Lecture Notes 2
Creating value and capturing value.
Creating Value
A firm creates value by producing a product for which customers are willing to pay more than the full cost of delivering the product to that customer. Thus, an important question in strategy is how to generate a healthy gap between the amount customers are willing to pay, and costs. Since customers differ in their preferences, part of this process involves selecting target customers and tailoring the product for those customers.
Strategic choices normally involve a trade-off between willingness-to-pay and costs. Companies adopt activities that raise willingness-to-pay more than they raise costs (for target customers), and you want to scale back activities if the cost savings are larger than the loss of willingness-to-pay (for company target customers).
Capturing Value
Capturing value involves securing profits from the value that the company creates. If a firm creates value but doesn’t capture it, then the benefits from the value creation all go to customers and/or suppliers, and not the firm itself.
Location Choice as a Part of Strategy
Reasons for Going Global: There are two primary reasons for going international and a third less common reason.
1. To expand sales by accessing new markets,
2. To reduce costs, and/or
3. To reduce risk.
When going international to access new markets, a critical issue is the degree to which Companies adapt the product for the foreign market. The choice on how these companies adapt the product should be driven by the cost versus willingness-to-pay trade-off.
When going international to save costs, Companies normally pick a place that has a cost advantage. However, a firm should not necessarily carry out each activity precisely where it can be done cheapest. This is because each activity within the firm interacts with other activities, and there is a cost to interacting at a distance. For example, the R&D group interacts with the marketing group to know what the market’s needs are, and the marketing group wants to know what is coming down the pipeline from R&D. Interaction is less effective and less efficient if these groups are physically in different places.
The key factors in making those choices are the effects on cost, and the effects on customers’ willingness-to-pay.
Key cost concerns include:
•labour costs
•Costs of supplies (raw materials, real estate, energy, local services, etc.)
•Transportation costs
•Communication/coordination costs within the firm
•Tariffs and trade barriers
•Economies of scale
Key willingness-to-pay concerns include:
•Product adaptations
•Responsiveness to customers’ orders and service requirements
•Communications with customers
•Reputation
Broad Categories of Strategies
There are three broad strategies – “exporting”, “multi-domestic” and “global”. Additional variations and hybrids of these three basic strategies include the “transnational”, “branching” and “offshore outsourcing strategies.
While the location decisions can be done on an activity-by-activity basis, it is sometimes helpful to identify a general approach – for two reasons:
a. Once the first activity is placed in a foreign location, it becomes less costly to add a second activity to the same location. Thus, whether a firm selects a particular location for a particular activity depends quite heavily on whether the firm already has an international presence in that location. When a firm chooses to place one activity in a new location, several other activities may then become feasible there too.
b. When the location choices follow a basic theme, it becomes easier to build an easily-understood organization structure and to draw understandable lines of accountability.
The main categories of strategies are briefly described below.
1. Exporting Strategy
Under this approach, everything is done in one place – typically the home country. Foreign markets are served by exporting. In a sense “centralization” would be a better name for this strategy, since several of the other strategies involve exports too – albeit not all from the home country.
An exporting strategy would normally be adopted by companies that exhibit some of
the following traits:
•large fixed costs
•high internal communication costs
•low transportation costs, low border costs
•the home country is the major market, even in the long run
•the home country has a cost advantage
2. Multi-domestic Strategy
In a pure multi-domestic organization, each subsidiary is a self-sufficient entity. Each subsidiary obtains its own inputs and provides all its own supporting services. The firm’s activities are replicated in each location.
A multidomestic strategy would normally be adopted by companies that exhibit some
of the following traits:
•high transportation costs, high border costs
•low fixed costs
•no substantial cost differences between countries
3. Global Strategy
Under a global strategy, each function is performed in one place, but the functions are not all performed in the same place. For example, a firm following this strategy might do all its finance in the US, all its R&D functions in Germany, all its production of components in the U.S. and all its final assembly in the Philippines.
The global strategy could also be called a “specialization” strategy.
•A specialization strategy would normally be adopted by companies that exhibit some
of the following traits:
•costs vary substantially across countries for different kinds of production and services
•low transportation costs, low border costs
•fixed costs are large
Sometimes companies switch a specialization strategy when facing competitive pressures.
Hybrid strategies
- Branching strategy
The “branching” strategy is a hybrid of the exporting and multidomestic strategies. Some functions are centralized and other functions are decentralized. For example, R&D, finance, and key component production may be centralized, while final assembly and marketing may be decentralized. Examples include some of the Japanese automakers, who tend to make their key components in Japan, but do final assembly and marketing in North America, Europe and Asia. (Final assembly plants in a branching strategy are sometimes called screwdriver factories.)
A branching strategy would normally be adopted by companies that exhibit some of the following traits:
•high transportation costs on final goods and low transportation costs on parts
•high border costs on final goods and low border costs on parts
•low fixed costs on final assembly and high fixed costs on parts
•large economies of scale in engineering, design, strategic management and the
•manufacture of key components, and high communication costs between these
•functions
•home country has cost advantage on parts, but there are no substantial cost
•differences between countries on final assembly .
- large foreign markets
- Offshore Outsourcing Strategy
Under this strategy, the firm contracts other firms to carry out its foreign operations. In a sense, this is a combination of the exporting and global strategy. The functions are carried out according to the global pattern, but the firm itself does not carry out the offshore activities. Thus, the firm’s own activities are centralized. An example is Nike, whose products are manufactured by independent companies in various Asian countries.
- Transnational Strategy
The transnational strategy is another strategy often identified as one of the main strategies. Proponents of the transnational strategy sometimes claim that this strategy has the advantages that both the multidomestic and global strategies have. But they gloss over the disadvantages of these strategies. For example, if a firm has high fixed costs, and then replication is expensive. If the transnational strategy involves a presence in each market, then it has to bear the cost of replication. There is no way around that problem.
Transnational strategy is really a hybrid of the other strategies, and that the firm uses a multidomestic strategy only for those activities where that strategy makes the most sense, and uses the global strategy for the activities where the global strategy makes the most sense.
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