1.1Getting StartedBefore discussing strategy itself, let us begi.docx

1.1Getting Started
Before discussing strategy itself, let us begin by discussing
the context of strategy. How does strategy fit within the general
field of business? How does it compare to the other disciplines
of business?
Many experts would argue (depending on the industry) that
marketing, finance, and/or human resources are most important
to the success of the company. How can a business survive,
they argue, without adequate human capital, a solid marketing
campaign and money for daily operations? However, business
strategy is somewhat different from these disciplines because
strategy is more holistic than other areas of business. Business
strategy touches every other area of business and a business can
use any company resource to further its overall strategy.
Strategy is at least as important as other areas of business
because it encompasses and integrates with the other business
disciplines.
In other words, effective strategists will use the organization's
accounting system, operations, information systems, human
capital, marketing, and any other available tool as part of its
strategy. Used appropriately, strategy will use every discipline
within the organization to accomplish its organizational
goals.1.2What is Strategy?
Strategy is the method that an organization uses to reach its
goals. According to this definition, strategy is fundamentally a
broad term. In the right context, almost any plan of action can
be considered an organization’s strategy. Most academic papers
on strategy, as well as this book, focus on competitive
strategy. Competitive strategy is the way that an organization is
going to compete in its industry. However, the tools and
techniques of competitive strategy can be adapted to an
organization’s quest for other goals.
Since competitive strategy (by definition) is focused on
competition, competitive strategy is often expressed in terms of

sports, war, history, survival, and board games. This
terminology is transferred to the field of strategy as a whole.
For example, when a manager states, "What is our game plan?"
the manager is asking for clarification about the organization's
strategy. When an organization ‘crafts' or builds its strategy, it
is specifically choosing the actions it will take in the
marketplace, including how it is going to compete with and
outperform other organizations.
Stakeholders can often observe an organization's chosen
strategy by evaluating what the firm does in the marketplace
and asking questions such as the following:
· What industry does the firm operate in?
· What products and/or services does the firm market and sell?
Does the firm take an offensive or defensive position?
· What is the firm's target market?
· Does the firm invest in research and development? Why or
why not?
· What product or services does the firm offer that are different
from competitors?
· What makes the firm successful or unsuccessful?
· Where does the majority of the firm's money come from?
· What type of employees does the firm invest in?
· How does the firm choose to market its products?
· Why type of manufacturing does the firm use?
Stakeholders can also come to understand an organization's
strategy by evaluating statements made by upper management.
Often, these statements can be found in mission statements,
newsletters, press conferences, employee meetings, and even a
company's annual report to shareholders. For example, consider
Microsoft's 2012 annual report by its CEO Steven A. Ballmer:
Excerpt from Microsoft's 2012 Annual Report
"As we enter this new era, there are several distinct areas of
technology that we (Microsoft) are focused on driving forward –
all of which start to show up in the devices and services
launched this year. Leading the industry in these areas over the
long term will translate to sustained growth well into the future.

These focus areas include:
· Developing new form factors that have increasingly natural
ways to use including touch, gestures, and speech.
· Making technology more intuitive and able to act on our
behalf, instead of at our command, with machine learning.
· Building and running cloud services in ways that unleash
incredible new experiences and opportunities for businesses and
individuals.
· Firmly establishing one platform, Windows, across the PC,
tablet, phone, server and cloud to drive a thriving ecosystem of
developers, unify the cross-devise user experience, and increase
agility when bringing new advancement to market.
· Delivering new scenarios with life-changing improvements in
how people learn, work, play and interact with one another."
It is clear that Microsoft Corporation's strategy over the coming
decade will be to capitalize on an emerging market that focuses
on intuitive machine learning, touch and speech technology,
cloud services, and life-changing improvements in how people
learn, work, play and interact one with another.
In essence, Microsoft is experiencing a shift in its strategy -
going from a producer of operating systems - to an industry
leader in cloud, interface and life-changing technologies. As
part of its strategy, Microsoft is trying to develop products and
services that will create a competitive advantagethat will
benefit Microsoft in the marketplace. When an organization has
a competitive advantage, it has an ‘advantage' or ‘unique
capability' that sets it apart from all other players in the market.
A central part of any strategy is the organization's ability to
create a sustained competitive advantage.1.3The Future of the
Firm
Since strategy touches so many different aspects of a company,
it can be difficult to know where to begin. In order to create a
starting point and build a foundation for strategy, a firm should
continually ask itself the following three questions:
1. Where are we currently?
2. What are our goals?

3. How will we reach our goals?
Where are we currently?
Before managers can refine a company's strategy and decide on
any future course of action, they must first understand the
organization's current status. Unfortunately, understanding the
status of a firm can be a challenging and difficult process that
many organizations overlook. In deciding where the firm is
currently at, it is helpful to get feedback from shareholders,
customers, partners, and employees. Frank and honest feedback
from stakeholders can help the firm improve processes, improve
customer service, lower cost, and improve overall productivity.
Organizations can also use strategic financial numbers to help
the organization understand its current profitability, revenue,
market share and sustainability. Later in the course, we will
discuss and examine financial statements in an effort to better
understand the financial health of organizations. We will also
learn about and discuss common financial ratios and how to
compare financial ratios with other firms to help understand the
competitiveness of the firm.
What Are Our Goals?
Determining the future path of the organization is one of the
most important decisions that any organization can make. When
done correctly, deciding the goals and objectives of the
organization can bring alignment and purpose to the firm.
Furthermore, when organizations both define and communicate
a common purpose for shareholders, it allows employees,
partners, vendors and others to work together and influence one
another towards organizational goals.
Organizations can choose from a variety of paths and directions.
Obviously, some of these paths will result in sustainability,
profitability, and success. Some paths will lead to decreased
market share, lower profitability, and possibly closure. In
choosing a path, firms must decide which product or service to
sell, which industry to pursue, and which markets to enter.

How Will We Reach Our Goals?
After management has decided where they want to take the
organization, they must then identify and implement the steps
and actions that will help the organization to achieve both it's
long-term and short-term goals. While most organizations want
to increase market share, lower cost, and increase profitability,
organizations must understand how best to do so. While most
business goals are worthy endeavors, many organizations fall
short in identifying and understanding the steps required to
reach their objectives. And, even in situations where
management is able to accurately identify necessary steps, firms
often fail to reach their desired goals because of lack of
understanding of the goals and resistance by employees.
Furthermore, leadership within the organization may not put
forth the required work, time, money and other resources
needed to reach the goals.
Because of the fast-paced global environment of business today,
even if management does gain companywide acceptance of
goals and invests the necessary resources required to reach
those goals, factors in the external environment – such as an
increase in competition, economic risk, disruptive technologies
and political disruptions – may still prevent the firm from
reaching where it wants to go. In order to respond to the
challenges of today, organizations must be flexible, adaptive
and responsive to both the internal and external
environment.1.4The Internal and External Environments
The internal environment and external environment are
foundational concepts for understanding strategy. At first, the
distinctions between these environments seem trivial - one is
about factors outside the firm, the other about the factors
within. Yet many of the most influential tools in business
strategy are rooted in this distinction. A clear understanding of
and distinction between the internal and external environment
will guide strategic actions because the organization can focus
on what it can control, instead of becoming frustrated with

external factors. Throughout this book, many of the tools and
ideas will build upon this foundation.
Strategic fit is one such idea. It would be difficult to understand
strategic fit without an understanding of the internal and
external environments. Strategic fit is the degree to which an
organization can match its internal resources and capabilities
with opportunities in the external environment.
Influencer spotlight: Michael PorterMichael Porter
Michael Porter is one of the most influential figures in business
strategy. His ideas have not only shaped the academic field of
business strategy but are widely used by successful businesses
around the world.
What made Porter's work so influential? Part of its influence
came from his training in economics - he brought concepts and
ideas from economics into business strategy, changing the way
businessmen talk and think about strategy. This focus on
economics, combined with his expertise on competition, gave
him a unique ability to advise countries on their economic
strategy.1
Porter's ideas and tools are discussed throughout this book,
including Porter's Five Forces, Porter's Four Corners Analysis,
Strategic Fit, and CSR.Education
· Undergraduate - Aerospace and Mechanical Engineering -
Princeton
· M.B.A. - Harvard Business School
· Ph.D. - Business Economics - Harvard Department of
EconomicsCareer Progression
Upon finishing his Ph.D., Dr. Porter's work focused on
corporate strategy and industry competition. During this time,
he published widely influential articles and books - How
Competitive Forces Shape Strategy (1979), Competitive
Strategy(1980), and Competitive Advantage (1985). 2
During the 1990s, Porter's research centered around how regions
and nations could use microeconomic principles to improve
their competitiveness. In particular, he looked at the idea of
clusters - regions where companies of a particular industry were

clustered close together in a way that is mutually beneficial.3
Starting in the 2000s, Dr. Porter began analyzing the economics
of health care. This work included measuring patient outcomes,
reimbursement models, and health systems with multiple,
integrated locations. 4
The External Environment
There are, obviously, many events and circumstances outside of
a given organization. The external environment focuses on a
subset of these events and circumstances - the factors that will
impact the organization. Some difficulty arises in considering a
broad enough range of factors that impact the organization
without considering unnecessary factors. Some strategic tools,
such as the STEEPLE Analysis, help broaden the manager's
perspective on what impacts the firm. Other tools, such as the
Weighted Comparative Strengths assessment, narrow the
manager's view to focus on certain important factors.
Organizations cannot directly change the external environment.
However, they can respond to changes in the external
environment. An incorrect response could spell disaster for the
company, while a spectacularly good response could create a
temporary comparative advantage.Factors in the External
Environment
· Legal oversight and regulation
· Macroeconomic trends
· Interest Rates
· Labor market constraints
· Industry growth or decline
· Competition
· New Market Entrants
· Relative strength of competitors
· Political FactorsTools to Analyze the External Environment
· Porter's 5 Forces - provides a broad perspective on
competition.
· STEEPLE Analysis - a comprehensive analysis of the external
environment.

· SWOT Analysis - an integrated top-level analysis of both the
internal an external environments.
Questions to analyze the External Environment
Organizations that can respond well to the external environment
reach new customers, provide innovative products and services,
and integrate technology before their competitors do. The
following questions can help you understand the external
environment:
1. From an economic perspective, what are the dominant
features of the industry?
2. Given the current information available, what is the future of
the industry?
3. What are the dominant forces that competitors must overcome
in this industry?
4. How impactful are the dominant forces within the industry?
5. What market position does each competitor occupy?
6. What moves are competitors likely to make?
7. Which products/services will make this industry succeed?
8. Are there players currently not in the market, which could
easily compete within it?
9. Are there disruptive technologies that could change the
landscape of the industry?
10. Are there economic and/or political changes that could re-
define the industry?
Questions like these can highlight which factors in the external
environment are most important to the organization.
The Internal Environment
The internal environment refers to the conditions, events,
entities, and factors that occur within (or internal to) the
organization. As companies define their internal environment,
they can align their resources to compete most effectively. An
effective internal environment can provide a firm with the
competitive advantage it needs to succeed in its
industry. Factors in the Internal Environment
· Employee skills and experience

· Technology
· Organizational structure
· Trademarks, patents, and trade secrets
· Management
· Production capabilities
· Team cohesionTools to Analyze the Internal Environment
· SWOT Analysis - - an integrated top-level analysis of both the
internal an external environments.
· Pareto Analysis - an analysis based on the 80 - 20 rule.
· Organizational Resources - the resources available to an
organization
· Measuring Productivity
1.5Strategic Management
One of the most important responsibilities of top management
teams is to develop and execute plans to align the internal
environment with the external environment in a way that will
provide a competitive advantage. In order to achieve this
objective, managers follow a process of developing and
implementing a competitive strategy. The strategic management
process consists of the following:
· Crafting the principal mission of the organization.
· Evaluating the internal strengths and weaknesses of the
organization.
· Analyzing the opportunities and threats in the external
environment.
· Developing the plans that the organization should implement
that will enable it to best compete in the changing environment.
· Executing an action plan that will achieve organizational
goals.
Figure 2-1:1.6Choosing Strategy and Goals
Based on the strengths and weaknesses of the firm and the
opportunities and threats that prevail in the environment,
managers must formulate a strategy and goals. There are many
levels of strategy and goals that build on one another and
ultimately should be consistent with the overall mission of the

organization. The grand strategy is the overarching plan for the
firm. Under that grand strategy umbrella there may be corporate
level strategies and business level strategies. Furthermore, those
strategies can consist of more specific strategic goals, tactical
goals, and operational goals.
Grand strategy is high level strategy for the organization that
provides basic direction and long-term goals.1 Grand strategies
typically consist of the objective to grow the business, seek to
maintain current revenue and profit levels, or reduce the size of
the business to restructure for the future. Facebook is an
example of a company that is seeking high growth. Many
owners of lifestyle ventures—small businesses that provide
income for the owners—have the grand strategy of maintaining
a stable size from year to year. General Motors recently enacted
a retrenchment strategy as they cut brands like Oldsmobile and
Saturn, and downsized the company to seek greater
competitiveness.
The corporate level strategy determines the types of business in
which the firm will compete. For example, Coca-Cola is in the
business of making soft drinks and other beverages. Coca-cola
is focused on making and distributing beverages. On the other
hand, PepsiCo competes in the same business as Coca-Cola but
PepsiCo's management team has also determined to be a major
player in snacks (Frito-Lay) and other related foods (Quaker
Oats). At the corporate level, executives must determine the
right business mix to create a competitive advantage for the
corporation. PepsiCo executives feel that there are significant
synergies between snack foods and beverages insomuch that
they are able to leverage those synergies to grow both business
segments in a way that they would not be able to accomplish if
they were independent businesses.13 Therefore, they have
sought more diversification in their businesses than Coca-Cola
has.
Diversification is seeking to expand into related or unrelated
industries. PepsiCo's diversification strategy sought related
businesses that might benefit from shared distribution and

marketing efforts. In contrast, General Electric has broadly
diversified the company into many unrelated industries. GE
competes in kitchen appliances, commercial finance, medical
technologies, and jet engines, among others.
Executives may also choose to diversify through vertical
integration. Vertical integration is defined as the integration of
new businesses that expand the range of value chain activities
for the company. For example, PepsiCo could choose backward
integration by moving into supplier businesses. They could
purchase agriculture businesses to grow their own oranges for
orange juice or sugar for soft drinks. Or they could choose
forward integration by entering the retail market. PepsiCo could
begin to compete in the restaurant industry (which they have
done in the past) or convenience store industry in order to
emphasize the sale of the beverages and snack foods that they
manufacture and distribute.
Managers may consider a number of strategic options to
accomplish the desired business mix. Mergers, acquisitions, and
strategic alliances are frequently used strategic tools.
A merger happens when two or more organizations combine to
become one. In 1965, Pepsi-Cola merged with Frito-Lay to
create PepsiCo.14 Mergers often result in a company with a new
name, but that is not a necessity. In 2001, PepsiCo participated
in another merger, this time with the Quaker Oats Company, but
retained the name of PepsiCo.15 Such mergers allowed PepsiCo
to diversify their overall business mix with related but separate
product lines.
An acquisition differs from a merger in details of ownership
control and ongoing management control. Strictly speaking, in
an acquisition, one company purchases and assimilates another
company. From a strategic viewpoint, mergers and acquisitions
are very similar as the net result is a combination of the
resources and capabilities of the two companies. PepsiCo
acquired Tropicana in 1998 and the juice beverages were
integrated into the PepsiCo beverage business unit.
If a firm has a deficiency in resources or capabilities but does

not want to pursue a merger or acquisition, it may seek a
strategic alliance with another firm. A strategic alliance is an
agreement between two or more distinct companies in which
they choose to share strategic resources or capabilities.
Strategic alliances are commonly used in product development
when one or both companies lack the needed expertise or
resource to develop, manufacture, or sell a new product
offering. At times, allying with a partner may be more timely
and cost effective than trying to develop that particular
expertise in house. In 2012, Ocean Spray Cranberries entered a
strategic alliance with PepsiCo in Latin America. PepsiCo will
have the exclusive rights to manufacture and distribute some of
Ocean Spray's juice products in the Latin America
market.16 Ocean Spray does not have the manufacturing and
distribution resources that PepsiCo has in Latin America.
PepsiCo does not have the brand recognition or expertise in
cranberry based drinks that Ocean Spray has. The strategic
alliance allows both companies to benefit from sharing
important resources and capabilities.
The business level strategy is concerned with how the business
unit competes within the industry. Business level strategy
focuses on developing the right product line within the chosen
business, effectively marketing and selling the products or
services, efficiently managing the operations, and so forth.
Business level strategy is best accomplished by setting clear
goals for the business.
A goal is a desired future result that the organization strives to
achieve. Goals provide direction and motivation to
organizational members. Effective goals are specific,
measurable, relevant, challenging but achievable, and linked to
appropriate time periods and rewards. Goals act as a guide to
action and can be used to provide direction for future decisions.
Goals also help to motivate employees to work towards a
common purpose.2 They provide a standard of performance that
can be used to measure the organizations performance.
In order to achieve higher level strategic goals, managers may

set specific tactical and operational goals. Each of the lower
level goals should be directly tied to the accomplishment of a
higher level goal. For example, a strategic goal may include "we
will achieve 40% market share in the U.S. market by the end of
2013." Tactical goals related to marketing, e.g. launch a new
online product promotion, might be set to help improve market
share during the next quarter. Furthermore, the web based
marketing team may set an operational goal to increase the page
views of the new promotion by 25% during the next 30 days.
Such goals will direct and encourage employees to develop and
execute plans to achieve the stated objectives.1.7Implementing
Strategy
The final step in the strategic management process is the
implementation of the strategy. No matter how brilliant the
strategy, it can all fall short of expectations if it is not
effectively implemented. Strategy falls primarily under the
planning function of management. Implementation incorporates
the organizing, leading, and controlling functions of
management which will be covered in detail in the remaining
chapters of the textbook.1.8References
1 Kawasaki, G. 2004. The art of the start, New York: Portfolio.
2 Bartkus B, Glassman M, McAfee B. Mission Statement
Quality and Financial Performance. European Management
Journal, 24(1), 86-94.
3http://www.telegraph.co.uk/finance/newsbysector/retailandcon
sumer/9024539/Kodak-130-years-of-history.html
4 http://www.informationweek.com/news/global-
cio/interviews/232400270
5 http://www.reuters.com/article/2012/01/19/us-kodak-
bankruptcy-idUSTRE80I1N020120119
6 http://www.reuters.com/article/2012/01/19/us-kodak-
idUSTRE80I08G20120119
7 Barney, J, & Hesterly, W. Strategic Management and
Competitive Advantage. (New Jersey: Pearson, 2010)
8 Porter, M. Competitive Advantage (New York: Free Press,
1985)

9 Kim & Maugborgne (2000), Knowing a Winning Business
Idea When You See One. Harvard Business Review, 2000 Sep-
Oct;78(5):129-38, 200.
10 Porter, M. Competitive Advantage (New York: Free Press,
1985)
11 http://www.usatoday.com/money/industries/technology/story
/2012-06-26/google-io-tablet/55844912/1
12 Pearce, J. "Selecting Among Alternative Grand
Strategies," California Management Review. Spring 1982: 23-
31.
13 http://www.pepsico.com/Investors/Corporate-Profile.html
14 http://www.pepsico.com/Investors/Corporate-Profile.html
15 Ibid.
16 http://www.pepsico.com/PressRelease/PepsiCo-and-Ocean-
Spray-Announce-Strategic-Alliance-in-Latin-
America01172012.html
17 Locke, E. & Latham, G. "Building a practically useful theory
of goal setting and task motivation: A 35-year
odyssey." American Psychologist. Vol 57(9), Sep 2002, 705-
717.
Chapter 2:2.1Introduction to Strategic Analysis
Learning Objectives
1. Explain the importance of matching strategy to a specific
business.
2. Differentiate Between Planning, Craftng, and Emergent
Strategies
3. Use SWOT and PESTLE Analyses to evaluate companies.
4. Explain how mission and vision statements can improve an
organization.
5. Define Points of Parity and Points of Differentiation.
6. Describe various organizational resources that impact a
company's strategy.
7. Describe the components of a Balanced Scorecard and
Product Revenue Analysis.
8. Evaluate the competitive advantage of a company using the
VRIO Framework.

9. Explain how Internal and External Evaluation Matrices are
used.
10. Use the McKinsey 7S Model to describe how various parts
of a business are interrelated.2.2Setting/Choosing a Strategy
How do you craft a business strategy that is a great fit for your
business? This is certainly not an easy question, but this book is
designed to help. By exposing you to a wide variety of
strategies and strategic tools, we hope to give you the
perspective and frame of reference to better create and
implement a strategy for your business.
Why do you need a strategy?
Why does your business even need a strategy? Why can’t you
just do business? Using a specific strategy helps your company
to gain a competitive advantage, use resources efficiently, and
narrow your focus. Inevitably, all good companies implement
some sort of strategy that fuels their success. However, many
failed companies also had a strategy. Thus, the task becomes
choosing the right strategy.Benefits of Great Strategy
A great strategy is one that effectively drives growth, solves
problems in your company, and is easily turned into actions that
employees can put into practice. This is obvious, but identifying
which strategy will actually accomplish those things is rather
difficult. For that reason, we have provided strategy tools
throughout this book. These are ways of looking closely at your
business and the competitors to figure out an effective strategy.
Examples include the SWOT analysis, the PESTLE analysis,
the Pareto analysis, and a variety of other analyses and
assessments. These allow you to identify where your company is
at, what drives its growth, what it is good at, and where it is
struggling.
Match Your Strategy to Your Business
It is important that your strategy matches your business.
Perhaps too often, people will look at a successful company like
Apple and copy its strategy. Fundamentally, Apple is at a

different point than your company is, and is probably positioned
much differently than yours. Look at your company: are you the
low cost leader, the premium brand, or a middle-priced
competitor? Do customers buy because your product has nice
features, or because it is the only product that fulfills a need?
Do you service the high-end of the market, or some other
section? Unless you offer a premium product and have fierce
customer loyalty that allows you some exclusivity, you can’t
realistically copy Apple’s current strategy. Instead, look for
strategies that match your company. This will help your
company have great strategic fit in future decisions.
Look at where your business operates. Do you focus on a certain
region of the country? Who are your customers? Do you focus
on private label or on wholesale? Your location and distribution
strategy will likely play a role in which strategy is right for
you. It is practically impossible to have a strategy that doesn’t
align with your distribution model. If your business is mainly
focused on distributing through some local retail stores, you
cannot have a low-margin, high-volume strategy and hope to
succeed.Set Yourself Apart
How does your company differentiate itself from the
competition? This is a fundamental question when choosing a
strategy. If you can’t set yourself apart from the competition,
you will likely fail. If your strategy doesn’t focus your time and
effort on the things that set you apart, your company is
misusing its resources. Find what you do well and set up the
business so the profits follow your expertise.
As you go through this book, you will likely notice that many of
the strategies overlap, and some of them seem very similar to
each other. This simply lets you craft more precisely what you
want in your business’s strategy. We invite you to modify and
adapt any of the ideas and frameworks explained in this book to
match your business’s specific needs.2.3Planning, Crafting, and
Emergent Strategies
Planning Strategy

Imagine that you are a professional basketball player and are
playing in the national championship game. Before the game,
the coaching staff likely created a plan – or strategy – to win
the game. The strategy will likely be based on hours of film and
careful evaluation of the other team. As the strategy is
developed and planned, the coaching staff will have evaluated
both the strengths and weaknesses of the opponent and
compared those to your own team’s strengths and weaknesses.
The purpose of the strategy is to exploit the opposing team’s
weaknesses and emphasize your team's strengths in order to win
the game.
Notice that the entire process of designing the strategy takes
place before the game even starts. For most coaches, careful
study, analysis, and benchmarking before the game is key to
success. Similarly, in the business world, most senior managers
and executives plan their strategies long before they are
implemented. In fact, when most people think of strategy they
often imagine a group of high-level executives sitting in a
boardroom, using various analyses to better understand the
organization and the direction it should go. In fact, many of the
tools throughout this book are designed to be used in strategic
planning. Such board meetings often include an analysis of the
industry and a thorough evaluation of rivals. As such, most
managers would agree that strategy is a plan, or course of
action, that the firm should follow. This approach to strategy is
often referred to as planning strategy. Planning strategy
involves a careful analysis of rivals and markets to plan specific
objectives, goals, and courses of action.
Crafting Strategy
While planning strategy is both important to organizational
success and frequently used, there are other methods for
creating strategy. Henry Mintzberg, a professor at McGill
University and one of the pioneers in strategic management,
challenged the traditional approach of planning strategy. He
claimed that many important strategies are not planned before

they are implemented but are crafted during the process of
implementation. These strategies come about on their own in
response to situations that arise. In the basketball example,
imagine that halfway through the championship game your team
is behind by 20 points and struggling to maintain possession of
the ball. Obviously, the predetermined – or planned – strategy
was not actually a good course of action (or the opposing team’s
strategy was simply better than yours). It was impossible to
know before the game that your team’s planned strategy would
be ineffective during the game. In this case, should your team
change its predetermined strategy or stay true to the plan? Are
there adjustments that your team should make to the defense and
offense? Suppose that your team deviated from the planned
strategy for a few plays and scored several points. Should you
change your strategy mid-game so that your team will have a
chance of winning? Henry Mintzberg refers to the process of
learning, adapting and changing while engaged in business as
the process of crafting strategy. In other words, crafting
strategy is the process of developing strategy through action,
learning, trial-and-error, self-analysis, and experience.
Mintzberg suggests that crafting strategy, instead of planning
strategy, is more likely to result in a successful strategy.1
One simple way to craft a strategy is to use your own products.
By experiencing what it is like to be the consumer, you will
likely discover how to craft your strategy.
Emergent Strategy
When an unplanned strategy emerges, it is often referred to as
an emergent strategy. In other words, an emergent strategy is a
strategy the simply comes about on its own that was not
expressly intended.
According to Mitzenberg, emergent strategy is like weeds that
pop up uninvited. The company either doesn’t have a clear set
of goals or the emergent strategy doesn’t align with the
original, outlined strategy. The clearest examples are companies
that started out in one line of work, failed, and changed to

pursue a different direction. 3M was originally founded as a
mining company but transitioned into Scotch Tape, Post-It
Notes, and Scotch-Brite cleaning products. Another example is
Groupon. Originally, it was founded as The Point, a website
which allowed users with a common cause to unite into a more
powerful group. They had essentially no success. However,
when a group got together with the cause of “saving money,”
they enlightened the company leadership on a much better
business plan—to offer an incredibly good deal every day to a
local business, based on enough people signing up for it.
Business could bring in a windfall of new customers or could
unload extra inventory. The business became so popular that
they hired 10,000 people in less than two years. No one in the
original company planned on creating Groupon. Instead, their
winning strategy emerged out of the market.2.4SWOT Analysis
Strengths, Weaknesses, Opportunities, and Threats
One of the most frequently used analyses in business strategy is
the SWOT analysis. A SWOT analysis looks at the favorable
and unfavorable aspects of both the internal and external
environment of a company. SWOT is a relatively powerful
analysis because it can be used to both mitigate risks and
potential competitive advantages. To begin, ask yourself the
following four questions:
1. What are the company’s internal strengths?
2. What are our internal weaknesses?
3. What external opportunities do we have?
4. What external threats stand in our way?
Elements of a SWOT AnalysisStrengths
A strength is a resource or capability that provides the
organization with an advantage relative to its competitors.
Strengths may include the ability to develop new technologies,
a reputation for exceptional customer service, superior
efficiency in production, or accuracy in predicting customer

needs. Organizations may have a unique strength in marketing,
operations, design, or other specialties that leads to a
competitive advantage.Weaknesses
A weakness is a shortcoming or vulnerability in an
organization's capability compared to competitors. Weaknesses
generally stem from a lack of resources or competencies. For
example, an organization may lack the financial resources to
build a larger factory, resulting in missed profits and a decline
in market share. A firm may not have the needed technical or
design talent required to effectively compete. Sometimes, it can
be a weakness to be slow-moving in industries that are rapidly
changing.Opportunities
An opportunity is a condition in the external environment that
represents a prospect to improve the organization's competitive
position in the market. Changes in technology, a growing
middle class in international markets, or new sociocultural
trends may provide fresh opportunities for businesses in the
general environment. Stakeholders may also present
opportunities such as improving relationships with key
suppliers, finding a new segment of customers that had not
previously been targeted, or partnering with a social cause to
build goodwill.Threats
A threat is a condition in the external environment that is
unfavorable to the competitive potential of the firm. Examples
of threats from the general environment might include a poor
economy, changing sociocultural trends, or new laws and
policies implemented by governments. Threats may also come
from stakeholders in the external environment such as new
competitors entering the market, poor relations with strategic
partners, or special interest groups criticizing the
organization.Examples - SWOT Analyses at Different
LevelsPersonal SWOT Analysis
Let’s personalize this idea by performing a SWOT analysis on
you. We will begin with the internal environment, which
corresponds to your individual personality traits and
characteristics. What are your strengths? As a student, you’re

most likely young, bright, and educated (or becoming educated).
Maybe you have specific talents that make you especially
likable or brilliant in a certain subject. What are your
weaknesses? Are you sometimes lazy, prone to lose your
temper, or spend too much time on social media? What aspects
of your personality prevent you from living a more meaningful
life?
The external environment (your surroundings) also influences
your state of being. What opportunities do you currently have?
You have the opportunity to educate yourself, prepare for future
employment, and choose what you want to make of your life. In
fact, you have countless opportunities. Finally, what are your
current threats? What could knock you off your feet if not
addressed correctly? Is there a threat of not doing as well in this
class as you’d like? Are you afraid you may not be accepted
into your preferred grad school or maybe struggle to find a job?
Performing a SWOT analysis allows for full understanding of
what is most important to an individual, project, business, or
even industry. It provides a way to understand a situation,
analyze it, and then take the necessary steps towards
improvement.Industry SWOT Analysis
While a SWOT analysis is generally used to analyze a company,
it can also be used to analyze an industry. Consider, for
example, the online industry of goods and services (companies
like Amazon and eBay operate in this industry). Strengths of
such an industry could be its accessibility, convenience, and
popularity. Weaknesses may include stiff competition, laws that
make it difficult to operate, and security issues. An opportunity
has developed in the online goods and service industry as the
world has turned towards the internet as a replacement for old
business practices. Threats to the industry involve heavy
competition, compromised security, and lost or stolen devices
and ideas.Company SWOT Analysis
Now consider ramengobblers.com, a small online business that
specializes in university student goods and services. Ramen
Gobblers allows students to post housing contracts, textbooks,

and merchandise they are willing to sell to other students at
their university.
Strengths
· Low startup costs - the company is very asset-light
· Easy maintenance (low variable costs)
· Well-identified target market and clear ability to market
specifically to customers (college campuses gather students
together)
Weaknesses
· Low brand recognition (the company is relatively unknown)
· Limited capital
Opportunities
· Potential partnerships with college - can gain quick access to
lots of students if the app is approved by the college's
administration for an exclusive partnership
Threats
· Low barriers to entry invite competition
· Revenue model relies on advertising - requires a large
consumer base to be profitable
· Potential for hacking
As the CEO of Ramen Gobblers, how would you address your
concerns and utilize the company's strengths and opportunities?
You could minimize your threats by getting the site up and
running quicker than other rising competition. You could
instigate a marketing plan to promote the app and make sure
that proper security measures are taken. To take advantage of its
strengths and opportunities, Ramen Gobblers should stress its
niche in the college market and try to capture the market
quickly.2.5Mission and Vision Statements
Definitions for mission and vision statements vary widely,
nearly as much as opinion does on how to use them. Some
believe vision and mission statements are exactly the same.
Others say the vision statement explains the “what” and the
mission statement explains the “how”. Others think it’s the
other way around. In the end, your organization’s vision and
mission statement can be whatever you want it to be. Almost all

organizations come up with a flowery phrase they like, tie a
bow on it and call it either the mission or vision statement. The
goal of this section is to show how vision and mission
statements can actually be useful to your organization and drive
your business strategy forward.
Vision Statement
For our purposes, a firm’s vision statement is the overall
dream that a firm hopes to accomplish. It is a snapshot of the
future the firm hopes to create in the world; a timeless phrase
that outlives changing market strategies and fluctuations within
the company and can be as flowery or concise as necessary, so
long as it accomplishes its purpose. The vision statement
expresses the organization’s reason to exist which is useful in
providing the organization a flagship to follow; something to
always look to for direction. For example, a local food bank
might have the following as their vision statement: “To bring an
end to hunger in our community”. The vision statement explains
quickly and distinctly the overarching goal of the organization
and may be what motivates the firm. The vision statement
however, does not provide the direction to take in order to
achieve that goal. It gives the what without the how.
Mission Statement
An organization’s mission statement takes the vision statement
to the next level by providing insight on how the organization
will achieve its overarching goal. Using the example of a local
food bank, an appropriate mission statement might be the
following: “To alleviate hunger within our community through
efficient collection and distribution of food products that
effectively reach those in need”. As you can see, the mission
statement repeats the vision statement but then takes the next
step to express how to achieve the vision. However, it’s still
vague. Our example for the food bank could be just as
applicable to any other food bank in the world. AGCO, a
fortune 500 company, has the following mission statement:

“profitable growth through superior customer service,
innovation, quality, and commitment”.1 That statement could be
applied to any other business in the world. It is clear that some
mission statements are better than others. What really makes the
difference is the strategy behind the statement.
Sample Mission Statements
Organization
Mission Statement
AXA
Help customers live their lives with more peace of mind
The Church of Jesus Christ of Latter-day Saints
Invite all people to come unto Christ, and be perfected in him
Coca Cola
To refresh the world ... To inspire moments of optimism and
hapiness ... To create value and make a difference.
FIFA
Develop the game, touch the world, build a better future.
Google
Organize the world's information and make it universally
accessible and useful.
General Motors
Design, build, and sell the world's best vehicles.
London Business School
To advance knowledge and nuture talent in a multicultural
learning environment for positive impact on the way the world
does business.
McDonalds
To be our customers' favorite place and way to eat.
Petrobras
Operate in a safe and profitable manner in Brzil and abroad,
with social and environmental responsibility, providing roducts
and services that meet clients' needs and that contribute to the
development of Brazil and the countries in which it operates.
Samsung
We will devote our human resources and technology to create

superior products and services, thereby contributing to a better
global society.
United Way
Improve lives by mobilizing the caring power of
communities. Connecting Mission Statements to Strategy
No mission statement is complete if it’s not based on your
strategy. Taking the example from the food bank, “To alleviate
hunger within our community through efficient collection and
distribution of food products that reach those in need”, we can
break it down as such:
· Goal: Alleviate hunger
· Method: efficient collection and efficient distribution that
reaches those in need
Now we can complete the utility of the mission statement by
applying strategy to our methods. This involves taking each
method and strategizing what the company will do to
accomplish each. For example, using the food bank’s method of
efficient collection of food, an appropriate strategy may involve
teaming up with local volunteers to collect food, advertising
through pamphlets or signs, or heading up food drives at local
schools.
The most important thing to remember is that vision and
mission statements are meant to be useful. If they don’t actually
help an organization accomplish anything, there is no use in
having them. The utility of the vision and mission statements is
best found through creating a culture oriented around them and
strategy which define how to accomplish them. Plan on
spending much more time on the implementation of the
statements than on the creation of the statements.2.6Points of
Parity and Points of Differentiation
Points of Differentiation
Companies care obsessively about how they compare to their
competition, and continuously look for ways to get a
competitive advantage. These measures fall into the category of
points of differentiation, or things that a company does

differently from its competitors.
Points of Parity
It’s also important to look at the points of parity in your
industry. These are things which are done by all competitors in
an industry because they can’t realistically win over consumers
without them. What are the points of parity in your market?
What things does your company have to offer in order to even
begin competing? Example - Smartphones
For instance, let’s look at the smartphone market. In order to
compete, all companies must offer a phone with certain points
of parity. The phone has to be able to text, use wifi, connect to
bluetooth, call people, and download apps in order to even be
considered by a consumer.
However, you don’t buy a phone because it has wifi
capabilities. You buy it because it has the points of parity AND
you like the points of differentiation it offers. For smartphones,
points of differentiation could be flexible screens, edge display,
increased memory, faster operating systems, or a better camera.
Apple seeks to differentiate itself by having a sleek operating
system that connects seamlessly with your other apple devices
and can even link with other iPhones.Advertise Points of
Differentiation
In strategy, you need to assure that you are doing well on the
points of parity, but you market your points of differentiation.
If you advertise that “customer satisfaction is our most
important goal,” you probably are advertising something that all
companies in your industry practice. This won’t set you apart.
This won’t sell more product. This simply says, “We’re good
enough to be in the same market with everyone else.” Instead,
focus on what makes your product more attractive to a segment
of the consumer base.
A few exceptions to this rule exist, but hopefully you can avoid
them. If your company has historically failed to provide a point
of parity feature, you may have to advertise that feature in order
to restore customer confidence in your brand. For instance,

Nature Valley granola bars were historically so hard and
crunchy that they were practically impossible to chew. When
they finally fixed the problem, they ran an ad campaign making
fun of their previous granola bars and showing customers that
the new granola bars were soft on their molars. Essentially,
advertising points of parity is only a good idea if you are an
extremely weak competitor that needs to convince people that
you are good enough to be in the market or if you have
historically failed to provide a point of parity necessary to your
industry.2.7PESTLE Analysis
Changes in a business environment bring both opportunities and
threats to a firm. To help a firm understand the opportunities
and threats they face, a PESTLE Analysis can be performed to
see the broader picture and situation of the firm.
Elements of a PESTLE Analysis
Elements of a PESTLE Analysis
· Political (political environment, unrest, balance of power,
public ideology, etc.)
· Economic (state of the economy, inflation, interest rates, etc.)
· Social (customer culture, demographics, consumer attitude,
etc.)
· Technological (new technologies, technology research and
spending, internet, etc.)
· Legal (business regulation, government laws, ordinances, tax
laws, trade laws, etc.)
· Environmental (climate, weather patterns, temperatures,
seasons, fault lines, etc.)
By analyzing each of the above factors and changes which
affect each factor, a firm is better able to identify market
opportunities and threats. The PESTLE analysis is carried out
by considering each factor and identifying changes within each.
In regards to these changes, opportunities which arise are
determined, followed by possible threats also incurred. When
possible opportunities and threats are accounted for, an action
plan is created which takes advantage of opportunities and

defends against threats. The final step in PESTLE analysis is
initiating the action plan.
When is PESTLE most helpful?
PESTLE analysis can be particularly helpful for international
companies that deal with global politics, economies, cultures,
advancements, laws, and environments. The PESTLE framework
helps these types of companies make sound decisions on where
to expand and how to do it or to decide not to altogether.
Sample Analysis: Point - Pest Control
Consider the following. As the cofounder of Point, a recently
founded pest control company, you would like to better
understand the market you’re involved in, its opportunities and
threats. To better understand Point’s position, let’s perform a
PESTLE analysis on the company.Political Factors
First we analyze the political situation and political changes.
Point does not operate outside of the US, but you have plans to
take the company across the US. Luckily, there doesn’t exist
any terrible national political feelings which may limit the
existence of Point. However, depending on the state Point
decides to perform its business within, different feelings do
exist on a more local and state level. After searching through
the state governments websites it’s easy to determine which
states are pushing for policies in favor of or against your
business.Economic Factors
Second, we analyze the local and national economy. Since Point
operates nationally, areas in which the economy has improved
immensely will likely create the greatest opportunities. The
general improvement in the economy is already an advantage to
Point however. Social Factors
Third we analyze our customer culture, demographics, and
consumer attitude. Many American residents have negative
opinions of door to door salespeople. Areas which have already
experienced an oversaturation of such sales strategies are less
likely to have a positive response to Point’s sales approach.

Areas of the country in which pests are a major problem,
however, are far more likely to react well to
Point. Technological Factors
Now we analyze technological changes. Door to door sales have
evolved with the recent application of technology. The use of
iPads and tablets has allowed for enhanced product presentation
as well as the ability to transact sales on the spot. Point sees
great opportunity in the development and use of a new customer
app which will increase feedback as well as improve customer
relations. Legal Factors
Next we take into account the legal aspects. At this part of our
analysis we consider national and state regulations, laws and tax
codes. As it turns out, depending on the state, laws have been
created which specify the types of pesticides which can legally
be used. Other regulations by both the EPA and OSHA limit
pest control practices to a certain extent. Knowing these laws
affects the operation and sales location of Point. In addition to
state laws, many cities have laws which require door to door
salespeople to have specific licenses and city permission.
Depending on where Point can obtain licenses will also
determine business operation. In areas which are more strict,
less competition is likely to exist, which provides Point with an
opportunity to monopolize certain areas. Tax code, which
fluctuates by state, may also play a role in Point’s business
strategy.Environmental Factors
Finally we consider the environmental aspects to Point. The
environment plays a huge role in Point’s business operations as
it is the climate which determines if pests are even a problem.
Point can easily determine states with year round warmer
weather will be better candidates than states with freezing
temperatures as warmer states will naturally have greater
problems with pests than others. Other environmental aspects
such as locations in danger of environmental catastrophes only
have to be considered when deciding where to place Point’s
headquarters.Action Plan
Based on the threats and opportunities determined up to this

point (no pun intended), we now determine an action plan that
best allows Point to defend against these threats and take
advantage of these opportunities. The PESTLE framework
becomes a key decision making tool for determining this plan.
The action plan, which will not be detailed in this paper, would
consist of exactly which states Point would target, products
Point would sell, the integration of Point’s customer app, and
the specifics of employee training activities.
The final step to PESTLE analysis involves integrating the
action plan by picking a place to start and beginning.
On an international level, companies have a lot to consider
when performing a PESTLE Analysis due to the extreme
differences in the cultures and countries around the world. The
PESTLE Framework can guide companies to make sound
decisions and appropriate strategies.2.8Organizational
Resources
Resources
Human capital, physical capital, financial capital, information
capital and raw material all make up the resources available to
organizations. Rightly named, these assets combined are known
as a firm’s organizational resources. These play a vital role in
shaping a company’s strategy. Human Capital
Human capital consists of everything to do with the employees
of an organization. It consists of all the experience, knowledge,
education, creativity, and abilities of the individuals within a
firm. Human capital carries incredible value as a firm’s premier
source of innovation and profitability. Without credible human
capital, all other capital is useless and unprofitable.Physical
Capital
Physical capital includes everything a firm uses for the creation
of a product apart from raw materials. Physical capital may
include all production equipment, computers, vehicles, and
buildings a firm owns and uses for operation. Financial Capital
Financial capital is the money a firm uses to purchase assets
necessary for business operation. Access to financial capital can

determine how quickly an organization can expand and how
much interest it has to pay on loans.Information Capital
Information capital includes information technology –
databases, networks, and software – and business intelligence.
These form the backbone of the business and its operation. For
many companies, information is as valuable as any other
resource a firm may have.Natural Resources
Natural resources are raw material and substances used in
production. Materials such as minerals, lumber, water,
livestock, land, and crops are classified as natural resources.
Manufacturing firms are most likely to be concerned with
natural resources since the price of raw materials heavily
impacts their profits.
Realizing a firm’s organizational resources is the start to
strategic organizational thinking. Finding where a firm’s
strengths and weaknesses are is critical. For example, firms
lacking in human capital may consider finding new employees.
Those with remarkable human capital should initiate programs
which boost employee autonomy and creativity in order to best
fit the value of their resources. Google, for example,
recognizing the incredible human capital within their firm,
gives their employees one day of work time a week to work on
whatever projects they want. Such a loose and unorthodox
program has been the birthplace to key services such as Gmail.
Strengths and Weaknesses
What are the strengths and weaknesses in your company’s
organizational resources? How can you craft your strategy to
get the most value of your company’s strengths and fix any
debilitating weaknesses?When to Focus on Weaknesses
If your company has some weaknesses that really hold you back
from realizing profits, your strategy should focus on fixing
these. For instance, if your company is weak in information
capital because all the computer systems are outdated, you
might focus on fixing this by investing both in new systems and
in employee training so they can use the new computers. When

to Focus on Strengths
However, if your firm doesn’t have any weaknesses that
significantly hamper the company, you should consider focusing
on a strength. If your company has lots of cash available, you
could take advantage of your financial capital to grow the
company. You could invest in higher quality machinery, recruit
some higher-quality employees, or even acquire another
company. By focusing on your strengths, you exploit your
competitive advantage.
If you find that your strengths all center around one aspect of
your company, you could consider outsourcing the other
business processes to other companies. If they can perform the
operations for less than you can, perhaps you should focus on
the part of the chain where you add the most value to the final
product.
In the end, it works both ways. Your strategy needs to align
with the organizational resources that you excel at, and your
organizational resources must align with your strategy. Make
sure that either your strategy fits the organizational resources
that you posses or that you acquire the organizational resources
needed to carry out your strategy.
2.9Balanced Scorecard
Businesses put a lot of effort into developing effective long
term strategy. Such strategies and the processes used to create
them can be complicated and illusive. The Balanced Scorecard,
which was developed in 1992 by Robert Kaplan and David
Norton, identifies four key perspectives which ultimately
determine long term strategy.
· Financial Perspective - Includes shareholder value, economic
value, net income, etc.
· Customer Perspective - Includes customer loyalty, customer
satisfaction, and market share
· Business Process/Internal Perspective - Includes quality and
delivery of product or service, output, production, etc.
· Learning and Growth Perspective - Includes elements of
continual growth and value creation, employee skills, training,

satisfaction and retention.
The Balanced Scorecard can be represented by the four legged
diagram below.
To use the balanced scorecard to its full potential, goals and the
actions taken to reach those goals are determined for each
perspective. Creating goals and a plan of action for each of the
four aspects of long term success can become the backbone of
long term strategy and thus determine long term
success.2.10Product Revenue Analysis
Most businesses with inventory sell more than one product.
These products vary in their prices, their costs of production,
their turnover rate, and how much of each product is sold.
Product Revenue Analysis is a tool developed specifically to
evaluate these product variations and help a firm make strategic
decisions in regards to their products. Such decisions might
involve deciding which products to focus on, how or if to
change prices, which product lines to consider or cut, etc.
Sample Product Revenue Analysis
Imagine a startup that specializes in selling shovels, garden
hoes and hatchets. The company is doing well but isn’t growing,
and management isn’t sure how to extend their product line.
They know what it costs to produce each of their products, they
know how much each product sells for, and they know how
much of each product is sold. On the other hand, the company
doesn’t know how this information is helpful to making
business decisions to developing company growth. As a college
student intern who the company has hired to work in the
warehouse, you see the company’s lack of strategic thinking as
an opportunity to show your true value as an employee by
performing a product revenue analysis.
You begin by compiling a spreadsheet that shows each of the
company’s products, the revenue brought in by each, the costs
associated with the production of the products, and
subsequently the income (sales-costs) of each. Your spreadsheet

looks like the following.
Table 2.1
Products
Revenue
Cost
Income from Product
Shovels
$605,000.00
$395,000.00
$210,000.00
Garden Hoes
$50,000.00
$9,000.00
$41,000.00
Hatchets
$30,000.00
$18,600.00
$11,400.00
Total:
$685,000.00
$422,600.00
$262,400.00
The next step you take is to determine the profit margin,
percentage of sales, and percentage of income of each product.
Profit margin is determined simply by dividing the income of
each product by the revenue brought in by the product.
Percentage of sales is calculated by dividing the revenue of
each product by the total revenue of all product sales.
Percentage of income is found by dividing the income from each
product by the total income of all products. At this point, your
spreadsheet looks like the following.
Table 2.2
Products
Revenue
Cost
Income from Product

Profit Margin
Percentage of Sales
Percentage of Income
Shovels
$605,000.00
$395,000.00
$210,000.00
34.7%
88.3%
80.0%
Garden Hoes
$50,000.00
$9,000.00
$41,000.00
82.0%
7.3%
15.6%
Hatchets
$30,000.00
$18,600.00
$11,400.00
38.0%
4.4%
4.3%
Total:
$685,000.00
$422,600.00
$262,400.00
This is when you astonish management by pointing out simple
figures that they’re ashamed to have overlooked. First, you
point to the profit margin and indicate how much larger the
profit margin of garden hoes is compared to shovels and
hatchets. You note that the profitability of a product is affected

greatly by its profit margin. 82%, compared to 38% and 34.7%,
is a pretty stark difference. Next you point to the relationship
between percentage of sales and percentage of income. Having a
higher percentage of sales than percentage of income indicates
that the product isn’t as profitable as it should be compared to
other products. Having a percentage of income higher than
percentage of sales, on the other hand, indicates that a product
has a higher profitability in relation to other products. Knowing
this you are able to point out that the percentage of sales and
income of shovels indicate that focusing on selling more
shovels would not be as profitable as focusing on selling more
garden hoes, which have an incredible difference in percentage
of income and sales.
With a simple product revenue analysis you are able to impress
the management of the company who subsequently promotes
you from a warehouse worker to head of business strategy.
Congratulations!2.11The VRIO Framework
Comparative Advantage
VRIO is a framework designed to aid in determining the
comparative advantage of a product, resource, idea, or service.
Knowing the comparative advantage of what a firm has to offer
before the implementation aids in the decision making process
and helps the firm or individual succeed. In order to determine
the comparative advantage, the questions of value, rarity,
imitability, and organization are taken into account.
Value
Starting with value: Does the product in question provide value
to your company? If not, why is the firm even considering it?
Putting out a product with no value will only be
disadvantageous to the firm. Rarity
Moving on to the question of rarity: Is the product we are
offering new to the market or already existing in one form or
another? If we are offering a simple but different product, are
the changes we’ve made significant enough to consider it rare?
If not, there’s no expectation of a competitive

advantage.Imitability
Now considering imitability: Imitability brings to question the
ease of copying or imitating the product being offered. Is the
product you are offering difficult or easy to duplicate? Is it
expensive or inexpensive to develop? If another firm is willing
and able to replicate the product and undertake associated costs,
our firm can only expect to hold a competitive advantage for a
limited time (the time it takes our competition to develop their
similar product). Organization
Finally considering organization: When our product
demonstrates value, rarity, and difficult imitability, the final
and possibly most important element to consider is
organization. Is our firm organized and operate in such a
manner that we can capture as much profit from our product as
possible? What changes need to be made to promote innovation
within the firm, create a more dedicated culture, and support a
more effective management strategy? If our firm leaves
unclaimed value in the market for another firm to take
advantage of, our competitive advantage won’t last but when
our organization can capture all available value, as well as pass
the questions of value, rarity, and imitability, we expect a
lasting sustainable competitive advantage.
Sample VRIO Analysis - The iPhone
Here’s a VRIO framework of the iPhone to better explain this
concept. The each step of the process and determine the strength
of the iPhone’s competitive advantage.
· Value: There is value in the iPhone because of its ease of use,
popularity, quality in hardware and software, and brand name.
· Rarity: Although there are many smart phones which are in
competition with Apple’s iPhone, the iPhone is rare in its
unique software, hardware, and brand.
· Imitability: Many phones do the same functions just as well as
iPhones but what can’t be imitated is Apple’s brand and
software.
· Organization: Somehow Apple has captured a large portion of

the smartphone market simply on brand name. They have
amassed an army of iPhone diehards that refuse to support any
other brand. The main aspect of the iPhone that passes all steps
of the VRIO framework is Apple’s brand name
2.12Internal and External Factor Evaluation Matrices
One issue with many business analyses, especially those which
involve examination of a firm or market, is how subjective they
can be. One way to remove some of the subjectivity of internal
assessment and external analyzation is to quantify the results
with some sort of weight or rating. An Internal Factor
Evaluation Matrix (IFE) and an External Factor Evaluation
Matrix (EFE) have both a weight and a rating. An IFE Matrix is
an auditing tool a firm can use to assess its own internal
strengths and weaknesses and an EFE Matrix is an analyzation
tool a firm can use to assess the market and external elements of
the business.
Example: Johan's Furniture Store
Johan owns and operates a growing furniture store with several
employees. Business is going well but he wants to better
analyze the internal and external factors of his business to
understand his business’ strengths and what should improve as
well as the opportunities and threats of the local market. He can
use an Internal Factor Evaluation Matrix to better understand
his own business and an External Factor Evaluation Matrix to
better understand the market.
We’ll start by demonstrating how Johan would perform an IFE
Matrix.Internal Factor Evaluation Matrix
First, Johan identifies the main internal factors of his business.
Such factors may include customer service, quality of product,
his company location, storage capacity, etc. He lists these
factors and categorizes them as either strengths or weaknesses.
Second, Johan gives weight to each factor depending on the
importance of each. The weights must be made so that they total
exactly 1. Elements of his business such as reputation and
market share are naturally his highest weighted strengths and

his limited storage capacity weighs in as his most detrimental
weakness.
Once appropriate weights are determined, Johan gives each
factor a rating. If the factor is a vitally important strength it is
given a rating of 4, valuable but not vital strengths are given 3
as a rating, weaknesses which can be treated lightly are rated 2,
and important weaknesses that need to be addressed are rated 1.
Table 2.3
Internal Factor Evaluation Matrix
Key Internal Factors
Weight
Rating
Weighted Score
Strengths
1.
Largest Market Share
0.12
4
0.48
2.
High Quality Product
0.1
4
0.4
3.
High Quality Service
0.08
3
0.24
4.
High Product Variety

0.08
3
0.24
5.
Good Location
0.09
3
0.27
6.
Great Reputation
0.14
4
0.56
Weaknesses
1.
Limited Storage
0.11
1
0.11
2.
Low number of suppliers
0.09
2
0.18
3.
Unreliable software
0.1
1
0.1
4.
Untrained employees
0.09

2
0.18
Total
1
2.76
The weighted score of each factor is determined by multiplying
each factor’s rating by it’s weight. The total weighted score is
calculated simply by the sum of every factor’s weighted score.
An average total weighted score for a company is 2.5. A score
lower than 2.5 indicates an internal situation that is weak but a
score higher than 2.5 indicates an internal situation that is
stronger than average. In Johan’s IFE Matrix , Johan determined
that his business had a score above average of 2.76.External
Factor Evaluation Matrix
An External Factor Evaluation Matrix is performed similarly as
follows.
First, Johan identifies the main factors of his market and
categorizes each factor as either an opportunity or threat. Such
factors might include whether the market is growing or
shrinking, the state of Johan’s competition, or economic
conditions.
Second, Johan gives weight as to the importance of each factor,
as seen previously in the IFE Matrix.
Just as Johan did when performing the IFE Matrix, Johan’s third
step is to his EFE Matrix is to rate each factor from 1 to 4.
When performing an EFE Matrix however, each rating is a
representation of how responsive the firm can be to each factor.
A rating of 1 infers a very poor ability to respond to the factor
and a rating of 4 shows a phenomenal ability to respond to the
factor.
The weighted scores and the average total weighted score are
determined exactly how they were in the IFE Matrix example,
as we can see in Johan’s EFE Matrix. An average score is still
2.5, below average is below 2.5, and above average is above

2.5.
Table 2.4
External Factor Evaluation Matrix
Key External Factors
Weight
Rating
Weighted Score
Opportunities
1.
New Homes Under Construction
0.2
4
0.8
2.
Declining # of Competitors
0.19
3
0.57
3.
New Suppliers
0.15
3
0.45
4.
New Custom Furniture Market
0.1
2
0.2
Threats

1.
RC Wiley store in Construction
0.23
2
0.46
2.
Poor State of the Economy
0.13
1
0.13
Total
1
2.612.13McKinsey 7S Model
It is rare that a single element of your business will either drive
success or prevent it completely. Instead, different parts of the
business overlap and interact to create success or failure. The
McKinsey 7S model is a simplified way of looking at your
organization and each element which may affect the company’s
success or failure.
In order for your business to be successful, you need to do well
in each of these areas. As all elements are interconnected in the
framework, each influences how well your organization does in
the other areas.
Elements of the McKinsey 7S Model
The framework divides the factors into two groups - Hard S
areas and Soft S areas. The top three, Strategy, Structure, and
Systems, are hard areas. This means that these areas are easier
to identify, manage, and work with. They are very tangible. The
rest - Staff, Style, Skills, and Shared Values - are soft areas,
meaning that they are harder to manage because they are

difficult to define, alter, and control.
Hard areas:
1. Strategy
2. Structure
3. Systems
Soft areas:
1. Staff
2. Style
3. Skills
4. Shared ValuesStrategy
Strategy is a company’s plan for how to be successful - how to
stay ahead of competitors, how to grow, and how to improve on
all these areas. Do your employees act in accordance with your
strategy? Does your strategy drive growth? Does your strategy
create long-term results?Structure
Structure refers to the organization (structure) of your business
- the organization of different departments and teams, as well as
the leadership hierarchy. Can employees communicate problems
to managers? Do you lose a lot of efficiency waiting for
approval or other bureaucratic processes? Are your employees
engaged and dedicated to the success of the company?Systems
Systems are the business processes that make up your company.
Do you have smaller profit margins than many companies in
your industry? Do your manufacturing processes frequently
cause delays in the orders you are sending out? Is your
workplace a safe environment? Skills
Skills are the things your employees are good at doing. Do you
have productive employees who surprise you with how much
they accomplish? Are there technical issues that you frequently
have to hire outside help to solve? Could you get one very
skilled employee instead of two lesser skilled employees? Do
you have a competitive advantage thanks to your employee
skills?Staff
Staff deals with who you hire, how many of each type of job
you need, and other Human Resource functions. These include
recruitment, training, motivation, and compensation. Do you

have enough people to keep up with the tasks at hand? Are
employees frequently idle? Do you have the greatest number of
people in the departments which drive the most growth in your
company? Style
Style means leadership style, or how the top-level managers
lead the company and interact with each other and employees.
Are your employees motivated by what your leaders say and do?
Do you have lots of workplace conflict? High turnover? Perhaps
solving issues in leadership will solve many issues throughout
the company. Shared Values
Shared Values means that each of the elements of the model are
interconnected around the standards and culture that guide both
how employees act and what the company chooses to do. These
are the foundation of your organization. Do you have strong
mission and vision statements? Are you an ethical corporation?
Do you accomplish good in the world?
The McKinsey Model takes these categories and looks closely at
each to see if it is working or not and how well each supports or
diminishes others. You must balance the different areas of the
company, addressing the elements which are either significantly
better or significantly worse than the others. For instance, if
your business has a fantastic strategy and great skills, it would
seem that your company will be successful, however, if your
systems are inefficient (maybe your computer systems are
ancient and crash often), it is possible that your strengths will
be undermined. Great strengths within the company may be
utilized to improve those areas in which the company is lacking.
A careful analysis of these 7 items will show your company’s
balance and give a fairly accurate forecast into the future
success of the firm.2.14Strategic Fit
Strategic fit is a very broad term with several loose definitions.
It can be used as a way of looking at many aspects of your
business, all under the broad label of strategic fit.
For instance, you can determine if a particular project is a good
strategic fit for your company. Does this specific project align
with the overall corporate strategy? Does it align with

the resources you have available? Does it align with the
opportunity that is present in the market?
Strategic fit can refer to how the activities a business
undertakes fit together with the strategy of the company to
match a need in the market, producing a competitive advantage
for the company. For instance, if your company offers lower-
cost software to small businesses because your small size allows
you to create customized solutions for your clients, you have
achieved strategic fit for a specific segment of the market.
Mergers and Acquisitions
Many people will talk about strategic fit in terms of mergers
and acquisitions. If the merger or acquisition doesn’t further
your strategic aims, then don’t do it. The strategic value of the
firm must fit your company strategy, the culture must fit your
culture, and their employees must be a good strategic fit for
your company. It is difficult to achieve strategic fit with
mergers and acquisitions. Determine Overall Objectives and
Market Needs
In order to determine strategic fit, it is necessary to establish
the organization’s overall objectives, and identify the need in
the market. All projects, mergers, acquisitions, and processes
should align both with the company strategy and with the
market need.
Company and Strategy Alignment
Match your company to your strategy and match your strategy
to your company. Fundamentally, your strategy and your
company should align almost perfectly. If you have decided that
a certain strategy is the best way for your business to move
forward, you may have to adapt how you do business to fit that
strategy. On the other hand, when creating a strategy, it is often
wise to build the strategy around the business and success that
you already have.
Example - Premium Watches

For instance, let’s pretend that you sell classy watches. Your
strategy is to offer a premium product to high-class
customers. Supply Chain
Your supply chain needs to have strategic fit. You must get
quality materials in order to build premium watches, so you
need to find both adequate suppliers and high-quality
manufacturing companies to create the watches. Distribution
Your choice of distribution should also match your strategy.
You’ve decided that you are going to pursue an exclusivity
strategy, in which you only sell your watches from certain,
sophisticated stores. Selling your fancy watch in a gas station or
in a big-box store works against your strategy. Price, Branding,
and Advertising
Along with location, your price and your branding should fit
with your strategy. You have to charge a high price to cover
your costs, but you will probably increase this price even
further to give the impression of majestic quality. Everything a
customer sees about your product should speak of its quality
and prestige. Strategic advertising will promote your brand and
create a clear picture in the mind of your consumer as to what
your company is. Human Resource Management
Your decisions in human resource management should also
align with your strategy. If you want to sell classy watches,
your sales reps need to be class, well-dressed individuals. You
are unlikely to hire cheap employees who want a quick,
temporary job. Organizational Resources
Organizational resources play a big role in whether or not you
can achieve strategic fit with a given strategy. Making those
premium watches may require hiring experts in the watch
industry to continually develop better watches and inspire
confidence from the customers. Research and Development or
Technology may have to be improved to achieve strategic fit
within your organization.Leadership and Customer Support
Other support functions also need to work with your company
strategy. Your business leadership has to make strategic sense,
and your customer support must work together with the rest of

your branding to give the correct impression to customers.
Potentially, you could look at every aspect of your business and
determine whether it fits strategically with the rest of your
company or not. In general, you should focus your efforts to
achieve strategic fit on the most impactful areas (these will
change depending on your strategy) which are most important to
your company.2.15Summary
Starting Out: Analyzing Your CompanySetting/Choosing a
Strategy
A brief introduction to the basic process of choosing a strategy,
as well as how to use the book. Ask various questions to help
the reader think about what his/her business really excels at and
will be successful at.Planning, Crafting, and Emergent
Strategies
Planning strategy is essentially when a person sits down, creates
a plan for the business, and puts it into action.
A Crafting strategy is one where business leaders adapt the
strategy as they learn more about the market and the business. It
is molded and shaped over time.
An Emergent strategy is a strategy that comes about without
structured plans or delineated changes but comes from the needs
of the market. This kind of strategy could be thought of as a
pivot from the planned or crafted strategy.SWOT Analysis
A SWOT analysis looks at the Strengths, Weaknesses,
Opportunities, and Threats that face your business. This is a
very common analysis to perform when assessing a company for
potential strategies. Mission and Vision Statements
Mission and Vision Statements focus on the big picture of a
company - the reason it exists, its overall dream, and how it will
achieve its goals. These help a company see its core focus and
desires.Points of Parity and Points of Differentiation
Points of parity are the features and services that all companies
in your market must provide in order to compete. Points of
differentiation are the features or services that set your
company apart.PESTLE Analysis

A PESTLE analysis looks in greater depth at the opportunities
and threats a firm is confronted with. PESTLE stands for
Political, Economic, Social, Technological, Legal, and
Environmental factors facing a firm.Organizational Resources
Organizational Resources are the different forms of capital
(human, physical, financial, informational, etc.) that are
available to an organization. An effective strategy must be
backed by the correct organizational resources.Balanced
Scorecard
The balanced scorecard looks at your business from four
different perspectives: a financial perspective, a customer
perspective, a business process/internal perspective, and a
learning/growth perspective.Product Revenue Analysis
The Product Revenue Analysis looks at which products bring in
the greatest percentage of your revenue, allowing you to
determine what to focus your company efforts on.The VRIO
Framework
The VRIO Framework looks at the comparative advantage that a
company offers to consumers. It looks at the value, rarity,
imitability, and organization of the product, service, resource,
or idea that it offers to customers.Internal and External Factor
Evaluation Matrices
The Internal and External Factor Evaluation Matrices seek to
take some of the subjectivity out of assessments by giving each
relevant business factor a weighted score. This allows for more
objective evaluations of both your company and your
competitors.McKinsey 7S Model
The McKinsey 7S Model looks at the Strategy, Structure,
Systems, Shared Values, Staff, Style, and Skills of your
business. It helps you balance your company, seeing which
areas you excel in and which areas are weaknesses.Strategic Fit
Strategic fit looks at how well various aspects of your business
mesh with your strategy. This can be seeing if your strategy fits
your market, looking at whether a particular project fits with
your strategy, or determining if you have the organizational
resources to accomplish your strategy.

Chapter 3: 3.1Introduction to Competition
Learning Objectives
1. Describe Porter's 5 Forces.
2. Differentiate between Red Ocean and Blue Ocean Industries.
3. Explain the Product and Industry Life Cycles.
4. Define Disruptive Technologies.
5. Define Benchmarking and its use.
6. Describe a Weighted Competitive Strength Assessment.
7. Explain how to develop Core Competencies.
8. Perform a Four Corners Analysis.
9. Describe Incumbency Advantage, Diversification, and
Diffusion of Innovations.3.2Porter's 5 Forces
The 5 Forces
Introduced by Dr. Michael Porter, Porter’s five forces are a tool
used to determine the level of competition and analyze the
opportunity of an industry, individual, project, or firm.
According to Porter, managers often look at competition too
narrowly, focusing exclusively on the fight between the
companies within an industry.1 Instead, he argues, the five
forces shape how competition occurs. Without looking at all
five forces, a manager cannot have a broad enough view to
adequately create a business strategy. The five forces are the
following:
· Supplier Power
· Buyer Power
· Threat of Substitution
· Threat of New Entrants
· Competition
Supplier Power
Supplier power refers to the ability suppliers have to drive up
prices for the firm. An example would be copper suppliers
selling to microchip companies or sugar producers selling to
Coca Cola. Supplier power is often determined by the number of
suppliers, their market share in the industry, and the difficulty
for a firm to switch to a different supplier. Given that suppliers

value firms the value of a firm decreases in the eyes of the
supplier with each additional firm supplied, suppliers are most
powerful when they hold a large market share and supply many
firms.Buyer Power
Buyer Power refers to the ability customers have to drive down
prices offered by a firm. Consider for example how much
influence Apple’s customers have over the price of iPhones or
how much customers control the price of Colgate toothpaste.
Neither of these companies would be impacted by one customer
switching to competitors but both would face difficulty if there
was a mass exodus of thousands or millions of customers to
competitors. Threat of Substitution
Threat of substitution points to the possibility of customers
switching from the products or services of one firm for those of
another. The threat of substitution increases as product quality
and value decrease, prices increase, or with the ebb of product
uniqueness. Such substitutions can even completely disrupt the
market for any given product. The computer substituted the
typewriter. Digital cameras substituted film. Cloud storage is
replacing hard storage. When considering this threat, a firm
tries to innovate and stay ahead not only in the product market
but in the industry as a whole.Threat of New Entrants
Threat of new entrants brings to question the possibility and
likelihood of new firms entering the market to compete. This
threat is determined by ease of entry, the profit opportunity
within the market, and the protection of existing firm’s system
ideas and technology. Compare opening a lemonade stand with
starting a new hotel chain. Out of the two, obviously opening a
lemonade stand is far less expensive, easy to replicate, and
incomparably easier to manage, therefore we can assume there
is a higher risk of new entrants. Competition
Competition or rivalry refers to the existing market in which a
firm is located. The competition is determined by how many
other firms exist in the firm, the differences between those
firms and their products, price differences, how much of the
market share a firm holds, and the loyalty of customers. If we

consider the beverage industry from the perspective of Coca-
Cola it’s safe to say their biggest competitors are Pepsi and Dr.
Pepper. Because of competitive rivalry, all three beverage
companies are forced to keep their prices low and rely heavily
on brand promotion to increase customer loyalty. They all hold
a large enough market share that competition remains high as
the three firms innovate and offer new products.
Dynamic forces, not static forces
It is important to remember that the five forces are dynamic, not
static. Over time, any or all of the forces may change
dramatically. These changes in the competitive environment
necessitate changes in your company's strategy. Do not make
the mistake of only looking at the five forces once and using the
same strategy after the forces shift and realign.3.3Blue Ocean
vs. Red Ocean Strategy
Blue and Red Ocean Strategies are two different market
competition strategies. Red Ocean Strategy involves competing
companies working to outperform rivals and capture a greater
portion of share in the same market where Blue Ocean Strategy
focuses on the creation of new uncontested markets where no
competition exists.
Different Types of IndustriesRed Ocean
So what do these oceans represent? Red Oceans represent
industries and markets which have existed long enough to
become saturated by competition. The car industry, paper
industry, oil industry, and paint industry are all examples of
highly saturated markets which have existed for decades, if not
centuries. These industries are few of the thousands which are
Red Oceans.Blue Ocean
Blue Oceans are new industries, new technology, and new
product markets that have never existed before. Examples of
Blue Oceans include future software concepts, ideas that have

yet to be released, and some very recent new product industries
(which will likely become Red Oceans in time) including smart
glasses, virtual reality sets, self-driving cars, and new medical
procedures and vaccines.
CharacteristicsRed Ocean - Stiff Competition
Red Ocean Strategy is characterized by a cut-throat approach
which entails competition to death. The ocean is dyed red as
firms engage in a bloody fight for larger market share and niche
markets. This strategy can be successful for firms that keep
becoming more efficient and effective at attracting customers
but if the market is teeming with competition, both profit and
growth become challenging.Blue Ocean - New Rules, New
Boundaries, and New Vision
Blue Ocean Strategy is manifest when a firm innovates to create
its own market with no competitors. They create new demand
and capture what they create. When other firms follow suit they
are too late to compete with the blue ocean firm. Blue Ocean
Strategy challenges the existing market and allows a firm to
define new rules, new boundaries and a new vision.
Examples of Blue Oceans
Ford made a blue ocean move when they introduced the Model
T, which was the first time the automobile was available to the
general public. In a similar move, Canon offered the first
personal printer to be used in customers’ homes. With Apple’s
introduction of iTunes, a new blue ocean market of digital
music was born.
Application
Think of how your company can enter blue markets. What
innovations are not currently on the market? Are you
significantly ahead in a certain sector of software development
or other area? Look specifically for areas that you can enter but
would be difficult to replicate or enter once the original has
been released. If it is too easy for other companies to enter the

market, the blue ocean will quickly turn red. This doesn’t mean
that your company shouldn’t enter the blue ocean, it just means
the blue ocean won’t protect you from competition.
The incumbency advantage may be great enough to carry you
through, or the temporary surge in sales may be worth the
effort. If you choose to implement a blue ocean strategy, you
must be prepared to invest enough in research and development
to stay ahead of the competitors.3.4Product and Industry Life
Cycle
Industry life cycle is a concept of different stages an industry
will undergo from first introduction to eventual decline. Product
life cycle is similar in principle, only it refers to the stages a
product undergoes from introduction to decline rather than an
entire industry. Although the life cycle of an industry is
generally much longer than those of its products, both life
cycles follow the same four phases from beginning to end
starting with introduction, followed by growth, then maturity
and finally terminating with Decline.
Phases of the Product and Industry Life CycleFirst Phase -
Introduction
The first phase of the cycle is the introduction of the product or
industry. This phase is heavily characterized by endorsement
and advertisement to promote and attract early buyers and
participants. Let’s consider a new candy bar created by Mars
Inc. called the Snickers Crisper. At stage one, the Snickers
Crisper was advertised on major television in order to promote
the product.Second Phase - Growth
The second phase, growth, is characterized by product
innovation and expansion. During this phase firms seek to
expand their market share by making their product attractive
and accessible to everyone. It will be during this phase that we
can expect the Snickers Crisper to come out in king size, mini,
and family sized portions and be wrapped in holiday specific
packaging.Third Phase - Maturity

The third phase of the cycle is maturity. At this phase, a firm
hopes to see great results from the previous two phases and the
efforts that went into their product. There may be some
continued innovation and product alteration but only
moderately. During this phase, Mars Inc. expects large profit
from the Snickers Crisper as its popularity and availability will
likely reach its peak.Fourth Phase - Decline
The fourth phase of the life cycle is the product’s or industry’s
decline. Most products reach a point where they are less and
less interesting to consumers. They become less popular than
they once were, but this is not to say such products are no
longer profitable to a firm. They still may bring a firm
considerable profit even if sales decline. For Mars, the Snickers
Crisper will eventually be on its decline and Mars will decide
how long to continue its production. As long as profit made is
greater than expenses incurred, the Snickers Crisper is likely to
remain in production.
Innovation is Key
Innovation is the key to beating the product and industry life
cycle. If a company can successfully innovate and develop their
industry and products to continually fulfill consumer demand,
they can avoid decline. An innovative company is one that
continually seeks to improve by investing enough time, talent
and money into its next generation products. Innovative
companies keep their eyes on their competitors and watch for
advancements not only in their own industry but in others as
well. They seek to create disruptive technologies.3.5Disruptive
Technologies
What are Disruptive Technologies?
Every once and awhile a new idea or technology comes along
that seemingly changes everything. These new technologies
change the status quo, they alter markets, reshape businesses,
and modify our livelihoods. In an article published in 1995,
Clayton M. Christensen classified such innovations

as disruptive technologies.
For a new innovation or technology to be considered disruptive
it must drastically alter a current market, much like the
invention of the wheel changed transportation thousands of
years ago and the mass production of the affordable Ford Model
T altered the same market more recently. The invention of steel
as a replacement for iron completely altered the construction
market. The internet has completely disrupted multiple markets
including communication by mail, retail, information, and
socializing. Thousands of other technologies have disrupted our
way of life including personal computers, printers, smartphones,
word processing software, cameras, LED lights, advanced
robotics, 3D printing, and cloud storage.
Adapting and Creating Disruptive Technologies
Recognizing disruptive technologies is fine, but ultimately we
want to adapt to and create disruptive technologies. Firms who
fail to adapt to disruptive technologies will be destroyed by
them, and firms who create disruptive technologies will become
extremely successful. Watching Competitors and Other
Industries
Two ways a firm can be best prepared to take advantage of
disruptive technology is to watch their competition closely and
to watch other industries. If a firm keeps a close enough eye on
all of their competition they can likely catch on to shifts in the
market and be one of the first to benefit from the disruptive
technology. Watching other industries is equally important
because modern business ideas and technology transfer
effortlessly across industries. If your firm is the first to notice a
disruptive technology in another industry you might become a
pioneer in applying it to your own industry.
No Secret Recipe
There is no secret recipe to creating a disruptive technology, but
in order for a firm to be at least in a position where they could
create their market’s next disruption, the firm must be awake,

watching, listening, and keeping up with their customers. They
need to be aware of advances in society, technology, and
production capacity as well as aware of changing customer
needs and wants.3.6Benchmarking
When benchmarking, a company compares their business
processes/performance to the best practices of other similar
companies.
Common Benchmarks
Although quality, time, and cost are three of the most common
areas to benchmark in essentially all industries, benchmarking
can be used to evaluate any quantitative measure of
performance. The following list includes some of the most basic
benchmarking areas:
1. Cost to produce a single unit
2. Productivity per unit
3. Cycle time per unit
4. Defects per unit
Benchmarking Example
Let’s pretend that I want to benchmark my beer company,
Chad’s Blue Collar Beer. First, I’ll identify which companies in
the beer industry have the best quality, time, and cost.
Generally speaking, the industry leaders are very good at all of
these. Perhaps I’d benchmark Chad’s Blue Collar Beer against
Anheuser-Busch InBev (maker of Budweiser), MillerCoors,
Heineken, and Pabst. These companies are among 11 brewers
that make more than 90% of all beer in the United States, which
shows their high industry performance.
First, how much does it cost to produce a single bottle of beer?
Perhaps Chad’s BCB spends $0.75 on each bottle. If Heineken
spends $0.25 per bottle, MillerCoors spends $0.28, and Pabst
spends $0.26 per bottle, it is easy to see that Chad’s BCB
should look into decreasing costs as it grows. Obviously, the
benchmark companies will be cheaper because of the volume
they are producing, but the sizable gap in cost highlights an

area to investigate.
We then perform the same comparison to benchmark Chad’s
BCB productivity per bottle of beer, the cycle time per bottle of
beer, and the number of defects we average.
Hypothetically, I may find that my company does proportionally
much worse in the cost per bottle of beer and has a very long
cycle time compared to the other beer companies. However, I
may actually have fewer defects per 1,000 bottles than any of
the other companies.
This opens up several possibilities. Perhaps Chad’s BCB should
decrease the amount of time for a bottle to be made and filled
(cycle time) even if it means that the number of defects
increases to the industry average. This will allow us to produce
a greater volume while the factory is open, decreasing the
operating costs even if some money is lost on defects.
Or perhaps I will choose to work on decreasing my cycle time
while still maintaining the relatively low rate of defects,
attempting to gain a competitive edge on other
companies.Internal Benchmarking
Benchmarking can also occur within a company. If my beer
company has 4 factories and each has several different bottling
lines, I can measure the results of each line within the factory
and make a comparison. Then a comparison can be drawn
between the different factories, analyzing each of the measures
listed above. Benchmarking from other Industries
Benchmarking can also be used from other industries. For
example, Bill Smith and Mikel Harry introduced the statistical
process control system called six sigma while making cell
phones and other products for Motorola. Other industries
recognized that six sigma control was preventing most costs
from defects at Motorola (roughly 3.4 defective features per
million opportunities), so many manufacturing companies began
using six sigma within their respective industries.3.7Weighted
Competitive Strength Assessment
Weighted Competitive Strength Assessment is a tool used to
quantify competition and simplify firm comparison and

analyzation. When followed correctly, the process allows a firm
to understand and see clearly its own strengths and weaknesses,
as well as those of its competitors which help the firm make
sound business decisions. Follow these steps to perform a
Weighted Competitive Strength Assessment:
1. List key factors that determine industry success
2. Rate the firm you are analyzing and its competitors on each
industry factor from above.
3. Give a weight to each element based on the value each factor
has in the market (the total sum of all weights are 1.00).
4. Determine the competitive score for each firm by multiplying
each rating by each weight and then summing totals for each
firm.
5. Analyze the firm in question, comparing each success factor
to its competitors.
Sample Weighted Competitive Strength Assessment
Johan owns and operates a growing furniture store with several
employees. Business is going well, but he’s not really sure
where he stands in regards to his competitors. He decides to
perform a weighted competitive strength assessment to help him
decide how to improve his business. Here is an example of what
that weighted competitive strength assessment might look like.
Strength / Measure
Weight
Johan
Competitor 1
Competitor 2
Rating
Score
Rating
Score
Rating
Score

Quality of Product
.18
9
1.62
6
1.08
9
1.62
Price of Product
.17
7
1.19
9
1.53
7
1.19
Service
.21
9
1.89
3
.63
9
1.89
Size of Inventory
.1
6
.6
9
.9
4
.4
Variety of Product
.1
7
.7

8
.8
3
.3
Reputation / Image
.24
9
2.16
6
1.44
8
1.92
Overall Strength Rating
8.16
6.38
7.32
Rating Scale: 1-weak, 5-average, 10-strong3.8Core Competency
Many markets are saturated with similar firms offering similar
products for similar prices. Every once and awhile, however, a
firm manages to set itself apart by offering something more than
the standard product. This differentiation could be due to the
firm’s unprecedented manufacturing process or possibly their
phenomenal customer service. Perhaps the firm has a particular
marketing strategy that gives them a market advantage.
Whatever it may be that differentiates the business, this skill, or
combination of skills and capacities that a firm has over its
competition compose the organization's core competency. A
core competency is a deeply developed aptitude which
empowers an organization to offer greater value to its
consumers.
A core competency must be something difficult to emulate by
competition and as such, provide somewhat of a sustainable
advantage within the market. Because many of the skills and
advantages emulated by a firm are fully transferable and
applicable in multiple markets, having strong core competencies

increases a firm’s ability to enter new markets and succeed.
Developing Core Competencies
C. K. Prahalad and Gary Hamel developed and presented the
idea of core competencies in a 1990 Harvard Review. They
cited three things to do in order to develop core competencies.1.
Invest in Needed Technologies
First, invest in needed technologies. Imagine the advantage had
by the first dairy farmer who used automated milking machines.
While his neighbors still milked 12 or so cows by hand the
farmer with the new technology had a milking capacity that
dwarfed those of his competition.2. Distribute Resources
Second, distribute resources throughout business units to create
variation. Google is an example of a company which has its
hands in a bit of everything. Yamaha has also created a wide
variety of products from their core competencies. Companies
which effectively do this gain recognition, brand name, image,
loyalty and improved distribution channels.3. Strategic
Alliances
Third, forge strategic alliances. An alliance between Starbucks
and Barnes and Nobles bookstores was created to put to use
core competencies through the instigation of in-house coffee
shops. The alliance between Spotify and Uber allows customers
paying for a hired vehicle to be welcomed by their favorite
music playlist.
Developing core competencies which continue to develop and
evolve to stay on top of the market determines the success and
competitive advantage of a firm. According to Prahalad and
Hamel, the key is to clarify core competencies, build core
competencies, and cultivate a core competency mind-
set.3.9Four Corners Analysis
Guessing at your competitor's next move is difficult. There’s no
way of knowing exactly what they are going to do.
However, Michael Porter’s Four Corners Analysis provides
insight on how to gain insight on your competitor’s future
strategy. The analysis is built up of a systematic process that

helps you look through the eyes of your competitors and think
as they do. This allows you to identify areas where you can
have an advantage; for instance, you may find that they are
completely focused on selling their current product and aren’t
innovating. By focusing on innovation, you can bring a new
product to the market, rendering their current product obsolete.
Your strategy can be influenced by what they will likely do.
Elements of a Four Corners Analysis
In the four corners analysis, you will look at each of the
following. Try to imagine how your competitors would think
about each of the following:Drivers
What things motivate your competitor? Your competitor’s
drivers consist of the things which motivate them, including
their financial and performance goals, corporate mission
statement, leadership backgrounds, and organizational structure
and culture.Current Strategy
What are they currently striving to do? We often think that
corporate strategies are kept secret (unless they are published),
but it’s not very hard to figure out what a given company’s
strategy is. Look at what your competitor is doing for it’s
customers, where they are investing their time, money, and
effort, and what relationships they are developing.Management
Assumptions
How does your company see the world? Do they see themselves
as the underdog? The hero? The revolutionary? Look at how
they view their own strengths and weaknesses. Then look at
how they view the market. Are they holding on to a product that
is quickly becoming outdated? Are they missing any key market
insights? Do they understand the market better than you? What
changes do they anticipate occurring in the market? When
looking at how they view the market, it can be difficult to
separate your own perceptions from theirs. Finally, how do they
view their competitors (including you)? Are they focused on
fighting you, or is there a bigger competitor to worry about?

Are they only competing in the same markets as you are, or do
they have other industries with competitors to worry about.
Your competitor’s management has perceptions of themselves,
the market and their competition (including you). Determining
what those perceptions are is understanding their management
assumptions.Capabilities
What are the strengths of your competitor? These are their
capabilities. Such elements of their business as their financial
strength, quality of their product, marketing, customer service,
skills of their employees and qualities of their leadership
determine their capabilities. These show how well the company
can react to external factors and adjust to the market.
Understanding each corner of the four corners analysis allows
you to think like your competitor and determine their future
strategy as much as possible. The diagram shows the
relationship of all four corners.3.10Incumbency Advantage
Incumbency Advantage in Politics
What’s the easiest way to win an election? It’s really quite
simple; run for an office or position that you already hold and
get reelected. The incumbent, or person currently holding a
political office, generally has a huge advantage over a
challenger. This is referred to as incumbency advantage.
Why does this happen? Incumbents often have structural
advantages that play in their favor. In most cases, incumbents
have more name-recognition than their competitors, simply
because voters already know who they are from previous
elections and from their time in office. In areas where there is
not a set schedule for elections, the incumbent can choose an
election time that is favorable to them. Additionally,
incumbents have huge advantages in fundraising. Financial
backers are more likely to support an incumbent, and lobbyists
logically see giving money to incumbents as a safer investment-
there is a lower risk of losing the election and squandering the
funds. For instance, in the 2016 Senate elections, incumbents
raised an average of about 10 times as much as challengers

($7,900,000 per Senator vs. $756,000).
Incumbency Advantage in Business
The incumbency advantages is also very prevalent in business,
and it parallels that of the political sector. Just as in elections,
name recognition is a huge advantage in attracting potential
customers and investors. Consumers trust the brands they
already know. A new company can spend millions of dollars
trying to get their name out into the market, whereas established
companies don’t have to spend a penny for the name recognition
they already have. Beyond name-recognition, incumbent
companies also have customer loyalty, obviously a powerful
factor. Even when Apple Maps proved to be a fiasco, customers
held onto their religious-like devotion to Apple
products.Barriers to Entry
Invaders face problems from barriers to entry. Primarily,
economies of scale prevent usurpation of incumbent companies.
Initial costs can completely exclude many competitors from
entering a market. After the initial costs, incumbent companies
still are at an advantage. The sheer volume of customers allows
them to keep costs low and quality high. Available money from
investors also allows them to raise funds almost instantly,
allowing for growth and innovation. Incumbents are likely to
capture a large share of the market.Market Share
With this market share, incumbents can attract more innovative
employees, recruiting the best of the best. Both the better pay
and the history of success brings in brilliance. For example,
many of the best computer programmers dream of working for
Google because it is one of the most successful companies ever
created.
The list of incumbent advantages could stretch on forever, from
better consumer research to established supply chains and
distribution channels. In the end, companies new to a market
have to overcome the incumbency advantage if they want to
flourish in a market or find something new to which they
themselves can benefit as the incumbent.Disadvantages to Being

an Incumbent
There are several possible disadvantages to being the first
company into a certain market or being the established
incumbent. Initially, it is difficult to sell a product that has
never been sold before. Essentially, you must first teach
customers what the product is, and then why they need it. You
may have to do all of the original research into a product to
prove that it will work, whereas other companies can simply
copy what you’ve already done. Companies who follow you into
the market may learn from your mistakes, and may find ways to
offer better features. This can cause your customers to switch
from your brand after their first few experiences. Incumbents
tend to follow the same path that they originally started on,
which may lead to the eventual demise of the company when
market changes occur. It is easier for small, new entrants to a
market to pivot and adapt to changing customer demands.
Followers also have less risk because the concept has already
been proven in the past. First movers may also launch a new
product before a market is ready, causing the company to
stumble.3.11Diversification
What is Diversification?
Many companies specialize in one product and stay focused
solely on the production, marketing and distribution of that
product. For some this is an effective strategy. For other
companies, however, their chosen strategy involves creating
varied products or acquiring other companies with different
products. This strategy is called Diversification.Parallels in the
Stock Market
Diversifying a business is like diversifying an investment
portfolio. In a portfolio you can put all your eggs in one basket
by investing in one stock, you can purchase a plethora of stocks
related to one market which adds some diversification, or you
can invest in stocks and bonds across boundaries in different
and unrelated markets, diversifying your portfolio as much as
possible. Diversification decreases risk because, while a single

company or a single industry could potentially crash, broad
market crashes affecting unrelated industries are rare. In the
stock market, there is generally a trade-off between the
potential to earn a large return and the risk associated with an
investment portfolio.
Diversification of a Business
Businesses have the same decision to make in regards to where
they decide to invest their time and money. If a business
focuses on selling a single product, it could make a lot of
money by perfecting their production of that product. However,
if that product fails, goes out of style, or otherwise suffers, the
company could soon be out of business. On the other hand, a
diversified portfolio prevents the risk of the business going
under after a single failed product.How to Diversify
Businesses also have the decision of how to diversify. If they
decide to diversify they can either expand within the market in
which they already operate or they can diversify into new
markets they haven’t yet explored. Procter and Gamble started
in 1837 as a candle and soap manufacturer now owns brands in
the food industry, consumer goods, and pharmaceuticals.
Samsung, which we know as an electronics company also owns
businesses in the financial industry, healthcare, and
construction. Google and Apple, on the other hand, have both
largely stayed focused on diversifying within the tech industry.
Both own so many companies within the tech industry it seems
every corner of software, hardware, and next-generation tech
has Apple and Google involved.3.12Diffusion of Innovations
Diffusion of Innovations explains the process by which ideas,
products, and technologies are adopted by customers and
accepted into the market. Adoption is diffusion from the
perspective of customers and can be graphed in a normal
distribution.
As shown in the graph, innovators represent the first 2.5% of
consumers who adopt the new product being offered. Early

adopters generally embrace the new technology due to the
positive response from innovators and represent the next 13.5%.
Consumers who have aversion to risk and rely on the experience
of other consumers fall into the early majority and represent the
following 34% of consumers. The ensuing 34% who fall into the
late majority consist of consumers who are generally skeptical
or apathetic towards a product and adopt only after the product
has become commonplace. Laggards, as the name suggest
represent the last 16.5% of consumers who resist the new
product and may not even accept it until conventional
substitutes are no longer accessible.
Price SensitivityInnovators and Early Adopters
The different categories of consumers have very different levels
of price sensitivity. Innovators are generally willing to pay a
much higher price for a product, particularly if it seems
particularly novel. They may be unusually interested in the
particular market, causing them to apportion a greater
percentage of their disposable income towards products in that
market. Early Adopters will pay premium prices, assuming the
innovators had a positive experience with the product.Early
Majority
As a product transitions into the early majority, price begins to
become more of an issue. The early majority are moderately
price sensitive, and may shy away from the prices which were
acceptable in the earlier stages of the diffusion of innovations.
However, they are not so price sensitive that your product risks
being destroyed by excessively low margins.Late Majority
The late majority are very price sensitive. Small differences in
the price can make a huge difference to the conservative, late
majority. They have watched most people around them adopt a
product without buying it, so they are fine with waiting a bit
longer if they can enjoy a lower price. If you want to attract the
late majority, make the product cheaper, in addition to easier to
use and more convenient.Laggards
Laggards are at least as price sensitive as the late majority.

However, a decrease in price won’t necessarily attract them to a
product. They will stick with the way they did things before
either until their previous product becomes so outdated that it is
no longer a good option to keep using or until their previous
product is no longer offered.3.13GE-McKinsey Matrix
Originating from The Boston Consulting Group Matrix,
McKinsey and Company developed the GE-McKinsey Matrix to
help General Electric strategize which projects to undertake.
The GE-McKinsey Matrix was designed to overcome the
shortcomings of the Boston Consulting Group Matrix.
The matrix is made up of two axes, Business Competitive
Strength and Industry Attractiveness. Both are analyzed for a
specific project and given a rating of either high, medium, or
low. The diagram below shows a GE-McKinsey Matrix.
Industry Attractiveness
The rating for Industry Attractiveness is determined based on a
number of industry elements:
· Market size
· Barriers to Entry
· Competition (Porter’s Five Forces)
· Political, economic, sociocultural and technological factors
(PESTLE analysis)
Business Competitive Strength
The rating for Business Competitive Strength is determined by:
· Market share of the company
· Core Competencies of the company
· Customer loyalty and brand strength
· Financial strength
· Management strength
After rating the industry attractiveness and business competitive
strength for projects a firm is considering, the firm will be
better able to choose those projects which are most likely to
succeed.3.14Summary

Here is a brief summary of each of the strategic tools discussed
in this topic.
Porter's Five Forces
Porter’s Five Forces are one of the fundamental ways of
evaluating the competition in a market. The Five Forces are
supplier power, buyer power, threat of substitution, threat of
new entrants, and competition.
Blue Ocean vs. Red Ocean Strategy
All companies compete in either a Red Ocean or a Blue Ocean.
A Red Ocean is a market saturated with competition, and
companies battle between themselves over the available
customers. Blue Oceans are new industries or products which
are not saturated with competition.
Product and Industry Life cycle
Products generally go through the 4 major stages of the Product
Life Cycle: Introduction, Growth, Maturity, and Decline. Each
of these stages is characterized by different pricing and
promotional strategies.
Disruptive Technologies
Sometimes, a technology will completely change the nature of a
market, rendering products obsolete or changing the way people
live day to day. These disruptive technologies are both difficult
to achieve and tricky to plan for, but can provide some of the
best possible growth for a company.
Benchmarking
Benchmarking is when a company compares itself to different
businesses in their industry. This gives a telling look into
possible explanations for their success in the market, which can
be put in place by your business.
Weighted Competitive Strength Assessment

The Weighted Competitive Strength Assessment gives a weight
and a rating to the most important factors in an industry, and
then compares them between different companies. This provides
a more objective representation of the comparative strength of
different companies.
Core Competency
A company’s core competency is a specific feature or service
that distinguishes a firm from its competitors. Strategies should
seek to make the most of this competitive advantage.
Four Corners Analysis
The Four Corners Analysis is a way to potentially predict your
competitor's future strategy. It looks at the Drivers, Current
Strategy, Management Assumptions, and Capabilities of the
competitor.
Incumbency Advantage
Companies that have operated for a period of time in a market
do enjoy many advantages because of their past success.
These incumbency advantages include name recognition, lack of
barriers to entry, and economies of scale and scope.
Diversification
While some companies focus on a single product or service,
other companies diversify their product lines.
This Diversification decreases the risk of any one product
failing and ruining the company.
Diffusion of Innovations
As new products are offered on the market, there are different
categories of consumers that adopt the products. These are, in
chronological order: Innovators, early adopters, early majority,
late majority, and laggards. Your business strategy should
match the categories your product currently appeals to within
this Diffusion of Innovations.

GE-McKinsey Matrix
The GE-McKinsey Matrix helps companies decide which
projects it will undertake. It looks at the business’s competitive
strength and the industry attractiveness to determine whether
the project is a high, medium, or low rating.
Chapter 4: 4.1Introduction to Creating and Handling Growth
Learning Objectives
1. Differentiate between Organic and Inorganic Growth.
2. Explain the strategic value of divestment and outsourcing.
3. Describe Growth Hacking Strategies.
4. Describe Horizontal and Vertical Integration.
5. Describe the elements of the BCG Growth-Share Matrix.
6. Explain international issues in strategy facing international
businesses.4.2Organic Growth
Companies want to grow. This is at the basis of all strategy
efforts - “how can we grow?”
Many companies experience a trend where they start out with
strong, even aggressive growth. As time goes on, the growth
flattens out and they find themselves in the “low growth”
category, a situation that isn’t nearly as attractive to investors.
Ways to Create Growth
There are many different ways to remedy this situation. Mergers
and acquisitions allow the company to grow very quickly and
expand into new markets. Strategic alliances can also push
growth as companies combine strengths without becoming one
entity.
However, these options often cause stagnated companies to
forget organic growth. Growth can be promoted the way the
company was originally built, by increasing sales and
decreasing costs over time. If the size of the business is a
limiting factor, new buildings can be built and additional
employees can be hired as cash becomes available for
reinvestment.

What is Organic Growth?
Organic growth simply means expanding your business through
normal everyday business operations. It is often compared
to inorganic growth, which is growth from mergers,
acquisitions, and alliances. Advantages of Organic Growth
Internal expansion can lead to several advantages:
· Low up-front cost: Mergers and acquisitions initially cost
huge sums of money to perform. Organic growth usually does
not require the same quantity of capital. In the event that it will
take an equivalent amount of capital, the investment is usually
spread out over some period of time.
· Maintaining control: Unlike a merger, no control is transferred
to another company. All control is maintained by you or your
executives. Even an alliance can result in some loss of decision-
making ability
· Lowered risk: Many mergers and acquisitions fail. They
simply do not generate the expected amount of revenue, and the
majority of them actually lead to less growth than the
companies would have experienced separately. Organic growth
allows you freedom to adjust and adapt as you go along. If the
direction proves to be disastrous, less capital was invested
originally, so less is lost.
· Greater flexibility: As you grow your business organically,
you can choose from a wider range of options. You can control
how fast you grow. You can pivot to quickly capitalize on new
markets. You know your business inside and out, and can adapt
very quickly to change.
· Less risk of culture-clash: Often, mergers and acquisitions
suffer from differing cultures clashing when the companies are
combined. Growing organically allows HR to be more selective
about employees, finding the best fit for the
culture.4.3Inorganic Growth
Pepsi vs. Coke
We all know that Pepsi and Coke have been battling it out in
carbonated beverages for over 100 years. In 2005, PepsiCo

passed The Coca-Cola Company in valuation for the first time
in 112 years. This was due, at least in part, to the inorganic
growth strategy that PepsiCo undertook.
What is Inorganic Growth?
Inorganic growth is when a company uses either a merger, an
acquisition, or an alliance to grow their business instead of
growing through internal expansion. Although PepsiCo has also
divested several entities in order to focus on their core business
and raise capital it is the inorganic growth through mergers and
acquisitions that we will discuss below.Mergers
A merger is when two companies combine into a single entity.
For example, the Frito Company and the H.W. Lay Company
combined to create Frito-Lay in 1961. Four years later (1965),
Frito-Lay merged with Pepsi-Cola to form PepsiCo Inc. By
merging together, these companies formed a much larger
company, and thus switched to having the available capital,
marketing power, and market presence.Acquisitions
As PepsiCo grew, it began acquiring companies. It bought both
Pizza Hut Inc. and Taco bell in the 1970s. It later acquired
Tropicana Products, Kentucky Fried Chicken, and Mug Root
Beer, among others.Strategic Alliances
In 1994, PepsiCo and Starbucks formed an alliance called the
North American Coffee Partnership to make ready-to-drink
coffee beverages.
Deciding to Merge, Acquire, or Form an Alliance
Now, how do we decide whether to merge, acquire, or form an
alliance, or to do none of them? Not an easy question. PepsiCo
successfully used all three, and it can often seem the inorganic
growth strategies are always great. After all, if Google, Apple,
Pepsi, Coke, and Facebook are doing it, should we always
pursue inorganic growth?
Not necessarily. Different studies estimate the failure rate of
mergers between 50 and 85 percent. This is judged based on
whether the merged company has a stockholder valuation of

more than the two companies did separately. It’s important to
determine whether a merger, acquisition, or alliance fits in with
your company’s overall strategy.
PepsiCo learned some lessons in this. Originally, they
purchased Pizza Hut and Taco Bell, probably because both were
very successful. Over time, PepsiCo determined that their
strategy was to focus on the snack food and beverage items.
While Pizza Hut and Taco Bell were good companies, they
didn’t align with PepsiCo’s strategy, and so they were sold,
along with the California Pizza Kitchen, KFC, and others.
Key lesson: Only merge, acquire, or form an alliance if it aligns
with your corporate strategy.
Choosing Between Mergers, Acquisitions, and Strategic
Alliances
Now, which one to choose? Again, it depends on your
company’s strategy and the specific situation. For instance,
Microsoft historically embraced a strategy of buying out
competitors, killing the competition. In a red-ocean strategy
like this, acquisitions are obviously the choice. Acquisitions
allow the company to do whatever they want with their
acquisition, whereas merged companies both retain some
control.
Mergers are beneficial when both companies are doing pretty
well and would do better when combined, but don’t have the
money to acquire each other outright. In general, mergers and
alliances tend to happen between companies of similar size,
while acquisitions tend to be a larger company buying out a
successful startup. Mergers should create additional value
beyond what the two companies are valued at separately. Many
people overestimate the synergistic value between two
companies and assume that together they will be much better
than either one currently is. If the companies don’t each bring
something to the table that the other one doesn’t have or doesn’t
excel at, will they really be better together?When to acquire:
· When your large company wants to combine with a small one

· When you want to buy their employee talent
· When you want to gain control of a supplier (vertical
integration), decreasing cost of supplies
· For example, PepsiCo acquired its two largest anchor bottlers
in 2010, consolidating these suppliers under the PepsiCo
company.
· When you want to kill off competitors
· If you believe that you can sell the company later at a much
higher price (more risky)
· When you want to get the assets of the company and the price
makes it worth buying the whole company (less common)
· When you want to enter new marketsWhen to merge:
· When both companies are of similar size
· When buying the other company is unrealistic
· When you want to combine both corporate structures
· When the value of the combined company exceeds the value of
the individual companies added together (synergy)
· When previously underutilized personal can work effectively
for both companiesWhen to form an alliance
· When you only want to work together for a limited time
· When you only want to have one (or a few) products in
common
· When neither company wants to give up its autonomy
· When the cultures between the two companies would clash if
combined
· For a specific promotion
While these are general guidelines, they won’t apply to every
situation. Again, make sure that inorganic growth aligns with
your overall strategy and that you’ve done adequate research to
assure that the combined company will be more valuable than
they were separately.4.4Divestment
Divestment essentially means selling part of a business. Where
an acquisition infers the growth of a company by acquiring or
investing in new subsidiaries, a divestment infers the
downsizing of a company by selling subsidiaries or other assets.
Also known as disinvestment and divestiture, divestment is the

opposite of investment, meaning that rather than buying an
asset, a company is selling an asset to other companies.
Reasons for Divestment
Reasons for divestment vary widely from financial,
governmental, ethical, or simply logical. As a general rule,
companies make divestment decisions based on whether or not a
project, asset, subsidiary, or branch aligns with company goals
and direction. For example, in 2012 Google divested a
profitable 3D modeling software subsidiary called SketchUp.
SketchUp was a profitable business with millions of users and
was likely to grow, so it didn’t make sense from an outsider's
perspective for Google to divest it. Looking at the divestiture
closer however, we can see that Google bought SketchUp for
the sole purpose of using it for the 3D modeling of buildings in
Google Earth. Once the modeling project was done, Google no
longer had interest in keeping the company as it was no longer
needed to accomplish an organizational goal.
How Divestments Usually Occur
Divestments are generally done through a direct sale of the
subsidiary, spin-offs, or asset liquidation. Often companies will
sell the divestment directly to another company through a mess
of debated contracts and traded patents, much like Google
selling Motorola to Lenovo in 2014. In spin-offs a parent
company issues new stock to existing shareholders and creates a
new entity out of a subsidiary. Equity carve outs involve selling
a percentage of a subsidiary to stockholders in the form of
stock. Liquidation of assets is a fairly straight forward
divestment practice. When the assets of a subsidiary have
higher value than the subsidiary itself, the parent company will
likely liquidate the assets to optimize profit. Spin-offs and
equity carve outs are tax sheltered but both the direct sale of a
subsidiary and asset liquidation, on the other hand, are
taxable.4.5Growth Hacking Strategies
New companies have an up-hill battle to fight against

established companies. In order to effectively fight this battle,
new companies will sometimes implement “growth hacking”
strategies. Growth hacking means using tactics to create
explosive growth in the early stages of a company. These
strategies are often to get your name out there and to build
customer recognition.
In 2010, Sean Ellis came up with the term Growth Hacking
when writing a job description. He worked as a consultant for
startups, and wanted to find a stellar replacement who would
continue the aggressive growth when he moved on to a new
company. Beyond just someone who could market or someone
with a marketing degree, he wanted someone who could create
massive growth very quickly.
Creating Explosive GrowthWord of Mouth
Word of mouth is a key part of growth hacking. If you want
your small company to grow aggressively, you have to get
people talking about your company. Creating buzz about your
product can be great for going viral and growing
quickly. Marketing and Scalability
Growth hacking is inseparably connected with marketing, and
often is best achieved in tech companies or similar industries
where growth is easily scalable. For instance, once Snapchat
was developed as an app, it could be downloaded hundreds of
times or thousands of times without changing very much.
Snapchat is easily scalable. Producing a tennis shoe is not as
easily scalable. Every time someone orders another tennis shoe,
production has to go up. The difference between producing 50
shoes and 10,000 shoes is vast. If demand for shoes jumped up
this drastically, it would cause a major crisis, meaning that
growth hacking is simply not as effective.
Sample Growth Hacking Strategies
There are many different growth hacking strategies. They all
share similarities, which are best seen by looking at a few
examples.Invite a friend

This works by having built-in incentives for people to share the
product with their friends. For instance, Dropbox offers you
free storage space for every friend whom you invite to open an
account and actually does. Similarly, Cotopaxi will refund your
money from the Questival if you get 5 additional people to sign
up.
This creates very impactful marketing because it is done
between friends and connections. If I see an ad for a new
program, I am very unlikely to sign up. If a friend tells me to do
it, I almost assuredly will consider it.Free content
A popular growth hacking strategy employeed by many modern
companies is to offer a free version first, with the option to
upgrade later. This is great if your business model requires
thousands upon thousands of people using your product in order
to work. Think of Spotify - the usefulness of Spotify grows with
the number of people using it, so they generate value through
volume by offering it for free. Revenue comes both from
advertising to people on the free version and from monthly
subscriptions.
Currently, many business offer their product for free -
YouTube, Twitter, Facebook, and a million others. They make
money by having everyone use their product often, creating
huge advertising and leveraging
opportunities. Embedding/Pairing
This is actually part of the reason that YouTube is the second-
biggest search engine - long ago when MySpace was popular,
YouTube offered the ability to embed their videos easily with
MySpace. This quickly grew the number of users, and YouTube
gained plenty of stability to survive the eventual demise of
MySpace.
By linking your product to existing products, you can quickly
access a huge number of people that are currently using a
successful product. The method of accomplishing this will
change vastly depending on the industry.
Growth Hacking is by no means a strictly defined strategy that
includes only a few ways of achieving explosive growth.

Instead, any tactic that can lead to your company becoming
huge extremely quickly could be considered a growth hack. If
it’s in the best interest of your company, be creative and think
of innovative ways that could spark massive amounts of growth
over a short period of time.4.6Outsourcing
What is Outsourcing?
Outsourcing is when a company pays another company to do
part of their work rather than doing it internally. Benefits of
Outsourcing
There are many benefits of outsourcing, including the
following:
· Outsourcing allows the company to focus on its core
competencies, while allowing other companies to do the same.
· Outsourcing often benefits from inexpensive labor in foreign
markets, lowering costs
· Outsourcing reduces the need for specialized staff required in
the processes which they are outsourcing
· Outsourcing allows the business to operate on a smaller scale,
with less capital and lower operating expenses
· Outsourcing sometimes improves overall quality, as each
company focuses solely on what they do best
· Companies generally reduce spending by about 15% by
effective outsourcing
As Peter Drucker said, “Do what you do best and outsource the
rest.”Costs of Outsourcing
There are some costs of outsourcing that are not immediately
apparent. Outsourcing requires additional inspection and quality
control on all products that are being brought in from an outside
firm. There are often costs associated with travel and close
communication with the company being outsourced to. An
increased lead time from waiting for products to ship may
decrease a company’s agility. Time and energy must be spent to
draft, negotiate, and sign contracts.
The main issue with outsourcing is communicating effectively
to the outsourcing firm about exactly what is wanted.

Many entrepreneurial students releasing a new product plan on
outsourcing almost immediately. They see the lower cost of
making it in China and envision tons of money pouring in.
However, it is often wise to start domestically and eventually
outsource. This is because overseas manufacturers almost
always have a minimum order quantity (MOQ). This ensures
that the manufacturing companies will produce enough volume
to justify the costs of making molds and setting up the assembly
line. MOQs are fine, as long as the product will be successful.
With a very new product, it is a good strategy to make the
product locally in small quantities, and test the market by
selling the first 100 or so. Even if these first products are sold
at a loss, the money spent prevents huge losses by ordering
thousands of products from China and then discovering that the
market isn’t willing to actually buy them.
Ultimately, companies must simply do adequate research on the
costs and benefits of outsourcing and determine if it will be a
strategically beneficial decision.4.7Horizontal and Vertical
Integration
Horizontal Integration
In 2009, Pilot Corporation, a company which specialized in
truck stops and convenience stores, merged with Flying J’s
truck stop division. The two companies were previously two of
the largest truck stop location providers in the western US.
After the merger, the resulting Pilot Flying J chain dominated
the US market as the largest truck stop location provider in the
US.
This business strategy—expanding business operations to grow
within one specific market—is known as horizontal integration.
Horizontal integration is when a company grows within the
same market with the hope of gaining as much market share and
control as possible. When Heinz and Kraft Foods merged in
2015 they were similarly following a strategy based on
horizontal integration.

Vertical Integration
Vertical Integration, on the contrary, involves growing a
business to either the preceding or succeeding market in the
path a product follows. For example, a retail business that
expands into the production of their products would be
integrating vertical integration. Pilot Flying J is not only
involved with truck stops but also owns the fuel pumps which
supply the trucks with fuel. The company also owns the oil
refineries which produce the fuel, the trucks which ship the
fuel, the convenience stores at their truck stop locations, and
the restaurants the truck drivers eat at. This strategy is a great
example of vertical integration.
Companies may use both horizontal and vertical integration,
such as Pilot Flying J, in efforts to find success or focus on one
strategy as needed. The goal of vertical integration is to cut
down on costs because there aren’t companies taking a profit
out at every stage of the process. Horizontal integration allows
the company to have economies of scale and/or dominate a
particular market. Consider what ways your company can use
these strategies to expand your business.4.8Boston Consulting
Group (BCG) Growth-Share
First developed in the 1970’s, the BCG Growth-Share Matrix
was created to help large business organizations apportion their
resources throughout the different entities of the business. The
matrix is created by looking at the market share and market
growth rate of different aspects of the business. It looks at how
you use cash, what generates cash for you, and what determines
overall success.
The BCG Growth-Share Matrix is represented by the following
table:
Figure 4.1:
Elements of BCG Growth-Share MatrixCash Cows
Business entities which have large market share in mature
industries or industries with slow growth are characterized by

cash cows. Cash cows require little by whey (pun intended) of
investment but cash generation is high due to their market
share.Dogs
Entities with small market share in slow growing or mature
industries are referred to as dogs. Dogs require little cash to run
but also have low cash generation. Such entities often best serve
the company as divestitures as the money tied up in the entity
may be put to better use elsewhere.Stars
Entities that have a large relative market share within a fast
growing industry are the stars of an organization. Stars may be
profitable given their large market share but they require
investment to maintain. Stars can develop into cash cows as the
market growth rate decreases.Question Marks
Entities characterized with small market share in a fast growing
industry are referred to as question marks. These entities will
require resources to grow in market share but whether they
successfully develop into stars or not is questionable. The goal
of a company is to develop question marks into stars, and stars
into cash cows. Doing so requires a strategic disbursement of
resources.
Some criticize the BCG Growth-Share Matrix for being too
simple and failing to take into account other aspects which
affect the profitability of a market besides market share and
growth. The GE-McKinsey Matrix tries to better address
elements of the market not covered by the BCG Growth-Share
Matrix.4.9International Issues in Strategy
Expanding internationally is obviously a huge advantage for
many companies, as they gain access to a much larger market,
different suppliers, and new partners. However, there are many
things to take into consideration, both when deciding if you will
begin international expansion and in deciding how to handle
continued international operations.
Currency Exchange
Currency exchange rates can have a huge impact on an
international business. For starters, these rates fluctuate

continuously, making it necessary to monitor rates to prevent
losing thousands of dollars by transferring money on the wrong
day. Exchange rates add a layer of uncertainty to doing business
as a changing exchange rate may vastly decrease the margin on
a given product at a given price.
The strength of a currency will even influence your company
through supply and demand. If you source many of your
materials through a particular country, the cost of supplies may
rise dramatically if the currency of that country gains in
strength, compared to the dollar. This potentially could make
your supply chain ineffective, or erase the margins on some of
your products.
Demand in foreign countries for international goods depends
heavily on the buying power of their currency. The economic
strength of a nation will determine, in large measure, how much
the people of that country will spend on consumer goods.
Be sure that you factor in currency exchange rates in your
thought process when designing an international strategy. You
may need to compensate for the fluctuations with a higher price,
changing your demand calculations.
Tariffs, shipping, imports, and exportsTariffs
Tariffs are a tax on a certain product when it is imported to a
country. Effectively, they add an additional cost to the products
that you want to sell in a foreign country, decreasing the
likelihood that it will be profitable to sell that item in that
country. Tariffs are put in place for many reasons - raising
money for a government, protecting infant industries, increasing
domestic employment, as a national defense measure, and to
protect consumers from certain goods. Before expanding
internationally, look at the tariffs that are already in place for
the target country, as well as the probability that a tariff could
be put in place on your products.Shipping Costs
Shipping costs are an added cost, quite similar to a tariff. The
profitability of shipping a product will depend in large measure
on the weight of what you are shipping. If you are shipping a

rather sizable product, it may be worth reengineering it to weigh
less. In addition to the cost of shipping goods internationally,
there is also a delay in time for any goods that have to be
shipped. This increased lead time will make it more difficult to
adapt order quantities and product specifications in response to
the market.Other Issues with Imports and Exports
There are many issues in imports and exports that affect
businesses. Every country has its own rules and regulations on
what can be imported, as well as constraints on how items can
be imported and exported. Products can be lost or damaged in
transit, and shipping companies don’t always cover the loss.
Theft, accidents, and natural disasters all increase the risk of
importing and exporting.
Your company may need to buy export credit insurance, either
through the private sector or through the government to prevent
against non-payment issues. If you send a shipment of product
to a client and the client is unable to pay for the imported
goods, you face a substantial loss in bringing the product back
to where you shipped it from.
In some cases building a foreign manufacturing plant may be
more cost effective than producing goods domestically and
shipping them abroad.
International Taxes and Repatriation
When a company makes money overseas, it does not have to pay
taxes on the money until it brings the funds back into the United
States. This “repatriation” tax is at around 35% (this rate varies
depending on the taxes the company has paid in the foreign
company) and gives companies a huge incentive to keep money
in foreign countries. This practice is allowed by law, even
though some question it on ethical grounds.
Sometimes, these funds are used to pay for manufacturing or
other expenses in foreign countries. As the money is both made
and spent abroad, it wouldn’t make sense to bring it into the
United States and lose more than a third of it.
In other cases, companies use creative accounting practices to

seemingly shift profits to tax havens, or places such as Bermuda
and the Cayman islands (both have extremely low tax rates).
The money is kept there until the company needs to use it for
something, in which case it can be shifted around.
Over 2 trillion is held overseas by U.S. companies, including
companies like Apple (~$180 billion), General Electric (~$119
billion) and Microsoft (~$108 billion). It is particularly easy for
computing, IT, and pharmaceutical companies to report their
profits in foreign countries and keep their money outside of the
country.
Bribery and CorruptionBribery
Corruption and bribery also play a role in international
business. Many people who work for US companies pride
themselves on working for an ethical company, and are thus
very surprised to find that their company pays bribes when
operating in foreign markets. Some argue that these bribes are
essentially required to operate in certain countries and thus are
justified. Others disagree, saying that US companies should
maintain a higher standard of ethics, even if it means refusing
to enter certain foreign markets. Foreign Corrupt Practices Act
of 1977
Whatever your business’s position on the matter, one item of
consideration is the Foreign Corrupt Practices Act of 1977. This
Act makes it illegal for many companies to bribe foreign
government officials in order to obtain or retain business.
Compliance with this act is necessary, and the Act should be
reviewed before entering foreign markets. As this Act also
includes provisions on how accounting practices should be
handled in order to prevent bribery and corruption, all
companies should assure that they comply. Even if a certain
bribe isn’t illegal under the Act, it is still a costly measure and
should be avoided, if possible. Corruption
Corruption is very costly to companies. Working with corrupt
businesses, dealing with corrupt employees, and performing
internal corruption checks all cost far more than many people

realize. Unfortunately, corruption is widespread across the
world.
When entering a new country, consider the relative corruption
of the country you are entering. The more widespread the
corruption is, the more likely it will be costly to operate in that
country. In order to prevent internal corruption and white-collar
crime within your own company, invest additional resources in
hiring quality employees and vetting them for corruption.
Perform frequent internal checks to assure that money isn’t
leaking out of your company.4.10Summary
Creating and Handling GrowthOrganic Growth
Organic growth is the traditional method of growing a company
- by expanding your operations, cutting costs, hiring additional
employees, and doing the necessary work. This is the alternative
to inorganic growth.Inorganic Growth
Inorganic growth is when a company grows by merging with
another company, acquiring another company, or forming a
strategic alliance with another company. Inorganic growth tends
to be a strategy used by larger companies.Divestment
Divestment is when a business decides to sell part of itself to
other companies. This can mean selling off a department,
subsidiary, acquisition, or other asset and can be a useful
strategy for focusing on the most profitable part of your
business.Growth Hacking Strategies
Growth Hacking Strategies are effective ways for a small
company to have explosive growth in the early stages of
business creation. Outsourcing
Outsourcing allows a company to strategically focus on the
parts of their business that add the most value to the final
product, leaving other companies to do the rest.Horizontal and
Vertical Integration
Horizontal Integration is when a business buys out or merges
with competitors to gain a larger share of the market. Vertical
Integration is when a company will either grow to control its
own suppliers or grow to own the distribution channels that it

generally has sold the product to.Boston Consulting Group
Growth-Share Matrix
The BCG Growth-Share Matrix focuses your business strategy
on the most profitable products which you offer. It involves
identifying your products or services as cash cows, dogs, stars,
or question marks. International Issues in Strategy
Expanding internationally is a tricky process. This essay
explains several issues to consider when
undergoing international expansion.
Chapter 5: 5.1Introduction to Dealing with Change
Learning Objectives
1. Explain the importance of Change Management.
2. List several ways a company can reduce complexity.
3. Perform a scenario and stakeholder analysis.
4. Describe Scenario and Contingency Planning.
5. Discuss how war gaming is used in an organization.
6. Define business process reengineering and restructuring.
7. Explain the benefit of performing early warning scans.
8. Identify the roles assigned in the decision-rights
tool.5.2Change Management
Change management is the process of managing organizational
change. Seems simple right? Sometimes, all an organization
must do to make a necessary change is tweak a few processes or
implement a simple safety rule. However, in many cases,
organizational change and change management is a huge
undertaking. Change management is the tool used to drive such
change.
Change is Part of Life
Change is a fundamental part of our lives. The world changes,
markets change, people change, technology and understanding
change. Everything around us develops and adopts alterations.
Organizations which don’t realize this—those who don’t adapt
to stay on top of change—will die.
Identify Needed Changes through Business Analysis

Organizations identify necessary changes through a variety of
business analysis. Any of the business analysis explained in this
book could be used to identify necessary change, such as SWOT
analysis, Scenario Analysis, Value Chain Analysis, Market
Segmentation, Porter’s five forces, etc. Once the crucial
changes have been identified, change management comes into
play.
Change management styles, steps, and theories differ in use and
subjectivity according to situations, processes and problems
faced by the organization. However different the situations may
be, there are a few general change management principles that
apply to most situations.
Principles of Change ManagementChange Includes Top
Management
First, change must include the leaders of the organization.
Organizations won’t change until top management can change
themselves and prove the change worthwhile.Give People Roles
Second, Change is facilitated when as many people as possible
are given roles within the change process. Letting people within
the organization feel part of the change will boost their morale
and desire to initiate change.Small Victories
Third, small victories will give your change momentum to drive
it throughout the organization from start to finish. Take the
process of change one baby step at a time. When you
accomplish small goals let everyone in the organization
celebrate the success together and then move forward towards
the next victory.Communication
Fourth, communication is key. Effectively communicating the
change over and over again to every individual and team in the
organization and helping them see the need for change will
move mountains during the change process.
Keep in mind that change is about people. The main challenge
faced in change management is getting people to alter the things
they have done for years. Getting people to support
organizational change and changing their habits is not an easy

task. However, when done effectively, it will make the
difference between temporary and lasting change.5.3Complexity
Reduction
Successful businesses usually expand and keep expanding until
they reach some sort of limiting factor. The complexity of doing
business created by this expansion can sometimes become that
limiting factor unless such complexity is effectively managed
and reduced.
Complexity Reduction Example - FLIP
Imagine a small flip flops company called Footwear Lounging
Instant Provider (FLIP). Initially, the concept and process are
simple; FLIP makes extra comfortable flip flops for stylish
teenagers. As their business takes off, they increase their
product line from 3 different styles of shoe to 7 different styles
in 4 distinct sizes. As business continues, they begin
outsourcing most of their process, creating a more complex
supply chain. FLIP continues to grow and begins to distribute
across the country, necessitating sales reps and customer service
support. A board of directors is created, as well as a marketing
and HR department. Upper management determines that FLIP
could vastly increase shareholder value if they expand to global
markets. This requires design teams familiar with international
fashion experience, as well as a massive network of distributors.
Now FLIP offers a total of 25 different products, each in 5
sizes, in 15 different countries.Complexity Creates High Fixed
Costs
It is obvious that operating FLIP has become incredibly
complex, and this complexity creates problems. The main
problem is in high fixed costs—no matter how much sales
volume FLIP has in the next month, it still has to pay for its
massive organization, with all of its employees, computer
systems, and manufacturing facilities. So FLIP starts looking
for ways to reduce its complexity.Looking for Ways to Reduce
Complexity
First, FLIP should look at the most complex parts of their

business and determine if each is necessary. Suppose that the
smallest size of shoe is very difficult, and thus costly, to
manufacture and is subject to lots of government regulations
because it is for small children. This size makes up 8% of sales,
and the largest size makes up 3% of sales. FLIP probably should
discontinue both of these sizes - they create too much
complexity without sufficient return.
Then FLIP realizes they are using 8 different computer systems
across its many global offices. Files transferred between offices
have to be re-formatted to work on other systems anytime
important documents are sent. Consolidating to 1 or 2 systems
will be expensive, but will reduce a huge amount of complexity.
Some other possible areas that FLIP could reduce in
complexity:
· Materials - one style of flip flop is made using a particular
type of foam that is difficult to source. Cut that style.
· Markets - Essentially the same styles are common in the
United States, Western Europe, Canada, and Mexico. By
limiting themselves to these markets, FLIP can avoid making
multiple styles for foreign markets.
· Production plants - Instead of having 6 different plants making
flip flops in different parts of the world, FLIP can consolidate
down to the 2 largest manufacturing plants by investing in some
additional technology to speed up their production.
There are many ways to reduce complexity, which vary
depending on the market and the business model. According to
The Global Simplicity Index, the largest companies in the world
are each losing $1 billion+ from complexity that could be
reduced.
Complexity Reduction can be a useful strategy for most
companies. In some companies, reducing complexity can be the
overall strategy until the complexity is significantly reduced. In
most companies, it will help them in other strategies and in
achieving company goals.5.4Scenario Analysis
What is a Scenario Analysis?

Scenario Analysis is the process taken by a firm to project into
the future and analyze possible different circumstances and
events. Such projections include considering the future
economy, future opportunities, competition, and threats. The
analysis can go as far as attributing a probability as to the
likelihood of each event occurring. Once future scenarios have
been developed, strategy for each possibility is crafted so as to
be ready for implementation in the occurrence of any future
scenario.
The idea of scenario analysis is fairly simple, but the actual
execution of the analysis is far more complicated. Without a
magic crystal ball, it can be very challenging to project what the
future holds. It is also difficult to provide an accurate
probability of each scenario. As a firm matures and management
becomes more practiced, scenario analysis, in theory, develops
an accuracy that prepares the firm for future possibilities and
makes employees ready to react quickly and resolutely in a way
that best benefits the organization.
Example - Sunrise Cyclery
Consider Sunrise Cyclery, a local bicycle shop in business since
1981. The cyclery has never grown bigger than a small town
repair shop and distributor but they have stayed in business now
for 35 years. Let’s perform a scenario analysis on their business
by projecting 1 year, 5 years, and 10 years into the future. First
we create a chart that takes into account possible scenarios that
could occur in the future of Sunrise. Using market and business
trends, history and projections, a probability is then attributed
to each scenario.
Projection Period
Increase in Demand
Decrease in Demand
Increase in Competition
Decrease in Competition
Economic Prosperity
Economic Stagnation

Economic Digression
1 Year
0.6
0.4
0.5
0.5
0.3
0.5
0.02
5 Years
0.8
0.2
0.7
0.3
0.4
0.5
0.1
10 Years
0.9
0.1
0.9
0.1
0.5
0.45
0.05
After the general analysis is finished, appropriate strategies
must be planned out for each scenario.
In one year from now it has been determined there is a 60%
chance there will be an increase in demand. To ensure customer
loyalty and attract as many new customers, our short term
strategy will be to run a promotional campaign just as mountain
biking season is starting in order to take advantage of this
increase in demand. Given the 40% chance that demand will
decrease, we will focus on keeping the customers we currently
have by offering discounted repairs to those who originally
bought the products from us.

As probabilities for increased or decreased competition are
equal, our overall competition strategy in the first year will
involve exploiting our years of business experience and
advertising ourselves as a historical, local, and family friendly
small business that truly cares for its customers.
Different strategies will be initiated depending also on the
overall prosperity, stagnation or digression of the economy. If
the overall economy is in economic prosperity we can expect
more users of our products. Offering a wide variety of product
would help take advantage of such prosperity. If the economy is
stagnant it will be vital to our company to keep the current
customers we already have by making customer service our
number one priority. If the economy is digressing we can expect
demand for our products to also decrease. The most effective
way for our firm to react to this circumstance is by tightening
up our budget, offering only our popular products, and doing
everything necessary to create a loyal base of customers.
Similar analysis with some time-dependent changes are done for
the other projection periods as well.5.5Scenario and
Contingency Planning
The future is always uncertain, and that uncertainty can be vital
in the world of business. Scenario Planning involves
anticipating possible future events and opening the mind to
basically any feasible situation. Such is not as easy as it sounds,
as humans have the habit of incorrectly assuming the future will
be similar to the present.
Scenario Planning
Scenario planning is performed by anticipating possible
directions of the market and plausible changes to its current
situation. Based on the anticipated directions of the market,
opportunities and risks can be identified for each scenario and
an appropriate action plan can be created. Effective scenario
planning can create an organization based on creative thinking
and strategy; prepared for nearly any possible change.
For instance, you may be experiencing wonderful growth and

near total market domination. A scenario plan could include the
hypothetical that a new competitor enters the market and begins
to snatch up your original, loyal customers. If you have a
loyalty rewards program in mind, you could quickly create
additional incentives for your loyal customers to stay with you.
Or perhaps you can lower prices quickly and use your
economies of scale to sell product at a price new entrants to the
market cannot match.
Contingency Planning
Contingency Planning, much like Scenario Planning, involves
imagining what the future holds and planning accordingly.
Rather than thinking of any possible scenario, however,
contingency planning focuses solely on cataclysmic and
disastrous possibilities. Such catastrophic scenarios may include
what a company might do if their building caught fire and
burned down or if their employees were all killed in a plane
accident. Such events are incredibly unlikely but they do occur.
Being prepared for such events can make the difference between
the survival of a company or its demise.
Cantor Fitzgerald, a financial services company, successfully
instigated their contingency plan after losing 658 of its 960
employees to the 9/11 terrorist attacks. The company was well
enough prepared that it only took them one week before
resuming business. Fitzgerald had very strong strategic
partnerships, which helped them through this process. They
focused heavily on their core business practices so the company
was at least functional as quickly as possible. Even though they
were back online within a week, it took 5 years of operation to
fully recover what they had lost.5.6Stakeholder Analysis
Imagine that you are Tony Stark and you are contemplating if
you should convert your empire, Stark Industries, from a
weapons company into an energy company. Assuming that you
don’t have an overriding social cause to accomplish, you might
want to conduct a stakeholder analysis before making such a
monumental shift. This is essentially an analysis of the effects a

given action will have on stakeholders. Stakeholders are people
or groups that are either affected by the company or have some
sway to influence the company. Thus, Tony will want to
consider what effects this decision will have on his customers,
his staff, the board of directors, shareholders of Stark
Industries, and the federal government. By ranking both the
amount of power and the level of influence each group holds, he
can use the following chart to determine how much sway each
constituency holds in the decision. The chart shows what
actions you should do towards each category of stakeholders.
StakeholdersPowerful but Uninterested
If someone has lots of power over your company, but is not
interested in a specific decision, you should avoid aggravating
them. For instance, Tony should avoid aggravating Pepper Pots,
his PA, because she has a lot of power to influence him, but
isn’t very concerned with how he runs his company.Interested
but Powerless
If someone is very interested in a decision, but has no real
power, they should be given status updates. This keeps them
happy, but does not base the decision on their ideas. Think of
your nosy friend who takes an incredible amount of interest in
your dating life, even though you aren’t very close. You can
keep this friend informed about what’s going on, but they
shouldn’t determine how your relationships go.Uninvolved
People with little interest and little power are generally not
even considered in decision making. They don’t care about this
decision, and they couldn’t do much about it even if they do
care. Don’t spend time or effort on them.Key Individuals
The focus is obviously on the key people. They can sway
decisions quite heavily, and they care a lot about this specific
decision. For Mr. Stark, these people are his board of directors
and his consumers. They have a huge vested interest in how he
decides to run his company, and will ultimately determine the
success of the company.

Given that consumers decide whether the company continues to
be profitable or if it fails financially from lack of income, they
should rank among the key stakeholders to consider.
Timing
Timing is also very important to stakeholder analysis. If the
analysis is made after the finalization of plans, it doesn’t serve
any strategic purpose. If made before a course of action is
adequately planned, it may be difficult to determine
stakeholders’ position on the matter at hand, and it is likely that
the plan will change and force an additional analysis, which
may be costly and time consuming.
Stakeholder analysis is a useful way to evaluate a corporate
decision. This style of analysis prevents loud spoken groups
without any power in the organization from unduly influencing
the decision. It also forces the decision makers to adequately
consider the effect the decision will have on the people that
have the most real effect on an organization.5.7War Gaming
What is War Gaming?
War gaming in business is a method of simulating future
situations and determining how your organization would react to
each one. Essentially, an outside organization comes in and sets
up a game that mimics real-life business situations. The goal is
to provide insights about how the future will unfold and to
create plans accordingly.Included Groups
Generally, the game will include groups representing 1) the
market or consumer 2) a set of competitors and 3)
uncontrollable factors or entities, as well as the team of
executives from your company. Multiple rounds are undertaken
in which all groups are given the same information and each
determines how they will react.Benefits of War Gaming
If performed correctly, war gaming can provide several
benefits. These can include:
· Providing leadership with a specific plan of action
· Highlighting potential problems that may arise and determine

how to respond to them
· Building confidence in a proposed plan
· Streamlining execution of the plan
For example, let’s pretend I own a shipping company and
China’s economy just suffered a major downturn. In order to
understand how to deal with it, I hire a team to help us through
some extensive war gaming. They likely will run many
scenarios and see how well our business model and strategic
plans hold up under each.
For instance, if shipping to and from China was to be cut by
50%, how would our company react? Do we have enough other
customers? Would competitors start a price war to maintain
their current volume? Can we stay in business if we are forced
to lay off 45% of our employees?
Or what if shipping simply shifted from China to South
America. Do we have the relationships with strategic partners to
enter markets there? Do we have the necessary set-up to engage
those markets? How long would it take us to conform to health
and safety regulations in the new countries?
Obviously, this example is rather dramatic, but it shows at least
on a small scale how war gaming would work.When is War
gaming Useful?
War gaming can be useful in a variety of situations. When
considering mergers, acquisitions, and corporate splits, war
gaming can help determine what each affected group will do.
Introduction of new products or large changes in price may
necessitate war gaming to determine how consumers and
competitors are likely to respond. Large shifts in corporate
strategy or organization may also call for some insights on how
to company will be affected.
Usually, war gaming is performed by an outside firm who
charges a certain fee in order to perform the evaluation. As the
fee is generally substantial, companies should assure that the
game is actually needed and will impact the bottom line. There
should exist a moderate level of uncertainty. Too much
uncertainty means that the game can’t predict what will happen

with any degree of accuracy. Too little uncertainty means that
the game is not really needed.5.8Business Process
Reengineering
When a certain process or department of a business is
underperforming, business process reengineering (BPR) may be
the best solution. BPR is a complete overhaul of a business
entity, redesigning it to improve its success. Such change can be
motivated by financial goals to improve, customer satisfaction,
employee well-being, or by a social cause.
Example - Nestle's Safety Program
A Nestle ice cream manufacturer in Santiago Chile used
business process reengineering to restructure their safety
program. With an increase in occurring accidents, the Nestle
plant decided to take action to protect both their employees and
their reputation as a well managed organization.Discovering the
Causes of Accidents
Nestle started their Business Process Reengineering by
analyzing the reasons for the increase in accidents, which
involved getting feedback from 1300 employees. They
discovered that their intense focus on employee productivity
was largely the reason for the increase in accidents. Stressing
the importance of efficiency and the need to run the production
line at full capacity caused many employees to take shortcuts in
their work, often reaching their hands into machines to quickly
solve a jammed part or remove an obstruction. Safety rules that
had been previously observed were ignored in order to keep up
with production goals.
The next step Nestle took was to strategize a plan to revamp
their production safety process. They determined safety
improvement methods from team training meetings, company
conferences and bring your family to work events.Shifting
Focus from Productiviy to Safety
Nestle then initiated their plan by changing their focus from
productivity to safety and launching their business process
reengineering plan. Each team training and company conference

was focused on safety improvements for a period of several
months. They held employee events which involved each
employee in the safety improvement process and Nestle even
invited the families of each employee to get involved in the
process. The effects were nearly immediate and as a result of
Nestle’s plan, there was a 76% decrease in accidents.
Can you reengineer your business process to significantly
improve the process? This process may be expensive, but often
has very high returns if a significant change is made. What are
the biggest problems in your company? What things seem to
resist all efforts to fix them? The solution may be in business
process reengineering.5.9Restructuring
What do you do if your business used to be successful, but now
it is struggling? Much like Business Process Reengineering,
which involved overhauling a particular business process or
entity, Restructuring is a complete overhaul of the entire
business; each entity, process, and in many cases even the
mission of the organization. Thus the term restructure means to
structure again, or basically re-create your business.
Purpose/Goal of Restructuring
The general purpose behind restructuring is to improve the
operation of a business. Other reasons for restructuring may be
in response to a crisis, an acquisition, a change in law, or
bankruptcy.
The overall goal of a restructure is to increase a business’s
efficiency, cut down on costs, deal with problems, and create
new value. Put simply, the goal of a restructure is to improve
the profitability of a company.
If a company’s restructure is more than an emergency, the
company should ensure that some things are in order before
attempting to restructure. Before a restructure is attempted, a
company needs to forecast what the effects of the change will
be. They then must assure that the company has enough cash to
float through several months of perhaps decreased revenue.
Every aspect of the restructure should be planned out before the

change occurs in order to assure efficient time usage. A clear
line of communication between line management, top
management and shareholders, must be established before and
maintained during the restructure.
Increase in Profitability
A restructure is successful if the business runs better and has an
increase in profitability after the change. If the restructure was
done in response to a crisis, success may be based on the
survival of the company. If the restructure was in response to
bankruptcy, success may be based on the company’s new ability
to pay its creditors. If the restructure was done as part of an
acquisition, success may be based on the company's increase in
resale value.5.10Early Warning Scans
Businesses generally have trouble keeping up with the pace of
the modern world. External Factors change so quickly and
unexpectedly, it is difficult to keep up. No one can perfectly
predict the future. Forecasting is based on historical data and
projects of that data into the future, so big changes in the
market can make forecasts become completely inaccurate.
So what do you do? How can your company be ready to deal
with the uncertainty of the future? How can you adapt quicker
than your competitors will?
How to Perform an Early Warning ScanConstantly Search for
Irregularities
One way of doing this is through early warning scans. Some
companies choose to perform early warning scans internally by
looking at the market, while others invest in computer systems
to scan for them. The first step in scanning for early warning
signs is to constantly search for irregularities, or things that
could indicate a fundamental shift in the market or in your
business. Many of these will seem minor, caused by normal
fluctuations in demand and in market conditions. Analyze
Trends
Next, you look closely at each of the irregularities. What are the

possible explanations for this? If this evolved into a trend, how
could your company strategically change to deal with it? Are
there other irregularities that also support this trend? What are
the possible implications of this trend? Try to think of creative
solutions to these theoretical trends. As you analyse them, focus
your resources on the trends and issues that seem most likely
and most relevant to your business.Monitor and React to
Important Trends
As time continues, pay attention to the trends that you spent the
most time analysing (those deemed to be most important). If
future data aligns with the trend, look out! It may very well be
developing into a game-changing trend. Have a strategy
prepared to deal with these trends. You may not end up using it,
but if you do, you might save your company.
For instance, let’s imagine that I run a small firm that produces
material for deaf-blind children and their parents. We are
heavily subsidized by state and federal governments, which
gives us the needed margins to stay in business. One year, our
subsidies were cut by 5%. We are efficient enough to deal with
this without any problems, so the temptation is to ignore the cut
and blame it on a tougher budget year for the government.
However, because we have been performing early warning
scans, we noticed that last year, the government increased the
funding to cochlear implants (devices that allow hearing
impaired children to hear sound like everyone else). If this trend
continues and the government continues to support cochlear
implants more heavily, our business will certainly go under. As
this year’s budget cuts align with this theoretical trend, we
begin making plans to deal with a complete transition away
from material for the hearing impaired.
Problems with Early Warning Scans
There are some problems to confront when using early warning
scans to shape action plans and corporate strategy.
· Potential for inaccuracy The future is impossible to predict
with perfect accuracy, so there is a chance that the early

warning scans will put you on a false path that eventually leads
to the company’s downfall.
· Resistance to change People often drag their feet when they
are asked to change how they do things, especially when their
current actions are still bringing in profit for the company.
· Wasted resources It takes time, human capital, and other
resources to perform early warning scans. In most companies
and most industries, these resources are worth the decreased
risk. However, in extremely stable industries, it may not be
worth the cost the perform these scans.
Despite these problems, it is generally valuable to do early
warning scans and create hypothetical plans to deal with them.
It could be the difference between going out of business and
becoming vastly successful.5.11Strategic Planning
In strategic planning, a company determines what its strategy
will be and makes plans to carry the strategy out. Generally,
this involves using several different tools to analyse the
business and determine what its goals are, as well as the things
preventing it from getting there. During the 1960s, companies
began strategic planning to a much greater extent than they had
previously.
Plum Incorporated
Let’s imagine that I own a small software company called Plum
Incorporated. Given that Plum is rather small, there isn’t a
budget to hire a strategist, so I decide to do the strategic
planning myself. Analyzing Current Position
I start by reviewing our mission and vision statements, followed
with a SWOT analysis of my company. As competition seems to
be a weakness of our firm, I look at each of Porter’s Five
Forces. On top of that, I benchmark my company against similar
organizations in my industry. From these tools, I can see that
Plum is extremely innovative and can charge premium prices for
their software, but is very susceptible to new companies coming
in and stealing customers. Despite the premium prices, Plum
loses much of its revenue due to high costs, giving surprisingly

low margins on all products produced.
Previously, our strategic plan at Plum had a lot of meaningless
buzzwords and phrases, like “Leverage our robust business plan
to achieve greater synergy” and “Optimize performance through
outside-the-box paradigm shifts.” These strategic plans are not
specific or applicable enough to help the company, so I will
throw them out and make a strategic plan that we can actually
implement.
What will make the biggest difference at Plum?
That’s the big question. In the short term, we have to decrease
our costs. We simply cannot have low profit margins on
premium priced items. Eventually, cutting costs won’t be an
effective strategy - you can only cut costs for so long until the
decreasing marginal returns are so low as to render the strategy
completely ineffective. To deal with this, our strategy will have
three stages. Stage One
In stage one, we will focus on complexity reduction,
outsourcing, and total quality management in order to help
decrease our costs. Once our overall margins are to 53% of the
total price, we will shift to stage two. Stage Two
In stage two, we will focus on segmenting the market and
dominating our core customers, driving home our advantage in
creating customizable programs for mid-sized
corporations. Stage Three
In the third stage, we will plan for a crafting strategy and a blue
ocean strategy. We want to adapt as we go forward to
continually enter markets with products that espouse blue ocean
opportunities.
Am I scared about this strategy? Of course. I’m betting the
company on our predictions of the future. By choosing a set of
activities to focus on, I am inevitably not focusing on other
activities. I’m cutting out the business practices that I don’t
think will have the most value long-term, even if some of these
are good practices. By focusing on the strategies listed above, I
am inevitably not focusing as much time and energy on

employee engagement, customer relationship management, or
mergers and acquisitions.
Ultimately, that’s the catch; you can’t focus heavily on
everything. In fact, Plum is probably focusing on too many
different strategies in the above example. As I debate my
proposed strategy with advisors, board members, and
employees, we are likely to cut out several of the parts of the
strategy in order to focus more heavily on the parts that really
matter.
As you do strategic planning, focus on creating a meaningful
strategy that can guide future actions. You can’t be good at
everything right now, so be good at whatever presently matters
most to your company.5.12Decision-Rights Tool
Making decisions is often very difficult. For many
organizations, a systematic approach to decision making is
optimal to ensure the quality of the decision. This systematic
approach is called the Decision-Rights Tool. Within the
decision-rights tool, specific roles are assigned for each step of
the process to maximize the quality of each element of decision
making.
Essentially, you choose some subject-matter experts to provide
input, after which different members of your team make a
recommendation, evaluate the recommendation, and finally
make the decision. By forcing your team to work through all of
these steps and by giving individuals specific tasks to
concentrate on, you hopefully will arrive at a better decision.
Roles in the Decision-Rights ToolInput
The first role assigned is that of input. Those given the role of
input are the professionals of the field; those with experience
and background in the subject in question. The inputters provide
relevant information, facts, and figures to be organized and
analyzed by a recommender.Recommenders
The second role assigned is to the recommender who, after
receiving information and input related to the decision at hand,
assesses the input and analyzes possible options. After a

thorough dissection of information and directions the decision
can take, the recommender presents an educated and fact-based
recommendation.Agreers
Agreers are involved in the next step of the process. The
Agreers listen to the recommender and seek to better understand
the facts involved. It becomes the role of the agreers to either
approve a recommendation, disapprove a recommendation, or
initialize delay if more information is necessary.Decider
Ultimately, the decision comes down to one individual who
holds the role of the decider. When a recommendation makes it
through the agreement process it becomes the responsibility of
the decider to either finalize and initialize the decision, veto it
or send it back down the process line for further consideration
and fact finding.Performers
The last people involved in the decision-rights tool are the
performers; those who perform the job of implementing the
decision once it is made.
The decision-rights tool can be very effective at obtaining an
incredibly well studied and backed up decision, but at times the
steps can be cumbersome. In time sensitive decisions it may be
most effective to skip the role of agreers and going straight to
the decision maker. The goal of the decision-rights tool is not to
make decision making harder it is to help assure the quality of
the decision. The tool is to be used when
effective.5.13Summary
Dealing Effectively with ChangeChange Management
A general introduction to managing change within an
organization.Complexity Reduction
As businesses grow, they inevitably encounter increasing
amounts of complexity, which threatens to increase the cost of
operating. Reducing complexity results in a more agile,
profitable business.Scenario Analysis
Scenario analysis is when a company looks at the most likely
situations that will arise in the next projected time period and
estimates how likely each of them is to occur. This allows your

business to plan for strategies to deal with the most likely
scenarios.Scenario and Contingency Planning
Scenario planning is the process in which companies look at
possible changes in the market and create plausible plans to
deal with these changes. Contingency planning is much like
scenario planning, except that it is focused on cataclysmic and
disastrous possibilities.Stakeholder Analysis
If your company is planning on undergoing a major change, it
may be beneficial to perform a stakeholder analysis. This is a
process of evaluating the different groups who are involved in a
decision and planning on how to interact with them.War Gaming
War gaming is a simulation of future events, with people
assigned to represent customers, competitors, your executive
team, and other factors. Various situations are presented, and
each group reacts as the group they are representing
would.Business Process Reengineering
Instead of making minor changes to a department or process
within your business, you can completely overhaul the entity to
improve its success. This is called business process
reengineering.Restructuring
Restructuring is the process of overhauling your entire business,
redesigning it to have success when it has been failing in the
past.Early Warning Scans
After something disastrous happens in a business, it’s easy to
wonder how you didn’t see it coming. Early warning scans are a
method to help you see disastrous or fantastic events earlier
along the way, allowing you to start creating plans earlier
on.Strategic Planning
If you want to create an effective strategy, you need to do
effective strategic planning. This is the process of creating a
strategy that you can put into practice.Decision-Rights Tool
The Decision-rights tool is a systematic process of making
decisions within an organization where members of the team are
assigned differing roles and accomplish specified tasks.
Chapter 7: 7.1Introduction to Decreasing Costs and Creating
Efficiency

Learning Objectives
1. Explain the basics of Total Quality Management and Six
Sigma Process Control.
2. Describe how to perform a Pareto analysis.
3. Discuss the pros and cons of zero-based budgeting.
4. Discuss ways to improve organizational time management
and ways to measure productivity in the workplace.
5. Differentiate between Economies of Scale and Economies of
Scope.
6. Describe the principles of the Shingo Model of Excellence.
7. Explain the importance of employee engagement, business
location, and effective forecasting.
8. Describe basic concepts in forecasting including accurate vs.
effective forecasting, strategic forecasting, and principles of
effective forecasting.7.2Total Quality Management
Total Quality Management is the effort to continuously improve
an organization’s processes to create better products in a more
efficient manner. Defects and errors are prevented and removed
as time goes on. The goal of TQM is to make the customer
happy by controlling every single step in the business process.
Dr. William Deming in Japan
Dr. William E. Deming played a major role in the development
of TQM when he introduced statistical process control to Japan.
Originally, he had attempted to implement his ideas in the
United States, but he was rejected. He taught his ideas on
creating better manufacturing lines through statistical control to
Japan, and helped fuel the strong Japanese economy between
1950 and 1960.
TQM Spreads to Many Industries
Even though Total Quality Management started in the
manufacturing sector, it is used in many types of organizations,
including medicine, finance, manufacturing, and banking. The
concept is broad and is consequently applicable and adaptable
to each individual kind of business. In large businesses where

there are multiple sizable departments, it is important to
coordinate efforts between the various departments. For
instance, if manufacturing discovers a new method which
prevents many defects but marketing and HR are unaware of
this method, new employees won’t be trained to implement the
procedure and marketing will not advertise the improvements to
customers.
Elements of TQMContinuous Feedback
A major part of Total Quality Management is continuous
feedback. As improvements are made to a system, the problems
and areas of concern from top management become outdated.
New problems arise, and areas that previously were considered
good enough become areas of improvement.Plan, Implement,
Monitor, Plan
Essentially, the organization plans the change they want to
implement. After the plan is created, it is carried out and checks
are performed to monitor progress. Finally, in the acting phase,
results are documented and insights are gathered to fuel the next
round of planning, doing, etc. Customer-Defined Quality
Total Quality Management focuses on customer-defined quality.
This means that the goal is to improve the product in the areas
that the customer actually cares about. For instance, a
manufacturer of potato chip bags could spend tons of time and
money creating a biodegradable bag, only to discover that the
consumer doesn’t care about that at all. Instead, they want a bag
that is easier to open and doesn’t make as much noise.7.3Six
Sigma
Defects are Costly
Every time you manufacture a defective part, you are losing
money. In early stages of a company, defects often don’t seem
to be a significant problem. They only occur every once in
awhile, and the net loss in profit is quite low.
However, as your company expands and starts producing
millions or billions of parts, defects start really adding up. Even

if only 1 part is defective in every thousand, it still is taking
away a sizable chunk of time, money, and energy to catch the
defects, remove them, recycle or dispose of them, and make a
replacement.
Six Sigma
In order to deal with this problem, many manufacturing
companies use a Six Sigma methodology.Statistical Process
Control
Six Sigma is a method of statistical process control designed to
reduce the number of defects. When manufacturing, there is
variation in the accuracy of making a given dimension on a part.
Most dimensions have a tolerance, or an acceptable range above
and below the specified size which is still acceptable (the
product will still work the same). The variation follows a
normal distribution. Depending on the precision of the process,
a certain amount of that distribution will be within the
acceptable range, or tolerance. Generally, most people think
that three sigma, or three standard deviations above/below the
mean is enough accuracy. After all, 99.73% of all parts will be
within the given tolerance.
However, 99.73% still means that in a million parts, 2,700 of
the parts will be defective. If you are making a million parts a
week and you lose $1 on each part, that’s $2,700 wasted every
week. Depending on your industry, a defective part can cost
much more than a dollar, and in some industries you may be
producing far more than a million parts in a week. Whatever the
case, you are effectively pouring money down the drain.Three
Sigma is Not Accurate Enough
Thus, three sigma isn’t accurate enough for mass production.
Six Sigma is far more accurate. 99.99966% of the opportunities
for defects will not result in a defect when using Six Sigma
process control. This means that there will be 3.4 defective
features per million.Shifts from the Mean
Six Sigma also allows for a shift away from the mean without
creating huge numbers of defects. Suppose that you have a

machine that is supposed to make a part that is 1 inch long.
Instead, it is calibrated to have the mean length of the part as
1.001. Six Sigma can effectively deal with a 1.5 standard
deviation shift from the mean without causing a large
proportion of the parts to be defective.
Both General Electric and Motorola, two of the early adopters
of Six Sigma, have estimated their savings due to Six Sigma to
be over 10 billion dollars.Using Six Sigma
How can you increase your accuracy to Six Sigma? Well, it is
difficult and depends on the process. Workers can be trained
and certified in Six Sigma. Better machinery can be bought,
which is more accurate and easier to calibrate. Jigs and fixtures
can be designed to hold parts while they are being made.
Becoming very familiar with the points where defects are
created or hiring someone who is experienced in Six Sigma
quality control are generally the most effective ways of
implementing Six Sigma.7.4Pareto Analysis
The Pareto Principle
Where do most of your problems come from? It’s likely that a
few key issues cause the majority of the problems in your life
which is the same in business. Usually roughly 80% of the
problems result from only 20% of the causes. This principle,
often known as the 80/20 rule, was named after an Italian
economist who recognized that 80% of Italian income was
allocated to 20% of the population. In Business, the Pareto
Principle can be applied in many instances such as the
following examples.
· 80% of company revenue results from 20% of products.
· 80% of the work is accomplished by 20% of the team
· 80% of customer complaints come from 20% of customers
· 80% of new ideas come from 20% of employees
Performing a Pareto AnalysisIdentifying Problems
A Pareto Analysis uses the Pareto Principle to evaluate a
problem and identify which 20% of causes result in 80% of the

problem. Based on statistical evidence, a Pareto Diagram can be
created and analyzed. To better understand Pareto Analysis and
creating a Pareto Diagram, we will use an example of a
university that has had problems with computers crashing over
the past year.Example - University Computer Crashes
To perform a Pareto Analysis, the team assigned to tackle the
computer problem first identifies all of the reasons for which
the computers have crashed over the past year, and how many
computers have been affected. They identify 10 reasons for
which 260 computers have crashed. The frequency of each
reason is then calculated which allows the team to order each
cause in descending order. The next step the team takes is to
determine the cumulative percentage in descending order, which
is calculated by adding each frequency by the frequency of the
preceding causes and dividing by the total number of
frequencies. Once all totals have been found, the diagram can
be plotted. The reasons for the computer crashes are placed on
the x-axis with the frequency of each occurring on the y-axis. A
second y-axis is given to show the cumulative percentage which
can be plotted on the same graph. The following is the example
of the diagram developed by the team.
Using the diagram, the team is able to identify the key issues
(the 20%) which are causing most of the computer crashes (the
80%). The team now knows exactly which problems to focus
their energy on to solve most of the computer crashing
problems.
In this example, there was easy-to-analyze data that allowed for
a Pareto Analysis. Suppose instead you wanted to figure out
which 20% of individuals on your team accomplish 80% of the
work. Without some way to measure productivity, the analysis
would likely be biased based on personal perceptions and
stereotypes. In the next section, we discuss ways of measuring
productivity that can help make such an analysis less
subjective.7.5Measuring Productivity
How do we measure productivity?

Your company makes money based on selling its products. If
you want to sell more product you need to produce more (as
long as there is demand). Other sections of this book focus on
increasing the firm's productivity, but in this section, we focus
on the best way to measure productivity - specifically, the
productivity of employees.Hours Worked
Measuring productivity by the number of hours worked is pretty
much useless in today’s society. If an employee works 8 hours
but spends 2 hours on Facebook, 1 hour surfing the web, and 1
hour texting, that employee clearly wasn’t productive. Despite
this, many companies still pay their employees by the hour,
incentivizing them to work for more time rather than to get
more done. Paying by the hour is still an acceptable practice as
long as other incentives are given to motivate an increase in
production.Output
Logically, the best way to measure employee productivity is to
measure how much they produce, and reward them for their
individual output. In some industries, this works fabulously. In
a manufacturing plant, the worker who can assemble more parts
in an hour is more valuable than a worker who assembles fewer
parts. However, in more complicated business, it is more
difficult to measure a single employee’s contribution. For
instance, in a large journalism firm, you can’t simply measure
the number of articles or words written in a given period of
time. This overlooks the quality of the article and makes for a
potentially disastrous situation. This can become even more
complex if multiple individuals helped research and write the
article - it is practically impossible to separate individual
contributions.Equation for Productivity
The basic equation for productivity is this: Productivity =
Output / InputIssues with Measuring Output
However, this equation may be deceptive if your measurement
of output doesn’t reflect the reality of your business. If you are
an artist and you measure your productivity by the number of
paintings you produce, the best way to improve your
productivity is to spend far less time on each painting. This

style of measurement doesn’t include a way to measure the
quality of production and doesn’t work well for knowledge jobs.
Ways to Measure Productivity
Here are several ways to measure productivity, as well as the
instances when they are most effective:Items produced per unit
of time
This is a method of measuring employee productivity that works
particularly well in manufacturing environments. Simply take
the number of items produced and divide it by how long it took
for that employee to produce them. For instance, you may find
that Jennifer can thread 50 shoelaces per hour at your shoe
factory.Sales
This obviously is an effective way of measuring the
productivity of any employee who is primarily responsible for
selling your product directly to a consumer. Any effective way
to incentivize employees whose productivity is measured by
volume of sales is through commission - the more she sells, the
more money she gets. For instance, Brian make 30%
commission on every Pest control sale he successfully makes,
and will receive a bonus if he sells more than 50 contracts in a
given month. 360 - degree feedback
This method provides a very in-depth assessment of an
employee by having co-workers, managers, and other employees
of the company evaluate how well an individual is doing. This
is an excellent method for small firms where everyone interacts
frequently, as well as for individual departments within a larger
organization.Accomplishing objectives
Setting goals and then measuring how well employees
accomplish those goals is a very customizable method that can
apply to business across industries, including those that are
more difficult to measure using other methods. Knowledge
workers can still be given goals, which can include a quality
component. For instance, instead of giving Janet a goal to write
500 lines of code this week, we could give her the goal to create
a program that works without any major flaws and is user-

friendly within the next 2 weeks. This method also works well
for companies that rely heavily on teams. For instance, Bill sets
a goal for his marketing team to increase gross sales by 2% and
it takes them 49 days to do it.7.6Zero-Based Budgeting
Reviewing Every Budget Item
Generally, budgeting is done by taking the previous year’s
budget and then justifying any changes for the upcoming year.
In zero-based budgeting, every item of the budget is reviewed
every time the budget is approved. Instead of basing the budget
on the past, it is based on zero costs. This process forces
executives to look at every single expense of the organization
and analyze whether it is still relevant and worth the
cost.Culture Shift and Cutting Costs
Effective zero-based budgeting embodies a culture shift to
being more cost-conscious. It is also often ambitious, seeking to
look from end-to-end of the business process and figure out
exactly where the company is adding value and where the
greatest costs are incurred.
Often, companies use this budgeting technique when they want
to cut costs to the bare minimum. However, executives can
decide how aggressively they will cut costs and base approvals
on that decision. Perhaps a very growth-oriented company could
use this tool to identify areas of waste, but plan on approving
almost all Research and Development expenses.
This process is useful in several ways. It almost always brings
costs down, as wasteful operations are eliminated. It also
prevents costs that were needed in the previous year but are no
longer necessary from being added onto the new budget.
Shaping Strategy through Zero-based Budgeting
Zero-based budgeting can help shape a company’s future
strategy. If management discovers that one particular aspect of
the business has abnormally high expenses, then they might
consider outsourcing it, or acquiring a small company that
specializes in that area in order to reduce costs.

Zero-based budgeting can be used in certain departments
without applying it to the entire organization. For instance, if
Google wanted to use zero-based budgeting, it would be
practically impossible. There would simply be too much
paperwork, time spent accomplishing it, and personnel required
to create the budget and gather enough data to make informed
decisions. However, they could create a zero-based budget for
an individual department or section of the company.
Issues with Zero-Based Budgeting
There are some issues with zero-based budgeting. It takes
forever—or at least a really long time. Being so meticulous
about what is approved for company spending means that every
detail of the business must be analyzed and scrutinized. Zero-
based budgeting also tends to favor areas that directly lead to
revenue or create production because these sectors produce an
immediate return on the money spent. Other areas, like research
and development, may be hurt because its benefits are long-term
and may not translate as readily into profit.
Organizations need to be careful about what items are cut in
Zero-based budgeting. Being overly zealous in cutting items or
misimplementing a Zero-based budget can limit a business and
prevent it from functioning to its potential.
Steps to Zero-Based Budgeting1. Identify and Rank Core
Business Activities
What drives your business? What activities add the most value
to the product? Which things do consumers value most?2.
Determine the Cost of Each Activity that the Business Does
You can decide how in-depth this will be, but generally it works
best if it is far-reaching and includes very detailed costs of each
aspect of the business3. Are the costs worth it?
Look at each listed cost. Is it worth it? Are you spending the
most money on your most important business activities? Are
there expenses that seem unnaturally high?
Cut each activity that doesn’t seem to be worth it. Align this

process of cost-cutting with how aggressively you want to cut
costs and with your overall business strategy.4. Establish
guidelines
Set up guidelines to keep your company within the budget you
have established, specifying which costs are no longer needed
and what things are most important to the
organization.7.7Economies of Scale
Cutting costs is great, as it naturally increases both your
margins and your overall profit. One way of cutting the cost to
produce each item is through economies of scale.
Economies of ScaleBenefits
Economies of scale are the advantages a company gets by
producing large quantities of their product. These include
decreased cost of materials, the ability to spread costs such as
research and development over a wider base, and increased
specialization of labor. Economies of scale can be divided into
both internal and external economies of scale.External
Economies of Scale
External economies of scale happen in an industry. The
industry, for whatever reason, has decreased costs as it grows.
This could happen because suppliers have specialized to deal
with the number of companies in the industry, decreasing the
cost of supplies. Or perhaps there is an increase of
infrastructure created to deal with the number of entrants to the
market, decreasing the cost for each of the companies in the
industry. The development of more efficient technology could
also be a factor.Internal Economies of Scale
Internal economies of scale are when a company decreases their
costs and expands their production. Generally, when you think
of the advantages of mass production, you are thinking of
internal economies of scale. Buying supplies in bulk usually
decreases the cost per unit of the supplies. The cost of
marketing is spread out over a greater number of products.
Research and Development costs are also spread across more
products. Internal economies of scale decreases both fixed and

variable costs.
Beyond spreading costs of certain departments across a greater
number of products and advantages in buying supplies,
economies of scale also allow for greater specialization of
labor. In small businesses, a few individuals do almost
everything - they market the product, handle the finances, order
supplies, and perform quality control. They may be decently
good at each of those aspects, but it is very unlikely that they
are expert in each fields. As the business becomes large enough,
it can hire an accountant to do the accounting, a quality control
expert to do quality control, and a marketing specialist to
handle marketing. The more a company grows, the more
specialized the labor can become.
Usually, we focus on internal economies of scale in business
strategy. External economies of scale are nice for our company,
but give us no competitive advantage over our competitors.
Diseconomies of Scale
Be careful of diseconomies of scale. This occurs when
increasing the production of a certain product no longer
provides an economic benefit, and may actually hurt the
company. For instance, if a company produces far above the
market demand, they can expect lower costs per unit, but they
will be unable to sell enough quantity to actually receive any
benefit. Increased complexity also causes diseconomies of
scale. As a company expands, the complexity of doing business
increases. Overseas suppliers are found, various distributors are
used, and the sheer number of employees grows. At a certain
point, the complexity becomes so great that the cost of the
complexity outweighs the economies of scale from increased
production.7.8Economies of Scope
As your business grows, what are ways to decrease the cost of
producing each item? Through economies of scale, we can
decrease the cost per item by mass producing them. Another
way to decrease the cost per item is through economies of
scope.

Economies of Scope
Economies of scope means that if you produce multiple
different products from the same fixed costs, profit will
increase dramatically with a small increase in cost. It can also
refer to other advantages obtained by producing multiple
different products. Example
For instance, take the Marriott Hotel in Cache Valley. The fixed
costs on a hotel are very high - no matter how many people stay
in the hotel, they still have to pay for the building and most of
the staff. If they just offer hotel services, they only make money
on the people who stay in the rooms. However, let’s say that the
Marriott starts hosting events - weddings, business conferences,
high school dances, and public speaking events. Now, many of
the costs stay the same (costs for the building, electricity, front-
desk staff, cleaning and maintenance, etc.) but these costs are
spread over two different sections of the business - hotel
services and events. The revenue from each pays for itself, and
thus the impact of fixed costs is much less, increasing the profit
on the bottom line. Diseconomies of Scope
Sometimes, instead of economies of scope, businesses can
experience diseconomies of scope. This is when companies
think that expanding to a new product will decrease the per-unit
cost, but instead it actually increases their per-unit cost. This
can be caused by a need for additional factories or other
buildings, decreases in efficiency, lack of demand for the new
product, higher-than-expected costs for raw materials or
specialized personnel, or a host of other reasons. Opportunities
What are opportunities for you to use economies of scope?
1. Look for excess capacity. Do you have machines that are idle
for much of the day? Specialized workers that have extra time?
Departments that are under utilized?
2. Is it easy for your machines to switch between tasks?
3. Are your fixed costs a very large portion of your overall
costs? If so, look for a way to spread these fixed costs across
multiple lines of revenue.

4. Do you have assets that aren’t used very often? What else
could they be used for?
5. Can technology create economies of scope in your business?
Historically, many of the problems preventing economies of
scope were caused by issues in manufacturing. It took a long
time to set machines up for different tasks, workers were much
more efficient when they only manufactured one item, etc. Now,
computer-aided manufacturing overcomes much of that. The
computer can switch between different parts instantaneously,
has no learning curve, and can create very precise
parts.7.9Shingo Model of Excellence
Twenty years before the Shingo Model of Excellence was
established, Utah State University created the Shingo Prize for
Excellence in Manufacturing in honor of a Japanese industrial
engineer named Shigeo Shingo. The prize was originally
focused on the presence of lean principles in manufacturing
companies but was eventually expanded to encompass principles
of effective organization within companies of many industries.
With this shift came the renaming of the Prize to the Shingo
Prize for Operational Excellence.
In 2008, the Shingo Model of Excellence was created to better
show companies what the Shingo Prize was looking for in
applicants, and to teach what they considered to be the best
practices in business and manufacturing. The model is as
follows:
Principles of the Shingo Model
The following principles are the core of the Shingo Model. As
the chart displays, these principles interact and shape the
culture, systems, results, and tools of an organization. Respect
Every Individual
Respect is valued highly by essentially all individuals in an
organization; everyone wants to be respected. This respect can
help employees be dedicated to the success of the company,
rather than merely worried about the next paycheck. Look

closely at your company. Do you help your employees progress,
following a development plan with appropriate goals? Are your
employees involved in improving the work around them? Do
your employees have access to coaching to help them through
difficult problems? Lead with Humility
How do your leaders interact with everyone else? Often,
companies will end up creating huge inefficiencies when
executives are unwilling to listen to anyone below them in the
corporate hierarchy. Strive for a corporate culture where leaders
seek input for improvement and are constantly learning better
ways to do business. As leaders listen to and follow their
subordinates, all employees will feel more invested and engaged
at work, giving them a sense of empowerment. Instead of
punishing mistakes, focus on fixing the process. Seek Perfection
Complacency is a sure way to halt improvement. Are there
problems where you’ve effectively said, “That’s just the way it
is, we have to live with it,”? If so, you will have to live with it.
Constantly seeking perfection will allow you to overcome the
major problems that hold back your organization. Perhaps they
won’t all be resolved right now, but as long as everyone is
looking for ways to fix problems instead of accepting them,
they will eventually be fixed. This creates a culture of
continuous improvement, which is a much healthier mindset for
an organization. What are the problems that hold your business
back? What are you doing to fix them? Are you simplifying
work? Do you generally implement long-term or short-term
solutions? Embrace Scientific Thinking
Scientific thinking involves repeating experiments, taking direct
observations, and learning from the past. This process is
powerful, and has driven the progression of the human race.
Explore new ideas. Find ways to test out ideas on a small-scale
to see if they work. When experiments fail, re-design them and
try again. Relentless pursuit of scientific thinking will drive
innovation and improvement. Do you have some sort of
structure to your problem-solving method? Does your
organization have an overriding fear of failure? Do you accept

the suggestions of the engineers or scientists who you have
employed? Focus on Process
Who’s to blame, the person or the process? Generally, the
problem is with the process. Even the best employees will fail if
the business process is deficient. When something goes wrong,
put off the natural tendency to blame people. Instead, look at
the process. How could the process be improved? Why did the
error occur? Can you establish a process that would prevent that
error from ever occurring again?Assure Quality at the Source
Do things right the first time. If they aren’t done right the first
time, track down the source and correct it at the point of
creation. This often means stopping work and waiting until the
errors are resolved before continuing.Flow and Pull Value
If a company produces more, it makes more money - right? Not
always. Value comes from customer demand, and everything
your company does should be to satisfy customer demand.
Demand is often distorted, which creates waste in the
organization. Structure things so that customer demand will pull
product through your business, and match the value offered to
the value demanded. Don’t overproduce and stockpile, and
respond quickly to customer demand.Think Systemically
Does your system allow ideas, materials, info, decisions, and
suggestions to flow from one group to another? Do you have
strong relationships built on clear communication? If your
system of passing ideas, materials, etc. is effective, it will
prevent a lot of inefficiency and frustration. Communicate goals
to the people that need to know them, and be inclusive.Create
Constancy of Purpose
Why does your business exist? Every person within the
organization should be able to explain why the business exists,
the direction it is heading in, and how the progress is going.
This allows individual actions to align with the overall purpose,
empowering employees and improving output. Individual goals
should align with organizational goals.Create Value for the
Customer
Value is what the customer wants and will pay for. At the end,

this is what your company must provide. Failure to achieve this
spells doom for your company. Gather data on your customers.
Ask them for feedback. Look for the things that the customers
care most about. These will drive the success of your business.
These principles, along with your business systems, tools, and
final results, are tied to and shape your company culture. In
order to have the most success in your company, you need to
optimize all of these areas.7.10Organizational Time
Management
It is obvious that every organization wants to have its
employees working diligently all the time. It is also clear how
easy it is to get distracted—think of how many times you’ve
gotten on social media when you should have been doing your
homework! In an organization, the question is far broader than
whether employees waste time. It applies to how they spend
their time, what they focus on, and who is assigned to a given
task. Time management has become such a prevalent problem
that many organizations are creating various programs to help
their employees better manage their time.
It’s often said, “Work smarter, not harder!” What does that
actually mean? How do you make your time more impactful?
How can you help your organization better manage time? There
isn’t one magic key designed to solve this problem. However,
here are some ideas that you can try when designing an
organizational time management program.
Ideas to Improve Organizational Time Management
First—spending time on organizational time management is an
investment. It is far too easy to say, “We don’t have time to
spend on time management.” This is a great attitude to stay
perpetually busy and never have enough time to catch-up or get
ahead at work. There will always be more things to do than time
to do them, so take some time to work on becoming more
productive.Establish clear priorities
It is incredibly important to communicate to employees what
matters most to the organization. Otherwise, they will

inevitably put too much time into projects that don’t really help
the organization or don’t impact the bottom line. Explain to
employees what their number one task is, and then explain what
other tasks are still important.Don’t try to do everything
Train your employees to stop trying to accomplish every
possible task that comes their way. Instead, teach them to
prioritize and focus on the most important tasks. This will keep
employees more motivated and productive at work. Have them
focus on the 20% of tasks that determine 80% of the results
(see Pareto Analysis). Streamline the process
Do you need so much paperwork? Do you need to mandate
approval from so many people? Trust your employees to do a
good job and cut out some of the organizational bureaucracy.
This empowers your employees to shine, and if they don’t, fire
them. It’s worth it to have great employees and trust
them.Delegate correctly
Delegation is a key part of almost every organization. Take time
to make sure that you delegate the right tasks to the right
people. It’s obviously a problem if your productive employees
are given tons of projects to do simply because they are
productive. This is essentially an incentive to not be productive.
Additionally, if an extremely important project comes up, what
are you going to do if all your best talent is bogged down on
other projects? As logical as this seems, it is very common in
organizations. It is equally ineffective to pass the best tasks up
to the most senior employees and the worst to the newest
employees. You will have high turnover rates and low
motivation among new employees. Instead, look objectively at
which people can best accomplish which tasks. Assign people to
projects that they enjoy and will be motivated to put in their
best effort at.Put limits in place
Can you limit the amount of wasted time? Better yet, can you
limit the amount of “good” activities that happen and focus on
the “best” activities? For instance, collaboration is important.
Yet it can often go too far, leading to people constantly barging
into each other’s offices, wrecking their train of thought and

distracting them from the project at hand. Maybe limit the
amount of time when employees are available to their co-
workers. Limit the number of reports given to managers. If
people need some isolation or insulation from each other, create
a system that can accomplish this. This has to be adapted to the
style of workplace you are in. Some places require collaboration
on everything, many will not.Work on your workplace
Are employees continually looking for tools? Files?
Documents? Collaborators? If creating an organizational
structure for these things would help save people time, do it.
Outline the wrench so it always gets put back on the same rack.
Have all employees on the same project put their documents in a
shared file. Simple annoyances like these become major
frustrations when deadlines or executives put lots of pressure on
employees.
If organizational time management is a main focus in your
company’s strategy, you should seriously consider paying an
outside consulting agency to come in and train your workforce.
As professionals, they have a lot of tools at their disposal, as
well as experience in helping other organizations. It may also be
useful to track employees’ time, looking closely at how the
typical employee in your firm spends his/her time. Software
programs or employee planners may also be worth the
investment. Look at Google Calendar, Microsoft Outlook,
Google Keep, iCal, Dropbox, Focus booster, Trello, and others.
Effective employees almost always mean a successful
company.7.11Employee Engagement
When do you work hardest at a job? While there are lots of
factors influencing this, you probably only work your very
hardest at jobs you care about. If you’re working in a call center
and aren’t passionate about calling random strangers, it is
unlikely that you will exert your best effort every day at work.
However, if you absolutely love skiing and work in a ski design
and development shop, you’re much more likely to put forth
extra effort to do a good job. The more engaged you are, the
harder you will work.

Increasing Employee Motivation
Employee engagement is a measure of employees commitment
to and passion for their role within an organization. Because
employee engagement measures the extent to which employees
are motivated to accomplish organizational goals, much of the
organization is dependent on an effective employee engagement
strategy. Everything from revenue, customer satisfaction,
product or service quality, and innovation is driven by
employee engagement. Modern companies realize the
importance of keeping employees dedicated and put time and
effort into creating an organization that cultivates employee
engagement.Employee Engagement Surveys
Companies with successful employee engagement strategies
generally have effective employee engagement surveys.
Employee engagement surveys consist of question series
distributed at least annually to every employee within an
organization. The survey examines each employee’s
understanding of and commitment to the organization's goals
and mission, their dedication to their coworkers and teams, and
motivation to accomplish projects. A well prepared and
distributed survey can give management a good idea of the level
of employee engagement within an organization.
Ideas to Boost Employee Engagement
Different sources cite different strategies for boosting employee
engagement, but the success of these strategies likely varies
depending on the nature of the organization. The following are a
few ideas which are likely to boost any organization’s employee
engagement.Improve the Employee Engagement Survey
Prove your employee engagement survey and tweak it to
perfection. A poor employee engagement survey will provide
poor results. A survey which can successfully measure
employee engagement will provide an organization with key
information needed to take engagement to the next level.Be
genuine and transparent

Genuineness and transparency are magic attributes which allow
subordinates to trust a leader and want to follow them. They
also allow leaders to offer constructive criticism employees are
willing to listen to. When genuineness and transparency are
present in an organization, devotion to that organization
increases.Understand the importance of communication
Employees cannot be dedicated to an organization’s mission or
goals unless the organization clearly communicates those ideas
to its subordinates. Employees also need to feel listened to and
asked to communicate ideas and give input to
management.Incentivize the right employee traits
In order to create a positive attitude towards the organization
and organizational goals, it’s a good idea to promote employees
who show extreme dedication to their role within the
organization.Realize employee engagement is contagious
Create an organization that allows employees infected with a
high level of engagement to spread it to others like a weird
desirable disease. Cultivate engagement within management and
team leaders and drive them them to do the same to those they
lead.Do more than just work with your employees
Involving your employees with volunteer opportunities,
recreation, and social and cultural events will help build
relationships which facilitate employee engagement. Create an
atmosphere which can provide for employees’ social and
recreational needs as well as their financial needs.7.12Location
How do we choose the location of our business?
When constructing a manufacturing facility, putting up a
restaurant, opening a bike shop, or creating any other kind of
business, location matters. It is tempting to simply find the
cheapest piece of land and build or jump into a contract with
either the cheapest or best located (and likely most expensive)
rental space, but this approach misses several crucial
factors.Markets
Where are you going to sell your product? Obviously, a retail
store needs to be in an advantageous location to effectively

reach your target consumers. For instance, stores targeting
tourists in downtown Verona pay huge premiums to be on the
same street as Juliet’s balcony because they are guaranteed to
have millions of potential customers see their store every year.
However, identifying the end market is also useful in deciding
where to place a manufacturing plant. If your product is made
closer to where the end customers are, you will save money on
shipping costs.Shipping materials
Look carefully at how you will ship supplies. Not all locations
are equally connected to interstate roads, ports, or railways. If
you are constantly shipping product in or out of your factory, it
may be worth paying more for a certain location in order save
on shipping costs. Know your supply chain by heart, and find
the best spot to make it efficient.Labor
Another factor to consider is the supply of labor. Placing your
business near a major city can give you a better supply of labor,
particularly if there is a high turnover rate in your industry. A
large labor supply also allows you to be more selective about
who you hire, focusing on employees who fit your company
culture and who are productive.Other issues
Taxes also vary by state, which may determine where it will be
most profitable to build a manufacturing plant or place your
headquarters. For instance, Utah attracts some businesses with
its favorable tax policies towards businesses. Also, some states
and cities regulate pollution and other environmental issues
more heavily than others, and may even charge a tax on
pollution (for instance, Boulder Colorado has a carbon tax on
electricity generation). If your company is likely to be affected
by these concerns, do your research before you pick a
location.Buying property vs. Leasing
A difficult question is whether your business should lease or
buy property. When starting out as a small business, buying
property outright is expensive and a down payment will likely
use up much of your startup money. As you grow, the question
to buy or lease becomes increasingly difficult.Leasing
Leasing has the advantage of freeing up capital for other uses.

Instead of using money for a down payment, that money can be
used to grow the business. If your business is successful, it
should grow faster than real estate can appreciate or than the
cost of leasing.Buying
Buying can have many advantages as well. In general, banks are
more willing to finance loans that are backed by real estate
because real estate tends to hold its value very well.
Additionally, once the loan has been paid off on the property,
your overall expenses will go down significantly.
How long is your business likely to stay in the same place? If
your company is likely to use the same building for the next
decade or longer, buying the property will save you money in
the long run. However, if your vision for the company involves
expanding and will require more space relatively soon, perhaps
leasing is a better option.7.13Effective Forecasting
Forecasting professionals are the first to tell you that
forecasting is always wrong. This means that forecasts are
always inaccurate in some way because no matter what you do
in the present, the future is out of your control, and
unforeseeable surprises are always waiting on the horizon. No
one can tell you how to make a perfect forecast because it’s
impossible. So why even bother? If no one can forecast with
100% accuracy, why do companies use forecasting?
Forecasting Improves Planning
Even though forecasting is never 100% accurate, it is still very
useful. It is useful because even when the forecast isn’t
perfectly accurate, it still can allow us to plan for the future in a
manner that maximizes profit and minimizes wasteful expenses
by giving a better idea of how the future will be. It is
particularly useful when it comes to projecting future sales,
expenses, inventory, accounts receivable, taxes and salaries—
those elements of a business that largely determine success.
Forecasting the critical elements of a business as accurately as
possible gives you a general idea of what to expect in the
future, allowing you to align your current actions with these

future expectations. If a firm expects future earnings to
decrease in the following year, they can start looking for ways
to minimize expenses now. On the contrary, if a business
predicts a rise in sales on the horizon, it allows the firm to start
looking for profitable avenues to invest their profits in now.
Accurate vs. Effective Forecasting
At first glance, we would assume that we want our forecasts to
be both accurate and effective. However, this isn’t necessarily
true. Accurate forecasting is either impossible or extremely
difficult to achieve. However, an effective forecast is a forecast
which allows you to shape the strategy of your company in a
way that gives you an advantage, even if the forecast is
inaccurate in some way. If your forecast is effective, it doesn’t
need to be any more accurate.
Forecasting takes more common sense than it does science,
mathematics, or an advanced degree. It takes critical thinking to
identify possible market shifts, and then the courage to make
educated guesses about how these shifts will affect the
company’s future. Traditional forecasting simply involves
looking at financial trends in a company’s own statements—
looking at your own past to predict your future.Strategic
Forecasting
However, this book focuses on strategic forecasting, which
takes traditional forecasting a step further. Strategic forecasting
involves understanding competitors and the unique industry and
allowing your company's differentiation strategy to influence
your forecast. Knowing what the competition is doing and how
their actions impact our firm gives you a powerful glimpse into
our company’s future.
It may be silly to give specific steps to performing an “accurate
as possible” forecast, but to provide you with some idea of how
to perform such a forecast, here are some valuable steps to take,
no matter the business element you are analyzing - sales,
expenses, taxes, inventory turnover, or general growth.

Basic forecasting
There are many different ways to create a forecast, and they can
vary in effectiveness depending on the sector of your business
that you are dealing with. Here are a few types of forecasting,
with examples based on forecasting quantity of products
demanded. Note that forecasts can be made for sales, revenue,
expenses, inventory, accounts receivable, salaries, taxes,
financial ratios, and other aspects of your business. We are
merely focusing on demand to make the methods easier to
understand.Naïve approach
This is the cheapest and easiest way to forecast. Simply take the
demand from last year and forecast that you will have the same
demand this year.
Forecasted demand = Demand from last yearTime Series
Methods
This is a collection of methods which rely on historical demand
data to predict future demand. The Naive method is one of the
time series methods. Another is the simple mean, which takes
the mean of all available demand data and projects that for next
year.
Exponential smoothing is perhaps the most frequently used time
series method because it doesn’t require a lot of data and it is
easy to use. The equation is
Forecast of this year = Alpha * Actual value of last year + (1-
Alpha) * Forecast of last year or
FT+1 = � AT + ( 1 - � ) FT
Alpha � is a smoothing coefficient between 0 and 1.0 which
determines how much you rely on last period’s data.
Time series methods are valuable because they don’t require
consulting outside individuals and they are based on data that is
generally easy to get. However, these methods are inaccurate
for any strong shifts in the market and are most accurate for
stable, slow-growth industries.Delphi Method
This method involves asking many experts in the field what they
think will happen to future market demand and aggregating
these opinions into a predictive forecast. In a series of rounds,

the experts are told the opinions of the other experts and are
given the chance to revise their predictions. Supposedly, the
opinions will eventually converge to a single prediction of the
future. This method is time consuming and rather difficult, but
can give insights into long-term developments in the market that
other methods are simply not effective in predicting.Other
Methods
Other methods include the drift method, seasonal naïve
approach, moving average, weighted moving average, Kalman
filtering, causal/econometric, regression analysis, and artificial
intelligence methods. If forecasting is a fundamental part of
your business, be sure to seek out the best method for your
company to use. Whatever the case, keep the following
principles in mind:
Principles of Effective ForecastingFocus on strategy
The first step to effective forecasting is to focus on your
company’s strategy. Mentioned earlier was the concept that
when you perform a strategic forecast, you consider how your
company is differentiating from the competition. Just as a firm
alters the rest of its operations to align with its strategy, it only
makes sense to do the same with forecasting.Determine levels of
uncertainty
In each forecast there is only one thing that is certain and that’s
uncertainty (see what I did there?) The next step in forecasting
is to determine the levels of uncertainty you’re dealing with. If
you happen to be be brainstorming on a giant whiteboard, you
might consider drawing a giant horizontal line from one side to
the other. Towards one end of the line, write the word certain
and towards the other end of the line write the word uncertain.
Then, write down all the elements of whatever it is you are
dealing with and place them in their appropriate location on the
uncertainty line. If you were projecting sales revenue for the
following year, you might place elements involving secured
customers or customers under contract closer to certainty than
you would place sales that, although might be scheduled,

haven’t yet closed. Doing this exercise allows you to get a
better feel for the factors affecting the forecast and see how
much you are relying on certain elements. If you feel a pit in
your stomach because you realize everything that will bring
certain success actually lie far on the uncertain side of the line,
you may have some strategic changes to make. Embrace what
doesn’t fit, but challenge it
Creative ideas and concepts should be embraced when creating
a strategy and forecasting on that strategy. Considering
everything from the most basic to the most outlandish of ideas
allows a firm to consider possibilities they never have. Often
when a crazy idea is even entertained, the idea can morph into
something alarmingly doable. Having such a good idea come
from such a surprising source will be shocking, but it will
happen. The roots to this step go back all the way to strategy.
As much as a firm should push for creative, out of the box
ideas, they should also challenge that idea. Just because an idea
seems original and packed with potential doesn’t mean it’s
going to fly, and certainly doesn’t necessarily mean it’s going
to attract as many customers as expected. When forecasting,
challenge projected sales volume, challenge projected expenses
and collection on accounts receivable. Question on what merits
you have projected numbers to be what they are. Have you
tested anything in the market on a smaller scale? Are your out
of the box ideas actually answering a customer concern and
need? Pepsi failed at this step when they introduced Pepsi
Crystal, the new pepsi version of Sprite. They projected the idea
would be wildly successful and failed to adequately challenge
it. In the end, Pepsi Crystal didn’t answer a customer need that
wasn’t already being met, and thus the idea failed. Be willing to
let go of your babies
Along the same lines as challenging ideas is being willing to let
them go. Especially the ones you feel emotionally attached to—
that is—your babies. To be too emotionally attached to a
specific outcome is likely to affect the outlook of your forecast.
Effective forecasts are based on objective facts, figures and

expectations but they are analyzed and constructed subjectively
by people with feelings and opinions that may or may not be
based on real facts. Some helpful practices to avoid human error
is to have multiple people or teams perform forecasts on the
same projections, pay an outside firm to perform your
company’s forecast, and keep individuals with high emotional
involvement as uninvolved as possible.Look forwards,
backwards, left, and right
The goal of forecasting is to look into the future with an “as
accurate as possible” idea of what’s coming. That is called
looking forward. Commonly understood in forecasting is the
need to also look backwards—that is—to use past financial
statements, company history, and trends to identify patterns that
will carry forward from the past. Less understood in forecasting
is the need to not only look backwards but look left and right as
well. What does that mean? When we say strategic forecasting
requires looking left and right we mean it requires analyzing
current market situations and watching our competitors closely.
When analyzing the market consider the following questions.
Are there new technologies or disruptive practices being
introduced in the field or in related fields? What new researches
have come out or are currently being performed? What does
popular consumer opinion support? Just as much as we’d like
our company to succeed so do all of our competitors. When
analyzing the competition ask yourself the following questions.
What are the assumptions we’ve made about our competitors in
the past? Are those assumptions still accurate or are they now
invalid? Is there a company in the industry that has done poorly
historically but is now making major changes? What effects will
those changes have? Realizing the effect the past and current
market has over the future as well as the effect competition in
the market and your own company’s past might have is
imperative to strategic forecasting.Stick to your guns, within
reason
When forecasting is done right, there comes a point when you
are satisfied with your predictions. You might still be concerned

about accuracy, but you can at least be assured that your
projections are as realistic as possible and involve a
comprehensive analysis of the important factors. You can be
satisfied with how well your projections reflect both reality and
your company’s strategy. When you’re sure your forecast is as
good as it will ever be, it’s now time to stick to your guns...to a
certain point. Why to a certain point? When a forecast is made,
the next step is ultimately to watch the future unfold and do
what is in the company’s control to assure that it unfolds
according to design. Naturally there will be elements of the
future outside of your control, and that is where the phrase
“within reason” comes in play. Stick to your guns until changes
need to be made to maximize the company’s success. When
appropriate changes are made and a course correction is put in
place, stick to your guns again—that is—within
reason.7.14Summary
Decreasing Costs and Creating EfficiencyTotal Quality
Management
TQM is when a company continuously works on improving their
business processes to create better products in a more efficient
manner.Six Sigma
Six Sigma is a process of statistical process control to reduce
the amount of defects that are produced by your business.Pareto
Analysis (80/20 rule)
A Pareto Analysis looks at both the problems and the solutions
that have the biggest impact in your business. In general, 80%
of problems come from 20% of the causes, and 80% the work is
accomplished by 20% of the people. By looking at what drives
growth and what holds your company back, you can better craft
your strategy to focus on the highest impact ideas.Measuring
productivity
Productivity will determine, in large measure, the success of
your firm. The question is, how do we measure
productivity?Zero-based budgeting
Zero-based budgeting is done by taking every single item of the

budget and reviewing its value whenever the budget is
approved. This helps identify wasteful spending and eliminate
expenses from previous operations that are no longer
necessary.Economies of Scale
As you produce more volume of a given product, your cost to
produce each unit go down. This is referred to as economies of
scale.Economies of Scope
Sometimes, you can reduce your cost per unit on one item by
also producing another item that shares materials, machines, or
processes. Essentially, by diversifying your product line, you
decrease your costs. This is referred to as Economies of
Scope.Shingo Model of Excellence
This model is a way of looking at the people, processes,
purpose, and stakeholders involved with your business and
finding the best way to structure each of these areas.
The Shingo Model relies on 10 core principles that should guide
business decisions.Organizational Time Management
Organizational time management involves looking at all the
aspects of our business that decrease employee productivity and
finding ways to remove or lessen the inefficiencies.Employee
Engagement
If you help your employees become engaged in your business
and invested in the success of your business, they are likely to
be more productive and work harder at the job.Location
The location where you decide to build retail stores,
manufacturing plants, and company headquarters can help
decreases many costs of your company.Effective Forecasting
Forecasting future sales, expenses, demand, and other critical
elements of your business will help your company align its
present actions with future expectations.8.1Introduction to
Financial Statements
Learning Objectives
1. Describe what a balance sheet is used for.
2. Explain what assets, liabilities, and shareholders' equity
mean on a balance sheet.
3. Explain what an income statement indicates about a company.

4. Describe what a cash flow statement is used for.
5. Evaluate a company based on its balance sheet, income
statement, and cash flow statement.8.2Balance Sheet
The financial statement which shows the balance of a
company’s assets, liabilities and owners’ equity at a certain
moment in time is appropriately named the Balance Sheet. In
accounting, you learned an equation: assets equals liabilities
plus owners’/shareholders’ equity. The balanced sheet is based
on this equation:
Assets = liabilities + owners'/shareholders' equity
The following is an example of what the balance sheet might
look like for Parts Manufacture Co., a parts firm which sells and
machines custom mechanical parts.
Balance Sheet for Parts Manufacture Co.
Assets
Current Assets
Cash
$ 85,000.00
Petty Cash
$ 1,000.00
Accounts Receivable
$ 23,000.00
Inventory
$ 198,000.00
Supplies
$ 12,000.00
Total Current Assets
$ 319,000.00
Property, Plant, and Equipment
Land
$ 78,000.00
Buildings

$ 75,000.00
Equipment
$ 65,000.00
Less: Accumulated Depreciation
$ (6,000.00)
Net Property, Plants, and Equipment
$ 212,000.00
Total Assets
$ 531,000.00
Liabilities
Current Liabilities
Notes Payable
$ 3,000.00
Accounts Payable
$ 17,000.00
Wages Payable
$ 23,000.00
Interest Payable
$ 212,000.00
Taxes Payable
$ 53,000.00
Warranty Liability
$ 27,000.00
Unearned Revenue
$ 15,000.00
Total Current Liabilities
$ 146,000.00
Long-term Liabilities
Bank Loan

$16,000.00
Total Long-Term Liabilities
$ -
Total Liabilities
$ 146,000.00
Total Owners' Equity
$ 385,000.00
Total Liabilities and Owners' Equity
$ 531,000.00
As we can see from the example above, there are three
distinctive sections to the balance sheet - assets, liabilities, and
stockholders’ equity.
Assets, Liabilities, and Stockholders' EquityAssets
Assets are the resources of economic value that a firm owns.
Assets are bought and traded with the intent to increase value.
A retail store trades inventory for cash which creates value both
for the store and the customer. On a balance sheet there are both
current assets (those which are more liquid) and assets
categorized as property, plant or equipment (those which are
less liquid). Current assets include cash, accounts receivable,
inventory and supplies. The section entitled “Property, plant
and equipment” includes land, buildings, and equipment such as
large machinery or vehicles. Assets can be further broken down
into either financial assets, such as investments, or intangible
assets, such as patents, trademarks or copyrights.Liabilities
Financial debts or obligations to pay a creditor are called
liabilities. Liabilities which will be paid within a year are
considered current liabilities and liabilities which will last
longer than a year are considered long-term liabilities. Current
liabilities might include notes payable, accounts payable, wages
payable, interest payable, taxes payable, warranty liabilities,

and revenue for which you’ve been paid but haven’t done the
work. Long-term liabilities would include such things as
mortgage loans, outstanding bonds, and other bank
loans.Shareholders' Equity
Owners equity, also known as Shareholders equity in a publicly
traded company, is made up of two elements, stock and retained
earnings. Stock or common stock in the case of our example,
represents the initial investment it took to get the business
started. Further issue of stock or expansion of ownership of the
company can be made by the business owner or other investors
by taking on more investment in the form of stock. Retained
earnings is a cumulative amount which shows how much net
income a company retains minus dividends if dividends are paid
to shareholders.
The sum of a company’s liabilities and its owners’ equity must
equal the sum of the company’s assets according to the
accounting equation. If the two do not equal each other, an
accounting error has occurred and needs to be corrected.
Besides showing everything that a company owns and owes and
how much the company is worth, the balance sheet is an
invaluable tool when performing ratio analysis to determine a
company’s health. The quick ratio, current ratio, other solvency
ratios, turnover ratios, and capital structure ratios are all based
on the numbers provided by the balance sheet. As an investor,
owner or shareholder in a company understanding these ratios
(many of which are explained in this book) and what they mean
is inestimable.8.3Income Statement
The financial statement used by a business to show the
business’s revenues and expenses over a financial period is
known as the income statement. The income statement
categorizes revenues and expenses into both operational income,
or income from the normal day to day operations of the
business, and non-operational income, or income from
exceptional activities.
The following statement is a fair example of what an income
statement might look for Parts Manufacture Co., a parts firm

which sells and machines custom mechanical parts.
Income Statement for Parts Manufacture Co.
Revenue
Sales
$876,000.00
Less: Sales Discounts
$14,000.00
Less: Sales returns and allowances
$12,000.00
$26,000.00
Net Sales
$850,000.00
Cost of Goods Sold
Opening Inventory
$180,000.00
Add: Purchases
$250,000.00

Add: Freight-in
$23,000.00
Less: Purchase Discounts
$5,000.00
Less: Ending Inventory
$86,000.00
Total Cost of Goods Sold
$362,000.00
Gross Profit
$488,000.00
Operating Expenses
Advertising Expense
$15,000.00

Salaries Expense
$234,000.00
Utilities Expense
$24,000.00
Rent Expense
$32,000.00
Supplies Expense
$4,000.00
Total Operating Expenses
$309,000.00
Operating Income
$179,000.00
Nonoperating Items

Interest Expense
$8,000
Depreciation Expense
$14,000.00
Gain from Sale of Equipment
$24,000.00
Total Nonoperating Items
$2,000.00
Income Before Tax
$181,000.00
Tax Expense
$53,840.00
Net Income
$127,160.00

Income StatementOperational Revenues and Expenses
The first major part of the income statement is made up of
operational revenues and expenses. In the case of this business,
revenue is earned by the sale of inventory (mechanical parts).
Net sales is determined by subtracting sale returns and
discounts from total sales.Cost of Goods Sold
Cost of goods sold (COGS), an operational expense, shows how
much the inventory or “goods” sold cost the business to supply.
The expense takes into account the purchase of the goods sold,
the cost of freight, any possible discounts and damaged goods.
You’ll notice the difference between beginning and ending
inventory is used to determine the amount of goods which were
sold. Gross profit is determined by subtracting cost of goods
sold from net sales.Determining Operating Income
Following COGS, the other operational expenses are taken into
account and subtracted from gross profit to determine the
business’ operating income.Non-Operating Items
The rest of the income statement takes into account non-
operating items. In this case interest on funds from either
bondholders or lenders (such as a bank) are accounted as the
interest expense. The gain from the sale of equipment is
accounting for the profit the business had from the sale of one
of their assets, in this case, an expensive piece of
equipment.Income Before Taxes and Net Income
Income before taxes is determined by accounting for all
expenses and revenues besides taxes which is the last expense
accounted for. Net income is finally determined when the tax
expense is subtracted from income before taxes. Revenue and
Expenses
The revenue and expenses shown on the income statement are
later transferred to the balance sheet to affect the company’s
retained earnings.
Understanding the income statement and the significance of
each term takes time and practice. As a stakeholder of a
company, however, developing this understanding is critical.
Ratios discussed later in this book such as return on

stockholders’ equity, earnings per share, operating margin and
price-earnings ratio will help you see the implication of the
income statement.8.4Cash Flow Statement
Cash Flow
A company’s cash account is purely liquid. Cash is what makes
a company operate from day to day and gives a company
financing as well as investing capabilities. Since cash is vital to
a company and to the company’s stakeholders, a cash flow
statement is used to show the inflow, outflow, and retention of
cash. A cash flow statement is divided into three components
which show the flow of cash: cash flow from normal operating
activities, cash flow from investment activities, and cash flow
from financing activities. All activities which affect a
company’s cash account fall into one of these three
activities.Operating Activities
Operating activities are the everyday transactions of a business
such as sales, purchasing of inventory, accounting for
depreciation, paying off accounts payable and receiving
payment on accounts receivable. Expenses paid are shown as an
outflow of cash from operating activities and income received
are shown as an inflow of cash from operating
activities.Investing Activities
Investing activities are transactions made for the purchase of
new equipment, land, or tradable securities. When such assets
are purchased (with cash) the cash flow statement shows an
outflow of cash from investing activities and when those assets
are sold (for cash) the cash flow statement shows the inflow
accordingly.Financing Activities
Financing activities involve the cash flow affected by the issue
of bonds, payment of dividends, or acquiring loans. When
capital is raised, the cash flow statement reflects an inflow of
cash and as debts are paid, it shows an outflow of cash.
Cash Flow for Parts Manufacture Co.
Cash Flow from Operating Activities
Sales

$267,000.00
Payment on Accounts Receivable
$45,000.00
Purchase of Supplies
$ (2,300.00)
Depreciation
$ (34,000.00)
General Operating Expenses
$ (175,000.00)
Sales Tax
$ (20,000.00)
Net Cash Flow from Operating Activities
$80,700.00
Cash Flow from Investing Activities
Sale of Land
$58,000.00
Purchase of Equipment
$ (15,000.00)
Net Cash Flow from Investing Activities
$43,000.00
Cash Flow from Financing Activities
Equipment Loan
$12,000.00
Notes Payable
$(5,500.00)
Dividend
$ (7,000.00)
Net Cash Flow from Financing Activities
$ (500.00)
Net Increase in Cash
$123,200.00
Cash at Beginning of Period

$57,000.00
Cash at End of Period
$ 180,200.00
The cash flow statement is particularly useful to stakeholders
interested in seeing where a company is acquiring its cash and
how that cash is being spent. If you as an investor are interested
in knowing how responsibly a company is with its liquid funds,
the cash flow statement is your premier source of knowledge.
An example of what a cash flow statement might look like for a
small retail store is found above.8.5Vertical and Horizontal
Analysis
Vertical and horizontal analysis are forms of financial statement
inquiry that are fundamental for managerial accounting. The
analyses involve using a firm’s financial statements (the income
statement and balance sheet) and giving a percent value to each
line item to see the ratio of each. This percent is whatever the
line item is divided by sales. Here is an example of a vertical
analysis performed on a firm’s income statement.
Vertical Analysis
Revenue
Percent
Sales
$456,000.00
100.00%
Cost of Goods Sold
$(213,000.00)
46.71%
Gross Margin

$243,000.00
53.29%
Operating Expenses
Advertising Expense
$(30,000.00)
6.58%
Salaries Expense
$(112,000.00)
24.56%
Utilities Expense
$(3,600.00)
0.79%
Rent Expense
$(6,000.00)
1.32%
Shipment Expense
$(59,000.00)
12.94%
Supplies Expense
$(1,800.00)

0.39%
$(212,400.00)
46.58%
Income before Tax
$30,600.00
6.71%
Tax Expense (5%)
$(1,530.00)
0.34%
Net Income
$29,070.00
6.38%
As observed, total sales represent 100% of revenue and the
other ratios are computed by dividing each line item value by
total sales. Performing a vertical analysis allows a firm to find
possible inefficiencies and understand which line items have
greatest ratio. Remember such analysis is also commonly
performed using the balance sheet.
Horizontal Analysis unlike Vertical, involves comparing line
value percentages over time. Consider the following example.
Horizontal Analysis
Revenue
2012
2013
2014
Sales

$ 456,000.00
100.00%
$ 498,000.00
100.00%
$ 536,000.00
100.00%
Cost of Goods Sold
$ (213,000.00)
46.71%
$ (229,000.00)
45.98%
$ (250,000.00)
46.64%
Gross Margin
$ 243,000.00
53.29%
$ 269,000.00
54.02%
$ 286,000.00
53.36%
Operating Expenses
Advertising Expense
$ (30,000.00)
6.58%
$ (32,000.00)
6.43%
$ (39,000.00)
7.28%
Salaries Expense
$ (112,000.00)

24.56%
$ (124,000.00)
24.90%
$ (145,000.00)
27.05%
Utilities Expense
$ (3,600.00)
0.79%
$ (3,600.00)
0.72%
$ (3,600.00)
0.67%
Rent Expense
$ (6,000.00)
1.32%
$ (6,000.00)
1.20%
$ (12,000.00)
2.24%
Shipment Expense
$ (59,000.00)
12.94%
$ (65,000.00)
13.05%
$ (75,000.00)
13.99%
Supplies Expense
$ (1,800.00)
0.39%
$ (1,900.00)
0.38%
$ (1,900.00)
0.35%
$ (212,400.00)
46.58%

$ (232,500.00)
46.69%
$ (276,500.00)
51.59%
Income before Tax
$ 30,600.00
6.71%
$ 36,500.00
7.33%
$ 9,500.00
1.77%
Tax Expense (5%)
$ (1,530.00)
0.34%
$ (1,825.00)
0.37%
$ (475.00)
0.09%
Net Income
$ 29,070.00
6.38%
$ 34,675.00
6.96%
$ 9,025.00
1.68%
In this example vertical analysis is performed on three years of
the firm’s operation and a horizontal analysis is performed
comparing those three years, side by side. The firm can see how
each line value ratios differ but perhaps not in the way the firm
would like. The following example shows a more common form
of horizontal analysis.
Common Horizontal Analysis
Revenue
2012
2013
% Change

2014
% Change
Sales
$ 456,000.00
$ 498,000.00
9.21%
$ 536,000.00
7.63%
Cost of Goods Sold
$ (213,000.00)
$ (229,000.00)
7.51%
$ (250,000.00)
9.17%
Gross Margin
$ 243,000.00
$ 269,000.00
10.70%
$ 286,000.00
6.32%
Operating Expenses
Advertising Expense
$ (30,000.00)
$ (32,000.00)
6.67%
$ (39,000.00)
21.88%
Salaries Expense
$ (112,000.00)
$ (124,000.00)
10.71%

$ (145,000.00)
16.94%
Utilities Expense
$ (3,600.00)
$ (3,600.00)
0.00%
$ (3,600.00)
0.00%
Rent Expense
$ (6,000.00)
$ (6,000.00)
0.00%
$ (12,000.00)
100.00%
Shipment Expense
$ (59,000.00)
$ (65,000.00)
10.17%
$ (75,000.00)
15.38%
Supplies Expense
$ (1,800.00)
$ (1,900.00)
5.56%
$ (1,900.00)
0.00%
$ (212,400.00)
$ (232,500.00)
9.46%
$ (276,500.00)
18.92%

Income before Tax
$ 30,600.00
$ 36,500.00
19.28%
$ 9,500.00
-73.97%
Tax Expense (5%)
$ (1,530.00)
$ (1,825.00)
19.28%
$ (475.00)
-73.97%
Net Income
$ 29,070.00
$ 34,675.00
19.28%
$ 9,025.00
-73.97%
As shown, this horizontal analysis, unlike the previous, shows
line value ratios as a percent change from year to year. This
type of analysis is particularly useful in determining which line
items have or have not been consistent. Performing this type of
horizontal analysis facilitates the firm’s ability to spot
irregularities and determine which line items to focus on.
Both vertical and horizontal analysis are used to compare trends
and industry averages. A firm uses these analyses to understand
its own ratio distributions but in comparing those results with
the average results of other similar firms, a firm understands
more clearly necessary areas to improve and line items
comparatively doing well.
Net revenue is a valuable number to compare various other parts
of your income statement to. Net revenue is synonymous with
net sales. These comparisons are very similar to a Vertical and
Horizontal analysis, except that instead of using gross sales, it

uses net sales. This gives a more realistic evaluation of how
much revenue your company has, allowing for more meaningful
comparisons.
Income Statement for Parts Manufacture Co.
Revenue
Sales
$876,000.00
Less: Sales Discounts
$14,000.00
Less: Sales returns and allowances
$12,000.00
$26,000.00
Net Sales
$850,000.00
Cost of Goods Sold
Opening Inventory
$180,000.00
Add: Purchases

$250,000.00
Add: Freight-in
$23,000.00
Less: Purchase Discounts
$5,000.00
Less: Ending Inventory
$86,000.00
Total Cost of Goods Sold
$362,000.00
Gross Profit
$488,000.00
Operating Expenses
Advertising Expense

$15,000.00
Salaries Expense
$234,000.00
Utilities Expense
$24,000.00
Rent Expense
$32,000.00
Supplies Expense
$4,000.00
$309,000.00
Operating Income
$179,000.00
Nonoperating Items

Price of inventory compared to net revenue
The price of inventory compared to net revenue looks at what
percentage of the money you made from sales was put into
buying inventory previously.
In the income statement above, price of inventory is $453,000
(Opening inventory $180,000 + Purchases $250,000 + Freight-in
$23,000). Net sales are $850,000, so 453,000 / 850,000 =
53.29% .
This means that it costs you roughly half of your net sales to
pay for inventory. Both investors and employees care
immensely about the level of inventory which you have and the
amount of revenue you bring in. If this ratio gets higher, it can
mean several things. It could mean that you aren’t selling as
much of the inventory you purchase. It could mean that the
price of inventory has gone up. It could even mean that your
company is no longer adding as much value to the product.
Cost of goods sold compared to net revenue
By looking at the cost of goods sold, we can see how much
capital it took to bring in our revenue. The cost of sales is found
by taking the opening inventory, adding in purchases/freight-in
costs, and then subtracting purchase discounts and our ending
inventory. Essentially, this tells us how much money we spent
on the inventory we sold during the month/year.
If we then make it a ratio of COGS / Net Revenue, it is easier to
compare and understand. 362,000 / 850,000 = 42.6% .
This means that a little more than 40% of our revenue goes
towards buying the goods that we sold in the last year. Ideally,
this percentage should be low, indicating that it you generate a
lot more revenue than it costs you to buy your product.
This is more telling than the comparison between the price of
inventory and net revenue because it takes into account the fact
that your ending inventory can still be sold and generate
revenue in the future.8.6Debt Financing vs. Equity Financing

Your company needs financing, and you are faced with two
options. You can either finance through debt, or you can sell
some of the equity of your company in the form of stock. How
do you decide which option is best for you?
Equity Financing
In selling stock options neither you or your company has any
obligation to pay back the money raised. Selling equity
increases the value of the company without increasing liabilities
and helps you gain financing without any interest.
However, equity financing dilutes ownership of the company.
Not only do you forfeit some ownership of the company but in
financing through equity, you also give the right to that
percentage of the company’s profits and possibly some of your
decision making power.
Debt Financing
Financing through debt allows you retain ownership and all
decision making power. The rights to the company’s profits will
also stay with your ownership. One of the most attractive
reasons for debt financing is that debt financing decreases your
taxable income. Loans and bonds require some form of interest
payment and on the income statement that payment is known as
an interest expense. It’s the last expense to be subtracted from
operating income before taxes are determined and subsequently
subtracted.
Debt financing does require payment which essentially means in
order to make a profit your business must not only cover normal
operating expenses but must also generate enough cash to cover
a non-operating interest expense. This is a tall order for some
companies. In some cases debt financing might just not be an
option if investors or creditors don’t feel your business is worth
the risk or if you consider the risk of taking on more liabilities
too great.
Leverage

Leverage is the term used to describe how much a company
relies on debt financing vs. equity financing. Leverage is
determined by dividing total liabilities by total equity so a
higher leverage suggests higher debt financing. Chances are
there won’t be a magic answer to whether you should pursue
debt or equity financing. Eventually using a mix of both options
to optimize the value of your firm, your firm’s leverage within
your industry, and the financial health of the entity, is likely the
strategy you’ll need to take.8.7Dividends
To Dividend or Not to Dividend, That is the Question
Paying dividends to shareholders is an important issue to a
company because that decision can affect everything, from how
happy the company’s shareholders are to how much disposable
cash the company has. Here are some reasons a company might
want to consider paying a dividend and reasons why a company
might choose not to. Reasons to dividend
· Many investors really like dividends (keep them happy)
· Paying dividend is a sign of a company’s strength
· Paying dividends shows company management expects good
earnings for the company
· Paying dividends can increase the value of a company’s
stockReasons not to dividend
· Paying dividends might hurt a new company trying to grow
· Paying dividends may make it difficult to acquire new assets
or companies
· Not paying dividends saves on taxes
· Keeping all retained earnings avoids risk of needing to issue
more stock
· Paying dividends once will give the expectation that dividends
will be paid in the future
Whether a company pays a dividend or not certainly does not
determine whether or not a company is successful. Apple is
known for paying out dividends and Amazon is not, yet both are
very successful companies. Whether a company pays dividends
or not, however, does affect the way the company is viewed by

investors and talked about in media. Some theories argue that
companies which pay dividends are viewed more favorably by
investors than those which don’t pay dividends. Other theories
argue that paying dividends overall has no effect. In the end, the
questions to consider are the reasons given above. There are
reasons a firm may decide to pay dividends and other reasons a
firm may decide not to.8.8Stock Repurchase
Right now (August 8, 2016 at 9:06 am) Apple stock is selling
for $107.72. Now let’s pretend it was actually selling for
$85.53, but Apple knew it could be selling for $107.72. What
could Apple do to get the stock price back up? How could they
signal to the market that their stock was undervalued?
Increase Value of Shares
If you know what they could do, A+ for you (or congratulations
for reading the title), but to those of you who aren’t sure,
consider this. If Apple were to repurchase a portion of their
outstanding stock so it was no longer traded on the open market
and then retire that stock, the stock that remained would
increase in value because the value of the company would be
represented by a smaller amount of shares. The market would
also value Apple stock higher because the company repurchase
would suggest that Apple thinks their stock is not being sold for
what it’s actually worth. So the most simplistic solution to
Apple’s problem is to repurchase some outstanding shares.
Does this actually work, or is it just hypothetical? Well, since
we’re using Apple as an example, let’s look at Apple’s history.
On August 9, 2013 Apple stock was valued at $64.92 and as
stated earlier, today, three years later the stock is valued at
$107.72. That’s a difference of $42.8. Are you curious to know
if there’s a difference in how many shares Apple had
outstanding in 2013 vs. today? Well, there is! In August of 2013
Apple had 6.359 billion shares outstanding, and today they only
have 5.388 billion—a repurchase of nearly one billion shares! It
would therefore appear that repurchasing shares really can send
a message to the market that the current price of the stock is

undervalued.
Other Advantages
Other huge advantages that give companies incentive to
repurchase stock include increasing earnings per share (EPS) as
well as boosting the company’s return on equity
(ROE).Earnings per Share
Earnings per share is perhaps the investor’s premier indication
of a company’s profitability. Earnings per share is calculated by
simply dividing a company’s net income by the number of
shares they have outstanding so when the earnings per share
starts dropping below an acceptable level, decreasing the
amount of shares outstanding through a repurchase is the easiest
way to increase the EPS to an acceptable level.Return on Equity
Return on equity is calculated similarly to EPS, only rather than
using the number of shares outstanding as the denominator, the
dollar amount of shareholder’s equity is used instead. A stock
repurchase affects ROE with the exact same positive correlation
as with EPS.8.9Summary
Financial StatementsBalance Sheet
A balance sheet shows a company’s assets, liabilities, and
owners’ equity. Useful in calculating various financial
ratios. Income Statement
An income statement shows a business’s revenues and expenses
over a period of time. Useful in calculating various financial
ratios.Cash Flow Statements
A cash flow statement shows the inflow, outflow, and retention
of cash in a company. Useful in calculating various financial
ratios.Vertical and Horizontal Analysis
A vertical analysis looks at what percentage of your revenue
goes to different expenses on your income statement. A
horizontal analysis compares these percentages over time. This
is a very valuable tool in determining areas of the business that
are improving, getting worse, or need attention.

Financial decisionsDebt financing vs. Equity financing
Debt and equity financing are ways to raise capital for your
company. Your company’s situation will determine which one is
ideal. Dividends
Determining whether to pay out dividends is a vital part of
shareholder relations. Stock Repurchase
Repurchasing stock signals the market that the stock is
undervalued, potentially attracting more investors. A stock
repurchase will boost the earnings per share and the return on
equity for your company.
Chapter 9: 9.1Introduction to Financial Ratios
Learning Objectives
1. Calculate a company's earnings per share, price/earnings
ratio, and interest coverage ratio and explain what these ratios
indicate about the company.
2. Calculate a company's current ratio, quick ratio, and return
on equity.
3. Perform a DuPont Analysis.
4. Calculate a company's debt to assets ratio, net profit margin,
and operating margin.
5. Explain what inventory turnover and days in inventory ratios
indicate about a company.9.2Earnings per Share
Investors are fixated on how much a company earns. Successful
companies generally earn more money than other comparable
companies. Earnings per Share is a tool used to determine the
profitability of a firm. Essentially, Earnings per Share (EPS)
tells you how much of a firm’s income is attributable to each
share of outstanding common stock within a firm. EPS is
determined by subtracting preferred stock yearly dividends from
the firm’s yearly net income and dividing the difference by the
weighted average number of common stock shares. The formula
is represented as follows:
Calculating Earnings per Share
Dauntless Inc. is a hypothetical manufacturing company which

specializes in tight black leather clothing, grappling hook guns,
tattoos, zip lines and mind control pills. Last year, the firm had
a net income of $2,350,000, and paid $132,000 in preferred
stock dividends. For the first 7 months of the year the firm had
200,000 common stock shares outstanding but after issuing
more stock the company had 240,000 common stock shares
outstanding.
Using the information from above, we can calculate the EPS of
Dauntless Inc. Since the amount of shares outstanding was not
the same for the entire year, instead of using either 240,000 or
200,000 in our calculation, we will compute the weighted
average of the two. The computation is as follows:
The chart above is not necessary to understand and compute the
weighted average number of common stock shares outstanding
but was used simply to clearly show the necessary steps. The
number of shares for each portion of the year are multiplied by
the total percentage of the year that each was present. There
were, for example, 200,000 shares for 7 of the 12 months so we
multiply 200,000 by 7/12. Once the weight of each period is
found, weights are totaled and the calculation is complete.
The rest of the calculation is fairly straightforward. Subtracting
the preferred stock dividends from the firm’s net income we are
then able to divide the difference by the weighted average of
outstanding shares and compute Earnings per Share. The
equation is as follows. The common stock is valued at $10.24
per share.
9.3Price/Earnings Ratio
Earnings are Important
Earnings are perhaps the single most important item to
shareholders. Any publically traded company has to be aware of
their earnings because it determines, in large part, how
favorably investors will view the company. One of the most
common ways to look at earnings is with a Price Earnings Ratio.
The Price Earnings Ratio is the market price of one share in a
company divided by the earnings per share of the company. For

example, pretend that a company is currently trading at $100
per share. It’s earnings over the last 12 months were $2.50 per
share. It’s P/E ratio would be $100 divided by $2.5 which
equals 40.00. In essence, if a stock is trading at a P/E of 40, an
investor can expect to pay $40 for every $1 of current earnings.
The formula is written as follows:
As you see in the above equation, it’s necessary to know EPS
before figuring out Earnings per Share. The EPS formula is
given below.
The cool kids on Wall Street talk often about the PE ratio, and
sometimes refer to it as a company’s multiple (“Amazon has a
multiple of 705! I’ve never seen it that high!”). PE is both easy
to understand and very logical to use in evaluations, so many
investors religiously follow the PE. Given the importance of the
ratio, companies will sometimes strive for a lower ratio as part
of their strategy if they want to attract more investors.
There are many ways to lower the ratio, some more
controversial than others. Obviously, most companies drive
themselves towards higher earnings. This will naturally bring in
investors. Creative accounting decisions like boosting the
balance sheet, overvaluing assets, inventory manipulation,
shifting depreciation, and other examples of “cooking the
books” are sometimes possible but are frowned upon and
ethically questionable. The Generally Accepted Accounting
Principles are rules designed to help prevent these practices.
A more strategy-based question is whether a company should
focus on short-term or long-term earnings. If your company
focuses exclusively on short-term earnings, you can boost your
PE ratio and attract investors who see the rising PE ratio as
evidence of a company’s profitability. However, this type of
focus often sacrifices adequate investment in research and
development. You can kill your company by focusing too
heavily on the short-term earnings and not on the activities that
drive long-term growth.

Another way of improving your ratio is taking on corporate
debt. In a Price Earnings ratio, the amount of debt on a
company’s balance sheet is not accounted for.
Types of PE Ratios
There are different kinds of PE Ratios.
· A trailing PE means that the ratio is based on the last 12
months
· A forward PE means that the ratio is based on projected
earnings for the next 12 months
Average PE Raio
An average PE Ratio has historically been between 15 and 25.
In general, a higher PE suggests that investors expect higher
earnings in the future, and are, therefore, willing to pay more
per share of stock. These are considered expensive stocks.
Sometimes, high P/E ratios can identify a more “risky”
investment, as the future expectations for the stock exceed the
current performance. A low PE can indicate if a company is
currently undervalued. Generally, a higher P/E suggests a
higher value firm, but PE should simply be one tool is an
analyst’s arsenal. Often, companies are either overvalued or
undervalued, and P/E is only one piece of the puzzle for
someone trying to determine whether to purchase a particular
stock.
Limitations to the PE Ratio
The PE ratio is helpful in comparing companies, but there are
limitations to this. PE can differ widely between different
industries because of differing company structure. For instance,
large margins and high growth rates for technology companies
can lead to a high PE valuation, whereas the fast food market
has low profit margins that may result in a lower
ratio.9.4Interest Coverage Ratio
Most companies have outstanding debt. Whether that debt be
from a bank loan, from creditors, or even from money loaned by

a friend or family member, chances are the company is paying
interest on that debt. You can use the Interest Coverage Ratio to
figure out how easily a company can pay the interest on its
outstanding debt. The calculation for the ratio involves dividing
the company’s earnings before interest and taxes (EBIT) by the
company’s Interest Expense for the same time period. The
formula is shown below.
Let’s say our company has an EBIT of $700,000 for the year
and interest payments of $35,000 for each quarter of the year.
To determine the interest coverage ratio we first multiply
$35,000 by 4 (for each quarter of the year) and then divide
$700,000 (EBIT) by the resulting 140,000. Our results show an
interest coverage ratio of 5, meaning that before interest and
taxes, the company could cover its interest payments 5 times
over.
Higher Interest Coverage Ratio = Healthier Company
A higher interest coverage ratio indicates a healthier company.
Ratios are normally acceptable until they drop below 2.5, at
which time a company may need take action to assure it does
not decrease any farther. A ratio of 1.5 is the bare minimum at
which a company may not have serious problems, but a ratio of
less than 1 indicates clearly that the company does not even
earn enough to cover the interest on its debts.9.5Current and
Quick Ratios
Current and Quick Ratios are liquidity ratios used to determine
the ability a firm has to pay its creditors; a critical aspect to a
firm’s strength. Both ratios contrast assets against liabilities
with slight differences in calculation.
Current Ratio
The Current Ratio is the broader of the two comparisons, and is
determined by adding the value of all current assets and
dividing the total by the sum of all current liabilities as shown
in the following formula:

Quick Ratio
By definition, a liability that is due next month and a liability
due in 12 months could both be considered current liabilities.
That being said, a liability due in 12 months is not near as much
of a concern as one due next month so the Quick Ratio is used
to show how well a firm can cover its liabilities with only the
most liquid of assets. The Quick Ratio is calculated nearly
identically to the Current Ratio except for inventory and prepaid
expenses are not accounted for when summing total current
assets. The formula is shown as follows:
Because both inventory and prepaid expenses are not easily
liquidated, the Quick Ratio excludes them in order to better
show a company’s ability to pay off it’s debt in the short term.
Both the Current and Quick Ratio are fairly elementary and
don’t necessarily prove or disprove the health of a company.
Generally speaking, a ratio below 1 for both ratios indicates a
firm may have trouble paying its outstanding debts, and
represents a financial risk to investors. A usually acceptable
current ratio is higher than 1.5 and an acceptable quick ratio is
higher than 1. These rules are not to be used blindly as ratio
averages vary from industry to industry and may not accurately
indicate the long term financial strength of a company. It’s
important to look at a firm as a whole and analyze it from
multiple angles.9.6Return on Equity (ROE)
Return on Equity is a percentage calculated to show the amount
of profit created by a company for each dollar of investors
money. It is calculated by dividing a company’s net income
(after dividends paid to preferred stock but before dividends
paid to common stock) divided by the total shareholder’s
equity. The formula is shown as follows:
Assume company Z had a net income of 3 million dollars over
the last fiscal year and the company’s shareholder’s equity
totaled 5 million. By dividing 3 million by 5 million we can

determine the company’s ROE of 60%. This means that the
company made a profit of $0.60 for each $1.00 of investor’s
money.
When shareholder’s equity fluctuates throughout the year, either
from issuing shares or purchasing shares outstanding, the
average shareholder’s equity will need to be used in the
calculation. Average shareholder’s equity is determined by
adding the beginning and ending shareholder’s equity and
dividing the sum by two.
Efficiency
Besides expressing the profitability of a company, ROE
especially shows the efficiency of a company. Comparing the
ROEs of companies within the same industry allows you to
determine which companies can turn investors dollars into the
most profit. The higher the ROE, the more efficient the
company but their can be a catch.
Limits of ROE
ROE does have it’s limits. Unfortunately, companies can
artificially boost the ROE rather easily through repurchasing
shares outstanding or through debt financing. ROE should also
only be compared between companies within the same industry,
as industry averages vary widely depending on the nature of the
industry. ROE fluctuation over years of business is a good
indication of long term profitability, efficiency, and
consistency.
9.7DuPont Analysis
The equation commonly used to determine a firm’s Return on
Equity (ROE) is as follows:
Return on Equity is particularly useful for investors and
shareholders as the ROE calculation shows how much income a
firm generates for every dollar of invested equity. It is a simple
way of understanding profit per investment dollar within the
firm.

DuPont Analysis takes Return on Equity to the next level by
breaking the equation up into the three calculations which affect
ROE, profit margin (net income/total sales), total asset turnover
(total sales/total assets), and the equity multiplier (total
assets/total equity). The formula is as follows:
As you can see, by canceling out total sales and total assets as
follows, both equations are the same; DuPont is simply an
expansion to better understand each factor affecting ROE.
In dividing ROE into profit margin, total asset turnover, and the
equity multiplier, it is easier to pinpoint exactly what is
affecting ROE. If ROE is increasing, DuPont analysis helps a
firm see where they are having success. If ROE is decreasing,
DuPont analysis helps a firm find the problem.9.8Debt to Assets
Ratio
Company Health
How do you assess the health of a company? It seems easy to
just look and see if the business is making a profit, but that
doesn’t paint a complete picture of the company. There are
countless factors which affect a company’s health. One obvious
key determinant of a company’s financial situation is it’s debt
to asset ratio.
Calculating the Debt to Assets Ratio
The debt to asset ratio is simply a ratio calculated by dividing
total debt (long term and short term) by total assets (current and
fixed). This ratio represents how levered a company is.
Leverage is the amount of debt a company has in respect to its
assets. Therefore, the higher the debt to asset ratio, the higher
the leverage. The higher the leverage, the greater the
obligations a company has to pay back its debt. The higher its
obligations, the higher the financial risk of investing in that
company.
Additionally, the debt to assets ratio shows how much of the

company's assets are financed through debt. A company with a
higher debt ratio than another is funding a greater percentage of
its assets through debt. Companies with higher debt ratios than
the industry average may represent companies which are less
likely to succeed during a recession. They are equally less
likely to qualify for additional loans if they are already in
debt.Take Other Factors into Consideration
This is not to say that any company with a high debt to assets
ratio is doomed to crash and burn. Other elements come into
play when considering the health of a company, not to mention
that the debt to assets ratio doesn’t take into account what kind
of assets and what kind of debt a company has. If a company
had to stretch out and risk a high debt to assets ratio in order to
be in a position that dominates its competitors, the risk is likely
to pay off and the ratio will likely stabilize as the company pays
off its debts. Knowing what a company’s debt to assets ratio
doesn’t truly serve a purpose unless you also know reasons
why.9.9Inventory Turnover and Days in Inventory Ratios
Making a profit through the sale of inventory is the goal of
every retail store. How quickly and how much inventory a
company manages to sell shows a lot about the profitability and
strength of the company, and is a closely measured ratio. This
ratio, known as Inventory Turnover, shows the number of times
a company’s inventory is sold over a period of time (usually a
year).
Inventory Turnover
Inventory turnover is determined by either dividing net sales by
average inventory or dividing cost of goods sold by average
inventory. Since using cost of goods sold proves more accurate,
our example will show the formula as follows:
The average inventory is used in this calculation to account for
fluctuations in inventory due to changes in growth and is
determined as follows:

Let’s assume our company’s COGS was $300,000, we had a
beginning inventory of $25,000 and an ending inventory of
$35,000. To determine the inventory turnover, we would first
determine the average inventory by adding $25,000 and $35,000
and dividing the total by 2 which equals $30,000. We then
divide $300,000 by $30,000 to get an inventory turnover of 10
meaning inventory is sold and replaced 10 times throughout the
year.
Days in Inventory
To find the Days in Inventory ratio we simply divide 365 (the
number of days in a year) by 10 (the number of times inventory
turned within that year) and find our inventory is on hand for
36.5 days. This tells us about how long it takes for inventory to
move.
9.10Net Profit Margin
Net Profit Margin is a ratio given as a percentage that shows
how much of each dollar earned by a company transfer into
profits. The formula for the ratio is given as follows:
Within this formula, Net Profit is calculated by subtracting cost
of goods sold, operating expenses, interest and taxes from total
revenue.
Net Profit Margin can vary greatly between industries and from
company to company. Some companies manage to be incredibly
successful on small margins. One example is Amazon, which
has a profit margin of a mere 1.76%. Other companies,
particularly in the tech industries survive on much higher
margins, such as Microsoft’s margin of 15.14% or Oracle’s
margin of 26.56%.
Companies often benchmark Net Profit Margin against other
companies in the same industry. Doing so gives both investors
and companies an idea of how their profitability compares
across the board. Knowing the profit margin of your competitors
also allows you to approximate their COGS, operating expenses,
interest and taxes.

9.11Operating Margin
The Operating Margin of a company is a percentage ratio which
tells how much of every dollar of a company’s sales are profit.
In other words, how much revenue is left over after operating
expenses are accounted for? The formula is shown as follows:
In this formula, operating profit (operating income) is
determined by subtracting operating expenses and depreciation
from total revenue. Net sales is calculated by accounting for the
values of returned, damaged, and missing goods, and discount
sales and subtracting each from total sales.
Let’s assume there’s a company with the following figures:
Total sales:
$435,000
Cost of Goods sold:
$200,000
Operating expenses:
$85,000
Depreciation expense:
$15,000
Damaged or missing goods:
$6,000
Discounts:
$7,000
To determine the operating profit, we subtract depreciation and
operating expenses from our total revenue.
Total Sales − ( Damaged/missing goods + discounts ) = Net
Sales
$435,000 − ( $6,000 - $7,000) = $422,000
Net Sales − ( operating expenses + depreciation) = Operating
Profit
$435,000 − ( $85,000 + $15,000 ) = $335,000
Operating Profit / Net Sales = Operating Margin
$335,000 / $422,000 = .794
What does this actually tell us? The operating margin
essentially shows how much of your sales are going to operating

expenses. The higher the ratio is, the more profitable your
company is. Obviously, it is unrealistic for companies to have
an operating margin of 1.0, but you should strive to improve
your operating margin by decreasing costs on products or by
raising prices. Analysts often look at operating margins and
operating leverage together to get a better picture of the
profitability of the company. Operating margins are useful for
comparing companies across industries.9.12Summary
Financial RatiosEarnings Per Share
Net income minus dividends on preferred stock divided by the
weighted average number of common stock shares outstanding
gives us the earnings per share. Earnings per Share is a great
way to judge the profitability of a company. Price/Earning Ratio
Price per share divided by earnings per share.
The Price/Earnings ratio is heavily used by investors when
evaluating a firm. Interest Coverage Ratio
Dividing the earnings before interest and taxes (EBIT) by the
company’s interest expense gives us the interest coverage ratio.
This ratio tells us how health a company is with regard to
debt.Current and Quick Ratios
The current ratio is found by dividing your current assets by
your current liabilities. A quick ratio is equal to current assets
minus both inventory and prepaid expenses, and then divided by
current liabilities. These ratios are liquidity ratios which show
how easily a company can pay its creditors. Return on Equity
Net income divided by shareholder’s equity. Return on
Equity shows how much money a business can make with a
dollar of investor’s money. DuPont Analysis
DuPont Analysis takes Return on Equity to the next level by
looking at the profit margin, total asset turnover, and the equity
multiplier that make up ROE. Very useful for seeing where a
company is having success. Debt to Assets Ratio
Total Debt divided by Total Assets. The Debt to Assets
Ratio shows how leveraged a company is, which can indicate
how much risk there is in investing in the company. Inventory

turnover and Days in Inventory Ratio
Inventory turnover is the cost of goods sold divided by the
average inventory. Days in inventory is number of days in a
year divided by the inventory turnover. These ratios help show
how much inventory you generally have and how long it takes
to move inventory out the door. Net Profit Margin
Net Profit divided by Total Revenue. Net Profit Margin shows
how much of each dollar earned transfers into profits. Operating
Margin
Operating Profit divided by Net Sales. The Operating
Margin gives insight into how much of your revenue is lost
through your operating expenses.
Chapter 10: 10.1Introduction to Customer Relations
Learning Objectives
1. Explain the importance of Customer Relationship
Management and the Voice of the Consumer.
2. Differentiate between geographic, demographic, behavioral,
and psychographic market segmentation.
3. Explain basic concepts in branding and marketing, including
the 4 Ps of Marketing and push vs. pull marketing.
4. Describe the impact of price on business strategy, including
the use of Price Optimization Models.
5. Explain why companies engage in Corporate Social
Responsibility and use a Triple Bottom Line.
6. Perform a Value Chain Analysis of a company
7. Use the Value Equation to conceptualize strategic
decisions10.2Customer Relationship Management
Customer Relationship Management (CRM) is essentially the
manner in which a company interacts with its customers. These
interactions include corporate guidelines, standards, and
practices which guide interactions with customers. Increasingly,
companies are turning to software and big data analytics to
improve the quality of their Customer Relationship
Management.
Benefits of CRM

By tracking customers and their interactions with a company,
the company can improve sales, marketing, and customer
support. Usually, a company will invest in a type of software
that allows them to track all of the interactions between a
customer and the company, including website, telephone, chat,
social media, and email interactions. By combining these points
of contact with a history of past marketing efforts to the target
audience, a company can better plan future marketing and
customer relation efforts.Target Predictions
Perhaps the most famous example of this was when Target
predicted a teenage girl’s pregnancy before her parents were
aware that she was pregnant. Target had developed a
“pregnancy prediction” score, based on the previous purchases
of the individual. Not only could the database predict with a
surprising degree of accuracy if the girl was pregnant, it could
also predict the delivery date within a narrow window.
This allowed Target to target girls in their second trimester, a
clear advantage because most other stores began targeting new
mothers as soon as the baby was born. Target was able to sell
many necessary products long before the baby arrived.
While this example is rather extreme and somewhat freaky,
Customer Relationship Management is very useful and generally
much less intrusive. Companies can either gather their own
data, or purchase data on demographics from independent
organizations.
Customer Insights
Collecting the data isn’t necessarily the difficult part of this
process. Once the data has been collected, analysts must
determine what meaningful changes can be made to marketing
and customer service plans. CRM software helps provide some
analytics, but in order to gain a comparative advantage in
Customer Relationship Management, analysts need to provide
insights.
Ultimately, the goal of Customer Relationship Management is to
keep customers coming back. If a company does a good job of

managing their relationship with a customer, that customer is
likely to become increasingly loyal to the organization. If a
company does a poor job, they will lose their
customers.10.3Market Segmentation
Market segmentation is a strategy used by firms in which they
analyze a market and subcategorize the elements of the market
into more precise and understandable parts. Markets are
commonly segmented into geographic, demographic, behavioral
and psychographic elements and then analyzed as market
subcategories. Much of market segmentation is straightforward
logic; nevertheless, following this systematic approach to
determine what strategy a firm applies in each subcategory of
the market is a catalyst for success.
Types of SegmentaionGeographic Segmentation
Geographic segmentation involves segmenting the market based
on region, climate and weather patterns, population, and urban
development. Examples of firms which utilize geographic
segmentation include a local grocery store that caters to a single
neighborhood or a commercial grocery store which caters to a
large city; both have different strategies to succeed in their
chosen market. A sporting goods store located in Utah’s Rocky
Mountains will cater to its customers through geographic
segmentation by providing goods such as mountain bikes and
rock climbing gear. In contrast, a sporting goods store located
near the Californian coast will provide its customers with
surfboards and beach equipment.Demographic Segmentation
Demographic segmentation involves segmenting the market
based on elements such as race, age, religion, gender, income,
and family. For gender a simple example would be a clothing
chain who markets ties to men and dresses to women. Many
companies have products which are specialized to fit people of
different demographics. Baby products, video games, and even
family sized food products all have specific demographics as a
focus.Behavioral Segmentation
Behavioral segmentation suggests segmenting the market based

on the behavior of customers towards a product or service. It
takes into account occasions in which customers buy a product,
benefits sought by customers, loyalty to which customers feel to
the firm, and the customer usage of a specific product or
service. Examples may include umbrella vendors that use a
rainstorm as an occasion to boost sales or toothpaste companies
which provide teeth whitening as a benefit to their products. A
hotel chain may attract the loyalty of a customer by providing
incredible customer service and reward cards and an internet
provider may take advantage of customer usage by providing
internet at 10 Mbps for $25 and internet at 35 Mbps for $40.
This gives incentive for many to opt for the higher-speed
internet given the price becomes cheaper per Mbps with the
faster internet.Psychographic Segmentation
Psychographic segmentation involves segmenting the market
based on customer lifestyle, preference, personality traits,
values, and attitudes. Because people prefer different products
and styles of the same product, firms use psychographic
segmentation to appeal to as many different customers as
possible. Vehicle manufacturers offer luxury vehicles, sports
cars, electric cars, off-road vehicles, and heavy-duty work
vehicles to entice customers with all different tastes and
lifestyles. Ski manufacturers market thousands of different
types of skis to appeal to those who prefer groomed ski runs,
park rails, jumps, deep powder, moguls, or backcountry skiing.
The goal of market segmentation is to design strategies to target
a specific segment, gaining a competitive advantage because
you offer more precisely what the consumer is looking
for.10.4Voice of the Consumer
In today’s world, information travels fast. At any given second
of the day you can pull out your phone and read headlines from
Turkey, you can see posts from your friends hundreds or
thousands of miles away, and you yourself can post to the world
what you’re doing in that very moment. There are 60 hours of
video uploaded to YouTube each minute alone! Just imagine
how much information is uploaded to Facebook, Instagram, and

Twitter! According to some sources, in 2015 there were 2.4
million emails sent throughout the world every second which
adds up to about 74 trillion emails for the whole year! These
informational advances, as you very well know, have changed
the face of business in many ways. One of the major changes
has come through an increase in communication between
businesses and their customers.
What is the Voice of the Consumer?
Customer’s opinions, expectations, apprehensions, and
preferences of a business and it’s products and services are
defined by a single term; Voice of the Consumer. Because of
information advancement, the voice of the consumer has become
louder and louder. Now more than ever, businesses can hear the
voice of their consumers and make sound business decisions
based on that voice. Vital to Successful Business
Successful businesses are those which successfully answer to
the voice of the consumer. In order to answer to respond to it,
they must first hear it. Online ratings and reviews often stem
from consumers who give their voice without being solicited
and can be useful sources to many businesses. Most consumers,
however, only give their voice if prompted. Data collection
companies like qualtrics and survey call centers have boomed in
recent years simply by providing businesses with the voice of
their consumers. Online data mining solicit consumer voice
through online surveys and questionnaires. Call centers do the
same through phone calls which target specific consumers.
These companies can reach thousands and thousands of people
and provide businesses with invaluable information on the voice
of their consumers.
Once a business hears the voice of the consumer they can
perform a simple analysis to better understand the wants, needs,
expectations, preferences and apprehensions of their consumers.
This knowledge helps businesses craft their services and
products to better suit the desires of their customers. Data
driven companies, companies which hear the voice of the

consumer, analyze the data, and make appropriate alterations
and developments to their products are the companies of the
future.10.5Branding
Let’s pretend you have the best strategy in the world, but you
are failing at branding. The impact your strategy can have is
now limited. Yes, you can have efficient operations, happy
employees, and great plans for continued growth, but if your
branding is terrible your customers will think that your
company is terrible.
Your Brand is the Face of Your Business
Your company’s brand is how you present your company to the
consumer. It includes the logo, marketing, and advertisements,
as well as the things that you can’t measure - like how your
customers feel about your brand.
Companies with fantastic branding come easily to mind - Nike,
Apple, Coca-Cola, and Disney. In fact, wildly successful
companies almost always have brilliant branding
strategies. Match Your Brand to Your Strategy
Make sure your brand strategy matches what you actually offer
as a company. Nike never could have positioned itself as a
premier sports apparel brand if it didn’t provide high-quality
clothing and equipment. Your brand and your product need to
support each other completely. Target Customers
Determine who your target customers are. What appeals to
them? What are they looking for from your type of product?
How can you create an emotional connection with
them?Emotional Reaction
Your brand should strive to create an emotional reaction with
your customers. This emotional connection to the brand
explains why people are willing to pay so much more for a
similar product when it is made by their favorite company. A
Promise to the Consumer
Your brand makes a promise to the consumer, and you have to
live by that promise. If you brand yourself as a fast-moving tech
company that works on the cutting edge, you have to deliver.

Every time your company interacts with the consumer, they
need to receive a message consistent with your brand and your
strategy.Remain Flexible
As a company however, you need to remain flexible. Ideally,
your brand will be broad enough to allow for some shift in
consumer preference. As you gather consumer data and discover
customer insights, you likely will have to make adjustments to
what you offer and how you advertise it. You may even have to
change your brand strategy to match what consumers want.
That’s ok. Powerful brands build upon the impressions that they
make and it’s impossible to make an impression if your strategy
does not match the wants of your consumers.10.6The Four Ps of
Marketing
Someone could have the most brilliant idea for a product or
service, but unless she knows how to get people to notice it,
accept the price it’s offered at, and find it through the right
distribution, the idea will fail. In other words, without proper
marketing, the business stands no chance. A marketing mix is
the specific way a company or individual brings a product or
service to market. Defined in 1960 by E J McCarthy, the four
P’s of Marketing is the most widely accepted and used
marketing mix strategy.
The four P’s are as follows (in no specific order):
· Product
· Price
· Place
· Promotion
Product
The product is simply the good or service you’re offering to the
consumer. To effectively plan the product part of a marketing
mix, whatever you offer to your customer must answer some
sort of unmet need. Your product must bring value to your
customers, hopefully in a new and improved way that differs
from the products of your competition. Otherwise, no one will
want to buy it.

Price
Price plays a huge role in the marketing of a product. How do
your prices compare with those of your competitor? Is your
product good enough to sell at a higher price? Will a higher
price actually give your product the impression of being higher
quality? These are just a few of the questions you need to
consider when determining price.
Place
In regards to a marketing mix, place refers to where your
product will be sold and how it will be distributed. Distribution
location depends greatly on who you are trying to market your
product to. This seems obvious, but perhaps there are
distribution channels perfect for your product that you hadn’t
considered. For example, the first person to sell their car
chargers at gas stations probably made some pretty good money.
Promotion
Promotion is where true marketing magic comes into play. The
promotion must take into account who the product is being sold
to, what distribution channel is being used, and what needs to
happen for the product to be more popular than that of the
competition. An appropriate median and appropriate content for
the promotion will have to be chosen based on the answers to
those considerations.
Creating a marketing mix that takes into account the Four Ps,
not only at it’s debut, but throughout the implementation and
continuation of a market strategy is the most effective way to
keep a marketing mix from going out of date or losing
impactfulness. You should continuously ask yourself if your
products, prices, places, and promotions, are optimized and
diligently make the necessary changes to keep your marketing
mix effective.10.7Pricing Strategy
Price is Important

At the end of the day, one of the most important parts of your
business is the price you charge for your products. If you charge
a price that consumers won’t pay, you inevitably will fail.Align
Price with Strategy
However, beyond just charging a fair price, your price should
align with your company strategy. Do you offer such a high-
quality product that you can charge premium prices? Are you
trying to be the low-cost leader in the market? Different Pricing
Strategies
There are a million different pricing strategies—loss-leading
pricing, discount pricing, dynamic pricing, keystone pricing,
psychological pricing, anchor pricing, and others. These provide
a framework for pricing effectively, and can be useful if your
business does not have an effective pricing model. Below are a
few brief explanations of some of these pricing strategies.
· Margin Based pricing - simply adding a markup to the cost of
the product
· Bundle pricing - combining products to increase price
· Psychological pricing - pricing using odd numbers that make a
price seem more attractive $199 seems like a much better price
than $200
· Price skimming - setting a high price and then lowering it with
time
· Penetration pricing - setting a low price and then raising it
with time
· Decoy pricing - pricing multiple different brands of the same
product to influence consumers to purchase a particular one.
Internet Pricing
The internet has created some difficulty in pricing effectively.
Customers can compare prices between different sources in an
instant, and they often do so while they are in a store. Be
careful to maintain positive retailer relationships. Generally,
retailers get a 40% increase in the price of a product. If you
don’t include a similar mark-up on your online price, your
internet distribution system will compete with your brick-and-

mortar retailers. One way of dealing with this challenge is by
using the MSRP as the online price.MSRP
MSRP is the Manufacturer's Suggested Retail Price. Stores use
MSRP both to standardize prices across stores and as a way of
promoting a product by showing how much less they are
charging than the MSRP. One major advantage of the MSRP is
that, even if you discount the price to drive sales (perhaps as a
promotion), you don’t necessarily create the expectation of that
lower price in future sales. By displaying the MSRP price, you
communicate to the customer where the price generally will be,
even though it is temporarily lower.10.8Price Optimization
Models
How much should you charge for your product? Price matters,
both to your potential consumer and to your business strategy.
Some companies try to create such a great product that they can
charge a premium price. Others try to undersell the competition,
stealing market share and making up for lower margins with
higher volume.
What are Price Optimization Models?
Price Optimization Models are a way for companies to
determine the best price for their product. Essentially, these
models show how demand will fluctuate based on a change in
price.Airline Industry
The airline industry was one of the first to embrace price
optimization models, which they began doing in the 90s. Instead
of using them just to determine a single price point, airlines use
them to deal with changes in demand. Most customers on the
same flight paid a different price because of price optimization.
For instance, if there is an extremely high demand for the
December 20th flight to Hawaii, airlines will charge a premium
price and likely increase the number of flights offered. If a
flight has very little demand however, prices are slashed in an
attempt to still fill up enough of the airplane, either breaking
even or turning a profit.Retail
Retail is different because there isn’t such a strictly limited

supply, as there is on an airplane, but the same principles apply.
Price optimization models tell the company where to put their
price to earn the most profit.
Obviously, there is some difficulty in accurately predicting the
future. However, given the immense complexity of markets with
thousands of different products offered at different prices, Price
Optimization Models are very helpful in providing insights as to
what the price should be.
Creating Price Optimization Models
Generally, Price Optimization Models are created by
mathematics-based computer programs provided by consulting
firms. First, the company executives or managers determine
which Price Optimization model will be used and what firm will
be providing it. Then they input historical product volumes,
prices, past promotions’ effects on volume and price, as well as
fixed/variable cost info, economic trends and conditions, and
seasonal fluctuations in volume. Market Segmentation
In order to effectively optimize price, customers within the
market are often divided into segments (see market
segmentation) and tested to find the optimal price. This way,
the price will reflect the business’s strategy in pursuing the
target audience. When a firm manages to meet the demand of
each market segment, the firm can maximize profit. Factors
Influencing Price Optimization
A few factors influencing Price Optimization
· Price elasticity
Some products are very price sensitive, while others are not.
For instance, the sales of grocery store products can vary as
much as 10% with a 1 cent change in price
· Seasonal items/constraints
The optimal price can change depending on the time of year for
some products.
· Product life cycle
Innovative new products can have a much higher price, as early
adopters are less price sensitive.

Later on in the product life cycle, more competitors enter the
space and drive down the price. Late adopters are much more
price sensitive.Making Price Optimization Models Useful
Price Optimization Models are most useful in the right set of
circumstances. If a company is determining its initial price of
the product, Price Optimization will be most accurate if the
products are commodity items or are very common in the
market. POMs can also be used very effectively to predict the
effect of a particular promotion or change in price of an existing
product with historical sales and volume data.
In other situations, price optimization models can still be
helpful, but with less accuracy. Nonetheless, it is essential that
businesses look closely at their price and determine if it is
optimal and if it aligns with their business
strategy.10.9Corporate Social Responsibility
Companies, particularly large companies, have an incredible
amount of power. They can hire or fire thousands of people,
boost or drag down economies, and destroy or preserve
environments. Sometimes, companies choose to use this power
to accomplish a noble cause, putting their money and influence
to bring about good. This is called corporate social
responsibility (CSR).
Examples of corporate social responsibility range widely,
including companies advancing education, protecting the
environment, offering healthier food options, fighting poverty,
creating fuel-efficient vehicles, and seeking cures to diseases
among others.
Controversy Over CSRProponents of CSR
There is a rich debate surrounding corporate social
responsibility. Proponents of corporate social responsibility
claim many advantages. One is that socially conscious
consumers will buy from socially conscious companies. Another
is that governments often offer advantages to companies who
engage in corporate social responsibility. Recruitment is
positively impacted, as some talented employees want to work

for socially responsible companies. This is particularly true of
Millennials, who tend to seek CSR much more than past
generations have. Michael Porter argues that CSR can be a
source of both innovation and competitive advantage. Of course,
a huge benefit is the opportunity to actually make a difference
for good in the world.Opponents of CSR
Opponents of corporate social responsibility argue that
companies have no obligation to improve society, and that a
company’s only responsibility is to generate money for
shareholders. Some even go as far as to argue that funds
allocated to CSR are being stolen from shareholders, the
rightful owners of that money. When companies strive to limit
their pollution or environmental impact beyond what is required
by law, opponents ask why the company is regulating itself
beyond what the government already does. Others argue that
CSR is just a way to get positive public relations (PR) and
doesn’t really serve other purposes.
Is Corporate Social Responsibility Right for You?
Rather than choose one of these sides, we are going to look at
some things to consider when deciding if corporate social
responsibility is a good strategy for your company.Company
Size
How large is your company? Realistically, there are many kinds
of CSR that small firms cannot perform. Building a school in an
impoverished community, donating large sums of money to a
charity, or investing in research to cure cancer are among
hundreds of CSR activities beyond the reach of a small
company. If you are small, consider things that contribute more
directly to the bottom-line of the company. Waste reduction is a
great start - if you can reduce the amount of waste in
production, you benefit the environment and save
money.Industry
Are you in an industry that values CSR highly? Some industries
are more socially-conscious than others. For instance, the
Outdoor Recreation Industry cares immensely about the

environment because damage to the environment destroy
recreational opportunities in the outdoors. Patagonia and others
have embraced CSR for years, and consumers in the industry
expect companies to be socially conscious. This explains, at
least in part, why new entrants to the Outdoor Product industry
generally are founded with CSR as a fundamental part of their
strategy. Cotopaxi is an example of this.Financial Benefit
Are you likely to benefit financially from CSR? Corporate
Social Responsibility is much easier to justify if it will attract
more customers, distinguish you from your competitors, or
allow you to charge premium prices.Public Relations
Do you need positive PR? While some question the ethics of
using CSR to create good PR, it certainly works. If your
company image has been damaged in some way, CSR can help
repair this image.
Even if you didn’t answer yes to the questions, you can still
have CSR as part of your company’s strategy. It may just be
more difficult to justify. Some companies, like TOMs shoes, are
created with CSR as a founding principle of the organization.
Others choose CSR for its intrinsic value, rather than the
benefits that come from it. Whatever the motivation or the setup
of Corporate Social Responsibility in your company, you should
carefully consider all of the options and benefits so you can
maximize both the good you do in the world and the benefit you
do for your own company and its shareholders.10.10Triple
Bottom Line
What should your company work towards? Some would argue
that companies are created for the sole purpose of making
money - the bottom line. In 1994, John Elkington introduced a
different idea. He argued that companies should be pursuing
three different bottom lines - profit, people, and planet.
Three Bottom LinesProfit
The first, profit, is what companies have been doing for
centuries. This is the traditional bottom line. Unless a company
makes a profit, they cannot stay in business and will fail.People

The second bottom line is “people”. This measures the impact
the business has on all of the people who interact with the
company. Companies who focus on this bottom line offer a safe
place to work, encourage employee health, and help employees
progress. Improving the social impact of your supply chain is
another way to focus on the people aspect, by not using child
labor and offering reasonable wages even in countries where
people will work for barely enough to survive.Planet
The third bottom line is planet, which encompasses the
environmental impact that the company has. Some companies
focus solely on trying to decrease the damage they do to the
environment. Others strive to go beyond that, benefiting the
environment instead of just preventing additional harm from
being done.
The triple bottom line is a framework for looking at Corporate
Social Responsibility. The same advice and suggestions that are
included in CSR are applicable to the triple bottom line.
Difficult to Measure
One of the greatest difficulties in implementing a triple bottom
line strategy is an inability to measure and compare the three
bottom lines. Profit can be measured in dollars, but the other
two cannot. How do you measure the positive impact you’ve
had on people who work with your company? How do you
measure the effect you’ve had on the environment? This
difficulty in measuring results causes difficulty in balancing
how many resources you dedicate to each of the bottom lines. If
you focus too heavily on one of the bottom lines, you can
deprive the others of the resources they need to keep going. To
help with this, the federal government has sponsored a website
to help companies effectively implement the triple bottom line.
Look carefully at each of the three bottom lines can be
implemented at your company. Which one needs the most
improvement at your company? Which one are you doing best
at? What measures can be taken in each area that align best with
your company’s culture and resources?10.11Push vs. Pull

Strategy
Push vs. Pull MarketingPush Marketing Strategy
Push marketing involves simply bringing products to customers
and convincing them to buy it. Conversely, pull marketing is
designed have consumer seek out the product themselves. If a
company is attempting to use a push strategy, they want to place
the product in front of a consumer as often and in every way
possible. If you are using a push strategy, you will actively
work with channels of distribution, pushing the product onto
retailers, middlemen, and selling it directly to your consumer.
Imagine this strategy like a door-to-door salesperson; he/she
attempts to explain to you all of the product features, the
benefits of buying, and why now is the right time. Some
examples of push marketing include trade shows, cold-calling,
and direct selling.
Push marketing is often characterized by direct sales. The
company will attempt to take the merchandise to the customer
and present the product to them. Company showrooms or
tradeshows can help place the product into the hands of
potential users. Pushing a specific product can originate with
manufacturers, who make lots of the product and then push it
onto wholesalers, possibly at a discounted price. The
wholesalers then try to sway retailers to stock the product in
their stores. Once the product is stocked, retailers are forced to
push the product to customers.Pull Marketing Strategy
Pull strategy is designed to bring customers to the business and
focuses on customers who will actively seek the product. For
instance, Rossignol has built its reputation as a manufacturer of
quality skis over the last 100 years. Instead of finding skiers,
explaining the product to them, and trying to “push” them to
buy the skis, Rossignol lets the customers seek out reviews,
specs, and features of each new ski. Consumers go to Rossignol,
so the Rossignol marketing department focuses on making sure
stores and websites adequately explain the product.
Pull marketing uses traditional advertising, referrals,

promotions, discounts, and today, social media to bring in
customers. Often, it is characterized by a solid advertising
campaign, intended to generate a large demand amongst
consumers. If customers are demanding a certain product and
are drawn into stores in order to find it, retailers typically find a
supply chain and will do what is necessary to make the product
available in their store.Example - The Grocery Store
A trip down to the grocery store highlights the difference
between push and pull strategy. Perhaps you went into Lee’s
because you know that they stock Lucky Charms, your favorite
cereal. The Lucky Charms have “pulled” you into the store and
you have planned on purchasing a box (or possibly several).
After you arrive at the store, you see a point-of-purchase
display case wonderfully showcasing Kit Kats. You didn’t plan
to buy a Kit Kat, but now you see those red wrappers and
pictures of beautiful people eating Kit Kats. Your mouth begins
to water, before you know it you’ve placed several bars in your
shopping basket.Mixed Approach
Push and Pull strategies are not mutually exclusive. A company
can both pull consumers into stores to buy the product and
promote the product through “push” methods. In fact, many
would recommend a mixed approach to marketing most
products. The balance between pull and push must be
determined by the market, the product type, and the company’s
vision.
Often, pull strategies are more widely used for products that
require a certain amount of forethought. Push strategies tend
towards lower-cost items that people will buy without much
planning. For instance, few people buy a car on complete
impulse; hence, car dealers seek to pull interested customers
into their dealership. Conversely, relatively few people make an
entire trip to the store to buy a pack of gum. However, if gum is
presented properly and at the right moment many people buy it
impulsively.10.12Value Chain Analysis
One mistake made by many firms is assuming that once they
have a successful product or service that provides the company

with a steady inflow of customers and profit that there’s nothing
left to do but continue to sell. Companies which forget the
importance of continual improvement are eventually highly
disadvantaged. One process which helps firms continuously
evaluate the value they offer customers and thus know how to
improve is called the Value Chain Analysis. The Value Chain
Analysis is a three step procedure used to improve the customer
experience by adding value to your firm. Here are the steps to
the process:
1. Determine the main services or activities involved in moving
products from producers to consumers. (Operations, Marketing,
Sales, inbound logistics, outbound logistics)
2. Identify what could be done to add the most value to the
services and activities found in step one and optimize the
customers’ experience.
3. Consider the ideas found in step two. Evaluate the
practicality of each idea and decide whether or not to implement
them. Make an organized plan of action to carry out the
implementation of the decided improvements.
Example Value Chain AnalysisKuru Design
To better understand this concept, we’ll apply a Value Chain
Analysis to a small local firm called Kuru Design. Kuru
specializes in the design and retail of travel-size
hammocks.Process from Producer to Consumer
First we need to determine the process Kuru’s hammocks take
from producer to consumer. The process starts with purchasing
and importing hammocks from a foreign manufacture. Once the
supplies have arrived, a quality control is conducted on each
hammock and the hammocks are packaged and readied for sale.
Most of Kuru’s hammock sales are performed at public markets,
fairs, festivals, and community events. They advertise and sell
their products by setting up hammocks at the event and
spending time talking to those walking by (much like other
vendors in such locations). Customers select and purchase their

hammocks on the spot, the transaction is made and inventory is
tracked.Identify Improvements
Now that we have a perception of the process Kuru products
take, our next step is to identify improvements that could be
made to optimize the customers’ experience. Small changes,
such as allowing customers to sit in a hammock before deciding
to purchase, might improve the buying experience for the
customer. Other improvements could be made to make the
products more pleasurable to Kuru’s customers, such as creating
a unique Kuru hammock pillow, implement a speaker system for
urban hammock users, or creating an innovative water-proof
winter hammock for extreme hammock users. Other
improvements could be made simply by varying hammock
colors offered by Kuru, or even personalizing hammocks
through stencils. There really are a lot of ideas for
improvements that can be imagined in any industry. If we can
think of a whole bunch within in the hammock industry,
imagine what else exists out there!Create an Action Plan
The final step to our Value Chain Analysis is to determine
which ideas to implement from step two and create an action
plan. After considering all of their options and conducting some
market research, Kuru’s owners determined the most effective
way to improve their customers experience would be to make
improvements to their products. They decided to pursue speaker
system implementation, winter hammock production, and have
all of their hammocks available for customers to try out at sale
locations. Their action plan consists of creating prototypes of
their new products and conducting product testing.10.13The
Value Equation
The Value Equation as a Strategic Tool
The value equation is a simple way to picture what a firm offers
to the customer. Ultimately, value is what the consumer bases
their purchase decision on. For example, a meal purchased at
McDonald's has a very different set of benefits and costs than a
meal purchased at Ruth’s Chris Steak House does. Yet both

serve the same utility; a meal. Likewise, BMW and Hyundai
both make automobiles that serve the same utility; they get you
from point A to point B. However, the features, benefits, and
costs are very different between the two. Value is created, in
different ways, for each of their respective purchasers (market
segments).
The equation looks like this:
The equation can help a firm conceptualize strategic decisions.
The greater the value the firm can offer the customer relative to
its competitors, the more likely the firm is to create greater
sales and thereby profits. From the diagram you can see two
generic growth strategies; increase benefits and/or reduce costs.
Also, the cost side of the equation includes the customer’s total
costs to acquire, some elements of which the firm may have
little or no control over. An example might be a trip to the store
to make the purchase.Understanding Customer Perceptions
The problem most firms run into is that they don’t understand
the customer’s perceptions. They think they do, but they really
don’t. Sometimes they understand what customers used to value,
but no longer do (markets are dynamic and change
often). Customer perception is what drives their view of Value,
and ultimately their purchase decision. It is vitally important
that firms understand what their customers actually
value.10.14Summary
Customer RelationsCustomer Relationship Management
Customer Relationship Management is how a company interacts
with its customers. It often involves tracking customers and
how they interact with the company. Market Segmentation
By breaking your consumer group into different categories, you
can better understand your consumers and more effectively
market to different market segments. Voice of the Consumer
Technology has given the consumer an increasingly strong voice
in specifying what is good and bad about a certain product.
Beyond unsolicited reviews on the internet, companies can use

call centers, data collection companies, and online data mining
to better understand what the consumer wants. Branding
Your brand is how your company presents itself to consumers.
Your brand should align with your strategy, and the two should
work together to drive sales.4 Ps of Marketing
Marketing is often categorized into price, product, place, and
promotion. These are the fundamental areas that will determine
the success of marketing efforts. Pricing Strategies
The price you set for a product says a lot to consumers about
the product you are selling. It is essential to match your pricing
strategy with your overall strategy. Price Optimization Models
Given the essential nature of setting the right price for your
product, it can be helpful to use a price optimization models to
determine what this ideal price is.Corporate Social
Responsibility
When companies seek to make the world a better place, they are
engaging in corporate social responsibility. There is a rich
debate over the value of CSR. Triple Bottom Line
The Triple Bottom Line states that companies should try to
maximize what they do for their profit, people, and the planet.
This is a further elaboration on corporate social
responsibility. Push vs. Pull Strategy
Push strategy involves attempting to push your product through
any and all channels of distribution to the consumer, throwing it
in front of them and convincing them to buy it. On the other
hand, pull strategy involves creating such high customer
satisfaction and anticipation that they will seek out your
product where they can find it, creating demand and pulling the
product through retailers and middlemen. Value Chain Analysis
Three steps are outlined under the value chain analysis in order
to continuously improve the value of the firm’s products or
services.The Value Equation
Value can be defined through one equation, benefits offered
divided by the cost incurred. Companies try to create value by
either increasing benefits, minimizing costs, or both.

Assignment/Chapter #8: Acquisitions, Merger, or
Partnership/Alliance: For this assignment, assume that for the
last two years you have been assigned as the chief strategy
officer for Ralph Lauren (Ticker Symbol: RL, Note: go to
www.yahoofinance.com and type in RL and you can get
incredible information about the company such as financial
statements, industry reports, analysist reports, etc).
As you probably already know, Ralph Lauren sells men’s,
women’s and children’s apparel, accessories, fragrances, and
home furnishing to customers worldwide. Last week, The CEO
of the company came and told you that Ralph Lauren
desperately needs to increase revenue, minimize costs, and/or
increase market share. The CEO tells you that they are
considering acquiring, merging and/or forming partnerships
with the following companies:
Ralph Lauren (Ticker Symbol: RL)
Option #1: PVH Corp (Ticker Symbol: PVH).
Option#2: GAP (Ticker Symbol: GPS)
Option #3: Under Armor (Ticker Symbol: UA) (this part)
The CEO has given you the responsibility to analyze each of the
following companies and decide what action you should take?
Should your form a merger, an alliance, or try to acquire one of
the above-mentioned companies? Should you take no action,
why or why not?
In doing you analysis, I recommend the following:
1. Better understand Ralph Lauren including its strengths and
weaknesses, what are its major products/lines? What is their
current strategy? What is their revenue like? Are they
profitable? Where do most of their customers reside? How can
they: 1) Increase sales to existing customers, or 2) Create new
customers? Where are most of the clothes made? Is there a way
to reduce cost while still maintaining brand name?
2. Understand each of the companies that you are considering a
merger/acquisition/partnership with. What are their
products/services like and how do they complement/compete

with Ralph Lauren? Are these companies profitable? What is
each of the companies’ market capitalization like (number of
shares times price of the stock)? Do you have the cash to buy
any of these companies, or would you have to provide cash
and/or stock in the purchase negotiations? Note: In order to
acquire a company that is larger than your own, you would have
to issue a large amount of debt and then use that debt to pay (at
market price) for the company.
3. How can you STRATEGICALLY build Ralph Lauren? USE
YOUR OWN CREATIVITY and INNOVATION – this is real
world stuff – companies make these decisions all the time!!!
I recommend using the Internet, company financial statements
on yahoo finance (all mentioned companies are public), CNN
Money, Fortune, and any other resources you can find. There
are a number of industry analysts that provide additional details
about these companies. Note: The library has access to a
number of databases that include analyst’s reports on both
Ralph Lauren (including the above mentioned companies) as
well as the Ralph Lauren’s industry. I highly recommend that
you use these resources

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