Business Strategy & Policy PSU MGMT #562

1. Business Strategy & Policy PSU MGMT #562 Week # 5 Blue Ocean, Risk & Flexibility Dave Garten daveoutside@alum.mit.edu

2. Apple Case – Key Learnings • Company culture has bred inconsistent success • Highly innovative & creative w/strong niche • Very insular -- stumbled on industry dynamics • Product advantage is not competitive advantage • As differentiation narrows (wintel vs. mac), substitution & economies of scale dominate • Windows of opportunity can be a significant factor in success (despite the “best” strategy) Dave Garten- Business Strategy

3. Apple Dave Garten- Business Strategy

4. Strategy Formulation Derived from Blue Ocean Strategy by W. Chan Kim and Renee Mauborgne, HBS, 2004 Dave Garten - Business Strategy

5. Strategy Formulation “Red Ocean” “Blue Ocean” Study of business launches in 108 companies… Dave Garten - Business Strategy

6. Strategy Formulation Reshaping boundaries  value innovation • Look across alternative industries • Look across chain of buyers • Look across complementary products & services • Look across functional or emotional appeal of buyers • Look across time Dave Garten - Business Strategy

7. Netjets Home Depot Insulin Bloomberg Movies & babysitting Swatch Starbucks Cisco Strategy Formulation Dave Garten - Business Strategy

8. Strategy Formulation Increase Value Lower Cost What can be created? What can be eliminated? What can be reduced below industry levels? What can be raised above industry levels? Dave Garten - Business Strategy

9. Strategy Formulation • Redefine target toward new market space • Simultaneously pursue differentiation & low cost to achieve a leap in value (utility) • Challenge deep reliance on: • Existing customers • Finer and finer segmentation • Focus on non-customers • Edge of market • Unexplored non-customers Costs Value Innovation Derived from Blue Ocean Strategy by W. Chan Kim and Renee Mauborgne, HBS, 2004 Buyer value Dave Garten - Business Strategy

10. High Low Strategy Formulation: Mapping Major Airline Car SWA Dave Garten - Business Strategy

11. Principles of Uncertainty • Decisions need to be made in an uncertain environment • NPV (traditional managerial finance) does not handle contingent or adaptive decision making • The creation of an option (to take action) is tangible and positive • Manages levels of commitment as certainty unfolds… • Flexibility: an option to manage uncertainty • Highest value under uncertainty and risk Dave Garten - Business Strategy

12. Sources of Uncertainty • Unpredictable environmental events (e.g. disruptive technologies) • Customer or stakeholder demands • Competitor’s moves • Actions of suppliers and buyers • Managerial actions • Employee actions • Government behavior (or lack there of) Dave Garten - Business Strategy

13. Uncertainty & Strategic Response Level of Uncertainty Response: Strategic intent Response: Tactics Source: Strategy Under Uncertainty by Hugh Courtney, Jane Kirkland and Partick Viguerie HBR 1997 Dave Garten - Business Strategy

14. Hedge Against Strategic Uncertainty Dave Garten - Business Strategy

15. Create/preserve options Selective flexibility Isolate volatility Move Up Flexibility in Uncertainty Low High Cost of Change Low High Uncertainty Dave Garten - Business Strategy

16. Some Option data Dave Garten - Business Strategy

17. Option Pricing: Black-Scholes • C = cost (price) of the option • S = the base value of the investment • E = the option exercise price • t = time until a decision (expiration) •  = the level of uncertainty (beta, std. dev) Dave Garten - Business Strategy

18. Scenario Analysis • Contingency planning – generally one uncertainty • Modeling • Scenario analysis – multiple uncertainties driven by subjective interpretation • Helps to breaks down bias, risk-aversion, disruption • Develop scenario descriptions, driven by key uncertainties • Model the scenarios • Develop indicators to track how the future unfolds. • Develop plans and (contingencies) for each scenario Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006 Dave Garten - Business Strategy

19. Scenario Analysis Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006 Dave Garten - Business Strategy

20. Scenario Example Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006 Dave Garten - Business Strategy

21. Scenario Example Source: A Note on Scenario Planning by David Garvin and Lynne Levesque, HBR 2006 Dave Garten - Business Strategy

22. Uncertainty & Flexibility Summarized • Flexibility/options are tools to manage uncertainty • Use flexibility in areas of high uncertainty • Isolate volatile elements – architect boundaries • Value of options changes with time • Volatility drops (less uncertainty) • Revisiting project valuation/options • Scenario analysis - a helpful tool to instill structure • In the real world… build an intuition • Framework to evaluate strategic options Dave Garten - Business Strategy

23. Backup Dave Garten - Business Strategy

24. Apple Case Source: UBS, 2006 Dave Garten- Business Strategy

25. Apple Case Dave Garten- Business Strategy

26. Jan 2011 Jan 2010 May 2008 Feb 2006 Feb 2004 July 2000 Feb 1996 Dave Garten- Business Strategy

27. Apple Case Dave Garten- Business Strategy

28. NPVq = value/cost lower 1.“Now” Act 6. “Never” 2. “Maybe Now” Manage Riskand Act 5. “Probably Never”  sqrt(t) 3.“Probably Later” Learn before Acting 4.“Maybe Later” ExplorePossibilities Before Acting higher 1.0 Source: Strategy as a Portfolio of Options by Timothy A. Luehrman, HBR 1998 Option Scenarios Dave Garten - Business Strategy

29. Selective 20-80% (20-3-8) Derived from: IT Outsourcing: Maximizing Flexibility & Control None < 20% (5-5-5) Full > 80% (2-3-9) Flexibility in Practice IT outsourcing: Cost containment vs. core competency Dave Garten - Business Strategy

30. Strengths (S) Weaknesses (W) 1. 2. . . 1. 2. . . SO Strategies WO Strategies Opportunities (O) Overcome weaknesses by taking advantage of opportunities Use strengths to take advantage of opportunities 1. 2. . . ST Strategies WT Strategies Threats (T) 1. 2. . . Minimize weaknesses and avoid threats Use strengths to avoid threats Strategy Evaluation Tools SWOT & Strategy Development Source: Strategic management by Fred R. David Dave Garten- Business Strategy