MGX5181

International Business Strategy

Week 4

Strategy Formulation and the

International Environment

• Scenario Planning

• Game theory

• Conceptual Mapping

Objectives

• To discuss a range of methods for

undertaking strategic planning including:

Scenario planning

Game theory

Sensitivity analysis

Options

• Review the use of strategic groups and

industry dynamics for international

opportunity development

Strategic decision making • (Following on from week 3) The long term

alignment of an organisation with its economic, social and political environment can be undertaken using a number of tools. The most common used are:

Country attractiveness (environmental scanning)

Macroeconomic analysis and forecasting

• Once a long term direction has been set a handful of strategic decisions on implementation can be made. Common approaches include:

Scenario Planning

Game theory

Sensitivity analysis

Options and other approaches

Scenario Planning

• A scenario is an imagined sequence of

future events.

• The purpose of scenario planning is to

develop an understanding of how an

industry’s underlying dynamics could move

it from the present state to each of several

alternative futures

• Scenarios consider not just trends or

forecasts, but ways that trends could be

upset or events could combine to create a

variety of outcomes

Scenario levels

• There are six primary levels of scenarios

considered most valuable to strategy

development:

Grand scenarios

• cover global issues such as political, legal, socio-

cultural, economic

Regional scenarios

• government initiatives, effect of GST

Industry scenarios

• such as farm subsidies, food standards

Scenario levels

Market scenarios

• including trends, market structures

Product and service scenarios

• technology and manufacturing developments

Organisation scenarios

• including competitor activity and strategic alliances

Developing a Scenario Matrix

• The six scenario levels can be overlaid onto a two

axis matrix to determine the level of radical thinking

across a spectrum from incremental to divergent.

• Incremental Scenarios

developed from rational projections. Start with

historical statistics, trends and cycles that can be

extrapolated into reasonable future alternative

cases that represent a “best”case, “worst case” and

“expected case”.

These cases are then broken down into snapshots

on a future time horizon, say 2 years, 5 years 10

years from now.

Scenario Matrix

Continued

• Divergent Scenarios

These are events that break away from

traditional trends or cycles eg high impact

scenarios such as war, recession, mergers,

change of government etc.

Steps to scenario planning

• Many variations on same theme

Wack 1985, Schnaars, 1987 – 5 step model

• Set the scene

• Generate and select factors

• Choose themes and develop scenario details

• Check the consistency of scenarios

• Develop and test strategies

O’Brien, 2004 – enhanced to an 8 step model

Steps to

Scenario Building

• Step one: Set the Scene

Define the scope of the exercise

• Eg specific problem, is it macro or micro. Eg price of oil might cover macro impact on govt of oil dependence or micro whether and oil company should open up a new oil field

• Step two: Identifying the key players and driving forces in the environment immediate to the problem

Who are the main stakeholders and how do they define success? Who will be affected and what are the key performance indicators.

• Note: The interests of the main stakeholders are a vital part of the exercise.

Steps to

Scenario Building

• Step Three: Generate uncertain &

predetermined factors

Identify in a general way the three factors which

influence outcomes:

• The driving forces for change

• The predetermined elements which provide stability

• The critical uncertainties whose unfolding underpins the

existence of markedly different scenarios

Components of

scenario building

• There are 3 main components of a scenario which

must be identified:

The driving forces

• Those factors which ensure that any system changes, and then

mould the nature of the new system and the way in which it

changes.

The predetermined elements

• Those factors from the past which continue as before,

providing stability to any system

The critical uncertainties

• Those areas where there are markedly different possibilities

but whose influence will determine the nature of the new world

Steps to Scenario Building

• Step Four: Reduce factors & specify factor ranges

Identify areas of critical importance to outcomes.

• Step Five: Choose themes and develop scenario details

Draft possible scenarios since the main themes or scenario drivers have been identified.

• There should be clear logic for each scenario – a sequence of cause and effect.

• Scenarios involve a choice of a plot or narrative story which give rise to different future.

Steps to

Scenario Building

• Step Six: Check the scenarios for consistency

and plausibility. • Check for internal logic and coherence of the narrative story.

• Stories become learning scenarios which should have titles

• Step Seven: Present scenarios • Gain feedback from key stakeholders

• Step Eight: Assess impact of scenarios

Draw out implications to scenarios

• How realistic are they? Impact on company,

• Under what situations should these scenarios be used in a

project or situation.

Steps to

Scenario Building

• Step nine: Develop and test strategies

Identify some leading indicators which are

easily monitored and can tell us which scenario

is to be realised.

• Signposts.

• Feedback loop – needs to ensure the information

coming back can be understood and acted upon in a

timely manner.

Recent trends

• There is a trend towards two approaches:

Quantitative

• In the 1980s, the Battelle consulting group

developed a product called “Interactive Future

Simulations”. This computer based modelling

process was grounded in analytical rigour.

• Deloitte & Touche took the 1970s work of the

Future group and developed a trend-impact analysis

model and added some qualitative data.

Qualitative

• Debate over whether this is the best approach

Benefits

• There are many benefits from using

scenario planning:

Enables companies to quickly respond to

changes in the environment

Alignment of thinking across the organisation

Building teams and getting commitment to

strategy

Provides a competitive advantage

Can builds corporate culture that welcomes

change

Challenges • There are a number of issues that must be

addressed to ensure the benefits of scenario

planning are achieved:

Careful selection of facilitator

• Weak or inexperienced = danger

Team selection

• Poor cross-selection = group think

Team leadership

• Problem of domination

Time consuming

Costly

Issue selection

• May choose the wrong things to focus on

Resource allocation

• Having the right resources to act on change

Game theory

• Developed by Johann (John) von Neumann, a

mathematician at Princeton University

• Game theories help decision-makers to make

sense (and react to) the actions of others.

By posing choice among alternatives in the form of

different games, decision-makers can judge to what

extent their assumptions about others’ rationality

are valid.

• McGee, Thomas & Wilson 2005.

http://www.youtube.com/watch?feature=player_detailpage

&v=aDxrnIP89EA

Game theory

• `Game Theory is about making predictions about

behaviour if people follow their own best interests,

Yet the insistence on rationality can produce

interesting paradoxes. ' Stefan Szymanski, senior lecturer in

economics at Imperial College Management School.

• A player locked in competition with a rival, for example,

might find it advantageous to be regarded as totally

irrational. If he could persuade the rival that he would be

prepared to pursue a price war to the extent of ruining his

own business, the rival might be less likely to initiate such

conflict lest it ruin him too.

Example • In 1987 the patents protecting Monsanto's NutraSweet - an

important ingredient of low-calorie soft drinks like Diet Coke and Diet Pepsi - began to run out. Well before they expired, a rival supplier appeared on the scene. The newcomer announced its intention of manufacturing the sweetener in generic form and proceeded to construct the necessary plant - with tacit support from Coca-Cola.

Despite this encouragement, however, when battle was joined and Monsanto responded to competition with aggressive price cuts, Coke (like Pepsi) remained loyal to its traditional supplier. Coke had achieved its end: for under a new agreement with Monsanto - a known and reliable supplier - it was able to buy its sweetener at a far lower price than previously.

Further example

• Powell, 2003:392 gave an example of two

firms facing investment opportunities in an

existing market. Each firm can invest in

process, quality or can make no investment.

Investment in the process should reduce

price, and investment in quality should

improve differentiation. Table below shows

payoffs

Example continued

Company B Company A

Invest in process Invest in quality Make no investment

Invest in process 50:50 30:70 85.15

Invest in quality 60:40 45:55 80:20

Make no investment 25:75 20:80 30:30

Example continued

• Rules:

Payoffs are provided in % to Co B and Co A in that

order. If both choose not to invest others can enter

therefore A&B will receive only 60%

If A went first they logically go for least worse case

(quality) where no matter what B does A will receive a

55% payoff. B would likely follow in quality and

receive 45% payoff.

If B went first then they would still most likely choose

quality when they can see the impact of choices A can

then make. If B chose not to invest A would choose

quality and get an 80% return.

Assumptions

• Players are assumed to be perfectly rational in their behaviours and choices.

• They are assumed to have perfect knowledge of the rules (shared equally between them) and

• Assumed they will always want to maximise their returns

• None of the above may be true however helps you assess options and returns available and make best use of resources and knowledge at your disposal (McGee et al, 2005).

HOW MANAGERS CAN USE

GAME THEORY:

• Create common language for modelling

strategic situations

• Classify situations & transfer strategic

insights

• Channel resources

• Generate specific prescriptions

STRATEGIC PRINCIPLES FOR

GAME THEORY

INTERPRETATION:

• Use strategic foresight

• Know yourself as well as others

• Differentiate between one-time & repeated

interactions

• Managers must unify minds to promote co-

operation

Why it works

• According to David Stout, director of the centre for business strategy at London Business School, all businesses are irrevocably self-absorbed.

• Putting yourself in the shoes of competitors, and focusing on their probable reactions to your moves (and therefore on what moves you can make to provoke certain responses) is called in the jargon 'allocentrism'.

• `Everything is interdependent, every company's development is a fruition of major moves by it and other companies,' he says.

Sensitivity analysis • Akin to scenario planning but operates at a more

operational level.

• Tests “what if scenarios” e.g. what happens if the assumptions underlying a strategic decision are questioned and changed. E.g. Launch a new product with five year horizon. No

price increase planned first 2 years then modest rise each year. Test to see what happens at different price rise levels i.e. demand/profit.

• To complete you need good portfolio of variables into a spread sheet and simulations run on the computer.

• This “mapping” of the decision trajectory under different conditions can help reveal impact of such things as demand, cost and competition levels.

Options • Helps identify options when current strategies are

failing or not working as well as projected

Called strategic decay by Williamson, 1999.

Measures of decline include:

• Reaching limits to profit generation: Diminishing returns

• Revenue growing faster than profits year after year (working

harder to run a growing co but with diminishing return to

profit)

• Higher profits but share value declines (low confidence to

sustain profits)

• Core competencies (strategic assets) begin to depreciate in the

amount of profits they generate (eg IP near end, long term

contracts finishing)

• Industry convergence – more doing the same as you. Result

profit squeezed.

Options Con’t

• Formal analysis of options can help.

• Options strategy relies on two related

dimensions:

The identification of additional or alternative

organisational capabilities that might be needed

to meet product or service needs in the future;

and

The identification of potential future markets

and/or new customer behaviours.

Options Con’t

Knowledge of new markets

Capabilities Low High

Low No options

Decision making limited to being reactive

and becoming part of others’ strategies

Trading options

Aware, but unable to do anything so

best option is to trade the information

High Bounded options

Capable but little awareness of new

markets

Full set of options

Ability to identify and follow strategy

options is high

Strategic groups and industry

dynamics

• Strategic Groups

Concept looks at groupings of firms within an

industry

• McGee, Thomas and Wilson (2005)

It is a cluster of firms within an industry

following similar generic strategies and having

similar market positioning..

It is a way of making sense of different types of

competitors and different competitive strategies

within the same industry.

Strategic groups and industry

dynamics • Membership of a strategic group rests upon

configurations of resources common to group members. These configurations act as “mobility barriers”.

• In most industries there are a relatively small number of strategic groups.

• Strategic group analysis offers a “map” of an industry based on the most significant dimensions of competitive strategy within that industry.

Sources of mobility barriers • Market-related barriers

Product line

User technologies

Market segmentation

Distribution channels

Brand names

Geographic cover

Distribution systems

Firm size

• Industry supply characteristics

Economies of scale: Production; Marketing; Administration

Manufacturing process

R&D capability

Marketing & distribution systems

Stakeholder relationships

Sources of mobility

barriers

• Characteristics of firms

Ownership (public, private)

Organisation structure

Control system

Management skills

Boundaries of firms:

• Diversification

• Vertical integration

Know-how, skills, expertise, routines.

Strategic Group Maps • Dimensions vary industry to industry

therefore axes on strategic group maps will

vary for different industries.

• The strategist must select those axes to

accurately capture the factors which drive

their particular industry. eg

Geographic

coverage

Market intensity (marketing expenditure as %

of sales

Strategic Group Maps

• The purpose of a map is to indicate the

positioning of the various strategic groups

in the industry and to reflect the resources

on which their positions are based.

Note: Mobility barriers may decay and others

arise in their place.

Strategic Space • By comparing strategies against maps you identify “strategic

space”.

McGee & Segal-Horn,1990,1992)

• Strategic space captures areas of potential opportunity within an industry, areas which are not yet available but whose potential under developing conditions becomes feasible.

• A strategic space is a currently unoccupied location on a strategic group map.

• Strategic space shows new directions for investment to be channelled but says nothing about the intensity of competition in any of the spaces.

• Issues to consider include:

Changing mobility barriers

Relative profitability of strategic groups

Firms ability to adjust resources

Problem of defining an “industry”