppliers power.

(2) Provide at least 2 ways that a firm can neutralize supplier power.

When supplier industries have strong bargaining power, they can charge higher prices, which tend to decrease average profitability for any industry. Two factors that give suppliers power are the number or concentration and size of suppliers and credible threat of forward integration.

1. Number or concentration and size of suppliers – follows the law of supply and demand. Few sellers, but lots of buyers, then the buyers have to compete to get the products that they want, often paying higher price.

2. Credible threat of forward integration – Supplier can threaten forward integration; that is, do what the buyers do, if the buyers don’t offer concessions. (See Google example in textbook.)

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Groups Assignment

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Ways a firm can neutralize supplier power include: 1. Narrow the sell options of the supplier through market consolidations, merger or alliances.

2. Develop alternative sources of supply.

3. Create a partnership with a supplier and encourage that supplier to make transactionspecific investments to provide inputs to you as the customer at lowest possible cost.

4. Diversify your product offerings (or expand capabilities) to diminish dependence of your business on any particular supplier (e.g. Buyer has a private fleet and is therefore not solely dependent on less-than-truckload or truckload carriers (supplier) for transportation of goods.)

Threats of New Entrants: (1) Explain barriers to entry.

(2) Provide at least 4 examples or ways to increase barriers to entry.

Barriers to entry is the way organizations make it more difficult for potential entrants to get a foot hold in the industry. Examples include: 1. Economies of Scale, Experience or Learning – occurs when cost/unit of production decreases as the firm produces more. Economies can come from mass manufacturing methods, purchasing discounts for high volumes, employees who are better at their work (experience, learning), ability to spread fixed costs such as cost of machinery, R&D, advertising and marketing across more units. New firms would be at a cost disadvantage.

2. Other costs not related to scale include: patents or proprietary technology, better locations, economies of scope (less expensive costs per unit created by bundling different types of products), preferential access to critical resources 3. Capital Requirements (R&D, equipment, access) 4. Network Effects – greater number of people using products from a given firm, the greater demand grows for that firm’s product. Trying to compete with Facebook would put a New Entrant at a disadvantage.

5. Government Policy Restrictions – Governments may increase the cost of entry by requiring bonding, licenses, insurance or environmental studies before a firm can enter an industry.

Substitute Products: (1) What are substitute products?

(2) Explain the factors that determine the intensity of a threat of substitutes.

(3) Provide examples(s) Substitute products are fundamentally different but serve the same basic function or purpose as another product.

Factors that determine the intensity of a threat of substitutes include:

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Groups Assignment 1. Awareness and Availability – Threat increases when substitute products are well known.

2. Price and Performance - Customers more likely to switch if costs of switching are low. The price of the substitute itself will also factor into the decision.

Example(s): 1. Fruit juice is a substitute for any number of other drink products: coffee, soda, wine.

All do essentially the same thing; that is, quench your thirst.

2. Apple iPhones and Samsung smart phones.

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Apply the Five Forces Model: (1) Select a company and conduct a high level Five Forces Analysis.

(2) Explain aspects of the Five Forces and examples from your company example in your report out.

This is an optional exercise. Time permitting, it is helpful to have students select a company in which they are interested or in which they have some knowledge and work through the Five Forces.

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General Environment: 1. Explain the concept of the General Environment 2. Describe and use examples for all 8 components of the General Environment.

Classification of Industries: 3. Briefly describe how the US government classifies industries.

General Environment – can affect firms in a variety of ways, including affecting the shape of each of the five industry forces. Aspects of the General Environment guide managers’ strategic decisions. The eight categories in the General Environment are highlighted on the slide below and a detailed explanation of each is provided in the text. A brief summary follows: 1. Complimentary Products/Services: Can be used in tandem with other industries, e.g. smart phone operating systems and applications that are complementary.

2. Technological Change: Has potential to radically reshape a firm’s landscape and sometimes society in general. Example: Smart phones (used for banking, communication, music).

3. General Economic Conditions: The state of the economy can affect a region or the nation and ability for a firm to be profitable. Analyzing the economic environment involves: measuring economic growth rate, interest rates, currency exchange rates and rate of inflation or deflation. a. Economic expansion tends to improve customer balance sheets, lowers price sensitivity and increases growth rate in an industry. As customers purchase more, it eases the rivalry. When the economy slows down, industry growth rate slows, customers are more price sensitive and suppliers struggle looking for ways to get profits.

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Groups Assignment b. Interest rates: Can affect rivalry by increasing or decreasing the demand for products. True for expensive items like houses, cars, education; that is, things that require people to take out loans. i. Interest rates low: industry growth rate increases/rivalry decreases. ii. Interest rates high: the opposite occurs. As interest rates increase, new investments becomes more difficult. c. Currency exchange rates: Reflect the value of one country’s currency in relation to the currency in another country. Exchange rates can have a large impact on prices that customers pay for products from firms in other countries. Example: Nestle (text). d. Inflation: A significant, consistent rise in prices can create problems for firms.

Inflation, or the opposite, deflation, means that the value of the dollar doesn’t stay constant. Today product sells for $1.00. Two percent (2%) inflation means the product sells for $1.02 next year. Inflation tends to decrease overall economic growth increasing rivalry. When firms can’t predict the price at which they will sell the product, investments in new product development are riskier.

4. Demographic (population) Forces: involves changes in the basic characteristics of a population including # of people, average age, # gender/ethnicity, income distribution.

These changes result in shifts in the product and geographic markets that firms target and thus, are accompanied by opportunities and threats.

5. Ecological/Natural Environment: Shortages for key inputs/raw materials, fluctuations in cost of energy, changing public perception of how business affects the environment.

6. Global Forces: Trade barriers have fallen in recent past, we have improved communication/ transportation technology. Firms have expanded operations and selling across borders.

7. Political, Legal, Regulatory Forces: Affordable Health Care, Same Sex Marriage, US tax rate (company decision to stay or leave) 8. Social/Cultural Forces: Refers to society’s cultural values and norms. McDonald’s had to change its marketing and products (perception of unhealthy). Facebook has changed social norms about connecting to others.

Classification of Industries: See Strategy in Practice “How the U.S. Government Defines Industries”.

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References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Porter, M. (2007). Understanding Industry Structure. Harvard Business Review.

3. Porter, M. (1979). How Competitive Forces Shape Strategy. Harvard Business Review.

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Chapter 3 – Internal Analysis: Strengths, Weaknesses, and Competitive Advantage Class Exercise – VRIO and Company Diamond

Teaching Note This exercise is from the chapter PowerPoint slides. This is an application (Bloom) level exercise where students apply the VRIO – Model of Sustainability and the Company Diamond. We use Starbucks for VRIO and ESPN for the Company Diamond. These exercises are split across two class sessions that include short lecture on key chapter concepts. Student handout includes the following slides and templates for VRIO Framework and Company Diamond. These slides are referenced in short lecture and exercise debrief.

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VRIO: Students are instructed to count on their own knowledge and experience with Starbucks along with the company website to complete the VRIO Framework. They are asked to post their small group discussion results on a flip chart and report out to the class. The flipcharts may contain some overlap information. In that case, I try to get each group to report out something unique on their chart and explain their rational for the VRIO designations.

The Company Diamond: Students are instructed to complete the Company Diamond for ESPN. This is a small group exercise.

A good way to debrief is to have the Diamond on white board and summarize/capture class input for each of the key questions. Sources that students can access include company website and http://espnmediazone.com/us/.

For this exercise you will likely get some of the following responses: The things we do to compete (Activities) • Movies, TV channel, games, all sports, radio • Cable sports • Original programming, • Produce other products – 30 for 30, pre-game shows • On demand video • Live sporting events • ESPN.com, ESPN Mobile, podcasts • Operate in over 200 countries • Apparel The assets we employ (Resources) • ESPN The Magazine, ESPN Mobile (mobile messaging on smartphones & tablets) • Brand • Operations in over 200 countries • People – former professional athletes 2

The processes we use (Capabilities) • Sports Center (cutting edge, funny, engaging) • Connect to local teams and markets (ESPN Cleveland, ESPN Chicago, ESPN LA, etc.)

• Radio contests, different venues, Twitter polls.

The values that guide us (Priorities) • Sports fans serving sport fans • Diligent about hiring sports fans to work for the company – former athletes • Emphasis on finding new and creative ways to deliver sports content (e.g. espnW) • Corporate citizenship and activities The above items are a snapshot. There are likely many other examples that can be added based on personal knowledge and further research.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. http://espnmediazone.com/us/ 3. http://www.starbucks.com/

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Chapter 4 - Cost Advantage and Chapter 5 - Product Differentiation Class Exercise Teaching Note This exercises combines concepts from two chapters on sources of cost advantage and sources of differentiation advantage. It could be adapted to many different real company examples. It is an application (Bloom) exercise that asked students to apply concepts from the textbook to real companies. I try to choose companies in which students might be interested (even if they are not familiar with the company) and companies with which they are likely familiar. I recommend checking company information each semester to be sure any information used in prior classes is still relevant and up to date. Each semester also brings the opportunity to include a company that may be in the news at that time.

This is a small group exercise. I give the students about 30 minutes in small groups to research their responses.

I then conduct a large group debrief. The debrief session is a great time for the instructor to provide additional “color commentary” regarding the chapter concepts and to clarify any misconceptions about those concepts.

The handout includes a summary of sources of cost advantage and differentiation advantage (noted below) along with the questions to complete.

Exercise Below is a summary of chapter (4, 5) concepts. Use them for reference in answering the questions. You may access company websites for additional information.

Sources of C/A – Cost Advantage 1. Economies of Scale or Scope 2. Learning & Experience 3. Proprietary Knowledge 4. Input Costs 5. Different Business Model Sources of Differentiation Advantage 1. Different Product/Service Features (better job, more jobs, unique job) 2. Quality and Reliability 3. Convenience 4. Brand Image (mere exposure effect, in social psychology/familiarity principle, prestige brands How to find Sources of Differentiation?

1. Customer Segmentation (product attributes on price, attributes of customers, job-to-be done view 2. Mapping the Consumption Chain

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Please document your responses to the following: 1. Select a public company that seems to have a cost advantage over its competitors – demonstrated by consistently lowest prices in the market. a. Describe one or more sources of advantage. b. Identify any resources or capabilities the company has that enable it to achieve low costs. c. What if anything prevents competitors from imitating this product or service? Explain.

This question gets the conversation started in a general way allowing students to come up with examples.

2.

How does the Toyota Production System provide a cost advantage for Toyota?

Among other things TPS allows Toyota to leverage Proprietary Knowledge as a cost advantage. A key principle of TPS is “just-in-time” delivery of components, both from outside suppliers and from different manufacturing stations within the plant. Delivering components close to the time they will be used keeps inventories at plants low and minimizes waste. TPS is also about a philosophy that permeates the corporate culture – company first, flexibility, solve problems.

3.

Airbnb is an on-line, homestay network that provides short term lodging. It is a very successful start-up that makes money by charging its users. Guest fee range from 6-12% depending on the size of the reservation subtotal. The higher the subtotal, the smaller the reservation fee percentage – which is nonrefundable. Airbnb also charges hosts a 3% host service fee which is applied to the subtotal. a. What sources of cost advantage apply to Airbnb’s business model? b. What sources of differentiation apply to Airbnb’s business model?

Input Costs (cooperation with suppliers, location advantages, and preferred access to variety of property options HomeAway.com and VRBO.com charge a 10% commission. Owners can list for free and pay HomeAway when the property is booked.

With Airbnb, the guest fee ranges from 6-12% depending on the size of the reservation subtotal. The higher the subtotal, the smaller the reservation fee percentage – which is non-refundable, if the guest cancels.

Airbnb also charges hosts a 3% host service fee. For example, if a guest books a four night reservation at $100/night, plus $50.00 cleaning fee, the 3% host service fee is applied to the $450 subtotal, which comes to $13.50.

Learning & Experience There may also be benefits from early learning & experience. In its first 4 years, Airbnb served 4 million guests. In year five alone it served five million more for a total of 9 million through 2013. That’s called hockey stick growth experienced by few startups. (See graphic)

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Source: Business Insider.com Sources of Differentiation: Different products such as exotic accommodations; e.g. tree houses, yurts, castles.

4.

Wal-Mart is the most obvious example of a company benefitting from economies of scale. As a dominant player in retailing, the company’s size provides it with enormous efficiencies that it uses to keep costs low. Size provides enormous efficiencies across it’s over 5000 stores worldwide. Wal-Mart has a ton of important information concerning consumer likes and dislikes and it spreads best practices across all its stores. (news.morningstar.com/classroom 2016) a. Beyond the obvious economies of scale, which other sources of Cost Advantage does Wal-Mart leverage? b. What approaches do you think Wal-Mart uses in “finding sources of differentiation”? Explain.

Input Costs & Scale: • Size allows Wal-Mart to gain efficiencies across its stores that allows it to keep costs low. For example, its size allows Wal-Mart to do its own purchasing more efficiently since it has about 5000 stores worldwide. This gives the company great bargaining power with its suppliers.

• It gets products cheaper AND its size allows for more inexpensive distribution.

• It has enormous amounts of information on consumer likes and dislikes – can spread best practices across its stores.

• Economies of Scale – o EXAMPLE: Wal-Mart buys a DVD from a supplier for $5.00. o Same DVD costs a small competitor $6.00. o It costs Wal-Mart $4.00 to distribute the DVD and pay for the overhead costs of the stores. o Costs the small competitor $5.00 to do same. o Wal-Mart can sell the DVD for $9.50 and still make $.50 profit. o The smaller competitor can’t charge that little, because at a cost of $11 per DVD it would be losing money.

• Scale would also allow Wal-Mart to spread costs of advertising across many stores in a local area.

Sources of Differentiation: One differentiator could be the Supercenters for convenience of one-stop shopping.

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5.

Dollar Shave Club’s retail disruption. As noted in theweek.com (August 2016), “in a deal that has shaken the stodgy consumer products industry, Unilever announced (2016) it will pay $1 billion to acquire Dollar Shave Club – a five year old firm that delivers no-frills disposable blades to subscribers for as little as $3 a month. Since launching in 2011, the Venice CA-based startup has grown to 3.2 million subscribers – earning $152 million in 2015 and becoming a case study in how a disruptive innovator can “break into a highly profitable and overserved industry”. DSC contracts with a South Korean razor manufacturer and then sells the blades directly to consumers over the web. The global razor business has long been built on convincing people they need more and more blinged-out blades at higher and higher prices (Terlep, Wall Street Journal). Doller Shave Club now claims 5% of the US men’s shaving market long dominated by Gillette (Proctor & Gamble). Since 2010, Gillette’s market share has fallen from 71 to 59 percent.” a. Which type of Cost Advantage applies to Dollar Shave Club? Explain. b. What sources of Differentiation Advantage does Dollar Shave Club leverage?

Cost Advantage – Different Business Model: • DSC uses a different business model to disrupt a mature industry.

• Shows how creative disruption results from technological change. o In past challenging a market leader like Gillette would have required factories, sophisticated distribution an enormous and experienced sales force, and TV marketing blitz. o But the internet, mass transportation and globalization destroy everything. o DSC doesn’t actually make its products. It contracts with a South Korean razor manufacturer and then sells the blades directly to consumers over the web, bypassing retail middlemen. o Because of its lean approach (190 employees), thanks to YouTube (initial advertising was free).

Its first video has been seen by more than 20 million times. o When startups can get free advertising though YouTube, easy distribution through the mail and low cost sales via the web, every other company should take notice.

• Who are the biggest winners in this new model? o Consumers. o By cutting out the inefficiencies of retail space and the marketing expense of TV, these companies can offer better products at lower prices. o Since brands born online live and die by reputation, their customer service must be fast and friendly.

• P&G is playing catch up with its own Gillette Shave Club and has launched the Tide Wash Club which sends consumers detergent refills for a monthly fee.

• Both firms are eying Amazon, which aspires to provide regular deliveries of everything from diapers to groceries through its “subscribe and save” program.

Sources of Differentiation Advantage • Different Product features – “better job” of meeting customer need than an existing product.

• Quality and Reliability – in this case, product may not do better job as far as performance. It simply lasts longer • Convenience – making products easier to find and purchase (in the mail).

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Customer Segmentation: • Product attributes based on price. Can get same or better quality, same price.

• Attributes of individuals – convenience, income levels (lower price) • Job to be done view – According to Clayton Christenson customers hire products to do jobs for them.

Understanding the functional, social and emotional dimensions of a job to be done is complex.

• Mapping the Consumption Chain: o How do find your product? o How to pay? o How to deliver?

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Job to be done view…..

6.

Duluth Trading Company – sells men’s and women’s clothing, accessories and outdoor gear. a. Which source(s) of Differentiation Advantage does Duluth Trading employ? Explain. b. In terms of “finding sources of differentiation”, what approach does Duluth take to Customer Segmentation?

Sources of Differentiation Advantage: • Different Product – does a better job. The entire premise of the company is about making things people can use. Started in 1989 with the Bucket Boss for tools.

• Quality and Reliability. Products are field tested on job sites by construction workers, dock hands, cycle riders and others. Testers now called the “Duluth Trades Panel” – they use, abuse and improve products in real-world conditions.

• Brand Image – use illustrations instead of photos on covers. The only requirement is that the drawings convey something in a quirky, fun and intelligent manner.

May segment customers via “job to be done” view. Clothes must withstand real life and work.

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Casper sells mattresses on line. a. Which sources of Cost Advantage does the company leverage? b. How does Casper apply the “Consumption Chain” to help with customer segmentation?

Cost Advantage: • No brick and mortar retail outlets like competitors.

• Boast a free 100 night trial. Can easily return for full refund if not satisfied.

• Lets consumers know how the trial process works in the simplest terms.

• Simple easy to use website

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Differentiation Advantage: • Different product features – better job.

• Quality and Reliability – trial process and return policy • Convenience – easy to access on line, get a new mattress without leaving home! Nice if you don’t have a truck or want to pay for delivery.

Mapping the Consumption Chain: • How do consumers make decisions? Their research told them what attributes were important. (comfort, support, temperature, durability) • How is the product delivered? (Due to using high quality, resilient foams, able to compress the mattress w/o undermining its integrity. Using a unique compression machine ensures no pressure on the sleep surface. – can be shipped in manageable box size.

• What if customers are not satisfied…..100 night free trail, can easily return for full refund if not satisfied.

8.

Nordstrom is known for its exceptional customer service. a. What sources of differentiation advantage is Nordstrom using?

Sources of Differentiation Advantage Convenience – products easy to find and purchase.

Brand Image – known for extreme customer service.

9.

LLBean – Free shipping, 100% guarantee. According to the LLB company website: Since 1912, we’ve believed in the adventure of a life lived outdoors, the promise of a fair deal sand the guarantee that everything we make is designed to last. So if any of our products isn’t working or fitting or standing up to its task, we’ll take it back. LL himself always said that he didn’t consider a sale complete “until goods are worn out and the customer still satisfied”. a. What sources of Differentiation Advantage is LLBean leveraging? Explain.

Sources of Diff Advantage: • Diff product feature – better job.

• Quality and reliability – sale not complete until the product wears out.

• Convenience – easy to find, free shipping.

• Brand Image: o Mere exposure effect – people familiar with the name.

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10. Prepare a cost and differentiation advantage comparison between Home Depot and a local hardware story in your area.

Depending on the examples available, there is opportunity here to emphasize economies of scale (HD) and other sources of cost advantage, as well as sources of differentiation we might see at a local hardware store.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Liker, J., (2004). The Toyota Way. New York, NY: McGraw-Hill.

3. Mcalone, N. (2015). Airbnb’s Summer Reach Has Grown by 353 Times in 5 years. Retrieved from http: //www. businessinsider.com. (2017) 4. Albert-Deitch, C. (2016). This $200 Million Mattress Company is Waking Up the Sleep Industry, Retrieved from http://www.inc.com. (2017) 5. Shaoolian, G. (2017). Improving Brand Credibility in 2017: What Can We Learn from Brands like Warby Parker and Casper. Retrieved from www.forbes.com (2017) 6. Gonzalez, G. (2016). Inside Dollar Shave Club’s Billion-Dollar Payday. Retrieved from www.inc.com (2017) 7. Dollar Shave Club’s Retail Disruption (2016). Retrieved from http://theweek.com/articles (2017) 8. Low-Cost Producer or Economies of Scale (2016). Retrieved from http://news.morningstar.com/classroom. (2017) 9. Solomon, M. (2014). Take These Two Steps to Rival Nordstrom’s Customer Service Experience.

Retrieved from http://www.forbes.com. (2017) 10. Casper.com 11. Duluthtrading.com 12. LLBean.com

7

Chapter 4 - Cost Advantage and Chapter 5 - Product Differentiation Class Exercise Teaching Note This exercises combines concepts from two chapters on sources of cost advantage and sources of differentiation advantage. It could be adapted to many different real company examples. It is an application (Bloom) exercise that asked students to apply concepts from the textbook to real companies. I try to choose companies in which students might be interested (even if they are not familiar with the company) and companies with which they are likely familiar. I recommend checking company information each semester to be sure any information used in prior classes is still relevant and up to date. Each semester also brings the opportunity to include a company that may be in the news at that time.

This is a small group exercise. I give the students about 30 minutes in small groups to research their responses.

I then conduct a large group debrief. The debrief session is a great time for the instructor to provide additional “color commentary” regarding the chapter concepts and to clarify any misconceptions about those concepts.

The handout includes a summary of sources of cost advantage and differentiation advantage (noted below) along with the questions to complete.

Exercise Below is a summary of chapter (4, 5) concepts. Use them for reference in answering the questions. You may access company websites for additional information.

Sources of C/A – Cost Advantage 1. Economies of Scale or Scope 2. Learning & Experience 3. Proprietary Knowledge 4. Input Costs 5. Different Business Model Sources of Differentiation Advantage 1. Different Product/Service Features (better job, more jobs, unique job) 2. Quality and Reliability 3. Convenience 4. Brand Image (mere exposure effect, in social psychology/familiarity principle, prestige brands How to find Sources of Differentiation?

1. Customer Segmentation (product attributes on price, attributes of customers, job-to-be done view 2. Mapping the Consumption Chain

1

Please document your responses to the following: 1. Select a public company that seems to have a cost advantage over its competitors – demonstrated by consistently lowest prices in the market. a. Describe one or more sources of advantage. b. Identify any resources or capabilities the company has that enable it to achieve low costs. c. What if anything prevents competitors from imitating this product or service? Explain.

This question gets the conversation started in a general way allowing students to come up with examples.

2.

How does the Toyota Production System provide a cost advantage for Toyota?

Among other things TPS allows Toyota to leverage Proprietary Knowledge as a cost advantage. A key principle of TPS is “just-in-time” delivery of components, both from outside suppliers and from different manufacturing stations within the plant. Delivering components close to the time they will be used keeps inventories at plants low and minimizes waste. TPS is also about a philosophy that permeates the corporate culture – company first, flexibility, solve problems.

3.

Airbnb is an on-line, homestay network that provides short term lodging. It is a very successful start-up that makes money by charging its users. Guest fee range from 6-12% depending on the size of the reservation subtotal. The higher the subtotal, the smaller the reservation fee percentage – which is nonrefundable. Airbnb also charges hosts a 3% host service fee which is applied to the subtotal. a. What sources of cost advantage apply to Airbnb’s business model? b. What sources of differentiation apply to Airbnb’s business model?

Input Costs (cooperation with suppliers, location advantages, and preferred access to variety of property options HomeAway.com and VRBO.com charge a 10% commission. Owners can list for free and pay HomeAway when the property is booked.

With Airbnb, the guest fee ranges from 6-12% depending on the size of the reservation subtotal. The higher the subtotal, the smaller the reservation fee percentage – which is non-refundable, if the guest cancels.

Airbnb also charges hosts a 3% host service fee. For example, if a guest books a four night reservation at $100/night, plus $50.00 cleaning fee, the 3% host service fee is applied to the $450 subtotal, which comes to $13.50.

Learning & Experience There may also be benefits from early learning & experience. In its first 4 years, Airbnb served 4 million guests. In year five alone it served five million more for a total of 9 million through 2013. That’s called hockey stick growth experienced by few startups. (See graphic)

2

Source: Business Insider.com Sources of Differentiation: Different products such as exotic accommodations; e.g. tree houses, yurts, castles.

4.

Wal-Mart is the most obvious example of a company benefitting from economies of scale. As a dominant player in retailing, the company’s size provides it with enormous efficiencies that it uses to keep costs low. Size provides enormous efficiencies across it’s over 5000 stores worldwide. Wal-Mart has a ton of important information concerning consumer likes and dislikes and it spreads best practices across all its stores. (news.morningstar.com/classroom 2016) a. Beyond the obvious economies of scale, which other sources of Cost Advantage does Wal-Mart leverage? b. What approaches do you think Wal-Mart uses in “finding sources of differentiation”? Explain.

Input Costs & Scale: • Size allows Wal-Mart to gain efficiencies across its stores that allows it to keep costs low. For example, its size allows Wal-Mart to do its own purchasing more efficiently since it has about 5000 stores worldwide. This gives the company great bargaining power with its suppliers.

• It gets products cheaper AND its size allows for more inexpensive distribution.

• It has enormous amounts of information on consumer likes and dislikes – can spread best practices across its stores.

• Economies of Scale – o EXAMPLE: Wal-Mart buys a DVD from a supplier for $5.00. o Same DVD costs a small competitor $6.00. o It costs Wal-Mart $4.00 to distribute the DVD and pay for the overhead costs of the stores. o Costs the small competitor $5.00 to do same. o Wal-Mart can sell the DVD for $9.50 and still make $.50 profit. o The smaller competitor can’t charge that little, because at a cost of $11 per DVD it would be losing money.

• Scale would also allow Wal-Mart to spread costs of advertising across many stores in a local area.

Sources of Differentiation: One differentiator could be the Supercenters for convenience of one-stop shopping.

3

5.

Dollar Shave Club’s retail disruption. As noted in theweek.com (August 2016), “in a deal that has shaken the stodgy consumer products industry, Unilever announced (2016) it will pay $1 billion to acquire Dollar Shave Club – a five year old firm that delivers no-frills disposable blades to subscribers for as little as $3 a month. Since launching in 2011, the Venice CA-based startup has grown to 3.2 million subscribers – earning $152 million in 2015 and becoming a case study in how a disruptive innovator can “break into a highly profitable and overserved industry”. DSC contracts with a South Korean razor manufacturer and then sells the blades directly to consumers over the web. The global razor business has long been built on convincing people they need more and more blinged-out blades at higher and higher prices (Terlep, Wall Street Journal). Doller Shave Club now claims 5% of the US men’s shaving market long dominated by Gillette (Proctor & Gamble). Since 2010, Gillette’s market share has fallen from 71 to 59 percent.” a. Which type of Cost Advantage applies to Dollar Shave Club? Explain. b. What sources of Differentiation Advantage does Dollar Shave Club leverage?

Cost Advantage – Different Business Model: • DSC uses a different business model to disrupt a mature industry.

• Shows how creative disruption results from technological change. o In past challenging a market leader like Gillette would have required factories, sophisticated distribution an enormous and experienced sales force, and TV marketing blitz. o But the internet, mass transportation and globalization destroy everything. o DSC doesn’t actually make its products. It contracts with a South Korean razor manufacturer and then sells the blades directly to consumers over the web, bypassing retail middlemen. o Because of its lean approach (190 employees), thanks to YouTube (initial advertising was free).

Its first video has been seen by more than 20 million times. o When startups can get free advertising though YouTube, easy distribution through the mail and low cost sales via the web, every other company should take notice.

• Who are the biggest winners in this new model? o Consumers. o By cutting out the inefficiencies of retail space and the marketing expense of TV, these companies can offer better products at lower prices. o Since brands born online live and die by reputation, their customer service must be fast and friendly.

• P&G is playing catch up with its own Gillette Shave Club and has launched the Tide Wash Club which sends consumers detergent refills for a monthly fee.

• Both firms are eying Amazon, which aspires to provide regular deliveries of everything from diapers to groceries through its “subscribe and save” program.

Sources of Differentiation Advantage • Different Product features – “better job” of meeting customer need than an existing product.

• Quality and Reliability – in this case, product may not do better job as far as performance. It simply lasts longer • Convenience – making products easier to find and purchase (in the mail).

4

Customer Segmentation: • Product attributes based on price. Can get same or better quality, same price.

• Attributes of individuals – convenience, income levels (lower price) • Job to be done view – According to Clayton Christenson customers hire products to do jobs for them.

Understanding the functional, social and emotional dimensions of a job to be done is complex.

• Mapping the Consumption Chain: o How do find your product? o How to pay? o How to deliver?

•

Job to be done view…..

6.

Duluth Trading Company – sells men’s and women’s clothing, accessories and outdoor gear. a. Which source(s) of Differentiation Advantage does Duluth Trading employ? Explain. b. In terms of “finding sources of differentiation”, what approach does Duluth take to Customer Segmentation?

Sources of Differentiation Advantage: • Different Product – does a better job. The entire premise of the company is about making things people can use. Started in 1989 with the Bucket Boss for tools.

• Quality and Reliability. Products are field tested on job sites by construction workers, dock hands, cycle riders and others. Testers now called the “Duluth Trades Panel” – they use, abuse and improve products in real-world conditions.

• Brand Image – use illustrations instead of photos on covers. The only requirement is that the drawings convey something in a quirky, fun and intelligent manner.

May segment customers via “job to be done” view. Clothes must withstand real life and work.

7.

Casper sells mattresses on line. a. Which sources of Cost Advantage does the company leverage? b. How does Casper apply the “Consumption Chain” to help with customer segmentation?

Cost Advantage: • No brick and mortar retail outlets like competitors.

• Boast a free 100 night trial. Can easily return for full refund if not satisfied.

• Lets consumers know how the trial process works in the simplest terms.

• Simple easy to use website

5

Differentiation Advantage: • Different product features – better job.

• Quality and Reliability – trial process and return policy • Convenience – easy to access on line, get a new mattress without leaving home! Nice if you don’t have a truck or want to pay for delivery.

Mapping the Consumption Chain: • How do consumers make decisions? Their research told them what attributes were important. (comfort, support, temperature, durability) • How is the product delivered? (Due to using high quality, resilient foams, able to compress the mattress w/o undermining its integrity. Using a unique compression machine ensures no pressure on the sleep surface. – can be shipped in manageable box size.

• What if customers are not satisfied…..100 night free trail, can easily return for full refund if not satisfied.

8.

Nordstrom is known for its exceptional customer service. a. What sources of differentiation advantage is Nordstrom using?

Sources of Differentiation Advantage Convenience – products easy to find and purchase.

Brand Image – known for extreme customer service.

9.

LLBean – Free shipping, 100% guarantee. According to the LLB company website: Since 1912, we’ve believed in the adventure of a life lived outdoors, the promise of a fair deal sand the guarantee that everything we make is designed to last. So if any of our products isn’t working or fitting or standing up to its task, we’ll take it back. LL himself always said that he didn’t consider a sale complete “until goods are worn out and the customer still satisfied”. a. What sources of Differentiation Advantage is LLBean leveraging? Explain.

Sources of Diff Advantage: • Diff product feature – better job.

• Quality and reliability – sale not complete until the product wears out.

• Convenience – easy to find, free shipping.

• Brand Image: o Mere exposure effect – people familiar with the name.

6

10. Prepare a cost and differentiation advantage comparison between Home Depot and a local hardware story in your area.

Depending on the examples available, there is opportunity here to emphasize economies of scale (HD) and other sources of cost advantage, as well as sources of differentiation we might see at a local hardware store.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Liker, J., (2004). The Toyota Way. New York, NY: McGraw-Hill.

3. Mcalone, N. (2015). Airbnb’s Summer Reach Has Grown by 353 Times in 5 years. Retrieved from http: //www. businessinsider.com. (2017) 4. Albert-Deitch, C. (2016). This $200 Million Mattress Company is Waking Up the Sleep Industry, Retrieved from http://www.inc.com. (2017) 5. Shaoolian, G. (2017). Improving Brand Credibility in 2017: What Can We Learn from Brands like Warby Parker and Casper. Retrieved from www.forbes.com (2017) 6. Gonzalez, G. (2016). Inside Dollar Shave Club’s Billion-Dollar Payday. Retrieved from www.inc.com (2017) 7. Dollar Shave Club’s Retail Disruption (2016). Retrieved from http://theweek.com/articles (2017) 8. Low-Cost Producer or Economies of Scale (2016). Retrieved from http://news.morningstar.com/classroom. (2017) 9. Solomon, M. (2014). Take These Two Steps to Rival Nordstrom’s Customer Service Experience.

Retrieved from http://www.forbes.com. (2017) 10. Casper.com 11. Duluthtrading.com 12. LLBean.com

7

Chapter 6 – Corporate Strategy Class Exercise - The J.M. Smucker Company .

Teaching Note The general approach for this exercise is to locate public information about a specific (perhaps local) company via corporate website, articles, press releases, assign students to read the relevant information and then answer questions about a company’s corporate strategy. The purpose is to determine if the student understands course concepts well enough to be able to then recognize a specific strategy (i.e. a concept from text such as “acquisition”) when reading real documents related to the company’s activities. With this exercise, the student is interpreting (Bloom Evaluation Level) the actions and relating back to concepts learned in class. For this example, I accessed public information from The J.M. Smucker Company website June 2016 Investor Presentation. Additionally, I provided a link to other sources for students to read in order to complete the exercise. This assignment was given as homework due to the reading required to complete. Students were asked to come prepared to the following class session to debrief the exercise. Additionally, in this case I ask the students to post their typed responses to an on -line Assignments Folder before class. I have noted the applicable links in References section of this document.

Exercise The J. M. Smucker Company (Retrieved from June 2016 investor presentation) ✓ Purpose: Helping to bring families together to share memorable meals and moments. ✓ Vision: Engage, delight, and inspire consumers through trusted food brands that bring joy throughout their lives. o A portfolio that combines #1 AND LEADING BRANDS with EMERGING, ONTREND BRANDS that will drive balanced growth ✓ 3 platforms for growth are: Coffee, Consumer & Natural Foods, Pet Food & Snacks ✓ FY 16 Results: o Coffee: $2.239 billion 1

o Consumer Foods: $2.270 billion o Pet Foods: $2.250 billion o International & Foodservice: $1.052 billion Please type your responses below including a brief explanation. Post your completed exercise in the Chapter 6 Assignment Folder no later than _____________. Additionally, please bring a copy or have access to your document for class discussion. Refer to the articles provided and the company website.

1. What method of Diversification did Smucker use when joining with Big Heart Pet Brands? Explain.

Acquisition. JMS now #1 in dog snacks/#2 in cat food.

2. Is this move an example of Vertical Integration OR Horizontal Diversification? Explain.

Horizontal Diversification – movement into an adjacent business or market; enters a new industry on the value chain. This could mean: • • •

Selling JMS existing products to new (pet) customers.

Bringing new products/services to existing customers.

Selling new products/services to new customers.

3.

If (as projected 2/23/16) 30% of Smucker’s sales is in pet food/snacks, what level of diversification would you apply to their corporate strategy? Also, how did they do on their projection?

Dominant Business: Firm earns 70% of revenue from its main line of business and remainder from other lines across different value chains. Very close on projections.

4. Explain how the acquisition of Big Heart Pet Brands meets the criteria of Smucker’s acquisition filter?

The acquisition filter focuses on a number of components beginning with “is the target a strategic fit?” To determine if an acquisition target is a fit, JMS evaluates: 1. Does it provide JMS with a leading brand? (Does since they are now #1 (dog food), #2 (cat food).

2. Is it an attractive category? (See US Pet Ownership stats from AVMA.) 3. Does it have center of store presence? (YES) 2

4. Is it North American focused? (YES)

5.

When it comes to creating value through diversification and considering the various activities in the value chain of Smucker brands, which of the Six Ss can be applied? (Note that according to their website, J.M. Smucker has a target of $200 million in savings from cost reduction programs projected by 2018 followed by a target of $350 million by 2020.)

Explain.

1. Slack – sales reps in stores already…just add pet food to their portfolio 2. Synergy - $200 million target annual synergies by 2018 (source Feb 2017 report to investors); exploits resources and capabilities 3. Share Knowledge – collective corporate knowledge that can be shared 4. Business Model – way to enable the creation and exchange of value between the companies. JSM model with clear strategy, proven execution, strong cash generation) 5. Spreading Capital – some companies create value through diversification by activing as an “internal capital market”.

6. Stepping Stone – Stone to new industries. Other 5 S’s work to exploit a company’s resources and capabilities. The Stepping Stone mechanism works to enhance capabilities by: a. Helping to get a path to new markets b. Firm acquires related resources and capabilities to prepare for a next step.

6. How do you think joining forces with Big Heart Pet Brands aligns with Smucker’s core purpose and vision?

Company Purpose: Bring Families Together…..pets are part of the family.

Vision: Trust brands….. (BHPB includes Milkbone, 9Lives, Gravy Train among others).

7. How do you think J.M. Smucker can Exploit and/or Expand its resources and capabilities as a result of the acquisition of Big Heart Pet Brand? Explain.

Exploit: Diversification allows companies to exploit existing customer-facing resources by adding new operational resources and capabilities.

• •

Pet food sold at specialty stores – sell JMS snacks there too.

Leverage scale for advertising and data buys – identify new customers.

Expand: New market helps prepare for future or expanding existing set of resources and capabilities. For example centralized shared services.

3

8. Explain the rationale behind the divestiture of The Eagle Family Foods Company.

Largest part of Eagle Brands was private label (made for another company). Remember the JMS “acquisition filter”? One of the questions is: Does it provide JMS with a leading brand? It did, but the private brand products were a bigger part of the EB business so it was no longer a fit for JMS.

9. Select and explain one of the ways value can be destroyed through diversification.

1. Hubris 2. Sunk Cost Fallacy 3. Imitation 4. Poor governance & incentives 5. Poor management (must eliminate redundancies, centralize shared services, and adapt common systems and processes.

10. Explain why the integration team in a merger or acquisition is so important Regardless of the integration template managers in the acquiring firm choose, attention to how integration processes work to create a smooth and successful acquisition is critical. See text for additional information regarding integrating the target.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Schroeder, E. (2013). Smucker outlines acquisition strategy. Retrieved from http://www.bakingbusiness.com. (2017) 3. Ramakrishnam, S., & Cavale, S. (2015). J.M. Smucker to sell U.S. canned mild business.

Retrieved from http://reuters.com (2017) 4. The J.M. Smucker company Fiscal Quarter 3 Results/Press Release (February 23, 2016).

Retrieved from http://www.jmsmucker.com/investor-relations/smuckers-financial-news-releases.

(2017) 5. U.S. Pet Ownership Statistics (2012). Retrieved from https://ww.avma.org

4

Chapter 6 – Corporate Strategy Class Exercise - The J.M. Smucker Company .

Teaching Note The general approach for this exercise is to locate public information about a specific (perhaps local) company via corporate website, articles, press releases, assign students to read the relevant information and then answer questions about a company’s corporate strategy. The purpose is to determine if the student understands course concepts well enough to be able to then recognize a specific strategy (i.e. a concept from text such as “acquisition”) when reading real documents related to the company’s activities. With this exercise, the student is interpreting (Bloom Evaluation Level) the actions and relating back to concepts learned in class. For this example, I accessed public information from The J.M. Smucker Company website June 2016 Investor Presentation. Additionally, I provided a link to other sources for students to read in order to complete the exercise. This assignment was given as homework due to the reading required to complete. Students were asked to come prepared to the following class session to debrief the exercise. Additionally, in this case I ask the students to post their typed responses to an on -line Assignments Folder before class. I have noted the applicable links in References section of this document.

Exercise The J. M. Smucker Company (Retrieved from June 2016 investor presentation) ✓ Purpose: Helping to bring families together to share memorable meals and moments. ✓ Vision: Engage, delight, and inspire consumers through trusted food brands that bring joy throughout their lives. o A portfolio that combines #1 AND LEADING BRANDS with EMERGING, ONTREND BRANDS that will drive balanced growth ✓ 3 platforms for growth are: Coffee, Consumer & Natural Foods, Pet Food & Snacks ✓ FY 16 Results: o Coffee: $2.239 billion 1

o Consumer Foods: $2.270 billion o Pet Foods: $2.250 billion o International & Foodservice: $1.052 billion Please type your responses below including a brief explanation. Post your completed exercise in the Chapter 6 Assignment Folder no later than _____________. Additionally, please bring a copy or have access to your document for class discussion. Refer to the articles provided and the company website.

1. What method of Diversification did Smucker use when joining with Big Heart Pet Brands? Explain.

Acquisition. JMS now #1 in dog snacks/#2 in cat food.

2. Is this move an example of Vertical Integration OR Horizontal Diversification? Explain.

Horizontal Diversification – movement into an adjacent business or market; enters a new industry on the value chain. This could mean: • • •

Selling JMS existing products to new (pet) customers.

Bringing new products/services to existing customers.

Selling new products/services to new customers.

3.

If (as projected 2/23/16) 30% of Smucker’s sales is in pet food/snacks, what level of diversification would you apply to their corporate strategy? Also, how did they do on their projection?

Dominant Business: Firm earns 70% of revenue from its main line of business and remainder from other lines across different value chains. Very close on projections.

4. Explain how the acquisition of Big Heart Pet Brands meets the criteria of Smucker’s acquisition filter?

The acquisition filter focuses on a number of components beginning with “is the target a strategic fit?” To determine if an acquisition target is a fit, JMS evaluates: 1. Does it provide JMS with a leading brand? (Does since they are now #1 (dog food), #2 (cat food).

2. Is it an attractive category? (See US Pet Ownership stats from AVMA.) 3. Does it have center of store presence? (YES) 2

4. Is it North American focused? (YES)

5.

When it comes to creating value through diversification and considering the various activities in the value chain of Smucker brands, which of the Six Ss can be applied? (Note that according to their website, J.M. Smucker has a target of $200 million in savings from cost reduction programs projected by 2018 followed by a target of $350 million by 2020.)

Explain.

1. Slack – sales reps in stores already…just add pet food to their portfolio 2. Synergy - $200 million target annual synergies by 2018 (source Feb 2017 report to investors); exploits resources and capabilities 3. Share Knowledge – collective corporate knowledge that can be shared 4. Business Model – way to enable the creation and exchange of value between the companies. JSM model with clear strategy, proven execution, strong cash generation) 5. Spreading Capital – some companies create value through diversification by activing as an “internal capital market”.

6. Stepping Stone – Stone to new industries. Other 5 S’s work to exploit a company’s resources and capabilities. The Stepping Stone mechanism works to enhance capabilities by: a. Helping to get a path to new markets b. Firm acquires related resources and capabilities to prepare for a next step.

6. How do you think joining forces with Big Heart Pet Brands aligns with Smucker’s core purpose and vision?

Company Purpose: Bring Families Together…..pets are part of the family.

Vision: Trust brands….. (BHPB includes Milkbone, 9Lives, Gravy Train among others).

7. How do you think J.M. Smucker can Exploit and/or Expand its resources and capabilities as a result of the acquisition of Big Heart Pet Brand? Explain.

Exploit: Diversification allows companies to exploit existing customer-facing resources by adding new operational resources and capabilities.

• •

Pet food sold at specialty stores – sell JMS snacks there too.

Leverage scale for advertising and data buys – identify new customers.

Expand: New market helps prepare for future or expanding existing set of resources and capabilities. For example centralized shared services.

3

8. Explain the rationale behind the divestiture of The Eagle Family Foods Company.

Largest part of Eagle Brands was private label (made for another company). Remember the JMS “acquisition filter”? One of the questions is: Does it provide JMS with a leading brand? It did, but the private brand products were a bigger part of the EB business so it was no longer a fit for JMS.

9. Select and explain one of the ways value can be destroyed through diversification.

1. Hubris 2. Sunk Cost Fallacy 3. Imitation 4. Poor governance & incentives 5. Poor management (must eliminate redundancies, centralize shared services, and adapt common systems and processes.

10. Explain why the integration team in a merger or acquisition is so important Regardless of the integration template managers in the acquiring firm choose, attention to how integration processes work to create a smooth and successful acquisition is critical. See text for additional information regarding integrating the target.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Schroeder, E. (2013). Smucker outlines acquisition strategy. Retrieved from http://www.bakingbusiness.com. (2017) 3. Ramakrishnam, S., & Cavale, S. (2015). J.M. Smucker to sell U.S. canned mild business.

Retrieved from http://reuters.com (2017) 4. The J.M. Smucker company Fiscal Quarter 3 Results/Press Release (February 23, 2016).

Retrieved from http://www.jmsmucker.com/investor-relations/smuckers-financial-news-releases.

(2017) 5. U.S. Pet Ownership Statistics (2012). Retrieved from https://ww.avma.org

4

Chapter 7 Vertical Integration and Outsourcing Class Exercise

Teaching Note This exercise challenges students to consider specific companies and relate company activities to chapter concepts (Bloom Analysis Level). The questions are mostly generic in nature, but any number of actual companies – well-known or local to your area – could be plugged in to the exercises to make an even stronger connection for students. This could be used for homework or in class. In class option includes small groups completing the worksheet and then a large group debrief led by instructor.

This approach encourages everyone to participate and if any responses are incomplete, the instructor can fill in the blanks to help the students better understand the concepts. With the expectation that students read the chapter before class, the exercise can be completed in about 25 minutes – with the balance of class (approximately 45 minutes) dedicated to the exercise debrief. Time permitting, the “Should you Make or Buy” exercise that is noted in the chapter slide deck is also included in this exercise.

1

Please answer the following questions using your textbook or company websites as your resources.

1. Sometimes U.S. companies choose to not share certain manufacturing “formula” information with their operations/manufacturing plants in other countries because Intellectual Property law may be more liberal in some countries compared to the U.S. In this case, what steps are being taken to keep a subcontractor from becoming a direct competitor?

Companies that outsource face a challenge – to NOT create a competitor as Dell did with ASUS (Dyer 2016). In the above example, a combination of steps might be used: • Build Barriers to Imitation – Contracts put in place to prevent copying and selling as their own; changing formulas and processes.

• Limit knowledge of the full product – Holding certain formula information confidential to U.S Operations. Using different formulas in other countries. Only manufacturing part of the product in a certain place.

• Take an equity stake in the supplier is another option to prevent problems.

2. Related to the two advantages of Outsourcing, what are the benefits to a university when it decides to outsource Dining Services to a company such as Aramark? Related facts include: ✓ First time food operations have ever outsourced food operations. ✓ Expected savings of approximately $ 1 million over 3 years. ✓ Aramark already provides dining services to hundreds of colleges. ✓ Goals – increased effectiveness and efficiency. ✓ Annual budget for our dining services $25 million For this question, any outsource example could be used. The above numbers are not actual, but is based on a real situation. The instructor may provide some related facts of expected benefits to explain why outsourcing makes sense in a local situation. This could be a very good conversation about effectiveness and efficiency especially if a situation at your university was used for any outsourcing function e.g. dining services, maintenance, mail services.

The 2 advantages (flexibility and focus) of outsourcing are “opposite” of the dangers of vertical integration (loss of flexibility, loss of focus).

•

•

1. Flexibility – A university may benefit by having flexibility to change suppliers if needed and from economies of scale that a company such as Aramark will bring to the partnership. Aramark is a supplier to colleges/universities, K-12 schools/districts, healthcare facilities, sports/entertainment venues, business and government workplaces, and convention centers.

(Aramark, 2017) 2. Focus – This choice allows the university to focus attention on being good at a narrower range of activities. What is/should a university be good at? a. Good at: Teaching, Research, Student Support

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b. Not a core competency: Hiring food workers, dealing with food suppliers, quality issues in food preparation, administrative responsibilities that go with managing in-house.

3. When a company such as Nike partners with other overseas firms to manufacture its products, what Outsourcing advantage is it leveraging? (Dyer 2016) Explain.

Flexibility: With low cost suppliers (e.g. low wage workers in emerging countries like China or Indonesia) can lower overall costs. Can easily change suppliers if necessary. Ability to move shoe/clothing products to lowest cost suppliers.

Focus: By outsourcing manufacturing, Nike can focus on what it does really well such as design and marketing. Those functions stay in-house because the company believes its capabilities are better than any outsourced provider would offer. Additionally, if Nike had had its own plants, it would likely have to develop manufacturing contracts with other companies/competitors to lower its costs. Would competitors (Reebok, Adidas, etc.) want Nike to manufacture their goods?

4.

Further, what steps does Nike take to build “barriers to imitation” its products?

Barriers to Imitation is something that prevents other companies from imitating what another company can do. In this case, we can see several: • Brand – well known, hard to compete with Nike even if a company could copy their products.

• Design – changes annually. Any copycat companies would be making things with old design technology.

• Contracts with suppliers that prohibit copying Nike’s design and ability to change suppliers if necessary.

5. After being hit with delivery problem in 2012, Under Armour dropped its low cost fleece sources in favor of costlier, but prompt, reliable delivery. Per CFO Brad Dickerson, they had incurred excessive air-freight charges at year-end holiday season with their suppliers. They decided to resource “to help serve our customer better” (Davis 2012). a. Compare aspects of Sources of Cost Advantage (Ch 4) and Sources of Differentiation (Ch 5) to provide rationale for their initial decision to go to a higher cost provider. b. If Under Armour went into the farming business to raise their own sheep for Fleece….this would be an example of what type of Integration?

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ANSWER: 1) Cost Advantage: incurred higher “input costs”, but was necessary to get the Quality of Product (Fleece), Brand Image, Convenience (access to products in stores.)

2) Raising own sheep….Backward integration. Occurs when company decides to grow by moving backward in the value chain (aka “upstream”).

6. Apple has its own retail stores. This is an example of what type of integration? a. Is the Genius Bar a downstream or upstream activity? Explain.

ANSWER: If a company wants to grow by moving forward in the Value Chain; that is “downstream”, we say that company engages in “Forward Integration”.

Genius Bar is a downstream activity involving sales and service.

7. Walmart’s cutting edge technological apps represent one of the biggest contributors to the success of the company (Greenspan 2017). Advanced inventory management is at the core of Walmart’s leadership in the retail industry (2017). Its system funnels information from stores such as point-of-sale data, warehouse inventory and real-time sales into a centralized database.

The data is shared with suppliers who know when to ship more products. If Walmart wanted to outsource this function, it would have to consider the “3 reasons to make or buy” – capabilities, coordination, control. Explain how each applies to this situation and would likely result in keeping these functions “inside”.

Capabilities: Can do it better than other firms – integrates all aspects of the supply chain.

Coordination: Keep internal due to high level of integration required between all activities. Three levels of Coordination that influence the “make” vs. “buy: decision: • (1) Modular – low teamwork, low level of coordination (Golf) • (2) Sequential – moderate teamwork, when one firm or individuals cannot perform its task until another firm has competed its tasks and passed on the results, team members must coordinate work. (Example: Design the car first, then the A/C.) • (3) Reciprocal – high level of teamwork, activities require a high degree of coordination.

(Example: Basketball team requires constant coordination because they are constantly running their offense and defense.)

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Control: Desire to maintain control over crucial steps in the value chain by conducting the activity itself. Control over supplier performance in fulfillment process.

8. Walmart instituted cross-docking at its warehouses which moves inventory directly from arriving or departing trucks. Products are taken from an arriving truck and packed in a truck bound for a store without lengthy storage in the warehouse (TradeGecko, Univ of San Fran online). They could easily outsource this operation but instead, Walmart chooses to vertically integrate – or keep this function in-house. Referring once again to the 3 reasons to make or buy, which do you think applies here?

Control. – The firm’s desire to maintain control over a valuable activity or input in the value chain.

The question is to what extent should a company maintain control over a crucial step in the value chain by conducting the activity ourselves?

This is an example of forward integration into transportation of goods. The company wants to control assets or inputs to keep TRANSACTION COSTS down. →Walmart is a retailer. Why don’t they just outsource all transportation/logistics needs?

• Too much dependence on LTL (less-than-truckload) carriers could put them in a situation of overdependence on this important activity. What if the company could not handle Walmart’s shipment volume? What if the company’s drivers went out on strike? (This would be a “weakness” in a SWOT analysis and could put the company at risk.)

9.

Richard Branson’s Virgin Records began as a lone record store which barely kept Branson afloat. Then Branson decided to expand into talent management and record production AND the product that once cost the record store money became a profit center. (Buchanan 2017)What type of integration is this?

Backward integration – Virgin Records was a seller (record store)…now wants to produce records and even further “upstream” manage talent.

10. Starbucks bought a coffee farm in China. Is this an example of backward or forward integration? Explain.

Backward Integration – Moving backward in the value chain (upstream). Sourcing its own beans for its own use.

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References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Davis, M., (2013). Under Armour Drops Low Cost Fleece Sources in Favor of Costlier But Prompt, Reliable Delivery. Retrieved from https://sourcingjournalonline.com/under-armourdrops-low-cost-fleece-sources-in-favor-of-costlier-but-prompt-reliable-delivery/ (2017) 3. http://www.aramark.com/ (Retrieved 2017) 4. Buchanan, R. Examples of Vertically Integrated Companies. Retrieved from http://smallbusiness.chron.com/examples-vertically-integrated-companies-12868.html (2017) 5. Burkitt, L., (2010). Starbucks to Open China Coffee Farm, Sourcing Global Supply. Retrieved from https://www.wsj.com/articles/SB10001424052748704462704575609733431622088 (2017)

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Chapter 8 Strategic Alliances Class Exercise Teaching Note This exercise challenges students to consider well-known companies and relate to chapter concepts. By doing so, students are able to label real world activities with the terms and concepts they are learning (Bloom Comprehension Level). As with other exercises, this one can be homework or small group in class exercise.

With this exercise, I require it be submitted on line before class to ensure students complete in its entirety. The exercise takes about 25 minutes (in groups) and another 25-30 minutes to debrief. Figure 3.1 from the course materials (Dyer 2016) is included on the handout for reference during the exercise.

Notes to students regarding Value Chain (Dyer 2016, p. 50) Remember the “value chain” is a visual description of the steps required to turn raw materials into finished products and/or services. The value chain also describes key functions of the firm linked to each stage and functions that span the productive activities of the firm.

Strategic Alliance – a cooperative arrangement in which two or more firms combine their resources and capabilities to create new value, aka “partnership”.

• Vertical Alliance is between firms who are positioned at different stages of the value chain, such as supplier and buyer.

•

Horizontal Alliance is between two firms that do not have a supplier-buyer relationship and are typically positioned at a common stage of the value chain such as competitors.

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Please answer the following questions.

1. When Starbuck’s and Barnes & Noble partner to create the Barnes & Noble Café, would you consider that a Vertical Alliance or a Horizontal Alliance? Explain.

•

• •

2.

Horizontal Alliance – they are competitors (to the extent that B&N wanted to sell coffee in its stores) at common stage of the Value Chain (marketing and sales / customer facing). Working together to improve performance for both companies. Come for coffee – buy a book. Come to buy or look at books – buy some coffee or related products.

This was groundbreaking in 1993. Had B&N decided to open its own café, it would have become a competitor to Starbucks.

What are the benefits to both? o Extra foot traffic for B&N when people want to go to Starbucks or relax with a beverage while looking at books, meeting for personal or business reasons. o Extra foot traffic for Starbucks when people come in for books and stop for a beverage before they leave. o Both companies want to create a comfortable place to work, think and hang out.

A major trucking company such as ABF does not deliver to a particular area in a small town due to cost issues such as dispatching a partially full trailer. However, they can hire a local delivery service/company to come to their distribution center to get the freight and then make the local delivery. a. Is this an example of a Vertical Alliance or a Horizontal Alliance? b. What value is created for both companies?

This is a Horizontal Alliance. Competitors positioned at common stage of Value Chain (Primary Activities: logistics and operations) and (Support Enabling Activities: Firm Infrastructure).

ABF has to consider whether it should set up an operation in the far away town (travel to that area) or lower its transaction costs. The local delivery service is going there anyway because they have more business in that area.

3.

SAIC and General Motors partner (Joint Venture: Shanghai GM) to manufacture automobiles in China.

(Dyer 2016) Explain why this is an example of Horizontal Alliance.

Horizontal Alliance is an alliance that occurs between two firms that do not have a supplier-buyer relationship and are typically positioned at a common stage of the value chain. In this case both companies do the same thing (operations/manufacturing of automobiles) and conduct those operations at a common stage.

What do both bring to the partnership?

• GM brings its expertise and technology.

• SAIC brings knowledge of Chinese market and experience managing a Chinese work force.

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4. When Toyota enters into an alliance with suppliers and encourages suppliers to locate its plants near Toyota manufacturing plants…is that considered a vertical or horizontal alliance? (Dyer 2016)Explain.

This is a Vertical Alliance; that is, an alliance between firms who are positioned at different stages along the value chain, such as a supplier and a buyer. Supplier input is critical to Toyota’s final product. You can refer to Dyer p.150 for discussion of which of the four kinds of inputs/apply. Of the four, I would emphasize #4 Coordination (inputs or activities that require significant coordination in order to achieve the desired fit).

5. There are several ways to create value in alliances: Combining unique resources, pooling similar resources, create new alliance-specific resources, lower transaction costs. Which one (or more) applies to the following examples/explain briefly: a. Starbucks and Apple (2006) partner to sell music in stores as part of in-house experience.

Combine Unique Resources – buy music as part of your coffee house experience.

Vertical alliance - buyer-supplier relationship b. Starbucks and Pepsico (1996) partner to bottle, distribute and sell the popular coffee-based drink, Frappuccino.

Combine Unique Resources. Resources include: Starbucks – brand recognition, formulas/recipes and PepsiCo – bottling plants, distribution network, marketing/sales advantages, supply chain retail stores. c. McDonald’s and Disney partner to distribute movie character toys in Happy Meals.

Combine Unique Resources. Disney creates promotional toys for movies. McDonald’s has the distribution network through its stores to distribute the toys in meals. Non-equity or contractual alliance d. Oprah Winfrey and Starbucks partner for a new drink: Oprah Cinnamon Chai Tea Latte.

Create new alliance specific resources. Vertical non-equity or contractual (preferred when interdependence between partners is low.) e. Tata Global Beverages Limited and Starbucks (2012) announce a 50/50 Joint Venture in India names TATA Starbucks Limited, which will own and operate Starbuck’s cafes branded as “Starbucks Coffee – A TaTa Alliance”.

Joint Venture – firms combine resources to form an independent firm in which they both invest.

Create New Alliance Specific Resources. Advantages for TATA – leverage Starbucks brand and grow. Advantages for Starbucks include international expansion and new store growth.

f. Starbuck’s enters into agreement with Hyatt Hotels (2001) Contractual – No cross equity holdings. Vertical Alliance – combining unique resources.

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g. Starbuck’s formed an alliance with Dreyer’s Grand Ice Cream introduced Starbucks super premium ice cream. Contractual – no cross equity holdings. Vertical alliance – combining unique resources. Resources: Starbucks (recipe), Dreyer’s (manufacturing, distribution network to groceries and other retail).

Companies have 3 choices – summarized as make, buy or ally – when deciding to engage in a strategic alliance.

The answers for 6, 7, and 8 can be accessed in the Tokyo Disneyland case at the beginning of the chapter.

Below are some helpful discussion questions.

6.

In the Disney and Oriental Land example: a. Which choice did Disney make: Make, Buy or Ally? b. In order to make the decision, what questions were asked by Disney?

7. Risks: a. What risks were associated with Disney’s decision? b. How did Oriental Land address the risks?

8. What mistakes had Disney made when they opened Euro Disney? a. Compare that to their partnership with Oriental Land.

9. Briefly describe three risks associated with alliances. (Dyer 2016) • (1) Hold up – when one partner tries to exploit the alliance – specific investments made by another partner.

• (2) Misrepresentation –when one partner in an alliance creates false expectations about the resources it brings to the relationship or fails to deliver what it originally promised.

• (3) Build trust to lower the risks of alliances: o Personal trust – initiate partnerships with those you trust. o Legal contracts – most contracts have clauses that clarify three categories of issues: ▪ Governance issues – how decisions will be made, how profits will be split and how disputes will be resolved.

▪ Operating issues – what performance is expected and how intellectual property will be shared and protected.

▪ Exit/termination issues – conditions under which partners can exit the alliance or the contract can be terminated. o Shared Ownership/Financial Collateral bonds – when one partner owns a financial stake in another partner.

Note: Being part of an alliance means the company loses some of its independence as it must rely on a partner to perform.

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10. Research shows that an effective dedicated alliance function develops a firm’s capability to perform four key functions. Briefly describe each of those four functions.

• (1) Improved knowledge management • (2) Increases external visibility • (3) Provides internal coordination • (4) Facilitates intervention and accountability

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. www.barnesandnoble.com 3. https://www.starbucks.com/ 4. Global Date and MarketLine Financial Deals. Retrieved 2017 5. French, R (2014). Leadership & Management. Retrieved 2017.

6. TATA Global Beverages and Starbucks Form Joint Venture to Open Starbucks Cafes across India.

(2012). Retrieved from https://news.starbucks.com/news/tata-global-beverages-and-starbucks-formjoint-venture-to-open-starbucks-ca (2017)

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Chapter 9 International Strategy Class Exercise: McDonald’s – “The World’s Largest Burger Chain Teaching Note This exercise focuses on McDonald’s recent activities regarding international expansion. The instructor should prepare a Fact Sheet for this exercise using public sources such as McDonald’s corporate website, Annual Report, current events and other sources noted in Reference listing at end of this exercise. This exercise, as with others, may be adapted to any company. Students are assigned to read the Fact Sheet prior to coming to class and then work on the exercise questions in small groups. The idea of compiling specific facts for the students and asking related questions helps students with their analysis (Bloom) skills as well as tests their comprehension (Bloom) of material. It challenges students to interpret what they are reading and link to chapter concepts. A Fact Sheet should include: Description of the Business, Strategic Direction, Organizational Structure, Description of Markets and any other relevant information.

This exercise should be updated with current information at a minimum of once a year.

Students – Please refer to your textbook and company Fact Sheet for additional insight and answer the following questions.

Recently McDonald’s announced its intention to open 1500 restaurants in Asia (China, Hong Kong and Korea) over the next five years. McDonald’s already has 2,800 (of the 36,000+ total) in those three countries. Most of the 2,800 are company-owned, whereas worldwide more than 80% of McDonald’s restaurants are operated by franchisees (90% in the U.S), that is, 5000 independent businessmen and women. McDonald’s views itself as a collection of small businesses. (2016) McDonald’s also closed 200 restaurants in 2015 in select areas. It also opened 400 restaurants in high-growth areas. Globally, comparable sales increased 2.7% in Q4 2016 and 3.8% across all segments for full year 2016.

1.

List the 5 reasons that firms expand internationally. Relate at least 2 of the 5 reasons to McDonald’s global expansion into Asia.

Growth, Efficiency, Managing Risk, Knowledge, Responding to Customers or Competitors.

A good discussion to have here is how the Growth reason for expansion helps McDonald’s attain its financial targets (noted in Fact Sheet).

2.

In terms of where firms should expand, an understanding of risks is important. Of the ones referenced in the text, which considerations and risks are relevant to McDonald’s decision to expand in Asia and/or other Foundational Markets?

Market-driven risks – will they buy? (Could pull in some country average income information from averagesalarysurvey.com for this discussion.)

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Political risks – government issues?

Economic risks – currency, labor, exchange rates (firm selling in foreign market earns profit in that market’s currency and it buys goods/labor in the local currency.)

3. Explain and relate the four types of Distance to McDonald’s decision to expand in Asia.

Cultural Distance – degree of differences between cultures of two nations. (Can include religion, trust, and gender expectations, how people follow rules or accept ambiguity and others mentioned in text.)

Could have an impact on how employees are managed.

Administrative Distance – degree of differences between legal and regulatory frameworks of two nations including how contracts are enforced, how local/national policies affect the firm, legal system.

Could have an impact on employment laws, intellectual property or other business issues.

Geographic Distance – how many miles separate the two countries? Impacts sourcing, organizational structure.

Economic Distance – the degree of difference between the average incomes of people in two different countries usually measured as per capital GDP (look at income levels, pricing and buying power).

4.

Looking at the two pressures that come into play when firms compete internationally (local responsiveness and standardization) – relate each to McDonald’s decision to expand in Asia.

As companies expand internally, they find themselves torn by two competing pressures: (1) Local Responsiveness – firms adjustments to products, services and processes in order to account for local culture and needs. (Religious e.g. daily prayer, important holidays, menu) (2) Standardization – Making products and/or processes consistent across different units and/or countries. Leverage knowledge gained in one area for growth in another. (e.g. menu item, paper products, marketing strategies, distribution processes) What other financial target would be impacted by standardization? (Operation Margin)

5. Regarding the three primary strategies that firms can use to do business internationally (multidomestic, global, arbitrage), which one(s) apply to McDonald’s decision to expand in Asia. Explain.

Multidomestic: 2

• • • •

Emphasizes local responsiveness over standardization (too much local responsiveness can make it harder to share knowledge across globe and develop competitive advantage) For firms in industries where customer needs and preferences vary widely between countries.

To enable autonomous decisions, significant parts of the value chain have to be replicated in each country.

Focus adaptation: Big Rosti(Germany) potato pancake

Global: • Involves selling standardized products, using standardized processes around the world.

• What products might be standardized for Asia….paper/non-food products where low costs can be achieved through economies of scale, possibly some menu items?

6.

What mode(s) of entry (export, licensing and franchising, alliances & joint ventures, whollyowned subsidiaries) will McDonald’s use in Asia? Refer to Table 9.2 for rationale behind your choice.

Licensing (Description of Business 2014 Annual Report) – developmental license agreement.

• Licensees provide capital, including real estate.

• McDonald’s has no capital invested.

• McDonald’s has equity invested in limited number of affiliates that invest in real estate and open/or franchise restaurants within a market.

Licensing – (2014) – franchise.

• McDonald’s views itself as primarily a franchisor.

For this question, I would work through the Entry Modes checklist (Dyer 2016).

7.

McDonald’s recently formed a strategic partnership with Terra Firma Capital Partners Chairman Guy Hands (English financier – private equity) for the Nordic Markets. (Graf 2017) McDonald’s is planning to transfer its ownership interest in McDonald’s Norway, Finland, Denmark and Sweden and allow Terra Firma to develop and operate the McDonald’s restaurants in these markets. This transaction involves approximately 435 restaurants in these four countries – 95% are franchises. The restaurants will keep McDonald’s name and products.

While the two firms agreed on the Master Franchise Agreement, this arrangement is also called a developmental license arrangement. a. Please explain what makes it developmental?

Terra Firma providing all the capital and will own everything. b. What would be the advantage for McDonald’s in this arrangement?

Limited investment, expansion of brand. c. Explain how this approach answers the “How should we expand?” question.

Through licensing agreement.

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References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Gibbs, A., (2016) McDonald’s eyes greater restaurant expansion in Asia. Retrieved from: https://www.cnbc.com/2016/03/31/mcdonalds-eyes-greater-restaurant-expansion-in-china-hongkong-korea.html. (2016) 3. https://www.mcdonalds.com/us/en-us.html 4. NBC News (2013). Retrieved from http://www.nbcnews.com/. (2016).

5. McDonald’s Annual Report (2014) 6. McDonald’s Press Release (2017) PRNewswire.

7. http://www.averagesalarysurvey.com/ 8. Graf, R., (2017). McDonald’s Continues International Reshuffling. Retrieved from https://www.thestreet.com/story/13970096/1/terra-firma-s-hands-buys-mcdonald-s-nordicrestaurants.html (2017)

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Chapter 10 – Innovative Strategies Class Exercise Teaching Note For this exercise, I use the Review Questions at the end of the chapter in addition to relevant examples.

The exercise is focused on understanding terminology related to Innovative Strategies (Bloom Comprehension Level). We also consider various companies and try to gain consensus on which category of Innovative Strategy applies. It is a good exercise for selecting new, interesting companies that students will either know something about and will generate interesting discussion. It is helpful to ask for examples of terms (e.g. Invention: Light Bulb)

1. What is the difference between an invention and an innovation? What are the differences between incremental versus radical innovations?

Invention: Creation of an idea or method, something novel.

Innovation: Conversion of a novel concept (invention) into a product, process or business model that generates revenues and profits.

Incremental: Building on the firm’s established knowledge base to create minor improvements to products or services.

Radical: Innovation that draws on a different knowledge base to deliver value in a unique way.

2.

How do companies create an innovative strategy by eliminating steps in the value chain?

(Provide an example.)

Most common is to eliminate step in the path from production to customer; e.g. eliminate a store, which means you can eliminate a sales person and inventory (Netflix, Redbox). Allows the disruptor to offer lower prices for similar products and services. Examples: Amazon books on line and used books sent direct from sellers; travel/tour companies selling direct; Southwest Airlines – must book travel on their website.

3.

What is the difference between “low end” and “high end” disruptive innovations? (Provide examples for each.)

Low-End: producing low-cost products and services for low-end (most price sensitive) then gradually moving up market as the product/service improves its technology and processes. Example: Honda smaller, low cc motorcycles. Harley-Davidson not concerned. H-D thought consumers would graduate to H-D. But Honda used profits from large volume small bikes sold to invest in development of larger bikes.

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High-End / Top Down Disruptive Innovations: High-end disruptions are new products or services that offer either superior performance or some other feature customers are willing to pay for. They outperform existing products when they are introduced and they sell for premium prices. Example: Apple iPod vs. Sony Walkman; Starbuck’s higher priced beverages and store atmosphere beating out smaller coffee shops. Starbuck’s disrupted business for small coffee shops.

New entrants launching high-end innovations typically rely on “radical” or leapfrog technological innovations that are more expensive in the beginning, then with improvements in technology and producing in higher volumes with greater scale, costs eventually decline.

4.

What does “mass customization” mean? How do companies use mass customization to succeed in the market? Provide an example.

Mass customization occurs when a company mass produces various modules of the product and then allows the customer to select which modules will be combined together. Examples: Build A Bear, American Girl dolls, Timuk2 (custom messenger bags, laptop bags, backpacks), Magnabilities (personalized jewelry – select necklace, holder for magnets in various designs to hang on necklace.

Bracelets too!)

What does it mean to target “non-consumption?” How does a company create new markets with a Blue Ocean Strategy? (Provide an example) Looking for consumers who do not currently purchase a product and offering a product (or service) that might induce consumption. Example: Cirque de Soleil (Dyer 2016) 5.

6.

What are the four behaviors of business innovators that help them generate ideas for innovative strategies?

1) Questioning – have a passion for inquiry, challenge the status quo, push people to think differently.

2) Observing – Carefully watch the world, make observations about customers, products, services, technology, companies to gain insight into new ways of doing things, i.e. ideas that can be adapted to their situations.

3) Networking – Spend time and energy funding and testing ideas through a diverse network of individuals. Actively search for new ideas by engaging with others.

4) Experimenting – Constantly try out new ideas – pilot test your ideas. Set assumptions aside and test new hypothesis.

This is a good place to encourage students to develop Discovery skills in all walks of life, be open to new ideas and ways of thinking.

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7. Which of the 6 “categories of innovative strategies” noted in the textbook apply to these companies? You may have to look up the companies if you need more information.

The case could be made for several correct answers for these companies. Use other companies. This exercise generally generates good discussion.

Company

What they did

Which Category of Innovative Strategy?

Explain your choice.

Uber

For hustling corporate business

Reconfigure the value chain to eliminate activities.

Call and pay with app. No need to hail a cab and provide your credit card or cash to pay for ride.

Netflix

For giving unexpected audiences exactly what they want.

Reconfigure the value chain to eliminate activities.

Get a movie anyplace, anytime, without leaving the house.

Taco Bell

For combining corn, beans, meat and cheese into genius

Airbnb

For democratizing authentic, local travel experiences

Low-end disruption. In 2014, the CMS said the goal was: To boldly disrupt …taking on McDonald’s in the breakfast space and with delivery service.

Low-end disruption. Use different approach to providing people with a place to sleep.

Fitbit

For taking health tracking mainstream

High-end/Top down. Blue Ocean – creating new demand in uncontested space (activity tracker)

Earnest

For building a better student loan

Low-end disruptive innovation. Lower cost for price sensitive consumers. Offer better student load rates through better data analysis. Consumers can use their own budget to customize rate and terms.

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References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. https://www.uber.com/ 3. https://www.fastcompany.com/ 4. https://www.tacobell.com/ 5. https://www.airbnb.com/ 6. https://www.fitbit.com/ 7. https://www.earnest.com/ 8. Fast Company (2016). Retrieved from http://www.prnewswire.com/news-releases/fastcompany-announces-50-most-innovative-companies-300218003.html. (2017)

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Chapter 11 – Competitive Strategy Class Exercise

Teaching Note For this chapter, I use either the Review Questions or one of the Application Exercises at the end of the chapter. I may skip this exercise depending on time. At this point in the semester, students are immersed in their group projects.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc.

Chapter 12 Implementing Strategy Class Exercise - Boeing

Teaching Note For this exercise, students are assigned to read an article in advance of class: (https://www.bloomberg.com/news/articles/2006-03-12/cleaning-up-boeing). Students are required (in small groups) to consider the actions outlined in the article and analyze those actions using the McKinsey 7-S Model, the Lewin Phases of Change Model and/or Kotter’s Eight Steps for Successful Change Model.

All or parts of this exercise could be completed with any company as long as there was enough information publically available to provide examples that work with one or more of the models from the chapter.

I give a short lecture on the models including how to use 7-S (Dyer 2016 p. 241): 1.

2.

3.

4.

Identify current state of the organization and misalignments.

Rank order misalignments based on importance.

Develop plans to create alignment.

Understand how proposed change affects other elements of the model (key message with the exercise).

5. Adjust plans accordingly.

Separate but related to this exercise, a Line of Site discussion fits well here. It’s interesting to talk about student jobs, discuss their line of site examples and why the concept is so important.

McKinsey 7-S Please consider which actions noted in the reading could become “targets for change” as they relate to each of the components in the 7-S model. For example, based on the article, what changes were made related to organizational structure.

Components of 7-S Model

Targets for Change

Strategy Structure

Example: Centralized leadership over three divisions.

Systems Style 1

Components of 7-S Model Staffing

Targets for Change

Skills Shared Values Lewin Phases of Change Using the three phases of change highlighted in your text (Lewin) and the Boeing article, identify activities that occurred or may have occurred at each stage of the company’s change initiatives.

Unfreezing

Changing

Refreezing

Example: CEO communicating reality of current state to management team.

Eight Steps of Successful Change (John Kotter).

What actions described in the article taken by Boeing (and its leader) can be applied or relate to each of the eight steps?

1. Generate a sense of urgency

Example: CEO Message.

2. Build a guiding coalition

3. Create a vision

4. Communicate the vision

Example: CEO leading by example

5. Empower individuals to act

6. Garner short-term wins

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7. Consolidate gains and move on for more change 8. Institutionalize the change

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Cleaning Up Boeing (2006). Bloomberg Business Week. Retrieved from https://www.bloomberg.com/news/articles/2006-03-12/cleaning-up-boeing (2016)

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Chapter 13 – Corporate Governance and Ethics Class Exercise

Teaching Note For this chapter, use either the Review Questions or one of the Application Exercises at the end of the chapter. At this point in the semester, students are immersed in their group projects so time is always a factor.

If time is limited, it can be useful to continue the discussion about the article “Cleaning Up Boeing” from Chapter 12 and related it to Chapter 13. Another approach is to review a company’s Corporate Governance statement and/or corporate values found on corporate website (in this case Boeing) and discuss how company activities support or conflict with the Corporate Governance statement.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc. 2. Cleaning Up Boeing (2006). Bloomberg Business Week. Retrieved from https://www.bloomberg.com/news/articles/2006-03-12/cleaning-up-boeing (2016)

Chapter 14 – Strategy and Society Class Exercise

Teaching Note For this chapter, use either the Review Questions or one of the Application Exercises at the end of the chapter. At this point in the semester, students are immersed in their group projects so available time is a factor.

References: 1. Dyer, J., Godfrey, P., Jensen, R., & Bryce, D. (2016). Strategic Management Concepts and Tools for Creating Real World Strategy. Hoboken, NJ: John Wiley & Sons, Inc.

Teaching Note

Walmart Stores: Gaining and Sustaining a Competitive Advantage Teaching Objectives This case is intended to be used as the first case in an introduction to strategy course or as a case to discuss cost advantage. The purpose of this case is for students to examine Walmart’s strategy using the framework outlined in the textbook that defines strategy as a plan to achieve competitive advantage that involves making four strategic choices: a) markets to pursue/compete in, b) unique value (low cost or differentiation) the firm will offer in those markets, c) the resources and capabilities required to offer that unique value better than competitors, and d) ways to sustain the competitive advantage by preventing imitation.” (See Real World Strategy, Chapter 1: What is Business Strategy?)

The case offers multiple reasons why Walmart has achieved a cost advantage but what students typically miss is the fact that many aspects of Walmart’s cost advantage stems from Sam Walton’s early decision to compete in rural markets where labor, rent, advertising costs were low (and where Walmart could price higher because of no competition from competitor discount stores because they avoided such markets because they weren’t deemed large enough to support a discount store).

The Decision portion of the case is introduced towards the end of the case with the primary question being: How should Walmart respond to the growth of online purchases, and specifically to Amazon.com as a competitor? Is the acquisition of Jet.com enough to help Walmart successfully respond to the Amazon threat, or are more actions needed? This discussion allows for an examination of whether the resources and capabilities that Walmart developed to succeed in brick-and-mortar retail are transferable to online success (including a discussion of what new resources and capabilities Walmart must develop to succeed online).

Study Questions

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1. Why has Walmart been successful? What is the single most important factor that has contributed to Walmart’s phenomenal success? [LO1] [AACSB Reflective Thinking] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Why exactly are Walmart’s costs lower than its competitors? Examine each element of the cost structure (e.g., COGS, labor, rent, advertising, distribution, technology, etc. as a percentage of total sales) and assess where Walmart’s costs are lower than competitors—and why. [LO1] [AACSB Analysis] [Difficulty: Medium] [Bloom’s 4 Analysis] 3. Why can’t Walmart’s competitors (e.g., Sears, K-Mart) imitate Walmart and realize similarly high profits? If you were running Sears-Kmart, what would you do differently? What, if anything, from Walmart would you want to imitate?

[LO1] [AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] 4. Why do you think Walmart has had difficulty succeeding in foreign markets, especially in emerging markets like Brazil and South Korea? [LO1] [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 5 Synthesis] 5. What should Walmart do to respond to the emerging trend of online purchases, and more specifically to the threat of Amazon.com as the dominant online retailer? [LO1] [AACSB Analytic] [Difficulty: Hard] [Bloom’s 6 Evaluation]

Multiple Choice Questions 1. Why has Walmart been successful? a. Store costs b. Distribution c. Supplier relationships d. All of the above “Answer:” D 2. What is the single most important factor that has contributed to Walmart’s phenomenal success? a. Choice of markets b. Differentiation c. Branding d. Innovation “Answer:” A Copyright ©2022 John Wiley & Sons, Inc.

3. Why exactly are Walmart’s costs lower than its competitors? Examine each element of the cost structure (e.g., COGS, labor, rent, advertising, distribution, technology, etc. as a percentage of total sales) and assess where Walmart’s costs are lower than competitors—and why. a. Because Walmart has very low store costs due to location b. Because Walmart has an extensive distribution network c. Because Walmart has great supplier relations d. Because Walmart uses cutting-edge information technology “Answer:” A 4. Why can’t Walmart’s competitors (e.g., Sears, K-Mart) imitate Walmart and realize similarly high profits? a. Because of Walmart’s economies of scale b. Because of Walmart’s economies of scope c. Because of Walmart’s brand awareness d. Because of Walmart’s market locations “Answer:” D 5. If you were running Sears-Kmart, what would you do differently? What, if anything, from Walmart would you want to imitate? a. Imitate Walmart’s scale b. Imitate Walmart’s marketing efforts c. Imitate Walmart’s human resource practices d. Imitate Walmart’s distribution methods “Answer:” D 6. Why do you think Walmart has had difficulty succeeding in foreign markets, especially in emerging markets like Brazil and South Korea? a. Because emerging markets do not recognize the Walmart brand b. Because emerging markets do not have sufficient suppliers c. Because emerging markets do not offer rural markets with growth potential d. Because emerging markets do not have the necessary infrastructure “Answer:” C

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7. What should Walmart do to respond to the emerging trend of online purchases, and more specifically to the threat of Amazon.com as the dominant online retailer? a. Imitate Amazon by eliminating brick-and-mortar stores b. Develop a web presence as ubiquitous as Amazon c. Leverage advantages through existing distribution d. Use brick and mortar presence as notes in a distribution network “Answer:” D Teaching Plan I. Aspects of Walmart’s competitive advantage II. Sources of Walmart’s competitive advantage III. How Should Walmart respond to Amazon?

IV. Summary of Key Ideas I. Aspects of Walmart’s competitive advantage

15-20 min 20-25 min 15-20 min 10-15 min

Question: Assume that you are hired by Sears/Kmart to identify the key elements that drive Walmart’s success. What is the single most important aspect of Walmart that you would recommend that Sears/Kmart imitate in order to experience similar success?

Examples of Facilitating Questions: • • • •

How does (____) help lower Walmart’s cost?

How much lower is Walmart’s cost because of (____)?

What does (____) have to do with Walmart’s success?

Walmart spends less than the competition on advertising. How do they get away with that?

While students may or may not identify the key aspects of Walmart’s strategy initially, the instructor should help students identify and quantify the varying aspects of Walmart’s competitive advantage. A summary of Walmart’s advantages, as well as questions to help facilitate discussion, is found below.

Distribution • Each distribution center serves roughly 150 stores within a 150-mile radius.

Technological innovations enable Walmart’s efficient distribution. Analysts estimated in the mid-1990s that Walmart’s inbound logistics expenses were roughly 1 percent less as a percentage of sales than its direct competitors. In 2011, Walmart was the world leader in cross docking procedures.

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Supplier Relationships • Walmart’s ability to put a supplier’s product on the shelves of over 10,900 stores gives it tremendous leverage with suppliers. Walmart’s ‘Worldwide Sustainability index’ uses various methods to track all stages of the product life cycle, from raw materials to disposal, and holds suppliers accountable for any unnecessary costs added to the supply chain. Walmart’s Electronic Data Interchange and RetailLink systems provided all of its suppliers with up to the minute, point of sale data from all Walmart locations worldwide. Walmart’s Scan ‘N’ Pay system made it possible for each product to be owned by the supplier until the product was actually sold by Walmart.

Information Technology • Walmart spent .1-.3% more on information technology, as a percentage of revenues, than competitors (5 to 10 times more than competitors in absolute dollars). Walmart was known to invest more in information technology to facilitate effective communication between its stores, distribution centers, and suppliers, thereby leading to more efficient distribution, fewer stock-outs, and lower inventories.

Human Resource Management • Walmart’s labor costs were 10.1% of sales compared to 11.2% of sales for its direct competitors. Walmart had no regional offices, which was estimated to save Walmart .5-1% of sales each year. Regional managers were located at Walmart’s headquarters and spent roughly 200 days a year visiting stores.

Members of the top management team typically earned more than 90% of their compensation from incentives based on their performance, and less than 10% as salary. Walmart’s lower labor costs were possible in part because a large percentage of stores were located in rural markets where labor costs were lower than in suburban markets. In addition, Walmart worked actively to prevent its labor force from unionizing. In one example, Walmart simply closed its meat cutters division and outsourced the entire operation to an external supplier rather than allow a meat cutters union to form.

Marketing and Merchandising • Walmart started with almost no investment in advertising which was unnecessary in small rural towns where advertising was unnecessary because EVERYONE in the town new Walmart had come to town. It was such a big deal, and advertising costs in 2010 were only 0.6% while Target’s were 2.0%. To ensure prices were low every day, Walmart conducted weekly price checks in nearly 99% of its competitors’ stores. In rural locations where Walmart was the

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only discount retailer in town, Walmart’s prices were 6% higher than in locations where a direct competitor was nearby.

Store Costs • A much larger percentage of Walmart’s stores were located in rural towns where land is cheaper than in suburban areas. Thus, Walmart’s cost of stores (land/rent) has been roughly .4% lower than for competitors.

Benchmarking Walmart’s Cost Advantage Inbound Logistics Information Technology Labor Costs No Regional Offices Advertising Costs Higher Rural Prices* Store Cost/Rental Rates Total Cost Advantage

+1% -.1% to -.3% +1.1% +1.5% to +2% +1.4% +2.9% +0.4% 8.0%

*’Higher Rural Prices’ advantage was calculated by multiplying the average price increase in rural Walmart stores (higher by 6%) by the percentage of total Walmart stores in rural areas (48.6%).

II. The key sources of Walmart’s competitive advantage The purpose of this section is to help students see that even though there are many aspects to Walmart’s competitive advantage, the main source of these advantages has come from Walmart’s choice of rural markets and its distribution system that supports its stores in those markets. The line of questioning below is meant to help students arrive at that conclusion.

Question: Assume that I am the owner of Walmart and that you are the senior management of Sears/Kmart. As owner, I am willing to give you some of the things that you identified. If I gave you ( ) would that be sufficient to effectively compete against Walmart?

Question: If I gave you ( ), why or why not would you be comfortable in your ability as Sears/Kmart to successfully compete against Walmart?

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Question: What else would you need to be able to effectively compete against Walmart?

Would ( ) be sufficient?

(The previous two questions may be repeated as students prioritize which of Walmart’s resources and capabilities are most critical to success. The teacher may also volunteer resources to the students, such as offering the Walmart brand, to help facilitate the discussion) Question: What have I not given you?

Question: Why would Walmart’s stores and distribution centers be the key to its competitive advantage?

At this point, it will be beneficial to show how the source of many of the cost advantages Walmart enjoys can be traced back to their choice of markets. Below are examples using each of the quantified advantages listed in the Benchmarking Walmart’s Cost Advantage section above.

Rural Markets vs. City Markets • In a typical large city market (such as Atlanta, Dallas, Philadelphia, Los Angeles), one would expect to find multiple discount retailers (an illustrative example of such a market is below).

*Each shape represents a different retailer such as Target, Sears, K-Mart, Costco, Kohls, etc.

Copyright ©2022 John Wiley & Sons, Inc.

Compare this to a smaller rural city market where Walmart decided to locate, such as Rogers, Arkansas (its first store) or Sikeston, Missouri and Claremore, Oklahoma (its first stores outside of Arkansas).

Question: Which of these looks markets looks closest to perfect competition? To a monopoly?

After establishing the generic benefit of operating as a monopoly compared to operating in a competitive market, it should be much easier to see how many of the cost advantages Walmart enjoys comes from its decision to operate in these smaller markets.

Labor Costs • Because Walmart is one of the largest, if not the largest, single consumer of labor in rural markets, it has significant bargaining power and can offer lower wages than it would be able to in large cities. It can also offer lower wages because the cost of living is lower in rural markets than larger cities.

Advertising Costs • When a retailer builds a new store in a large market, they would typically need to not only signal to consumers that they are in that market, but also that they are better than the competition. For Walmart in rural markets, the store itself is most likely sufficient in letting consumers know that Walmart has arrived.

There would also be less need, if any need, to signal to consumers that Walmart has lower prices if they are the only large retailer in the market.

Prices • When there is significant competition and competitors are selling relatively homogenous goods, rivals will most likely compete on price. This leads to lower operating margins in the large city market. In the rural market, where Walmart is the only large discount retailer competing with a group of “mom & pop” retailers, they can raise prices without the worry of losing consumers to competitors which do not have the scale to offer lower prices.

Store/Rental Costs • Real estate is cheaper in rural markets than it would be in large cities.

III. How Should Walmart Respond to Amazon and the growth of online?

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Question: What is the current situation with regard to the online retailing market and Walmart’s position in that market?

Walmart’s success in the future will require that the company respond effectively to the growing trend towards online purchases and the emergence of Amazon.com as a major competitor. The online retailing market, 11.7% of total retail sales in 2016, is expected to grow from roughly $390 billion in 2016 to over $1 trillion by 2026.

According to Internet Retailer, the problem for Walmart, and other companies trying to compete online, is that Amazon.com drove 65% of e-commerce growth in 2016.

Walmart is losing to Amazon online in a big way.

In response to this trend towards online purchases, and to attempt to better connect with millennials, Walmart decided to purchase Jet.com for $3.0 billion. Like Amazon.com, Jet.com was an online discount retailer but one that focused on more price sensitive customers by attempting to provide better pricing than Amazon.com using a dynamic pricing model. One of the first things that CEO McMillon did after the acquisition was make Jet.com founder Marc Lore President of Walmart’s U.S. eCommerce business. But the acquisition of Jet.com—and putting Lore in charge of Walmart’s e-commerce business—raised a number of questions going forward.

Question: If you were running Walmart, what actions would you take to compete more effectively online?

- Would you continue to run Jet.com as a completely separate site from Walmart.com? If so, for how long?

- Should Walmart.com adopt some of the innovative pricing approaches used by Jet.com?

- What other suggestions do you have for Walmart increasing its ability to compete effectively with Amazon.com?

IV. Summary of Key Ideas It may be useful to use PowerPoint associated with this case as the key ideas are summarized in this section.

Walmart’s Strategy: The inter-relatedness of Walmart’s 4 strategic choices.

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Choice of markets to serve o First to locate stores in cities with less than 50,000 population o 1762 stores in rural America vs 476 stores for Kmart and 48 for Target o Higher prices in small markets o Lower costs in small markets

Copyright ©2022 John Wiley & Sons, Inc.

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Walmart’s Unique Value (Value Proposition) o Everyday low prices for a broad range of goods that are always in stock in convenient locations; this explains WHY customers choose Walmart over other discount retailers.

•

Resources and capabilities to deliver that unique value o Large footprint of rural stores o Distribution capabilities o Bargaining power over suppliers o Fewer layers of management o Culture of cost reduction o All these things are important, but the key to Walmart’s strategy is the choice of Walmart’s markets which allowed all of these things to become a success

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Sustainable competitive advantage; what prevents imitation by competitors o Competitors rationally refuse to enter Walmart’s towns o First mover advantage which created a barrier to entry through a natural geographic monopoly o Success was initially driven by its choice of markets and its ability to offer lower prices than local competitors in those markets due to a more efficient business model

Note: Walmart has struggled globally because much of Walmart’s strategy/ business model is hard to replicate in international markets, especially the small-town strategy.

For example, this has not worked well in countries like Brazil an S. Korea due to: - Lack of income in small markets in most countries - Lack of vehicles for customer to drive to shop at a Walmart store - Distribution is difficult w/ poor infrastructure in rural areas - Managing in a foreign market is difficult, but even more difficult to find capable management in small towns

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Note

Coca-Cola and Pepsi: The Shifting Landscape of the Carbonated Soft Drink Industry Teaching Objectives This case provides an understanding of the underlying economics of an industry and its relationship to average industry profits. The concentrate industry is, on average, more attractive than bottling. It also provides students with an opportunity to create an entry strategy for a new player in the concentrate industry.

After completing this case, students should have a much clearer understanding of the five forces that influence an industry’s attractiveness. They also should have an increased ability to analyze each of those five forces to assess and measure the overall attractiveness of a given industry. The case provides all of the needed information for students to use the supplier power and rivalry five forces tools from chapter 2.

Study Questions 1. Analyze the structure (Porter’s 5 Forces) of the soft drink industry. Why are Coke and Pepsi so profitable? What prevents other firms from entering this industry and accessing some of those high profits? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension] 2. Compare the economics (costs and profits) of soft drinks (concentrate) versus bottlers. Why is the concentrate business more profitable than the bottling business? Why do you think Coke & Pepsi are in the bottling business? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] 3. Team Assignment: Create a 5-year proforma in Excel which projects the revenues, costs, and profits (both earnings before interest, taxes, and amortization (EBITDA) and earnings before taxes (EBT) for a company who enters the U.S. carbonated soft drink industry and who attempts to build a 10% market share position in the U.S. carbonated soft drink industry within a fiveyear time period (please include fixed and variable costs in your analysis). To calculate interest expense, assume that you will need to raise 50% of the capital you require through bank financing at 10% interest. To calculate depreciation expense, assume that only a niche player (with less than 5%

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market share) can access the bottlers/distributors of Coke or Pepsi, which means you will need to build bottling plants (which you can depreciate using straight line depreciation over a 30-year life). Please provide your assumptions along with a one-half page description of your market entry strategy. [AACSB: Analytic] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions 1. Analyze the structure (Porter’s 5 Forces) of the soft drink industry. Why are Coke and Pepsi so profitable? a. Firms can easily enter the market in concentrate manufacturing, but Coke and Pepsi dominate the competition b. Because profitability is very high for all companies in concentrate manufacturing c. Because Coke and Pepsi have low bargaining power over suppliers and buyers d. Because Coke and Pepsi create high barriers to entry and exploit high profitability in concentrate production “Answer”: D 2. What prevents other firms from entering this industry and accessing some of those high profits? a. Coke and Pepsi’s presence in the bottling business is what protects the concentrate business due to the increased barriers to entry b. Coke and Pepsi brand equity maintains the existing customer base and forces out rivals c. Taste tests reveal that IP in the form of proprietary formulas do create greater value for customers d. The sentence in incorrect. Other companies can easily enter the industry “Answer”: A 3. Compare the economics (costs and profits) of soft drinks (concentrate) versus bottlers. Why is the concentrate business more profitable than the bottling business? Why do you think Coke & Pepsi are in the bottling business? a. The franchise bottling system is very difficult to imitate b. It takes only one of the five forces to be a major threat to industry profitability in the concentrate business c. Concentrate manufacturers have very high profit margins d. All of the above

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“Answer”: D

Teaching Plan I. Taste Test II. Board Exercise: Concentrate Environment III. Board Exercise: Comparison to Bottling Environment IV. Conclusion

15 min 30 min 15 min 10 min

I. Taste Test While not required, this activity may help students understand more clearly that Coke & Pepsi are more differentiated by brand than they are by product.

In preparation for this activity, you will need a bottle of Coke, Pepsi, and generic cola.

It is best to put each brand in a pitcher or other type of generic container as the twoliter bottles are distinctive in appearance. Make sure you know which brand is in which container. This can be done with a number taped to the bottom of the container. Place each container on a table with a number in front of it. The students will use that number to identify which brand they think they are tasting.

Ask if any students drink a lot of cola and have a preference for a particular brand. At the end of the exercise, you will specifically ask those students if they correctly identified each brand and if they chose the right one as their favorite.

Write Coke, Pepsi, and Generic on the board. Have either all or a subset of students taste a sample from each bottle and write down the number of the container beneath the brand they believe they are tasting. While some professors like to use a subset of students to speed up the exercise letting all students do the taste test really piques their interest and engages them in the rest of the lesson. Also have the students select which cola they most like by placing an asterisk next to that selection on the board.

After each student has completed the test taste, reveal to them which soda was which.

Ask those who drink a lot of cola and were sure they could tell the difference if they got it right. While some may correctly identify all three, most of the students will likely not.

It may also be interesting to note that some students that have a favorite cola (Pepsi or Coke) will mistakenly choose another cola as their favorite (e.g., Pepsi drinkers may mistakenly identify Coke or the generic brand as Pepsi). While with some classes the majority identify each cola correctly; most of the time they do not, and the generic cola is often chosen as the overall favorite.

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Question: What does it mean that you can’t tell the difference?

The purpose of the Concentrate & Bottling Environment sections is to help students more concretely identify the sources of Coke & Pepsi’s profitability. These sections also give students an opportunity to identify what they would do to operate profitably in these environments (see Study Question #3).

II. Concentrate Environment Question: Coke & Pepsi make roughly 80% margins on a product that, according to the taste test, isn’t very differentiated at all. How can you explain how a company that sells a non-differentiated product makes higher margins than companies that make very differentiated products such as Intel or Apple?

As students answer, help them see that the profitability does not solely come from brand equity. For example, it may be useful to refer students back to the taste test and ask a question such as: If brand is the source of profitability, does that mean that Coke and Pepsi have convinced us that their product is better than the generic brand even though you can’t really taste a difference between them?

During this discussion, it is likely that students will mention Coke & Pepsi’s spending on marketing and advertising ($234m & 136m respectively). As they do so, it may be useful to ask the following: At this point, students should be describing characteristics of the competitive environment other than brand equity. A description of the concentrate industry environment is given below for reference.

This works well as a board exercise. Two approaches – one is to list the five forces on the board and fill in the various elements as students bring them up. Another approach, the one I typically use, is to ask for a five force, and then ask students to rate it low, medium, or high, and analyze why. As they do so write a summary of their analysis on the board. It is helpful to push the students to use the language from the chapter and identify the exact reasons that a force is high, medium, or low. For instance, one reason rivalry is low is because the concentrate manufacturing industry has few firms in it and they do not compete on price with their primary customers, the bottlers. Below is a simplified summary.

If you had the students use the rivalry tool as an experiential exercise when covering rivalry, you may want to show the answers to five forces worksheet so students can

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compare it with their answers and see how a thorough analysis can inform the more informal analysis they are doing in class.

Threat of New Entrants LOW—due to barriers such as limited shelf space* and the high brand equities of incumbents

Supplier Power

Competitive Rivalry

Buyer Power

LOW—All concentrate inputs are commodities

LOW—Coke and Pepsi have a large share of a shrinking market. Little price competition. Few firms in the industry

LOW—The Bottlers are the buyers. They are locked into long term contracts with no ability to switch suppliers

Threat of Substitutes HIGH—Multiple substitutes—any other beverage. Get students to see how Coke and Pepsi have managed this threat by purchasing major substitute brands

*Besides limited shelf space, limited fountain space and costs of vending distribution also create barriers to entry.

Question: Why can’t another company successfully enter the concentrate industry by simply investing a large amount into marketing and advertising?

If you had the students do study question #3 this would be the time to show the excel spreadsheet showing the 5-year proforma, focusing on the costs of advertising, creating a bottler network, and paying for shelf space.

III. Bottling Environment

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Question: Compare the attractiveness of the concentrate industry with the bottling industry? Why is the concentrate industry more attractive than the bottling industry?

Push students to apply the 5 Forces model to compare the two industries. This works well as a board exercise. As with the concentrate manufacturers ask students for a five force, have them choose if the threat is low, medium, or high, and then analyze why.

If you had the students use the supplier power tool as an experiential exercise when covering supplier power, you may want to show the answers to five forces worksheet so students can compare it with their answers and see how a thorough analysis can inform the more informal analysis they are doing in class.

A comparison between the two industries can be very instructive. At this point ask the students if the industries are attractive. On the surface both look attractive. However, you can point out that the concentrate manufacturers enjoy high profit margins while the bottlers do not. Ask the students why. While the bottling industry looks very attractive the lesson to be learned is that it can take only one of the five forces to be a major threat to industry profitability. In this case the extremely high supplier power that the concentrate manufacturers enjoy allows them to siphon off any extra profits from the bottling industry.

Threat of New Entrants LOW—due to high capital costs to enter and exclusive contracts with Coke and Pepsi Buyer Power Supplier Power

Competitive Rivalry

LOW for commodity inputs (such as glass) and Very HIGH for the soda inputs (such as Coke)

LOW—only two to three bottlers in any geographic area

Threat of Substitutes LOW—Bottlers control most methods of bottling including glass and aluminum

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MED—overall buyers are fragmented but in any geographic area supermarkets and warehouse stores are likely to represent a large percentage of sales

Question: Why are Coke and Pepsi in the bottling business if it is so much less attractive than concentrate?

Although the concentrate environment is attractive by itself, their presence in the bottling business is what protects the concentrate industry due to the increased barriers to entry. The purpose of this section is to help students understand why it would be difficult to directly enter the concentrate market and why Coke & Pepsi are experiencing such great profits.

IV. Conclusion •

This case provides an understanding of the underlying economics of an industry and its relationship to average industry profits. The concentrate industry is, on average, more attractive than bottling. Entry into the concentrate industry is limited by barriers to entry: o Brand Equity o Bottling/Franchise System o Limited Shelf Space

•

Relative to bottling, concentrate has: o Greater bargaining power over suppliers and buyers o A more attractive industry structure overall

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Teaching Note

ESPN in 2015: Continued Dominance in Sports Television?

Teaching Objectives This case asks students to apply the company diamond model and see how values and priorities lead to the development of resources and capabilities. Furthermore, it seeks to communicate the core elements of a business and revenue model, helping students understand how, when, and why a business model changes. In this case, students will evaluate ESPN’s response to competitive challenges to its business model and it will provide students with the opportunity to work in teams to propose solutions to ESPN’s challenges.

At the end of this discussion, students should be able to identify the elements of ESPN’s strategy and, using the company diamond model, explain how the different elements of the diamond work together to create competitive advantage. They will explain how and why ESPN’s core business model changed and the impacts of this change on different stakeholders. Finally, they will explore and discuss if ESPN has been able to generate competitive advantage and evaluate current challenges to ESPN’s business model, suggesting recommendations for the future.

Study Questions 1. What role do values and culture play in the creation of competitive advantage at ESPN? What resources and capabilities does the company possess? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Why did ESPN change their revenue model in the early 1980s? How did that change affect ESPNs growth? The cable industry in general? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] 3. Of the challenges facing ESPN in 2015, which one do you think is the most significant?

The biggest opportunity? Biggest threat? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 6 Evaluation] 4. (Optional pre-class preparation): With your learning team, develop a course of action for ESPN in 2015. How should ESPN respond to the changing technology landscape of sports programming? What impact will your changes have on ESPNs business and revenue model? You should prepare a 5–7-minute presentation that outlines your recommendations. [AACSB Analytic] [Difficulty: Hard] [Bloom’s 5 Synthesis] Copyright ©2022 John Wiley & Sons, Inc.

Multiple Choice Questions 1. What role do values and culture play in the creation of competitive advantage at ESPN? a. “No one is watching” culture led to risk-taking, flexible approaches to programming that encouraged creativity b. Sports fans serving sports fans created authenticity and enthusiasm for the work c. A focus on innovation revolutionized the way sports are covered d. All of the above “Answer”: D 2. What resources and capabilities does the company possess? a. 50+ sports properties b. The ESPN brand c. ESPN contracts d. All of the above “Answer”: D 3. Why did ESPN change their revenue model in the early 1980s? a. The massive growth opportunity in cable b. The subscription model allows more flexibility in programming c. Cable was a newly introduced technology d. ESPN needed reliable monthly revenue “Answer”: A 4. How did that change affect ESPNs growth? The cable industry in general? a. Cable became a viable alternative to network broadcasting b. ESPN’s business and revenue model lies in the monthly cable subscription revenue c. Cable subscription revenue is cash cow of the business, providing 78% of 2015 revenues d. All of the above “Answer”: D 5. Of the challenges facing ESPN in 2015, which one do you think is the most significant? a. Cord cutters b. Other streaming services c. The demise of cable Copyright ©2022 John Wiley & Sons, Inc.

d. Revenue models that rely on subscriptions to streaming services “Answer”: C 6. The biggest opportunity? a. The biggest opportunity is new streaming revenue b. The biggest opportunity is using social media recommendations to tailor new content c. The biggest opportunity is leveraging its existing network of contracts and viewers to create exclusivity d. The biggest opportunity is acquiring new sports markets for changing demographics (i.e., cricket and soccer).

“Answer”: C 7. Biggest threat? a. The biggest threat is other streaming services (competitors) b. The biggest threat is cord cutters (buyers) c. The biggest threat is ESPN contracts (suppliers) d. The biggest threat is non-sports streaming content (substitutes) “Answer”: B Teaching Plan

I. ESPN in 2015 II. Case Summary III. The Power of ESPN IV. ESPN and the Company Diamond V. ESPN: Going forward in 2015 VI. Summary and Wrap-Up

5 min 5 min 5 min 20 min 20 min 5 min

I. ESPN in 2015: Continued Dominance in Sports Television?

This topic has often been documented for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in conjunction with a module on internal business unit strategy, and firm resources and capabilities. The case provides students with opportunities to see how a company develops a unique set of resources and capabilities over time, and how those capabilities may be threatened by technological, demographic, and market changes. This note assumes the instructor is either using, or is familiar with, Strategic Management by Dyer, Godfrey, Jensen, and Bryce. Students need to Copyright ©2022 John Wiley & Sons, Inc.

have some facility in industry analysis and familiarity with the Company Diamond tool as discussed in Chapter 3, although the case touches on Chapter 5 (differentiation advantage) as well.

II. Case Summary The case begins by setting the core challenge of the case. In 2015 ESPN holds a dominant position in sports programming, but the company is seeing an erosion of subscribers due to the ability of online platforms to deliver content in ways that threaten ESPNs business model.

The case is set up to facilitate critical thinking and judgment by students about how ESPN should respond to a shifting marketplace.

The case then describes the founding of the company in 1979 and its early history. ESPN began as the brainchild of entrepreneurs Bill and Scott Rasmussen. The viability of ESPN depended on its using a new, disruptive technology in TV programming: cable TV. The case describes how ESPN was able to establish itself in the cable TV landscape, and with a change in its business model in the early 1980s, cable and ESPN would fuel each other’s rapid growth.

The case provides a timeline of major milestones in ESPN’s history: its first contract with the NCAA, the role of NASCAR, the Americas Cup, and finally professional sports in completing the ESPN content portfolio.

The narrative provides students with the opportunity to understand how ESPN developed a unique culture, set of values, and brand that define the network as a differentiated competitor, even in the world of sports programming. The latter half of the case concerns the challenges the company faced by the year 2015. As the case closes, ESPN executives must decide upon a strategy for dealing with the rise of streaming online video feed (usually for free). Executives must also face the possibility that the rise of social media makes much of ESPNs historical competitive advantage obsolete. Finally, ESPN leadership must face the reality that its traditional business model of being bundled in basic cable and satellite packages is under threat. The case concludes with some data about the overall threat that streaming and social media technology pose to the overall ESPN business and revenue model.

II. The Power of ESPN ESPN is as a cultural icon. As both an icon and a source for sports programming, ESPN has historically been very popular among college students. I like to begin by tapping into the passion that many sports fans have for the network by polling students about how many of them watch ESPN. The instructor may ask: “how many of you have watched ESPN in the last week?” this can be followed by a question of how much? Among those who watch ESPN heavily, the instructor should probe to draw out two elements: 1. How dominant ESPN is in their viewing habits in terms of time and commitment, and 2. How does ESPN fit within their overall viewing habits (what else do they watch). Heavy viewers of ESPN tend to fall into two broad categories: Those who watch a lot of ESPN and do so almost exclusive of other Copyright ©2022 John Wiley & Sons, Inc.

viewing, and those who are “heavy viewers” of cable and other media in general, and ESPN fits in that mix. This section should conclude with a question for heavy viewers, and the class in general, about the “magic” of ESPN. Question: Why is the network so popular? What hold does it have on viewers?

III. ESPN and the Company Diamond The previous question creates a natural segue way into a one of the core purposes of the case: To allow students to see how ESPN has created a dominant position through amassing a valuable set of resources and capabilities. The answer to the final question in the introduction will almost always fit, or can be gently massaged to fit, into a discrete activity the company engages in (such as SportsCenter) or a strength of the company (such as cutting-edge sports reporting, extensive coverage, or the humor and wit of ESPN commentators). The instructor should probe for other strengths of the company and develop a list of these on upper section of the black (white) board.

When students have created a list of 5-6 strengths, the instructor should probe for weaknesses and develop a similar list. Students may list weaknesses as the lack of a free video streaming option from ESPN (as of 2015, one could only stream ESPN if already a cable customer). Students may also note other weaknesses mentioned in the case: ESPN is no longer the source of breaking news, the company has been accused of unfair market behavior by competitors, and that ESPN is losing subscribers. Student critics of ESPN may also list other weaknesses.

Question: What resources and capabilities drive ESPNs strengths and competitive advantages?

Resources can be thought of as assets the company possesses, and capabilities as the processes that the company uses to deploy its resources in the marketplace?

Resources •

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50+ sports properties (including restaurants, the magazine, web properties, and the broadcast networks). o Exhibit 4 illustrates that ESPN has three branded properties in the top 15, 4 if one recognizes that ESPN is a driving partner behind the SEC network.

The ESPN Brand. o Forbes ranked the ESPN brand as the 32nd most valuable in the world in 2015, valued at $16.2 billion. The brand ranked just behind Nescafe in beverages ($17.3 billion) and ahead of retailer H&M ($15.3 billion).i The ESPN contracts. o ESPN has contracts with most major sports leagues (it gave up the NASCAR franchise after helping to build that brand in the 1980s-1990s). Contracts give ESPN the ability to broadcast exclusive content.

Viewers.

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o With 94.5 million viewers, ESPN ranks as the top sports programming network, and ESPN2 comes with the same viewership. FS1 (Fox Sports 1) comes very close with 91 million subscribers, but the next closest competitor is NBC with 83 million viewers. Having the largest viewing base gives ESPN the ability to charge the most for advertising rates.

Capabilities •

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The ability to develop content and original programming. The network produces not only live sports programming, but a number of commentary and reporting shows.

ESPN films should be brought up here and the Sports Century project showed that ESPN was great at journalism as well as sports. ESPN also created the ESPYs, which is an excellent example of positioning the network in the middle of the entire sports ecosystem.

SportsCenter may be considered a resource, but the discussion in the program in the case should help students see the set of capabilities that drive the asset. These include: o A focus on sports journalism and breaking stories, not merely the reporting of sports news. The instructor can pause here and note the role of John Walsh in making SportsCenter must-see TV by focusing on getting great sports journalists to staff the show. o The ability of ESPN to leverage SportsCenter programming throughout the day.

For example, in the mid-1990s, SportsCenter, with Keith Olberman and Dan Patrick, re-ran 6 times per day. The company proved able to leverage a relatively low-cost production to fill the airwaves.

Brand Management. The instructor might ask “what are the key elements of the ESPN brand?” Students can refer to the “magic” elements of ESPN noted by their heavyviewing classmates, and they can also note that the brand communicates professionalism, leadership in sports programming, innovation (the first mic’d up competitors, etc.), and a certain irreverence and refusal to take things seriously. The case makes clear that ESPN pays a lot of attention to the brand and spent significant corporate effort in the late 1990s to refine the brand and its message.

Core Values and Priorities With a list of capabilities in place, the instructor should move to a discussion of the core values and priorities in play at ESPN. Three elements, at least, should appear on this list: •

The mission of sports fans serving sports fans. The instructor should highlight that this is more than just a brand, the notion of sports fans serving sports fans was embedded in the founding DNA of the company. The Rasmussen’s, the early investors, and Stuart Evey were all attracted by the potential of an all sports network, in some measure

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because of their love for sports. Scotty Connel and Chet Simmons laid the foundation of this value as they began hiring staff for the new network. The instructor should highlight the initial hiring protocol sifted applicants based on their love of sports. How an organization selects and retains its human capital has tremendous impact on culture; in the case of ESPN, that imprint came at founding.

“No one is watching anyway.” Since no one was watching—at the beginning— broadcasters could take huge risks in both programming style (an irreverent attitude at SportsCenter) and content (it made sense to pick up sports with very small viewing audiences since no viewer group was too small). The pursuit of small market sports proved to be a long-term advantage for the network. Televising the NFL draft provides an excellent example. None of the major networks thought the draft was worth televising—the viewership was too small to move the dial and justify the production cost. However, the viewership of ESPN was so small (“no one is watching”) and so televising the draft made sense. The NFL draft has now become a central off-season event for dedicated fans.

A focus on innovation. The very idea of an all sports network was a radical innovation in 1979, as was the belief that Cable TV would be more than a distribution provider to the rural U. S. population, Scotty Connel imprinted the organization with the ability to “make two cameras do the work of five” and to find innovative angles to cover events.

Most students will think that coaches and players have always been wired for sound, but this was another ESPN innovation. John Walsh’s dedication to sports journalism innovated the role and stature of sports reporting by taking the genre beyond merely the reporting of scores and showing highlights.

The instructor should conclude this discussion by helping students connect the dots between the values (culture) of ESPN, its resources and capabilities, and its competitive strengths and weaknesses. As a first cut, the instructor can ask about the synergy created between the values and priorities at ESPN. An organization of dedicated sports fans would always be thinking of new ways to view and talk about sports, and that natural desire for innovation would be greatly assisted by a culture of “no one is watching” that allowed employees ample space and freedom of movement.

The instructor should also point out the vertical relationship between values, priorities, resources, capabilities, and strengths/weaknesses. Probably the best example here is the revision of the brand in the late 1990s. If the value is sports fans serving sports fans, then the brand ought to be about a personal connection with fans, one based on emotional connection rather than merely the large objective of worldwide leadership in sports. That intense focus on brand and a real connection can be seen in the breadth and depth of how ESPN has deployed its brand over its different properties (TV, Radio, Print, and Internet).

The instructor might conclude this section by asking “which came first?” to help students see that competitive advantage in the Company Diamond flows upward: the foundational element is values, culture, and priorities. With these in place, a company can, over time, Copyright ©2022 John Wiley & Sons, Inc.

develop a set of powerful resources and capabilities that can drive competitive advantage— activities and strengths. The instructor can conclude this section by asking: “So, ESPN has created the dominant sports property in the world. How seriously should the network take the challenges posed by changes in internet technology?”

IV. ESPN: Going forward in 2015 The most important element of this section of this discussion is to manage the timing. It’s easy to run out of time and allow some of the most interesting learning points to slip away.

If the instructor has not pre-assigned question #4, I’d suggest giving teams 5 minutes to huddle together and think about what types of things ESPN might do. After about 7 minutes the instructor should ask two different teams for their general ideas. If the instructor has used preparation question #4, then student teams will arrive ready to present their ideas on the case. It helps to have at least 2 teams prepared to present; I like to pick one team at random and then ask for another team that has come up with a different set of recommendations.

Once the class has a couple sets of recommendations to look at, the discussion can begin. In general, there are two key, interrelated issues for discussion: the content issues around both streaming and social media, and the impact of whatever choice ESPN makes on its revenue stream.

Question: To what extent will the student recommendations create meaningful differentiation for ESPN? Throughout its history, the network has thrived when it has brought something new and unique to sports programming. The network’s first success was to expand NCAA coverage to a nation of sports fans that cared about a variety of NCAA schools, not the few that dominated network coverage. Similarly, SportsCenter moved sports reporting from a 2–3-minute segment on the evening news to a 30-60 minute extended, in depth report.

Social media provides an interesting area for discussion. With all major sports teams, colleges, and conferences having their own social media presence, the ability of ESPN to create breaking news is severely limited. In a world where fans get their news directly from their favorite team, how does ESPN add value? The goal of this discussion is to help students think through the strategic, as opposed to tactical issues involved here.

ESPN still has a couple of strategic advantages that it can leverage. First, the network can provide un-biased, third-party coverage of events. Second, the network can play the role of an aggregator and provide analysis and coverage that individual teams cannot. For example, Michigan (and almost every other school) fans have access to everything the Wolverines put out, but those fans may still want ESPN to provide analysis of the implications of Michigan’s moves on the Big 10, the other P-5 conferences, and college sports in general.

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Question: How will the recommendations play with the ESPN revenue model?

The goal of whatever ESPN wants to do has to be to drive paying eyeballs to ESPN. One challenge with online streaming video is the difficult in monetizing the revenue. Streamers such as Netflix, Hulu, and others have figured out one solution—subscribers pay for direct access to the core content of the service—movies or TV. Students will likely raise such a possibility, and the instructor can then ask: “if ESPN offers to stream its most valuable content (games and other sporting events) live, what happens to the Cable TV subscription business?” “What type of price would ESPN charge for such a service?”

The instructor should point out that many of the technology suggestions that students usually make have the net effect of moving ESPN away from a “bundled” cable service and toward an “a la carte” network. Students need to understand the power of bundling, exemplified in the Fox Sports quotation at the end of the case. If only ½ of subscribers actually watch ESPN in a given month, ESPN has about $3.75 billion in annual “gifted revenue” from subscribers who never watch. Moving to an a la carte network (cutting its own cable “cord”) puts in jeopardy just about 1/3 of the network’s total revenue.

These questions are designed to prompt students to think about the challenge of monetizing sports content.

Question: Will consumers be willing to pay $6.60+ per month for ESPN as a part of a cable package, and pay an additional amount on top of that? Would consumers be willing to pay $25 per month to stream ESPN? The quotation near the end of the case gives $300 per year as the going rate for NFL Sunday ticket—a service that actually closely maps a streaming ESPN. What other parts of ESPN would consumers need to receive as a part of a streaming package?

Question: More importantly, however, how does ESPN manage its product offering to ensure that a streaming service complements the cable properties and does not substitute for them?

The instructor should help students see that the power of ESPNs business and revenue model lies in the monthly cable subscription revenue. That’s the cash cow of the business, providing 78% of 2015 revenues. The instructor may ask, “What’s the relationship between advertising revenue and subscriptions?” In brief, it’s a highly correlated and positive relationship: The more eyeballs visiting the network, the higher the advertising rate ESPN can charge. A review of the data in Exhibit 1 is instructive. Subscription revenue covers ESPNs costs, with about $500 million to spare. Advertising revenue flows directly to the bottom line.

One reality here is that ANY streaming or other online model that encourages people to “cut the cord” from cable creates three negative forces on ESPNs revenue. First, the direct loss of subscription revenue, and second the lowering of advertising rates due to fewer subscribers.

Question: With fewer viewers one wonders if cable providers will continue to allow ESPN to charge six times some of its key competitors?

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The data in exhibit one show that ESPN has countered the loss of subscribers by raising rates by about 10% each year over the past couple of years.

The point of this discussion is to focus students on a version of the “competence trap:” ESPN has a highly successful business and revenue model; however, the success of that model makes changes—such as moving to a new medium (streaming)—more threatening to the overall model.

The instructor should conclude this section by asking: Question: “How big is the real threat of online streaming to ESPN?” If a student has not previously raised this issue, the instructor should point students to Exhibit 5. Panel A presents data that suggests that the use of mobile devices as a viewing platform continues to grow. This suggests a threat to viewing from mobile devices. Panel B presents a more nuanced story, however. As of 2015, streaming seems to have made inroads only in the top Quintile—the second quintile of streaming minutes is 11% of the first quintile, and the third quintile is just over one quarter (26%) of the second quintile. While streaming may prove an eventual threat to ESPN, the data in Panel B suggest that extensive streaming is currently limited to a small segment of the overall viewing public.

Additionally, the top Quintile also watches the most TV. This suggests that streaming and TV may not be substitutes, and that if properly managed, an ESPN streaming service may not lead to a reduction in viewership. The critical strategy question for ESPN may be “for whom is streaming a substitute to cable, and for whom is it a complement?” “What type of data would help us answer that question?”

Finally, the instructor may note that the data in Panel B suggest that, while streaming may eventually prove a viable substitute to TV for a large number of people, that day has not arrived yet. It appears that ESPN has some time to figure out how they ought to respond to the potential threat of streaming. The answer to the question “how big is the real threat of streaming” seems to be that in the short run at least, the ESPN model does not appear to be in danger of collapsing.

VI. Summary and Wrap Up The previous section of the discussion may substantially shorten the time available to the instructor for a session summary. I try and emphasize three key points: •

The power of the Company Diamond in helping strategy analysts understand how a company creates a sustainable competitive advantage. At ESPN, one can easily trace a few core, founding beliefs and values to the development of resources and capabilities and on to competitive strengths and advantages.

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The development of a winning revenue model creates its own set of vulnerabilities.

The change of the revenue model back in 1983 provided the cash that fueled ESPNs tremendous growth and its current dominance. That model, however, creates real reluctance on the part of executives to change. If the subscription model comes under sustained attack (as streaming becomes more pervasive), then ESPN will face a set of difficult choices that students have merely sketched out in the discussion.

Good strategy relies on both strong formulation and good timing. Smart executives look for deeper data to help them understand the timing of trends. Secondary and aggregated data, such as averages and population level data, provide insight on trends and direction; however, the more nuanced the data become, the more able they are to provide insight around velocity. With a revenue model as solid as the one at ESPN, executives should think very clearly about the risks of moving too soon as well as moving too late.

http://www.forbes.com/powerful-brands/list/#tab:rank, accessed 21 December, 2015.

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Teaching Note

ESPN and ESPN+ in 2021: Challenges of growth Teaching Objectives ESPN and ESPN+ in 2021: Challenges of growth has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in conjunction with a module on internal business unit strategy, and firm resources and capabilities. The case is a follow-on and update for ESPN in 2015: Continued Dominance in Sports Television. That case provides students with opportunities to see how a company develops a unique set of resources and capabilities over time, and how those capabilities may be threatened by technological, demographic, and market changes. The update allows students to see the complex issues involved in strategic change at a business unit with a strong corporate parent. This note assumes the instructor is either using, or is familiar with Strategic Management by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in industry analysis and familiarity with the Competitive Advantage Pyramid tool as discussed in Chapter 3, although the case touches on Chapter 5 (differentiation advantage) as well. Some instructors may choose to use the case along with Chapter 6 (corporate strategy).

Case Summary This case looks into the executive suite at ESPN five years into a decline in subscribers. James Pitaro has been President and Co-Chair at the Network for two years, and the case invites students to put themselves in his shoes and think about the future of the network. PItaro’s predecessor, John Skipper, left ESPN in December of 2018 to deal with a substance abuse problem. Skipper took two steps in response to the loss of subscribers. First, he doubled down on the network’s commitment to sports programming with a new and extended contract with the National Basketball Association (NBA). This, and other decisions not detailed in the case, doubled ESPN’s annual programming costs. Second, Skipper raised subscription fees a total of 30% over four years. Those price increases did not continue into 2019 and 2020, but the exodus of subscribers continued. Exhibit 1 shows that price increases offset the loss of subscribers, and ESPN grew revenue over the period.

The case gives students insight into two particular problems for ESPN: its continued foray into political and social issues such as the Black Lives Matter movement, and the recent performance of the ESPN+ app. At the end of the case, students have the opportunity to sit in Pitaro’s chair and consider how they would respond to these challenges.

Learning Objectives (for Faculty) Copyright ©2022 John Wiley & Sons, Inc.

1. Provide students with the opportunity to see how a strategic decision plays out over a number of years (as a follow-on to ESPN in 2015).

2. Allow students to examine the complex nature of a commitment to a strategy, referred to in the case as the “Golden Goose” problem.

3. Examine the relationship between new, digital business models and the traditional revenue and cost structure of the cable business.

Learning Outcomes (for Students) 1. Understand and describe how a strategic decision takes place over a number of years, and the constraints facing decision makers.

2. Explain how a company’s commitment to a strategy limits its flexibility in changing that strategy.

3. Evaluate a course of action and attempts to create a balance between social and business issues, and between a digital and traditional strategy.

Preparation Questions 1. How much attention should James Pitaro give to the problems created by John Skipper around a “politicized” ESPN? 2. What strengths and weaknesses does the cable network have? What about the ESPN+ app?

3. What would you do if you were James Pitaro?

Case Presentation The short length of ESPN in 2021, and its connection with ESPN in 2015 gives the instructor substantial flexibility in using this case. In an 80-minute session, there will not be enough time to do both cases, and so the instructor must decide if ESPN 2021 is a “coda” to the first case, or if the issues in the case warrant a longer discussion. In that case, the instructor can use the ESPN 2015 case as background to provide texture for the 2021 case. The length of the case, and the number of issues it raises, also facilitates its use as an exam (mid-term or final).

If the case is used for a class discussion, the instructor can choose the amount of time dedicated to each question. The three preparation questions provide a nice framework and sequence to open up the case.

Opening Question: How much attention should James Pitaro give to the problems created by John Skipper around a “politicized” ESPN? (5-10 Minutes)

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The issue here is the “job-to-be-done” for which viewers have hired ESPN. If that job is the simple transmission of sports programming, then social commentary risks alienating this core audience. Some students will note this and argue that the network should curtail its social involvement and focus on sports broadcasting.

If no students see problems with this reasoning, the instructor may ask “What is ESPN’s core value proposition? Is it just sports broadcasting or does it involve analysis and commentary?”

Students should understand that the network has never been about exclusive sports programming but has always relied on is ability to provide thoughtful commentary, insight, and news about the sporting world to its viewers. The instructor might ask “If this is the case, then what’s the real issue in play here?” Students should identify two issues, both around balance. The first is the balance of social commentary to sports reporting. Could it be that social commentary is leaven, and a little bit lifts the loaf, but a lot ruins the taste? This would be a question of emphasis.

The second issue here is the balance between points of view. The Jemele Hill incident cited in the case, and other sources students might find online, suggests that the network propounds a “liberal,” progressive view of social issues in sport. The network may benefit from more balanced reporting as there are likely a number of viewers holding the opposite, “conservative” view.

The core question for students to wrestle with is about value creation, for viewers, reporters, and society. Some may believe that social commentary creates no value, while others will argue that powerful networks such as ESPN ought to be socially engaged.

At some point, after about 10 minutes or so, the instructor should hit the “pause button” and ask the next question: What are the strengths and weaknesses of the cable network? What about the App (1030 minutes)?

This question gets at the core of ESPN’s challenge. The strength of the network, as noted in the case, is the depth and variety of programming it provides. While the app has some features, such as viewing live sports, viewers of the cable network should get more value from commentary, insights, and longer programming such as the 30-for-30 programing. The other strength of the network comes from the fact that about ½ of its subscribers never watch.

Essentially, ESPN can subsidize its content programing costs on the backs of people who never watch.

The weakness of the cable network is that it exists in a platform of diminishing value. A cable subscription is over $9 per subscriber per month. As we see from Exhibit 1, ESPN seems to have lost the ability to continually raise prices to cover the decline in subscribers. Moving forward, each lost subscriber reduces direct revenue, and if enough subscribers defect, ESPN Copyright ©2022 John Wiley & Sons, Inc.

stands to see its advertising revenue decline. The real problem, however, comes from the fact that if a substantial number of sports fans defect to the app, Cable TV operators have more incentive to drop ESPN as a part of their package (the most expensive part). That puts the prime source of revenue, the subscriber who never watches, at risk and ESPN would lose $9 per month per lost subscriber.

The future profitability of the cable business is also a weakness. The instructor might ask about profit, as opposed to revenue. After all, the goal of a business is to generate profits, not merely revenue. Since 2014, ESPN’s programming costs have doubled to $4.7 billion each year. Total cable revenues (which students can calculate from the numbers in the case) has only increased $869 million from 2014-2019. Was the move for expanded NBA content a good investment? How will future cost increases, such as the upcoming NFL contract affect profitability?

The strengths of the app come from its acceptance of a new technological platform. As ESPN learns the ins and outs of streaming, it should be able to provide more content on the app; however, a central question of the case is how to grow the app without cannibalizing the cable business or killing the golden goose. Another strength is that the app should help build the brand by allowing fans to view an ESPN product wherever, whenever.

The primary weakness of the app also comes from the new platform. As of the case writing, it seems that the stand-alone ESPN app is close to its potential maximum price. There aren’t many single-use apps that can charge much more than that. The app can also be cancelled far more easily than a cable subscription, which usually comes with a 1-2-year commitment.

The instructor should help students see that, as the opportunity/threat from streaming plays out, the answers for ESPN will probably not be black-and-white/yes-no decisions. The executive team lives in a complex world of more competitors and more technological platforms than ever before. The right strategy might be a question of degree. In fact, with more competitors across more platforms, lower profitability might become the new norm.

The instructor might ask if lower profitability is the price Disney and ESPN must pay to continue to compete in a changing industry? Competitive streaming services are the reality for both Disney and ESPN, and how one network reacts might/ should drive how the other one does as well.

The case concludes with the final question: What would you do if you were James Pitaro? (5-15 Minutes) This question puts students in the role of decision maker and invites them to synthesize their thinking and make a recommendation. The instructor may give the question to teams and have them develop a plan for the future and use the time to have groups present.

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The more preparation time that students have to prepare potential strategies, the more thoughtful their responses will be, and the richer and deeper the class discussion.

The instructor may conclude the session by asking a few students for their key learning points from the case. If the instructor chooses to provide a summary, that summary should focus heavily on the “Golden Goose” problem ESPN faces.

When ESPN moved to a subscription model back in 1983, the company had found a new source of revenue to keep the network afloat and growing. 38 years later, the company continues to generate the vast majority of its revenues from these fees. Future growth depends on continued price inelasticity among subscribers for sports programming. One risk for the network is maintaining that elasticity by spending more on programming than they gain in fee increases. The other risk, and a consequential one, involves the loss of strategic flexibility. Executives may not be able to consider any action that threatens the “Golden Goose” which significantly limits their options in crafting strategies for an increasingly complex competitive market.

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Teaching Note

Southwest Airlines: Flying High with Low Costs Teaching Objectives The purpose of this case is three-fold.

First, it is to continue to solidify a framework of approaching strategy in the students’ minds. This framework defines strategy as a “plan to achieve competitive advantage that involves making four strategic choices: a) markets to compete in, b) the unique value the firm will offer in those markets, c) the resources and capabilities required to offer that unique value better than competitors, and d) ways to sustain the competitive advantage by preventing imitation.” (See Real World Strategy, Chapter 1: What is Business Strategy?)

Second, this case examines how Southwest has achieved a cost advantage (one of the two “generic” strategies for offering unique value) despite the fact that the company has been much smaller (in terms of number of passengers flown, planes, employees) relative to its larger competitors (e.g., American and Delta airlines). The case shows how Southwest’s “point to point” business model and the activities associated with that business model create cost advantages. The instructor can also introduce the concept of “reinforcing fit” among Southwest’s activities as a reason for its success at lowering costs—as well as a reason it is difficult for competitors to imitate. While earlier cases illustrate advantages gained from market choices, economies of scale, and product differentiation, this case illustrates Southwest’s cost advantage as the sum of many small decisions and activities (that help it turn its planes around quickly) and not one single decision.

Third, the decision portion of the case asks the question regarding how Southwest should grow, given that fact that it has largely saturated its short-haul markets with point-to-point service. Should it expand into long haul and add a longer-range aircraft? Should it expand into international service? If it does, how will this differ from its current strategy/business model and how will this influence performance?

Preparation Questions 1. What is Southwest Airline’s strategy and what are the key success factors?

What are the key things it does to keep its costs lower than competitors?

[AACSB Analytic] [Difficulty: Easy] [Bloom’s 1 Knowledge]

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2. What prevents larger competitors (e.g., American, Delta, United) from imitating Southwest’s approach? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] 3. What prevents new entrants from successfully imitating Southwest’s approach? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] 4. How should Southwest grow, given that fact that it has largely saturated its short-haul markets with point-to-point service? Should it expand into long haul and add a longer-range aircraft? Should it expand into international service? If it does, how will this differ from its current strategy/business model and how will this influence performance? [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 5 Synthesis]

Teaching Plan I. Review of Strategy Framework II. Southwest Strategy—Overview III. Southwest Strategy—Cost Advantage IV. Southwest Strategy—Barriers to Imitation V. Southwest’s Growth Strategy VI. Conclusion

10 min 10 min 15 min 10 min 15 min 10-15 min

I. Review of Strategy Framework This section is useful if this case is used for the purpose of solidifying the strategic framework described under Teaching Objectives. If not being used for that purpose, covering this section may not be productive.

One purpose of this section is to prepare students to identify Southwest’s strategy using the strategic framework described under Teaching Objectives. In preparing to do so, it may be useful to review the strategies of firms described in previous cases. Three examples (Walmart, Coke, and Intel) are given below.

Question: What was the strategy for (____)?

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Walmart o Markets ▪ Geographic—Rural

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▪ Type of store—Broad line, discount retailer o Unique Value ▪ Everyday low prices for a broad range of goods that are always in stock at convenient locations o Resources and Capabilities ▪ Large footprint of rural stores ▪ Distribution capabilities ▪ Bargaining power over suppliers ▪ Fewer layers of management ▪ Culture of cost reduction ▪ Stores and distribution centers o Barriers to imitation ▪ Competitors rationally refuse to enter Walmart’s towns ▪ First mover advantage/natural geographic monopoly Coke o Markets ▪ Geography—Global ▪ Product—Beverages o Unique Value ▪ Differentiated brand/brand identity ▪ Accessibility o Resources and Capabilities ▪ Brand ▪ Distribution ▪ Marketing/Advertising o Barriers to imitation ▪ Shelf Space Intel o Markets ▪ Microprocessors o Unique Value ▪ Differentiation • Product performance, speed, battery life, etc.

▪ Brand o Resources and Capabilities ▪ Volume production ▪ R&D ▪ Speed to market ▪ Marketing/Advertising o Barriers to imitation ▪ Patents ▪ Brand

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Cost to entry Steep experience curve

II. Southwest Strategy—Overview Question: What is Southwest’s strategy?

This section gives students the opportunity to apply the strategic framework specifically to Southwest. At this point, it is not necessary to ‘deep dive’ into each facet of Southwest’s strategy. It is more useful here to help students frame their answers in context of the strategic framework introduced earlier.

• • • •

Markets o Smaller airports; point to point routes Unique Value o Low prices Resources and Capabilities o Fast turnaround time; same type of aircraft throughout fleet; fun culture Barriers to imitation o High market share between city-pairs o Access to gates at airports

III. Southwest Strategy—Cost Advantage One assumption students may make is that airlines experience economies of scale, or in other words, airlines experience lower costs per passenger (and greater profits) as they increase their capacity to service more passengers. As shown in the graphs at the end of this section, this is not the case in the airline industry.

This section gives students the opportunity to identify a characteristic of the airline industry that appears counterintuitive and then propose hypotheses to explain why.

Question: When a firm is able to offer low prices, in many cases it is due to that firm experiencing lower costs. One technique to identify whether a firm’s cost advantage is a result of economies of scale is to examine the relationship between some measure of volume (such as market share or total output) and a firm’s profitability. What does that relationship look like in the airline industry?

While Available Seat Miles (ASM) is used to measure market share in the above example, other measures such as revenue and revenue passenger miles will produce a similar result.

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Many students may first view airlines’ relationships between market share and profitability as a negative relationship. The purpose of the rest of this section is to help students see that there is a distinct difference between Southwest’s performance and the performance of its competitors. To facilitate this, it may be useful to illustrate that there appear to be two distinct groups in the graphs below: Southwest/JetBlue airlines and the rest of the airlines (see the best fit lines illustrated in both graphs in the section).

Question: Why is Southwest able to outperform its much larger competitors?

Southwest’s decision to minimize plane turnaround time has been a large factor in lowering its overall costs and outperforming the competition. A comprehensive list of what Southwest has done to lower costs is given below.

Savings from faster turnaround time • Time: 23 minutes (half of industry average) • Aircraft hours saved through faster turnaround: o 30 min saved/flight x 3,400 flights/day = 1,700 extra hours of aircraft utilization per day • Additional aircraft that would be required to add 1,700 flight hours per day: o 1,700 extra hours/12.36 (average daily flight time/aircraft) = o 138 Boeing 737s • Capital savings from extra aircraft utilization: o 138 Boeing 737s x $75 million/aircraft = $10.35 billion • Additional profits from extra aircraft utilization: o $10.35 billion x 10% costs of capital = $1.035 billion Choices that allow Southwest to have faster turnaround time • No meals • Limited checked luggage (due to shorter flights) • One type of airplane (Boeing 737; created savings to training and also gave Southwest bargaining power with Boeing) • Team approach to ground service and plane turnarounds • Choice of less congested airports • High market share in city pair airports (allows economies of scale at airports) • Point to point model (no need for one flight to wait for an arriving flight) • Faster boarding process (having no assigned seats creates an incentive for passengers to arrive early) Other factors that affected Southwest’s cost

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Created proprietary online ticketing system (saved fees that were historically 510 percent of ticket prices and reduced commissions paid to agents; 79 percent of Southwest tickets were bought online vs. 35 percent of Delta tickets in 2010) Advertising (more expensive marketing campaigns led to more traffic at city pair airports) Fuel hedging (saved fuel costs after fuel prices skyrocketed in 2005) Employee culture (Southwest employees serviced 50 percent more passengers per employee than next leading competitor Delta)

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IV. Southwest Strategy—Barriers to Imitation As illustrated in the previous section, there are many factors that contribute to Southwest’s cost advantage over competitors. The purpose of this section is to show students that although competitors may be able to imitate a few of Southwest’s choices, it is very difficult for someone to imitate them all and thereby experience the full cost savings that Southwest has.

Question: The individual aspects of Southwest’s strategy don’t seem incredibly difficult to imitate. Let’s assume you are one of Southwest’s competitors. Why can’t you simply begin to copy Southwest’s strategy and experience the same profits that they do?

As students answer, help them see that much of what Southwest does ‘fits’ together.

For example, many of the factors that help them reduce turnaround time (such as no meals) would not be nearly as effective if Southwest used a hub and spoke model instead of a point-to-point model (the time saved may be outweighed by the time it takes to wait for arriving flights).

V. Southwest’s Growth Strategy

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Question: Southwest and all of the major airlines are achieving record profits as oil prices have dropped. How should Southwest grow, given that fact that it has largely saturated its short-haul markets with point-to-point service?

Asking this question will give students the opportunity to discuss whether Southwest should modify its strategy. They may decide to fly longer haul routes as long as Southwest continues to use only Boeing 737 planes. However, students will need to think through whether this will be profitable, given that 737 planes are relatively small with a typical Southwest Boeing 737 holding 137 passengers. Contrast that to the Boeing 787 Dreamliner which offers 220 seats, 36 of which are first class lay-flat seats (with pricing typically between $5,000-12,000 round trip for flights to Europe), 70 Economy-Plus seats (priced 10-20 percent higher than a typical economy seat, and 114 Economy seats). Thus, a single flight across the United States, or to Europe, Mexico, or the Caribbean will be more profitable for Delta than for Southwest because of almost 100 additional passengers. To get at this issue, the instructor might ask: Question: Will long haul flights be as profitable for Southwest as short-haul flights? Why or why not? Will they be as profitable for Southwest as for Delta or JetBlue? Why or why not?

As students consider whether it will be as profitable for Southwest to succeed in long haul markets, they may simply argue that Southwest can simply raise the price of the seats until it is profitable. This is a viable option. However, help the students understand that there may be limits on their pricing because they are competing with operators flying airplanes that are better equipped for a long-haul flight experience. In other words, will customers be satisfied and happy with a Southwest long-haul flight?

You might ask something like this: Question: What will limit Southwest’s pricing on long haul flights? Will they be able to charge as much, or even slightly below, competitors? Why or why not?

As students consider this question, you might just compare a long-haul flight from JetBlue vs. Southwest. JetBlue can offer more seats, more comfortable leather seats, advanced reservations, and entertainment, including LiveTV. Why would anyone pay the same for a Southwest flight that offers none of these amenities? Moving into long haul means that Southwest will need to continue to be low price in order to attract customers. Of course, this begs the question as to whether Southwest should add a long-haul plane to its fleet. This, of course, changes the firm’s strategy somewhat because it is not targeting new markets (long haul) with a somewhat different value proposition, which requires different resources (e.g., long haul planes) and capabilities (processes to deploy, service, and fly those planes).

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VI. Conclusion • Southwest profitability relative to industry o Southwest led industry from 1990-2002 • Southwest Airline’s unique value proposition o Low prices; frequent departures; friendly service; on time arrivals; fast transport o Full-service airlines are appealing to a very different demographic • How Southwest wins o Fast plane turnarounds lead to high airplane and labor utilization ▪ SW employees have 20 percent higher revenue per employee ▪ Savings calculation from faster turnaround time o High market share by airport city pair ▪ Economies of scale at individual airports allow for lower labor and overhead costs per passenger • Market share predicts hub and spoke profitability o But not Southwest or JetBlue profitability o Higher market share for hub and spoke airlines leads to higher profitability • Disadvantages of scale in an economic downturn o Higher hub and spoke market share results in lower profits during an economic downturn.

• Airline industry market cap o Southwest had 60 percent of the market value of all major airlines back in 2004. This has changed over the past few years with Delta, American Airlines, and JetBlue, now accounting for over 50 percent of the market value of all major airlines.

• Labor, fuel, and fleet lead airline expenses o Goal of a firm: Lower major expenses relative to competitors o Southwest has been able to do that, and they lead in labor, fuel, and fleet lead costs • Why is it hard to imitate Southwest? o While each individual strategic choice made by Southwest may not be impossible to imitate, imitating them all, and having the same reinforcing fit, to accomplish the same thing (in this case fast turnaround time) is very difficult.

• Cost reduction at US auto plants o Cost reduction increases exponentially the more a plant imitates Toyota’s production system • Why is Southwest’s strategy so hard to imitate? o Strategy is a bundle o Protected by barriers including: ▪ Control over gates at secondary airports

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High market share in city pair markets Incumbents are constrained by their current structures.

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Teaching Note

Harley-Davidson: Growth Challenges Ahead Teaching Objectives This case gives students an opportunity to examine a company’s sources of differentiation advantage. It also demonstrates that differentiators cannot completely ignore costs without experiencing serious consequences.

This case also illustrates how competitors can start at the low end of the market and then move upmarket (as Honda did with both motorcycles and cars). It also illustrates how difficult it can be to replicate sources of differentiation in new markets (geographic and demographic) when those sources are largely emotional (countryspecific) and not functional (e.g., Harley has had a difficult time replicating its differentiation advantage with women and in international markets).

Study Questions 1. Harley-Davidson is known for its strong brand name and loyal following and yet by 1980 Harley was on the verge of bankruptcy. Why was Harley in deep trouble even with such a strong brand name? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. After almost going bankrupt during the invasion of Japanese motorcycle manufacturers (Honda, Yamaha, Kawasaki) into the U.S. market, HarleyDavidson has re-emerged as a highly successful, and profitable, motorcycle manufacturer. What have been the keys to Harley’s success? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 3. What key “job” or “jobs” are Harley customers buying a Harley-Davidson motorcycle to do for them? (In other words, Harley is typically hired to do what job for customers?). In what ways does Harley-Davidson attempt to differentiate its products relative to Honda, Yamaha, and BMW? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 4. Looking into the future, what threats does Harley face (from rivals such as Honda and BMW)? What opportunities does it have? How might Harley modify its strategy to respond to its opportunities and threats? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 4 Analysis] Copyright ©2022 John Wiley & Sons, Inc.

Multiple Choice Questions 1. Harley-Davidson is known for its strong brand name and loyal following and yet by 1980 Harley was on the verge of bankruptcy. Why was Harley in deep trouble even with such a strong brand name? a. Competitors beat Harley on reliability and cost b. Harley-Davidson bikes are technologically inferior c. Harley-Davidson cannot compete in foreign markets d. All of the above “Answer”: D 2. After almost going bankrupt during the invasion of Japanese motorcycle manufacturers (Honda, Yamaha, Kawasaki) into the U.S. market, HarleyDavidson has re-emerged as a highly successful, and profitable, motorcycle manufacturer. What have been the keys to Harley’s success? a. Selling larger, more muscular motorcycles b. Selling an experience rather than a product c. Improving technology through innovation d. Making a quieter motorcycle to match competitors “Answer”: B 3. What key “job” or “jobs” are Harley customers buying a Harley-Davidson motorcycle to do for them? (In other words, Harley is typically hired to do what job for customers?). a. Harley-Davidson produces a more muscular, rugged motorcycle that can overpower competitors b. Harley-Davidson produces a motorcycle that buys status such as ‘coolness,’ and ‘club membership’ c. Harley-Davidson produces a technologically superior motorcycle d. Harley-Davidson produces a more efficient motorcycle “Answer”: B 4. In what ways does Harley-Davidson attempt to differentiate its products relative to Honda, Yamaha, and BMW? a. A brand/image that embodies adventure, defiance, and rugged individualism b. A customizable product

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c. Harley uses its brand name to sell other products offering the same image d. All of the above “Answer”: D

5. Looking into the future, what threats does Harley face? a. Competitors produce more reliable motorcycles at lower cost b. Emissions regulations have become tighter c. Changing demographics change customer preferences d. Threats of new entrants increases “Answer”: A 6. What opportunities does it have? a. Strong appeal of Harley-Davidson in the Chinese market b. Technological innovation c. Growth in the super heavyweight market d. Strong and large community of Harley-Davidson motorcyclists “Answer”: D 7. How might Harley modify its strategy to respond to its opportunities and threats? a. Use its brand image to increase merchandising sales b. More customization in the heavyweight class c. Reduce cost through outsourcing d. Diversify into other industries “Answer”: A Teaching Plan I. Honda’s Strategy II. Harley-Davidson’s Strategy III. Segmentation Analysis IV. Harley Davidson Differentiation

20 min 10 min 15 min 25 min

I. Honda’s Strategy Question: What was Honda’s strategy and why were they successful?

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Markets • American motorcycle market • “Starting on the West Coast of the US…moved eastward region-by-region” • “When entering a new market, Honda did so with its lightweight 50cc bikes” • “As demand for Honda’s smaller motorcycles in the U.S. increased, Honda would gradually introduce its heavier more powerful models including the 100cc, 150cc, and 250cc bikes.”

Unique Value • “…branded itself as the family friendly bike.” o “The ad campaign, ‘You meet the nicest people on a Honda,’ was a direct contrast to the rough, aggressive, and loud image of the American Harley-Davidson.”

• “When entering a new market, Honda did so with its lightweight 50cc bikes, weighed in at 150-200 pounds and sold for less than $250 retail.” o “A significant drop in weight and price compared to Harley motorcycles, which weighed between 450 to 800 pounds and retailed between $1,000-1,500.

• “Not only were the bikes smaller, quieter, and more fuel-efficient compared to the heavyweight Harleys, but they also required little or no maintenance due to Honda’s large and standardized production process.

• “As a result, Honda was able to offer a better-built motorcycle at a fraction of the cost.”

Resources and Capabilities • “Large and standardized production process” • “’Only 5% of Honda’s motorcycles failed to pass final quality inspection,’ while ‘over 50% of Harley’s failed the same test.”

• “Overall Japanese productivity was over 30% greater than at HarleyDavidson.”

• “Employed non-computerized just-in-time (JIT) production methods that required far less amounts of buffer inventory for both work-in-process (WIP) and finished motorcycles.”

• “Honda built each bike to order instead of building for inventory.”

Barriers to Imitation • Honda invested “in a 30,000-unit-per-month manufacturing plant, a capacity 10 times in excess of demand at the time of construction.”

• “Honda was able to offer a better-built motorcycle at a fraction of the cost” due to a steep experience curve.

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o “A study done by the Boston Consulting Group in 1975 showed that Honda’s prices were dropping by roughly 15 percent with each doubling of volume (see Exhibit 3).”

II. Harley Davidson’s Strategy Question: What is Harley Davidson’s strategy?

Market • High-end motorcycles Unique Value • Brand image, customizability.

Resources and Capabilities • Brand • Loyal customers (Harley Owners Group) • Customization Question: We know from the case that Harley-Davidson runs into some trouble competing with Honda because of their high costs. What does Harley-Davidson do to recover and get back on track?

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Fix quality (new manufacturing processes) Improve costs (new manufacturing processes) Leverage brand o Begin merchandising (expand licensed products) Specify a unique value that its products offer o An “experience” instead of “just a bike”

III. Segmentation Analysis This section allows students to see how the motorcycle market may be segmented based on features customers seek in a motorcycle. To conduct this analysis in class, ask students to identify features that might matter to a customer for a midsize motorcycle and record their answers on the board horizontally on the x-axis with ‘importance’ on the y-axis (see example below).

Ask a few students who have owned (or are close to others who have owned) a Harley Davidson motorcycle to rank the importance of each of the features identified earlier.

Average and mark their answers on the chart. Do the same for students who have owned a competitor’s bike (Honda, BMW, etc.).

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Using the completed ‘segmentation analysis’ show students that groups of consumers may be looking for different types of products. Explain that this type of analysis may help you understand how you should tailor your product to meet the needs of consumers that may currently be under/over served in the current market.

IV. Harley Davidson Differentiation The following question should be used before showing the Harley Davidson commercials that are included in the corresponding PowerPoint presentation.

Question: What is the differentiator that Harley Davidson is emphasizing in these commercials? Why would these people want to ‘hire’ a Harley motorcycle?

Although answers will vary, some example responses are that these individuals are buying status, ‘coolness,’ and ‘club membership’ by buying a Harley Davidson motorcycle (in the advertisement where the guy is trying to impress the girl, the “job to be done” could be described as “get girls to like you.”

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Harley succeeds through differentiation, offering: o A brand/image that embodies adventure, defiance, and rugged individualism—and which sells other products o A customizable product so that each Harley is unique

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o Access to a community of like-minded bikers (Harley Owners Group events) Compared to Honda and Yamaha, Harley sells somewhat technologically backward, overpriced motorcycles, yet still dominates the super-heavyweight segment of the U.S. market Harley uses its brand name (valued at $6 billion) to sell other products offering the same image; almost one third of Harley’s total profits in 2012 came from its licensed products

Question: Harley Davidson is looking to grow. We have seen a growth in their revenues and profits, but it isn’t clear if they will be able to sustain that growth because they have saturated their traditional customer segment. Can Harley Davidson be successful in China? Should they try to expand there?

Why Harley Davidson doesn’t sell well in China • Harley’s primary sources of differentiation are emotional (not functional) and don’t transfer well across country borders • Chinese perception: Motorcycles are for transportation, not leisure. Few are greater than 600 cc • HD’s Touring Ultra Classic bike costs $53,000 in Beijing, 20% more than a BMW 320i or Audi A4 • By law, motorcycles have to be scrapped after 11 years • Beijing and Shanghai have restrictions on motorcycles, including banning them from elevated highways and major thoroughfares to curb noise and thefts Harley clearly has a lot of barriers in China that are not related to the product itself.

However, even without these barriers, Harley’s experience illustrates that it is often difficult to deploy the same differentiation strategy in different geographies with the same success (particularly if the sources of differentiation come from emotional and social components as opposed to functional components). Harley Davidson’s are largely purchased for emotional and social reasons (jobs-to-be done) rather than functional reasons. The Harley Davidson brand simply doesn’t have the same history and cache in China (or other countries) like it does in the United States and it is difficult to replicate.

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Teaching Note

Ecolab and the Nalco Acquisition: Sustainable Advantage Through Shared Values Teaching Objectives Ecolab and the Nalco Acquisition: Sustainable advantage Through Shared Values has been written for use in undergraduate or first year MBA courses in business strategy. The case has been designed for use in conjunction with a module on corporate strategy, or it can be used as a summary case to explore how internal sources of competitive advantage within a business unit can translate into corporate advantage. This note assumes the instructor is either using, or is familiar with Strategic Management by Dyer, Godfrey, Jensen, and Bryce, as this case can be used with Chapters 3, 6, 12, or 14 of that text. The breadth of the case, including issues of firm strategy and evolution, and the social impact of a sustainability strategy, also allows instructors to use it as a summary case towards the end of a course.

Students should identify the origins of a company’s competitive advantage and examine how that advantage underlies a successful acquisition, understand the financial basis of the transaction and the subsequent impact on stock price, and examine in some detail the process of value creation from day one—the three WOW projects and the integration team.

Finally, they should describe the process of pre- and post-merger integration, explain, and critique how a company uses these tools to create value through an acquisition.

Study Questions 1. How did the shared values of Ecolab and Nalco provide the foundation for a merger?

[AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Was the acquisition financially successful? What evidence supports your assessment?

[AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 3. Optional: One way to measure the attractiveness of a merger (at the outset) is to estimate whether the acquisition is accretive (adds value to shareholders) or dilutive (destroys shareholder value). Was the Nalco acquisition accretive or dilutive? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 4 Analysis] Copyright ©2022 John Wiley & Sons, Inc.

4. What did Ecolab learn from the integration of Nalco that will be useful to them moving forward? [AACSB: Analytic] [Difficulty: Hard] [Bloom’s 6 Evaluation]

Multiple Choice Questions 1. How did the shared values of Ecolab and Nalco provide the foundation for a merger? a. They both focused on innovation b. Competitive advantage on a differentiation platform c. Customers paid a premium for products and systems, but made the premium back, and more, in lifetime cost savings d. All of the above Answer: “D” 2. Was the acquisition financially successful? What evidence supports your assessment? a. Yes, because investors saw a 100% return ($32.5 closing market cap - $11.8 opening market cap - $10.3 billion acquisition costs [$8.1 billion for Nalco and $2.2 billion for Champion] = $10.4 billion return) b. Yes, because in terms of share price appreciation, Ecolab’s shares more than doubled (106%) between the announcement day and the close of 2014. In contrast, the S&P Index went up 56%, so an investor would have more than doubled their money by buying Ecolab rather than investing in an S&P index fund c. Yes, because Ecolab grew revenues almost 27% (26.56%) from the 2011 pro forma to the 2014 actual sales, just over 8% CAGR d. All of the above Answer: “D” 3. Optional: One way to measure the attractiveness of a merger (at the outset) is to estimate whether the acquisition is accretive (adds value to shareholders) or dilutive (destroys shareholder value). Was the Nalco acquisition accretive or dilutive? a. Accretive b. Dilutive c. Neither d. Both Answer: “A”

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4. What did Ecolab learn from the integration of Nalco that will be useful to them moving forward? a. A solid “investment thesis” is the basis for a good acquisition b. Mergers are really better when there are synergies up and down the business model c. A proactive integration process adds value by overcoming natural inertia and speeding the returns from the merger. Ecolab worked hard to create an environment that created synergies, both on the cost and revenue side d. All of the above Answer: “D” Teaching Plan I. Opening II. The Strategic Rationale for the Acquisition III. The Rationale for the Acquisition IV. The Transaction and Financial Value V. The Creation of Value through the Merger Integration VI. The Success of the Merger VII. Conclusion

5 min 20-30 min 10 min 15 min 10-15 min 10-15 min 5 min

I. Opening Question: “What type of case is this?”

This helps students understand the goals for the day. This is a diagnostic case, where the goal is to determine what worked and what did not; the case doesn’t really have a decision point.

Once we’ve established the nature of the case and our goals, I move to the second framing question.

Question: How would we assess the “success” of the Nalco merger?

There are two ways to measure the success of an acquisition: Financially and Strategically.

Put simply, are Ecolab and Nalco shareholders better off because of the merger? To assess this, we’d primarily look at market-based performance in terms of share price and market cap. The instructor might note that 70% of acquisitions fail to create the value intended, and this case provides enough detail to allow us to see if Ecolab escaped this majority or not. We

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can also assess success through the creation of financial synergies—did the company grow revenue or cut costs through the merger?

Strategically we would term the merger a success if the combination created new resources and capabilities for the combined company, and if Ecolab’s competitive position in its markets had strengthened. In terms of the 8S’s, Ecolab hoped to create value in the merger through synergies, where the complementary skills and assets of Nalco would create more value combined with Ecolab than on their own. As the discussion moves forward, students should ask themselves: Question: Did the combined company create new knowledge, skill, or product/ process capabilities that it didn’t have before? Did the company’s positions in its markets (in terms of market share or competitive position) improve because of the merger?

I. The Strategic Rationale for the Acquisition Ecolab’s strategy (5 Minutes) Question: What is Ecolab’s core strategy?

The case makes clear that from its inception, the company has focused on selling products, and later integrated systems, at a price premium. Simply put, Ecolab pursues a differentiation strategy. Customers paid a premium for these seeming commodity goods because Ecolab offered three factors.

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Lower total cost of operations. The company’s core value proposition appears in the case on Page 2: “While we are only a very small part of our customers’ cost to operate, because we ensure their ability to operate and protect their brand equity, we impact a large part of their P&L.” Further, Ecolab solutions directly impact their customer’s material cost of goods sold (energy, water, chemicals), labor costs (equipment downtime and maintenance), and asset life (longer asset life due to better conditioning).

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High levels of customer service. Ecolab is an operating company, and the field staff is on call 24/7/365. One Ecolab Executive explained it this way: “If you want to take a vacation, you find someone to cover for you. If a customer’s commercial dishwasher goes out on a Friday night, an Ecolaber is in there washing dishes. It’s this commitment and passion that typifies everything at Ecolab, from ethics to sales, to CSR, to sustainability.” Customers knew that their price premium entitled them to a high level of service for what could be a mission-critical business application (think about what happens at a high-volume restaurant with no dishwasher).

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Innovation. Ecolab seeks to build relationships with customers rather than just sell products. In its industrial businesses, Ecolab hires people with technical backgrounds (engineers, chemists), and they expect those people to know more about the challenges their customers face than the customers themselves. Ecolab’s goal is to identify customer problems (hopefully ones experienced by multiple customers) and then create a solution of chemistry, dispensing, training and service to solve their customers’ problems.

Ecolab focuses on creating and maintaining value (CMV) for customers in 3 areas: reliability and system assurance, continuous improvement, and innovation. Because Ecolab delivers for customers on these dimensions, they generate lots of customer satisfaction and that creates a strong willingness to partner with the company.

II. The Rationale for the Acquisition At this point, the case introduces the high-level rationale for the Nalco acquisition. The instructor may choose to have students identify and describe Nalco’s strategy and ask: Question: What was Nalco’s core strategy?

Nalco, much like Ecolab, built its competitive advantage on a differentiation platform: customers paid a premium for Nalco products and systems, but made the premium back, and more, in lifetime cost savings. The strategy was supported by the following elements: • •

• •

Deep knowledge and expertise in the area of water treatment and management— Masters of Water.

Innovation--3D TRASAR™ technology, developed and patented in 2004, an innovative water treatment system that automatically DETECTS variations in water quality (chemical makeup, pH, scaling minerals, flow rates), DETERMINES the best response, and DELIVERS that response within seconds or minutes to improve water quality, reduce asset maintenance and downtime, and increase asset useful life.

Customer intimate approach—strong field sales staff, continuous monitoring, great process knowledge and ability to apply that to customer problems.

Recurring revenues through equipment sale that leads to ongoing chemical sales, monitoring and advisory services contracts

If students create a list of Nalco’s strategy alongside Ecolab’s, they will see that the companies pursue almost the same strategy across the board. These lists mean that the acquisition may have one of two outcomes: Either the companies are so similar that no knowledge-based advantages or cross-selling opportunities exist, and Ecolab will never make back the price premium, or the similarities between the two companies can be leveraged to create substantial revenue and cost synergies.

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Question: What’s the strategic rationale for this merger? How does Ecolab hope to add value?

Some students might argue that this is a manifestation of shared knowledge or similar business models. Shared knowledge doesn’t fit because that model assumes the Ecolab’s knowledge base will become the strategic blueprint, but Ecolab wants to buy Nalco for its complementary knowledge about water and its treatment. Similar business models assume that the only value created in the acquisition is the sharing of business knowledge, not blending technical knowledge and skill. So, the correct rationale for the merger is the creation of synergies between the two businesses.

With this in place, I’ll ask the class to outline the bases upon which those synergies would build. The list should include: •

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•

• •

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A common commitment to sustainability as a guiding value and mission. The consonance of values should allow the two companies to work together in an environment of trust.

The same core strategy and values (customer intimacy, differentiation). The companies speak the same basic language and employ the same assumptions and logic to the business.

Serious consideration to the role of culture in making the deal work. See the quote by Christophe Beck on pages 7-8. The companies realized that, while they had very similar business models, the companies also had real cultural differences. Ecolab was a sales culture while Nalco was more technical/ engineering. The proactive stance of focusing on people and creating joint value allowed these cultures to merge.

The role of innovation and technical expertise in both businesses.

Little overlap in the businesses and industries served— The companies fit together well. Ecolab had a strong presence in Food and Beverage and Food Services, where Nalco was a bit player. Ecolab also had acceptable positions in healthcare and hospitality; again, Nalco had a minor presence. Nalco led in Energy, industrial and pulp and paper, three segments where Ecolab had little to no business. The similarities in business models, but the lack of overlap in markets served, suggests that Ecolab and Nalco would enjoy tremendous opportunities for cross-selling as well as innovation and knowledge transfer.

Cost synergies available (1/3 GSA, and 2/3 Supply Chain cost savings). Baker indicated that he thought the combined company could realize $150 million run-rate of cost savings. While that number pales in terms of the purchase price and premium, that would represent 25% of the combined companies pro forma net income of $631 million.

IV. The Transaction and Financial Value

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One way to think about whether the deal is financially successful is to ask what is does for the shareholders of Ecolab. They stand to lose if the additional stock issued to complete the deal dilutes their earnings (a dilutive merger). If the growth outlook of the combined company goes up (an accretive merger), then Ecolab’s shareholders should be happy.

Both Baker and Busch argue that the merger will be accretive for shareholders, and the case contains data for students to validate their argument. Students can estimate the impact of the merger on Ecolab’s 2011 Pro Forma earnings. This involves the following steps: 1. Estimate the Pro Forma Net Income of the combined entity. Exhibit 1, taken from Ecolab’s 2011 Annual Report, contained a Pro Forma Analysis of the Nalco Acquisition in terms of revenues and operating profits. The students need to flesh out this column and estimate the Pro Forma Net Income. This can be done by subtracting the estimated Interest Expense and Income Tax Expense from Pro Forma Operating Income. As a rough estimate, students can add the interest expense of Ecolab in 2011 (actual) with Nalco in 2010 (actual). The same can be done for the Pro Forma Income tax expense. These numbers are ($306.10) and ($319.6), respectively. Which gives a Pro Forma Net Income of $631 million.

2. Estimating the number of shares outstanding after the merger. To estimate this, students will need to estimate the number of shares of Ecolab Stock for 2011 Actual plus the number of shares created in the merger. This can be done by dividing Ecolab’s 2011 Net Income (actual) by the Earnings Per Share ($1.91). This gives us 242.57 million shares outstanding for Ecolab, net of the merger.

Students now need to estimate the number of new Ecolab shares issued as a part of the merger. Students begin by estimating the number of Nalco Shares outstanding, which can be done by dividing Nalco’s 2010 Net Income ($201.7) by 2010 EPS ($1.41).

Nalco had approximately 143.05 million shares outstanding.

Ecolab agreed to buy 30% of Nalco’s shares in cash and issue 0.7005 shares of Ecolab stock for the remaining 70% of Nalco’s shares. Ecolab will need to issue 70.14 million new shares of stock to swap for the Nalco Shares (143.05 X 0.70 X 0.7005).

The total number of Pro Forma Ecolab shares outstanding will be 312.71 million (242.57 + 70.14). Students then divide the Pro Forma Net Income for the merger by the number of Pro Forma shares outstanding, which yields a Pro Forma EPS of $2.02.

Ecolab CEO Doug Baker estimated EPS accretion of $0.10 through the merger, and our rough and ready calculation is pretty close.

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So, the merger with Nalco will be immediately accretive to Ecolab Shareholders and the structure of the deal means that one of the criteria for judging a successful merger has been met.

V. The Creation of Value through the Merger Integration Students will see at this point that the financial structure of the deal means that Ecolab’s shareholders should be better off immediately. The ability of the company to create meaningful synergies is still an open question. Synergies don’t simply appear; they must be developed and managed. The presentation of material in this section allows the instructor to help students identify the conditions under which such synergies can best be realized.

Question: How important were the four guiding assumptions in creating synergies?

Students will offer a variety of responses, which the instructor should organize into the following categories: “stress reduction” and “speed to realization.” The fact is that mergers and acquisitions are stressful events for organizations and their employees. An acquisition creates substantial uncertainty for the acquired organization.

Question: How will it change? What is the new owner really like? And for individuals, the most important questions are: Will I keep my job? How will my compensation change? How will my career and advancement prospects change?

The acquiring firm, unless it has done similar deals, faces much of the same uncertainty, and the questions that individuals in the acquiring company have tend to be similar in scope and intensity to their acquired company counterparts.

The most natural reaction to uncertainty is fear, fear which leads to either withdrawal and inaction, or negative action such as politicking, the creation of pockets of resistance, or outright sabotage. The first three of Baker’s assumptions should help alleviate the fear that accompanies that uncertainty.

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The first assumption helps people in both companies recognize the reality of uncertainty but reminds them that they have control over some aspects of the change.

Both companies will be better off if people work proactively to determine the course of change.

The second assumption helps people in both companies remember that this is not a conquest—both companies bring valuable knowledge to the merger, and the goal is to build something new, and that both parties can learn much from each other.

The third assumption should reassure people that they will be no worse off because of the acquisition. If Nalco’s benefits package turns out to be better (in terms of effectiveness and efficiency) than Ecolab’s, then that package will be the one that carries forward. Christophe Beck and Mary Kay Kaufman reinforced this assumption

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by realizing that alleviating stress and making sure that the people in both organizations were well treated and bought into the merger was their top priority.

These three assumptions did more than reduce fear, however. They also worked to increase the overall acceptance of the merger. People could be confident that the uncertainty of the acquisition presented an opportunity for growth and experimentation, not an occasion to hide in their office. When people view change as an opportunity rather than a threat, they invest themselves in the change, which has a clear effect on the speed with which integration and growth will occur.

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The fourth assumption targets speed in a direct manner. Ecolab is laying out $8.1 billion to purchase Nalco, and there is a natural tendency to cut corners in the integration process and control costs. Baker realizes the flaws in this logic: shortchanging the integration process delays the creation of synergies. Remember that Ecolab has paid a 32% premium to acquire Nalco. Given the time value of money, the longer it takes to recoup that premium, the larger the total amount of synergies that must be created.

I’ll then ask about the integration teams, and students will quickly recognize that the equal composition of the team (1/2 Nalco and ½ Ecolab) creates a tangible signal that both parties are equally invested in the merger. It also meant that decisions from the team would reflect the desires and thinking of both parties—neither Ecolab nor Nalco could steamroll the other.

What students might miss is the “heavyweight” composition of the leadership team.

Christophe Beck and Mary Kay Kaufman were members of senior management and so their words and actions carried more weight than an integration team made up of middle managers.

The creation of 28 teams signaled a willingness to look at all aspects of the combination to identify best practices or build new solutions. Teams ranged in scope from reinventing the mission and vision of the organization, to developing innovative solutions made possible by the merger. The breadth of integration work should help create a truly “best of” enterprise, and the willingness to reexamine the overall vision meant that Ecolab had no untouchable elements in creating a new company.

I’ll spend time on the three Winning as One (WAO) projects, and I’ll begin by asking students: Question: What impresses you about the three WAO projects?

The three projects represent the search for “second-level” synergies. The most basic, and easiest, search for synergies would be the cross-selling of existing products into each other’s customer base. Nalco customers would be encouraged to use existing Ecolab products, and vice-versa. For Ecolab, this would convince neither investors nor customers that the financial premium and organizational distraction of the acquisition were worth it. However, the three

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projects, while not radical innovations, would bring new products to existing customers, ones that had a “wow” factor to them. These three products manifested to the market that the merger would create new value, and each project provided a platform for further innovation.

VI. The Success of the Merger As the case closes, Baker wonders which measures of success he should bring to the board. I like to begin with financial metrics of success. The case notes that, in terms of market cap, investors saw a 100% return ($32.5 closing market cap - $11.8 opening market cap - $10.3 billion acquisition costs [$8.1 billion for Nalco and $2.2 billion for Champion] = $10.4 billion return). In terms of share price appreciation (Exhibit 4), we see that Ecolab’s shares more than doubled (106%) between the announcement day and the close of 2014. In contrast, the S&P Index went up 56%, so an investor would have more than doubled their money by buying Ecolab rather than investing in an S&P index fund.

I then turn to the strategic success of the merger, and ask “Was the merger a strategic success?” Students may point to the following evidence: •

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Exhibit 1 that Ecolab grew revenues almost 27% (26.56%) from the 2011 pro forma to the 2014 actual sales, just over 8% CAGR. That’s great for a slow-growing industry like sanitation, cleaning, and water treatments. About $1.5 billion comes through the Champion acquisition, which grew Oil and Gas revenues by 51% in 2013. The instructor should point out that the Champion Acquisition only makes sense because they owned the Nalco Oil and Gas business. Ecolab went from an insignificant position in the energy market to one of market leadership.

Sales went up 26%, but operating income went up almost 56%. What drives this are cost synergies, which Ecolab executives estimated at $250 million run-rate by the end of 2015.

The combined company created several innovation-based synergies, of which the three launch products/ projects are indicative.

Question: What are the key lessons Baker should take to the board?

Students should have a number of suggestions here, and I’ll make sure that those suggestions include the following points: •

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A solid “investment thesis” is the basis for a good acquisition—why and where the merger will create value. Ecolab knew what it wanted from the acquisition (to become a “master of water”) and that strategic objective laid the framework for how Nalco would be integrated.

Mergers are really better when there are synergies up and down the business model.

The fact that both companies had similar core values (sustainability, customer service,

Copyright ©2022 John Wiley & Sons, Inc.

•

innovation, technical expertise) provided a strong platform upon which to build synergies in products and operations.

A proactive integration process adds value by overcoming natural inertia and speeding the returns from the merger. Ecolab worked hard to create an environment that created synergies, both on the cost and revenue side.

VII. Conclusion The instructor may conclude the session by asking 2-3 students to summarize their learning.

These responses may be listed on the board. If this discussion flags, I’ll note that the best estimates are that 70% of all acquisitions fail to create the value intended; this case is one of the 30% that succeed. I’ll point out to students that they now have some tools to measure the success of a merger (will it be accretive or dilutive, looking at overall changes in stock price and market cap). The case also offers a template for creating an environment where the two companies can pursue and implement meaningful revenue synergies.

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Teaching Note

Nike: Sourcing and Strategy in Athletic Footwear Teaching Objectives This case gives students an opportunity to examine the costs and benefits (pros and cons) of vertical integration and outsourcing as vehicles for achieving a firm’s strategic objectives. Specifically, this case demonstrates that much of Nike’s success with its differentiation strategy has been possible in part due to its outsourcing strategy.

Nike’s outsourcing strategy has allowed the company to plow cost savings into shoe design and marketing and has also allowed it to focus its attention and efforts on building a narrower set of core competencies. The case also demonstrates some of the potential dangers of outsourcing by detailing New Balance’s experience of having an international (Chinese) supplier produce its shoes without New Balance’s approval.

The case also addresses the question of how Nike can prevent “knock-offs” (fake Nike products sold on the black market), one of the other dangers of outsourcing.

This case covers Nike’s history beginning with its launch in Oregon by a U.S. track coach. It details its outsourcing strategy and supplier management practices as well as how Nike’s costs compared to Adidas, the world leader in athletic footwear during the 1950s-60s. It also describes how Nike responded to charges that its suppliers were not treating their workers well.

In addition to examining the pros and cons of outsourcing, this case allows for discussion of a final question: How can Nike maintain a competitive advantage now that all competitors use similar sourcing strategies?

Study Questions 1. What were Nike’s key sources of competitive advantage relative to Adidas that allowed it to overtake Adidas to become the worldwide leader in athletic shoes? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Estimate the magnitude of the cost advantage that accrued to Nike from producing in countries like Indonesia and China versus Adidas, which produced primarily in Germany. [AACSB: Analytic] [Difficulty: Hard] [Bloom’s 4 Analysis] 3. How would you characterize the core resources and capabilities of Nike?

[AACSB: Reflective Thinking] [Difficulty: Medium] [Bloom’s 3 Application] Copyright ©2022 John Wiley & Sons, Inc.

4. What prevents Nike’s subcontractors from entering the U.S. market to compete with them? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 5 Synthesis]

Multiple Choice Questions 1. What were Nike’s key sources of competitive advantage relative to Adidas that allowed it to overtake Adidas to become the worldwide leader in athletic shoes? a. Nike focused on footwear and athletic apparel b. Adidas labor costs per shoe were roughly 60 times greater than Nike’s when Nike emerged as the world leader in athletic footwear c. Subcontractors became partners rather than competitors d. Nike leveraged vertical integration “Answer:” B 2. Estimate the magnitude of the cost advantage that accrued to Nike from producing in countries like Indonesia and China versus Adidas, which produced primarily in Germany. a. The comparable cost per pair of shoes is roughly $0.25 in China versus $80.00 in Germany, assuming an industry average of .96 labor hours per shoe and equal labor productivity b. The comparable cost per pair of shoes is roughly $1.50 in China versus $40.00 in Germany, assuming an industry average of .96 labor hours per shoe and equal labor productivity c. The comparable cost per pair of shoes is roughly $9.50 in China versus $28.50 in Germany, assuming an industry average of .96 labor hours per shoe and equal labor productivity d. The comparable cost per pair of shoes is roughly equal in China versus Germany “Answer”: C 3. How would you characterize the core resources and capabilities of Nike? a. Shoe design and marketing b. Barriers to imitation such as consistently producing new shoe designs, brand, and shelf space in key athletic footwear distribution channels c. Low costs (via outsourcing) d. All of the above

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“Answer”: D 4. What prevents Nike’s subcontractors from entering the U.S. market to compete with them? a. Keep IP only in the domestic market b. Use multiple subcontractors; don’t let any individual subcontractor get too big c. Pursue vertical integration with subcontractors d. Force subcontractors to produce key components “Answer”: B

Teaching Plan I. Nike’s Strategy II. How Nike Wins III. Overview of Outsourcing

20 min 20 min 20 min

I. Nike’s Strategy Question: What is Nike’s strategy?

Market • Athletic footwear; athletic apparel; athletic equipment Unique Value • A differentiated shoe designed to enhance playing performance that is heavily endorsed and associated with big name athletes (i.e., Michael Jordan) Resources and Capabilities • Shoe design • Marketing Barriers to Imitation • Low costs (via outsourcing) o Note that, although this helped Nike greatly in the past, its competitors use similar outsourcing strategies today.

• Consistently producing new shoe designs • Brand • Shelf space in key athletic footwear distribution channels (e.g., Foot Locker)

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II. How Nike Wins Question: What is Nike’s cost advantage over Adidas?

At the extreme, Adidas labor costs per shoe were roughly 60 times greater than Nike’s in the 1970s and 1980s when Nike emerged as the world leader in athletic footwear.

Adidas had most of its shoes manufactured by suppliers or its own factories in Europe which used high-cost European labor while Nike outsourced to Asia where average textile labor costs per hour were 1/60th the cost of European textile costs. Industrywide, labor costs represent 20 percent of the cost of manufacturing shoes.

The comparable cost per pair of shoes is roughly $9.50 in China versus $28.50 in Germany, assuming an industry average of .96 labor hours per shoe and equal labor productivity (see below for explanation of labor hours per shoe) *Assumes identical materials ($6.84) and overhead costs ($2.28) in Asia and Germany and a weight average industry labor wage of $2.38 (assuming 61% of Industry production is done in China and Indonesia, 33% in Korea, 6% in Germany and the U.S.); this translates into an industry average of .96 labor hours/pair shoes based upon the following calculation: $2.28 (industry labor cost per pair of shoes) Note: this figure is given in the case Divided by $2.38 (average industry wage/hr. based upon calculation above) = .96 industry avg. hours/pair OR 2.28 (labor cost per) / $2.38 (average industry wage/hr) = .96 industry average hours/pair of shoes III. Overview of Outsourcing Question: What are the advantages of using an outsourcing strategy?

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Advantages of Outsourcing o Flexibility to move to new suppliers that offer lower costs or better technology. o Lower costs or better performance from a company that specializes in that activity and benefits from economies of scale. o Focus: Keeps the firm focused on a narrower set of core competencies o Minimizes capital investment

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Question: What are the disadvantages of using an outsourcing strategy?

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How to prevent a subcontractor from becoming a competitor o Build barriers to imitation ▪ Brand, annual design changes, processes to develop relationships w/ athlete endorsers, distribution o Don’t allow subcontractor to know everything about making a product ▪ Produce a key component or separate production of components or subsystems of the product to multiple suppliers o Do a joint venture or take a minority equity stake ▪ Like IBM could have done with Intel o Use multiple subcontractors; don’t let any one get too big

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Dangers of Outsourcing o Loss of Control/Power. May give an outside supplier undue power or control if the outsourced activity is critical to success. o Loss of Capabilities. May set in motion the loss of capabilities that may be important for the future—and create a future competitor.

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Reasons for Vertical Integration o Capabilities ▪ Conduct the activity internally when the firm has or can develop better capabilities to perform it than other firms. o Coordination ▪ Conduct the activity internally when effective coordination and tight integration of the activity with other firm activities provides product performance (differentiation) advantages. o Control ▪ Conduct the activity internally to control scarce inputs (e.g., Alcoa integrates back into bauxite to secure scarce and critical raw material for aluminum) or to control co-specialized asset investments (e.g., oil refinery controlling the pipeline).

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Dangers of Vertical Integration o Loss of Flexibility to move the activity to a company or supplier that offers lower costs or better technology. o Loss of Focus associated with managing too many activities may result in poor performance because the firm can’t do them all well.

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Teaching Note

AT&T and Apple: A Strategic Alliance Teaching Objectives This case centers on the alliance between AT&T and Apple that was formed in 2007.

Using this case, students have an opportunity to understand each firm’s incentives to ally with each other. This case also gives students the opportunity to go beyond just describing the mechanics of an alliance, but to also quantify the benefits and costs of an alliance to each of the parties involved. Finally, the instructor can discuss whether both parties were better off as the result of the alliance or whether they might have been better off without the alliance (particularly Apple, since the alliance with AT&T limited Apple’s market penetration with smartphones before Android launched).

Study Questions 1. Do you think it was advisable for both AT&T and Apple to enter into the strategic alliance? Why or why not? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 6 Evaluation] 2. Which company do you think got the better deal in the alliance? Why? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 6 Evaluation] 3. If you were running AT&T at the time of the alliance, what would you have wanted to change about the alliance terms to make it work better for AT&T? If you were running Apple, what would you have wanted to change about the alliance terms to make it work better for Apple? [AACSB Analysis] [Difficulty: Medium] [Bloom’s 5 Synthesis] 4. Can you think of any alliances that you think AT&T or Apple should consider today to help them achieve their strategic objectives? [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 5 Synthesis]

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Multiple Choice Questions 1. Do you think it was advisable for both AT&T and Apple to enter into the strategic alliance? Why or why not? a. Yes, because they both grew in market share b. Yes, because they both increased revenue c. No, because the benefits to the companies were highly unequal d. No, because neither company really benefitted “Answer”: C 2. Which company do you think got the better deal in the alliance? Why? a. Apple, because they drastically increased market share b. Apple, because they took in far greater payments than they paid out c. AT&T, because they drastically increased market share d. AT&T, because they took in far greater payments than they paid out “Answer”: A or B 3. If you were running AT&T at the time of the alliance, what would you have wanted to change about the alliance terms to make it work better for AT&T? a. A higher percentage of subscriber fees b. More control over design and development of the iPhone c. Reduced concession on the subscriber bill (less than $10) d. All of the above “Answer”: D 4. If you were running Apple, what would you have wanted to change about the alliance terms to make it work better for Apple? a. Nothing b. Non-exclusivity to carry the iPhone on the AT&T network c. A smaller percentage of sales revenue of the iPhone paid to AT&T d. More sharing of control over iPhone design and development “Answer”: C

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5. Can you think of any alliances that you think AT&T or Apple should consider today to help them achieve their strategic objectives? a. Apple should consider an alliance with a competitor network b. Apple should consider re-introducing exclusivity with AT&T c. AT&T should consider an alliance with an Apple competitor (Samsung, LG, etc.) on better terms d. AT&T should consider an alliance with an Apple competitor (Samsung, LG, etc.) on similar terms “Answer”: C Teaching Plan I. AT&T-Apple Alliance Decision II. AT&T-Apple Alliance Outcomes

25 min 30 min

I. AT&T-Apple Alliance Decision Question: What were the strategic objectives of AT&T and Apple at the beginning of the alliance?

Though students’ interpretations may vary, below is a summary of AT&T and Apple’s objectives as outlined in the case. A summary of the known details of the alliance is also given.

AT&T “AT&T was a ‘sclerotic mess of assets’ with a future that lay in ‘a glitchy, hodgepodge cellular network cobbled from deals past.’ As its voice business continued to fade fast due to fierce competition and price wars, AT&T had a large incentive to grow its wireless business—and add more data customers through expanded smartphone use."

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Apple “Apple was designing the iPhone and looking for the optimal way to launch it into the brand-new smartphone market.”

“As mobile phones became more integrated with other applications (like music), Apple could see that the iPod business would be negatively affected with increased competition from phones. Apple was looking for their next big product and felt that the smartphone market was where they needed to be, but only if they could do it on their terms.”

“Apple was looking for a partner that could help fund the development of the iPhone but would grant Apple full control of the development and design.”

“Apple…wanted a partner with a large retail network that would be effective at selling the iPhone.”

“Apple...wanted a partner that would give Apple a percentage of the annual service bill for iPhone users.”

“Apple didn’t want to provide long term exclusivity to any one carrier.”

AT&T Would Get:

Apple Would get:

5 years Exclusive Carrier of iPhone

Millions of dollars from AT&T to support development of the iPhone

10% of iPhone sales in AT&T stores

$10 a month of AT&T iPhone subscriber’s bill

Thin slice of iTunes revenues

Control of design, manufacturing, marketing

Question: What did Apple and AT&T give up to achieve their objectives?

While the table above shows clearly some of the immediate costs to each firm (such as the slice of iTunes revenue Apple paid AT&T or the development dollars AT&T paid Apple), it may not be as easy for students to see some of the other tradeoffs that the alliance required. The list below summarizes some of the most notable tradeoffs that AT&T and Apple made to achieve their objectives via their alliance.

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AT&T •

$10/month per AT&T iPhone subscriber

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“Millions of dollars” to support the development of the iPhone

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Increased investment spending (to update infrastructure to support iPhone and surge in data usage)

Apple •

The ability to sell the iPhone through other carriers

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Foregone growth from other carriers due to exclusivity with AT&T

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Brand safety—Apple took a risk by attaching the success of the iPhone to AT&T’s ability to sell and support it

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10% of every iPhone sale and a small slice of iTunes revenue

II. AT&T-Apple Alliance Outcomes Question: Was the alliance equitable to both parties? If not, who got the better deal?

How would you calculate or estimate the value that each company got from the alliance?

The purpose of this question is not to introduce or teach one single way to value alliances. Instead, it is intended to help students in their ability to quantify benefits (and costs) of an alliance relationship. Below are three examples of such calculations: Effect on Market Value AT&T 2006 Market Value: $183.5 billion 2012 Market Value: $188 billion (peaked at $227 billion) Total Growth: 2.45%

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Apple 2006 Market Value: $56 billion 2012 Market Value: $494 billion Total Growth: 782.14% Value of Payments Made Note: Calculations do not reflect the time value of money AT&T Payments received from Apple “Thin slice of iTunes revenue” +10% of each iPhone sale =Total payment received from Apple

1% x Total iTunes revenues during alliance +10% x Total iPhones sold during alliance x Average iPhone Price x % sold in AT&T stores =Total payment received from Apple 1% x $15,894 million +10% x 85 million units sold x $399 Average Price x 28% $1,105.56 million Payments to Apple “Millions of dollars to support iPhone development” +$10/iPhone subscriber/month =Total payments to Apple $100 million +$10,435.24 million $10,535.24 million Total Payments received from Apple -Payments to Apple =Net payments received

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$1,105.56 million -$10,535.24 million -$9,429.68 million *For Apple, reverse payments received and payments made. Note that this simple estimate only takes into account the exchange of cash between Apple & AT&T to show the specific costs/benefits the alliance outlined.

Note that when the added value of the additional market share AT&T gained is included, the above net changes to -$5,916.84 million.

Effect on Market Share AT&T 2006 Market Share: 36% 2012 Market Share: 38% 2% of market share is roughly 5.63 million subscribers In 2012, average revenue per subscriber is $623.95 & the operating margin is 23.36%.

Annual Revenue from additional subscribers: $3.5 Billion Annual Operating Profit from additional subscribers: $820.6 Million Question: Was the alliance worth it for AT&T and Apple?

Students will likely answer this question ex-post. While this is useful it may also be helpful to show whether Apple & AT&T’s original strategic objectives were met (see below).

AT&T “AT&T was looking for a competitive advantage in the wireless market and to fully transition its brand into that of a wireless company.”

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Although AT&T didn’t gain a majority share of the wireless market, it was not only able to increase its share (from 36% to 38%) but also was able make a name for

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itself in the wireless market. Attaching itself to the Apple brand for several years helped accomplish this objective.

Apple “As mobile phones became more integrated with other applications (like music), Apple could see that the iPod business would be negatively affected with increased competition from phones. Apple was looking for their next big product and felt that the smartphone market was where they needed to be, but only if they could do it on their terms.”

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Although iPod sales experienced cannibalization due to the introduction of the iPhone, Apple was able to successfully sustain its iTunes business.

“Apple was looking for a partner that could help fund the development of the iPhone but would grant Apple full control of the development and design.”

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Apple received millions of dollars from AT&T to help fund the iPhone while still retaining significant control over the design and development of the iPhone. This point is pointedly illustrated when AT&T complained to Apple about the iPhone using too much data. AT&T asked Apple to take measures to throttle back data usage but Apple responded with a simple ‘No.’ (see p. 12 of the case)

“Apple…wanted a partner with a large retail network that would be effective at selling the iPhone.”

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Although it is difficult to estimate the number of iPhones that would have been sold if a competitor such as Verizon had entered into an alliance with Apple, we can be fairly certain that Apple gained a much wider reach with AT&T than it would have been able to do on its own. After only three years, the iPhone overtook the iPod and Mac sales. By year 5, iPhone sales exceeded iPod and Mac sales combined.

“Apple...wanted a partner that would give Apple a percentage of the annual service bill for iPhone users.”

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As illustrated earlier, Apple received $10/subscriber/month.

Copyright ©2022 John Wiley & Sons, Inc.

“Apple didn’t want to provide long term exclusivity to any one carrier.”

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This point is self-explanatory. Apple was able to jump start the sales of a new product and then expand those sales to other carriers outside of AT&T after only 5 years.

Question: Was Apple really better off choosing an exclusive alliance with AT&T than they would have been if they had offered the iPhone through all carriers simultaneously?

Although Apple received definite, quantifiable benefits from the exclusive alliance with AT&T, it may also be useful to help students explore whether that exclusivity helped or hurt Apple in the long run. Below are some points to consider when discussing this topic: •

Due to the fact that many users chose not to adopt the iPhone due to the contracts they were under with carriers other than AT&T, Android smartphones (beginning with the HTC Dream in 2008) were able to gain a strong footing in the smartphone market. If Apple had launched the iPhone through all available carriers, would Apple have gained a stronger hold on the smartphone market?

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AT&T had strong incentives to update its network in order to handle the large increase of traffic due to data usage after the iPhone was released. If all the carriers were supplied the iPhone, would there have been as strong of an incentive to update their infrastructure to support the extra data traffic?

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Apple’s deal with AT&T created an environment where it had almost no risk involved in the development and release of the iPhone. Was that benefit enough to justify the potential losses that came from releasing the iPhone exclusively with AT&T?

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Teaching Note

Competing With Free in Video Communications: Zoom vs. the Tech Giants Teaching Objectives This case examines how Skype pioneered the free video communications market and how different companies use different “free” revenue models to compete in video communications. In particular, the case examines multiple ways to offer “free” video communication services, including examining the freemium revenue model (used by Zoom, Teams and Skype), bundling (used by Apple), and third-party pay (used by Google Meets, and Facebook’s WhatsApp). The case allows for a rich discussion of the pros and cons of the different free strategies and the conditions under which each type of free strategy might be optimal. It also allows for a discussion of whether Zoom will likely be able to keep its strong position when tech giants Microsoft, Google, and Apple are also pursuing video communications. We would expect Zoom to be able to hold its dominant position video conferencing unless a competitor comes up with a much better “free” way, or a competitor comes up with a less expensive way (not freemium; bundling or 3rd party pay) with the same features as Zoom.

Teaching Materials Case, Competing with Free in Video Communications: Zoom vs. the Tech Giants.

Preparation Questions 1. Consider Skype’s strategy when it entered the telecommunications industry (and video communications segment). Why was Skype so successful in the early years? What was Skype’s strategy as the pioneer in this industry?

2. What is Skype’s revenue and cost model?

3. What are the characteristics of the “free” strategies employed by Zoom, Microsoft Teams, Apple, Google (Meets) and WhatsApp (Facebook)? What are the pros and cons of each?

4. Do you think Zoom will be able to hold onto its dominant position? What might competitors do to pull customers/users away from Zoom? Do you see any of the different free strategies providing a competitive advantage in this industry?

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Plan I. Skype’s Entry Strategy and Demise II. Emergence of Zoom and other Free Competitors; comparison of Free Strategies III. Future Competitive Dynamics: How might Zoom hold its position and how might competitors pull users/customers from Zoom?

20 min 20 min 15-20 min

I. Skype’s Entry Strategy and Demise Question: Consider Skype’s strategy when it entered the telecommunications industry (and video communications segment). Why was Skype so successful in the early years? What was Skype’s strategy as the pioneer in this industry?

Market- Where to Compete • Telecommunications Unique Value (Proposition) • Face-to-face video calls for free Resources and Capabilities • Software writing capabilities • Technology o Skype did not use servers to enable service. Instead, they used peer-topeer networking (see illustration below) o Super node technology found the shortest path between computers which improved call quality Traditional Client-Server Network (Napster)

P2P Network (e.g., Skype)

PC PC

PC Server

PC

PC PC

PC

Question: What is Skype’s revenue and cost model?

Revenue Copyright ©2022 John Wiley & Sons, Inc.

PC

PC

“Freemium” Strategy Upsell premium users (roughly 5 percent of Skype customers go premium; this tends to be a typical “rule of thumb” regarding the percentage of free users that move to a premium product) Marginal Cost Skype: Zero Customer: Zero (if you already have a computer and Internet service) Niklas Zennstrom’s reasoning for offering Skype for free: “We decided that Skype needed to be free because the marginal cost of placing a phone call for us was basically zero. When the marginal cost of providing a product or service is zero, the price will naturally fall to zero.”

2. Why did Skype lose its dominant market position? How did Zoom emerge as the new leader in video communications?

Skype Barriers to Imitation • Network effect o Each Skype customer could only communicate with others if they were able to get their friends, colleagues, etc. to become Skype customers.

This essentially turned Skype customers into a “sales force” for Skype.

PayPal/Venmo was successful for a similar reason (you could only do a financial transaction via PayPal/Venmo if you got others to join PayPal).

According to a Google executive: “We compete with, and against, Free offerings. The only way we can win is by offering a better Free. We can only win if our offering is better by an order of magnitude.”

Zoom offered a better, more user friendly, free offering with the same revenue model.

Discuss what is better about Zoom than Skype with regard to meeting customer needs. Why did it get adopted in schools and businesses over Skype? Here are some reasons offered in a recent review article.

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Better user experience. Easier to navigate and do what you want to do like including share a screen, record, etc.

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Zoom's virtual backgrounds. You can swap out whatever is behind you in the video for, say, the Milky Way galaxy, or the top of the Burj Khalifa, or the interview area from The Office.

Better call quality. “I prefer the user experience and find call quality consistently better,” one user who operates a small business said.

"You can record the meeting," another user pointed out.

An associate who works in video game development said, "You can stream much higher quality video via Zoom than Hangouts. Trying to view a video clip (or live gameplay) over Hangouts was impossible. Zoom is much higher quality than Hangouts by a long shot."

Zoom has a built-in beautification filter, which is one of several relatively silly little details about the service that help it stand out.

Overall, compared to Skype, Zoom offered: • better user experience • easier to navigate • better call quality • the ability to record meetings • ability to share high-quality video over that call II. The Emergence of Zoom and other Free Competitors; comparison of Free Strategies Question: What are the characteristics of the “free” strategies employed by Zoom, Microsoft Teams, Apple, Google (Meets) and WhatsApp (Facebook)? What are the pros and cons of each?

This next question gives you the opportunity to discuss the different types of free strategies employed by Zoom, FaceTime, Google(Hangouts/Meets), WhatsApp, and Teams. This helps students understand the different options associated with using a free revenue model. This also allows you to discuss the pros and cons of each.

Produ ct

Type of Free Revenue Model

Number of Daily Active Users

Primary Market Segment

Zoom

Freemium

300 million

Business and Education

FaceTi me

Bundle

20 million

Consumer

Google

Freemium

100 million

Business and

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Meet

Consumer

WhatsA pp

Third-party pay

2 billion

Consumer

Teams

Freemium

155 million

Business and Education

Video Communication Competitive Landscape (2021) Source: WhatsApp.com, Apple Stockholder Meeting, TheVerge.com.

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“FREE” definition o Product at a ‘price’ of zero o Not a one-time promotion pricing—the price is “FREE” over an extended period of time Strategies for competing with free o Free Upsell Strategy (“Freemium”) – Zoom, Teams/Skype ▪ Offer a free version to gain attention and widespread use; then offer a premium product with advanced features for customers willing to pay ▪ Requirements • A free product that appeals to a very large user base so that even a low conversion rate of free users to paying customers will generate substantial revenues OR • A high percentage of users willing to pay for the premium version o Free Cross-Sell Strategy ▪ Offer a free version to gain attention and widespread use; then offer other products for which customers are willing to pay ▪ Requirements • A broad product line (preferably products that complement the free product) OR • The ability through partnerships to sell a broad line of products to users of the free product o Free Third Party Pay (Advertising) Strategy—Google, WhatsApp ▪ Make the product/service free to generate a community (network externality) for which you get paid by a third-party company who desires access to that community ▪ Requirements

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▪

A free offering that attracts either many users who can be segmented for advertisers or a targeted group that comprises a customer segment AND • Third parties willing to pay to reach these customers Converting product users into revenues • Google is the ‘big winner’ when it comes to converting users into revenue because they can target/segment users extremely well. Advertisers know this and are willing to pay for access to those users

o Free Bundling Strategy (Direct cross subsidy) – Apple FaceTime ▪ Bundle the free product with non-free products and derive revenues from non-free products; can’t get the one without the other ▪ Requirements • Products or services that can be bundled with the free offering OR • A free product that needs regular maintenance or complementary products (e.g., free printer but costly ink) For more information on free strategies/revenue models see: Bryce, Dyer & Hatch (2011). “Competing Against Free.” Harvard Business Review.

III. Future Competitive Dynamics: How might Zoom hold its position and how might competitors pull users/customers from Zoom?

Question: Do you think Zoom will be able to hold onto its dominant position?

What might competitors do to pull customers/users away from Zoom? Do you see any of the different free strategies providing a competitive advantage in this industry?

This last question allows for a discussion of how Zoom could lose its dominant position in the industry. We would expect Zoom to be able to hold its dominant position unless: a) A competitor comes up with a much better “free” way to do video conferencing with features that Zoom will not quickly or easily match. For this to succeed, the new entrant will likely need rapid market penetration, which means it will likely need to be a tech giant that already has access to millions/billions of users (e.g., Facebook, Google, Microsoft, Amazon). b) A competitor comes up with a less expensive (not freemium) way to do video conferencing with the same features as Zoom. Zoom ultimately requires users to pay for the most desired features. A competitor could use a bundling model Copyright ©2022 John Wiley & Sons, Inc.

(which still has a direct subsidy, and something must be purchased) or a free party pay model to offer similar functionality. Free party pay is actually the free strategy that is most truly “free” to the end user.

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Teaching Note

Tesla Motors: Disrupting the Auto Industry?

Teaching Objectives The Tesla case provides the opportunity to discuss core strategy and innovation topics, such as patterns of innovation (e.g., new technology generations competing to replace older generations), types of disruptive innovations (e.g., low end versus innovations coming from the high end), innovation ecosystems (e.g., expanding student views beyond a focal technology to the interdependence of focal technologies with the ecosystem of supporting technologies), systems strategy (e.g., expanding student views beyond products to understand the role of technology architectures and systems), and innovation processes (e.g. the entrepreneurial process of learning under conditions of uncertainty versus scaling up for execution). The teaching note is organized around a broad set of discussion questions that bring out each of these issues in the case (you will likely need to choose a subset of these discussion questions).

The case is set at the end of 2016 after Tesla has recently made the cover of Forbes magazine as the world’s most innovative company. Tesla has launched the Roadster model, the Model S, has launched the Model X and is preparing to launch the Model 3. On the one hand the company seems to be potentially on the verge of transforming the auto industry with aggressive plans to offer affordably priced electric vehicles—starting with the Model 3. On the other hand, skeptics point out that Tesla is not a classic low-end disruption and that the established auto companies can easily respond and beat out Tesla.

Study Questions 1. What features make the auto industry an attractive or unattractive industry to enter?

[AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Clayton Christenson popularized the idea of disruptive innovation, but he argues that Tesla is not disruptive. Do you agree? Why or why not? [AACSB: Reflective Thinking] [Difficulty: Medium] [Bloom’s 6 Evaluation] 3. What are the biggest obstacles that Tesla must overcome to successfully commercialize electric vehicles? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 4 Analysis] Copyright ©2022 John Wiley & Sons, Inc.

4. What do you expect Tesla’s cost, and profit, to be on the Model 3 at different annual unit volumes (e.g., at 200,000 per year, 300,000 per year, 400,000 per year)? How many will Tesla have to sell per year in order to be profitable? What is the implication of your analysis for Tesla's viability as an auto company? [AACSB: Analytic] [Difficulty: Hard] [Bloom’s 3 Application] Multiple Choice Questions 1. What features make the auto industry an attractive or unattractive industry to enter? a. Attractive, because of the ease with which the industry can be disrupted from the high end. b. Attractive, because of the ease of which the industry can be disrupted from the low end. c. Unattractive, because of high barriers to entry, high rivalry, and high buyer power. d. Unattractive, because of mature learning curves and low profitability.

Answer: “C” 2. Clayton Christenson popularized the idea of disruptive innovation, but he argues that Tesla is not disruptive. Do you agree? Why or why not? a. Tesla is not disruptive because there was not a large population who historically did not have money, equipment, or skill to use the product. b. Tesla is not disruptive because Tesla did not create a business model that allows earning attractive profits at discount prices from overserved customers. c. Tesla is disruptive because Tesla follows the definition of a low-end disruption as defined by Christensen. d. Tesla is disruptive because Tesla is a “high end disruption,” meaning a technology that starts at the high-end of a market as too expensive for mainstream users.

Answer: “D” 3. What are the biggest obstacles that Tesla must overcome to successfully commercialize electric vehicles? a. Difficulty in selling expensive cars (e.g., Model S, Model X) to generate profits. b. Scaling up production. c. Meeting sales goals of the Model 3. d. Keeping production costs per vehicle down.

Answer: “C”

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4. What do you expect Tesla’s cost, and profit, to be on the Model 3 at different annual unit volumes (e.g., at 200,000 per year, 300,000 per year, 400,000 per year)? How many will Tesla have to sell per year in order to be profitable? What is the implication of your analysis for Tesla's viability as an auto company? a. Tesla needs scale to survive and succeed. b. Tesla will only start to make money if the company can sell more than roughly 300350,000 units per year. c. The Model 3 should cost less per vehicle. d. All of the above Answer: “D” Teaching Plan I. Introduction II. Musk’s Strategy III. Analysis IV. Results of Analysis V. Ecosystem of Supporting Technologies VI. Conclusion and Discussion

20 min 5 min 30 min 20 min 10 min 15 min

I. Introduction Question: Is Tesla a Disruptive Technology?

The case presents the opportunity to discuss entry into an industry—and whether that entry is likely to prove disruptive to incumbents. To this end the case has been written to offer a two-sided perspective on Tesla (Tesla’s strategy and business model WILL be proven disruptive to incumbents vs. incumbents will be able to easily respond to Tesla’s electric vehicles and business model) in hopes of drawing out debate that enriches the core theories of strategy and innovation. There are multiple questions that can be employed to draw out the key issues in the case.

Question: Tesla recently topped the list of Forbes list of the world’s most innovative companies.

Who would like to invest in Tesla and who would not?

Some would say that topping the list of the world’s most innovative companies means investors believe the company will produce far more innovations in the future. Others would say it means Tesla is grossly over-valued. Push students to justify their perspectives briefly. Of Copyright ©2022 John Wiley & Sons, Inc.

those who say they will invest in Tesla, ask how many actually have. Actions speak louder than words.

Question: Why would Tesla enter such an unattractive (relatively unprofitable) industry (from a 5 Forces perspective)? What are the risks to Tesla in entering such an unattractive industry?

This question helps push students to examine the real risks of entering a well-guarded industry and creates more dramatic tension in the discussion. Using frameworks discussed previously in strategy classes address the problems with entering the auto industry (by most analyses the auto industry is an unattractive industry for new entrants because it has high barriers to entry, high rivalry, and high buyer power as well as mature learning curves, immense capital costs, and low profitability). The goal here is to show that while prior strategy frameworks raise real concerns about Tesla, they don’t fully answer why Tesla would enter the industry or predict the success or failure of Tesla.

Question: Is Tesla a disruptive technology (innovation), in the way that Clay Christensen describes disruptive innovations?

If students are unfamiliar with the pattern of disruption, briefly describe the pattern of disruption and have a general discussion with the students (or have them read “Tesla’s Not as Disruptive as You Might Think”). If students have previously read about disruptive innovation, have them outline the elements and patterns of disruptive innovation. According to Christensen, there are three litmus tests of disruptive innovation: •

There is a large population who historically did not have money, equipment, or skill to use product OR customers currently use the product but need to go to inconvenient, centralized location.

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There are customers at low-end of market who would be happy to purchase a product with fewer features at lower price OR can a firm create a business model that allows earning attractive profits at discount prices from overserved customers.

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Is the innovation disruptive to all the relevant players in the industry? Christensen’s team concludes that Tesla does not fit this pattern. The debate about Tesla and disruption represents a central opportunity in the case to clarify their understanding of technology and strategy.

While low-end disruptions are conceptually appealing, many innovative new technologies may not fit this pattern. When viewed at the level of the car, Tesla is not a low-end disruption as defined by Christensen. But this does not mean Tesla is not “disruptive” in the broader dictionary sense (disruptive or disruption means to “throw into disorder”) by which most Copyright ©2022 John Wiley & Sons, Inc.

students use the term, and it does not mean that Tesla is simply “sustaining” according to Christensen’s framework. Rather, if you choose, you could point out that Tesla could be classified as a radical innovation as described by Abernathy and Clark (1985) or an architectural innovation as described by Henderson and Clark (1990). However, it may be simpler to argue that Tesla is a “high end disruption”, meaning a technology that starts at the high-end of a market as too expensive for mainstream users, but through production and continued improvement, becomes affordable for the mainstream market (for more on highend disruption see Dyer and Bryce, 2015). Arguably many new technologies follow this pattern (for example, cell phones vs. landline phones, iPod vs. Walkman, micro-computers vs. typewriters, electronic fuel injection vs carburetors, and internal combustion engine vehicles vs. horse and buggy).

II. Musk’s Strategy Musk has indicated that Tesla's strategy is to sell expensive cars (e.g., Model S, Model X) to generate profits to sell less expensive vehicles (e.g., Model 3). Tesla has been running losses each year.

Question: If Tesla can't make profits selling expensive high-end vehicles, how can they make money selling vehicles (Model 3) at half the price?

Musk has indicated that the key to the company's profitability is selling large numbers of the Model 3. Tesla hopes to sell up to 400,000 units (the number of reservations) in 2018.

Question: Assuming Tesla does sell 400,000 units in 2018, what do you think the profit (or loss) per Model 3 unit will be at the end of 2018? (Estimate profit or loss based on estimated revenue per unit minus estimated production cost per unit; also do it for estimated total cost per unit).

What is the implication of your analysis for Tesla's viability as an auto company?

III. Analysis In order to address the answers to these questions, the students will need to do some analysis to understand Tesla’s costs, and profit, per unit. And then they need to use that analysis to project Tesla’s cost, and profit, per unit on the Model 3. To provide accurate estimates, you may want to have the students calculate a scale or experience curve for Tesla’s Model S to try to understand whether there are any particular benefits to scale or experience that may inform Tesla’s strategic decisions moving forward (the data on production cost per unit for the Model S can be found in table 1 and 2).

Question: Are there benefits to pursuing a scale-based strategy?

Copyright ©2022 John Wiley & Sons, Inc.

Tesla started making the roadster in the late 2000’s but did not start a mass production vehicle until 2012 when they introduced the Tesla model S. Thus, to examine the scale and experience curve benefits it may make the most sense to focus on the time period between when they introduced the Model S and when they introduce the Model 3. This will give us a general sense of the benefits they gain from scale and experience without worrying about two substantively different models with different costs embedded into the calculation.

If we go back to 2012, then we really only have three years of data, but we can use quarterly data to increase from three data points to 12 data points. Tesla conveniently gives us a line item for the cost of automobile manufacturing in the annual and quarterly reports. This makes finding the total cost of auto manufacturing by quarter relatively easy to find. We could try to adjust it in a number of ways, but taking their line-item measure is probably good enough. (See the Cost of Production column in Table 1 below). Once we know the total cost of auto production in the quarter, we can use an estimate for the number of vehicles produced in that quarter to calculate the average cost per unit produced. Tesla, unfortunately, does not publish production numbers. But there are a number of Tesla enthusiasts and analysts who have developed estimates of sales volume by quarter. Since Tesla has a backlog for Model S vehicles and typically ships as soon as it produces, it is likely that the sales volumes match tightly the production volumes in any given quarter. After doing a few Google searches we can build an estimate of quarterly model S unit sales since 3Q 2012. This is all shown in Table 2 of the case.

With volume and cost of production data, we can then easily calculate cumulative volume for any given quarter and the cost/unit for any given quarter (see relevant columns in Table 1 below, drawn from Table 2 in the case).

Table 1: Raw Data for Scale and Experience Curves Volume (units) 3Q 2012 4Q 2012 1Q 2013 2Q 2013 3Q 2013 4Q 2013 1Q 2014 2Q 2014 3Q 2014 4Q 2014

250 2400 4900 5150 5500 6892 6457 7579 7785 9834

Cumulative Cost of Average volume production $/unit (units) ($) 250 58865 235.46 2650 312793 130.33 7550 461818 94.25 12700 303599 58.95 18200 324883 59.07 25092 453578 65.81 31549 436254 67.56 39128 519811 68.59 46913 552987 71.03 56747 800959 81.45

Copyright ©2022 John Wiley & Sons, Inc.

1Q 2015 2Q 2015 3Q 2015 4Q 2015 3Q 2014 4Q 2014

10045 11532 11597 17400 7785 9834

66792 78324 89921 107321 46913 56747

631745 6663 86 628729 896442 552987 800959

62.89 57.79 54.21 51.52 71.03 81.45

If we use these data to generate scale and experience curves (see our scale/experience curve video animation for guidance on how to calculate a scale or experience curve), then we get the following:

Copyright ©2022 John Wiley & Sons, Inc.

Using the methods described in the video animation, we can then calculate the experience curve slope as ~85%. This means that every time we double our cumulative experience our cost decreases by 15%. Our scale curve slope is ~77%. This means that every time we double our quarterly volume, we decrease our costs by 23%. Tesla’s cumulative output by the end of 2015 was almost 110,000 vehicles. At current production levels it will take more than a year to double volume, but then doubling volume again will be quite difficult. In contrast, going from 17,000 vehicles in 4Q 2015 to 34,000 vehicles during 2016 is more reasonable.

The nice thing about calculating these curves is that they allow us to project (hopefully with some confidence) what Tesla’s future costs per vehicle will be if they ramp up production on the model 3. Table 2 shows the projected per vehicle production cost at different production levels using the best fit equation from the scale curve above.

Table 2: Projected costs per unit for different production volumes Projected volume Projected (units per quarter) cost/unit (000s) 10000 $ 62.84 20000 $ 48.69 30000 $ 41.94 40000 $ 37.73 50000 $ 34.76 60000 $ 32.50 70000 $ 30.71 80000 $ 29.24 90000 $ 28.00 100000 $ 26.93 110000 $ 26.00 120000 $ 25.18 130000 $ 24.45 140000 $ 23.79 150000 $ 23.20 This table provides useful data for several reasons. First, notice that Tesla’s cost of production for the Model S at the end of 2014 is likely around $50K per vehicle. This is not bad for a Model S that sells for $75-100K. At a cost of $50K per vehicle they have excellent margins on the Model S. But they are not focused on ramping the model S up to 500,000 units per year.

They are hoping to ramp up volume with the model 3, a lower end car targeting mass market consumers. Tesla has announced a starting price tag of $35K with an expected average selling price of around $42.5-45K for the model 3.

Copyright ©2022 John Wiley & Sons, Inc.

Let’s assume for a moment that the model 3 will cost the same to produce as the model S. This is probably not an accurate assumption, but it shows the very high range of what it should cost to produce the Model 3. The Model 3 should cost less per vehicle because it is a slightly smaller vehicle and it won’t have all of the bells and whistles (or speed) of the Model S. However, Tesla is not likely to go from an aluminum frame for the Model S to a steel frame for the model 3. They are not likely to remove the 17-inch touch screen from the model 3, and they are not likely to sacrifice range too much. Certainly, the battery, per KW, will have the same price for the model 3 as the model S since they are coming from the same source (the Gigafactory).

Although the assumption that the Model 3 will cost the same, per unit, as the model S is going to give us estimates that will be too high, let’s use it anyways for a moment since many of the main components will have similar costs across models (it creates a conservative assumption of the cost per Model 3; in other words, a worst-case scenario for Tesla).

Tesla hits a production cost of $35k per vehicle at around 50,000 units per quarter – 2.5 times current production volumes of the Model S. If we assume that Tesla needs a gross margin of 25% to cover R&D and overhead and break even then they need production costs down at around $26K per vehicle, which is right around 110,000 vehicles per quarter. This is almost up to the estimated Gigafactory capacity of 125,000 units per quarter.

Long story short here is that Tesla is going to have to ramp up production almost to full capacity in the Gigafactory in order to generate profits on the model 3 vehicle, assuming cost per unit is the same as the model S and the required gross margin to cover overhead is 25% (what they’ve needed historically to cover R&D and overhead). If costs are 10% lower per unit it means production volume can drop by roughly 10% (to 100,000 units per quarter) and they can still break even. If the gross margin required to cover R&D and overhead is only 15% instead of 25%, it means they can sell 10% fewer units and still break even. By making these adjustments to our assumptions the breakeven volume would drop to roughly 90,000 units per quarter which is likely a bit more accurate.

Now, of course, we could make some additional adjustments to our assumptions (assuming even lower costs per unit for the Model 3 relative to the Model S (e.g., 20 percent lower), but the numbers are still a bit scary.

IV. Results of Analysis Question: What do we learn?

Copyright ©2022 John Wiley & Sons, Inc.

One thing is that Tesla needs scale to survive and succeed. Tesla will only start to make money if the company can sell more than roughly 300-350,000 units per year.

Question: Is there a market for more than 400,000 Tesla’s per year? How long will it take to build to that market?

If Tesla can sell more than 400,000 units per year the company should be profitable (it is still uncertain exactly how profitable Tesla will be but based on these calculations the company should be profitable). Tesla’s strategy of producing beautifully designed electric vehicles seems to have worked in the luxury car market; but a big question is whether Tesla has the resources, capabilities and systems and processes needed to economically produce a midrange economy electric vehicle. So far, we have looked at Tesla through the lens of classic strategy frameworks that explain competitive advantage (e.g., Porter’s five forces) and a classic innovation framework (disruptive innovation). But what if we expanded the lens of our analysis from products (which is the traditional focus in strategy) to the system (meaning all the players and technologies that contribute to a focal technology).

V. Ecosystem of Supporting Technologies Question: What is the “system” that impacts Tesla and its ability to succeed?

The purpose of this question is to explore the “ecosystem” of supporting technologies that must come in to place for a new innovation to succeed. Let the class map the ecosystem of activities (e.g., batteries, charging stations, dealer networks, repair shops, recycling facilities).

Then have the class assign two values to each component (difficulty to establish and incentives of players outside of Tesla to establish the component). This will highlight the challenges of developing the ecosystem for Tesla and many of the key determinates of Tesla’s success. This may be an opportunity to bring in Ron Adner’s concept (in the Wide Lens) of reallocating value along the ecosystem to incentivize ecosystem players to participate in building the ecosystem.

Second, and just as importantly, when viewed through the lens of a “system” we could see Tesla in a different light. While it is true that the Tesla car may not be disruptive in the classic sense as defined by Christensen, Tesla has also designed a low-cost lithium-ion battery and is investing heavily to produce this battery at scale and further drive down costs. In some senses, the battery may be a “low-end” disruption, as defined by Christensen, in that it could disrupt the markets for industrial lithium-ion batteries in cars as well as in renewable energy, storage, and related industries. You may choose to discuss this idea here or later when you discuss question 6 or question 7 that relate to the giga-factory.

Copyright ©2022 John Wiley & Sons, Inc.

Question: Is Tesla foolish to pioneer a new architecture and make everything themselves? Does this lower or increase their risk? Why is Tesla’s factory so different than many other factories around the world?

Clearly introducing a new architecture increases the risks to the company. Furthermore, producing all the parts themselves also increases their risk but allows them to learn more quickly from their failures and the flexibility to change quickly. Notably, early in their history, Tesla tried to operate like a standard automobile company with a global supply chain sourcing components from leading suppliers in low-cost locations. However, Tesla found what many new manufacturers discover in trying to manage such a supply chain: while such global supply chains may reduce costs for well-established products, any uncertainty leads to significant delays and coordination problems. Tesla encountered massive delays in production of the Roadster as a result and discovered that lead times with suppliers could be months and that suppliers often sent their “B” teams to service Tesla, leading to even more inferior components and longer timelines.

What few outsiders appreciate (including many of the manufacturing executives who tour the plant) is that Tesla redesigned itself for a different purpose: to learn as quickly as possible under uncertainty. Producing their own parts allows Tesla to learn more about how to produce the vehicle and adapt it quickly. For example, when Tesla discovered a problem with the steering column they could quickly redesign and replace it. Similarly, when they received feedback that the seats in the rear of the Model S were not as comfortable as expected by customers, they quickly swapped out the seats (sourced from another company) without waiting for the “next model year.”

Question: Why has Tesla opened up their patents? What are the pros and cons of such a move? If Tesla has opened up their patents, why are there no tours of the giga factory? What does this tell us about their strategy?

One perspective balances the value of protecting your intellectual property against opening your intellectual property. Teece (1986) argued that many times the firms who create value are not the ones who capture the value. Intellectual property in the form of a patent is one way to capture value employed in industries like pharmaceuticals (where compounds can be easily imitated). But there are other ways to capture value, including trade secrets, which may be one reason why Tesla is open about their patents (which are already open to the public by nature of their publication) but secretive about certain operations, such as battery production. Additionally, one could argue that Tesla is opening up their patents to encourage others to innovate in the space and thereby increase momentum in the ecosystem overall (in particular it may encourage other automakers to use a similar charging station technology).

Lastly, one could argue (and some commentators have) that Tesla opening their patents may not be as open as they appear, since patents are publicly available anyway, and Tesla really Copyright ©2022 John Wiley & Sons, Inc.

has only said they would not prosecute use of their patents in “good faith.” Tesla has not actually licensed or assigned patents to third parties.

Another perspective looks at the tendency of technologies to evolve from integrated to modular over time. In the early days of a technology, firms often need to develop an integrated product to satisfy the needs of customers but as technology mature and become more modular, value capture goes to those who control the modules or components that have a performance bottleneck. If we applied this theory to IBM when they were developing the PC, what areas would we predict at that time IBM should move into (processors, software, operating systems—the area with persistent performance bottlenecks and that earn the most profits today—rather than computer design which was the space where IBM stayed). If we apply the same analysis to Tesla, what components are likely to become performance bottlenecks as electric vehicles evolve? Batteries have long been the performance bottleneck of electric vehicles and many other technologies, including renewable energy and consumer electronics. Batteries are likely to remain the most valuable component as electric vehicles evolve, and potentially to many more industries than automobiles. Likely the Gigafactory is an attempt to move down the learning curve, lower the cost of batteries, thereby giving Tesla a competitive advantage (and potentially turning them into a battery supplier to other auto manufacturers or to other industries). Indeed, perhaps Musk believes that if the electric vehicle venture fails then perhaps Tesla could become a battery supplier to the world.

Frequently new companies struggle because they try to do too many things at once. Tesla is already making all their own components, charging stations, dealerships, and repair centers.

Should Tesla have diversified into Tesla PowerWall (back up battery product for home energy). Is it a distraction from the core or a plus to the core?

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OPTIONAL DISCUSSION: Better Place recently attempted to commercialize electric cars in a more attractive environment (geographic confines of Israel), more support from industry (Renault) and government (Israeli government), and a great deal of capital. Is Tesla likely to meet the same fate?

VI. Conclusion and Discussion Regarding the company Better Place, on the board outline the similarities and differences, and have a debate.

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Similarities o Both led by visionary entrepreneurs o Both heavily funded o Both commercializing electric cars

Copyright ©2022 John Wiley & Sons, Inc.

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Differences o Better Place had advantageous geography o Better Place had different architecture (swap out battery rather than charge battery (arguably better but increases cost) o Better Place arguably had a better charging infrastructure o Better place cars were unpleasant and ugly to drive -> Tesla thinks of system

Regarding whether Tesla is scaling too fast and spreading themselves too thin versus strategically diversifying, the answer could arguably be “both.” In many senses Tesla Wall is a distraction that takes up precious time, capital, and engineering talent. It adds risk to the business at the same time that it adds attractiveness (the revenue to Tesla from the battery is inconsequential compared to the strategic move to create a low-end battery disruption). That being said this is a significant risk (Better Place failed in part because they scaled too fast) that must be taken into account. Pursuing other business lines eats up precious capital.

Lastly, most likely the “issues” around revolutionary new battery technologies that may make Tesla obsolete are overblown since new “revolutionary” technologies have been promised for decades and few have delivered this promise (see the struggles of A123 batteries for an example).

Question: At the end of the day, what factors do you think are most important for predicting Tesla’s future success? Do you think electric vehicles will disrupt internal combustion engine vehicles (meaning that eventually the majority of cars will be electric powered)? Do you believe that electric vehicles can grow share from less than 1 percent to more than 33 percent of new cars sold in the United States in 10 years? Why or why not?

Tesla will be more successful if battery technology continues to improve at a faster rate than internal combustion engines (ICE) so that at some point the cost/performance of battery electric vehicles (BEV’s) is clearly superior to ICE’s. An article by Randy Carlson (see link below) shows some data on battery performance over time and suggests the Model 3 will be the tipping point of electric cars having better performance than internal combustion engine (ICE) cars at same cost.

At this point, the data seem to suggest that battery technology is improving at a much faster rate than internal combustion engine (ICE) technology…and if it is truly the case then electric vehicles will likely overtake ICE vehicles. Of course, not only will cost/performance need to be superior for BEV’s to displace ICE vehicles, but also the charging system (to eliminate range anxiety) will need to be adequate. These two factors seem to be critical to BEV’s ability to displace ICE vehicles.

Question: Do you think Tesla will be successful even if all incumbent automakers successfully produce electric vehicles that are comparable in cost and quality to Tesla’s vehicles?

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Of course, even if BEV vehicles overtake ICE vehicles, that doesn’t mean Tesla will necessarily become the new industry leader from a volume standpoint….most existing car makers will likely make the move to BEVs. However, even if that happens, Tesla has at least two important potential advantages in a BEV dominated auto market: •

Battery technology capabilities (with economies of scale in production); the Giga factory should provide a cost advantage in battery production, at least in the short run (e.g., 5-10 years). Of course, it’s possible a new leapfrog battery technology could come along but if Tesla can stay the leader in battery technology for vehicles, they may supply this technology to other firms as they are currently doing with Daimler Benz and Toyota on select vehicles; so being a leader in the key powertrain component could produce a long-term advantage.

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Distribution/business model. Tesla has company owned dealers/stores, without all of the overhead of typical dealers. This could be a major advantage in a BEV world because service/maintenance costs for BEVs are estimated to be less than 20% of the service/maintenance costs of ICE vehicles. Other carmakers will have legacy costs/challenges with a network of dealerships that largely make money on service/parts—and revenues for those services will decline significantly.

It is possible, however, that ICE vehicles will combine with batteries (e.g., hybrids) to provide better overall cost/performance for a majority of customers. If hybrids can get to 100 miles per gallon and gas is cheap, then BEV’s may not displace hybrids. Moreover, oil companies have a strong incentive to do everything in their power to keep combustion engines in business because roughly 50 percent of oil usage in the United States is from gas engines.

One thing we do know is that both incumbent automakers and oil companies will do everything possible to prevent the move to BEVs. Associated Readings “It’s Game Over. Tesla Wins.” Randy Carlson http://seekingalpha.com/article/3537486-its-game-over-teslawins?auth_param=vp591:1b0ippk:a469de0af5fd6ea040297388414571a2&dr=1 Christensen (1997). “The Innovator’s Dilemma”.

“Tesla’s Not as Disruptive as You Might Think.” Harvard Business Review https://hbr.org/2015/05/teslas-not-as-disruptive-as-you-might-think Dyer, Gregersen and Furr (2015). “Tesla’s Secret Formula.” Forbes Dyer and Bryce (2015). “High End Disruption.” Forbes.

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Teaching Note

Tesla and Panasonic’s Strategic Alliance Teaching Objectives This case examines the alliance between Tesla and Panasonic that was formed in 2008. Using this case, students have an opportunity to understand each firm’s incentives to ally with each other. It also allows students to consider the other options that Tesla had for accessing battery cells for their EV vehicles (e.g., they could have tried to develop these skills internally using a “make” instead of “buy” option). This case also gives students the opportunity to understand the challenges of managing an alliance as they assess the costs and benefits of the alliance to each of the parties involved. Finally, the instructor can discuss whether or not both parties were better off as the result of the alliance or whether they might have been better off without it.

Teaching Materials Case, Tesla-Panasonic’s Strategic Alliance Real World Strategy, Chapter 8, Strategic Alliances Preparation Questions 1. What were the strategic objectives of Tesla and Panasonic at the beginning of the alliance?

2. Do you think it was advisable for both Tesla and Panasonic to enter into the strategic alliance? Why or why not? What were their other options?

3. Which company do you think got the better deal in the alliance? Why? More generally, what allows one company to get a better deal than another company in an alliance?

4. If you were running Tesla at the time the alliance was initiated, what would you have wanted to change about the alliance terms to make it work better for Tesla? If you were running Panasonic, what would you have wanted to change about the alliance terms to make it work better for Panasonic?

5. What were the main causes of problems with the alliance? How were disputes resolved? What are the current problems facing the partnership and how would you work to resolve them?

6. Why has Tesla’s market value increased during the term of the alliance so much more than Panasonic’s? Could Panasonic have done anything to capture a bigger piece of the jointly created pie?

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Plan I. Tesla-Panasonic Alliance Objectives II. Tesla-Panasonic Options for Overseeing Activities (Make vs. Buy vs. Ally) II. Tesla-Panasonic Alliance Outcomes VI. Tesla-Panasonic Alliance: Observations on why Tesla’s market value has increased more than Panasonic’s (and what Panasonic might have done about it)

25 min

30 min

I. Tesla-Panasonic Alliance Objectives Question: What were the strategic objectives of Tesla and Panasonic at the beginning of the alliance?

Though students’ interpretations may vary, below is a summary of Tesla and Panasonic’s objectives as outlined in the case.

Tesla Tesla needed to secure a supply of quality lithium-ion batteries, the most expensive and difficult-to-make component of every Tesla. Tesla believed that Panasonic’s cylindrical lithium-ion battery cell was the best on the market and would lead to immediate improvements in vehicle performance. In addition, as a world leader in lithium-ion chemistry, Panasonic was expected to provide continual advancements to their technology in coming years, allowing Tesla to further enhance the longevity, safety, cost, and performance of its vehicles.

Panasonic brought capital to the alliance, investing $1.6 billion in the Gigafactory, and managing the battery area in the factory. Panasonic also purchased 2 percent of stock for $30 million. Additionally, Panasonic’s willingness to repeatedly work towards aggressive expansion targets and its dogged pursuit of improvements in chemical efficiency were crucial for the rapid scaling of Tesla.

Panasonic

Copyright ©2022 John Wiley & Sons, Inc.

Panasonic was struggling to realize growth as many of its flagship consumer products such as TVs and DVD players reached maturity. Overinvestment in the company’s plasma TV line was beginning to show heavy lossesi, increasing pressure on management to find a promising new source of revenue. Panasonic saw Tesla as an opportunity to leverage its existing strength in lithium-ion technology to establish a presence in the emerging, and high growth, EV market.

Tesla Would Get:

Panasonic Would Get:

Preferred access to Panasonic’s cylindrical lithium-ion battery cell which Tesla felt was the best on the market Capital (more than $1.6 billion) to build the Gigafactory Ability to focus on product design, manufacturing, and sales/distribution without needing to develop deep expertise in batteries

Large volume orders of its lithium-ion batteries in an entirely new growth market (automobile) with a successful new EV start-up Ability to acquire 2 percent of Tesla stock for only $30 million Opportunity to invest heavily in the development of battery technology for the EV market Opportunity to build scale in battery production for the EV market

II. Tesla-Panasonic Options for Overseeing Activities (Make vs. Buy vs. Ally) Question: Do you think it was advisable for both Tesla and Panasonic to enter into the strategic alliance? Why or why not? What were their other options?

This question allows for a brief discussion of the make vs. buy. vs. ally options for conducting activities that are important to delivering a firm’s value proposition. This allows for a discussion of what resources and capabilities are important to own and control vs. just access through another firm.

Tesla could have decided to: a) develop the battery technology internally by hiring expertise and raising the capital to do R&D and manufacturing internally. b) purchase another company (like Panasonic) with the technology. c) create a standard design for lithium-ion batteries to go into the company’s EVs and then source the lithium-ion batteries from multiple different suppliers.

Panasonic could have decided to: a) develop EV production capability internally by hiring expertise, etc. b) purchase Tesla (or another EV manufacturer).

Copyright ©2022 John Wiley & Sons, Inc.

III. Tesla-Panasonic Alliance Outcomes Question: Which company do you think got the better deal in the alliance? Why? More generally, what allows one company to get a better deal than another company in an alliance?

Tesla received high quality batteries at a good price and minimized the investment it needed to make in the Gigifactory and in scaling the battery side of the business. This helped propel Tesla to a market valuation of $650 billion by 2021—by far the largest market cap among auto makers.

Panasonic improved its brand awareness and visibility as a battery-maker for EVs. It dramatically increased its scale as a producer of li-ion batteries for EVs. It acquired 2 percent of Tesla’s stock for $30 million in 2010 which it sold for $3.6 billion in March of 2021.

Though we cannot see the road not traveled, both companies appear to be better off as a result of the alliance. It seems unlikely that Tesla could have grown as quickly, or successfully, without Panasonic; and it seems unlikely that Panasonic would have enhanced its brand, built scale in EV batteries, or generated $3.6 billion in investment income without Tesla.

Companies that get the best terms in the alliance are the ones that bring the more scarce resources and capabilities to the alliance. Tesla were the only EV start-up looking for a battery supplier. However, there were multiple li-ion battery suppliers like Panasonic that could have provided batteries for Tesla’s EVs. IV. Tesla-Panasonic Alliance Terms Question: If you were running Tesla at the time the alliance was initiated, what would you have wanted to change about the alliance terms to make it work better for Tesla? If you were running Panasonic, what would you have wanted to change about the alliance terms to make it work better for Panasonic?

Tesla appeared to strike a pretty hard bargain which allowed for low prices from Panasonic on li-ion batteries but also gave Tesla the flexibility to develop battery technology on its own. Tesla might have preferred not to give Panasonic an exclusive on much of its business; but it did retain flexibility to develop battery technology for future vehicles.

Panasonic could have negotiated stock/option incentives to receive greater stock in Tesla as the company sold more vehicles and as Panasonic hit certain targets for Copyright ©2022 John Wiley & Sons, Inc.

battery production. That would have allowed the company to participate in the benefits created by the success of Tesla’s EV vehicles. Larger companies that team with smaller growth companies typically have bargaining power at the beginning of the relationship to acquire (or be awarded) a greater percentage of the smaller company’s stock so as to participate in market value growth of the smaller company.

Panasonic could have pushed to be the exclusive supplier on certain models or for a certain period of time.

V. Tesla-Panasonic Alliance Problems Question: What were the main causes of problems with the alliance? How were disputes resolved? What are the current problems facing the partnership and how would you work to resolve them?

This question offers an opportunity to discuss problems that arise in the course of an alliance. One of the key challenges in an alliance is building trust between the two parties. This offers an opportunity to discuss three different kinds of trust.

1. Competence trust: trust in the other party’s competence to deliver what they say they will.

2. Goodwill trust: trust in the other party’s “goodwill” which means they are unlikely to try to take advantage of the partner even if they have the chance.

3. Contractual trust: trust that the contractual arrangements are enforceable and will provide the needed protections against opportunistic behavior by the partner.

One of the key challenges in an alliance is maintaining some sense of trust and equity while bargaining over how much each party gets of the jointly created pie. To be successful and to stay in the alliance, parties must feel like they are treated fairly and equitably. They must try to verify and feel confident in their partner’s competence and goodwill, but also in the contractual arrangement that has hopefully anticipated potential problems and provided for them.

The Tesla-Panasonic alliance also had conflicts due to different expectations by the two firms that were rooted in country cultural differences. There were also communication difficulties due to language differences. This provides an opportunity to discuss that all conflict in relationships is due to unmet expectations. So making sure the expectations are clear is very important.

VI. TESLA-Panasonic Alliance: Observations on why Tesla’s market value has increased more than Panasonic’s (and what Panasonic might have done about it) Copyright ©2022 John Wiley & Sons, Inc.

Question: Why has Tesla’s market value increased during the term of the alliance so much more than Panasonic’s? Could Panasonic have done anything to capture a bigger piece of the jointly created pie?

Tesla’s market value has increased in large part by building a brand name and loyal customer base for its differentiated and relatively unique EVs. During the past 10 years no other company has produced as many, or as desirable, EVs as Tesla. Panasonic is producing an important component of the vehicle but is not perceived by EV customers as particularly important (and Panasonic can be more easily replaced with another li-ion supplier or a supplier working on a breakthrough battery like QuantumScape which is making solid-state batteries). Panasonic has clear competitors and substitutes (Tesla can replace them), but Tesla cannot be easily replaced by another EV maker because of its brand, its car designs, and its loyal customers.

Panasonic could have taken a much larger equity stake early in the alliance or could have negotiated to receive additional stock awards each year as it met certain alliance milestones. iNikkei staff writers (2019). Sparks Fly: Inside the Strained Tesla-Panasonic Relationship, Nikkei

Asian Review.

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Note

Smartphone Wars in 2013 Teaching Objectives The purpose of this case is to immerse students in the competitive dynamics of an industry with which they should be well familiar: Cell phones. The case is complex because it traces the history of the industry and the dynamics among the leading players through the years from industry inception. Instructors and students will find much to discuss in the case and several different angles from which to approach the case. This teaching note identifies several of these key points and makes suggestions for potential class discussions.

The cell phone industry was chosen as a companion case to Chapter 11 - Competitive Strategy because it contains so many of the features relevant to modern competition.

These features include especially frequent new product introduction, technological advance, oligopolistic gaming, new market entry, and the maturing of an industry in which leading players find themselves increasingly out of options for new sources of advantage. As described above, these features confront students with numerous opportunities to analyze different aspects of competition, and to strive for the difficult goal of determining how the major players will continue to perform as they do battle with rivals.

The cell phone industry was selected to illustrate competitive strategy because it presents a very good example of non-static competition. As such, using game theory to analyze the case would only be useful around local skirmishes of price and feature matching, but this would miss the larger story. Likewise, disruption from the low-end is not a particularly useful framework for this industry. The larger story of the industry is that companies compete over time in long skeins of moves and counter moves driven by innovation and speed of product introduction. These are the competitive strengths that are crucial to effective competitive strategy in “dynamic environments” as Chapter 11 describes. Industry players discover new features, come up with new capabilities, build these into their phones, and strive to gain temporary advantage repeatedly, with no clear endgame in view. The case is written with this view in mind— to describe the explicit back and forth of competition in the industry and the way this competition is repeatedly restructured by the entry of new players, such as Apple. This

Copyright ©2022 John Wiley & Sons, Inc.

makes for exciting and dynamic competition and hopefully exciting and dynamic class discussion.

Study Questions 1. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft?

[AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension] 3. What was Google’s unique positioning in contrast to Apple? Why was this effective? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 5 Synthesis] 4. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 4 Analysis] 5. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? Which companies appear to have advantages in developing these capabilities?

[AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions 1. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft? a. Leveraged position in an adjacent market. Apple leveraged the fact that they had been highly successful with their music playing iPod to enter the smartphone space by developing an operating system and placing cellular capabilities on the device b. Apple made a tradeoff by going after consumers instead of the business market. Apple’s iPhone immediately appealed to consumers who were already using the iPod c. Innovative product design d. All of the above Answer: “D” Copyright ©2022 John Wiley & Sons, Inc.

2. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google? a. Blackberry dominated market share, especially in the corporate market, and did not need to focus on insignificant competitors b. RIM was already focused on internal innovation tailored to the business professional c. Internal organizational obstacles may have limited RIM’s ability to perceive and act on the threat d. All of the above Answer: “C” 3. What was Google’s unique positioning in contrast to Apple? Why was this effective? a. Google built a superior product b. Google took an open source approach c. Google linked their products to their domination of websearch and analytics d. Google outsourced manufacturing Answer: “B” 4. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership? a. Apple should open iOS to other phone manufacturers b. Samsung should continue efforts to leapfrog Apple in hardware capabilities c. Google should integrate even more tightly with Samsung as the leading Android manufacturer d. All of the above Answer: “D” 5. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? a. Superior technological prowess b. A fully proprietary operating system with applications c. The need to build internal organizational processes that drive innovation and product introduction speed d. Branding

Copyright ©2022 John Wiley & Sons, Inc.

Answer: “C” 6. Which companies appear to have advantages in developing these capabilities? a. Apple b. Google c. Samsung d. Microsoft Answer: “A”

Teaching Plan I. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft?

II. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google?

III. What was Google’s unique positioning in contrast to Apple? Why was this effective?

IV. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership?

V. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? Which companies appear to have advantages in developing these capabilities?

VI. Key Takeaways

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Some instructors will want to begin by briefly tracing the history of the industry.

Perhaps the best way to do this is to ask a student to summarize how the industry moved from feature phones to smart phones and who the key players were at the outset. In this discussion, students may mention that companies like Nokia and Palm had resources early on that should have prepared them to be highly successful in the emerging smartphone market. Nokia held a dominant position in feature phones, and Palm held a dominant position in personal digital assistant devices which they later leveraged into a smart phone offering called the Treo. Early arrivals to the smart Copyright ©2022 John Wiley & Sons, Inc.

phone market included Nokia, Palm, Research in Motion (RIM), and Microsoft.

Following this brief period of dominance by these companies, Apple entered the market. The instructor may wish to now ask: I. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft?

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Leveraged position in an adjacent market. Apple leveraged the fact that they had been highly successful with their music playing iPod to enter the smartphone space by developing an operating system and placing cellular capabilities on the device. So many consumers already had purchased the iPod that Apple had a ready market of loyal customers who would like to see an iPod with cell phone capabilities. If the company hadn’t had the success with the iPod, Apple may not be a smartphone player today. It’s worth pointing out that Apple effectively did the same thing as the early players Nokia and Palm, by leveraging its own unique resources and market position to enter the smart phone market

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Apple made a tradeoff by going after consumers instead of the business market.

Apple’s iPhone immediately appealed to consumers who were already using the iPod rather than to business customers who needed a solution for secure corporate email (as RIM had appealed to with the Blackberry product). This move opened up a new market that the established players largely did not serve. The effect of this was to send corporate IT staff scrambling. Consumers were suddenly carrying their iPhones into work asking for access to corporate email which launched many security concerns.

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Innovative product design. Apple also brought innovative product design to the smartphone market. Apple’s iPhone looked more like an iPod than the cell phones of Nokia or RIM.

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Available applications. An extensive set of applications was immediately available for customers to download and use as part of their daily lives.

II. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google?

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Apple did not initially compete with or threaten RIM. Since Apple went after the consumer market, and RIM largely served the corporate market with a secure

Copyright ©2022 John Wiley & Sons, Inc.

email solution, it is unlikely that RIM considered Apple (or Google Android) an immediate threat.

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RIM had developed the Blackberry but didn’t seem to possess strong innovative capabilities in product design, or operating systems. To respond effectively, to the threat, RIM might have released products that contained many features of the Apple iPhone much earlier than they did.

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Internal organizational obstacles may have limited RIM’s ability to perceive and act on the threat.

III. What was Google’s unique positioning in contrast to Apple? Why was this effective?

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Google took an open source approach with its Android operating system, making the OS available to any hardware manufacturer who wished to use it. In contrast to Apple, whose system was proprietary, this insured that ultimately, Google could have access to a much wider market by leveraging the reach of third-party hardware manufacturers.

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The approach relieved hardware manufacturers from the difficulty of developing their own OS and instead to concentrate on pure hardware manufacturing while using the clout of Google.

IV. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership?

Answers to this question can potentially occupy much of the time allotted for case discussion. Students are likely to have a wide range of opinions on what should be done. The instructor can channel this energy by pressing students to consider what strategic principles they are employing in their recommendations (Question 5 below).

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Apple o Go after business market o Expand internationally with cheaper version of iPhone o Continue to release upgraded products on an annual basis o Open iOS to other phone manufacturers? o Note: Apple is in a precarious position. Apple has to figure out what to do to keep the franchise going. Is it just about continuing to release better and better phones? What if Samsung trumps them on technology, which some

Copyright ©2022 John Wiley & Sons, Inc.

people say they have? Apple is not a manufacturer, Samsung is. Samsung can innovate in process technology and can advance those product innovation capabilities at a much faster rate than Apple can. Apple has to rely upon HTC as their manufacturer and whatever process innovation is coming out of HTC is what Apple winds up with, so they’ve outsourced manufacturing innovation and this is a precarious position, especially now that HTC is launching their own phones to the consumer market •

Samsung o Continue efforts to leapfrog Apple in hardware capabilities o Develop cheaper phones for international markets, such as India and Africa

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Google o Ensure that additional releases of Android exceed iOS capabilities o Integrate perhaps even more tightly with Samsung as the leading Android manufacturer

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Microsoft o Continue to pursue business customers, striving to get Surface tablets and other Microsoft ecosystem software into wide use and hoping this will drive adoption of Windows phone

Special Note: War Gaming As a twist on case discussion, the instructor may wish to set up and run a “war game” in order to get students thinking specifically about the next competitive moves each company might make. Set the game up as follows: •

Divide the class into teams for Apple, Samsung, Google, and Microsoft.

Depending on the number of students, the instructor may wish to designate multiple teams for individual companies. The point is to make teams small enough that the students are able to participate actively in discussion. The instructor may wish to combine Samsung and Google around the Android platform, or add RIM to the mix.

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Ask each team to determine for their company what the next major strategic move is. Give each team approximately 10 to 15 minutes to determine this. (Ask them to utilize principles of competitive strategy to make this determination, taking into account the moves that are likely to be made by the other companies.)

Copyright ©2022 John Wiley & Sons, Inc.

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Ask each team to explain their strategic move. (To save time, prior to asking for this announcement, if multiple teams exist for each company, you may want to ask teams to reconcile their move with other same company teams in the room.) Be sure to have teams explain the reasoning behind their moves. Write these moves down on the board so that the class can seem them.

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Ask for feedback on the different moves that are now up on the board. Ask students for feedback about which moves the think are strong and why.

Continue this discussion for approximately 10-15 minutes.

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To determine which company wins the round, ask for a vote from the class for which move they think is the best. You may wish to instruct students not to vote for their own move and also to require them to vote once and only once.

Score the round.

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For round two repeat these steps from No. 2 above. Tell the students to assume that each company made the moves that are on the board and that now you’re asking for the “next move” that follows. War games usually stop after two or three rounds.

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Summarize the war game experience by asking students what they learned from the process about competitive strategy and who is likely to win in this market. Often times a clear winner will begin to emerge and this will give students confidence that the reasoning process that they went through is useful in predicting actual competitive behavior.

V. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? Which companies appear to have advantages in developing these capabilities?

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This discussion is intended to draw out principles that have been discussed during the case. Students may find many of these principles in the reading for Chapter 11.

For example, the following principles can be seen in the case: o Know your strengths and weaknesses o Bring strength against weakness o Protect and neutralize vulnerabilities o Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

Copyright ©2022 John Wiley & Sons, Inc.

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Other principles include those that are suitable for competitive environments, such as the need to build internal organizational processes that drive innovation and product introduction speed. The way that these capabilities are developed is through repeated practice and relentless focus on bringing products to market.

Organizations must have good sensing mechanisms that allow them to scan the environment and rapidly incorporate new developments into their products.

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Apple, in particular, appears to have these types of capabilities at their disposal.

Long years of practice at innovation have resulted in leading capabilities in product design. The company also seems quite able to maintain the annual cadence of new product release for the iPhone. Nevertheless, whether these capabilities will be sufficient going forward for Apple to maintain its lead in the midst of changing market dynamics is still unclear.

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Google is known as an innovative company, but hardware innovation is not something they are concerned with. Instead, Google is only required to continue updating the Android operating system. This appears to be a small task for companies such as Google with market leading innovation capabilities.

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Samsung has been very adept at product development and new product release.

However, it is less clear whether innovation or imitation lie at the root of its capabilities. In either event, Samsung has strong capabilities in bringing products to market in timely fashion.

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Microsoft is solid in product innovation around software operating systems but it is less clear whether they have the focus and ability to garner leadership in this market. The Windows phone is having difficulty gaining traction although a growing portion of business customers are finding it appealing.

VI. Key Takeaways A number of important themes should emerge from the case as it pertains to competitive strategy. Some of these are found below. Companies in dynamic markets must develop or possess strengths in product innovation and speed to market.

As Chapter 11 points out, these are the key capabilities required for any company expecting to compete in rapidly changing, dynamic markets. Some of the old smart phone regime players, such as Nokia and Palm, did not appear to have these

Copyright ©2022 John Wiley & Sons, Inc.

capabilities, while new players, such as Apple, obviously did. Arguably, RIM failed on this very notion—the inability to innovate and rapidly release new products as Apple came in with their prodigious capabilities in this area.

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Companies should leverage their strengths for competitive position

The history of the industry clearly shows that firms identified a market opportunity in smartphones and then leveraged crucial resources and capabilities in order to enter that market. This was true from the early days of the industry and continued with Samsung, Google, and Apple. This makes the question of whether a new entrant will come into this market somewhat unpredictable. There may be a set of capabilities possessed by a company somewhere in the world that can be leveraged into this space. As it relates to competitive strategy, the notion of leveraging resources for new market entry is a well-known idea.

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Companies must make tradeoffs as they enter markets, choosing to invest in key areas that are differentiated from the status quo

Rivals in this industry and had to grapple with a number of key trade-offs as they enter and compete in the market. Choosing which side of a trade-off to pursue is a key competitive decision since it relates to whether it a rival will be matching or differentiating itself with respect to others. o Tradeoffs between consumer and business (Apple vs. Microsoft, RIM) When Apple entered the market they chose to pursue the consumer. This was revolutionary. Up until that time all of the rivals had instead pursued business customers. Arguably, this was the single most important factor in the rise of Apple in smartphones. o Tradeoffs between proprietary and open (Apple vs. Google Android) - Here as well, Apple made a key choice to launch a proprietary, closed system.

Google took the opposite approach of launching an open system that many hardware manufacturers could utilize. This has given Android a much broader distribution, touching many more customers, and has made Samsung the top smartphone manufacturer in the world. o Tradeoffs between button and touch screen (Apple/Google vs. RIM) - Apple took a risk when it launched a touch screen interface. At the time, there was a belief in the industry that email could not be done except with a buttonbased device. This was the approach that RIM used. By rejecting this notion, Apple sharply differentiated itself. By making the touch screen “good

Copyright ©2022 John Wiley & Sons, Inc.

enough” many came to adopt it and it is now the standard preference even among business customers.

In the selection of different sides of these trade-offs, the companies also demonstrate the competitive strategy of bringing strength against weakness. Google clearly did this when it launched an open system against Apple’s proprietary approach.

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Most companies must eventually grapple with the issue of industry maturity and the slowing of technological advances

It is arguable in the case that technological advances are slowing and this is creating the conditions for even more intense competition. The question of how companies grapple with competitive strategy in this type of environment is a strong consideration in the case. While the answers do not emerge from the case directly, they should emerge in class discussion wherein students identify some of the difficulties that they are having determining exactly what each company should do. Most students will assume that the companies should just continue releasing upgraded products, but over the long run this is unlikely to be sufficient. New, structural changes in the industry may be warranted such as new alliances among industry players, new entrants, or new acquisitions. Further, new technology that is fundamentally different could emerge that would take over the smart phone market. This could be wearable technology or other approaches that are different from the standard device-based approach. Even now, smart watches are beginning to change the landscape in this particular way.

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If a company can bring competitive capabilities from an adjacent market it has a very strong opportunity to make serious inroads in its new target market.

One of the most interesting dynamics of the case is how the industry moved from a Nokia, Palm, RIM, and Microsoft-dominated world to an Apple, Samsung, Googledominated world. This happened very rapidly and by all rights some of the earlier companies should have had staying power. The key mechanism that seems to lie at the root of this transition is the fact that Apple had already obtained such a large base of customers in an adjacent market. It was the leveraging of this customer base who would clamor for an “iPod with cellular capabilities” that made Apple’s initial launch so popular. Recall that analysts thought the iPhone would be a disaster; it simply did not look like the standard phones that were then in the market and being used by business customers. By going after this new niche, Apple paved the way for Google

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and Samsung as well to capitalize on the growth in consumer demand for smartphones.

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Teaching Note

Smartphone Wars in 2021 Teaching Objectives The purpose of this case is to immerse students in the competitive dynamics of an industry with which they should be well familiar: Cell phones. The case is complex because it traces the history of the industry and the dynamics among the leading players through the years from industry inception. Instructors and students will find much to discuss in the case and several different angles from which to approach the case. This teaching note identifies several of these key points and makes suggestions for potential class discussions.

The cell phone industry was chosen as a companion case to Chapter 11, Competitive Strategy, because it contains so many of the features relevant to modern competition.

These features include especially frequent new product introduction, technological advance, oligopolistic gaming, new market entry, and the maturing of an industry in which leading players find themselves increasingly out of options for new sources of advantage. As described above, these features confront students with numerous opportunities to analyze different aspects of competition, and to strive for the difficult goal of determining how the major players will continue to perform as they do battle with rivals.

The cell phone industry was selected to illustrate competitive strategy because it presents a very good example of non-static competition. As such, using game theory to analyze the case would only be useful around local skirmishes of price and feature matching, but this would miss the larger story. Likewise, disruption from the low-end is not a particularly useful framework for this industry. The larger story of the industry is that companies compete over time in long skeins of moves and counter moves driven by innovation and speed of product introduction. These are the competitive strengths that are crucial to effective competitive strategy in “dynamic environments” as Chapter 11 describes. Industry players discover new features, come up with new capabilities, build these into their phones, and strive to gain temporary advantage repeatedly, with no clear endgame in view. The case is written with this view in mind, to describe the explicit back and forth of competition in the industry and the way this competition is repeatedly restructured by the entry of new players, such as Apple. This makes for exciting and dynamic competition and hopefully exciting and dynamic class discussion.

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The 2021 update provides students with the opportunity to revisit the industry. The industry has matured since 2013, new competitors have entered the market and the basis of competition has changed from individual companies and product features to the creation of competitive ecosystems that rely on partners, acquisitions, or government support as important elements of competition. The teaching plan for the 2021 update appears at the end of this note.

Preparation Questions 1. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft?

[AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension] 3. What was Google’s unique positioning in contrast to Apple? Why was this effective? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 5 Synthesis] 4. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 4 Analysis] 5. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? Which companies appear to have advantages in developing these capabilities?

[AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions 1. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft? a. Leveraged position in an adjacent market. Apple leveraged the fact that they had been highly successful with their music playing iPod to enter the smartphone space by developing an operating system and placing cellular capabilities on the device

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b. Apple made a tradeoff by going after consumers instead of the business market. Apple’s iPhone immediately appealed to consumers who were already using the iPod c. Innovative product design d. All of the above Answer: d 2. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google? a. Blackberry dominated market share, especially in the corporate market, and did not need to focus on insignificant competitors b. RIM was already focused on internal innovation tailored to the business professional c. Internal organizational obstacles may have limited RIM’s ability to perceive and act on the threat d. All of the above Answer: c 3. What was Google’s unique positioning in contrast to Apple? Why was this effective? a. Google built a superior product b. Google took an open-source approach c. Google linked their products to their domination of websearch and analytics d. Google outsourced manufacturing Answer: b 4. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership? a. Apple should open iOS to other phone manufacturers b. Samsung should continue efforts to leapfrog Apple in hardware capabilities c. Google should integrate even more tightly with Samsung as the leading Android manufacturer d. All of the above Answer: d

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5. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? a. Superior technological prowess b. A fully proprietary operating system with applications c. The need to build internal organizational processes that drive innovation and product introduction speed d. Branding Answer: c 6. Which companies appear to have advantages in developing these capabilities? a. Apple b. Google c. Samsung d. Microsoft Answer: a

Teaching Plan: Smartphone Wars in 2013 I. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft?

II. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google?

III. What was Google’s unique positioning in contrast to Apple? Why was this effective?

IV. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership?

V. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? Which companies appear to have advantages in developing these capabilities?

VI. Key Takeaways

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5-15 min

5-15 min

5-15 min 5-15 min 5-15 min

5-15 min

Some instructors will want to begin by briefly tracing the history of the industry.

Perhaps the best way to do this is to ask a student to summarize how the industry moved from feature phones to smart phones and who the key players were at the outset. In this discussion, students may mention that companies like Nokia and Palm had resources early on that should have prepared them to be highly successful in the emerging smartphone market. Nokia held a dominant position in feature phones, and Palm held a dominant position in personal digital assistant devices which they later leveraged into a smart phone offering called the Treo. Early arrivals to the smart phone market included Nokia, Palm, Research in Motion (RIM), and Microsoft.

Following this brief period of dominance by these companies, Apple entered the market. The instructor may wish to now ask: I. How was Apple able to make rapid and significant inroads into a market that had been largely owned by Research in Motion (RIM), Nokia, and Microsoft?

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Leveraged position in an adjacent market. Apple leveraged the fact that they had been highly successful with their music playing iPod to enter the smartphone space by developing an operating system and placing cellular capabilities on the device. So many consumers already had purchased the iPod that Apple had a ready market of loyal customers who would like to see an iPod with cell phone capabilities. If the company had not had the success with the iPod, Apple may not be a smartphone player today. It is worth pointing out that Apple effectively did the same thing as the early players Nokia and Palm, by leveraging its own unique resources and market position to enter the smart phone market.

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Apple made a tradeoff by going after consumers instead of the business market.

Apple’s iPhone immediately appealed to consumers who were already using the iPod rather than to business customers who needed a solution for secure corporate email (as RIM had appealed to with the Blackberry product). This move opened up a new market that the established players largely did not serve. The effect of this was to send corporate IT staff scrambling. Consumers were suddenly carrying their iPhones into work asking for access to corporate email, which launched many security concerns.

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Innovative product design. Apple also brought innovative product design to the smartphone market. Apple’s iPhone looked more like an iPod than the cell phones of Nokia or RIM.

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Available applications. An extensive set of applications was immediately available for customers to download and use as part of their daily lives.

II. What are some possible explanations for why RIM (Blackberry) did not respond effectively to Apple and Google?

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Apple did not initially compete with or threaten RIM. Since Apple went after the consumer market, and RIM largely served the corporate market with a secure email solution, it is unlikely that RIM considered Apple (or Google Android) an immediate threat.

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RIM had developed the Blackberry but did not seem to possess strong innovative capabilities in product design, or operating systems. To respond effectively to the threat, RIM might have released products that contained many features of the Apple iPhone much earlier than they did.

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Internal organizational obstacles may have limited RIM’s ability to perceive and act on the threat.

III. What was Google’s unique positioning in contrast to Apple? Why was this effective?

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Google took an open-source approach with its Android operating system, making the OS available to any hardware manufacturer who wished to use it. In contrast to Apple, whose system was proprietary, this insured that ultimately Google could have access to a much wider market by leveraging the reach of third-party hardware manufacturers.

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The approach relieved hardware manufacturers from the difficulty of developing their own OS and instead to concentrate on pure hardware manufacturing while using the clout of Google.

IV. What should Apple, Samsung, Google, and Microsoft do to maintain or regain leadership?

Answers to this question can potentially occupy much of the time allotted for case discussion. Students are likely to have a wide range of opinions on what should be done. The instructor can channel this energy by pressing students to consider what strategic principles they are employing in their recommendations (Question V below).

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Apple o Go after business market o Expand internationally with cheaper version of iPhone o Continue to release upgraded products on an annual basis o Open iOS to other phone manufacturers? o Note: Apple is in a precarious position. Apple has to figure out what to do to keep the franchise going. Is it just about continuing to release better and better phones? What if Samsung trumps them on technology, which some people say they have? Apple is not a manufacturer, Samsung is. Samsung can innovate in process technology and can advance those product innovation capabilities at a much faster rate than Apple can. Apple has to rely upon HTC as their manufacturer and whatever process innovation is coming out of HTC is what Apple winds up with, so they have outsourced manufacturing innovation. This is a precarious position, especially now that HTC is launching their own phones to the consumer market

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Samsung o Continue efforts to leapfrog Apple in hardware capabilities o Develop cheaper phones for international markets, such as India and Africa

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Google o Ensure that additional releases of Android exceed iOS capabilities o Integrate perhaps even more tightly with Samsung as the leading Android manufacturer

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Microsoft o Continue to pursue business customers, striving to get Surface tablets and other Microsoft ecosystem software into wide use and hoping this will drive adoption of Windows phone

Special Note: War Gaming As a twist on case discussion, the instructor may wish to set up and run a war game in order to get students thinking specifically about the next competitive moves each company might make. Set the game up as follows: 1. Divide the class into teams for Apple, Samsung, Google, and Microsoft.

Depending on the number of students, the instructor may wish to designate multiple teams for individual companies. The point is to make teams small enough that the students are able to participate actively in discussion. The

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instructor may wish to combine Samsung and Google around the Android platform or add RIM to the mix.

2. Ask each team to determine for their company what the next major strategic move is. Give each team approximately 10 to 15 minutes to determine this. (Ask them to utilize principles of competitive strategy to make this determination, taking into account the moves that are likely to be made by the other companies.)

3. Ask each team to explain their strategic move. (To save time, prior to asking for this announcement, if multiple teams exist for each company, you may want to ask teams to reconcile their move with other same company teams in the room.) Be sure to have teams explain the reasoning behind their moves. Write these moves down on the board so that the class can seem them.

4. Ask for feedback on the different moves that are now up on the board. Ask students for feedback about which moves the think are strong and why.

Continue this discussion for approximately 10-15 minutes.

5. To determine which company wins the round, ask for a vote from the class for which move they think is the best. You may wish to instruct students not to vote for their own move and also to require them to vote once and only once.

Score the round.

6. For round two repeat these steps from No. 2 above. Tell the students to assume that each company made the moves that are on the board and that now you are asking for the next move that follows. War games usually stop after two or three rounds.

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Summarize the war game experience by asking students what they learned from the process about competitive strategy and who is likely to win in this market. Often times a clear winner will begin to emerge and this will give students confidence that the reasoning process that they went through is useful in predicting actual competitive behavior.

V. What principles of competitive strategy are the most useful for competing in this industry? How are these capabilities developed and maintained? Which companies appear to have advantages in developing these capabilities?

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This discussion is intended to draw out principles that have been discussed during the case. Students may find many of these principles in the reading for Chapter 11.

For example, the following principles can be seen in the case: o Know your strengths and weaknesses o Bring strength against weakness o Protect and neutralize vulnerabilities o Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

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Other principles include those that are suitable for competitive environments, such as the need to build internal organizational processes that drive innovation and product introduction speed. The way that these capabilities are developed is through repeated practice and relentless focus on bringing products to market.

Organizations must have good sensing mechanisms that allow them to scan the environment and rapidly incorporate new developments into their products.

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Apple, in particular, appears to have these types of capabilities at their disposal.

Long years of practice at innovation have resulted in leading capabilities in product design. The company also seems quite able to maintain the annual cadence of new product release for the iPhone. Nevertheless, whether these capabilities will be sufficient going forward for Apple to maintain its lead in the midst of changing market dynamics is still unclear.

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Google is known as an innovative company, but hardware innovation is not something they are concerned with. Instead, Google is only required to continue updating the Android operating system. This appears to be a small task for companies such as Google with market leading innovation capabilities.

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Samsung has been very adept at product development and new product release.

However, it is less clear whether innovation or imitation lie at the root of its capabilities. In either event, Samsung has strong capabilities in bringing products to market in timely fashion.

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Microsoft is solid in product innovation around software operating systems, but it is less clear whether they have the focus and ability to garner leadership in this market. The Windows phone is having difficulty gaining traction although a growing portion of business customers are finding it appealing.

VI. Key Takeaways

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A number of important themes should emerge from the case as it pertains to competitive strategy. Some of these are found below. Companies in dynamic markets must develop or possess strengths in product innovation and speed to market.

As Chapter 11 points out, these are the key capabilities required for any company expecting to compete in rapidly changing, dynamic markets. Some of the old smart phone regime players, such as Nokia and Palm, did not appear to have these capabilities, while new players, such as Apple, obviously did. Arguably, RIM failed on this very notion. The inability to innovate and rapidly release new products as Apple came in with their prodigious capabilities in this area.

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Companies should leverage their strengths for competitive position

The history of the industry clearly shows that firms identified a market opportunity in smartphones and then leveraged crucial resources and capabilities in order to enter that market. This was true from the early days of the industry and continued with Samsung, Google, and Apple. This makes the question of whether a new entrant will come into this market somewhat unpredictable. There may be a set of capabilities possessed by a company somewhere in the world that can be leveraged into this space. As it relates to competitive strategy, the notion of leveraging resources for new market entry is a well-known idea.

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Companies must make tradeoffs as they enter markets, choosing to invest in key areas that are differentiated from the status quo

Rivals in this industry and had to grapple with a number of key tradeoffs as they enter and compete in the market. Choosing which side of a tradeoff to pursue is a key competitive decision since it relates to whether it a rival will be matching or differentiating itself with respect to others. o Tradeoffs between consumer and business (Apple vs. Microsoft, RIM) When Apple entered the market, they chose to pursue the consumer. This was revolutionary. Up until that time, all of the rivals had instead pursued business customers. Arguably, this was the single most important factor in the rise of Apple in smartphones. o Tradeoffs between proprietary and open (Apple vs. Google Android) - Here as well, Apple made a key choice to launch a proprietary, closed system.

Google took the opposite approach of launching an open system that many hardware manufacturers could utilize. This has given Android a much

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broader distribution, touching many more customers, and has made Samsung the top smartphone manufacturer in the world. o Tradeoffs between button and touch screen (Apple/Google vs. RIM) - Apple took a risk when it launched a touch screen interface. At the time, there was a belief in the industry that email could not be done except with a buttonbased device. This was the approach that RIM used. By rejecting this notion, Apple sharply differentiated itself. By making the touch screen “good enough” many came to adopt it, and it is now the standard preference.

In the selection of different sides of these tradeoffs, the companies also demonstrate the competitive strategy of bringing strength against weakness. Google clearly did this when it launched an open system against Apple’s proprietary approach.

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Most companies must eventually grapple with the issue of industry maturity and the slowing of technological advances

It is arguable in the case that technological advances are slowing, and this is creating the conditions for even more intense competition. The question of how companies grapple with competitive strategy in this type of environment is a strong consideration in the case. While the answers do not emerge from the case directly, they should emerge in class discussion as students identify some of the difficulties that they are having determining exactly what each company should do. Most students will assume that the companies should just continue releasing upgraded products, but over the long run this is unlikely to be sufficient. New, structural changes in the industry may be warranted such as new alliances among industry players, new entrants, or new acquisitions. Further, new technology that is fundamentally different could emerge that would take over the smart phone market. This could be wearable technology or other approaches that are different from the standard device-based approach. Even now, smart watches are changing the landscape in this particular way.

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If a company can bring competitive capabilities from an adjacent market, it has a very strong opportunity to make serious inroads in its new target market.

One of the most interesting dynamics of the case is how the industry moved from a Nokia, Palm, RIM, and Microsoft-dominated world to an Apple, Samsung, Googledominated world. This happened very rapidly and by all rights some of the earlier companies should have had staying power. The key mechanism that seems to lie at the root of this transition is the fact that Apple had already obtained such a large base of customers in an adjacent market. It was the leveraging of this customer base who

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would clamor for an “iPod with cellular capabilities” that made Apple’s initial launch so popular. Recall that analysts thought the iPhone would be a disaster; it simply did not look like the standard phones that were then in the market and being used by business customers. By going after this new niche, Apple paved the way for Google and Samsung as well to capitalize on the growth in consumer demand for smartphones.

Teaching Plan: Smartphone Wars in 2021 The 2021 case presents instructors with a number of options for teaching the case: As a stand-alone 80-minute class discussion, as a group project for in-class or graded presentation, or as an examination case. Teaching the case presents two decisions that instructors must make in how and where the case is used. First, the 2021 case, at half the length of the 2013 case, provides adequate data on the major evolving competitors; however, it lacks the richness and historical perspective that the 2013 case establishes. The case 2021 case may be used as a “B” case, a 20 minute add on to the 2013 case.

Second, the instructor needs to decide how using an 80-minute teaching block that continues to focus on competitive strategy fits into the course. The 2021 case incorporates issues of business unit strategy (unique resources) and elements of corporate-level strategy (M&A, Alliances, and Vertical Integration), and so the 2021 case may be positioned as a summary case for strategy development.

Third, the case follows naturally from the 2013 case, and the instructor must decide whether to “change things up” in discussing the second case. As we have used this type of cases, there is much to be gained by changing the teaching paradigm in this case. We will describe this below.

I.

A 20-Minute “B” Case.

If the instructor uses the case as a short update and extension to the longer original case, the discussion should focus around two core questions: 1. How has competition in the industry “matured?” Two answers should come out here. First, competition no longer turns on features; gaining market share is likely to come through price reduction rather than improved feature sets.

Second, the basis of competition now extends beyond the boundaries of the firm. Apple depends on partners to help it penetrate the corporate market, and

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it is an active acquirer of new technologies in “adjacent” markets. Samsung creates partnerships to grow, and Huawei has a relationship with the Chinese government. The nature of this relationship is unclear, but all three of these competitors depend on parties beyond themselves to succeed in the market.

2. What does it mean to create a long-term position in the industry? Competitive positions appear to solidify as we move from 2013 to 2020, and the relevant challenge for company executives is to be intentional, rather than accidental, about a long-term position. Google is a nice example of a company whose position is largely accidental. They tried a number of ways to enter the handset market, but none of these were pursued with enough consistency to attain a solid position.

Since this is a short discussion, I will conclude by asking “If you were CEO of X company (choose one of the five discussed in the case), how comfortable are you with your position in the industry? What would you change? Why? How?” This allows students to evaluate the strength of the strategic positions in the industry and create plans to strengthen their positions.

II.

The exam

Some instructors will be concerned that students have access to an exam case before the exam, but we find that, as long as the case is not used every semester as an exam, students will pay scant attention to the case before the exam period opens.

We would suggest a number of potential questions, each centered around a particular competitor (and the instruction can run at least four different versions of the exam—Apple, Samsung, Google, Huawei): 1. How is X performing in each of the following areas? o o o o

Know your strengths and weaknesses Bring strength against weakness Protect and neutralize vulnerabilities Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

Provide examples of where X is doing well, and where X could improve?

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2. How has competition in the industry matured? How has competition changed?

3. If you are the CEO of X, how comfortable are you with your company’s position in the industry? What would you change? Why? How? III.

An 80-Minute session

Given that we have just held a large-group, class-wide discussion, we would use the 2021 case as an opportunity for individual study teams to do a deep dive on one of the competitors. This may result in a class presentation by some or all of the groups (which would extend over multiple days), or this may become a graded group assignment. This note is based on the preparation of a 15-20-minute in-class presentation to be given by 3-4 groups, one for each major competitor.

Each group will be assigned a particular company, and their task will be to 1. Describe the main competitive moves made by their company between 2013 and 2021. I will be looking for research that goes beyond the narrative in the case and brings in other source material for a richer description of the moves by various competitors in the industry.

2. What is the company’s current “strategic position?” Are they following a strategy of cost leadership? Differentiation? Innovation? How does corporate strategy help the company sustain its position? (M&A, Alliances, Vertical Integration, Outsourcing)?

3. “If you were CEO of X company (choose one of the five discussed in the case), how comfortable are you with your position in the industry? What would you change? Why? How?” In an 80-minute course, we will have 4 15-minute presentations (1 on Apple, Samsung, Google, and Huawei), followed by Q&A from others in the class. We will usually have about 10 minutes at the end for some summary.

Conclusion We will conclude by noting the following takeaways: 1. As an industry matures, the basis of competition changes from features and rapid introductions to, generally, competition based on cost. Apple must

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constantly grapple with pricing issues and seems to be following the lead of Samsung and others in creating lower-price models.

2. As an industry matures and competitive positions harden, the basis of competition shifts from business unit strategy (cost leadership and differentiation) to corporate strategy (M&A, alliances). As competition matures, executives and their organizations must learn and master new skills in order to continue to compete.

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Teaching Note

Lincoln Electric: Aligning for Global Growth

Teaching Objectives This case should provide students with an opportunity to examine the alignment between strategy and operating policies that drives a very successful company, to uncover how tight alignment becomes a strategic disadvantage for a company when the operating environment changes, and how to evaluate the steps Don Hastings took to return Lincoln to profitability.

By the end of the case, students should be able to identify and explain the elements of successful alignment between Lincoln’s strategy and its organization, describe the rational for globalization and the challenges of moving a unique business model across borders, and evaluate the actions of Don Hastings in helping Lincoln navigate its way in a global marketplace.

Study Questions 1. How successful is Lincoln Electric? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Why has the company been so successful over the years? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 3. Where did Lincoln make mistakes in its effort to become a global producer?

Has the company learned from its mistakes? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] 4. What challenges do you see for Lincoln moving forward? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 3 Application] Multiple Choice Questions 1. How successful is Lincoln Electric? a. Very, they are the market leader in arc welding since the 1920s. By 2013, the company was the recognized leader in the global market

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b. Very, they have a history of innovation and product development, including releasing over 100 new products at the height of the Great Recession in 2009 c. Not very much, Lincoln gave away their technology during WWII to their leading competitors, Westinghouse and GE d. Both A and B “Answer”: D

2. Why has the company been so successful over the years? a. Piece rate b. Bonuses c. Guaranteed employment d. All of the above “Answer”: D

3. Where did Lincoln make mistakes in its effort to become a global producer? a. Promote from within policy b. Focusing on domestic production c. Relying on a single individual to manage global diversification d. Being a victim of their own success “Answer”: C 4. Has the company learned from its mistakes? a. No, they are still a dismal failure in global diversification b. No, they have not managed to pay off debt incurred from their initial globalization attempt c. Yes, CEO Don Hastings brought in talent with international experience who could guide globalization efforts d. Yes, CEO Don Hastings resigned and his replacement was able to rectify his mistakes “Answer”: C 5. What challenges do you see for Lincoln moving forward? a. Paying off the debt incurred by attempting to go international b. Going international without changing some key assumptions c. Convincing employees to relocate abroad to train replacements

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d. Diversifying into new lines of business “Answer”: B

Teaching Plan I. How successful is Lincoln?

II. Why is Lincoln so successful?

III. Lincoln’s Global Failure IV. Conclusion

10 min 30-40 min 20-25 min 10 min

The instructor can safely follow the preparation questions as an overall teaching plan.

NOTE: Depending on the relative emphasis the instructor places on different elements of the case, this discussion can easily occupy two sessions. If the instructor chooses the two-session approach, the first day considers the questions of how and why Lincoln has been so successful, while the second day focuses on globalization.

I. How successful is Lincoln Question: How successful is Lincoln and what evidence do we have of their success?

Students will begin to list the accomplishments of the company including: • • •

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Market leader in arc welding since the 1920s. By 2013 the company was the recognized leader in the global market.

A history of innovation and product development, including releasing over 100 new products at the height of the Great Recession in 2009.

Satisfied employees and very low turnover. The instructor can point out that the cost of turning over employees runs about 3X their annual salary. Thus, if Lincoln’s workers average about $82,000 per year (in 2013), then the cost of turnover would be $240,000. If Lincoln’s annual turnover is ¼ to 1/5 of the industry average, that means Lincoln’s costs of labor are that much lower than their competition.

Lincoln gave away their technology during WWII to their leading competitors, Westinghouse and GE. Both companies would later exit the market as they were unable to keep pace with Lincoln.

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While each of these is a valid measure, the instructor can point to Lincoln’s Return on Equity, found in Exhibit 1.

Question: How good are returns that hover around 18%, on average?

Most students will find this very impressive. The instructor may ask some students to search Yahoo Finance or some other site to look at ROEs for comparable manufacturing companies. For 2013, for example, Lincoln’s ROE approached 20% while GE’s ROE barely missed 12%. Lincoln ROE beat one of the world’s premiere companies by 66%.

II. Why is Lincoln so successful?

This discussion is the heart of the case, in terms of understanding why Lincoln has been so successful over its almost 115-year history. To frame this discussion the instructor should explicitly call on the 7S model, described in the textbook chapter noted above. The case provides rich detail on the compensation system at Lincoln and students will naturally gravitate to this element as key to Lincoln’s success. The compensation system receives its own treatment, and so the instructor should forestall such a discussion by asking “what is Lincoln’s strategy?” The instructor should work through the 7S model, arriving at the compensation system (systems) last. The following points should come out: • Strategy: Increasingly higher quality at lower prices • Structure: Very flat. Lincoln has 1 manager per 100 employees • Staffing: Lincoln promotes from within and has very little turnover. This is related to the compensation system • Skills: Manufacturing, focused on welding. Ample evidence in the case of Lincoln’s prowess as an engineering company • Style: Egalitarian. The Employee Advisory Council provides workers and management the opportunity to interact with each other and solve problems jointly • Shared Values: Entrepreneurship, autonomy, flexibility, hard work, and money • Systems: The Lincoln Compensation system The instructor should ask students to describe the particular elements of the system.

The three key elements and their effects on Lincoln’s operations are: Piece Rate

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Piece Rates provide strong incentives to workers to be as productive as possible. Piece rates went out of style at the end of the 19th century because they were abused by both workers and managers. The instructor should ask “how has Lincoln solved the problems with piece rates?” The students should recognize that at Lincoln the piece rate only changes when the underlying production technology of the job changes.

That means that management can’t renege on its promised payouts. From the management side, the fact that workers stamp each piece, and have to rework mistakes and poor quality without getting paid helps ensure that workers focus on quality. The instructor may segue into the bonus by asking, “What keeps workers from producing as much as they can? How do they work together as a team?”

The Bonus The bonus system is the answer. First, students should understand that the bonus, on an average year, runs about 40% of a worker’s total compensation, on average ($34,000/$82,000 for 2012). That means that an average worker almost doubles his or her earnings through the bonus. The bonus keeps people from overproducing through two mechanisms. First, if I produce more than the next person in the assembly process, I begin to build up work in process inventory. That means I increase inventory and the related costs, which drive down profits. More importantly, however, I get rated on teamwork as one of the 5 determinants of the bonus. If I overproduce, my coworkers will rate me as less of a team player. Although the bonus averages 40% of total compensation, if I get rated highly, I get more bonus. If I get rated low, then I get less.

What this means is that Lincoln has internalized the decision about marginal productivity. As I sit at my workstation and consider making one more unit or going home, I can—in theory—tradeoff the potential loss in bonus (through inventory and a poor team rating) against the piece rate for additional production. Since the contribution of the bonus is almost equal to my piece rate earnings, I have a strong incentive to maximize the bonus.

Guaranteed Employment Students may not initially see the value of the guaranteed employment policy.

Consider my position as a manufacturing employee. What incentive do I have to innovate in my job, particularly if I discover ways to do my job so well that I innovate myself out of job? None, unless I am guaranteed that I won’t lose my job! From Lincoln’s position the guarantee has several advantages. First, turnover runs about 25% of the industry average, so I save money, time, and energy in not having to constantly search for new employees. Second, employees agree to work overtime when necessary without complaint, which allows the company substantial flexibility

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to handle upward production spikes. Third, by retaining workers the company has rich store of organizational and technical knowledge to draw on.

Finally, when the economy turns down (and Lincoln is very, very vulnerable to cyclical shocks), the company has substantial flexibility. If the average work week is 40 hours (in fact it’s about 45 at Lincoln) and management has the flexibility of reducing 10 hours per week/employee, then Lincoln can absorb a 25% (33% in practice) decline in sales before having without having to lay off any workers. Lincoln’s sales went down in 2009 by 30%, but the decline did not persist and the employment policy allowed it to absorb the lost business without laying off workers.

If the instructor has used a black/white board to organize this discussion, he or she may ask students to “connect the S’s.” How does Lincoln’s compensation system reinforce its strategy? It creates an incentive for continuous improvement in quality and efficiency. How does it support a flat structure? By pushing production decisions down to the individual level, the company doesn’t need a lot of mid-level managers.

This in turn contributes to the strategy of low cost. Similar questions can be used to make connections between all the elements of the 7S model. The instructor may sum up this section by asking one or two students to evaluate the 7S model at Lincoln. The typical response is that the company has created a system with tight alignment between the organization and its strategy.

Question: If Lincoln is so good, then why did they fail so miserably at globalization?”

III. Lincoln’s Global Failure Question: Was going global a bad strategy, or did Lincoln just execute it poorly?

Students should see that the basic notion of becoming a global competitor represented a sound strategic move. Lincoln was totally dependent on a single market and the company would benefit from diversifying its country-specific risk to macroeconomic fluctuations. It may have also been a good strategic move to enter the markets of its rivals, forcing them to allocate resources to protect their home turf.

What seems clear, however, is that Lincoln made several faulty assumptions and did not execute well.

Question: What assumptions did Lincoln have about globalization?

Three important assumptions should come out of this discussion: •

Globalization could be led by a single individual without accountability to the entire management team. This reveals a deeper assumption: that there are no

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•

•

substantive differences in doing business when one crosses borders. Lincoln’s managers and Board ceded the globalization process to Ted Willis. Willis made all decisions on a unilateral basis and there seemed to be little real accountability for how $325 Million had been invested.

Lincoln could not export its products and had to enter foreign markets by producing in those countries. Lincoln simply believed the conventional wisdom it heard from suppliers and industry insiders. Sensing a need for speed, Lincoln entered new markets Greenfield and through acquisition. The fastest, and cheapest, way to enter new markets is through export; however, Lincoln failed to market-test its assumption that customers would not buy products shipped from Cleveland. Hastings later found that this assumption was quite false as customers proved very willing to buy top-quality equipment even if it was made in the United States.

Workers and managers in other countries would adopt the Lincoln system.

Executives did not consider that legal barriers (Brazil) or cultural traditions (Germany) would stymie the transfer of the Lincoln productivity system around the globe. The previous discussion establishes the central role of the unique employment relationship at Lincoln as a key to its competitive advantage; without that system it is not at all clear why Lincoln would win in any foreign market. If the class has non-U. S. students, the instructor may ask “would the Lincoln system work in your home country?” Many students will indicate that it would work for a while, but people in many countries would have issues with various elements of the Lincoln system.

Question: What lies at the root of these failed assumptions?

The instructor may ask this question, or may simply point out that these assumptions all arise from the tight alignment of the Lincoln system. Lincoln’s executive team had no practical experience in global operations because all of them had risen through the ranks of the Cleveland facility. The “promote from within” policy crippled the company because it didn’t provide a source of new knowledge when the market, or the strategy, changed.

Similarly, Lincoln seems to be a victim of its own success. The company had been so successful for 90 years; there was a presumption that with hard work, and the adoption of their wonderful compensation system, any problems encountered would be easily solved. Lincoln’s managers acted with extreme hubris.

The instructor should then move the discussion forward and ask two to three students to evaluate Don Hastings response to the crisis. He took three significant actions. First, he went to the Cleveland employees, explained the problem and admitted that it was a management mistake, and asked the employees to bail out the company. He also

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made the tough decision to take on more debt to pay the employee bonus. The Cleveland employees responded to this call and exceeded their sales target by more than $1 million per day.

Question: What kind of trust does this exhibit between Lincoln’s managers and workers?

Is this common in industry?

Hastings moved to London to take personal control of the global operations. As the CEO he did not delegate this important crisis to someone else; he got out of his proverbial comfort zone and learned the true nature of the problem and worked through to a solution.

Hastings and the Board also brought in talent with international experience. They admitted that their lack of knowledge and their “promote from within” policy had created the problem. They could have solved it by divesting all the global operations and focused on succeeding in the United States. Hastings realized that globalization was an important strategy for Lincoln going forward and the company brought in outside talent to help make that happen. In fact, one of those outsiders became the next CEO. It appears that Lincoln learned from its mistakes. The instructor may conclude this discussion by asking about the performance of Massaro and Stropki. Data in the case is intentionally limited; however, students should see that Lincoln moved forward by going global in a more sensible, controlled, and logical way. The company also returned to its historic roots as an innovation leader and has maintained its global dominance by introducing new products and processes for the welding industry.

IV. Conclusion The instructor may conclude the session by asking 2-3 students to summarize their learning. These responses may be listed on the board. If the instructor wishes to make concluding comments, he or she may make the following points: • Creating alignment between the different elements of the organization, the strategy, and the operating environment can be a powerful source of competitive advantage. Lincoln has been the world leader in welding for almost a century.

• Creating alignment takes time. It took James Lincoln several decades to work out the complete Lincoln compensation system. Piece rates had pretty much always been in the system, but it took James twenty years (1933) to see the need for an additional bonus. It took another 25 (1958) years to formalize the guaranteed employment policy.

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•

Our strengths can be our weaknesses. Lincoln’s success and the tight alignment of the 7S’s lay at the core of its failed first globalization moves.

Hubris kills, or almost. Lincoln solved the problem, and the data in the case indicate they really did learn how to globalize more effectively.

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Teaching Notes

ICARUS Revisited: The Rise and Fall of Valeant Pharmaceuticals Teaching Objectives ICARUS Revisited: The Rise and Fall of Valeant Pharmaceuticals has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in conjunction with a module on corporate governance and ethics. The case provides students with opportunities to see how a company’s business strategy and executive compensation systems create a climate for ethical violations to occur. This note assumes the instructor is either using, or is familiar with Strategic Management by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in strategic analysis, and the case is designed to accompany Chapter 13.

Students should be able to examine the ethics of Valeant’s business strategy. There are 6 key ethical issues that the case highlights: 1) The existence of a culture of ethical violations in the early history of both ICN Pharmaceuticals and Biovail Corporation. 2) Valeant’s inversion to lower its tax rate. 3) Pricing decisions around prescription drugs, and what is the basis of a “fair price” 4) Fraudulent accounting and questionable business relationships with a distributor (Philidor). 5) The creation of a monopoly position in the contact lens production market, with the intent to price as a monopolist. 6) The structuring of executive compensation to reward and encourage growth.

Students should also explore the power of stakeholders (from activist investors to politicians) in creating/exposing problems at Valeant to bring about the destruction of 90% of the company’s value and think about changes to Valeant’s strategy, governance, and compensation systems that would improve both business and ethical performance.

By the end of this case students should be able to describe Valeant’s business strategy and governance procedures, identify the ethical issues that Valeant faced, explain how those ethical issues were linked to, and arose from, Valeant’s core business strategy and articulate and defend their judgment about the ethical issues in Valeant’s business strategy.

Study Questions 1. What were the important elements of Valeant’s business strategy, before and during the Michael Pearson era? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 1 Knowledge] 2. In what ways were Milan Panic and Michael Pearson similar? How did they differ?

[AACSB Analytic] [Difficulty: Medium] [Bloom’s 3 Application] Copyright ©2022 John Wiley & Sons, Inc.

3. Did Valeant’s practice of re-pricing drugs constitute a breach of ethics by the company? Come to class prepared to defend your position. [AACSB Ethics] [Difficulty: Medium] [Bloom’s 6 Evaluation] 4. How much did “tone at the top” matter in the problems Valeant faced with its stakeholders? [AACSB Ethics] [Difficulty: Easy] [Bloom’s 6 Evaluation] 5. What type of executive compensation plan would you recommend to the Board if you were an outside consultant? [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 5 Synthesis]

Multiple Choice Questions 1. What were the important elements of Valeant’s business strategy, before and during the Michael Pearson era? a. Before Pearson, Valeant focused on R&D b. Before Pearson, Valeant focused on M&A c. After Pearson, Valeant focused on R&D d. After Pearson, Valeant focused on diversification “Answer”: A 2. In what ways were Milan Panic and Michael Pearson similar? a. They both lacked ethical integrity b. They both took on a great deal of debt c. They both took on intelligent risk in order to drive growth d. They both focused on M&A “Answer”: A

3. How did they differ? a. Panic pushed the limits of professional behavior, while Pearson did not b. Panic promoted high standards of ethics, while Person did not c. Pearson’s pushing the limits attitude was manifest primarily in financial risk d. Pearson was accused of sexual harassment

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“Answer”: C 4. Did Valeant’s practice of re-pricing drugs constitute a breach of ethics by the company? a. No, because the market bears the price increases b. No, because the company had no internal ethics c. Yes, because people have a right to access health care including drugs d. Yes, because drug therapies are cheaper than other interventions “Answer”: B 5. How much did “tone at the top” matter in the problems Valeant faced with its stakeholders? a. Very much, Panic set a tone of trying to push R&D unsustainably b. Very much, Pearson pushed a tone of uncontrolled debt-fueled acquisition c. Very little, because shareholders drove the company’s strategy d. Very little, because the Board drove the company’s strategy “Answer”: B 6. What type of executive compensation plan would you recommend to the Board if you were an outside consultant? a. A compensation plan concomitant with growth b. A compensation plan concomitant with profit c. A compensation plan concomitant with the debt to equity ratio d. A compensation plan concomitant with ROI “Answer: C” Note: The other metrics would not have demonstrated Valeant’s weaknesses of debt growth and unethical pricing which drove growth, profit, and return.

Teaching Plan

I. Opening II. Valeant’s Business Strategy III. The Ethical Issues IV. The Fall Copyright ©2022 John Wiley & Sons, Inc.

5 min 15 min 30 min 10 min

I. Opening Introduce the case by asking a student to tell the story of the Icarus myth. Deadalus, Icarus’s father, had designed the famous Labyrinth of Crete for King Minos. After a falling out, Minos imprisoned Deadalus and Icarus in the Labyrinth. Deadalus realized their only chance to escape was through the air and he designed and build wings so that he and his son could escape. The wings were constructed of branches and feathers held together by wax. As Deadalus and Icarus took flight, Deadalus warned his son to avoid flying to close to the sun lest the wax melt and the wings disintegrate. Icarus, filled with youthful enthusiasm and the freedom of flight, flew too close to the sun. His wings melted and Icarus fell to his death.

Icarus provides a nice introduction to the case because, in many ways, Valeant behaved as he did. Valeant had the potential to execute a strategy designed to grow both revenues and earnings; however, the company “flew too close to the sun” with its strategy of rapid and massive price increases for its drugs. When investors began to question the long-term viability of the company’s strategy, its stock price collapsed.

Question: How do business strategy, corporate governance, and ethical conduct interact and what should the Board do to ensure that Valeant’s future course combines a sustainable business model with ethical behavior?

II. Valeant’s Business strategy I interviewed the former President of Notre Dame, Father Ted Hesburgh, as a part of a research project about business ethics. Father Hesburgh led Notre Dame from 1952-1987; during his tenure he served on a number of government and non-profit boards, but also on the board of Citibank. Father Ted told me that his philosophy was that “you can’t understand the ethical issues until you understand the business issues.” That provides a backdrop for a solid discussion about Valeant’s business strategy.

Question: What was Valeant’s original business strategy? How did it change with the hiring of Michael Pearson?

Students should quickly respond that, initially, ICN’s strategy relied on internal products (Ribavariin), acquisitions, and competing in markets with little competition from Big Pharma (Eastern Europe after the fall of the Iron Curtain). After the Board ousted Panic, Valeant tried to play a Big Pharma strategy of heavy investments in R&D. Because of its size, however, this strategy proved untenable.

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Pearson designed and implemented a strategy that eschewed R&D and relied instead on M&A. Valeant searched for drugs in categories where Big Pharma was less likely to have blockbuster offerings, markets where patients had chronic illnesses and long-term medication use, and products that were “mispriced.”

Question: Was Valeant’s new strategy more sustainable than its old one?

I’ll call on 2-3 students to gauge their opinions. I like to point out that, while Valeant’s strategy worked for about 6-7 years, it had elements that made it difficult over the long term.

Specifically, the strategy had four problems:

Cutting R & D Valeant had no internal pipeline or source of revenue. If, or when, the well ran dry on attractive M&A targets, Valeant had no serious fall back drug development pipeline to generate revenue. The strategy was clearly boom or bust, and almost guaranteed to bust in the long term. In June of 2014, investment banker Morgan Stanley referred to Valeant’s business model as a “house of cards.”1 The Math of Growth Growth forecasts worked against Valeant. Buying $50 million worth of business is 10% growth when for a $500 Million company, but it’s only 1% growth for a $5 billion one. Therefore, to continue to grow, Valeant would have to buy larger and larger targets, and move into drug categories that get away from what they liked (stable, long-term drugs with lots of renewals, little Big Pharma presence). It was their entrance into the cardiac medication Nitropress and a significant price increase that put Valeant on the radar for external stakeholder critics.

The Strategy of Buying “Mispriced” Drugs This is self-limiting. Part of the ability to “rep-price” drugs had to do with their overall small markets. The number of mispriced drugs is itself limited, and as Valeant’s strategy became apparent, orphan drug companies would demand higher payouts for selling to Valeant, raising the cost of each acquisition. When Valeant moved into larger markets, it’s more likely that major insurers will negotiate lower prices for drugs, or push patients to generic formulations.

Debt-fueled Acquisition Cash flow becomes king and, consequently makes potential reductions/interruptions in cash flows particularly dangerous. During Pearson’s tenure, the company went from no debt to 1

Soyoung Kim and Olivia Oran, Morgan Stanley calls Valeant 'house of cards' in Allergan pitch, 16 June 2014, Reuters, available at http://www.reuters.com/article/us-allergan-morganstanley-idUSKBN0ER1L120140616, accessed 02 May, 2016.

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$30 billion. The non-trivial problem with debt, as opposed to equity, is that you have to pay it back. If there are any hiccups in cash flow (let alone profitability), debt payments become more difficult to make.

As a transition to the discussion about the ethical issues involved here, I make the point that Valeant pursued its strategy as the health care market was becoming more politicized.

Question: How did ObamaCare affect Valeant’s business model?

Valeant’s new strategy rolled out as Barack Obama was pushing, and congress was passing, the Affordable Care Act. The Affordable Care Act took effect in 2014, and while there is no evidence that Valeant’s strategy was jeopardized by the ACA, the passage and roll-out of the ACA raised the public’s (and politician’s) sensitivity to health care issues. With stakeholder more attuned to health care issues, the likelihood that large price increases would come to light increased.

III. The ethical issues involved The bulk of the discussion should focus on the ethical lapses and challenges in the Valeant case. There are at least six separate ethical issues that can be discussed, and an instructor can focus on all, or a subset of them. The ethics of drug pricing issue will certainly generate good debate and expose a number of different opinions and view, as will a discussion of Pearson’s compensation package. For me, however, the most important issue is the first one I choose to discuss.

Question: What are the ethical issues in play here?

I’ll generate a list, and then move to the first issue. I’m hopeful that a student will have recognized this and brought it up, but if not, I’ll lead with it anyway.

The Ethical Climate and Culture at Valeant The preparation questions should prime students to look for similarities between Panic and Pearson.

Question: Imagine that you worked at Valeant since the mid-1990s. What do you think the ethical culture there would be like? What imprint did Panic likely leave? How was Pearson similar? Different?

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I’ll then point out that both ICN Pharmaceuticals and Biovail had a history of ethical lapses.

ICN’s founder faced charges of inflated and false claims about Ribavarin’s use, and Panic had a history of sexual harassment during his tenure. In both cases, neither the board nor internal stakeholders spoke up. It appears that from its founding, Valeant had a culture that pushed limits of appropriate behavior, and discouraged reporting or questioning such behavior.

Biovail problems with accounting fraud led to several years of investigations and a fine.

Accounting fraud usually involves multiple people across several levels of the organization. At the least, accounting fraud involves neglect by superiors in internal audit.

Question: To what extent would these founding cultures of “pushing the limits” encourage Pearson and others at Valeant to engage in questionable and fraudulent practices? To what extent could you trace Valeant’s problems of “tone at the top” all the way back to its founding?

Before moving on, I’ll ask students to think about the role of cultures they’ve experienced (family, school, work, national cultures) that either encourage or discourage aggressive behavior.

Question: How do these cultural imprints create challenges later, when one moves to a culture with a different set of ethical values? What responsibilities does a leader have to set the right “tone at the top” and create a culture that upholds ethical standards?

Question: What about the tax inversion? Should a company be allowed to change its headquarters just to lower its tax rate?

Most of Valeant’s operation remained in the United States, but its formal headquarters was in Ontario. How should the government respond? The Obama administration enacted rules in 2016 to make inversions much more difficult, with the argument that U. S. companies had a citizenship obligation to pay their fair share of taxes.

Question: Is this right, or should the US just cut corporate tax rates to be more competitive with the rest of the world?

This may not be a fruitful field for a deep discussion, but you may find students who care deeply about the issue on one side or the other. I hope to have students see is that there is plenty of room for people to disagree. How much one pays in taxes has more to do with politics than morality. I’ll also ask if the inversion had any impact on Valeant’s other problems. I’ll point out two issues here. First, doing an inversion would be a natural consequence of a culture that focused on creating economic value for shareholders. Second, the inversion used up goodwill that Valeant may have had with stakeholders. When the other issues came to light, the inversion provided further evidence for external stakeholders and activists who wanted to paint Valeant in the worst light possible.

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The Drug Pricing Issue This issue can absorb most, if all of the time for ethical issues.

Question: Is it ethically acceptable for Valeant to raise the price of its drugs by the amounts it did? Did Valeant add more value to these medications that would justify these price increases?

One or more students will note that Valeant violated no laws by raising prices to the extent it did. Others will be outraged. Before proceeding, I always highlight the difference between something being legally versus morally permissible. It may be legal to raise the prices of drugs by 1,800%, but is it ethical?

As this discussion proceeds, I’ll ask students to ground their judgments in more than just their visceral reactions. Students who see the increases as unethical will often do so by referencing a “rights logic.” People have a right to health care that is affordable and effective. For those who see the increases as ethical, their argument usually takes the form of a “utilitarian logic” allowing pharmaceutical companies to charge high prices for drugs fosters innovation in the industry and the creation of new drugs. Without such an incentive, this camp argues, there would be less innovation, and society as a whole (not merely individual patients) would be worse off.

It’s useful to examine the logic of Valeant’s own responses to its critics, as a deep investigation of these arguments reveals that Valeant may not have thought through its moral logic. Here are Valeant’s arguments: •

The market will bear price increases. The argument here is that people are still willing to pay, and so they still find value here. Valeant is merely reducing—but not eliminating—consumer surplus. What this argument fails to account for is that health care is an inelastic good. Most of us would pay whatever it takes to preserve our health and lives. Valeant has focused a customer set particularly prone to inelastic demand: chronic conditions that need constant medication. Demand becomes extremely inelastic in the absence of generic alternatives, or when your own specialty pharmacy fraudulently won’t allow generic substitution. Valeant’s acquisitions often focused on the former, and its business practices encouraged the latter.

•

Drug therapies are cheaper than other interventions and Valeant is just closing the “value gap.” This argument focuses on the economic argument that price follows value, not cost. While this is a foundation of a market system (Karl Marx believed that cost should drive price), in regulated markets such as health care cost often becomes a basis for price because value alone may not result in fair and reasonable prices.

Valeant did nothing to make its drug therapies more effective, and one can ask what

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right they would have to capture value for a product they did nothing to create or enhance.

Further, the difference between drug therapies and alternatives rests in economies of scale, Drug costs are all incurred up front while alternative therapies incur costs at the point of service. We all accept that drug prices should be set high enough to provide an attractive return on investment, but that once amortized, drug prices should more closely resemble their costs, not move in the opposite direction.

•

We are not charging customers, just their insurance companies. This is a version of the “no harm, no foul” defense of questionable conduct. This argument holds little water for two reasons. First, insurance companies don’t print money, they just raise health insurance rates for everyone. The wealth transfer to Valeant comes from every health plan user, rather than individual patents. Second, we know for data in the case that end users saw their bills rise. So, there was “some harm,” and that probably means “some foul.”

Question: At what point did Valeant cross the line between legitimate, value driven price increases and “gouging” ones?

This gives students who are concerned about the price increases to probe the limits of their moral aversion. Data in the case suggests that price increases of around 12% were the norm in the industry. Is the average Valeant increase of 60%+ excessive? As an instructor there is no clear answer here, but the instructor can conclude by inviting a few students to explain where and why they might draw the line between legitimate and excessive, aggressive versus gouging.

The Philidor Scandal This may be the easiest one of all to deal with because, as the case details, Valeant engaged in clearly questionable and some illegal actions. Valeant almost certainly engaged in fraud here on three levels. First, having their own employees falsely represent themselves as Philidor employees. Second, changing prescriptions to read “no substitutions” when they were not written that way by the prescribing physician. Third, reporting Philidor sales as their own and lying about a financial stake in Philidor. The impact of the Philidor scandal for the company was to delay the 10K filing, restate earnings, and risk running into default status with creditors. The Philidor issue is likely to plague the company into the future through state and federal investigations.

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The Contact Lens Button Monopoly Question: Should companies be allowed to acquire monopoly positions? Do companies that control critical inputs have a responsibility to price them fairly, or should they raise prices to whatever the market will bear?

It appears from the case, and from Valeant’s critics, that the company moved into this market with a clear motive to implement its strategy of substantial price increases.

Executive Compensation for Mr. Pearson I like to end with this discussion, and I like to spend at least 10 minutes here. There are two issues for discussion here.

Question: Is it right that a CEO would make $3 billion in compensation? What about when that wealth is made not through innovation (like Mark Zuckerberg, Sergei Brin, or Bill Gates), but simply by re-pricing? What should we reward as a society?

This question should spark a lively debate with advocates on both sides. Some students will argue that placing a limit on earnings destroys the incentive for innovation and/or the hard work of creating an efficient and profitable business. This employs a Utilitarian Logic. Others will argue that companies, and society at large, should spread pay more evenly. They might argue that a $3 billion stock package for a CEO makes sense as long as the accounting clerk would be making $1 million. These are arguments grounded in a “Fairness” or “Rights” Logic.

I conclude this discussion by noting that options here certainly differ, and this seems to be an ethical issue where all views have some validity.

I like to focus more on the second issue, both on its own merits and because it moves to the conclusion of the case.

Question: To what extent did Pearson’s compensation plan drive the questionable ethical choices by Valeant executives?

The instructor should detail the structure of the compensation package; stock compensation became more valuable as the rate of the company’s stock price grew. There are two issues here. First, to get to 60% growth over a three-year period requires really aggressive action.

The problem is, in practice, that the line between ethical and unethical gets really hazy under the pressurized conditions of aggressive growth. Further, the math of growth—that it’s harder to grow at the same rate as you get larger—makes unethical behavior look that much more appealing. Raising prices, or looking for acquisitions that bestow monopoly positions, becomes easy to justify to “make the numbers.” The Valeant board accepted this logic in the 2015 10K filing by acknowledging that the compensation scheme created a “tone at the top” that encouraged ethical lapses.

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IV. The Fall Question: What impresses you about Valeant’s fall? What caused Valeant’s shares to collapse?”

Understanding why shares would collapse so quickly, and fall so markedly, requires understanding Valeant’s business model and how investors price shares. Investors calculate bid prices for shares based on 1) future earnings growth, and 2) short term prospects to make money on price appreciation (the greater fool theory holds that I’ll pay a ridiculously high price if I believe there is still a greater fool out there who will pay an even higher price). So, threats to future earnings growth will lead investors to begin to revise their bids for a stock at lower prices. Downward momentum, including rapid and substantial price declines, builds on itself over time as no one wants to be “the last fool in the game.” The problems for Valeant began in earnest in September of 2015 with the negative publicity instigated by Hillary Clinton. The stock dropped 16% in one day, and this likely set in motion a free fall.

Question: What caused the fall?

The point to make here is that Valeant miscalculated stakeholder risk. The problem starts when Valeant—and a related company Turing Pharmaceuticals—become objects of interest in the U.S. Presidential campaign. While the effect of negative press is debatable, in this case the attention threatens the two sources of earnings growth for Valeant—acquisitions and price increases. Acquisition targets, if they lacked information before, would be expected to bid up the sales prices of their companies to extract value from Valeant. Such increases would require larger price hikes to pay off the acquisition premium; however, scrutiny from the public sector will make price increases more difficult over time.

The problems with Philidor just add fuel to the fire as investors now have reason to wonder about the legality of the business, Valeant’s veracity in reporting its financial condition, and the future of its ability to get its prices in the market. Investors love good news, but they really despise being lied to by a company.

Once the downdraft on the stock begins (or the wax melts in Icarus’s wings), it builds its own momentum. With $30 billion in Long Term Debt, disruptions in cash flow and earnings growth threaten the financial health of the company and run the risk of a default and bankruptcy.

Long Term Debt doubled in 2015, and flat or falling cash flows would jeopardize the company’s ability to service its debt. Since shareholders lose everything in a bankruptcy proceeding, there is a strong desire not to be the last investor holding shares. The delay in filing the 2015 10K increased the risk of default, which increased the risk of bankruptcy, which encouraged more shareholders to sell.

One other thing that the instructor may point out is that when a company becomes vulnerable, activists and stakeholders, both public and private, all want to jump in and extract their pound of flesh. What begins with Bernie Sanders and Hillary Clinton extends to Copyright ©2022 John Wiley & Sons, Inc.

John Hempton (who wants the stock to drop), the Federal Trade Commission (Contact Lenses), and by the end of the case an alphabet soup of federal and state investigations. As Icarus fell to the earth, gravity hastened his descent. As Valeant fell from grace, stakeholder action played the same role and hastened the decline.

V. Conclusion As the case ends, Valeant has a new CEO and the Board Chair Ingram ponders how to manage the new CEO and help Valeant recover.

Question: “What should the Board do?”

Their responses will generate a list of options. I like to focus students on the Board level issues involved. Does Valeant need a formal code of ethics? A C-level ethics officer? An ethics committee of the board? What steps should the Board take to build an ethical culture?

Question: How should compensation change?

Valeant is clearly in turnaround mode as the case ends. Turnarounds are attractive to new CEOs because they often come with a substantial upside, usually in the form of stock-based compensation that incentivizes the executive to take decisive action to move the stock price up. Given that executive compensation was a part of the original problem, how should it be designed to change the “tone at the top” regarding ethics?

I always conclude by asking 2-3 students to summarize their personal learning from the case.

I’ll finish the case by noting that, for me, the core lesson here is that an unsustainable business model creates a strong incentive, and creates many opportunities, for ethical misbehavior.

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Teaching Note

Safe Water Network: Mastering the Model at Dzemeni Teaching Objectives Safe Water Network (SWN): Mastering the Model at Dzemeni. This case has been written for use in advanced undergraduate courses on business strategy social entrepreneurship, innovation, or economics at the base of the pyramid. The case can also be used in elective or required MBA level courses on business and society, business ethics, corporate social responsibility, entrepreneurship, or strategy. If used in a strategy course, the case makes an excellent concluding case and can be used in conjunction with Chapter 14, Strategy and Society, of Strategic Management: Concepts and Tools to Create Real World Strategy by Dyer, Godfrey, Jensen, and Bryce. Students need to have some knowledge of different business strategy models, the innovation process, and/or approaches to serving the Base of the Economic Pyramid (BoP). The case invites students to analyze the challenges that SWN faced, and continues to face, as the organization works to bring potable drinking water to residents of rural Ghana.

Students will explore and identify the challenges social entrepreneurs face in implementing strategy, evaluate the economic viability of the SWN business model and the strength of the constraints that inhibit its financial sustainability, evaluate the actions SWN has taken so far to remedy the problems, suggest additional actions the organization should take to make its model truly sustainable.

At the conclusion of this case, students should be able to identify and catalog the challenges faced by social entrepreneurs as they attempt to provide products and services to their target clientele, Evaluate the economic viability of for-profit social entrepreneurship and identify the major constraints to financial and operating sustainability, and recommend a viable course of action to help a socialentrepreneurial organization improve the sustainability of their enterprise.

Study Questions 1. In terms of the objectives of social entrepreneurship described in Chapter 14, what type of social entrepreneurship does SWN engage in? Do they have leaders with the right skills and capabilities to accomplish their goals? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension]

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2. Which of the actions that SWN took after assuming control of the Dzemeni site, in your opinion, proved most beneficial? Why? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension]

3. Is the SWN business model sustainable? Do you see fatal flaws in the operational model? If so, what adjustments would you make to the model? If not, which remaining challenge should SWN focus on first? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 3 Application] 4. Should SWN expand their network to include Tongor? Why or why not? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 6 Evaluation]

Multiple Choice Questions 1. In terms of the objectives of social entrepreneurship described in Chapter 14, what type of social entrepreneurship does SWN engage in? a. SWN provides clean water to the poor. b. SWN provides water filtration for commercial services. c. SWN provides grants for poor communities to improve infrastructure. d. SWN provides food and medicine to refugees.

Answer: “A” 2. Do they have leaders with the right skills and capabilities to accomplish their goals? a. Yes, their leaders have many years of combined corporate experience. b. Yes, their leaders have many years of combined NGO experience. c. No, their leaders have many years of irrelevant corporate experience. d. No, their leaders have many years of irrelevant NGO experience.

Answer: “C” 3. Which of the actions that SWN took after assuming control of the Dzemeni site, in your opinion, proved most beneficial? Why? a. SWN installed an expensive, gold standard filtration system in a community that badly needed it. b. SWN played a public health role in educating Dzemeni residents on the role of clean water in disease.

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c. SWN seemed to help increase demand for the filtered water, although the ultimate results of these efforts would take years to become apparent. d. SWN charged for water by the jug.

Answer: “B” 4. Is the SWN business model sustainable? Do you see fatal flaws in the operational model? If so, what adjustments would you make to the model? If not, which remaining challenge should SWN focus on first? a. The model is sustainable because SWN has achieved operating sustainability at Dzemeni. Revenues cover the cost of operating the site on an ongoing basis. b. The model is sustainable, but insufficient because SWN should adopt a “philanthropic investment” model where the organization funds the start-up and capital costs while communities then run the selfsustaining sites. c. The model is unsustainable because SWN can’t cover the management fee and related costs with running the site. The kiosk would have to double their current sales to cover the management fee. d. None of the above.

Answer: “C” 5. Should SWN expand their network to include Tongor? Why or why not? a. No, because the cost of expansion, $280,000 will not be enough to make the operation profitable. b. No, because the cost of expansion, $280,000 will burden the operation and ensure that cost recovery never occurs. c. Yes, because the cost of expansion, $280,000 will increase demand enough to ensure operational sustainability. d. No, because SWN could not run the Dzemeni site sustainably with the current demand and management staff.

Answer: “D”

Teaching Plan I. SWN as a Social Entrepreneurial Organization II. Water Consumers at the BOP III. The SWN Business Model and the Challenges of Supply

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20 min 15 – 20 min 20 min

IV. The Tongor Expansion V. Conclusion

15-20 min 5-10 min

The following plan is for an 80-minute course, and all recommended time frames are approximate. The instructor should adapt the following plan to the customized needs and talents of the students.

I. SWN as a Social Entrepreneurial Organization The instructor can begin by inviting students to share their responses to the first preparation question. Most students will correctly see that SWN is engaged in the provision of products and services to the poor at the base of the pyramid. The appropriate leadership skill set for this type of organization is the social constructor, a person who can create a new product or business model to fit the situation. If students look closely at the backgrounds and skills of those running the Dzemeni project they should question whether any of these individuals has the skill set of a constructor.

Although the SWN President enjoyed a career as a successful entrepreneur, the leaders of the project all have backgrounds in large corporations. The skill set to implement and operate a business model within a large organization is quite different from the entrepreneurial skills required for a social constructor. This may partly explain why SWN initially chose to contract with WHG to run the site. The corporate backgrounds of SWN personnel may be relevant factor in the underlying economic challenge at Dzemeni: SWN installed an expensive, gold standard filtration system in a community with few resources to pay for such a system.

A few students should recognize that SWN’s mission involves capacity building in the local community. The goal of the organization involves helping people use clean drinking water, not merely have it in their possession. First, SWN had to build the structure that housed the filtration equipment and the network of pipes that brought water from the lake and delivered it to the kiosks. In the role of building out physical and related communications infrastructure, SWN assumed a role normally played by government. The threat that local or national government leaders could enter the “market” for clean water meant that SWN’s investments may be non-recoverable.

Second, SWN discovered that many residents used contaminated drinking water from nearby Lake Volta because it is free and the lake has been the water source for their entire lives. The organization hired people to educate and train local residents on the need for and proper use of clean water. Clean water represents a unique product in that one must drink, cook, and clean with potable water 100% of the time in order to gain any benefit. SWN thus played a public health role in educating Dzemeni residents on the role of clean water in disease; these roles have been played historically by governments or other NGOs, but not by private businesses.

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The leadership skill set that supports capacity building is the bricoleur, a leader or team that can assemble resources from different sectors of society and focus them in a local community to build capacity. On this measure the Dzemeni team scores well; the leadership could combine resources and models from private industry as well as Ghana’s public health organizations and infrastructure. In fact, the education programs seemed to help increase demand for the filtered water, although the leadership team admitted that the ultimate results of these efforts would take years to become apparent.

At the end of this discussion the students should be able to identify the links between the goals of the organization and the different skill sets of its leaders. To transition to the next discussion area the instructor can ask, “Why can’t America’s corporate titans provide drinking water to small villages in Africa?”

II. Water Consumers at the BOP? The answer to the transition question should be something like “because people running large American corporations seem to have little understanding of the challenges faced by people at the BOP.” Question: How is consumption of clean water different in Dzemeni than New York?

The resulting list should include, but not be limited to: • Paying for water by the jug as opposed to a (hidden) monthly fee. Students will see quickly that Dzemeni residents will pay by the jug, but some of them may not see that they also pay for water, either as a separate “utility” bill, or as a part of their rent. Two key differences arise: (1) paying by the jug is quite a bit more expensive than paying by the month, and (2) the costs can be separated out and Dzemeni consumers can choose NOT to consume clean water.

• The presence of a “free” alternative. Residents can rely on rainwater catchment or simply fill their containers in the lake. The first source of water would be clean but the second would not. Lake water may have no financial cost; however, it may be quite costly in terms of disease. The presence of a perceived free alternative creates a viable substitute that limits the residents’ willingness to pay.

• Transporting water to one’s home instead of having it piped in. This introduces the weight factor, a factor that looms large in the original lack of demand for SWN’s product. Weight means that purchase of the clean water occurs primarily within a 200-meter radius. SWN installed the remote Kiosks to overcome this challenge.

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•

•

Using contaminated containers, living in a contaminated environment, and the challenge of keeping water clean. Clean water is not a stand along product; it exists within a physical delivery and storage system. SWN realized they had to provide more elements of that system, including clean containers for people to use.

Cultural challenges. Water, essential for life, also exists in a cultural subsystem.

SWN educators had to dispute culturally bound myths and falsehoods that dampened demand for clean water. The organization also had to work against the cultural tradition of drawing water from the lake as well as the belief that water-borne disease was just an accepted fact of life.

SWN seemed to effectively respond to each of these challenges; however, solving each problem added costs to the overall system. The price rise did not substantially decrease demand although it may have shut out some of the poorest potential consumers. The instructor should note that this is a unique and difficult challenge that social entrepreneurs face: financial sustainability at the cost of excluding precisely those the organization most wants to serve.

While demand did not decrease, the increase in cost meant that larger and larger volumes would be required for the operation to become truly financially sustainable.

Question: How would these increased capital costs impact the overall goal of community ownership and assumption of operating control?

The SWN solutions also created a more complex organization, one that would require more managerially skill to run. This also made the transfer of the Dzemeni site to community leaders less likely.

III. The SWN Business Model and the Challenges of Supply With a deeper understanding of and appreciation for the challenges of working at the BOP, the instructor can now shift the discussion toward the “supply side” of SWN’s business model. Exhibit 6 provides an overview of the steps in the process from community selection to the final consumption of the project. The case provides extensive detail on the purification technologies SWN has at its disposal and the instructor may begin with a brief discussion of these technology options. The instructor may ask several students which filtration technology they believe would be the most appropriate. Students with a science or engineering background may help others understand the basic process of water filtration and purification.

The instructor should help students appreciate the tradeoffs involved in the selection of a filtration technology. Exhibit 7 should be a focus during this part of the discussion.

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There are three essential technology tradeoffs: availability, cost, and sophistication.

LMS technology only filters water, and it requires existing wells or boreholes. Its advantage lies in low cost. MSSF filtration requires surface water and works in a community like Dzemeni. While it is relatively low cost to install and operate, it may not be as effective in filtering out bacteria and viruses. The mechanical UV systems can be used with multiple water sources and provide excellent filtration; however, they have the highest cost, both to install and operate.

The point of this brief discussion is to help students understand that social entrepreneurs, given the complexity of the BOP environment and a lack of critical resources, must make difficult tradeoffs in choosing how to reach their goals.

At this point the students should be primed for the larger question: is the overall SWN model sustainable? The instructor can poll several students and ask for responses.

Most students will note that SWN has achieved operating sustainability at Dzemeni.

That is, revenues cover the cost of operating the site on an ongoing basis. Some students will argue that operating sustainability is a valuable outcome and that SWN should adopt a “philanthropic investment” model where the organization funds the start-up and capital costs while communities then run the self-sustaining sites. Others will be uncomfortable with this solution. The fact is that SWN can’t cover the management fee and related costs with running the site, and recovery of the original capital investment seems impossible. The data in Figure 1 proves useful here. The kiosk would have to double their current sales to cover the management fee, and if demand increased 2.5-fold from its base (from 400,000 units to 1,000,000) before the site earns enough to enable sustained repayment of the original capital costs.

Question: Does it seem reasonable that SWN can generate that much additional demand?

The instructor may then ask about the human capital sustainability of the project. A few students may have thought about this, but it may be new territory. The original business model calls for transfer of the SWN facilities to local ownership and control.

The issue of ownership is primarily financial—if the stations can’t generate real profits, then it will be very difficult to transfer ownership. The issue of control, however, is primarily human. SWN needs skilled individuals at all levels to operate the facility, from education specialists to equipment technicians and operators. SWN also needs overall management talent to run the entire operation; there is no evidence that SWN has a plan in place to find or develop such talent.

The instructor can then probe into potential solutions to this challenge. Drawing on the core strategy concept of “make versus buy” the instructor might ask:

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Question: Where can SWN buy the talent it needs to run the facilities? Can it afford such talent?

Students can list the challenges to buying talent: lack of supply in terms of trained managers in private industry, the difficulty of bringing in managers with a not-forprofit background to run a for-profit business, and the similar challenges of bringing people from the public sector. If the model reaches financial sustainability, then running a site would probably provide a competitive income, but the question about such viability remains.

Question: How could SWN make its own management talent?

Students then have the opportunity to think about the career development path that would qualify someone to take over a SWN safe water station. One route, the most obvious, would be for SWN to hire a potential candidate internally and then train them to take control of the station. Other options include partnerships with Ghanaian NGO or faith-based organizations to find potential future managers. There are also opportunities to have SWN create an internship/development program in conjunction with Ghanaian universities. The instructor can have students do a Google search for business universities in Ghana and spend a few minutes trying to understand what the supply of future managers might look like in this context.

Since many business students have participated in internships the instructor can then probe about the types of experiences that SWN would need to offer to induce an intern to join the organization full time. What types of internship experiences have students had that offered them valuable preparation? On the other hand, the instructor should try and elicit some student responses from less-than-optimal internship experiences. What types of activities characterized these wasted opportunities?

To bring this discussion to a close, and to bring the discussion full circle, the instructor may ask: Question: What evidence do you see that SWN has the resources and capabilities to engage in management development?

The case offers little evidence that the team in place at Dzemeni has programs or processes in place to develop managerial capacity. The instructor may ask why this may be. The objective here is to help the students see that the leadership team has been pre-occupied with fighting the current “fires” that threaten the organization’s survival and have not had the time to focus on the longer-term issues. Again, this aspect of SWN characterizes many (social (and commercial) entrepreneurial ventures.

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The instructor may conclude by having students identify the key tradeoffs they have seen in the case. The final discussion area of the case can be introduced with a question such as Question: Would expanding the Tongor alleviate or exacerbate the tradeoffs and challenges faced by SWN? IV. The Tongor Expansion Question: Should they expand into the neighboring town of Tongor and create a “microutility?

This discussion may center on the pros and cons of entering Tongor. The instructor may ask 2-3 students whether they believe the leadership team at SWN should expand into Tongor and to list their reasons for or against the expansion. The discussion can be broadened to include other class members who may add items to each list or offer critiques of the listed reasons.

As a part of this discussion, the instructor should probe into the sustainability issue.

Will expansion—at $280,000—enable the scale that makes the operation profitable, or will it burden the operation and ensure that cost recovery never occurs?

Question: Is Tongor throwing good money after bad in the hope of scale? Similarly, what about the leadership and human capital challenge? Will a larger operation allow SWN to “hire” professional management or will it so focus the organization on a larger number of day-to-day problems that internal talent development rests perpetually on the back burner?

A powerful conclusion comes as the instructor chooses a student who has remained silent for this phase of the discussion and asking, “Would you expand”? There is power in personalizing the question as the student must now assume the role of leader, rather than advisor, and decide whether to pull the trigger. Such a conclusion invites students to consider how deeply they believe that SWN can accomplish its mission by becoming bigger, or is the best course of action to build smaller facilities that would serve fewer customers but provide greater financial stability?

V. Conclusion The case invites students to tackle several complex issues about the nature of social entrepreneurship and the challenge in having the reality of the operation approach the broad vision that motivates these organizations. The challenge of talent, skill, and

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finding the right human capital becomes pronounced for organizations such as SWN. The first challenge entails finding a leadership team that combines the right passion for the mission with the necessary skills to implement it (SWN needed social constructionists but seemed to be staffed with bricoleurs).

Further, the challenges created by having two important purposes—to serve the poor and to maintain financial sustainability—mean that social entrepreneurs must manage these hybrid goals delicately. Balancing the social vision with the financial reality proves to be a difficult and delicate task. The instructor may ask students how they would face such tradeoffs. Finally, the case highlights the real entrepreneurial challenge of working to solve short term problems of survival while paying attention to the longer term, strategic needs of the organization.

The conclusion may be handled a number of ways. The most profitable of these involves asking 3-5 students to share what their key “takeaways” are from the case.

Such a question invites not only the student responding, but the class as a whole, to internalize their key learning points from the case.

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Teaching Note

Facebook at a Crossroads: Russian Interference in the 2016 Election Teaching Objectives Facebook at a Crossroads: The aftermath of the 2016 election has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in conjunction with a module on the larger social context of business, or an expanded discussion of the ethical obligations businesses have. The case provides students with opportunities to see how a company develops a unique set of resources and capabilities over time, and how those capabilities often create unanticipated and unintended side effects.

This note assumes the instructor is either using, or is familiar with, Strategic Management by Dyer, Godfrey, Jensen, and Bryce, as this case can be used with Chapter 13 of that text. The breadth of the case, including issues of firm strategy and evolution and social impact, also allows instructors to use it as a summary case towards the end of a course.

The case allows students to analyze the sources of Facebook’s competitive advantage as well as the strategic and tactical challenges Facebook encounters as it responds to the allegations and considers organizational or policy changes. The case invites students to assume the role of Schrage, or a consultant to him, and chart a course that adopts a platform, media, or mixed strategy.

Students should assess the underlying challenges presented in the case.

Question: How did the structure of the News Feed, and Facebook’s desire to be market-driven and hands off with information, give rise to the events of the 2016 election? Which challenges and problems can Facebook control? Which ones should the company respond to?

Students should also consider how a company crafts an effective response to an ongoing issue that affects public policy, and judge the adequacy of the response.

Question: Do students believe that Facebook’s actions will mitigate the challenges of fake news?

What other actions might the company take.

Finally, debate the larger societal issues at stake here.

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Question: What are the business and social implications of Facebook and other social media players should they choose to maintain their “platform” status? What happens if they become a media company? Does Facebook have responsibilities as an “information fiduciary?”

Students should identify the ways in which key features of a company’s strategy and operations may create unanticipated and unintended abuse, critically assess a company’s response to an external crisis as that crisis evolves and certain claims and evidence become clearer, and evaluate the adequacy of the actions Facebook proposes to resolve the underlying structural conditions that allowed the event to occur.

They need to then craft and argue a logically consistent position about the larger issues involved in the case.

Question: What are the business and social implications of Facebook and other social media players should they choose to maintain their “platform” status? What happens if they become a media company? Does Facebook have responsibilities as an “information fiduciary?”

Study Questions 1. Which features of Facebook strategy and operations created conditions that others exploited during the 2016 Election cycle? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. How well did Mark Zuckerberg and Facebook respond to the allegations of Russian involvement through Facebook? What would you have done differently? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 6 Evaluation] 3. Evaluate the adequacy of the actions Facebook proposes to mitigate the problem of false news and foreign involvement in US elections. Has the company done enough?

Why or why not? What else should the company consider? [AACSB: Ethics] [Difficulty: Hard] [Bloom’s 6 Evaluation] 4. What do you see as Facebook’s role as “information fiduciary?” What would a “platform +” solution look like? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 4 Analysis] Multiple Choice Questions

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1. Which features of Facebook strategy and operations created conditions that others exploited during the 2016 Election cycle? a. My Story b. News Feed c. Tagging d. Photos and Videos Answer: “B” 2. How well did Mark Zuckerberg and Facebook respond to the allegations of Russian involvement through Facebook? What would you have done differently? a. He responded well by proposing immediate new tough screening procedures b. He responded well by acting as a publisher rather than a platform c. He did not respond well because he did not act as an information fiduciary d. He did not respond well because he allowed interference in the election Answer: “A” 3. Evaluate the adequacy of the actions Facebook proposes to mitigate the problem of false news and foreign involvement in US elections. Has the company done enough?

Why or why not? What else should the company consider? a. The company has not done enough because future elections are still imperiled b. The company has not done enough because they are still not actively restricting fake news c. The company has done enough within its role as a neutral platform by introducing additional screening d. The company has done enough because they cannot be responsible for all information on their site Answer: “C” 4. What do you see as Facebook’s role as “information fiduciary?” What would a “platform +” solution look like? a. Facebook should not become an information fiduciary because Facebook is politically neutral b. Facebook should not become an information fiduciary because it is too costly c. Facebook should become an information fiduciary to protect democracy d. Facebook is already an information fiduciary because it publishes some content and restricts others Copyright ©2022 John Wiley & Sons, Inc.

Answer: “B”

Teaching Plan I. Opening II. Facebook’s Strategy III. The Facebook Response IV. The Larger Issue: The Role of “Information Fiduciary” V. Conclusion

10 min 20 min 15 min 25 min 10 min

The liveliest part of the discussion will, and should, take place around question four. The objective of this case is to have students engage in this type of intensive discussion; however, the goal of the instructor should be to ensure that the debate does not simply devolve into a war of words, but becomes a thoughtful exploration of the implications of social media for social issues in general and political speech in particular. To set up the final debate, I like to discuss the case preparation questions in order.

I. Opening I like to open by focusing on the challenge facing Schrage.

Question: What’s the decision the Mr. Schrage faces? What are his options?

Students should lay out the three basic options in the case: Facebook can remain a platform company, they can fully adopt a model as a media company, or they can search for middle ground, what I call platform +. The instructor needs to make sure that students understand the underlying issues here. The Communications Decency Act of 1996 absolves a “platform” company (technically an “internet intermediary”) of legal liability for information carried on its platform. If Facebook becomes more than a platform, then it accepts liability and responsibility for the information carried on its site. With over 2 billion users, the cost and difficulty of policing content would be astronomical.

Question: Clearly, Schrage and Facebook would have no desire to become a media company, and so why would they even consider it?

The quotation from Senator Dianne Feinstein (D-CA) provides sufficient reasoning. If Facebook does not self-police to the Government’s satisfaction, they can expect a formal regulatory response.

With the stakes well laid out, I’ll try and unpack the situation to see how we got where we are.

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II. Facebook’s Strategy The next preparation question asks students to link Facebook’s business strategy and the problems associated with the 2106 election cycle.

Question: Which features of Facebook strategy and operations created conditions that others exploited during the 2016 Election cycle?

Three features should come out of this discussion. The most obvious link between strategy and the election problems is the design and presence of the News Feed. The News Feed has four features that can be exploited by those peddling false information.

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• •

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The Feed filters information that a user receives based on what he or she has positively responded to in the past. Politically conservative users of Facebook who have viewed, clicked through, or “liked” politically conservative posts will see similar posts prominently displayed on their News Feed.

In the name of “relevant content,” Facebook will not present information in the feed that presents opposite opinions or perspectives.

These two features of the News Feed create an “echo chamber” where Facebook users receive news that confirms and supports their existing world views. The fact that the News Feed dynamically and automatically increases the reach of each post, magnifies post views, whether the information in the post is true or false. Dynamic updating also allows threads to update—once a user has “liked” a post, he or she will receive more posts over time, allowing messages to gain credibility simply through repetition.

Facebook’s micro-targeting capabilities present posts to a user based on content rather than source. The algorithm treats all content equally, in terms of truth value, and provides little background on the source that helps users determine the veracity of the information or the point of view of the source of that information.

The Russian ad buyers used many of these same features to spread false information and influence the opinions of potential voters in the election. The case details several false news stories regarding Secretary Clinton that spread across Facebook, often posted by Russian operatives using false profiles. The “relevant content” feature of the News Feed insured that this information would be automatically and repeatedly placed into the News Feeds of sympathetic US voters. These posts, and some 300 paid advertisements, reached some 135 million US Facebook users. The content of many of these posts, often written from a politically conservative perspective, was designed to heighten existing ideological and political divisions between people, and create a milieu where voters saw those with differing views as enemies and created an urgency to vote in order to stop those enemies.

Question: Are these capabilities of Facebook a problem?

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Students should note that these capabilities have made Facebook the dominant player in the social media space and highly profitable. Some students will also see that the Trump campaign realized the power of each of these elements and spent the majority of their media money (some $90 Million) on advertising and messages that leveraged these News Feed features. Campaign officials used Facebooks micro-targeting capabilities to hone and refine their message to both solidify support among likely voters, and to motivate those supporters to donate to the campaign.

The Trump campaign’s use of Facebook’s tools represented an insightful, and completely legal, use of the News Feed to reach and rally support among those sympathetic to their message. The Russian operatives used those same features to illegally (foreign actors are barred from purchasing advertising in US elections) and covertly attempt to influence the views of Facebook users.

The other element of Facebook’s strategy that set the stage for the 2016 challenges involved its early decision to let the market (the preferences of its users) drive the evolution of the site’s capabilities. From its inception, Facebook adopted the position that it was merely a distributor of information and had very little responsibility to filter the information users posted on its site. Facebook has always screened for and removed “objectionable” content such as child pornography, but the company always eschewed any responsibility for verifying truth claims of posts on the site.

Question: Is Facebook’s strategy inherently inappropriate?

Most students will respond that, in and of themselves, no elements of Facebook’s platform and strategy are “evil;” the problem lies when users with “evil” designs use those tools.

III. The Facebook Response This discussion has two parts, Mark Zuckerberg’s response to the crisis, and the company’s policy changes. The first discussion tries to unpack Zuckerberg’s response and try to help students understand why he may have responded as he did as the election issue evolved.

Question: How would you rate Mr. Zuckerberg’s response to the allegations?

Student responses will tend to vary, but I’ll keep taking answers until I find a student who sees the response as “evolving,” or some similar word. I’ll not follow-up on student comments that judge the response as “good” or “bad,” as one of the goals of this whole discussion is to help students see the nuance in dealing with a situation like the 2016 election.

Question: What factors would explain his initial comments that Facebook’s involvement was a “crazy idea”?

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One factor would be advice from his General Counsel to deny any involvement until proven otherwise in order to limit the company’s potential liability. I’ll ask a student if such advice should be followed and try and tease out the conditions where denial might make sense. I’ll also ask if Zuckerberg’s statement was a true denial (and it likely was not). The first comment at the opening of the case reflects the reality that Facebook would be criticized by both parties, no matter what he said or did.

Zuckerberg’s comment also reflects the core belief that Facebook is a platform company. As a neutral provider of information, Facebook would have no impact on voter behavior. The instructor can ask how an advertiser on Facebook would feel about the idea that Facebook influenced anyone would be “crazy.” Advertisers buy space on the platform in the solid belief that Facebook does have influence.

As data began to emerge, some of it from Facebook’s own internal investigations, Zuckerberg’s response changed. I’ll ask students to describe those changes. They should note that he never admits “guilt” or complicity, but he begins to admit over time that Facebook’s powerful algorithms set the stage for malicious use of the site to attempt to influence public opinion. The next set of responses reflects Facebook coming to grips with the fact that the site’s features had been abused, but he and the company couch their response in the inherent difficulties in this case—the company’s ability to truly self-police, and the fundamental conflict between “free speech” and electoral abuse.

As the case closes, Zuckerberg’s responses, and actions, set the company’s response in a much larger, and more macro context. The language he uses reflects the fundamental ideals upon which Facebook and the United States were founded, “meaningful interactions that improve well-being for Facebook, and the democratic ideals of freedom for the United States.” Zuckerberg seems to be using the 2016 election challenge to refocus the company on some of its core values.

The second response is by the company. The company announced in September of 2017 a series of steps to provide greater transparency regarding who purchased political advertising.

The company revealed few details about how this would actually work, and students can debate the potential effectiveness of this step.

Facebook announced in December of 2017 that it would hire an additional 1,000 screeners to help it filter content. Facebook also announced, in January of 2018, changes to its News Feed.

The first set of changes hopes to prioritize news from reputable sources by filtering News Feed posts based on the journalistic reputation of the publishers. Facebook also committed to greater transparency around political advertising, with information about the sponsor of the ad available to users. The other change Facebook announced is to strategically focus the News Feed on items likely to promote “meaningful interactions,” giving priority to posts by friends and family.

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I’ll ask several students to evaluate these moves. While these moves will solve some problems—such as identifying who is paying for advertising—it is unclear whether a focus on “meaningful interactions” will solve the “echo chamber” problem of Facebook users.

Question: What more Facebook might do to provide more balance in the News its users receive?

This question and discussion provide an excellent segue way to the final discussion topic.

IV. The Larger Issue: The Role of “Information Fiduciary” Question: Does Facebook have any responsibility to provide balance in its news coverage?

To set up this question, I’ll refer to Exhibit 3 that shows that many Facebook users receive the bulk of their news from the site. These data might imply that Facebook might have a moral, if not legal, duty to act as an “information fiduciary;” the company’s public statements eschew any role as an “arbiter of truth?”

This is the argument that Facebook is a de facto, if not de jure, media company. If Facebook is a news organization and subject to FCC regulations about news content, then it has clear, legal obligations in terms of honest reporting and balanced coverage.

Question: What challenges does such a regime present for the company and public policy? How does Facebook differ from a traditional news organization, be it network TV, cable TV, or print media?

Two differences should come out very quickly: 1. Traditional publishers produce content while Facebook merely provides a platform where others share their own generated content, or where existing news organizations provide sponsored content. Traditional news organizations have control over content they produce and can exercise editorial judgment to ensure that the content is factual and balanced in its presentation. Facebook cannot do this.

2. Traditional media has limited page space, run time, or at least a limited budget for production. Facebook, on the other hand, has 2 billion unpaid news producers, with a limitless supply of bytes to publish content. Traditional news organizations, driven by scarcity of “shelf space” can more easily sort news that is “important” and vital from that which is peripheral. Facebook operates under no such constraint.

These issues create the case for the company to remain a platform: monitoring content would be prohibitively expensive and may prove unworkable.

Question: How many of you would see the retreat to a platform as the best option?

From a short-term business perspective, remaining a platform company is clearly the best option, but I’ll ask about the drawbacks to this approach. There are two: Copyright ©2022 John Wiley & Sons, Inc.

1. To remain a “pure platform” may create a public relations nightmare for the company and raise the specter of congressional regulation. While it may be good in the short term to claim no responsibility for information, that stance may lead to government regulation of the site that would likely run counter to Facebook’s long-term interest.

2. Facebook already filters and monitors some content—such as child pornography or excessively graphic violence—and the company has announced that it will begin to identify the sources, and in some sense trustworthiness of those sources, of information.

Question: At what point does Facebook cross the line from a protected platform into something more? What would a “platform +” company look like?

While there are no hard and fast models, I’ll probe students to invite them to think about the limits in terms of content monitoring, vetting sources and providers of information, ads, and news, and moves to provide balanced coverage.

Question: Taken together, do these constitute an “information fiduciary” role for Facebook?

I’ll focus on helping students wrestle with the limits of that responsibility. This is the highest value learning for students: to identify the lines that constitute moral and social responsibility. The instructor must be careful to provide a safe and constructive environment; the value here is in having students wrestle with this issue, not in their reaching a coherent and comprehensive position on these issues thought out in advance.

IV. Conclusion I’ll ask 2-3 students, some who have actively participated and some who have sat on the sidelines, to summarize their learning for the day. There may be a sense of hopelessness that the issue is intractable, but I’ll remind students that in issues of the social responsibilities of business, the choices rarely include “perfect” solutions, and that policy makers, from CEOs to Senators, look for the “best” solutions given the information they have.

I’ll close with this statement from Mr. Zuckerberg about trying to thread the needle: “First, let me say this. I care deeply about the democratic process and protecting its integrity. Facebook's mission is all about giving people a voice and bringing people closer together. Those are deeply democratic values and we're proud of them. I don't want anyone to use our tools to undermine democracy. That's not what we stand for. . . Now, I wish I could tell you we're going to be able to stop all interference, but that wouldn't be realistic. There will always be bad people in Copyright ©2022 John Wiley & Sons, Inc.

the world, and we can't prevent all governments from all interference. But we can make it harder. We can make it a lot harder. And that's what we're going to do.”i i

Mark Zuckerberg, Facebook Post, 21 September, 2017. Available at https://www.facebook.com/zuck/posts/10104052907253171, accessed 22 January 2018.

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Teaching Note

Uber Teaching Objectives The Uber case provides an overview of the rapid rise of Uber and the disruption that the company has wrought upon the ridesharing and food delivery industries. It also identifies many of the recent issues the company has struggled with, including regulatory hurdles, criminal acts by drivers, and claims of bias against women in its internal culture. The case ends with Dara Khosrowshahi pondering the future of Uber. The case discussion may proceed in several different directions depending on the needs of the class. Instructors may use the case to discuss disruption dynamics corresponding to Chapter 10 on innovation strategies. Here students can be invited to identify the particular elements of the Uber strategy that made it disruptive and to explore why taxi companies have had a hard time responding. The case can be used to address Uber as a growth company that is now beginning to diversify into related business lines, such as Uber Eats and others. Students should be able to identify an ultimate goal of Uber, such as becoming a ubiquitous, subscription-based supplier of a community’s transportation needs using autonomous vehicles. Instructors may wish to invite students to identify the “stepping stone” sequential investments that Uber could make to evolve itself toward that future. In this light, the case becomes a type of corporate strategy (Chapter 6) case, but in an innovative, tech-oriented context in which students will enjoy imagining alternatives for the company.

Preparation Questions 1. Why has Uber been so successful? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Why have taxicab companies had a difficult time maintaining market share in the face of Uber’s offering? Is Uber disruptive to taxicabs? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 3. What are the threats that face Uber? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 4. What could Uber do to deal with negative publicity? [AACSB: Ethics] [Difficulty: Medium] [Bloom’s 4 Analysis] 5. What is/should be Uber’s ultimate goal? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Copyright ©2022 John Wiley & Sons, Inc.

6. How can Uber become profitable in its ridesharing and food business? [AACSB: Analytic] [Difficulty: Hard] [Bloom’s 5 Synthesis] 7. What sequence of investments or actions should Uber make to achieve its goal?

[AACSB: Analytic] [Difficulty: Hard] [Bloom’s 5 Synthesis] 8. What are the next strategic steps for Uber? [AACSB: Analytic] [Difficulty: Hard] [Bloom’s 5 Synthesis]

Multiple Choice Questions 1. Why has Uber been so successful? a. The brand name b. Competing successfully with traditional taxis c. Accessing network effects brought about by smartphones d. The company culture Answer: c 2. Why have taxicab companies had a difficult time maintaining market share in the face of Uber’s offering? a. Taxis are more risky for passengers in terms of physical safety b. The convenience of network effects via smartphones has created efficiencies for customers that taxi companies cannot match c. Taxis lack price transparency d. Uber allows you to rate your driver Answer b 3. Is Uber disruptive to taxicabs? a. Yes, because Uber fits the disruption model by Christensen b. No, because Uber has no low-end foothold, and the business model is not based on new market expansion (ride services is a traditional market) c. Yes, because Uber has deeply changed the basic way that the service works d. Yes, because the causal mechanism for disruption is whether incumbents can easily copy the business model Answer d 4. What are the threats that face Uber?

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a. Claims of sexism and sexual harassment b. Competitors like Lyft c. Driver misbehavior d. All of the above Answer: d 5. What could Uber do to deal with negative publicity? a. Publicize steps the company is taking, such as hiring female executives and female engineers b. Post a statement on Twitter c. Deny culpability d. Create a catchy PR campaign against sexual harassment Answer: a 6. What is/should be Uber’s ultimate goal? a. Become the best rideshare service b. Beat competitors c. Revolutionize transportation d. Any or all of these Answer: d 7. What sequence of investments or actions should Uber make to achieve its goal? a. Invest in robotaxis b. Investments should carry the company toward whatever goal the company wishes to achieve c. Launch a local pilot service in Pittsburgh d. Purchase companies that specialize in driverless trucks Answer: b 8. What are the next strategic steps for Uber? a. Improve the company culture b. Improve public perceptions c. Continue the expansion of Uber’s services into adjacent markets d. It depends on Uber’s goals

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Answer: d

Teaching Plan I. Why has Uber been so successful?

II. Why have taxicab companies had a difficult time maintaining market share in the face of Uber’s offering? Is Uber disruptive to taxicabs? (Optional discussion) III. What are the threats that face Uber? What could Uber do to deal with negative publicity?

IV. What is/should be Uber’s ultimate goal?

V. What sequence of investments or actions should Uber make to achieve its goal?

VI. What are the next strategic steps for Uber?

VII. Key Takeaways

5-15 min 5-15 min

5-15 min 5-15 min 5-15 min 5-15 min 5-15 min

I. Why has Uber been so successful?

•

Several different factors may be discussed under this heading. Students may respond that the company is “cool,” “hip” or generally made for the millennial generation.

Obviously, the discussion can go much deeper, but these are, in fact, some of the reasons the company has been so successful. Millennials like riding Uber and business people have caught on to the trend. Somehow, the company has made its service “cool” to consume. The cool factor is no doubt related to the ability to conveniently summon a ride on a smartphone app, and to have a driver who is not a professional but rather a peer or member of the community.

•

Going deeper, Uber has been successful largely through its ability to build a two-sided market—a platform—and access network effects. The company has done this in the context of peer-to-peer sharing, a phenomenon that has grown dramatically since a majority of potential users came to hold a smartphone in the palm of their hands.

Furthermore, transportation services represent a mass market. The taxi ride experience in large urban centers has for years been substandard and variable. The experience of riders in taxicabs is typically impersonal. Riders of taxis often find themselves sequestered in a backseat with a wall of plastic separating them and their driver. Payment at the end of the ride is inconvenient and time-consuming.

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Communication with the driver may be inconsistent due to language barriers or a limited orientation of the driver toward conversation.

Building a two-sided market—a platform— requires a company to build both buyers and sellers (“two sides”). This is difficult because without sellers there will be no buyers and without buyers there will be no sellers. For this reason, successfully establishing a new platform can be expensive. Uber’s efforts to establish itself in China required the company to pay drivers while passengers rode for free or at deeply discounted prices, which led to a $1B loss. The company employed this approach in order to help riders become accustomed to the service in hopes that they would begin to use it.

•

Network effects, or more specifically, network externalities, arise when the value of joining a network increases in the size of the network. The larger the network, the more valuable it is for individuals to join. This increasing-returns-to-scale phenomenon drives the growth of many modern-day businesses. Facebook is perhaps the best example. With Uber as well, riders are more likely to try the Uber app in the presence of drivers, and drivers are more likely to select the app in the presence of riders. Therefore, as the number of drivers and riders increases, the value of any one rider participating in Uber rises. One could argue that this network phenomenon is present with taxis as well, but it really is not. With taxis, cities issue medallions to limit the number of cars available and all of those cabs are controlled by individual companies. Uber, on the other hand, uses non-professional, community-based drivers. Because there are no constraints to driver self-selection—the number of drivers and riders can grow together exponentially. Network effects power Uber but not local cab companies.

Uber diversified into businesses beyond ridesharing. The most apparent diversification came through Uber Eats. This new business has provided the company with a new revenue stream, and potentially a way to retain drivers by offering them greater earning opportunities. Customers may be more likely to remain with Uber because the company offers them more services, or “jobs-to-be-done.” Uber Eats helped the company weather the challenges of the Coronavirus pandemic. The company has also diversified into autonomous vehicles, particularly the software that would run these vehicles. Uber could certainly utilize this software in its own operations, and it may be able to generate revenue by licensing the software to others.

To summarize this discussion, instructors may simply want to list out the various reasons that students offer for the success of Uber while steering the discussion to bring out main points of smartphone convenience, peer-to-peer sharing, and network effects.

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II. Why have taxicab companies had a difficult time maintaining market share in the face of Uber’s offering? Is Uber disruptive to taxicabs? (Optional discussion) To begin this discussion, the instructor may want to ask if there is any evidence that taxis are on the decline based on the growth of Uber. Data in the case indicate that taxi market share has fallen dramatically in the face of competition from Uber. Exhibit 7 shows the proportion of business car expenses between 2014 and 2016. Uber and Lyft together account for nearly 50 percent of these expenses through Q2 2016 up from just 8 percent two years previously.

Taxi companies have had a difficult time competing with Uber for some of the reasons already mentioned. Network effects have led to rapid propagation of the Uber app.

Smartphone apps have personalized the service allowing riders to immediately order a ride.

The convenience of this motion has created efficiencies for customers that taxi companies have a hard time matching. Also, as mentioned above, many riders find the Uber ride experience to be superior to the taxi experience. Further, there is a perception among some users that an Uber will arrive more quickly than a cab after a call to a taxi company. Taxis seem to suffer by comparison to the Uber experience.

The instructor may want to apply the principles of disruption to answer the question of whether Uber is disruptive to taxicabs. According to Clayton Christensen, a disruptive technology begins at the low end of a market with an inferior technology and goes after customers overserved by mainstream offerings. In time, technology improves and moves up market as its growing capabilities appeal to more and more customers. Eventually, the technology enters mainstream market segments where it displaces incumbents with a new way of doing things. This is the classical disruption story. In Uber’s case, Clayton Christensen originally stated that Uber did not fit the disruption model and was therefore not disruptive.1 The reasons Christensen gave include that Uber (1) had no low-end foothold and (2) the business model was not based on new market expansion (ride services is a traditional market). Because of this, the technology was not disruptive, at least not in the way that Christensen had defined disruption. Here, instructors may want to lay out the principles of Christensen disruption (see Board Plan).

Another argument against disruption is that the service has remained largely the same.

Although the company offered different classes of service, the basic way that the service works has not changed. Therefore, one could say that the technology has not improved (some improvements to the app have been made), and that it has not moved up market in the classic sense of Christensen.

Nevertheless, most students will regard Uber as disruptive because the company “disrupted” the taxi industry using a dictionary definition of that term. More specifically, some students will regard Uber’s ridesharing technology to be inferior to taxicabs upon introduction, Copyright ©2022 John Wiley & Sons, Inc.

perhaps largely for the reason that the vehicles are privately owned and subject to a wide degree of variance in cleanliness and newness. It is important to note that Uber’s initial service was a black car limousine service. Therefore, at start up, it is difficult to argue that Uber offered an inferior product. Nevertheless, Uber black car service is not well known, and Uber really took off after it went peer-to-peer. This service seemed to disrupt taxicabs.

Despite earlier claims that Uber was not disruptive, Clayton Christensen seemed to change his mind a year later when he stated in Forbes: “Uber helped me realize that it isn’t that being at the bottom of the market is the causal mechanism, but that it’s correlated with a business model that is unattractive to its competitor. So yes, it is disruptive.”2 Christensen’s revised understanding of disruption in the Uber case is that coming in at the low-end of the market is not necessary. The causal mechanism for disruption, according to Christensen, is whether incumbents can easily copy the business model. In the case of taxicab companies, imitation is difficult. Taxicabs have many barriers to delivering an Uber-like experience; going through these in class may provide opportunities for students to think about this element of disruption (see Board Plan).

If students are familiar with Clayton Christensen and disruption theory, Christensen’s seemingly contradicting perspectives can help set up an interesting discussion. For example, the instructor could ask, “Would Clayton Christensen say that Uber is disruptive, yes or no?”

Lively debate could ensue before the instructor reveals that in fact both answers are correct.

This provides an opportunity for the instructor to clarify the mechanisms of disruption, Clayton Christensen style.

Ultimately, these debates may not matter much to students for the simple reason that Uber has obviously been successful and has obviously taken share from taxicabs. This reason alone makes Uber a very interesting and successful business to discuss aside from any considerations of whether it fits the textbook definition of disruption. Whether or not the company is regarded as “disruptive,” it is definitely innovative and its peer-to-peer sharing business model fits squarely into the latest trend of this type of innovative business model.

III. What are the threats that face Uber? What could Uber do to deal with negative publicity?

Profitability Threat Students should spend time with Exhibits 2 and 3. A good question to ask is “Is Uber losing more or less money as it grows?” A nice point of comparison is 2020 versus 2018. Revenues were about the same, but the company lost more than twice as much in 2020 as in 2018. The biggest differences on the revenue side are the growth in Eats and Freight. The major cost differences do not come from the cost of revenue, but from all of the corporate activities that support the system.

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Question: How does Uber make money, and what are the natural constraints on its business model, particularly in the Eats business? The major challenge for Uber is that there are plenty of substitutes for both ridesharing and food delivery. People can walk, use public transportation, do a longer-term rental, or buy their own car. The presence of so many substitutes puts a natural price ceiling on what Uber can charge. In the food delivery business, customers can dine in or take out. During the pandemic, many restaurants improved their take-out option. Again, the presence of many substitute ways of getting the job done will act as a constraint on Uber’s ability to raise prices.

Internal Threats Uber’s first, most public encounter with claims of sexism and sexual harassment came from a blogpost published on February 19, 2017, by Susan Fowler, a female engineer who had recently left Uber.3 The blogpost claimed that a male manager propositioned her soon after she joined the company and that, after reporting the incident, HR dismissed her concerns.

However, the blogpost went viral and soon the CEO, Travis Kalanick, responded forcefully by saying that the behavior Susan Fowler described was “abhorrent and against everything Uber stands for and believes in.”4 He went on to say that “anyone who behaves this way or thinks this is OK will be fired.” Despite this, new allegations continued to emerge. They seemed to reveal a culture that was fraught with sexism. One new revelation detailed how an Uber manager told a female engineering recruit that “sexism is systemic in tech,” implying in a sense that “it’s ok, everybody does it.”5 The case mentions this issue briefly but does not discuss it. However, it is important backstory should instructors wish to take the discussion in this direction. The blogpost set off a kind of reckoning at the company that led to departures of several senior executives and finally Travis Kalanick (CEO) himself. Senior executives departing during this period included Uber president Jeff Jones, who left because Uber was “incompatible” with his values; Brian McClendon, Uber’s vice-president of maps and business platform, who left for politics; and top engineering executive Amit Singhal, who left Uber five weeks after the company announced his appointment. Singhal had failed to disclose that he had left his previous job at Google over a sexual harassment allegation.6 Question: How could these events affect Uber’s strategy or ability to be successful?

Answers could range from: •

Affects the ability to hire talent

Copyright ©2022 John Wiley & Sons, Inc.

• •

Affects public perceptions and some customers will not want to be associated with the company Affects the ability of the company to be its most productive and innovative self since internal culture could have a chilling effect on individual contributors’ well-being

Question: How can Uber manage the public fall-out?

• •

Public apology and other statements from executives Publicize steps the company is taking, such as hiring female executives and female engineers; examining and revising internal promotion guidelines; implementing a zerotolerance policy for sexual harassment; etc.

Question: What can Uber management do to change the culture?

Here students might consider internal initiatives that could educate and inform in order to build a more inclusive culture. Taking the case in this direction ventures into change management terrain and instructors will need to decide whether they want to go this route.

It is worth noting that the sexual harassment issues facing Uber were a kind of early warning signal before the Harvey Weinstein debacle broke near the end of 2017 that opened wide a national debate on these issues. Clearly, the problem is systematic even if the problem is particularly acute in the male-dominated culture of Silicon Valley. The opportunity here is for instructors to connect such issues to the question of company performance from a strategic perspective. Clearly, the distractions, the personal offenses, the hostile environments that sexual harassment creates degrade not only employees but also company performance and are therefore highly relevant for strategy. Instructors can conclude this section by stating that companies everywhere must develop internal cultures that are inclusive and friendly for all employees if they want to perform at top levels.

Another internal threat to Uber is the issue that drivers are difficult to fully vet because they are independent contractors. Nearly anyone can “volunteer” to be an Uber driver by filling out a simple application online. Fortunately, Uber does require a Social Security number in order to perform a simple background check. Nevertheless, Uber drivers have committed several high-profile crimes that have led to loss of public confidence in the company. If riders perceive Uber to be unsafe, the company will suffer the results of lower performance.

Question: What can the company do to mitigate the risk that drivers commit crimes or cause customers to feel unsafe?

Answers here are straightforward, such as increase the level of background checking, or discontinue drivers immediately if they do not strictly follow rules and guidelines. The company should also be sure that it is including and promoting safety in its messaging in order to mitigate these downside risks.

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External Threats External threats include competition, public backlash, and government restrictions and regulations. The goal of this discussion is to identify whether any of the external factors pose a serious threat to Uber. Lyft, a company that, as the case points out, conducts a deep (7 year) background check and thorough screening for every driver candidate, has met head-on the negative publicity surrounding some Uber driver actions. By positioning itself as a higherquality choice, Lyft has convinced some customers that they are the better choice.

Nevertheless, Lyft remains a distant second place competitor behind Uber. As Exhibit 5 shows, while 11 percent of Uber customers use a competitor (Lyft?), 71 percent of Lyft customers use a competitor (Uber?). Instructors may want to ask students: Question: What would Lyft have to do to overtake Uber in market share?

May include lower price, increase quality, or hope for more tactical errors by Uber. The bottom line is that these companies are likely to coexist into the future and, barring serious mistakes by Uber, Lyft is unlikely to capture much in the way of additional market share. Part of the reason for this is the already-established network effect that Uber enjoys which creates a barrier to entry. While some switching has occurred, Uber remains dominant as a competitor and is likely to continue this dominance. Sidecar as a competitor left the market after receiving intense competition from Lyft and Uber.

The case outlines the serious difficulties that Uber had establishing itself in the Chinese market. Its largest competitor, Didi Chuxing, joined forces with Lyft to dominate the market and eventually drive Uber out. The case does not discuss why Didi Chuxing chose Lyft over Uber, but speculation would suggest that the reason pertains to the respective companies’ different approaches to the market. Uber appeared to “go it alone,” while Lyft sought out partnerships and executed its ride service through Didi Chuxing’s service network. Companies familiar with the issues involved in successfully entering the Chinese market understand that the most successful approach is to partner with a local Chinese company. While Uber employed partners for payment services, the company appeared to have bypassed partnerships in the implementation of its ride service. Instructors might ask: Question: What could Uber have done differently to be successful in China?

Answers include partnering with local firms for ride service and to do so before competitors become too large. As it was, Uber lost nearly $1 billion on its failed China strategy. Although not stated in the case, it appears that most of this money was lost trying to buy a two-sided market, i.e., heavily subsidize riders.

As an approach to discussion on competitors and competitive strategy, instructors might invoke the principles of competitive strategy in Chapter 11 of the text. In particular, these

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strategies can be applied from Uber’s perspective as a way to guide discussion toward what Uber can do to respond. The principles can also shape discussion about particular competitor approaches to Uber.

The four principles are: (1) Know your strengths and weaknesses; (2) Bring strength against weakness; (3) Protect and neutralize vulnerabilities; (4) Develop strategies that cannot be easily imitated or copied. One option for instructors is to write these principles on the board and ask students to identify answers for Uber in each category. This can help to identify an emergent strategy for Uber.

For example, Uber’s strengths include network effects, first mover advantages, and ubiquity with respect to brand awareness for customers. Its weaknesses include its culture, its relatively poor screening of drivers, and public backlash. These latter points are likely to be exploited by competitors. In other words, Uber should expect competitors to launch attacks at its weakest points. Indeed, Lyft has directly attacked Uber’s weakness of driver qualifications.

To bring strength against weakness of competitors, Uber should also identify the weaknesses of Lyft. These weaknesses include lower market share, less share of mind (brand familiarity), and higher prices (see nearly 33 percent higher prices from Lyft in Exhibit 4). To compete effectively against Lyft, Uber might bring strengths of brand awareness and lower pricing to launch specific promotional attacks on Lyft in local markets.

To protect and neutralize its own vulnerabilities, Uber should shore up its weaknesses in culture, reputation, and driver qualifications. Instructors may wish to discuss particular ways that the company can do this.

Lastly, instructors may want to discuss whether Uber has any strategies at its disposal that cannot be easily imitated or copied. Clearly, the case references Uber’s effort in autonomous vehicle technology. This is a strategy that will be difficult for its competitors in rideshare services to imitate. However, Google remains a formidable competitor in this arena. Another strategy that students might consider would be a corporate strategy in which Uber repeatedly launches related services in core or adjacent markets to build out a unique portfolio of offerings competitors cannot easily match. This approach provides instructors an opportunity to discuss principles of diversification and corporate strategy.

IV. What is/should be Uber’s ultimate goal?

Discussions on competitive strategy lead naturally to the question of what Uber’s ultimate goal should be. Students may offer a number of perspectives on this. These could include, “Become the best rideshare service”; “Beat competitors”; “Become the best place to work”; or “Revolutionize transportation.” The case makes it clear that something like the latter is

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probably Uber’s goal. In an extreme rendering of this goal, one can imagine that Uber would supply the entire transportation infrastructure for a city, including the delivery of an autonomous vehicle to riders upon request, supplying a subscription service that eliminates the need for personal car ownership.

Regardless of the goal that students decide upon, the important point is to chart a series of sequential moves that would allow Uber to achieve that goal. This is the essence of strategy: Creating a plan to achieve a goal or result, which is usually competitive advantage. Thus, to help students create a strategy for Uber during the discussion, it would be important to first identify a worthwhile goal (perhaps through voting once a list is created), and then second to brainstorm the steps to get there. Students could do this in small teams and later report out to the class, or the instructor may wish to take the entire class through the discussion together.

V. What sequence of investments or actions should Uber make to achieve its goal?

The case deliberately takes the discussion in the direction of sequence by speculating on Uber’s ultimate goal and also providing Exhibit 11 which is a list of sequential investments that Uber has already made in extending its core service in various directions. The spirit of the exercise on sequence is to identify “What’s next?” The answers should carry the company toward whatever goal the instructor or students wish to achieve. If that goal is to revolutionize transportation infrastructure, for example, logical steps would be some of those already undertaken and described in the case, such as investing in software and human resources, launching a local pilot service in Pittsburgh; and purchasing Otto, the driverless semi-truck company. As the case points out, Uber seems to want to own the software for autonomous vehicles, but not necessarily the vehicles themselves. If students agree that this is an appropriate direction (and it may be the subject of debate), logical next steps include creating alliances with makers of vehicles or licensing software to such companies, points that the case briefly mentions. Other steps would include negotiating with local governments to operate its fleet, possibly in Pittsburgh, and fully proving out the concept of robotaxis.

Here it is worth noting that Tesla may be coming at this opportunity from a different perspective—that of having personal car owners employ integrated Tesla software to enroll their cars in a robotaxi network while they are at work. This threat, combined with Google’s investment in driverless technology, implies that Uber’s efforts will be fraught with competition at every step.

Some students may not agree with the ultimate goal of revolutionizing transportation infrastructure. In fact, some students, and investors as well, may be more comfortable with Uber simply continuing to incrementally expand services into adjacent markets. This is certainly a viable approach to strategy routinely pursued by companies. Students may want

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to brainstorm or supply various opportunities for expansion that they see. One way to evaluate which of these opportunities should be pursued first under an incremental strategy is to test them against two dimensions: a cost dimension and a customer dimension.

Specifically, ask the question whether a proposed new service shares costs with existing services. New services that share costs with existing services will be both more efficient to launch and potentially more successful because they access well-developed capabilities. On the customer dimension, students might consider whether new offerings can access the experience that existing customers or customer segments have had with other Uber services.

For example, once users of the rideshare service were familiar with the smartphone app and the way that the Uber service worked, layering in Uber Eats, a food delivery service, was an easy matter for the company. Plotting possibilities on a graph defined by a cost and a customer axis may allow instructors to take students through a ranking process in which activities to the upper right are likely to be the most successful new launches. This activity can provide a sequential set of activities that the company could strategically pursue.

VI. What are the next strategic steps for Uber?

This segment provides students with the opportunity to think creatively and look into the future. This discussion should refer back to the “ultimate goal” discussion for the company and should go beyond the implementation steps in the last segment of the discussion. This discussion can be framed with a question: What should be keeping Dara Khosrowshahi up at night? Students will create a list of things, which leads to the final question: Question: Do you think the goal and steps (or activities) we have identified are sufficient to help Mr. Khosrowshahi sleep well at night?

By looking back at the strategy developed in this way, students may be able to identify additional factors that should be included, such as improving the culture, improving public perceptions, or continuing the expansion of Uber’s services into adjacent markets. The instructor may wish to circle key elements of this more complete strategic view on the board as a way to summarize the strategy.

VII. Key Takeaways The key takeaways from the case include: • • • •

Culture can have a negative effect on company performance.

Public perceptions and reputation need to be managed carefully.

The key to disruption is to launch a business model that competitors cannot easily imitate.

Building a profitable business model is hard work and evolves over time.

Copyright ©2022 John Wiley & Sons, Inc.

• • •

Strive for innovation in business models and employ network effects where possible.

Employ principles of competitive strategy to win against competition.

Think about ultimate goals and sequential steps to create strategy; or sequentially expand from a core into adjacent services that leverage cost and customer experience to grow.

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1

Christensen, Clayton M., Michael Raynor, and Rory McDonald. "What Is Disruptive Innovation?" Harvard Business Review 93, no. 12 (December 2015): 44–53.

2

Christensen, Clayton M., “Clayton On What He Got Wrong About Disruptive Innovation,” Forbes Oct. 3, 2016.

3

https://www.susanjfowler.com/blog/2017/2/19/reflecting-on-one-very-strange-year-at-uber. https://www.theguardian.com/technology/2017/feb/20/uber-urgent-investigation-sexual-harassment-claimssusan-fowler.

5 https://www.theguardian.com/technology/2017/mar/24/uber-manager-sexism-systemic-tech-kamilah-taylor.

6 https://www.theguardian.com/technology/2017/mar/20/uber-president-quit-as-firm-was-inconsistent-with-hisvalues.

4

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Teaching Note

Tabitha’s Way Local Food Pantry: Entrepreneurship in Feeding the Hungry Teaching Objectives Tabitha’s Way Local Food Pantry: Entrepreneurship in Feeding the Hungry has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use near the end of the course in conjunction with a module on strategy implementation. The material in the case can also be used to highlight social entrepreneurship. This note assumes the instructor is either using, or is familiar with Strategic Management by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in industry analysis and familiarity with concepts of strategic alignment and change as discussed in Chapter 12 of that text. The case can also be used to discuss concepts in Chapter 14 on Social Innovation.

This case provides students with the opportunity to understand the role of passion and mission in starting a social venture, analyze how and where entrepreneurs obtain the initial resources to start their ventures, see the growth pattern and sequential problem-solving process that all entrepreneurs go through, apply the 7 S model of organizational alignment to describe how an organization evolves, and consider the challenges of future growth and expansion.

At the end of this case, students should be able to describe the different sources of passion and mission that motivate social entrepreneurs, explain the process through which entrepreneurs obtain resources to start their ventures, identify how growth creates a new set of challenges for an entrepreneur to solve, use the 7 S model to describe how an organization evolves and grows, and relate a coherent, logic-based recommendation for future growth.

Study Questions 1. How important was Wendy’s “call from God” in making Tabitha’s Way a success?

[AACSB Ethics] [Difficulty: Easy] [Bloom’s 1 Knowledge] 2. What are some unique challenges that Wendy faced in growing the food pantry?

[AACSB Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension]

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3. As a consultant, which of the issues Wendy is considering should she pay attention to first? Why? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 3 Application]

Multiple Choice Questions 1. How important was Wendy’s “call from God” in making Tabitha’s Way a success? a. Not important, Wendy is not religious b. Somewhat important, Wendy had support from a church c. Very important, Wendy did not have any experience forming a non-profit and likely would not have persisted through difficulties d. Wendy did not receive a call from God “Answer”: C

2. What are some unique challenges that Wendy faced in growing the food pantry? a. It took Wendy several years to finally develop a system for training and deploying volunteers b. Developing logistics for collecting, inventorying, and distributing both food and clothing c. Creating sophisticated measurement and accounting systems d. All of the above “Answer”: D 3. As a consultant, which of the issues Wendy is considering should she pay attention to first? Why? a. Leadership - managing the organization’s culture b. Network Development - finding ways to transplant what worked well and doesn’t need customization c. Operational Management - leveraging learning across the two sites d. All of the above “Answer”: D

Teaching Plan

I. The Challenges of Food Insecurity II. Wendy Osborne and the Founding of Tabitha’s Way Copyright ©2022 John Wiley & Sons, Inc.

10 min 10 min

III. Implementing the Vision and Growing the Business IV. Expansion V. Conclusion

40-45 min 15-20 min 10 min

This case was written to help students understand the challenges of strategy implementation; the use of a social venture provides a different, and particularly challenging context. Because the real value of the case lies in helping students understand the challenges that come after having a great idea, the 7 S model, as outlined in Chapter 12 of the textbook, provides a solid framework to discuss the case. Before diving into the specifics of Tabitha’s Way, however, I like to invite students to think about the “industry” of hunger, and how the nature of hunger and food insecurity will shape the particular challenges Wendy will face.

I. The challenges of food insecurity Question: “What type of problem is Hunger? What are its causes?

Students should identify Hunger (technically defined as food insecurity) as a complex, multifaceted problem that arises from multiple sources: low income (which has its own chain of causes), health issues (both physical and mental), social and economic conditions (recessions, local booms and busts), social group (refugees, migrant workers), changes in location, changes in family status. The data on the effects of food insecurity on children may lead to some impassioned comments by students about the importance of solving the problem, but the real value of that data comes as it helps students see that hunger, like many problems, creates complex and multifaceted consequences. Hunger creates physiological, psychological, and social problems for individuals and families.

Question: How can people solve a problem like Hunger? What type of solution is Tabitha’s Way? The broad question about finding solutions to food insecurity can be effectively refined by asking students “is all food insecurity the same?” In the very short-term sense, hunger is hunger, but in a longer term view it’s important to sort out episodic vs. chronic hunger.

Solving episodic hunger entails giving people food to meet their nutritional needs. Episodic food insecurity presumes that individuals and families have, fundamentally, the resources they need to feed their families, and hunger is the result of an interruption of those resources.

Solving chronic hunger has proven elusive—the problem is complex and intertwined with other social problems. The challenge for those working on hunger is to avoid scope creep and overreach—delving into helping people in areas where one has little competence. So, organizations fighting against hunger must be extremely disciplined to focus on providing food but avoiding the pull of clients with needs that extend far beyond food.

Copyright ©2022 John Wiley & Sons, Inc.

Question: What type of venture is Tabitha’s Way? Is the organization supply- or demand-driven?

In terms of entrepreneurship, one can think of two types of ventures: supply-driven and demand-driven. Many new ventures are supply driven in that they develop a new product or service and then search for a set of customer needs that lead to a profitable market. They begin with supply and have to create demand.

Another set of ventures begin with a known, unmet demand and work to create the supply to meet it. For these ventures, the set of needs is often well known, customer groups exist and may be clearly identified. The challenge for these entrepreneurs lies in creating supply in such a way as to create a profitable (or sustainable) market. Food insecurity is a problem with clear demand, and the challenge for Tabitha’s Way was to bring together “supply” in a way that created a sustainable market and solution.

Sustainability in this sense would mean two things: the sustainable provision of food to the hungry (as opposed to numerous one-off events such as Thanksgiving dinners) by a sustainable organization (one that has enough input resources to exist over the long haul).

One implication of being a demand-driven business is that a food pantry is an inherently local business. The weight and nature of food products means that transporting food efficiently requires either huge scale (think of a Walmart distribution center), or a very local market. Of necessity, Tabitha’s Way chose the latter.

II. Wendy Osborne and the founding of Tabitha’s Way For students who come from a faith tradition, the notion of a divine calling will likely resonate. For those coming from a more secular background, the idea of a divine calling may be a foreign concept, but one worth pursuing in discussion. Rather than ask about the religious foundations of Tabitha’s Way, I begin this segment by asking:

Question: How did Wendy’s passion and sense of transcendent mission influence her work? Why does passion matter for entrepreneurs?

Belief, and the passion that it begets, is a critical element for success in any type of high-risk venture. Wendy faced a number of very high hurdles; she had no experience running an organization or dealing with the particular issues of food insecurity. Without a sense of mission and the passion it engenders, she would likely have given up.

Charles Duhigg, in his bestselling book The Power of Habit, writes about the success of Alcoholics Anonymous in helping people overcome the alcohol addictions. He writes:

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• •

“Alcoholics who practiced the techniques of habit replacement, the data indicated, could often stay sober until there was a stressful event in their lives—at which point, a certain number started drinking again, no matter how many new routines they had embraced.

“However, those alcoholics who believed [ ] that some higher power had entered their lives were more likely to make it through the stressful periods with their sobriety intact.

“It wasn’t God that mattered, the researchers figured out. It was belief itself that made a difference. Once people learned how to believe in something, that skill started spilling over to other parts of their lives, until they started believing they could change.” (p. 84-85)

Wendy was engaged in doing something quite different from giving up an alcohol addiction, but there are important similarities here. Like alcoholics wishing to change, Wendy had no little knowledge of how to proceed, had a set of habits that needed to be changed and new skills to learn, and Wendy would face significant stress and hardship on her journey to begin Tabitha’s Way. Without a deep sense of calling, it’s unlikely that Wendy would have persisted long enough for Tabitha’s Way to succeed.

Question: In what ways was Wendy’s lack of knowledge helpful as she began the pantry?

In many ways, her lack of experience may have actually helped her succeed. First, without any idea of the difficulties in the details of operating a food pantry Wendy failed to see—and be stopped by—many barriers that would have stymied people with prior knowledge. Second, she was not bounded by accepted protocols, rules, or customs about “how things ought to be done.” Put simply, she didn’t have to unlearn routines, she only had to learn new ones.

Question: “What do you think of Wendy’s decision to forego government funding?”

There’s no right answer here: some will think it foolish to leave “money on the table” when starting a venture. Others are likely to agree with her logic, and note that government funding, unlike the money from selling clothes, often comes with constraints about how the money might be used. Regardless of the wisdom of such a move, the decision to operate as a private entity meant that Wendy was now a social entrepreneur, not just the administrator of a non-profit. She had to both run the pantry and create a sustainable way to pay for it.

III. Implementing the vision and growing the business In this section, I focus less on the details of each element of the case, setting up and running the clothing business or running a food collection and distribution business, and focus on how Tabitha’s Way developed its unique structure and competencies.

Question: In terms of the McKinsey 7 S framework, which S came first at Tabitha’s Way? Copyright ©2022 John Wiley & Sons, Inc.

I’ll invite student responses, and most of them will fall into two S’s: Strategy or Shared Values.

For those who answer that Strategy came first, I’d ask the follow-on question “is feeding the hungry an organizational strategy?” Wendy began with a goal, but hardly a clearly defined strategy about how to accomplish that goal. If we think about Tabitha’s Way’s strategy in late 2015 or 2016, we would see a clear set of activities and resource commitments: • • • • •

An effective system for grocery rescue and other food intake Operating funds through the clothing donation bins and resale Volunteer labor to keep costs down A tight focus on food, not operating a thrift store A strong set of community relationships

In many ways, Tabitha’s Way provides an excellent example of what Henry Mintzberg referred to as emergent strategy—a set of resource commitments, capabilities, and decisions that happen over time and create a coherent organizational strategy.

So, if Tabitha’s Way did not begin with Strategy, it began with Shared Values. The transcendent (divine) framing of the Wendy’s passion clearly exists as a value. The case documents how, from the beginning, the shared belief and value of God’s call to create the pantry had a polarizing effect—people tended to react with scorn or support. In a way, acceptance of and commitment to the transcendent mission helped Wendy sort out potential partners and resource providers—many of them self-selected through their disbelief. A Christian mission also provided Wendy with access to social networks and other resources available through faith-based networks (she received supplies for the thrift store from another ministry). This made it eminently easier and less costly to find those willing to help.

The other important Shared Value was concern for the hungry and a commitment to fighting food insecurity. Members of the secular community—from the Utah Food Bank to the local school district and the local business community. Leaders did not have to buy in to the religious origins of the foodbank, the shared societal value of compassion toward the hungry motivated many in these groups to action.

Style, Staffing, and Skills These are the other elements of the Soft Square—come next as we build out a 7S map of Tabitha’s Way. There’s not much direct data on the case about Wendy’s style, but there are clues in the case. I’ll ask a student or two to describe what they think Wendy’s Style would be.

The most likely responses include things like: committed, willing to listen and learn, high energy, flexible, and humble. While many of these would become shared within the organization over time, Wendy exemplified each of these traits for others to follow. I like to ask a follow-up question about Style, “would you be willing to work with someone like Wendy?” For many students, her commitment, flexibility, and willingness to learn outweigh concerns about her original lack of competence.

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Staffing came first from Wendy’s immediate social network: family and friends. As word of the organization grew and the pantry opened, there is little evidence that recruiting individuals to enroll with Tabitha’s Way was a constraining problem. Training volunteers and Board Members was another issue, however. It took Wendy several years to finally develop a system for training and deploying volunteers. In many new organizations, there is an “all hands on deck” mentality where everyone does everything. While this works for a while, as the organization grows, dealing with staffing issues, particularly training, become more important. Over time, the division of labor and specialization enables growth and scale; all hands on deck becomes a recipe for mediocrity or failure.

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Skills developed at Tabitha’s Way out of necessity and could be classified primarily as “logistics.” Tabitha’s Way become adept at collecting, inventorying, and distributing both food and clothing. The case narrative describes the challenges each activity entails, and how the organization developed a resource set (trucks, trailers, and buildings) and capabilities/ routines (daily and weekly pickups) to handle the logistical challenges of the business. The other major skill of Tabitha’s Way would be “marketing and development.”

Wendy, with no previous experience in sales, had no fear of approaching community resource providers to obtain what she needed. She learned very early to “multi-task” with the events—using them to provide needed goods to her clientele and attract funds and potential volunteers.

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The hard triangle elements of Strategy, Structure, and Systems, evolved late in the game and arose both of necessity but also because the organization finally had time and the skill to develop these elements. As discussed above, Strategy emerged over time.

Structure evolved slowly, for the first couple of years the organization was small enough to handle everything through personal interaction and communication: there seemed to be little need for a formal structure. With the advent of employees and the division of labor, as well as the increasing scale of the organization, a structure emerged to help the organization solve key problems it faced.

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Herbert Simon and James March noted back in 1958 that an organization’s structure represents the encoded solutions to problems the organization faced. Tabitha’s Way exemplifies this. One challenge of structure is that it arose to solve yesterday’s problems; when new problems and unfamiliar challenges appear, the current structure may no longer be appropriate.

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Systems at Tabitha’s Way also developed late, and again in response to the problems the organization faced. As the committee structure took hold, systems around volunteer recruiting and training emerged, as did more sophisticated measurement and accounting systems. These systems were still fairly new as the organization began to consider the expansion challenges presented at the end of the case. Wendy knew that these systems

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were “bottom-up” creations, and that caused her some concern about both the new building and the new location.

IV. Expansion: Physical and Organizational With a way of describing Tabitha’s Way that makes sense for Strategic Analysis, the class can now pivot and consider what Wendy should do and be concerned about going forward. The preparation question for the session that asked students to think about which issue Wendy should pay attention to first is a great way to start this discussion.

Question: As a consultant, which of the issues Wendy is considering should she pay attention to first? Why? It’s helpful to frame this discussion for what it is: The challenge of scaling a venture. The challenges that Wendy faces are ones common to all entrepreneurial ventures as they grow and succeed. I like to remind students that more ventures fail because they can’t effectively scale than fail because they can’t find an initial market. While the specific issues have to do with a food pantry, the general principles will apply across many different venture settings.

I like to let this discussion be student-driven as it gives them a chance to put themselves in Wendy’s shoes. I focus on the Why question and like to have several minutes of discussion about whether the leader begins with their own behavior (changes in style), leveraging social resources in building new networks, or in focusing on the operational challenges of modifying the 7 S model for a new physical and geographic location. There are great arguments for each one, and the stakes are pretty high—the ability to provide help for thousands of additional families.

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For those choosing leadership, it seems that Wendy must become much more focused on “doing the right things” in the new organization. To this point, Tabitha’s Way has largely operated informally, with the commitment to the shared value—transcendent or practical—as the glue that held the organization together. Wendy’s ability to rally an expanded, and probably expanding, organization around Shared Values will be her most important task. In that light, Wendy would be well advised to step away from an operational role and focus her energy on managing the organization’s culture.

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For those choosing network development, the challenge for Tabitha’s Way will be finding ways to transplant what worked well and doesn’t need customization. It seems that the events, including the HFAN, should work well in the new setting. Relationship building will take time, however, and significant energy on the part of Wendy and the Board. It’s easy for leaders to forget how much time and energy they actually spent developing relationships and there is a natural impatience at having to begin again.

Wendy would be well advised to spend lots of time in this area and not get frustrated as she sorts through a new set of partners.

Copyright ©2022 John Wiley & Sons, Inc.

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Finally, for those choosing operational management, the important thing to focus on here will be leveraging learning across the two sites. The reality that some students will recognize is that the physical layouts of the two locations will be more similar than they are different, in terms of loading docks, cold storage, warehouse space. The default tendency may be to “import” what has worked in Spanish Fork, but the American Fork location will have to modify much of what worked in the South to fit a new layout and clientele. When the new Spanish Fork location opens in 2017, it may be American Fork that exports knowledge, structure, and systems.

V. Conclusion After a lively debate about how to position Tabitha’s Way for the future, I conclude the session by asking 2-3 students to summarize their learning points and key takeaways.

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Teaching Note

Netflix: Battling Redbox, Amazon, Hulu, Disney+ and Others in Home Movie Entertainment Teaching Objectives This case is intended to be used to help students see how disruptive new strategies (where companies use very different business models) can change the nature of competition. In particular, it shows how Netflix disrupted the traditional video renting industry by mailing DVDs directly to customers (and later through streaming) instead of having customers come to a store/kiosk to rent them. The case also examines the entry of new streaming competitors, Amazon, Hulu, Disney+, and how they are competing with Netflix.

The case allows for a rich discussion of how different business models offer different value propositions. Beyond discussing how different business models deliver different value propositions, the case allows for a discussion of make vs. buy strategies. In particular, Netflix (along with Amazon and Hulu) have backward integrated into content creation in order to have a differentiated entertainment offering.

Interestingly, Disney+, Paramount, and Peacock (NBC Universal) have forward integrated into distribution with their own streaming platforms.

This teaching note is divided into three sections. The first reviews the strategies and business models of Blockbuster, Redbox, and Netflix. The purpose of this section is to set the stage for comparing business models among the three firms. Therefore, during this section, it may be useful to help students map out how each business model delivers value to customers. It may also prove useful to examine the costs associated with each model.

The second section compares the advantages and disadvantages of each firm’s business model. Most importantly, this section should help students understand that comparing companies on measures such as return on sales (ROS) may not give a clear “apples to apples” comparison of performance when the firms being compared employ different business models. This section outlines how return on assets/capital employed (ROA or ROC) can be a better measure. It uses that measure to compare the performance differences between Blockbuster, Netflix, and Redbox.

The final section discusses Netflix’ strategy in comparison to other streaming competitors, such as Amazon, Hulu/Disney+, etc.

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Materials Case, New Business Models from Netflix, Redbox, Hulu, and Others in Home Movie Entertainment Preparation Questions 1. What is a business model? How is a business model different from strategy (or how does it fit into strategy)?

2. What is Blockbuster’s strategy and business model?

3. What is Netflix’s strategy and business model?

4. What is Redbox’s strategy and business model?

5. How does Netflix’s business model differ from Blockbuster’s?

6. What advantages does Netflix gain from its different business model over Blockbuster and Redbox?

7. How does Redbox’s business model differ from Blockbuster’s?

8. What advantages does Redbox gain from its different business model over Blockbuster?

9. Let’s assume that both Blockbuster and Netflix had the same return on sales. If you had to choose one, which would you choose to invest in? Why? 10. What is the Return on Assets/Capital employed (ROA or ROC) for Redbox, Netflix, and Blockbuster?

11. What recommendations do you have for Netflix competing with Amazon, Hulu/Disney+ Apple, HBO, Paramount, Peacock, etc. for online streaming?

12. How might others try to unseat Netflix as the leader in streaming?

Note: Possible Team Assignment: Estimate the cost advantage (as a percentage of sales) that Netflix had versus Blockbuster renting videos in 2000 and 2005. What areas do you think are contributing most to the cost advantage? In addition to comparing operating profits for the two companies, estimate the return on capital (operating profit/capital employed) for both Netflix and Blockbuster in 2005. We are interested in the long-term investment in the business, which suggests that we can define capital as Total Assets minus Cash.

Teaching Plan I. Blockbuster, Netflix, and Redbox Business Models 30 min II. Comparing Performance of Business Models 10 min III. Netflix vs. Streaming Platform Competition 20 min I. Comparing Business Models

Copyright ©2022 John Wiley & Sons, Inc.

This case is about new business models in home entertainment.

Question: What is a business model? How is a business model different from strategy (or how does it fit into strategy)?

Because this case is focused on the business models of Blockbuster, Netflix, and Redbox, it is important that students understand how to define a business model.

Business model definition: The rationale of how an organization delivers and captures value. More specifically, business models typically differ on one of three dimensions: a) The choice of customer segments to serve and the unique value (value proposition. b) The choice of activities the company performs and the resources utilized to deliver value to customers. c) The way a company generates revenue streams to get paid for the value it delivers.

Think about the four key questions of strategy: • Where to compete?

• What value proposition to offer?

• How to deliver that value proposition?

• How to capture value and prevent imitation?

A business model does a good job at helping strategists answer the last three questions. It does not provide insight into “Where to compete?” Moreover, while it describes the pricing strategy/revenue model, it provides little insight into the fifth question of strategy on how a firm can create barriers to entry/imitation.

Question: What is Blockbuster’s strategy and business model?

Strategy •

Market o Home entertainment/videos

•

Unique Value o Convenient to access immediately (assuming a store is close) o Access to a moderately large library of titles (roughly 1,000/store)

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Resources and Capabilities o At their peak they had nearly 9,000 stores. They also made heavy investments in developing their brand

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•

Barriers to Imitation o None except for initial investment in infrastructure (stores, warehouses, etc.)

Blockbuster Business Model

Estimate of cost of business model: Warehouses: Estimate at 5 percent of total store investments: $135 million Stores: $200k-$400k each, depending on location. If average is $300k, the total cost to build 9,000 stores is roughly $2.7 billion.

Inventory: If each store has 1,000 titles that turns over every quarter, at $6/Video, Blockbuster must invest roughly $270 million each year in inventory.

Labor: If each store requires two employees to operate, and each employee works roughly 2,000 hours/year at $10/hour, annual labor cost is roughly $36 million/year.

Question: What is Netflix’s strategy and business model?

Strategy •

Market o Home entertainment/videos

•

Unique Value o More than 90,000 titles o Convenient (DVDs are sent directly to your home) o More attractive to frequent renter

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Resources and Capabilities o 50 warehouses o Fulfillment capability o Technology (easy to use website) o Relationships with movie studios o 97 percent of customers within 1-day distance of 50 shipping points

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Netflix Business Model

Estimate of cost of business model: Warehouses: At $5 to $10 million each, total warehouse cost is $250-$500 million, assuming roughly 50 warehouses, or one per state Shipping Points: At $2 million each, total shipping point cost is $100 million Question: What is Redbox’s strategy and business model?

Strategy •

Market o Home DVD

•

Unique Value o Convenient for the impulse user (doesn’t require a subscription to use) o Low price

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Resources and Capabilities o Kiosks (47,000) located throughout the United States

Redbox Business Model

Estimate of cost of business model: Kiosks: At $15,000/kiosk, all 47,000 kiosks cost roughly $700 million. Assuming roughly 50 warehouses at $1 million each, warehouse costs could be roughly $50 million Question: How does Netflix’s business model differ from Blockbuster’s?

Copyright ©2022 John Wiley & Sons, Inc.

While some aspects are similar, such as receiving content from film distributors and storing that content in warehouses, Netflix differs in that it removed the need for actual stores by shipping DVDs directly to customers (see graphic below).

Question: What advantages does Netflix gain from its different business model over Blockbuster and Redbox?

Cost advantages due to no investment in stores, labor, and inventory. This reduces equity investment and dramatically increases return on capital.

Convenience advantages because customer transaction costs are reduced (they can order at home instead of going to a store).

Selection Advantages due to a wider selection of products (90,000 titles at Netflix vs. only 1,000 titles at a Blockbuster store).

Information advantages (for product selection) allows for the creation of a database of customers with insight into revealed customer preferences (captured electronically).

Question: How does Redbox’s business model differ from Blockbuster’s?

In a similar manner to both Blockbuster and Netflix, Redbox receives its content from film distributors. However, it differs by allowing customers to go to kiosks to pick up content (instead of using stores or home delivery).

Copyright ©2022 John Wiley & Sons, Inc.

Question: What advantages does Redbox gain from its different business model over Blockbuster?

Cost advantages due to less investment in stores, labor, and inventory (kiosks are less expensive than stores). This reduces equity investment.

Convenience advantages because it is able to have more kiosks (5 × more) than Blockbuster is able to have stores.

Selection disadvantage due to limited space in a kiosk. Redbox can have 100-200 titles available in one area with multiple kiosks while Blockbuster can have up to 1,000 titles available in one store.

II. Different Business Models—from Netflix, Blockbuster, and Redbox—offer Different Levels of Performance.

Question: Let’s assume that both Blockbuster and Netflix had the same return on sales. If you had to choose one, which would you choose to invest in? Why? The purpose of this question is to help students understand that the return on sales comparisons isn’t incredibly useful if the two different companies are employing different business models. Most students will understand this intuitively (by choosing Netflix as their investment choice). At this point, it may be useful to compare the return on capital of Blockbuster and Netflix (see the charts at the end of this teaching note for figures and comparisons).

Question: What is the Return on Assets/Capital Employed (ROA or ROC) for Redbox, Netflix, and Blockbuster?

Because Blockbuster, Netflix, and Redbox utilized different business models, comparing return on sales does not give a clear picture of how the performance of each firm compares to the others. Instead, comparing the return on capital makes it Copyright ©2022 John Wiley & Sons, Inc.

easier to see how well each model uses the capital invested. The charts below show the return on sales, return on assets, and return on capital for each firm.

Definitions Return on Sales—Operating profit/Total Revenue Return on Assets—Operating Profit/Total Revenue Return on Capital—Operating Profit/Capital Employed Capital Employed—Total Assets – Cash and Cash Equivalents

Return on Sales for Blockbuster, Netflix, & Redbox 40%

30%

20%

Blockbuster Netflix

10%

Redbox 0% 1993

2000

-10%

-20%

Return on Sales = [Operating Profit] / [Total Revenue]

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2005

2010

2013

Return on Assets for Blockbuster, Netflix, & Redbox 40%

30%

20%

Blockbuster Netflix

10%

Redbox 0% 1993

2000

-10%

-20%

Return on Assets = [Operating Profit] / [Total Assets]

Copyright ©2022 John Wiley & Sons, Inc.

2005

2010

2013

Return on Capital for Blockbuster, Netflix, & Redbox 40%

30%

20%

Blockbuster Netflix

10%

Redbox* 0% 1993

2000

2005

2010

2013

*Redbox ROA is used in place of ROC

-10%

-20%

Capital = [Total Assets] – [Cash & Cash Equivalents]

III. Netflix vs. Streaming Platform Competition Question: What recommendations do you have for Netflix competing with Amazon, Hulu/Disney+ Apple, HBO, Paramount, Peacock, etc. for online streaming?

This question allows for a discussion of the different streaming platforms. Which ones are in the strongest positions? Do any of them have any differentiation advantages?

Differences in resources and capabilities among firms include differences in number of subscribers, in capability to create content, in brand awareness/value, in technology capabilities, etc.

Netflix currently has the largest subscriber base and the most original content. We might expect that advantage to keep Netflix in the lead for the foreseeable future.

One important question to address is: How many different streaming platforms are most individuals willing to purchase? If most individuals are not willing to purchase more than 2 or 3 streaming platforms, then that means many of the platforms will fail unless they can figure out an alternative (free?) revenue model.

Question: How might others try to unseat Netflix as the leader in streaming?

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A typical pattern in this situation is that the various competitors vie for position. The weaker ones end up merging or being purchased by the stronger competitors as the market consolidates to the number of streaming options that customers are willing to pay for. So competitors may try to merge and team together to overtake Netflix. This may allow the competition to develop more, and more desirable, content (assuming they combine their resources and capabilities, and this produces some synergies).

A second way that Netflix could lose its leading position is if a competitor is able to provide a “bundled” free offering where users get the video streaming content they want for free because they are purchasing other services (e.g., Amazon Prime).

Another way that Netflix could lose its leading position would be if a new competitor launched a superior technology for accessing and viewing home entertainment content. This would only work if Netflix was unable to develop or imitate the new technology.

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Teaching Note

Intel (A): Dominance in Microprocessors Teaching Objectives Intel (A): Dominance in Microprocessors. This case has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use early in the course in conjunction with a module on internal analysis.

This note assumes the instructor is either using, or is familiar with, the Company Diamond© model for identifying a firm’s resources, capabilities, and sources of competitive advantage. That model is found in Chapter 3, Internal Analysis, of Strategic Management: Concepts and Tools to Create Real World Strategy by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in industry analysis and should be familiar with important micro-economic concepts such as economies of scale and marginal cost. Students should be able to use the Company Diamond© to identify the historical and current sources of Intel’s competitive advantage in the semi-conductor industry. The case allows students to see how the different elements of the diamond interact to create a strong competitive advantage for Intel. Students should also understand the competitive dynamics in the industry, such as the role of economies of scale, the importance of second source agreements, and the process of technological “leapfrogging” that competitors in this industry use. Finally, students will evaluate Intel’s current position and potential threats as executives viewed the situation in 2005. The instructor should invite students to think about what the future looked like for Mr. Otolleni and Intel in 2005, not as they may retrospectively view it in light of the rise of tablets and smartphones.

At the conclusion of this case, students should be able to use the Company Diamond© strategy tool to analyze the historical and current sources of a company’s competitive advantages, and explain how the different elements of the diamond interact to reinforce and strengthen competitive advantage. They should also employ industry analysis tools to identify the level of fit between the economic structure and dynamics of an industry and a firm’s strategy for responding to those elements. Finally, they will recommend a viable course of action to help a company improve its competitive position in a changing marketplace.

Study Questions

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1. What are Intel’s competitive advantages in 2005? Where did those advantages originate and how have they changed over time? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. What factors determine success in the semiconductor industry? How has Intel responded to these important factors? [AACSB: Analysis] [Difficulty: Medium] [Bloom’s 2 Comprehension] 3. If you were Paul Otolleni, what would keep you up at night in 2005? What opportunities and threats does Intel face as he begins his tenure as CEO? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation]

Multiple Choice Questions 1. What are Intel’s competitive advantages in 2005? a. Intellectual property and intellectual capital b. Strong management principles c. World class manufacturing d. All of the above Answer: “D” 2. Where did those advantages originate and how have they changed over time? a. These advantages originate from the resources and capabilities that Intel has built over the years b. These advantages originate from the environment and have not changed over time c. These advantages originate from the values and priorities of Intel and have changed over time d. Both answers (a) and (c) are correct Answer: “D” 3. What factors determine success in the semiconductor industry? a. Very high barriers due to regulation prevent entrants b. There are very limited suppliers and buyers in this new industry c. There is no threat of substitution at the component level d. Competitive rivalry is low, which enables companies to create a competitive advantage Answer: “C”

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4. How has Intel responded to these important factors? a. Intel produced its first chips in a converted factory without cleanrooms, advanced equipment b. With the rise of the PC, retail consumers now became a viable and approachable market segment c. Intel’s relentlessly used to legal means to protect its important intellectual property d. All of the above Answer: “D” 5. If you were Paul Otolleni, what would keep you up at night in 2005? What opportunities and threats does Intel face as he begins his tenure as CEO? a. Rise of mobile computing b. Rise of Web 2.0 technology c. Cost of source materials d. Nothing Answer: “A” Teaching Plan I. Industry Analysis II. Intel’s Competitive Advantage III. Otolleni’s decisions IV. Conclusion and Key Takeaways

25 - 30 min 25 - 30 min 10 - 15 min 5 - 10 min

I. Industry Analysis Question: How does a company make money in the semiconductor industry?

There are three major areas of discussion for this case, and the preparation questions will prepare the students for a discussion based on these elements. The instructor can begin by using either the Company Diamond® or 5-forces model to analyze Intel or the industry. I choose to begin with an industry analysis because I find that setting the industry context, and understanding the core economic drivers that influence profitability and advantage, provides a solid platform to help students better understand the causes and consequences of Intel’s actions.

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Alternatively, you can use a more directed question that invites students to use the 5forces model to analyze the industry. Whichever opening the instructor uses, he/she should be sure to place this discussion in 2005. The instructor can use the board to create a five forces map and then invite students to fill in the blanks.

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Barriers to Entry • Huge fixed costs of Fab’s ($2.5 Billion) • Huge R&D expenditures (From exhibit 3 we see that Intel spent $5 Billion a year on R&D) • Long development cycles across generations • Brand name and equity (Intel inside, AMD competing with Athlon, etc.)

• Economies of scale and learning curves Supplier Power • Basic product inputs negligible (Silicon and transistors) • Engineering labor abundant • Equipment manufacturers build to specification

• • • • •

Competitive Rivalry Global competition Homogeneous products Price competition within any generation Lawsuits and hardball tactics to stall competition High exit barriers

Buyer Power PC Manufacturers Retail Consumers • Microprocessors are critical • Microprocessor not purchased inputs separately • Buy on technical • Buy on brand or reputation, specifications/ superior chips unaware of technical specifications • Many PC Manufacturers vs. few microprocessor suppliers • Little knowledge of products • No second source requirements

Substitutes • No viable substitutes to microprocessors

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Four important details should emerge from this analysis. First, in 2005 the Microprocessor industry looks very attractive. Very high barriers to entry limit the number of potential competitors to firms with deep pockets and some industry knowledge. Suppliers have very little power in the industry, as do buyers. There is no threat of substitution at the component level. Competitive rivalry is quite high, which raises the question whether individual companies can create a lasting competitive advantage.

Question: How things have changed since the early days of the industry?

Three changes stand out. 1) The rise of barriers to entry. The costs of fabrication and R&D have gone up substantially. Intel produced its first chips in a converted factory without cleanrooms, advanced equipment, or all the process quality controls it would later adopt. By 2005 these plants were a world unto themselves, with clean room technology and sophisticated equipment and process controls. Intel’s branding campaign created another barrier to successful entry into the industry. 2) Buyers had become two segments. Until the 286 chip arrived on the scene, Intel and its competitors sold only to technical specialists and business executives. With the rise of the PC, retail consumers now became a viable and approachable market segment. 3) The change in the nature of competition. Intel’s relentless use of legal means to protect its important intellectual property transformed the industry from one where trade secrets were rarely secret to one where security and confidentiality were important competitive advantages.

Question: What larger forces may be in play?

The case notes that overall demand for microprocessors is cyclical. When the economy slows down, business buyers and retail consumers curtail their upgrade schedules of hardware and software. The instructor can point to Exhibits 3 and 4 to illustrate this cyclicality. The instructor should note that during the downturn in 2001, Intel largely maintained their R&D and Capital Expenditures: companies that win must invest well in advance of demand.

Fourth, the cost structure of production—the lion’s share of costs is incurred before the first chip comes off the line—means that volume is the key to success in this industry. Anything a company can do to create volume sales, from a branding campaign to locking in customers across generations, will insure profitability.

II. Intel’s competitive advantages

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Question: Why does Intel win in the microprocessor industry?

Students may give a number of rather generic responses, which the instructor should list. The instructor may choose to list only those reasons that could be considered “activities” within the Company Diamond. These may include “making great products,” “holding a huge market share,” “volume sales,” or “continuous innovation.” Students may also comment on the pricing structure that Intel uses, pointing to the data around the 386 and how Intel garnered great returns from sole sourcing.

Question: How does Intel win? What resources and capabilities drive Intel’s competitive advantage?

Again, student responses will be quite varied; however, the following items should appear on the list: • Intellectual property and intellectual capital (Bob Noyce and Gordon Moore) • Strong management principles (Andy Grove’s attention to discipline and detail and constructive confrontation) • World class manufacturing • “Two-in-a-box” product development teams to focus on design and implementation • Great engineering talent • Strong incentive compensation systems • Brand • Technology strategy that builds on platforms and then a proliferation of products (P6 generates a number of processors) • Capability of product generations that fit together (e.g., from 286-386) • Cash—the ability to fund heavy investments in R&D and process technology (Fabs) • Relentless innovation and willingness to cannibalize their own sales (386, 486, and Pentium) • IP protection and legal acumen • Focus on certain segments, willingness to exit others • Cost structure of production. It may be particularly useful to point out how semiconductor cost has decreased as cumulative volume increases (see Exhibit 5 in the case). Each time Intel’s cumulative output has doubled, their average cost per unit decreased between 11.7% and 25.7%. If students calculate an experience curve using the data in Exhibit 5, they will find that cost per unit drops 20.2 percent with each doubling of volume (see graph below).

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With this list complete, the instructor can move one of two ways. The instructor may begin to link the resources and capabilities with the activities they underlie. For example, huge market share could be linked to brand, the technology strategy, product generations, or relentless and constant innovation. The goal here is to help students understand that Intel’s activities would be difficult for competitors to copy because those activities build upon very unique and valuable resources.

Alternatively, the instructor may choose to focus on values and priorities at Intel.

There are four that seem to drive all of what Intel does: • The purpose of the company is to make money (Gordon Moore) • Innovation and attention to quality (Intel is noted for product leadership) • Discipline (Andy Grove’s personal values) • An overwhelming desire to win (see the “Crush” campaign) It is important to link these priorities and values to the creation of resources and capabilities. The focus on profit helps explain why Intel would abandon memory chips even though that was a significant legacy product. It also helps explain why product generations are so important and why Intel is willing to cannibalize its own sales in pursuit of innovation.

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Whichever route the instructor pursues, this discussion should close with a board with a number of lines connecting the areas of activities, resources, and priorities. Students should see that competitive advantages don’t “just happen,” nor are they built quickly and easily. Intel’s core values of money making, extreme discipline, and relentless innovation can be traced back to the company’s beginning in 1968. I always emphasize that all that Intel has become, for good or bad, flows from its fundamental values and priorities.

III. Otolleni’s decisions At this point the instructor can fruitfully address the issue of what Intel should do going forward.

Question: What should Mr. Otolleni do and what would you do if you were CEO of Intel?

The challenge facing Mr. Otolleni in 2005 is that Intel is on top of what appears to be a very profitable industry. Exhibit 4 shows that PC shipments grew in 2005 at over 15%, their highest growth rate since 1999. While the growth is impressive and would be the highest year over year growth since that time, students may note two “clouds” on the horizon. First, the rise of mobile computing represents a change in the industry.

Mobile computing relies on a processor that connects to the internet wirelessly and Intel’s Centrino processor is only two years old. Second, the rise of Web 2.0 technology appears to continue the trend for the internet to become more central in the daily lives of the global population. To the extent that people continue to access the internet from desktop or laptop PCs, Intel seems well positioned to continue its dominance in the industry.

The obvious strategy for Intel is to essentially do nothing in terms of changes. Intel seems to be a well-oiled machine that continues to produce winning products that maintain its competitive position. Students may not think that “do nothing” is a viable strategy. If students don’t point this out, then the instructor can ask about the viability of a “do nothing” strategy. The instructor should follow this question with one about the benefits and risks of pursuing this strategy to help students think critically.

Question: What strategic changes would you make at Intel?

Responses can be listed and discussed. Again, the instructor should push for critical thinking skills in identifying both the potential gains and losses from various strategic changes.

Question: What should Mr. Otolleni do?

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By calling on a different group of students to answer this question, the class can explore the constraints facing Mr. Otolleni that they might not have thought of as outsiders. Students may note that as the first non-engineer to run Intel, Otolleni may face real pressure from others if he chooses to radically change Intel’s strategy.

Typically, students will recommend that Otolleni follow a more conservative course of action than they chose.

Question: What actually happened?

While access to data in the case is somewhat limited, as one looks at Intel’s later performance, they seem to have chosen to make no significant changes to their strategy, at least for a while. The instructor can conclude by noting that students will visit Intel again later in the course and see how Intel responded to the changes in the industry caused by the rise of tablet computing and smart phones.

IV. Conclusion and key takeaways Question: What did they learn from the case and what their key takeaways were?

I’ll ask 3-5 people, from different sections of the room, to answer this question and then I’ll open up the floor for more responses. The things students learn during a discussion will vary tremendously and will often differ from the “official” learning points an instructor chooses to make. The instructor can follow-on to any non-obvious or interesting learning points by probing the student as to why that learning point might be valuable, or how that might apply in other areas of study or business practice.

I see two “official” learning points that instructors can make. The first regards the linkages between industry structure and the generation of competitive advantage.

Competitive advantage comes to those who garner the greatest volume, and most of what Intel has done since 1968 has been designed to make it the highest volume producer in the industry. Intel makes money, at the end of the day, because they figured out the rules of the game and mastered them. Through their actions with the Intel Inside campaign they actually changed the nature of the industry. This point can be reinforced later with the discussion on competitors.

Second, I like to point out the value of the models the students are learning. The 5forces model allows them to meaningfully describe the industry and to see how the industry has changed and evolved over time. The Diamond model, on the other hand, helps students categorize information they learn about a company into a coherent picture of that company. The diamond also helps students see the complexity of competitive advantage. One of the benefits of taking a course in strategy, as opposed

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to “going it on your own,” is the acquisition of models and tools that help make sense of the business world and how a company can/should effectively respond.

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Teaching Note

Intel (B): Responding to the Smart Phone Threat Teaching Objectives Intel (B): Responding to the Smart Phone Threat has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in the middle of the course in conjunction with a module on corporate strategy. This note assumes the instructor is either using, or is familiar with, Strategic Management: Concepts and Tools to Create Real World Strategy by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in industry analysis and familiarity with concepts of dynamic, Schumpeterian competition will greatly facilitate the overall discussion of the case. If the instructor has previously used Intel (A), the purpose of this case is to provide students with an opportunity to revisit a very successful company, and to see how the company responds to new challenges.

Instructors should examine the rise of ARM as an alternative business model, illustrate the challenges of using acquisition as a strategy to compete in a market, evaluate the logic and rational of the McAfee purchase and provide students with an opportunity to critically evaluate Intel’s assumptions, capabilities, and resources, offering their assessment of the success of the acquisition.

At the end of this case, students should be able to identify and explain the environmental and internal challenges facing Intel in 2013, describe the differences in the business models of ARM and Intel, explain Intel’s assumptions for the McAfee purchase, and evaluate the potential of success for the acquisition and identify actions Intel managers should take to make the acquisition successful.

Study Questions 1. Why did Intel fail to capture share in the emerging market for tablets, ultralights, and smartphones? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. How does the ARM business model differ from Intel’s? As you look at the long term, how would you evaluate Intel’s chances of competing effectively?

[AACSB: Analytic] [Difficulty: Medium] [Bloom’s 4 Analysis] 3. How effective has Intel been at responding to the ARM threat? Why has Intel diversified into software? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 6 Evaluation] Copyright ©2022 John Wiley & Sons, Inc.

4. What is the rationale for the McAfee purchase? Do you believe the acquisition will create value for Intel and its shareholders? Why or why not? [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions 1. Why did Intel fail to capture share in the emerging market for tablets, ultralights, and smartphones? a. Intel invested too much in R&D b. Intel focused too much on performance c. Intel did not focus on power usage d. Both (b) and (c) are correct Answer: “D” 2. How does the ARM business model differ from Intel’s? As you look at the long term, how would you evaluate Intel’s chances of competing effectively? a. ARM focused on low power usage b. ARM pursued a relentless focus on design c. ARM ensured backward compatibility d. ARM produced chips in house Answer: “A” 3. How effective has Intel been at responding to the ARM threat? Why has Intel diversified into software? a. Not effective, it only took Intel 4 years to develop the Atom chip, and when Atom hit the market, it outperformed ARM b. Not effective, Intel largely resorted to stripping out transistors and features of its x86 product family c. Effective, Intel’s long-standing policy of backward compatibility meant that the chip could not radically depart from what came before d. Effective, backward compatibility makes a lot of sense in the mobile and tablet markets Answer: “B” 4. What is the rationale for the McAfee purchase? a. McAfee fulfills Otelleni’s vision of the three pillars b. Security seems to be less important to mobile device users

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c. As history suggests, security will be a major point of value creation going forward d. The acquisition of McAfee fits into Intel’s overall strategy of acquiring small competitors Answer: “C” 5. Do you believe the acquisition will create value for Intel and its shareholders?

Why or why not? a. Yes, because Intel has paid a handsome price for the second-best company in the industry b. No, because the ability of Intel to create synergies with such a large target is not apparent c. No, because Intel has never done this before d. Yes, because McAfee and Intel have no poor habits that will hinder them Answer: “B”

Teaching Plan I. Intel’s Failures II. The ARM Business Model III. Intel Responds to ARM IV. The McAfee Acquisition V. Conclusion

20 min 10 – 15 min 30 min 10-15 min 5-10 min

The instructor can safely follow the preparation questions as an overall teaching plan.

The instructor may choose to begin with question 1, or he/she may choose to focus students on the eventual highlight of the case: the probability of success in the McAfee acquisition If the instructor chooses this opening, he/she may ask two or three students: Question: In your opinion, was the McAfee purchase a good move by Intel?

The instructor should call on enough students to obtain 2-3 reasons why the acquisition may be a good strategic choice, and an equal number of reservations.

Regardless of the opening, the instructor should move quickly (within 5 minutes) to question 1.

I. Intel’s Failures

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Question: Why did Intel fail to capture share in the emerging market for tablets, ultralights, and smartphones?

The instructor may wish to briefly present the central concept from Clayton Christensen’s work on disruptive innovation. These ideas can be found in The Innovator’s Dilemma, HBS Press, 1997. In a nutshell, ARM created a product that Intel’s current customers did not value.

Intel had, since the first days of creating the microprocessor, committed to a strategy that valued performance as the most important metric. If the instructor has used the Intel (A) case, he or she can refer to Exhibit 2, which displays the growth in the number of transistors on each new generation of chips. The number of transistors determines the performance capacity, and the energy utilization, of a chip. As the PC and server markets have developed over the years, customers valued high performance chips.

Intel, with its massive investments in R&D, fabrication, and marketing naturally dominated this market. ARM represented a “low end” disruptor by creating and bringing to market a chip with features that Intel’s customers would not value.

Unlike the classic disruption, however, ARM did not continually upgrade its technology to eventually surpass Intel’s leading chips. In this case the market itself shifted; a new market segment emerged that highly valued ARM’s low energy usage. The new market valued and “untethered” experience with their devices; constant power had been a necessity in the PC days, but having to stop and recharge a phone or iPad proved a substantial nuisance. The students will see the story in terms of technology quite simply as they are users of these devices and intuitively understand the value of low power utilization.

What students may see less clearly, however, is the alignment of the Intel business model around its high-performance chips. To bring out these points the instructor may fall back on the discussion generated in the Intel (A) case. To slavishly follow Moore’s law and reap the gains from continually improving chip performance, Intel had to build its entire business to fit with this objective. That meant: •

•

Relentless focus on design, engineering, and process improvement. Intel began its next generation of chip design when the current generation came to market, if not before. Thus, Intel incurred huge R&D costs in creating generations of chip families. Recovering these investments required selling high volumes of high margin chips.

A commitment to backward compatibility. From its earliest days, Intel created a next generation of chips that could still operate software designed for its earlier generations. This allowed customers a clear migration path and reason

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•

•

•

•

to stay with Intel; however, the strategy tied Intel’s hands in terms of its opportunity set in designing new chips.

Producing chips in house to capture high margins. Outsourcing production or chip marketing would cut costs for Intel, but would also mean they would share margin with other producers, eroding markings.

Huge investments in process technologies and fabrication facilities (fabs). At upwards of $5 billion per fab, Intel had substantial sunk costs in a chip family before it even came to market.

Protection of intellectual property. As the sole provider (since the 80386 generation), Intel had to constantly guard against it losing its core intellectual property to others. Intel ruthlessly enforced its patents, which made licensing core technologies unthinkable for the company.

The development of a very strong, arrogant culture. Intel had invented the microprocessor, and events in its history like the “Crush” marketing campaign had convinced Intel of the quality of its products and the company’s prowess in the marketplace. Such a culture, by 2005, could easily explain both how Intel missed the emerging smartphone market and why it would suffer from the NotInvented-Here (NIH) syndrome.

At the close of this discussion, the students should understand that the problem for Intel lies in its core business model, not merely in technology. If it were merely a question of technology, Intel’s resources and capabilities should allow it to quickly overtake ARM in the market.

II. The ARM Business Model The case contains information about the operating and financial model used at ARM. ARM chooses to focus solely on design of new chips and chip sets and then license them to producers around the globe. The instructor may reference the data in Exhibit 2 to begin this discussion. 2012 shipments for PCs were 350 million units. If we assume that Intel sold every chip in this market, which it does not, that would still constitute just over 22% of ARM’s output of 8 billion chips. How does the ARM model work? It rests of two pillars: 1. Design chips and chipsets. ARM devotes all of its resources in the design of increasingly sophisticated, yet low power, chips.

2. License designs to others for production. In this way, ARM avoids the entire cost structure that Intel incurs: production, fabrication, transportation, etc.

Question: How well does this model perform?

A comparison between Exhibits 1 and 3 reveals some key differences. Note that ARM spent just over $160 Million on R&D compared to $10 Billion for Intel. Of course, ARM’s

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revenue is substantially lower that Intel’s; however, they earn that revenue with far less financial investment and risk than Intel.

Question: Which mode will win long term?

The ARM model appears strong, yet it has some drawbacks as well. Internally, the ARM ecosystem prospers as long as the chip designs continue to gain market acceptance. If Intel, or some other manufacturer, can erode ARM’s share, then contract producers may move away from production. While it seems unlikely that the system would collapse, ARM manufacturing partners have little reason—no sunk costs—to stay with ARM should the chips begin to falter.

Externally, one wonders about how long low power utilization will be the most important factor in mobile technology markets. The long-term historical trend in technology indicates that customers prefer higher performance, all else equal.

Changes in battery technology or demands for consumers for more sophisticated and feature-rich mobile applications would all tend to favor Intel and its preference for performance over power.

Regardless of the long-term potential of the ARM model, Intel faces a strong and facile competitor in the mobile device market. The next question considers Intel’s effectiveness in responding to the ARM threat.

III. Intel Responds to ARM Product Development (10-15 Minutes) As the case describes, Intel responded by focusing on product development and they adopted a strategy of acquisitions. The instructor may ask a small group of students to evaluate Intel’s Atom product. Based on the discussion above, students should identify that the Atom project faced several constraints from its inception that would limit the chip’s ultimate potential.

Intel had a difficult time responding to the technological challenges presented by ARM. It took them 4 years to develop the Atom chip, and when Atom hit the market, it struggled to merely match the power usage of ARM. Intel largely resorted to stripping out transistors and features of its x86 product family.

Question: Why did Intel revert back to a previous architecture to build the Atom?

Two reasons suggest themselves. First, Intel’s huge sunk costs in its fabrication facilities allowed it to produce the Atom chip with very little new capital investment;

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however, minimizing fabrication costs meant that the Atom chip would need to be as close as possible to existing Intel designs to forestall capital investments in new process technologies.

Second, Intel’s long-standing policy of backward compatibility meant that the chip could not radically depart from what came before. The demand for backward compatibility meant that the Atom chip would have to be larger and more powerful in order to run a host of x86 applications. The instructor may note that backward compatibility made very little sense, particularly in the mobile and tablet markets.

These devices had no history with Intel chips, and backward compatibility added very little value to these users. Backward compatibility would only appeal to ultra-light producers, and this segment was the smallest of the three emerging segments. The data in Exhibit 4 show that the Atom chip is unlikely to propel Intel to competitive success in the mobile device market.

Question: Why did Intel produce a chip that would only appeal to ultra-light product manufacturers?

Such a question gets at the core of the business issue and highlights Intel’s culture, mindset, and strategic orientation toward its existing PC business. While we don’t know for sure, one plausible answer to this question would be that Intel understands the basics of competition in the ultra-light market, but they do not in the smartphone or tablet market. They designed for a market they were comfortable with, not one that held the greatest profit potential.

Acquisition strategy (15-20 Minutes) Intel responded to the threats to its business by buying a number of software companies.

Question: What resources is Intel exploiting in its purchases of these software companies?

Most of the acquisitions are small companies; indeed, Intel did not release purchase price data for most of these acquisitions. Intel’s core capability lies in hardware. The instructor should push students who see Intel exploiting its hardware capabilities in any of these acquisitions. Intel may claim to sell more hardware because they provide software and support, but this does not answer the question of how Intel will compete in mobile devices, since they have very little presence in this market. Simply put, it’s difficult to see how Intel is exploiting its core resources and capabilities by entering the software market. Intel’s sales in software approach $2 Billion annually, making them one of the top ten software vendors. $2 Billion is less than 4% of Intel’s total

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revenue; it becomes hard to argue that software will represent a huge growth business for Intel.

Question: How do these acquisitions enhance Intel’s resources and capabilities?

A close look at the twelve companies Intel purchased reveals very little systematic or strategic overlap between these companies. Intel appears to have purchased software vendors with a variety of skills, but in a variety of markets. One writes in Russian, a couple write for the gaming market, one in visual recognition, and two in security.

Most of these are small companies as students will discover if they search for any of these acquisitions on the web. It is unlikely that any of these vendors brings a large trove of intellectual property or deep skills to Intel, and it becomes difficult to create a scenario where all of these acquisitions create a strong competitive position in any market segment.

Question: How well known is Intel in visual recognition applications? What type of portfolio would Intel have to acquire to create a competitive advantage through acquisition?

The correct response here is a set of small, or large, acquisition targets that clearly exploit Intel’s current strengths in hardware. An example of this would be Intel’s presence in supercomputing; software offerings there probably do help sell Intel silicon. The other correct answer would be to assemble a portfolio that allows Intel to create a competitive advantage in some clearly definable, winnable segment. Some of their acquisitions appear to create such a beach head in gaming; however, as gamers in the class may note, competitors in this market possess resources (game developers, titles, brands), and capabilities (creating serial offerings) that Intel does not seem to possess.

Question: How does Intel deal with companies once they acquire them?

Intel fully integrates (Buries), partially integrates (Blends), or allows the acquisition to operate as a standalone entity (Bolt on). Integration seems difficult for Intel as the NIH syndrome means that acquisitions end up being discarded rather than usefully integrated. With the Wind River purchase, however, Intel chose to operate the company as a standalone, bolt on acquisition. While this allowed Wind River to operate successfully, the lack of integration limits the ability of Intel to create true and valuable synergies.

IV. The McAfee Acquisition

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The focus of the case now turns to the McAfee acquisition, the largest in Intel’s history.

The acquisition certainly holds promise: Otelleni’s vision of the three pillars is almost certainly correct. Security, however, as yet seems to be less important to mobile device users; however, as history suggests that security will be, if it is not already, a major point of value creation going forward. The acquisition has several downsides, however. Intel has paid a handsome price for the second-best company in the industry, and the ability of Intel to create synergies with such a large target is not apparent. Intel has never done this before. On the positive side, they have no poor habits that will hinder them; on the other hand, they have no positive experience to draw on.

The instructor may choose to simply work through the questions listed at the end of the case. They provide a framework for getting at the core issues in the acquisition.

The instructor should focus some attention on the Bolt-On nature of the acquisition.

Intel hopes to create some valuable synergies and bring to market an entirely new product class. Doing so suggests the need to work much more closely, and in a very collaborative fashion, with the software teams at McAfee. Such close collaboration seems unlikely if the two companies operate independently. Students may note that the culture at Intel may mean that such collaboration is unlikely to occur in any case.

Question: What would you do differently in order to maximize the value of the acquisition?

Some students may respond that they would sell McAfee as it has little chance of succeeding. The instructor should ask how shareholders win when an expensive acquisition sells at a likely loss. Others will suggest tighter integration with Intel. The instructor should probe here about what types of integration would be likely to work.

For example, how would McAfee, at 4% of revenue, effectively compete for the resources it needs, and create the collaboration that would realize a hardware-based security platform.

V. CONCLUSION The instructor should ask 2-3 students to summarize their learning from the case.

There are many lessons that could be identified, and a wise instructor will reinforce and supplement the students’ own takeaways. The instructor may summarize the discussion by highlighting the following points: • Companies, like Intel, may dominate at one phase of industry competition, but be displaced in the next generation.

• The causes of displacement may be external (the market choosing a new set of important competitive dimensions) or internal (complacency, corporate inertia).

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•

Acquisition is an expensive strategy and should be guided by concerns about exploiting current resources or enhancing and creating new ones.

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Teaching Note

Amazon Versus Walmart: The Battle for Online Dominance Teaching Objectives The Walmart and Amazon case was written in recognition that Amazon had become the largest online retailer in the US, and yet by all rights, that title should’ve gone to Walmart because they are the largest retailer in the US. Students should come to class prepared to discuss the question that Duke himself wonders at the end of the case introduction.

Study Questions 1. What was Walmart’s online strategy and how did it evolve over time? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Why was it so hard for Walmart to get going online, meaning to build significant revenue? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 3. What was Amazon’s strategy during the time when Walmart was struggling in the last decade? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 4. What was the motivation for Amazon to begin adding additional products?

[AACSB: Analysis] [Difficulty: Medium] [Bloom’s 2 Comprehension] 5. What should Walmart do now? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions 1. What was Walmart’s online strategy and how did it evolve over time? a. The online channel was not integrated in Walmart’s operations but later online and retail were integrated b. The online channel was not integrated and it remained a separate business model c. The online channel was integrated with retail and it later became a separate business model

Copyright ©2022 John Wiley & Sons, Inc.

d. The online channel was integrated and eventually became Walmart’s only business channel Answer: “A” 2. Why was it so hard for Walmart to get going online, meaning to build significant revenue? a. A tension or belief in the viability of online as a real business b. The fact that everyone was distracted by the main business model and online didn’t really play into that very well c. Walmart was also trying to expand internationally d. All of the above Answer: “D” 3. What was Amazon’s strategy during the time when Walmart was struggling in the last decade? a. Originally, Bezos intended to use bookselling as a platform for other products b. Jeff Bezos had designs on world domination or at least generating a $70 billion retailing company c. By mid-last decade, Amazon had clearly moved aggressively into categories beyond books and adopted a strategy of becoming a retailer to the world d. Bezos saw the internet as a means to develop a brick-and-mortar presence that could rival large retailers Answer: “C” 4. What was the motivation for Amazon to begin adding additional products? a. Amazon saw huge upside potential in distribution efficiencies b. They weren’t making money in books c. They needed to expand market share in retailing d. They wanted to serve as a distributor for small third-party firms Answer: “B” 5. What should Walmart do now? a. Move into China b. Retreat from online retailing c. Have on-demand ordering d. Use return customers and deliver directly basic daily goods

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Answer: “D”

Teaching Plan I. Walmart in E-Commerce II. Amazon Boots Up III. What Should Walmart Do Now? IV. Key Takeaways V. Conclusion I. Walmart in E-Commerce

20 min 10 – 15 min 30 min 10-15 min 5-10 min

Question: Why has Walmart not been able to make greater inroads online? Where did Walmart go wrong?

Walmart got online in 1995 at about the same time Amazon did, along with much of the rest of the business world. This was right as the Internet was taking off commercially. Walmart already had an entire infrastructure of goods that they could sell online, yet for the next twenty years they get beaten year after year in online retail by the Amazon upstart. Furthermore, Walmart is being beaten by a company that in the beginning was only selling books. Perhaps this is why Walmart didn’t seem to see the threat. Perhaps the reason is that nobody really believed Internet commerce would be that big in 1995. In spite of this, what the case makes clear is that Walmart knew they should be in the online market, but they just couldn’t execute organizationally. It wasn’t the main business so few at the company seemed to care about the online channel.

As evidence of the company’s comprehension of the need to be online, Walmart.com operations were moved to Silicon Valley. That seemed to work for a short period of time, but it was eventually pulled back into Walmart, apparently for the reason that the company figured they should be integrating their online business with their retail business. But this notion didn’t seem to occur to management for too long a period of time and when it finally did, Walmart.com was woefully behind.

Walmart should’ve recognized much earlier, as any good strategist would, that they have some resources and capabilities that should be leveraged, not ignored. They seemed to ignore the fact that they had this gigantic distribution system; they seemed to ignore the fact that they had massive store footprint the world over; they ignored the fact that they had brand cache; they ignored the fact that they had scale in purchasing, which delivered low prices. All of these resources could have and should have been employed as part of comprehensive online strategy much earlier.

Copyright ©2022 John Wiley & Sons, Inc.

Meanwhile, Amazon was taking off in book selling and then adding category after category until they had become a full-line retailer online. At the time of the case, Amazon has $70 billion+ of revenue against Walmart.com’s $9 Billion.

What’s interesting at the end of the case is that with Walmart.com finally beginning to leverage their brand, their infrastructure, and their shipping and fulfillment capabilities, along with other established resources, Amazon begins to recognize that they don’t have some of the resources that Walmart seems to have, and this starts them scrambling a bit. For example, they don’t have distribution centers like Walmart does.

Walmart is starting to look like they could even beat Amazon in the area of rapid delivery where a customer orders online and doesn’t have to wait three days. A customer can order online and go pick it up that afternoon, or somebody pulls up in a truck and delivers it to the customer that afternoon. In fact, Walmart is now testing this model in China having purchased a company, Yihaodian, in which they do rapid turnaround for online ordering and delivery. A customer orders, and within a couple of hours somebody shows up at their residence with their order.

Walmart may have the resources to move in that direction in certain markets in the United States as well. Amazon, now seems to be saying, “If that’s where this market is going, we really don’t have the infrastructure; we’ve been relying on the postal service.” It appears that Walmart has resources that are going to trump them, and therefore Amazon seems to be looking to invest in areas, such as drones, that could finally get faster deliveries going.

Question: What will it take for Walmart to finally participate in the e-commerce revenues at a rate more consistent with its dominant retail store presence? In particular, just how could it finally beat Amazon?

Class discussion can follow the study questions. In doing so, it will be important to bring out a number of themes about competitive strategy: •

Each of the companies begins with (or builds) key competencies for their main markets – Walmart for traditional retail, and Amazon for online retail, and then leverages these strengths for benefit; these strengths in turn begin to look like traps near the end of the case. Key point: leverage strengths but be flexible as environment shifts.

•

Internal organizational issues seemed to lie at the heart of Walmart’s difficulties.

Myopia created by the need to drive a traditional retail business, and the

Copyright ©2022 John Wiley & Sons, Inc.

accompanying inability to perceive how to integrate Walmart.com left Walmart floundering online for years.

•

At 1/7th the size of Amazon, Walmart.com will need some radical thinking in order to catch up; ironically, they may already have the infrastructure and capabilities to do this, but Amazon’s growth doesn’t seem to be slacking.

Question: What was Walmart’s online strategy and how did it evolve over time?

What should emerge from that conversation is a contrast between online as a distinctive channel or distinctive business, and online as an integrated aspect of operations.

Question: Why was it so hard for Walmart to get going online, meaning to build significant revenue?

The answers that would come back could be: • A tension or belief in the viability of this as a real business, the fact that everyone was distracted on the main business model, which is retail stores and retail sales, and online didn’t really play into that very well. This all led to a starving of resources in the early days from Walmart.

• You may also want to bring up that at this time Walmart is also trying to expand internationally. Their focus is on bricks and mortar in Germany and other parts of Europe.

II. Amazon Boots Up Question: What was Amazon’s strategy during the time when Walmart was struggling in the last decade?

This discussion presents a good opportunity to compare and contrast the strategies of the two companies and the specific moves they make to enhance their competitiveness.

It is important to note that Amazon’s original strategy was to sell books. In the beginning Jeff Bezos just wanted to start a company online and take advantage of the Internet. He was literally just going through product categories thinking about what would be a good thing to sell online and he just decided to do books based on some criteria he developed. Bezos simply signed up a wholesale book company and distribution system and basically put a store front on the web.

Copyright ©2022 John Wiley & Sons, Inc.

Jeff Bezos in the mid-1990s did not have designs on any kind of world domination or $70 billion general retailing company. I can’t imagine that he could have even envisioned that at that time, that was not his aspiration. I’m going to assert that he was just trying to get into this market and see if he could make it work. Amazon had these strategies that did not recognize the ultimate power of this as a channel and delivery system, and if they had been able to look ahead, I think that things would’ve been a lot different.

Things would certainly have been different for Walmart. Perhaps Bezos couldn’t have gone beyond books in the very early days even if he had wanted to (no knowledge or infrastructure), but Walmart definitely could have been much more thoughtful about online as a channel and integrated delivery with its main business than they were.

By mid-last decade, Amazon had clearly moved aggressively into categories beyond books and adopted a strategy of becoming a retailer to the world.

I go through that history and characterize how Walmart was looking at online.

Question: How did they see this opportunity?

They seemed to see it as something interesting to dabble in and maybe get a few sales, but certainly not anywhere near the volume of the core business. Perhaps they felt that it was not going to be essential to them in any way, and this could have been their conclusion. It may still be their assumption even now with only $9 Billion in revenue.

Relative to Walmart’s reaction to Amazon in the 2000’s, I give some further history in the last decade about how Walmart evolves their model as they go back and forth a couple of times on integration versus standalone channel. The online division continues to require executive attention but it’s not getting anywhere, so there are opportunities to discuss again why the organizational issues are so difficult.

Question: What was the motivation for Amazon to begin adding additional products?

I personally think the reason is because they weren’t making money in books, they came in and took margins down in that market in the extreme and even they couldn’t make margin there. They started looking elsewhere, initially offering an online affiliate program, and now they’ve got mainline retailers as sellers on Amazon. Amazon has become literally an online channel for small retailers across the globe, and that’s been a very successful strategy for them. That strategy did not become clear until sometime last decade. But I think it’s important to trace through so that students understand that aspect of the competition.

Copyright ©2022 John Wiley & Sons, Inc.

III. What Should Walmart Do Now? This question could be further developed in class by asking: Question: Is there anything more that they can do than what they’ve done? Should they be trying to, for example, go aggressively into home delivery? Should they be trying to shift more business to online? Should they be encouraging people who are coming to their stores to be going online instead? Can they do that in their stores? Should they have a strategy for the future that suggests they might close stores in certain areas and instead try to drive online business, turn stores into retail distribution for local cities (i.e., customers no longer come to stores, the company takes the products directly to your home)? Could it become this sort of massive home delivery system like they’re building in China right now?

Of course, the population density in China helps them do that a little bit better, so this would only work in certain areas, but that might be something to think about because it seems that’s where Amazon is going right now.

From a competitive strategy perspective, if you’re Walmart.com, you want to push back on what Amazon thinks they’re going to do. Part of the reason Amazon is coming in on them with these new ideas about fast delivery is because they see that as Walmart’s strength, and they want to attack it. For me, the strategic advice to Walmart would then be, “Absolutely then, you should go for it.” That’s the knockout punch if you can take competition from the level it’s been, where customers get online and fill a shopping cart and then put in a credit card number and the products come to me through the mail. If you can take that model to the next level which is, customers have an account at Walmart, they get on almost daily and order all the goods they need and Walmart drops it on the porch.

If this can happen, Walmart fundamentally changes the game. I think Walmart has the resources to build that model in many of the big cities. I think that would be a knockout punch for Amazon. Again, strategically; why? Because Walmart.com has assets and resources that in the history of their online strategy have been totally ignored or underutilized (e.g., physical locations, built in distribution system, ability for rapid fulfillment). Now that they understand these resources, it’s time to exploit them to the fullest.

IV. Key Takeaways Utilize the principle of bringing strength against weakness

Copyright ©2022 John Wiley & Sons, Inc.

•

• • •

In the case discussion, I ensure that students get to the point where they see that the key take away from this case for competitive strategy perspective is to take those resources in areas where a company is strong and a competitor is weak and knock them out. Let’s take our strengths, let’s press those all the way to the wall, and change the game. That’s where there’s a possibility for how Walmart trumps Amazon in the end.

Walmart’s store footprint and distribution capabilities were ignored for too long as an essential ingredient of competitive strength against Amazon.

Now that these resources are being more fully utilized Amazon senses the need to build such capabilities themselves.

Walmart.com could potentially push much harder here.

Utilize the principle of protect and neutralize vulnerabilities • •

Amazon appears to be doing this as they strengthen their capabilities in rapid delivery of products.

The very areas that Walmart is attacking--those areas of weakness for Amazon—are the areas that Amazon should strengthen.

Online strategy for bricks and mortar stores should typically leverage resources in the core business rather than ignore them •

Walmart stands its best chance of gaining ground on Amazon by fully exploiting those resources that Amazon simply cannot copy; yet Walmart.com ignored this fact for much too long during its history.

Organizational obstacles can create myopia for companies who then have difficult executing in new areas •

Walmart.com had a difficult time figuring out how to garner enough internal investment and attention from Walmart to flourish; the company was much too focused on the core business of traditional retailing.

V. Conclusion In concluding the case you could get into talking about what could Amazon do to neutralize Walmart’s threat. Perhaps drones are part of the answer. Or alternatively what are Amazon’s strengths that they could bring against Walmart weakness. I think Amazon is the quintessential online brand. That’s a huge strength.

Question: How does Amazon leverage that against Walmart.com more than they have?

Copyright ©2022 John Wiley & Sons, Inc.

Amazon’s brand recognition and the fact that they have such a broad user base is a huge asset and resource to them, and I think fundamentally that makes the mobility barrier (obtaining dramatically more market share) for Walmart very difficult to overcome. But again, I think Walmart can do this by leveraging resources. It’s possible that Amazon could be the loser here over time if they’re not careful because Walmart has the market power and resources that if they could focus, they could eventually prevail against Amazon.

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Note

Amazon Versus Walmart: The Battle for Online Dominance2021 Teaching Objectives The Walmart and Amazon case was written in recognition that Amazon had become the largest online retailer in the US, and yet by all rights, that title should have gone to Walmart because they are the largest retailer in the US. Students should come to class prepared to discuss the question that Doug McMillon himself wonders at the end of the case introduction.

The 2021 update provides students with a description of some of the competitive moves made by Amazon and Walmart since 2013 and discusses the role of the Coronavirus pandemic in propelling growth at both sites. The case ends with Walmart CEO Doug McMillon pondering his next moves.

Preparation Questions 1. What was Walmart’s online strategy and how did it evolve over time? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Why was it so hard for Walmart to get going online, meaning to build significant revenue? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 3. What was Amazon’s strategy during the time when Walmart was struggling in the last decade? [AACSB: Analysis] [Difficulty: Easy] [Bloom’s 2 Comprehension] 4. What was the motivation for Amazon to begin adding additional products?

[AACSB: Analysis] [Difficulty: Medium] [Bloom’s 2 Comprehension] 5. What should Walmart do now? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] 6. For the 2021 update, how should McMillon frame the competition with Amazon? Should dominance be the goal? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions

Copyright ©2022 John Wiley & Sons, Inc.

1. What was Walmart’s online strategy and how did it evolve over time? a. The online channel was not integrated in Walmart’s operations but later online and retail were integrated b. The online channel was not integrated and it remained a separate business model c. The online channel was integrated with retail and it later became a separate business model d. The online channel was integrated and eventually became Walmart’s only business channel Answer: a 2. Why was it so hard for Walmart to get going online, meaning to build significant revenue? a. A tension or belief in the viability of online as a real business b. The fact that everyone was distracted by the main business model and online did not really play into that very well c. Walmart was also trying to expand internationally d. All of the above Answer: d 3. What was Amazon’s strategy during the time when Walmart was struggling in the last decade? a. Originally, Bezos intended to use bookselling as a platform for other products b. Jeff Bezos had designs on world domination or at least generating a $70 billion retailing company c. By mid-last decade, Amazon had clearly moved aggressively into categories beyond books and adopted a strategy of becoming a retailer to the world d. Bezos saw the Internet as a means to develop a brick-and-mortar presence that could rival large retailers Answer: c 4. What was the motivation for Amazon to begin adding additional products? a. Amazon saw huge upside potential in distribution efficiencies b. They were not making money in books c. They needed to expand market share in retailing d. They wanted to serve as a distributor for small third-party firms

Copyright ©2022 John Wiley & Sons, Inc.

Answer: b 5. What should Walmart do now? a. Move into China b. Retreat from online retailing c. Have on-demand ordering d. Use return customers and deliver directly basic daily goods Answer: d

Teaching Plan I. Walmart in E-Commerce II. Amazon Boots Up III. What Should Walmart Do Now? IV. Key Takeaways V. Conclusion I. Walmart in E-Commerce

20 min 10 – 15 min 30 min 10-15 min 5-10 min

Question: Why has Walmart not been able to make greater inroads online? Where did Walmart go wrong?

Walmart got online in 1995 at about the same time Amazon did, along with much of the rest of the business world. This was right as the Internet was taking off commercially. Walmart already had an entire infrastructure of goods that they could sell online, yet for the next twenty years they were beaten year after year in online retail by the Amazon upstart. Furthermore, Walmart was being beaten by a company that in the beginning was only selling books. Perhaps this is why Walmart did not seem to see the threat. Perhaps the reason is that nobody really believed Internet commerce would be that big in 1995. In spite of this, what the case makes clear is that Walmart knew they should be in the online market, but they just could not execute organizationally. It was not the main business so few at the company seemed to care about the online channel.

As evidence of the company’s comprehension of the need to be online, Walmart.com operations were moved to Silicon Valley. That seemed to work for a short period of time, but it was eventually pulled back into Walmart, apparently for the reason that the company figured they should be integrating their online business with their retail business. But this notion did not seem to occur to management for too long a period of time and when it finally did, Walmart.com was woefully behind.

Copyright ©2022 John Wiley & Sons, Inc.

Walmart should have recognized much earlier, as any good strategist would, that they have some resources and capabilities that should be leveraged, not ignored. They seemed to ignore the fact that they had a gigantic distribution system; they seemed to ignore the fact that they had a massive store footprint the world over; they ignored the fact that they had brand cache; they ignored the fact that they had scale in purchasing, which delivered low prices. All of these resources could have and should have been employed as part of comprehensive online strategy much earlier.

Meanwhile, Amazon was taking off in book selling and then adding category after category until they had become a full-line retailer online. At the time of the case, Amazon has $70 billion+ of revenue against Walmart.com’s $9 Billion.

What is interesting at the end of the case is that with Walmart.com finally beginning to leverage their brand, their infrastructure, and their shipping and fulfillment capabilities, along with other established resources, Amazon began to recognize that they do not have some of the resources that Walmart seems to have, and this started them scrambling a bit. For example, they do not have distribution centers like Walmart does.

Walmart is starting to look like they could even beat Amazon in the area of rapid delivery, where a customer orders online and does not have to wait three days. A customer can order online and go pick it up that afternoon, or somebody pulls up in a truck and delivers it to the customer that afternoon. In fact, Walmart is now testing this model in China, having purchased a company, Yihaodian, in which they do rapid turnaround for online ordering and delivery. A customer orders, and within a couple of hours somebody shows up at their residence with their order.

Walmart may have the resources to move in that direction in certain markets in the United States as well. Amazon, now seems to be saying, “If that’s where this market is going, we really don’t have the infrastructure; we’ve been relying on the postal service.” It appears that Walmart has resources that are going to trump them, and therefore Amazon seems to be looking to invest in areas, such as drones, that could finally get faster deliveries going.

Question: What will it take for Walmart to finally participate in the e-commerce revenues at a rate more consistent with its dominant retail store presence? In particular, just how could it finally beat Amazon?

Class discussion can follow the preparation questions. In doing so, it will be important to bring out a number of themes about competitive strategy:

Copyright ©2022 John Wiley & Sons, Inc.

•

Each of the companies begins with (or builds) key competencies for their main markets – Walmart for traditional retail, and Amazon for online retail, and then leverages these strengths for benefit; these strengths in turn begin to look like traps near the end of the case. Key point: leverage strengths but be flexible as environment shifts.

•

Internal organizational issues seemed to lie at the heart of Walmart’s difficulties.

Myopia created by the need to drive a traditional retail business, and the accompanying inability to perceive how to integrate Walmart.com left Walmart floundering online for years.

•

At a seventh the size of Amazon, Walmart.com will need some radical thinking in order to catch up; ironically, they may already have the infrastructure and capabilities to do this, but Amazon’s growth does not seem to be slacking.

Question: What was Walmart’s online strategy and how did it evolve over time?

What should emerge from that conversation is a contrast between online as a distinctive channel or distinctive business, and online as an integrated aspect of operations.

Question: Why was it so hard for Walmart to get going online, meaning to build significant revenue?

The answers that could come back might be: • A tension or belief in the viability of this as a real business, the fact that everyone was distracted on the main business model, which is retail stores and retail sales, and online did not really play into that very well. This all led to a starving of resources in the early days from Walmart.

• You may also want to bring up that at this time Walmart is also trying to expand internationally. Their focus is on bricks and mortar in Germany and other parts of Europe.

II. Amazon Boots Up Question: What was Amazon’s strategy during the time when Walmart was struggling in the last decade?

This discussion presents a good opportunity to compare and contrast the strategies of the two companies and the specific moves they make to enhance their competitiveness.

Copyright ©2022 John Wiley & Sons, Inc.

It is important to note that Amazon’s original strategy was to sell books. In the beginning Jeff Bezos just wanted to start a company online and take advantage of the Internet. He was literally just going through product categories thinking about what would be a good thing to sell online and he just decided to do books based on some criteria he developed. Bezos simply signed up a wholesale book company and distribution system and basically put a store front on the web.

Jeff Bezos in the mid-1990s did not have designs on any kind of world domination or $70 billion general retailing company. He probably did not imagine that he could have even envisioned that at that time; that was not his aspiration. He was probably just trying to get into this market and see if he could make it work. Amazon had these strategies that did not recognize the ultimate power of this as a channel and delivery system, and if they had been able to look ahead, perhaps things would have been a lot different.

Things would certainly have been different for Walmart. Perhaps Bezos could not have gone beyond books in the very early days even if he had wanted to (no knowledge or infrastructure), but Walmart definitely could have been much more thoughtful about online as a channel and integrated delivery with its main business than they were.

By mid-last decade, Amazon had clearly moved aggressively into categories beyond books and adopted a strategy of becoming a retailer to the world.

Go through that history and characterize how Walmart was looking at online.

Question: How did they see this opportunity?

They seemed to see it as something interesting to dabble in and maybe get a few sales, but certainly not anywhere near the volume of the core business. Perhaps they felt that it was not going to be essential to them in any way. It may still be their assumption even now with only $9 Billion in revenue. give some further history in the last decade about how Walmart evolved their model as they went back and forth a couple of times on integration versus standalone channel. The online division continues to require executive attention, but it is not getting anywhere, so there are opportunities to discuss again why the organizational issues are so difficult.

Question: What was the motivation for Amazon to begin adding additional products?

Copyright ©2022 John Wiley & Sons, Inc.

This could be that because they were not making money in books, they came in and took margins down in that market in the extreme, and even they could not make margin there. They started looking elsewhere, initially offering an online affiliate program, and then they got mainline retailers as sellers on Amazon. Amazon has become literally an online channel for small retailers across the globe, and that has been a very successful strategy for them. That strategy did not become clear until sometime last decade. It is important to trace through so that students understand that aspect of the competition.

III. What Should Walmart Do Now? This question could be further developed in class by asking: Questions: Is there anything more that they can do than what they have done? Should they be trying to, for example, go aggressively into home delivery? Should they be trying to shift more business to online? Should they be encouraging people who are coming to their stores to be going online instead? Can they do that in their stores? Should they have a strategy for the future that suggests they might close stores in certain areas and instead try to drive online business, turn stores into retail distribution for local cities (i.e., customers no longer come to stores, the company takes the products directly to your home)? Could it become this sort of massive home delivery system like they’re building in China right now?

Of course, the population density in China helps them do that a little bit better, so this would only work in certain areas, but that might be something to think about because it seems that is where Amazon is going right now.

From a competitive strategy perspective, Walmart.com would want to push back on what Amazon thinks they are going to do. Part of the reason Amazon is coming in on them with these new ideas about fast delivery is that they see fast delivery as Walmart’s strength and want to attack it. The strategic advice to Walmart could then be, “Absolutely then, you should go for it.” That is the knockout punch if you can take competition from the level it has been, where customers get online, fill a shopping cart, put in a credit card number, and receive the products through the mail, to the next level, where customers have an account at Walmart, get online and order all the goods they need almost daily, and get home delivery on their porch from Walmart.

If this can happen, Walmart fundamentally changes the game. Walmart probably has the resources to build that model in many of the big cities, which may be a knockout punch for Amazon. Again, strategically; why? Because Walmart.com has assets and resources that in the history of their online strategy have been totally ignored or underutilized (e.g., physical locations, built in distribution system, ability for rapid

Copyright ©2022 John Wiley & Sons, Inc.

fulfillment). Now that they understand these resources, it is time to exploit them to the fullest.

IV. Key Takeaways Utilize the principle of bringing strength against weakness •

• • •

Take resources in areas where a company is strong, and a competitor is weak and knock them out. Let’s take our strengths, let’s press those all the way to the wall, and change the game. That is where there’s a possibility for Walmart to trump Amazon in the end.

Walmart’s store footprint and distribution capabilities were ignored for too long as an essential ingredient of competitive strength against Amazon.

Now that these resources are being more fully utilized, Amazon senses the need to build such capabilities themselves.

Walmart.com could potentially push much harder here.

Utilize the principle of protect and neutralize vulnerabilities • •

Amazon appears to be doing this as they strengthen their capabilities in rapid delivery of products.

The very areas that Walmart is attacking, those areas of weakness for Amazon, are the areas that Amazon should strengthen.

Online strategy for bricks and mortar stores should typically leverage resources in the core business rather than ignore them •

Walmart stands its best chance of gaining ground on Amazon by fully exploiting those resources that Amazon simply cannot copy; yet Walmart.com ignored this fact for much too long during its history.

Organizational obstacles can create myopia for companies who then have difficult executing in new areas •

Walmart.com had a difficult time figuring out how to garner enough internal investment and attention from Walmart to flourish; the company was much too focused on the core business of traditional retailing.

V. Conclusion In concluding the case you could get into talking about what Amazon could do to neutralize Walmart’s threat. Perhaps drones are part of the answer. Or alternatively

Copyright ©2022 John Wiley & Sons, Inc.

what are Amazon’s strengths that they could bring against Walmart weakness.

Amazon is the quintessential online brand. That is a huge strength.

Question: How does Amazon leverage that against Walmart.com more than they have?

Amazon’s brand recognition and the fact that they have such a broad user base is a huge asset and resource to them. Fundamentally that makes the mobility barrier (obtaining dramatically more market share) for Walmart very difficult to overcome.

Walmart can do this by leveraging resources. It is possible that Amazon could be the loser here over time if they are not careful, because Walmart has the market power and resources to eventually prevail against Amazon.

The 2021 Update Instructors should think carefully about how they want to use the update. The 2021 update makes a great “B” case. In an 80-minute session, the instructor may shorten the original case discussion to about 60 minutes, and then allocate about 20 minutes to the update. Most of this note assumes that instructors will use this option.

The other option is to use the 2021 update as a full 80-minute session. If the instructor chooses this option, we recommend using the 2021 case as a group exercise. Study groups, either existing throughout the semester or formed just for this exercise, will use the case to provide a brief summary of the actions of Amazon and Walmart since 2013 and will prepare a presentation around the following questions: 1. Walmart made significant moves since 2013 to enhance its online offerings.

These included more effectively utilizing their stores as delivery, pickup locations, and buying a number of companies to broaden their inventory selection. In spite of all these moves, their revenues lag Amazon by a factor of 8, and their market share is a seventh that of Amazon. Given this, what should Walmart’s goal be in the online retailing business?

2. Given your answer to Question 1, what investments should Walmart make to achieve its online goals? What new capabilities will they need? How will they implement this new strategy?

Each team should prepare a 15-minute presentation that covers these questions and lays out their plan. The instructor may call on four different teams during an 80minute session (15-minute presentation, 5-minute Q & A). Teams that do not present should submit their slides for grading and evaluation.

Copyright ©2022 John Wiley & Sons, Inc.

If the 2021 update becomes a 20-Minute “B-case” discussion in conjunction with the original case, begin by asking: What did Walmart and Amazon do that surprised you?

There will be a range of answers, but look for two broad themes: 1. Walmart seems to have adopted a much more coherent strategy that links their online and brick and mortar stores. Walmart began to leverage its stores as pickup and return centers and began to see that online and in-store could coexist. The pandemic helped them to build their online business by making instore pickup safe and convenient. Walmart worked to buy into the online market by dramatically expanding the number of items for sale on its website.

2. Amazon responded in kind. When Walmart began leveraging its stores, Amazon bought Whole Foods to give it a physical presence as well. Students should note that Walmart did little that was competitively unique or difficult for Amazon to mimic. Given Amazon’s huge advantage in size and scale, but not net income, it could respond to most of Walmart’s competitive moves.

Then move on to the final question: “If you are a board member of Walmart, should “dominance” in online retailing and working to overtake Amazon be the goal?”

Students should note that, for all its extensive moves since 2013, Walmart remains far behind Amazon and the prospects for catching up and overtaking (dominating) seem remote. Students should begin to think about what the strategic goal of Walmart should be. Get students to create a list of alternative competitive goals for Walmart, which will not be easy. Students will need to think beyond the typical frame of competitive strategy. Think about a world where Walmart is successful without closing the competitive gap with Amazon.

Conclude this short segment by reviewing some of the key takeaways from both case discussions. You could conclude by asking a couple of students: “What would be your next strategic move?”

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Teaching Note

Skype: Competing with Free Teaching Objectives This case gives students an opportunity to understand the competitive dynamics when ‘free’ offerings are involved. In particular, this case should help students understand the different types of ‘free strategies’ and when each may be appropriate.

This case also helps students understand how firms should react when free offerings enter into their market and what types of responses are most appropriate given the situation.

Study Questions 1. What is Skype’s strategy and why do you think Skype has been so successful?

[AACSB: Analytic] [Difficulty: Easy] [Bloom’s 3 Application] 2. How should incumbent (e.g., landline, wireless) telecommunication companies such as AT&T, Verizon, Sprint, and the Baby Bells (e.g., PacBell/SBC) respond to the competitive threat from Skype? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 6 Evaluation] 3. What do you think about Microsoft’s decision to buy Skype? What potential synergies are there and what new competitive advantages can they possibly create together? [AACSB Reflective Thinking] [Difficulty: Medium] [Bloom’s 6 Evaluation] 4. Skype has not grown revenues as quickly as hoped. Do you think Skype should start charging even a small amount for their basic telephone service? Why or why not? [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] 5. How should Skype attempt to compete with the increasing popularity of companies like Apple and Samsung that have developed their own FREE applications which they include with their products (phones, tablets, etc.)?

[AACSB Analysis] [Difficulty: Hard] [Bloom’s 5 Synthesis] 6. How can it best compete against a giant like Google that I s also competing with FREE? [AACSB: Analysis] [Difficulty: Hard] [Bloom’s 5 Synthesis]

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Multiple Choice Questions 1. What is Skype’s strategy and why do you think Skype has been so successful? a. They use a client-server network that was fast and inexpensive b. They use a peer-to-peer network with super-node tech that has zero marginal cost c. They use a freemium strategy that rapidly spread across the peer-to-peer network d. They brought unique value through videoconferencing Answer: “B” 2. How should incumbent (e.g., landline, wireless) telecommunication companies such as AT&T, Verizon, Sprint, and the Baby Bells (e.g., PacBell/SBC) respond to the competitive threat from Skype? a. Ignore it b. Develop own “free” offering with similar technology c. Focus more on wireless—Move with market away from wireline d. Bundle with other services (e.g., TV, internet) Answer: “B” 3. What do you think about Microsoft’s decision to buy Skype? What potential synergies are there and what new competitive advantages can they possibly create together? a. It was a good decision because Microsoft can leverage Skype to popularize its existing products b. It was a good decision because Microsoft can leverage Skype technologies to enhance its portfolio c. It was a bad decision because Microsoft cannot operate a free service d. It was a bad decision because Microsoft cannot easily monetize a free service Answer: “D” 4. Skype has not grown revenues as quickly as hoped. Do you think Skype should start charging even a small amount for their basic telephone service? Why or why not? a. No, because it would undermine the customer base b. No, because it would reduce international calling c. Yes, because a nominal fee would generate revenue without eroding market share d. Yes, because the business model is unsustainable without charging fees

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Answer: “C” 5. How should Skype attempt to compete with the increasing popularity of companies like Apple and Samsung that have developed their own FREE applications which they include with their products (phones, tablets, etc.)? a. Free Up-Sell Strategy (“Freemium”) b. Free Cross-Sell Strategy c. Free Third Party Pay (Advertising) Strategy d. Free Bundling Strategy (Direct cross subsidy) Answer: “B” – This would be similar to the Apple model.

6. How can it best compete against a giant like Google that is also competing with FREE? a. Free Up-Sell Strategy (“Freemium”) b. Free Cross-Sell Strategy c. Free Third Party Pay (Advertising) Strategy d. Free Bundling Strategy (Direct cross subsidy) Answer: “C” – This would be similar to the Google model.

Teaching Plan I. Skype’s Strategy II. Skype’s Competition III. Competing Against Free I. Skype’s Strategy Question: What is Skype’s strategy?

Market • Telecommunications Unique Value (proposition) • Face-to-face video calls for free Resources & Capabilities • Software Writing capabilities • Technology

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25 min 15 min 15 min

o Skype did not use servers to enable service. Instead, they used peer-topeer networking (see illustration below) o Super Node tech—found shortest path to improve call quality Traditional Client-Server Network

P2P Network

PC PC

PC Server

PC

PC PC

PC

PC

PC

Barriers to Imitation •

Network effect o Each Skype customer could only communicate with others if they were able to get their friends, colleagues, etc. to become Skype customers.

This essentially turned Skype customers into a “sales force” for Skype.

PayPal was successful for a similar reason (you could only do a financial transaction via PayPal if you got others to join PayPal).

Question: What is Skype’s revenue and cost model?

Revenue “Freemium” Strategy Upsell Premium users (roughly 5% of Skype customers go ‘premium’; this tends to be a typical “rule of thumb” regarding the percentage of free users that move to a premium product)

Marginal Cost Skype: Zero Customer: Zero (if you already have a computer and Internet service) Niklas Zennstrom’s reasoning for offering Skype for free: “We decided that Skype needed to be free because the marginal cost of placing a phone call for us was

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basically zero. When the marginal cost of providing a product or service is zero, the price will naturally fall to zero.”

II. The Source of Skype’s Competitive Advantage Question: Who are the incumbents that are ‘losing’ to Skype?

VoIP • • • • • •

Vonage Oovoo Cable Vision Apple Google Cable Companies

Fixed Line • AT&T • Verizon • Baby Bells Wireless • AT&T • Verizon • Sprint • T-Mobile Question: Of these groups of companies, which gets hurt the worst when Skype comes into the picture?

Fixed Line • Within 5-7 years, more than 25% of all international calls are through Skype • Fixed line lost market share • Fixed line was forced to lower prices in order to better compete with Skype Question: How did/can fixed line respond?

• • • •

Ignore o Not a viable option because current customers are leaving now Develop own “free” offering with similar technology Focus more on wireless—Move with market away from wireline Bundle with other services (e.g., TV, internet)

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III. Competing Against Free •

•

“FREE” Definition o Product as a ‘price’ of zero o Not a one-time promotion pricing—the price is “FREE” over an extended period of time Strategies for competing with free o Reactions to the entry of a FREE product ▪ You have been in the industry selling a paid product and a competitor makes their product FREE—what should you do? o Should you make your product FREE? ▪ Under what conditions should you decide to make your product FREE? ▪ How can you create value when your product is FREE? o Free Up-Sell Strategy (“Freemium”) ▪ Offer a free version to gain attention and widespread use; then offer a premium product with advanced features for customers willing to pay ▪ Requirements • A free product that appeals to a very large user base so that even a low conversion rate of free users to paying customers will generate substantial revenues OR • A high percentage of users willing to pay for the premium version o Free Cross-Sell Strategy ▪ Offer a free version to gain attention and widespread use; then offer other products for which customers are willing to pay.

▪ Requirements • A broad product line (preferably products that complement the free product) OR • The ability through partnerships to sell a broad line of products to users of the free product o Free Third Party Pay (Advertising) Strategy ▪ Make the product/service free to generate a community (network externality) for which you get paid by a third-party company who desires access to that community.

▪ Requirements • A free offering that attracts either many users who can be segmented for advertisers or a targeted group that comprises a customer segment AND • Third parties willing to pay to reach these customers ▪ Converting Product Users into Revenues

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•

Google is the ‘big winner’ when it comes to converting users into revenue because they can target/segment users extremely well and advertisers know this and are willing to pay for access to those users o Free Bundling Strategy (Direct cross subsidy) ▪ Bundle the free product with non-free products and derive revenues from non-free products; can’t get the one without the other.

▪ Requirements • Products or services that can be bundled with the free offering OR • A free product that needs regular maintenance or complementary products (e.g., free printer but costly ink).

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Teaching Note

Sears Holdings Corporation: In Need of a Turnaround Strategy Teaching Objectives This case is intended to be used sometime in a strategy course after chapter 5 and gives students the opportunity to practice what they’ve learned as they attempt to come up with a new strategy for Sears. In particular, it gives students an opportunity to use the framework outlined in the textbook that defines strategy as a plan to achieve competitive advantage that involves making four strategic choices: a) Markets to pursue/compete in b) Unique value (low cost or differentiation) the firm will offer in those markets, c) The resources and capabilities required to offer that unique value better than competitors d) Ways to sustain the competitive advantage by preventing imitation.” (See Strategic Management: Concepts and Tools for Creating Real World Strategy, Chapter 1: What is Business Strategy?)

This case is intended to give students an opportunity to work in teams to come up with a new strategy for Sears and then present their strategies to the class/instructor.

It is intended that student groups will present proposed strategies for Sears. A grading rubric of these presentations will be found at the end of this document. There are also examples of student presentations on the Wiley tools website. These are intended for instructor education and not intended to be passed out to students. The purpose of this teaching note is to provide a brief overview of Sear’s current strategy and strategic position as well as offer a tool/rubric to evaluate the viability of students’ proposed strategies.

Study Questions 1. Sears’ current strategy is not working and its market share and financial performance are declining. How would you turn Sears around by making a substantial change to its strategy (i.e., the markets it’s targeting, its value proposition, its resources and capabilities, and barriers to imitation)? [AACSB Analytic] [Difficulty: Hard] [Bloom’s 3 Application] Note: Be as specific as possible regarding the changes you would make and why you think it would lead to improved performance for Sears.

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Multiple Choice Questions 1. Sears’ current strategy is not working and its market share and financial performance are declining. How would you turn Sears around by making a substantial change to its strategy (i.e., the markets it’s targeting, its value proposition, its resources and capabilities, and barriers to imitation)? a. Leverage successful brands such as Craftsman tools and Kenmore appliances and sell them on other platforms such as Amazon or in competitor stores b. Improve operating margins by cutting costs c. Entirely re-work the Sears value proposition d. Identify a new target market Answer: “C”

Teaching Plan I. Sear’s Current Strategy/Strategic Position II. New Strategies for Sears

20 min 40 min

I. Sears’ Current Strategy/Strategic Position Market • Merchandise & services o Includes hardline & softline goods, apparel, food, drug, services, etc.

Unique Value • According to Lampert, Sears’s goal is to “offer customers a new, more compelling shopping experience with a differentiated and expanded product range.”

• In reality, Sears offers very little in terms of differentiation with the possible exception of the brands associated with some of its products, such as Craftsman tools and Kenmore appliances.

• Sears has tried to succeed as a discount retailer but is at a cost disadvantage compared to its major retailer competitors (see below for a comparison of each firm’s 2013 operating margins) o Sears: -2.56% o Wal-Mart: 7.50% o Target: 5.83%

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Resources & Capabilities • 2,429 stores as of 2013 o Since 2005, 1,414 stores have been closed down o 1,152 (47%) of these stores are K-Mart locations • 14,000 technician network for repair services • “Shop Your Way” loyalty program/social network • Name brands such as Kenmore, Craftsman, & Diehard Barriers to Imitation • Currently, their older barriers have been eroded by newer players such as Target and Wal-Mart.

II. New Strategies for Sears The purpose of this section is not to outline a ‘right answer’ concerning what Sear’s new strategy should be. Instead, this section provides a list of questions that should be answered by the students’ proposed strategies.

Market • Question: What specific customers will Sears target? Why? • Question: What types of products/services will Sears offer? Why? Unique Value • Question: How will Sears win with its target customers? Why should customers choose Sears over a competitor such as Wal-Mart or Target?

Resources & Capabilities • Question: What resources (locations, products, employee type, etc.) are necessary to bring the new value proposition to the target markets? Does Sears already own these resources? If not, how should it obtain them?

• Question: What capabilities (type of service, processes, etc.) are necessary to bring the new value proposition to the target markets? If Sears does not already possess these, how should it develop them?

Barriers to Imitation • Question: Will Sear’s competitors be able to imitate the new strategy? Why or why not?

Below is a ‘Strategy Analysis Grading Rubric’ that may be used to help evaluate the validity of students’ proposed strategies.

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Sears Strategy Analysis Grading Rubric Evaluation for: ____________________________________________________________ Dimension

1

1. Extent to which the proposed value proposition is clear and understandable from the customer’s perspective (it’s clear why a customer segment would choose Sears’ offering over another offering).

Strategy lacks a clear and understandable value proposition. Not clear that the value proposition clearly meets a need/does a job for a customer.

Value proposition is not unique; possible to get same thing elsewhere.

Unclear how Sears will reasonably be expected to leverage or build R&C needed to deliver the V.P. Lack of frameworks to guide analysis or frameworks applied thoughtlessly (all but the kitchen sink)

2. Extent to which proposed value proposition for Sears is unique relative to the value offered by other companies.

3. Extent to which there is a clear and reasonable explanation for how Sears will effectively leverage/build the resources and capabilities (R&C) to deliver the value proposition (V.P).

4. Extent to which the analysis draws upon appropriate strategy concepts/frameworks to evaluate Sears’ strategy and identify and propose changes to it.

5. Extent to which espoused strategy is supported by data and analysis, including recognizing both the strengths and weaknesses of proposed actions 6. Extent to which overall recommendations are clear, specific, and actionable 7. Extent to which the presentation/report was professional (e.g, well organized, effective use of graphics, charts, figures, quotes, and references).

Little data, unexamined assumptions, no attention to weaknesses and risks Vague, unspecific, and general recommendations.

Presentation/writing was unclear, rambling; presentation was sloppy or unprofessional with numerous errors.

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2

3

4

5 Value proposition is very clear and understandable (why customers will choose Sears over competing offerings)

Value proposition is unique relative to the value offered by competitors/substitutes.

Logical and reasonable explanation for how Sears can leverage or build the R&C to effectively deliver the V.P. Frameworks are thoughtfully applied. Frameworks are used not only to describe but also to critique and identify recommendations Compelling use of supporting data, clearly elucidated assumptions and good attention to company weaknesses and risks Clear, insightful, specific, and actionable recommendations Presentation/writing was clear, concise, well-organized, professional, made effective use of

Your Score

graphics, free of errors and convincing.

Total Score

Comments:

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Teaching Note

Redbox: What’s Next? Redbox History Teaching Objectives The Redbox case is designed to help students evaluate the options of a company with its primary business in decline. The challenge is to push students to deeply understand the company’s strategy/business model (and its strengths and weaknesses relative to key competitors) as the basis for generating ideas for how to change the strategy in a way that might lead to improved performance going forward.

Redbox is experiencing declining DVD rentals through its kiosks as more customers turn to streaming for home video entertainment. Moreover, projections on the purchase of DVD players suggests that this market will continue to decline. Since Redbox generates the majority of its revenues by renting newly released movies on DVDs kiosks, it needs a strategy that will either: a) Encourage customers to continue to rent physical DVDs (not likely). b) Allow Redbox to successfully enter the streaming market which is becoming increasingly competitive with the entry of Disney+ and other content providers. c) Leverage the company’s existing resources and capabilities (e.g., brand, kiosk technology) to provide value in different industries.

This can be given as a case where students prepare a write-up or presentation on their recommended changes to Redbox’ strategy. If the case is discussed in class, the majority of class time should be devoted to discussing the students’ recommendations for modifying Redbox strategy to help the company be more successful going forward.

The teaching note is divided into two sections. The first reviews the strategies and business models of Redbox with Netflix and Blockbuster (now bankrupt), or you may decide to eliminate Blockbuster and focus on Redbox in comparison with the streaming competitors: Netflix, Hulu, Disney+. The purpose of this section and discussion is to compare Redbox’s business model with that of its key competitors to understand its strengths and weaknesses. During this first section, it may be useful to help students map out how each business model delivers value to customers. It may also prove useful to detail the costs associated with each model. As part of this discussion, it is useful to compare the advantages and disadvantages of each firm’s business model.

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The second section is focused on discussing the options that Redbox may have for improving its value proposition or changing it all together in order to survive going forward.

Preparation Questions 1. Compare the strategies and business models of Redbox, Netflix, Hulu, and Disney+. What are the strengths and weaknesses of each? Which company is in the strongest position to succeed in the home entertainment market over the next 5-10 years? What metric of success are you using? Can all of these companies coexist in the market? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension] 2. How would you modify/change Redbox's strategy/business model (markets, unique value offered, resources and capabilities, business model) to improve its chances of being successful going forward? How might Redbox use the "strategy vehicles" to modify/change its strategy, e.g., change horizontal scope through diversification, vertical scope through vertical integration or outsourcing, access new resources through alliances, or expand geographic scope through international expansion. [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 3 Application]

Multiple Choice Questions 1. Compare the strategies and business models of Redbox, Netflix, Hulu, and Disney+. What are the strengths and weaknesses of each? a. Redbox: Strengths: low price way to rent newly released movies and pay per use rentals. Weaknesses: business model is nearing obsolescence. b. Netflix: Strengths: variety of titles (more than 90,000 titles over time), convenient (DVDs are sent/or streamed directly to your home). Weaknesses: content creation not yet part of the business model. c. Hulu: Strengths: direct contacts mainstream networks like NBC. Weaknesses: most content is duplicated from other sources. d. Disney+: Strengths, the quality of the Disney catalog. Weaknesses: Disney+ does not partner with any other streaming services.

Answer: a

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2. Which company is in the strongest position to succeed in the home entertainment market over the next 5-10 years? What metric of success are you using? Can all of these companies coexist in the market? a. Netflix, using the metric of market share. b. Hulu, using the metric of subscriber growth. c. Redbox, using the metric of profitability. d. Disney+, using the metric of total assets.

Answer: a 3. How would you modify/change Redbox's strategy/business model (markets, unique value offered, resources and capabilities, business model) to improve its chances of being successful going forward? a. Redbox could partner with national pizza delivery companies by putting a kiosk at stores and have customers order pizza and a movie. b. Redbox could expand internationally to countries where there is high DVD player penetration and streaming services are likely to emerge only slowly due to the cost (e.g., Mexico). c. Redbox could expand more into video game rentals to complement DVD rentals. d. Redbox could introduce a full streaming service to compete with Netflix and Disney+.

Answer: b 4. How might Redbox use the "strategy vehicles" to modify/change its strategy, e.g., change horizontal scope through diversification, vertical scope through vertical integration or outsourcing, access new resources through alliances, or expand geographic scope through international expansion? a. Redbox should diversify into different products relevant to travelers. b. Redbox should diversify into specific high growth products such as marijuana kiosks. c. Redbox should vertically integrate by producing some of the content that they offer at kiosks. d. Redbox should expand internationally.

Answer: d

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Teaching Plan

I. Compare business models of Redbox, Netflix, Hulu, Disney+.

II. Discussion of recommendations for how Redbox can change its strategy/business model to improve performance going forward.

30 min 30 min

I. Compare business models of Redbox, Netflix, Hulu, Disney+ This case is about evaluating Redbox’ strategy and business model to understand its strengths and weaknesses relative to the competition and how it might change its strategy going forward.

Question: First, let’s understand Redbox’s strategy and business model versus its key competitors such as Netflix. What is Redbox’s strategy and business model? What is Netflix’s strategy and business model? Please evaluate the strengths and weaknesses of each firm’s strategy/business model.

The starting point for this case analysis is understanding the different strategies/business models of Redbox and Netflix to assess the strengths and weaknesses of each.

Business Model Definition (see Chapter 10 description and definition of a business model): The rationale of how an organization delivers and captures value. More specifically, business models typically differ on one of three dimensions: a) The choice of customer segments to serve and the unique value (value proposition). b) The choice of activities the company performs, and the resources utilized to deliver value to customers. c) The way a company generates revenue streams to get paid for the value it delivers.

Question: What is Redbox’s strategy and business model?

Strategy •

Market o Home DVD

Copyright ©2022 John Wiley & Sons, Inc.

•

Unique Value o Low price way to rent newly released movies o Pay per use; infrequent movie watchers pay for each use and do not have to pay a monthly subscription

•

Resources and Capabilities o Kiosks (47,000) located throughout the United States

Redbox Business Model

Estimate of cost of business model: Kiosks: At $15,000/kiosk, all 47,000 kiosks cost roughly $700 million Warehouses: Estimated to require 40-50 smaller warehouses at $1-3 million each.

Distribution from warehouses to kiosks: Redbox is said to have roughly 1000 personnel involved with restocking the movies in its kiosks.

Cost of DVDs/movies: Estimates are 20-30 percent of the retail cost of a DVD. Question: What is Netflix’s strategy and business model?

Strategy •

Market o Home video entertainment

•

Unique Value o More than 90,000 titles o Convenient (streaming or DVDs sent directly to your home) o More attractive to frequent renter

•

Resources and Capabilities o 50 warehouses o Fulfillment capability o Technology (easy to use website) o Relationships with movie studios o 97 percent of customers within 1-day distance of 50 shipping points

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Netflix Business Model

Estimate of cost of business model: Mail Order Business: Warehouses: Estimated at $10 million each, total warehouse cost is $500 million Shipping Points: Estimated at $1-$2 million each, total shipping point cost is $50-$100 million Cost of DVDs/movies Netflix reportedly spent $13 billion (85% on original content) in 2018 https://www.marketwatch.com/story/its-not-your-imagination-netflix-doesnthave-as-many-movies-as-it-used-to-2019-12-04 Streaming Business: Cost of content: Estimated at more than $10 billion per year.

Question: What advantages does Netflix gain from its different value chain over Redbox?

•

Cost advantages due to no investment in kiosks, fewer warehouses, and physical inventory of DVDs. This reduces equity investment and increases return on capital.

•

Convenience advantages because customer transaction costs are reduced (they can order at home instead of going to a kiosk).

•

Selection advantages due to a wider selection of products (90,000 titles at Netflix at one point in time (15,000 in 2020) vs. only 1,000-1250 titles at a Blockbuster store and 70-150 at a Redbox Kiosk).

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•

Information advantages (for product selection) allows for the creation of a database of customers with insight into revealed customer preferences (captures electronically).

Question: When Redbox entered the market, how did its value chain differ from Blockbuster’s?

Similar to both Blockbuster & Netflix, Redbox receives its content from film distributors. However, it differs by allowing customers to go to kiosks to pick up content (instead of using stores or home delivery).

Question: What advantages did Redbox gain from its different value chain over Blockbuster?

•

Cost advantages due to less investment in stores, labor, and inventory (kiosks are less expensive than stores). This reduces equity investment.

•

Convenience advantages because it is able to have more kiosks (5 times more) than Blockbuster is able to have stores.

•

Selection disadvantage due to limited space in a kiosk. Redbox can have 100200 titles available in one area with multiple kiosks while Blockbuster can have up to 1,000 titles available in one store.

II. Discussion of recommendations for how Redbox can change its strategy/business model to improve performance going forward

Copyright ©2022 John Wiley & Sons, Inc.

Question: How would you modify/change Redbox's strategy/business model (markets, unique value offered, resources and capabilities, business model) to improve its chances of being successful going forward?

Question: What are the strategic options for a company, like Redbox, where its primary business is in decline? Can Redbox extend the life of its kiosks and DVD rental business?

How might it do that?

This question opens the door to a discussion of things that Redbox might do to extend the life of its DVD rental business. Students may offer up some of the following options.

•

Redbox could partner with national pizza delivery companies (e.g., Pizza Hut, Dominoes) by putting a kiosk at stores and have customers order pizza and a movie.

•

Redbox could partner with food delivery companies (e.g., Door Dash) and have them deliver a movie with food.

•

Redbox could expand internationally to countries where there is high DVD player penetration and streaming services are likely to emerge only slowly due to the cost (e.g., Mexico).

•

Redbox could expand more into video game rentals to complement DVD rentals.

•

Redbox could use its Kiosk technology to deliver other types of goods (perhaps marijuana in states where it is legal [maybe call it “Greenbox”?]; or perhaps travel goods [Travelbox?] or medications/health goods, etc.).

Question: Is streaming really an option for Redbox? What options do they have for successfully competing with key competitors like Netflix, Hulu, Disney+?

This question provides the opportunity to discuss how Redbox might possibly compete successfully in streaming. At this point Redbox has not been successful in streaming and is unlikely to have the resources and capabilities to compete successfully in the streaming market. However, students may still have suggestions for how Redbox might compete in streaming.

•

Students may recommend a streaming service that leverages its current value proposition—newly released movies. Perhaps Redbox could provide a

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streaming service for a limited number of newly released movies only. Redbox would remain top of mind for customers who want to rent a newly released movie at a reasonable price.

•

Students may recommend a streaming service in partnership with Dish, Direct TV, or some other TV service.

Question: What other businesses or industries might Redbox expand into that would leverage its current resources and capabilities (e.g., kiosks)?

Kiosk technology and nationwide distribution to kiosks seems to be the primary resources and capabilities possessed by Redbox. Is it possible for Redbox to leverage these resources and capabilities to expand into other businesses? What are some realistic options?

•

Students may recommend that Redbox look for opportunities to put a wide variety of products and services in kiosks. In Japan, there are many vending machines, particularly at train, subway, and bus stations, with a wide variety of products relevant to travelers. Students may recommend exploring this opportunity, perhaps kiosks at airports that might be a “Red Travel Box” kiosk to provide goods that travelers might want to purchase.

•

Students may recommend that Redbox explore entering specific high growth industries where customers may prefer to purchase a product at a kiosk. One option would be to have marijuana kiosks in the United States where people can purchase marijuana or other kinds of health medicines or oils after verifying their age with a scanner that scans the customer’s drivers license to verify age.

The case discussion can conclude by offering some key takeaways from the case, which include: •

Different strategies/business models follow the S-curve pattern that has been observed across multiple products and businesses. Redbox’ business model is in decline. What are the options for a company when its primary business is in decline?

•

It is very difficult to improve the performance of a company when its primary business is in decline. This requires creativity and innovation with regarding to find new ways to deploy its existing resources and capabilities or new

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complementary resources and capabilities that it can build to succeed in new ways.

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Teaching Note

What Will Happen to Grandma? An Examination of the Long-Term Healthcare Industry in the United States* Teaching Objectives This mini case helps students identify general environment factors that influence businesses.

The health care industry focused on the elderly may not be entirely relatable to students, but the case highlights important societal issues that students should understand. While the case focuses on the healthcare industry in the United States, the lessons are applicable to most developed nations. When I teach this case, I use a modified PESTEL framework to explain the general environment factors influencing the long-term healthcare firms. Along the way, I may informally introduce some industry environment/Porter’s Five Forces through discussion.

Finally, I have students attempt to come up with solutions to the issues presented from the perspectives of individuals, firms, and the government.

Study Questions 1. What are the general environment factors influencing the healthcare industry?

How do political/legal factors influence the industry? What about economic, sociocultural, technological, and ecological factors? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. Using a Porter’s Five Forces framework, how would you assess the threat of new entrants, threat of rivalry, buyer and supplier power, and threats of substitutes in this industry? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 4 Analysis] 3. Given the increasing costs of healthcare, what would you suggest that individuals, firms, and government can do to cope with the upcoming challenges? [AACSB Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation]

Multiple Choice Questions

* This Case and Teaching Note contributed by David Thornblad Ph.D. and Zachary Sumner

Copyright ©2022 John Wiley & Sons, Inc.

1. What are the general environment factors influencing the healthcare industry? How do political/legal factors influence the industry? What about economic, sociocultural, technological, and ecological factors? a. Political/legal factors are the most relevant factors because the healthcare industry and the government are deeply intertwined. b. Economic factors influence the ability of the government to pay for programs like Medicare, of employers to offer benefits with their jobs and investors in healthcare firms. c. Sociocultural factors may increase life expectancy and lower healthcare costs but issues like obesity remain a problem. d. All of the above.

Answer: “D” 2. Using a Porter’s Five Forces framework, how would you assess the threat of new entrants, threat of rivalry, buyer and supplier power, and threats of substitutes in this industry? a. The threat of new entrants is high because there is demand for healthcare services. b. The threat of substitute is high because it is common for individuals to take care of their loved ones. c. The power of buyer is low because there is plenty of room for differentiation of services. d. The power of suppliers is low because the work of skilled employees such as nurses or physical therapists can be easily automated.

Answer: “A” 3. Given the increasing costs of healthcare, what would you suggest that individuals, firms, and government can do to cope with the upcoming challenges? a. Firms could spend more on lobbying to prevent the revenue reductions from the government. b. Individuals could save more money for retirement or think about moving to cheaper countries and get healthcare services there. c. Government should expand the services that Medicare, Medicaid and Social Security recipients receive and find alternative ways to cover the costs. d. Firms should devote all their efforts in finding a cure for cancer.

Answer: “B”

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Teaching Plan I. Identifying General Environment Factors Influencing the Industry II. Introducing Industry Factors III. Discussion Questions

15 min 15 min 15 min

I: Identifying General Environment Factors Influencing the Industry Political/Legal I combine political and legal aspects of the PESTEL model due to some overlap and similarity.

This factor is probably the biggest influence on the US healthcare industry. Students should be able to identify the following factors, discuss what the factor is and why it is important.

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Affordable Care Act: More people in the United States should have health insurance.

This is a good thing overall for traditional hospitals since more people will be able to pay for services. However, the aging 65+ year old demographic tends to not have traditional health insurance and relies on Medicare which is paid for by the government. Perhaps one benefit of the ACA is that people may go to the doctor more often before 65 and have preventative care completed that could save the government money once they turn 65.

Medicare: Health insurance for people over 65 years old. Hopefully these people would have paid into Medicare when they worked when younger. As shown in Exhibit 3, Medicare pays for about 33% of services by Genesis, National Healthcare, and Ensign.

Medicaid: Provides health insurance for low-income individuals. It can often be coupled with Medicare as long as the patient has exhausted personal assets. As shown in Exhibit 3, Medicare pays for almost 38% of services by Genesis, National Healthcare, and Ensign.

Anti-Kickback Statute: Firms are not allowed to pay doctors or others to refer patients to a specific long term healthcare firm.

It is important that students understand how closely the healthcare industry and the government are intertwined with one another. Any legal change the government makes has ramifications on the industry and most likely the services patients receive.

Economic Students sometimes struggle to see how the economy influences the healthcare industry. I attempt to elicit the following connections from students.

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When the economy is doing well, the government collects more in taxes, and it will be able to support programs such as Medicare and Medicaid more easily. The reverse is true as well.

When the economy is doing well, more people have jobs that may provide health benefits. This will help people obtain preventative care which may allow them to avoid major issues later in life that Medicare may need to pay for. There is a double edge to the sword though; preventative care may allow people to live longer which would place more of a burden on Medicare/Medicaid programs in the future.

If the economy is doing well, there may be more investors that are willing to invest in long-term healthcare firms.

Sociocultural •

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Per Hofstede’s Cultural Dimensions, people in the United States are very individualistic and care more about themselves than their society or others. This may have two outcomes: o People may not want their taxes increased to pay for other people’s healthcare. o People are less likely to take care of an aging family member on their own.

People may put elderly family members in a long-term healthcare related home such as a skilled nursing facility or an assisted/senior living facility.

There has been an increasing focus on health and wellbeing in the United States over the last decade. This may help people live longer lives. If this is the case, it may be a cause of the increasing life expectancy shown in Exhibit 2. If people live longer, Medicare and Medicaid will need to pay for their healthcare longer.

On the other hand, the Centers for Disease Control cites that more than one third of Americans are obese. Obesity can lead to diabetes, high blood pressure, coronary artery disease, coronary vascular disease, heart attacks and strokes. These are serious issues for people over 65 that are costly for the government to pay for.

Technological The case does not discuss any specific technologies as being important. However, by now students should have seen the following theme occurring. As medical technologies improve, allowing people to live longer, people will tend to have better lives. However, when people live longer, that places more possible liabilities on Medicare and Medicaid to pay for those extra years of life. It is important that the long-term healthcare industry be mindful of the technologies used on their patients and that the technologies are used to prevent further expensive health interventions (surgeries) in the future.

Ecological Few ecological concerns influence the industry. However, the industry does create a large amount of medical waste which needs to be disposed of properly.

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II: Introducing Industry Factors Once I have completed the above analysis of the general environment with the students, I ask students questions as a way to begin introducing the topic of industry analysis without explicitly stating so. Using a Porter’s Five Forces framework, I ask variants of the following questions.

Threat of New Entrants Question: We know that there will be a lot of demand for long-term healthcare facilities as baby boomers age. How hard is it to get into this industry? As an entrepreneur what would you need to do?

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The evidence from the Genesis Healthcare part of the case states that it is fairly easy to get into the industry. It is most likely easiest to enter into the less skilled assisted/senior living facilities side of the industry. You need a building, beds, and people to help patients with their daily needs of eating, medication, hygiene and perhaps transportation. The harder aspects would be getting the appropriate licenses and developing a good reputation, but there will be sufficient demand for services and Medicare and Medicaid would be stable revenue sources. Overall, there is a high threat of new entrants, but it is dependent on the skill of service you need to provide.

Threat of Rivalry Question: Ok, now that we have our business, do you think it will be hard to compete with other firms?

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As noted in the case, there are about 67,000 regulated providers servicing 9 million patients. This means there is a lot of competition and rivalry is most likely fierce: staying open may be tough.

Buyer Power Questions: Do we think we can charge a premium for our services compared to other firms?

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If we treat Medicare and Medicaid as the buyers of our services, we have little power. They set rates and we would be price takers. Our job is then to provide acceptable services while attempting to provide them at low cost. There is very little room for differentiation; Exhibit 3 suggest that private insurance and the patient’s assets are only 30% of our revenue and therefore there may not be a big enough market for high-end care.

Supplier Power Question: Is there any group of people or other firms that can charge us a lot of money for services that we need from them?

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The most important group would most likely be the employees. Highly skilled employees such as nurses or physical therapists could negotiate higher wages. The business model is dependent on employees providing care to our patients, so it is difficult to automate these services. Giving support to the importance of employees, as noted in the case, National Healthcare Corp provides tuition reimbursement to employees in order to recruit, retain, and maintain a qualified staff.

Threat of Substitutes Question: Are there any other industries or people that can replace what we offer patients?

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There does not seem to be other industries that can replace long term healthcare facilities. However, individuals could take care of their loved ones and not use our services. This may not be likely in the United States given the individualistic culture.

III: Discussion Questions Question: Given the increasing costs of healthcare for an aging population, the current health care industry model may not be sustainable in the long term. What options do individuals, firms, and the government have to deal with this issue?

There are a host of possible solutions, but the following are the most common suggestions from class. These ‘solutions’ are far from perfect, but it provides an opportunity for the class to have a lively debate on how likely they are to fix the problem and postulate other consequences of the solution.

Individuals • •

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Take care of the elderly at home, though that can place a burden on a family’s income as well as expenses.

Seniors are now moving to lower cost countries to live and be taken care of there instead of the United States. All-inclusive treatment may cost $2,500/month in the USA, but it can cost $1,000/month in Mexico (McCleery, 2015). There is an interesting video you can show in class about this trend on PBS’s website at the following link: http://www.pbs.org/newshour/bb/foreign-retirees-flocking-mexico/ Save more money before retirement to aid in the cost of long-term healthcare.

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Find ways to lower costs through technology to cope with revenue reductions from the government.

Expand to other countries so that they become less reliant on the US government. o Genesis is opening operations in China. They are trying to diversify their revenue sources and possibly lower the buyer power Medicare and Medicaid have.

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Increase the retirement age as life expectancy increases so that people do not get Medicare benefits until some point after 65 years of age.

Increase taxes on individuals or firms.

Reduce the benefits that Medicare, Medicaid, and Social Security recipients receive.

Put a ‘maximum age’ on which people will receive care. For example, if the maximum age is 100, once a person turns 100 their benefits become more limited; perhaps only pain killing drugs and not more advanced treatments.

It is interesting to have a thought experiment with students about the advancement of technology.

Question: If a cure was found for cancer and this caused the population to live 10 years longer on average, what ramifications would it have on the industry and government?

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One effect may be that less people would need the services of the long-term health care industry since people may be able to live longer on their own, thereby reducing short term demand in the industry.

A second effect would be that the government needs to pay for ten more years of care for other ailments that afflict people as they age. In this situation, a cure for cancer may hurt the industry and hurt the solvency of programs like Medicare and Medicaid.

By this time, the students should have a much clearer understanding of the situation the long-term healthcare industry, and the nation, faces. Individuals depend on the long-term healthcare industry to take care of themselves and loved ones. The long-term healthcare industry depends on programs like Medicare and Medicaid for their revenue. These programs depend on a strong economy, but the percentage of the population that is of ‘working age’ (18-64) is shrinking and may provide less tax revenue to the government. Further, Medicare and Medicaid need people to pass away at a ‘reasonable’ age because it reduces expenses for the programs. Inversely, as people live longer, it increases the financial strain on the government. In the end, there are a lot of long-term problems facing these programs, with no easy solutions.

The point of the case is not to create a depressed mood in the classroom by the end of class.

Instead, refocus back to the topic at hand: analyzing the general environment. This short case should provide an excellent way to show students how to conduct a general environment analysis as well as inform them of an important topic influencing society.

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Teaching Note

Vivint Smart Home: Finding New Pathways for Growth Teaching Objectives This case is intended to be used to help students develop an understanding of how companies pursue different growth options. Many companies have multiple growth options to consider, and leaders must decide which growth options have the greatest likelihood of success. Vivint has pursued growth by using new channels to attempt to sell their smart home products (e.g., Best Buy, AirBnB, e-commerce), by adding additional products to their mix (e.g., internet, smart drive, doorbell camera), by pursuing new customer segments for their alarm system and smart products (businesses, apartments), and by using their salesforce as a channel to sell a partner’s products (e.g., solar) that they do not install or service. The Vivint case provides an opportunity to discuss the different growth options attempted by Vivint and the logic for each growth option (for example, cost synergies, such as leveraging existing resources and capabilities; or customer experience synergies, such as leveraging the customer’s prior experience with Vivint).

Teaching Materials Case: Vivint Smart Home: Finding New Pathways for Growth Preparation Questions 1. What are the different growth options pursued by Vivint? How would you categorize or group them in terms of different logics for how they generate revenue growth (e.g., new products, different channels, etc.)?

2. Let’s discuss each of the different growth options in each category. What are the keys to success with regard to each growth option? What criteria would you use to determine whether a particular growth option should be pursued?

3. Why was Vivint more—or less—successful with each growth option? What lessons do you take away from Vivint’s experience pursuing different growth options?

4. What do you think are Vivint’s current best growth options? Where should Vivint focus on to grow from here?

Teaching Plan I. Comparing Business Models Copyright ©2022 John Wiley & Sons, Inc.

10 min

II. Discuss Different Growth Options Pursued and Vivint’s Success with Each III. Discuss Lessons Learned from Vivint’s Experience.

IV. Discuss Vivint’s Current Best Growth Options

25-30 min 10-15 min 10-15 min

I. Comparing Business Models Question: What are the different growth options pursued by Vivint? How would you categorize or group them in terms of different logics for how they generate revenue growth (e.g., new products, different channels, etc.)?

Vivint has pursued growth by: 1. Using new channels to attempt to sell their smart home products (e.g., Best Buy, AirBnB, e-commerce).

2. Adding additional new products to their mix of smart home products (e.g., internet, smart drive, doorbell camera).

3. Pursuing new customer segments for their alarm system and smart products (businesses, apartments).

4. Using their salesforce as a channel to sell additional products from a partner (e.g., solar) that they do not install or service.

II. Discuss Different Growth Options Pursued and Vivint’s Success with Each Question: Let’s discuss each of the different growth options in each category.

What are the keys to success with regard to each growth option? What criteria would you use to determine whether a particular growth option should be pursued?

The purpose of this question is to help students think about and discuss the criteria that companies use to decide whether to pursue particular growth options.

Generally speaking, students should identify cost synergies that might make a particular growth option attractive or customer experience synergies which lower customer acquisition costs and make a customer more likely to be aware of and try out and adopt a new product.

The slide below shows cost and experience synergies for three Amazon growth options: • Amazon Web Services (AWS), which leveraged cost synergies • Kindle, which leveraged customer experience synergies Copyright ©2022 John Wiley & Sons, Inc.

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Amazon Marketplace, which leveraged both cost and customer experience synergies

The slide below provides a more detailed description of cost and customer experience synergies.

Vivint Growth Options New Products/Services Copyright ©2022 John Wiley & Sons, Inc.

Internet – leveraged customer experience synergies (tried selling primarily to existing alarm system customers) and cost synergies with regard to the sales channel.

Smart drive – leveraged customer experience synergies (tried selling primarily to existing alarm system customers) and cost synergies with regard to the sales channel.

Doorbell camera – leveraged customer experience synergies (sold to existing alarm system customers or bundled with smart home devices to new customers) and cost synergies by leveraging the sales channel and some existing design capabilities.

Solar products – leveraged customer experience synergies (tried selling primarily to existing alarm system customers) and cost synergies with regard to the sales channel.

New Channels Best Buy – leveraged Best Buy’s sales channel to access new customers and lower customer acquisition costs.

AirBnB – leveraged AirBnB’s sales channel to access new customers and lower customer acquisition costs.

New Customer Segments Business/enterprise segment – there were very minor customer experience synergies (only a few business owners had purchased Vivint Smart Home) and only minor cost synergies with the smart home equipment (it leveraged prior experience designing smart home equipment for the home; but this equipment needed to be redesigned for a larger commercial building footprint, so it didn’t work particularly well). The salesforce/channel needed a different way of selling and somewhat different skill set selling to enterprise customers than existed within the typical salesforce channel to the home.

Apartment segment – once again, there were very minor customer experience synergies (only a few apartment owners had purchased Vivint Smart Home); but there were greater cost synergies with the smart home equipment in apartments than in the business/enterprise segment (apartments better leveraged the use of existing smart home equipment because apartments are like a very small home). However, like the business segment, the salesforce/channel needed a different way of selling and a somewhat different skill set selling to apartment owners than existed within the typical salesforce channel to the home. Apartment owners typically wanted a much

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more basic offering (for example, some just wanted a way to open a door remotely to let someone into the apartment; few wanted an alarm system).

III. Discuss Lessons Learned from Vivint’s Experience.

Question: Why was Vivint more—or less—successful with each growth option?

What lessons do you take away from Vivint’s experience pursuing different growth options?

This question allows for a discussion of the lessons learned about trying to grow a company.

1. Leveraging Different Ways to Grow Revenues. There are a number of different ways that a company can try to grow revenues, including: a. Offering new products/services (the way we typically think about a company growing). b. Entering new market segments/geographies (this often requires modifying or adapting products to meet the needs of customers in the new market segment/geography). c. Developing and using accessing new sales channels (this is an avenue for growth that doesn’t require the development of new products).

2. Leveraging Existing Resources and Capabilities Every growth option was designed to leverage some of Vivint’s existing resources and capabilities. In practice, some of the key resources and capabilities did not translate into new ventures as well as they had anticipated.

What could Vivint have done differently to more accurately identify what cost or customer synergies existed before investing in a new growth option?

3. Pilots Like most organizations, Vivint had run pilots of its new growth opportunities to test whether they were likely to work. However, experience had taught Eyring and the Vivint team that pilot tests of new initiatives were often misleading. Pilot tests received better resources (human capital) and extra attention; in addition, they were typically two to three times as productive as the actual rollout, leading to inflated performance expectations of the new offering. Eyring wondered how he could best account for this phenomenon (which he noted had been called the “Hawthorne effect” in academia due to early studies at the Hawthorne plant where increased attention to a pilot resulted in better performance). Was designing pilot tests representative of the initiative at full scale possible? At the very least, it appeared that Vivint should discount the results of all pilot tests by a predetermined rate. Based on Vivint’s pilot experiences, the results were likely Copyright ©2022 John Wiley & Sons, Inc.

to be 2-3 times more effective than the rollout of a growth initiative at full scale.

Using pilots effectively to assess growth options was important and yet presented challenges for interpreting and acting on the pilot results.

4. Customer Acquisition Costs In some new growth initiatives Vivint was trying to leverage its direct salesforce, but even when leveraging its existing salesforce, customer acquisition costs were usually higher than initial projections. Growth options that targeted new customers instead of relying on existing customers to fuel growth were especially challenging. In most cases of targeting new customers, customer needs differed enough that customer acquisition costs were much higher than expected. Vivint Properties was an exception, the costs of acquiring apartment customers were more in line with expectations. The Vivint team wrestled with how it could better tap into the existing customer base to decrease customer acquisition costs. How could they do a better job at estimating customer acquisition costs for each new growth initiative?

5. Spread Too Thin?

Eyring’s team noted that Vivint had perhaps spread itself too thin at times.

Pursuing multiple growth options simultaneously had left some initiatives starved for resources. When promising new growth options emerged, they received more time, attention, and company resources, and other ventures with slower growth were neglected before they could be adequately tested or funded. Some experts on creating growth advocate starting many different ventures because it is difficult to predict which ones will succeed. According to this quantity-produces-quality view the best strategy is to let “1,000 flowers bloom”. However, Eyring saw that in many cases the growth of some flowers was an impediment to the growth of others, which were starved for attention and resources. Going forward, he wondered whether Vivint should be more selective in its pursuit of growth options or continue to test multiple growth options simultaneously.

6. Partnerships Vivint had created two different channel partnerships, with Best Buy and Airbnb, as it pursued new areas of growth. While both partnerships looked ideal on paper, neither provided as much value as expected. Had Vivint overestimated what each side of the partnership could bring to the table? Did Vivint need to develop stronger partnership capabilities? If so, how might Vivint become more effective at creating value through partnerships with other companies?

IV. Discuss Vivint’s Current Best Growth Options

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Question: What do you think are Vivint’s current best growth options? Where should Vivint focus on to grow from here?

This question allows students to apply the criteria and framework to discuss other ways that Vivint might attempt to grow.

Some potential growth opportunities.

Products/Services - Smart lighting systems - Senior monitoring systems for health and safety (e.g., voice activated requests for assistance) - Smart appliances - Smart blinds - Smart sprinkler systems (adjusting to changing temperature, rainfall, etc.)

- Smart outdoor lighting New Customer Segments/Markets - International markets (Canada, Mexico, UK, etc.)

Channels - Use existing sales channel to the home to sell Cable/Satellite TV/Internet Service, PEST, etc.

Copyright ©2022 John Wiley & Sons, Inc.

Teaching Note

ESPN in 2019: A Network in Search of a Solution Teaching Objectives ESPN in 2019: A network in search of a solution has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in conjunction with a module on internal business unit strategy, and firm resources and capabilities. The case is a follow-on and update for ESPN in 2015: Continued Dominance in Sports Television? That case provides students with opportunities to see how a company develops a unique set of resources and capabilities over time, and how those capabilities may be threatened by technological, demographic, and market changes. The update allows students to see the complex issues involved in strategic change at a business unit with a strong corporate parent. This note assumes the instructor is either using, or is familiar with Strategic Management by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in industry analysis and familiarity with the Competitive Advantage Pyramid tool as discussed in Chapter 3, although the case touches on Chapter 5 (differentiation advantage) as well. Some instructors may choose to use the case along with Chapter 6 (corporate strategy).

Students should have the opportunity to see how a strategic decision plays out over a number of years (as a follow on to ESPN in 2015) which will allow students to examine the complex nature of a commitment to a strategy, referred to in the case as the “Golden Goose” problem. They should also examine the relationship between a business unit and corporate parent in the value creation process. They should also understand and describe how a strategic decision takes place over a number of years, and the constraints facing decision makers, explain how a company’s commitment to a strategy limits its flexibility in changing that strategy, and identify the corporate level forces that influence how business unit managers craft their own strategies.

Study Questions 1. Why has ESPN done so little to respond to the streaming threat since 2015? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension] 2. How much attention should James Pitaro give to the problems created by John Skipper around a “politicized” ESPN? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 6 Evaluation]

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3. Is relying on subscription fee increases a good long term strategy for ESPN? Why or why not? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 6 Evaluation]

4. How tightly linked should ESPN and Disney be in any online streaming service?

[AACSB: Reflective Thinking] [Difficulty: Medium] [Bloom’s 5 Synthesis] 5. What would you do if you were James Pitaro? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 5 Synthesis]

Multiple Choice Questions 1. Why has ESPN done so little to respond to the streaming threat since 2015? a. Because they already have a strong subscription model that brings in sufficient revenue b. Because sports does not lend itself to streaming c. ESPN has responded but has not yet done enough d. Because ESPN is partnering with Disney on streaming Answer: “C” 2. How much attention should James Pitaro give to the problems created by John Skipper around a “politicized” ESPN? a. Much, because social commentary is not their primary “job-to-do” b. Much, because social commentary risks alienating a core audience c. Little, because ESPN has always relied on its ability to provide thoughtful commentary d. Much, because the network may benefit from more balanced reporting Answer: “D” 3. Is relying on subscription fee increases a good long term strategy for ESPN? Why or why not? a. Yes, because it deepens ESPN’s reliance on its relationship with cable b. Yes, because If ESPN creates an app untethered form its cable offering, then sports fans might “cut the cord” and just view sports through the app c. No, because the app costs $5/ month, while a cable subscription is close to $10. So, the network loses $5/ month for each “cord cutter” who moves to the app Copyright ©2022 John Wiley & Sons, Inc.

d. Yes, because ESPN has substantial room for further price increases due to high price inelasticity Answer: “D” 4. How tightly linked should ESPN and Disney be in any online streaming service? a. Very, because Disney’s can combine its unique content with that of 21st Century Fox to drive eyeballs to the service b. Very, because if ESPN were included in the service, then the service would have content that appealed to important audiences and demographics and increase the likelihood of success c. Not very, because the classic Disney library (Snow White, The Lion King) seems distant from ESPN d. Not very, because any action by Disney that weakens the network’s value over the cable platform risks inviting more subscribers to “cut the cord” Answer: “D” 5. What would you do if you were James Pitaro? a. Continue to generate the vast majority of revenues from cable subscription fees by leveraging price inelasticity b. Move into a proprietary streaming platform to compete with Netflix and Amazon c. Partner with Disney on their streaming platform d. Protect the “golden goose” while slowly offering streaming options Answer: “D” Teaching Plan I. Why Has ESPN Done so Little to Respond to Streaming?

II. How Much Attention Should James Pitaro Give to The Problems Created by John Skipper Around a “Politicized” ESPN? III. III. Is Relying on Subscription Fee Increases a Long-Term Strategy for ESPN? Why or Why Not? IV. How Tightly Linked Should ESPN and Disney Be in Any Online Streaming Service?

V. What Would You do if You Were James Pitaro?

Copyright ©2022 John Wiley & Sons, Inc.

5-15 min 5-15 min

10-30 min 5-15 min 5-15 min

The short length of ESPN in 2019, and its connection with ESPN in 2015 gives the instructor substantial flexibility in using this case. In an 80-minute session, there will not be enough time to do both cases, and so the instructor must decide if ESPN 2019 is a “coda” to the first case, or if the issues in the case warrant a longer discussion. The length of the case, and the number of issues it raises, also facilitates its use as an exam (mid-term or final).

If the case is used for a class discussion, then the instructor can choose the amount of time dedicated to each question. The five preparation questions provide a nice framework and sequence to open up the case.

I. Why has ESPN done so little to respond to the streaming threat since 2015?

This question is a loaded opener, because while the network has made little progress in streaming and mobile platform applications, the company has not been inactive. A nice follow-on question is: “do you agree with Skipper’s assessment that the losses in subscribers would not be a critical issue?” Some students will note that the number of subscribers continues to decline, and others will note that the rate of loss seems to be slowing.

Question: How many subscribers can ESPN afford to lose before the company is jeopardized?

Some students will note, from the ESPN in 2015 case, that only about half of ESPN’s subscribers actually watch the network, and so the network might be able to lose another 510 million subscribers without damage. Other students should raise the following issue: Programming costs have doubled, and profitability has decreased, and so any additional losses will damage ESPN’s overall performance.

II. How much attention should James Pitaro give to the problems created by John Skipper around a “politicized” ESPN? The issue here is the “job-to-be-done” that viewers have hired ESPN to do. If that job is the simple transmission of sports programming, then social commentary risks alienating this core audience. Some students will note this and argue that the network should curtail its social involvement and focus on sports broadcasting.

Question: What is ESPN’s core value proposition? Is it just sports broadcasting or does it involve analysis and commentary?

Students should understand that the network has never been about Exclusive Sports Programming, but has always relied on is ability to provide thoughtful commentary, insight, and news about the sporting world to its viewers.

Question: If this is the case, then what’s the real issue in play here?

Students should identify two issues, both around balance. The first is the balance of social commentary to sports reporting. Could it be that social commentary is leaven, and a little bit lifts the loaf, but a lot ruins the taste. This would be a question of emphasis.

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The second issue here is the balance between points of view. The Jemele Hill incident cited in the case, and other sources students might find online, suggests that the network propounds a “liberal,” progressive view of social issues in sport. The network may benefit from more balanced reporting as there are a likely a number of viewers holding the opposite, “conservative” view.

The core question for students to wrestle with is about value creation, for viewers, reporters, and society. Some may believe that social commentary creates no value, while others will argue that powerful networks such as ESPN ought to be socially engaged.

III. Is relying on subscription fee increases a long-term strategy for ESPN? Why or why not?

This question gets at the core of ESPN’s challenge. The activity of systematically raising subscription fees (especially in an environment of flat advertising rates) deepens ESPN’s reliance on its relationship with cable. The ESPN+ app highlights this problem. If ESPN creates an app untethered form its cable offering, then sports fans might “cut the cord” and just view sports through the app. The app, however, costs $5/ month, while a cable subscription is close to $10. So, the network loses $5/ month for each “cord cutter” who moves to the app.

The real problem, however, comes from the fact that if a substantial number of sports fans defect to the app, Cable TV operators have more incentive to drop ESPN as a part of their package (the most expensive part). That puts the prime source of revenue—the subscriber who never watches—at risk and ESPN would lose $10 per month per lost subscriber.

In terms of economics, the ESPN subscription seems to be quite price inelastic. If students were to calculate the price elasticity, based on data in the two cases, they would find that ESPN’s price increases have not led the bulk of customers to abandon the network. Students can calculate the price elasticity of demand from the data in Exhibit 1, and it’s easiest to use the percentage change for subscribers and fees. The price elasticity of demand is the Percentage Change in Subscribers divided by the Percentage Change in Fees. If the Price Elasticity of Demand is less than one (<1), then price is inelastic. Price increases over the last five years have varied between 1.8 and 5.5%. Losses in subscribers has never exceeded 2%. It looks, just from the numbers, that ESPN might have substantial room for further price increases. Revenue should continue to climb.

The instructor might ask about profit, as opposed to revenue. After all, the goal of a business is to generate profits, not merely revenue. Since 2014, ESPN’s programming costs have doubled to $4.7 billion each year, for an increase of $2.35 billion. Revenues have increased by $1.7 billion a year. That’s a $600 million shortfall.

Question: Was the move for expanded NBA content a good investment?

This loops back to the earlier discussion about the job-to-be-done. If subscribers really want live content, then providing more content is the type of investment the network should make.

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If, however, commentary and analysis provide significant value for viewers, then ESPN’s tripling of its contract with the NBA might not have been wise.

The instructor should help students see that, as the threat from streaming plays out, the answers for ESPN will probably not be black-and-white/ yes-no decisions. The executive team lives in a complex world of more competitors and more technological platforms than ever before. The right strategy might be a question of degree. In fact, with more competitors across more platforms, lower profitability might become the new norm.

Question: Is profitability the price Disney and ESPN must pay to continue to compete in a changing industry?

Competitive streaming services are the reality for both Disney and ESPN, and how one network reacts might/should drive how the other one does as well.

IV. How tightly linked should ESPN and Disney be in any online streaming service?

The final challenge that Pitaro faces arises from the Disney relationship. Disney intends to create its own streaming service to compete with Amazon and Netflix. CBS has not fared particularly well with its service, only generating 8 million subscribers as opposed to Netflix’s 139 million. Disney’s bet appears to be on content—that by combining its unique content with that of 21st Century Fox, the company will have enough content to drive eyeballs to the service.

Question: What role should ESPN play here?

The assumption is that if ESPN were included in the service, then the service would have content that appealed to important audiences and demographics and increase the likelihood of success. The instructor should probe this assumption and see if students believe it. On the one hand, the classic Disney library (Snow White, The Lion King) seems distant from ESPN, but on the other hand, Marvel Studios and ESPN may experience substantial overlap.

Whether or not students believe the assumption, the reality is that including ESPN in the service raises the same Golden Goose problem discussed above. Any action by Disney that weakens the network’s value over the cable platform risks inviting more subscribers to “cut the cord” and cable providers to resist further price increases. The instructor should remind students that it’s not just about subscribers, but it’s really about losing those cable subscribers who never watch ESPN and are unlikely to move to the Disney streaming service.

Question: In what venue does ESPN create the most value?

The current state of affairs seems to be that ESPN creates the most value as a deeply embedded cable property. Will that continue to be true into the future?

V. What would you do if you were James Pitaro?

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This question puts students in the role of decision maker, and invites them to synthesize their thinking and make a recommendation. This instructor may give the question to teams and have them develop a plan for the future, and the instructor might use the time to have groups present.

The more preparation time that students have to prepare potential strategies, the more thoughtful their responses will be, and the richer and deeper the class discussion.

The instructor may conclude the session by asking a few students for their key learning points from the case. If the instructor chooses to provide a summary, that summary should focus heavily on the “Golden Goose” problem ESPN faces.

When ESPN moved to a subscription model back in 1983, the company had found a new source of revenue to keep the network afloat and growing. 35 years later the company continues to generate the vast majority of its revenues from these fees. Future growth depends on continued price inelasticity among subscribers for sports programming. One risk for the network is maintaining that elasticity by spending more on programming than they gain in fee increases. The other risk, and a consequential one, involves the loss of strategic flexibility. Executives may not be able to consider any action that threatens the “Golden Goose” which significantly limits their options in crafting strategies for an increasingly complex competitive market.

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Teaching Note

Samsung: Overtaking Philips and Panasonic/Sony as the Leader in the Consumer Electronics Industry Teaching Objectives This case examines the international strategies (and organizational structures) of Philips, Panasonic, Sony, and Samsung in the consumer electronics industry and how each was able to emerge as the world leader in the industry. In particular, this case shows how Philips emerged as the leader from 1920-1980 following a multi-domestic strategy that relied on a decentralized structure for implementation that allowed for local market differentiation. Panasonic (then Matsushita) overtook Philips following a global strategy that treated the world as a single market and provided cost advantages due to a highly centralized organization structure. Finally, Samsung overtook Panasonic/Sony following a transnational strategy that successfully allowed for local differentiation on some dimensions (e.g., product design) while centralizing on other dimensions (e.g., R&D, manufacturing). The case is particularly effective at considering a firm’s options for geographic expansion as well as the important link between strategy and structure (i.e., structure follows strategy and is key to implementation of the strategy).

Study Questions 1. How did Philips become the worldwide leader in the consumer electronics industry? How did Panasonic overtake Philips? How did Samsung overtake Panasonic and Philips? What core competencies (resources and capabilities) did each firm possess that helped it to be successful? [AACSB Analytic] [Difficulty: Easy] [Bloom’s 2 Comprehension] 2. What were the key success-factors in the industry during the 1920-1980 period when Philips was the world leader? How did those key success factors change during later time periods when Panasonic and Samsung overtook Philips to become leaders in the consumer electronics industry? [AACSB Analytic] [Difficulty: Medium] [Bloom’s 4 Analysis] 3. What are the major problems/challenges that each firm faced? What additional steps should each firm take to strengthen their respective competitive positions? [AACSB Analytic] [Difficulty: Hard] [Bloom’s 5 Synthesis]

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Multiple Choice Questions 1. How did Philips become the worldwide leader in the consumer electronics industry? a. National organizations excelled at tailoring products to local markets b. Standardized and reliable products offered at low price c. Low-cost manufacturing of components d. All of the above “Answer:” A 2. How did Panasonic overtake Philips? a. Breakthrough technologies b. Differentiate products for different geographies/regions c. Standardized and reliable products at a good price d. Tailoring products to local markets “Answer:” C 2. How did Samsung overtake Panasonic and Philips? What core competencies (resources and capabilities) did each firm possess that helped it to be successful? a. Samsung had a different value proposition depending on the target market b. Samsung manufactured many products in Europe c. Samsung had the highest volume production d. Samsung was able to provide a wide variety of reliable products while Panasonic and Philips could not “Answer:” A 3. What were the key success-factors in the industry during the 1920-1980 period when Philips was the world leader? How did those key success factors change during later time periods when Panasonic and Samsung overtook Philips to become leaders in the consumer electronics industry? a. Companies increasingly needed to address a broad range of customer needs in different customer segments and different geographies b. The product/service changed from being customized in each country to becoming more standardized worldwide c. Differences between countries became smaller d. All of the above

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“Answer:” D 4. What are the major problems/challenges that each firm faced? What additional steps should each firm take to strengthen their respective competitive positions? a. Panasonic lacked economies of scale because of how decentralized they were, so centralization is essential b. Philips has scarce capabilities in terms of R&D so they should create additional labs in each major country/region that allowed for cross fertilization of ideas c. Panasonic has scarce efficiency so they should increase the standardization of their products d. Companies should follow Samsung’s strategy of creating “best value” by differentiating where you have to (e.g., product design) but standardizing in all other activities (e.g., R&D, components, etc.).

“Answer:” D

Teaching Plan I. Philips’ Strategy II. Panasonic’s Strategy III. Samsung’s Strategy IV. International Strategies

15 min 15 min 15 min 15 min

Note on International Strategies: As each firm’s strategy is reviewed, it may prove helpful to focus the discussion on the type of international strategy each firm had and how that was reflected in how they were organized (an illustration of each organizational structure is included below). Such a discussion may make it easier to understand why each firm was overtaken by its successor.

I. Philips Strategy Question: What was Philip’s strategy?

Market • International • Consumer Electronics Unique Value (proposition) • Differentiate products for different geographies/regions

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•

Wide variety of electronics products (started in light bulbs, added vacuum tubes, x-ray tubes, etc.)

Resources and Capabilities • Research & Development o Philips was known for developing breakthrough technologies through a corporate R&D lab with additional labs in each major country/region that allowed for cross fertilization of ideas • National organizations o Philips national organizations excelled at tailoring products to local markets with local design, manufacturing, and sales and service.

Organizational Structure CEO and Management Board

International Concern Council

Administration

National Organizations

-Finance, Legal HR

(U.S., U.K., Germany, Japan, etc.

R&D

Product Development

Legal

Manufacturing

Product Divisions

Marketing

Development

Production

Distribution

Question: What kind of problems did Philips run into as Panasonic & Sony began to overtake them in the 1970s and 1980s?

Philips products began to be high cost: - Philips lacked economies of scale because of how decentralized they were (the organizational structure created redundancies across markets) - Philips manufactured many products in Europe where labor costs were high - Philips had to close 100 out of 356 manufacturing plants in an effort to centralize operations Copyright ©2022 John Wiley & Sons, Inc.

Philips was slow to market with worldwide product launches: - Philips structure required agreement among the national organizations before worldwide product launch plans could be created which make coordinated global activity difficult II. Panasonic’s Strategy Market • Consumer Electronics • International (after WWII) Unique Value (proposition) • Standardized and reliable products offered at low price (perceived as good value by customer) Resources & Capabilities • Efficiency • High volume production • Centralized organizational structure Organizational Structure

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Question: Sony is first to market with the Beta video player, which, according to most, was the superior technology. Why does Sony lose the battle for the VCR even though they were the first to market with superior technology?

Beta Max • More expensive • Only offered through Sony; didn’t license to other companies Panasonic VHS • Cheaper • Greater availability (VHS technology was licensed out to all competitors; thus, multiple VHS players were sold in the market; not just Panasonic) • Network Effect—because VHS players were more available, videos were released more often on VHS leading to VHS becoming more popular in the market III. Samsung’s Strategy Markets • Consumer Electronics Unique Value (proposition) • Different depending on the target market; Samsung offers a range of products around the globe appealing to full range of customers, from those interested in lower cost products (e.g., in price sensitive emerging economies) to those wanting higher end differentiated products (e.g., in major industrialized nations) Resources & Capabilities • Began with low-cost manufacturing of components • Vertically integrated forward into the manufacture of final products for consumers (e.g., DVD players, TVs, phones, etc.). This required committing significant resources and investment to R&D and technology to develop new products • Invested in digital technologies as they overtook analog technologies Organizational Structure

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IV. International Strategies •

Types of International Strategy o Multi-Domestic Strategy (Differentiation/adaptation) ▪ Product/service is customized in each country.

▪ Decentralized federation of national organizations. Local decision-making authority.

▪ Effective when differences between countries are large ▪ Sources of advantage • Differentiation • Local responsiveness • Minimize political & exchange rate risks o Global Strategy (Cost/aggregation) ▪ Product/service is standardized worldwide ▪ Centralized organization structure. National subsidiaries possess little decision-making authority.

▪ Effective when differences between countries are small.

▪ Sources of advantage • Cost • Ability to coordinate activities • Speed in new product development

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o Transnational Strategy (Best value through balancing differentiation/cost) ▪ Effective when attempting to provide a full range of products worldwide to both high end and low-end customers ▪ Organization structure is more decentralized than a global strategy but more centralized than a multi-domestic strategy ▪ Effective when addressing a broad range of customer needs in different customer segments and different geographies ▪ Sources of advantage • Value in each customer segment/market • Economies of scale and scope from producing a wide range of products.

•

A Multi-Domestic Strategy o Strategy: ▪ Differentiate in local markets drawing on worldwide resources. o Policies: ▪ Tailor products to national idiosyncrasies ▪ Sacrifice efficiency for market focus ▪ Reach economies of scale upstream ▪ Maximize local value added

•

Global Strategy o Strategy: ▪ Gain global market share ▪ Cost/Leadership o Policies: ▪ World products to build volume and global product roll-out ▪ Break down value chain and exploit low-cost locations around the world ▪ Optimize global network at local expense

•

Transnational Strategy o Strategy: ▪ Create “best value” by differentiating where you have to (e.g., product design) but standardizing in all other activities (e.g., R&D, components, etc.). o Policies: ▪ Break the world into regions where customers have similar needs/similar demographics ▪ Develop products for each region depending on needs.

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▪ ▪

Break down value chain and exploit low-cost locations around the world whenever possible.

Balance needs of global operations vs. local demands

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Teaching Note

CVS in 2015: From Neighborhood Pharmacy Provider to Healthcare Company Teaching Objectives CVS in 2015: From Neighborhood Pharmacy Provider to Health Care Company has been written for use in undergraduate or first year MBA core classes in business strategy. The case has been designed for use in conjunction with a module on corporate strategy; the case provides students with opportunities to see several different manifestations of corporate strategy. This note assumes the instructor is either using, or is familiar with Strategic Management by Dyer, Godfrey, Jensen, and Bryce. Students need to have some facility in industry analysis and familiarity with concepts of corporate strategy as discussed in Chapter 6, although the case touches on Chapters 7 and 8 as well.

The case provides you the opportunity to help students understand the changing nature of the pharmacy services industry, illustrate how a firm can successfully use M&A activity to maintain/extend its competitive position in a changing industry, and allows students to make the case current by considering the steps CVS should consider next.

At the end of this case, they should be able to identify the important drivers of competition in the pharmacy industry and explain how CVS uses mergers and acquisitions to extend its position in the changing pharmacy market. Using the 6 S model, they will identify how each of CVS’s acquisitions adds value to the corporation and will evaluate the post-acquisition integration methods that CVS uses to create an integrated offering.

Study Questions 1. What is the competitive context in which CVS operates? How can the pharmacy industry be described using the Porter 5 forces model? [AACSB: Analytic] [Difficulty: Easy] [Bloom’s 4 Analysis] 2. What factors drive the industry? What leads to success in each of the industry segments? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 2 Comprehension] 3. How did CVS use acquisitions as a value creation tool? [AACSB: Analytic] [Difficulty: Medium] [Bloom’s 5 Synthesis]

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4. What should CVS do in the future? What are the strategic challenges that is likely to face in the near future? [AACSB: Reflective Thinking] [Difficulty: Hard] [Bloom’s 6 Evaluation] Multiple Choice Questions 1. What is the competitive context in which CVS operates? How can the pharmacy industry be described using the Porter 5 forces model? a. In the pharmacy industry all Porter 5 forces are very strong b. The power of buyers and suppliers is very low, whereas threat of substitution, competitive rivalry, and barriers to entry are very high c. Competitive rivalry and barriers to entry are of medium strength, supplier and buyer power are high, and threat of substitution is very low d. In the pharmacy industry all Porter 5 forces are very weak Answer: “C” 2. What factors drive the industry? What leads to success in the industry segments? a. Convenience, product selection, and price lead to success in the PBM segment b. Efficiency in transaction processing and scale are success factors in the Retail pharmacy segment c. Efficiency in transaction processing and scale are success factors in every segment d. Convenience, product selection, and price lead to success in the Retail pharmacy segment Answer: “D” 3. How did CVS use acquisitions as a value creation tool? a. CVS creates value by creating synergy or shared knowledge throughout the corporation b. CVS uses diversification to enter new market segments and expand geographically c. CVS uses diversification to buy new capabilities and market presence d. All of the above Answer: “D” 4. What should CVS do in the future? What are the strategic challenges that CVS is likely to face in the near future? a. CVS will face limited challenges and can continue to successfully use acquisitions to increase scale and market power because there are few technological limits to growth b. CVS can continue to successfully use acquisitions to increase scale and market power, but acquisitions may become more difficult over time Copyright ©2022 John Wiley & Sons, Inc.

c. CVS will face challenges because it won’t be able to acquire the best targets available for acquisition d. Acquisitions will lose attractiveness for CVS because in the pharmacy industry scaling rapidly does not lead to competitive advantage Answer: “B”

Teaching Plan I. Industry Analysis II. Acquisition as a Value Creation Tool III. CVS Diversification IV. CVS in 2015: Omnicare, Target, and going forward V. Concluding Comments

20 min 15 min 25-30 min 15-20 min 10 min

I. Industry Analysis Begin with a discussion and analysis of the pharmacy industry, usually starting with a simple question such as “What’s the nature and structure of the pharmacy industry?” Students should note that the industry in 2015 had at least four separate, but related, segments: Retail Pharmacies (where CVS is the recognized market leader), Pharmacy Services (Where CVS is second in overall market share), Mail Order and Specialty (where CVS is also a leader) and Institutional Pharmacy (hospitals, nursing homes, prisons, and other institutional settings).

Before moving on, the instructor needs to ensure that students understand that Retail represents the “front of the house” for a pharmacy, and Mail Order/Specialty and Pharmacy Services the “back of the house.” This relationship underpins the logic behind many of the moves CVS and its competitors have made.

The next area for analysis is a five forces analysis of the pharmacy industry. This analysis reinforces for students the critical importance of understanding the context of competition; without a knowledge of how the industry works, strategic moves like scaling up make less sense.

Barriers to Entry •

Medium due to entry at scale and government regulation. Small players can enter the market, but unless they belong to a PBM network, they’ll have a hard time competing.

Because there are multiple PBMs, however, entry is possible. New entrants must also compete against pharmacies like CVS and Walgreens, who have focused on locking up the most convenient retail locations for their shops.

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Supplier Power •

Very high as you are dealing with the larger pharma houses. While industry concentration data on pharmaceutical companies is not given in the case, students should be able to connect the high costs of drug development ($2.6 Billion per drug) with large scale and a need for high prices in the Pharmaceutical industry. The instructor might ask “What’s the trend in Pharma?” 1. Higher drug development costs, 2. Targeting smaller, niche therapies. Exhibit 1 provides students with detail about the changes in drug prices over the past four decades.

Buyer Power •

Moderate/ High and increasing. This is a two-tiered market, with those who use the drugs and those who pay for them often different. Consumers have a tendency to NOT be price sensitive, but 3rd parties (health insurance companies) are. With the adoption of the Affordable Care Act (Obamacare), the trend toward price conscious purchasing is likely to increase for two reasons: 1. More people covered by health insurers (giving plans greater clout), and 2. More “sick” people in health plans. The sick use more medication, and those medications—for chronic cases—tend to be more costly. The Federal Government is a huge player in this market through its actions in Medicare Part D. Medicare sets reimbursement rates for all medications covered under its plan and these reimbursement rates serve as a benchmark for insurance reimbursement rates beyond Medicare. Medicare is a very price sensitive buyer.

Threat of Substitution •

Low and almost non-existent. For many ailments, medication provides the only solution, and medicating people is still cheaper, and more effective, than in-patient treatment or other options.

Competitive Rivalry •

Medium. Data in the case inform students that, by 2015, the pharmacy industry was large and fairly concentrated. It’s unlikely that there will be more consolidation (due to anti-trust concerns) and that competition will be administered between the large pharmacy groups. With a few large players, price wars make little sense as one competitor is unlikely to knock another one out, the result is lower overall industry profits. Exhibit 2 details the size of the Retail segment and CVSs share since its inception.

With this analysis in place, the instructor should ask “What factors drive this industry?” Two factors prove crucial, one technological and one economic. Technologically, the “low hanging fruit” in drug therapies has already been plucked. The search for new drugs involves greater and greater technological leaps (chemically or biologically). Also, many new drugs aren’t Copyright ©2022 John Wiley & Sons, Inc.

“blockbuster” drugs with huge markets. Economically, demand for Health Care is very inelastic; most individuals won’t be truly price sensitive when their health and lives are at stake. This means that the drive for cost control will be “institutionally driven” by insurers and the government.

An excellent follow-on question would be “what leads to success in each segment?” For the Retail Pharmacy segment, convenience, product selection, and price will lead to success— similar to most of the retail sector of the economy. For a PBM, the name of the game is efficiency in transaction processing (to make the most of very thin margins) and scale in order to negotiate the largest discounts possible from the large pharmaceutical companies. The instructor should not move on until students see that without being a part of a PBM network a pharmacy would have a difficult time; without the scale of a PBM to help control drug costs, a retail pharmacy would not be price competitive. Here’s an example of how this works, based on data from the state of Vermont: •

A local or regional insurer, such as a Blue Cross/Blue Shield company might process 1 million claims per year and spend over $250 Million on those claims. By contrast, CVSs PBM unit, CVS Pharmacy Services, processes over 800 million claims, and spends over $62 Billion on those drugs.i Because it is 800 times larger than a local entity, CVS has far greater leverage in negotiating discounts with major pharmaceutical houses. Lower prices translated to greater volumes for member pharmacies, reduced out of pocket costs for consumers, and a smaller drug spend by third party payers.

II. Acquisition as a Value Creation Tool With an industry analysis complete, I like to consider the larger process of value creation through diversification before moving into the details of the CVS case. Diversification adds value to a corporation by allowing it to EXPAND its capabilities, resources, and market presence, or diversification allows a company to EXPLOIT capabilities and resources in new market segments. The instructor might ask “does the expand/exploit distinction holds in this industry?” Insightful analysis reveals that diversification moves in this industry tend to do both. For example, when CVS originally diversified into the pharmacy segment in 1967 it expanded its capabilities and product offerings (prescription drugs) but also exploited its existing customer base, reputation for value, and convenient locations.

The instructor may note here that the Pharmacy Services (PBM) segment seems to enjoy a positive externality. A positive externality occurs when there are increasing, rather than diminishing, returns to scale. As a PBM network expands, the increase in scale allows it to negotiate lower prices, provide improved formulary protocols, and use its increased data to better manage patient outcomes such as compliance. This increased ability, in turn, makes the PBM more attractive to both existing and new network members.

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The instructor should ask at this point “what are the limits to the benefits of scale?” Students should recognize that in terms of technology there are few, if any limits—increased computing power, storage, and data analysis software mean that more data will yield greater insights. Economically, the advantages of scale probably cease when the size and concentration of pharmacy companies, pharmaceutical houses, and third-party payers reach parity. The largest constraint on growth has been, and will continue to be, concerns about anti-trust violations from the Department of Justice.

The instructor should note these limits and then move on, the insights from this discussion will reappear as students think about what CVS might do in the future.

III. CVS Diversification Begin this segment with a discussion of Melville Corporation, how it added value through agglomeration, and key differences with CVS. I begin by asking “Why was Melville so successful for so long?” Students should note that Melville generated 15% annual earnings growth for the better part of two decades. In terms of the 6 S model, Melville added value through Spreading Capital or by Similar Business Models. Melville, originally a shoe manufacturing company, developed a competence in helping specialty retail businesses grow and prosper. Melville was not an operating company, but as a holding company it shared knowledge, best practices, and management knowledge useful to all specialty retailers. A review of the portfolio companies mentioned in the case reveals that Melville held businesses that were very different. It owned Mall Store format businesses, but Kay-Bee toys operated at the low end while Wilson Leather was a high-end retailer. It owned stand-alone CVS and Marshalls, a broader line retailer. Melville added value by instituting a set of financial controls on each business unit, monitoring performance, and shifting capital between divisions in order to fuel growth in rapidly growing businesses.

Melville struggled, and eventually sold off its various businesses, because of changes in the nature of retailing. By the early 1990s, the specialty retail model was under attack at the low end from discounters such as Walmart, who could offer the same branded merchandise at lower prices. Retailers such as The Gap also changed the nature of the game by offering private label merchandise and focusing on rapid product turnover. Melville faded, like many conglomerates, because it failed the Acid Test for the value of diversification, including acquisition: How is the acquired firm more valuable because it belongs to the corporate parent? How is the parent more valuable because it holds the acquired firm?

The Acid Test provides a nice way to frame the rest of this discussion. The instructor might ask: “In terms of the acid text, how does CVS add value to its acquisitions?” How does this value creation differ from the Melville model?” First, CVS is an operating company that manages its stores directly. CVS creates value in one or a combination of four ways, each of which creates some type of Synergy or Shared Knowledge throughout the corporation:

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Greenfield diversification •

Diversification into new market segments. The best example of Greenfield diversification was the addition of pharmacy departments to the original Health and Beauty format of CVS stores. Pharmacy constituted a closely related market and diversification made immediate sense. Existing customers could now fill prescriptions and new customers had access to a larger selection of health and beauty products than they would have at their local pharmacy. In the early days, adding pharmacies essentially doubled the revenue of a CVS store.

The case mentions that CVS started its own PBM in the mid-90s. The instructor can point students to Exhibit 4 and review the financial data on the Pharmacy Services Segment. The instructor might ask “If the operating profit for a PBM is 40% of profit in the Retail segment, why would CVS invest in its own PBM? Is this a good use of capital?” Students should realize that owning a PBM makes sense because the only way for a retail pharmacy to compete effectively is to belong to a PBM. Thus, CVS can own its own PBM and capture the profit of that business, or it can pay fees to belong to another PBM. Geographic Expansion •

Expansion through acquisition. The case has a number of examples of this type of value creation, including the Revco and Longs Drugs purchases. The instructor here should pose the Acid Test questions: why were these targets more valuable inside of CVS than outside? After the formation of its own PBM, these new pharmacies would participate in the positive externality of PBM scale. The instructor, or a student, might note that in its first 30 years CVS went from 1-1,250 stores, but in the next 20 years it went from 1,250-9,500. It made increasing economic sense to geographically scale when those pharmacies would be added to the PBM network.

The instructor might ask about what post-acquisition integration would look like at a Longs Drugs or other pharmacy. CVS buried its targets. Customers would see a new brand and most likely a slightly different selection of non-drug merchandise. Employees would now be paid

by CVS, and the information system would likely change in order to accommodate the CVS PBM. Scale and Synergy •

The Caremark merger is the prime example of creating synergy through scale.

Caremark had created a huge PBM network and the data in the case help students see the magnitude of the difference. Data in the case allow students to see that the combination appeared to create value for both parties, CVS by merging its PBM

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with the much larger Caremark. Caremark would also add almost 6,000 pharmacies to its network (about 10% of its total).

If desired, the instructor can talk about the timing of the purchase and the counteroffer from Express Scripts. This segment gives students some of the drama typically associated with M & A activity. CVS chose to act while Caremark was undervalued, hence the all-stock transaction.

Express Scripts recognized the potential for the CVS/ Caremark combination to dominate the industry and they made a somewhat risky counteroffer. Because of the size difference between the companies, Express Scripts was willing to “leverage the farm” in order to obtain the advantages of owning Caremark. Express Scripts bid a 25% premium, and they offered a mix of cash and stock to lure shareholders. The bidding war did result in a shareholder vote, and the Caremark board could reasonably argue that CVS was the safer, if not better, suitor.

The case notes that CVS made a substantial investment in IT. Why? IT capabilities represent a critical source of advantage for PBMs. The ability to efficiently administer drug claims and standardize the type and format of data collected drove competitive advantage. A $100 Million investment in IT systems would ensure that CVS/ Caremark would wring out every possible cost saving.

Acquisitions to enter new markets •

The Soma.com acquisition represents a nice example of buying new capabilities and market presence. This acquisition expanded CVS’s capabilities, without the time and investment to learn from the ground up. It also allowed CVS to exploit the new sales channel to add value to its existing customer base. As an early entrant in on-line prescriptions, CVS likely garnered new customers as well.

The instructor might ask at this point “why did CVS create an alliance with Minute Clinic rather than buy them at the beginning?” Minute clinic represented a new market, primary care, and would move CVS into the role of health care provider rather than just a pharmacy company. An alliance allowed both companies to explore the intricacies of making this business work. CVS, for example, could not merely bury Minute Clinics, but needed to blend their operations in order to capture the learning and the changes to the business model.

Minute Clinic, on the other hand, could leverage CVSs IT capabilities and relationships with third party payers to scale its reimbursement model. Once the alliance proved that it would succeed, CVS bought out its partner.

An analysis of the financial data in Exhibit 4 shows that, over the past 5 years, the increases in scale and entry into new markets has moved operating margins up from 7.9% (Retail) to 9.9%.

This section gives the instructor the opportunity to explore and reinforce course concepts about how a company can create value though diversification, merger, and acquisition activity. The final segment of the discussion invites students to evaluate CVSs current position and think through what the future might look like.

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IV. CVS in 2015: Omnicare, Target, and Going Forward As the discussion and analysis come to a close, I like to invite students to evaluate the most recent moves by CVS. At this point, it’s good to loop back in the discussion about the limits to growth and scale available in this industry. Again, there seem to be few technological limits to growth, but economics and regulatory issues imply that adding scale may not always be profitable, or possible.

If the instructor wants to spend more time in this segment, a good way to begin is by canvassing the class to see who thinks that the Omnicare and Target acquisitions will add value to CVS. A range of opinions should come out. Each acquisition represents unique challenges for CVS. The instructor may start with either Omnicare or Target, but I like to take them in chronological order. A good question here is “Does Omnicare pass the Acid Test for acquisition value?” On the plus side, Omnicare and its patients would become a part of the CVS PBM business. Omnicare, with its nursing home and Medicare patients, gives CVS more patients with chronic, long-term conditions. This may help with formulary management, and cost control for Omnicare. “Is CVS more valuable because it owns Omnnicare?” The answer here may be more mixed. While CVS continues to add scale, and may find synergy with its Coram infusion business, the biggest benefit to CVS may be a large patient cohort in dealing with Medicare Part D reimbursement rates. IF, and it’s a big IF, increased scale gives CVS leverage and clout in setting Medicare Part D reimbursement rates, CVS would gain market power.

However, if Medicare Part D rates continue to decline, then CVS may have bought itself into an even lower margin business than its current PBM offering. As of 2015, enrollment in the Affordable Care Act has yet to demonstrate significant pressure to hold down health care— and prescription drug—costs; indeed, premiums for the 2016 year jumped over 25% in some cases (a smart instructor will ask students to search for the latest data on ACA costs). Rather than cutting costs through increased enrollment, ACA may bring about cost control in ways that jeopardize CVS and its PBM business.

With the remaining time in this segment, instructors can move to the Target acquisition: •

Will both companies be more valuable because of the arrangement? Target seems to be the clear winner here, as it offloads pharmacy management to CVS and can refocus its energy on the other retail segments of its business. How CVS wins is less clear. Again, adding 1,600 stores benefits the PBM side of the business. What about Retail? Will, for example, retail customers move more purchasing to Target to have a larger retail, “front of house” offering of goods? CVS stores aren’t “mini-Targets” and I’d worry about geographic overlap. So, if I live in an urban area with both a Target and CVS, would I drive 10 extra minutes to the Target where I can buy more things? Examples of major corporations sharing space exist, McDonald’s inside of Walmart works because they don’t really compete. Target may not view CVS as a competitor, but CVS probably ought to

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think about Target as one. The potential downsides of “co-branding” Target pharmacies may prove costly (both real costs and opportunity costs). CVS typically “buries” its acquisitions, but it seems like the Target situation will require more of a “blend” approach than “bury.” What new capabilities will CVS need in order to make this acquisition work?

•

What other options might CVS have had to create such rapid growth? As the retail pharmacy market becomes more concentrated, other opportunities to grow by acquisition may have even greater challenges. Namely, future acquisitions may be limited to individual stores or very small regional/rural chains. Even with the challenges of “dual branding” that may face CVS inside a Target store, this may have been the best opportunity.

•

A final question focuses students on the issue of future growth. As the case indicates, CVS has grown organically (they didn’t buy every new store) and they have diversified through Greenfield investment. The bulk of their growth, however, has come through acquisition.

As a company grows, it picks the best targets first. As CVS heads into the future, when will it reach the limits of its acquisition strategy? What steps should it take to prepare for that day?

V. Concluding Comments The instructor may conclude the session by asking 2-3 students to summarize their learning.

These responses may be listed on the board. If the instructor wishes to make concluding comments, he or she may make the following points: •

Companies can use M&A activity to create growth in a variety of ways. Melville generated value through Spreading Capital and Similar Business Models. CVS creates value primarily through Synergy and Shared Knowledge.

•

Acquisition works well in industries that reward scale. The nature of Pharmacy Services, and the importance of that segment for the Retail and Institutional lines of business make acquisition a potent strategic tool. Companies can use acquisitions to scale rapidly and gain competitive advantage.

•

Acquisition becomes more difficult over time. As a company grows, it tends to absorb the most attractive targets first. As the case closes, CVS seems to be using acquisition as a way to enter new and emerging markets, because it has fully elaborated its geographic footprint.

i

Murphy, Brian. Pharmacy Benefit Manager Overview. 14 April 2015. Available at http://legislature.vermont.gov/assets/Documents/2016/WorkGroups/House%20Health%20Care/Bills/S.139/Witne ss%20testimony/S.139~Brian%20Murphy~Pharmacy%20Benefit%20Manager%20Overview~4-14-2015.pdf, Accessed 27 November, 2015.

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Strategic Management Instructor’s Manual

Chapter 1: What Is Business Strategy?

Chapter 1: What Is Business Strategy?

Learning Objectives Studying this chapter should provide you with the knowledge to: • Define business strategy, including the importance of competitive advantage, the four choices that are critical to strategy formulation, and the strategic management process.

• Summarize the information that the company’s mission and thorough external and internal analysis provide to guide strategy.

• Discuss how strategies are formulated and implemented in order to achieve objectives.

• Explain who is responsible for, and who benefits from, good business strategy.

Purpose Although this is no one tool acquired in this chapter, the purpose of the lecture is to familiarize the student with what strategy is and instill the realization that being understanding strategy is vital to competitiveness.

Outline Strategy at Tesla WHAT IS BUSINESS STRATEGY? Competitive Advantage Strategy in Practice: Measuring American Home Products’ Competitive Advantage The Strategic Management Process WHAT INFORMATION AND ANALYSIS GUIDES STRATEGY FORMULATION? Mission External Analysis Strategy in Practice: Apple’s Evolving Mission Internal Analysis HOW ARE STRATEGIES FORMULATED?

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Strategy Vehicles for Achieving Strategic Objectives Strategy Implementation Strategy in Practice: Walmart Functional Strategies Implement the Overall “Low Cost” Strategy WHO IS RESPONSIBLE FOR BUSINESS STRATEGY? Ethics and Strategy: The Price Companies Pay to Stay Competitive Who Benefits from a Good Business Strategy?

Strategy in Your Career Summary • Key Terms • Review Questions • Application Exercises • References

Answers to Review Questions 1. Why is it important for you to understand business strategy?

When starting a company or being president or general manger within one, developing strategy is a primary job. As a junior officer in a company, developing and implementing ideas that are consistent with corporate strategy could lead to early promotions. You can also evaluate the potential success of companies that you may work for by understanding their strategy.

2. How would you describe/define strategy?

A plan to achieve competitive advantage 3. What are the four choices that are part of strategy formulation?

What markets or industries will the company pursue?

What unique value should the company offer the customer in those markets?

What resources and capabilities will allow the firm to deliver unique value better than competitors?

How will the company sustain its advantage and prevent imitation of its strategy?

4. What are the two generic strategies, or primary ways, in which companies attempt to offer unique value relative to competitors?

Low cost or differentiation

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5. Who is ultimately responsible for a company’s strategy? Who does this individual (or individuals) call on for help in formulating strategy for the firm?

Strategic leaders who develop strategy through the strategic management process. They usually turn to the Board of Directors and other top management for guidance.

6. According to Michael Porter’s “Five Forces” model, why do some firms earn higher profits than other firms?

Firms with higher profits may be in an industry with higher average profitability.

7. What are resources and capabilities, what is the difference between them, and why do firms need to assess them?

Resources are the tangible and intangible assets a firm employs to create value and competitive advantage. Capabilities are the processes and activities that a firm develops using its resources. Firms need to assess resources and capabilities in order to allocate them properly to achieve key objectives.

8. What are three keys to the successful implementation of a company strategy?

Functional strategies need to be well aligned with delivering the unique value identified in the overall strategy.

Structure, systems, staff, skills, style, and shared values need to be designed to facilitate the execution of the strategy.

9. Who are the four primary stakeholder groups that influence strategic decisions in a company?

Capital market stakeholders Product market stakeholders Organizational stakeholders Community stakeholders

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Chapter 2: Analysis of the External Environment

Chapter 2: Analysis of the External Environment: Opportunities and Threats Learning Objectives Studying this chapter should provide you with the knowledge to: • Explain the importance of correctly identifying and choosing a firm’s industries and markets.

• Identify and measure the five major forces that shape average firm profitability within industries to evaluate the overall attractiveness of an industry.

• Discuss how understanding the five forces that shape industry competition is useful as a starting point for developing strategy.

• Discuss situations in which entry into both attractive and unattractive industries follows “new thinking” rather than conventional wisdom.

• Identify the factors in the general environment that affect firm and industry profitability.

Purpose The purpose of this chapter is to introduce students to the forces that influence industries internally and externally. Students will learn how to apply Michael Porter’s Five Forces framework to evaluate the attractiveness of industries in the broader scope of the general environment. The Five Forces framework will be basis of analysis for the remainder of the course.

Students will learn this tool through class lecture, end of chapter assignments, mini cases in chapter and finally with the Coca Cola case.

Outline State Farm Adjusts to a Changing World DETERMINING THE RIGHT LANDSCAPE: DEFINING A FIRM’S INDUSTRY Strategy in Practice: How the U.S. Government Defines Industries

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FIVE FORCES THAT SHAPE AVERAGE PROFITABILITY WITHIN INDUSTRIES Rivalry: Competition among Established Companies Buyer Power: Bargaining Power and Price Sensitivity Supplier Bargaining Power Threat of New Entrants Threat of Substitute Products OVERALL INDUSTRY ATTRACTIVENESS WHERE SHOULD WE COMPETE? NEW THINKING ABOUT THE FIVE FORCES AND INDUSTRY ATTRACTIVENESS HOW THE GENERAL ENVIRONMENT SHAPES FIRM AND INDUSTRY PROFITABILITY Strategy in Practice: COVID-19 Alters Industry Profitability Overnight Complementary Products or Services Technological Change General Economic Conditions Demographic Forces Ecological/Natural Environment Global Forces Political, Legal, and Regulatory Forces Social/Cultural Forces • Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool: Evaluating the Intensity Threat of New Entrants • References

Answers to Review Questions 1. Why is it important for a firm to accurately determine what industry it is in?

So that executives can identify who their real competitors are and the economic forces that will influence the strategies they hope to pursue. Industries also differ in terms of their profitability and performance, and identifying the right industry tells managers and investors what types of returns to expect.

2. How should a firm decide what industry it is in?

Firms should use the U. S. Government’s NAICS codes to determine their industry.

3. What are the five major industry forces? How do they shape average profitability in an industry?

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The five forces are: Barriers to (or threat of) Entry, Supplier Power, Buyer Power, Presence of Substitutes, and Competitive Rivalry. The impacts on average profitability are Threat of Entry—the lower the threat the higher the average profitability Supplier Power—the lower supplier power, the higher the average profitability Buyer Power—the lower buyer power, the higher the average profitability Substitution—the lower the threat of substitution, the higher the average profitability Rivalry—the lower the degree of rivalry, the higher the average profitability.

4. What factors determine the intensity of rivalry?

(1) the number and size of competitors; (2) standardization and perishability of products; (3) costs to buyers of switching to another product; (4) growth in demand for products; (5) levels of unused production capacity or fixed costs; and (6) the difficulty for firms of leaving the industry.

5. Which type of industry has more rivalry, fragmented or concentrated, and why?

Fragmented industries will have more competitive rivalry, for two reasons. First, there are more competitors, and that naturally means more new competition.

Second, no competitor is big enough to be a “price leader” and set a standard for the industry.

6. Explains what happens to buyer power when buyers have increased price sensitivity?

Buyer power increases because they are more likely to switch to a competitor offering a lower price. Firms have to lower prices or provide other benefits (such as after sales support) to keep buyers from moving to competitors.

7. Explain what it means for suppliers to have a credible threat of forward integration.

This happens when a supplier can easily compete with the firm because it may have the same technology or distribution system. With very little expenditure, the supplier could produce and sell the same product.

8. What factors determine the intensity of the threat of new entrants?

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The presence of economies of scale, experience, or learning or other cost advantages; capital requirements to enter the industry; network effects, government policies and regulations.

9. What are substitutes? Can you name any substitutes for the laptop most of your classmates are using? What about substitutes for watching your university play football on Saturdays?

A product that is fundamentally different yet serves the same basic function or purpose as another product. A smart phone is a natural substitute for a laptop. In a classroom setting, a physical notebook would be one as well. There are many substitutes for watching a football game (entertainment). These would vary from watching the “big game” between 2 national powerhouse teams, to hiking, the going to a symphony.

10. Under what conditions does the traditional advice concerning entering attractive markets and staying away from unattractive ones not hold? Besides the examples used in the book, can you think of any other examples?

A firm may choose to enter an unattractive market because it has a new or unique value proposition, or it may be able to target its offering to a particular segment that is underserved by existing competitors. Similarly, it may avoid entering an “attractive” industry, in terms of structure, because it has no way to differentiate itself from the industry incumbents.

11. Can you identify some of the eight general environmental factors that might be important for the personal care industries that Procter & Gamble participates in, such as shampoo, dish and laundry detergents, toothpaste, and cough medicine, to name a few? Please feel free to use the Internet to get more information about Procter & Gamble. The appendix also has a guide about how to gather information about the eight general environmental trends. If your professor assigns this question as part of a larger project, you may find the appendix to be very useful as a starting point.

The biggest factors would be ecological/ natural environment, as more people are concerned about sustainability. This would involve the content of their products, but increasingly it’s about packaging. Global competitive forces would also be huge here as P&G competes against Unilever around the world, but also a

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number of regional and national players. Third on my list is population dynamics.

As populations age in the developed world, that will change the product mix and value proposition for its product portfolio. Conversely, demand will be growing in Africa and other regions of the world with high birth rates. This will necessitate different packaging and distribution strategies to reach developing markets where demand is growing.

12. How does each of the eight general environmental factors influence industry profitability? Take your time in answering this one and examine how at least one general environmental factor affects each of the five forces (you can use a different environmental factor for each of the five forces).

Complementary products or services—raise the attractiveness of the industry’s products, and hence its price Technological change—technology can either enhance profitability (by creating new complements) or it can destroy profitability by creating a new and better substitute product.

General economic conditions—General economic conditions, such as interest rates, affect the cost of capital as well as consumer’s overall willingness to spend.

Population demographics—affect the composition, and number, of customers. An aging population is bad for toys and games, but good for vacations and retirement living.

Global competitive forces—Global competitive forces can drive down profitability by removing trade barriers and inviting global competitors to enter the market.

However, globalization also helps profitability by giving firms access to new, and sometimes very large, markets.

Political, legal, and regulatory forces—Regulations can increase the costs of doing business or make some products and services less attractive to buyers.

Conversely, government regulations can also raise barriers to entry and increase industry profitability.

Social/Cultural forces—this force influences consumer tastes and preferences.

Changes in tastes can reduce profitability (think of the fast-food industry), or it can raise profitability (think of all the accessories that make your smartphone more attractive and easier to use).

Ecological/Natural Environment—emerging concerns about the natural environment may open new and profitable industries, such as renewable energy.

Threats of ecological damage can invite government regulations or activist concerns. These would drive down profitability.

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13. What are the elements of a complete external analysis?

Managers should begin by defining the industry. They should then analyze and evaluate the 5 forces, and then they should examine the current—and future— impacts of the eight general environmental forces on the industry. A complete analysis will consider how each force or element has changed over time, and what future changes might be expected.

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Chapter 3: Internal Analysis

Chapter 3: Internal Analysis: Strengths, Weaknesses, and Competitive Advantage Learning Objectives Studying this chapter should provide you with the knowledge to: • Identify the steps in the value chain a firm uses to create competitive advantage.

• Distinguish among the core concepts of strengths, weaknesses, resources, capabilities, and priorities.

• Evaluate the strength and sustainability of internally generated competitive advantages using the VRIO model.

• Analyze a company and identify its strengths or weaknesses, resources, capabilities, and priorities using the competitive advantage pyramid tool.

Purpose The Company Diamond is the most important concept and tool in this chapter. The company diamond brings together the concepts of activities, resources, capabilities, and values in a coherent picture of how firms create competitive advantage. Our main purpose for this chapter is for the students to become proficient in using the company diamond. They will have the opportunity to create a company diamond in the following assignments: • in class, using the Disney example • in class, using a company of their choosing • practice problems at the end of the chapter • in the Intel A Case

Outline Disney: No Mickey Mouse Company

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THE VALUE CHAIN THE RESOURCE-BASED VIEW Resources Capabilities Strategy in Practice: Preserving Disney’s Capabilities: Don’t Mess with the Mouse!

Strategy in Practice: Values and Priorities at Pixar Priorities CREATING A SUSTAINABLE COMPETITIVE ADVANTAGE: THE VRIO MODEL OF SUSTAINABILITY Value Rarity Inimitability Ethics and Strategy: Nondisclosure and Noncompete Agreements Organized to Exploit Assessing Competitive Advantage with VRIO Strategy in Practice: Disney Responds to a Competitive Threat THE COMPETITIVE ADVANTAGE PYRAMID: A TOOL FOR ASSESSING COMPETITIVE ADVANTAGE Gathering Data for the Competitive Advantage Pyramid Analysis Strategy and Your Career Using the Competitive Advantage Pyramid • Summary • Key Terms • Review Questions • Application Exercise • References

Answers to Review Questions 1. Identify and describe the two major elements of the value chain. How can the value chain help you do internal analysis?

The two major elements are: the primary or core activities (logistics, production, and marketing), and support activities (firm infrastructure, human resource management policies, and technology development).

2. What is a resource? What types of resources can firms employ in their search for competitive advantage?

Resources are the tools or assets a firm employs to create value for its customers.

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Chapter 3: Internal Analysis

intangible resources (such as brands, intellectual property, and reputation).

3. What is a capability? How do capabilities work together with resources to enable companies to create value?

Capabilities are processes that firms have developed to perform activities.

Capabilities and resources work hand in hand to create value. Resources are the “what” of value creation, and capabilities are the “how” those get employed.

4. How is a resource different from a capability? How are the two similar? How do different types of resources work together to create competitive advantage?

The easiest way to think about this is that resources are assets that can be booked on a balance sheet (including intangibles like IP), or otherwise valued (like brand equity). Capabilities are processes or internal routines. Resources are what firms employ, and capabilities are often how they employ them.

Different types of resources work tougher as complementary bundles to create competitive advantage. When the combination of multiple resources creates more total value than the sum of each individual resource, you have synergy or a resource bundle. Bundles are also harder to imitate than stand-alone resources.

5. Under what conditions will resources lead to competitive advantages? When will those advantages be sustainable?

Resources will lead to competitive advantages when they create value and are rare (see Figure 3.2). Those advantages will be durable when the resources prove difficult for competitors to imitate, and they will be truly sustainable when the firm is organized in a way to capture and exploit the gains from those resources.

6. Identify three situations in which a competitive advantage pyramid analysis would be useful to you. What two rules about data collecting should you remember when you do a pyramid analysis?

Three situations: 1) When you are looking for a job (or a new job), the pyramid will help you assess the viability of the company, as well as your fit with the organization.

2) When you are formulating a strategy for the organization, the pyramid allows you to identify the important values and priorities that will enable your ability to create and implement a new strategy. It will also help you identify important resources and capabilities.

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3) When you need to evaluate a competitor to see how they will respond to your strategic moves. Understanding their resources, capabilities, values, and priorities will help you anticipate their response.

The two rules are: 1) Garbage in—Garbage out, or the quality of the data you collect (and spend time verifying and comparing to determine its accuracy) will determine the quality of your conclusions, and 2) Collect data from multiple sources to get an accurate picture of the company.

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Strategic Management Instructor’s Manual

Chapter 4: Cost Advantage

Chapter 4: Cost Advantage Learning Objectives Studying this chapter should provide you with the knowledge to: • Differentiate between economies of scale and scope, and describe how both produce cost advantages.

• Describe what an experience curve is and how it can be used to make effective business decisions.

• Discuss sources of lower input costs and how they provide the basis of a cost advantage strategy.

• Explain two changes in a firm’s business model that can enable a cost advantage strategy.

Purpose There are many types of business problems that can be solved by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (e.g., how much labor costs go down per unit with increases in volume). The principal tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit.

This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis). The students will have the opportunity to examine the relationship between scale/experience in the following assignments: • the homework assignment involving calculating an experience curve in semiconductors.

• Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis).

• the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry.

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Outline Watch Out Walmart … Here Comes Aldi ECONOMIES OF SCALE AND SCOPE Ability to Spread Fixed Costs of Production Ability to Spread Nonproduction Costs Specialization of Machines and Equipment Specialization of Tasks and People Evaluating Economies of Scale: The Scale Curve Strategy in Practice: The Downside of Size and Scale in the Airline Industry Economies of Scope LEARNING AND EXPERIENCE The Learning Curve The Experience Curve Experience Curves and Market Share Strategy in Practice: The Relationship Between Market Share and Profitability in Retail Industries How Strategists Use the Scale and Experience Curves to Make Decisions Proprietary Knowledge LOWER INPUT COSTS Bargaining Power over Suppliers Cooperation with Suppliers Location Advantages Preferred Access to Inputs DIFFERENT BUSINESS MODEL OR VALUE CHAIN Eliminating Steps in the Value Chain Performing Completely New Activities Tata Nano: A Cautionary Tale • Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool: How to Calculate a Scale Curve or Experience Curve • References

Answers to Review Questions

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1. What are the five sources of cost advantage?

Economies of scale, learning and experience, lower costs due to proprietary knowledge, lower input costs, and different business models.

2. Which of the five major sources of cost advantage contributed to the Tata Nano being the world’s least expensive car?

Proprietary knowledge (note: Tata also uses low-cost production labor in India).

3. Explain three ways that economies of scale produce cost advantages.

• The ability to spread fixed costs of production such as plant and equipment by having more customers (revenue).

• The ability to spread non-production costs. High volumes of production spread the costs of R&D, advertising, and G&A. • Specialization of machines and equipment. Companies with large volumes can invest in specialized machines and equipment that small firms cannot afford.

• Specialization of tasks and personnel in specific tasks.

4. What is a scale curve, and how is it different from an experience curve?

The scale curve shows the relationship between unit volume for a given time period, usually a year (x-axis) and the cost per unit (y-axis) for the unit volume for each year. An experience curve shows the relationship between cumulative unit volume (y-axis) and the cost per unit (y-axis) at different levels of cumulative volume. The scale curve does not require cumulative volume on the x-axis, whereas the experience curve does. Therefore, the experience curve is better at capturing the effects of cumulative learning on cost per unit.

5. What data would you need to calculate a scale curve or experience curve?

• Scale curve: total costs and unit volume over a period of time (usually for each year over a number of years; preferably at least seven years to see a pattern).

• Experience curve: cumulative volume and cost per unit at different levels of cumulative volume (usually just units per year and cost per unit for each year like the scale curve but then the units per year can be added together to create a measure of cumulative volume on the Y-axis).

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6. Why do companies have difficulty increasing their profitability by simply buying market share (e.g., lowering prices to increase market share)?

If one company were to lower prices to increase market share, the rest of the market would do the same, which results in a price war and lower profits. No one then captures more market share.

7. Identify at least two ways that companies can achieve a cost advantage through lower-cost inputs.

• Bargaining power over suppliers by high purchasing volume or purchasing and negotiating tactics • Cooperation with suppliers (Toyota example) • Location advantages that lower costs through wage rates, exchange rates, and/or raw material and energy costs • Preferred access to inputs 8. Give an example of a company that has a cost advantage because it uses a different business model or shorter value chain than its competitors.

Ryanair cuts costs by not offering some services such as in-flight meals, pillows blankets, or even “sick” bags. Amazon also cut high costs of brick-and-mortar stores by eliminating buildings.

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Chapter 5: Differentiation Advantage

Chapter 5: Differentiation Advantage Learning Objectives Studying this chapter should provide you with the knowledge to: • Define product differentiation.

• Describe the four major categories or sources of product or service differentiation.

• Explain how to find sources of product differentiation.

• Discuss how to build the resources and capabilities to differentiate.

Purpose This chapter will introduce students to product differentiation as an alternative to low cost as a way of delivering unique value to the customer. A few tools are introduced to the students to discover differentiation strategies and rate the success of these strategies. Customer segmentation and mapping the consumption chain allow students to recognize potential areas of differentiation. The Net Promoter Score is a tool that can be used to assess how well a differentiation strategy is working.

These strategy tools will be learned through class lectures, end of chapter assignments, mini-cases in the chapter and, finally, with the Harley Case.

Outline The Rise of Facebook WHAT IS PRODUCT DIFFERENTIATION? SOURCES OF PRODUCT DIFFERENTIATION Different Product/Service Features Quality or Reliability Convenience Ethics and Strategy: At What Point Does Marketing Become Lying?

Brand Image

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HOW TO FIND SOURCES OF PRODUCT DIFFERENTIATION Customer Segmentation Mapping the Consumption Chain BUILDING THE RESOURCES AND CAPABILITIES TO DIFFERENTIATE Strategy in Practice: How Starbucks Built the Resources to Differentiate New Thinking: Achieving Low Cost and Differentiation Assessing Differentiation Performance Strategy in Your Career: What Is Your Unique Value?

• Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool: The Net Promoter Score • References

Answers to Review Questions 1. Define a differentiation strategy.

Gaining competitive advantage by offering value that is not available in other products or services or that other products and services don’t offer at the same level.

2. What are the four major categories or sources of product differentiation?

1. Different product/service features 2. Superior quality or reliability 3. Convenience 4. Brand image 3. What are two processes that companies can use to search for differentiation opportunities?

Customer segmentation and mapping the consumption chain.

4. What is customer segmentation? Describe three different ways that customer segmentation can be done.

The process of grouping customers based upon similar needs. This can be done by demographics/customer attributes, products attributes, and “job to be done”.

5. What is the consumption chain? Describe as many stages of the consumption chain as you can.

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The consumption chain includes the stages through which customers pass through from the time they first become aware of your products to the time when they have to dispose of it or discontinue using it. See below.

6. What is a “net promoter score” and how is it calculated? Why is the net promoter score a useful indicator of how successful a company is at differentiating its product?

This metric is used to assess how well differentiated a product or service is. It is based on how willing a customer is to recommend your company (or product) to a friend or colleague on a scale of 1-10. A rating of 1-6 is classified as detractors, 7-8 as passives, and 9-10 as promoters. The “net promoter score” is calculated by the percentage of customers who answer 9 or 10 minus the percentage who answer 6 or below.

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Chapter 6: Corporate Strategy

Chapter 6: Corporate Strategy Learning Objectives Studying this chapter should provide you with the knowledge to: • Describe how a corporate strategy differs from a business unit level strategy.

• Identify the eight ways in which a company may create value through diversification, and the advantages of each source. Be able to evaluate a diversified company’s ability to create value using one or more of these sources.

• Use a portfolio management tool to characterize a company’s different business units and to evaluate how well a company manages its portfolio.

• Explain how a company would choose whether to diversify by greenfield entry or by acquisition. Explain how a company should decide how tightly to integrate an acquisition into its current business portfolio.

Purpose The overall goal of this session is to help students understand 1) that a corporate strategy is different than business unit strategy, and 2) creating real value from a corporate strategy takes deliberate action in both the formulation stage (which markets to enter or buy into?) and implementation phase (how do we manage different business units).

Why does corporate strategy matter?

• About 80% of your students will live through a corporate strategy “event”, such as buying someone out, being bought out, or working in an alliance. So, it pays to know about whether these things add value because you may want to change jobs.

• About 70% of mergers and acquisitions (a major way of executing a corporate strategy) fail to create value. That’s a pretty high failure rate, and it doesn’t have to be that high.

Outline

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Chapter 6: Corporate Strategy

Cisco Systems—Growth Through Diversification and Acquisition CORPORATE VERSUS BUSINESS UNIT STRATEGY CREATING VALUE THROUGH DIVERSIFICATION Levels of Diversification Value Creation: Exploit and Expand Resources and Capabilities The Eight Ss Strategy in Practice: The Value of Diversification: Uber Beats Lyft During the Pandemic Strategy in Practice: The Challenges of a Conglomerate: The Fall of General Electric Destroying Value through Diversification METHODS OF DIVERSIFICATION THE ACQUISITION AND INTEGRATION PROCESS Making the Acquisition Integrating the Target Ethics and Strategy: Transparency During the Acquisition Process Strategy in Practice: Questions Every Acquirer Should Ask • Summary • Key Terms • Review Questions • Application Exercises • References

Answers to Review Questions 1. Why and when do firms create value through diversification?

Diversification adds value when it allows the combined businesses to deliver greater value and utility to new or existing customers than the firm could without being diversified. Diversification also adds value if the combined businesses reduce the firm’s overall cost of producing goods or services.

2. Apple is primarily an electronics company, creating products for business and consumer markets. Apple also operates its own chain of retail outlets. In terms of Richard Rumelt’s categories of the level of diversification, where does Apple fit?

Apple would be a dominant business since most of its revenue comes from direct product sales, and only about 10% (as of 2013) came from the retail operations.

3. List the reasons why diversification fails to add value. Which one do you believe is most common? Which is least?

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Hubris—overconfidence on the part of managers in their ability to add value through diversification.

Sunk Cost Fallacy—the belief that a failing investment just needs more cash and time to become successful.

Imitation—managers enter a new market, or make an acquisition, simply because a competitor did so.

Poor Governance and Incentives—managers have weak financial incentives to focus on value creation and strong incentives to focus their energy on politics, resource allocation constraints, or transfers of assets between divisions.

Poor Management—managers use the wrong resource allocation criteria, do not understand the new business, or just make bad decisions.

Lack of Resources—managers lack adequate resources to make the investment pay off.

4. What factors should executives consider when making a decision on entering a new market through greenfield entry versus making an acquisition?

Managers should consider how easily their existing resources and capabilities will transfer to the new market and business. If they can be transferred easily and successfully, then the firm may want to use Greenfield entry. If not, the firm should use acquisition. Also, if entering at large scale, or very quickly is important for success, then the firm should enter through acquisition. If these two things are less important, then Greenfield is preferred.

5. How can acquiring firms increase the likelihood of a successful integration of an acquired firm?

Acquisitions that have a strong strategic rationale and fit have the highest chance of success. The acquirer must do comprehensive due diligence to determine an accurate price and avoid overpaying. Finally, with a clear strategic understanding, the acquirer can choose the level of integration that creates the most value from the acquisition.

6. Why do acquiring companies have to pay a premium when they acquire another firm? How does that premium create challenges for the acquiring firm?

Acquiring companies need to pay a premium in order to induce the owners (shareholders) of the target firm to sell their shares to the acquirer. Shareholders will be indifferent between management teams unless they are offered a premium by one team. The premium makes value creation more challenging

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because, given the basic structure of net present value, the acquisition must create more value, or the same total value over a much quicker time horizon, to make the acquisition profitable. This puts more pressure on the acquirer to grow revenues or cut costs to increase profit.

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Chapter 7: Vertical Integration

Chapter 7: Vertical Integration and Outsourcing Learning Objectives Studying this chapter should provide you with the knowledge to: • Define vertical integration, forward vertical integration, and backward integration.

• Describe the three Cs that represent the primary reasons that firms choose to vertically integrate (make) and perform an activity internally versus outsource (buy) the activity to (from) a supplier.

• Describe the two F’s, which examine the potential dangers of vertical integration.

• Explain the advantages of outsourcing and the conditions under which it might be advantageous to outsource an activity to an external supplier.

• Discuss the actions a manager could take to prevent a subcontractor from becoming a competitor.

Purpose In this chapter, students will learn about vertical integration. They will learn to use the “3 Cs” framework to make the decision of whether to vertically integrate. Using the strategy tool Make vs. Buy can provide important guidance to managers in deciding whether to outsource an activity to a supplier or develop the resources and capabilities to conduct the activity in house. This strategy tool will be learned through class lecture, end of chapter assignments, mini-cases in chapter and, finally, with the Nike Case.

Outline Dell and ASUS: A Tale of Two Companies WHAT IS VERTICAL INTEGRATION? Copyright ©2022 John Wiley & Sons, Inc.

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The Value Chain Forward Integration and Backward Integration THREE KEY REASONS TO VERTICALLY INTEGRATE Capabilities Coordination Control Strategy in Practice: A Classic “Make vs. Buy” Mistake DANGERS OF VERTICAL INTEGRATION Loss of Flexibility Loss of Focus ADVANTAGES OF OUTSOURCING Ethics and Strategy: Should You Outsource to Subcontractors That Use Child Labor?

Strategy in Practice: Outsourcing via Crowdsourcing DANGERS OF OUTSOURCING Strategy in Practice: How to Prevent a Subcontractor from Becoming a Competitor • Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool: Make Versus Buy Assessment • References

Answers to Review Questions 1. Define vertical integration, forward vertical integration, and backward integration.

Vertical integration is bringing business processes or activities previously conducted by outside companies in-house. Vertically integrating downstream in the value chain is forward vertical integration, and vertically integrating upstream in the value chain is backward integration.

2. What are the three Cs, and how do they explain why companies choose to perform an activity internally (make) versus outsource (buy) the activity to a supplier?

1. Capabilities-companies can develop more capabilities when performing activities internally.

2. Coordination-companies can better coordinate activities in the business when activities are performed internally.

3. Control-Companies have more control over activities that are performed internally.

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3. Describe what the chapter calls a “classic mistake” that firms make when deciding whether to make versus. buy.

Firms compare the price of buying from suppliers to the cost of internally making a product, but the price that suppliers put on a product includes a profit margin, not the actual cost. When firms don’t consider this profit margin, they are making the “classic mistake”. A firm may be able to negotiate prices down closer to the actual cost of production.

4. Describe the advantages of outsourcing and the conditions under which it might be advantageous to outsource an activity to an external supplier.

Outsourcing creates flexibility and focus within a firm. Flexibility is the ability to adjust easily to market shocks or demands. Focus is the ability for a firm to place attention on a narrower range of activities. A firm may want to outsource when the industry requires flexibility and the firm wants to be the best in the world at performing a particular activity.

5. Define crowdsourcing and explain the different ways companies can use an external crowd to do its work (e.g., the different types of crowdsourcing).

Crowdsourcing is outsourcing tasks to “crowds” or large groups of anonymous people.

This can be done through the following: • Crowd-tasking - enlisting a crowd to complete a simple, repetitive task.

• Crowd-creating - turning to a crowd to create content or complete a task that requires specific knowledge or expertise on the part of the members of the crowd.

• Crowd-voting - using a crowd to evaluate an offering or to make predictions about uncertain events.

• Crowd-innovation - using the crowd to solve a challenging problem that requires an innovative solution.

6. Explain what actions you could take to prevent a subcontractor from becoming a competitor.

• Build barriers to imitation such as a strong brand, i.e., Nike.

• Limit knowledge of the full product by manufacturing the key component of a product or not allowing one supplier to capture production.

• Take an equity stake in the supplier, which prevents the supplier from becoming too powerful and becoming a competitor.

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Chapter 8: Strategic Alliances

Chapter 8: Strategic Alliances Learning Objectives Studying this chapter should provide you with the knowledge to: • Differentiate among strategic alliances, vertical integration, and arms-length supplier relationships.

• Explain the different types of strategic alliances, how they are governed, and the conditions under which each type is preferred.

• Describe the different ways value is created in alliances.

• Discuss the two potential dangers of strategic alliances and three ways that firms can protect themselves against these dangers.

• Describe the importance of building an alliance management capability.

Purpose In this chapter, students will learn the three types of strategic alliances a company can establish to create new value. Alliances are a vehicle for accessing the resources and capabilities of another firm that will help a company lower costs or differentiate an offering. Students will be introduced to a strategy tool to assist in deciding whether to choose an alliance or an acquisition strategy.

This strategy tool will be learned through class lecture, end of chapter assignments, mini-cases in the chapter and, finally, with the AT&T and Apple Case.

Outline Tokyo Disneyland WHAT IS A STRATEGIC ALLIANCE? Choosing an Alliance Strategy in Practice: Walt Disney and Oriental Land: Why Ally?

TYPES OF ALLIANCES

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Nonequity or Contractual Alliance Equity Alliance Joint Venture Vertical and Horizontal Alliances Strategy in Practice: Bose: Working with Suppliers in Vertical Alliances WAYS TO CREATE VALUE IN ALLIANCES Combine Unique Resources Pool Similar Resources Create New, Alliance-Specific Resources Lower Transaction Costs THE RISKS OF ALLIANCES Hold-Up Misrepresentation Building Trust to Lower the Risks of Alliances Ethics and Strategy: The Blame Game in Strategic Alliances BUILDING AN ALLIANCE MANAGEMENT CAPABILITY Improving Knowledge Management Increasing External Visibility Providing Internal Coordination Facilitating Intervention and Accountability • Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool: When to Choose an Alliance Versus an Acquisition • References

Answers to Review Questions 1. What is a strategic alliance?

A cooperative arrangement in which two or more firms combine their resources and capabilities to create new value.

2. Describe and give examples of the three different types of strategic alliances.

Identify the conditions under which each type is preferred.

1. Contractual alliance - interdependence between partners is low and it’s easy to measure the contributions of each partner and write it in a contract.

2. Equity alliance - interdependence between firms is moderate and firms bring knowledge or difficult-to-measure contributions, but each can perform their roles separately.

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3. Joint Venture - interdependence between firms is very high and firms bring knowledge or difficult-to-measure contributions that must be combined into a single organization to coordinate effectively.

3. What is the difference between a vertical alliance and a horizontal alliance?

Vertical alliance is an alliance between firms who are positioned at different stages along the value chain. Horizontal alliance is an alliance between firms that are typically positioned at a similar stage of the value chain.

4. What are four primary ways in which firms create value through strategic alliances?

1. Combine unique resources 2. Pool similar resources 3. Create new alliance-specific resources 4. Lower transaction costs 5. Describe the two potential dangers of strategic alliances summarized by the initials H&M, and four ways that firms in alliance can build trust to minimize the risk of these dangers.

Hold-up occurs when one partner tries to exploit the alliance-specific investments made by another partner. Misrepresentation occurs when one partner in an alliance creates false expectations about the resources it brings to the relationship or fails to deliver what it originally promised. Four ways that firms can build trust: 1. Personal trust 2. Legal contracts 3. Shared ownership 4. Financial collateral bonds 6. What is a “strategic alliance function”? Identify at least two ways that a strategic alliance function helps a firm be more successful with its alliances.

A strategic alliance function is a function within a company that has a VP or director with his or her own staff and resources dedicated to all alliance-related activity. This function helps in the following ways: 1. Improves knowledge management 2. Increases external visibility 3. Provides internal coordination 4. Facilitates intervention and accountability

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Chapter 9: International Strategy

Chapter 9: International Strategy Learning Objectives Studying this chapter should provide you with the knowledge to: • Discuss the globalization of business.

• Explain why firms choose to expand internationally.

• Describe different kinds of distance, how they affect successful international expansion, and how this affects the choice of where firms should go when they expand.

• Explain the three primary types of international strategy and be able to use the international strategy triangle to determine which international strategy is right for a specific firm.

• Explain when a firm should use each of four major ways to enter a foreign market.

Purpose Students will learn about the four types of economic distance that need to be addressed to determine ideal expansion choices. There are different types of international strategies and methods of entering new regions. The International Strategy Tool will help students determine which strategy to use in different circumstances.

The strategy tool will be learned through class lecture, end of chapter assignments, mini cases in chapter and, finally, with the Samsung case.

Outline Huawei: An Emerging Global Consumer Electronics Giant THE GLOBALIZATION OF BUSINESS WHY FIRMS EXPAND INTERNATIONALLY

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Growth Efficiency Managing Risk Knowledge Responding to Customers or Competitors WHERE FIRMS SHOULD EXPAND Cultural Distance Administrative Distance Geographic Distance Economic Distance Strategy in Practice: How Unilever Manages Economic Distance in Rural India HOW FIRMS COMPETE INTERNATIONALLY Multidomestic Strategy—Adapt to Fit the Local Market Strategy in Practice: National Competitive Advantage Global Strategy—Aggregate and Standardize to Gain Economies of Scale Ethics and Strategy: Is Economic Arbitrage Ethical? Won’t It Lead to Workers’ Exploitation?

Arbitrage Strategy Combining International Strategies Strategy in Your Career HOW A FIRM GETS INTO A COUNTRY: MODES OF ENTRY Exporting Licensing and Franchising Alliances and Joint Ventures Wholly Owned Subsidiaries Choosing a Mode of Entry • Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool: The International Strategy Triangle—Determining Which Strategy to Use • References

Answers to Review Questions 1 What are the five main reasons firms expand into international markets?

Growth, efficiency, managing risk, knowledge, and responding to customers or competitors.

2. Describe the four types of distance that firms should consider when choosing which Copyright ©2022 John Wiley & Sons, Inc.

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foreign markets to enter. What factors help managers determine which type of distance is most likely to affect the success of an international expansion?

1. Cultural - differences in language and culture, the way people live and think about the world 2. Administrative - differences in legal, political, and regulatory institutions 3. Geographic - how many miles separate two countries 4. Economic - differences in the average income of customers, usually measured as per capita GDP 3. Describe the concepts of local responsiveness and standardization. Determine which international strategy is best suited to each pressure and explain why.

Local responsiveness is the need to tailor products, marketing, and distribution strategies to local customers in a foreign country. Standardization is not adjusting to local customers, which results in achieving economies of scale (cost reduction). Multidomestic strategy is suited for local responsiveness because companies are trying to adapt to customer preferences in different regions, whereas a global strategy is suited for standardization because products will be standardized globally for cost reduction.

4. Describe the three primary international strategies.

1. Multi-domestic strategy - local responsiveness over standardization 2. Global strategy - standardization and economies of scale over local responsiveness 3. Arbitrage strategy - country-comparative advantages such as sources of low cost or unique resources 5. What does a multidomestic strategy look like? What are the key elements?

Comparatively, what are the key elements of a global strategy? Can you name a firm that pursues each strategy?

A firm pursuing a multi-domestic strategy offers a slightly different value proposition in each country or geographic market. They do this to respond to the different needs of customers that may vary in each country or geographic market. The key elements involve localizing product development and manufacturing in local markets to effectively tailor products to the needs of customers in that particular market. By comparison, a firm pursing a global strategy treats the world as a single market, with all customers having similar needs. As a result, the company can design products in a standard way to meet the needs of customers who are relatively homogeneous across geographic markets. Apple and Sony pursue a global strategy, with standard products

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around the globe, while Samsung pursues more of a multi-domestic strategy by tailoring products to each different geographic region.

6. What makes an arbitrage strategy different from a multidomestic or global one?

Name the four types of arbitrage and explain how each one works.

The arbitrage strategy allows a multi-national corporation to benefit from countrycomparative advantages, such as economic arbitrage (lower labor costs, energy costs), capital arbitrage (cheaper capital), cultural arbitrage (unique technical skills), and administrative arbitrage (favorable tax laws).

Economic arbitrage capitalizes on differences in costs by buying where costs are low and selling where prices are high. This is the traditional, age-old definition of arbitrage.

Capital arbitrage capitalizes on differences in the cost of capital by acquiring capital where it is less expensive.

Cultural arbitrage capitalizes on differences in culture between countries by actively using the culture of one country as a selling point for products being marketed in another country.

Administrative arbitrage capitalizes on differences in taxes, regulations, and laws between countries by operating where taxes are lower or regulations more lax.

7. Describe the ways that managers can help keep multi-domestic strategies from becoming too costly and global strategies from failing to meet local needs.

Multi-domestic strategies: To prevent from becoming too costly, manage variation in the following ways: 1. Focus adaptations - focus on a particular product, customer segment, or geographic area.

2. Externalize adaptations - arrange for local customers to adapt to local needs, such as using franchises or alliances.

3. Design adaptability - cheap adaptation through flexible manufacturing or creating a set of standard interfaces that allow many different types of alternatives to plug into one another.

Global strategies: To prevent from failing to meet local needs, companies may not centralize all parts of the value chain. Some functions can be localized, while others are centralized.

8. Explain the international strategy triangle and list the steps to construct one.

The International Strategy Triangle is a tool for determining which international

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strategy a company should pursue. It consists of three axes labeled multi-domestic, global, and arbitrage. To construct where companies fall on the triangle, follow these steps: 1. Determine the appropriate measures to use for the three axes. For many manufacturing industries, these measures will be: • Multi-domestic axis –Advertising to sales • Global axis – R&D to sales • Arbitrage axis – Labor to sales 2. Plot the median and 90th percentiles for the industry as a whole on each axis. You will do this by gathering data on the measure for each axis from the most important firms in the industry you are examining. When you have the data, calculate the median and the 90th percentile point, where 90 percent of the firms are below that point. This is likely to be close to the firm who is farthest along the axis.

3. Plot the appropriate point on each axis for the firm you are analyzing. Draw a triangle connecting these three dots. You may also want to carry out this process for two or more of the firm’s major competitors.

4. Use the shape of the triangle to help determine the appropriate international strategy for the firm being analyzed and to understand competitive dynamics in the firm’s industry.

9. Explain how you would use the international strategy triangle to identify which international strategy a firm should use. Explain how you would use it to evaluate the strategies of firms that have already gone international.

If a company ranks at any point beyond the median along any axis, managers should consider pursuing that strategy. If a firm ranks beyond the 90th percentile, it is critical that a firm consider that strategy. This can be used to look at the dynamics of competition in the industry, including who is likely to win and who is likely to lose.

10. What is a mode of entry? Describe the four main types of entry a firm can choose.

A mode of entry is the way or strategy a firm uses to enter foreign markets. There are 4 main types: 1. Exporting - producing goods in a single location and selling them in foreign markets.

2. Licensing and franchising - selling the rights to produce a firm’s products or services.

3. Joint venture and alliances - alliances involve sharing resources, risks, and

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rewards. Joint ventures are a special form of an alliance involving the joint creation of a new firm.

4. Wholly owned subsidiaries - local units owned outright by the entering firm.

11. Which type of entry mode is most appropriate for each of the primary international strategies? List the factors that firms using each primary strategy should consider when choosing an entry mode.

Factors to consider include amount of control a firm wants to keep and the risk it is willing to take. Global strategies require more control, moving firms toward exporting and wholly owned subsidiaries. Multi-domestic strategies need local innovation, so franchising, joint ventures, or autonomous wholly owned subsidiaries would be more appropriate choices. Arbitrage requires ownership, so exporting and licensing/franchising will not be good choices.

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Chapter 10: Innovative Strategies

Chapter 10 Innovative Strategies That Change the Nature of Competition Learning Objectives Studying this chapter should provide you with the knowledge to: • • •

Discuss innovative or disruptive strategies and the differences among the types of innovation.

Identify the different categories of innovative strategies.

Describe the accelerating pace of innovation and the product, business, and industry life cycle.

Purpose The purpose of this chapter is to expose students to the notion of innovative strategies. While there is no specific strategy tool, students will learn to differentiate between an incremental versus radical innovation and various types of innovative strategies.

The role innovation plays in strategy will be explored throughout the text, mini-cases, end-of-chapter questions, and the New Business Models Case regarding home entertainment.

Outline Hey Google … Here Comes Alexa, Siri, and Cortana WHAT IS AN INNOVATIVE STRATEGY? Incremental Versus Radical Innovation Strategy in Practice: Understanding Business Models CATEGORIES OF INNOVATIVE STRATEGIES Copyright ©2022 John Wiley & Sons, Inc.

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Reconfiguring the Value Chain to Eliminate Activities (Disintermediation) Low-End Disruptive Innovations Strategy in Practice: The Internet as a “Disruptive” Technology High-End/Top-Down Disruptive Innovations Strategy in Practice: Why Incumbents Don’t Respond Effectively to Low-End Disruptions Reconfiguring the Value Chain to Allow for Mass Customization Blue Ocean Strategy—Creating New Markets by Targeting Nonconsumers Create a Platform to Facilitate Transactions Free Business/Revenue Models Strategy in Practice: Where Do Innovative Strategies Come From?

Hypercompetition: The Accelerating Pace of Innovation INNOVATION AND THE PRODUCT/BUSINESS/INDUSTRY LIFE CYCLE (S-CURVE) Introduction Stage Growth Stage Maturity Stage Decline Stage • Summary • Key Terms • Review Questions • Application Exercises • References

Answers to Review Questions 1. What is the difference between an invention and innovation? What are the differences between incremental versus radical innovations?

Invention is the creation of a unique or novel concept, method or process, whereas innovation is the conversion of a novel concept into a product, process, or business model that generates revenues and profits. Incremental innovation builds on a firm’s established knowledge base and steadily improves the product or service it offers, whereas radical innovation draws on a different knowledge base, technologies, or methods to deliver value in a truly unique way.

2. How do companies create an innovative strategy by eliminating steps in the value chain?

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similar products and services. One example is that of Amazon offering books online.

3. What is the difference between low-end and high-end disruptive innovations?

“Low-end” disruptive innovations offer a low-cost product or service with less technology or ability, whereas “high-end” disruptive innovations offer products that outperform existing products and are sold for a premium price rather than a discount.

4. What does mass customization mean? How do companies use mass customization to succeed in the market?

Mass customization means providing products or services that are customized for individual customers but on a large scale, such as Build-A-Bear Workshop. This works in markets that have customers with a variety of different needs where many want a product that is personalized to those needs.

5. What does it mean to target nonconsumption? How does a company create new markets with a blue ocean strategy?

Targeting “non-consumption” means looking for individuals who do not currently purchase a product or service and offering a product or service that might induce consumption. A company creates new markets by creating new demand in an uncontested market space.

6. What are four behaviors of business innovators that help them generate ideas for innovative strategies?

Observing, questioning, experimenting, and associating.

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Chapter 11: Competitive Strategy and Sustainability

Chapter 11: Competitive Strategy and Sustainability Learning Objectives Studying this chapter should provide you with the knowledge to: • Create a strategic group map and a strategy canvas of a competitive landscape.

• Analyze a company’s competitors to identify the likely ways they will respond to the company’s strategic moves using a competitor response profile and the tools of game theory.

• Describe the different types of competitive strategies that can be deployed contingent on the environment in which a company operates.

• Choose or create a competitive strategy suitable to a company’s competitive situation.

• Analyze the sustainability of a company’s competitive advantage.

Purpose Various tools are used to better understand a competitive landscape. Two tools discussed in this chapter are the strategy group analysis and the strategy canvas. The strategy group analysis is done by identifying the main differences in the ways in which firms in an industry compete to deliver value. Two important factors for the selected industry are chosen and then used on the horizontal and vertical axes. By then plotting the companies in this space, clusters of companies (strategic groups) will emerge to show the competitive landscape. Switching strategic groups is very difficult. A strategy canvas rates firms (ratings are on the y-axis) on various features that customers care about (features are displayed on the x-axis) to show how competitors differ in the industry. This will allow companies to see where they are positioned and, perhaps, where they would like to improve their products to compete more effectively.

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Delta Simplifies Its Fares UNDERSTANDING THE COMPETITIVE LANDSCAPE Strategic Groups and Mobility Barriers Strategy Canvas Strategy in Practice: A Real-World Strategic Group Map EVALUATING THE COMPETITION What Drives the Competitor?

What Is the Competitor Doing or Capable of Doing?

How Will a Competitor Respond to Specific Moves?

Using Game Theory to Evaluate Specific Moves Ethics and Strategy: Is Collusion Ethical?

PRINCIPLES OF COMPETITIVE STRATEGY Know Your Strengths and Weaknesses Bring Strength Against Weakness Protect and Neutralize Vulnerabilities Develop Strategies That Cannot be Easily Copied COMPETITIVE ACTIONS FOR DIFFERENT MARKET ENVIRONMENTS Competition under Monopoly Competition under Oligopoly “Perfect” Competition Strategy in Practice: Tacit Collusion Between AT&T and Verizon Dynamic Environments SUSTAINING COMPETITIVE ADVANTAGE

• Summary • Key Terms • Review Questions • Application Exercises • Strategy Tool When Does Defecting from Collusion Make Sense? • References

Answers to Review Questions 1.

Name two frameworks for understanding the competitive landscape.

Strategic group map, the strategy canvas, competitor response profile, and game theory.

2.

What is a strategic group analysis, and how is it useful?

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A strategic group analysis breaks down the structure of a market or industry into constituent groups. These groups are shown on a diagram with axes represented by factors that are particularly key to the industry or market. This analysis helps companies visualize and identify the major arenas of competition and who competes directly with whom.

3.

What factors might limit a company’s ability to switch strategic groups?

Factors that are not easy to change quickly and require significant investments.

This would include structures and capabilities that are built over time such as cost structures, organizational culture, large, fixed costs, etc.

4.

What is a competitor response profile, and how is it useful in evaluating competitors?

A competitor response profile identifies characteristics of a competitor in order to assess how they might respond in the face of rival actions. This involves the answers to such questions as “What drives the competitor?”, “What is the competitor doing or capable of doing?”, and “How will a competitor respond to specific moves?” This assists companies in predicting the reaction of competitors and understand whether they will make certain moves or decisions.

5.

Define the Nash equilibrium used in game theory to predict the outcome of competitive interaction.

The Nash equilibrium is reached when a decision in game theory maximizes each firm’s payoff given the choices of rivals and removes incentives to defect so that no player can improve his payoffs by changing his choice.

6.

Identify the four general principles of competitive strategy.

1. Know your strengths and weaknesses 2. Bring strength against weakness 3. Protect and neutralize vulnerabilities 4. Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

7.

What are the three types of market structures?

Monopoly, oligopoly, and perfect competition (sometimes referred to as just “competition”).

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8.

What are the strategies most likely to be useful for a monopolist?

Raising entry barriers, limiting competitive access to scarce resources, innovating and patenting, and introducing new products frequently.

9.

What are the strategies most likely to be useful for an oligopolist?

Monitoring and mimicking rival behavior and employing tit-for-tat strategies.

10.

Why do firms in an oligopolistic environment often hesitate to make moves that will take them outside of the status quo?

Because the companies are locked in tight competition with only a few other firms that are watching behavior very closely. Other firms will respond accordingly.

11.

What strategies are most likely to be useful for firms in perfectly competitive markets?

Consolidating markets, pursuing low cost, or pursuing differentiation strategies.

12.

What types of strategies are most useful for firms operating in dynamic markets?

Reconfiguring processes and capabilities to emphasize both innovation and speed.

13.

Name five tactics that can be used to sustain competitive advantage.

Create or preempt rare resources—prevent competitors from accessing the sources of your advantage Secure government sanctioned barriers—such as patents or tariffs Create buyer switching costs—buyers are less likely to switch when they have to endure costs (such as learning or investing in new tools or inventory) in order to use a new product. Switching costs keep the total cost of the product in favor of the firm in place.

Leverage network effects—This is when your product becomes more value the more people use it. Think of Excel, LinkedIn, or eBay. Each of these products or firms becomes more valuable to users as the total number of fellow users increases.

Leverage rare intangible assets—This would be brand equity, customer or employee loyalty, or the power of habit. Sometimes each of these make it more difficulty for customers or employees to switch to another firm.

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Chapter 12: Implementing Strategy

Chapter 12: Implementing Strategy Learning Objectives Studying this chapter should provide you with the knowledge to: • Describe how the 7S model can be used to determine the level of alignment within a company and between the company and its environment.

• Evaluate a strategic change effort and explain the underlying reasons why the effort succeeded or failed.

• Discuss how creating effective line-of-sight measures can assist managers in the strategy implementation process.

Purpose The most important points that you want to make in this chapter are: As difficult as it is to formulate strategy (the first 11 chapters), it’s just as difficult to actually implement strategy.

The only time a firm creates a strategy without having to worry about implementation is when it’s a brand new, entrepreneurial firm. Every other time, executives have to worry about creating alignment and change.

Outline Alphabet: Reorganizing to Create Value at Google ALIGNMENT: THE 7S MODEL Strategy Structure Strategy in Practice: How to Use the 7S Model Systems Staffing

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Skills Ethics and Strategy: Creating an Ethical Climate and Culture through the 7S Model Style Shared Values Strategy in Practice: How to Develop a Mission Statement STRATEGIC CHANGE Strategy in Practice: The 7S Model and COVID-19 The Three Phases of Change The Eight Steps to Successful Change Strategy in Practice: Work Gloves Create Change Strategy in Practice: Pret a Manger to the COVID-19 Pandemic Measurement Strategy in Practice: Creating Line of Sight Measures Strategy and Your Career: How to Use Line of Sight to Advance Your Career • Summary • Key Terms • Review Questions • Application Exercises • References

Answers to Review Questions 1.

When using the 7S model to create alignment, why do managers need to make sure all the Ss align with the organization’s strategy? What problems follow misalignment?

Strategy is the S around which to align the others because having a successful strategy allows the organization to compete in its market place and create value for customers. If the different Ss don’t align with the strategy, the organization will not be successful.

2.

What tools do managers have to realign the hard triangle? The soft square?

Strategy, structure, and systems constitute the hard triangle, while skills, staffing, style, and shared values represent the soft square.

3.

Is it true that the “soft stuff is the hard stuff” in creating alignment? Why or why not?

The elements of the hard triangle can be employed relatively easily and quickly, and they can be changed abruptly. The soft square, on the other hand, takes

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diligent effort over time, measured in months (for elements like skills or staffing) or years (for elements like shared values and style).

4.

If change projects seem to stall and fail to progress, which of the eight steps of successful change have not received enough attention?

When change projects stall, it is almost always because managers have not spent enough time generating a sense of urgency or building a coalition. These two elements are the most important to help the organization unfreeze.

5.

What does it mean to institutionalize change? How long will this process take? Why? Institutionalizing change means to make the change so essential that it is taken for granted and becomes part of the central values of the culture. Change becomes permanent when routines such as sales methods, accounting procedures, or operating processes embody the new set of behaviors and activities.

6.

Define line of sight. List three examples from your own career or educational experience where the principle of line of sight helped you make a better decision.

Line of sight is a measurement system that helps everyone, from top management to front line employees, understand how their daily work contributes to strategic success. Line of sight helps all organizational members decide which of the many tasks that they could perform they really should do, because they contribute to strategic success.

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Chapter 13: Corporate Governance and Ethics

Chapter 13 Corporate Governance and Ethics Learning Objectives Studying this chapter should provide you with the knowledge to: • Discuss the purposes of a corporation, including the shareholder primacy model and the stakeholder model.

• Explain the role of the board of directors in governing the corporation and their duties to shareholders and other stakeholders.

• Identify major ethical challenges managers face at each stage of the value chain.

Purpose The main ideas that I try to communicate in this lecture are that there are some “big” questions that people who work in business ought to think through and be concerned about. Depending on how this session and the accompanying cases fit into your syllabus, you can spend one day talking about the big issues in a lecture/abstract way and one day applying them in cases, or you can mix the cases in with the discussion.

The Two big issues are: 1. What is the role of business in society? Is the role simply to make money, or does business have a larger set of obligations to its stakeholders?

2. How can business leaders set up their organizations so that people have incentives to act in ethical ways?

Of course, the issues about governance—the board and managerial incentives—have a lot to do with both of these big issues.

Outline Governance Failures at Wells Fargo Copyright ©2022 John Wiley & Sons, Inc.

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THE PURPOSES OF THE CORPORATION The Shareholder Primacy Model The Stakeholder Model Strategy in Practice: The Purpose of a Corporation GOVERNANCE: BOARDS AND INCENTIVES The Board of Directors Compensation and Incentives Strategy in Practice: California Leads the U.S. Toward More Diverse Boards CORPORATE ETHICS Strategy in Practice: Ethics and Your Career Corporate Culture and Ethics Strategy in Practice: Facebook, Free Information, and Privacy Issues Creating an Ethical Climate Strategy in Practice: The Johnson & Johnson Credo • Summary • Review Questions • Application Exercises • Key Terms • References

Answers to Review Questions 1.

What is governance? Why is it important for strategic managers to understand the role that governance plays in the operation of the firm?

Governance is the process by which the corporation is directed, or as the chapter describes it, the ship is steered. Governance involves three questions: for whom do we operate the business (Shareholders, Stakeholders, or both), who steers (the Board of Directors and incentives), and how do we steer (what ethical principles guide the corporation)?

Understanding these broader questions creates the context of goals and values that managers use to formulate and then implement strategy.

2.

Explain the role of the board of directors in running a public company.

What is their primary job? What distinguishes inside from outside directors?

The Board of Directors is a group of individuals who monitor the executive team of the corporation and ensure that those executives are acting in the best interests of the shareholders. Good boards play this monitoring role and they

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provide a source of expertise and knowledge to help executives guide the firm.

Inside directors also hold executive positions in the firm, while outside directors are not otherwise employed by the corporation.

3.

Define the agency problem in corporate governance and describe the mechanisms many companies use to align the incentives of managers and owners.

The shareholders of a corporation, also called the principals, want to maximize the return on the dollars they’ve put into the firm; they want the corporation managed in a way that maximizes revenue and minimizes cost, leaving the most profit. The managers who act as the agents of the principals in operating the firm want to maximize their own utility.

Companies use two primary tools to overcome the agency problem: monitoring through the board of directors and defining incentives that align the interests of managers and owners. The most common incentives are “pay for performance” in the form of bonuses, stock options, or outright grants of stock.

4.

How can a company’s culture encourage members to engage in unethical behaviors? Ethical ones?

A company’s culture is like a third piloting mechanism, in addition to monitoring and incentives. Culture provides the norms, behavioral patterns, and assumptions that guide individual behavior within an organization. A culture tells employees the correct way to see the world around them. Second, culture provides a set of justifications for action.

If the company culture teaches people to deny or overlook the ethical dimension of their work, then people will be more likely to act in unethical ways. Conversely, if the culture sensitizes people to ethical action, then people will be more aware of the ethical ramifications of their work.

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Chapter 14: Strategy and Social Value

Chapter 14 Strategy and Social Value Organizations Learning Objectives Studying this chapter should provide you with the knowledge to: • Explain the difference between economic and social value.

• Use the value net to identify a social-value organization’s key stakeholders and use that model to discuss opportunities for and threats to value creation.

• Explain how economic-value organizations can create value through activities known as corporate social responsibility.

• Categorize the major focus areas of social entrepreneurship and the challenges unique to each focus.

Purpose The major themes of this chapter are twofold: 1. Social value organizations are important. It turns out that almost 10% of American workers are employed in the not-for-profit or philanthropic sector, and that excludes education and most health care. So, there’s a good chance that many of your students will work in the social sector. Even for those who work in business, they’ll often be involved, either as a volunteer, or board member, of many social value organizations.

2. The tools of strategy matter and can help social value organizations operate more effectively.

Outline Giving It All Away at Newman’s Own STRATEGY AND SOCIAL-VALUE ORGANIZATIONS THE TOOLS OF STRATEGY AND THE CREATION OF SOCIAL VALUE External Analysis and the Value Net Copyright ©2022 John Wiley & Sons, Inc.

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Internal Analysis: Resources and Capabilities Cost Leadership, Differentiation, and Innovative Strategies Strategy in Practice: Detroit Mercy Law School—Creating Unique Value for Students Corporate Strategy and Alliances Implementation and Governance STRATEGY AND SOCIAL CHANGE Corporate Social Responsibility (CSR) Strategy in Practice: COVID-19 Vaccine Development: Walking a Tightrope CSR and Firm Performance SOCIAL ENTREPRENEURSHIP Types of Social Entrepreneurship Strategy in Practice: Community Enterprise Solutions Strategy in Practice: Kinder, Lydenberg, and Domini, and the Creation of Socially Responsible Investing Skills of Social Entrepreneurs Challenges in Social Entrepreneurship • Summary • Key Terms • Review Questions • Application Exercises • References

Answers to Review Questions 1.

Define economic value and social value. Why do organizations tend to focus on the creation of one type of value, but not both?

Economic value focuses on the creation of income, wealth, and other economic outcomes for individuals and organizations. Social value, on the other hand, concerns improvements in the non-economic elements of individual’s lives and community well-being.

We have a long history in the West of separating economic activity (business) from social activity. Today, many scholars believe that if a business tries to create social value, it will end up creating less economic value and will lose its ability to compete.

2.

What is corporate social responsibility? How can philanthropy add value to a company’s shareholders? Stakeholders?

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Corporate Social Responsibility refers to activities that companies engage in that are designed to further some social objective and that lie beyond the direct economic interests of the firm.

Recent research suggests that CSR activities, such as philanthropy, help preserve a company’s resource-base when things go wrong. These researchers believe that the positive reputation for creating social value through CSR acts like an insurance policy that protects the underlying economic value of the firm when accidents or other negative events occur.

3.

Explain the three types of social entrepreneurship and give examples of each type. When does each type of social entrepreneurship create lasting social value?

Capacity building happens when social entrepreneurs focus on transferring skills from one group to another. Fundacion Paraguaya, and many other educational ventures, engage in capacity building of the poor.

Some social entrepreneurs focus on Products and Services that can be adapted from a developed, rich country setting and brought to developing, impoverished markets. Unilever’s Project Shakti represents one company’s attempt to design and distribute its products to create value for impoverished rural residents in India.

Institutional change happens when social entrepreneurs work to change the way people and groups think about problems and design institutions to create lasting change. Groups that fight larger social problems, such as prescription drug abuse, represent attempts to create institutional change.

4.

Do you believe that social entrepreneurship will be able to solve difficult problems at the base of the pyramid? Provide a logical and fact-based explanation to support your belief.

Students’ answers will vary.

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