the Business and Economic Environment

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Guildhall School of Business and Law
FE4055
Understanding
the Business and Economic
Environment
2020-21
Guildhall School of Business and Law
An Introduction to
Business Strategy
Guildhall School of Business and Law
What is Strategy?
• A company’s objectives and philosophy
• Defining strategy
• the five ‘Ps’ of strategy
• a plan
• a ploy
• a pattern of behaviour
• a position with respect to others
• a perspective
• strategy as a mix of the five Ps
Guildhall School of Business and Law
Q Meeting with employees to explain the business’s goals in an
attempt to get everyone ‘on board’ would be an example of a:
A. plan.
B. ploy.
C. pattern of behaviour.
D. position with respect to others.
E. perspective.
Guildhall School of Business and Law
What is Strategy?
• Strategic management
• strategic and day-to-day management
• the components of strategic management
• strategic analysis
• strategic choice
• strategic implementation
• different business types
• big or small business
• manufacturing or service provider business
• domestic or multinational business
• private-sector or public-sector business
• for-profit or not-for-profit organisations
Guildhall School of Business and Law
Q Deciding who in the organisation would be responsible for carrying
out a strategy would be an example of:
A. strategic analysis.
B. strategic choice.
C. strategic implementation.
D. routine management.
Guildhall School of Business and Law
Q Deciding to diversify into new products would be
an example of:
A. strategic analysis.
B. strategic choice.
C. strategic implementation.
D. routine management.
Guildhall School of Business and Law
Strategic Analysis
• Factors affecting strategic choices
• Vision and mission
• attitudes towards various stakeholders
• influences on a firm’s vision and mission
• corporate governance
• stakeholders’ interests
• business ethics
• cultural context
Guildhall School of Business and Law
Factors influencing organisational purpose
Organisational
purpose
Stakeholder
views
Cultural
context
Business
ethics
Corporate
governance
Guildhall School of Business and Law
Strategic Analysis
• The business environment
• PEST analysis
• focusing on the ‘economic’
• Porter’s five forces model
• the bargaining power of suppliers
• the bargaining power of buyers
• the threat of potential new entrants
• the threat of substitutes
• the extent of competitive rivalry
• factors affecting each of the forces
• limitations of the five forces model
Guildhall School of Business and Law
Industry competitors
Potential
entrants
Threat of
new entrants
Suppliers
Bargaining power
of suppliers
Buyers
Bargaining power
of buyers
Substitute
products
Threat of
substitutes
Porter’s Five Forces Model
Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
Rivalry among
existing firms
Guildhall School of Business and Law
Strategic Analysis
• Value chain analysis
• nature of value chain analysis
• sustainable competitive advantage
• the value chain
• primary activities
• inbound logistics
• operations
• outbound logistics
• marketing and sales
• service
• secondary activities
• procurement
• technological development
• human resources management
• firm infrastructure
Inbound
logistics
The value chain
Operations
Outbound
logistics
Marketing
and sales
After-sales
service
Firm
infrastructure
Technological
development
Human resource
management
Procurement
Guildhall School of Business and Law
Strategic Choice
• Environment or market-based strategy
• types
• cost leadership
• differentiation
• focus
• importance of establishing:
• the basis of a firm’s competitive advantages
• the nature of the target market
• Resource-based strategy
• exploiting core competencies
• defining and establishing core competencies
Guildhall School of Business and Law
Strategy: Evaluation and Implementation
• Evaluation
• importance of weighing up alternative strategies
• how feasible are they?
• how do they relate to the firm’s goals?
• how will they affect the firm’s competitive position?
• Implementation
• need to assess the following
• resourcing
• business culture and structure
• managing change
Guildhall School of Business and Law
Growth Strategies
• Growth by internal expansion
• product differentiation
• vertical integration
• diversification
• Growth by external expansion
• types of external expansion
• mergers and takeovers
• strategic alliances
• horizontal expansion
• vertical expansion
• conglomerate expansion
Guildhall School of Business and Law
(1) Horizontal expansion
Same product,
but increase in market share or
diversification into new varieties
(1) Horizontal integration
Merger or acquisition of firms
producing same product
at the same stage of production
(2) Vertical integration
Merger or acquisition of firms
producing at different stages of
same process
Mergers and acquisitions
(2) Vertical integration
Same product,
but expanding to different stages
of the productive process
(3) Conglomerate
Diversification – introduction of
totally different products
(3) Conglomerate
Diversification – merger or
acquisition of firms producing
totally unrelated products
(1) Horizontal alliances
Informal or contractual alliance
between firms at a technically
similar stage of production that
may lead to a joint venture
(2) Vertical alliances
Informal or contractual alliance
between firms producing at
different stages of same process
that may lead to a joint venture
(3) Networks
Informal or contractual alliance
between firms across sectors,
including the development of
supply chain clusters
External expansion
Strategic alliances GROWTH OF A FIRM
Internal expansion
Growth Strategies
Guildhall School of Business and Law
Q If a car manufacturer merges with a car retailer, this
is an example of:
A. a vertical merger.
B. a horizontal merger.
C. a conglomerate merger.
D. upstream integration.
E. a network.
Guildhall School of Business and Law
Internal growth
• Growth by vertical integration
• Types of vertical integration
• backward integration (‘upstream’ integration)
• forward integration (‘downstream’ integration)
• Measuring the extent of vertical integration
• primary production
• auxiliary operations
• Examples of vertically integrated firms
Guildhall School of Business and Law
Internal growth
• Why vertically integrate?
• greater efficiency
• production economies
• co-ordination economies
• managerial economies
• financial economies
• reduced uncertainty
• innovation
• monopoly power
• barriers to entry
Guildhall School of Business and Law
Internal growth
• Problems with vertical integration
• lack of flexibility
• risks
• Tapered vertical integration
• partial vertical integration
• advantages
• better cost information
• more leverage over suppliers
• smaller capital outlay
• disadvantages
• possible lack of economies of scale
Guildhall School of Business and Law
Internal growth
• Growth through diversification
• Directions of diversification
• using existing technological base and market area
• using existing technological base and new markets
• using new technological base and existing market
• using new technological base and new markets
• Why diversify?
• stability
• maintaining profitability
• growth
Guildhall School of Business and Law
External Growth through Merger
• Mergers and takeovers
• distinction between mergers and takeovers
• three different types
• horizontal
• vertical
• conglomerate
• Motives for mergers and takeovers
• growth
• economies of scale
• monopoly power
• increased market valuation
Guildhall School of Business and Law
External Growth through Merger
• Motives for mergers and takeovers (cont.)
• reduced uncertainty
• opportunities
• other motives
• to avoid being taken over
• White Knight strategy
• asset stripping
• empire building
• geographical expansion
• reduced levels of taxation
Guildhall School of Business and Law
External Growth through Merger
• Do they result in the anticipated gains?
• how do you measure success?
• share price before and after the merger
• compare with other firms in the same sector
• results
• approximately two thirds of deals failed to achieve the anticipated gains
• problems include
• lack of due diligence
• overestimated synergies
• failure to recognise insufficient strategic fit
• problems integrating management teams
Guildhall School of Business and Law
External Growth through Strategic
Alliance
• Types of strategic alliance
• horizontal
• franchising
• licensing
• vertical
• consortia
• contractual arrangements
• outsourcing / subcontracting
• networks
• multi-firm alliances across sectors
Guildhall School of Business and Law
36.6%
26.6%
36.8%
Air Berlin,
American Airlines, BA,
Cathay Pacific,
Finnair, Iberia, Japan Airlines,
LAN, Malaysia Airlines,
Qantas, Qatar Airways,
Royal Jordanian, S7 Airlines,
SriLankan Airlines, TAM,
Mexicana
Figures show
percentages of total
alliance passenger
numbers (2017)
Aeroflot,
Aerolíneas Argentinas,
Aeroméxico, Air Europa, Air
France, Alitalia, China Airlines,
China Eastern, China Southern,
Czech Airlines, Delta Air Lines,
Garuda Indonesia, Kenya
Airways, KLM, Korean Air,
Middle East Airlines, Saudia,
TAROM, Vietnam Airlines,
XiamenAir
Adria Airways,
Aegean Airlines,
Air Canada, Air China,
Air India, Air New Zealand,
ANA, Asiana Airlines,
Austrian Airlines, Avianca,
Brussels Airlines, Copa Airlines,
Croatia Airlines, EgyptAir,
Ethiopian Airlines, EVA Air,
LOT Polish Airlines, Lufthansa,
Scandinavian Airlines, Shenzhen
Airlines, Singapore Airlines,
South African Airways,
SWISS,
TAP Portugal, THAI,
Turkish Airlines,
United Airlines
Star Alliance
Airline strategic alliances
Guildhall School of Business and Law
External Growth through Strategic
Alliance
• Why form strategic alliances?
• new markets
• risk sharing
• capital pooling
Guildhall School of Business and Law
External Growth: Transactions
Costs
• Transactions costs
• when firms deal with other firms through markets
• these costs can be high when there are:
• large sunk costs
• high level of transactions between the firms
• information asymmetries between the firms
• reliance on contracts
• problem of moral hazard
• Incentive for merger or alliance to reduce these transactions costs
Guildhall School of Business and Law
Q Which of the following would be likely to reduce transactions
costs?
A. A vertical merger
B. A horizontal merger
C. Long-term contracts with suppliers
D. Greater asymmetry of information
E. Increased outsourcing
Guildhall School of Business and Law
Pricing Strategies
• Do firms know their costs and revenues?
• difficulties in identifying the profit-maximising price and output
• difficulties in predicting rivals’ behaviour
• Cost-based pricing
• the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
• variations in the mark-up
• the supply curve
Guildhall School of Business and Law
Price Discrimination
• Meaning of price discrimination
• Types of price discrimination
• first degree
• charging consumers the maximum each is prepared to pay
• third degree
• characteristics, traits or attributes used to ‘group’ different
consumers
• second degree
• offering a range of different pricing options for the consumer to
choose from
Guildhall School of Business and Law
Price Discrimination
• First-degree price discrimination
• perfect price discrimination
• difficult to establish the maximum people are willing to pay
• asymmetric information
• personalised or person-specific pricing
• approaches pure first-degree price discrimination
• more likely when there is scope for bargaining and the seller is a skilful
haggler
• a model of first-degree price discrimination
• revenue equals area under the demand curve
• captures all the consumer surplus
Guildhall School of Business and Law
1
MC = AC
Profit-maximising
single price = P1
MR
AR = D
£
O Q
Q1
P2
P1
First-degree price discrimination
Guildhall School of Business and Law
2
3
MC = AC
Additional Gains = 2 + 3
1
AR = D
MR
Q
£
O Q1
P1
P2
Q2
First-degree price discrimination
Guildhall School of Business and Law
Price Discrimination
• Third-degree price discrimination
• firms discriminates according to some consumer characteristic
• e.g. age or location
• the characteristic must be:
• relatively easy for the firm to observe
• provide some information about the consumer’s willingness to pay
• are not illegal to use (e.g. discrimination by ethnicity or gender)
• acceptable to the consumer
• should be impossible or costly for consumer to change
characteristic
Guildhall School of Business and Law
Characteristic Example
Age 16–25 or senior rail card; half price children’s tickets in the cinema.
Gender ‘Ladies’ night’ in a bar or club where men pay the full price for
drinks while women can get the same drinks at a discounted price.
Location Pharmaceutical companies often charge different prices for the
same medicine/drug in different countries. Consumers in the USA
are often charged more than those from other countries.
Occupation Apple, Microsoft and Orange provide price discounts to employees
of educational institutions.
Business or individual Publishers of academic journals charge much lower subscription
rates to individuals than university libraries.
Past buying behaviour Firms often charge new customers a lower price than existing
customers for the same product or service as an ‘introductory offer’.
Examples of third-degree price discrimination
Guildhall School of Business and Law
Price Discrimination
• A model of third-degree price discrimination
• profit maximisation for a single-price firm
• horizontal summation of the demand curves
• discontinuity in the MR curve
• profit maximising under third-degree price
discrimination
• split customers into market H and market L
• equate MC with MR in each separate market
Guildhall School of Business and Law
MC
DL
P*
k DM
c l
PL
f
i
j
£ £
b
e
a
g
d h
DH
MRL
MRM
O O O
MRH
PH
QH QL Q*
(a) Market H (b) Market L (c) Total market
(markets H + L)
£ Q Q Q
Third-degree price discrimination
Guildhall School of Business and Law
Price Discrimination
• Second-degree price discrimination
• discounts for greater purchases
• quantity discounts
• block declining tariff (e.g. electricity companies)
• coupons/vouchers
• time and effort
• intertemporal pricing
• airline tickets
Guildhall School of Business and Law
MC
PL
£
AR1
AR2
MR2
O Q1 O
MR1
PH
Q*
(a) Type ‘I’ consumer (b) Type ‘E’ consumer
£ Quantity Quantity
Second-degree price discrimination: a quantity discount
Guildhall School of Business and Law
f e
g
MC
B
C
P
H
z
D
AR1
MR2 AR2
A
£
L
MR1
Q1
Q2 Q3
Q*
O
Quantity
O PH
Q*
(a) Type ‘I’ consumer (b) Type ‘E’ consumer
£ Quantity
PL
PSecond-degree price discrimination: a quantity discount
Guildhall School of Business and Law
O
Price
Quantity
D
Second-degree price discrimination: block declining tariff
P2
Q2
P1
Q1 Q3
P3
Guildhall School of Business and Law
Price Discrimination
• Second-degree price discrimination and product
differentiation
• versioning – different versions of core product
• first class vs. economy seats
• different specifications of computers/software
• combinations of versioning and inter-temporal pricing
• hardback and paperback books
Guildhall School of Business and Law
Price Discrimination
• Other discriminatory pricing practices
• peak-load pricing
• higher bus and train fares during ‘rush hours’
• two-part tariff
• fixed fee plus price per unit
• mobile phones/energy
Guildhall School of Business and Law
Price Discrimination
• Conditions for price discrimination
• firm must have some market power
• faces a downward sloping demand curve
• re-sale of the product between customers must be
difficult/impossible
• i.e. consumed at time of purchase/perishable/high transaction
costs
• demand elasticity must vary between customers at any
given price
Guildhall School of Business and Law
Q If a supermarket has a ‘buy 2 get a 3rd one free’ offer,
this is an example of:
A. first-degree price discrimination.
B. second-degree price discrimination.
C. third-degree price discrimination.
D. demand pricing.
E. mark-up pricing.
Guildhall School of Business and Law
Q Some firms provide coupons and vouchers on their websites. Any
customer can print off these vouchers and use them to obtain their
next purchase from the firm at a discounted price. This is most likely to
be an example of:
A. first-degree price discrimination.
B. second-degree price discrimination.
C. third-degree price discrimination.
D. uniform pricing.
E. It is impossible to say without more information.
Guildhall School of Business and Law
Price Discrimination
• Advantages to the firm
• earn higher revenues from
• a given level of sales
• extra sales
• Price discrimination and the public interest
• distribution
• impact of extra sales
• misallocation effects
• competition effects
Guildhall School of Business and Law
Multiple Product Pricing
• Firms producing a range of products
• Interrelated demand
• drawbacks of independent pricing
• full-range pricing
• loss leaders
• Interrelated production
• shared inputs
• by-products
Guildhall School of Business and Law
Pricing and the Product Life Cycle
• The nature of product life cycles
• the four stages
• launch
• growth
• maturity
• decline
Guildhall School of Business and Law
O
(1)
Launch
(2)
Growth
(3)
Maturity
(4)
Decline
Sales per period
Time
Product not
becoming
obsolete
Product
becoming
obsolete
The stages in a product’s life cycle
Guildhall School of Business and Law
Pricing and the Product Life Cycle
• The nature of product life cycles
• the four stages
• launch
• growth
• maturity
• decline
• Policy in each stage
• the launch stage
• the growth stage
• the maturity stage
• the decline stage
Guildhall School of Business and Law
Q In which stage is it likely that price competition is intense
and firms invest in product innovation to stimulate growth in
sales?
A. Launch
B. Growth
C. Maturity
D. Decline

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