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Session 1: Introductory lecture: Strategy - Behavioral Foundatien, Theoretical Perspectives and the link to Corporate Social Responsibility (Sara) e
Grant, R. M (1997): The concept of Strategy, Chapter 1 in R.M. Grant: Contemporary Strategy Analysis, Oxford: UK, Blackwell (25 p.)
Key words: Strategy, business stj:ategy, corporate strategy Main frame: Strategy is an important determinant of success in most areas of human activity. This text deals with a lot of issues regarding strategy. AlTIOng others the concept of strategy, strategy as a success factor, the development of strategy over time etc.
aStratcgy is not a detailed plan or program of instructions; it is a unifying theme that gives coherence and direction to the actions and decisions of an individual or organization." The role of strategy in success Examples arc given of four people's success. These arc, Madonna, General Giap, 13i11 Clinton and Tony Blair. The author believes that the success of the above mentioned are neither due to ovcrwhelmingiv superior resources nor to lucie It is his opinion that their successes are due to soundly formulated and effectively implemented strategy. The author believes that there arc four characteristics of the successful strategies; 1. Goals are siJ7~ple! consistent and 100{g term. Madonna's career features an uncompromising drive for stardom. Bill Clinton and Tony Blair focused on the goal of being elected for government. 2. Prifosnd undenftwditlg qf the cotJJjJetitille environment. Giap understood his enemy and the battlefield conditions where he would engage them. 3. O~jectil}e ap!,rai.ra! qf reJOHrCCJ. Clinton's and Blair's election strategies exploited the candidates' youth, sociability and superb debating skills. 4. F~ffrrtil!e iJiljJlemeNtation. Without effective implementation the best strategies are of little usc.
It framework fOf an.aly?;ing business strategy The author views strategy as forming a link between the: firm and its external cnVirODJI1CnL Most approaches to designing and evaluating business strategy distinguish between the external and internal environment of the firm. Tho S\x/01' analysis is one of them, however it has a weakness; it Gin be difficult: to distinguish strength from weakness and opportunity from threat. Sirat~f)'.Fl is concept that states that for a firm to have a successful strategy it must be consistent with. the goal's and values of the firm, the external environment and the resources afld capabilities of the firm.
l1. brief history of business strategy The concepts and theories of business sU:ategf have their antecedents in military stra.tegy, Strategy in the militatv and business sphere share common characteristics. They arc important, involve a significant ccmmirmcnt of resources and they arc not easily reversible In the 19505 and the 1960~s the development of financial budgeting procedures provided a basic mechanism for control, this emergc.d due to an increasing DI.HTJber of brgc and complex enterprises. The 1960~s was characterised by longer-term planning. This was done to achieve coordination and consistency in investment planning durin.g a period of stability and expansion. During the 1970)s, portfolio planning matrices Came into vogue as frameworks for selecting strategies and allocating resources within the diversified corporation. Increased turbulence forced firms to abandon their corporate plans in favour of more flexible approaches to strategic management, where focus where the focus was less on planning for diversification. and more on. achieving competitiveness. During the late 1970's and into the 1980)s the focus was on firms' market environments with particular emphasis on the analysis of industry structure and competition (Michael Porter)
Page 1 of 118
During the late 1980's and the early 1990's the resource-based view has developed, this pointed to the firm's resources and capabilities as the primary source of its profitability and the basis for formulating its longer-term strategy.
The distinction between corporate and business strategy Corporate Jtrategy defines the scope of the firm in terms of the industries and markets in which it competes. This includes investment in diversification, vertical integration, acquisitions and new ventures: the allocation of resources between different businesses of the firm. (Bourgeois: domain selection) Business strategv is concerned with how the firm competes within a particular industry or market. If the firm is to prosper within an indus tty it must establish a competitive advantage over it rivals. (Bourgeois: domain navigation) Functional strategies are the elaboration and implementation of business strategies through individual functions such as production, F&D, marketing, human resources and finance. Different approaches to strategy: design versus process The "design school' of strategy views strategic decision making as a logical process in which strategy is formulated through rational analysis of the finn, its performance and the external environment. The "process school' of strategy focuses on the realities of how st.rategies emerge. The central issues arc processes through which strategic decisions arc made in practice. Inicnded strategy is strategy as conceived by the top management team. Realized strategy tends to be only about 10-30 percent of the intended strategy BmeJ;gcnt stratc,p:y is the patterns of decisions that emerge from individual managers adapting to changing external circumstances and the ways in which the intended stxategy was interpreted. The different roles of strategy within the firm Strategy as a decision support: Strategy can be used as a pattern that gives coherence to the decisions of an individual or organisation. Strategy as a vehicle for coordination and communication: To coordinate decision making the strategy process must act as a communication mechanism within the finn. Strategy as target: The purpose of having a vision and mission is not just to establish 2. direction to guide the formulation of strategy) but also to set aspirations for the con.1jnny.
Conclusion '1'h1S text deals with a lot of issues rcgnding strategy. the development of cvvex tin-e etc.
others the concept of S\1:"I'''<''i. '''Sl.qZY as a success
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Abstract '[heme The text is Porter's suggestion to a theory for dynamic strategy analysis, based on his previous line of thought regarding strategy and competitiveness of firms, based on his work over the course of time.
Key words Understand and develop a theory of strategy for an industry or a business hy examining the following; â&#x20AC;˘ Positioning perspective on strategy (five forces, generic strategies) e Perspective on the firm (Value chain, value systems) e Perspective on regional environment (the diamond)
Set of problems/fucal points, main arguments ami conclusion Page 2 of 118
Porter argues it is difficult to develop a truly dynamic model for strategy analysis, because situations are too diverse to draw theoretical conelusions on empirical observations. To understand strategic decisions and success of firms the chain of causality can be examined. This is what brings Porter to develop his various frameworks (five forces, ect.). Using these in a combination can solve the longitudinial problem - the problem of understanding why certain firms are able to gain competitive advantage and stay in such a position. Basically Porter advocates for using all of his frameworks in combination with theories such as game theory, the resource-based view.ect. To ask the questions enhancing the understanding of how competitive advantage is created and sustained.
Theories/models and their relation to the set of problems Generic Strategies Five forces Value Chain Value System The Diamond. - Like Jens I assume you are all familiar with these and will not explain them further.
Related theories Mintzberg 10 - Industrial Organization theory (classical industry theory, without the business optimizing perspective Porter is pursuing)
Extra information from class Be aware ofthe critique of Porter (sec slides from lecture) Abstract 2 Theme The text presents a dynamic theory of strategy (The Diamond) which includes the cross ..sectoral and longitude problems.
Five-Forces, value-chain, cross-sectoral (What causes superior performance in. a given period of time) and longitude problems (What is the causes of the dynamic process hy which competitive positions arc created), and the Diamond
Abstract In this text Porter builds on his prior work on competitive strategy (Sec Porter, M. (1985) "Competitive Advantage"), eg. Five forces and value..chain, The aim is to move down the chain of causality. To move down the chain he divides the problem into cross..sectoral (industry structure) and longitude (initial conditions). See figure 2 p. 100. The main focus is on the longitude problem. Porter reviews three streams of research, namely the Game-theoretical, Commitment and uncertainty, and resource..based view. He finds them to be unable to describe the problem. Porters answer to the problem then is his own "Diamond", which consist of the: factor conditions; Firm Strategy, structure and rivalry; Demand conditions; Related and supporting industries. Page 3 of 118
"The differences (in performance) are partly a function of managerial choices, differential rates of resource accumulation or chance. The differences appear, however, to be partly a function of the sub environment of each particular firm - its particular early customers, supplier relationships, factor market access, etc." P. 115. " The diamond highlights new issues for strategy that are normally ignored, such as the importance of developing and nurturing home based suppliers, the importance of local specialised factor markets and the balance between home based activities and those dispersed to other locations as part of a national or global strategy." P. 115 Theories Porter, M (1985) "Competitive Advantage" Abstract 3 Theme The text presents a dynamic theory of strategy (The Diamond), which includes the cross-sectoral (what causes superior performance in a given period (if time) and longitude problems (what is the causes of the
dynamic process by which competitive positions are created). Abstract In this text Porter builds on his prior work on competitive strategy (See Porter, M. (1985) "Competitive Advantage"), e.g. five forces and value-chain. The aim is to move down the chain of causality. To move down the chain of causality, he divides the problem into cross-sectoral (industry structure) and longitude (initial conditions). See figure 2 p. 100. The main focus is on the longitude problem. Porter reviews three streams of research, namely the Game-theoretical, Commitment and uncertainty, and resource-based view. He finds them to be unable to describe the problem. Porter's answer to the problem. is his own "Diamond" ~ which consist of: factor conditions (labour, raw materials, education etc.), Firm Strategy, structure and rivalry (clusters feeding each other .. N1S), Demand conditions (early customer interaction), Related and supporting industries (propelling the innovation). "T'11c differences (in performance) are partly a function of managerial choices, differential rates of resource accumulation or chance, The differences appcar~ however, to he partly a function of the sub environment of each particular firm its particular cady customers, supplier relationships, factor market access, etc.') Firms must understand and exploit their local environment in order to achieve competitive advantages. These differences in performance arc at the core of the longitudinal problem (managerial choices and initial conditions) and the environment, via the "diamond", affects both ofthem (P. j 15). "The diamond highlights new issues for strategy that arc normally ignored, such as the importance of developing and nurturing 110111C based suppliers) the importance of local specialised factor markets and the balance between home based activities and those dispersed to other locations as part of a national or global strategy." (I'. j j 5).
Porter trick J 9911: Due to a criticism of not taking into consideration the environmental perspective from the exclusive focus on the competitive industry context, he responded with the Diamond to also focns on the local and regional cooperative context; however missing the global environment.
e
Mintzbcrg, H. ana ,J, A, Waters (1985): Of Strategies, Deliberate ana Emergent, Strategic Monagement Journal, Vol. 6 (16 p.)
Page 4 of 118
Abstract 1 Themc Strategies in an organization can either be deliberate or emergent according to the level of management control and the stability of the environment. Key words Deliberate and Emergent strategies Set of problems/focal points, main arguments and conclusion Deliberate and emergent strategies can be seen as either end of a continuum. Deliberate strategy occurs when management articulates and communicates their strategic intentions to the organization and the strategy gets realized precisely as intended by management. Emergent strategy is consistency of action evident in the organization (realized strategy) but without having their origin in intentions by management. The authors label eight different strategies according to their deliberate or emergent characteristics these are summarized in the table below. High degree of management control and a stable environment are conditions for deliberate strategy, little management control and an unstable environment are conditions for emergent strategy. Theories/models and their relation to the set of problems
Purely Deliberate 1.
2. 3.
The planned strategy (deliberate, rationalistic strategy) The entrepreneurial strategy (one person imposes a vision, environment benign) The ideologicalstrategy (intentions exist as collective vision, controlled by indoctrination and/or socialisation)
3. 5. 6. 7. fL
The umbrella strategy (general guidelines, delegation/control, dynamic environment) The process strategy (top management control of the process, rather than the content, of strategy; highly complex/dynamic environment) The unconnected strategies (one section realizes its own strategy, independent of the rest; no/limited control; dynamic environment) The Consensus strategy (Originate through mutual adjustment 0 factors intentions) The imposed strategy (strategy imposed from environment)
Purely EUlergent Definitions Strategy is a pattern in a stream. of decisions/action in the organization, Deliberate strategy: Pattern realized as intended Emergent strategy: Pattern realized despite, or in the absence of intentions Related theories Other strategy theories i.c. Porter Extra infurmarion from class See slides from class on different strategy perspectives
Abstract 2 Definitions: Organisation: A collection of people joined together to pursue some mission in common ...to act deliberately. Abstract: Strategy formation has tended to he treated as an analytic process for establishing long-term goals and action plans for an organisation; formulation followed by implementation. This perspective is limited according to the authors and they take up the distinction between deliberate and emergent strategies. Deliberate strategies are those, which are realised as intended and thought trough. Emergent strategies are patterns of consistencies, which are realised despite, or in the absence of, intentions. The two forms are opposite poles Page 5
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on a continuum, visualising the emergence of strategies, and the authors argue that in between the poles are various other ways in which, strategies take place. Mintzberg and Waters perspective on strategy: Strategy: A pattern in a stream ofdecisions (not a definition, just the authors' perspective on the term). Streams of behaviour in organisations conld be isolated and strategies identified as patterns of consistencies in such streams. Note the difference between intended (leadership plans and intentions) and realised (what the organisation actnally did) strategies. Comparing intended + realised strategies has allowed the authors to distinguish deliberate strategies (realized as intended) from emergent strategies (patterns/consistencies realised despite, or in the absence of, intentions. A perfectly deliberate strategy is where the realized strategy (pattern in actions) forms exactly as intended: Three conditions need to be satisfied: o Must have existed precise intentions in the organisatiou, articulated with a concrete level of detail, so that there is no doubt about the intentions. o In order for the intentions to be truly organisational they must be common to all actors. o The collective intentions must be realised exactly as intended, which means that no external force could have interfered with them. In other words, the environment must have been either perfectly predictable, totally benign, or else under the full control of the organisation. For a strategy to he perfectly emergent, there must be ordcr a consistent pattern of actions over time ..in the absence of corresponding, precise intentions. i-
Since both the pure deliberate and emergent strategies are extremes they are not found in reality. Instead we find some tendencies of deliberate and emergent strategies in real-world strategies in between the two.
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Conclusion Emergent strategies do not mean that management is out of eontrol - it is just more open, flexible, responsive and willing to learn. This is an important strategy in a complex, uncertain and ehanging environment. In best ease scenario, it enables managementto act before everything is fully understood. Deliberate strategies help to manage, to impose intentions on the organization and to provide a sense of direetion. The eonclusion by the authors is therefore, that strategy formation walks on two feet, one deliberate, and the other emergent. And the relative emphasis on one or the other may shift from time to time, but not the requirement to attend to both sides of this phenomenon. Abstract 3 Strategic learning Unintended order Emergent strategy Deliberate strategy
References to numerous Mintzbcrg texts (1972
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Overall theme: Intra . ~ The behavioural Foundation of Strategy Abstract The text tells us that strategy often has been understood as wbat leaders plan to do in the future treating it as an analytical process to establish long-range goals and action plans for the organization,
Mintzberg defined strategy as: "a pattern in a stream of decisions" ., making it strategy operational and tangible. From here one could analyse the leader 's plans and intended goals compared to what the organization actually did. The authors argue that strategy can and must be seen in a wider perspective. They distinguish between deliberate strategies (realised as intended) and emergent strategies (strategies that emerge in an organization, but not guided by intentions.) Definitions: Deliberate strategy: A perfectly deliberate and intended strategy must satisfy :1 conditions: @ Precise and articulated intentions must exist in a concrete level of detail e Seeing organizations as collective action, intention must be common knowledge to virtually all the actors in the organization. @ These collective intentions must have been realized exactly as intended ~, (also meaning that no external forces could have interfered with them).
Page 7 of 118
Emergent strategy: A perfectly emergent strategy is characterised by order, but in the absence of intention about it. It is although difficult to imagine action in the total absence of intention. Emergent strategy does not mean chaos, but in essence unintended order
The authors expect that purely emergent strategies are as rare as the purely deliberate one. It is more likely to find tendencies in the direction of deliberate and emergent strategies rather than perfect forms of either. As a consequence of the above, the authors see emergent and deliberate strategies as two poles, where different types of strategy can bee said to exist in the space between them. They introduce the following strategies, where the first strategies fall closest to the deliberate strategy-pole and ending in the last strategies closest to reflecting the characteristics of emergent strategies.
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The authors tells us that the fundamental difference between deliberate and emergent strategy is that whereas the deliberate focuses on direction and control - getting desired things done "" the emerging strategy opens up for the notion of "strategic learning" Page 8 of 118
Conclusion Emergent strategies do not mean that management is out of control - it is just more open, flexible, responsive and willing to learn. This is an important strategy in a complex, uncertain and changing environment. It best case scenario, it enables management to act before everything is fully understood. Deliberate strategies help to manage, to impose intentions on the organization and to provide a sense of direction. The conclusion by the authors is therefore, that strategy formation walks on two feet, one deliberate, and the other emergent. And the relative emphasis on one or the other may shift from time to time, but not the requirement to attend to both sides of this phenomenon.
â&#x20AC;˘
Porter, M. and M.R. Kramer (2006): Strategy & Society. The Link between Competitive Advantage and Corporate Social Responsibility, Harvard Business Review, December (1] p.),
Session 2: Strategic Positioning Games ill the Automobile Industry: The Battle Between Alternative Fuel Platforms (Emil) s
Dyerson, R. and Pilkington (200S): Gales of Creative Destruction and the Opportunistic Incumbent: The Case of Electric Vehicles in California, Technology Analysis & Strategic Management, no. 4 (16 p.),
Theme; The paper explores the introduction. of electric vehicles in response to Californian. regulatory pressures as an example of a disruptive technology,
Main thesis; The disruption (the electric vehicles) may open up the automobile market to new entrants¡¡ but only
ifthey collaborate with incumbent car manufacturers. This is due to the fact that the large incumbent firms have innovative advantages over 111e sl11a11 entrant firms. These advantages lie" however, in the downstream complementary assets required for being successful in the ear market
Keywords: Electric vehicles, Californian emission regulations, disruptive technologies, complementary assets, technological trajectories, co-oeptition.
Content: Page 9 of 118
The changes in the Californian environment emission standards are a potential source of disruption in the otherwise very mature car antomobile industry. They mandate that new technology should be introduced in the industry. These new technologies are incompatible with the existing technologies (Internal Combnstion Engines (ICEs禄, and thus open up the market.
It is a quite unique sitnation- pressure coming from outside the industry shifts the prevailing
technological trajectory and may leave many of the existing technologies obsolete.
The authors draw on evidence from the Californian vehicle emission regulation, which suggests that synergic benefits exist if a strategy ofalliance building and cooperation is adopted.
Schumpeter (p. 392-392 in the text): They draw on Schumpeter to discuss the changing nature of innovation during the
zo" century.
Schumpeters early work regarded the entrepreneurs (the small entrants) as the key innovators. But during the century the nature of innovation shifted. The innovation activities were re-located from enthusiastic individuals into the laboratories of larger industrial firms. Schumpeter recognized this, and re-formulate his theory to focus more on stuff like access to capital, resources and skills (instead ofjust on opportunity 路路-linked to the entrepreneurial individual). He docs maintain however that smaller firms may have an advantages in the early stages of innovation, but that larger companies have the advantages in the later stages and in improving and sealing up early innovations.
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better with the developrneut of the automotive industry, which is
dominated by very large firms.
They (THESE SJIORT POINTS FROM THE DIFFEIO(EN'lrHEORlSTS MAY
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SPICING UP OUR WRITINGS DURING THE EXAM .. )
Pavitt, p. 393: Finns do not search for innovation in a general pool of knowledge, but rather in "zones" akin to their existing stock of knowledge and technologies Clayton Christensen, p. 394 (See the abstract made by Julius, session 13): Disruptive technologies. Incum bent firms become locked in to an existing trajectory. Radical changes in the industry (like with ears in California) can rattle the incumbents. Often the disruptive
Page 10 of 118
technologies evolve outside of the industry, and are not perceived to be a threat until it is too late. Cohen & Levinthal, p. 395: Absorptive capacity. Firms ability to absorb and exploit knowledge from their environment is largely conditioned by their prior accumulated knowledge, and this will affect the firms perception offuture technological advances. Teece et.al, Utterback, Tushman & Anderson, Edith Penrose - see p. 395 Chesbrough & Teece, p. 396: Autonomous & systemic innovation - a distinction of the two.
History of tile electric ear>- from the 90's and forward See pages 398 -. 403
Final discussion and conclusion: The changed regulations have begun to threaten the previously stable and sustaiuing path of technology development enjoyed by the incumbent major car manufacturers. The unique thing here is that the possible disruption is not brought forth by the development of new technology. but rather from governmental regulations.
The car makers must and arc now realizing that they need to expand their current knowledge base. What they do is to form strategic alliances with suppliers and specialized firms. Often suppliers take the lead role in the joint development of new electric vehicles/technologies. This implies that the otherwise closed industry has now been, opened up, and
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entrants can join
They do however need to collaborate with the large incumbents in order to commercialize the innovation :--, they must a co-opctition strategy of collaboration, joint venture and licensing.
From Kampmann" s slides:
o
Suffers a bit from old age, but a nice illustration of applying different theories to the Electric Vchicle Industry
(2004): Competing technologies and the stmggle towards a new dominant design: the emergence of the hybrid vehicle at the expense of the fuel cell vehicle, Greener Management International 47: 29路路44 (14 p.). Theme: The text takes it starting point in the need for a shift in the sociotechnical systems (the interplay between technology and our social world) towards more sustainable approaches. With personal Page] I of 1] 8
transportation (cars) as the example it analyses an incremental approach and a radical approach to new technologies. The Hybrid electric vehicle (HEV -like the Toyota Prius) is the incremental approach and the Fuel-cell vehicle (FCV -like hydrogen fuel cell vehicles currently being developed and tested) is the radical approach to substituting the Internal Combustion Engine (ICE).
The authors seek to analyse and conclude which of the two approaches that will be likely to "win the battle" of becoming the dominant design ofthe future.
Main thesis: Although there was great interest concerning the FCV technology (which is more sustainable in the long run) at the time of the articles conception, the authors wish to point out that the incremental approach ...the HEV . should not be overlooked as a candidate for becoming the dominant design.
Content: The text briefly recaps two kinds of technology theory: (Both have the issues of competing technologies, technology substitution and dominant desing as a major part ofthem)
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Frames competing technologies as a variation and a selection process following each other: 0-)
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ariation process: many alternative technologies arc developed
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The text draws on Tuchman & Anderson (1990) who describe how the process of a design becoming dominant takes place in different stages: o
Creation of a technological discontinuity
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Stage of fenncnt (synonyms> uproar, tumult, confusion etc.)路.. new technology competes with the old '"
During this stage, competition selection takes place and the new technology becomes the dominant design
Page 12. of 118
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The an area of incremental change occurs (a series of minor improvements on the technology) until a new technology starts to challenge the position of the dominant design.
Both Fev and HEV can be seen as technological discontinuities. The HEV however is further along the process - it has entered the stage of ferment.
To analyse the case of the two technologies the authors focus on the technological systems in which they arc being innovated: o
also called technology-specific innovation systems, and are systems built around the specific product/technology (as opposed to Innovation System _. a broad term covering a matrix of economic, social, political, organisational and other factors affecting the innovation - see p 31)
For a model of the factors their analysis covers - see P 32. Tha authors go through all 5 factors quite precise and brief in the text: p. 32路40
Conclusion: Often a shift from one major technological trajectory (Like ICEs) to another major (Like FCV) take place over a transition technology. Some see HEV as snch a transition technology. The authors doubt this however, since HEV do not offer any experience in building fuel cells (" it is not a part of a transition towards FeV). The HEV is on the way of becoming the dominant design (own reflection: largely due to the success Toyota has with the Prius and licensing out their Hybrid platform)
i.f it becomes
1:11C
dominant design, the chances for FeV are reduced, The authors only
sees this happening, if the regulatory systems become far 11101'e strict and focus on zero-emission (instead ofjust on reducing C02 emission as now).
From Kampmann's slides: o
Argues that hybrids may become dominant design rather than fuel cell vehicles
o
Nice illustration of different socio-economic approaches
o
Bu.t suffers from being obsolete with respect to technology
Struben, ,I.; Sterman, JD (2007): Transition challenges for alternative fuel vehicle and transportation system, Environment and Planning B, (forthcoming, available as MIT Sloan
Page 1301'118
Schoo! working paper at http://papers.ssrn.com/sol3/papers.efm?abstract_id=881800). (Details of model analysis not required).
Sorry guys _. the text is 48 pages long and reading it corresponds very badly with my current exam study plan ... (I'll need to focus on the more core texts in the syllabus) I've copy/pasted the Abstract from the text in here instead (If you feel like it - remember to download it before the exam): "Automakers are now developing alternatives to internal combustion engines (ICE), including hydrogen fuel eells and ICE-eleetrie hybrids. Adoption dynamics for alternative vehicles are complex due to the size and importance of the auto industry and vehicle installed base. Diffusion of alternative vehicles is both enabled and constrained by powerful positive feedbacks arising from scale and scope economics, R&D, learning by doing, driver experience, word of mouth, and complementary resources such as fueling infrastructure, We describe a dynamic model of the diffusion of and competition among alternative fuel vehicles, including coevolution of the fleet, technology. consumer behavior, and complementary resources. Here we focns on the generation of consumer awareness of alternatives through feedback from consumers' experience, word of mouth and marketing, with a reduced form treatment of network effects and other positive feedbacks (which we treat in other papers). We demonstrate the existence of a critical threshold for sustained adoption of alternative technologies, and show how the threshold depends on economic and
behavioral parameters.
VI!e ShO\N
that word of 1.'11.o1.1t11.
frOID
those not driving an altcmativc vehicle is
important In stimulating diffusion.. Expanding the model boundary to include learning, technological spillovers and spatial coevolution of fueling infrastructure adds additional feedbacks that condition the diffusion of alternative vehicles. Results show scenarios for successful diffusion of alternative vehicles, but also suggest that marketing programs and subsidies few alternatives must rcmam
place for long periods for diffusion to become self-sustaining,
Suggested Jhrther r"'i:lging:.1Je~\'!~dirming'i Futurist (2007): The Hybrid Phenomenon, The Futurist, July-August (7 p.) e WSJ (2007) "Hybrid or All-Electric? Car Makers Take Sides" Wall Street Journal Online 2007-路 10,24. e WSJ (2007) "Eyes on the Road: Electric Car Maker Aims For the Top With Sports Car ...,- Tesla Readies $98,000 Roadster And Looks to Expand Downward" Wall Street Journal Online 200710-14 e FS13 (2007) "Putting the Zoom Into Electric Cars" Fortune Small Business 17(10) 2007-12-1 e WSJ (2007) "From software to autos _..- Former SAP official raises $200 million for electric-car plan" Wall Street Journal Europe 2007-10-30 @
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â&#x20AC;˘
Agassi (2007) Presentation of Project Better Place http://www.projectbetterplace.com/(accessed 2007-11-26) Suggested viewing: movies: â&#x20AC;˘ Paine (2006) Who killed the electric car?
Session 3: Industrial Organization, Platform Leadership ami Business Strategy (Andreas) e
Brcshnahan, T. F. and S. Greenstein (1999): Technological Competition and the Structure of' the Computer Industry, Journal ofIndustrial Economics, 47: 1-40. (37 p.)
Theme: The persistence of IBM platforms up to the "competitive crash" in the 1990s.
Key words: Endogenous sunk costs (ESq, the economies of persistence, competition fleeing, and mobility. Set of problems/focal points, main arguments and conclusion For the most of the computer age the same dominant firm, IBM, sold mainframe computing to the same customers (the business segment). The entrants opened new market segments sucb as minicomputer and micro computers rather than competing with the established leader. In the 1990s the competitive crash made firms that had preciously supplied different segments now competed for the same customer. This is explained through two levels; the segment- and the industry-wide level. The segment level is concerned with industry concentration and persistence in market structure, the industry level asks what factors led entrants to flee competition against the establish finn in one era, but to challenge them later. 5truQ(\l[§UeaturqQL'chc,-QQDljLuter jmbd!lJIY First, there is rapid and sustained technical innovation. Second, the commercialization of the innovation is done through specialization and vertical disintegration. However the transition did now resemble an inefficient organizational form being replaced by a new and better one, The entry became efficient slowly because the different market segments value different aspects, Third, the demand side increases and changes the characteristics of the market structure. The interaction between seller and buyer is organized around platforms. .rI1eJ2,;r$i;;rgDggQfJJ3M The first mainframe IBivl 8Y8tem/360 had operating system compatibility and thus set technical standard. The technical advance made it possible to increase capacity, and the resulting market structure became quite concentrated, and IBM the dominant platform. 1.2JYi<ied teehniea,Lkadership and theQQ.DlJ2.ctitiye clllsh When technicalleadership is divided, it is quit difficult for a single finn to maintain leadership over a platform. The divided technical leadership between Microsoft and IBM following the Intel. Compaq combination undermined IBM claim that it steered the platform. IBM played an aggressive entrant in several of the events that presaged the competitive crash.
Theories/models am, their relation to the set of problems
Page] 5 of I ] 8
Industries in which there are endogenous sunk (ESC) costs will exhibit concentrated structure even if there is a great deal of demand. This means that only a few platforms with be able to compete. Sutton's theory classifies the expenditures undertaken by the seller and users as ESC if they exhibit the following properties: 1. Irreversibility. The expenditure must be sunk (irreversible). 2. .fuJeeificity, Expenditures raise the buyer's valuation of a specific product or set of interrelated products. 3. Unlimited efficacy. The efficacy of additional expenditures cannot be exhausted. At any level of expenditure, it must be possible to spend still more to attract customers. 4. (Near-) Unanimity about efficacy. A large fraction of potential customers must respond to the expenditure. The four properties match IBM's mainframe platform because the expenditures were sunk and the customers could upgrade with additional components. An ESC industry arose in computing with the invention of the IBM System/360 and was reinforced by the IBM System/370 that was backwards compatible with the 360. Jhe economies of persistence A central idea of this theory is positive feedback among the components constituting a platform. Assumptions: 1. Persistence .5pecificity, Buyers and sellers of technology make platform specific investments ... An interface standard governs compatibility among components within the platform. 2. Tny-,,~tment durability. At least some of the platform-specific investments are long-lived; these influence the costs and benefits of future technical improvements by sellers and market choices available to buyers. The IBM. System/360 achieved the critical mass needed to positive feedback. The challenge in '路"getting over that hump" of acceptance made entrants nee competition.
!3J21IYiJ110J21QQil!1L.D f platform" The new markets include minicomputers, microcomputers and to an extend workstatiou.Werc the 1131\11 mainframes 'were well suited for the business segment; these new segment computers went for the technical users, who did not value compatibility in the same manner. 'rhus the companies, such as DEC, avoided competition with the mainframe providers. With the platform mobility however the new supermini- and microcomputers started to engage on the business segment, yet in the beginning only in administrative tasks. This was ad the margin for mainframe computers. Indirect entry A new platform increases its likelihood of attracting a critical mass if serving a new segment, and then later on it will develop its ESC around the standard embedded in the platform, and edge closer to the competitor's market segment. ResP.2.Ilses from the incumbent The first response was the IBM PC that successfully demonstrated the strength connected to having an unsponsored structure, i.c, being able to set industry standard because the system is not tied to on Page 16 of 118
company. This was enhanced by the PC's compatibility with the previous IBM systems. The second response during the late 1980s and early 1990s with the IBM superminicomputer AS/400 was also a success, however did in a sense opened the entries. Divided technical leadership The coordination role of decentralized technical progress slipped to IBM's early partners Intel and Microsoft, as Intel launched the 80386 microprocessor. The new generation of PC was defined by an Intel chip, not the IBM design. It became the new industry-standard and not simply IBMcompatible. IBM tried regaining control through a new-generation (PS/2) and a new operating system (OS/2). This strategy failed mostly because the new operating system was unreliable. The system that started as collaboration, a divided technical leadership, between IBM and Microsoft turned into a competition between OS/2 and Windows. Microsoft launched a successful version of Windows before the OS/2 could create a critical mass. The client/server application Client/server applications served responded to the weakness of large-scale mainframe platforms; the difficulty of use for the ultimate demander of information processing service, the end user. When IBM lost control over the PC platform their client/server strategy was bound to fail. Related theories: Gawer et al. (2002), McGahan (2004) e
Gawel', A. and M. A. Cusumano (2002): Introduction. Platform Leadership and Complementary Innovation, Chapter 1 in Gawel', A. and M. A. Cusumano (2002): Platform Leadership and Complementary Innovation; Boston, Mass.: Harvard Business School Press (Hi p.)
Theme The 3 eases of Palm Inc . NT.!' DoCoMo and Linux illustrate how strategic platforms can determine a EnD)s success in an industry deeply dependent on technological developments, and especially the need for correlating customer needs with firm's technical product development. The 3 cases is all concerned about the strategic platform formation and how sonic competitors through a long period oftrial and error has learnt how to become a platform leader wannabe and later actually becoming a platform leader. Key words Handheld computer, platform leadership, platform wannabes, Palm Inc. architecture, Microsoft's trial and error. Set of prublems/focal points, main arguments and conclusion The platform leadership is highly dependent. on the 4 strategic choices (scope of the firm, product technology, relationships with external complementors, internal organization). These choices illustrate how a firm can design a platform that is somewhat superior to its competitors. However competitive advantages don't last forever. Competitors can imitate and copy the successful platform and become a strategic platform wannabe. The paradigm for the players in the competition is to determine at an early stage of the product life cycle if they want to become an imitator (meaning always being one step behind) or set-up a production with its own strategic platform. The latter needs to be backed-up with sufficient information from user communities, competitors and the market. Page 17 of 118
Definitions Scope of the finn = DNA of the firm. Should the finn make or buy the product? What is the level of the vertical integration and is the firm a specialist in this specific product field? Product technology = Modular design and product development. How is the product designed and developed? How the architecture is designed and how is intellectual property rights implemented? Relationships with external complementors = Implementing external knowledge and using competitors, customers and user communities to gain competitive advantages and knowledge. How can be use external elements for our own benefit? Internal organization = How is the internal organization designed and dynamically changed for supplying the customers and market needs? Extra information from class The competition history between Palm Inc. and Microsoft illnstrate that being superior with technology and financial assets is not enough if you don't use the resources to what the customers want instead ofjust focusing about having the best platform. The Palm case illustrates the importance of developing a strategic platform that is suitable for the customers .- and not overloads them with features and technical details that are not demanded for. Furthermore Microsoft has agreed strategic alliances with cell network operators and thereby implementing vertical integration of mobile handset opportunities, and broadening their technological horizon and improving their PDA platform. McGahan, A. (2004): The Foul' Trajectories of Industry Evolution, Chapter 2 in How Industries Evolve; Harvard Business School Press (38 pages). Theme @
If an organization has the flexibility to redefine its strategy around the opportunities created by the trajectory of evolution, then the chances for improving your profitability are compounded. Successful companies develop strategies that capitalize on untapped opportunity as change takes hold in the industry.
Key words Four Models of industry evolution: progressive" creative, intermediating, and radical. Architectural and Foundational change, Rules of change: defining rules, corollaries, and guideline Set of problems/fecal arguments and conclusion Core assets and core activities can become obsolete if threats may emanate from new technologies. change in government policies) the opening of new markets, or shortage of a critical. raw material, lor example, To understand the four trajectories you have to keep in mind these principles: every industry follows a trajectory; every industry follows just one of the trajectories; shins between models arc rare; and structural change can be significant even when the industry docs not face a threat of obsolescence, The acid test is in applying the criteria comprehensively to examine the status of both the activities and the core assets in the industry.
Theories/models and their relation to the set of problems
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Architectural transformation Yes (threat to core activities) No Creative (i.e, film, oil)
Radical (i.e. typewriter)
Intermediating (i.e. auction) I
Progressive
(i.e. auto, disc. retail) -.L
_
Shifts between evolutionary trajectories are pretty rare. As mentioned, the criteria for a shift lie on emergences of threat of obsolescence, When a threat emerges, then an industry is snapped onto a new path. When an old threat fades, the structure of the industry evolves by a different set of rules that depend on whether a residual Architectural or Foundational transformation continues. This dynamic challenges strategies and type of innovations. Developing a strategy that exploits the opportunity in industry evolution depends on understanding the phase of change under each trajectory. By innovating to take advantage of the specific character of the trajectory the firm can substantially improve its chances of achieving a superior return on investment over the long run. Definitions and further arguments ArchitecturaLtral1SfQImatiou occurs when the industry's buyer and supplier relationships are thrown into jeopardy and consequently the architecture of profitability is under This term mainly to activities, .Em.msimiol111Ltn-l.!l8QDI1!J1inn occurs when the durable underlying structure that supports core activities come under fire. This term refers mainly to assets. .EIQg,I~ssb(q. Ch~112gQ occurs when neither the industry' s core activities nor core assets with its durable structure.. are threatened. A central feature of almost all Progressive industries is that almost all activities are core. Creative Charlg~ occurs with a threat of obsolescence to core assets but with not a threat to the industry's core activities. In this evolutionary path there is no stable foundation to the business. They key long-term survival is in developing a system of supporting activities so that commercialization of projects through the organization is as efficient as possible, Companies in this industry are very profitable yet highly risky.
Intennediatiugj;;bJJ,wsQ involves a threat of obsolescence to the industry's core activities and often occurs when changes in information Dow make new ways of transacting more efficient. It rarely leads to total eradication, although many firms may undergo bankruptcy or merger. Performance ultimately depends on developing new relationships and reconfiguring activities while preserving brand capital, knowledge, and physical resources. Page 19 of 118
Radical change involves both architectnral and foundational change and is defined by a threat of obsolescence to both an industry's core assets and core activities. Two classical examples are railroad vs. efficient high way system; and desktop computers vs. typewriters
Related Theories Innovators' Dilemma, Clayton M. Christensen
Session 4: Industry convergence and innovation strategy: the case of the handheld computer (Andreas) e
Stieglitz, N. (2003): Digital Dynamics and Types of Industry Convergence - The Evolution of the Handheld Computers Market in the 1990s and beyond, in: J.F. Christensen and P. Maskell: The Industrial Dynamics ofthe New Digital Economy, London: Edward I~!gar (25 p.)
Abstract 1
Theme Stieglitz explains four types of industry convergence based on the aspects of supply (technology) and demand (products).
Key wonts Convergence, supply/demand, technology substitution, technology integration, product substitution, product complementarity, Set of problems/focal points, main arguments ami conclusion Stieglitz argues that the development of previous unrelated industries is that they evolve into each other, hence creating entirely new industries and industry convergence,
Theories/models
n,iathm to the set of problems This framework shows the four different types of industry convergence, as suggested by Stieglitz:
Substitutes Techncloqv-based converqence
Fechnoloqy su bstltution
Technology integration
Product-based converqence
Product su bstltution
Product complementarity
Often, product innovations are triggered by product complementarity, not because the manufacturers of the products need to integrate features from the opposite product in order to make them work together, but because the old products are found to be used in nove! contexts.
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Definitions Technology substitution: A new technology replaces different technologies in an estahlished industry. Technology integration: Various technologies previously associated with different industries are fused or integrated, thereby giving rise to entirely new industries. Product substitution: An established product from one industry evolves to integrate product features that are similar to those of another product in a different industry. Product complementarity: Two formerly unrelated products are turned into complements. The products create synergy by the joint use of both products. Related theories Recommendation: Read "Blue Ocean Strategy" by W. Chan Kim & Renee Mauborgne (2005), Harvard Business School Press. Abstract 2 Digital Dynamics and Types of Industrial Convergence The Evolution ofHandheld Computers Market in the 1990.1' and beyond By: Nils Stieglitz. 2003
Industry convergence Technology substitution Technology integration Product substitution Product
Various different authors
Overall theme: The notion of industry convergence goes back to Rosenberg (1963) who termed this process technological convergence, because different industries increasingly relied on the same set of technological skills in their production process. Product markets.. which were apparently unrelated from a market perspective, became closely related from a technological point of view Both Porter and Hamel and Prahalad independently argue that technological innovation may change the boundaries of traditional industries. As a result, different existing products are often becoming closer substitutes.. since their functions arc increasingly unified and bundled in innovative products.
Definition Definition of a PDA: A handheld computer or Personal Digital Assistant (PDA) is a compact, palmsized computing device. One of its defining product characteristics is the user's ability to hold the device in one hand while entering data with the other hand.
Convergence Defined Convergence signifies the movement towards the same point or the meeting of two or more elements. Thus industry convergence involves the meeting of at least two industries. Since industries can be defined both by demand and supply criteria, we can make a distinction between technology-based convergence from the supply side and product-based convergence from the demand side. Page 21 of 118
Technology- Based Convergence Technology-based convergence implies that unrelated product markets become related from a technological point of view, because they begin to share the same technologies. Technology substitution Technology substitution is triggered by the introduction of a new process technology. Unlike all other forms of industry convergence, process innovation thus drives technology substitution. Technology substitution is characterised by the development and diffusion of the new technology. Eventually the older technologies are replaced, and the former unrelated industries become related from a technological point of view. An example of this might be hand writing recognition replacing keyboards.
Technology integration Like technology substitution, technology integration may be triggered by the development of a new technology. While the new technology replaces existing technologies in technology substitution, technology integration creates the opportunity to combine the new with existing technologies and to produce an entirely new product. An example of this might be that advances in hand writing recognition technology enabled companies from the telecommunication, computers and consumer electronics industries to offer the first handheld computers by combining and integrating this technology and various other technologies.
Product- Based Convergence In the case of prodl.1ct-based converg£nce. unlJ.'I'!19Q prod]Jct marl&cts bcc0111e related from a marke,t QQ!Jl.1 of vLgy{" Th"Y..Jl£gin to_ Sbi3xco.JiLmUar or,comJ)km.£}}1.i\LL1.lIQ9uctsJ1!Jl~acteri,~t!c;;;,J<00girl)ZJQ ]lrocljJ£L~u bsDJQt!Qn OJJ.JEJcl.11ct cQmn!el1l£nt"xilY respe£t!yelyc
Product substitution leads 1:0 a substitutability between formerly unrelated products as hey increasing come to share the same product characteristics. Once again this type of industry convergence is often sparked by a new technological capability that enables the changes in product characteristics. The industrial dynamics of product substitution involve increasing cross-industry competition in which firms from two or more industries expand their existing technologies of the other industry, This means that product substitution is often followed and accompanied by technology-based convergence as the technological features of firms in both industries converge. In the extreme case.. the industries merge into one larger industry with similar technologies and product characteristics. An example of convergence through product substitution is the dynamic relationship between the markets for mainframes and minicomputers in the] 970s and early 19808. It could also be PDAs replacing mobile phones,
Industry convergence through product complementarity means that existing products that were once used independently become complementary from a user perspective. Successful product complementarity leads to a situation in which two or more products deliver a higher value if used together. An example of this is hand writing recognition, e-mail and internet complementing each other. Page 22 of 118
The Case of Handheld Computers The first generation of handheld computers were the so-ealled eleetronie organizers from 1988 whieh emerged due to the development in LCD (liquid erystal display) screens and due to the development in semieonduetors. Among the first pioneers were Casio, Sharp, Hewlett- Paekard and Psion. The seeond generation of handheld eomputers was brought into the market in 1993. This generation was ealled PDAs and they had handwriting recognition and eommunieation features. However the seeond generation failed due to ineffeetive funetionality. The entrants like AT&T, Apple, Motorola and Sony had left the market already in 1998. Overall growth was less that industry observers had predicted. The third generation called can be called the break-though due to its commercial success domination of the market. The pilot was developed by the company Palm Computing and therefore named the Palm Pilot. With the Pilot, Palm established what quickly became the dominant design of handheld computers. They probably succeeded because they did a few things very well and not tried too much too early! The forth generation could be called the post break-through generation and is characterised by wireless communications, standards and smart phones, which is a combination of mobile phones and PDAs.
Conclusion As we have seen there are different forms of industry convergence and they shape industry dynamics in different ways. The developed taxonomy allows for the identification and analysis of these complex constellations by highlighting the different roles played by the various forms of convergence. However, our understanding of the dynamic interdependencies between the different types of convergence remains limited.
Ce"u'c.-gc,nec IÂťefined Convergence signifies the movement towards the same point or the meeting of two or more elements. Thus industry convergence involves the meeting of at least two industries. Since industries can be defined both by demand and supply criteria, \VC can make a distinction between technology-based convergence fhJDJ the supply side and product-based convergence :1i0111 the demand side. Technology- Based Convergence Technology-based convergence implies that unrelated product markets become related from a technological point of view, because they begin to share the same technologies.
Technologysubstitution Technology substitution is triggered by the introduction of a new process technology. Unlike all other forms of industry convergence, process innovation thus drives technology substitution. Technology substitution is characterised by the development and diffusion of the new technology. Eventually the older technologies are replaced, and the former unrelated industries become related from 3 technological point of view. An example of this migbt be hand writing recognition replacing keyboards. Technology integration Like technology substitution, technology integration may be triggered by the development of a new technology. While the new technology replaces existing technologies in technology substitution, technology
Page 23 of 118
integration creates the opportunity to combine the new with existing technologies and to produce an entirely new product. An example of this might be that advances in hand writing recognition technology enabled companies from the telecommunication, computers and consnmer electronics industries to offer the first handheld computers by combining and integrating this technology and various other technologies. Prod uct- Based Convergence
In the case of product-based convergence, unrelated product markets become related from a market point of view. They begin to share similar or complementary product characteristics, leading to product substitution or product complementarities respectively.
Product substitution Product substitution leads to substitutability between formerly unrelated products as hey increasing come to share the same prodnct characteristics. Once again this type of industry convergence is often sparked by a new technological capability that enables the changes in product characteristics. The industrial dynamics of product substitution involve increasing cross-industry competition in which firms from two or more industries expand their existing technologies of the other industry. This means that product substitution is often followed and accompanied by technology-based convergence as the technological features of firms in both industries converge. In the extreme case, the industries merge into one larger industry with similar technologies and product characteristics. An example of convergence through product substitution is the dynamic relationship between the markets for mainframes and minicomputers in the 1970s and early 1980s. It could also bc PDAs replacing mobile phones.
Product complemefltaritp Industry convergence through product complementarity means that existing products that were once used independently become complementary from a user perspective. Successful product complementarity leads to a situation in which two or more products deliver a higher value if used together. of this is hand writing e-mail and internet each otber. An
Replacing tech in established industry.
Established products evolve and replace products another industry.
Two unrelated products arc comhinod complements
The Case of Handheld Computers The first generation of handheld computers were the so-called olectronic organizers from 1988, which emerged due to the development in LCD (liqnid crystal display) screens and due to the development in semiconductors. Among the first pioneers were Casio, Sharp, Hewlett- Packard and Psion. The second generation of handheld compnters was brought into thc market in 1993. This generation was called PDAs and they had handwriting recognition and communication features. However the second generation failed due to ineffective functionality. The entrants like AT&T, Apple, Motorola and Sony had left the market already in 1998. Overall growth was less than industry observers had predicted.
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Technology integration dominated the early phases ofthe handheld computer industry. Technologies that had their roots in different industries were combined in the development ofthe first waves ofPDAs The third generation called Can be called the break-though due to its commercial success domination of the market. The pilot was developed by the company Palm Computing and therefore named the Palm Pilot. With the Pilot, Palm established the dominant design of handheld computers. They probably succeeded because they did a few things very well and not tried too much too early; part ofjudo strategy! Product complementarities a big reason for the success ofPalm and the PDA The forth generation could be called the post break-through generation and is characterised by wireless communications, standards and smart phones, which is a combination of mohile phones and PDAs. Product Substitution Conclusion As we have seen there are different forms of industry convergence and they shape industry dynamics in different ways. The developed taxonomy allows for the identification and analysis of these complex constellations by highlighting the different roles played by the various forms of convergence. However, our understanding of the dynamic interdependencies between the different types of convergence remains limited,
Abstract 3 Mainframe
The author talks about the concept of industry convergence and how it can actually be divided into 2 categories of convergence, namely Technology-based and Product-based. Technology-based convergence consists of two types of convergence, namely the technology substitution and the technology integration. Technology substitution is triggered by the introduction of a new process technology. The adoption of this technology in the production of existing products represents a technological substitution of hitherto existing other fonns of industry convergence process innovation process technologies in these industries. Unlike thus drives technology substitution, thus no products arc affected
an
Like technology substitution, technology integration may be triggered by the development of a new technology. While the new technology replaced existing technologies in technology substitution, technology integration creates the opportunity to combine the new with the existing technologies to produce an entirely new product. Product-based convergence; also consists of two types of convergence, namely the product substitution and product complementarity. Product substitution leads to a (greater) substitutability between formerly unrelated products as they (incrcasingly) come to share the same product characteristics. Once again, this type of industry convergence is often sparked by a new technological capability that enables the changes in product characteristics. Industry convergence through product complementarity means that existing products thai: were once used independently become complementary from user perspective. While the new technology or standard is not needed to produce the different products individually, its task is to provide the "glue" to align the two products. Some kind of standard or technical interface is necessary to govern the complementary use of the prod nets. The author talks about the term industry convergence which goes back to Rosenback and his study of the early evolution of the US machine tool industry. It is important to note that industry convergence not only implies the convergence of technologies but also of pro duets. According to Merriam Webster (2000) dictionary, convergence signifies the movement towards the same point or the meeting of two or more clements. Thus industry convergence involves the "meeting" of at least Page 25 of 118
two industries. Since industries can be defined by both demand and supply criteria, we can make a distinction between technology-based convergence from the supply side and product-based convergence from the demand side.
Industry convergence is an inherently dynamic process, which can be conceptualized as consisting of three distinct stages. In the first stage, two existing industries are unrelated from the viewpoint of both the supply and the demand side. A process of convergence is then triggered by an outside event, for example by the invention of a new technology. In the second stage, the industries converge, implying changes in industry boundaries, market structures and corporate strategies. Finally, in the third stage, the industries are related from a technological or product market perspective, and industry structures may stabilize, or new processes of convergcnce may evolve. Technology-based convergence
Technology-based convergence, implies that unrelated product markets become related from at technological point of view, because thcy begin to share the same technologies. Technology substation: Technology substitution is triggered by the introduction of a new process technology. The adoption of this technology in the production of existing products represents a technological substitution of hitherto existing process technologies in these industries. Unlike all other forms of industry convergence process innovation thus drives technology substitution, thus no products arc affected. Technology substitution is characterised by the development of and diffusion of the new technology. Eventually, the older technologies are replaced, and the former unrelated industries become related from a technological point of view. Despite the technology-based convergence of the industries, their horizontal boundaries are not usually affected by technology substitution. What often changes, however, is the degree of vertical integration. Because the new technology does not build on the existing technological capabilities of incumbent firms, entrants or firms from different industries are often a primary source of innovation. Since the new technology can be applied in more industries, firms arc able to specialize in its development and commercialization. This leads to the emergence of a specialised supplier industry upstream from the traditional industries, and correspondingly, an increasing tendency among incumbents to outsourcc their process technologies. This type of industty convergence is identical to Rosenberg's elassic notion ofteehnological convergence. Technology hrtegration: Like technology substitution, technology integration may be triggered by the development of a new technology. While the new technology replaced. existing technologies in technology substitution, technology integration creates the opportunity to combine the nO\\I with the existing technologies to produce an entirely new product. Since technology integration draws, at least in part, on existing technologies, established firms are able to utilize their technological. capabilities, possibly in combination with DeY\, externally developed technologies, as a springboard for entering the emerging new industry. Their pre-entry experience with established technologies could give them a competitive advantage over new entrants. However) a new entrant may be a serious threat to incumbents if it not only possesses a new distinct technological capability but also is an early mover in the emerging flew industry, Pro duc t-b ascd convergence
In the case of product-based convergence, unrelated product markets become related from a market point of view, They begin to share similar or complementary product characteristics, leading to product substitution or product complementarity respectively. Product substitution: Product substitution leads to a (greater) substitutability between formerly unrelated products as they (increasingly) come to share the same product characteristics. Once again, this type of indnstry convergence is often sparked by a new technological capability that enables the changes in product characteristics. Products become closer substitutes the more product characteristics they share. The industrial dynamics of product substitution involve increasing cross-industry competition in which firms from two or more industries expand their existing products by incorporating features from the other industry's products.
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Correspondingly, besides having to assimilate the new technology, firms in both industries also have to adopt existing technologies of the other industry. In contrast to technology integration, the learning process associated with product substitution takes its departure in existing dominant designs and firms can more incrementally build on and extend their existing products to develop convergent product offerings. The subsequent redrawing of industry boundaries may, however, lead to renewed uncertainty and ambiguity for established firms. Firms have to discover who their new competitors and customers are, what bundles of product characteristics customers want and which new capabilities to build. Product complementarity: Industry convergence through product complementarity means that existing products that were once nsed independently become complementary from user perspective. Again, this type of product-related convergence is often caused by technological development and the creation of a standard interface, which creates the opportunity to jointly usc the two existing products. Successful product complementarity leads to a situation in which two (or more) products deliver a higher value if used together. While the new technology or standard is not needed to produce the different products individually, its task is to provide the "glue" to align the two products. Some kind of standard or technical interface is necessary to govern the complementary use of the products. Unlike product substitution, product complementarity does not lead to technology-based convergence, since incumbents do not have to attain the technologies underlying the product features of the complementary product. This is not to say that product complementarity has no impact on the established products. Often, product innovations arc triggered by product complementarity, because the old products can be used in novel contexts. Tbe internet, for example, sparked a wave of product innovations in computer hardware and software, but also telecommunications. Empirical processes of industry convergence often combine two or more types of industry convergence and are paralleled by other sorts of innovative activities which have nothing to do with convergence. It is the main proposition of this chapter that the suggested typology of industry convergence allows the identification and disentanglement of different drivers of change in converging markets, and provides a basic framework for analysing complex patterns of industry convergence. Hereafter, a case on handheld computers follows. However, I honestly don't think that much can be drawn from it so I will not make a summary on that part of the text but have focused more on this first part.
"
B.. Mrmt.!2;OI1ncr'y (1988): Strategic li1anagenwflt Journal) VoL 9~ 41 (18
I'
irst-movcr advantazes,"
/\.hstrad 1 When a finn has the opportunity to be a first mover it is because asymmetry has been generated between firms. Without this asymmetry, first-mover advantages do not arise, This asymmetry can come from luck, unique resources or foresight (proficiency). The author's start out by considering 3 mechanisms that leads to first-mover advantages. I) Technological leadership. First-movers can gain advantage through sustainable leadership in technology. Advantages can be derived either from the learning/experience curve, by generating barriers to entry or sustainable cost advantages or through R&D expenditures and patents (Due to inter-industry differences lead-time and learning-curve advantages arc mentioned as the most dominant approbiability mechanisms in most industries). 2) Preemption ofscarce assets. First-movers can gain advantage by preempting rivals in the acquisition or control of scarce assets. Advantages can be derived by e.g. first-mover firms having superior information which make them able to preempt input factors or through preemption of locations in geographic and prodnet characteristics space i.e, niches for product differentiation. Thereby the firstPage 27 of 118
mover can establish positions in geographic or prodnet space such that late-movers find it unprofitable to occupy the interstices. 3) Switching costs and buyer choice under uncertainty. First-movers can gain advantage through buyer switching costs. Late entrants must invest extra resources to attract customer away from the firstmover firm. Furthermore buyers may rationally stick with the first brand they encounter that performs the job satisfactorily. The author's also examine 4 potential disadvantages of first-mover firms, which are in effect advantages enjoyed by late-mover firms. l) Free-rider effects. Late-movers may "free-ride" on pioneering firm's investments in e.g. R&D, buyer education and infrastructure development. (This is an important issue due to rising inter-firm diffusion of technology in indnstries and labor market mobility). 2) Resolution of technological or market uncertainty. Late-movers can gain advantages through resolution of technological or market uncertainty e.g. set industry standards in its favor. 3) Shifts in technology or customer needs. Late-movers may exploit technological discontinuities to displace first-movers or existing incumbents (Schumpeters (1961); "creative destruction"). Customer needs are also dynamic creating possible opportunities for later-movers. 4) incumbent inertia. Incumbent inertia may leave the first-mover vulnerable e.g. the firm may be locked into a specific set of fixed costs, the firm may have become organizational inflexible or the firm may be reluctant to cannibalize own products. These factors inhibit the ability of the firm to respond to environmental changes or competitive threats. Geucra! conceptual issues Pioneering opportunities arise endogenously; the firm cannot simply choose whether or not to pioneer. It is difficult to define a first-mover empirically; the article docs not attempt to define a first-mover but simply make the reader aware of the difficulties. First-mover advantage is not necessarily a lasting one, often a first-mover will enjoy a temporary advantage carlyon which fades with time. This is one reason why many pioneers exit markets or sell out to others in time. It is also possible for first-mover and late-mover advantages both to be present in the same market just at different times. Conclusion This article gives an overview of the literature on the subject of first-mover advantages, stating the empirical conclusions from other articles for some of the points of discussion. The authors do not arrive at many conclusions but seem to focus more on making the reader aware of both pros and con's in order to enable the reader to make an enlightened decision, ld)stn~ct
:2
Overall theme: Advantages and Disadvantages ofFirst-Movers
First-Mover Advantages When a firm has the opportunity to he a first mover it is because asymmetry has been generated between firms. Without this asymmetry first-mover advantages do not arise. First-mover advantages come from three primary sources:
L Technological Leadership Sustainable leadership in technology can be gained through; advantages derived from the learning or experience curve where costs fall with cumulative output, or success in patent or R&D races.
2. Pre-emption of Scarce Assets
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The first-mover can gain advantage by controlling already existing assets, snch assets can be physical resources e.g. natural resource deposits, process inputs e.g, employees (provided there are switching costs), or space e.g. market space or shelf space. The pre-emptive investment in plant and equipment can deter entrance to the market by serving as a commitment to maintain greater output even following entry with ability to cut costs.
3. Buyer Switching Costs First-movers gain advantage from buyer switching costs because late entrants will have to invest extra resourees to attract customers away from the first-mover finn. Not only will the product need to be better for buyers to switeh but late entrants must also make buyers aware of this fact. First-Mover Disadvantages or Advantages of Late-Mover Firms L Free-riding on first mover investments Late-movers may be able to free-ride on a pioneering firms investment because imitation costs are lower than innovation costs in most industries. The ability of follower firms to free-ride reduces the pioneers incentives to make early investments.
2. Resolution of technological and market uncertainty First-movers have a higher degree of risk entering the market than do late-movers. However, first-movers may be able to set industry standards in their own favor. Larger firms may be better equipped to wait for resolution of uncertainty. 3. Technological discontinuities that provide gateways for new entry Late-movers can wait for opportunities in the marketplace to arise from new technology or shifts in customer needs and attempt to catch first-movers off guard
4. Incumbent inertia The first-mover may be locked into some of its assets, become organizationally inflexible or he
unwilling to cannibalise existing products, Attempting to harvest from previous investments may leave (1 finn vulnerable to new entrant technologies, Genenll conceptual issues Pioneering opportunities arise endogenously:" the firm cannot simply choose whether or not to pioneer. It is difficult to define a first-mover empirically, the article does not attempt to define but simply make the reader aware of the difficulties.
<1
first-mover
First-mover advantage is not necessarily a lasting one, often a first-mover \V111 enjoy a temporary advantage early on which fades with time. This is one reason why many pioneers exit markets or sell out to others in time,
It is also possible for first-mover and late-mover advantages hoth to be present in the same market just at different times.
Conclusion This article gives an overview of the literature on the subject of first ..mover advantages, stating the empirical conclusions from other articles for some of the points of discussion. The authors do not arrive at many conclusions but seem to focus more on making the reader aware of botb pro's and eon's in order to enable the reader to make an enlightened decision. Page 29 of I 18
The article finishes up with a discussion of the managerial implications of a strong emphasis on pioneering and specific decisions of whether to pursue pioneering opportunities or not. This is done in much the same manner as the rest of the article, going back and forth but ultimately saying that these decisions are best made situation specific. Definitions First-Mover advantages: the ability of pioneering firms to earn positive economic profits Endogeneity: The partly uncontrollable way that pioneering opportunities arise, through Environmental change, Firm proficiency and Luck (Figure I, pg. 42) The Incumbent: the first-mover Abstract .3 The aim of the article is to analyze the advantages and disadvantages of being a first-mover. First- mover advantages is defined in terms of the ability of pioneering firms to earn positive economic profits. First-mover advantages anise endogenously within a multi-stage process, as illustrated in fig. 1 at page 42.
In the first stage some asymmetry is generated, enabling one particular firm to gain a head start over rivals. This first-mover opportunity may occur because the firm possesses some unique resources or forsight, or just luck.,
First-mover advantages arise from three primary sources:
r.
Technologicalleadership
2. Preemption of assets
30 Buyer switching costs, \\iithiD each category there arc a number
specific mechanisms.
J?irst"1J10VerS can gain advantage through sustainable leadership in technology where mechanisms are considered:
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basic
1. Advatages dcrrivcd from the "learning" or "experience" curve, where the costs fall with cumulative output 2. Success in patent or R&D races, where advances in product function of R&D.
0)'
process technology arc a
Learning curve In the standard learning..curve model, unit production costs fall with cumulative output.This generates a sustainable cost advantage for the early entrant if learning can be kept proprietary and the can maintain leadership in market share. Diffnsion occurs more rapidly in most industries and learning-based advantages arc less widespread than was commonly believed in the 70's. Mechanisms for diffu.sion include workforce mobility, research publication, informal technical communication, "reverse engineering", plant tours etc. Page 30 of 118
R&D and Patents When technological advantage is largely a function of R&D expenditures, pioneers can gain advantage if technology can be patented or maintained as trade secrets. According to the author a general defect of the patent race litterature is the assumption that all returns go execlusively to the winner. As an empirical matter such patent races is only important in a few industries, such as pharmaceuticals. In most industries, patents confer only weak protection, with the pharmaceutical industry as the exeption. Preemption of scarce assets The first- mover may be able to gain advantage by preempting rivals in acquisition of scarce assets and gain advantage by controlling assets that already exist, rather than those created by the firm through development of new technology Preemption of input factors If the first- mover has superior information, it may be able to purchase assets at market prices below those that will prevail later in the evolution of the market. The returns garnered by the first-mover are pure economic rents.
Preemption of locations in geographic and product characteristics space In many markets there is "room" for only a limited number of profitable firms, so the first-mover can often chose the most attractive niches and may be able to take strategic actions that limit the amount of space available for subsequent entrants. However, empirical evidence suggest that successful preemption through geographic packing is rare. Preemptive investment in plant and equipment The enlarged capacity of the incumbent serves as commitment to maintain greater output following entry, with price cuts threathened to make entrants unprofitable. However, these investment tactics do not seem to be seem to be particulary important in practice.
ยง,'vH,ching costs First- mover advantages may arise from buyer switching costs) since late entrants must invest extra resources to attract customers away from the first-mover firm. Several. types of switching costs can anse. .j They can stern horn initial transactions costs or investments that the buyer makes in adapting to the seller's product. L Switching costs that arises due to supplier specific learning by the buyer. 3, .A third type of switching cost is contractural switching cost that may be intentionally created by the sell cr. <
Buyer choice under unccrtatnty Buyers might stay with the first brand they encounter that performs the job satisfactorily. This is especially the ease regarding low-cost "convenience goods".
Free- rider effects Eventhough free-riders may benefit from the pioneering firms investments in R&D, buyer education, etc, the pioneering finn still enjoy an initial period of monopoly.
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Resolution of technological or market uncertainty Late-movers can gain an edge through resolution of market or technological uncertainty. Early entry is argued to be prefcrrable when the finn can influence the way that uncertainty is resolved.
Shifts in technology or customer needs Here Schumpeters notions on technological progress as a proeess of vcreative destruction" is used to explain how firms exploiting teehnologieal diseontinuities to displace existing ineumbents. Sinee customer needs are dynamic this might create opportunities for later entrants unless the first-mover is alert and able to respond.
Incumbent intertia Vulnerability of the first mover is often enhanced by "incumbent intcrtia", which can have several root causes. I. The finn may be locked into a specific set of fixed assets
2. The finn may reluctant to cannibalize existing product lines 3. The firm may become organizationally inflexible
The appropriate choice between adaption and harvesting depends on how costly it is to convert the firm's existing assets to alternative uses.
General conceptual isslies As illustrated in fig. I profits earned by first ..movers arc fundamentally attributable to proficiency and luck, rather than "pioneering" per se. As 8. practical matter it is difficult to distinguish between proficiency and luck, especially at the stage where first-mover opportunities arc generated. In a purely conceptual way profits linked to first-mover opportunities arising from exceptional skiI] or forsight can he viewed as returns to superior entrepreneurship.Luck can affect profits directly and indirectly by influencing the quality of first-mover opportunities available, to the JJ.rJTL
Following chapter is a discussion of how to define first-mover wl,,-,'" the authors supports the definition based on market entry.
Magnitude and duration of first-mover advantages 'The pioneering firm might gain some economic first-mover advantages but when comparing the profitability of the first and later moving firm over a longer period of time the latter might. be more profitable, due to patent expiration etc. Implications for managers Managers must decide whether to invest resources in search of first- mover opportuinitics. Moreover, managers will have to decide whether and how to exploit such an opportunity. Managers who have chosen to emphasize pioneering can partly protect themselves with patents, designs that are difficult. to reverse engineer. However, pioneering firms will have to guard themselves from changes in the environment as mentioned above.
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Markides, Costas and Gcrosld, Paul A. (2004) "Racing to be 2"d," Business Strategy Review, Winter, pp. 25-31 Pisano, Gary P. and Teece, David .J. (2007). "How to capture value from innovation: Shaping intellectual property and industry architecture," California Management Review, 50 (1), Fall, pp. 278-296.. Grindley, Peter (1995). Standards Strategy and Policy (Oxford University Press), pp. 20-54.
Session 6: Dynamics of technology launch strategies (Sabina) e
Barraba, V. et at (2002) A Multi-method Approach for Creating New Business Models: The General Motors Onstar Project. Interfaces 32(1): 20-34. (Download from e.g. h Up: lfin terfa ccs, i 0 urnal.informs. 0 rglcgi/reprin t/32/1120.)
The Onstar ease is about OM's move into telematics in 1997. In the article, Barraba et al (2002) develop a multi-method modeling approach to evaluate strategic alternatives for OM's OnStar communications system. The Onstar ease is a good example of what Oliva ct al define as first mover advantages from network externalities and use of system dynamics in corporate strategic decision making (see below). The Onstar concept is an electronic communication system to be added to a ear that functions as a virtual human advisor. By use of satellite and cellular links, it offers instant roadside assistance, traffic reports, e-mail, fax, address book, voice mail, internet, news, directions, security and safety services. Services range from: e e m @
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Airbag deployment notification Emergency services Stolen vehicle tracking Remote door unlock, horn, lights and diagnostics Online concierge
GlvI had to make a decision whether to implement Onstar as a car option or as a separate service business. It was decided to let it run as a separate service business, but it was further evaluated whether it should launch an incremental evolutionary (i.e. retrofitting) marketing strategy or factory installation). As is often the whether it should he aggressive and revolutionary (OBI", case, the management was afraid of bleeding edge, hut on the other hand the industry could not afford to miss out on opportunities. like they did when car phones where first introduced and took over by cell phone companies. There were many advantages and spill over effects in running a service business. OM experienced more frequent customer contact (which was new to the company). This resulted in better customer acquisition as well as retention. The service level. increased but so did uncertainty. In order to analyse the new, emerging tclematics industry, Barraba et al used an integrated simulation model consisting of six sectors: customer acquisition, customer choice, alliances, customer service, financial dynamics, and dealer behavior. The modeling effort had important financial, organizational, and societal results (sec details in article, it is quite short. .. REMEMBEP. ro PRINT IT AND BRINO TO EXAM!!)
It was recommended that OM implemented an aggressive launch strategy: Page 33 of 118
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• e e
Rapid launch (improve/polish later) Factory installation on all models Aggressive development of alliances To be sold as separate system Aggressive pricing (at first), i.e. hardware discounts, one year free subscription etc ... Systematically overstaff call centers to maintain high service quality
It was believed that GM would make money later on service revenues and fees. When the article was done in 2002, the OnStar business had two million subscribers (4.5 million in 2006 - now adding 4-5000 subscribers per day), an 80 percent market share of the emerging telematics market (still valid), and was valued at between $4 and $] 0 billion (estimated to reach 24 billion $ in 2010). Ford's more cautious approach (RESCU system) closed down.
•
OnSta1" website:
!:dtp://www.onst~!..com.
Take a look for yourself ©
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Oliva, R.; Sterman, JO, Giese, M (2003) Limits to growth in the new economy: exploring the 'get big fast' strategy in e-commcrc«, System Dynamics Review J 9(2): 83-J J 7. (Details of model analysis not required) (32 p.).
Oliva ct al study the dynamics of e-cornmerce and discuss how companies can gain first mover advantages from network effects and positive feedbacks such as scale economies, learning curve effects, standards formation and accumulation of complementary assets. They also discuss the challenges of rapid launch and emphasise the importance of system dynamics. Making "what analyses and conducting hypothesis testing call. help reveal trade-off; risks and alternatives.
A Grow Big Fast (GBr:) strategy includes 101;V prices" rapidly expanding capacity, heavy advertising and vertical intcgration/allianceamaking it difficult for others to enter the market and bc competitive. It requires heavy capital investment, and the willingness to run with negative profits in the beginning. It is a balancing act A lot of GBF c-cornmerce companies fail (i.c, the burst ofthe iT bobble). Amazon is an exception in the online book market. Failures arc often caused by collapsing capital markets, lack of positive feedbacks or internal disability to balance growth. (might develop this a bit further, it was done quite fast and only emphasizes the main points)
Session 7: Resource- ami competence-based perspectives: Implications Innovation Strategy (Philip) e
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Barney, J. (199]: Firm Resources am! Sustained Competitive Advantage, Journal ()f Management, J 7: 99-120 (19 p.) Pagc 34 of J 18
Theme Competitive advantage
Key words Sustained competitive advantage
Set of problems/focal points, main arguments and conclusion This article examines the link between firm resources and sustained eompetitive advantage. To have sustained eompetitive advantages the firm's resources has to be valuable, rare, imperfect imitable and substitutable (4 empirieal indieators). Firm resourees include all assets in the firm, and can be classified in 3 eategories: physical, human and organizational capital resources Conclusion To get or to keep sustained eompetitive advantages the firm's resources has to be valuable, rare, imperfectly imitability and substitutability. Otherwise competitors can eopy the resources and the firm will not have sustainable competitive advantages. Figure 2: Theories/models and their relation to the set of problems
Finn
ressources I-Ictcrogcn and
Immobile
Value Rareness Imperfect Imitability -History dependent -Causal Ambiguity -Social Complexity Substitutability
Sustained competitive advantage
Definitions Sustained competitive advantage: implementing a value creating strategy not simultaneously being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy. Compctitsve advantage: implcrncnting a value creating strategy not simultaneously being implemented by any current or potential competitors
Core compctenccs and rigidities (Leonard ¡13arton)
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Christensen, " in a of Open in It Chesbrough er (Z006): Open Innovation: Researching II New Paradigm, Oxford University Press (Z9 1'.). Dyer, ,1. it and It Siugh (I 998): The Relational View: Cooperative Strategy and Source" of Inter organizational competitive advantage, Academy of Management Review, 23 (17 p.)
Abstract 1. The text criticises the previous two views of super-normal returns; the industry structure view, which focuses on the industry (market power and industry barriers to entry) and the resource-based view (RBV). which
focus on the competitive advantages and disadvantages within the firm. The authors bring up a new view, the relational view of competitive advantages; this focuses routines and processes in a network. It is argued that sources of rents and competitive advantages, in an alliance, only can be achieved if the partners move away from arm's-length market relationships.
Pagc35 of] ] 8
Four potential sources of inter-organizational competitive advantages is proposed: 1) Relation-specific assets: a firm may choose to seek competitive advantages by creating assets that are specialized in conjunction with the assets of an alliance partner. 2) Knowledge-sharing routines: a production network with superior knowledge-transfer mechanisms among users, suppliers, and manufacturers will be able to "out innovate" production networks with less effective knowledge-sharing routines. 3) Complementary resource Endowment: distinctive resources of alliance partners that collectively generate greater rents than the sum of those obtained from the individual endowments of each partner. 4) Effective governance: Distinguish between two types of governance. The first relies on third-party enforcement of agreements, whereas the second relies on self-enforcing agreements such as trust (informal is subject to opportunism) or financial hostages (formal), in whieh no third party intervenes to determine whether a violation has taken place. Relational rents may be preserved through: All of Diericks & Cool's points and then the following: lnterorganisational asset interconnectedness will create a snow-ball effect between present relation-specific investments and future ones. Partner scarcity: relational rents depends on the firms ability to find a partner with complementary strategic resources and the firm's willingness to partner. Partner scarcity can make it difficult for competitors find a partner and thereby difficult to imitate products and processes. Resource indivisibility can occur when alliance partners combine resources. A problem with combining resources is that the partners' resources and capabilities might change over time, thereby making each company's ability to control and redeploy the resources less. Institutional environment can increase relational rents by encouraging trust among the alliance partners and has the necessary formal rules" Definitions Relational rent is a supernormal profit jointly generated in an exchange relationship that cannot be generated by either firm in isolation and can only be created in through the joint idiosyncratic contributions of the specific alliance partners. Partner-specific absorptive capacity refers to the idea that a firm bas developed the ability to recognize and assimilate valuable knowledge from a particular alliance partner. CI'W,me of Dyer &, They do not see anything between arm-length and alliances, which is not good enough. You do not need an alliance to create some relational rents as firms do interact 11lO1'C than just a normal buyer-seller relationship and create joint contributions without making contracts etc, .which is not easily imitable.
Abstract Z Relation-specific assets Knowledge-sharing routines Complementary resources/capabilities Effective governance Relational rents
Powell, W. \V. (1996) -- the text from 01'1 Dicrickx & Cool (1989)
Overall theme: Economic theories of organization, strategy and innovation I: Resource- and competence-based perspective
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Abstract: The text criticises the two views of super-normal returns, the industry structure view and the resource-based view (RBV), because they only focus on the competitive advantages and disadvantages within the firm, not in its network. The authors bring up a new view, the relational view of competitive advantages; this focuses routines and processes in a network. It is argued that sources of rents and competitive advantages, in an alliance, only can be achieved if the partners move away from arm's-length market relationships. To have a competitive advantage a firm must have something specialised, it could e.g. be assets. Site specific assets where immobile production facilities are located elose to one another, Physical asset specificity it is transaction-specific capital investment which is design for specific exchange partners, Human asset specificity is the know-how that is shared by long-time relations. e
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Proposition I: The greater the alliance partners' investment is in relation-specific assets, the greater the potential will be for relational rents. Proposition Ia: The greater the length of the safeguard is to protect against opportunism, the greater the potential will be to generate relational rents through relation-specific assets. Proposition Ib: The greater the volume of exchange is between the alliance partners, the greater the potential will be to generate relational rents through relation-specific assets.
Many studies have realised that networking and alliances partners arc one of the largest sources of new ideas, and that it is through these ideas that the companies can create competitive advantages. e
Proposition 2: The greater the alliance partners' investment is in interfirm knowledgesharing routines, the greater the potential will be for relational rents.
Knowledge is often divided into information/explicit knowledge and know-how/tacit knowledge. When sharing knowledge it is important to have partner-specific absorptive capacity with the ability to recognise potential ideas from. the alliance partners, It is dependent on the creation of overlapping knowledge-bases and interaction routines. II;
o
Proposition 2a: The greater the partner-specific absorptive capacity is) the greater potential will be to generate relational rents through knowledge sharing. Proposition 2b: The greater the alignment of incentives by alliance partners is to encourage transparency and reciprocity and to discourage lice riding, the greater the potential will tJC to generate relational rents through knowledge sharing.
Some companies posses' very good resources, hut they can only generate their full value if put together with other specialised resources, This makes an incentive for the companies with the different resources to create an alliance. e
e
Proposition 3: The greater the proportion is of synergy-sensitive resources owned by alliance partners that, when combined; increase the degree to which the resources are valuable, rare, and difficult to imitate, the greater the potential will be to generate relational rents. Proposition 3a: The ability of firms to generate relational rents by combining complementary resources increases with the firm's (l) prior alliance experience, (2)
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investment in internal search and evaluation capability, and (3) ability to occupy an information-rich position in its social/economic networks. In order to benefit from complementary strategic resources the firms need to develop organisational complementarity e.g. decision processes, control systems, culture. Failures in alliances and acquisition are often due to lack of organisational complementarity. e
Proposition 3b: The ability of alliance partners to generate relational rents from complementary strategic resources increases with the degree of compatibility in their organizational systems, processes, and cultures (organizational complementarity)
Governance plays a large role in the creation of relational rents because it influences transaction costs. There are two types of governance used by alliance partners: one relies on third-party enforcement of agreements e.g. legal contracts, and the other one relies on self-enforcing agreements. Self-enforcing agreements are divided into formal safeguards e.g. financial and investment hostages and informal safegnards e.g. goodwill trust or embeddedness. The ability to exchange partners in order to meet the governance structure can turn out to be a big advantage. e
e
e
Proposition 4: The greater the alliance partners' ability is to align transactions with governance structures in a discriminating (transaction cost minimizing and value maximising) way, the greater the potential will be for relational rents. Proposition 40.: The greater the alliance partners' ability is to employ self-enforcing safeguards (e.g. trust or hostages) rather than third-party safeguards (e.g, legal contracts), the greater the potential will be for relational rents, owing to (l) lower contracting costs, (2) lower monitoring costs, (3) lower adaptation costs, (4) lower recontracting costs, and (5) superior incentives for value-creation initiatives. Proposition 4b: Thc greater the alliance partners' ability is to employ informal self-enforcing safeguards (e.g. trust) rather than formal self-enforcing safeguards (e.g. financial hostages), the greater the potential will be for relational rent, owing to (I) lower marginal costs and (2) difficulty of imitation.
Evert though informal safeguards are best at developing relational they have tlfiO problems: 1) they take a long time t.o develop and 2.) they create a "paradox of trust.", because it can be abused through opportunism. Relational rents may be preserved through: Intcrorganisational asset interconnectedness will create a snow- ball effect between present relationspeci fie investments and future ones, Partner scarcity: relational rents depends on the firms ability to find a partner with complementary strategic resources and the firm's willingness to partner. Partner scarcity can make it difficult for competitors find a partner and thereby difficult. to imitate products and processes. Resource indvisibility can occur when alliance partners combine resources. A problem with combining resources is that the partners' resources and capabilities might change over time, thereby making each company's ability to control and redeploy the resources less.
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Institutional environment can increase relational rents by eneouraging trust among the alliance partners. Unfortnnately, I am not sure how to operate our scanner! So let me just inform you that there are 6 reasons to why relational rents are preserved on p. 673-674.
Conclusion The relational view seems to be superior to the industry structure view and the resource-based view, because it sees a company's network/alliances as a possible way to create competitive advantage and relational rents.
Definitions Relational rent: a very high profit, which is generated in an exchange relationship and which cannot be generated by either firm in isolation. Interfirm knowledge-sharing rontines: a pattern of interfirm interactions that allows the transfer, recombination, or creation of specialised knowledge. Complementary resource endowments: are special resources of an alliance that generate more rents, than they would have done individually. Abstract :3 Strateov and Market Development relational view: cooperative strategy and sources of inter-organizational competitive advantage
Jeffrey H. Dyer & Harbir Singh
'The relational view, inter-organizational competitive advantage, relational rent, Two prominent views have emerged regarding the sources of super-normal returns: the industry structure view associated with Porter and the resource-based view of the firm. However they botb overlook the fact that the (dis) advantages of an individual firm are often linked to the (dis) advantages of the network of relationships in which the firm is embedded. This article is based on a relational view and suggests that a firm's critical resources may be embedded in inter-firm resources and routines. Four potential sources of inter-organizational competitive advantage are identified: 1) relation specific assets, 2) knowledge sharing routines, 3) complementary resources and 4) effective governance. Relational rent is defined as a "supernormal profit jointly generated in an exchange relationship
that cannot be generated by either firm in isolation and can only be created through the joint idiosyncratic contributions ofthe specific alliance partners ". (p.662) Sources of relational rents 1) Inter-firm Re latio n .. specific Assets: Page 39 of 118
Speeialization of assets is a neeessary eondition for rent, but a firm may ehoose to seek advantages by ereating assets that are speeialized in eonjunetion with the assets of an allianee partner. Three types of asset speeifieity: Site speeifieity: When sueeessive produetion stages that are immobile in nature are loeated close to one another. Site-speeifie investments ean substantially reduee inventory and transportation eosts as well as the eosts of eoordinating aetivity. Physieal asset speeifieitYIJransaetion speeifie eapital investments (e.g. in eustomized machinery, tools, etc.) that tailor proeesses to partieular exehange partners. It ean allow for produet differentiation and may improve quality by inereasing produet fit. Human asset speeifieity: transaction specific know-how accumulated by transactors through longstanding relationships. This reduces communication errors and thereby enhancing quality and increasing speed to market. Proposition 1: The greater the alliance partners' investment is in relation-specific assets, the greater the potential will be for relational rents. Furthermore, the greater the length of the safeguard is to protect against opportunism and the greater the volume of exchange is between the alliance partners, the greater the potential will be to generate relational rents through relation-specific assets. 2) Inter-finn Knowledge-sharing Routines: Inter-organizational learning is critical to competitive success and organizations often learn from collaborating with other organizations. Alliance partners can generate rents by developing superior interfirm knowledge-sharing routines, which arc institutionalised interfirm processes that arc purposefully designed to facilitate knowledge exchanges between alliance partners. Knowledge can be divided into two types: A) Information (easily codifiablc knowledge that can be transmitted. It includes facts and symbols) B) Know-how (knowledge that is tacit, sticky, difficult to codify and thereby difficult to copy or transfer) The ability to exploit outside sources of knowledge is a function of the rccipients "absorptive capacity". Par.tllÂŁL~P.9giJj(:41;J!3Q1J)tive_(;1;PQ,GiJcY refers to the idea that a firm bas developed the ability to recognize and assimilate valuable knowledge from a particular alliance partner. Partner..specific absorptive capacity is a function of L) the extent to which partners have developed overlapping knowledge bases and 2) the extent to which partners have developed interaction routines that maximize the frequency and intensity of sociotechnical interactions. Proposition The greater the alliance partners ~ investment is in interfirm knowledge-sharing routines, the greater the potential will be for relational rents. Furthermore: .. the greater the partner..specific absorptive capacity is and .. the greater the alignment of incentives by alliance partners is 1.0 encourage transparency and reciprocity and to discourage free-riding q the greater the potential will be 1.0 generate relational rents through knowledge sharing.
3) Complementary Resource Endowments:
Page 40 of 118
Leveraging the complementary resource endowments of an alliance partner is another way whereby relational rents can be generated. Complementary resource endowments are defined as "distinctive
resources of alliance partners that collectively generate greater rents than the sum of those obtainedfrom the individual endowments ofeach partner "(p.666-667). Proposition 3: The greater the proportion is of synergy-sensitive resources owned by alliance partners that, when combined; increase the degree to which the resources are valuable, rare, and difficult to imitate, the greater the potential will be to generate relational rents. Furthermore, the ability of firms to generate relational rents by combining complementary resources increases with the firm's 1) prior alliance experience, 2) investment in internal search and evaluation capability, and 3) ability to occupy an information-rich position in its social/economic networks. However, although complementarity of strategic resources creates the potential for relational rents, the rents ean only be realized if the firms have systems and cultures that are compatible enough to facilitate coordinated action. Thus, a distinction can be made between initial complementarity l.搂.trii.ts:~ comQlementarity) based on potential combinations of resources, and revealed complementarity~Ilizational complementarity), based on the realized results of cooperation between the firms involved in the partnership. Proposition 3b: The ability of alliance partners to generate relational rents from complementary strategic resources increases with the degree of compatibility in their organizational systems, processes, and cultures (organizational complementarity). In short, hoth strategic and organizational complementarity is critical for realizing the potential benefits of combining complementary strategic resources. 4) Effective Governance: An important objective lor transactors is to choose a governance structure (safeguard) that minimizes transaction costs, thereby enhancing efficiency, 1\ distinction can be made between two classes of governance used by alliance partners:
I) Those relying onthird:J)'lI:ty(c))fQ):c;(;m.(;JlLQf~gt:(;Cmellts(e.g. legal contracts) and
Those relying on .~s:lf路ellf.:m:_ciDL~JlgLQ~~Jl}~:12~路 Within this class a further distinction can be made between "formal" safeguards (financial and investment hostages) and "informal' safeguards (goodwill trust or embcddcdncss). Informal safeguards (such as goodwill trust) arc the most effective and least costly means of safeguarding specialized investments and facilitating complex exchange, Thus, self-enforcing safeguards result in transaction costs that are lower than they arc in situations 'where transactors must erccrmore elaborate governance structures (such as contracts), which arc costly to write, monitor, and enforce, Proposition 4: The greater the alliance partners" ability is to align transactions with governance structures in a discriminating (transaction cost minimizing and value maximizing) way, the greater the potential will be for relational rents. Furthermore, The greater the alliance partners' ability is to employ self-enforcing safeguards rather than third-party safeguards, the greater the potential will be for relational rents, owing to I) lower contracting costs, 2) lower monitoring costs, 3) lower adaptation costs, 4) lower recontracting costs, and 5) superior incentives for value-creation initiatives.
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Likewise, within the self-enforcement mechanism category, informal self-enforcing safeguards (e.g. trust) are more likely to generate relational rents than are formal self-enforcing safeguards (e.g. financial hostages) owing to 1) lower marginal costs and 2) difficulty of imitation. Although informal safeguards have the greatest potential to generate relational rents, they are subjects to two key liabilities: 1) they take time to develop, because they require a history of interactions and personal ties, and 2) they are subject to the "paradox of trust" meaning that there is the risk of abuse through opportunism. This is why many alliances begin with the use of formal mechanisms and then, over time, employ more informal ones. Mechanisms that preserve relational rents Why do competing firms not simply imitate the partnering behaviour and thereby eliminate any competitive advantages that might be gained through collaboration? A variety of isolating mechanisms preserve the rents generated by alliance partners: o e
Causal
amb[glJity~ Competing
firms cannot ascertain what generates the returns.
Time comj2ression diseconomies~ Competing firms can figure out what generates the returns but cannot quickly replicate the resources.
s
InterorganizatLol1al asset interconnecJedness: . competing firms cannot imitate practices or investments because of asset stock interconnectedness (they have not made the previous investments that make subsequent investments economically viable) and because the costs associated with making the previous investments arc prohibitive.
o
PartneL.ยงcarcltr. competing firms cannot find a partner with the requisite complementary strategic resources or relational capability.
o
lZesourc9... incliyisihility: competing firms cannot access the capabilities of a potential partner because these capabilities are indivisible, perhaps having cocvolved with another firm.
e
lJ1."-titutiollill.<eJ1YU:o\1Jnenl: competing firms cannot replicate a distinctive, socially complex institntional environment that has the necessary formal rules (legal controls) or informal rules (social controls) controlling opportunism/ encourage cooperative behaviour.
In tJ1C end of the text the authors compare the Industry Structure VicV\1 and the Resourec-Based View with their own Relational View (sec Table 1 p. 674,)
,
(1995): II Neview,VoL ZO: 986-
of the
Theme Competitive advantage by rethinking production to meet the constraints nf operating in an increasingly stricter ecological. environment.
Key words Envirornental concerns, Business strategy of the future, recycling
Set of problems/local points, main arguments ami conclusion The industrialization has damaged the ecological environment on a global scale. Governments are concerned with the development of pollution emphasizing the importance of environmental consideration in companies production strategy. Environmental constraints challenge companies to operate in a more considerative way, whereas learning to operate within the environmental contraints becomes a future competitive advantage. Page 42 of! 18
Theories/models and their relation to the set of problems To obtain competitive advantage in an environmental economy, companies ought to be concerned with: pollution prevention: a) control: emissions are trapped, stored, treated and disposed of using pollution-control equipment( expensive, non-productive, "end -of-the pipe" pollution control technology) or b) prevention: emissions are reduced, changed or prevented through better house-keeping, material substitution, recycling or process innovation(reduces pollution during the manufacturing process). On a longterm basis companies can achieve significant savings and herby improve a cost advantage towards competitors. (p992) Product Stewardsshi12: The managerial challenge is implement environmental materials in to the productionfacilities. Hereby achieving a green production system that hinders govermental penalties of waste produced. Considerations involve a choice of partners at all levels ofthe valuechain. Firms can a) exit envirorunentally hazardous businesses, b)redesign existing prodnct systems to reduce liability, c) develop new products with a lowlife cycle.(p994) Sustainable Development: By environmental consideration companies are able to develop competitive advantages in relation to non- environmental considerative competitors, thereby increasing their future perfomance due to experience of being able to operate on a high production scale within the boundaries of environmental constraints.( A green First-mover advantage) A natural-resource-based strategy is costly in the beginning, however it companies will benefit from it on a longterm basis due to increasing penalitics of extending the allowance of waste produced. Conclusion: Companies competitive strategies will eventually fail if companies do not integrate the notion of a green economy in to their bnsiness philosophy. The enviroment has become a crucial factor supervised by Governments that penalize actors who exceed waste limitations. The solution is to prepare the production facilities towards a green economy quickly, obtain experience with the new factors involved, and thereby obtain 8 competitive advantage.
Extra informatien from. class ".
overview 0 f cO!l~i d.\;!8!i2 n s.J.:;.££2l!.ill,2Y.~Jl(~1~(1i:le.DJlpm.:~lE
Strategic capability
Environmental driving force
'Carget areas
Key resource
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Pollution
prevention Product stewardship
Sustainable development
Minimize emissions/waste
Minimize lifccycle costs of
products
Production/ operations
Continuous improvement
Product/tech" nology development
Minimize All functions environmental burden of firm growth and development
Lower costs
Stakeholder integration
Shared
01
Di fferentiation
V1SlOi1
e Future position
e Rcnutation
Session 8: Building competencies for competitive advantage through environmental benchmarking and strategies for sustainability (Michael) Page 43 of 118
e
Hall, 1. and Vredenburg (2003): The Challenges ofInnovation for Sustainable Development,
MIT Sloan Management Review, 45 (8 p.) e
Further material may be provided prior to session.
Session 9: Simulation "game" based on the pharmaceutical company Alza (Michael) e Alza and ADDs, pp. 1-3 (simulation developed by Jerome Davis, based on an INSEAD case). Theme This was the first simulation we had in elass. The case is only 3 pages.
Keywords The ALZA negotiating team vs. Ciba-Geigy negotiating team
Set of problems/focal points, main argnUl.cnts and con elusion This ease was in the lectures about make or buy decisions. ALZA, specialized in advanced drug delivery systems (ADDS) bad financial difficulties and was looking for rescue. They found Ciba-Geigy, a large Swiss chemical/pharmaceutical company that were interested. The class was divided in 6 groups, 3 from ALZA and 3 from Ciba-Geigy. The negotiations had following options: 1. Ciba can purchase 100% of ALZA 2. Ciba can purchase 80% of ALZA shares
3, Ciba can enter various cooperative research contract arrangements for specific projects 4. Ciba can enter various licensing agreements whereby they can. use patents and know how. 5. From -4. Ciba can extend a loan partncring.
ill
conjunction with licensing agreements and
k1.10\\I
how
Many different solutions from the different groups
information frORYR class ALZA in real life: ALZA did approach Ciba in reallife, and they did have a collaboration but it didn't last. 1990' s ALZA builds up its own sales and marketing department 2001 Johnson & Johnson acquires ALZA, making it a who11y owned subsidiary
Session 10: Transaetion cost perspectives: Make or buy? (Lisa) â&#x20AC;˘
Williamson, Oliver (1981). "The economics of organizatlon: The transaction cost approach," American Journal of Sociology, 87 (3), pp. 548¡557.
Page 44 of 118
Introduction Transaction cost theory and the ability to economize thereon. Transaction based costing is an analytical tool it is mostly used to explain economic problems where asset specificity plays the key role Economic approaches to the theory of organization, transaction cost analysis included, generally focus on efficiency. The focus on efficiency is established by making the transaction - rather that the commodity - the basic unit of analysis, and by assessing governance structures, of which firms and markets are the leading alternatives.
II. Some rudiments The theory oftransaction costing was then Coase realised that the boundary of the finn was the 'decision variable' for which an economic assessment was needed. "What is it that determines when a finn decides to integrate, and then instead it relies on the market?" A transaction occurs whcn a good or service is transferred across a technologically separate interface. One stage of activity ends and another begins. Any friction; loss of time, money, energy, (mishandling, conflict, delay, malfunction) is a transaction cost. Thc comparative costs of planning, adapting and monitoring task completion under different governance structures. Can we identify the factors that allow for small (or large) transaction costs? Two behavioural assumptions on which transaction cost are based 1) Humans arc subject to bounded rationality! 2) At least some humans arc opportunistic Should humans not
opportunistic, contracting would be sufficient.
The critical dimensions for describing transactions arc I) uncertainty 2) frequency of transaction 3) the degree to which transaction specific (unique to the product) investments are necessary. (asset specificity) The paper takes recurrent transaction 8S necessity so only uncertainty and asset specificity are discussed Asset specificity -_. meaning that investments arc specialised to a particular transaction, it is important because it means that future trades are tied to this transaction. If investment is not specified then the seller can sell to a variety of buyers without problem, and vice versa. Asset specificity arises in 3 ways Site specificity - proximity to the buyer Physical asset specificity - when the finished product is a component usable by one buyer Human asset specificity -. due to learning by doing The reason asset specificity is critical is that, once an investment has been made, buyer and seller are effectively operating in a bilateral (or at least quasi-bilateral) exchange relation for a I That humans will make the choice they think serves them best. But this choice is not always best as humans have an inability to process and compute the expected utility of every alternative action
Page 45 of] 18
considerable period thereafter. The supplier is 'locked into' the transaction -- and the buyer will uot be able to obtain from other suppliers at favourable terms as the cost of supply from a nonspecialised asset is (much) greater. There is a mutual commitment and both parties will design an exchange that has good continuality properties.
HI, Efficient Boundaries Explains what transactions are to be included in the organization and effectively defines organisational boundaries. Two choices arc considered, a firm makes a component itself _.- or buys it from a supplier. Tbe point is to describe how economising decisions that define the outer boundaries of a firm are made. Transaction cost reasoning is central to this analysis: trade offs between production cost economies (in which the market has the advantage) and governance cost economies (advantages may shift to the internal organisation) need to be recognised. The choice between firm and market organisation is thus: If assets arc nonspecific, markets enjoy advantages in both production cost and governance cost respects; (because) static seale economies can be more fully exhausted by buying instead of making; markets can also aggregate uncorrelated demands, thereby realizing risk-pooling benefits; and external procurement avoids many of the hazards to which internal procruement is subject" Classical market contracting is best when _. assets arc non specific to trading partners Bilateral or obligational contracting is best when - assets are semi specific Internal organisation when .n. assets arc highly specific advantages of Finns over markets are: internal organization is ethic to invoke fiat to resolve differences "" better access to information ,路k
Example: OM entered into a bilateral exchange agreement with Fisher motors. The 10 year contract included pricing details. After demand from OM rose they urged Fisher to move closer to the OM site to realise transport and efficiency economics. The components were physical asset specific, and there was site specificity. As per the theory internal procurement of the parts would have been preferable, and in the end OM bought Fishel'. Furthermore, there were substantial demand and cost uncertainties .u_ which give incentive to shift transactions inside the.
IV, Managing Human Assets: The Employment Relation According to transaction-cost approach, "skills acquired in a learning-by-doing fashion and imperfectly transferable across employees need to be embedded in a protective governcnce structure, Meaning that employees with codified skills learned within the organization, must be retained.
Page 46 of 118
Output in a finn is yielded by a team, and not by the sum of its individual workers. The tasks between the workers are inspeperable. A way to order to 'meter' or measure produetivity must be devised. Human assets can also be measured by 1) degree of finn-specificy and 2) difficulty of individual productivity measurability Low of 1 and 2 is a internal spot labor market. Low l/High 2 is a primitive team. High 1ILow 2 is an obligational market with defined rules for performance. J:ligh 1IHigh 2 is the relational team where assets are specific and individual output hard to measure. Diffieult .._. to monitor . .._ .. . Easy to Monitor . .._._..... .. . ... Nonspecific Human Internal Spot Market Primitive Team Assets Neither workers nor firms have an Membership can be altered efficiency interest in maintaining the with losing much association productivity, compensation can be difficult to match with performance. Specific 1·1 uman Relational Team Obligational Market The firm will engage in Assets Both workers and firms have an considerable efforts to keep efficiency interest in maintaining the employees, but this will be association seen on a finn-wide level. Ic, Benefits and job security, and will not b e ' "., ~-
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Transaction cost theory is an interdisciplinary approach to the slody of organizations that joins economics. organizational theory and aspects of contract law, Its application to commercialrather than non-commercial is higher and governance structures that have better transactional cost economizing properties will eventually displace those that have worse.
e
P. (J 990). Managing Business Trensactions. York Chapters 1 and 2, "Make or Buy?" Complex
Abstract 1
Theme There are two main themes: I) When to make or buy inputs needed in a firm. 2) Transactional terms when buying complex inputs. Keywords Page 47 of 118
Press. "pp. 3·A2. (40 pp.)
Complex transactions, Hold up, Opportunistic behaviour, Quasirents (def. page 5), Vertical integrations
Set of problems/focal points, main arguments and conclusion The decision of wither making or buying an input depends on the type of input needed. Is the input of a simple character or is it of a more complex structure. If it is complex there will be an asset specificity that could be characterised by either a geographic linkage (fx distance is crucial) between the purchasing company and the supplying company or it could be of a more physical character. (fx product is only useful for one customer) If a transaction is complex the contract will most likely also be complex, A complex contract is said to be incomplete as it is impossible to specify a contract which will cover all eventualities, and still avoid any opportunistic behaviour. If exploitation of the quasirent occurs the firm should consider making instead of buying (vertical integration). Vertical integration will not save costs bnt if a hold up possibility exists efficient transactions may not occur. The presence of potential hold up problems does not by itself guarantee that such integration will be beneficial; it rednces possibilities for cost control as compared with use of markets, so the cost of the hold up problems must be greater than the loss in efficient cost saving for such integration to pay. Another aspect is the ownership of the asset. Should the asset be owned by the firm it self or by a supplying firm (most useful with assets used in production). The advantage of ownership is the ability to prevent opportunistic behaviour associated with the use of the asset with respect to residual rights. So the firm should decide if they should be owned by that party whose investments in the asset are more important for maximizing total productivity. If both firms has equally importance they should integrate, if this is not the case for nay of the firms involved then the firms should not integrate. If a decision is made to vertically integrate, then the firm will often buy an existing, ongoing business. In many eases the transaction will not take place instantaneously and the value at the time of closing may depend on events which occur between the time of the agreement and the time of closing. The selling party might have incentives to under spend on maintenance during the interim period. which would increase earnings although it will reduce the value of the company by more than this increase. Therefore it will he uscfu: to agrce on a method of valuation which will not create any inefficient incentives, Vcrtical integration Is one solution to potential opportunism. However there will be circumstances under which this will not be feasible and firms will transact with each other even though there arc possibilities for opportunism. There are several methods of reducing opportunism. as both involved parties have an incentive to make the transaction as efficient as possible since this will increase the amount to be divided between the parties. One method is a contract, but as stated above it is impossible to write a contract which is sufficiently complete to protect a firm's interests in a situation of a complex contract, why other mechanisms should be used when possible. Self enforcing agreement can also he of subject. No formal contract is written but each party abides by the agreement only so long as it pays to do so. The price for the product needs to be such that the expected future profits form continuing the transaction will he greater than the one-shot profits from cheating. No fixed termination date must be known for this agreement to be usable; otherwise the parties will cheat in the last period as no penalties will be given. Reputation is most often of great importance for firms, so to keep their good reputation companies will not cheat. So a firm with a good reputation is more reliable. Page 48 of 118
Intrafirm transactions can in some occasions be very similar to transactions between firms. In a company with many divisions there will often be transfers of produets between the divisions, whieh may create ageney problems of opportunism. Two teehniques for controlling these kinds of transaetions are market techniques and direct hierarchical control. Simulating a market: The division will deal with each other in ways similar to independent firms. The divisions will have the option to buy or sell outside, in addition to dealing with the other division. Managers will seek to be promoted, and promotion prospects may depend on the relative profitability of the division. If the two divisions can interact efficiently only through market-like mechanisms, then they should probably be independent and actually use the market. Hierarchieal structure: Selling division will essentially be subordinate to the buying division. The buying division will function as a profit center, while the selling division will function as a eost centre. For this structure, rewards depend in direct monitoring of the efficiency and performance for each party. Conclusion The firm needs to decide whether it is most feasible to make or buy the input needed. If the iuput is complex either to produet or need complex production facilities, opportunistic behaviour could very well oceur. If the cost of the hold up problems is greater than the loss in efficient cost saving, vertical integration was most likely not the correct decision. If the cost of the hold up problems is not greater than the loss in efficient cost saving, then the firms should find a feasible way for both parties to interact. A written contract is not the best solution and if used it should be followed up by other incentives. Definitions Complex transactions: Involve terms other than simple price and quantity, a need for special machines/competencies/ inputs to manufacture and use the product. One party of the transaction knows more than the other and the less knowledgeable party do not want to be exploited because of his ignorance. Opportunistic behaviour: When 8 supplier or customer takes advantage of its (specialised) position, as the assets arc closely linked and the purchaser is in a great need for the input. Hold up: When opportunistic behaviour occurs and the supplier increase prices, demand additional payments, increase delivery time etc. Quasirents: The difference between the amount 'which would be needed to justify an, investment and the 8J110unt which justifies operating it after it is undertaken, Vertical integrations: If the firm owns the production it self. The assets together arc worth more if they are owned by one party than if they are separately owned, Residual rights: Those rights which arc not specified in the contract. Ahstrael 2 Strategy and Markel Development
12MclH:::h2004
Ole Knstian Aagotncs H. Rubin
Managing Business Transactions
+C+C+C-S+
Make-or-buy decision, vertical integration, hold-ups, opportunistic behaviour, quasi-rent exploitation, assets specificity, Buying and selling businesses -7 Transactional issues m",
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This chapter examines different aspects of whether a company should vertical integrate or buys its services/products. Point of departure is when and why a company should vertical integrates, and ClS an example of this matter is the case of a hauling firm and a landfill company. f-urthermore it raises the issue of when and how to assets should be under joint ownership. The author takes the asset ownership issue further and highlights aspects related to the problems of buying products in the market -7 asymmetric information ~ high cost related to quality control -) incentives to vertically integrate. All in all thc chapter scrutinize various aspects on how to avoid exploitation and how to optimize your investments and profits through join! ownership, buy a supplier etc. Chapter two examines various aspects of buying complex products and how to avoid opportunism in the transactions.
~~~~~~~-~,-~
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"Make or Buy" decision The "make or buy" decision is a classical issue in managerial concerns. However majority defines this issue as an accounting or financial issue. This is indeed true, but there is more to it than so. The accounting and financial issnes are last mile aspects, whereas the managerial issues are the basis of the "make or buy" decision. Initially it would make sense to buy in the market. Other things equal, it is easy and cheaply to control costs related to buying products/services in the market; hence the best way to control cost is through the market. Therefore, the first presumption should always be for purchasing inputs on the market. However this should not be employed as the almighty truth, since there are several situations were it is necessary to integrate vertically. Therefore in order to make a "make or buy" decision we need to examine factors, which interfere witb market provisions of the inputs. In order to understand this we need to ask why tbe market will not provide the products/services cheaply, or why sometbing may happen to make the input unavailable. The issue of exploitation
In relation to the abovementioned it the "make or buy" decision is a matter of how much power a given supplier has -7 that is to what degree is the supplier capable of exploit its buyer -7 To what degree is the firm and supplier open to opportunistic behaviour, tbat is taking advantage of its position with respect to another firm. The author exemplifies this subject matter witb a case. The two case agents arc a hauling firm and a landfill company. The Hauling company is depended on the landfill finn in order to dump its garbage. The question here is then whether the bauling company should buy the landfill company in order to avoid quasirent (hold up) exploitation. There are several issues to consider related to this. [J
The Hauling Company should not buy the landfill firm, if the quasi rent cost is lower than the investment of buying. They still generate higher profits than if they buy it.
[I
The Hauling company could go into joint ownership with the landfill company路路路 share of assets
[J
The Hauling Company could use another landfill arca even though this may be located far away it may still he cheaper than pay the extra cost to the current landfill company. >
These arejust a few examples ofhow to avoid "quasircnr/hold-up" but enlighten the issue of the complexity of the problems (the case is described at page 5-7). Contractual Solutions
An obvious move to avoid exploitative behaviour is to draw specific contracts on future relationships. Unfortunately it is impossible to specify a contract, which will cover ali eventualities. Even if a contract would be written with sufficient specificity, enforcement would be difficult. In many cases where exploitation is possible} time is important, so that the delay associated with litigation (rver <1 contract breach might itself impose substantial costs on the finn,
Vcrtical integration
As mentioned before the best way to control cost is through the market; however in the case of high risk of exploitation it is in some situation better to integrate vertically) and hereby avoid quasirent exploitation. When you as a buyer owe you own assets and your suppliers you can avoid this hold-up problem. More specific the two companies arc worth more under joint ownership than they arc worth if owned separately. This is basically due to that the two sets of assets (se case) arc closely linked (and depended), and therefore a possibility of opportunistic behaviour exists if they arc separately owned. Moreover if the two companies arc separately owned they may be investment averse due to the possibility of bold-ups from the other side. Worst case scenario is that no efficient investment will be undertaken and can lead to market failure! However it is essential that the two assets in the respective companies are vital 10 one and each other. If the buyer can find another supplier at low transaction cost it is not necessary to vertically integrate. More specific if there are no specialized assets and no measurement costs, the firm should not even contemplate Page 50 of 118
internal production. Moreover in examining the issue of ownership of assets it should be clear that those parties whose investments are most important in increasing the value of tile assets should own the assets. Additional problems related to the "buy or sell" decision can be the issue of when a seller may exploit a buyer by selling a lower quality product than was expected or agreed npon. This will increase the profits of the seller at the expense of the buyer. The seller can know more about quality than the buyer (asymmetric information). Point being is the marc difficult it is to measure quality of an intermediate good, the more likely it is for vertical integration to be justified. Vertical integration should occur when quality monitoring and measurement is least costly. Buying or selling a business If the firm decides on vertical integration, then it may be useful to acquire an ongoing company. After profound analysis (both managerial, accounting and financial) whether to vertical integrate or not, there are substantial other issues to deal with in order to avoid opportunism L1
At what price should the sale occur
L1
The managerial insight of the attorneys
[J
Future valuation - when a sale takes place in the future, how should seller and buyer agree on price
11
The seller may undercut its expenses in the interim period in order to maximize profits .. how to make legal agreements related to this.
L1
Informational issues - is there fnIl information related to the sale "'" incentive to provide full information and incentives not to.
-7 The author gives some examples on how to make the transactions marc transparent; that
IS
a
verifications of information (two methods) "'" Indemnifications and third party certification Buying Complex Products As discussed in the previous section, vertical integration is one solution to potential opportunism. However one can not always execute this action due to certain circumstances or situations. Moreover the company need to evaluate potential economics of scale and scope. If these arc not existence then the company should identify other alternatives. As one alternative route to this the company can buy the products. However there arc several precautions a company need to take when buying complex products. In relation to this Rubin suggest several methods to avoid opportunism and exploitation, however an determined by the specific situation the company: are to be found in. Efficient contracts .-) Is one 'way of dealing between a "performing" and a "paying" part)', however there arc certain pit-falls related to this method n
The performing part}! may not perform as agreed upon, or the paj-ling party may not pa~y full amount or delayed payment. However most companies have an incentive for the contract to be efficiently written, monitored and enforced. Both companies arc willing to make an extra effort in order to make the transactions as S111001:h as possible (other things equal this is a time and money saving process)
[J
However one party 111ay have an intention to breach OJ' behave opportunistically one way to avoid this is 10 propose methods of efficient contracting, if the other party rejects these proposals it may be a sign that he or she is not negotiating in good faith. Therefore a good way to avoid dealing with such parties is to rely on reputation.
l:J
Sum sumarum: Both parties should make an effort to make the transaction as smooth as possible in order to optimize the profits and benefits.
L1
A last resort method is to rely on a contract is to introduce explicit contracts which can be enforced by law however it is nearly impossible to use these contracts as a point of departure in negotiation due to ~
It is impossible to write a contract that is sufficiently complete. Page 51 of 118
~
It is very time consuming to use courts as a mean to determine frauds and opportunism.
~
Therefore courts should be viewed as a last resort method; however they are useful and very
necessary
111
some cases
Other methods of reducing opportunism
A common method of negotiating and make agreements is to structure a contract to be self-enforcing. It requires no fixed ending date for the transaction due to the possibility of opportunism if such date is set. Example of this can be lower quality than agreed upon, or lower sales volume thau agreed upon. However most business agreements are performed by self-enforcing agreements and the transactions between suppliers and their customers are mostly marked an informal basis and the major sanction for opportunism is simply the loss in future business. Therefore, an important aspect of this is the reputation of each patty and moreover the integration between the patties. Another way of assuring performance is to offer a hostage - a valuable asset which will be lost if a contract or agreement is not honoured. Hereby the parties are locked and they will optimize their performance in order to avoid asset loss. Examples of hostages []
Cash bond - a performing party establishes a bond which is to be forfeit if he does not performs
D
Damage payments - for delayed or inadequate performance.
A pit-fail related to this can be the incentive for the hostage "keeper" to induce breach. Hereby they will "win" the other party's hostage asset. To avoid opportunism the two parties can engage in reciprocal exchange, so that each has an automatic performance bond with respect to each other. One example of this can be joint ventures and strategic alliances (e.g. Japanese companies). As before mentioned a very good yardstick to guarantee performance is the reputation of the involved company, and in most cases firms should invest in acquiring such a reputation. Again as a wrap-up it can be argued that the only technique always available is the explicit written contract with reliance on the courts for enforcement. However this should only be used as a last resort, since the process is very time consuming and costly.
"
,
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I
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The managerial basis for <:1 Make- or Buy decision (chapter 1) i Transactional terms when buying complex inputs (chapter 2) ! Complex transactions,
i Holdup Opportunistic behaviour
I, Quasircnts
I
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I
Overall theme: When to make- or buy inputs needed in a firm Abstract The decision of either making or buying an input depends on the type of input needed, is the input of a simple character or is it of a more complex structure. If complex their will be an asset specificity that could he characterised by either a geographic linkage (fx distance is crucial) between the purchasing company's asset and the supplying company's asset, or it could be of a I110m physical character (product is only useful for one customer). If a transaction is complex the contract will most likely also be complex, a complex contract is said to he incomplete as it is impossible to specify a contract which will cover all eventualities, and still avoid any opportunistic behaviour. If exploitation of the quasircnt occurs the firm should consider making instead of bnying (vertical integration). Vertical integration will not save costs but if a Page 52 of 118
holdup possibility exists then efficient transactions may not occur. The presence of potential holdup problems does not by itself guarantee that sueh integration will be beneficial; it reduces possibilities for eost eontrol as eompared with use of markets, so the cost of the holdup problems must be greater than the loss in efficient eost saving for sueh integration to pay. Another aspect is the ownership of the asset, should the asset be owned by the firm it self or by a supplying firm (most useful with assets used in produetion). The advantage of ownership is the ability to prevent opportunistie behaviour associated with the use of the asset with respect to residual rights. So the firm should decide if they should own the assets or if the assets should be owned by another firm. In general the asset should be owned by that party whose investments in the asset are more important for maximising total productivity. If both firms has equally importance they should integrate, if this is not the case for any of the firms involved then the fil111S should not integrate. If a decision is made to vertically integrate, then the firm will often buy an exrstrng, ongoing business. In many cases the transaction will not take place instantaneously and the value at the time of closing may depend on events which occur between the time of the agreement and the time of closing. The selling party might have incentives to underspcnd on maintenance during the interim period, which would increase earnings although it will reduce the value of thc eompany by more than this increase. Therefore it will be useful to agree on a method of valuation which will not create any inefficient incentives. Vertical integration is one solution to potential opportunism. However there wilI be circumstances under which this will not be feasible and firms wilI transact with each other even thongh there are possibilities for opportunism. There arc several methods of reducing opportunism, as both involved parties have an incentive to make the transaction as efficient as possible since this will increase the amount to be divided between the parties. One method is 3 eont1'3ct, but as stated above it is impossible to write a contract which is sufficiently complete to protect. a finn's interests in a situation of a complex contract, why other mechanisms should be used when possible. If the part produced itself requires a special input (specialised tooling) and moreover a m"bjJro (another manufacture can 1:211<:c over), The customer could own the machines etc itself and opportunism will be reduced. SelLÂŁ11fo!'(o.i!lgAgI;<::,otDent can also be of subject. No formal contract is written but each party abides by the agreement only so long as it pays to do so. The price for the product. need to be such that the expected future profits from continuing the transaction win he greater than the one-shot profits from cheating. No fixed termination date must be known for this agreement to be usable; otherwise the parties will cheat. in the last. period as no penalties will be given. Reputation is most often of great importance for firms, so to keep their good reputation companies will not cheat. So 3. firm with a good reputation is more reliable. Intra1J,nn Jl:ijJ1sacjjons can in some occasions be very similar to transactions between finns. In 3. company with many divisions there will often be transfers of products between the divisions, which may create agency problems of opportunism. Two techniques for controlling these kinds of transactions arc market techniques and direct hierarchial control. Simulating a market: The divisions will deal with each other in ways similar to independent. firms, The divisions will have the option to buy or sell outside, in addition to dealing with the other division. Managers will seck to be promoted, and promotion prospects may depend on the relative profitability of the division. If the two divisions can interact efficiently only through market-like mechanisms, then they should probably be independent and actually use the market. Page S3 of 118
Hierarchial strueture: Selling division will essentially be subordinate to the buying division. The buying division will funetion as a profit center, while the selling division will funetion as a eost center. For this structure, rewards depend in direct monitoring of the effieieney and performance of eaeh party.
Conclusion The firm needs to decide whether it is most feasible to make or huy the input needed. If the input is eomplex either to produee or need eomplex produetion facilities, opportunistic behaviour could very well occur. If the eost of the holdup problems is greater than the loss in efficient cost saving, vertical integration could be preferable. If vertical integration is decided, the most preferable structure would be hierarchial structure, as if market simulation is the only feasible way then vertieal interaction was most likely not the correct decision. If the cost of the holdup problems is not greater that the loss in efficient cost saving, then the firms should find a feasible way for both parties to interact. A written contract is not the best solution and if used it should be followed up by other incentives
Definitions Complex trmlsactions: Involve terms other tban simple price and quantity, a need for special machines! competencies! inputs to manufacture and use the product. One party of the transaction knows more than the other and the less knowledgeable party do not want to be exploited because of his ignorance. Qrmortuni'itic;jl_,"haviour: When a supplier or customer takes advantage of its (specialised) position, as the assets are closely linked and the purchaser is in a great need for the input. Holdu];J.: When opportunistic behaviour occurs and the supplier increase prices, demand additional payments, increase delivery time etc. (D!a,sire:lJts: The difference between the amount which would be needed to justify an investment and the amount whichjustifies operating it after it is undertaken. Yf.Dcal intflJ!xatiol15_: If the finn owns the production it self T11C assets together are worth 1n01'e if they are owned by one party than if they arc separately owned. geBLcJ,JltlUjg!lta: Those rights who are not specified in the contract. !\.hstnH路[ "
Theme The text deals with the classic managerial concern of whether to make or buy inputs needed in a firm. If a company decides to make an input, it will transact internally with a division or another part of the company. If it decides to buy it will contract with another organization.
Abstract
The decision of either making or buying an input depends OJ] the type of input needed; is the input of a simple character or is it of a more complex structure. If complex their will be an asset specificity that could be characterised by either a geographic linkage (fx distance is crucial) between the purchasing company's asset and the supplyiug company's asset, or it could be of a more physical character (prodnct is only useful for ouc customer). When it is a simple transaction and the capabilities to make don't exist in-house or is important to take in house, buy on the market. If it is a simple transaction and the two assets together are worth more if owned by one party take the input in-house. If the input is complex, certain managerial elements need to be taken into consideration before deciding whether to buy or make, Contracting Page 54 of 118
If a transaction is cOl.!!plex,' the contract will most likely also be complex; a complex contract is said to be incomplete as it is impossible to specify a contract which will cover all eventualities, and still avoid any opportunistic behaviour. Vertically Integrating If exploitation of quasi-rents' can occur the firm should consider making (vertical integration) instead of buying. Vertical integration will not save costs but if a hold-up' possibility exists then efficient transactions may not occur. The presence of potential hold-up problems does not by itself guarantee that such integration will be beneficial; it reduces possibilities for cost control as compared with use of markets, so the cost of the hold-up problems must be greater than the loss in efficient cost saving for such integration to pay. Moreover if a decision is made to vertically integrate, then the finn will often buy an existing, ongoing business. In many cases the transaction will not take place instantaneously and the value at the time of closing may depend on events which occur between the time of the agreement and the time of closing. The selling party might have incentives to under-spend on maintenance dnring the interim period, wbich would increase earnings although it will reduce the value of the company by more than this increase. Therefore it will be useful to agree on a method of valuation which will not create any inefficient incentives. Even though vertical integration is one solution to potential opportunism, opportunism within the company is also a potential issue. lntrafinn transactions can in some occasions be very similar to transactions between firms. In a company with many divisions there will often be transfers of products between the divisions, which may create agency problems of opportunism. Two techniques for controlling these kinds of transactions are market techniques and direct hierarchical control.
Simulating a market: The divisions will deal with each other in ways similar to independent firms. The divisions will have the option to buy or sell outside, in addition to dealing with the other division. Managers will seek to be promoted, and promotion prospects may depend on the relative profitability of the division. If the two divisions can interact efficiently only through market-like mechanisms, then they should probably be independent and actually usc the market.
Hierarchial structure: Selling division will essentially be subordinate to the buying division. The buying division will function as a profit center, while the selling division will function as a cost center For this structure, rewards depend in direct monitoring of the efficiency and performance of each party.
Tr',mSf"rti"gnn the rm'ยง.rke{ llowevcr it is not always feasible to vertically integrate and firms will need to transact with each other even though there arc possibilities for opportunism, There axe several methods of reducing opportunism, as both involved parties have an incentive to 1113ke the transaction 8S efficient E1S possible since this will increase the amount to be divided between the parties. If the part produced itself requires a special input (specialised tooling) and moreover manufacture can take over), opportunism will. be reduced.
3 n1"Q12jJ~L.(anothcr
1.Involveterms other than simple price and quantity, a need for special machines/ competencies! inputs to manufacture and use the product. One party of the transaction knows more than the other and the less knowledgeable party do not want to be exploited because of his ignorance. 3 The difference between the amount which would be needed to justify an investment and the amount which justifies operating it after it is undertaken. 4 When opportunistic behaviour occurs and the supplier increase prices, demand additional payments, increase delivery time etc.
Page 55 of! 18
Self enforcing agreemcnt can also be of subject. No formal contract is written but each party abides by the agreement only so long as it pays to do so. Tbe price for the prodnct need to be such that the expected future profits from continuing the transaction will be greater than the one-shot profits from cheating. No fixed termination date must be known for this agreement to be usable; otherwise the parties will cheat in the last period as no penalties will be given. Reputation is most often of great importance for firms, so to keep their good reputation companies will not cheat. So a finn with a good reputation is more reliable.
Hostage,i Hostages are nsed to prevent opportnnistic behaviour by providing a valuable asset, if contract is broken or not honoured. Another aspect is the ownershirLof th".1lsset, should the asset be owned by the firm it self or by a supplying finn (most useful with assets used in production). The advantage of ownership is the ability to prevent opportunistic behaviour associated with the use of the asset with respect to residual rights'. So the firm should decide if they should own the assets or if the assets should be owned by another firm. In general the asset should be owned by that patty whose investments in the asset are more important for maximising total productivity. If both firms has equally importance they should integrate, if this is not the case for any of the firms involved then the firms should not integrate. Conclusion The firm needs to decide whether it is most feasible to make or buy the input needed. If the input is complex either to produce or need complex production facilities, opportunistic behaviour could very well occur. If the cost of the hold-up problems is greater than the loss in efficient cost saving, vertical integration could be preferable. If vertical integration is decided, the most preferable structure would be hierarchical structure, as if market simulation is the only feasible way then vertical interaction was most likely not the correct decision. If the cost of the hold-up problems is not greater that the loss in efficient cost. saving, then the firms shonld find a feasible way for both parties to interact. A written contract is not the best solution and if used it should be followed up by other incentives o
Fahre, Johannes airports .... a
Beckers, Thorstcn (2fJl:l6). "Vertical governance between airlines and cost )'; Review ofNetwork 5 PI!'.
386路41 :L
Firms have particular institutional capabilities that allow them to protect knowledge from expropriation and imitation more effectively than market contracting. This is in direct contrast to tradition a] transaction costing, which dismisses institutional capabilities. Liebcskind points out that transaction costing is a dissatisfying theoretical framework for theorizing about the relationship between organization and competitive advantage, She argues that it fails to include key elements of strategy such as rent generation, and creating/sustaining sources of competitive advantage. She argues that transaction..costs theory can be extended to accommodate knowledge in a way that is useful for strategy research. Firms, as institutions, playa critical role in creating and sustaining competitive advantage: that of protecting valuable knowledge. 5 Those
rights who arcnot specified in the contract.
Page 56 of] 18
Because property rights in knowledge are weak, and are costly to write and enforce, firms are able to use an array of organizational arrangements that are not available in markets to protect knowledge. Firms can (a) differentially prevent expropriation of knowledge and (b) differentially reduce the observability ofknowledge and its products. In this way, firms are able to create 'possession rights' to knowledge that are just as valuable, if not more valuable, than the limited property rights to knowledge accorded under the law. Incentives to innovate depend on the degree to which the innovator can appropriate future rent streams. Thus, we should expect to observe a long-run correlation between a firm's rate of innovation and its success at protecting the knowledge that it generates.
Knowledge "information whose validity has been established through tests of proof" Through its value and scarcity, knowledge can create both Rieardian6 and monopoly rents. A firm must protect its knowledge from appropriation or imitation by its competitors, but this is costly and difficult. Due to: Intellectual property laws bcing narrowly defined under the law, and are costly 1.0 write and enforce. The difficulty in detecting expropriation, or illegal imitation of knowledge Table L
,\,
Limits 10 !ega! protections for knowledge Parents
Copynghts
Trade Secrets
X
x
X
Limits 10 scope Codir;ed klluwkdgcc 'ml)' 'i",difi,w; ,'wi, '" i,,,,!lu,,,,, :"01';';';1',,' is excluded Applies only (I) products: procc;;,,-c,; excluded Applies only to entirely original products or precesses Protection has limited lifetime No Pl\H.CC\lOl1 against de /lOW) irni{<\lion by third panic>:
X
X
X
X f"
No protection again';l observation/publicity B,
i~r definition. registration, and Costly to define and/or rcgi.~"路l
Costs
enforcemeiu
x
Cosily to enforce
X
Requires supplementary protections \0 be enforceable
As such, it may he more effective and more efficient to conduct knowledge transactions within firms than across markets. Removing the 'transaction cost' of knowledge loss due 1.0 working with other firms. IIIRMS AND KNOWLEDGE PROn~CnON
6
Obtaining higher output/profit from the same inputs. (essentially)
Page 57 of 118
Transaction-costs economics suggests that a finn may have three types of advantage relative to markets for managing, or 'governing,' knowledge transactions.
1) By unifying ownership of knowledge and other assets within a firm, the incentives of the contracting parties can be better aligned, attenuating incentives for opportunistic behavior. 2) A firm can substitute an employment contract for a market contract for human capital services, increasing the scope of control over knowledge workers' actions 3) It is possible that 'social networks' may provide some protection against expropriation or imitation in knowledge transactions in some specialized circumstances, such as exchange of valuable knowledge within certain professional networks.
Incentive alignment and knowledge protection When rights of control accrue to separate parties, these parties may have incentives to use them in their own favor. When the ownership of the assets is unified within a single firm, the firm becomes the sole owner of the residual rights, allowing these rights to be administered by a single managerial hierarchy. In essence, the firm converts uncontractable property interests into contractable corporate ownership interests that can be monitored and enforced through the courts by the interested third party owner. Thus, internalization of knowledge transactions within a firm can extend protection of knowledge where legal protections are absent or arc costly to write and enforce because incentives to expropriate are reduced. Essentially, firms create quasi-property rights in knowledge. 1 call these quasi-rights possession rights.
A second institutional capability that allows employment contracts.
to protect knowledge is their ability to
Through an employee contract 8. firm can restrict the actions of au employee in ways that would not be permitted in a market contract for human capital services. Thus, employment supports the enforcement of possession rights to knowledge. Two types of rules arc particularly important in relation to knowledge protection: employee conduct rules (restricting the employee from sharing knowledge), and job designs (compartmentalizing of information and disaggregating of jobs to decrease the knowledge base of individual employees),
Reordering rewards and knowledge protection The firm may be able to increase an employee's costs of leaving by deferring the timing at which an individual receives payments for her knowledge. These deferred rewards include deferred stock options; pension plans with delayed vesting; and promotions over time. All these arrangements impose exit costs on employees By providing credible long-term incentives, a GIm also increases the incentive for an employee to invest in forming personal relationships with other employees, thereby increasing the likelihood that Page 58 of 118
an employee will become emotionally attached to other employees or to the organization as a whole.
The costs of knowledge protection The most important of these are increases in sunk costs, increases in administration costs, and the costs of loss of communication.
Discussion First, firms must resolve the question of what knowledge should be protected and what should not. Second, what mechanism or combination of mechanisms should be used to protect its valuable knowledge. . Table2. The institutional capabilities of firms and their implications for Knowledge protection Institubcnal capability I.
Incentive alignment
Knowledge protection benefits relative to market contracting Extends the scope of control over knowledge transactions to include rcskloa! rights ;lIld their <ls"u<.:il1led rewards Reduces the
2.
CO;;!
of ncgonanng and enforcing rights
Efilployml'1J1
(a) Employee conduct rules
Extend the scope of control over iudividuats' actions Reduce employee mobility. reducing Inc mobility of knowledge and
increasing the effectiveness of employee monitoring ib) Job designs
Allow for protection of knowledge through disaggregation and the
coordination of disaggregatcd production 3.
Re-ordcnne
Increasing futurity of incentives reduces employee mobility
(1989) Ar4 C1H :y MC<ffll1gC,'ilCilf Hevf,S'w, i 4
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n,view, A coAenlY 0/
(i), FP,
urne"" of "Agency theory (a) offers unique insight into information systems" outcome uncertainty, incentives, and risk and (b) is an empirically valid perspective, particularly whcn coupled with complementary perspectives" Agency theory can be used in all kinds of principal/agent relationships to find the most efficient contract of goals and attitudes towards risk, e.g. manager/employee, mcrgcrs and acquisitions, franchising, coopcrate RlieD structures. Key words: principal, agent, information asymmetric information, agency problems, adverse selection, moral hazard, behavior (make) and outcome (buy) based contracts.
Main themes; According to Eisenhardt an agency theory explains how to best organize relationships in which one party (thc principal) determines the work, which another party (the agent) undertakes. Eisenhardt argues that under conditions of incomplete information and uncertainty, which characterize most business settings, two agency problems arise: adverse selection and moral hazard. Page 59 of 118
Adverse selection is the condition under which the principal cannot ascertain/verify if the agent accurately represents its ability to do the work for which it is being paid. Moral hazard is the condition under which the principal cannot be sure if the agent has put forth maximal effort. A typical agent problem occurs when a fixed wage might create an incentive for the agent to shirk since his compensation will be the same regardless of the quality of his work or his effort level. Therefore other incentives can be necessary to align the interests of the principal and agent, thereby decreasing the agency problems. Eisenhardt states 10 propositions of the conditions between pricipal and agent (p.60-63). E.g. to discover the agents behavior one must invest in information systems, positively related to behavior-based (make: e.g. salaries, hierarchical governance) contracts and negatively related to outcome based (buy: e.g. commissions, stock options, transfer of proprietary rights, market governance) contracts. Agency theory extends organizational thinking by pushing the ramifications of outcome uncertainty to their implications for creating risk. This perspective examines make/buy decisions; make = risk neutral, i.e. when the principal can monitor the agent and buy -~ risk averse, since agency problems increase under uncertainty, i.e. leaving the responsibility with the agent.
Conclusion: Agency problems provide a unique, realistic, and empirically testable perspective on problems of cooperative effort.
Lecture: The agency theory was used in the case of the ship platform, how cooperating firms create a framework within they can successfully develop products of commercial value, choosing a behavior or outcome based contract. Abstract 2 Purposc of thcJ;@l'.St: The purposes of the paper arc to describe agency theory and to indicate ways in which organizational research can use its insights. Structurally) the paper is organized around four fundamental questions in relation to agency theory: 1.
VVhat IS agency theory?
2- VVhat does agency theory con tribute to o(fsanizdtional theory? 3.
Is agency theory empirically valid?
4, \Nhat contexts and topics are fruitful for orgarnzational researchers who use agency theory?
M.?iI1points9f discu,,'ii91L Origins of f\gcncy Theory @
e
Agency theory
@
Positivist agency theory vs. Principal-agent theory
o
Contributions of agency theory
e
Recommendations for agency theory research
Page 60 of] 18
Agency theory (AT) is founded in literature from the 1960s and 70s which dealt with the issue of risk-sharing among individuals. AT broadened the horizon of the risk-sharing literature by adding another dimension, the so-called agency problem. In general the agency problem occurs when cooperating parties have different goals, e.g. the employer and the employee. AI' is not solely a relation between the latter mentioned examples; on the contrary, AT seeks to describe the relationship among any given parties by using the notion of a contract and the principal-agent assumptions. The principal is the party who deluges work to another (the agent). AT is concerned with sol ving two kinds of problems in relationships. At all times the focus of the theory is on determining the most efficient contract governing the principal-agent relationship. The two problems are: 1.
The agency-problem occurs when a) a goal or desire of the principal conflicts with the agent, and b) when the principal has difficulties verifying that the agent has behaved accordingly to the contract
2.
The problem of risk-sharing occurs when the principal and the agent have different approaches towards risk
Agency Thcm)' Agency theory can be distinguishes along two lines; the positivist (more behavior based), and the principal-agent (more pragmatic) theory. Before describing the characteristics of each, an overview of agency theory is summarized below: Agency Theory overview _ ---c--_. Key idea Principal-agent relationships should reflect efficient organization of information and risk-bearing costs Unit of analysis Contract between principal and agent Human assumptions Organizational assumptions
assumptions Contracting assumptions Problem domain
Self interest Bounded rationality, risk aversion Partial goal conflict among participants Efficiency as the effectiveness criterion Information asymmetry between principal and agent Information as a purchasable commodity Agency (moral hazard and adverse selecting) Risk-sharing Relationships in which the principal and agent have different goals and risk preferences (e.g., compensation, regulation, leadership, impression vertical transfer nrir-ino
Tbe positivist theory deals with the mechanism that governs the relationship between the principal and the agent. Furthermore, aim of the theory is identify various alternatives to a contract. In general there exists two proposition that identify the mechanisms in the positivist stream 1. When the contract between the principal and agent is outcome-based, the agent is likely to behave in the interest of the agent 2. When the principal has information to verify agent behavior the agent is more iikely to behave n the interests of the principal
The above propositions can be said to have their assumptions in an opportunistic approach, hence the behavior of the agent is directly linked to its benefits of the contract. Where the positivistic stream is more concerned with the contract alternatives the principal-agent theory indicates which Page 61 ofll8
contract is the most efficient under various levels of uncertainty, risk-aversion, information and others (i.e., behavior vs. outcome). The theoretical arguments in the principal-agent relationship can be distinguished by using two descriptions: 1.
When the principal has complete information about the agent's behavior: In the case of full transparency a behavior-based contract is favored since an outcome-based contract would the risk to the agent.
2. When the principal does not know exactly what the agent has done: when the agent is unobservable the principal does not have the necessary information to estimate the behavior of the agent. This approach would call for an outcome-based contract since the principal cannot tell whether the agent has put forth the agreed-upon effort. E.g., in a situation where a scientist (agent) claims to have experience in a specific matter, it can be very difficult for the principal to determine whether the agent is actually telling the truth (this is referred to as adverse selection).
In the case of unobservable behavior the principal has the following possibilities: 1. Discover agent's behavior by investing in information systems, or 2.
Contracting on the outcome of the agents behavior (the agent acquires the risk)
In the words of thc author: "(...) the heart of principal-agent them}! is the trade-offbetween (a) the cost ofmeasuring behavior and (b) the cost ofmeasuring outcomes and transferring risk to the agent. "(pp. 61) With relation to behavior, outcome.uncertainty, and risk aversion five propositions have been put forward in the Information systems are positively related to behavior..based contracts and negatively related to outcomebased contracts Outcome uncertainty is positively related tc behavior bas(;d contracts and negatively related to outcome based contracts The risk aversion ofthe agent is nodii""i,v related to behavtor-bnscd contr'acts and Hel;minnii,Yrdai.ed to outcome-based contracts The risk aversion ofthe nrtuclnal is ncgartvely reb ted to behavior-based contracts and positively related to outcome-based contracts The
is
related
contracts
Finally, the author describes a term named task programmability.. i.c. when the behavior of an agent can be specified in advance, e.g. a job as a cashier in a supermarket, or sales person working in a cloth retail store. In other words, the more programmable an agent's task is the more plausible is a behavior-based contract. This leads to the three final propositions in the paper:
Task programmability is positively related to behavior-based contracts and negatively related to outcomebased contracts Outcome measurability is negatively related to behavior-based contracts and positively related to outcomebased contracts The length of the agency relationship is positively related to behavior-based contracts and negatively related to outcome-based contrac.ts
Page 62 of 118
Needless to say, agency theory is only nseful in certain areas of academia, hence before ventnring into an agent-theoretical analysis, the author recommends us to keep in mind that, agency theory is most relevant in situations which contracting problems are difficult. These include situations where: a) Substantial goal conflict between principal and agent such that agent opportunism is likely b) Sufficient outcome uncertainty to trigger the risk implications of the theory c) Un-programmed or team-oriented jobs in which evaluation of behavior is difficult
@Floriccl, S. and Lampel, J. (1998). Innovative contractual structures for interorganizational systems, Int. J. Technology Management 16 (112/3), pp. 193-206, Pm:pose Q.fthe paper: The aim of the paper is to investigate the types of contracts that are used between project owner (principal) and the prime contractors (agents), The paper follows a trajectory of two questions: 1, Are real contracts designed in accordance with the key principal-agent theory predictions? 2,
Do successful projects more closely follow the prescriptions of principal-agent theory than those that are less successful?
The questions above are tested empirically on two samples of 30 power plants in the US, one made up of successful projects, and the second of less successful ones, A general assumption in the paper is that the agent (the party to whom work is delegated) is the only one who has an actual affect of the outcome of the task, The paper is structured by firstly discussing generic, theoretical aspects of principal-agent theory and secondly, summarizing thosc in a in a hypothesis, In the second part of the paper the analysis of the 30 power plants unfolds, reaching answers on the questions asked above, The empirical data is analyzed statistically hut the methods used are not present in this paper. Instead, the results arc listed in a table, making it rather confusing for the reader to decipher the motives for the statistical calculations. IY1~5!j)J.JlQint搂_~QLd i S.f_l-J2:~iQr~~ I)
Bc;hav!or路路based \IS. outcome-based contracts
8>
Cost-plus-fixed-Fee contract (or simplv cost plus)
o
information gathering
"~
I-\dverse selection
I)
incentive-based contracts
"
Turnkev approach
e
Risk and uncertainty
e
Risk aversion
Abstract
Page 63 of 118
The abstract will be summarized in a table, presenting the six hypothesizes from the paper to the left and the arguments in favor of, to the right. I am not going to carry out a detailed review of the analysis of the 30 power plants since it is absolutely unintelligible.
Theoretical hypothesis The more goal congruence between principal and agent, the more likely it is that behavior-based contracts will be adopted.
Arguments that sunnort the hypothesizes The cost of having goals too far from one another result in #J a higher degree of monitoring the agents behavior, why a goal congruence between the two parties arc likely to abolish the necessity of monitoring. This will save time and resources for the principal and result, accordingly to .._._ ... ..._ _......._ ... _. _ the O,eory in a behavior-based contract. Monitoring is a mean of control and it is used by the I! 11 The more competencies the principal has for principal to determine whether the actions taken by the monitoring the agent the more likely is it that agent is on the interests of the principal. Monitoring an behavior-based contracts will be used. agent is not necessarily a real-time action. Information about an agent can be gathered in the pre-phases ofproject launch. The richer the information the principal has about an agent the less monitoring is needed during the actual performing of the task. Secondly, monitoring is as well difficult if the principal is not acquainted within the field of the agent In other words: how do you monitor an agent if you do not know what to look for? ...........-.-~~-~· · · -..........·-·-··-c··~,··I·~'-c--c---'-----'-----'-----'--=---'--==c'--··, ..·,- --- . ft III The more risk averse the agent the less likely it is Risk is a central theme and point of analysis in agency I that outcome-based contracts will be used, theory. Firstly, there can exist many reasons as to why an agent is more risk averse, e.g. due to high competition in the market. Secondly, the nature ofthe task can shape the agent's risk aversion, e.g., in an engineering project where the major uncertainty is the final cost of the project, the cost is not solely dependent of the agent's efforts (behavior) but on unforeseen factors that arc beyond the agent's control. Final extra cost ofa project may be shifted onwards to the principal hence a behavior-based contract is H!V The more innovative arc the 1-',,\ incorporated in the project, the more likely it is that behavior-based contracts will be used .
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Contracting Simulation: The Beowulf field - A tmTet and swivel stack system (Mal'eh, 2006) The paper is a basis of a simulation carried out in class. The paper presents various details whieh allow the partieipants in the simulation to assess relevant information in a negotiation about a contract. Depending on outcome of the negotiations, there exist three overall solutions to a contraet: â&#x20AC;˘
A fixed price: the contractor guarantees its delivery at a fixed price. Added to this will be a service fee for services rendered a fee which generally runs a 10 percent of the overall cost of development.
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A cost-plus contract: the contractor is assured that the owner will cover all its costs, as long as they do not exceed 20 percent of a maximum price, and pay a fixed service fee of $3 million.
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A risk sharing contract: the parties agree on a way to share costs and risks of the contract, and specify how this might be done, along the delivery date.
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Contracting Simulation: The Beowulffield -A turret and swivel stack system (March, 2006), 4 pages."
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Foss, N.J. (2002): Selective Intervention and Internal Hybrids: Interpreting and Learning from the Rise and Decline of the Oticon Spaghetti Organization, Organization Science 14 (3), May-June, pp. 331-349,
Abstract I Definitions
External hybrids': market exchanges infused with elements of hierarchical control. Internal hybrids': hierarchical forms infused with clement of market control. Internal hybrids combine the ability to achieve efficiencies through specialization that characterizes the functional form with the relative independence that can be granted in a. divisional form, and the ability to transfer resources and capabilities across division and business unit boundaries that characterizes the matrix organization. Complementarities: between elements of an organizational form exist when increasing the level one element increases the marginal return from increasing the level of all rC1.11;:1in1.ng elements. Abstnu:t In 1990 Lars Kolind introduced a radically different organizational structure in Oticon. '1"11e new organizational form, namely the "spaghetti organization" would support the strategic reorientation at the time. The name emphasises the point that it should be able to change rapidly, yet still possess coherence. Furthermore, the new form should he explicitly "knowledge-based" that is, consisting of knowledge centres connected by a multitude of links in a non-hierarchical structure. Designing the jobs so that these would fit the individual person's capabilities and needs was argues to provide the motivational support for this knowledge network. Problems of coordination emerge In some eases knowledge tended to he held back within projects, because ofthe widespread and correct perception that projects were essentially in competition over corporate resources. Thus, by stressing so strongly a marketlike competitive ethos and by making incentive systems more highpowered than they had been under the old organization, the spaghetti organization to some extent worked against its stated purposes. There seemed to he fundamental problems involved in playing market inside hierarchies. Managers could always he overruled by the planning authorities and were thus not likely to take a long view of projects. This also meant that managers did not make efficient decisions. Page 65 of 118
Problems of intervention Organizations that adopt internal hybrids that amount to drastically reducing the number of hierarchical layers, such as the spaghetti organization are more prone to motivational and incentive problems that may emerge form managerial selective intervention, than traditional hierarchical firms. This is due to: I) decision rights are more solidly established in traditional hierarchy, which is associated with well-defined, distinct positions than in a flat, project-based organization where decision rights are more fleeting. 2) a top manager who selectively intervenes in a hierarchical organization risks overruling the whole managerial hierarchy whereas this may be a smaller concern in a flat organization where the CEO may only harm motivation in a specific project team ifhe overrules the team. In 1996, Oticon started retreating from the spaghetti organizational form due to the stated problems. Oticon is still characterized by considerable deeentralization and delegation of rights but resembles more tbat of a matrix strueture. Discussion It was a wise decision to move to a matrix structure - the one level strategy could have killed them, because people become exhausted not knowing their exact position. History also matters. Perhaps a period with the 'ultimate' spaghetti structure was necessary in order to settle with the matrix. Oticon was lucky to survive the spaghetti adventure. They allowed a great degree of freedom and structure was lacking along with direction. However, at the time they eould afford to risk the spaghetti. Oticon had an ideal, but bad to learn how it worked in reality 路lueky it didn't go completely wrong. Freedom? The employees were able to handle the freedom, so why did it go wrong. Lot of success accrue to spaghetti but it went out of hand. Human nature was the cause, people took advantage they could not handle to be entrepreneurs. The employees were not trained to be entrepreneurs but was forced to in six months. Had to take control but could not. They were not entrepreneurs and they could not learn it in so short a time. Docs more hierarchy/matrix solve competitive behaviour/opportunistic behaviour? The Spaghetti bCCCH11CS more personal) and social consequences are greater. One ruust balance knowledge sharing, but not to the level were they will defend it internally. The social walls in the spaghetti org. were too high,
Concluding remarks: Lee Davis: Perhaps Oticon could/should havc used some of the mechanisms known from transaction cost economics, principal-agent theory and hybrid organizational forms too remedy some of the malfunctions of the spaghetti organization and modify it instead of replacing it for a. matrix structure. Abstract 2 Definitions External hybrids: market exchanges Infused with elements of hierarchical control. Internal hybrids: hierarchical forms infused with element of market control. Internal hybrids combine the ability to achieve efficiencies through specialization that characterizes the functional form with the relative independence that can be granted in a divisional form, and the ability to
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transfer resources and capabilities across division and business unit boundaries that characterizes the matrix organization. Complementarities: between elements of an organizational form exist when increasing the level of one element increases the marginal return from increasing the level of all remaining elements. Abstract In J 990 Lars Kolind introduced a radically different organizational structure in Oticon. The new organizational form, namely the "spaghetti organization" would support the strategic reorientation at the time, The name emphasises the point that it should be able to change rapidly, yet still possess coherence. Furthermore, the new form should be explicitly "knowledge-based" that is, consisting of knowledge centres connected by a multitude of links in a non-hierarchical structure. Designing the jobs so that these would fit the individual person's capabilities and needs was argued to provide the motivational support for this knowledge network; freedom was given to all employees to do whatever project they wanted. The spaghetti organization was an attempt to infuse the organizatiou with strong elements of market control.
Problems ofcoordination emerge In some cases knowledge tended to be held back within projects, because of the widespread and correct perception that projects were essentially in competition over corporate resources. Thus, by stressing so strongly a market-like competitive ethos and by making incentive systems more high-powered than they had been under the old organization, the spaghetti organization to some extent worked against its stated purposes. There seemed to be fundamental problems involved in playing market inside hierarchies. Managers could always be overruled by the planning authorities and were thus not likely to take a long view of projects. This also meant that managers did not make efficient decisions. Moreover, each project leader conld attract employees; convince them to join, in competing projects, which often lead to overburdened employees that could not be monitored leading to few completed projects.
Problems of intervention Organizations that adopt internal hybrids that amount to drastically reducing the number of hierarchical layers such as the spaghetti organization are more prone to motivational and incentive problems that may emerge form managerial selective intervention, than traditional hierarchical firms. This is due to: 1) decision rights arc more solidly established in traditional hierarchy, which is associated with well-defined, distinct positions than in a flat, project-based organization where decision rights arc more fleeting. 2) a top manager 'who selectively intervenes in a hierarchical organization risks overruling the whole managerial hierarchy: whereas this may be a smaller concern in a nat organization where the cr~o may only harm motivation in a specific project team if he overrules the team. In the case of Oticon, selective intervention was motivation-destroying because of inconsistencies between the rhetoric of delegation anel then reality where the committee overruled projects initiated by employees. Top-management often overruled project managers, which led to decreasing motivation, lack of ownership feeling etc.
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can be summarised below; e Size of company to Monitoring systems dId, not funetion as intended (~ Long term .., too much freedom 10 No structure 6! No ownership f{~eIing by managers as they were not the residual claimants and could always be overruled, o Too broad strategic focus e The final decision rights was sWI centralized at PPC o Ineffective ill allocating compctcnces, Multi job at the cost of specialization o Many employees joined more projects than they had time for e Ineffective knowledge sharing due to battle for company resources @
In 1996, Otieon started retreating from the spaghetti organizational form due to the stated problems. Oticon is still characterized by considerable decentralization and delegation of rights but resembles more that of a matrix structure. Like Zenger, Foss argues that if the complemcntarities in a hybrid form are not protected
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and aligned with structure, measurements and incentives, it will lead to fundamental problems like Oticon faced with their spaghetti. Discussion It was a wise decision to move to a matrix structure - the one level strategy could have killed them, because
people become exhausted not knowing their exact position. History also matters. Perhaps a period with the 'ultimate' spaghetti structure was necessary in order to settle with the matrix. Otieon was lucky to survive the spaghetti adventure. They allowed a great degree of freedom and strncture was lacking aloug with direction. However, at the time they could afford to risk the spaghetti. Oticon had an ideal, but had to learn how it worked in reality -lucky it didn't go completely wrong. Freedom? The employees were able to handle the freedom, so why did it go wrong. Lot of snccess accrue to spaghetti but it went out of hand. Human nature was the cause, people took advantage - they could uot handle to be entrepreneurs. The employees were not trained to be entrepreneurs but were forced to in six months. Had to take control but could not. They were not entrepreneurs and they could not learn it in so short a time. Does more hierarchy/matrix solve competitive behaviour/opportunistic behaviour? The Spaghetti becomes more personal, and social consequences are greater. One must balance knowledge shariug, but not to the level were they will defend it internally. The social walls in the spaghetti org. were too high. Concluding remarks: Lee Davis: Perhaps Oticon could/should have used some of the mechanisms known from transaction cost economics, principal-agent theory and hybrid organizational forms too remedy some of the malfunctions of the spaghetti organization and modify it instead of replacing it for a matrix structure.
Abstract :I Purpose of t!1,UlliPÂŁJ:: The purpose of the paper is to analyze why the Oticon spaghetti organization declined during the 1990s through the usc of organizational economics. The problem statement suggests that frequent managerial meddling with delegated rights led to a severe loss of motivation, and arguably caused the change to a more structured organization, l"ry_words oUhrp?pr1iJle: External hybruls: market exchanges infused with elements of hierarchical co11.t1'010 Internal hybrtds: hierarchical forms infused YV1.t]1 clements of market control. Selective intervention
Abstract: Oticon had for many years been positioned as market leader in behind-the..ear hearing aids-market while simultaneously harnessing huge revenues from sales. They were situated nicely and did not really have any incentive to research in any new technology. During the 1980s new technology in the market began ascending, moving along a new trajectory of knowledge paving the way for inthe-car hearing aids. Especially competition from the US caused Otieon to lose huge market shared in a dying market. One could argue that Oticon was stuck in a competence trap failing to see the changes in the market. The dominant opinion in Oticon was that this new technology was going to turn into a fiasco. Since they were highly dependable nn revenues from behind-the..ear hearing aids, Oticon began losing income from sales since newer and more modern technology was replacing the old. In 1988 Lars Kolind assumed the position as CEO. He completely reorganized Oticon into, what in this paper is referred to as, the spaghetti organization. The new organization had three main characteristics: 1. There were no restrictions on the number of projects that employees could voluntarily join.
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2. Employees were actively encouraged to (in the beginning actually required) to develop and include skills outside their existing skill portfolio. 3. Although project teams were self governing, projects still had to be approved by the Projects and Products Committee (PPe) Kolind began infusing the organization with elements characteristic of market exchange. It was argued that the market mechanisms in the internal hybrid (Oticon) would assure that decision rights on a given project would be allocated to the person who possessed the relevant knowledge. That is, the internal hybrid was a deliberate attempt to mimic the decentralization of decision and income rights that characterizes the market in an attempt to improve efficiency processes of discovering, creating, and using new knowledge. The affect of the reorganization of Oticon had instant affects. Ideas that were dormant were revitalized and it turned out, that research within the field of in-the-ear hearing aids had already been going on previous in the company, but management had shelved the idea. This gave Oticon a huge leap forward in the race of acquiring market shares. The organizational complemcntaritics changes as well within Oticon. Small coffee shops were placed randomly in the firm in order to let the employees meet over a cup of coffee and (hopefully) exchange ideas. To foster a greater incentive for the employee to give their fullest to the company, employees were allowed to purchase a fixed amount of stock, which nearly 50 percent of the employees did. In the following, the second part of the paper will be summarized. The author asks the question, why the spaghetti organization was gradually abandoned in favor of a more hierarchically structured organization. In the analysis of this, the author's basis point of reference is organizational eCOnOll11CS.
Firstly, in the table below are listed the differences between the market organization and the spaghetti organization. .._..__m_.._... --::-------;--:;--_... __._._.. ._~.~
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The Spaghetti. Organization Transfer pricing not used
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Employment contracts (employment ];:1\0') Approximated by delegating rights to suggest and join projects Variable pay: initially based on objective input and output measures Employee stock schemes
Dispersed decision rights
Very widespread delegation of rights
Dispersed ultimate decision rights (dispersed formal authority) Resource allocation decentralized and strongly influenced by local entrepreneurship Strong autonomous adaption properties
Concentrated ultimate decision rights (concentrated formal authority) Local entrepreneurship very strongly encouraged, Project approval easily obtained Secured through extensive delegation of decision rights
I-I ian-powered incentives
From the organizational economics perspective, different suggestions offer explanations for the failure of the spaghetti organization. bllocating.fQlJ:lj:letglee: the argument goes that a hierarchical approach in an organization is an efficient method to allocate competence. In Otieon any employee were allowed to initiate a project and, as well claiming the position as the project leader. In alignment with the organizational economics, Oticon was destined to fail, or at least not being able to allocate the necessary knowledge in the hands of the right people since management chose to abolish hierarchy. Page 69 of I 18
Nevertheless, competences seemed to be allocated in the right places within the organization thus this we are able to refuse this argument. Eliminating tournaments: the argument goes that "tournaments" within an organization is an effective incentive enhancer, e.g. expanding one's effort in specific areas leading to a step up the hierarchical job ladder. The history indicates that this was not the case in Oticon. Instead, a system of performance pay and was initiated. In other words, the organizational economic approach is not capable to explain this point as well. Sacrificin.1Upecializing advantage: the argument goes, that allocating personnel with specialized skills create advantage efficiency. This did as well not seem to be the case. On the contrary, eliminating specializing advantages may have created an inter-organizational knowledge exchange. Problems of coordination: the arguments goes, that if no control of coordination is present, personnel is going to spend too much time on projects that might not turn into something useful. Furthermore, employees were allowed to work on as many projects they preferred, hence one could get the idea that this would havc caused a high degree of inefficiency. What seems to be the case though, is the contrary. Probl,"-ms QL!<11Qwledg(;2haring~.due to the internal hybrid structure project teams were almost competing against each other within the organization in order to get the project approved by the Pl'C. Sometimes knowledge was withheld in the organization because of this internal rivalry, bui was seemed to be the case was that the degree of ideas and knowledge creation in the spaghetti organization was very high. Influence activities: briefly described, the assumption goes that in a hierarchical organization there will necessarily be some sort of lobbying for one's superior. This, as well, seemed to be the case in Oticon where the 1'1'C was the only place where governing actions were made, hence lobbying for the committee was a useful way to influence members and make them sec specific projects as being more important than others. All of the above mentioned approaches did not bring forward any substantial evidence as to why the spaghetti organization was abandoned. Finally the author moves on by examining the degree of selective intervention hy the PCe. This approach, on the contrary has very accurate, significant evidence of being one of the generators behind the actual abolishment of the spaghetti org. firstly, the PC:C was the only managerial institution in Oticon with power to intervene in projects. Secondly, there were no actual plans for how, and when the PPC intervened, which created a very insecure environment for project team members not knowing when OR ifthe PPC would intervene. Thirdly, according to the author, this caused the incentives and motivation to gradually decrease within the organization creating an environment not fit for novel ideas and knowledge creation. The conclusion therefore is that (in Oticon) some sort of bier arc hical system is needed in order to sustain the incentives among employees. An internal hybrid can never function similar to the mechanisms oftbe market because (an argument among others) markets do not rely on resource allocation by means of authority whereas firms do. Furthermore, hierarchy is needcd when talking about decision rights. Ultimately, there has to he a governing court, otherwise the very essence ownership would not exist.
Session] 2: Strategy under uncertainty (Thor) e
Rosenberg, N, (J (95): Why technology forecasts often fail, The Futurist, .Iuly-August, pp, 17-21.
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Abstract 1 Theme There are several uncertainties related to the impact of an innovation and it does not disappear even after a new technology is introduced commercially. The difficulty of foreseeing an innovations future impact can be view through the six dimensions of uncertainty. (This text is only 4 Yz page long. I recommend that you just read it).
Key words The six dimensions of uncertainty: The dimensions relate to the uncertainties that exist in trying to foresee a future impact. The uncertainties are defined below.
Set of problems/focal points, main arguments ami conclusion "The ability to foresee the commercial possibilities in new technologies is perhaps an even more valuable skill than being able to invent them". Rosenberg states that the first mover has very limited and poor information about the future and that being a mere imitator is fairly easy because all they need to do is follow the successful footsteps of the entrepreneur/ first mover. This is said with some modification because new uncertainties will arise continuously through a products or a technology's lifetime. There are new uncertainties emerging that represent aspect of the constantly evolving relationship between changes in the market, the technology and improvements in economic performance. The conditions under which the invention emerges are crucial to whether or not the invention succeeds. He uses the six dimensions of uncertainty to try and define categories with major and general uncertainties that relate to the difficulty of foreseeing the future impact of an innovation. These uncertainties do not only relate to the technological change uncertainties but they go beyond the innovative process because they reflect the relationship between technological change and improvements in economic performance. Theories/models ami their relation to the set of problems
l]leHnitkH1S Thc dimensions of uncertainty: q uses: New uses for a technology or innovation which creates 1.1(;\V impacrs on. society. The uncertainty related to the potential uses of a product. Q innovatlons: The impact of invention A will often depend upon invention 13, and 13 may not yet exist. An important impact of invcntion A is to increase the demand for invention EL o System integration: Major technological innovations often constitute entirely new technological systems which are difficult to conceptualize. In a system, improvements in performance in one pari will not be significant without improvements in another part. & Prohlem-solving myopia: The solution to a very narrowly defined problem has been fonnd but the invention turns out to have significant applications in totally unanticipated contexts. Passing the "needs" test: Meeting the customers or certain human needs in a novel or cost effective way. Competing with the past: Old technology is still alive and kicking in the present but as there will be strong incentives to invent new technologies there will also be strong incentives to improve the old ones. @
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Related theories Rosenbergs text relates to the texts from the same class but mostly the Courtney text on strategy under uncertainty. Here it is discussed how to react and make a strategy when considering the different uncertainties.
Extra information from class We used Rosenberg to analyze the Virgin Galactic. Here we also touch upon some critism in that Rosenberg does not look at competitors or make a weighing of the dimensions.
Abstract 2 Abstract: Rosenberg argues that one of the major problems concerning innovation strategy is the inability of firms to anticipate the future application of their suecessful innovations. The reason why it is so difficult to foresee an innovation's future impact is that there are several interrelated dimensions of uncertainty connected to an innovation. Uncertainty docs not disappear even after a new technology is cornmercialised successfully. New uncertainties, especially economic ones start to emerge. 6 dimensions arc proposed to be the reason: L Potentia! uses: There often exits uncertainty about the unexpected beneficial new uses of many innovations. EX pharmaceutical industry; medical products have several times shown to have effects that were not originally anticipated This can expand the products market, by creating a new user segment. 2. Complementary innovations: The impact of invention A) will often depend upon invention D, and D may not yet exist. Ex: laser and telecommunication; fiber optics needed to be appreciated before laser technology could be used in telecommunication. 3. System integration: Technological systems comprise clusters of complementary inventions. Thus, in a system improvements in performance iu one part are only of limited significance withoul simultaneous improvements in other parts. 4. Problem solving myopia; Once a solution has been found, the invention turns out to have significant applications in totally unanticipated contexts. Ex: the steam engine was invented in order to pump water out offlooded mines. Later it was used as a source a/power/or textilesfactories etc. 5, Passing the needs test: New technologies need to pass an economic test not just a technological one. Ex: the Concorde. Success in terms qfflight performance but afinancial disaster. 6-, (~ompeting with the past: Y路..JC\v technology is competing with old technology and in highly competitive industries there arc just as strong incentives to iUl]JrO\/C old technologies, as there are strong incentives to invent new technologies, This makes it hard to forecast what will happen once the innovation is released and also where the existing technology will go in response to this. !i'X: competition between technologies such as' VI];Y vs'. Beta.
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Page 72 of 118
Uncertainty should not be seen in a binary/black or white way. Uncertainty exists in different levels, and determining which strategy to chose, depends on the level of uncertainty a company faces. The uncertainty that remains after the best possible analysis has been done is called residual uncertainty
Four levels of Uncertainty Level I: A Clear-enough future - the forecast will be sufficient narrow to point to a single strategic direction. In this case residual uncertainty is irrelevant to making strategic decitions. Level 2: Alternate Futures .- the future can bc described as one of a few alternate outcomes or discrete scenarios Level 3: A range of futures that are defined by a limited number of key variables, but the actual outcome may lie anywhere along a continuum bounded by that range. There are no discrete scenarios. Level 4: True Ambigurity ..... here multiple dimensions of uncertainty interact to create an environment that is virtually impossible to predict. It is not even possible to indentify the relevant variables that will define the future. These kind of uncertainties are rare and tend to migrate towards level 3 or 2 over time. How fQ
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As the figures above indicate, the authors believe that for level 1 uncertainty there is still a need for the traditional strategy tool kit, like market research, analysis of competitors cost and capacity, value chain analysis, Michael Porter's five forces etc. In level 2 situations there may be a need for different valuation models to evaluate the scenarios pointed out. This process will identify the likely winners and losers of alternate scenarios IS moving level 3 situations analysis should focus on the trigger events signalling that the toward one or another scenario. The job is harder that level 2~ because there arc no clearly defined scenarios. There arc general rules to 1c\7(;1 3: Develop only a limited number of alternative scenarios, avoid developing redundant scenarios that helve no unique implications for strategic decision making.
In level 4 situations managers have to catalogue systematically what they know and what is possible to know. Usually managers can identify a subset of variables that will determine how the market will evolve over time. Early market indicators and analogies from similar markets will help sort out whether beliefs arc realistic or not. Basic vocabulary for talking about strategy: Strategic postures: a company can choose to shape thefuture, adapt or reserve the right to play Posture defines the intent of a strategy relative to the current and future state of an industry Shapers: aim to drive their industries toward a new structure of their own device, Their strategies arc about creating new opportunities in a market Adapters: take the current industry structure and its future evolution as givens and they react to the opportunities the market offers. &servers of J!lrUlght to play: This is only relevant in level 2,3 and 4. and involves making incremental investments today that put the company in a privileged position in the future. Page 74 of 118
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pay-offs in 30n1.C scenarios and large losses in others. C2r>1ipns: Are designed to secure the big payoffs of the best-case scenarios while minimizing losses in worst case scenarios. This asymmetric payoff structure makes them resemble financial options N.Q.:L£fU];ts Xl2Q'!.es: Moves that will payoff no matter what happens. Even in highly uncertain environments, strategic decision like investing in capacity and entering certain markets can be now regrets 1110veS,
Putting the above into the different levels of uncertainty: In level 1, when the underlying analysis is sound, the strategies are by definition made up of a series of no-regret moves. Adapter strategies in level I situations are not necessarily incremental or boring. It is also possible to be a shaper in level I situations, but it is risky and rare since the amount of residual uncertainty will increase in an otherwise predictable market.
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a shaping strategy is designed to increase the probability that a favoured industry scenario will occur. But even the best shapers must he prepared to adapt. In uncertain environments, Page 75 of I 18
it is a mistake to let strategies run on autopilot -- because trigger variables are often relatively simple to monitor in level 2, it can be easy to adapt or reserve the right to play. If at level 2, shapers are trying to make a discrete outcome occur, at level 3, they are trying to move the market in a general direction because they can identify only a range of possible outcomes. An adapter posture at uncertainty levels 3 or 4 is often achieved primarily through investments in organizational capabilities designed to keep options open. Adapters need quick access to the best market information and the most flexible organizational structures. Reserving the right to play is a common posture in level 3. In level 4, even though the situations contain the greatest uncertainty, they may offer higher returns and involve lower risks for companies trying to shape the market than in both 1evel2 and 3. Tbis is because the shapers role is to provide a vision of an industy structure and standards that will coordinate the strategies of other players and drive the market forward. Reserving the right to play is common but potentially dangerous in level 4 situations. The difficulty of managing options in level 4 situations often drives players toward adapter postures. As in level 3, an adapter posture in level 4 is frequently implemented by making investments in organizational capabilities.
Levels of uncertainty regularly confronting managers today are so high that they need a new way to think about strategy. The approach outlined will help avoid thc dangerous binary views of uncertainty. It offers a discipline for thinking thoroughly about uncertainty. Abstract 2 Courtney, Kirkland and Viguerie (1997): "Strategy under Uncertainty" Theme: '[he authors outline an approach which offers a discipline for thinking rigorously and systematically about uncertainty, On one plane, this discipline makes it possible for companies to judge which analytic tools can and can't help them make decisions at various levels of uncertainty. On a broader plane) their framework provides a way to tackle the most challenging decisions executives have to make, offering a more complete and sophisticated understanding of the uncertainty they face and its implications for strategy. (pg. 79) Ahยงtrad:~
At the heart of the traditional approach to strategy lies the assumption that executives, by applying a set of powerful analytic tools" can predict the future of any business accurately' enough to choose a clear strategic direction for it, The process often involves underestimating uncertainty in order to layout a vision of future events sufficiently precise to be captured in a DCF analysis. These traditional approaches lead executives to view uncertainty in a binary lFaYJ however, when the future is truly uncertain, this is at best marginally helpful and at worst downright dangerous, (pg. 68) Underestimating uncertainty can lead to strategies that neither defend a company against the threats nor take advantage of the opportunities that higher levels of uncertainty provide. If managers can It find a strategy that works under traditional analysis, they may abandon the analytical ill
D)
rigor of their planning process altogether and base their decisions on gut instinct.
Four Levels of Uncertainty: Available strategically relevant information tends to fall into two categories. (pg. 68-69): , It is often possible to identify clear trends, such as market demographies, that can help define potential demand for a company's future products or services. , If the right analyses are performed, many factors that arc currently unknown to a company's management are in fact knowable.
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The uncertainty that remains after the best possible analysis has been undertaken is what is referred to as residual uncertainty (basically just uncertainty). In practice, the authors have found that the residual uncertainty facing most strategic-decision makers falls into one of four broad levels. Level one - a clear enough future: The residual uncertainty is irrelevant to making strategic decisions at level one, so managers can develop a single forecast that is a sufficiently precise basis for their strategies. To help generate this usefully precise prediction of the future, managers can use the standard strategy tool kit, e.g. market research, analyses of competitors' costs and capacity, value chain analysis, Porter's five-forces framework, and so on. A DCF model that incorporates those predictions can then be used to determine the value of alternative strategies. Level two - alternative futures: The future can be described as one of a few discrete scenarios at level two. Analysis can't identify which outcome will actually come to pass, though it may help establish probabilities. Most important, some, if not all, elements of the strategy would change if the outcome were predictable. Level three - a range of futures: A range of potential futnres can be identified at level three. A limited number of key variables define that range, but the actual outcome may lie anywhere within it. There are no natural discrete scenarios. As in level two, some, and possibly all, elements of the strategy would change if the outcome were predictable. Companies in emerging industries or entering new geographic markets often face level 3 uncertainty Level four - true ambiguity: A number of dimensions of uncertainty interact to create an environment that is virtually impossible to predict at level four. In contrast to level three situations, it is impossible to identify a range of potential outcomes, lct alone scenarios within a range. It might not even be possible to identify, much less predict, all the relevant variables that will define the future. Level four situations are quite rare, and they tend to migrate toward one of the others over time. Strategic postures - shaping, adapting, and reserving the right to play: Fundamentally, a posture defines the intent of a strategy relative to the current and future state of an industry. (pg. 73路路74) ITI Shapers aim to drive their industries toward a new structure of their own devising. Their strategies are about creating new opportunities in a market, either by shaking up relatively stable level one industries or by trying to control the direction of the market in industries with higher levels of uncertainty. f& Adapters take the current industry structure and its future evolution as givens and react to the opportunities the market offers. e} Reserving the right to play is a special. form of adaptation relevant only' in levels two through foul.'. 11 involves making immediate incremental investments putting a company in a privileged position .. through superior information, cost structures) or relations between customers and suppliers that allows the company to wait until the environment becomes less uncertain before formulating a strategy> A portfolio of actions hig and moves: A posture is not a complete strategy: it clarifies strategic intent but not the actions required to fulfill that intent. There are three types of moves arc especially relevant to implementing strategy under conditions of uncertainty. (pg. 74路路75) re Big bet,')' .. large commitments, such as major capital investments or acquisitions) which will produce large payoffs in some scenarios and largo losses in others. Not surprisingly, shaping strategies usually involve big bets; adapting and reserving the right to play do not Options are designed to secure the big payoffs of the best-case scenarios while minimizing losses in the worst-case ones. Companies reserving the right to play rely heavily on options, though shapers usc them as well, either to shape an emerging but uncertain market as an early mover or to hedge big bets. m No-regrets moves are just that - moves that will payoff no matter what happens. Managers often focus on obvious no-regrets moves such as reducing costs) gathering competitive intelligence, or building skills. However, even in highly uncertain environments" strategic decisions such as investing in capacity and entering certain markets can be no-regrets moves. ,f,
Strategy ill level one's deal" enough future: In predictable business environments, most companies arc adapters. Analysis is designed to predict an indnstry's future landscape, and strategy involves making positioning choices about where and how to compete. When the nnderlying analysis is sound, such strategies by definition consist of a series of no-regrets moves. (pg. 75-76)
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Strategy in level two's alternative futures: If shapers in level one try to raise uncertainty, in levels two through four they try to lower it and create order out of chaos. In level two, a shaping strategy is designed to increase the probability that a favored industry scenario will unfold. For example, a shaper in a capitalintensive industry might commit their companies to preempting competition by building new capacity far in advance of an upturn iu demand, or they might consolidate the industry through mergers and acquisitions. (pg, 76-77) Strategy in level three's range of futures: Shaping takes a different form in level three. If at level two shapers are trying to promote a discrete outcome, at level three they are simply trying to move the market in a general direction because they can identify only a range of possible outcomes. (pg. 77-78) Strategy in level four's true ambiguity: Paradoxically, though level four situations involve the greatest uncertainty, they may offer higher returns and lower risks for companies seeking to shape the market than situations in levels two or three. Recall that level four situations are transitional by nature, often emerging after major technological, macroeconomic, or legislative shocks. Since no player necessarily knows the best strategy in these environments, the shaper's role is to provide a vision of an industry structure and standards that will coordinate the strategies of other players and drive the market toward a more stable and favorable outcome. (pg. 78-79)
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Kolk, Am and Pinkse, Jonathan (2005). Business responses to climate change: Identifying emergent strategies, California Management Review, 47 (3), Spring, pp. 6-20.
Theme: Today, Companies face much uncertainty about the competitive effects of regulatory measures in regards to climate change and emission reduction. Instead of opposing a range of market responses is emerging, to address the problem through product and process improvements. Strategic positioning on climate change is therefore an integral future competitive parameter, and this articles offers a range of solutions to how business Can best respond. Responses depend On the perceived risk and opportunities and the type of regulation relevant for the industry and nation in which the company operates.
Key words: Strategic positioning on climate change, challenges and opportunities) Innovation or Compensation, emission trading, Certified emission reductions (CERs) . Flexible mechanisms.. internal, vertical and horizontal interaction, Abstract: In the absence of sufficient support for the Kyoto Protocol, the international policy arena on climate change is far removed from being a 'level playing field'. Companies thus face much uncertainty about the competitive effects of the Protocol and (upcoming) regulatory measures. According to the article, climate change policies arc generally becoming more flexible, giving the companies the opportunity to usc Flexible mechanisms that allow companies to achieve reductions of emissions through interaction with other parties. It is therefore up to the company how to achieve the goal or restriction, with an expectation that this is an incentive to solve the problem in a creative way. Under a flexible regulatory regime, managers have the possibility to choose between more emphasis on improvements in their business activities through innovation or On compensatory approaches such as emissions trading; and to do this merely on their own or by interacting with external actors, be it other companies in the supply chain or industry, NGOs or (local) governments. Innovation and Page 78 of 118
compensation can be executed internally in the company, vertically in the supply chain, or horizontally beyond the latter, through partners. 'Make' or 'buy' emission reductions: Certified emission reductions (CERs) is an emission trading scheme that allows companies to buy or sell emission credits in the market. For some companies it is simpler to buy the balance(compensation) from more efficient companies while innovating slowly on processes. Six strategic options surface in the face of these opportunities:
Three innovation strategies (company's own business activities) 1. Process improvement (Internal) Typically energy reduction or higher energy efficiency in processes. 2. Product development (Vertical路路~ supply chain) Developing new efficient products 3. New product/market combinations (Horizontal路~路 beyond I and 2) Exploring new combos through strategic alliances or positioning outside traditional markets. Three compensation strategies (leaves company's
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assets unaltered)
I. Internal transfer of emission reductions (Internal) Large companies that operate across borders. Transferring high emission activities to low-restrictive areas. Or integrate targets for emissions into investment decisions. 2. Supply-chain measures (Verticalv- supply chain) move sources of high emissions elsewhere in the supply chain. E.g. Only purchasing ,green ~ cncr gy. 3. Acquisition of emission credits (Horizontal beyond 1 and 2) Emission trading on the JT181'kc1:, balancing excess emissions.
The conclusions in the paper are based on a study of large 136 companies, part of the: Global 500. The article goes OJl to categorize six different configurations of climate strateg.}" from these companies' environmental strategy/approach, which can be summarized here:
Cautious planners: preparing for action but haven't done much (31 %) Emergent planners: have set targets but have not yet implemented them (36'%) I:l Internal explorers: have begun to implement internal process improvements (14%) Vertical explorers: considering product improvements, especially in cooperation with suppliers (10%) [I Horizontal explorers: considering opportunities in related markets, perhaps in cooperation with partners (5%) Emission traders: engage in trading emission rights or facilitate this trading (4%)
The majority of companies fall in the first two clusters, who arc still in the preliminary phase, while the last four have a more proactive strategy and arc more advanced I n exploring opportunities related to climate change. Page 79 of 118
e
Brigham, Lawson W. (2007). Thinking about the Arctic's future: Scenarios for 2040," 111e Futurist, September-October, pp. 27-34.
Theme: Temperatures in the arctic arc rising at unprecedented rates and arc likey to continue increasing throughout the century. The combination of two major forces - intense climate change and increasing (untapped) natural resource development in the region - can transform it into a new area of importance to the global economy. - Environmental refugees?l Bah! This articles maps out possible future impact-scenarios within this development. Key words: Arctic scenarios, Circumpolar cooperation, arctic council, Abstract: The four arctic scenarios for 2.040, laid out in the article, are based upon the following key thcmcs: Global Climate Changc: Results in significant regional warming in each of the four scenarios Transportation systems: Especially increases in marine- and air accss.
Resource development: E.g..Oil, gas, minerals, fisheries, frcshawatcr and forestry..
lndigcnous Arctic peoples: Their economic status and the impacts of change on their well-being. Regional environmental degradation: And environmental protection schemes
The Arctic council: And other coiopcrativce arrangements of the arctic states and those of rcgiona' (mel local governments.
Overall geopolitical issues: Facing the region) such as Law of rhc Sc-r.'.l. and boundary disputes.
Scenario t .... Globalized Frontier Become integral component of the global economic system, . . Abundant resources, less harsh climate. Age of Polar transportation .. shorter global air and sea routes between North America and Eurasia, increased commercial shipping. Put increased environmental pressure on the entire Arctic. Natural resource exploitation has become viable; Oil and gas development, as well as exploitation of the regions boreal forest have been extensive. Overfishing, depletion of many seas. Environmental concerns of the Arctic council arc superseded by economical and social interests. Growing industrial activity in the Arctic causes environmental disaster. Many Pipelines experience serious spills. The five coastal states assert their sovereignty over seabed resources. Several coastal communities in Alaska and Canada are simply washed away. Page 80 of] ] 8
Scenario 2 -Adaptive frontier The arctic is being drawn into the globalization much more slowly. But more international cooperation and harmony among actors. The circumpolar nations have realized their responsibilities. Environmental impacts are serious and widespread, but keener awareness is present. No full scale assault on oil and gas resources. Some development, but still not feasible in comparison to world prices. Transportation is very robust, but emissions are controlled. Commercial fishing is well-developed, but also regulated better with harvest quotas. Arctic tourism is flourishing. Arctic council is a proactive forum, with dispute resolving power. Arctic environmental contingency planning is generally well-planned and coordinated. Multinational response teams. Scenario 3 - Fortress frontier Widespread resource exploitation and increased international tension. Arctic perceived as storehouse of natural riches that is being jealously guarded and developed by handful of wealthy circumpolar nations. Everything economical is orchestrated by the most powerful arctic stated. Still undergoing extreme environmental stress as global warming continues. Indigenous population displaced form homelands, much environmental immigration is plaguing the subarctic states. Foreign aircraft and ship access have bcen periodically suspended. Sea routes arc tightly controlled, .- Same as with access to the natural resources. Arctic council is lTIUcI) Jess concerned with sustainable development than envisioned. Their lonf~'" 'M term strategy is making the arctic independent from natural resources from outside the region. ~
Sccnar!o 4 ...., Equitable {'''''H,ii"r The arctic remains integratedwith the global economic system in 2040, but the sustainabilny paradigm. has resulted in a strategy emphasizing gradualism. Mutual respect and cooperation among the circumpolar nations arc the norm. Arctic governance system. ViCVi7Ccl as a model for resolving complex sustain ability issues and regional disputed. Global warming has taken its toll in this scenario as well. Oil production has plummeted, but gas and freshwater are thriving. Social well-being and quality of life has been transformed. Poverty reduced because of revenue sharing from tourism, transport and minerals. Quality education within reach for most.
No Utopia, but social equity and environmental has become the vision of consensus. Little tension between 8 arctic states.
Page 81 of 118
Globalized Frontier
Adaptive Frontier
Fortress Frontier
Equitable Frontier
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Dramatic increase
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Tightly controlled; restrictions
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LeO!liI.nl-Bal'ton, R (1995): from the Market, '7 Wellsprings ofKnowtedg«. Boston, MA: Harvard Business School
(36 IL)
Abstract 1 Technological design maturity ; Market alignment
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Overall theme: Understanding user needs through non-traditional market research techniques in order to feed market information into new-product development projects.
Abstract Page 82 of I 18
Leonard-Burton describes the two basic factors shaping new-product development situations facing firms: The technological design maturity; the degree to which a proposed product is entirely new to the world or more of a incremental modification of earlier products. This can be seen as a life cycle, where the product becomes more mature as the product changes shift from fundamental to more cosmetic. Eventually a dominant design occurs in the design hierarchy. Market alignment; the degree to which a proposed product aligns with the desires and need of the firm's current eustomers or whether a new customer base is needed for the newproduet. low
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The figure sugge~li~~,i~ll!Lrc'JrrumilltITUrnlliLCll'iLl1路lC.e'C"_'::::;~ Jow 1) User-driven Enhancel11ent~ T',}1.1lrnvpd liso!utiton to R known need XfH.!JllllClll ofnroutt6 l禄:lCWllIfcll rcn cu~t()flicr1)asc 2) Developer..driven Development; New solution to a known need 3) User-context Development; New solution to an unexpressed need 4) New application or combination of Technologies; Novel solution to an identified need (resembles the second, but technology drives this development rather than the market demand) Technology/market co-evolution; Evolving solution to an uncertain need (Strong element of uncertainty) These five situations are what determine the knowledge needed to be imported
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the: 11rst situation, the major activity is inquiry. This :ls the more traditional market research r.e. focus groups, SUf\iCYSJ lead users and latent needs. 'The second, third, and fourth situation. require more non-traditional research methods, that the Leonard-Barton calls emphatic design. Emphatic design is the creation ofproduct or service concepts based on a deep (emphatic) understanding ofunarticulated user needs. (p.194). There arc three types of empathy inducing mechanism 1) Developer's market intuition, which implies that firms in different ways should develop an intuition of what the market wants now and in the future. This could be through User..Developers or Industry Experts. 2) Market matching, which means the ability to identify applications for which user arc incapable of imagining solutions for, i.e. through technology transfer or partnering with customers. 3) Anthropological expedition, probably the most unusual hut also the most promising way of understanding of the user's world. This can be done through observing user practices, capturing practices on film, or role-playing the future. Of course emphatic design can be combined with the more traditional market research methods. In the fifth situation, where neither technologies nor customers are known the firm must in the words of Leonard-Barton "create a new market". This can be done through extrapolating trends, making scenarios of the future, market experimentation. There are three strategies of market Page 83 of 118
experimentation; Darwinian selection, product morphing, and vicarious experimentation (see fig. 78 page 208). Finally Leonard-Barton discusses the use of prototypes to co-evolve the product concept, especially useful when product developers cannot communicate the full potential of the new product. Abstract 2 Overall theme Understanding user needs through non-traditional market research techniques in order to feed market information into new-product development projects. Leonard Barton's (J 995) framework can be used to identify different sitnations on a market each requiring special tools in order to learn from it and thus secure successful new product innovations. Abstract Leonard-Burton describes the two basic factors sbaping new-product development sitnations facing firms: The technological design maturity; the degree to which a proposed product is entirely new to the world or more of a incremental modification of earlier products. This can be seen as a life cycle, where the product becomes more mature as the product chauges shift from fundamental to more cosmetic. Eventually a dominant design occurs in the design hierarchy. Market alignment; the degree to which a proposed product aligns with the desires and need of the firm's current customers or whether a new customer base is needed for the new-product. low
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These five situations are what determine the knowledge needed to be imported from the market. The D10ckI below illustrates the tools needed to import the required knowledge for each of the five situations.
Page 84 of 118
Importing knowledge from the market: Creating new Markets o Market Experimentation o Scenarios ofthe Future
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Ad 1: The major activity is inquiry as the customers are known. Traditional market research i.c. focusgroups, surveys, lead users and latent needs. Ad 2+3+4: Non-traditional research methods, which Leonard-Barton calls emphatic design. Emphatic design
is the creation (~f product or service concepts based on a deep (emphatic) understanding of unarticulatcd user need, (1'. j 94). Three types of empathy: ill Ad 2: Developer's market intuition, which implies that firms in different ways should develop an intuition of what the market needs/wants now and in the future i.e. through User-Developers or Industry Experts. e Ad 3: Anthropnlogical expedition, probably the most unusual but also the most promising way of understanding of the user's world. This can be done through observing user practices, capturing practices on film, or role-playing the future. Purpose: is to introduce new products for new customer set. 0' Ad 4. Market matching, which means the ability to identify applications for which users are incapable of imagining solutions for as they do not know that the technology exists, i.e. through technology transfer or partnering with this new types ofcustomer. Ad 5: Neither technologies nor customers arc known. Tools to be used: extrapolating trends, making scenarios of the future, market experimentation (three strategies of market cxpcrimentationo Darwinian selection, product morphing, and vicarious experimentation).
"
Christensen, eMo and MoE. Raynor (2003), The Innovator's Solution; (Chapter 2 and 3) Boston MA: Harvard Business Schoo! Press (69 po)
Terms: Disrupter: The (often small and new) company who disrupts Disruptce: The (often large and incumbent) firm who's product or services arc disrupted Innovation Types: (Context will be provided in Abstract section) 1. Sustaining Innovation (often utilized hy large incumbents): Targets demanding, high-end customers with better perIormance than what was previously available. Some sustaining Page 85 of 118
innovations are the incremental year-loy-year improvements that all good companies grind out, other can be leapfrog-beyond-the-competition products. The established actors almost always win the battles of sustaining technology. 2.
Disruptive Innovation: In contrast to the above, it doesn't try to bring better products to established customers in existing markets. Rather they disrupt and redefine that trajectory by introducing products that are not as good as currently available products. They do offer other benefits - typically, they are simpler, more convenient, and less expensive products that appeal to new or less demanding customers. Once the innovation gains foothold, the improvement cycle begins, and thus the disruption of the sustaining innovation begins.
1. Two types of Disruptive Innovation (will be explained in abstract). a.
Low-End
b.
New-Market
Value Network: is the context within which a firm establishes a cost structure and operating processes and works with suppliers and channel partners in order to respond profitably to the common needs of a class of customers. Within a value network, each firm's competitive strategy, and particularly its cost structure and its choices of markets and customers to serve, determines its perceptions of the economic value of an innovation. These perceptions, in turn, shape the rewards and threats that firms expect to experience through disruptive versus sustaining innovations. Main questions proposed ill the article 3.
"How can we know in advance whether we're going to be able to beat the competition?"
b.
"Why has disruption proven to be such a consistently effective strategy for causing strong
incumbent competitors to flee from their entrant attackers, rather than fight them?" c.
"How can a business idea be shaped into a disruptive strategyF!
d.
Nean the winner in a (ace for innovative growth really be predicted'?"
Page 86 of 118
Abstract: Initially the article proposes the paradox of CEOs of large, resource-rich companies base their strategies upon the assumption that larger companies with more resources to throw at a problem will beat the smaller competitors, despite repeated evidence that the level of resources committed often bears little relationship to the outcome.
Figure 1 The disruptive innovation model
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The figure above illustrates the three critical elements of disruption. First, in every market there is a rate of improvement that customers can utilize or absorb (dotted center line (which represents the ' Car manufacturers keep median of the distribution). There arc in essence several tiers). providing lW)9 and improved engines, but lve can '{ utilize the performance because offactors such as' traffic, speed limits and safety concerns, Second, in every market there is a distinctly different trajectory of improvement that innovating companies provide as they introduce 1"lC\\7 and improved products. As depicted on the innovation lines' angle, companies arc likely to overshoot wbat those same customers arc able to utilize. This happens because of increasing intensity of competition in an industry, and thus the constant strive to provide better and more advanced products. Exantples: Whenpersonal computers (1983) started to replace type writers, the technology was not good
enough, but todays processors offer much more speed than mainstream customers can use except for afew customers in the most demanding tiers ofthe market with specialized needs', The Third element is the distinction between sustaining and disruptive innovation (sec explanation in the Terms section). Disruption has a paralyzing effect on industry leaders. With resource allocation processes designed and perfected to support sustaining innovations, they arc constitutionally unable to respond. They arc always motivated to go up-market, and almost never to defend the new or low-end markets that the disrupters find attractive. This is called Asymmetric Motivation, and it is the Gore of the innovator's dilemma, and the beginning of the innovator's solution,
Case: Disruption at Work: How Minimills Upended Integrated Steel Companies Throughout history the steel industry has been dominated by large companies producing steel in Integrated Steel Mills costing around $8 billion to build today. Minimills in contrast melt scrap steel
Page 87 of 118
in electrie furnaces and can today with their straightforward technology make steel of any given quality for 20 percent lower cost than an integrated mill. You would think that every integrated steel company in the world would have aggressively adopted the straightforward, lower-cost minimill technology. But yet as of year 2000 not a single integrated steel company had successfully invested in a minimill, even as the minim ills had grown to account for nearly half of North America's steel production and a significant share of other markets as well. % of Total
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The figure above illustrates how the minimills' technology was perfected over time because of the improvement cycle. Initially the mills could produce the lowest quality steel product, concrete reinforcement bars, and when they completely conquered this market they made it possible to produce angle iron, bars and rods and so forth.
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Page 88 of 118
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This is where it gets real interesting, because firms can choose either strategy; New-Market og Low-End to disrupt their sustaining competitors. And on the other hand, incumbents can use this model to be aware of disrupters. The article furthermore provides Three Litmus Tests to shape ideas to become disruptive, as they rarely are when they emerge from the innovator's mind. Sec the specific sets of questions on pp,49. The Article furthermore provides a list of disruptive strategies and companies in Table 2·2 on pp.56·65. Chapter three provides a mobile devices case as well (15 an perspective on the disruption phenomenon with a holistic segmentation approach.
~J"" /,,'~ . ., 'f'· ,,>q1t'.;; 1; -ft» II o ,HegiC II ans orma ron ,'"ftPa,lb intensive innovation into Hew horizons (Sara) ;;;"r,.,,~,
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Porter, M.K (1987): FrOB} Competitive Strategy to Corporate Strategy, Harvard Business Review, May·Jnnc (20 p.)
Abstract 1 and market development
Frisbrek Jensen Page 89 of 118
From competitive advantage to strategy
MichaclE. Porter
Corporate strategy. A diversified company has two levels of strategy: business unit (or competitive) strategy and corporate (or company-wide) strategy. While the former deals with how to create competitive advantage in each of the businesses in which a company competes the latter concems what businesses the corporation should be in and how corporate office should manage thc array of business units. It is this latter lcvel of - the corporate strategy- Porter examines throughout this text.
Porter studied the diversification records of 33 large U.S companies over the 1950-1986 period and found that they had divested many morc acquisitions than they had kept. He calls for the necessity of rethinking corporate strategy. Successful corporate strategy builds on a number of premises: â&#x20AC;˘
Competition occurs at thc business unit level - successful corporate strategy must grow out of and reinforce competitive strategy.
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Diversification inevitably adds costs and constraints to business units
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Shareholders can easily diversify themselves - even more cheaply than a corporation because they can buy shares at the market price and avoid high acqnisition premiums.
These premises mean that corporate strategy cannot succeed unless it truly adds value to the BUs by providing tangible benefits that offset the inherent costs oflost independence and to shareholders by diversifying in a way they cannot replicate. The conditions under which diversification will truly create shareholder value can be summarized in three essential tests: a) The auractivcncss test: The industries chosen for diversification must be structurally attractive or capable of being made attractive (a company might benefit from entering before the industry shows full potential). h) The cost-of-entry test:
The cost of entry most not capitalize all the future profits. c) The better-offtest: Either the new unit must gain competitive advantage from its link with the corporation or VIce versa.
Four concepts of corporate strategy that have been put into practice: 1) Portfolio management: This concept of corporate strategy is based primarily on diversification through acquisition. The corporation has a rather passive role serving merely as banker and reviewer. Acquired units do not have to be in the same industries as existing units, but often portfolio managers limit their range of businesses in some way, in part to limit the specific expertise needed by top-management. The corporation provides capital on favourable terms (much cheaper than the BU s could obtain on their own). Furthermore it introduces professional management skills and discipline and provides high-quality review and coaching. Page 90 of 118
Portfolio management is not as popular as it used to be because the benefits from following this strategy have more or less eroded. - In Porter's opinion portfolio management is no way to conduct corporate strategy. 2) Restrueturing: Unlike portfolio management a company that bases its strategy on restructuring becomes an active restructurer of BU s. The restructurer seeks out undeveloped or threatened organizations or industries. The value chain defines the two types of interrelationship that may create synergy. The first is the company's ability to transfer skills or expertise among similar value chains. The second is the ability to share activities 3) Transferring skills: While each BU has a separate value chain, knowledge about how to perform activities is transferred among the units. However, the existence of similarities is crucial for the success of this type of diversification. Transferring skills leads to competitive advantages if the similarities among businesses meet three conditions: The activities involved in the businesses arc similar enough that sharing expertise is meaningful The transfer of skills involves activities important to competitive advantage. The skills transferred represent a significant the receiving unit.
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of competitive advantage for
4) Sharing activities: Sharing activities enhances compctmvc advantage by lowering costs or raismg differentiation. It is a good idea to make a cost-benefit analysis of prospective sharing opportunities to determine whether synergy is possible. Sharing must involve activities that are significant to competitive advantage, not just any activity. /.". company Vv'iJI create shareholder \IHIne through diversification to a greater and greater extent as strategy 1110\lC5 from portfolio management toward sharing activities. Porter argues that a company win create better shareholder value if it bases its strategy on interrelationships than if it focuses on transforming companies in unfamiliar industries. Corporate strategy should thus) be argues, if possible be based on the transfer of 51<:i11s or shared activities.
Diversification, corporate strategy, attractiveness test, cost-of-entry test, better-off test, portfolio management, restructuring, transferring skills, sharing activities
Overall theme: Discussing how diversification successfully creates shareholder value. To guide diversification, 4 concepts of corporate strategy arc discussed. The first 2 (portfolio management, restructuring) require no connections among business units, the last 2 (transferring skills, sharing activities) depend on connections among the business units. Testing how sound a concept of corporate strategy is, can be done through the 3 tests: attractiveness test, cost-of-entry test and better-off test.
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Abstract: 2 levels of strategy: business unit (competitive) and corporate (company-wise), focusing on the latter. Premises of corporate strategy: I. Competition on business unit level 2. Diversification adds cost and constrains to business units 3. Shareholders can readily diversify themselves Testing how sound a concept of corporate strategy is: I. f',.ttr'lctiveness..test: Industries chosen must be attractive (high average ROT, high entry barriers, modest bargaining power of suppliers and buyers, few substitute products and services, stable rivalry between competitors) 2. .cost-of:91l!1:Y....1",st: The cost of entry must not capitalize profits. Entering is either through acquisition or start-up. 3. Better-off test: The new unit must provide competitive advantage from link with corporation or vice versa. 4 Concepts of corporate strategy: 1. .1'.Q!:t19Ji'L mi!!1j!g""menl: Based primarily on diversification through acquismon. Acquired units remain autonomous. Existing corporation has rather passive role: provides capital, reviews, coaching, assists in professional management. Portfolio management has failed because of the number of tasks being too much to handle (seems like the control is primarily of a financial nature). 2. Restructuring: The new businesses need not be related to the cxisnng unit. Potential candidates have unrealized potential, arc underdeveloped, sick, or threatened organisations on the threshold of significant change. Existing unit becomes more active following restructuring strategy than if fol1owing a portfolio management strategy. Pitfall: Companies find it hard to dispose business units once they arc restructured and performing well (Like with stocks) you always hope foi.. a little more). If the company docsn t dispose the new business, it no longer [0110V';8 CI. restructuring strategy (active), but rather a portfolio management strategy (passive) and thus faces the pitfalls mentioned under point 10 r
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Creating synergy: transferring skills or expertise among similar value chain activities. Transferring skills lead to competitive advantage is the following conditions arc met: 1) sharing expertise makes sense, 2) transfer of skills involve activities important to competitive advantage and 3) skills transferred give the receiving unit a significant competitive advantage,
4. Sharingactiviti""s.: Based on sharing activities in the value chain among business units. Ex. Sharing distribution system and sales force. Pro's of sharing activities: it can lead to lower costs through economies of seale and it can help a company move faster along the learning curve. Con's of sharing activities: huge coordination costs and the fact that both units have to agree on compromise (ex, Compromise on a design which is not as complex as required by the one unit, and a sales person who handles the products of the two business units must operate in a way that he wouldn't if he was only seeking the interest of the one business unit). The pitfall is resistance to even beneficial sharing possibilities. Exhibit 4 on pp. 16-17 sums up the differences between the 4 concepts of corporate strategies. Page 92 of 118
The last pages provide a how-to-do guide to choose a corporate strategy.
Abstract 3 Theme Discussing how diversification successfully creates shareholder value. To guide diversification, 4 concepts of corporate strategy are discussed. The first 2 (portfolio management, restructuring) reqnire no connections among husiness units, the last 2 (transferring skills, sharing activities) depend on connections among the business units. Testing how sound a concept of corporate strategy is, can be done through the 3 tests: attractiveness test, cost-of-entry test and better-off test. Abstract A diversified company has two levels of strategy: business nnit (competitive) strategy and corporate (company-wide) strategy, Corporate strategy is what makes the corporate whole add up to more than the sum of its business unit parts.' Three premises arc observed in relation to diversification, which is facts of life and cannot be altered. J) Competition occurs at the business level 2) Diversification inevitably adds costs and constraints 10 business units 3) Shareholders can readily diversify themselves. Keeping these three premises in mind, it can still prove successful to diversify for a company, if the diversification can pass three conditions or tests ontlined by Porter:
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Jhe ilttractivcn"ssJ£eJ; the industry must have favorable structures that support returns exceeding the cost of capital TIlc.£ost-of:entJy test; diversification cannot build shareholder value if the cost of entry into a new business cats up its expected returns. A company can enter new industries by acquisition or start-up. Thc.bctter··olftest; a corporation must bring some significant competitive advantage to the new unit, or the new unit must offer potential for significant advantage to the corporation.
Four Concepts of Corporate Strategy: 5. j>ortfoliolllanagcn2£Ll!: Based primarily on diversification through acquisition. Acquired units remain autonomous. Existing corporation has rather passive role: provides capital, reviews; coaching) assists in professional management. Portfolio management has failed because of the number of tasks being too much to handle (SCCJJ1S like the control is primarily ora financial nature).
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RQJ?.tI1~g.tl!.dng: The new businesses need not be related to the existing unit. Potential candidates have unrealized potential, arc underdeveloped, sick, or threatened organisations on the threshold of significant change. Existing unit becomes more active following restructuring strategy than if following a portfolio management strategy. Pitfall: Companies find it hard to dispose business units once they arc restructured and performing well (LjI\.c with stocks, you always hope for a little Inure). If the company doesn't dispose the new business) it no longer follows a restructuring strategv (active), but rather a portfolio management strategy (P<18Sivc) and thus faces the pitfalls mentioned under point I.
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:rlim'ii2[1:i.nK_,;lsLU,-~.Creatlng synergy: transferring skills or expertise among similar value chain
activities. Transferring skills lead to competitive advantage is the following conditions arc met: I) sharing expertise makes sense, 2) transfer of skills involve activities important to competitive advantage and 3) skills transferred give the receiving unit a significant competitive advantage, 8. f~_.h~lrinK,Jl~~iyj.t~9.~ Based on sharing activities in the value chain among business units. Ex. Sharing distribution system and sales force. Pro's of sharing activities: it can lead to lower costs through economics of scale and It can help a company move faster along the learning curve. Con's of sharing activities: huge coordination costs and the fact that both units have to agree on compromise (ex. Compromise on a design which is not as complex as required by the one unit, and a sales person who handles the products of the two business units must operate in a way that he wouldn't if he was only
7
What businesses should the Corp. be in and how should the corp. office manage the array of businesses. Page 93 of 118
seeking the interest of the one business unit). The pitfall is resistance to even heneficial sharing possibilities. The purpose of the first two strategies is to create value thru a company's relationship with each autonomous unit, whereas the last two strategies exploit the interrelationships between businesses. A eompany will create shareholder value thru diversification to a greater and greater extend as its strategy moves from portfolio management toward sharing activities (p. 19). Porter espeeially favors the last two concepts, transfer of skills and shared activities. Porter's Action Program: 1) Identify the interrelationships among already existing business units 2) Select the core businesses that will be the foundation of the corporate strategy 3) Create horizontal organizational mechanisms to facilitate interrelationships among the core businesses and lay the groundwork for future related diversification 4) Pursue diversification opportunities that allow shared activities 5) Pursue diversification thru the transfer of skills if opportunities for sharing activities are limited or exhausted 6) Pursue a strategy ofrestructuring if this fits the skills of management or no good opportunities exist for forging corporate interrelationships 7) Pay dividends so that the shareholders can be the portfolio managers
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Christensen, .1.1'. (2002): Corporate strategy and the management of innovation and technology, Industria! and Corporate Change, 11 (2): 263~288 (23 p.)
Abstract 1 Christensen considers the interrelationship between overall organizational structures and business strategies and innovation and technology strategies (a term he uses instead of R&D strategies). Froslev argues that a company's overall organizational structures and business strategies arc closely related to its innovation and technology strategies. The article presents a comparative analysis of Danfoss and Grundfos, and their respective innovation and technology (1&,'1') strategies. Danfoss represents the example of a "related diversifier", while Grundfos illustrates the "vertical integrator". These arc the 1\'1'0 most dominant strategies for technology based companIes. Abstmd I'he analytical framework built to develop the three propositions tested through the empirical study, is based on two types of organizational structures, and 1:\i'/0 generic diversification strategies expected to be seen in technology-based companies. the organizational structures considered arc: rVK-¡ form. structures: multidivisional structures. These are considered to be decentralized and therefore accommodate unrelated diversification and Financial economics. lJ-fonn strucnu-es: unitary/functional structures. These arc, considered to be centralized. and accommodate vertical integration and vertical economies. ThCBJC:
The generic diversification strategies considered in theframework are: Related diversiflcation: The related diversifier either diversifies into technology related areas, where it can exploit existing technological capabilities in new product markets, or it diversifies into market related areas" where it can exploit existing market positions (like distribution or marketing capabilities). The related diversifier is expected to have a M¡ shaped organizational structure, as it allows for decentralized management of innovation and technology. 31v1 is a good example of a technology related diversifier. Ver-tical integration: The vertical integrator has a narrow range of businesses and diversifies through integrating vertically in the value-chain of its existing produetlincs. The vertical integrator is associated with U structures, which relates well to the centralized mode of managing l&T needed to achieve coordination and vertical economics. The 3 propositions tested (sec below) build furthermore on two insights on technical innovation: o "Technological innovation is by nature interactive, involving cross-functional and/or crossdisciplinary learning and R&D at different levels". Page 94 of ] 18
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"The ranges of teehnical eapabilities tend to grow relative to the range of products or business areas in technology-based companies. Based on these insights and the framework described above, following three propositions were developed and tested on Danfoss and Grundfos:
I) The organizational structure for managing innovation reflects innovation strategy as characterized by the type (if interface structure and the depth and novelty (if the R&D processes. (By interfaee foeus Froslev refers to upstream linked or downstream linked innovations. Upstream innovations refer to radieal innovations and bear on R&D labs. Downstream innovations refer to incremental innovations and focus on the interaction between R&D and business functions like marketing).
2) The choice of organizational design for managing technology is a function (if the cost and time horizon involved in technology diversification, and the ease with which the existing R&D personnel can assimilate new technologies. 3) Decentralized technology integration, is feasible when the technologies 10 be integrated are mature or embedded in in components for modular product architectures. A centralized unit is, on the other hand, needed to integrate technologies that are high~V complex and tacit (like new technologies often are) The empirical study of Dan foss and Grundfos supports the propositions posed by Froslev.
Danfoss vs, Gnmdloss within Froslev's Framework
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Danfoss acts as a prime example of (J 'related diversifier', where structure determines integration strategy, The development of the organisation og I1~~'r has been primarily determined by the overall development in corporate: strategy and structure, and de/acto innovation and technology strategies have adopted accordingly. Grundfoss acts as a prime example of a 'vertical integrator' where Integration strufegy determines structure. The development of the organisation of I&T has to a larger extent been determined by specific objectives of innovation and technology strategies, Modern version of Chandler proposition is that structure follows strategy, which is in turn constrained by structure leading to corporate inertia (Burgclmann).
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Modes of managing innovation in Danfoss and Gnmdfos Dunfoss
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Theme The improvement of understanding of the interdependencies between the overall strategy-structure dynamics of the large corporation" and the particular dynamics associated with the management of I&T, Kcy words Related diversifier " Synergistic economies, Vertical integrator" Vertical economics, Abstract This paper provides a comparative study of the two categories of corporate strategies that are most important to technology-based companies, namely related diversification and vertical integration (tables 1 to 4 explain the main differences very well),
Page 96 of 118
The study is a comparative analysis of two large Danish manufacturing companies, Danfoss illustrating a 'related diversifier' company, and Grundfoss illustrating a 'vertical integrator' company. The case The two companies are close to being ideal types of these two categories, in terms of their overall growth strategy and governance structure. But despite those differences, they share many similarities. Both grew out of strong entrepreneurial organisations, have both been highly growthoriented for over 50 years, have grown to large and global companies while still remaining predominantly family-owned (see Table 5, page 273). Both started out as Ll-forrn companies with top-down management and while Danfoss bas changes over the years to an M-form organisation, Grundfoss has never serionsly considered taking the step into the M路form. The differences of the two companies' are in their corporate strategy and structure. While Danfoss diversifies in operating in thousands of products within refrigeration controls, motion controls, and heating and water controls, Grundfoss operates within pumps and pump systems (the circulator pumps account for a dominant share of the company's turnover). Danfoss versus Gnmdfoss _.. structural differenecs and overall strategy-structure profile Prcdnmiuant
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-'.CI'lC suggestions made in, this concerning the interplay between innovation and technology' strategy and the management and organisation of 1&:1':, were illustrated by the t\\TO case studies. they also revealed that the dctcrruinants of a specific mode of organizing 1&.'1' may differ. Danfoss acts as a prime example of a "related diversifier) where structure determines integration strategy. The development of the organisation og I<'k'r has been primarily determined by the overall development in corporate strategy and structure, and de [acto innovation and technology strategies havc adopted accordingly. 'I
Grundfoss acts as a prime example of a 'vertical integrator' where Integration strategy determines structure. The development of the organisation of I&T has to a larger extent been determined by specific objectives of innovation and technology strategies. The insights from this text might bc explained by, that some growing and diversifying companies gradually sec their de facto innovation and technology strategies constrained by the increasingly decentraliscd and financially controlled governance structures,
Definitions e The related diversifier seeks to obtain' synergistic economics'. Tends to impose an organisation on management ofJ&T, that severely constrains the strategic scope for Page 97 of I 18
innovation and technology strategy. The organisations are more divisional and financially driven, and the economic incentives drive divisions away from explorative, high-risk and long term orientation in R&D projects and towards incremental low-risk projects. e
The vertical integrator pursues 'vertical economies'. Divisions are less constrained by the overall strategy-structure constellation when choosing its mode of managing I&T. It's easier for them to choose its distinct innovation or technology strategy and design an organisation that is appropriate for the implementation of the strategy. Their strength is therefore to be able to show commitment to large explorative investments in high-risk projects with a long horizon.
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l&T (Innovation & Technology) is used by the author instead of the more institutionalised, but also narrower term, R&D.
Related theories Chandler (1991), and Sanchez (1996), are among those who come with related theories to this text.
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Burgelman, RA. (2002): Strategy as Vector and the Inertia of Cocvolutionary Leek-In, Administrative Science Quarterty, Vol. 47: 325-357 (33 p.).
Abstract J This article uses Intel to examine the consequences ofa period of extraordinary success/or the long-term adaptive capability ofa company's strategy making thereafter. Key words ra Coevolutionary lock-in: a positrvc feedback process that increasingly tics the previous success of a company's strategy to that of its existing product-market environment, thereby making it difficult to change strategic direction. w Burgclmans evolutionary internal drivers of corporate dynamics: , Induced strategy: exploits initiatives wlin the scope of a company's current strategy; extends company further in its current product-market environment; a deliberate top down approach. '" Autonomous strategy. exploits initiatives that emerge through exploration outside the scope of the current strategy; provides the basis for entering into lJCVV product-marker environments; emergent bottom-up approach. 8 Burgchnans evolutionary external drivers of corporate dynamics: " Variation mechanism (e.g. tech revolution, new entrants with new biz: models) a Selection mechanism (e.g. market selects the new tech or new bizz model), , Retention mechanism (c.g. the maturing of new tech, the growth ofncw entrants).
problems/focal points, main arguments and conclusion Paper's core theoretical idea: a company's relentless and successful pursuit of a narrow business strategy through the induced strategy process may produce coevolutionary lock-in and reduce effectiveness of the autonomous strategy process, which weakens a company's long..term adaptation " Coevolutionary lock ..in as a double-edged sword: strategic dominance produces dependence. m
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Theories/models and their relation to the set of problems â&#x20AC;˘
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Figure 1. Effects of a strate qy vector on the internal ecology of strategy making.
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microprocessor business with the rapid ascendance of the IBM PC and to turn good luck into a strategy vector, i.c. he was able to drive Intel into the intended strategic direction. Hc made Intel focus on a narrow bnsincss strategy and established an induced strategy process that tightly aligned strategy and action and produced extraordinary success. Study reveals a complex reciprocal causation bit his strategic intent and the structures and processes that he put in place and how the very success of the strategy vector resulted in the emergence of coevolutionary lock-in and impeded new business development. The heavy focus on the microprocessor business made it difficult for new ventures to thrive inside Intel, His strategic leadership approximated. the classical rational-actor model in pursuing Intel"s enormous opportunity in the PC market segment, but at the cost of reducing Intel ~ s capability to develop new businesses in the words of the Intel CE':O: "success can trap vou If the growth of the PC market had continued unabated, Intel's induced strategy would probably have sufficed to secure continued adaptation, thereby reducing further the relevance of the autonomous strategy process. It, however, became clear for Intel that their future growth would also depend on new business development and that the strategies for new businesses might have to he defined by general managers who were closer to the front line. Inertial consequences of cocvolutionary lock-in, however, had significantly reduced the effectiveness of intcl's autonomous strategy process. Paper emphasizes the importance of striking the balance b/t induced and autonomous strategy processes and b/t exploitation and exploration in orgal learning when determining a company's strategic context. In order to take advantage of new developments and escape the strategic inertia associated with co evolutionary lock-in you have to transform your organization to match new tendencies.
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Successful Corporate Strategy depends on... ~
Dynamic congruuy between external nnd internal drivers
• Dynamic balance between Induced and autonomous strategy processes
Session 16: The Strategic Turnaround of Lego and Implications for Management of Innovation (Denice) Literature: To be distributed in due time prior to the session
Session 17: Maximizing the value of intellectual property (Sabina) MAXIMISING THE VALUIE OF INTELLECTUAL PROPERTY How the characteristics of information affect firm' strategy e Asymmetric information @ Incomplete information e "Public good" nature of information Background e Increasing importance ofIPRs (and piracyl) o Intangible assets have become central to competitive advantage o Globalization of business activities o Advances in digital technologies of replicability and transferability o Changes in the regulatory framework governing intellectual property IPRs integral to business strategy @
The problem of appropriability e Knowledge difficult to protect ® Market failure: innovators cannot appropriate the returns from their investments in I,&D Conclusion: profit-seeking agents invest less than optimally in R&D sa IPIZs can only partly restore the incentive to perform R&D ® Importance of creating right balance between exclusion and di ffusion @
Strategies of appropriability @ Intellectual property rights o Patents. copyrights, trademarks. etc @ Time-based o Lead time o Learning curve e Organizational o Secrecy o Complementary investments in sales & services Page 100 of U8
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Economic rationale for patents o Patents motivate invention o Patents inducc disclosure and wide usc of inventions o Patents induce the development and commercialization of inventions o Patents enable orderly technological development
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Rivette, Kevin G. And Kline, David (2000). Discovering new value in intellectual property, Harvard Business Review, January-February, pp. 54-66.
Rivette and Kline (2000) • Patents: "Rembrandts in the attic" o Waiting to be exploited for profit and competitive advantage e Integration of patent strategy into R&D, production and marketing strategy • Patents as "signals" COPYRIGHTS - and the digital revolution • Economic function of copyrights o Purpose: to create incentives for the creation and further development of literary, musical, and artistic works o Protect the expression of the idea, not the idea itself e The work must be original o Gives thc right to prevent unauthorized use ., Though "fair use" is allowed e
Shapiro, Carl and Varian, HaL R (1999). Rights management, Information Rules (Harvard Business Schoo! Press), pp. 83-Hl2.
The text examines IP strategies of different companies, i.c. Gillette's Sensor "chose a design that competitors would have most difficulty getting arouns". Another example mentioned is Texas Instruments move into Digital Subscriber Line (as demand for high speed internet was increasing) they acquired a smaller company. Lockheed Martin used their patented 3D flight simulator (which was just attracting dust) to create a new venture, Rea13D, to compete in the PC graphics and video game business. Revenues from licensing out patent rights have increased from 15 billion USTJ in j 990 to 110 billion USD in 2000. A Stern study by Deng reveals that "companies whose patents were frequently cited in patents of other companies saw their stock prices rise far more rapidly than those companies with less frequently cited patens (1999) Maximising the value of intellectual property Proprietary or give-away strategies? o An example: Disney/Barney the Dinosaur &
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Digital technologies: drastic reduction in distribution and reproduction costs, , But also new opportunities e Creating value from lower distribution costs o For ex: Give products away to increase sale of m The physical good a Similar products o Limitations of pirate copies e Creating value from lower reproduction costs o Most customers: network externalities Tradc-offs: e More liberal access conditions increase the value to the consumer (increasing demand) Page]020fl18
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o But also more imitation and common use (falling sales) Challenge: to choose the conditions that maximize the value of IP
Trademarks and innovation? • Purpose of trademarks is not to stimulate innovation • Yet innovating firms extensively use trademarks o CIS: Innovating firms take out more trademarks than non-innovating firms, and more trademarks than patents o (but so do non-innovative firms) Of key importance: trademarks are key to marketing! (branding) @
How are trademarks linked to innovation? 1. Direct incentives to incremental innovation o Most such innovations cannot be patented 2. Supplement other appropriability strategies Means of approprla biltty
Patent
Raise imitation costs Appropriability after patent expiry
--.-.--.-.m··--·-b,----:-:---;:------:-c-;--·------Lead time Delay competitors from catching up Enable appropriability even jf lose first position Secrecy
Raise imitation costs Enable appropriahility even if secret disclosed
To what extent do trademarks deter innovation? e I\1.-Ight lead to more incremental innovation at expense ofbasic innovation 10 Barrier to entry to a 1110re innovative firm SUpplc,lTterlt to patent (which can. block innovation) if)
How important arc the effects of 'I'M}; on innovation? es
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All depends on power of brand-based marketing: however: o Limited monopoly power o Trademark-based licensing docs not involve innovation Much depends on consumer perceptions o TMmay signal innovativcness for a particular product, but this does not necessarily apply to other products, or the firm more generally
Trademarks can help to protect "the unprotected" e Red Hat: successful business model fully based on Open Source Software applications o Red Hat gets Linux source code free, tests and improves the software, and distributes applications that can be downloaded without charge from the Internet o Bnt most customers prefer to buy a customized program, and they arc also covered by Red Hat's guarantee and offer of technical support
INDUSTRY DIFFERENCES (e.g. Cohen et al., 2000) Page 103 of 118
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e
Firms in most industries rely on more than one method of appropriability (occasionally for the same innovation) o different methods used at different stages Three main approaches to appropriability o Complementary capabilities and lead time o Legal mechanisms (especially patents) o Secrecy
Most effective methods • Patents the least effective ofthc major appropriahility mechanisms (particularly for process innovations) • Most effective methods o secrecy and lead time for product innovations o secrecy and manufacturing capabilities for process innovation e Most striking finding: Secrecy the most effective method (particularly for process innovations) Industry differences: patents N",w drugs or chemicals: • Typically consist of a relatively discrete number of patentable elements o Patents can exist relatively independent of others • Patents occasionally used for negotiations (but mainly to obtain license revenues) e Blocking patents used to create patent fences £::ojllplex jJroduet industries Typically comprised of a larger number .- often hundreds . . of patentable clements Firms hold rights U\'Cf technologies that others need Patents used often for negotiations (both for cross-Iiccnsing and lie. revenues) Blocking patents used to extract licensing revenue or to force inclusion cross-licensing @
@
,f)
Is)
Appropriability and patenting itl. very small Danish firms • Empirical data: Thirty-four Danish firms in three industries • Research questions o How arc patent-related activities integrated with innovative activities more generally within the small high tech firm? o How does the small high-tech Ern] strategically manage the patent application process? Results of the empirical study
How are patent-related activities integrated with innovative activities more generally within the small high.. tech/inn? e
e
Industry differences: o Telecom: patents important, but also problems (too many patents, difficult to navigate) o Software: patents take away resources from R&D, not that important to innovation o Biotech: patents integral to innovative activities, cannot proceed without patents Number of patents not necessarily linked to employee R&D performance Page 104 of] I 8
e
Davis, Lee. (2008). Com peting on IP: Licensing strategies of the new intellectual property vendors, forthcoming in California Management Review. Winter 2008
(February). Her article explores licensing strategies pursued by firms whose business model is based on developing and licensing out their intellectual property (firms that do not engage in production). LICENSES e Legal permission to use patent rights and/or know-how e Come motivations to license out patented technology o Not interested in going into market themselves o Lack the resources to exploit the invention themselves o Desire to disseminate the technology quickly o Way to enter a foreign market o Facilitate the exchange of knowledge o Earn royalties Licenses as an element of firm strategy â&#x20AC;˘ Licensing choices o Function mainly to protect proprietary technology, or as the basis for knowledge sharing? o Large or small royalties? o Encourage license partner to further develop the innovation, or not? o Wide or narrow geographic scope? Strategic use of licenses e Different types of licenses o Exclusive/non-exclusive o Cross licenses e Enable firms to develop innovations using technologies o Compulsory licenses ,11 can be important for: o Establishment of standards o International business strategy Benefits and costs of licensing c~ More efficient commercialization o Promote development of markets for know ¡bow New marketing outlets o Earn royalties c¡ Problems of finding suitable partners e Negotiation e Enforcement @
Vendor strategies can be differentiated along two main dimensions Stand alone licensing or "licensing plus" Degree of tcclmological cumulativeness @
@
Four licensing strategies J. Independent Page l05 of 118
L'rOD}
several sources
o License provides legal basis for transfer of rights, enabling vendor to earn royalties o Block to fence 2. Complemental' o License provides legal basis for transfer of rights, enabling vendor to earn royalties o Block to play 3. Directed o License is part of a larger package of cooperative R&D agreements o Block to fence 4. Recip. knowledge-sharing o License is part of a larger package of cooperative R&D agreements o Block to play Some implications e Royalties and/or relational rents e Each strategy involves trade-offs ill Alternatives to licensing e Understanding buyer risk II': Future trends e On the one hand: increasing use ofIPRs by firms o Strategic positioning e On the other hand, a flood of new technologies challenging the basis ofInced for IPRs Proposals for reform of the IPR system @ Changes in the legal system o Raise the criteria for obtaining protection o Greater use of compulsory licenses e More sui generis forms of protection o Other ideas () Patent buyouts (Kremer, 1998) o Innovation warrants (Kingston, 20(1) Alternative incentive systems (f}
Conclusion: IPRs represent a choice G Society o Different kinds of IPRs () IPRs vs. other forms of incentives {/; Finn o IPRs and other ways to capture profits () IPRs and business strategy e Important to see IFlis in this larger context () S& V Maximizing the value ofIP () How can IFlis best be structured ...and/or combined with other incentives .. to achieve this goal?
CASE STUDIES:
Page 106 of l! 8
m
Ryan, Paul, Moroney, Mike, Geoghegen, Will and Cunningham, James (2007). A framework for a strategic repositioning strategy: A ease study of Bulmcrs Original Cider, The Irish Journal ofManagement, pp. 83-102.
โ ข
Kling, Katarina and Gotell1an, Ingela (2003). IKEA CEO Anders Dahlvig on international growth and IKEA's unique corporate culture and brand identity, Academy ofManagement Executive, 17 (1), pp. 31-37.
Session 18: Case on IP. Guest lecture by Corporate Patent Officer (Philip) e
Chesbrough, H. (2006): A Framework for Advancing Your Business Model, Chapter 5 in OPeIl Business Models, Harvard Business School Press (28 p.).
Session 20: Rounding up development (Michael) e
011
theory and practice of strategy and market
Williamson, O.Eo (I 9<)9): Strategy Research: Govcrnancc and Competence Perspectives, Strategic Management Journal, Vol. 20 (21 p.)
Ke-y:wo rd s : Strategy, Governance, Competence, Opporurnism, Contracts, transaction cost, l,carnng OvcK.?ILthcm c:. A discussion of different dangers and possibilities of inter- an intra organizational transactions Stri.I~Jgrc of tlL~4Jticlc The articles overall goal is to raise a discussion of transaction cost, through the perspectives of governance and COI11pctCfJ.ce. 'rJ.1C discussion raises way mote questions than its answers, and can in some respect be seen more as a listing of different organizatiolul scholars view on the therno, than a concluding- article. /\hhough it goes for the entire article. cspcciall; the 12.;;1: Inri: Gl.1SCS further "research opportunities',
The initial pari of the article is divided into two p~u:ts; the governance and die competence i\S transaction cost [viewed in the go>/em8J1Ce perspective) traditionally 1.S subdivided into six l\cy moves, so is the COlllj)ctcncc perspective in order to make critique. 'I'he six moves human actors, unit of analysis, describing the finn, Imrpo\,cs served, empirical and effi.ciency criterion. Both perspectives combine economic reasoning with orgi1ni%ation mcorv. 53enQKยง.LfHfu':: U Qยง.iDJlc
Business strategy is a complex subject and is usefully examined from several perspectives, The article applies the lenses of governance and competence to the study of strategy. Strategy is by nature interdisciplinary and includes all of the social sciences, especially economics, organization theory and contract law. In the high-tech arena, engineering and the law of intellectual property rights is also of importance. The gove.rntl.ncc. perspective is dominated by economic theory, as the choice among nlrernativc modes of govcr.nance is principally explained in transaction cost terms. The competence perspective is dominated by organization theory and especially by the importance of process. There are many respects in which the competence and transaction cost perspectives arc congruent. Both take exception with orthodoxy, both arc bounded rationality constructions, and both maintain thai: organization matters. They often deal with partly overlapping phenomena, often in complementary ways. The main differences is that governance is more microanalytical (the transaction is the basic unit of analysis) and adopts an economizing approach to assessing comparative economic organization, whereas competence is more composite (the routine is the unit of analysis) and is more concerned with processes (icspecially learning) and the
Page 107 of 1] 8
lessons for strategy. Healthy tensions ate posed between them. Both ate needed in the effort to understand complex economic phenomena, Governance challenges the competence perspective to apply itself more assiduously to operationalization, including the need to choose and give definition to one or more units of analysis (of which the 'routine' is a promising candidate). The research challenges posed by competence to which governance can and should respond include dynamic transaction costs, learning, and the need to push beyond generic governance to address strategy issues faced by particular firms (with their distinctive strengths and disabilities). A lively research future for these two perspectives, individually and in combination, is projected. Even though the article is build upon discussion rather than conclusions, some statements arc made on the two different perspectives, ThÂŁ..gQyeruajJce-P_t;fSpecJiv~ The governance perspective has been around the longest, and is therefore more fully opcrationalized.
A finn is often viewed as black box, but it is seen as important to dig into it and find the internal. structure. To do this, transaction cost economics can be used to describe the firm in organizational terms (as a governance structure), rather than in technological terms (as a production function). Transaction cost economics ascribes foresight rather than myopia to human actors. A transaction occurs when a good or service is transferred between technologically separable stages. Problems of organisation arc not predominantly technical, but attributes of transactions on the one hand and of hUI1UD actors on the other. Both firms and markets are viewed as alternative modes of governarlcc that differ in discrete structural ways. The three main attributes that describes a mode of governance are; incentive intensity, administrative controls and the legal values regim.e. These gives in turn) rise to different adaptive capacity, in both autonomous and corporative adaptive respects. All. complex contracts arc unavoidably incomplete by the reason of bounded rationality Economic organization can be used to economize on the bounded rationality and to reduce the hazards that accrue to opportunism. Governance is a means by which to infuse order in a relation where potential conflicts threatens to undo or upset opportunities to realize mutual gilins. Credible contracting is about foreseeing, recognize hazards and device hazards j:nitigating responses, and thereby to realize dlCSC mutual g,tins. '1'11CSC safqz;uatds arc mechanisms of govcrna.Hcc, which permits parties to work though their differences. Go-vcrnancc structures nrc predominantly instruments for adaptati()n,.\1 being the case: that adaptation both autoriorrious ,H1d corporative kinds) is the central problem of economic 1\'('0 thoughiTCi.ditional economic measures show transaction cost and opportunism.
,111
action to be feasible, i:
not be, because of
The capabilitics Zcornpcteucc perspective states the importance of the process, but it is not obvious how to put important processes together. Not only is process analysis liard to do) there arc also many important processes. The competence perspective ascribes a narrow scope) myopia rather than foresight (opposite of the governance pcrspecti\rc) A competence is the capability of an enterprise to organize, manage, coordinate or govern sets of activities. There is no present appai'atus by which to advice firms on when or how to reconfigure their corc con1petenccs. The analysis views the firm as bundles of routines (evolutionary theory) and bundles of resources (resource based theory). Routines inform the idea of core competence as the notion of ::1. hierarchy of organizational. routines is the key building block of core organizational routines. The competence perspective emphasizes management and organizational features rather than the idea of the firm as a production function. Firms exists because they can 11101'e efficiently coordinate collective learning processes that market organizations is able to do. Herein does interpersonal relations playa large tole in the success of a firm.
Page 108 of 1] 8
â&#x20AC;˘
Teece, n.J., G. Pisano and A. Shuen (1997): Dynamic Capabilities and Strategic Management, Strategic Management Journal, Vol. 18:7: 509-533 (22 p.)
Abstract 1 Theme In this artiele the anthors develop a dynamic capabilities approach, which confronts the question of how firms achieve and sustain competitive advantages Keywords Dynamic capabilities (processes, positions, and paths), Resource-based perspective, competitive forces, Strategy conflict. Abstract The authors identify three existing paradigms (models of strategy) and the authors develop the fourth (dynamic capabilities approach): 1. Competitiveforces: pioneered by Porter. The approach views the essence of relating a competitive strategy formulation as relating a firm to its environment. Firms in an industry earn rents by impeding the competitive forces (five forces framework). 2. Strategy Conflict: This approach uses game theory to analyze the nature of competition between rival firms. By manipulating the market environment, a firm may be able to increase profits. The approach ignores competition as a process involving unique skills and capabilities. Both of these approaches emphasize the exploitation of market power and lack a dynamic view of the firm. 3. Resourced-bascd perspective: What a firm can do is not only a function of the opportunities it encounters, bnt also a fnnction of the resources it can bring about. The resource-based approach focuses on strategies for exploiting existing firm-specific assets, but it is also concerned with developing new capabilities. 8 ' capatntuieÂť "1" 1 : iY " diynamtc apprOUCI1 In order to understand how competitive advantage is achieved, the authors claim that we need. an .~, .. 11C
extended paradigm. ---- the dynamic capabilities approach. The resource-based strategy is often not enough to support a significant competitive advantage. Firms must dcrnonstrare timely responsiveness, rapid and flexible production, and innovation, coupled with the management capability to effectively coordinate and redeployinternal and external compctences, The authors refer to this ability to achieve new forms of competitive advantage as dynamic capabilities. There arc several dimensions of the firm that must be understood in order to understand firm-level distinctive capabilities. The authors have grouped them into three categories.: s Processes: refers to the way things are done in the firm could also be referred to as routines. Organizational processes encompasses three things: Coordination/integration, learning, and reconfiguration. (p. 518) Positions: refers to the current state of technology, IP, complementary assets, customer base, and the firm's external relationship with suppliers etc. (p. 521) Paths: refers to strategic alternatives available. A firm is path dependent Where it can go is a function of its current position and the path ahead. The current position is shaped by the history of the firm - history matters, The concept of technological opportunities can also be used in relation to paths (p. 522) @
@
g
Please refer to page 516 for definitions of the terminology used with regards to the dynamic capabilities approach.
Page 109 of 118
The competitive advantage lies with the firm's managerial and organizational processes, shaped by its specific asset position and the paths available to it. A firm can only sustain the competitive advantage and thereby extract value from it, if the capabilities creating the competitive advantage are difficult to imitate or emulate. A concluding point of this article is that even though the four paradigms are very different, complex problems are likely to benefit from insight gained from all of them. The conclusion (2 pages) can complement this abstract very nicely, Abstract 2. Theme In this article the authors develop a dynamic capabilities approach, which confronts the question of how firms achieve and sustain competitive advantages Abstract The authors identify three existing paradigms (models of strategy) and the authors develop the fourth (dynamic capabilities approach):
I. Competitive forces: pioneered by Porter. The approach views the essence of relating a competitive strategy formulation as relating a firm to its environment. Firms in an industry earn rents by impeding the competitive forces (five forces framework). 2. Strategy Conflict; This approach uses game theory to analyze the nature of competition between rival firms. By manipulating the market environment, a finn may be able to increase profits. The approach ignores competition as a process involving unique skills and capabilities. Both of these approaches emphasize the exploitation of market power and lack a dynamic view of the finn. 3. Resourced-bascd perspective. What a finn can do is not only a fnnction of the opportunities it encounters, but also a function of the resources it can bring about. The resource-based approach focuses on strategies for exploiting existing firm-specific assets, but it is also concerned with developing new capabilities. 4. The dynamic capabilities approach'; In order to understand how competitive advantage is achieved) the authors claim that we need an extended paradigm the dynamic capabilities approach. The resource-based strategy is often not enough to support a significant competitive advantage. Firms must demonstrate timely responsiveness, rapid and flexible production, and innovation, coupled with the management capability to effectively coordinate and re-deploy internal and external compctences. The authors refer to this ability to achieve new forms of competitive advantage as dynamic capabilities. or-here are several dimensions of the firm that must be understood in order to understand firm-level distinctive competcnces and dynamic capabilities, The authors have grouped them into three categories and they both enable and constrain the company: If; Processes: refers to the \vay things are done in the firm could abo be referred to as routines. Organizational IJl"ocesscs encompass three things: Coordination/integration) learning) and rcconfiguration. (I'. 518) (,) Positions: refers to the current state of technology, IP complementary assets, customer base, and the firm's external relationship with suppliers etc. It can also be referred to as Stocks ofstrategic assets 01 Paths: refers to strategic alternatives available. A firm is path dependent. Where it can go is a function of its current position and the path ahead. The current position is shaped by the history of the firm- history matters. The concept of technological opportunities can also bc used in relation to paths (I'. 522)
The competitive advantage lies with the firm's managerial and organizational processes, shaped by its specific asset position and the paths available to it. II finn can only sustain the competitive advantage and
9 Dynamic capabilities is the firm's ability to integrate, build and reconfigure internal and external competcnccs to address rapidly changing environments,
Page 110 of] 18
thereby extract value from it, if the capabilities creating the competitive advantage are difficnlt to imitate or emulate see Dierickx & Cool to understand which types of assets are difficult to imitate. A concluding point of this article is that even thongh the four paradigms are very different, complex problems are likely to benefit from insight gained from all of them.
Critique of Teece: Dynamic capabilities seem to rely on rapid environments, which is not necessarily the casco Abstract 3 4
of Feb
Teece, Pisano and Shuen
In this article four models of strategy are discussed to come up with a superior model for today's business world. The four approaches (including dynamic capabilities) discussed are: 1. Competitive forces approach ..... actions a firm can take to create defensible positions against competitive forces. (I'. 510) 2. Strategic conflict approach focuses on product market imperfection, entry deterrence and strategic interaction. Usc game theory and view competitive outcome as function of effectiveness through which firms keep their rivals off balance through strategic investments, pricing strategies, signalling and the control of information.
3. Resource based perspective --- emphasize firm-specific capabilities and assets and existence of isolating mechanisms as fundamental determinants of firm performance. I.L DYl1aI11ic capabilities approach: exploiting existing internal and external compctcnccs to address changing environments.
firm specific
The fourth approach is an approach is an approach, which is developed, as the authors believe the three approaches put forward up until now have some flaws. Therefore, the authors spend quite a hit of time on this approach The 4 approaches arc divided into 2 types of models:
I. The model of strategy emphasising the exploitation of market power, which covers the competitive forces approach and the strategic conflict approach.
.m odel of strategy ernphasiziug efficiency, which covers the dynamic capabilities approach Summing up on thc four approaches:
IS!
type of model
Competitive Forces ,
Porter (1980) .- essence of competitive strategy formulation as 'relating a company to its environment'. Key aspect of environment is industry in which it competes. "Industry structure strongly influences the competitive rules of the game as well as the strategies potentially available to firms". (p. 511) Page I 1I of I 18
e
Five forces: entry barriers, threat of substitutions, bargaining power of buyers, bargaining power of suppliers and rivalry among industry incumbents.
e
Economic rents arc monopoly rents -finns cam rents when they can impede competitive forces that tend to drive returns to zero.
Strategic Conflict e
Shapiro (1989) - how a firm can influence the behavior and actions of rival firms and thus the market environment (investment in capacity and advertisement).
e
By manipulating market environments, firm may be able to increase profits.
•
Authors think that strategic focus applicable where firms' competitive positions are more delicately balanced. "Rare in industries where there is rapid technological change and fastshifting market circumstances." (p. 512)
•
Ignores entrepreneurial side of strategy: how significant new rent streams arc created and protected. 2nd type of Model
Resource-based perspective •
Firms with superior systems and structures arc profitable because they have markedly lower costs or offer markedly higher quality or product performance.
c
Real key to a company's success is its ability to find or create a competence that distinctive.
•
Firms arc heterogeneous with respect to resource capabilities. Resource endowments are 'sticky' at least in the short run because firms lack the organizational capacity to develop new cornpctcnccs quickly.
1S
truly
Dvnamic Capabilities Approach (.,
e
Winners have been firms that can demonstrate timely responsiveness and rapid and flexible product innovation) coupled with the management capability to effectively coordinate and redeploy internal and external cornpctcnccs. 'dynamic capabilities'. Dynamic: capacity to renew competcnces so as to achieve congruence with the changing business environment. 'capabilities': key role of strategic management in appropriately adapting, integrating and reconfiguring organization and functional cornpctcnccs to match requirements of changing cnvironmeut.
A key step in building a conceptual framework related to dynamic capabilities is io identify the foundations upon which distinctive and difficult-to-replicate advantages can be built, maintained and enhanced. A useful way to vector in on the strategic elements of the business enterprise is first to identify what is not strategic. To be strategic a capability must be honed to a user need, unique and difficult to replicate. Accordingly any asset or entity, which arc homogenous and can be bought and solei at an established price, cannot he all that strategic. Indeed what is distinctive about Finns is that they are domains for organizing activity in a non market-like fashion. Accordingly, as the authors discuss what is distinctive about firms, they stress competences/capabiiitics, which are ways of organising and getting things done which cannot be accomplished merely by using the price system to coordinate activity. The very essence of most capabilities/competcnces is that they cannot be readily assembled through markets. There arc many dimensions of the business firm that must be understood if one is to grasp firmlevel distinctive competcnces/capabilities. In this paper the authors merely identify several classes Page 1 l2 of 1 J 8
of factors that will help determine a firm's distinetive competence and dynamic eapabilities. The authors organise these in three categories: processes, positions and paths: Organizational Processes: e
Coordination and integration - prodnction organization is source of difference competence in various domains.
e
Organizational processes interrelated - cannot change one with out changing others.
e
Explains why radical innovation often comes from outsiders.
•
Learning: process by which repetition and experimentation enable tasks to be performed better and quicker.
e
Rcconfiguration: adaptation/transformation of existing firm to meet environment.
1ll
firms'
Positions: not just learning, but also specific assets: •
Technological asserts
•
Complementary assets: assets related to technology, which enhance or destroy the value of assets.
e
Financial assets: cash position.
o
Rcputational assets: intangible asset that enables firms to achieve various goals in the market.
e
Structural assets: formal. and informal structure of organizations.
•
Institutional assets: regulatory systems, laws, higher education, national culture.
«
Market (structure) assets: often overrated by other perspectives
e
Organizational boundaries: degree of integration (vertical, lateral and horizontal)
Paths: (I
e
Path dependency: where a firm C<1n go is a function of its current position and the paths ahead. Current position shaped by path it has travelled. I-Ii story matters. Learning tends to be local! so firms repertoire of routines constrains future behaviour. Technologies! opportunities: tcchnologica: opportunities lagged diversity in basic science,
{'
,
.
JUnCTIOn
of foment and
o
Firms have some say because of investment and innovative activity
,
Opportunity recognition shaped by organizational structures that link research institutions to business enterprises.
Thus tar, it is argued that compctcnces and capabilities (and hence competitive advantage) of a firm rest fundamentally on processes, shaped by positions and paths. However, competences can provide competitive advantage and generate rents only if they arc based on a collection of routines, skills and complementary assets that arc difficult to imitate!'! I The conclusion to all of this is that the dynamic capabilities approach is best in the following areas: e
Efficiency vs. market power. Competitive forces approach: sources of competitive advantage arc at industry level Dynamic capabilities/Resource based view - competitive advantage stems from highperformance routines operating 'inside the firm', shaped by processes and positions. Page 113 nf 118
Competitive sueeess occurs in part beeause of polieies pursued and experience and effieieney obtained in earlier periods. e
Normative implieations Strategie analysis must be situational. (Competitive force approaeh not partieularly firm speeifie. It is industry and group speeifie) Incremental vs. leap-frog strategie ehanges. (Dynamie eapabilities is ineremental) Entry deeisions made with references to the competences and capabilities, which new entrants have, relative to the eompetition. "The dynamie eapabilities approaeh suggests that if a firm looks inside itself, and at its market environment, sooner or later it will find a business opportunity." (p. 529)
Markides, C. (1997): Strategic Innovation, Sloan Management Review, Spring (14 p.) Abstract 1 e
Strategy and Market Development Miehael Kaae Olsen
of Feb
Strategie Innovation
Markides
breaking the rules of the game and thinking of new ways to compete, a company strategically redefine its business and catch its bigger competitors off guard. The is not to play the game better than the competition but to develop and play an altogetherdifferent game. Over and above deciding when it makes sense to break the rules and when it is better to play the existing game, the real question is: How do innovative strategists hit on their strategic masterstrokes? Five generic approaches of the successful strategic innovators can provide clues: I . Redefine the business I 2. Redefine the who! Who is our customer? 3. Redefine the what! What products or services are -4. Redefine the howl 5. Start the thinking process at different points:
y'"rc
offering our customers?
By breaking the rules of the game and thinking of new ways to compete, a company can strategically redefine its business and catch its bigger competitors off guard. The trick is not to play the game better than the competition but to develop and play an altogether different game. Without the benefit of a new technological innovation, it is extremely difficult for any firm to successfully attack the established industry leaders or to successfully enter a new market where established players exist The strategy that seems to improve the probability of success in those situations is the strategy of breaking the rules - strategic innovation. Over and above deciding when it makes sense to break the rules and when it is better to play the existing game, the real question is: How do innovative strategists hit on their strategic masterstrokes? Before tackling the idea of how to come up with new strategic ideas, the author makes five crucial points: 1. The strategy of breaking the rules is NOT new. Page 114 of 118
2. Breaking the rules is ONE way to play the game. All firms should NOT adopt it and they should not adopt it at all times. 3. How to break the rules depends on the business that the firm is in as well as the firm's strengths and weaknesses. 4. The strategy is, by definition risky.
5. Coming up with new ideas does NOT guarantee success. As already proposed by Abell, all companies in an industry have to decide three basic issues at the strategic level: Who is going to be om customer? What products or services should we offer the chosen customer? How should we offer these products or services cost efficiently? The answers that a company gives to the who-what-how questions are conditioned by what that company thinks its business is. Who you see as your customers depends on what business you believe you arc in, This is crucial!!! Strategic innovation occurs when a company identifies gaps in the industry positioning map, decides to fill them, and the gaps grow to become the new mass market. Obviously, the first requirement for becoming a strategic innovator is to identify gaps before everybody else does. The focus of this article is how a company can identify a gap through a proactive thinking process. Five generic approaches ofthe successful strategic innovators can provide clues: 1. Redefine the business!
2. Redefine the who! Who is om customer? 3. Redefine the what! What products or services are wc offering our customers? 4. Redefine the how! 5. Start the thinking process at different points I
Redefine the business \\/hat business a company believes it is determines who it sees as its customers, its competitors, its competitive advantage. and so on, It also determines what the company thinks are the success factors in the market and thus ultimately determines how it plays the game. If a company starts playing the garne in a totally different \vay from. everyone else, the reaSOTJ. 111ay be- that it is playing, a different game altogether. A company should go through
1
<
3. four-step
exercise to define
business:
List all possible definitions of the business
2. Evaluate each definition according to a series of criteria
3. Choose one definition,
This is a crucial step.
4. Ask these questions
1f om competitor redefined the business, what strategy would it be
following? How can we prepare for it? Redefine the who
The second source of strategic innovation is a fundamental rethinking of "Who is my customer?" Companies should choose their customers strategically rather than accept as a customer anyone who wants to huy. The trick is to identify which customers are good for the company and which are not. In terms of strategic innovation, the purpose of thinking strategically about this question is either to identify new customers or to rcscgrnent the existing customer base more creatively and thus form Page 115 of 118
new customer segments, However, remember: Merely choosing a niche is not strategic innovation. For the choice of niche to qualify as strategic innovation, it must grow to eventually become the mass market, and the company's way of playing the game must become the new game in town. Redefine the what The third source of strategic innovation is an honest rethinking of the question: "What products or services should we be selling to our customers?" Many companies seem to believe that the choice of customers automatically lead to the choice of products and services to offer. This may be true, but, from a strategic innovation perspective, it also helps to think of the "what" first and then think of whom to target. Thus, instead of saying" these are our customers, so let's think wbat they want so we can offer it to them" it may help to start like tbis: "These are tbe products and services tbat we want to offer, so let's think about who would want to buy them." Redefine tbe bow Another possible source of strategic innovation builds on the organisation's cxistmg core competencies to create a new product or a new way of doing business tbat is totally different from the way competitors currently do business. Companies can dynamically exploit existing core competencies in three ways. 1. Share core competencies among the various SBUs. 2. Reuse competencies from one SBU to another. 3. Expand eompctcncies from one SBU to another. Start tbe tbinking process at different points The final source of stratcgic innovation is tbe thinking proccss for developing new ideas. New ideas emerge more easily if managers can escape their mechanistic way of thinking and look at an issue from different perspectives or angels. The goal, therefore, is to start the thinking process a different points. For example, instead of thinking, "This is our customer, this is what he or shc wants, and this is how we can offer it," start by asking: "What arc our unique capabilities, what specific needs can Vile satisfy and who win he the right customer to approach. Abstract 2. Thcmc How a company can redefine its business and capture rents from competitors by! breaking the of the game and thinking of new ways to compete. words Strategic innovations, gaps.
Abstract The author discusses companies that succeeded dramatically in attacking an established leader without the help of a radical technological innovation and how these companies accomplishes this. According to the author, they do this by innovating strategically by breaking the rules of the game in their industry. Without the benefit of a new technological innovation, it is extremely difficult for any firm to successfully attack established industry leaders or to successfully enter a new market where established players exist Strategic innovation seems to improve the probability of success. The process of strategic innovation has five crucial points:
Page 116 of 118
+ The strategy of breaking the rules is not new + Breaking the rules is one way to play the game; All firms should not adopt it, and they should not adopt it all the time + How to break the rules depends on the business that the firm is in as well as the firm's strengths and weaknesses + The strategy is, by definition, risky; Yet a firm can manage the risk, primarily by experimenting + Coming up with new ideas does not guarantee success; The whole organization must be managed appropriately to give the new strategy a chance Also, the author identifies the source of strategic innovation. It seems to occur when a company identifies gaps in the industries positioning map, decides to fill them, and the gaps grow to become the new mass market. Gaps are: + New, emerging customer segments or existing customer segments that other competitors have neglected + New, emerging customer needs or existing customer needs not served well by other competitors + New ways of producing, delivering, or distributing existing or new products and services to existing or new customer segments Gaps can be identified by accident or luck, by experimenting, through a series of seemingly unrelated steps or actions, or through a proactive thinking approach. The last mentioned is the focus
of this article. In the thinking approach, there are five ways to kick-start strategic innovation: (I) Redefine the business (2) Redefine the who (3) Redefine the what (4) Redefine the how (5) Start the thinking process at different points
A company can usc anyone or a combination of the above tactics to strategically innovate. It is worth reemphasizing that corning up with new ideas is one thing; succeeding in the market is another, Similarly, there arc numerous examples of companies that tried to strategically innovate by redefining their business) only to discover that it did not guarantee success. -s
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Consrantinos Markides (1997): "Strategic Innovation This article is trying to align 10 perspective with a resource perspective. 5 forces are about positioning oneself within existing positions. Markides differ by encouraging finding new positions .~~ a dynamic 5 forces. Abstract
The author discusses companies that succeeded dramatically in attacking an established industry leader without the help of a radical technological innovation and how these companies accomplish this. According to the author, they do this by innovating strategically -- by breaking the rules of the game in their industry. Without the bencfit of a new technological innovation, it is extremely difficult for any firm to successfully attack established industry leaders or to successfully enter a new market where established players exist. Strategic innovation seems to improve the probability of success. The process of strategic innovation has five crucial points, which is derived from studying 30 successful attackers: '" The strategy of breaking the rules is not new Page I 17 of I I 8
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Breaking the rules is one way to play the game; All firms should not adopt it, and they should not adopt it all the time How to break the rules depends on the business that the firm is in as well as the firm's strengths and weaknesses The strategy is, by definition, risky; Yet a firm can manage the risk, primarily by experimenting Coming up with new ideas does not guarantee success; The whole organisation must be managed appropriately to give the new strategy a chance
Also, the author identifies the source of strategic innovation. It seems to occur when a company identifies gaps in the industries positioning map, decides to fill them, and the gaps grow to become the new mass market. Gaps are: ~ New, emerging customer segments or existing customer segments that other competitors have neglected (it is more than that. Dot com's are about changing distribution and communication not product) 10 New, emerging customer needs or existing customer needs not served well by other competitors 10 New ways of producing, delivering, or distributing existing or new products and serviecs to existing or new customer segments Gaps can be identified by accident or luck, by experimenting, through a series of seemingly unrelated steps or actions, or through a proactive thinking approach. The last mentioned is the focus of this article. In the thinking approach, there are five ways to kick-start strategic innovation: (6) Redefine the business (7) Redefine the who! Who is our customers new customers or new customer segments (8) Redefine the what/ What products are we offering? Think ofnew customer needs and wants (9) Redefine the how! Leverage existing competencies to build new products or a better way of doing' /Jizz (10) Start the thinking process at different points by asking basic questions.
Conclusion A company can use anyone or a combination of the above tactics to strategically innovate, It is \v01'1:h roemphasizing that coming up with new ideas is one thing; succeeding in the market is another. Similarly, there arc numerous examples of companies that tried to strategically innovate by redefining their business, only to discover that it did not guarantee success.
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I INTRODUCTION & THEME 1 CONTROL CONCEPTIONS: Lecture 1: Management Control (Julius) â&#x20AC;˘ Simons, R. (1995) Control in The Age of Empowerment, Harvard Business Review, MarchApril The chall enge for managers regarding control and empowerment is twofold: I) Empowering the organizations members to be creative, flexibl e and innovative 2) Preventing the organization from risks evo lving through empowerment (damaged reputation, financial losses, missed opportunities. .. ) Diagnostic control systems: (monitor critical performance output) Systems mana gers use to measure progress against plans to guarantee the predictabl e achievement of goals. These systems produce performance variables, budget s, objectives, tracks the progress of individuals, and monitor that goals and profitability is achieved. The problem is that the diagnostic contro l system often define s the goals (i.e. performance measures). When this is the case, employees might find new ways of doing their job s in order to do well on the high perform ance meas ures. However, there is no guarantee that this new way is good for the company in general. Beliefs systems: (comm unicate core values) Companies have used belief systems for years in an effort to articulate the values, direction and mission of the company. The communication of values inspires employees to act in accordance to these values which then create a control mechanism for top-management. Without a formal belief system, employees in large, decentra lized organizations often do not have a clear and consistent understandin g of the core values of the business and their place within the business. Boundary systems: (declaring what NOT to do through codes of conduct) "The power of negat ive thinking". It is much better to tell the employees what NOT to do than what to do. For example, many companies have codes of business condu ct - declaring clearly which behaviours will NOT be accepted. This way the employees are limited by some boundaries making it further possible for managers to control the organization . Workin g together, the beliefs systems and the boundary systems creates a dynamic tension between commitment and puni shment. Interactive control systems: (distribute emerging information) As compani es grow large, new formal systems must be created to share emerging information and to harness the creati vity that often leads to new products. Interactiv e control systems are the formal information systems that managers use to participat e in decisions of subordinates and to focus organizational attention and learning on key strategy issues . Thes e systems are generally simple to understand . Th is system differ from the diagnostic system in four ways.(read p. 87 line 8) Balancing empowerment and control: (Conclu sion) Using these systems correctly, managers can be confident that the benefits of innovation and creativity are not achieved at the expense of control. Abstr act no. 2: Simons, R. (1995): Cont r ol in the Age og E mpower ment THEME The themes is about the prob lem a manager faces in exercising control in an organization and still maintaining flexibility, innovation, and creativity.
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iNTRODUCTION & THEME 1 CONTROL CONCEPTIONS: Lecture 1: Management Control (Julius) o Simons, It (1995) Control in The Age of Empowerment, Harvard Business Review, MarchApril The challenge for managers regarding control and empowerment is twofold: 1) Empowering the organizations members to be creative, flexible and innovative 2) Preventing the organization from risks evolving through empowerment (damaged reputation, financial losses, missed opportunities ... ) Oiagnostil: systems: (monitor critical performance output) Systems managers use to measure progress against plans to guarantee the predictable achievement of goals. These systems produce performance variables, budgets, objectives, tracks the progress of individuals, and monitor that goals and profitability is achieved. The problem is that the diagnostic control system often defines the goals (i.c. performance measures). When this is the case, employees might lind new ways of doing their jobs in order to do well on the high performancÂŤ measures, However, there is no guarantee that this new way is good for the company in general. Beliefs systems: (communicate core values) Companies have used belief systems lor years in an effort to articulate the values, direction and mission of the company. The communication of values inspires employees to act in accordance to those values which then create a control mechanism for top-management. Without a formal belief system, employees in large, decentralized organizations often do not have a clear and consistent understanding of the core values ofthe business and their place within the business. Boundary systems: (declaring what NOT to do through codes of conduct) "The power of negative thinking". It is much better to tell the employees what NOT to do than what to do. For example, many companies have codes of business conduct -- declaring clearly which behaviours will NOT be accepted. This way the employees are limited by some boundaries making it further possible for managers to control the organization. Working together, the beliefs systems and the boundary systems creates a dynamic tension between commitment and punishment. Interactive control systems: (distribute emerging information) As companies grow large, new formal systems must be created to share emerging information and to harness the creativity that often leads to new products. Interactive control systems are the formal information systems that managers use to participate in decisions of subordinates and to focus organizational attention and learning on key strategy issues. These systems are generally simple to understand. This system differ from the diagnostic system in four ways.tread p. 87 line 8) Balancing empowerment and control: (Conclusion) Using these systems correctly, managers can be confident that the benefits of innovation and creativity are not achieved at the expense of control. Abstract no. 2: Simons, R. (1995): Control in the Age og Empowerment THEME The themes is about the problem a manager faces in exercising control in an organization and still maintaining flexibility, innovation, and creativity.
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KEYWORDS • Diagno stic control systems • Beliefs sys tems • Boundary systems • Interactive control sys tems
Set of problems/foc al points, main arguments and conclusion The main issue is the management task of balancing empowerment and control. To exe rcise control Simons presents four control systems; Diagnostic Control, Belief, Boundary, and Interact ive Control systems. These control systems are a tool for the manager to use to exe rcise control and still let the employees innovate and be creative. The actions of the employees will create more or less risk for the com pany . Relying and lettin g the emp loyees seek out opportunities, be creative, and innovative is necessary in a competitive business. But some of these opportunities mig ht cause a company serious risks in more than one way. Therefore the management wi ll need to control the emp loyees on different levels. This is where the four levers are introduced. Through monitoring the performance output by the employees, communicate the company's core va lues and beliefs, telling them what NOT to do, and gather information about possible pitfa lls wi ll help the manager to control and guide the employees in the direction that is profitable and beneficial for the company. Com bining the Bou ndary system and Beliefs system can establish direct ion, motivate and inspire, and protect aga inst damag ing opport unistic behav iour. Co llectively these four levers of control reinforce one another and effective ly help to balance the empowe rment of the employees and the necessary contro l from the management. "By using the contro l levers effectively, managers can be confident that the benefit s of innovation and creat ivity are not achieved at the expense of control". THEORIES/MODELS AND THEIR RELATION TO THE SET OF PROBLEMS The model on page 85 put s the four levers of control together with Business Strategy. It shows how Beliefs systems, Boundary systems, and Diagnostic Control systems all are controlled by strategy . The last one, Interactive Control systems, has an arrow going back to business strategy (though not on the drawing but information from class). This means that there is constant goin g back and forward between the Interactive Control system and the strategy. DEFINITIONS • Diag nostic Control systems: "Allow managers to ens ure that important goa ls are being achieved efficiently and effectively" . This is basically performance evaluation and targets and a reward based on these targets but without the manager having to consta ntly monit or. So this system monitors critical performance outcomes. • Beliefs systems: "Empower individuals and encourage them to search for new opportunities". This means that this contro l system is the tool for management to articulate the values of the company and the direction . In the absence of this control and therefore clearly stated values the emp loyee wi ll create own assumptions. It might encourage the employees to search for new ways of creating va lue. Therefore this sys tem communicates the core va lues. • Boundary systems: "Establish the rules of the game and identify actions and pitfalls that employees must avoid ". In other words the Bo undary System is where the manager tells the emplo yee what NOT to do so innovation is allows within clearly defined limits. It is stated in negative terms or as minimum standards • Interactive Control systems: "E nable top-level managers to focus on strategic uncertainties, to learn about threats and opportunities as com petitive conditions change, and to respond proactively". This means that this system is designed to gather information that
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might change the future for the company because it highlights shortfalls against plans. It is a "hot button" for management.
RELA'nm THEORIES With the benefit of hindsight I can say that this text relates to almost every topic we have had during this course including many from the strategy course. This is because it relates to control (MCl") and what strategy to use in assessing how much control is needed in regard to maintaining creativity. It also relates to last year curriculum in II( with Amabile (1997): "How to kill creativity." Extra information from class SofThranc said about the Beliefs systems that some of it is a bit naive and that the mission statement should be guidelines and obviously not to the extent in the text. Also that the Diagnostic Control system is the traditional way of understanding control. Simons text has gained a lot of respects because he has broadened the concept 0 i' control.
Aim: 1-10\\/ do managers protect their companies Irorn control failures when empowered employees arc encouraged to redefine 110\\/ they go about doing thcirjobv Thcre seems to conflict between crcativitv and control. However. it is the aim ofthis review to account Cor four different control systems that can be utilized while still harnessing the founders of creativity. Diagnostic control systems: (monitor critical performance output) Systems managers usc to measure progress against plans to guarantee the predictable achievement of goals. These systems produce performance variables, budgets, objectives, tracks the progress of individuals, and monitor that goals and profitability is achieved. The problem is that the diagnostic control system often defines the goals (i.e, performance measures). When this is the case, employees might find new ways of doing their jobs in order to do well on the high performance measures. However, there is no guarantee that this new way is good [or the company in general. (read Nordstrom example p. 81 line 2"d last line. ) Beliefs systems: (communicate core values) Companies have usee! belief systems for years in an effort to articulate the values, direction and mission of the company. The communication of values inspires employees to act in accordance to these values which then create a control mechanism for top-management. Without a formal belief system, employees in large, decentralized organizations often do not have a clear and consistent understanding of the core values of the business and their place within the business. Boundary systems: (declaring what NOT to do through codes of conduct) "The power of negative thinking". It is much better to tell the employees what NOT to do than what to do. For example, many companies have codes ofbusiness conduct declaring clearly which behaviours will NOT be accepted. This way the employees are limited by some boundaries making it further possible for managers to control the organization. Working together, the beliefs systems and the boundary systems creates a dynamic tension between commitment and punishment. The warm, inspirational, positive believes are a foil to the dark, cold constraints. Interactive control systems: (distribute emerging information)
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As compani es grow large, new forma l sys tems m ust be created to share em erging information and to harness the creativi ty that often leads to new products. Interacti ve co ntro l system s are the formal info rmation sys tems that managers use to participate in decisions of subordinates and to focus organi zational atte ntion and learn ing on key strat egy issues. These sys tems are generally simple to understand. Th is system differ from the diagnostic system in four ways.(read p . 87 line 8) Balancing em powe r ment and control : (Co ncl usion) Using these systems co rrect ly, managers can be confident that the ben efits of innova tion and creativity ar e not achieved at the ex pense of co ntro l. â&#x20AC;˘ Henri, J-F (2006) Management control systems and strategy: A resource-based perspective. Accounting, Organizations and Society 31 529-558
Granlund, M & Taipaleenmliki, J (2004) Management control and controllership in new economy firms - a life cycle perspective, Management Accounting Research 16
Theme/problem The article analyses management control practices in new economy firms (NEFs). As these companies face different challenges opposed to class ic firms (e.g. cf. fO), as we ll as facing high pressures to meet expectations places by certain externa l parti es (venture capita lists and later on by e.g. stock market players), to deve lop management co ntro l systems is cha racte ristic of the new economy env ironment. NEFs have furth ermore bee n in the spotlight of publi c writing, as many of them have faced severe financial tro ubles. The authors argue that one reason for this has been the lack of pro per manage me nt control systems - and thus a pressure to establish such sys tems. But a spec ific challenge of this in the NEF con text relates to R&D intensity and intangibility: how to measure and manage inta ngible issues which form the co re of a NEF's op eration? Terms New Economy Firm : A business targeting at fast growth or already fast-growing firm s that operate in information and communications techno logy businesses and biotech (life sciences) industry. They are furth erm ore characterized by R&D and know ledge intensity as well as venture capital finan ce, particul arl y in the early stages of their life cyc le. A bstract The life-cycle of NEFs cannot be ana lyzed using classic "cradle to the grave" models (M iller & Friesen, 1984), as it wo uld cause major pro blem s in study ing NE Fs because they have typically not yet reached even early maturity, but instead und ergo fast organizational fine-tuning in their birth and growth phases. Th ey cho se Co rporate Evolution Life Cyc le Mod el (Vi ctor & Boynton, 1998) as a foundation for analys is instead . See Figure 1 on page 26 for an overv iew of lifecycle approaches . Stages are (1) Craft wo rk, (2) mass production wo rk, (3) process enha nce ment, (4) mass customization, (5) co-configuration - a firm can tr y to renew and go back to basic s, to utilize those very first sources of innovative potential, characteri zed by the early stages of organ ization al evolution. They furth erm ore expand by introdu cing 6 ve ntu re capital life-cycle stages based on VC finance literature (e.g. Foster & Kap lan, 20 00). Stages are ( 1) Seed capital, (2) start- up finan cing, (3) first stage finan cin g, (4) expansion financing, (5) br idge fin ancing, (6) spin-off. The last stage is where the ve nture capita list typ ica lly either partly or complete ly leaves the enterprise.
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The organization and its resources From a task perspective, the authors identify tasks which the NEFs prefer highly and least. These evolve as the company moves through the stages. Initially, bookkeeping is typically outsourced, and the CEO takes care of financia l calculations, if even considered necessary. As the firm grows, a CFO (chief financial officer) to take care of statutory accounting processes and a controller isn' t typically hired before the report ing requirements totally exceed the time capacity of the CFO. Due to rapid growth requirements of the venture capitalists, there is no time for profitab ility analysis, they ju st have to sell. If not, you may give a farew ell to future funding. Their analysis leads onwards into models combining the 5 life-cycle stages and 6 venture capital life cycle stages, and thus analyzing the correlation between the two. They found correlation between these two indicating that there was a linier interdependence, meaning that firms located in the later stages of the life-cycle had advanced and established control systems, and the opposite for firms located in the early stages of the lifecycle. They furthermore found that the mast customization life-cycle stage was where the contradiction between innovation and control reaches its culmination, and tum into a distinct contro l challenge. Thus in most NEFs the constantly ongoing renewal leads back to the ultimate origin of value: the unique insights and inspiration of the craftsperson.
Conclusion It is very typical of NEFs that very limited resources are allocated to their financial contro l activities. One important explanat ion for this was the fact that particularly in NEFs is that they have invest in the very ear ly stages of operat ion in R&D , and somewhat later in sales and marketing: the interest is simply in different issues than accounting systems. - making core financial control less preferred tasks. This was justifiable also regarding both the technologically oriented corpo rate culture, and the future expectatio ns placed by venture capitalists. Furthermore, the accounting personnel do not at first have the time for other roles than ones related to statutory requirements. Howeve r this role may expand along the corporate life cycle, but it is typical ofNEFs that investments in administrative systems are not considered crucial, possi ble even later on. In layman 's terms this 37 page article describes why NEFs usually doesn' t employ Management Accounting Systems. Read this article at your own risk - you might die from boredom.
ATKINSON, A.A, BANKER, R. D., KAPLAN, R. S. & YOUNG, S. M (1997) "MANAGEMENT ACCOUNTING" PRENTICE HALL, NEW JERSEY Theme/p roblem This sections purpose is to provide the foundation for cost concepts, cost behaviour, cost allocation and activity-based costing systems. Due to its nature I will not try to provide a thorough walkthrough of all 110 pages, but rather give a quick overview of the conce pts, based on the learning objectives in the beginning of each chapter. The article includes concrete examples, but they are really bad, and don' t make much sense by themselves.
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CHAPTER I: COST CONCEPTS Cost classification based on cost function Cos t is defined as the monetar y value of goods and serv ices expended to obta in current or future benefits. This is necessaril y not the same as expense, which can represe nt costs for which benefits have already been received in the fiscal period, such as cost of goods so ld. Expenses can also represent period costs, such as advertising, resea rch or R&D, whose benefits cannot be mathed directly with the products sold. Product costs are all the costs incurred for the volume and mix of products produced duri ng the per iod. Direct a nd in d irect costs Direct manufacturing costs can be traced directly to a product. Examp le: Materials All Costs: (are comprised of the following, and their sub-costs) Manufacturing costs Direct costs Direct material and labour Indirect costs Manufact uring suppo rt No nmanufacturing costs Distrib ution, Selling, Marketing, R&D , Administrative Su ppor t activity costs Indirect manufacturing costs: All manufacturin g costs other than direct manufacturi ng costs Is the same as: Manufacturing support costs: Indirect cost of transforming raw materials into finish ed product Activity cost drivers Unit-r elated activities: Activities who se levels are related to the number of units produ ced. EX: Item inspection, supervision of direct labor, pow er and oil for machines Cost Drivers: Number of units, Direct labour hours, machine hours Batch-related activities: Activiti es who se levels are relat ed to the numb er of batches produced EX: Machine setup, purchase orderin g, material s handling, production scheduling Cost Drivers: Setup hours , inspection hours, numb er of: orders and production runs Product-sustaining activities: Activities performed to support the product of individual produ cts EX: Product design , parts administration, engineering, expediting production orders Cost Drivers: number of: products, parts and ECOs Facility-sustaining activities: Activiti es performed to provide the managerial infras tructure and to support the upkeep of the plant EX: Plant manag ement, accounting and personnel, housekeeping, lightin g, rent, depreciation Cost Drivers: Square feet of space, number of workers.
Cost concepts in service or ganizations The text furthermore proposes methods for using activity-based costing in serv ice organizations. The text uses a case of a hospital to describe the methods. Basically, they group the different operating costs into activities, such as nursing services, labora tory and housekeeping etc. These are furt hermore allocated cost drivers, such as nursing hours, number of tests and square feet of space. Lastly they are grouped into unit-related-, batch-related and facility-sustaining activities. This provides a good measure for estimating costs of future fiscal periods.
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Standard costs Efficient and attainable benchm arks established in adva nce for the costs of act ivity resources that should be consumed by each produ ct. Three principal uses of standard cost systems : I. Estimate product costs: Consumption of direct materi als, direct labor and support activity resources requ ired by each produ ct. Mu ltipol ying these quanti ty standards by the standard prices for the resources and adding all the resources consumed by a product yields standard costs for individu al products. This is used to help set bid prices for customer orders and eva luate prod uct profitability. 2. Budget for costs and expenditures: Measuring the standard quantity ofconsumption of an actibity required to manu facture different products and the planned production levels for those products. This is used to plan expend itures for a forthcoming period. This can though be misleading in some cases, because of the time lag that can occur between recognizing costs. 3. Control costs relative to standards: Decision makers can compare actual costs with standard costs, with the expectation that the actual costs should approximately equal standard costs. (Cost variances: Differences between actual and standard costs)
Uses and limitations of standard cost systems The usefu lness of these systems is restri cted largely to settings in which the production technol ogy is stable and the numb er of business changes tak ing place is small. If there is much volatility in the produ cts or the manufacturin g processes, the standards need t be changed frequently, which requires much organi zation al effort. More importantl y, overrelian ce on managing with a standard cos t accounting system creates a mind-set of simply meetin g the standards. It diverts attention from the organizations strategic needs to remain a step ahead of its present and potenti al competitors by being able to respon se to a changing environme nt. C H APTER 4: C O ST BEHAVIOUR
Difference between fixed and variable costs Fixed costs: Costs that are independent of the level of production (or sales) Variable costs: Costs that change proportionally w ith product ion (or sales) volume. They represent reso urces whose consumption can be adjusted to match the demand placed for them. Mixed costs: Costs comprising both fixed and variable cost component s. As an examp le the total operating costs ofa truck is mixed , as it is compri sed of truck rent (fixed) , Gas and Maintenance costs (both variable). Capacity constraints: Limitations on the quantity that can be produced because the capacity committed for some activity resources (such as plant space or numb er of machines) cannot be changed in the short run. Economies of scale: Decreasing average costs with increases in production volume. Disecon omies of scale: Increasing average costs with increases in production volume Re levant range: The range of production levels over whic h the classification of a cost as fixed or variable is appropriate. Step fixed costs : Imagine a chart with co lumns starting low and ending high, and the sta ircase line for which the function Y(x) evolves. The costs increase in relative ly wide discrete steps. Oppose d are the Step va r ia b le costs: which is when the cost co lumns are so small that the function resembl es an almos t straight line.
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The significance of breakeven analysis in decision making Breakeven point: Productio n level at which sales volume results in zero profit Contribution margin per unit : Differences between the price and variable cost per unit. Contribution margin ratio: contribution margin expressed as a percent of sales. In practice an airline company must know how many flights they must operate to break even if it expects the passenger load factor to be 70% per flight. Calculations in exhibit 4-13 (p. 160) indicate that they must operate 58 round-trip flights each week to break even. This is a good foundation for decision making.
Relationship among revenues , costs incurred and production volume through planning models This is illustrated through extending the airline company case. Instead of an expected load of70% for each flight, the load factor is expected to be 92% for the first flight. Each additional round - trip flight is expected to result in a decline in average load factor by 4%. How many round-trip flights should the company operate? Through an algebraic expression they determine the number of flights that max imize profits? The plotted expression is shown in exhibit 4-16 (al 62).
How commitment and usage of activ ity resources influence cost variability Understanding the behaviour of costs is sometimes challenging because cost behaviour is contingent on time frame, range of activity levels and a variety of other factors. For instance, the cost driver for direct materials is the number of units produced. Direct labour hours, the cost driver for direct labour cost is also a unit-related measure. Therefore it is commonly assumed that both direct materia l and direct labour costs are variable. This assumption is not always correct. Take for example a car factory which plans to build 11 0 chassis's, but only build 100. Steel for the remaining 10 units can be put in storage and be used another time. Therefore direct material costs are usually variable even in the short term. In contrast, the supply of direct labour resources often cannot be changed readily in response to short-term fluctuations in production levels, as workers are usually paid a fixed amou nt of wages.
Normal costs of an activity Normal unit cost: The average cost of the activity when the demand for the activity exact ly equals the capacity made available by the resources committed to the activity. Thus the normal unit costs of an activity measure the average or unit costs as if the activity were perfectly variab le. When the demand is less than the available capacity supplied and manager can not adj ust the supply oflabour to actual demand, then actual unit costs will be higher than normal unit costs because of idle time. It works the other way as well - if production surpasses capacity, then the unit cost will in essence be higher than the normal unit cost, because of over time e.g.
Why activity costs tend to be variable in the long run Managers need to understand the behaviour of costs so that they can estimate the impact of their decisions. A number of factors, including the range of activity levels and time frames, influences the way costs behave. Cost behaviour: The way costs change with changes in activity cost drivers or with production volume. Managers must commit to supplying many production resources before knowing the actua l
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demand for them. In this case , the cost of supplying these resources is incurred whether or not the reso urces are fully used to perform productive work. The cost of these reso urces will appear to be fixed with respect to actual production volume as long as the capacity of the reso urces supplie d is not exceeded. Managers have more flexibility over the longer term to adjust staffing levels to meet anticipat ed seas onal or long-term changes in production volume. Managers have furthermore tried to eliminate or greatly reduce worker job categories so that potentially idle workers could be deplo yed to perform different tasks. The supply of resources such as direct labour cannot usually be adjusted to demand in the very short run. Such costs are fixed ove r the short-term horizon, but in the longer run managers can make adj ustments by adding, retrenching or redeploying workers to match the anticipated demand for direct labour. Therefore, the cost of direct labour appears to vary with production volume over longer-term horizons. The behaviour of many other manufacturing costs can be explained in a similar way depe nding on the different degrees of commitment requ ired for different types of resources.
Variability of Support Activity Costs : Support activity resources may be any ofthe following: Flexible resources: resources that are acquired as needed ; their costs vary with prod uction activity; examples include indirect materials and electric power to operate machines. Discretionary costs: Costs resulting from strategic and tactica l decisions of managers; exa mples include advert ising, publicity and R&D Committed resources: Resources made avai lable before their demand is known precis ely; cannot be reduced if demand is lower than planned.
The link between support costs and the production of multiple products The thinking behind comm itment and consumption of activity reso urces becomes more complicated when more than one prod uct is produced and sold. In this case managers must also consider the relative mix of products when estimating activity costs. Different customers may require products to be manufactured in different size batches. As a result, the demand for support activities can vary considerably as the product mix changes.
Difference between the costs of resources supp lied and the costs of resources used for an activity The expenditure for setup and inspection labour of a fictiona l plant that shows up on the financial accounting statements does not change each week because it depends only on the managerial decision about the numb er of workers supplied in the time period. The actual usage of the resources supplied, however, depends on the production volume. Therefore the amou nt of idle time each week changes because of unused resource capacity or due to production delays attributable to resource short ages. Even when a permanent change in the production levels produces repeated unused or exce ss capac ity for an activity, managers often delay adjusting the quantity of resources supplied for an activity to match the new demands for the resources. When the production level goes down, co mmitted activity resources often remain in place for several months before the managers find an alternative use for the excess resource s or make the politically difficult decision to permanently eliminate the surplus reso urces.
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Therefore, there is often a lag between the productio n demands on activity reso urces and expenditures for the resource cap acity supplied to perform the activities.
Breakeven analysis of committed resources One can apply breakeven analysis to decisions about the quantity of committed reso urces to supply. Tak e a fictional auto shop; A breakeven analysis could in this case prove that if 77 or fewer orders are expected only seven or fewer mechanics should be employed. If 78 or more orders are expected, eight or mor e mechan ics should be employed. Breakeven analysis in this case help managers choose between supplying additional quantities of resources (increasing the amount of fixed costs) or payin g higher variable cos ts (Due to overtime pay) should a high level of dema nd be realized.
CHAPTER 6: TWO-STAGE ALLOCATIONS AND ACTIVITY-BASED COSTING SYSTEMS
The difference between production and service departments Produc tion de partments: Departments directly responsib le for some of the work of converting raw materials into finished prod ucts . Service d ep a r tmen ts: Departments that perform activ ities that support production but are not responsible for any of the conve rsion stages. Conventional product cos ting systems assign indi rect costs to jo bs or products in two stages, in the first stage, the system identifies indirect costs with various production and service departments, and then all of the service department costs are allocated to production departments. In the second stage, the system assigns the acc umulated indirect cost s for the production departments to individual jobs or products based on predetermin ed departmenta l cost driver's rates.
The importance and method of allocation of service department costs to production departments Stage 1 allocations: Identification of costs with individual production and service departments (step I) , followed by allocation of serv ice depa rtment costs to produ ction departments (step 2). The first step in Stage 1 ofthe cost allocation p rocedure involves estimation ofthe normal manufa cturi ng support costs incurred in each departm ent. The second step is allocating costs from service departments to production departm ents. Direct allocation method: A simp le method to allocat e service department costs to production departments that ignore s interdependencies betw een service departments. Seq uential allocation method: A method that recognizes interdependencies between serv ice departm ents and allocates services department costs one service department at a time in a sequentia l order. Reciprocal allocation method: A method to determine serv ice department cost allocations simultaneously that recognizes the reciprocity between pairs of service departm ents. Stage 2 allocations: Assignment of costs accumulated in production departments to individual products. It requi res the identificat ion of appropriate cost drivers for each production department and assign production department costs to j obs and products while they are worked on in the departments.
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Why decis ion makers shou ld know how conventional two -stage allocation methods often distort production costs Product costing systems installed in many plants employ the two-stage allocation method j ust described. The structure of these systems, however, can actually distort product costs. The reason for the distortion is the break in the link between the cause for the support activity costs (setup hours e.g.) and the basis for assigmnent of the costs to the individual prod ucts (machin e hours e.g.). Two related factors contribute to these cost distortions: 1. Allocations based on unit-related measures 2. Differences in relative consumption ratios Consider two fictional products A and B. They have the same number of mach ine hours per unit; therefore, both are assigned the same amount of setup costs. In reality however, the demand for setup activity is less for product A because it is produced in larger batches. Cost disto rt ions are driven by the difference between the relative proport ion of the cost driver for the activity (setup hours e.g.) and the relative proportio n of the basis for second -stage assignment of support costs (machine hours e.g.). The difference in the actual cost driver consumption ratio and the unit-level cost drivers used by conventional syste ms results in an overcosti ng of prod uct A and an undercosting of product B.
Activity-based costing systems to estimate product costs Activity-based costing systems: Product costing systems that assign support costs to products in the proport ion of the demand each product places on various activities. Activity-based costing rejects the fundamental assumption of the two-stage allocation method and its absence of a strong direct link between the support activities and the products manufactured. Instead it develops the idea of cost drivers that directly link the activities performed to the products manufactured. These cost drivers measure the average demand placed on each activity by the various products. Then activity costs are assigned to products in proportion to the demand that the products place on average on the activities. This usually eliminates the need for the second step in Stage I allocation s that allocates service department costs to production departments before assigning them to individual jobs and products.
Assigning selli ng and distribution costs to products Up until now all the product costing systems descr ibed considered only manufacturing costs but not selling and distribution costs. This focus is though typical of conventiona l cost accounting systems because only manufacturing costs can be considered in valuing inventories for external financial reportin g purposes. Recently with the increasing emphasis on customer orientation and technological innovation to obtain a competitive edge, selling, distributio n and technology expenses have been growing. It is therefore crucial for manager to understand which product s demand more of selling, distribution, techno logy and other nonmanufacturin g activities and determine how to incorporate products' different consumption patterns into the determination of product costs.
Conclusion I have now described the two stages of allocations typically used in conventional product-costing procedures. The first stage traces all support costs includin g those pertaining to support services to the production departments in two steps. The second stage assigns the support costs accumulated in the production departments to individual products based on unit-related measures, such as direct
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labour hours or machine hours. With conventional costing systems, products manufactured in small batches or in small annual volumes are undercosted because batch-related and product-sustaining costs are assigned only in proport ion to the number of units. Activity-based cost ing corrects these distortions by using separate cost drivers for different activiti es and assigning costs to products based on unit-re lated, batch-related, product-sustaining or facility-sustaining cost drivers as appropriate. Activity-based costing princip les also apply to nonmanufacturing costs, such as selling and distribution as well as to service industries.
I THEME 2: COST AND OPERATIONSMANAGEMENT Lecture 2: Activity Based Costing and Activity Based Management (Christoffer) •
Kaplan, R. S & Cooper, R (1998): Cost and effect, Chapters: 6-7, Boston Harvard University Press
T HEM E Introduction to Activity Based Costing a Stage III costing system, activities consume resources and products consume activities. KEYWORDS ABC, ABM, allocation of overhead costs . Set of problems/focal poin ts, main arguments and conclusion Traditional stage 2 accounting method such as fullcost allocates cost arbitrary using a volum e driver (labor or machine hours). Most costs today refer to the complexity of a given activity not volume. ABC aims at being appro ximately right rather than precisely wrong in capturing the economics of complex, multip roduct production processes. The imprecise nature ABC makes it inadequate for financial reporting. It is based on estimation, meaning that it is mostly localized knowledge. The ABC usually reveals inefficient business processes and unexpectedly costly or profitable customers and products. Activities consume resources and products consume activities. The cost of an activity is measured by assigning it with an activity cost driver either a: • Transaction driver: e.g. Cost per setup change in the production • Duration driver: e.g. Cost per customization of product • Intensity driver: Cost of resources actually used Cost of an activity is determined by how many times, for intensity or for how long the activity has been used. A rule of thumb , ifan activ ity takes less than 5 % of individua ls time or resource's capacity it is not assigned any cost, to lower complexity. The best place to implement ABC is where one or both of these rules apply: I. The Willie Sutton rule: Areas with large overheads which have been grow ing. 2. Diversity rule: Situations where there is a large variety in prod ucts, customers, or processes. Cost are not seen as either being fixed or variable rather as flexible and committed resources.
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CHAPTER 6: TWO-STAGE ALLOCATIONS AND SYSTEMS
VITY-BASED COSTF'iG
The difference between production and service departments Production departments: Departments directly responsible for some of the work of converting raw materials into finished products. Service departments: Departments that perform activities that support production but are not responsible for any of the conversion stages. Conventional product costing systems assign indirect costs to jobs or products in two stages, in the first stage, the system identifies indirect costs with various production and service departments, and then all of the service department costs are allocated to production departments. In the second stage, the system assigns the accumulated indirect costs for the production departments to individual jobs or products based on prcdctennincd departmental cost drivcrs rates.
importance and method production denartments . , Stage 1 allocarions: Identification of costs with individual production and service departments (step I), followed by allocation of service department costs to production departments (step 2). Thefirst step in Stage j ofthe cost allocation procedure involves estimation ofthe normal manufacturing support costs incurred in each department. The second step is allocating coStSfi-OI1I service departments to production departments. Direct allocation method: A simple method to allocate service department costs to production departments that ignores interdependencies between service departments. Sequential allocation method: A method that recognizes interdependencies between service departments and allocates services department costs one service department at a time in a sequential order. Reciprocal allocation method: A method to determine service department cost allocations simultaneously that recognizes the reciprocity between pairs of service departments. Stage 2 allocations: Assignment of costs accumulated in production departments to individual products. It requires the identification of appropriate cost drivers for each production department and assign production department costs to jobs and products while they are worked on in the departments.
Why decision makers should know how conventional two-stage allocation methods often distort production costs Product costing systems installed in many plants employ the two-stage allocation method just described. The structure of these systems, however, can actually distort product costs. The reason for the distortion is the break in the link between the cause for the support activity costs (setup hours e.g.) and the basis for assignment of the costs to the individual products (machine hours e.g.). Two related factors contribute to these cost distortions: I. Allocations based on unit-related measures 2. Differences in relative consumption ratios Consider two fictional products A and B. They have the same number of machine hours per unit; therefore, both are assigned the same amount of setup costs. In reality however, the demand for setup activity is less for product A because it is produced in larger batches. Cost distortions are
Lecture 2: Activity Based Costing ami Activity Based Management (Christoffel") e
Kaplan, R S & Cooper, R (1998): University
and effect, Chapters: 6路7, Boston
'HiEME Introduction [0 Activity Based Costing a Stage III costing system, activities consume resources and products consume activities.
KEYWORDS ABC.. ABM. allocation of overhead costs.
problems/tocat and conclusion 'I'ruditional stage 2 accounting method such as fullcost allocarcs cost arbitrary using a volume ,In',u'<, (labor or machine hours). Most costs today refer to the complexity of a given activity not volume. ABC aims at being approximntcly right rather than precisely \\Tong in capturing the economics of complex, multiproduct production processes. The imprecise nature ABC makes it inadequate for financial reporting. It is based on estimation, meaning that it is mostly localized knowledge. The ABC' usually reveals inefficient business processes and unexpectedly costly or profitable customers and products. Activities consume resources and products consume activities. The cost of an activity is measured by assigning it with an activity cost driver either a: e Transaction driver: e.g. Cost per setup change in the production e Duration driver: e.g. Cost per custornization ofproduct e Intensity driver: Cost of resources actually used Cost of an activity is determined by how many times, for intensity or for how long the activity has been used. ArnIe of thumb, if an activity takes less than 5 % of individuals time or resource's capacity it is not assigned any cost, [0 lower complexity, The best place to implement ABC is where one or both of these rules apply: 1. The Willie Sutton rule: Areas with large overheads which have been growing. 2. Diversity rule: Situations where there is a large variety in products, customers, or processes. Cost are not seen as either being fixed or variable rather as flexible and committed resources. Chapter 7 of the text gives an example for how the analyst can determine cost of a given activity using historical data. Measuring and managing used and unused capacity is the central focus of ABC. It is important to use the practical capacity for an activity and not the theoretical when estimating the cost driver lor it to avoid a death spiral (overcosted cost driver),
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Handle Customer Inquiry 44 1.400 Perform Credit check 2.500 50 Used Unused C, Total l'otal cost (minutes ., Capacity cost rate) Managers can easily update the cost drivers and change the equation the ABC model is less flexible. Cost drivers can change in two ways: 1. Change in price of resource applied
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2. ShiH in efficiency in the activity (cutting time for each activity in half fix example)
TDABC benefits: e Easier and faster to build an accurate model o
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Process time and complexity: The TDABC model can be used even with complex products and services. Example of order processing time (minutes): Order processing: 10 (+5 if new customer)(+ 10 if credit hold) (+2 if customs form are to be used) (+2 for international orders) etc. adding up the minutes and hence the individual resource cost. Hence, it is possible to use thc 1DABC model even with several activities and the Resource cost does not have to be calculated for each activity wasting time and money. Building the time equation there arc 6 stages to go through when implementing the TDABC framwork: l . Begin with the most costly processes- -where most money and time is spent since the potential impact will be greater 2. Define the scope of the process and the activities to be measured 3. Determine the key drivers of time (The most significant factor that consumes resource time) 4. Use readily available driver variable (Use existing CRM systems or other available data, reducing time spent on the framework) I ERP A computer program whichcombines all individual programs in an organization and makes them work together, or the data flow easier between the different systems =;
Conclusion: e
The ABC never met the needs of Marconi for making rational product decisions due to the failure of accepting the model amongst the employees
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Moreover} ABC became a symbol for staff reductions and a threat to the occupational identity
It was a success for the commercial departments within Marconi, who used the system vividly.'. However since production used their own physical system instead ignoring the ABC model, the mode! became dccouplcd in the organization and therefore not efficient enough to benefitfrom
Chapter 7 of the text gives an exa mple for how the ana lyst can determ ine cost ofa given ac tivit y using historical data. M easuring and managing used and unused capacity is the ce ntra l foc us of ABC. It is imp ortant to use the practical capac ity for an activity and not the theoretica l when est imating the cost driv er for it to avoid a death spiral (overcosted cost driver) .
T HEORIES/MODELS AND THEIR REL ATIO N TO THE SET OF PROBLEMS Cost of resou rces supp lied
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DEFINITI ONS Overhead cost: (costs not huge ly influenced by volume e.g. adm inistration) Theoretica l capacity: Ideal wo rld scenario capacity (100 % utilizat ion of the resource) Practical ca pacity: Rea l life estimate ( 100 % utilization minus slack , breakdown, brakes etc .) ABM (activity based management) : e.g ., activity based cost contro l, customer profitability, value added analys is. Flexi ble resource : (sho rt term) Cost of acqu iring the resource = using the resource Committed resource: (lo ng term) Commitment or cas h outlay for reso urces to be used for current and future act ivities
RELATED THEORIES Stage 2 cost sys tems, target cost , theo ry of co nstra ints . TQM.
Extra information from class Read the slides from lecture 3
• •
•
Kaplan, R. S & Anderson, S.R (2007): Time-Driven Activity-Based Costing, Chapters: J2 (page 3-40), Boston, Harvard University Press . Hopper, T. & Major, M (2007) Extending Institutional Analysis through Theoretical Triangulation:Regulation and Activity-Based Costing in Portuguese Telecommunications, European Accounting Review Vol. J 6, No. J, pp. 59-97 Text: Data services at Armistead: Darden Business Publishing. European Case Clearing House. (Case can be bought at IVS)
Lecture 3: New Product pricing (Thor) • Hinterhuber, A (2004) Towards value-based pricing-An integrative framework for decision making, Industrial Marketing Management 33 pp. 765- 778 Th eme: Pricing has a hu ge impact on financial res ults, but is largely ignored by compa nies and academics. Th e text presents a theoretical framework for pricing deci sions that conside rs all relevant dimensions of the process.
Keywords: A fram ework for pricin g, sources of va lue for customers, econo mic value ana lysis, Cost Vo lume Pro fit(CV P) analysis, Th e strategic triang le, pricing tru ly inno vative products too low, T he surp lus va lue
Abstract:
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The text makes a strong case for pricing being a serious underestimated and unutilized tool in the marketing mix, in contrast to the rest of the four P ' s. It has been largely neglected by ma nagers(l ess than 15% of com pan ies do systemic research in this field) and has received very little acade mic investigation. The neglect derives from the misco nception that pri ce is an im portant purchase cr iteria for custome rs, and that impact of price on pro fitability is limited . Incorrect assumptions include that pricing is a zero-sum game, and that prices are mo stly dictated by the market. The autho rs claim that , on average, a 5% price increase leads to a 22% imp rovem ent in operating profits, which is far more than other tools in operational ma nagement. The first sections con tinue to disprove two co mmon myths in pricing:
"Prem ium prices and high marke t share are incompat ible" o
Traditio nal advice of marketing lite rature: Penetration pricing, price skimming etc. is how you build market share, premi um pricing is best suited for small niche mar kets
o
Pharmaceutical industry is used as an example of t he opposite case. In most segments the most expensive drug was the market leader.
"Custo mers are highly price sensit ive" o
One st udy showed supermarket shoppers to be generally unaware of th e pr ices of purchased produ ct s. A price increase of 10% lead to a volume decrease of only 3%.
A framework for pricing: Th e framework can be seen in fig.3 on page 768. The process is basically ou tlined like this: 1. De fine pricing obj ectives, 2. Ana lyze the key elemen ts of pricing decisions(main dimension), 3. Select profi tab le price ranges , 4. Implement price change
1. Define pricing objectives The starting poi nt of pri cing strategies. Depending on the overall pursuited strateg y of the firm, the pricing strategy requ ired is variable. The obj ectives can be profits over time, rapid ma rket share growth, penetration, cro ss-selling, tran smit sign als to the marke t and so on ... Pricing strateg ies are very context-spec ific, which is exemp lified by the fact that a tru ly globa l pricing strategy is rarely adopted by multination als.
2. Analyze th e key eleme nts of pric ing deci si ons The strategic triangle by Oma ha is usefu l to view the dimensions of price decision and the instruments used to ana lyze them . The Triangle: The Customer - w here Economic Value Analysis should be used t o understand sources of value fo r
cust omers The Comp any - w here Cost Volume Profit(CVP) analysis should be used The Competition - involving compet it ive analysis
The instruments:
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1. Economic value analysis "The und erstanding of the sources of eco nom ic va lue of a produ ct to different c lusters of customers" The essence is that it at least as important to create customer value by innovative products and services, as it is important to quantify and to communicate the va lue of these products to customers through pricing and marketing activities. Di fferent definitions of customer value if presented in this section, and the one proposed is " A product' s econom ic value is the pr ice of the cu stomer ' s best alternati ve - reference va lue - plus the value of whatever differentiates the offerin g from the alternative - di fferenti ation value" To quantify thi s econom ic value correctl y, six step need to be performed:
Step I : Identify the cost of the competitive product and process that consumer views as best alternative As this is perceived by the customer, th e reference produ ct doe s not need to be a physically similar product, but could be somet hing e lse th at fulfills the same function. The economic value should be calculated against the principal best thre e alternatives.
Step 2: Segment the market How does different customer segments use and value t he product? Observat ion and inten se field research into the customer habits and req uiremen ts,
Step 3: Identify all factors that differentiat e the product f rom the competitive product and process es. Anyt hing from reliabilityto ease-of-use or safety. Again, t he custo mer is the o ne perce iving th e value and defini ng t hese facto rs
Step 4: Determine the value to the customer ofthese differentiating factors Monetary values are assigned to th ese factors, for each segment of t he market. Co njoint analysis can be used for t his, which capt ure trade-offs in product features in a system ic way through interactive custome r-preference testing.
Step 5: Sum the ref erence value and the differentiation value to determine the total economic value As defined above, straightforwa rd. It will crea te a value pool, rath er than one value, as different categories of custo mers will ass ign different values to the product examined.
Step 6: Use the value p ool to estimate f uture sales at specific price points Sales estimates for different prices points. Case ex amples on the analys is are illu strated on page 770.
1.1 Why we buy(buying behavioiur) :
Wi llin gness to bu y = Surp lus value + Perceived fairness of the transaction See fig. 5 on pa ge 772 for a simp lified mod el of wh y we bu y. The surplus va lue of products and servi ces is the diffe renc e be tween the eco nomic va lue assigned to them and their pri ce. The Perceived fa irness of the tra nsaction is influ enced by the price paid co mpa red w ith intern al re ference pr ices.
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The internal reference price is simply the price and price level which is expected and perceived to be ' fair' for the product category in question. It tells us that other factors influence rational buying decisions than econo mic value versus price. A 600% price premium may not be considered fair even if the perceived value is estimated as such.
1.2. M anaging economic value:
Econom ic value has a hard and a soft compo nent; Hard: the buyers best alternative and its price, identifiable product. Soft : differentiation value, a subjective source of value The following points highlight how it can be managed: Increase the value of the product's perceived substitutes(substitutian effect): choose highest(expensive) reference as compa rison when market ing the product .
Emphasize the products unique value Create switching costs between products Render comparisons between products difficult and impossible (difficult comparison effect): through differentiat ion
Increase prices (price quality effect): exploit t he positive connotation between price and quality or prest ige
Relate the produ ct to an important end-benefit (end-benefit effect): especially when th e prod uct circumvents risks.
Be f air (or, at least, create the impression of being 50): like, creat ing a estab lishing a limited introducti on price. instead of usual pr ice increase on norm al price.
2. Cost vo lume profit analysis (CVP)
Attention is now on the company itself and its cost structure. A typical question raised, which few managers are able to answe r, is: "If prices are raised by x%, how much turnover can the company afford to lose, if overall profit s are at least to be maintained?" This is what CVP answers, through different calculations which can be observed on page 774-775. Knowing how to do this should not be impo rtant, but knowing what they do in essence will be explained here. The answer to the question above depends on the prod ucts profi tability, that is, on its contribution and gross margin (net sales revenue, less variable expenses) Take a look at Fig. 6 to see how a price increase or reduction relates to a required volume of change in turnover. A low margin prod uct generally requires a proportionally larger sales increase to be profitable when the price is reduced. Whereas a high margin product(70%) can make a profitable price increase if sales decline no more than dictated in fig. 6, which is fairly advantageous. The break even sales change(%)=
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CM + '" P p= pr ice, CM= co ntribution margin/gross margin = the minimum percent age of product sales increase/decline necessary/acceptable for profits to stay
the same when the price is chan ged . The next calcu lation s integrate special fixed price investment s, like promotional ca mpa igns . The campa ign wou ld have to result in $xxx more in sales for the investm ents to break even. Furt her calculations ca lculate both a pri ce redu ction and the investme nt of commu nicat ing the offer.
3. Competitive analysis Requi res the following eleme nts: Threat of new e ntra nts Price trends in existing markets Compet itive strategies Information abo ut distribution channels Reference values for custo me rs groups Likely react ions to price changes
3. Determine a range of profitable prices The thr ee instruments of the last section should be compared to anal yze th e potenti al financi al imp lications of the price increases suggested by custome r analysis. Staff from sales, marketin g and distribution should consulted to de em wh ether to sales increase or redu ction seem s rea listic.
4. Implement prices changes The follow ing iss ues sho uld be considered : Involve sales exec ut ives in any pricing decisions Implement a fixed price policy (give sales perso nal little pricing authority, se ll on value not price) Rewards sales personnel for profits and not sales (not volume but margin(value)) Involve sales personnel in the strategy process Be creat ive with ma rketing strategies Make the company easily accessible for custo mers Commerical and t echnical personnel should converge
Conclusion T he paper presents a framework for implementation of a va lue -based pricing strategy.
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After taking a company's objectives into consideration, it is suggested to use the tools of economic value analysis, cost-volume profit analysis(CYF) and competitive analysis to reflect the customer, company, and competitor perspective relevant for strategic decisions. As a result, ranges of profitable prices are determin ed. In the last step price change is implemented. The main focus was econom ic(or customer) value analysis, which provides the solid understanding and quantification of customer value that is key to profitable pricing. cost-vo lume profi t analysis(CYF) is the too l which can be used to j ustify price increases to customers. Price is a cont inuous process, external and internal changes should lead to modification. Lastly, it agues for the customer-oriented strategy as opposed to the competitor oriented one.
â&#x20AC;˘ Marn, YoM, Roegner, EoY, & Zawada, C.C (2003) Pricing new products, (1) The McKinsey Quarterly, pp, 40-49 T heme How much should you charge for a new product? The paper deals with the problems of charging too Iow a price, why it happens and how to break the habit. Key words Me-too (replicating) products, evolutionary (incremental) products, revolutionary products, Expansive rather than incremental approach, Range of pricing options: The highest price, The floor . Four aspects of new product pricing: Ref erence price, Competitors ' reactions, Life cycle strategy, Cannibalization Abs tract The Claim: 80 to 90 percent of all poorly chosen prices are too low. Understandably, market forces as competition, consumers asking more for less, pricing transparency etc. push prices down, while companies try to make a quick grab for market share with low prices. But the problem also rises from the incremental approach of using existing products as reference points for pricing, which underestimates the value of new products for customers. Especially revolutionary products, when their prices are mostly based on production costs and price of competitive products, can suffer from setting the markets price expectations at too Iow a level, and be locked in to the price, which failed to capture the full value of the prod uct. The authors recognize the traditional forces' part in the pric ing puzzle, but suggest an expansive rather than incremental approach. Price should be part of the early development process, and managers should learn the highest and lowest price they can charge. Even me-too(replicating) or evolutiona ry(incremental) products should consider the pricing possibilities as the smallest deviation from the right price could mean forfeiting significant profits, while the more revolu tionary, novel prod uct will demand a broader view of pricing possibilities. T he highest price Even though competing at this price ceiling might be unrealistic, it ensures that every potential price point is considered. It requires a clear understandin g of the product's benefit to the customer. Open-ended feedback research is emphasized here, which is not limited by choice questionnaires, or trade-offteqniques (comparisons) that limit responses in any way.
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The floor Cost-plus pricing (cost of prod uct + acceptab le profit) is ofte n disregard ed as weak , but it is esse ntial for sett ing the pricing optio ns' floor. Resemb les the lowest reasonable level. - Should remember to bring R&D and other indirect factors into the cost calc ulation howev er. The range of pric ing optio ns are usually sma llest for mee-too produ cts, which makes correct assessment of costs even more important.
The size of the mark et Estimating the size of a market at various price point s, at and below the ce iling, clarifi es the range of pricing options and increases the accuracy of est imates of profitabili ty along the spect rum. The lower the price - the higher the demand is not always true . Mid-price products might end up in a dead zone where no target segments exists, and too low-priced products might not be taken seriously.
Setting the release price Targeting the largest market might not necessari ly mean maximi zing profi ts. The four aspects of new product pricing might cou nse l against this: 1. Reference price - the release price minus any discounts or oth er incentives. The produ ct' s ture value as judged by its maker. T he price must not confl ict with the value position that is being estab lished . 2. Competitors' reactions - especially for evolutionary prod ucts. Low- price strat egy typica lly generates price war, wh ile higher pric e strateg ies usua lly generate few immediate actions from competitiors.
3. Life cycle strategy - kno wing that the segments will expand will help matching demand with product ion capac ity
4. Cannibalization - on ow n product lines. Set price higher to differentiate towards smaller segme nt, or set price lower to make custom ers shift more qui ckl y to new line..?
Going to market Presenting a prod uct to the mark et requires both astute communication with it and patience. A prod uct ' s fortun es during the first six months to a year after it hits the market have a critical influ ence on its value position. There are oth er ways to push a product quickly than discounting, which might sabotage a product' s referenc e price or the market's perception of it' s value. Offering free samples, free trial-p eriods give products to high profile custom ers are some ofthese methods.
Penetration pricing When low-pri cing schemes are legitim ate:
High customer value, elasticity: underdeveloped markets, where nenefits of products are high, and cutoers are part icu lary price sens itive. Supplier can bui ld presence fast, ahead of competition, especially if high sw itching costs are present. Risky strategy, however.
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Cost-to-serve advances: when costs fall because of scale economies or learning curve effects. Margins shuld rise over tim e. Weak competition: if com petitors cost structures are higher or are locked into channel agree ments. High labor costs is one exam ple.
â&#x20AC;˘ Marn, V.M & Leszinski, R (1997) Setting Value not Price, The McKinsey Quarterly, (1) pp. 98-115 Theme Often, appar entl y sound mark eting strategies and tactics produces unexpe cted and costly results, that might cou ld have been avoid ed. The text explores how comm on and expensive mark eting missteps might be averted by appl ying a discipline called "dynami c value mana gement" to the pricin g and product positioning that are at the core of what most mark eters do.
Key words Dynamic versus static va lue management, Customer value, the value map, customer-perceived benefit s minus customer-perce ived price, customer horizon, transferred surplus (between customers and suppliers). Abstract According to the authors the real essence of 'value' revolves around the tradeoff between the benefits a customer receives from a product and the price he or she pays for it, and not low or bundled prices.
Markete rs often fail on two dimensions when managing this tradeoff: 1. They fail to determine what the " static" positio ning for their produ cts on a pricelbenefit basis against competitors should be. 2. They ignore the "dynamic" effect of their price/b enefit positioning - react ions trigge red on the market and the effect on total industry profitability and on the transfer of surplus between supp liers and customers. Customer value equals customer-perceived benefits minu s customer-perceived price. So the higher the customer benefit and/or the lower the price the higher the customer value. Sta tic value mana gement Th e val ue map can be an efficient too l to analyze the value position of a firm and its competitors, and how customers are distributed within the map for a given segme nt.
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ÂŽ Customer -perce ived benefits 1 The Value Map
As shown in the figure each dot represents a competitor's product or service. Higher-priced, higherbenefit competitors are toward the upper right, lower-priced, lower-benefit competitors are at the lower left. The VEL is thus the value equivalence line on which all the value pos itions offer a price equal to the perceived benefits and the customer "gets what he pays for" or, the company charges what is expected and accepted. A market share gaining competitor would therefore be posit ioned below the VEL and be "ValueAdvantaged", since his customer-perceived benefits are greater than the perceived price. In contrast , positions above the line would be classified as value-disadvan taged. Once again, it is recommended for extensive market-customer analysis to understand and quant ify the benefit dimension and its tradeoff against price. Gaining a clear understanding of real attributes driving the customer choice and their relative importance is integral to constructing the value map properly. A case on value-mapping is illustrated on page I 02. Alpha Computer placed itself and its competitors in a value map, and discovered that the customer- perceived attributes were quite different from what they had believed and were not value advantaged as they thought. It concludes that softer, non-technical, supportive features can be as important as the technical ones, and that it is a fatal mistake to trust internal percep tions of the product attributes. Distribution of customers on the value map All positions on the VEL line are not equally attractive, as customers are not spread equally along the line, but typically clustered. This can be explained by the fact that they are not always wellinformed about all prod ucts on the market. Or, for instance, there are benefit-bracketed customers who explicitly want minimum or maximum benefit levels, or price-capped customers who are unwilling to pay more than a certain amount on a particular product. Understanding volume distribution along the VEL is therefore crucial to making an intelligent decision about prod uct positioning.
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Dynamic value management Getting a produ ct to the righ t pos ition on a static map is only part of managing value effectively. Va lue maps are constantly changing, because change of on e will lead others to mov e. The MTE cas e illustrates how the company positioned its new product with a value-advantage below the VEL line which made the competitors follo w with a price decrease, resulting in all market shares to return to norma l, but at lower prices . . . thu s the VEL on ly shifted downwards in the value map, transferring surplus from the suppliers to the customers (see exhibit 8 on page 108). If they had increased price furth er and stayed on the VEL, they wo uld have provoked litt le action from compet ito rs and held tradi tional ma rkets share at a high er price. Changing you r position in a dynamic world This result s in two basic options for improving a product position: 1. Repositio ning olong t he VEL - a less aggressive move. Company will need to understa nd the tradeoff between cluster s of customers t hat it implicates, choose product feat ures that att ract new wit hout losing old custo mers and choose changes least li kely to provoke compet ito r reaction. There might also be latent demand outside t he estab lished compet itive clusters on t he VEL. 2. Moving off the VEL - t he value-advataged te rritory might seem attract ive but it is necessary to
understand the dynamics and risks. This move ofte n t hreate ns all competit iros, as opposed to one or two on the VEL li ne, as this move defines a new VEL lin e in the mind of the customer. The competitor's response to this is eit her cutt ing prices or improving benefits, usually they choose to move along a similar axis as the challenging product. By moving off the VEL, the company expands its customer horizon, as it addresses a wider range of potential custom ers below the VEL line(see exhib it 9 page 110 for example). Moving below the VEL is always a risky strategy, and requires a carefu l consideration of direct ion(w here are the customer volumes?) and distance(how far to differentiate and expand customer horizon eno ugh?). Using dynamic va lue management to r espon d to external changes Dynamic va lue management can also be used for prescrib ing reac tions to the competitors ' positioning moves or other changes, and not j ust for how to initiatiate them. To res pond to a competitor's move the follow ing quest ions need to be considere d to be sure it is necessary to react: Is it a move off the VEL?(in the mind of the customer?), has its hor izon expan ded sufficiently? Are our custom ers buying the new product? What kind of reaction is needed and how strong?(price or benefit or comb ination? )
â&#x20AC;˘ Ingenbleek, P.,Debruyne, M. , Frambach, RT., Verhallen, T.M.M., (2003) Successful New Product Pricing Practices: A Contingency Approach, Marketing Letters 14:4, 289-305. 2003 C ourse : Abstractor: Tit le:
Management Control and Finance M onir Azz ouzi
Lecture :
3
Successful New Product Pricing
A ut hor(S ):
Ingenb leek P. et. al.
220f150
Date:
5th of J une ' 08
Practices: A Contingency Approach Keywords:
Pricing, New product pri cing development, pricing strat eg y
Ingenbl eek examines new product pricing practices and und er which co nditions the different pricin g mod els have to be used. Three pricing models are tested; Value based, compet itio n based and costs based (information) prici ng. A total of 78 questionn aires were returned out of 590. Because the use of customer value, competition and cost information should be seen as a matter of degree, rather than mtually exc lusive categories, Ingenbleek use the terms, cost-informed , com petition- informed and value- informed pricing instead of cost- , co mpetitive-, va lue-based pncmg,
Value-informed pricing Informs the firm about; what is the customer's perception of our product va lue? Can be quantified by assessing the monetary amount customers are willing to pay for the perceived benefits they will rece ive if they accept the market offering. This could be in form of cost savings or increases in prod uctivity the customer or firm receives by adopting the prod uct Procides a better understanding of the price cei ling. Even more the case if relative product advantage is high. In this situation, the prod uct is more difficult to compare to alternative offerings. The custome rs's perception is the most imp ortant source of information to understand how much the product is worth, If competitive intensity increases, the relative advantage is likely to erode faster. Competition-informed pricing Informs the film abo ut; How and how much do competitors charge for the perceived benefits they offer? If ones firm s produc t offers slightly less benefits than the competitor' s product, an assessment based on competit ion information probab ly result s in a price slightly below the competitor' s pric e. Helps the firm to understand the upper-limit of the pric e discr etion. Thi s is only the case if relative product advantage is low . Ifrelativ e product advantage is high, competit ion-informed pricing can be con sidered as bad practice. Good pract ice if the product to be launched is more similar to competitors pro ducts in term s of the va lue it offers to customers Cost-informed pricing Quantifies the variable and fixed costs with respect to the development, productio n and marketing of the new produ ct. Inform s the firm about the botto m line price needed in order to be profitable. He lps understand lower-boundary of the price discretion. Bes t practive if competi tive intensity is high and bad practice if competitive intensity is low. Re lative product advantage appers not to influence the success of cost- informed pricing.
The authors test some hy pothes is and comes up with some logical answers, which one can come up with, without the test. Some of the hypothesis with their results are listed below
H i: Value-informed p ricing is more effect ive when the relative product advantage is higher: â&#x20AC;˘ Correct
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•
•
Products that offe r low relative advantage hardly distinguish themselves from competitors' products. Therefore, these products will be compared by customers, using the competitor's price as a reference price. The higher relative product advantage, the less competition-informed pricin g contributes to performance
H2: Competition-informed pricing is more effective when the relative product advantage is lower • Correct • The lower relative product advantage, the more cost-informed pricing inform s the firm about the price discretion , thus contributing to performance • If the product advantage is low, customers' might change to other substitutes offered by competitors H3: Cost-informed pricing is more effective when the relative p roduct advantage is lower • Correct • If the product advantage is low, custome rs' might change to other substitutes offe red by competitors • The higher comp etitive intensity, the less value inform ation will help firms to understand price discretion and, therefore, the less this type of information enhances performance Some concluding remarks and points from Ingenbleek's text are listed below • Value-informed pricin g generally contributes to new product performance, whereas the two others have no significant effect • Firms pick a price between the upper limit determined by relative value of a prod uct and the lower limit determined by costs . Relative product advantage and co mpetition may change the shape of the price discretion and make pricing even more complex • Unlike the two other models, value-informed pricing there are no situations where value-informed pricing can be considered bad practice. This confirms conventional market ing wisdom that understand ing the customer's value perception is key to successfu l pricing • Jorgensen, L.H & Sveoningsen, K. (2007) New Product Pricing The Challenge of Creating and Capturing Economic Value from Innovation. Working paper. Please do not quote This is a short paper (to be publi shed) which is based on an o ld MIB master thesis on new product pricing and the challenge of creating and capturing economic value from innovation. They talk about the importan ce of pricin g as a powerful profit lever. They argue that pricing and innovation should not be seen as separate and sequential processes. They draw on other authors within the field of pricing practic e and combine them into their own framework . They mention three pricin g practices: Cost informed pricing, competitor informed pricing and value informed pricing (latter rarely used). For the launch of new products with a high degree of novelty and technological uncertainty, customers are early adopters and value informed pricing is recommended. The economic value of a product is de fined as: the price of the customer's best alternative reference value - plus perceived value of whatever differentiates the offering.
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The framework includes 8 eleme nts which are beli eved to be imp ortant for a pro fitabl e pricin g decision: 1. Pricing strategy (ali gnment of bu siness and pr icing strategy, i.e. cost Ieadershipldi fferenti atio n/fo cus) a. S kimming price (hi gh di fferentiation , sacrificing vo lume to ga in higher profits effective with early ado pters and customers that do not know the product and are less price sensitive - risk : large initial marg ins may attract new entrants, pen etration is slowe r, delay in exp loitation of econom ies of scale) b. Penetration price (low price, ofte n be low market pr ice, to win market share fast create entry barriers - used when demand is elastic, scale economies availabl e, supply chain is effective , in mass markets, to ugh com peti tion is expected ) c. Neutral pricing (pricing w ith some degree of equivalence between perceived value and pr ice - hea lthy profits) 2. Segment the market (which potential custo mers will have the highest potential ROTby purchasing our products?) 3. Assess competition (und erstand customer preferences and availab le alternatives) 4. Design-to-price (imp lem ent pr icing strategy early in the NPD process, avoid overengineering) 5. Construct price metric (offer buyer a convenient way of paying i.e. cash, lease, increm ental payment) 6. Value selling (effectively co mmun icate value ofthe prod uct to the customer) 7. Transaction (rul e of thumb: the price ofa produ ct should indicate the value of the product, and the amount of disco unt should ind icate the customer's value to the company) 8. C u stomer relat ion sh ips (priced often closer in close customer relation s)
Lecture 4: Target Costing (Lisa) â&#x20AC;˘ Cooper, R. & Slagmulder, R. (1999) Develop profitable new products with target costing. Sloan Management Review, Summer, pp 23-33 This article disc usses a three step pro cess that allows firms to develop new produ cts that make a profi t and please custome rs through the use of target costing .
Ab stract Th e authors studied the mature, highl y effective target costing systems of seven Japan ese companies and documented their costin g pro cedures. Although practices differ among these firm s, the authors identified an underlying gene ric approach for impl em enting targ et costing sys tems. Market-dri ven costing, Product- level target cos ting and Component-lev el target costing The cardinal rule of the companies studied is: "Never ex cee d the target cost." Th is is enforced via; offs etti ng des ign improvements that resu lt in increased costs with savings elsewhere in the design, by not launching products that exceed the target cos t, and by carefully managing the transition to manufac tur ing in orde r to achieve the target cost.
Introduction Target costing, to be effective, m ust be a highl y di scip lined process. The discipli ne starts by forc ing alignmen t with the marketplace and requiring a new leve l of speci fici ty abo ut what customers want and what price they are prepared to pay.
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Market analysis plays a critical role in shaping the market-driven costing section of target costi ng by determining so-called allowab le costs. Target costing systems use these allowab le costs to transmit the competitive cost pressures that the company faces to the product designers. Productlevel target costing disciplines and focus es the product des igners' creativity on achieving the cost aspect of thi s objective. Once a company establishes product level target costs, it decomposes them to the component level, thus tran smitting its cost pressures to its suppliers. Suppli ers, in tum, mu st find ways to design and manufacture the company 's externally source d co mpo nents so that they ca n make adequate returns when they se ll their co mponents to the compan y. Thus, com po nent-leve l target costing help s di scipline an d focus supp liers' creativity in ways ben eficial to the buyer. Market analys is -7 product level costing disc iplines -7 component level costing diciplines -7 Supplier level costing disciplines All processes are iterative and shou ld be started as early as possible, but genera lly happen in the above sequent ial orde r.
Market Driven Costing Ma rket- driven costing focuses on custo mer requirements and uses the concept of allowa ble cost to trans mit the competitive pressure of the mark etpl ace to the compa ny 's product design ers and supp liers. Market-dri ven costing can be broke n down into five steps (the first two of these steps cove r all the company's products; the next three are perfo rmed for each new product) : I) Set the com pany's long-term sales and profit objectives, high lightin g the pri mary role of target costing as a techn ique for pro fit managem ent.
o
primary objective is to ensure that each product, over its life, contributes its planned share of profits to the company's long-term profit objectives
2) Structure the product lines to achieve maximum profitabi lity.
o
For product lines to be successful, they must be structured carefu lly to ensure that they satisfy as many customers as possible but do not contain so man y products that they confuse cu stomers.
3) Set the prod uct's target se lling price.
o
Target prices are set by tak ing into account a number of internal and external factors. The internal factors include the position of the model in the product matrix and the strategic and profitability objectives of top management for that model. The external factors include the corporation's image and level of cus tomer loyalty in the product's niche, the product' s expected quality level and functionality compa red to competitive offerings, its expected market share, and the ex pected pr ices of competitive models.
4) Establish the target profit margin the co mpany mu st earn on the produ ct to achi eve its long-term pro fit objecti ves. o
Two impo rtant conside rations in setting target profit margins are to ensure that the margins are reali stic and that they are sufficient to offset the life-cycle cos ts of the prod ucts.
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Set Realistic Profit Margins 1. Starts with the actual profit margin of the predecessor product and then adjusts tor changes in market conditions. 2. Starts with the target profit margin of the entire profit line (or other grouping of pro duets) and raises or lowers the target profit margin for individual products, depending on the realities of the marketplace.
3. Withou.t determining life cycle costs the company risks either launching products that do not earn an adequate return or not launching products that \:\/i11 earn an adequate return over their lives. 5) Compute the allowab!e cost by subtracting the target profit margin from the target selling price. o
Allowable cost
target selling price
profit ruargin
The process ofproduct-level target costing increases the product's ullowahlc cost to a target cost that the company can reasonably expect to achieve, given its capabilities and its suppliers. Productlevel target costing can be broken into three steps:
1) Set the achievable product-level target cost
10 The degree of cost reduction required to achieve the allowable cost is the target costreduction objective, derived by subtracting the allowable cost from the current product cost. The current cost of the new product is determined by adding up the current manufacturing costs of each major function of the new model, assuming no cost reduction activities are undertaken
Cost-reduction objective = current cost- allowable cost 2. The product-level target cost is then determined by subtracting the new product's target
cost-reduction objective from its current cost
Product-level target cost
=
current cost- target cost-reduction objective
3. Negotiations with the chief engineer and the product designers and major suppliers establish the product level target cost. All concerned should consider the target costreduction objective achievable. The unachievable part of the cost-reduction objective is called the strategic cost-reduction challenge, which is the difference between the allowable cost and the target cost:
Strategic cost-reduction challenge = product-level target cost- allowable cost This process identifies the profit losses that will occur if the product designers are unable to achieve the allowable cost, and signals that the company is not as efficient as demanded by competitive conditions. The challenge should reflect the company's true inability to match its competitors' efficiency.
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The co mpany establishes the strateg ic cost-reduction challenge thro ugh negotiations between the chief eng ineer and sen ior managers. Senior managers push for the smallest number possibl e, while the chief enginee r pushes for a number high eno ugh to ensure that the product-level target cost is ach ievabl e. Since the target cost- reduction objective and the strateg ic cost-reduction challenge add up to the gap between the current cost and the allowab le cost, these negotiations maintain the pre ssure on the product designers to reduce costs. 2) Disc ipline the target cost ing process Once the company has established the target costreduction objective, it can begin the process of designing the product so that it can be manufactured at its target cost. App ly the Cardinal Rule "The target cost must never be exceeded" First, whenever improvements in the des ign result in increased costs, the company must find alternative, offsetting sav ings elsew here in the des ign. Second, the company does not launch produ cts whose costs exceed the tar get. Third, the company carefully manages transition to manufacturing to ensure that it achi eves the target cost. 3) Achieve the product's target cost
Component Level Target Costing Once a co mpany has established a product's target cos t, it develops target cos ts for the product's co mponents. Thi s component- level tar get costing pro cess enables the company to achieve the second objective of target costi ng : tra nsm itting the co mpetitive cos t pressure it faces to its suppliers Once a company has established the target costs of the major funct ions, it decomposes them to the group co mpo nent and parts level as appropriate. The objective is to set a purchase price for eve ry externally acquired co mponent. This is usuall y und ertaken in three steps. 1. Deco mpose the product- level target cost to the maj or function level. 2. Set component- level tar get costs. 3. Manage suppliers.
Conclusion Given a highl y competitive environment, companies must manage costs aggressiv ely if they are to surv ive. Cos t manage ment must start at the earliest stages of a product's life because the ability to change the pro duct significantly increases the degree to which costs can be reduced . Three target-costing processes together discipline the product develop ment process to help ensu re that only profita ble produ cts are laun ched.
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â&#x20AC;˘ Ibusuki, U & Kaminski, P.e. (2007) Product development process with focus on value engineering and target costing : A case study in an automotive industry, International journal of'production economics (105) pp. 459-474 This paper looks into Value Engineering (V E) and target costing in cost management. Abstract VE and target-cos ting are com plementary processes, because while one allows the identifi cation of where cost reduction could be achieved, the other shows the target to be achieved . A case study was unde rtaken that focused on the engine-starter sys tem of a vehicle, aiming at improved product cost, functionality and quality accomplishme nt, in acco rdance with customer needs and the com pany strategy . K eywords: Va lue engineering; Target-costing; Cost management ; Cost reduction; Product development Theory of target-costing A target-costing system has two objectives:
1. Red uce the cost of new products so that the level of requ ired profit could be gua ranteed , simultaneously satisfying the levels of qualit y, development time and pric e demanded by the market
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2. Achieve the target-profit during the new product development, turning target-costing into an activity of profit admin istration for the whole company, using the creativ ity of employees from several departments to draw up alternative plans that allow higher cost red uctions. The definition of target-costing involvesproduct planning so as to satisfy customer attributes and the profit generation to the company, given the market requirements. This information is essential so that the product cost can be considered an active variable of the project. Stages to determine the target-cost The implementation of a target-costing approach and the determination of the product target-cost involve the ten steps describ ed below. I. Re-orient culture and attitudes. Re-orient thinking toward market-driven pricing, prioritizing customer attrib utes as a basis for product development. 2. Establish a market-driven target-price. A target-price needs to be established based on market factors such as the company posit ioning in the market place (market-share), the market penetration strategy, com petitors and competitive price, the targeted market-niche and the elasticity of demand. 3. Determine the target-cost. The target-cost should be calcu lated by subtracting the target-profit and any uncontroll able allocations, such as taxes and some indirect fixed costs. 4. Balance target- cost with requirements. Before the target-cost is conc luded, product requirements must be considered. The greatest opportunity to control prod uct costs is through proper setting of requirements and specificat ions. 5. Establish a target-costing process and a team-ba sed organization. A well-defined process must integrate activities and tasks to support the target-cost, such as marketing, engineering, manufacturing, purchase and finance. 6. Generate ideas and analyze alternatives: Opportunities for cost reduction lie in the multiple alternatives of product concept and design, its manufacturing and support processes at each stage of the development cycle. 7. Estab lish product cost models to support decision-making.These models are based on parametric estimation or analogy techniques. As product and process become more defined, these models are based on industrial engineering or bottom-up estimation techniqu es (reverse engineering). They need to be comprehensive to address all of the proposed materials and prod uction processes, assuring reasonable accuracy. 8. Use tools to reduce costs . Tools and methodologies related to design for manufacturing and assembly (DFMA), design for inspection and test, modularity and part standardization, and YE. 9. Reduce indirect cost application. Re-engineering indirect business processes and minimizing non-value-added costs is essential. Develop an understanding of the relationship of these costs to the product and process design decisions they make. 10. Meas ure results and maintain management focus
300f150
'The paper looks at VE in three different steps Concept, Project and Validation Concept-Vii: Concept -VE is the search ofpossible innovation at the conceptual level ofa product, before the requirements of quality, cost and investment are set, It represents the logical extension of the VE,
focused on improvements at an early stage.
The search for functional improvement of a product still at the design stage
The search fen tuncrional improvement of a product at its validation
The case study was developed based on an idea proposed by an employee or-the VF~ department of applying new technology concepts to the existent systems of the product/vehicle, aiming at a break of paradigm that could lead to great innovations.
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Conclusion Any attempt to forecast pro fit or market participation will be unsucessful without the definition of target-cost for the who le productive chain, without the involvement and the commitment of suppliers and employees to the objective ofreaching the target-cost and without taking into consideration the product life cyc le. VE and target-costing are complementary processes, because while one allows the identification of where cost reduct ion could be achieved, the other shows the target to be achieved to guarantee the long-term profitability plan of a company. NOT FROM THE SYLLABUS - but can offer some clarification of what VE does : Value eng inee r ing is a systematic method to improve the "value " of goods and serv ices by using an examination of function. Va lue, as de fined, is the ratio of function to cost. Value can therefore be 32 of 150
increased by either improving the function or reducing the Cil5L It is a primary tenet of value engineering that basic functions be preserved and not be reduced as a consequence of pursuing
value improvements. VE follows a structured thought process to evaluate options. Gather information I. What is being done now')
Who is doing if) What could it do') \Vhal must it not do?
2.Hcnv will the alternatives be measured? \Vhat arc the alternate ways of meeting requirements?
Wbat else can perform the desired function? Analyze 3.What must be done? What does it cost? Generate 4.What else will do the job') Evaluate
5. Which Ideas arc the best? 6. Develop and expand ideas What are the impacts') What is the cost? What is the performance?
7. Present ideas Sell alternatives
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â&#x20AC;˘ Davila, A & Wouters, M (2004) Designing cost-competitive technology products through cost management, Accounting Horizons, March pp 13-26 This artic le discusses the limitations of target costin g (and occasionall y ABC) and propo ses some ways to circumvent thes e limitations. SUI1lI1lQlY
As manufacturing innovations are becomin g more important, product developm ent is becoming a more important source of competitive advantage. Within product deve lopment, cost manage ment is receivin g increasing attention. To date, cost management in new product developm ent focused primarily on target costing, a management practic e used inside the produ ct development process by the developm ent team. Although this practice is appropriate for produ cts competing ma inly on cos ts, it presents several limit action s when factors such as technology, time-to-market, or customer needs are more pressing. Alternatives to target cos ting a sugges ted that facilitate cost management around the projects. These alternatives are: parallel cost management teams, modu lar design for cost, clearly defined cost management strateg ies and cost policies, and product portfolio planning.
Introduction During the product development stage, the organization design s the features that give the product an edge over com peting offerings but also affect the costs that will shape profit marg ins. Product des ign significantly affects the revenue side - technological performance, custome r appea l, and timely market introduction - before the first unit is so ld. As a rule of thum b, 80 percent of the costs are engineered in during product development (Blanchard 1978; Cooper and Slagmulder 1997). Target costi ng forces cost criteria into the deve lopment stages ofNPY and redirects the deve lopment team's attention toward achiev ing cost targets. In projects where technology, time -tomarket , or demanding customer needs are crit ical to a product's success, shifting attention to cost may not be the best course of action. Target costi ng in product development also requires cost models that reflect the economics of direct as we ll as shared resources. Such cost models may be hard to develop and to use in comp lex and uncertain environments.
Diff icu lties ill Ma naging Costs during Product Development Two forces help explain the difficulty of managing product costs during the development phase: â&#x20AC;˘
technology challenges, fast time-to -market demands, and the com plexity of managing knowledge limit the attention that produ ct deve lopment teams can devo te to cos t cons iderations
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The sophi sticated cost models that encompass cost externalities are extremel y hard to translate into practic e
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FOCUSIN G ATTENTION ON MANAGING COSTS DURING PRODUCT DEVELOP MENT The challenge is how to incorporate cost criteria during the development stage w ithout excessively shifting the development team's attention to cost and away from oth er objectives. In particular, technology performance, time-to -market, and developm ent budgets are more important than product cost for the development team. The artic le identifies two approaches to manage the tension that emerges between ( I ) moving cost reduction opportun ities into product deve lopment and ( 2) keeping the deve lopment team focused on the product's critica l success factor s
PARALLEL COST MANAGEMENT TEAMS Parallel cost management team s work outside but alongside the product development team , rather than inside. Their main objective is to redesign for cost as ear ly as possible in the product's life cyc le, without shifting the attention of the core deve lopment team away from the critical technology, market, and speed criteria. The challenge for parallel cost management teams is to open a communication channel with the core development team and to identify the part s and processes where they can most profitably use their knowledge.
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MODULAR meSICN FOR COST This application calls for developing modules that arc not core to product performance, outside the development project, where costs can receive adequate attention. The main objective of using modularity is not to offer a broader product line (the most common objective of modularity) but to allow the design team to put more effort into reducing costs.
MANACJING THE COS'fS OF SIIARED RESOURCES IN PRODUCT DI路:VELOPMENT
The point here is to encourage the management of costs around product development and not to raise the raise the cost consciousncsses within project development teams. This section examines four different management practices identified during the research that companies usc to manage cost externalities in the development stage: C92(JIH.milg~DJQntgr~ru;g)~
Two relevant issues: ([) the importance of having a clear cost management strategy that people throughout the company can relate io. and ( 2) the notion that cost reductions require a companywide perspective that individual product dcvclopmenr tcams may not have. Without an overall vision, development teams chase different "design for" cost objectives and ignore reducing particular support C03ts that can only be accomplished witl: an overall effort .E.;;,ll'tS CQ)IlJI}()n~U.iJY Activity-based costing theory indicates that complexity leads to higher amounts ofshared resources and higher indirect costs. If products share common parts, complexity can be substantially reduced. Commonality also differs from modular design lor cost. The primary objective of modular design lor cost is to move the design of subsystems out of largcr projects that have different design priorities to better manage the development teams' attention. Commonality calls lor sharing to reduce complexity. Parts commonality probably best illustrates the need for a broad view of cost management.
I'.rgyess commonality The locus is on using common processes to reduce shared resources Pr.Q~I.!.!llilat19rms
Product-platform planning takes into account the cost effects oftoday's design decisions on future costs. A product platform is a product architecture that allows components, processes, and knowledge to be shared across a set of products (Robertson and Ulrich 1998). Product-platform planning envisions the future product portfolio and the future cost implications oftcday's decisions. These practices diller significantly from applying activity-based costing to product development. The purpose of activity-based costing is to give development teams sophisticated cost models that allow them to consider the cost trade-on's of their design decisions. The relevance of these practices to management accounting is not only economics of scale and scope, but also their impact upon shared resources and the need to adopt a business-unit perspective on cost management in product development.
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Tabl e 2 describes the limitations of cost models for product development. CONC LUSIONS AND FU TURE RESEARCH Deci sion s mad e during product development determine a significant proportion of product costs Target costing (Koga 1999 ; Ansari and Be ll 1997) - the most popu lar management process to keep the cost element of the profit equation in mind during product deve lopment - appears to be more effective when pro duct cost is very important to the success of the product and when modeling cost behavior at the organizational level is simpler. Target costing may be oflimited app lication in a diverse set of indu stries where pro duct developmen t emphasizes objectives other than costs , and modeling cost behav ior is complex The best way to overcome this is to develop a cost management approach that removes ' cost consc iousness' from the proj ect development team and places in it cross bu siness unit functions. • Toyo - Komatsu case. Cooper & Slagmulder (1999) "Supply Chain Development for the Lean enterprise" New Jersey: The IMA Foundation for Applied Research, Inc., 1999 Toyo - Komatsu case
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The Case is about the Japanese compani es Toyo Radiator Company (suppli er to the Japanese car industry) and its customer since 1955 Kom atsu (producer of bulldozers and excavators). Competition in the market for bulldozers and excav ators was dom inated by competitive parameters such as time-to-market and price. Kom atsu therefore had to form new, better relationships to its suppliers, involving them early in the design process to ensure effective target cost ing. Toyo and Komatsu engaged in ajoint research program (simultaneous eng ineering) where performance requirements for components were discussed and researc h, deve lopment and experiments were conducted by Toyo and Komatsu engineers under one umbrella. This way Komatsu reduced its number of supp liers and Toyo could grow bigger. Toyo became market leader in the construction equipment/heat exchange market with a market share of 80-90% in Japan and the world's second largest. Modine was a major competitor in the U.S. and also competed on customer relationsh ips. Toyo engineers worked on a new high performance fan and increased standardization of parts whereas Komatsu engineers worked to improve operator friendliness, functionality and noise reduction. They used two cost management systems: target costing and cost balance verification (CBV) both app lied at the design stage. Target costing helped identify whe n cost reduction techniques were requ ired. Scatter diagrams were used to determine coo ling capac ity vs. radiator size as well as cost to manufacture against size of radiators. Komatsu had bargaining power to down sca le bids from their suppliers if regarded too high. Ko matsu deve loped target costing for each supplier and each com ponent. However, Toyo was also able to negotiate. Toyo shared all cost information with Komatsu - this could lead to conflict of interest (i.e. if Toyo were making high profits). The CBV system was implemented to allow Toyo to produce a new cooling system, sell it at the target cost and still make the desired profi t. A value analysis depicted thre e ways in which value could be improved without changing functionality: eliminating parts, elim inate major components through product redes ign and the developme nt of a system to contro l level of heat generation which allowed for lower cooling capacity design. Cost reduction approaches further included: changing shapes of components and how they are wired. Despite the close cooperation, the companies regarded themselves as independent but as important business partners. A critical element of the joint research program that led to success was to expand the design engineers' respon sibility to include cost managem ent.
Lecture 5: Management accounting and information in Networks (Lisa) â&#x20AC;˘ Tomkins, C. (2001): "Interdependencies, trust and information in relationships, alliances and networks". Accounting, Organizations and Society vol. 26, pp. 161-191. Loooonnggg article, I have tried to shorten it as much as possible to get the essentials. This paper examines fundamental concepts that relate to the needs for inform ation, including accounting informat ion, in cross-company relationships, alliances and comp lex business network s. It considers, initially, some conseque nces for acco unting when planning and contro l are to be exercised across organisat iona l boundaries, the finding of the paper is the fact that all relationships depend to some exten t on trust. The interaction between trust and information in personal relationships is explored to serve as a template against which to consider whether the information needs of inter-organisational
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relationships are similar. The paper looks at how the growth of business allianccs and networks impact upon bnsiness information, including accounting. Finding that business alliances and networks imp lie a much closer relationship between different parties than is involved in occasional buying and selling. It recognises that even a regular pattern of trading creates social bonds between parties based upon mutual understanding and trust and, consequently, lower transactions costs. Moreover, the interactions between companies often develop much further into supply chain "partnerships" with an implied sense ofshariilg in knowledge, decision-making and the collective rewards. Introduction
I'his paper will 1. Undertake a brief consideration of some basic points relating to how accounting and business information is used when trying to master events across more than one organisation 2. Provide a more extensive consideration of how the provision ofinformation needs to take into account the strength of social bonds or trust that exist in an alliance. Basic Accounting analyses for alliances have to capture effects through at least two organisations, rather than one. This can cause a variety ofproblems including disagreements in: budgeting, cost reductions, quality levels, responsibilities, and financing issues. As such, there is the need for cross organizational design of management accounting systems. 'The argument follws that well companies may not reach the stage where they share accounting principals, it is evident that with a movement to collaboration across organisations, there must be a greater emphasis on negotiation to determine terms of that co-operation. And this negotiation is based on trust. The relationship between trust and information
Hierarchical levels ofcollaboration Three different hierarchical levels of collaboration exist: relationships, alliances and networks. A relationship is taken as the bedrock upon which any alliance is formed. Networks are complex and formed from configurations of alliances and relationships that range from intimate partnerships to simply bnying and selling on a competitive basis or even just exchanging views and other information.
Summary of arguments and their significance for practice The initial motivation for this paper was to explore the likely influence of the growth in business networking on business information. 1) At the first level: there will be a greater emphasis on the use of management accounting within inter-organisational negotiation processes and it was proposed that this would mean that accountants would have to be more agile in providing information needed to present and respond to arguments. 2) At the second level: it was felt to be necessary to examine in detail how information is needed to support first relationships and then alliances, both of which are the basic building blocks of networks. Trust is a fundamental factor in deciding what amount and type of information should be presented. The consideration of trust is the fundamental consideration before all other determinants come into play. It is surprising, therefore, that trust seems to be absent from accounting theory, although it is obviously implicit in many accounting procedures.
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3) There is a simp le monotonic inverse relationship between employment of trust and the prov ision of information, Th is only ho lds at a specific po int of time for a specific decision. An inverse Ushaped function is appropriate when the dynamics of relation ship life cycles are considered. It was also found to be conceptually useful to distinguish between information needed to create and support continuing trust (Information Type 1) and information need ed for ma stery of eve nts (Information Type 2). Both typ es exhib it, over time, an inverse U-shape fun ction between trus t int ensity and information.
Basically - An inverse U shaped fnnction means that the more trust there is, the more information flows AND the more information that flows between the organizations, the higher the trust levels. And that accounting must take this into consideration in the future and as always - more research is necessary: ) â&#x20AC;˘ Dekker, H., and Van Goor, A. R. (2000). Supply Chain Management and Management Accounting: A Case Study of Activity-Based Costing International Journal of Logistics: Research and Applications, Vol. 3, No.1, Management accounting plays an as yet undefined role in Supply Chain Managem ent (SCM). An ABC model der ived from a case study of the pharmaceutica l indu stry was developed to calculate the consequences of changing activities in a sup ply chain.
Introduction Inte r-organisation cooperation is SCM. What role does management accounting information pl ay within th ese relation ships? A typology of 4 ways for ho w to app ly SCM in practice is introduced. F urtherm ore, accounting measur es can be important to support improvement s in the supply cha in, but in ord er for SCM to be success ful there are several othe r factors in play.
Cooperation within Supply Ch ain s Cooperation in a supply chain is typically referred to as partnering. (A few defi ning quot es by Ellram & Hendrik, by Gardner et al., by Cooper et al. and som e others are given on pa ge 42) . SMD refers to firms in a channel cooperative ly m anaging flows of m aterial (backward and forward) thro ugh the channe l. The main goals of SCM are 1) improve the efficiency of the process, reducing costs and 2) improvi ng the effectiveness of channel o utco mes, enhanci ng value. Ano ther incent ive to engage in a partnersh ip mi ght be to lower uncertainty and to secure input/output.
For ms of SCM The various forms of SCM depend on th e inten sity of integration . There are 4 forms; physical integration , info rmation integration, control integration and infrastruc ture integration. Ph ysical integration : Integration in the ph ysical movem ent of products etc . in the cha in (can be standardised in ways of packaging or in material handling) . Information integration : Integrat ing the flows of operation information such as orderings (can be heightened by sending the co rrect and useable information) Control integration : Integrating for ex ample extended data flow s to contro l the processes in the chain for th e two main goals above.
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Infrastructure integration: Integration in the form of partners takin g over part s of the partner' s activities in order to improve processes (e.g. logistics planning)
SCM and Management Account ing SCM has several implicati ons for management accounting. The role of management acco unting in SCM sti ll has many unanswered ques tions. The literatu re is very scarce and not we ll developed. ABC is the only area in the literature where there are some concrete (normative) directions, so this wi ll be the remaining focus of this paper.
Activity-Based Costing in Supply Chain Management About ABC in SCM it is typ ical ly only mentioned that it is useful but not how and in which ways. Theoretical speculation of using ABC in SCM has not yet been validly proven. This paper will present a case study of ABC in SCM.
A Case Study of ABC It is a specific application of ABC at the inter-firm level, wh ich is a model to ca lculate the cos ts of a supp ly chain's logist ics act ivities. A Dutch producer, wholesaler and four retailers in the pharm aceutical indu stry decided to develop a model for ca lculating the costs in their chain. They still co ordina ted most of their orderings by telephone back the n. Below is a description of the model (fig. 1, page 46).
Structure ofthe Model There are four leve ls of costs for eac h of the firm s: I) Accumulated costs for each firm 2) Proc ess cost in each firm; purchasin g, warehousing and outbound logistics 3) Category cost such as ordering/receiving and transport/expedition/revers es 4) Activity cost in terms of salary, communication, postage and automation
Development ofthe Model They wanted to present their costs in equal term s to be able to compare and to analyse effects of changes in activities in on e point in the chain. However, the model is too rou gh to give exact calculations of changes in cos ts. It does provide a useful indication of expected cost changes. Table 1 + 2 shows the actu al financial information output of the model.
Possibilities ofthe Model The purpose of comparing the act ivities for decision making is doable with thi s mod el. Also, it indicates the result of investments in one firm affecting the entire chain.
Limitations of the Model The model only con tains logistic act ivities and costs while there are many other factors. Resu lts should no t be interpreted as exact ca lculations. Not all act ivit ies are perhaps co mparable between the actors. This model can not be used on the produ ct level but is for the aggregat e firm level. Two examples will be given of how it has ac tually been used.
Example 1: Supply Logistics Changing supply logistics to fit the wholesa ler meant lower cos ts for all.
Example 2: Stock-Keeping Upstream Tab le 4 shows the chain' s financial savings when stock-keeping upstream .
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Conclusion The role of management accounting in SCM is still not clearly determin ed. This case stud y is about an ABC mode l in a chain which reveals how cost data us used to support certain decision s of the partnering organisations.
(Maya) â&#x20AC;˘ Kajiiter, P. Kulmala, H I (2005). Open-book accounting in networks. Potential achievements and reasons for failure" Management Accounting Research, 16, pp. 179-204.
Kajuter, P. Kulma la, H. I. (2005) "Open-book accounting in networks. Potential achievements and reasons for failure" Abstract Open-book accounting is said to improve cost efficie ncy of supply chains and improve relations. However, it is also experienced to fail and have many pitfa lls. This text investigates these failures through two cases with a Ger man and Finnish compa ny, respectively.
Introduction Manu facturing firms have started to coop erate muc h more closely with its suppliers and customers. The organ isational boundaries become increas ingly blurred with more information sharing and shared development processes. This turns into what can be called manufacturing networks and shapes the basis for inter-organisational cost management. Open-book accounting (transparency in cost structures) thus becomes necessary for cost allocation in such networks. This text broadens the perspective of cost man agement theories by including network-specific factor s to the contingency framework.
Review of previous research
Networks Network theory agrees that firms are seen as legal individual entities and the differences lie within the boundaries of the network. On the one side it is seen as an open system of business relations with an arbitrary boundary where one relationsh ip affects others and so forth (the view ofthis text). The opposite is the closed system where the networks compete against each other and are measured on the end product produced and delivered between actors . Networks can differ in its requiremen ts, characteristics, functions and form. Manage ment of networks is not that greatly emphasised in modem literature such as the use of open-boo k accounting. Contingency theory Contingency theor y has its origins in exp laining the structure of organisations by part icu lar circumstances. This has furthe r been used to deve lop management accounting. See figure 1 for a basic contingency framework. It tells that exogenous environmen tal factors and endoge nous firm- specific factors influence the competitive strategy of a firm, which then affects the organisation structure (management acco unting practices such as planning &
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contro l, perfor mance measuring and cost managem ent) , which then together with "other factors" affect the perform ance of the firm . Th e performance then derives a learning loop to the competitive strategy and organisational structure. This was for a sing le firm but for a netwo rk with several firrn s the fram ework needs to wide n. That has not bee n done yet but Figure 2 shows how it could be wide ned j ust for the use of open-b ook acc ounting. This perspective w ill be broad further and used in the comi ng cases. It builds on both con tinge ncy and network theo ry and helps this text to explain its po int.
Open-book accounting in inter-firm relationships Open-book accounting is a relatively very new th ing and research in inter-organisation cost management is not that de veloped also beca use it is not tha t standardised. Cost data is one of the most confidential pieces of information in companies (on ly 30% of UK suppliers in electronics shared their cost info to custom ers) and op en-book solutions have been cus tomised to fit specifically (on ly 25% of N issan ' s UK suppliers were op en-book). Re lating to figure 2 the affecting factors on the ex istence of them are said to be: Environmental facto rs: Intense competition also within cost reductions Network-s pec ific factors: Mutual trust Firm-specific factors: Deficiencies and diversity in acco unt ing sys tems For the outco me of open-book acco unting it is understood that customers are to benefit more from open-book than the suppliers du e to cost op enness. In conclus ion, the study is still in a exp loratory state and no factors have been examined in depth and detail.
Research design
Methodology The study is an empirical one which derives conc lusions from emp iri gathe red in a cas e of a German company and another case of another type with a Finnish company . The networks they participate in are different. The common factors that can be iden tified will be drawn into the general con tingency mod el Data collection Internal documents were used but mainly a lot of interv iews with many differe nt people in the two compan ies and netwo rks are the empirica l basis. Open-book accounti ng in a German car manufacturing network
Eurocar and its approach to inter-organisational cost management Eurocar produces cars and has a network of many suppliers, who produces the individual parts com bined by Euroc ar. The role of inter-organi sation costs on Eurocar' s cos t structures is significant. They use Total Cost Management (TCM) to manage costs w ithin the supp ly chain. It is develop ed according to the Target Costing methodology. Because most costs originate at the supp liers it is important that the cost red uction tools (value-engineerin g, cost tab les etc.) are also applied at them. Open-book p ractice For this purp ose ope n-book practice s are necessary. Fu rthermore, the tier 1 suppliers are expected to transfer the ope n-book approach to its own suppliers. Trust thro ugh teams is necessary to develop open-book practices and opportunism wo uld destroy this opportunit y. Eurocar offers consultancy support for its suppliers in regard to pro cess optim isation . Also
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Eurocar has developed the optimal cost data analysis too ls. A flow chart is helpful for creating the useful transparency (see fig. 3 - value chain flow chart). The detai led cost breakdown makes it po ssible to identify important cost elements and helps to discover co streduction opportunities. Th ere are two constraints for the success, whi ch is that the accounting systems (data output) must be compatib le and comparabl e and that th ere is the possibility that a supplier is alr eady invo lved in a network which works by a different syste m.
O pen- book accou ntin g in Finnish manufacturing networks
Network A Ne two rk A consists of a globa l mi ning and construction indu stry eq uipment provider for rock dri lling and tun ne lling an 8 of its supp liers. Figure 6 illustrates the supp ly re lations of network A. Thro ugh the dominant position of the main co ntractor, the suppliers revealed their books. It was on the bas is of the promises that they would be ab le to se ll significantly to this main contractor. However, some other supp liers did not want to reveal the ir books due to various reasons.
Network B Network B consists of a Finnish-base d intern ational pu lp and pap er indu str y pump eq uipm ent provider and fiv e of its supp liers. F igure 7 illu strates the supply relat ion s of network B. The main contractor here did not emphasise open book processes much relative to other measures and there was the saying that if one supp lier ' s co st was found too hig h it wou ld be rep laced with another w hen possib le. All this led to an env ironment in wh ich suppliers could not have resource support from the main contractor but were continuously afraid oflosing their business.
Network C Network C consists of an aircraft subassembly provider and four of its suppliers. F igure 8 illustrates the supply re lations of the network . Th e managerial team wanted to increase openness toward measurement of production , through-put time, and labour productivity, for example, and not openness toward costs.
Su mmary of the open-book implementation fa ilures In all thr ee networks, the main contractor expected suppliers to disc lose cost data so that opportunities for cos t reduction co uld be ide ntifie d. However, except in two cases of network A, the supp liers were not willing to do so and, conse que ntly, the books remained ma inly closed. The main reasons for open -book account ing not tak ing place in each supplier-main contractor relationship are presented in table 1 (page 196). A list of six major reasons for the failure of implementation can be compiled. 1. Suppliers expe rie nce no extra ben efit from openness and main co ntractors do not offer win-win so lutions 2. Supp liers think that acco unting informat ion should be kept in-h ou se 3. Ne two rk embe rs cann ot produce accurate cos t inform ation and see no sense in sharing poor co st data 4. Suppliers are afraid of being ex ploited if they reveal their co st structure 5. Suppliers do not have capable resources or reso urce support from main contractors for the development of accounting sys tems 6. Ne twork members cannot agree on how op en-book practice should be imp lem ent ed
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Discussion Figure 9 illustrates the contingency framework for open-book accounting in networks derives from the case analysis. There arc 3 factors (exogenous environmental, networkspecific and endogenous firm-specific) which determine open-book practice. Exogenous factors would involve competition and the economic trend. Endogenous factors would involve the size of the firm, the cost accounting system, competitive policy and commitment long .. term. Network-specific factors would involve the type of network, the type of product, infrastructure and social nature of network relationships, In addition to general characteristics (c.g. firm size type of network, degree of competition), a number 0 [' requirements have to be met on botb the firm and the network level to ensure fulfilment of open-book expectations. These requirements can be categorised as either tcchnica ; c.g. the design ofthe system and expertise, or social, e.g. member commiuncnt and trust.
Open-book accounting is 1a fairly new concept that made its appearance with the spread of lean production and supply in the 1990's. The empirical findings that open-book accounting depends on a number 0 fen vironmcntal and finn-spec: fie context factors.
Case: Allied Office Products
The TFC Business Allied office Products was a corporation in business forms and speciality paper products, such as writing paper, envelopes, note cards, and greeting cards. In 1998 the company had expanded into business forms inventory management services. Allied embarked on a campaign to enrol its corporate clients in a program which it called Total Forms Control (TFC) Allied used a sophisticated computer systems network to monitor a client's forms inventory, forms usage, and ordering activities,
Current cost accounting system From 1990 financial data about costs, Allied charges its clients a price lor the [arms which was high enough to allow for an additional 32.2% of product cost to cover warehousing and distribution expenses.
Understanding customer profitability Profitability started to suffer in 1992 and the distribution charges were questioned. RO 1 had dropped from 20% to 6% in 4 years. The answer was to charge the customers Jar their usage of services differently. Customer A and B required different service levels but were charged the same. Customer B induced shipment costs of $7500 a week and customer A only $2250 for approximately the same purchases.
Distribution center: activity analysis In order to solve this, they went to the distribution center and interviewed them (activity analysis). They identified the customer service activities. 45 of 150
Services based pricing (SBP) They came up with service based pricing and initiated this activity based cost ing system with cons iderations for the sales force and the main customers. The team felt they were on the right track for improv ing account profitabi lity and wondered what should be the next step. They also wondered what other issues might be important for improving the overall profitabi lity ofTFC. Questions 1. Us ing the information in the ext and in exhibit 2, calculate ABC based services costs for the TFC business 2. Using your new costing system, calculate distribution services costs fro customer A and B 3. What inference do you draw about the profitability of these two customers 4. Should TFC implement the SBP pricing system 5. What managerial advice do you have for Allied abo ut the Total Forms Control (TFC) business? How does exhibit 6 relate to this quest ion Exhibit 1-6 Calculation of service fee charges, Breakdown of expenses by activity, TFC net sales, Top 20 TFC accounts for august 1992, Bottom 20 TFC accounts for august 1992, The value chain concept - TFC
I THEME 3: Perfor mance measurement Lecture 6: Non-Financial Performance Measures (Emil) â&#x20AC;˘ Kaplan, R.S. & Norton, D.P. (2001): Transforming the Balanced Scorecard from Performance Measurement to Strategic Management: Part 1, Accounting Horizons, 15,87104 Course :
Management Control and Finance
Abs tractor:
Michael Kaae Olsen
Lecture:
Title:
Using the Balanced Score Card as a Strategic Manage ment System
Author(S) : Kaplan and Norton
Keywords:
Balanced Scorecard, holistic vision, strategic feedback, strategy review The Balanced Scorecard was introduced as one of the newest management tools. The purpose was to allow organizations to be better able to use their intangible assets. The scorecard allows managers to introduce four new processes; 1. Translating the vision, 2. Communicating and linking, 3. Business planning and 4. Feedback and learning. Translating the vision is a means of expressing the mission/ vision statements with an integrated set of objectives and measures. Communicating and linking is a process that facilitates the communic ation of strategies throughout the entire organization. To have goal congruence between the
Main Frame
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17th
Date:
29-03 2004
individual employees and the company, scorecard users engage in three activi ties: communicating and educating, setting goals, and linking rewards to performance measures which are in tum linked to the ove rall strategy. Business planning is the third process used by managers with the balanced scorecard. By using the scorecard, businesses will integrate their strategic plann ing and budgeting processes. This makes sure that the budgets support the strategies of the company. The fourth, and final, proce ss is feedback and learning. With the balanced scorecard in place mana gers can moni tor feedback and relate this to the strategy. The balanced scorecard supplies three essential items to strategic learning. First, it articulates the vision. Second, the scorecard supplies a strateg ic feedback system. Th ird, the balanced scorecard facilitates strategy review. The balanced scorecard facilitates an organization's plan to align manage ment processes and focuses with the long-term strategy of the company. The Balanced Scorecard was introduced as one of the newest management too ls. The purpo se was to allow organizations to be better able to use their intangib le assets. The balanced scorecard is to be used as a supplement to traditional financial measures. It measures performance from three additional perspectives; customers, internal business processes, and learnin g and growth. The scorecard can help top-level managem ent link the long-term strategy with the short-term actions. Managers using a balanced scorecard do not only have to rely on the short-term financial results as indicators of the company' s progress. It brings in other indicators that provide information about how the short-term results have affec ted the long-term strategy. The scorecard allows managers to introd uce four new processes; 1) Translating the vision, 2) Communicating and linking, 3) Business planning, and 4) Feedback and leaming. Translating the vision is a means of expressing the mission/vis ion statements with an integrated set of objectives and measures. This forces the top management to develop operatio nal measures, which requires them to discuss, and eventually agree on, a means of achieving the goals of the company . Communicating and linking is a process that facil itates the communication of strategies throughout the entire organization. Departmental and individual objectives must be aligned with the strategy through evaluation proc edures and incentives. To have goal congruence between the individual employees and the compan y, scorecard users engage in three activities: communicating and educating, setting goals, and linking rewards to performance measures which are in tum linked to the overall strategy. Communicating and educating is achieved by maintaining policies that ens ure all employees are aware of the strategies of the organization. Also, it is important for the lower level employees to be able to communicate upwards about whether or not the strategies are realistic from the competitive or operat iona l perspective. Setting goals alone is not sufficient to change employee's mind -set. One technique to ensure the objectives related to the goals are achieved is the use of a persona l scorecard . It is simply a card that has information that describes corporate objectives, measures, and targets. Employees would
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carry it with them. This allows employees to better translate these objectives into meaningful tasks that will help reach these goals. Linking rewards to performance is an important incentive to help an organization achieve its purpose. What the balanced scorecard adds to the traditional means of linking rewards to financial performance is that it takes a more holistic look at the organization. It ensures that the correct criteria arc used as a measure ofperformance before rewards arc given. The idea is that, if you arc not using the correct indicators to evaluate performance, there is a high risk in rewarding this behaviour. Business planning is the third process used by managers with the balanced scorecard. By using the scorecard, businesses will integrate their strategic planning and budgeting processes. This makes sure that the budgets support the strategies of the company. The users of the scorecard pick measures that represent each of the four perspectives, and then set targets for each. Then they will decide which specific actions wil: help them in reaching those targets. Using shorr-tcrm milestones to evaluate the progress toward the strategic goal is what resultsfrom using the balanced scorecard. The fourth, and final, process is feedback and learning. \Vith the balanced scorecard in place mar.agcrs can monitor feedback and relate this to the strategy. The first three processes arc very important, but they demand a constant objective. Any .lcviation from the plan is considered a defect. By adding the feedback and learning process, the scorecard becomes balanced by prov real time information to enhance strategic learning.
The balanced scorecard supplies three essential items to strategic learning. First, it articulates the vrsron. The holistic vision IS communicated to the entire organization, and the individual efforts are linked to business unit objectives. Second, the scorecard supplies a strategic feedback system. This system views the strategies as hypotheses, and should be able to test, validate, and modify these hypotheses. Third, the balanced scorecard facilitates strategy review. Instead using periodic meetings to evaluate past performances as the traditional financial review process does, scorecard users review the feedback in a way to gain a better understanding of if the strategy is being reached, how is it being reached, and should the strategy he modified based on new information. This gives the organization a forward locus.
or
The balanced scorecard facilitates an organization's plan to align management processes and focuses with thc long-term strategy of the company. Without the scorecard it would be nearly impossible to maintain a consistency of vision and action while attempting to introduce new strategies and processes. "The balanced scorecard provides a framework lor managing the implementation of a strategy, while also allowing the strategy to evolve in response to changes in the company's competitive, market, and technological environments." Using the balanced scorecard as a strategic management system (1996) By Kaplan, R.S. & Norton, D.P
Balanced scorecard 4 new processes (sec below in the abstract) Personal scorecard Strategic learning Holistic vision Strategic feedback Facilitates Strategic review
Linked to Intellectual Capital Statements
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Overall them e: Non-Financial Perf ormance Measu res Abs t ract The Balanced Scorecard was introduced as one of the newest management tool s. The purp ose was to allow organizations to be better ab le to use their intangibl e asse ts. The balanced scoreca rd is to be used as a supplement to traditional financial measures. It measures performance from three additiona l perspecti ves; customers, internal business proc esses, and learning and growth. The scorecard can help top- level managem ent link the long-term strategy with the short-term actions. Managers using a balanced scorecard do not only have to rely on the short-term financ ial results as indicators of the company's progress. It brings in other ind icators that provide information about how the sho rt-term results have affected the long-term strategy. The scorecard allows managers to introduce four new processes; I. translating the vision, 2. communicating and linking, 3. business planning, and 4. feedback and learning. Translating the vision is a means of expressing the mission/vision statements with an integrated set of objectives and measures. This forces the top management to deve lop operational measures, which requires them to discuss, and eventually agree on, a means of achieving the goa ls of the company. Communicating and linkin g is a process that facili tates the communication of strateg ies throughout the entire organization. Departmental and individual objectives must be aligned with the strategy through evaluation procedures and incentives. To have goal congruence between the individu al employees and the company, scorecard users engage in thr ee activities: communicating and educating, setting goa ls, and linkin g rewards to performance measures which are in tum linked to the overall strategy. Comm unicating and educating is achieved by maintaining policies that ensure all employees are aware of the strategies of the organization. Also , it is important for the lower level employees to be able to communicate upwards about whet her or not the strategies are rea listic from the competitive or operationa l pers pective. Sett ing goa ls alone is not sufficient to change employee's mind-set. One technique to ensure the objectives related to the goa ls are achieved is the use of a personal scorecard. It is simply a card that has information that describes corporate objectives, measures, and targets. Emp loyees wou ld carry it with them . This allows emp loyees to better translate these objectives into meaningful task s that will help reach these goals. Linki ng rewards to performance is an important incentive to help an organization achieve its purpose. What the balanced scorecard adds to the trad itiona l means of linking rewa rds to financia l perfo rmance is that it takes a more holistic look at the orga nization. It ensures that the correct criteria are used as a measure of performa nce before rewards are given. T he idea is that, if you are not using the correct indicators to evaluate performance, there is a high risk in rewarding this behavior. Business planni ng is the third process used by managers with the balanced scorecard. By using the scorecard, businesses will integrate the ir strategic planning and budge ting pro cesses. Thi s makes
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sure that the budgets support the strategies of the company. The users of the scorecard pick measures that represent each of the four perspectives, and then set targets for each. Then they will decide which specific actions will help them in reaching those targets. Using short-term milestones to evaluate the progress toward the strategic goal is what results from using thc balanced scorecard.
The fourth, and final', process is feedback and learning. With the balanced scorecard in place managers can monitor feed hack and relate this to the strategy. The first three processes arc very important, but they demand a constant objective. Any deviation hom the plan is considered a defect. By adding the feedback and learning process, the scorecard becomes balanced by providing real time information to enhance strategic learning.
The balanced scorecard supplies three essential items to strategic learning. Âť
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the balanced scorecard facilitates strategy Instead of using periodic meetings to evaluate past performances as the traditional financial review process docs, scorecard users review the feedback in a way to gain a better understanding of if the strategy is being reached, how is it being reached, and sbould the strategy be modi ficd based on new information. This gives the organization a forwardfocus.
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The balanced scorecard facilitates an organization's plan to align management processes and focuses with the long-term strategy of the company. Without the scorecard it would be nearly impossible to maintain a consistency of vision and action while attempting to introduce new strategies and processes. "The balanced scorecard provides a framework for managing the implementation of a strategy, while also allowing the strategy to evolve in response to changes in the company's competitive, market, and technological environments."
Kaplan & Norton (1996): Using the Balanced Scorecard as a Strategic Management System The Balanced scorecard was introduced several years ago as a supplement to the traditional financial measures. In the mid 90's companies moved beyond the vision of the scorecard and discovered its value as the cornerstone of a new strategic management system. Managers using BSc do not have to rely on short-term financial measures as the sole indicators of the company's performance. The scorecard lets the management introduce lour new management processes that, separately and in combination, contribute to linking long-term strategic objectives with short-term actions, 5. Translating the vision - forces the top management to express the mission/vision statements with an integrated set of objectives and measures that they can agree on; creating consensus, 6. Communicating and linking - lets managers communicate their strategy up and down the organisation and link it to departmental and individual objectives, To align employees' individual performances with the overall strategy scorecard users engage in three activities; Communicating & educating (maintaining policies that ensure all
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emp loyees are aware of the strategies of the organ ization), Setting goals (not sufficient to change emp loyee's mind -set. The use of a personal scorecard describing corporate objectives, measures, and targets, helps each employee to better translate thes e objectives into meaningful tasks that will help reach goals and Linking rewards to performance measures (important incentive to help an organi zation achiev e its purpo se) 7. Business Planning - enables compani es to integrate their business and financial plans. The creating of the BSc forces companies to integrat e their strategic plannin g and budget ing processes and therefore helps to ens ure that their budgets support their strategies. 8. Feedback and learnin g - The BSc suppli es three elements that are essential for strateg ic learnin g: It articulates the company's shared vision; defin ing the results the company wa nts to achieve, it supplies the esse ntia l strategic feedbac k system, and finely it faci litates the strategy rev iew that is essen tial to strateg ic learning. With the balanced scorecard in place managers can monitor feedback and relate this to the strategy . The first three processes are very important, but they demand a constant objective. Any deviation from the plan is considered a defect. By adding the feedback and learning process, the scorecard becomes balanced by prov iding real time informat ion to enhance strategic learning. The balanced scorecard facilitates an organization's plan to align management processes and focuses with the long-term strategy of the company. Without the scorecard it would be nearly impossib le to maintain a con sistency of vision and action while attempt ing to introduce new strategies and processes. "The balanced scorecard prov ides a framework for managin g the implementation of a strategy, while also allowing the strategy to evolve in response to chan ges in the company' s competitive, mark et, and techno logical environments." â&#x20AC;˘ Kaplan, R.S. & Norton, D.P. (2001): Transforming the Balanced Scorecard from Performance Measurement to Strategic Management: Part 2 , Accounting Horizons, 15 â&#x20AC;˘ Merchant, K. A. (2006): Measuring general managers' performances Market, accounting and combination-of-measures systems. Accounting, Auditing & Accountability, Journal Vol. 19 No.6, pp. 893-917. â&#x20AC;˘ Mouritsen, J., Larsen H.T. & Bukh P.N.D (2001) Intellectual capital and the capable firm: narrating, visualising and numbering for managing knowledge, Accounting, Organisation and Society THEME Outline of what they call ' the new reporting system': Intellectual Capital Statements, that focus on know ledge management activities of the firm and makes management intervention possible. This article incorporates an actor-network-theory aspect of trans lation. KEYWO RDS Intellectu al capital (IC), IC State ments (ICS), Actor-netwo rk-theory (ANT), Knowledge Management, Man agement intervention , Dator, Systematic, Carl Bro. T he knowledge and information society >- Knowledge is becomin g the key economic driver in soc iety (Drucker). >- The re is a growing difference between firms' market value and book value - IC and immaterial assets are sources of increased va lue creation .
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ICS are in demand to ex plain the difference betw een mark et and book va lues and show where the firms' IC is hidd en. Management of knowledge >- Prior attempts to define IC and to open up the areas where financial state me nts do not go has been through the three-way mod el (division ofIC into hum an, organizationa l and customer capital). This is not suffic ient though (See also M ouritsen et al abstrac t # I) >- ANT is applied as it is concerned with the investigation of how soc iety is held togeth er by a set of heterogeneous set of eleme nts . >- Kno wledg e should not be dealt with as an isolated entity that ex ists ind epend ently o f organizational and soc ial act ivities, but rather as an integral part of soc iety (Latour, Fo uca lt, Giddens, Loytard). â&#x20AC;˘ }- ICS s act like centres of translation that allow for the capturing, transportation and eva luation of know ledge -7 a technology for acting at a distance. }- ICS are conce rned with the reporting on assets related to employee knowl edge and expertise, customer confide nce in the company and its products, co mpany infrastructure, efficacy of busin ess processes and the sophistication of techn ology. ,. ICS are used to track the knowledge management activities that are put to wo rk in order to organize the knowledge resources of the firm . IC S :;... Is the complex reporti ng which comb ine numbers, narratio n and visualization >- ICSs are organized around three dimensions: o A knowledge narrativ e/knowledge strategy (the identity story line of the capabilities of the film , that relates to the custom ers' use and value) o A set of managem ent challenges (efforts in the realization of the narrati ve) o A repo rt of indicators (related to the knowledge narrative and the management cha llenges ), which shows the development of the firm ' s knowledge resources. o See fig. 4 p.745 . The mapping of indicators is don e through mapping along four domains (employees, customers, proc esses and technology) and three categories of information about the knowledge managem ent activities performed by management (effects , qualifying activiti es and resources). Th e four dom ain s are the obj ect s that the numbers/indicators describe and the y tell a story about the firm ' s IC . The resourc es are about the portfo lio of reso urces; the activities desc ribe the acts to improve the resou rces; and effects describe the co nseq uences of the relationship between the portfolio and the qualifying activities. (See fig. 5, page 747) Note that there is no clear causa lity and that all numbers can appear in com binations with eac h other. There is much more to ICS tha n numbers tho ugh, as it involves interpretation, which connects the knowledge management act ivities to a sto ry line. Together the numbers, visua lizations and narratives form a network, which constitute the report - they are interrelated.
The case study of Dator, Systematic and Carl Bro >- All three firms used num bers, sketches and stories in their formulation of their ICS. }- T he firms asse mbled their own indi vidual co nfiguration of management cha llenges, which makes it necessary to have eac h number acco mpanied with an interpretation (some thing which the sketches and stories help to accomp lish) . }- Strateg y of the firm s visible thro ugh the ir ICS: o Dator focus on knowledge embed ded in people/empl oyees. o Systematic foc us know ledge in high quality processes. o Carl Bro focus on intelligent solutions through innovation and cultural sens itivity.
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~
All three firms exhibited different efforts that were tied to their local situation and they varied greatly in their translation processes.
GENERALLY ~ The le S helps to lift out the knowledge from the individual's dark tacit inner space into the light of numbers where it is made amenable to a wide set of management actionslinterventions. ~ leS helps illuminate knowledge manageme nt - it allows a translat ion ofKM into activities about employees, technologies, processes and customers.
Extra information from class ~ le A is the information society's managerial technology. :;... To explain the translation and representation issue Sof used a somewhat weird analogy of the mapping of a forest (from 3D to 2D) o Informat ion is lost along the way in the translation process. o However the translation allows for important comparisons.
• Bremser, W. G, & Barsky , N.P (2004) Utilizing the balanced scorecard for R&D performance measurement, R&D management (3) pp. 229-238. • Store24: Harvard Business schoo l, European Case Clearing House . (Case can be bought at IVS)
Lecture 7: Corporate Social responsibility (Andreas) Teac her: Esben Rahbek Pedersen
Framework: Firms are increasingly finding it necessary to comply with pressures from various stakeholders' demands for environmental and social responsibility. This lecture discusses various framework s for and perspectives on corporate social responsibility. The goals of the lecture is: To understand the background and element of e SR To be able to discuss various perspectives and approach es to eSR
• Windsor, Duane (2001), The Future of Corporate Social Responsibility, International Journal ofOrganizational Analysis, Vol. 9 Issue 3, 225-256. Keywords:
eSR, economic responsibility, corporate citizenship, stakeholder management Abstract:
The article examines the future of corporate social responsibility. It is argued that there are three emerging alternatives or competitors to responsibility: 1. An economic conception of responsibility
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2. G lob a l corporate citizenship 3. Stakeholder management practices The article furthermore assesses the prospects for business responsibility in a globa l context. Two fundamentals of soc ial responsibili ty remai n: I. The prevailin g ps ychology of the manager 2. The normative framework for addressing how that psychology should be shaped. The economist's long-standing cr iticism of corporate social responsibility (mainly Friedman) has during the years changed into a form of new models explicating a purely economic or private costbenefit conception of responsibility. This approach argues that firms are in business for private wealth creation; and that every component of business (including stakeholder management) should be directed to that goal. 1: The economics of Responsibility
It was earlier arg ued that econom ic responsibility involved: I. Reduced marginal returns 2. Purely voluntary activities, and 3. act ual corporate expenditure rather than a conduit for individual philanthro py (menneskekeerlighed). T he implication is that responsibi lity is costly. Mcwilliams and Siegel form alized later on the eco no mic approach . They usefull y outlined "a supply and dem and model of CSR" treated as product or process changes that direc tly support social responsibility or signal the firm s co mmitme nt to CSR They differentiated CSR demands from multiple stakeholder group s into co ns ume r dem and and demand from other stakeholde rs. The key-point in the model is that CSR-otientate d supply occurs at higher cost. A pur ely instrumental cost-benefit ca lculus invests in advertised CS R attributessigna ls, so ld to consumers at higher prices, to the point at wh ich add itiona l revenu es (reflecting downward- slop ing demand) equals additiona l cos t (reflecting upward- sloping supp ly)
2: G lobal corporate citizenship It was suggested by some scholars in 1991 that the philanthropy dim ension inclu ded corporate citizenship. Bu t it is a fact that the dim ension has first become important the recent yea rs. The key-argum ent holds that citize nship activities enhance corporate reputa tion and hence lon gterm financial performance; or at least that a bad reput ation wi ll damage lon g-term financial performance. Corporate citizenship can be addressed in terms of four faces 1: econom ic 2: legal 3: ethical 4: phil ant hropic Corporate citizenship is a marriage of two circumstances: 1. Ri sing societal expectations of corporate benefits in an age of gove rnme ntal cutbacks; and 2. Strategic managem ent aimed at value creation in all funct ions and activities of a firm . It can more or less be argued that it is a strategy for direct ben efit s (i.e. actual gain s or red uctions in losses) are generated for all stakeholders of a firm through va lue creation orientation.
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Said in another way the essence of citizenship is a strategic investment in the firm ' s social and national environments for sustainable corporate growth and profitabi lity. The notion of global corporate citizenship releases corporations from traditional national sovereignty.
3: STAKEHOLDER MANAGEMENT PRACTICES Stakeholder theory is attractive in that it addresses concrete interests and practices. In favor of stakeholder thinking is Carroll's (1995) argument that "stakeholder thinkin g is a powerful way of visualizing organizations and their social responsibilities". Stakeholder management practices can be viewed as a superior path to corpo rate socia l performance compared to any responsibility concept.
GLOBAL ENTERPRISES The contex t for corporate social responsibility has shifted to a world economy in which multinationa l enterprises are key actors. It is argued that multinational companies have great power and shou ld take responsibility for the improvement of worldw ide social and environmental conditions. It is furthermore argued that serving the poor in developing areas can be highly profitable business, as well as good sustainable development strategy for multinationals
In 1998 it was conclud ed that among the 500 largest U.S . public corporation s, the 26.8 percent committing in annual reports to ethical behavior toward stakeholders or compliance with corpo rate code of cond uct have higher financial performance measures than the other firms that do not. Manager should be fully aware of the fact that there are serious deviations between short run impacts of business activities and the long run alignment of business and social interests in wea lth creation.
â&#x20AC;˘ Clarkson, M.B.E. (1995), A Stakeholder Framework for Analyzing and Evaluating Corporate Social Performance, Academy of Management Review, 20, 1, 92-117. Keywords: Stakeholders, social performance
Abstract: The article is presenting the conclu sions from a 10-year researc h program, the purpose of which has been to develop a framework and methodology, grounded in the reality of corporate behavior, for analyzin g and evaluating corporate social perform ance.
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The author argues there are no definitions of corporate social performance (CSP) , corporate social responsibility (CSR I) , or corporate social responsiveness (CSR2) that provi de a framework or model for the systematic collection, organization, and analysis of corporate data relating to these important concept s. On the first pages he explains how he carried out the research program and what methods he used etc. - not very interesting! !! The principal conclusions drawn from the research program are as follows : I . It is necessary to distinguish between stakeholder issues and soc ial issues because corporations and their managers manage relationships with their stakeholders and not with society. 2. It is necessary to conduct analysis at the appropriate level: institutional, organizational, or individual. 3. It is then possi ble to analyze and evaluate both the social performance of a corpo ration and the performance of its managers in managing the corporation's responsi bilities to, and relationships with, its stakeholders.
DEFINING STAKEHOLDERS AND STAKEHOLDER GROUPS Stakeholders are persons or groups that have, or claim, ownership, rights, or interests in a corporation and its activities, past, present, or future. Such claimed rights or interests are the result of transactions with, or action s taken by, the corporation, and may be legal or moral, individual or collective. A primary stakeholder group is one without whose continuing participation the corporation cannot survive as a going concern. Primary stakeho lder groups typically are comprised of shareholders and investors, employees, customers , and suppliers, together with what is defined as the public stakeholder group: the governments and communities that provide infrastructures and markets, whose laws and regulations must be obeyed and to whom taxes and other obligations may be due. Secondary stakeholder groups are defined as those who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival. The media and a wide range of special interest groups are considered as secondary stakeholders under this definition.
CONCLUSION The meas urement of corporate success has traditionally been limited to the satisfaction of and creation of wealth for only one stakeholder, the shareholder. Managers can no longer be held responsible for maximizing returns to shareholders at the expense of other primary stakeholder groups. Instead , managers are now accountable for fulfilling the firm' s respons ibilities to its primary stakeholder group s. This means that managers must resolve the inevitable conflicts between primary stakeholder groups over the distribution of the increased wealth and value created by the corporation.
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The moment that corporations and their managers define and accept responsibi lities and obligations to primary stakeho lders, and thereby recognize their claims and legitimacy, they have entered the domain of moral princip les and ethical performance, whether they know it or not.
â&#x20AC;˘ Brown, J. & Fraser, M. (2006). Approaches and Perspectives in Social and Environmental Accounting: an Overview of the Conceptual Landscape, Business Strategy & the Environment; 15,2,103-117. KEYWORDS: CORPORATE SOCIAL RESPONSIBILITY (CSR), SOCIAL AND ENVIRONMENTAL ACCOUNTING (SEA)
Abstract Different groups have different understanding CSR and SEA. The artic le provides an analysis of these differences by comparing three broad approaches to SEA: the bus iness case, stakeho lderaccountability and critical theory approac hes.
Introduction: It is arg ued that there has in the recent years been a renewa l of interest in the areas of CSR and SEA. Growing numbers of companies have begun to publish triple bottom line and sustainable development reports. Governments, public policymakers, private sector organizations and professional bodies have set up work ing groups on various aspects of SEA and have issued a number of discussion papers and best practice guidelines.
Business case approacb: This approach view CSR and SEA initiatives primarily from the perspective of "w hat" is in it for business and shareho lders . SEA is widel y recognized as a way of managing threats to organizational legitimacy, for example, as key stakeholders perceive significant discrepancies between their own and the company's values. Companies can use it to demonstrate their positive impact on society and to head off campaigns from NGO s and activists, which have the potential to threaten business interests. CSR is primarily situated in the traditional context of creating value for the business (owners), through a focus on the potential for win-win relationships. Understanding, managing and respond ing to stakeho lder expectations in promoted as enlightened self-interest.
Stakeholder-Accountability Approach: While stakeho lders share common interests, there is also considerab le potential for confl icts of interest. Stakeholder-accountability advocates have no quarrel with the idea that stakeholder-business relationships can be mutually beneficial. A firm that treats its employees decently may well reap benefits through increased productivity. Similarly, business must have regard for evolving social attitudes and expectations ifi t is to maintain its social license. However, stakeholder theorists note that the business case typically proceeds as if there is a self-evident harmony of interests betwee n managers, shareholders and other stakeholders.
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Accounting helps to create new visibiliti es and facilitate discu ssion and debate amon g interested parties. It promotes dialogic rather than mono logic conce ptions of reason and thus facilitates the layers of talk required in a multi-perspectival environment. The role of SEA under the stakeholder-accountability approach has elements in common with tradi tional acco unting - to provide information for accoun tabili ty purpose and assisting users to make informed decisions. How ever, stakeholder-acco untability proponents firml y reject the dominance o f shareholders and capital market s that has been the conve ntional focus of acco unting.
I THEME 3: ORGANIZATIONAL ARCHITECHTURE Lecture 8 (Denice) â&#x20AC;˘ Brickley, J.A, Smith, C. W & Zimmerman, J.L (2005): Corporate governance, Ethics and Organizational Architecture. Journal of Applied Corporate Finance, 3, 34- 46 In the literature, companies are portrayed with all the ir wrongdoings and the typical explanation is due to poor corporate gove rnance suc h as a too emphasised focus on profits with acco unting earnings as perform ance meas ures. However, the authors state that it has to do with the organi sat ional design/architecture which deal s with three elements: I . The assignment of decision-making authority 2. Performance evaluation 3. Compensation structure (reward and punishm ent) They see the elements as the legs of a stool, where if you do not bal ance them all, it will fall over. They are interrelated in the way that authori ty should be divided where the knowl edge and experience is and through performance evaluation the desired goa l for the decisions is shaped where finally the right decision s must yield some benefits through comp ensation. The thought is that the environment always changes and thus constant new balanc es between the three are needed. There is an example of Enron and how/wh y they failed in this perspective. The corporate goal: Shareholder value There is a larger focus on shareholder value, the stock price. Shareholders buy because they expect a return through either dividends, stock repurchases or realized capital gains. But all of these depend on the company's net cash flow and therefore the stock price is said to reflect the present value of the expected future cash flow. Hence, boosti ng the acco unting earnings should not be a focus for managers but instead long term business strategy. Strategy a nd a rchitecture If compan ies do not continue to move forward and improve or innovate, then they will loose to their competitors. The proposal is for managers to focus and deve lop on core competencies. There are some examp les of orga nisational architect ure and how it affected some companies.
T he first leg: Decision-making authority
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The challenge is to ens ure that deci sion makers have both the relevant information to make good decisions and the incen tives to use it. The decision-making process generally compr ises 4 steps: I . Initiation (formulating and choos ing among dec isions) 2. Rati ficat ion (appro val of dec ision and modifications to it) 3. Imp leme ntation (executing it) 4. Mo nitoring (evaluatin g the outcome and rewardi ng on it) Initiation and Impl ementation is decision-making and Ratification and Monitoring is contro l of deci sion s. These two should be separate and is on many organisat ional levels (e.g. CEO vs. board of directors). In smaller organi sat ions they are more mixed . A key issue in organi sing decision-making authority is the degree of decentrali sation . It can add value by having more specialised knowl edge and information (about markets for instance) and it can increase incenti ve conflicts (managers going their own way or against each other). The oth er two legs can help to contro l these incentive conflicts.
T he seco nd leg: Performance eva luation Performance evaluation is important for at least two reasons and is used for both employees and ope rating business units. First of all, to get feedback from allocated resources in order to optimise and to prepare for new resou rce allocation. Second of all, it provides and indication of perform ance (e.g. shareholder va lue contribution) and is thus useful for compensation purposes .
Evaluating individual employers The impact of a single employee on share holder value can not be stated. It is indirect, happens in cooperation with others and can not be accurate. Other measures com prise productivity (somehow), hours worke d (or other quantifiable ind icators) and quality of work (subjective). Ma nagers should kee p two things in mind. First, the cos ts of measuring should not exceed the benefit of tying com pensation to performance. Employees might tend to play the system for rewards as we ll. Secondly, random factors (weather etc.) might influence the system and disrupt co rrect compe nsat ion in which inves ting in a more cor rect system cou ld be better. Evaluating operating units : ROA versus Residual Income The same two basic purposes serve business unit evalu ation, feedback on how it is doing and input to the reward system. The business unit' s contribution to shareholder value is its present value of its net operating cash flows. The most commonly used measure for this purpo se is the return on assets, ROA (net income divided by total assets). It is good for compari son and bench mark ing but is based on accounting numb ers which are not always entirely correct or precise. Also if a manager is evaluated by the ROA then he/she might skip proj ects that lower ROA even though it increases shareholder value. To offset this problem residual va lue can be used wh ich is the dollar cost of capital employed in the business unit subtracted from the operating pro fits. This mea sure also has pitfalls not discussed in this text. One is though that the num bers of calculated yearly and therefore they can be boos ted by cutting R&D or ma intenance which will limit future shareholder value. Projects might also be chose n because they have a short run impact.
T he t hird leg: Compensation and incentive pay
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The term incentive pay is tradition ally piece rates, commissions or cash bonus plans on the basis of some quant ifiable performance measures. Now stock and stock option awards are emphasised despite their lesser incentive-effect for employees in larger organisations. It does not have to be monetary but can also be the corne r office, parking place, dining privileges or the like. A more precise and accurate measurement will decrease incentive conflicts but also reduce the amount of penalisation for factors beyond the control of the employee and the amount of rewards for results they did not playa direct role in. Perhaps most important, an accurate incentive plan strengthens the link between the organisation and its strategy by factor ing it in the incentive plan. Employees will be guided by the incentives to know what to do.
Organisational architecture and ethics How corporate ethics can be addressed through organ isational architecture. Peo ple have a good idea about what ethics are (the values of hones ty etc.) but on some issues we j ust can not decide (animal testing, stem cell research etc.). Also our ethics and values change with time in society. Therefore corporate governance and responsibility has come under scrutiny. Determining what to do not only depends on what is legal or not because customs and laws around the world vary a lot and are hard to define under a single rule. If it is norm al to bribe in a foreign country should an American company then refuse to do so there? An approach by the authors is to print a test-article about a business conduct and evaluate on the expected reaction. A code of conduct can also be used to minimi se comp any risk. If an employee is found guilty in something, then the company can state that it has trained the employee according to the code of conduct and that it is an individual mistake and not the compan y' s (to avoid prosecution and fees). However, a code of conduct is not enough to guarantee ethical behaviour. To become a values-based organisation you need realised strategy. A concept in this area is corporate social responsibilit y. Ralph Nader started this for companies to start address social ills. But many follow the way of Milton Friedman, who says that companies should try to make as much money as possible under the basic rules of society. According to the authors gains can be made from acting ethically correct and the breaches of ethics are results of an unbalance in the three stool legs (e.g. rewards for unethical behaviour).
QJncIusi.n Leadership demands more than j ust creati ng a strategic and ethical plan. It needs to be implemented and realised. Therefore it requires the creation of an organ isation architecture, which can change the existing one to fit the goals. Also good leadership is to know how to work in the existing architecture and not to impose too many frequent shifts but also to go for long-run goals (link to BSC). Achieving the right balance among decision authori ty, performa nce evaluation and compensation will ultimately drive shareholder value as well as ethical behaviour. â&#x20AC;˘ J ens en, M.C & Mecklin: (1 ~'5) : Specific and General Knowledge, and Organizational Structure, Journal of Applied Corporate Finance, 8,4-18
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Specific kno wledge is knowledge that is cost ly to transfer amo ng agents and general knowledge is know ledge that is inexpensive to transmit. Spec ific knowledge requi res decentralisation of decision rights and this is the case in both the economy and in the individu al firm. This delegation involves two problems: â&#x20AC;˘ R ights assignment (Determ ining who should exercise a decision right) â&#x20AC;˘ Control or agency (Agents must decide in line with organisational objectives) In the market, capita list economic systems so lve the rights assignmen t pro blem by gran ting alienability of dec ision rights to agents. Alienability means that the agent is the ow ner and has the right to sell it and capture the proceeds (they have the right to alienate their rig ht). It is the same as the term propert y rights according to the authors. Organ isations do not delegate alienab ility (e.g. an emp loyee can handle mac hinery but not sell it). They have to substitute the alienability. Th is text will discuss the critica l role of alienability in the market and organisations.
Collocation of knowledge and decision authority F. A. Hayek was among the first eco nomists to note the importance of know ledge and its distribu tion to a we ll-functioning economy. He arg ues that the distribution of knowledge in society calls for decentra lisation.
if we ...agree that the economic problem ofsociety is mainly one ofrapid adaptation to changes in the particular circumstances oftime and p lace ...decisions must be left to the people who are familiar with these circumstances, who know directly ofthe relevant changes and ofthe resour ces immediately available to meet them. We cannot expect that this problem will be solved by fi rst communicating all this knowledge to a centraI board which, after integrating all knowledge, issues its orders. We must solve it by some f orm ofdecentr alisation. Ha yek (199 4) Hayek assum es that markets automatically mov e decision rights to the agents wit h the relevant knowledge, and that those agen ts will use the dec ision rights properly. Unfortunately, he never discusses how this occ urs. This text will focus on the organisational and managerial problems of firm s from understandin g this issue.
Knowledge The set of opportunities for each individual is a function of the indi vidu al' s know ledge. Decision-makers confront this front at two leve ls; techno logical feasibility (pu shing development) and specific limits to the individual (limited mental and sensory capac ity). Due to our individual limits (e.g. memory, understanding, etc.), kno wled ge tran sfer does become costl y. Th erefore when knowledge is valuab le there are benefits of collocating (sharing) decision authority. There are two basic ways of accomplishing collocation; to move knowledge to those with the decision rights or grant dec isio n rights to those with knowledge. The former has gotten the highest focus in research and the latter not. In the market the idea is that actors would assess the cost of acqu iring either decision rights or knowledge and buy one or the other. Knowledge and the cost oftransfer The cost of transfer depends on factors of the nature of the knowledge, the organisat ional environment and techno logy. Knowledge is more specific (idiosyn cratic) , the more costly it
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is, and the other way around. Transfer is meant not on ly as information transfer but effective knowledge transfer. Transfer of know ledge yields benefit when it enab les the acq uirer to make better choices but it becomes the same if the cost s of acquiri ng this know ledge equal. There are situations of successful transfers (e.g. forma l education and Amer ican Airlines). The trend to comply with high information-transfer costs is evident in the large numb er of cross -functional and cross-organi sational team s today. Another wa y is scientific knowl edge to resolv e key questions which is evident in some industries wh ich rely heavy on it (e.g. pharmaceuticals). Lastly, knowledge is acquired by assembling it from experiences, exercise, statistical methods of combining knowledge and conducted anal ysis.
Rights systems Decision rights are the power to make decisions and take actions with resources. In a private property capitalist system, most of these rights are ass igned to private individu als and organisations. In a socialist or communist system , most of these rights are assigned to the state or governing party. Alienability (transferabl e) in dec ision rights provides the basis for our pricing system and guides human behav iour (Adam Smiths invisible hand). Once the rights are distributed they are redistributed through contracts, licensing, purchase and sale. To manage this arbitrage is the court system , which through cont inuous evolution has developed itself thro ugh the last tho usands of years. The functions of alienability Alienability is the effective combination of two rights: The right to sell or transfer rights The right to capt ure the proceeds of exchange Alienab ility is a necessary cond ition for exchange and is the foundation of markets and the institutional device by which market both co llocat e (forbinde) knowle dge with dec ision rights and exerc ise control over dec ision makers. Alienability solves the Rights Assignment Problem: When decision rights are alienable, vo luntary exchange creates a process in which the purchase and sale of rights by max imizing individuals co llocates knowledge and dec ision rights. It does so by conveying (fore ) dec ision rights to the site of know ledge. Voluntary exchange ens ures that decision rights will tend to be acquired by those who value them most highly, and th is will be those who have spec ific know ledge and abilities that are most valuable to the exercise of the right. Alienability solves the Control Problem: Process and rules of Performance measurement - meas urements of individuals act ions and the rewards and punishm ents. The control system plays a maj or role in determining which choices individuals make from their opport unity set. Transfers of decision rights without the right to alienate those rights are intra-firm transaction s. They cannot pocket the proceeds (p rofit). So within firms no alienab le rights=> person s generating value do not have the rights to the va lues they generate + measurement is difficult.
The existence offirms Film s must obtain advantages from the suppression (inddragelse) of alienability that are
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large enough to offset the costs assoc iated with its absence, or they cou ld not surv ive open competitio n with independent agents. The value of proprietary knowledge to competitors is a reason for long-term emp loyment relationships. Long term contracts reduce the costs of restr icting the flow of valuable knowledge to outsiders. Finall y, long-run relat ionships encourage individual participants to invest in firm-specific knowledge that has little or no value except within the particu lar organization .
The organisational problems of the firm: Trade-offs between information costs and agency costs Firms exist due to eco nomies of scale/ scope and transactions cost , and especially (in this article) to by bringing diverse set of know ledge together The modern corporation vests all decis ion rights in the board of directors and CEO 's office. In delegating authority to maximize survival, the CEO wants to partition the decision rights out among agents in the organization so as to maximize their aggregate value. Agency costs: costs resu lting from conflicts of interest in cooperative behaviour - the sum of the costs of designing, implementing, and maintaining appropriate incentive and contro l systems as we ll as the residu al loss resulting from the difficulty of solving these problems completely. Because agenc y costs inev itably result from the dele gation of decision right s, the CEO must dev ise a control syste m (a set of rules) that fosters desirable behaviour.
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The figure above provid es an intuitive way to think about the trade-offs associated with assigning a particular dec ision rights to different levels in the organization ' s hierarchy. The vertical axis measures costs and the horizontal axis measures the distance of the decision right from the CEO's office. The figure deals with the debate over centralization versus decentral ization in organizations. A detailed description of the figure can be found on p. 12.
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Factors affecting the degree ofdecentralisation Determ ining the opt imal level of decentralisation requires balancing the costs of bad decisions due to poor information and those due to inconsistent objectives. The opt imal degree of decentralisation depends on factors like size of the organization , information technology and the rate of change in the environment, government regulation and the control technolog y. - Information technolo gy: When impro ved technology makes it easier to transfer specific knowledge effective ly from lower to higher levels in the organ isation, there will be a shift toward centralization. When improve technology makes it easier to transfer to lower levels in the organization information that was form erly spec ific to higher levels in the organization, there will be a shift toward decentralization. - Governmental regulation: Tends to increase centralization. I does so by increasing the amou nt of spec ific know ledge in the headquarters office dealing with the regulatory agency. Improvements in contro l technology - such as communication and measurement techniques that reduce the marginal agency costs associated with delegating decision rights - will tend to increase decentralization in an organ ization. The technology for partitioning decision rights in the firm Systems and technologies for structuring decis ion rights:
Job descriptions Decision rights are allocated to agents within firms in various ways . Many are allocated directly to individuals or positions through jo b descriptions. These descriptions are often the best source of written documentation of the assignment of decision rights in an organ ization. Budgeting: Physical and monetary budgets are common techniq ues of partitioning decision rights in firms. Ru les, regulations or fiat The rules and regulations that accompany budgets are examples of regulatory constraints on behaviour that exist because employees are self-interested. Regulations when the office has the relevant spec ific knowledge or where the prohibited behaviour (theft or embezzlement) is clearly not consistent with the objectives of the CEO. The con trol system A control system that ties the individual ' s interest more closely to that of the organization is required. The control system specifies: - the performance measurement and evaluation system for each subdivision of the firm and each decision agent. - the reward and punishment system that relates individuals' rewards to their performance.
Cost centres and profit centres as performance measurement systems Cost centers are subdivisions that are directed to minimi ze the total cost of providing a specified quantity of service. Profit centers are product subdivisions where the measure of performance is the difference between some measure of revenues and costs.
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The role ofbudgets in performance measurement Two majo r points about the use of budgets in performance evaluation. When b udgets are used to delegate dec ision rights , measures of violations of budgeted expenditures must be part of performance measurement, if expenditure limits are to have meanin g. The use of some kind s of budgets can cause major probl ems for large organizations. Probl ems becau se its success depend s critically on setting cor rect plan s or targets for each division and decision agent.
Measuring, rewarding and punishing individual performance - Pay for performance systems - Promotion-based rew ards As decentralizat ion of corporate dec ision rights becomes more valuable, the prediction is that many firm s will choose to replace their promotion-based systems with sign ificantly greater use of the incentives held out by profit-sharing and stock ownersh ip (pay for performance system). Conclusions This paper analyzes the relations between knowledge, contro l and organ izational struct ure, both in the mar ket system as a who le and in private organizations. The limited capacity of the hum an mind and the costs of produ cing and transferring knowl edge mean that knowledge relevant to all decisions can never be located in a single individual or body of experts. Thus, if knowledge valuable to a particular dec ision is to be used in making that decision, there must be a system for assigni ng dec ision rights to individuals who have the knowledge and abilities or who can acqu ire or produce them a t low cost. In addition, self-interest on the part of individual dec ision- makers means that a control system is requ ired to motivate individuals to use their spec ific know ledge and decision rights properly. • The FBI-Case. (Case can be bought at IVS) Think Sof choose to skip this case! !?
Lecture 9: Lean accounting & organisational architecture (Sabina) • Womack, J.P & Jones, D.T (2002): Lean thinking: banish waste and create wealth in your corporation. New York: Simon & Schuster, 1996 Muda = Waste - any human activity which absorbs reso urces but creates no va lue (i.e. provi ding the wring good in the right way), first identifi ed by Toyota executive Taiichi Ohno - i.e.: • Mistakes • Unconsumed inventory • Unnecessary process ing steps • Unpurposeful transportation of goods and emplo yees • Waiting time between up and downstream activities • Goods that do not meet needs of the customers (i.e. crisis in the German industry after the cold war: complex custom ized designs and sophisticated processing technologies favoured by German engineers were too expensive for the customers and often irrelevant to their desires)
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Antodo te to Muda: Lean thinking = a way to spec ify value, line up va lue creat ing actions in the best seq uence and enhance efficiency - do more and more wit h less and less Step 1: Specify valu e Defin ition of value is skewed by the power of pre-existin g organ izat ions, technologies and assets as we ll as outdated thinking such as economies of scale. I.e. Japanese mana gers: stay-at-home-at-allcosts (to satisfy societa l expec tations about long term employme nt). Backwards thought process needed ! Reth inking value from the perspective of the customer. Examp le: Current time airline industry - large aircrafts at mai n term inals (effic ient utilisation of reso urces) instead of small aircrafts with more connectio ns (more convenient to customers). Step 2: Identify value stream Value stream = set of all spec ific actions requi red to bring a specific product thro ugh the three critica l management tasks of any business: I . probl em solving task (co ncept - des ign - production) 2. information management task (order-taking - scheduling - deliv ery) 3. physical transformati on task (raw materials - finished product) Man y steps wi ll be found to unambiguou sly create value, create no value but to be unavoidable with current techno logies and production assets (type one Muda) or create no value and be immediately avoidable (type two Muda). Common cause of Mu da: lack of transparency and communication between entities and stake ho lders. Lean think ing mu st go beyond the firm (verticall y) to create a lean enterprise and eliminate Muda. Step 3: Make the remaining value-creating steps flow Common notion : activities sho uld be grouped by type - in batches - to be performed mo re efficient ly and managed more eas ily. Not acco rding to lean! Examp le: Henry Ford - first to realize the potential of flow - lined up mach ines needed to prod uce the Mo del T in the COlTect sequence. Lean alternative: Redefi ne the work of funct ions, departments and firms to make positive contribution to value creation - make valu e flow. Kaikaku = radical improvement Kaizen = continuous incremental improvement Fourth principle: Pull instead of push ... and accommodate shifting demands Fifth pri nciple: Perfection
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... no end to the process of reducing effort, time, space, cost and mistakes. Transparency important! Benefits of lean Rule of thumb : Converting classic batch-and-queue production system to continuous flow with effective pull by the customer will double labor productivity, cut production throughput times by 90%, reduce inventories by 90%, cut errors as well as job related injuries in half. Time to market for new products are halved and a wider variety of products can be offered at modest additional costs. = kaikaku bonus - followed by kaizen improvements en route to perfection. • Baggaley, B & Maskel, B (2003): Value stream management for lean companies part 1 2, Journal of Cost Management, pp, 24-30 and 23-272003 Part I Although lean manufacturing methods entail abovementioned benefits , it puts pressure on manageme nt systems geared by traditional means. The article provides a framework for implementing lean systems and controls (the abstract is short because it repeats a lot from above text ). Three dimensions of the lean management issue: 1. Developing and appropriate managem ent fo cus (focus on customers) 2. Organizing by value stream (a company made up of several sma ll entrepreneurial companies - rather than production departments/'centers of excellence') 3. Costing by value stream Moving from Materials Resou rce Planning (MRP) to kanban (complex/unnecessary to simple) similar to the move to value stream organisation. T he Maturity Path to Lean Value Stream Organization
I. Pilot Lean Production Cells (identify and map value streams - induce improvement to the flow) 2. Lean Manufacturing Widespread (manage by value stream, assign value stream managers and performance measures, introduce CI teams) 3. Lean throughout the Company and Partners (reorganise around value streams, create entrepreneurial mini businesses, ensure cooperation between streams) Support functions needed: • Production control (kanban = principal production control mechanism) • Transportation (materials and tools available when and where needed) • Procurement (SCM - right quantities, right time) • Manufacturing engineering (continuous improvement) • Maintenance (of equipment) Cross-training for employees across value streams is recommended
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Value stream organisation can be implemented whi le, in the beginning, keeping the old organi sat ion and reporting systems - a matrix management structure Rule of thumb : a value steam should contain between 25 and 100 people HR, IT and other support functions are not directly related to value streams PART II
About shortcomings ofstandard costing techniques Va lue stream costing does not distinguish between direct and indirect costs
all costs are di r ect
Sta ndard cost ing assumption : ove rhead costs relate to amo unt oflabour requ ired to make a product (motivates non-lean behaviour in operations such as effic iency attempts by produci ng large batches and creating inventory) \JOh'O-'o'e 'I S ~..i"e.ol lean relates to the whole va lue stream If" Cb'/;t<; in lean, maximum profit comes from maximum flo w (not so much utilisation of resources) Va lue stream costs are typically calculated wee kly, biweekl y or month ly total value stream material cost = everything purc hased this week the only alloca tion used regularly = square meters (cost for facil ity) value stream costing = reduction in cost centers information on the value stream income statement = rea l support functions = sustaining costs of the business (not allocated to value streams) Standard costing requires an exp ens ive and wasteful data co llection system Standard costing typically used for: pricing dec isions profit margins on product lines and customer orders performance measurement process improvement makelbuy dec isions product and customer rational ization inventory va luation In lean : pricing dec isions never made with reference to the costs - fo cus is on value created
In va lue stream costing: reporting must be by va lue stream people must be assigned to value streams with little or no overlap few shared service departm ents producti on process under contro l - low variabi lity thorough tracking of "out of control" situations inventory must be low and consistent â&#x20AC;˘ Wruck, H.K & Jensen, M. C (1994) Science, specific knowledge and total quality management, Journal of accounting and Economics 18 pp 247-287
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TQM = new organizing techn ology that is science based , non-hierarchical and non-market oriented - encou rages pro ductivity and quality Science based because employees are trai ned to use scientific method (statistics, i.e. scatter diagrams, histograms, pareto diagrams) in decision mak ing Non-hierarc hical because it decision rights are decentra lised (my comment: not really???) Non-market orie nted because it does not use prices and transfer price systems to motivate cooperation (my comment: hmm . . . a little unc lear what exactly they mean by ' market' they do sti ll have a customer focus) TQM creates value by effective creation and utilization of va luable specific know ledge at all levels of the organization Specific knowledge = know ledge valuable to decision makin g that is costly to transfer among agents TQM = establishes a process for allocating decision rights to where the spec ific know ledge is located This article focuses on important organisational aspects of effective TQM prog rams, based on Jensen & Mecklinh (1992) E ffective imp lementation requires fundamental changes in the critical organisational rilles ofthe game (allocation of dec ision rights, performance measurement system and reward/pu nishm ent systems), as we ll as large and con tinuous investment in em ployee training Implementation ofTQM can be difficult! (quantitative data on the effect ofTQM is scarce) Examp le used throughou t the article: Sterling Chemicals Inc. implementing TQM Plant culture: inflexible, resistant to change Fear that TQM would emp loyment (mitigation : management promi sed no lay-offs due to TQM) R ule of t hu mb : Ask who , what, where, when, why and how - what causes bottlenecks ill this production process ? Using spe cific knowledge effe ctively: Unlike ideas imposed by management, employees are more comm itted to successful imp lementation of own ideas. ~
TQ M philosophy is similar to the philo sophy behind employee empowerme nt, participat ive man agement and sugges tion systems.
Ma nage rs tend to over-centralise: overestim ate agency costs and underestimate va lue of specific knowledge. Centralised decision mak ing in large organisations run the risk of failur e becaus e they are unable to utilise specific knowledge . General knowledge such as prices and quantities are inexpe nsive to transfer, but spec ific knowledge (info on customers, machines or processes) is costly to transfer and cannot be utilised by top management alone.
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Risks of collocating deci sion rights: conflict of interest and agenc y problems - requires control system! When specific knowledge is dispersed across individuals: TQM encourages assembly ofteam Hackman (1986) : availability of expert coaches is critical to the success of self-managed teams Risk: if an employee is empowered to both identify the problem and imp lement a solution, he will allocate resource to the project that he finds important, fun and interesting - not necessarily in alliance with overall corpo rate interests... Direct quote: " individual employees are often unable to jud ge correctly at the best procedures to ensure successful implementation of their proposed solutions." (my comm ent: Hmm. .. "Pisken og guleroden"? ! ... doesn' t seem like TQM is as committed to empowerment as they would like for it to sound - no trust in the employees !) Solving team mania: sep arating decision management/rom decision control Three essential objectives for allocating decision rights: I. Ensures individual/team efforts focus on important issues taking into account interdependencies 2. Ensures TQM efforts address issues that are important, well defined and solverable (see chartering document below) 3. Prevents corporate hierarc hy from interfering with TQM (TQM teams must be able to bypass old hierarchical chain of command) Four separate decision-making rights : 1. initiation rights 2. ratification rights (approve/reject - usually at a higher level: if in a single department, by departmental committee, if across department, by divisional committee) 3. implementation rights 4. monitoring rights (evaluate success/failure) In order to be well-defined: use chartering document with following informat ion:
purpose of the project team members scope ofthe project results expected sponsor Once a project is finished , the team and decision rights are disbanded - to avoid bureaucracy and inflexibility The organ isation's objective must be communi cated to employees ! Common performance measures: Manufacturing cycling time, product failure rates, late deliv ery rates, order lead times , new product development times, customer complaints, waste rates (all TQM productivity and qualit y measures are/rom the standpoint ofthe customer - and they are operations oriented rather than dollar-denom inated, esvs funaion/task specific rather than traditional measures isolating activities from performance) Many TQM companies benchmark perform ance to peer companies.
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TQM companies tend to emphasize weaknesses rather than strengths this leads to the dilemma: when the company rewards people from finding weaknesses on the positive side: it prevents people from avoiding/hiding problems but on the negative side (my comment): it encourages people to look lor problems that may not exist or be irrelevant
Rewards (monetary and non monetary): benefit of making one's job easier/safer, public recognition} raises) promotions, bonuses, profit-sharing plans, equity ownership programs Rewards based on tournaments (based on individual pcrformaucc) may encourage sabotage. Rewards based on learn effort encourage cooperation.
study on Toyota Kyushu the latest 01 Toyotas plants. Question asked: is Toyota fc({vinp," Icon? The 233,() 18 In2, 2,000 employees ()()O part time/seasonal, average age: female (unusual). Six shops: plastic moulding, welding, stamping, body, painting and assembly. Annual production: 200,000 vehicles (800 per day). Exports 3040 '%. 100 supplying companies (incl. 40 local), 150 deliveries per day from local companies. Located outside Aiiehi where all other plants arc located (to get access to vast amounts of land + facilitate recruitment particularly of young people who will stay long). Efforts were made to transfer' Toyotas culture (half the employees were from another plant and 300 were sent to another plant for the first two years) The plant incorporates innovations to make the work more appealing to shop floor employees
Split assembly line: 11 mini lines of J00 meters, a buffer 01'3 vehicles between each line (3.5 minutes). Aim: to give employees a sense of accomplishment and keep up quality. People can see their own role and arc less afraid to stop the line. Onc team controls the line (rather than two which makes coordination more difficult). Downside: more space needed. Quality assurance
=
number one priority
Work environment: Coexistence between workers and machines. Windows in the ceiling. Decreasing noise. Usc of support tools Work Organisation: 01'680 factory workers there arc 80 inspectors and 30 dedicated to take parts to assembly lines. Selection criteria lor supervisors: ability to think positively + whether trusted by employees. Rotation every time there is a break (every two honrs)
~~
Training: Two weeks training in general morale and work attitude Production System and language (i.e. kanban and andoni.
-l-
Employees involved in continuous improvement (Cl) teams (lcaizen)
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to create peerness. training in the Toyota
Plant performance: lead time of22 hours, assemb ly lead time of8 hours (about the same as other plants). Costs are the same (transport costs are higher but wages lower), quality of plant higher (number one). Conclusion: Toyota has not left lean.
THEME 4: CRITICAL PERSPECTIVES ON MANAGEMENT CONTROL AND FINANCE Lecture 10 (Monir) â&#x20AC;˘ Willmott, H. (1993): Strenght is ignorance; Slavery is freedom: Managing culture in modern organisations, Journal ofmallagemelit studies. 30, pp. 515-552 Abstract 1 Course:
Management Control & Finance
Abs tractor : Bj arke Hansen Ti tle: Keyw ords : Main Frame
Strength is ignorance, Slavery is freedom (1993)
Lecture:
10
I Date: I 02.03.05
Author(S) : Willmott, H.
Corporate culturism (which he argues to some extent is the same as HRM- and TQM programs) and "doublethink", The central argument of the text IS that corporate culturism has totalitarian implications, and that the promi se of autonomy to the employees which culturism is said to give is a masquerade, as members can' t use their autonomy in very many ways when their minds are controlled by the corporate culture.
The author starts out by placing culturism in a theoretical context from the days of Fordism and Taylorism, toward more flexible management theories like the Human relations theory (Mayo 1933), institutional theory (Selznick, 1957), Theory Y (McGregor 1960). Through out the text the author uses Peters and Waterman' s book "in Search of Excellence" (1982), as a primary reference when talking about corporate culture, and provides more or less direct evidence/arguments of totalitarian implications to each reference. He identifies a paradox in the argument that corporate culture provid es autonom y to its members, as the conditions under which autonom y is given, restrains the autonomy. Finally he concludes that corporate culturism preys on employees who are faced with the challenge of choosing between many diverse options and possibilities, but lack a point of reference to guide them in decision. Furthermore he argues that " under the guise of giving more autonomy to the individual than in organisations governed by bureaucratic rules, corporate culture threatens to promote a new hypermodern neo-authoritarianism which, potentially, is more insidious and sinister than its bureaucratic p redecessors." (p. 541). The challenge as he sees it is to replace the corporate culture doublethink. Explanation of central terms
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Culturism: Corporate culture, HRM- or TQM programs "Doublethink": An expression introduced by Orwell in his book" 1984" (fiction), which describes the ability to repress certain memories or "un-rcmember" them, until a time where the memories arc needed,
Theoretical perspectives and argument
The " .. concern ofa corporate culturisrn.. isto win {he hearts and minds ofemployees: to define their purpose by rnonoging what they think andfeel, and notjust how thcv behove,", (p. 51 (j)
Culturism is said to have its origin partially in institutional theory (Sclznick, 1(57) Thcory Y (['v1cGrcgor 19(0)? as it assumes that employees \-vilJ react positively to a sense of purpose and autonomy, which. cuiturism purist argue, are central clements of a good corporate: culture. The eli tfcrcncc between culturisrn and the theories it is clamcd to helve originated from, is that the earlier theories do not acknowledge the presents of conflicts of interest in organisations, which culturisrn docs. Culturism is argued to provide members with a point 01' reference to which thcy can measure what is right and wrong, and thereby addressing the conflict of interest in organisations.
What culturism shares with the earlier theories is; "understanding that the distinctive quality of human action, and labour power, resides in the capacity ofself-determination." (p. 525). Corporate culture as Doublethink According to the author Peters and Waterman (1982) has provided numerous examples 01' companies with strong cultures that has gained a lot by giving autonomy to their employees. Nevertheless the author argues that this results in a paradox as employees are given autonomy under the condition that they will comply with the cultural values 01' the corporation. It is argued that in complying with these values the employees are giving back their autonomy, as they accept to act according to the morals and norms set by the corporation.
In a bureaucracy employees can have en opinion that goes against the corporate values or even challenge corporate authority, without ever getting in trouble lor it, as long as the employee behave according to company policy. In an organization with a strong culture challenging corporate values would be taboo, and someone who tried would most likely be punished or fired.
Culturism vs. Fordism or Taylorism In Fordism or Taylorism management focuses of the behaviour of the employees
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Culturism seeks to create a sense of purpose lor its members, to make them feel a responsibility towards the success of the culture and in that sense the organization housing the culture in other words utilizing "mind control" in managing the employees
The author argues that even though culturism comes from a part of the management theory" which focuses on, and accepts that, the human aspects ()f management are vaguel y defined and needs to be addressed, it docs not attempt to come to terms with these issues, Actually it docs the opposite and keeps the members of the culture from addressing this lSSUC to avoid them questioning the culture it self Another example is in this quote: "Corporate culture progrnrnmcs arc designed 10 deny or Irustratc the development of conditions in which critical reflection is fostered" (p. 534)
Course: m,m
mm'
"
Management Control and +,,"""' "
Finance ",m,",',,""""","
'T""""'"
Monir Az/ouzi
Abstractor:
is ignorance; slavery is Managing Culture in Organisations
Title:
mmm
mm,"""""""
mmm,
10 Authur(S):
Willmott, H
corporate culturalism for doublethinking, Corporatcs want employees to be and at the same time think and feel as the corporation wants
Keywords
Willmott claims that corporate culturisrn and post-Taylorism management theory concerns are to increase co-operation and commitment by enabling employees to derive a sense of meaning and esteem, as well as payment, by directing their creative energies towards the realisation of key corporate objectives, The purpose of corporate culturism as Willmott characterise it, is to win the hearts and minds of employees, To define their purposes by managing what they think and feel and not just how they behave.
Corporate Culturisrn Vs, opst-Taylorism Equalities: e
e
The distinctive quality ofhuman action, and oflabour power, resides in the capacity of self-determination Corporate performance can be maximized only if the capacity is simultaneously respected and exploited
Differences: â&#x20AC;˘
e
Management theorists take identity and integration of individual and organizational needs as given and see therefore no reason to manage employee values Corporate culturism commend and legitimise the development of a teehnology of cultural eontrol that is intended to yoke in totalitarian fashion to realise corporate values
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Cor porate culture as doublethink In corporate culturism respect for the individual is equated with complying with the values of corporate cult ure. In bureaucratic, rule-governed organizations, employees are at least perm itted to think what they like so long as they act in a technically competent manner. In principle, communication between employees that challenges bureaucratic authority is tolerated as long as the rules themselves are not overtly violated. In organ isations with strong corporate culture, such "disloyal" communication is at best strictly coded if it is not entirely tabooed. You either buy into their norms or you get out. Corporate culture invites employees to understand that identification with its values ensures autonomy. That is the seductive doublethink of corporate culture; the simultaneous affirmat ion and negation of the conditions of autonomy A strategy to comm unicate corporate control is thro ugh vision, symbolic action and recognition. According to Willmott corporate culture programmes celebrate, exploit, distort and drain cultural resource of caring, democratic values. In the doublethi nk monological world of corporate culture, the values of community and autonomy are simultaneously celebrated and contradicted. Conclusion The guiding aim and abiding concern of corporate culturalism, as 1 shall characterize it, is to win the "hearts and minds" ofemployees: to define their purposes by managing what they think and f eel, and not just how they behave" (Wi llmott , 1993). According to Willmott, corporate culturism not only communicate what they expect from employees, furthermore conv ince has to convince employes about why they shou ld act in accordance to the corporates culture. Especially the contradiction between autonomy and control of the frames is criticised by Willmott. I suggest making a comparison with Simon 's article about control (the first text in volume I) at exam. â&#x20AC;˘ Jones, C & Dugdale, D (2002): The ABC bandwagon and juggernaut of modernity, Accounting, organizations and Society, 27 pp 121-163 T H EME The article explores the creation of activity-based costing (ABC) from an actor-network theory (ANT) perspecti ve. The Authors portray ABC as a socio-technical expert system created from the actor-network. KEY W ORDS : Activity-based costing (ABC), actor-network theory (ANT), Bandwagon, Lato ur, intermediaries, system building, translation, Giddens, Cooper, Kaplan, Johnson, black-box, cost allocation, overhead costs.
ABSTRACT The article is based on a research based by Jones and Dugdale. The agenda is to explore the creating of ABC through an ANT- perspective. They draw upon the ANT presented by Latour Secondly Giddens' is used in the discussion of dynamics of modernity.
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An actor-network is a network consisting of actors and is formed by the enrolling and controlling of actors who are allies. Between these allies there is the intermediaries, who are "anything passing between actors which defines the relationship between them" ( p.123) Further on they draw upon Giddens' and his expert systems. Expert systems are institutions that functions across time and space because they are disembedded, transformed and reembedded. The Authors start their research by finding the earliest start of ABC and they find Cooper's text from 1989 as a starting point. Kaplan looked for new innovative managing systems, due to the American market being threatened by new Japanese management systems such as JIT (Just in Time) and TQM (Total Quality Management) Cooper a Harvard colleague finds the first signs of ABC in a company called Schrader Bellows Group. Here administration and sales are allocated as costs. Kaplan finds his own company using ABC in the case of John Deere. ABC was introduced here due to difficulties in profit in sales. A similar research is made by Johnson, who finds signs of ABC in the case of Weyerhauser. Here managers focus on activities rather than costs (p.130). ABC is launched as a world-class management accounting system. ABC is told to be more realistic and accurate. Besides the Harvard network there are other actors like the CAM-I (Computer-Aided Manufacturing, International. This actor primarily focused on developing computer-based tools. The Valve Costing Table is shortly after introduced and disembedded into "activity-based-costing" Kaplan and Cooper conclude that ABC can not only be used for costing but also for raising prices and redesigning processes. Johnson's approach to ABC has a larger focus on the management side of ABC. Thereby the Harvard network is varying its focus. 2nd wave of ABC ABC undergoes a transformation mainly due to it is challenged from academics and competing theories. Part of this transformation is seen in a change in terms i.e. "excess capacity" is redefined as" unused capacity". This transformation is called the second wave from the Harvard authors. In the second wave ABC is redefined from "more accurate" to "sufficiently accurate". Furthermore ABC is now more a question of interpretation. All cost are no more variable. ABC transforms to a "contribution margin analysis" (p.143) ABC now undergoes a new translation. Kaplan works with ABC and Balanced Scorecard. The texts authors conclude that ABC is a stable socio-technical system by the end of the 1990s and it becomes black boxed in computer systems (p.145). The ABC network is expanding noteworthy to some large consultancies. ABC also finds its use in downsizing and right sizing of companies. Conclusion: The authors conclude that ABC neither was invented nor discovered. They neglect this distinction" What we conclude is that ABC was created in the heterogeneous network that enrolled, translated and transformed all of its various human and non-human elements " Regarding Giddens' system theory the relationship between theory and practice is mutually depending. Meaning practice waits to be theorized about and theories searches for practice to observe. In Giddens' terms ABC is like other expert systems disembedding-reembedding.
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In the spreading and guaranteeing the authenticity of ABC consultancies played a profound role and academics only a minor. Consultancies also played a large role in spreading ABC through the implementations of computers. Hereby black boxing ABC. Another major factor in the spreading and creating of ABC was the global change in market and production. Yet another factor in shaping ABC was the defending 01' it against other theories, especially Theory of Constraint by Eli Goldratt. 'The result of the forming of ABC is "that the term ABC now covers a IlIel(/nge ofcompeting, and often contrtulictorv, ideas and practices.
Course: Abstractor:
Lecture:
14
TitIe:
Author(S):
T. COIV路/Yll
02 03 OS
[)avid [)ugdalc
Keywords: Main Frame
The construction of the ABC accounting system is the point of departure. However, this text is general and can be used as a tool to analyse how new theories or systems come into being through a network ofhumans and non-humans.
As all other techno economic system, ABC has developed over time and is today in a steady stage where it has become an expert system wrapped in a 'black box' that few people question. This text takes ABC a step beyond its practical level of usc and look at the accounting system from an actor- network theoretical perspective. It is interesting in two ways; firstly because it looks at ABC before it was constructed and secondly it provides a tool to analyse management systems or theories in general. Sum up on theory- Recalling the different subjects and objects in the actor-network theory? System builders: Actors such as Cooper&Kapland 'fighting' with various networks, i.e. consumers, economic forces etc. Translation: When systems like the ABC systems are constructed it happens among various system builders, each having a distinct perception or agenda for its use. As Latour puts it: 'ambiguity is a part of translation ...a good swapshop for goals' (p.139. Translation only takes place if you are able to attract attention to your agenda of a new system. Intermediaries: Objects passing between actors defining their relation, e.g. reports, articles.
'" " global-abstract level
/
dis8mbeddifl()
moO/beOding
/
local-concrete level
77 oflSO
Giddens ~ model
ABC and its dynamic forces : In order to understand the network dynamics in ABC, Giddens identify two key institutions: 'expert systems' and 'symbolic tokens ', implied that ABC is the expert system that calculate one of our times strongest symbolic token- money. ABC is a typical example on a system that has become recognized as an expert system, disembedded from local settings and defining a universal standard of how social relations, in this case token-money, should be measured. This knowledge then becomes basis for acting back upon local contexts through reembedding. However, as we learn from the construction of the ABC, such systems are not perfect, and ' operator failure' may undermine the existing system. In such case powerful actors/system builders will be our trustees to construct a new expert system , on which the whole should rely. Before such reconstruction/disemebedding can take place, the new suggestions for amendment must be codified to a global-abstract level. The ' reconstructed' system is now ready to be reembedded into local settings. The reemebdding process involves mediation in local context where it is selectively adopted, amended, opposed and rejected. Over time a new 'ex pert system' will be built. The history of the ABC system The ABC system has been subject to exact same process. The changes have actually been quite radical even though some authors try to come about the change as a mere elaboration. Phase 1. Preface: Local context-critique on traditional accounting, ROI and financial accounting. T ranslation process: Based on cases Cooper&Johnson, KPMG CAM-I get involved in the abstraction process (different NETWORKS of actors) Various reports and articles are a passing between the different actors defining their relation (INTERMEDIARIES) Disembedding process: A selective process decides what case material is to be extrated. 1989- ABC a blue print for worl d-class management accounting: A short steady stage where congrue nce on its use is reached- 'overhead costs are allocated more accurately to product, allocating not only manufacturing but also, sales, general, and administrative costs. ' Struggle amongst academics is going on, as Latour notes, the establishment of a socio-techn ical system involoves struggles on many fronts. One of these was against the anti program of the Theory Of Constraints (TOC) confronting the prob lem of measurements. Phase 2- a system focused on bottlenecks To defend the ABC, Cooper&Kapland revise their concept of ' resources' . The notion of excess capacity is redefined as 'un used capacity' , emphasizing the fact that to skip producing one product not necessarily leads to cost savings, since you will suffer from unused capacity. The distinction between ' resources supplied and ' resources used' is now seen as crucial. (p.140). (Recall case on the audit company!) Hierarchical cost system is introduced: (unit, batch, product sustaining and facility level), th e latter is not allocated! Another important change was the abandoning of the concept allocation. It should describe the costs of performing e.g. a setup, information that was gathered from interviews, operating data etc. However by using the word allocation people, taught that allocation is arbitrary, got confused. Estimation is now used, emphasizing the fact that ABC system is not one of decision-making.
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In addition the notion of ' variable costs' that described all costs under the 1sl phase is changed. In the 2nd wave: costs are not intrinsically fixed or variable. It is all about managers' ability to adjust production to output, hence whether costs are fixed or not depends on the manager not on a definition !
Final points Both systems are based on activity analysis, but in technical accounting terms they are quite different. According to the text what holds them together is that they are both referred to as ABC. ABC today: In comparison with the transformation that takes place durin g the 1980-90 's we will find ABC becomin g a stab le socio-technical system. SInce the end of 1990 ' s ABC has actually been ' black-boxed in computer systems such as Enterprice Resource Planning systems (ERP)- A new powerful systems package!! ABC can be seen as a part of a broader agenda in society- 'A real Bandwagon ' There might be some fashion to it: CEOs are a bit stupid and ju st jumps on the first and best idea This text gives a fundamental insight: Makin g a black box which is not questioned. ABC as a new alternati ve: it is the creation of a new socio techn ic network You need some external pressure for a new system, in this case there was a climate of cost cutting which can explain some of its success. You need people to read your papers (allies).
â&#x20AC;˘ Tobin, J., On the Efficiency ofthe Financial System, Lloyds Bank Review, July, 1984 On the Efficiency ofthe Fina ncial Syste m - Lloyds Bank Review July 1984 By James Tobin Overall them e: A sceptical view of the effici ency of our fin ancial markets and institutions Abstr act: Tobin sees frequent departures from efficiency in a less restricted sense of the word . He accepted that financial markets possessed what he called 'inf ormation arbitrage effi ciency ', that is, that they were informationally efficient in the weak and semi-strong sense. You can not systematically make money trading on the basis of generally available public information. He did not believe that financial markets cons istently possessed 'fundamental valuation effi ciency': financial asset prices do not necessarily reflect the rational expectations of the future payments to which the asset gives title. Key financial markets, including the stock market, the longterm debt market and the foreign exchange market are characterized both by exce ss volatility and persistent misalignments, that is, prices deviating persistently from fundamenta l valuations. Tobin challenges the notion that the finan cial markets delivered ' value for money' in the social sense. ' .. .the services of the system do not come cheap. An immense amount of activity takes place, and considerable resources are devoted to it. Tob in referred to this aspect of efficiency as 'functional efficiency'.
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Finally, th e system of finan cial markets can be efficient in the techn ical, inform ation arbitrage, funda mental valuation and functional senses w itho ut possessing what Tobin called Arrow -Debreu full insurance effi ciency , that is, without supporting Pareto- efficient economy-w ide outcomes. The reason is that rea l world financial mark ets interact with labou r and goods markets that are inefficient in every sense of the word.
Conclusion This scepticism abo ut the efficiency of financi al markets was no doubt among the cons iderations that led him to advocate a Tob in tax on foreign exchange market turnover.
Abstract no. 2: Tobin Co urse:
Management Control and Finance Date:
1st of March ' 04
Mark Mayland
Lecture:
9
Title:
On the Effic iency of the Financial Syste m
A uthor(S):
Tobin, J
Keyw ords:
Inform ation- arbitrage effic iency , fundamental - valuation efficiency, full-insurance efficiency, and functional efficiency
Abs tractor:
Main point of the paper: the comm on notion of the financial system being efficient becomes disputab le when looking at the four categories of efficiency . Tob in argues that there are quit e few areas wh ere this is not the case. Moreover, Tobin has no sovereign solution to the efficiency prob lems, but merely points them out in this paper. Conclusion: The financial market serves in man y respects both the individual and the society very we ll, but this doesn ' t mean that the system is efficient. Nor are its shortcomings entirely do to gove rnment regulat ions. The process of regulations should be guided by sober pragmatic consideration of what we can reasonably expect the financial system to achieve and at what social cost. Tobin criticises the financial system in the USA. In the paper he explains that he is not willing to accept that "markets" work for the best. Furthermore, he is not willing to blame the government interventions and regul ations solely for distortions. Therefore Tob in uses this paper to illus trate his views on the efficiency of the financial market. In order to define "efficiency" Tobin divides " efficiency" into information-arbitrage effic iency, fundamental-valuation efficiency , full- insurance-efficiency and functional effic iency. Information-arbitrage efficiency: this means that the market is so efficient that only insiders can make money becau se the market has already "discounted" all information. A ll information is taken into consideration by the market and therefore only insiders can beat the market. Fundamental efficiency : "a mark et is in a financial asset is efficient if its valuation reflect accurately the future payments to which the asset gives title; meaning if the pric e of the asset is based on rational expectations of the future payments" Full-insurance efficiency: this is based on a theory by Ar row and Debreu. This theory suggests a complete system of markets in which commodities are defined not only by physical characte ristics,
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but also by the dates and contingencies at which they are to be exchanged. Meaning that everyon e could exchange goods at exactly the price their bud get would allow. Functional efficiency: Serv ices that the financial industries perform for the econo my as whole. Tobin exemplifies that these four categories are seldom fulfilled and therefore the financial system can not be called "efficient". The result is, as Tobin explains it, that the financial system does not come cheap and a lot of resource s are spent; reso urces that cou ld be used else where to generate value for the society as a whole.
Abstract no. 3: Tobin Tobin (1984): On the Efficiency of the Financial System TH EM E The text discusses the efficiency of the financial system in the US ... in 1984. The text introduces four different kinds of efficiency in the financial market. Tobin sees frequent departures from efficiency in a less restricted sense of the wo rd. Information-arbitrage efficiency: If it is on average impossible to gain from trading on the basis of generally available public information. In efficient markets only insiders can make money. You cannot systemat ically make money trading on the basis of generally available public information. Fun da menta l-val uation efficiency : A market for a financial asset is efficient if its valuations reflect accurately the future payments to which the asset gives title. Financial asse t prices do not necessarily reflect the rational expectations of the future payments to which the asset gives title. Key financial markets, including the stock market, the long-term debt market and the foreign exchange market are characterized both by excess volatility and persistent misalignments, that is, prices dev iating persistently from fundamental valuations i.e. the internet bubble talks against fundamental valuation efficiencies.
Full-insurance efficiency: It enables economic agents to insure for themselves deliveries of goods and services in all future contingencies . The system of financial markets can be efficient in the technical, information arbitrage, fundamental valuation and functional senses without possessing what Tobin called Arrow-Debreufull insuran ce efficiency, that is, without supporting Pareto-efficient economy-w ide outcome s. The reason is that real world financial markets interact with labour and goods markets that are inefficient in every sense of the word. Functional efficiency: Related to the economic functions of the financial system. The services the financial industries perform for the econom y as a whole. Tobin challenges the notion that the financial markets delivered ' value for money' in the social sense. ' .. .the services of the system do not come cheap. An immense amount of activity takes place, and considerable resources are devoted to it. These four factors are also referred to in the OEeD text where it is stated that the efficiency with which a financial system performs the first 3 interdependent functions canno t be directly observed, let alone measured.
â&#x20AC;˘ Burrell, G. & Morgan, G. (1979) Sociological Paradigms and Organizational Analysis, Aldershot p. 1-10 & 16-25.
8 10f l5 0
Course:
Manage ment Control & Finance (additional literature)
Ab stractor:
Jonas Warre r Pete rsen jopeOOac@student.cbs.dk
Lect ure :
Beyo nd
T itle:
Soc iological Paradigms and Organ isationa l Analys is
A ut hor(S):
Burre l & Morgan
Keywords:
Social Sciences, Paradigms, Radical Humanism, Radical Structuralism, Interpretive Sociology, Functionalist Sociolo gy
Main Frame
The Social Sciences can be grouped into four different paradigm s along two dimensions, ' radical chan ge - regulati on ' and ' subj ective - objective' . Insights into how different theori es or concepts is located in this respect can give valuable know ledge about which implicit assumptions the theories or concepts possesses, allowing for comparison and grouping of these.
Date :
14.04.05
Note : I was not able to get my hands on the articles handed out. I hope and believe that it is the right article I have found . Please check that before you read further (look in Title) . Different thoughts within philosophy have affected the way we think about organizations and the social world. The article emphasizes Critical Theory (Haberrnass), Phenomeno logy (Ihde) , Socio logical Pos itivism (Comte) and Marx ist Theory (Max) amongst a few. Those four should definitely be mentioned as good starting points if one wants to dig further into this topic ... Voila - you have just gone through thoughts from each of the paradi gms mentioned above. The social sciences can be grouped into four different paradigms along two dimensions. The dimensions entail assumptions of an ontological nature (conc erns about the very esse nce of the phenomena under investigation) and assumptions of an epistemo logical nature (about the grounds of knowledge, how we understand the wor ld).
OBJECTIVE - SUBJECTIVE DIMENSION (ASSUMPTIONS ABOUT THE NATURE OF SCIENCE) Objective: (Ontology) Realism. The social world external to individual cognition is a real world made up of hard tangible struct ures. Whether or not we label and perceive those structures, the realist maintains, they still exits as empirical entities. (Epistemology) Pos itivism. Seeks to explain and predict what happens in the social world by searching for regularities and causal relationships. In an essence based upon the traditional approac hes that domi nate the natural sciences. Subj ective: (entology) Nominalism. The social world external to individual cogn ition is made up of nothing more than names, concepts and labels which are used to structure reality. The nominalist does not admit to there being any ' real' structure to the world which these concepts are used to describe. Briefly, the world ex its as part of our cognit ion - in our perception of it. (Epistemology) Anti-Positivism. The social world is essentially realistic, and can on ly be understood from the point of view of the individuals who are directly involved in the activities which are to be studied.
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A brief examp le: Phenome nology. A group of peopl e sta nds aro und an elephant. Each being blindfolded. One thinks he' s dealing with a snake, ano ther guy thinks he' s dealing with a cow (the tail) and so on and so forth . Th is amazing story serves as a metap hor for how Don Ihde (father to Phenomeno logy) thinks abo ut the world. Regulation - Radical Chan ge dimension (assumptions about the nature of society) Thi s dimension bui lds upon previous discussions about an ord er - conflict debate. The order emphasizes:
view
of
society Th e conflict emphasizes:
Stability Integration Functional co-ordination Consensus
view
of
society
Change Co nflict D isintegration Coercion
Source: Ass umptions about the Nature of Society p. 13 Those terms can mis lead one to think of the regu lation rad ical change dimension as a continuum which is all wrong (remember we are dea ling with paradigms which we are ' trapped within'). Therefore, Burre ll & Morgan introduces the regu lation radical change dimension.
The soc iology of REGULA T ION is concerned with: The statu s quo Social Order Consensus (voluntary and spo ntaneo us) Social integration So lidari ty Need Satisfaction Actuality
The sociology of RADI CAL CHANGE is concerned with : Radical Change Structural Conflict Modes of dom ination Contradiction Emancipation I Deprivatio n" Potentiality
The two perspectives sho uld be seen as separate and distin ct from eac h other, even thou gh we under each ma y use word s that cou ld confuse the polar ization.
Examp le of Regul ation perspective: Social Sys tem Theo ry. Essentially, an organisation shou ld be seen as a system in which the different elements wo rks together to do something. Remember that one is not naive und er eac h of the perspectives - in Social System Theory one co uld use terms as dom ination . What is impo rtant is the overall theme, that an organi sation is a sys tem of part s working togeth er to achi eve a unifi ed goal (instead of viewing the organi zation as a web that dom inates people where peop le should break free) . Examp le of Radical Change perspective: Bourdieu and his perspectives about power and violence. Essentially, every soc ial interaction involves distribution and use of power. As so, the thought about one mak ing tru e perc eptions about the world through con version (thinking of Socrates) is obscure. There wi ll always be a master and an apprentice (thinki ng of Yoda), and the apprentice can merely I
2
Di ctionary: E mancipate, to free somebody D ictionary: Not having sth that you need
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do anything else than to believe what the master says . What Bourdieu is pointing too, is the fact that when we read an article made by Porter, the very fact that we know that Porter has made it (and believe that he is the man) perverts our true acknowledgement of the world or the reality. We shou ld be aware of this, and try to free ourselves to make good or true science. Like in class when we are discussing this article and some puppets mere ly says the same as the teacher (master) while nodding their heads, because they fail to see the power in the interaction (slaves). To make it even more perverted, by reading this abstract you are distribu ting power to me. Now your perception of reality has been affected by me!
The/our paradigms THE FUNCTIONALIST PARADI GM: Sociolo gy of regu lation - Objective Theories with in this parad igm are concerned with providing explanations of the status quo, social order, consensus, social integration and solidarity. In its overall approach, the paradigm seeks to provide essentially explanations of social affairs and to understand society in a way which generates know ledge which can be put to use. Effect ive regulation and control of soc ial affairs by ' measuring' the social world (typically using approaches from natural sciences). A good examp le is Comte (classic positivism) which experienced the hunger, killing, pain and so on and so forth during the French revolut ion. Comte saw the social science to be the ' highest' and most complex, with a firm believe in equations and cause-effect relationships. It wou ld truly be this science that would be most difficult to understand - but this must be our ultimate goal - to be able to regulate the society to avoid human suffering. As so he employed a typically standpoint with this paradigm, the desire to explain, predict and regulate, which can be linked to many theories about organisations. The Interpretive Paradigm: Sociology ofregulation - Subjective Theories within this paradigm are concerned with explaining the world as it is, to understand the fundamental nature of the soc ial world at the level of subjective experience. The socia l world is an emergent social process. Given this view of social reality, it is hard ly surprising that the commitment of the interpretive sociologists to the sociology ofregulation is implicit rather than explicit (after all, it is through our social interaction that we are able to create/perceive the world). An example within theories about organisations could be Communities-of-P ractice (no truths and a lot of understand ing about the socia l processes taking place).
THE RADICAL HUMANIST PARADI GM: Sociology of Rad ical Change - Subjective One of the most basis notions underlying the whole of this paradigm is that the consciousness of man is domin ated by the ideological superstructures with which he interacts. The paradigm emphasises the import ance of overthrowing or transcending the limitations of existing social arrangements.
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Example: Anti-organisation theory (if there is something like this). Beyond mere organisation theories one should mention Habermas, Horkheimer, Bourdieu (see elsewhere) and Descartes (I think he also belongs here) - and so on and so forth. Besides it is my opinion that Latour and our very own Kjell Tryggestad belongs here. This opinion is not shared by Sof Thrane I should mention. Looking into Latour and Kjell, one starts to wonder about the purpose of explaining technologies effect on the social world of humans. In sum, the very purpose of pointing to some humans becoming actors, non-humans and maybe even made of steel, for me carries an implicit warning that we should be aware of this fact. In 'science-in-the-mak ing' or in everyday life where people are 'turned into steel', we should be able to recognize this and seek liberty, free thoughts and so on. Think about why Latour and Kje ll uses words like: war, steel, non-actor, impose on, non-human. Surely, those words are not ju st used to describe without looking for something (freedom) . Seeing the interactions during class discussion (see Examp le of Radical Change perspective) just enhanced the perspectives in this paradigm. Some were indeed turned into steel! THE RADICAL ST RUCTURALIST PARADIGM Sociology of Radical Change - Objec tive Whereas the radical humanists forge their perspectives by focusing upon 'co nsciousness' as the basis for a radical critique of society, the radical structuralists concentrate upon structural relationships within a realist social world. They emphasise the fact that radical change is built into the very nature and structure of contemporary society, and they seek to prov ide explanations of the basic interrelationships within the context of total social formations. Common to all theorists is the view that contemporary society is characterized by conflicts which generate radical change through political and economic crises. It is through such conflict and change that the emancipation of men from the social structures in which they live is seen as coming about. In other words, Karl Marx rules here. One fundamental conflict with emancipation of workers as the final goa l. Within management accounting perspectives that acknow ledges those conflicts can be found . Typica lly they take the standpoint of the capitalists. CONCLUSION Thinking about the underlying assumptions in theories that we use, we are able to compare and group those theories to enhance our understanding and learning. Moreover, we can avoid the risks of mixing pears with bananas. Finally, it looks damn smart to include some of the words used aboveŠ>. â&#x20AC;˘ Brickley, J.A, Smitb, C. W & Zimmerman, J .L (2005): Economists' View of Behavior, Chapter 2, 16-41 Course : Abstracto r: Title:
Management Control and Finance Monir Azzouzi
Lec ture :
10
Economists' View of Behavior
Author(S):
Brickley, J.A, Smith, C. W & Zimmerman, J.L
850f150
Date: 4th of June ' 08
Keywords :
How individuals behave and basic microeconomic theory.
The text starts with an explanation of basic micro economic theory such as opportunity costs, utility, indifference curves, constraints etc. It' s on basic level which everybody should still remember. So that part will not be explained in this abstract. The text takes Merri ll Lynch as a case example and try to explain the behaviour of its employees by different behaviour models and why they act dishonest. Managers are interested in affecting the behaviour of individuals such as employees, custome rs, union leaders etc. The economic approac h views individual actions as the outcome of maximising persona l utility. The outcome of individuals making economic choices is a function of both constraints and preferences. Economists view of behaviour: • Individu als are seen as having unlimited wants but limited resources • They rank alternati ve uses of limited resources in terms of preference and choose the most preferred alternativ e • Individuals are not necessarily selfish, they also care about charity, family, religion and society
Happy-Is-Productive Model • Happy employees are more productive • Psychological theories such as Mas low's and Herzberg's are often used as guides to increase job satisfaction • More interesting jobs, increasing pay rate and better work environment are the solution for more producti ve employees • Employees exert high effort when they are happy O nly-Money-Matters M odel • Employees exert effort because of the monetary rewards
Good-Citizen Model • Employees have strong personal desire to do a good job, they take pride in their job • If employees do wrong, the reason is usually because they misunderstand what is best for the firm • Employees place the interests of the company first. • No conflict between emp loyee' s interests and the company ' s interests
' Prod uct-of-the-environment Model • The behaviours of individuals are largely determin ed by their upbrin gings • Cultur and house hold encourage to positive or negative values What is useful to use depends on the situation, but the most accepted is the economic framework. The author claims following:
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• • •
Happ y employees are not necessarily more productiv e. Little relation between job satisfaction and perform ance. The good citizen mode l is not realistic. Otherwise employees would work harder and produc e higher quality ju st by request. Not realistic.
If you have forgotten about risk aversion, risk prem ium and how the individu al make decisions, look at page 35. It will take to much time to make all the equations and figures ... sony guys ©.
THEME 5: ENTREPRENEURIAL FINANCE: BUSINESS PLANS AND INVESTOR-LENDER RELATIONSHIPS Lecture 11: Entrepreneurial Finance introduction (Monir) • Smith, J.K. & Smith, RL., (2004) Entrepreneurial Finance, Wiley, Chapter, I-2 and 11-16 . Smith & Smith (2004) - Chapter 2: An overview of New Venture Finan cinz
Co urse:
Management Control and Finance
Abstractor : Rasmus Hannemann Moller
I Date: I 02.02.04
Lecture:
I
A uthor(S):
Smith & Smith
Ti tle:
Chapter 2
Key words
Venture financing, organisational forms, venture devel opme nt stages
An Ove rv iew of New Ve nt ure F i nanc ing C ho os ing the O r gan i sat iona l F o r m One of the earliest decisions an entrepreneur must mak e concerns the organi sation al form of the venture. The choice has important implications for a var iety of factors, includ ing taxes, liabil ity, succession, and ability to attract financing and emp loyees. The choice of organi sational form can be addressed most effectively by using criteria such as those in the first table to exclude alternat ives. , Organisatio nal Form
Ownership Rules
• - -----
•••- - . - - - . -
Tax Treatment
"n'_ _ _._n ' . - -- • •
. ,. Liability
--._--------:1
Transferability ro I. owners lip
Fin C a
Sole propri etors h Ip
A single own er
Earnings pass through to owner
Owner is liable for business debts
Only thro ugh sale of the business
Limited by financial capacity of owner
Partnership
Two or more coowners
Earnings pass through, flexibility concern mg allocation of gains and losses
Each partner is fully liable for business debts
Partnership interests may be transferable through sale, subject to approval of other partners
Limited by combined financial capacity of the partners. Partners may disagree abou t borrowing to support the venture.
870f l5 0
Limitedliabilit y partnership
Two or more coown ers
Earn ings pass thro ugh, flexibi lity concerrung allocation of gains and losses
Liability of partners is limited to the extent of their investm ents
Partnership interests may be transferab le through sale, subject to approval of other partn ers
Limited by combined financial capac ity of the partners. Partners may disagree about borrowing to support the venture.
Limited partnership
General partn er(s) with contro l and limited partn ers who are passive investors
Earn ings pass throu gh, flex ibi lity conce rnmg allocation of gains and losses
Each general partner is fully liable for business deb ts. Limited partners are liable to the extent of their investments.
Partn ership interests may be transferable through sa le, subj ect ( 0 approv al of other partners
Limited by combined financial capac ity of the partn ers. Limited partn ers may have substantial financial capac ity.
S corporation
Up to 75 shareholder s, one class of stock
Earnings pass through to owners
Liability of shareho lders is limited to the extent of their investments
Shares are transferable without approval of other investors as long as guidelines and SEC rules are followed
Limited by constraint on max imum num ber of shareho lders
C corporation
Unlimited numb ers of share ho lder sand classes of stock
Taxa ble to the corpo ration whe n earned and to shareho lder when reali zed.
Liability o f shareholders is limited to the extent of their investments
Shares are transferable without approval of other investors as long as guidelines and SEC rules are followed. Registered shares of public corporat ions are freely transferable.
Unlimited, since numb er of investors is not limited
The choice of organisational form is of strategic importance to a new venture. Sole pro prietorships and sma ll partnershi ps are oft en eas y to con vert to other forms, but as the venture grows and more
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parties become invo lved, the ability to transition from one form to another decrea ses. Thus, it is important to select organi sational form in light of overa ll strategic orientation. Information Prob lems Facin g th e E ntre p re ne u r and Inv e stors Three basic information problems characterise the market for financing new ventures. First, the entrepreneur' s information about the value of the opportunity may be incomplete and uncertain. Second, information about the value of the idea and the abilit y of the entrepreneur is held asymmetrically: The entrepreneur may have more accurate informat ion about the idea's technological merit, whereas outside investors may have superior inform ation about economic value. The entrepreneur probabl y knows more about his or her own abilities, managerial skills, and commitment than does an outsider. Asymmetry of information leads to the third problem - i.e. risk of appropriation of intellectual property. How can an entrepreneur convince prospective investors of the merits of the project without risking appropriation? S t a g i n g of fi na ncin g - Financing one stage does not comm it an investor to finance additional stages. Indeed, the source of financing often is different at each stage. Thus, staging reflects the common-sense idea of "wait and see". Staging can be beneficial and advantageous to both the entrepreneur and the outside investor. Meas uring Pr ogr es s w ith Mil e ston e s Reliance on milestones enables the parties to postpone financi al commitments until they are needed, and to base infusion on the levels of risk and expected return that exist on the time of investment. The particular nature of the venture determines which milestones provide the most potential to assess progress and facilitate the venture's development. The nature of the venture also deter mines the order in which the various milestones are likely to be reached. The key is to select the milestones that resolve uncertainty about potential success. Stages of New Venture Deve lopment To avoid over-generalising, the figure represents a high-tech, single-product venture for a product 8 6 4
2
o - - R e v e n ue
-2
- - N e t Inco m e - - C a s h F lo w
-4 +---...,~~
Development
..EE-----,l~~ Slart -up
..E E-----i~. ..EE------!~~ .. EE----- - - - - - + Early Growth Rap id Gro wth Ex it
that gains rapid market accepta nce after it is introduced. Seq ue nce of New Ve nt ure F inancing
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It should be evident that the stages in the above figure correspond roughly to measurab le mil estones . A correspondence also exists betw een the milestones and the opportunities to attract outside financin g.
S o u rces of New V entur e F ina nc i ng . ~ ~e,?p~~!JI~Stort-uplP.'f!"路
Early Growth
RapId Growth
EXit
Entrepreneur Friends ond Fami ly Ang el Inv estors
Strategi c Portner Ven ture Capital Asse t-b a sed l ende r Equipmen t Lesso r
sale Tra de Credit
rector Me zzanine l ender Public Debt
,PO Ac q uisition, LBO. M BO Bloc" shoding incicotes primary locus of investor type. Groy shading indicates secondary rcccs.
Of
focus of a subset o f investors.
T he De a l A central aspect of an entrepreneur's attempt to raise reso urces is negotiation o f the dea l with the owner of the reso urces . The dea l defin es the allocation of risk and returns and defin es other rights and obligations of the entrepreneur and the outside investor. A we ll-structured deal has the potential to create value for the entrepreneur and to provide the investor with a return that compensates for the risk. Smith & Smith - C hap ter 2: An Overview of New Venture Financing Abstract The purpose of the chapter is to introduce common term inologies and the organization behind a new venture's financing. Organizational forms : So le proprietorship - a single owner who is liable for busine ss debts Partnership - two or more owners where each partn er is fully liable Limited liab ility partnership - liability is limited to all partners ' investments Li mited pa r tnership - eac h general partner is fully liable for debts while limited partners on ly are liable to the extent of their investment S & C Corporations - liability of shareho lders is limited to the extent of their investments Due to the uncertainty of a new venture's future and the information asymmetry held by investor and entrepreneur, you postpone financing comm itments by dividing it into stages or milestones thereby reducing the risks and mini mizing the entrepre neurs' loss of equity. 1) Exploration ofa concept - seed capital financing 2) Start-up activities focused on later research and development to initi ate sales - start-up financing 3) Early growth as production is generating revenues but is not profitable - first stage financing
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4) Rapid growth is a com pany ope rating on arou nd the breakeven po int but consumes cash to keep up - second stage financing 5) There can be third stage and fou rth stage capital requirements, which is not rare.
So urces offinancing: Ad 1: The entrepreneur, friends and famil y, angel investors Ad 2: Ange l investors, strat egic partner, VC, lenders Ad 3+4+5: Strategic partners, VC (is more than just capital, bu t also a sort of com pleme ntary asset)
Importan t term s ofcapital etc. Me zzanine financin g - Debt finance to support the expansion of profitable businesses Bridge financing - temporary financi ng between later stages and harvesting amo ng other things also to help facilitate LBO and MBa !P O finance from pub lic offer ings The Deal - defines the allocatio n of risk and return s and oth er rights and ob ligations of the entrepreneur and investor s Smith & Smit h - Chapter 11: Financial Contracting with Symmetric Information Symmetric info enta ils that both the entrepreneur and the investor possess the same expectations about the venture and know they share the same expectations. Two types of sharing of risk and return between the investor and entrepreneur
Proportional sharing of risk and return between the inves tor and entrepreneur: 75% invested = 75 % Equity
Non -proportional sharing of risk and return between the investor and entrepreneur is more rea listic due to the fact that I) co mpe tition betw een investors occur and 2) a venture is in pure financial terms more va luab le to a div ersified investor (on ly market risk) than to an un-diversified entrepreneur (tot al risk as he puts all the eggs in one basket), if they share the same beliefs about risk and future cash flo ws. Th ereb y a lower discount factor can be used by the inve stor on the investm ent. The risk (total risk) is higher for the entrepre neur makin g him requ ire higher returns; the refore entrepreneurs need to value proj ects on higher discount rate s. Giv ing up some of the venture, risk and return s to an investor, will decrease cost ofequity/disco unt factor and increase a more positive NPV for the actor. Contracting w ith outside investors is a way to reduce the overall required rat e of return on the venture 3) investors need to keep the entrepreneurs incentives aligned and not take all of the equity, which they do not need to as they use lower discount factors. Sm it h & Smit h - C hap ter 12: Infor mation and I ncentive Pr ob lems a nd Fi nancia l C ontracts Co ntracting und er symme trica l beliefs are rather easy because there does not exist any complexity in the contract due to an identical und erstand ing of the risk and returns . Du e to the fact that each party has ince ntives to m isrepresent their true information or beliefs, creates information prob lem s under contrac ting. Bounded rationality - you cannot specify all possi ble contingencies in a contract. Inf ormation asymmetry - One party has information that the other one does not have and may have an incentive to misrepresent what he knows, which can cau se risk and return to be allocated less efficiently than if information was shared. Thi s makes asymmetry diffi cu lt to overcome. A dverse selection - Differences in exp ectations can make cap ital raising difficult; ex ant e info asymmetry.
Possible to overcom e by: â&#x20AC;˘
Sending strong signals that you are a peach (giving up privileges such as mov ing, lower wages etc .)
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â&#x20AC;˘
Screenin g by offerin g a choice between alternative terms such that the part y with private inform ation reveals that information by choosing (e.g. low produ ctivity wo rkers choose hourl y paid jobs where high productivity wo rkers choose output payments)
Moral hazard - ex post inform ation asymmetry when sunk costs have been made occ urs when contracts are incompl ete and when monitoring is difficult. Financial contracts give rise to moral hazard as the entrepreneur feels less urgent to achieve success when investors share benefits. Shifting from outside equity to debt changes the entrepreneur's incent ives, if he is the residu al claimant. This is called a discrete contract as long as co llateral ex ists i.e. a house, car etc.) Thi s will not happen, if the debt is risky. Possible to overcome by: Relational contract - creates the poss ibility for the investor to cont inue funding only as long it is in his interest. Flexibility helps the two parties to make the financial contract and resolves some of the moral hazard problems as the entrepreneur will work hard to obtain the next round of financing. Bonding - pena lty for engaging in opportuni stic behaviour Reputation as a bond - a dam aged reputation is a high bond but requires that there is a valuable reputation Extensive monitoring, ifpossible It is not unhea rd that an investor has required a sma ller ownersh ip for putt ing cap ital in a venture that the entrepreneur was willing to give. This has to due with the investors' fear of decreasing the incentives of the entreprene ur to make an effort too much.
S mlith & S miith - Ch apter t 13 : Co urse :
MCF
Abstractor:
Steen Blaabj erg
Lecture:
I
Title:
Chapter 13 "Financial Contracting"
Author(S):
Smith & Smith
Keywords:
Staging, Asymmetrical info , Values of new venture financial claims, financial contracts
Main Frame
The objective of financial contract design is to dev elop contracts that enhance and allocate value. Contract terms can enhance value by helping parties overcome information asymmetries and by aligning their incentives + through the structure of real options that com prise the venture and the allocation of decision rights to the opt ions. The financial contract brings together issues of real options, incentive alignment, information signalling, and va luation of complex financial claims. Throughout the chapter asymmetric information is recognised.
I Date: I 2-2-2 004
Staging of investment: The venture capital method This chapter exp lores the differences between sing le-stage and multi stage investments. Single-Stage: E.g. when the entrepreneur wants to raise enough cash at time zero to cover projected cash flows for the entire period . M ulti-Stage: E.g. instead of requiring that the entire amo unt be invested at time zero, the entrepreneur is willing to acce pt the investor ' s counterproposal to contribute the capital in stages, if staging wi ll enable her to maintain control and majority ownership . Based on the valuation method, it is claimed that with staging the entrepreneur can retain control and majority ownership of the venture. 92 of I SO
Why does staging reduce the outside ow nership share? To understand why staging reduces the ownership interest of the investor and benefits the entrepreneur, it is important to know why the hurdl e rates in the different calculations change for investments at later stages. How is the investor 's commitment different in a single-stage investment from a multi-stage investment? For a single stage the commitment is absolute. Even if it becomes clear, during the investment period, that the project is estimated to fail, the investor's capital is irrevocably committed. It follows that the lower hurdle rates in the later stages of multi-stage investments arise because
some of the uncertainty about venture performance is resolved before the decis ion to invest must be made. The later-stage investments are made only if the venture continues to be attractive. Thus with staging, the entrepreneur is accepting some risk that the investor will not provi de future rounds of financing or that the terms will be different from those originally envisioned. Because additional risk is shifted to the entrepreneur, it is not clear whether to choose the single or multi -stage investment as the best deal for her. In multi-stage investment, the entrepreneur can expect to retain control and majo rity of ownership if the success scena rio is realised, but bears more risk that financing will not be available or that the investor will require a larger fraction of equity if the success scenario is not realised. The venture capital method provides no guidance to the entrepreneur for comparing these alternatives; she cannot choose between the investments simply by comparing the fraction of equity that she retains in the success ratio. Hence, valuation models (from earlier chapters) are used to evaluate the entrepreneur' s choice. In connection, mainl y the CAPM valuat ion method and the interplay between real and financial options are used to illustrate how valuation can be used as guidance for the entrepreneur. Valuating the Staged venture at each round & Design ing the investment agreement When investment is staged, the investor 's financial claims and those of the entrepreneur can be adj usted at each investment round. The value of staging the investment der ives prima rily from reduct ions of uncertainty about the likelihood of success or failure. As the uncertainty is reso lved and the venture moves closer to harvest, the value of the venture changes . These value chan ges affect the compensation the investor must receive for investing cash in a financing round. The challenge of a valuation based contracting model is to design an investment agreement that enables the investor to realise the intended shares of harvest value depending on which scenario is achieved and on whether the entreprene ur's expectations or the investor' s proves to be more accurate. The agreement should also allow for the possibility that different parties may invest in some of the later stages.
Dea ling with parties' different beliefs E.g. the parties differ in the belief that the venture will fail. Because failure is determined in the first investment round and we can never know the ex ante probabiliti es (i.e. different scenarios), there is no way to address this issue other than by staging the investment. By staging, the parties reduce the fraction of equity and amo unt of capital that are exchanged at the point when their beliefs are most disparate. The contract may appear to be complex with the many aspects of uncertainty. However, that is only true if parties insist on negotiating the entire contract at the outset. If the parties can operate with a degree of mutual trust, they may only need to contract explicitly for their initial difference in
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beliefs. A fter stage I. is com plete, the parti es expectations' are likely to co nverge and elaborate wa rrant structures may no longer be importan t. Us ing contracts to increase value, signal beliefs, and align incentives Assuming that the parties to a venture have symme trical beliefs and that the contract structure do es not affect e ffort or other decisions of the parties, the value of the venture is maximised if all nonmarket risk is borne by a we ll diversified investor. Ho wever, information and incentive problems operate aga inst the propos ition that the investor should bear all the risk. Suppose the entrepreneur recognises the value of shifting risk to the diversified investor and pro poses a mo re extreme allocation; e.g . the entrepreneur pro poses that the investor buy her out and hire her back at a salary equal to her opportunity cost. Altho ugh this proposal may lead to an increase in NPV, the investor is like ly to be sceptical of the entrepreneur's proposal due to 3 reasons: I. The investor may interpret the entrepreneur's wi llingness to se ll as a negative signal and reduce the valuation to co mpensate
2. The investor may be co ncerned that, because the entrepreneur has nothi ng at stake, she may not wo rk as hard to achieve success and the venture may not do as we ll.
3. The prop osal to sell out leaves the entrepreneur mu ch worse off than if she can find a way to convince the investor that the entrepreneur's proj ections are co rrect. Dea ling effectively with these incent ive and information prob lems is an important aspect of new venture financ ial contracting. Us ing simulation to design financial co ntrac ts Simulat ion affords an expedient and insight ful way of com paring alternative financial con tracts (i.e. rather than discrete sce nar io analysis) The value of any venture depend s on how the financial co ntrac t is structures, and spec ific contract alternatives can only be assessed in the co ntext of the venture. In this sense , a 5 step process (fig. l3-I I) is prop osed to design and evaluate a financial co ntract (by simulation) from the perspect ive of the entrepreneur. I wont go into details of the mod el, but is provides a basic understanding of using simulation to design financial co ntracts; note at step 2 that for an y real opt ions it is necessary to make spec ific ass umptions abo ut the co nditions under which the option wou ld be exercised. Info rmation, Ince ntives, and co ntract cho ice This sect ion examines ways of applying financial modelling and simulation to address other co ntracting issues: I . Types of finan cial claims
â&#x20AC;˘
Debt financing: Straight debt financing is easy to incorporate in a financial mod el of a new venture. If the entrepreneur is willing to rely on the market to generate a competi tive interest rat, then it is not neces sary to value the finan cial interests of an outside creditor. Th e primary factors that affect value of a debt claim are duration , co ntractual interest rate, and market risk. Unlike an equity claim of a new venture, debt normally ge nerates periodic cas h flows from paym ent of interest and repayment of princ ipal. T hus, it is not reaso nable to ass ume that all of the cash flows are received at the time of a liquid ity eve nt.
â&#x20AC;˘
Personal Guarantees: No matter how poorly a venture perform s, the entrepreneur's ability to guarantee the ventures' obligations is always limited by the entrepreneur's wea lth. This is a good poin t of departure when va luing financial c laims .
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•
Warrants: Are long term call options whereby exercising the option increases the numb er of shares outstanding. Can e.g. be issu ed to an outside investor as a swee tener for a loan or an equ ity investment, or to the entrepreneur. (e.g. a first-stage investor receives a warrant that can be exe rcised if he mak es an additiona l investment.)
•
Ratch ets : Is a right to rece ive future shares of the venture in the eve nt that value per share is lower in a subsequent round of financ ing.
•
Aban don ment: The investor can abandon the second-stage investment on the condition that a certain mi lestone is not ach ieved.
•
C ont r ol r ight, Termination right, and other rights: E.g. there is no reason that voting control of the venture must be proportional to shares held; the investor may have the right to terminate the entrepreneur if certain conditions are not met.
2. Number of contractin g pmties Many new ventures involve three or more parties. •
Direct Explicit involvement of a third party: E.g anot her than the existing investor can provide the second-stage financ ing; B/C entrepreneur want to distribute contro l rights and ownership or gain strategic know ledge from the new investor.
•
Dir ect I mp licit involvement: Occ urs when the parties to a nego tiatio n are cons idering financial term s that couls affect the conditions under which a subsequent party wo uld invest (e.g. if the option of a first-stage investor is not exercised to invest in the seco nd stage, then anoth er investor might be found .
3. Use of contract provisions to reso lve information and incen tive prob lems M any contract pro visions he lp mitigate information asymmetry and align incentives. If the parti es have symmetrica l expectations, then the highest-valued contract is one in which most of the risk is born e by the we ll-diversified investor. Venture contracting goes in this direction, but the entrepreneur still bears a large fraction of total risk. •
Debt Financing: Expected cas h flows to the entrepreneur usually are higher if outside financin g is in the form of debt , but the risk of the equity cash flows also is highe r. Substituting outside debt for outside equity shifts total risk from the investor to the entrepreneur. B/C the entrepreneur is concerned w ith total risk, subst ituting outside debt for outside equity is likel y to reduce value. However, if an entrepreneur is optimi stic but unable to convince the equity investor, debt financing may seem compelling as the investor will demand more of the equity. Also , by rais ing outside capital in the form of debt, the entrepreneur can signal optimism.
•
Earn-ups: Protecting the entrepreneur: The entrepreneur's ownership stake depends on the financia l performance of the venture; the investor commits cap ital based on a pessimi stic forecast of performance, but ow ners hip is transferred to the entrepreneur if the vent ure meets or exceeds the perform ance benchm arks.
•
Protecting the entrepreneur: E.g. the entreprene ur is concerned that subsequent financin g will be difficu lt to arrange, the existing investor can agree to give the entrepreneur a call opt ion on add itional fund s, where the entrepreneur's righ t to exercise the ca ll is tied to achievement of a verifiab le mileston e.
Sm ith & Smit h - C hapter 13: Financial C ont ract ing Staging reduces the outside own ership share:
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•
Does not tie all of the necessary cap ital at once, wh ich lowers risk from the investors ' perspective, born by the entrepreneur in stead , requiring a lower hurd le rate to value the project (rate of return). Putting less money in the beg inning where uncertainty is very high and more money alon g the way when risk of the venture is reduced resu lts in a smaller ownership requirement by the investor relati ve to bear the whole risk imm ediately (sunk cost) .
The financial contract is one of the key drivers for a vent ure turning out successfully or experience a failure. • Aligning incentives • Sweeteners & bonds • Plans for real options • Signalling to stakeholde rs i.e. other investors, suppliers, customers beliefs in the venture, prod uct if a VC with good reputation is support ing the ven ture Course:
Ma nagement Co ntro l and Finance in Technology Intensive Com pan ies
I Date: I 09 .02.2004
Abstractor : Rasmu s Hannemann Meller
Lec ture:
3
Ti tle:
Entrepreneurial Finance, chap. 14
Aut hor(S):
Smith & Smith
Keyword s :
Venture Cap ital Fu nds (org. structure, inve sting, how they operate, and significance of reputation)
V enture C a p it a l (pp. 466 - 506)
Venture capital does not only refer to capital invested in new ventures, but also cap ital suppli ed by a specific kind of financial institution, i.e. Venture Capital Funds (VCF), and they do not necessarily invest in new business ventures. These institutions are unique in their structure and in the way they operate (co ntinuously evo lving and innovating), and it' s important for entrepreneurs to contemplate this. In essence VCF search for high-risk dea ls with potential for huge payo ffs. In the early years of the venture capita l market, the investm ents wen t prim ari ly to seed, start-up, and early-stage ventures. In more recent years, VCF have focused increasingly on expans ion and laterstage investm ents. By 2001, seed and start-up stag e investm ents acco unted for a very small fraction of VCF investm ents. Moreover, the venture capital market is only a very small fract ion of the general financing market (pension funds, life insurance companies etc.). VCF are very active on the IPO market (Initial Public Offering, i.e. ' bersnotering'), though. Wh y? Because VCF serve a much spec ialised market niche - They tend to stay away from early stage ventures that require modest amounts of capital. Rather they seek ou t young firms with potential for rapid and substantial grow th and which require heavy capital investm ent to finance the growth. Thus, VCF fills a niche between early-stage private investments by the entrepreneurs, their friend s etc. and the established-co mpany market for public capital or priva te corporate acquisition. T he O rga ni sati on of V entur e Cap it a l F irm s Successful venture capital investing depends on findin g solutions to an array of complex probl ems. The fund manager must sort thro ugh a plethora of business plan s, each describing a venture with a negligible operating history. In addition to identifying the few ve ntures that are likely to be successful, the investor must be able to add enough value to th e dea ls to cover the extra costs of administering the fund ' s investm ent portfol io.
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Organisational structure: The ve nture capital limited partnership has become the dominant form of fund structure for venture capital investing. The general partner (can be severa l people) is the fund organ iser and is responsible for raising investment capital from the limited partners and deploying the capital by investing in portfolio companies. Inst itutional investors (un like private) are the predominant limited partners of a VCF. Investors commit to fund s for several years, with no convenient means of achieving liquidity. Because institutional investors (e.g . pension fund s) are long-term inve stors, the lack ofliquid ity is not a prob lem . Failure [of the limited partners] to deliver capital [to the general partner] when called upon to do so cou ld cause the fund to miss inve stment opportunities and could otherwise disrupt fund operation. (See Figure I) The Investment Process : Normally, it takes two to three years before a fund is fully invested. During thi s period , the gene ral partn er is busy scree ning pl ans, co nducting due dili gen ce on prospecti ve investm ents, and negoti atin g deals. Corresponding to these efforts, the general manager makes additional capital call s (i.e. asks the limited partner for the money that they have committed to invest) on comm itted investors and seeks to place the entire commitment wi th new ventures. A fund can have more than one clos ing (i.e. having invested all the mo ney that the current limited partners have comm itted to invest). During this fund ing period, the general manager may bring in new investors and oversee a second or third closi ng. A closi ng defines a group of investors who are treated identicall y as the fund progresses. The norm al target life of a fund is seven to ten yea rs. Typically, the gene ral partner can extend the life of the fund for sev eral years to permit managem ent of harvest timing. The finite life o f the fund lim its and co ntro ls the general partner 's be haviour. A gen eral partner who is successful in adding value for investors will have littl e trouble gen erat ing comm itments to a new fund, whereas one who has not been successful is unlikely to attract new investors. Here, again, long-term re lations hips and reputation are important. How Venture Capitalists Add Value The general partn ers of VCF charge substantial fees for fund management and also share sign ificantly in the success of their investments. Although the general partners' return may seem excessive, VCF attract most of their financial resources from sophisticated institutional investors. Reputation and relations hips p lay an essential ro le. General partners, if they are to survive, must be ab le to add sufficient value to cover their compensation. Ultimately, they try to find the harvest opportunities that create the most va lue for investors. Managing a VCF is complicated blc the fund supplies a joint product consisting of investment capital and consulting services. Ad di ng Va lue by Selectin g Investments and Negotiating Deals: The ideal ventures to include in the fund portfolio are those in whi ch the venture ca pitalist can add significant value witho ut an excessive commitme nt of tim e. Beyond thi s, a venture is more attractive if its need s meld w ith the specific capabilities of the ve nt ure capitalist. A pros pective ve nture is more attractive if the timing is right for the required investm ent. Th is mea ns that the time interval for ve nture ca pitalist involvement corresponds to a time over which the market wi ll come to recognise the va lue of the ve nture, so that ex it is possible. Similarly, the general partner does not want to ho ld a portfolio company after the market recognises its value. Adding Value by Allocating E ffort E ffi cien tly: Recent estimates of how fund man agers allocate time to the various acti vities show that consulting, monitoring, and man aging act ivities represen t approximately 70 pet of time; find ing investments and negot iat ing deals, another 15 pet ; and capital raising and harvesting, 15 pet. Deal eval uation is another activity that consume s significant amo unts of time. Reported ly, three fulltime weeks are spe nt, on average, ove r a period of a hundred day s to evaluate a single deal after it gets through preliminary screening. In contras t, the scree ning may tak e on ly a few minu tes.
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Adding Value by Monitoring and Advising Portfolio Companies: Evidence suggests that venture capital firms foster innovation. Venture capital backing is assoc iated with job creation, higher levels of patent awards, more citations to patents, and more patent litigation. It appears that venture capital backing plays a certification role in the !PO process, as venture capital backing is associated with lower underpricing of !POs, with lower total cost of going public, and going public sooner. Syndication and Venture Capital: Syndication occurs when venture capitalists co-invest in ventures. The authors find that syndicated investments have higher retums than venture capital investments that are not syndicated. They interpret the finding as favouring the value-added rationale. I nvestme nt Se lect ion an d Ve n ture Cap it a lis t C om pe ns at ion The general partner is a residual claimant on fund value. If a portfolio company does well, then the genera l partner realises a significant return. If the portfolio company performs poorly most of the loss of value accrues to the limited partners. This has a bearing on the type of investments that the general partner will select. A venture with an attractive expected retum , but limited upside potential, is unlikely to be a prospect for venture capital, even if downside risk is small. The financial claims most common ly sought by venture capital investors are those that align the interest of the general partner with those of the limited partner. Interests are aligned when both types of partners participate in new venture success but are protected against losses if the venture perform s poorly. Vent ur e C ap it a l Co ntra cts w ith Port fo lio Co mp an ies A typical VCF portfolio includes a small number of highly successful investments, combined with a much larger number that are unsuccessful. One way to improve the overall investment selection process is to adopt contracts that limit investor reliance on ex ante due diligence efforts and valuation. Staging is well recognised as a contracting device that has this effect. Staging forestalls the investment decision until the investor gains experience with the entrepreneur and until more information arrives about the prospective success of the venture. Staging preserves some of the strategic options of the investor. In one respect, it affords greater control to the investor while enabling the entreprene ur to retain a larger ownership stake. The Ro le o f Rep utat ion in th e Ve nt u re Cap ita l Market Not only does the reputation of the venture capitalist affect the ability of parties to transact, so do the reputations of the investors who decide to participate in the funds and the reputations of the entrepreneurs who seek capital. Contractual relationships that are based partly on the reputations of the patti es can generate higher returns for the parties, blc less effort is put in contracts (covenants etc.) and the fund can act more freely. Figure 1: Organisational Structu re of Venture C a p it a l Investment
Genera! partner •
Generate deal now
•
SCreen opportunities
•
Negotiate deals Monitor and advice
Harvest investments
I
t
Effortand 1
Annual
carried
management fee 2·3 pet
interest 20-3 0
pet of capital
t pet of gain
Investmentcapital andeffort -..
. - investment capital and effort _
Portfolio companies
L• - Value creation
---l
Tile Cap ital Ma rket
Investors: Smith & Smith - Chapter 14: Venture Capital
s-
W hat does the VC provide • • • •
Cash Management assistance Mon itoring Rep utat ional capital -Suppliers - Customers -Prospecti ve employees -Tnvestors
T he organization of venture capital firms : The limited partn ership model is the most common struc ture for ve nture capital comm itments Value creation and monitoring is at General pillrtner • Ge ner ate deal flow • Screen opportunities • Negotiate deals • Monitor and advise • Harvest investmen ts
the core ofVC when helping entrepreneurs. VC might sit on the
i
i
10/0 of capital
Annual management fee 2-3%
Carried interest 20-30% of ga in
~
I
I
I E(fort
and
board of directors, monitors operations, recruits management team members, arranges additional financing, provides expertise and
--1 ~"~bnen~ cap ital and ~
Venture cap ital
effort
+-+
fund
Fina!'cial cliUffi$
t 99% of Investment capital
I
t--
contacts Port folio companies • Valuecreation
The purpose is to make the ventures ready for harvesting and to distribute the proceeds.
I
Harvesting:
Capital appreciation
• • •
7O-W%0f gain
+
Lim ited partners • Pension plans • Life insurance companies • Endow ments • Cor'p?rations • Ind ividu als
•
IPO Acq uisition LBO Liquida tion
Distribute proceeds
Figure 14-4 Organizational structure of vent ure capita l Investment Vent ure capital funds usua lly are organ ized as limite d partnerships. The general partner manages the fund. and limited partners provid e investmen t capital. The fund invests in a portfolio of new ventures.
Co urse:
Management, co ntro l and finance
Abs tracto r :
Tina Frisbeek
Lect ur e:
•
Cash
•
P ublic shares
•
Other
3: The capital
Date:
090204
market Investors T it le:
Entrepreneurial finance ch.15 ; Choice of Finan cing
A ut hor(S):
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Janet K. Smith & Richard L. Smith
Keywords:
Immed iate-, near-term-, and cumu lative financial need, business angels (BAs), venture capital (VC), financial distress, strategic partnering, franchising, collateral, reputations
The objective of this chapter is to emphasize decision-making about the cho ice of financing and to provide a framework for evaluating financing alternatives. Factors that influence financing sources appropriate for new ventures: •
A venture's financial need includes considerations such as urgency of the need, size of nearterm need, permanency of need, and size of the cumulative financing need.
•
Financial condition and stage of development, the value of outsi de advisors, and ability to use assets as collateral and to service debt.
•
The nature of relationship with suppliers, customers, and others, and costs and benefits of centralized control.
•
Track record, reputation, and relationship of the venture and the entrepreneur bear on the basis for making investments in the venture and on conditions for investing.
Existing financial relationships affect ability to raise capital. Figure 15-1 lists 25 different sources of business financing. Why are there so many alternatives? •
Because the providers have different objecti ves, capabilities, and constraints. Some such as banks seek low-involvement, low-risk and short- term investments while others (e.g. business angels) seek high-risk , high involvement and relatively long-term investments.
•
Because businesses have different financial needs.
This chapter offers a structured approach for identifying appropriate financin g sources. Ste p I.
As se ss the N at ure of the V entures Financial Ne ed s (p.5l0)
The financial need faced by an entrepreneur can be divided into 3 periods: immediate, near-term, and cumulative. The influence of immediate financing needs: If a venture faces an immediate need many sources are foreclosed due to lengthy approva l processes etc. A venture that is underway and is already generating revenues can bring in immediate cash by taking longer to pay for materials and inventory but a development-stage venture have very few possibi lities and often rely on financing based on established relationships such as friends and family. The influence of near-term financing needs: Sources that are appropriate for immediate financing often are not desirable for ongoing financing. More alternatives are available for near term financing than for immediate financing. Two factors that influence the venture's choice of nearterm financing: •
Firstly, it depends on the amoun t the venture is seeking. For small amounts prospective sources are: economic developm ent agencies, the Small Business Administration (SBA)(See further the box on p 512), banks , a group of angel investors etc. For larger amounts likely sources are: private placem ent of debt with institutional lenders, venture capital investors and strategic partners. For very large amounts registered public offering of debt or equity should be considered.
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