SPStudynotesversion1.doc

Welcome:

Surviving the Strategic Planning Course---and the exam

A number of “Watercoolerites” have suggested only a cursory reading of the text is necessary as the previous exams, case studies, available study notes, and other “Blackboard” materials are sufficient. Although this may be true, I followed a different study process.

I read the text in great detail, and didn’t venture to the next module until I was satisfied I had a handle on the material. At this point, I didn’t attempt case studies, etc.

I downloaded DCohen’s (see below) study notes from the Watercooler site, and I added material that I felt important. This, of course was based on my own knowledge gaps, etc., and illustrates one reason why people should not rely solely on other’s notes: people write them based on individual needs that may differ from yours. Plus, course materials are often updated, and are not reflected in the online study notes provided by fellow students

After I had gone through all the modules, etc., I then referred primarily to the notes. Once I was comfortable with them, I started tackling the case studies, etc. I DID NOT look at any previous papers to this point.

I gathered some supplemental materials to assist me. I found www.netmba.com very useful. BCG matrix, supply chain, and other topics are covered succinctly.

I identified my personal weakness was in the financials, so I spent some time working on ratios, and interpreting this in the context of company/product evaluation.

About three weeks before the exam, I started with the previous papers. I left them to the last so I wouldn’t look for trends. Also, it creates a more exam-like atmosphere. I (almost) always believe the practice of looking for question types is a poor gamble, as there is almost one question in the HW exams that are set to test your

understanding of specific information from the text.

The model student answers were incredibly useful!

I read the FAQs and Faculty Board threads, but did not post. I feel the Watercooler is a much better forum…….but this is my personal slant.

I wrote the exam, felt I did poorly, fretted for 6 weeks----and passed with an “A”. PLEASE READ the following before accessing the notes!

DCohen’s Notes:

Therefore, I have embedded a footer to the notes, as below. If you make changes to the notes, perhaps you could follow suit.

DCohen—wherever you are: thank you for your notes. Chris Connolly

Module 1 – Introduction to Strategy, Planning, and Structure

1.2 – What is Strategic Planning?

Is there a pay off to the company from the resources devoted to strategic planning? Which is more appropriate, the informal approach, or the structured formal plan?

One description of strategy is “A pattern in a stream of decisions, the pattern may not be

comprehensive, unified or integrated.” The problem with strategy is the complexity of the business environment, however, evidence suggests that the most successful companies got that way because of effective strategies.

Strategy is about the unknowable and the unpredictable. There are no simple answers.

1.2.2 – Strategy in the Business Context

Central question: is strategy a rational process, in the sense that it was carefully thought out by senior management and then put into practice, or is it emergent in the sense that it develops over a period as the result of many influences from all levels in the organisation?

1.2.3 – Three Approaches to Strategic Planning

Strategy can be regarded as: - a purely planning exercise

- a course of action which emerges over time

- as the outcome of the resources which are available to the company The Planning Approach:

Definition: once a set of objectives have been determined, the business environment analyzed and forecasts made, a plan can be worked out by senior management which is then passed down for implementation.

Assumptions:

- The future can be predicted accurately enough to make rational choices.

- It is possible to detach strategy formulation from everyday management (new information is available every day)

- It is possible to forego short-term benefit in order to gain long-term advantage – In a situation of uncertainty and lack of knowledge about the future; it might be preferable to reap short-term benefits instead of long-term objectives.

- The strategies proposed are capable of being managed in the way proposed – Change management cannot be taken for granted.

- Strategies do not need to be altered – false

- Implementation is a separate and distinctive phase that only comes after a strategy has been agreed – False, we have to evaluate the feasibility of different courses of actions at every step.

Emergent Strategy:

Definition: starts from the premise that people are not totally rational and logical. Strategy is not planned before the event but emerges over time in an unpredictable manner and hence may appear to have little structure.

The decision maker is rational given the information at his disposal, but is quite aware that more information is likely to be available. The term “satisficing” was invented to reflect the fact that decision makers collect information and defer selecting a course of action until the costs of further delay and information collection are considered to be greater than the potential benefits of searching out a better option.

It can be argued, however, that:

- Just because the world is complex and changing, does not mean that decision makers should simply sit back and let things happen.

- The company can still be directed along the general lines of a broad mission. - There is need for efficient resource allocation (not randomly)

- Compromises are a constraint, not a barrier to action.

- Investments might take time to reach fruition; therefore a degree of long term planning is inevitable.

- The act of attempting to plan makes the basis for management action clear. Resource Based Strategy

Emphasis on the internal resources available to the company. It is primarily concerned with the search for competitive advantage and its source rests within the organisation’s resources. Examples: total quality management

1.2.4 – Rittell’s Tame and Wicked Problems

The old Soviet economy tried to plan everything. What if the basic premise is wrong, i.e., it is not possible even in principle to plan an economy or a company with any degree of precision?

Property Tame Wicked

Ability to formulate the

problem Can be written down No definitive formulation

Relationship problem x

solution Can be formulated independently of solution Understanding problem is same as solving it. Testability Either true or false Solutions good or bad relative

to each other

Finality Clear solution No clear end and no obvious

test Traceability Identifiable list of operations

can be used No exhaustive identifiable list of operations Level of analysis Can identify root cause Never sure whether a problem

or a symptom Reproducibility Can be tested over again as in

a lab Only one try; no room for trial and error

Replicability May occur often Unique.

We can visualize business strategy as a set of decision rules which guide the company’s

resource allocation process, taking into account both the short and long run, with the emphasis on allocating resources in uncertain conditions to achieve future objectives. The company which uses a form of strategic planning does not simply react to events in the present, but considers what should be done now in order to achieve future objectives.

1.3 – The Process of Strategy and Decision Making

The selection of a course of action depends on the availability and interpretation of information, analysis, intuition, emotion, political awareness and many other factors.

It is possible to have a structured analysis of the strategy, providing managers with insights into events.

1.3.1 – Strategy Dynamics

Strategy is a dynamic process, as the environment is always changing.: competitive environment, product life cycles, customer changes, government regulations, etc.

The Mythical Company – example: The CEO asks:

1) How well are we performing?

2)

What should we be doing in the future?

3)

How can we achieve successful change?

In response, the functional areas write their reports on how they each see things:

1)

Accounting Report

2)

R&D Report

3)

Marketing Report

4)

Finance Report

5)

Economic Report

6)

Production Report

7)

Manpower Report

The CEO then needs to integrate and synthesize these inputs, and decide on vision and direction. Strategy and Crises - How can you follow any strategic plan when you keep getting hit with pressing problems of the day? It must be accepted that no plan can be inflexible, and that it should be modified as additional information becomes available. Crises events can be regarded as sources as new information.

1.3.7 – Elements of Strategic Planning

Apart from recognizing that forward thinking of some sort is important, it is possible to extract some lessons of general applicability from the dynamic approach discussed above.

1)

Individual managers used a structure of thought to tackle problems within their area.

2)

Managers applied this structure to the analysis of data.

3)

The CEO integrated the different types of analysis presented by the managers in order to arrive at a decision.

1.3.8 – Structure

In order to make sense out of the complexity of life it is necessary to impose an intellectual structure on events and processes. A theoretical structure makes it possible to tackle new problems in a systematic manner; the lack of general principles which can be applied to seemingly different issues leads to inconsistency.

Example of structures: finance, accounting, OB, economics, marketing.

The CEO imposed a general structure on the information presented to him by thinking in terms of the company’s strengths and weaknesses: the threats posed by changes in market conditions and the opportunities existing in related markets.

Analysis

The information the functional managers provided was in the form of analyses based on their individual areas of expertise. The following issues were important:

- Do not confuse rigor with numbers – the use of theories and concepts to clarify problems and evaluate potential solutions can be independent of the precise numerical quantities. There is nothing to be gained by attempting to be highly accurate.

- Precision is not essential

- Data can be expressed as: relative orders of magnitude, positive or negative, quantitative or qualitative.

It is important for managers to determine the direction of change and the rough order of magnitude. There are likely to be significantly diminishing returns at the margin to the effort devoted to analytical detail.

1.3.10 – Integration

Integration is an essential component of strategy because the application of specific

recommendations in one area can have implications for other aspects of company operations. The CEO must understand how each of the functions think about things in order to integrate and provide constructive criticism—though he may not be best at doing a financial analysis himself.

1.3.11 – Evaluation

Performance must be evaluated, and in order to monitor performance it is necessary to devise measures which generate information on how well objectives are being attained.

There are many measures, make sure the measure used is relevant.

It is not possible to express all targets in quantitative terms (standards of service, corporate image, etc). Sometimes absolute measures are less important than measures relative to the competition.

1.3.12 – Feedback

If a company does not monitor, react to and learn from feedback its strategies will quickly cease to be aligned with actual events.

1.4 – Business Unit and Corporate Strategy

The strategic questions addressed by SBU’s are:

1)

What is the market?

2)

Which segments are products aimed at?

3)

What is the competition?

4)

Can a sustainable competitive advantage be achieved?

Corporate strategy is concerned with the portfolio of SBUs, ensuring that they do not behave in a way which is detrimental to each other, and allocating resources among them.

1.4.1 – Allocating Corporate Resources

How should companies allocate resources among SBUs? Two examples of approaches are: - allocate capital to groups on the basis of the total capital cost to each group of identified

value creating investments. Each group then allocates amount its SBUs. - Allocate capital directly to the individual SBUs using the ratio of value added.

1.4.2 – Development of Corporate Strategies

How does corporate add value to the SBUs? The costs should be less than the benefits. There are four ways by which the parent might add value:

- Stand-alone influence : parenting activities include agreeing and monitoring performance targets, approving major capital expenditures, selecting SBUs managers. It can extend to product-market strategies, HR management. It can be argued that the more the parent extends its influence into the affairs of the individual businesses, the more likely it is hat it will destroy value; this is the “10 per cent versus 100 per cent paradox”: why should a parent manager working as a part-timer do better than a business manager working full time?

- Linkage influence : encourage relationships to capitalise on synergy. But, why should the parent company do better than the SBU?

- Functional and services influence : provide functional leadership and cost effective services. But it can create a supplier insulated from outside competition and it is not guaranteed that it will be as efficient as the market. This is the “beating the specialists” paradox.

- Corporate development activities : buying and selling business, creating new businesses, redefining businesses. But since the majority of corporately sponsored acquisitions, new ventures and business redefinitions fail to create value, the odds against success are long: this is the “beating the odds” paradox.

1.5 – Is Strategic Planning only for Top Management?

1.5.1 – Company Benefits of Strategic Planning

1)

The individual manager is able to see where his subunit fits into the overall system of objectives.

2)

The manager will better understand which of his potential proposals are likely to contribute to the overall plan/

3)

Managers can better understand more clearly the strategies they are employing by participating in the strategy process.

1)

The manager will achieve a better understanding of where the company is going, and what it is attempting to achieve.

2)

Submitted proposals will become more consistent and relevant.

Module 2 – Modeling the Strategic Planning Process

2.1 – The Modeling Approach

A model of the strategic planning process provides a structure within which strategy problems can be analyzed. A model is a structured method of thinking which enables the component parts of complex processes to be identified and related to each other. However, no model can describe a process exactly.

The power of the modelling approach lies in simplifying and making understandable what at first sight appears to be impenetrable; different models can throw light on different aspects of the strategy process.

2.1.1 – The Components of a Model

Planning as a process flow: - setting goals - forecasting pay-offs - forecasting shortfalls

- Identifying potential strategies - Selecting the best strategy mix - Organization and implementation - Control and reappraisal

- Feedback to previous activities

Learning organization: able to adapt to change instead of ignoring it.

Models are intended to be explanatory rather than predictive. Their usefulness can be judged on the contribution which they make to understanding and improving the process of strategic planning.

2.1.2 – Benefits and Costs of the Modeling Approach

A strategy model is not a prescription for how strategic planning should be carried out. It is intended to help in understanding strategy making, and does not imply that a company should adopt a particular planning system which itself might constrain the inventiveness and innovation on which much of SP depends.

Benefits of modeling planning: provides a structure, simplifies complex processes, acts as a check list, and identifies areas of disagreement.

Costs of modeling planning: imparts a mechanistic impression to the process, introduces rigidity to a dynamic process, and gives impression that strategy can be derived from a model.

2.1.3 – A Functional Model

2.2 – Strategy Makers

Individuals, not companies, make decisions, but the decisions taken are constrained by the organisation and its traditions. Excellent companies have a strong leader, who made the company excellent in the first place. The leader set the style for the whole organization. When things go wrong, the leader is the first one to go.

If the setting of objectives is not systematic, is there any point in attempting to be systematic about meeting these objectives? Objectives are set by people, with their particular insights into the world, together with all their defects, but they are the only ones we have.

2.2.1 – Strategy and Evolution of the Company

Companies are always evolving. The decision makers to some extent depend on the stage of the company evolution. Three stages: small single-product company, integrated company, large diversified company. In smaller companies the individual owner plays a dominant role in determining the strategy. In big companies, the managers answer to shareholders rather than individual owners.

2.2.2 – Strategists

It is often difficult to identify the “ultimate” strategic planner in bigger companies. The managers’ functions are complex and continuously changing.

SP -> multidimensional role which is undertaken by many individuals working at different levels. There are strategists at corporate level (CEO, board), at the SBU level (executives, planning departments,

consultants). Companies should try to clarify who does the SP.

There are 12 boxes in the functional model, but these activities might overlap. The problem is when quick decisions are taken, without considering the whole process. Example: decisions on resource allocation may be made solely with reference to accounting rather than taking relevant marketing information into account.

The four eggs on the right indicate the different roles a manager can have:

- Strategists, entrepreneur and goal setter – while managers are constrained by existing plans and commitments, they have a role to play in making decisions about potential investments, reacting to changing circumstances, identifying new courses of action, and so on.

- Analyser and competitor – managers need to be aware of changes in the economic environment, efficiency of the firm, competitive position.

- Strategy decision maker – options must be identified and different point of view brought to access costs and benefits.

- Implementer and controller – managers must make decisions happen; allocate resources; monitor, adopt measure performance.

- Communicator – of changes as they occur

Module 3 – Company Objectives

3.1 – Setting Objectives

Devising a plan without objectives is a meaningless exercise.

Since strategy is at least partly concerned with confrontation with competitors, it may not always be advisable for a company to be explicit about its objectives. There is clearly a balance to be struck between informing managers about objectives and ensuring that competitors cannot pre-empt strategic moves.

3.2 – From Vision to Mission to Objectives

It is necessary to translate the vision (long term view for the company) into a tangible set of directions that can be used by employees to direct their efforts in a manner which is consistent throughout the organization. There are three steps for this:

 Develop the mission statement

 Disaggregate the mission

 Derive objectives

The characteristics of a mission statement are:

 Define the business the org is in

 Be clearly understood by employees

 Provide a focus for activities

3.2.1 – Defining the Business of the Organization

It is not always obvious what the business definition is even when a well defined product is involved (is a football club in the sport business or entertainment business?).

To better understand the business, there are four points to analyze:

 Productive scope : the extent to which it buys in its inputs and how it perceives its own supply chain. Do they control all stages of production or purchase all ingredients and merely mix them? Some companies are now only dealing with creating the product, leaving manufacturing to an outside company, usually in China.

 Market positioning : do the company control distribution and marketing channels? Do they market directly to the customer? Do they sell under their brand or other brands?

(Example: you can produce a computer, or buy and put your logo on it, or only sell to retailers, or directly to consumers)

 Breadth and Focus : what is the range of products, example: only desktops or everything from notebooks to servers?

 Target Markets : does the product stand alone or is it a complement of others?

3.2.2 – Deriving the Mission Statement

The Mission Statement may be related to factors such as the following:

 Quality of the company products.

 Degree of differentiation

 The geographical area which it intends to serve

Some people argue that the mission statement is merely a description of what the company is rather than providing any new direction to employees. It can represent, however, where senior management wish the org to be at some point in the future.

It is important not to produce a mission which employees see as being unattainable and to which they cannot relate.

3.2.3 – Disaggregating the Mission

The mission statement for the company as a whole can be quite general, but it can be modified and applied to individual parts of the org to ensure, as far as possible, that the focus of functional departments is aligned with the vision of the senior managers.

3.2.4 – Setting Objectives

It is necessary to determine what has to be achieved for the mission to be successful, to state objectives in terms of measurable performance targets. Otherwise, the mission has little operational significance and will probably be ignored by managers.

3.3 – The Gap Concept

Gap concept: difference between expected and desired future states. It is a comparison between two expected future states (with the existing strategy and with the new strategy) and not

comparison of the current state with the desired future state.

The closing of the gap is the company objective. There is a continual feedback between objective setting and gap analysis.

It is not easy to make projections for the company performance. This is usually done using the scenario approach, a series of what if projections. It is not a forecast.

Once the gap is identified, there are three questions to address:

 Does the gap arise because of external or internal factors?

 Does the company have potential resources to close the gap?

 Can a strategy be developed which will close the gap?

One result of the gap analysis could be that, while the difference between current and desired state is not large, the gap between expected and desired states is large. This happens when the company is not moving in the direction desired. It might be necessary a substantial redeployment of resources and changes in marketing strategy.

3.3.1 – External versus Internal Gap Factors

Internal gap factors: current allocation of resources is not consistent with achieving the future desired state. There might be insufficient resources in quantity or quality to achieve the desired objective (capital equipment, labor skills). Company can have control over these factors.

3.3.2 – Gap and Resources

Timing is important. We can combine gap analysis with the dynamic scenario approach to estimate the timing of resource acquisition and reallocation required to achieve a desired future state. We can identify the critical success factors, actions that are essential for implementation.

3.3.3 – Gap and Incentives

It is necessary to ensure that the workforce is given the appropriate motivation to change objectives and behavior at the required times. It is necessary to initiate a system of incentives, which converts the gap closing objective, which is conceptual in nature, into a series of attainable objectives.

3.4 – Credible Objectives

Objectives must be relevant to the managers involved and seen to be achievable if they are to have credibility and operational validity. An objective may appear to be unfeasible at the present, but in terms of gap analysis it can be demonstrated that it is achievable in relation to where the company is expected to be in the future.

3.5 – Quantifiable and Non-Quantifiable Objectives

Company usually express objectives in terms of a number of components or characteristics. Example: being associated with a high-quality product; having a happy and stable workforce; having a dominant market share; generating a specified ROI.

Some of these components are not readily measurable, and their relative importance is difficult to identify. These are the intangible factors. Example in text of highway overpass—what is cost when scenic place must be destroyed?

Using cost benefit analysis we can attempt to determine the values for these intangible factors. A company should try to determine, for example, how a happy workforce influences ROI. There is a point where even if they are happier, there will be no influence on ROI.

There are trade-offs in the objectives and they must be analyzed.

3.6 – Aggregate Objectives

The corporate objective, derived from the mission statement, is an aggregate concept as it applies to overall company performance, size, target markets, and so on.

The notion of maximizing shareholder wealth is central to corporate strategy.

The objectives of managers might be different than the shareholder’s. Example: executive bonus calculated based on size on the company, regardless if it increases shareholder wealth.

Converting the aggregate objectives into series of objectives for managers at lower levels. The objectives at corporate level might go against (conflict) objectives of individual managers. There might be constraints at all levels.

3.8 – The Principal / Agent Problem

The manager (principal) and the subordinate (agent) might have different objectives. Example of conflict: a CEO may have a remuneration package which includes a bonus for growth in current profits; to ensure that current profits continue to grow the CEO may reduce expenditure on R&D, which has the effect of increasing current profit at the expense of long term competitiveness, against the main objective of increasing shareholder’s wealth.

3.9 – Means and Ends

What is to be achieved is different from how it is to be achieved. The distinction is sometimes not clear in real life situations. Example:

End: achieve 15 per cent ROI.

Marketing Means: achieve 23% market share, improve quality

Production Means: reduce unit cost by 4 per cent, stabilize labor force, improve sports facility.

3.10 – Behavioral versus Economic and Financial Objectives

Objectives must be primarily expressed in economic or financial terms, otherwise they are not related to market conditions, do not indicate the efficiency of the resource conversion process, and hence cannot be used as a basis for rational resource allocation.

3.11 – Economic Objectives

The question is “What is being maximized?” There is a point of diminishing returns where no additional resources would maximize our objectives. Resources should be devoted to the achievement of an objective up to the point where additional resources have no positive impact.

3.12 – Financial Objectives

The application of financial concepts makes it possible to quantify the profit maximization objective.

3.12.1 – Discounting and Present Value

Dollar today =

R = rate of interest or cost of capital of the company N = number of years in the future

NPV (look formula in the Financial textbook)

3.12.3 – Capitalized Value

Example: a bond paying $ 100 annually, with an interest rate of 5%, has a value of (100 / 0.05) = 2000.

Any future stream of income or cost can be converted to a capitalized value. It is also used to calculate the value of any asset, like a share, that has an expected future income stream accruing.

3.12.4 – Choice of Interest Rate: The Cost of Capital

Cost of Capital: cost to the company of raising money on the open market, through debt and equity.

Equity rate has a risk free rate and an allowance for risk (equity risk premium). The risk free rate is the market rate plus the expected inflation rate. The equity risk premium is based on the market assessment of the risk associated with the company. This is affected by the track record of the company’s managers, past dividend payments and profitability.

3.12.5 – Return on Investment

Profit maximization is maximizing the rate of return on investment (ROI). ROI is the net income divided by value of assets in a particular year.

Main drawbacks of ROI: figures for asset and income are historical (including depreciation procedures), and it does not capture the income earning potential of the company produced by recent investment. Different depreciation methods give different ROI.

Another method is to calculate the average ROI over several years.

3.12.6 – Shareholder Wealth

Shareholder wealth = (Expected Income Stream) / (Interest Rate)

The interested rate contains an allowance fore the risk associated with the company. How to calculate an estimate for shareholder wealth:

1 – Decide on the planning period (5 years is a common number) 2 – Determine the cost of capital

3 – Decide on residual cash flow (net cash flow at the end of the planning period) 4 – Determine the cash flows during the planning period

5 – Calculate net present value of cash flows during the planning period 6 – Calculate the present capitalized value of the residual cash flow.

7 – Add the net present value, capitalized residual value, marketable securities minus debt. (look at example in the textbook)

3.13 – Social Objectives

Friedman criticism: it can result in a misallocation of resources so that everyone ends up worse off. They lack efficiency criteria.

The problem is in determining of how much of its scarce resources to devote to any particular end. A company pursuing social objectives might be in disadvantage when competing against others that do not, due to its relative higher costs. If they go out of business, everybody loses.

3.14 – Stakeholders

3.14.1 – Stakeholder interests

Stakeholder: individuals and groups that have an interest in the org and the way in which it is managed. Each one has a different type of interest. Example: shareholders are concerned with return on their investment, customers with the quality and after sales service. Each one expects something in return from the company which is not necessarily expressed in financial terms.

 Shareholders (return on investment, risk)

 Managers (salary, advancement)

 Employees (salary, advancement, security, fair treatment)

 Suppliers (prompt payment, repeat orders)

 Customers (relative value for money, quality, availability)

 Creditors (cash flow, financial stability)

 Local community (lack of negative externalities, employment prospects)

 Government (payment of taxes, lawful operation)

There might be conflict of interests. When analyzing stakeholder interests and expectations, there are two distinct issues:

 Which interests are most important (how the company should be run)

 The influence which stakeholders have on the operation of the company (how the company is actually run)

3.14.2 – Stakeholder Interests: The Priorities

Shareholders: The most important because they provide the capital for the company. If the company is not efficient, they can withdraw their funds and invest it in something more profitable. Managers: They are responsible for the allocation of resources. There is a market for managers, and so long as the company treats them at least as well as companies which might compete for their services then they do not need to be singled out for special treatment. Their stakeholder priority is high, but it need not be at the expense of shareholder or employee returns.

Employees: The company depends on their productive effort. Like managers, there is a market here.

Suppliers: when the company is greatly dependent on one supplier its stakeholder priority is relatively high. Check if the company can substitute for other suppliers, or increase their numbers. If there is a high degree of dependence, it might be a case for vertical integration.

Customers: they are important because they can take their business elsewhere. No high priority as a stakeholder, however.

Local Community: It is important for the company to live in harmony with the local community. The community has a valid stakeholder interest and these need to be taken into account in company decision making.

Government: so long as the company pays its taxes and acts according to the law, no need to worry about the government in its decision making.

3.14.3 – Stakeholder Influence

Although in principle some stakeholders should have little interest in the company, the existence of legislative, institutional and historical factors can imbue stakeholders with a significant degree of influence. Example: strong union can result in employees having a significant impact on major company decisions.

It is not only the degree of influence which is important, but the fact that the interests of stakeholders are often in conflict.

Shareholders: despite their importance, they usually exert little influence on major company decisions or how the company is run from day to day.

Managers: large influence. Management incentive structure should be aligned with shareholder interests, which are largely profit maximization. This is, however, difficult to achieve. Stock options might be one alternative.

Employees: the company depends on their skills. It is not so much the direct influence of

employees on company decision making which is important, but the extent to which they are able and willing to collaborate in the changes which strategic decision making involves.

Suppliers: the important consideration is whether there are substitutes.

Customers: the number of customers determine their influence. The number of substitutes for the company product is also a factor.

Creditors: Some companies, specially high risk start ups, have representatives of creditors on the board. Their involvement diminishes as the management establishes a track record. Companies can finance from retained earnings, loans, or combination of both.

Local Community: the influence is through constraints. If the company pollutes the locality it will probably have difficulty obtaining permission for expansion.

Government: apart from regulation, the government ca influence companies by its own role as a purchases and its policies on subsidies and trade. Industries affected are defense, importers and exporters.

4.14.4 – Mapping Stakeholders

The influence of the individual stakeholders needs to be identified and prioritized. Then we map out the perceived influences. An org change which is not accompanied with some form of stakeholder mapping may well run into constraints which could have been identified well in advance.

Stakeholder Influence Priority

Shareholder H H

Managers L H

Employees H L

Customers L H

3.15 – Ethical Considerations

Managers should attempt to be clear about the distinction between means and ends. A related issue is whether a particular means justifies a particular end. Moral issues are never simple to resolve. It is argued that companies which attempt to meet social rather than profit related objectives may do more harm than good, and in that sense their well meaning attempts could be regarded as immoral.

Some companies impose a code of ethics on their employees, such as never accepting bribes. This is somewhat difficult to enforce in countries where bribery is socially acceptable, and is not seen as immoral behavior.

3.16 Are objectives SMART?

A useful acronym that captures many of the dimensions of objectives discussed above is SMART which stands for Specific, Measurable, Achievable, Relevant and Time-bound. Some versions use ‘Realistic’ instead of ‘Relevant’, but there is not much difference between ‘Achievable’ and ‘Realistic’, while ‘Relevant’ has a particular strategic implication.

• Specific objectives are unambiguous and convey what outcome, action or behaviour is required.

• Measurable is the ability to evaluate achievement using numbers, rates, frequencies or percentages.

• Achievable objectives are those which employees believe can be reached.

• Relevant objectives are linked to the organisation’s strategy and achievement of the objective is seen to move the business towards its goals. The more clearly aligned with the wider success of the organisation, the more motivated people are likely to be in achieving the objectives. On the other hand, targets which are not aligned (or the alignment is not clarified) are unlikely to be taken seriously

Typically it is asserted that objectives ‘should’ be SMART but in practice it is unlikely that objectives will meet these strict criteria fully.

• Specific objectives will tend to be disaggregated; it may be impossible to be specific about aggregate objectives such as ‘improve quality in order to meet increased competition due to technological progress’. It is also important not to confuse the means and ends, given that it is typically easier to be specific about the means than the ends.

• Measurable: some objectives are by their nature non-quantifiable, such as ‘to have a happy and stable workforce’. But just because they are not strictly measurable does not mean they should be left out of the equation.

• Achievable: different things can appear achievable and credible to different people. The top management team may believe that the company is capable of delivering a successful new market entry into France but this view may not be shared by middle management. It is often possible to identify after the event that the objective was not achievable but this may not be apparent when the decision is being made.

• Relevant: it is clearly important that objectives are aligned with the resource capabilities of the company – or the other way round. The resource based view of strategy discussed in section 1.2.3 highlighted the difficulty of identifying strategic capabilities based on company resources; therefore, it may not always be obvious whether an objective is aligned with strategic capabilities.

• Time-bound: while it may appear to add definition to the objectives to relate them to a time scale it has to be recognised that it is impossible to predict the future with any degree of certainty. That is a major defect of the planning approach to strategy identified in section 1.2.3. What can be concluded if 10 per cent market share in France is actually achieved after one year? Perhaps no more than that the guess was right.

Module 4 – The Company and the Economy

4.1 – The Company in the Economic Environment

Environmental scanning: systematic study that provides information about - PEST (Political, Economic, Social and Technological) and

- ETOP (Environmental threats and Opportunities)

4.2 – Revenue and Costs: The Basic Model

Central issues of cost and revenue must be maintained as the focus of attention.

The model is constructed by identifying the variables which determine revenue and costs and determining the factors which affect these variables.

Revenue = Total Market x Market Share x Price Outlay = Number Workers x Wage Rate +

Units of Capital x Price + Units of Material x Price

The factors which affect the variables in the model include:

Variable Determining Factors

Total Market National Income, Population, Preferences, Competing Products, Product Life Cycle

Market Share Price, Marketing expenditure, marketing strategies, competitors marketing expenditure and strategies.

Price Demand conditions, competitive reaction, competitive advantage, market segmentation.

Workforce Labor market conditions, wage rate offered, working conditions. Wage Rate Labor market conditions, unemployment rate.

Capital Capacity of the capital goods sector. Capital Price Capital Market Conditions

Materials Capacity of Suppliers

Materials Price Materials Market Conditions. The model is useful for current products and future ones.

The relative importance of the factors depend on the individual circumstances of the company. They are all dependent, for some extent, on the general state of economic activity.

4.3 – The Workings of the Economy

It is important to be aware of changes in the economy which may present opportunities or pose threats. Example: rise in interest rates.

While it is true that many things are unpredictable, this is not a valid argument for ignoring them.

Macroeconomic analysis is an important element of environmental scanning, and can provide the basis for strategic action. The main macroeconomics issues are:

- Determination of GNP and the effect of changes in demand and supply factors, full employment output, actual output, unemployment rate and inflation rate.

- Role of expectations.

- Money supply and the rate of interest. - Rate of interest and investment expenditure.

- Factors affecting demand and supply of imports and exports. - Determination of the exchange rate and international financial flows.

4.3.1 – Understanding and Using Economic Information

Example in how to use economic data. A manufacturer of machine tools is working close to full capacity at the beginning of the current year. Should it increase or decrease capacity now?

Last Year This year (early)

Economic Indicator Change over year Recent changes

Gross National Product 3.2% 0.5%

Industrial Output 1.1% -1.5%

Retail sales (volume) 4.3% -1.1%

Investment expenditure -1.1% -3.2%

Current Value

Unemployment Rate 5.8% 6.2%

Inflation Rate 9.3% 9.7%

Wage inflation Rate 12.2% 10.0%

Points to consider:

- Total output and consumer expenditure is increasing, but investment expenditure was declining and both prices and wages were increasing at a relatively high rate.

- Early this year there is a slow down. Growth in output ceased and both industrial output and consumer expenditure declined. Inflation rate stabilized. Unemployment rate increased and it helped reduce wage rate inflation.

- The increase in GNP in previous year is largely due to an increase in consumer expenditure (retail sales), there was a consumer boom.

- The consumer expenditure had not led to an increase in capital equipment, as investment

expenditure had fallen. As industrial output had not grown as much as retail sales, companies must have been selling from inventories or imports must have increased.

If we look the last year figures, we can calculate the impact on cash flow:

Revenue = Total Market x Market Share x Price Revenue = 0.989 x 1 x 1.093 = 1.08

0.0989 = 1 – 0.011 (decrease in investment expenditure) 1 = market share, assumption is that it will not change

1.093 = 1 + 0.093 (inflation rate – it assume prices will change according to inflation)

The same calculation can be done for Outlay, although the only figure we have is the wage inflation rate (1.122). If other costs are in line with wages, then outlay will increase by more than revenues, resulting in a reduction in net cash flow of about 4%.

having an effect on economic activity in the short term. This is what we see in the early year numbers, with a further decline in investment expenditure, increased unemployment rate.

4.3.2 – Supply and Demand in Economy

GNP (Gross National Product) – total value of goods and services produced in one year. Maximum output is constrained by the resources available.

Potential or full employment GNP – when labor force is fully employed. Actual output – might be different than potential output.

Can actual output exceed potential output? Yes, if there are shortages of labor and a great deal of overtime. Excess demand can increase inflation rate.

The effect on the unemployment rate depends on the relative rates of growth of potential and actual output. There are three types of unemployment: Structural unemployment (large disruptions in the economy when whole industries close down), Frictional unemployment (people changing of jobs) and demand related unemployment (difference between actual and potential output).

4.3.3 – Unemployment and Inflation

When the economy approaches full employment there is a pronounced tendency for supply bottle-necks to emerge, and as a result wage rates, capital costs and material prices tend to increase. On the other hand, when there is significant unemployment the wage rate is rarely observed to decline. Wage rates are “sticky”. Excess demand for final goods and services tends to push prices up. Taken together, these influences are known as “demand pull” inflation.

Stagflation: high unemployment and high inflation.

Philips Curve: relate unemployment with inflation (they follow opposite trends). The curve can shift over time.

Expectations: once inflation existed in the economy, everyone expected that it would continue and made their forward contracts accordingly, causing the inflation rate to carry on unchanged although the unemployment rate was greatly increased.

Monetary idea: keep the supply of money in check, removing the expectation that the government would accommodate inflation in the future. Inflation is difficult to get rid off, and expectations make it worse. In real life, there is a period of growing unemployment to check inflation.

4.3.4 – The International Economy

Those which sell directly in foreign markets are continuously exposed to changes in trading conditions. Companies which sell only in domestic markets are open to competition from imports.

Relative Inflation Rates:

There can be substantial differences in the inflation rates in different countries which are not compensated for by changes in the exchange rate. If domestic rate continue at a higher level than the foreign rate, domestic costs can be expected to increase relative to foreign costs. What might be an attractive market at the moment may contain the seeds of disaster as relative costs increase.

Exchange Rate Fluctuations:

There are various methods of hedging bets in relation to exchange rates, for example buying currency forward. This makes it possible to predict some future cash flows, but it means that the company will not gain from any favorable movements in the exchange rate. It is not possible for a company to cover future exchange rates entirely, because cash flows will extend for years in the future, and these cash flows are difficult to predict with any degree of certainty.

The Competitive Advantage of Nations

The impact of the national environment on the competitiveness of individual companies is largely determined by the following influences:

- Domestic factor conditions – highly specialized resources develop in different countries over time (Silicon Valley) with a large pool of highly skilled manpower.

- Related and supporting industries – accessible suppliers.

- Demand conditions – sophisticated consumers force companies to innovate and shape their market orientations (Japanese cameras).

- Strategy, structure and rivalry – a country which fosters competition at home potentially breeds a strong core of companies which is capable of competing in the international arena. There are few instances of powerful international companies emerging from protected or subsidized home markets.

A company must understand if is has a country specific or a company specific advantage.

If the advantage is country specific then foreign markets can be exploited by exporting. If the advantage is company specific, it can invest in the country concerned provided that these advantages can be transferred from one country to another (management skills, production techniques).

4.4 – Forecasting: What Will Happen Next?

There are a great numbers of forecasts available, but they all share the same poor track record. There are a number of approaches to forecasting, ranging from the intuitive to the highly quantitative. There is virtually no connection between the statistical complexity of the forecasting models and their accuracy.

The simplest approach to forecasting is to discover one statistic which serves as a reasonable indicator of what is likely to happen next, and this statistic is known as a leading indicator. A leading indicator is a statistic which signals when changes are about to happen in the economy, or in a particular industry.

One approach is to think in terms of business cycles. A period of boom tends to be followed by period of depression, resulting in a cyclical pattern which is repeated over and over again. The business cycle has three components: the general trend over time (a positive or negative line), the underlying smooth cycle (the “real” cycle), and random fluctuations (ups and downs along the smooth cycle).

Although no one is able to predict the business cycle with any degree of accuracy, it is possible to form a rational view as to whether the economy is in the upswing or the downswing.

**Unemployment is a “lagging indicator” (CNN reference)

4.5 – PEST Analysis

Trends and events in the national and international economy need to be monitored because of their impact on the company.

PEST = Political Economic Social Technological factors.

The PEST analysis deals with what is known about the environment, but it is possible to take this a step forward by speculating about the future, given the limited information available at the moment.

Environmental scanning is in a sense an attempt to predict well beyond the extrapolations of short term forecasting and market research type information. It serves as a kind of early warning system which, when it is correct, easily justifies the resources which it uses.

4.7 – Scenarios

Once some projections of possible futures have been made they can be used as the basis of scenarios. A scenario is not a forecast, but an attempt to investigate the implications of possible futures for the company. In some instances it may be based on a short run issue, such as the likely impact of a price reduction by a major competitor.

4.8 – The Economy and Profitability

Factors like economic activity, inflation rate, exchange rate, affect profitability.

4.8.1 – Implications for Company Sales and Revenues

GNP elasticity: the impact of changes in economic activity on the sales of a product. A product is elastic with respect to GNP when a 1% change in GNP leads to a greater than 1% change in the demand for the product. It is inelastic when the change is less than 1%. Example: potatoes are less affected by changes in GNP than high tech products.

When product is elastic and GNP goes down, the only way to keep revenues is to increase market share. When the economy starts to grow strongly, an effective response might well be to concentrate resources on those products with a relatively high GNP elasticity.

It is not only the size of GNP which is important, but also the distribution of national expenditure among its components. For example, a reduction in income tax, which leads to an increase in disposable incomes and hence to consumption expenditure, may be accompanied by a reduction in government expenditure, the net effect of which is to leave GNP unchanged.

Increase of interest rate affects the demand for investment goods.

4.8.2 – Competitive Reaction and the Economic Environment

It is also important to pay attention to how competitors will behave in the light of the changing circumstances. Will they react in the same way as our company?

4.8.3 – Implications for Inputs and Company Costs

Using the variation of increase of demand due to GNP, we can make scenarios for cost. Inputs will change value as they are related to wage costs. Wages go up but are sticky. Look at GNP and calculate its affect on both the revenue and cost side of the equations. Companies that analyze economic events can take pre-emptive action/

4.9 – Environmental Threat and Opportunity Profit: Part 1

 Use the PEST approach as a checklist.

 Apply macroeconomic ideas to economy wide influences.

 Consider international factors both in terms of exchange rates and international competitive influences.

 Use the environmental scanning approach to think beyond the immediate situation.

 Put together some scenarios to help put factors into context.

To put all this together into an ETOP, the following steps can be undertaken:

 List the relevant environmental factors which have been identified.

 Analyze whether each is likely to exert a positive or negative impact on potential sales and costs, or whether there appear to be openings for competitive response.

 Attempt to determine the relative importance of the threats and opportunities, and rank them accordingly.

We analyze in a profile all the positive and negative points regarding revenue and costs. Example of an ETOP:

Sector Threat or opportunity

International - Expected appreciation of exchange rates + Growth in Eastern block economies Macroeconomic - Tax rate increase to fight inflation

+ Prospect of reduced interest rates

Module 5 – The Company and the Market

5.1 – The Market

The market mechanism is the principal method by which resources are allocated in industrialized economies.

5.2 – The Demand Curve

Elastic curve – quantity changes by a larger percentage than the price. Inelastic curve – quantity changes less than the price

Assumption: other things do not change with price (tastes remain the same, income of buyers do not change)

When an attempt is made to estimate the shape of a demand curve, the information available usually relates to prices relatively close to the existing price. In the example above the estimates would refer to a small part of the demand curve in each case. In fact, it is misleading to talk in terms of an ‘elastic’ or ‘inelastic’ demand curve because whether it is elastic or inelastic actually depends on where the reading on the demand curve is taken.

Ceteris Paribus=all else being equal

5.2.1 – Demand Factors

What affects demand for a product: Determinants of Market Size:

 Product life cycle

 Business cycle

 Exogenous shocks (like new regulations)

 GNP elasticity

 Exchange Rates Determinants of Market Share:

 Price

The factors which influence the total market are usually outside the control of the company. The product life cycle could lead to a reduction in market size because the market had become saturated and demand only remained for replacement.

The curve can shift itself. It is useful to think of the direction in which the demand curve is likely to be shifted by a particular change, and the possible order of magnitude.

The important step is to visualize changes in the environment in terms of the position and shape of the demand curve.

Remember that changes in price do not shift curve, but the changes in the market conditions can….

Demand Curve and Revenues

If the company is operating in a highly competitive market (perfect market) it has no choice on which price to charge; it is a price taker. Most companies, however, are able to exercise some choice on price.

In every demand curve, there is a point where revenue is maximized, a certain combination of price and quantity that will maximize the company’s revenue.

5.2.2 – Demand Curve and Market Share

The emphasis in marketing strategy is on market share, as it is an important determinant of competitive advantage. The shape of the demand curve might indicate which reduction in price will give the company a higher market share.

Reduce price -> demand increases -> market share increases

It is revealing to translate market share objectives into demand curve terms, because doing so may reveal that the market share objective implies a demand curve which common sense suggests is impossible. Take for example two companies who both wish to increase their share of the total market by 2.5%, starting from rather different market shares:

Company Current Market Share Increase desired Increase in demand

A 5% 2.5% 50%

B 50% 2.5% 5%

Company A will have to think in terms of a much larger price reduction to achieve its objective than Company B.

The objective of maximizing the revenue might contradict the market share strategy. For some companies the increase in market share will only come with a decrease in revenues.

Always remember the expressions:

Revenue = Total_Market * Market_Share * Price And the demand curve is:

Revenue = Total_Units_Sold * Price

The relation of Market Expenditure (y) and Quantity Sold (x) is a positive slope curve. But there is a certain point where more marketing expenditure will only cause minimal increase in sales (diminishing return).

On the other hand, it might be predicted that after a marketing campaign more of the product will be sold at each price than before. Marketing expenditure shifts the demand curve to the right. In order to shift the demand curve it is necessary to change people’s preferences; to persuade people to buy more of this product and less of something else (or save less)

Decrease of price + increase of marketing expenditure -> more market share

(if the company is not near the top of the response curve of marketing expenditures).

The position of the demand curve can also change because of several factors, many of them outside the control of the company: falling prices of substitutes.

It is unlikely that the marketing effort of any one company will significantly affect the total market for a product. Thus an increase in marketing expenditure causes an increase in market share at a given price out of a given market, while an increase in the price of a substitute results in an increased total market; the latter leads to a higher level of sales at the existing market share and price. Some shifts in the demand curve have implications for market share, while others do not.

Thus:

It is important to distinguish between a shift along a demand curve and a shift of the demand curve:

a) It is necessary to focus on the potential impact of a price change on its own.

b) A shift of the demand curve can be caused by factors outside the control of the company c) It is difficult to change the position of the demand curve.

5.2.5 – Estimating the Demand Curve

It is difficult to estimate the demand curve, even when we take examples of past performance. Many factors might have changed between each observation on price and quantity, and

It does not mean we should not try to determine the demand, but while it may be possible to derive reasonable estimates of the industry demand curve, the manager should maintain a healthy cynicism of statistical approaches to the demand curve facing the individual company.

5.3 – Competitive Reaction

The attempt to predict competitive reaction presents many dilemmas, and the important point is to be aware that such dilemmas exist, rather than attempt to prescribe complex gaming rules.

5.3.1 – The Game Theory

Zero sum game – any gain made by one party is at the expense of the other (if you increase market share, someone loses it).

An industry with few competitors may find it of mutual benefit to have a tacit agreement on prices. In this way, they all make an acceptable profit, avoiding a price war, where both lose.

It is useful to have information about competitors: estimates of financial reserves, attitudes to uncertainty, company morale, and strength of the marketing department, previous successes and failures in new ventures, efficiency of the market intelligence department. However, the dominant characteristic of competitor reaction is unpredictability, and the company must be prepared for a variety of responses to any competitive action.

Trust in business is analogous to the prisoner’s dilemma…..

A great deal of stress is laid on trust and commitment in cooperative business

5.3.2 – The Kinked Demand Curve

When there are relatively few competitors in a market, the shape and position of the demand curve might depend on competitive reaction (example: air lines).

The current price is P, and above that price the demand curve is virtually horizontal (i.e. highly elastic), indicating that even a marginal price increase will lead to a substantial reduction in demand. At prices below P the demand curve is relatively steep (i.e. highly inelastic), indicating that price reductions will have very little impact on sales. The shape of the kinked demand curve has important implications for sales revenue

There is a point where sales revenue is maximized. From this point on the curve is almost inelastic. It means that if we reduce the price, the competitor will also reduce the price. At the end, both keep their market share but revenues are lower for everybody.

The idea of the kinked demand curve has an important strategic implication for pricing: if it is thought that the demand curve is kinked it follows that it is necessary to make a significant price change and stick with it. Otherwise the price change will have virtually no effect because of competitor reaction. But the danger is that a competitive pricing move may lead to a price war the outcome of which is unpredictable.

5.3.3 – Competitive Pricing

Price setting can be used as a competitive tool and short term revenue flows may be sacrificed in the pursuit of wider strategic objectives.

Three main forms of competitive pricing:

 Price leadership – the dominant firm in the industry announces its price changes before all other firms, which then match the leader’s price.

 Limit Pricing – it is an attempt by a firm to create an entry barrier by charging a low price in order to deter entry. This is only worthwhile if it has a cost advantage and can set the price low enough to deter entry but still make a profit.

 Predatory Pricing – a firm sets a price with the objective of driving new entrants or existing firms out of business.

These approaches to competitive pricing are encountered in textbooks, but they are rarely, if ever, found in practice. Probably this is because they characterize extreme forms of competitive behaviour which do not occur much in real life.

future lies in competing effectively rather than trying to destroy competition; the same applies to eliminating existing competition – it is one thing to try to win market share by pricing competitively, but it is quite another to set out deliberately to ruin a competitor. The point is that competition cannot be avoided, and a price change which deters or eliminates one competitor is unlikely to have a permanent effect on competitive pressures.

5.4 – Segmentation

It is the attempt to charge a different price for each segment of the market. It maximizes revenue for each segment.

Revenues = Total markets × Market shares × Prices

where s = 1, 2, . . . ,n and

n = segments of the market

The company would attempt to set Price in each of the n segments so that the sum of the Revenues is greater than the original revenue from the non-segmented market.

Can be segmented according to a multitude of variables: Age, sex, SEC, etc.

There are four main characteristics which a segment needs to have if it is to be potentially exploitable:

 Identifiable – there must be sufficient common features that enable the segment to be identified in the market place.

 Demand related – the identified segment must have at least one characteristic which translates into demand terms, such as the willingness to pay more for a high quality product.

 Adequate size – it needs to be large enough to generate a potentially attractive return on the investment required to exploit it.

 Attainable – the segment must be reached by available marketing and advertising approaches.

From this a number of key steps can be identified for carrying out a segmentation analysis:

1. Identify the Most Important Segmentation Variables

Difficult to systematically do, but must be attempted. The best that can be done is to approach the issue in a structured fashion, for example:

• identify the key product characteristics

• derive the characteristics of the target segment

• identify the location of the target segment; location can be in the physical sense or by income, social class etc.

2. Construct a Segmentation Matrix

Example of what restaurants are available in a particular area

This is a complex process, and involves the use of a variety of strategic models depending on the circumstances. These tools include demand and supply analysis, market structures, barriers to entry and many others which will be developed later in the course.

4. Identify the Key Success Factors

 Identify a source of totally fresh sea food;

 Obtain the services of a highly qualified Japanese cook (who are very rare);

 Find and decorate premises which provide a Japanese ‘look and feel’. Many ventures fail because they didn’t identify these factors

5.4.1 ----Pricing in Segments

It goes without saying that market conditions differ among segments, and that different prices can be charged in each--Known as discriminating monopoly. The monopolist will charge a higher price in a market with low demand elasticity than in a market with high demand elasticity.

Segmentation is therefore a potentially powerful tool for transforming a loss-making product into a profitable product without changing anything but the price charged to different groups of consumers.

5.4.2 – The Effect of Product Differentiation

Some products are difficult to differentiate (wheat). But it may be possible to change the

characteristics of a product in ways which will have particular appeal to different types of segment (car).

Product differentiation extends the concept of segmentation to the determination of which bundle of characteristics should be incorporated in the version of the product targeted at each group

There are times when differentiation may be more apparent than real. Differentiation may simply be a perception on the part of potential buyers (aspirine is sold under several brand names). Real or perceived differentiation has implications for marketing strategy and pricing policy.

A product with low perceived differentiation and high perceived relative price is likely to fail. A product with high perceived differentiation and low perceived relative price is likely to succeed.

That depends on competitor actions, technological change, changes in consumer preferences etc. Companies that carry out no environmental scanning and do not apply frameworks such as PEST or ETOP may well find that a product has shifted downwards in the matrix but they were not aware of it. Consider the case of a fur coat seller described in section 1.3.7: the desirable aspects of fur disappeared and in a sense differentiation collapsed to zero and it became difficult to sell a fur coat at any price for quite a long time until attitudes to farmed fur started to change. The outcome was that the demand curve (section 5.2) shifted far to the left and for some types of fur coat may have disappeared altogether.

5.5 – Product Quality

One of the most frequently encountered methods of product differentiation is by reference to the superior quality of a company’s product or service.

Several approaches to the definition and measurement of quality:

Transcendent Quality: the Platonic definition relates quality to high standards of excellence and achievement which can only be recognized in the light of experience.

The philosophical approach to quality is based on a form of circular reasoning which robs the concept of operational use for decision making purposes. Example of painting by old master may be “quality” to a collector, but valueless to a street orphan (at least from an esthetic point)

Product Base Quality

A product is a bundle of characteristics, most of which are susceptible to some form of measurement.

Characteristics are not determinants of product quality; this is because quality may be dependent on how well the characteristics are produced or combined together.

Sometimes manufacturers incorporate characteristics which have little relevance to consumers, but which are thought to enhance the quality image of the product (watches 100m under water). In service industries, quality and consistency are closely linked.

There can be very high costs associated with improving dimensions of quality. Example:

electricity without interruption. It is impossible to guarantee 0% of interruptions. A company will try to balance the marginal costs for improvement with customer satisfaction.

User Based Quality

There is a precise combination of characteristics and “design” that will be perceived as “quality” by consumers, even if there is no real difference in function

Production Based Quality

Production in conformance with specification Value Based Quality

Hybrid notion which combines the price or production cost, with the quality. It is the value perceived by consumers in relation to the price.

It is possible that a great deal of what is thought of as quality rests on a perception which is reinforced by the norms of society. An expensive running shoe might be merely a standard running shoe with an exclusive label attached.

5.5.1 – Dimensions of Quality

Garvin suggests:

 Performance

 Features

 Reliability

 Durability

 Serviceability

 Aesthetics

 Overall perceived quality

It is not claimed that these dimensions can be defined precisely; but it is possible for informed consumers to rate these dimensions to reflect their own perception. People with different backgrounds will attribute different weights to different dimensions.

A similar approach uses the price as the dependent variable and various product characteristics as the explanatory variables. The relationship would look like this for a washing machine:

Price = b1 ?Capacity + b2 ?Spin speed + . . . + b7 ?Reliability where b1, . . . ,b7 are

weights

The statistical analysis would be carried out for a vari