Generic strategies are plotted on two dimensions: competitive advantage and market served. Compare between differentiation and focus strategies. Discuss their advantages and pitfall of via the five forces model. Support your answer with examples

Question 1

 

Generic strategies are plotted on two dimensions: competitive advantage and market served. Compare between differentiation and focus strategies. Discuss their advantages and pitfall of via the five forces model. Support your answer with examples

Proposed Answer:

 

 

 

Differentiation strategy-  a firm’s generic strategy based on creating differences in the firm’s product or service offering by creating something that is perceived industrywide as unique and valued by customers. Firms may differentiate themselves in both primary and support activities. Firms achieve and sustain differentiation advantages and attain above-average performance when their price premiums exceed the extra costs incurred in being unique. Differentiation implies Products and/or services that are unique & valued. Emphasis on nonprice attributes for which customers will gladly pay a premium.

 

Differentiation requires:

• A level of cost parity relative to competitors
• Integration of multiple points along the value chain
  • Superior material handling operations to minimize damage
  • Low defect rates to improve quality
  • Accurate and responsive order processing
  • Personal relationships with key customers
  • Rapid response to customer service requests

An overall differentiation strategy

Creates higher entry barriers due to customer loyalty

Provides higher margins that enable the firm to deal with supplier power

Reduces buyer power because buyers lack suitable alternatives

Establishes customer loyalty and hence less threat from substitutes

 

Pitfalls of Differentiation

Uniqueness that is not valuable

Too much differentiation

Too high a price premium

Differentiation that is easily imitated

Dilution of brand identification through product line extensions

Perceptions of differentiation may vary between buyers and sellers

A focus strategy requires Narrow product lines, buyer segments, or targeted geographic markets Advantages obtained either through differentiation or cost leadership A focus strategy is based on the choice of a narrow competitive scope within an industry. A firm selects a segment or group of segments (or niche) and tailors its strategy to serve them. A firm achieves competitive advantages by dedicating itself to these segments exclusively. An overall focus strategy

• Creates higher entry barriers due to cost leadership or differentiation or both
• Can provide higher margins that enable the firm to deal with supplier power
• Reduces buyer power because the firm provides specialized products or services
• Focused niches less vulnerable to substitutes

Erosion of cost advantages within the narrow segment Pitfalls of Focus

Highly focused products and services still subject to competition from new entrants and from imitation. Focusers too focused to satisfy buyer needs.

You have to add illustrative examples on both strategies

 

Question Two

1. Briefly define the concept of vertical integration, acquisitions, and mergers.

Proposed Answer:

 

• Vertical Integration

Occurs when a firm becomes its own supplier or distributor. That is, it represents an expansion or extension of the firm by integrating preceding or successive production processes.

 

• Acquisitions

One firm buys another through a stock purchase, cash, or the issuance of debt.

 

• Mergers

Entail a combination or consolidation of two firms to form a new legal entity.

1. In making vertical integration decisions, five issues should be considered. List and explain these issues.

Proposed Answer:

• Is the company satisfied with the quality of the value that its present suppliers and distributors are providing?
• Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits?
• Is there a high level of stability in the demand for the organization’s products?
• Does the company have the necessary competencies to execute the vertical integration strategies?
• Will the vertical integration initiative have potential negative impacts on the firm’s stakeholders?

 

 

Question Three

Licensing and Franchising are considered effective entry modes of international expansion, differentiate between the two concepts “Licensing and Franchising”. Discuss benefits and limitations of each strategy.

Answer:

Licensing

A contractual agreement which enables a company to receive a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable item of intellectual property.

 

Franchising

a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its intellectual property; it usually involves a longer time period than licensing and includes other factors, such as monitoring of operations, training, and advertising.

 

 

Franchising has the advantage of limiting the risk exposure that a firm has in overseas markets while, at the same time, the firm is able to expand the revenue base of the company. An advantage of licensing is that the firm granting a license incurs little risk, since it does not have to invest any significant resources into the country itself. In turn, the licensee (the firm receiving the license) gains access to the trademark, patent, and so on, and is able to potentially create competitive advantages. However, the licensor gives up control of its product and forgoes potential revenues and profits.

 

Question Four

 

1. Strategic Alliance and Joint Ventures are considered effective entry modes of international expansion, briefly differentiate between the two concepts “Strategic Alliance and Joint Ventures”. Discuss benefits and limitations of each strategy.

 

Proposed Answer:

 

• Strategic Alliance

A cooperative relationship between two or more firms. Contractual alliances are simply based on written contracts between firms.

 

• Joint Ventures

New entities formed within a strategic alliance in which two or more firms, the parents, contribute equity to form the new legal entity.

 

 

Strategic alliances and joint ventures allow firms to increase revenues and reduce costs as well as enhance learning and diffuse technologies. However, trust is a vital element.

By using a joint venture or strategic alliance, corporations can pool the resources of other companies with their own resource base.

 

Question Five

Discuss the firm structure- strategy relationship and define organizational structure. Critically explain the divisional structure, identifying its advantages and disadvantages. Discuss the importance of organizational structure. Support your answer with an example of a divisional structure.

Proposed Answer:

A firm’s strategy and structure change as it increases in size, diversifies into new product markets, and expands its geographic scope.6

Exhibit 10.1 illustrates common growth patterns of firms.

A new firm with a simple structure typically increases its sales revenue and volume of outputs over time. It may also engage in some vertical integration to secure sources of supply (backward integration) as well as channels of distribution (forward integration). The simple-structure firm then implements a functional structure to concentrate efforts on both increasing efficiency and enhancing its operations and products. This structure enables the firm to group its operations into functions, departments, or geographic areas. As its initial markets mature, a firm looks beyond its present products and markets for possible expansion.

A strategy of related diversification requires a need to reorganize around product lines or geographic markets. This leads to a divisional structure. As the business expands in terms of sales revenues, and domestic growth opportunities become somewhat limited, a firm may seek opportunities in international markets. A firm has a wide variety of structures to choose from. These include international

division, geographic area, worldwide product division, worldwide functional, and worldwide matrix. Deciding upon the most appropriate structure when a firm has international operations depends on three primary factors: the extent of international expansion, type of strategy (global, multidomestic, or transnational), and degree of product diversityinitial markets mature, a firm looks beyond its present products and markets for possible expansion.

BUS310 Final

2019

Ch6

MAKING DIVERSIFICATION WORK: AN OVERVIEW

diversification moves, including those involving mergers and acquisitions, erode performance. The process of firms expanding their operations by entering new businesses. Whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development. Must be justified by the creation of value for shareholders. But this is not always the case. Acquiring firms typically pay high premiums when they acquire a target firm.

This can have two different type

First, a firm may diversify into related businesses. Here, the primary potential benefits to be derived come from horizontal relationships, that is, businesses sharing intangible resources (e.g., core competencies such as marketing) and tangible resources (e.g. production facilities, distribution channels).

Firms can also enhance their market power via pooled negotiating power and vertical. For example, Procter & Gamble enjoys many synergies from having businesses that share distribution resources.

Second, a corporation may diversify into unrelated businesses.
hierarchical relationships, that is, value creation derived from the corporate office. Examples of the latter would include leveraging some of the support activities in the value chain, such as information systems or human resource practices.

Such benefits derived from horizontal (related diversification) and hierarchical (unrelated diversification) relationships are not mutually exclusive. Many firms that diversify into related areas benefit from information technology expertise in the corporate office. Similarly, unrelated diversifiers often benefit from the “best practices” of sister businesses even though their products, markets, and technologies may differ dramatically.

RELATED DIVERSIFICATION: MARKET POWER

companies achieve related diversification through market power. We also address the two-principal means by which firms achieve synergy through market power: pooled negotiating power and vertical integration. Managers do, however, have limits on their ability to use market power for diversification, because government regulations can sometimes restrict the ability of a business to gain very large shares of a particular market.

Market power: firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment.

Pooled Negotiating Power

Similar businesses working together or the affiliation of a business with a strong parent can strengthen an organization’s bargaining position relative to suppliers and customers and enhance its position vis-à-vis competitors. When acquiring related businesses, a firm’s potential for pooled negotiating power vis-à-vis its customers and suppliers can be very enticing. However, managers must carefully evaluate how the combined businesses may affect relationships with actual and potential customers, suppliers, and competitors. For example, when PepsiCo diversified into the fast-food industry with its acquisitions of Kentucky Fried Chicken, Taco Bell, and Pizza Hut (now part of Yum! Brands), it clearly benefited from its position over these units that served as a captive market for its soft-drink products. However, many competitors, such as McDonald’s, refused to consider PepsiCo as a supplier of its own soft-drink needs because of competition with Pepsi’s divisions in the fast-food industry. Simply put, McDonald’s did not want to subsidize the enemy! Thus, although acquiring related businesses can enhance a corporation’s bargaining power, it must be aware of the potential for retaliation.

Vertical Integration

Vertical integration occurs when a firm becomes its own supplier or distributor. That is, it represents an expansion or extension of the firm by integrating preceding or successive production processes. The firm incorporate more processes toward the original source of raw materials (backward integration) or toward the ultimate consumer (forward integration). Vertical integration an expansion or extension of the firm by integrating preceding or successive production processes.

Benefits and Risks of Vertical Integration Vertical integration is a means for an organization to reduce its dependence on suppliers or its channels of distribution to end users. However, the benefits associated with vertical integration—backward or forward—must be carefully weighed against the risks

Benefits:

• A secure source of raw materials or distribution channels.
• Protection of and control over valuable assets.
• Proprietary access to new technologies developed by the unit.
• Simplified procurement and administrative procedures.

Risk:

• Costs and expenses associated with increased overhead and capital expenditures.
• Loss of flexibility resulting from large investments.
• Problems associated with unbalanced capacities along the value chain. (For example, the in-house supplier has to be larger than your needs in order to benefit from economies of scale in that market.)
• Additional administrative costs associated with managing a more complex set of activities.

In making vertical integration decisions, five issues should be considered:

Is the company satisfied with the quality of the value that its present suppliers and distributors are providing? If the performance of organizations in the vertical chain—both suppliers and distributors—is satisfactory, it may not, in general, be appropriate for a company to perform these activities itself. But if firms are not happy with their current suppliers, they may want to backward integrate. For example, Kaiser Permanente, a health provider with 10.6 million subscribers, launched its own medical school to better train physicians to provide the integrated style of care Kaiser is striving to provide.

Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits? Even if a firm is outsourcing value-chain activities to companies that are doing a credible job, it may be missing out on substantial profit opportunities. Consider Best Buy. When it realized that the profit potential of providing installation and service was substantial, Best Buy forward integrated into this area by acquiring Geek Squad.

Is there a high level of stability in the demand for the organization’s products? High demand or sales volatility is not conducive to vertical integration. With the high level of fixed costs in plant and equipment as well as operating costs that accompany endeavors toward vertical integration, widely fluctuating sales demand can either strain resources (in times of high demand) or result in unused capacity (in times of low demand). The cycles of “boom and bust” in the automobile industry are a key reason why the manufacturers have increased the amount of outsourced inputs.

Does the company have the necessary competencies to execute the vertical integration strategies? As many companies would attest, successfully executing strategies of vertical integration can be very difficult. For example, Boise Cascade, a lumber firm, once forward integrated into the home-building industry but found that it didn’t have the design and marketing competencies needed to compete in this market.

Will the vertical integration initiative have potential negative impacts on the firm’s stakeholders? Managers must carefully consider the impact that vertical integration may have on existing and future customers, suppliers, and competitors. After Lockheed Martin, a dominant defense contractor, acquired Loral Corporation, an electronics supplier, for $9.1 billion, it had an unpleasant and unanticipated surprise. Loral, as a subsidiary of Lockheed, was viewed as a rival by many of its previous customers. Thus, while Lockheed Martin may have seen benefits by being able to coordinate operations with Loral as a captive supplier, it also saw a decline in business for Loral with other defense contractors.

THE MEANS TO ACHIEVE DIVERSIFICATION

the types of diversification (e.g., related and unrelated) that a firm may undertake to achieve synergies and create value for its shareholders. There are three basic means.

 First, through acquisitions or mergers, corporations can directly acquire a firm’s assets and competencies. Although the terms mergers and acquisitions are used quite interchangeably, there are some key differences. With acquisitions, one firm buys another through a stock purchase, cash, or the issuance of debt. Mergers, on the other hand entail a combination or consolidation of two firms to form a new legal entity. Mergers are relatively rare and entail a transaction among two firms on a relatively equal basis. Despite such differences, we consider both mergers and acquisitions to be quite similar in terms of their implications for a firm’s corporate-level strategy. Acquisitions the incorporation of one firm into another through purchase. Mergers the combining of two or more firms into one new legal entity.

Second, corporations may agree to pool the resources of other companies with their resource base, commonly known as a joint venture or strategic alliance. Although these two forms of partnerships are similar in many ways, there is an important difference. Joint ventures involve the formation of a third-party legal entity where the two (or more) firms each contribute equity, whereas strategic alliances do not.

Third, corporations may diversify into new products, markets, and technologies through internal development. Called corporate entrepreneurship, it involves the leveraging and combining of a firm’s own resources and competencies to create synergies and enhance shareholder value.

Mergers and Acquisitions

Several factors influence M&A activity, When mergers and acquisitions pick up, that’s a good sign that businesses are feeling confident enough about the future that they’re willing to become aggressive, look for deals, look for ways to grow and expand their operations. And it’s also an indication that markets are willing to finance these transactions. So it’s optimism from the markets and from the businesses themselves.”40 Thus, the general economic conditions and level of optimism about the future influence managers’ willingness to take on the risk of acquisitions. Additionally, the availability of financing can influence acquisition activity. During boom periods, financing is typically widely available. In contrast, during recessionary periods, potential acquirers typically find it difficult to borrow money to finance acquisitions.

Mergers and acquisitions also can be a means of obtaining valuable resources that can help an organization expand its product offerings and services.

Motives and Benefits Growth through mergers and acquisitions has played a critical role in the success of many corporations in a wide variety of high-technology and knowledge-intensive industries. Here, market and technology changes can occur very quickly and

Acquiring firms often use acquisitions to acquire critical human capital. This is especially important in settings where the technology or consumer preferences are highly dynamic.

Mergers and acquisitions also can provide the opportunity for firms to attain the three bases of synergy—leveraging core competencies, sharing activities, and building market power.

Benefits of Mergers and Acquisitions

• Obtain valuable resources, such as critical human capital, that can help an organization expand its product offerings.
• Provide the opportunity for firms to attain three bases of synergy: leveraging core competencies, sharing activities, and building market power.
• Lead to consolidation within an industry and force other players to merge.
• Enter new market segments.

Limitations of Mergers and Acquisition

• Takeover premiums paid for acquisitions are typically very high.
• Competing firms often can imitate any advantages or copy synergies that result from the merger or acquisition.
• Managers’ egos sometimes get in the way of sound business decisions.
• Cultural issues may doom the intended benefits from M&A endeavors.

 

Strategic Alliances and Joint Ventures

A strategic alliance is a cooperative relationship between two (or more) firms. Alliances are simply based on written contracts between firms. Contractual alliances are typically used for fairly simple alliance agreements, such as supplier, marketing, or distribution relationships that don’t require a great deal of integration or technology sharing between firms and have a finite, identifiable end time period. If the terms of the agreement can be clearly laid out in contracts, then contracts can be a complete and effective basis for the agreement.  Joint ventures represent a special case of alliances, wherein two (or more) firms contribute equity to form a new legal entity. New entities formed within a strategic alliance in which two or more firms, the parents, contribute equity to form the new legal entity. Strategic alliances and joint ventures are assuming an increasingly prominent role in the strategy of leading firms, both large and small. Such cooperative relationships have many potential advantages.

• Entering New Markets Often a company that has a successful product or service wants to introduce it into a new market. However, it may not have the financial resources or the requisite marketing expertise because it does not understand customer needs, know how to promote the product.
• Reducing Manufacturing (or Other) Costs in the Value Chain Strategic alliances (or joint ventures) often enable firms to pool capital, value-creating activities, or facilities in order to reduce costs.
• Developing and Diffusing New Technologies Strategic alliances also may be used to build jointly on the technological expertise of two or more companies. This may enable them to develop products technologically beyond the capability of the companies acting independently
• Potential Downsides Despite their promise, many alliances and joint ventures fail to meet expectations for a variety of reasons. First, without the proper partner, a firm should never consider undertaking an alliance, even for the best of reasons. Each partner should bring the desired complementary strengths to the partnership. Ideally, the strengths contributed by the partners are unique. Thus, synergies created can be more easily sustained and defended over the longer term. The goal must be to develop synergies between the contributions of the partners, resulting in a win–win situation.

Internal Development

Firms can also diversify by means of corporate entrepreneurship and new venture development. In today’s economy, internal development is such an important means by which companies expand their businesses. Entering a new business through investment in new facilities, often called corporate entrepreneurship and new venture development. Compared to mergers and acquisitions, firms that engage in internal development capture the value created by their own innovative activities without having to “share the wealth” with alliance partners or face the difficulties associated with combining activities across the value chains of several firms or merging corporate cultures.

There are also potential disadvantages. It may be time-consuming; thus, firms may forfeit the benefits of speed that growth through mergers or acquisitions can provide. This may be especially important among high-tech or knowledge-based organizations in fast-paced environments where being an early mover is critical. Thus, firms that choose to diversify through internal development must develop capabilities that allow them to move quickly from initial opportunity recognition to market introduction.

 

Ch7

THE GLOBAL ECONOMY: A BRIEF OVERVIEW

Managers face many opportunities and risks when they diversify abroad. The trade among nations has increased dramatically in recent years, and it is estimated that recently the trade across nations exceeded the trade within nations. In a variety of industries such as semiconductors, automobiles, commercial aircraft, telecommunications, computers, and consumer electronics, it is almost impossible to survive unless firms scan the world for competitors, customers, human resources, suppliers, and technology.

The rise of globalization—meaning the rise of market capitalism around the world—has undeniably created tremendous business opportunities for multinational corporations. a term that has two meanings: (1) the increase in international exchange, including trade in goods and services as well as exchange of money, ideas, and information; (2) the growing similarity of laws, rules, norms, values, and ideas across countries.

FACTORS AFFECTING A NATION’S COMPETITIVENESS

Michael Porter: constitute what is termed the diamond of national advantage. In effect, these attributes jointly determine the playing field that each nation establishes and operates for its industries. These factors are:

diamond of national advantage. a framework for explaining why countries foster successful multinational corporations; consists of four factors—factor endowments; demand conditions; related and supporting industries; and firm strategy, structure, and rivalry. The type of factor are:

Factor endowments. The nation’s position in factors of production, such as skilled labor or infrastructure, necessary to compete in a given industry. Classical economics suggests that factors of production such as land, labor, and capital are the building blocks that create usable consumer goods and services. The supporting infrastructure of a country—that is, its transportation and communication systems as well as its banking system—is also critical. factors of production must be developed that are industry- and firm-specific.

Demand conditions. The nature of home-market demand for the industry’s product or service. Demand conditions refer to the demands that consumers place on an industry for goods and services. Consumers who demand highly specific, sophisticated products and services force firms to create innovative, advanced products and services to meet the demand. This consumer pressure presents challenges to a country’s industries. But in response to these challenges, improvements to existing goods and services often result, creating conditions necessary for competitive advantage over firms in other countries.

Related and supporting industries. The presence or absence in the nation of supplier industries and other related industries that are internationally competitive. Related and supporting industries enable firms to manage inputs more effectively. Related industries offer similar opportunities through joint efforts among firms. In addition, related industries create the probability that new companies will enter the market, increasing competition and forcing existing firms to become more competitive through efforts such as cost control, product innovation

Firm strategy, structure, and rivalry. The conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry. Rivalry is particularly intense in nations with conditions of strong consumer demand, strong supplier bases, and high new-entrant potential from related industries. This competitive rivalry in turn increases the efficiency with which firms develop, market, and distribute products and services within the home country.

Concluding Comment on Factors Affecting a Nation’s Competitiveness

 

ENTRY MODES OF INTERNATIONAL EXPANSION

A firm has many options available to it when it decides to expand into international markets.

1-Exporting

Exporting consist of producing goods in one country to sell in another. This entry strategy enables a firm to invest the least amount of resources in terms of its product, its organization, and its overall corporate strategy.

Benefits Such an approach definitely has its advantages. After all, firms start from scratch in sales and distribution when they enter new markets. Because many foreign markets are nationally regulated and dominated by networks of local intermediaries, firms need to partner with local distributors to benefit from their valuable expertise and knowledge of their own markets. Multinationals also want to minimize their own risk. They do this by hiring local distributors and investing very little in the undertaking.

Risks and Limitations Exporting is a relatively inexpensive way to enter foreign markets. However, it can still have significant downsides. Most centrally, the ability to tailor the firm’s products to meet local market needs is typically very limited. successful distributors shared two common characteristics:

1-They carried product lines that complemented, rather than competed with, the multinational’s products.

2-They behaved as if they were business partners with the multinationals. They shared market information with the corporations, they initiated projects with distributors in neighboring countries, and they suggested initiatives in their own or nearby markets. Additionally, these distributors took on risk themselves by investing in areas such as training, information systems, and advertising and promotion in order to increase the business of their multinational partners.

 

2-Licensing and Franchising

are both forms of contractual arrangements. Licensing enables a company to receive a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable item of intellectual property. a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable intellectual property. Franchising contracts generally include a broader range of factors in an operation and have a longer time period during which the agreement is in effect. a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its intellectual property; franchising usually involves a longer time period than licensing and includes other factors, such as monitoring of operations, training, and advertising.

Benefits In international markets, an advantage of licensing is that the firm granting a license incurs little risk, since it does not have to invest any significant resources into the country itself. In turn, the licensee (the firm receiving the license) gains access to the trademark, patent, and so on, and is able to potentially create competitive advantages.

Risks and Limitations The licensor gives up control of its product and forgoes potential revenues and profits. Furthermore, the licensee may eventually become so familiar with the patent and trade secrets that it may become a competitor; that is, the licensee may make some modifications to the product and manufacture and sell it independently of the licensor without having to pay a royalty fee.

 

3-Strategic Alliances and Joint Ventures

Joint ventures and strategic alliances have recently become increasingly popular. These two forms of partnership differ in that joint ventures entail the creation of a third-party legal entity, whereas strategic alliances do not. In addition, strategic alliances generally focus on initiatives that are smaller in scope than joint ventures.

Benefits: These strategies have been effective in helping firms increase revenues and reduce costs as well as enhance learning and diffuse technologies.

These partnerships enable firms to share the risks as well as the potential revenues and profits. Also, by gaining exposure to new sources of knowledge and technologies, such partnerships can help firms develop core competencies that can lead to competitive advantages in the marketplace.

Risks and Limitations Managers must be aware of the risks associated with strategic alliances and joint ventures and how they can be minimized. First, there needs to be a clearly defined strategy that is strongly supported by the organizations that are party to the partnership. Second, and closely allied to the first issue, there must be a clear understanding of capabilities and resources that will be central to the partnership. Without such clarification, there will be fewer opportunities for learning and developing competencies that could lead to competitive advantages. Third, trust is a vital element. Phasing in the relationship between alliance partners permits them to get to know each other better and develop trust. Without trust, one party may take advantage of the other by, for example, withholding its fair share of resources and gaining access to privileged information through unethical (or illegal) means. Fourth, cultural issues that can potentially lead to conflict and dysfunctional behaviors need to be addressed.

Wholly Owned Subsidiaries

A wholly owned subsidiary is a business in which a multinational company owns 100 percent of the stock. Two ways a firm can establish a wholly owned subsidiary are to (1) acquire an existing company in the home country or (2) develop a totally new operation (often referred to as a “greenfield venture”).

Benefits Establishing a wholly owned subsidiary is the most expensive and risky of the various entry modes. However, it can also yield the highest returns. In addition, it provides the multinational company with the greatest degree of control of all activities, including manufacturing, marketing, distribution, and technology development.

Risks and Limitations As noted, wholly owned subsidiaries are typically the most expensive and risky entry mode. With franchising, joint ventures, or strategic alliances, the risk is shared with the firm’s partners. With wholly owned subsidiaries, the entire risk is assumed by the parent company. The risks associated with doing business in a new country (e.g., political, cultural, and legal) can be lessened by hiring local talent.

Ch8

RECOGNIZING ENTREPRENEURIAL OPPORTUNITIES

entrepreneurship refers to new value creation. Even though entrepreneurial activity is usually associated with start-up companies, new value can be created in many different contexts, including: Start-up ventures, Major corporations, Family-owned businesses, Nonprofit organizations, Established institutions. Entrepreneurship the creation of new value by an existing organization or new venture that involves the assumption of risk.

For an entrepreneurial venture to create new value, three factors must be present—an entrepreneurial opportunity, the resources to pursue the opportunity, and an entrepreneur or entrepreneurial team willing and able to undertake the opportunity. The entrepreneurial strategy that an organization uses will depend on these three factors.

First, Entrepreneurial Opportunities

The starting point for any new venture is the presence of an entrepreneurial opportunity. Where do opportunities come from? For new business start-ups, opportunities come from many sources—current or past work experiences, hobbies that grow into businesses or lead to inventions, suggestions by friends or family, or a chance event that makes an entrepreneur aware of an unmet need. For established firms, new business opportunities come from the needs of existing customers.

changes in the external environment lead to new business creation, they spark creative new ideas and innovation. Businesspeople often have ideas for entrepreneurial ventures. However, not all such ideas are good ideas—that is, viable business opportunities. To determine which ideas are strong enough to become new ventures, entrepreneurs must go through a process of identifying, selecting, and developing potential opportunities. This is the process of opportunity recognition, the process of discovering and evaluating changes in the business environment, such as a new technology, sociocultural trends, or shifts in consumer demand, that can be exploited.

Experienced entrepreneurs discussing ways to look for new entrepreneurial opportunities identify several ways to undertake a structured search for entrepreneurial ideas:

Look at what’s bugging you. What are the frustrations you have with current products or processes? Search for ideas on how to address these annoyances to identify entrepreneurial opportunities.

Talk to the people who know. If you have a general idea of the market you want to go into, talk to suppliers, customers, and front- line workers in this market. These discussions can lead to insights on how these stakeholders’ needs aren’t being met and can also open avenues to hear what they would like to see in new products and processes.

Look to other markets. One of the most powerful ways of finding new ideas is by borrowing ideas from other markets. This could involve looking at other industries or other geographic markets to identify new ideas.

Get inspired by history. Sometimes, the best ideas are not actually new ideas. Opportunities in industries can often be discovered by looking to the past to find good ideas that have slipped out of practice but might now be valued by the market again.

 

 

Second, Entrepreneurial Resources

resources are an essential component of a successful entrepreneurial launch. For start-ups, the most important resource is usually money because a new firm typically has to expend substantial sums just to start the business. However, financial resources are not the only kind of resource a new venture need. Human capital and social capital are also important. Many firms also rely on government resources to help them thrive.

Financial Resources Hand-in-hand with the importance of markets (and marketing) to new venture creation, entrepreneurial firms must also have financing. In fact, the level of available financing is often a strong determinant of how the business is launched and its eventual success. Cash finances are, of course, highly important. But access to capital, such as a line of credit or favorable payment terms with a supplier, can also help a new venture succeed. The types of financial resources that may be needed depend on two factors: the stage of venture development and the scale of the venture. Although bank financing, public financing, and venture capital are important sources of small business finance, these types of financial support are typically available only after a company has started to conduct business and generate sales. Even angel investors private individuals who provide equity investments for seed capital during the early stages of a new venture.

Human Capital Bankers, venture capitalists, and angel investors agree that the most important asset an entrepreneurial firm can have is strong and skilled management. The ability of firms to extend their human capital base to outside partners is an especially important skill in the gig economy. Platform firms in this market will only succeed if they can deliver gig workers who deliver a high quality service.

Social Capital New ventures founded by entrepreneurs who have extensive social contacts are more likely to succeed than are ventures started without the support of a social network Even though a venture may be new, if the founders have contacts who will vouch for them, they gain exposure and build legitimacy faster. Strategic alliances represent a type of social capital that can be especially important to young and small firms. Here are a few types of alliances that have been used to extend or strengthen entrepreneurial firms:

Technology alliances. Tech-savvy entrepreneurial firms often benefit from forming alliances with older incumbents. The alliance allows the larger firm to enhance its technological capabilities and expands the revenue and reach of the smaller firm.

Manufacturing alliances. The use of outsourcing and other manufacturing alliances by small firms has grown dramatically in recent years. Internet-enabled capabilities such as collaborating online about delivery and design specifications have greatly simplified doing business, even with foreign manufacturers.

Retail alliances. Licensing agreements allow one company to sell the products and services of another in different markets, including overseas. Specialty products—the types sometimes made by entrepreneurial firms—often seem more exotic when sold in another country.

Third, Entrepreneurial Leadership

Whether a venture is launched by an individual entrepreneur or an entrepreneurial team, effective leadership is needed. Launching a new venture requires a special kind of leadership. Research indicates that entrepreneurs tend to have characteristics that distinguish them from corporate managers. entrepreneurial leadership, leadership appropriate for new ventures that requires courage, belief in one’s convictions, and the energy to work hard even in difficult circumstances; and that embodies vision, dedication and drive, and commitment to excellence.

Differences include:

Higher core self-evaluation. Successful entrepreneurs’ evidence higher levels of self-confidence and a higher assessment of the degree to which an individual control his or her own destiny.

Higher conscientiousness. Entrepreneurs tend to have a higher degree of organization, persistence, hard work, and pursuit of goal accomplishment.

Higher openness to experience. Entrepreneurs also tend to score higher on openness to experience, a personality trait associated with intellectual curiosity and a desire to explore novel ideas.

Higher emotional stability. Entrepreneurs exhibit a higher ability to handle ambiguity and maintain even emotions during stressful periods, and they are less likely to be overcome by anxieties.

Lower agreeableness. Finally, entrepreneurs tend to score lower on agreeableness. This suggests they typically look out primarily for their own self-interest and also are willing to influence or manipulate others for their own advantage These personality traits are embodied in the behavioral attributes necessary for successful entrepreneurial leadership—vision, dedication and drive, and commitment to excellence:

Vision. This may be an entrepreneur’s most important asset. Entrepreneurs envision realities that do not yet exist. But without a vision, most entrepreneurs would never even get their venture off the ground. With vision, entrepreneurs are able to exercise a kind of transformational leadership that creates something new and, in some way, changes the world. Just having a vision, however, is not enough. To develop support, get financial backing, and attract employees, entrepreneurial leaders must share their vision with others.

Dedication and drive. Dedication and drive are reflected in hard work. Drive involves internal motivation; dedication calls for an intellectual commitment that keeps an entrepreneur going even in the face of bad news or poor luck. They both require patience, stamina, and a willingness to work long hours. However, a business built on the heroic efforts of one person may suffer in the long run. That’s why the dedicated entrepreneur’s enthusiasm is also important—like a magnet, it attracts others to the business to help with the work.

Commitment to excellence. Excellence requires entrepreneurs to commit to knowing the customer, providing quality goods and services, paying attention to details, and continuously learning. Entrepreneurs who achieve excellence are sensitive to how these factors work together. However, entrepreneurs may flounder if they think they are the only ones who can create excellent results. The most successful, by contrast, often report that they owe their success to hiring people smarter than themselves.

 

 

COMPETITIVE DYNAMICS

intense rivalry, involving actions and responses, among similar competitors vying for the same customers in a marketplace. New entrants may be forced to change their strategies or develop new ones to survive competitive challenges by incumbent rivals.

The components of competitive dynamic analysis—new competitive action, threat analysis, motivation and capability to respond, types of competitive actions, and likelihood of competitive reaction.

1-New Competitive Action

Entry into a market by a new competitor is a good starting point to begin describing the cycle of actions and responses characteristic of a competitive dynamic process. new entry is only one type of competitive action. Price cutting, imitating successful product examples of competitive acts that might provoke competitors to react.

There are several reasons: companies launch new competitive actions

1-Improve market position. 2-Capitalize on growing demand. 3-Expand production capacity. 4-Provide an innovative new solution. 5-Obtain first-mover advantages.

2-Threat Analysis

a firm’s awareness of its closest competitors and the kinds of competitive actions they might be planning. Competitive dynamics are likely to be most intense among companies that are competing for the same customers or that have highly similar sets of resource. Two factors are used to assess whether or not companies are close competitors:

Market commonality. Whether or not competitors are vying for the same customers and how many markets they share in common. For example, aircraft manufacturers Boeing and Airbus have a high degree of market commonality because they make very similar products and have many buyers in common.

Resource similarity. The degree to which rivals draw on the same types of resources to compete. For example, Huawei and Nokia are telecommunications equipment providers that are based in different continents and have different histories, but they have patent rights to similar technologies, high quality engineering staffs, and global sales forces.

 

3-Motivation and Capability to Respond

competitors are faced with deciding how to respond. Before deciding, however, they need to evaluate not only how they will respond but also their reasons for responding and their capability to respond. Companies need to be clear about what problems a competitive response is expected to address and what types of problems it might create. There are several factors to consider, First, how serious is the impact of the competitive attack to which they are responding. Companies planning to respond to a competitive challenge must also understand their motivation for responding. What is the intent of the competitive response.

4-Types of Competitive Actions

organization determines whether it is willing and able to launch a competitive action, it must determine what type of action is appropriate. The actions taken will be determined by both its resource capabilities and its motivation for responding. There are also marketplace considerations. What types of actions are likely to be most effective given a company’s internal strengths and weaknesses as well as market conditions?

Two broadly defined types of competitive action include strategic actions and tactical actions. Strategic actions represent major commitments of distinctive and specific resources. Examples include launching a breakthrough innovation, building a new production facility,

Tactical actions include refinements or extensions of strategies. Examples of tactical actions include cutting prices, improving gaps in service, or strengthening marketing efforts. Such actions typically draw on general resources and can be implemented quickly.

 

 

Ch9

ENSURING INFORMATIONAL CONTROL: RESPONDING EFFECTIVELY

TO ENVIRONMENTAL CHANGE:

types of control systems: “traditional” and “contemporary.” As both general and competitive environments become more unpredictable and complex, the need for contemporary systems increases.

1- The traditional approach to strategic control is sequential: (1) strategies are formulated and top management sets goals, (2) strategies are implemented, and (3) performance is measured against the predetermined goal set. Control is based on a feedback loop from performance measurement to strategy formulation. This process typically involves lengthy time lags, Such traditional control systems.  They are most appropriate when the environment is stable and relatively simple, goals and objectives can be measured with a high level of certainty, and there is little need for complex measures of performance. Sales quotas, operating budgets, production schedules, and similar quantitative control mechanisms are typical.

 

2- A Contemporary Approach to Strategic Control

Adapting to and anticipating both internal and external environmental change is an integral part of strategic control. The relationships between strategy formulation, implementation, and control are highly interactive, two different types of strategic control: informational control and behavioral control. Informational control is primarily concerned with whether or not the organization is “doing the right things.” Behavioral control, on the other hand, asks if the organization is “doing things right” in the implementation of its strategy. Both the informational and behavioral components of strategic control are necessary, but not sufficient, conditions for success. Informational control deals with the internal environment as well as the external strategic context. This involves two key issues. First, managers must scan and monitor the external environment, Also, conditions can change in the internal environment of the firm, requiring changes in the strategic direction of the firm.

Contemporary control systems must have four characteristics to be effective:

• The focus is on constantly changing information that has potential strategic importance.
• The information is important enough to demand frequent and regular attention from all levels of the organization.
• The data and information generated are best interpreted and discussed in face-to-face meetings.
• The control system is a key catalyst for an ongoing debate about underlying data, assumptions, and action plans.

THE ROLE OF CORPORATE GOVERNANCE

corporate governance, define it as “the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the CEO), and (3) the board of directors.”

1-The Modern Corporation: The Separation of Owners (Shareholders) and Management

a key feature of the corporate form of business organization—its ability to draw resources from a variety of groups and establish and maintain its own persona that is separate from all of them. corporation is a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. The shareholder are able to participate in the profit of the enterprise without taking direct responsibility for the operations. The management can run the company without the responsibility of personally providing the funds. The shareholders have limited liability as well as rather limited involvement in the company’s affairs.

Agency theory: is concerned with resolving two problems that can occur in agency relationships. The first agency problem that arises (1) when the goals of the principals and agents’ conflict and (2) when it is difficult or expensive for the principal to verify what the agent is actually doing. The second issue is the problem of risk sharing. This arises when the principal and the agent have different attitudes and preferences toward risk. The executives in a firm may favor additional diversification initiatives because, by their very nature, they increase the size of the firm and thus the level of executive compensation. top-level managers engage in actions that reflect their self-interest rather than the interests of shareholders.

2-Governance Mechanisms: Aligning the Interests of Owners and Managers

the owners can implement some governance mechanisms. First, there are two primary means of monitoring the behavior of managers. These include (1) a committed and involved board of directors that acts in the best interests of the shareholders to create long-term value and (2) shareholder activism, wherein the owners view themselves as shareowners instead of shareholders and become actively engaged in the governance of the corporation.

-The key issue is what implications CEO duality has for firm governance and performance.

A Committed and Involved Board of Directors The board of directors acts as a fulcrum between the owners and controllers of a corporation. The directors are the intermediaries who provide a balance between a small group of key managers in the firm based at the corporate headquarters and a sometimes-vast group of shareholders.

Shareholder Activism As a practical matter, there are so many owners of the largest American corporations that it makes little sense to refer to them as “owners” in the sense of individuals becoming informed and involved in corporate affairs. individual shareholder has several rights, including (1) the right to sell the stock, (2) the right to vote the proxy (which includes the election of board members), (3) the right to bring suit for damages if the corporation’s directors or managers fail to meet their obligations, (4) the right to certain information from the company, and (5) certain residual rights following the company’s liquidation

Managerial Rewards and Incentives incentive systems must be designed to help a company achieve its goals. From the perspective of governance, one of the most critical roles of the board of directors is to create incentives that align the interests of the CEO and top executives with the interests of owners of the corporation—long-term shareholder returns. Shareholders rely on CEOs to adopt policies and strategies that maximize the value of their shares.

Ch10

 

TRADITIONAL FORMS OF ORGANIZATIONAL STRUCTURE

Organizational structure refers to the formalized patterns of inter actions that link a firm’s tasks, technologies, and people. Structures help to ensure that resources are used effectively in accomplishing an organization’s mission.

1- Patterns of Growth of Large Corporations: Strategy-Structure Relationships A firm’s strategy and structure change as it increases in size, diversifies into new product markets, and expands its geographic scope. This structure enables the firm to group its operations into functions, departments, or geographic areas. A strategy of related diversification requires a need to reorganize around product lines or geographic markets. This leads to a divisional structure.

2- Simple Structure

The simple organizational structure is the oldest, and most common, organizational form. Most organizations are very small and have a single or very narrow product line in which the owner-manager (or top executive) makes most of the decisions. The owner-manager controls all activities. Advantages The simple structure is highly informal, and the coordination of tasks is accomplished by direct supervision. Characteristics of this structure include highly centralized decision making, little specialization of tasks. Disadvantages A simple structure may foster creativity and individualism since there are generally few rules and regulations. However, such “informality” may lead to problems. Employees may not clearly understand their responsibilities, which can lead to conflict and confusion.

3- Functional Structure

When an organization is small it is not necessary to have a variety of formal arrangements and groupings of activities. as firms grow, excessive demands may be placed on the owner-manager in order to obtain and process all of the information necessary to run the business. Functional structures are generally found in organizations in which there is a single or closely related product or service, high production volume, and some vertical integration. Advantages a firm is able to enhance its coordination and control within each of the functional areas. Decision making in the firm will be centralized at the top of the organization. Disadvantages The differences in values and orientations among functional areas may impede communication and coordination.

4-Divisional Structure

The divisional organizational structure sometimes called the multidivisional structure is organized around products, projects, or markets. Each of the divisions, in turn, includes its own functional specialists who are typically organized into departments. Advantages By creating separate divisions to manage individual product markets, there is a separation of strategic and operating control. Divisional managers can focus their efforts on improving operations in the product markets for which they are responsible, Disadvantages It can be very expensive; there can be increased costs due to the duplication of personnel, operations, and investment since each division must staff multiple functional departments. Divisional managers are often evaluated on common measures such as return on assets and sales growth.

5-Matrix Structure

an organizational form in which there are multiple lines of authority and some individuals report to at least two managers. Advantages The matrix structure facilitates the use of specialized personnel, equipment, and facilities. Such resource sharing and collaboration enable a firm to use resources more efficiently and to respond more quickly and effectively to changes in the competitive environment. Disadvantages The dual-reporting structures can result in uncertainty and lead to intense power struggles and conflict over the allocation of personnel and other resources. Working relationships become more complicated.

 

 

 

 

 

BOUNDARYLESS ORGANIZATIONAL DESIGNS

The Modular Organization

The modular organization outsources nonvital functions, tapping into the knowledge and expertise of “best in class” suppliers, but retains strategic control. Outsiders may be used to manufacture parts, handle logistics, or perform accounting activities. chain can be used to identify the key primary and support activities performed by a firm to create value: Which activities do we keep in- house and which activities do we outsource to suppliers?

In a modular company, outsourcing the noncore functions offers three advantages:

1. A firm can decrease overall costs, stimulate new product development by hiring suppliers with talent superior to that of in-house personnel, avoid idle capacity, reduce inventories, and avoid being locked into a particular technology.
2. A company can focus scarce resources on the areas where it holds a competitive advantage. These benefits can translate into more funding for R&D to hire the best engineers and for sales and service to provide continuous training for staff.
3. An organization can tap into the knowledge and expertise of its specialized supply chain partners, adding critical skills and accelerating organizational learning.

The Virtual Organization

The virtual organization can be viewed as a continually evolving network of independent companies—suppliers, customers, even competitors—linked together to share skills, costs, and access to one another’s markets. The members of a virtual organization, by pooling and sharing the knowledge and expertise of each of the component organizations. Virtual organizations need not be permanent, and participating firms may be involved in multiple alliances may involve different firms performing complementary value activities or different firms involved jointly in the same value activities, such as production.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

organizational structure refers to the formalized patterns of interactions that link a firm’s tasks, technologies, and people.3 Structures

help to ensure that resources are used effectively in accomplishing an organization’s mission. Structure provides a means of balancing

two conflicting forces: a need for the division of tasks into meaningful groupings and the need to integrate such groupings in order to ensure efficiency and effectiveness.4 Structure identifies the executive, managerial, and administrative organization of a firm and indicates responsibilities and hierarchical relationships. It also influences the flow of information as well as the context and nature of human interactions. Thus a structure formally links

• Tasks

• Technologies
• People

• To implement strategy successfully, firms must have appropriate organizational designs.
• Structures help to ensure that resources are used effectively in accomplishing an organization’s mission.
• Structure provides a means of balancing two conflicting forces: a need for the division of tasks into meaningful groupings, and the need to integrate such groupings in order to ensure efficiency and effectiveness.
• Structure identifies the executive, managerial, and administrative organization of a firm and indicates responsibilities and hierarchical relationships.
• It also influences the flow of information as well as the context and nature of human interactions.

The Divisional Structure

Divisional structure is an organizational from in which products, projects, or product markets are grouped internally. Its sometimes called the multidivisional structure or M-Form. Each of the divisions includes its own functional specialists who are typically organized into departments.

Advantages

By creating separate divisions to manage individual product markets, there is a separation of strategic and operating control.

• Divisional managers can focus their efforts on improving operations in the product markets for which they are responsible.
• Corporate officers can devote their time to overall strategic issues for the entire corporation.
• Divisional structure provides the corporation with an enhanced ability to respond quickly to important changes.
• The problems associated with sharing resources across functional departments are minimized.
• The development of general management talent is enhanced.

Disadvantages

It can be very expensive; there can be increased costs due to the duplication of personnel, operations, and investment.

• There also can be dysfunctional competition among divisions since each division tends to become concerned solely about its own operations.
• If goals are conflicting, there can be a sense of a “zero-sum” game that would discourage sharing ideas and resources among the divisions.
• There is the chance that differences in image and quality may occur across divisions.
• There is an urge to focus on short-term performance since each division is evaluated in terms of financial measures such as return on investment and revenue growth.
• (Examples are individualized)

 

Question Six

Critically explain a traditional approach and contemporary to strategic control. You need to draw the relevant diagram

Proposed Answer:

A traditional approach to strategic control is sequential method in which: (1) strategies are formulated and top management sets goals, (2) strategies are implemented, and (3) performance is measured against the predetermined goal set.

 

• Control is based on a feedback loop from performance measurement to strategy formulation. This process typically involves lengthy time lags, often tied to a firm’s annual planning cycle. Vertical integration is an expansion or an extension of the firm by integrating preceding or successive production processes. Briefly list the benefits and risks of vertical integration and provide an example of a vertical integration.

 

• Benefits:

     –     A secure source of raw materials or distribution channels.

 

• Protection of and control over valuable assets.
• Proprietary access to new technologies developed by the unit.
• Simplified procurement and administrative procedures

 

    Risks:

 

• Costs and expenses associated with increased overhead and capital expenditures.

 

• Loss of flexibility resulting from large investments.

 

• Problems associated with unbalanced capacities along the value chain.
• Additional administrative costs associated with managing a more complex set of activities.

 

 

A contemporary approach to Strategic Management

 

• The contemporary approach to strategic controls allows managers to adapt to and anticipate changes in both the internal and external environment.
• The relationships between strategy formulation, implementation, and control are highly interactive.
• This approach utilizes two different types of strategic control: informational control and behavioral control.

 

 

Informational control is primarily concerned with whether or not the organization is obtaining the best fit between its goals and strategies and the external strategic environment: Is the organization “doing the right things,” given the external situation and the internal capabilities of the organization?. Informational control deals with the internal environment as well as the external strategic context. It addresses the assumptions and premises that provide the foundation for an organization’s strategy. Do the organization’s goals and strategies still “fit” within the context of the current strategic environment? Depending on the type of business, such assumptions may relate to changes in technology, customer tastes, government regulation, and industry competition.

Behavioral control, on the other hand, is a mechanism for making sure the employees of the firm are doing things correctly while implementing strategy: Are the employees “doing things right”? Both the informational and behavioral components of strategic control are necessary, but not sufficient, conditions for success. What good is a well-conceived strategy that cannot be implemented? Or what use is an energetic and committed workforce if it is focused on the wrong strategic target?

Behavioral control is focused on implementation—doing things right. Effectively implementing strategy requires manipulating three key control “levers”: culture, rewards, and boundaries. There are two compelling reasons for an increased emphasis on culture and rewards in a system of behavioral controls. First, the competitive environment is increasingly complex and unpredictable, demanding both flexibility and quick response to its challenges. As firms simultaneously downsize and face the need for increased coordination across organizational boundaries, a control system based primarily on rigid strategies, rules, and regulations is dysfunctional. The use of rewards and culture to align individual and organizational goals becomes increasingly important.

Second, the implicit long-term contract between the organization and its key employees has been eroded. Today’s younger managers have been conditioned to see themselves as “free agents” and view a career as a series of opportunistic challenges. As managers are advised to “specialize, market yourself, and have work, if not a job,” the importance of culture and rewards in building

organizational loyalty claims greater importance.

Each of the three levers—culture, rewards, and boundaries—must work in a balanced and consistent manner. In the contemporary approach, information control is part of an ongoing process of organizational learning that continuously updates and challenges the assumptions that underlie the organization’s strategy. In such “double-loop” learning, the organization’s assumptions, premises, goals, and strategies are continuously monitored, tested, and reviewed. The benefits of continuous monitoring are evident – time lags are dramatically shortened, changes in the competitive environment are detected earlier, and the organization’s ability to respond with speed and flexibility is enhanced.

Contemporary control systems must have four characteristics to be effective:9

1. The focus is on constantly changing information that has potential strategic importance.
2. The information is important enough to demand frequent and regular attention from all levels of the organization.
3. The data and information generated are best interpreted and discussed in face-to-face meetings.
4. The control system is a key catalyst for an ongoing debate about underlying data, assumptions, and action plans.

 

 

(Students need to draw the diagram)

 

 

Question 7: What is the role of corporate governance in contemporary control system?

Answer:

the issue of strategic control in a broader perspective, typically referred to as “corporate governance.” Here we focus on the need for both shareholders (the owners of the corporation) and their elected representatives, the board of directors, to actively ensure that management fulfills its overriding purpose of increasing long-term shareholder value. Corporate governance is defined as as “the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the CEO), and (3) the board of directors.”

Good corporate governance plays an important role in the investment decisions of major institutions, and a premium is often reflected in the price of securities of companies that practice it.

The need for sorporte governanace mechanisms stems from Agency theory is concerned with resolving two problems that can occur in agency relationships. The first is the agency problem that arises (1) when the goals of the principals and agents conflict and (2) when it is difficult or expensive for the principal to verify what the agent is actually doing.

Governance Mechanisms: Aligning the Interests of Owners and Managers

A key characteristic of the modern corporation is the separation of ownership from control. To minimize the potential for managers to act in their own self-interest, or “opportunistically,” the owners can implement some governance mechanisms. First, there are two primary means of monitoring the behavior of managers. These include (1) a committed and involved board of directors

that acts in the best interests of the shareholders to create long-term value and (2) shareholder activism, wherein the owners view themselves as shareowners instead of shareholders and become actively engaged in the governance of the corporation. Finally, there are managerial incentives, sometimes called “contract-based outcomes,” which consist of reward and compensation agreements. Here the goal is to carefully craft managerial incentive packages to align the interests of management with those of the stockholders

The board of directors acts as a fulcrum between the owners and controllers of a corporation. The directors are the intermediaries who provide a balance between a small group of key managers in the firm based at the

corporate headquarters and a sometimes vast group of shareholders.

Shareholder activism refers to actions by large shareholders, both institutions and individuals, to protect their interests when they feel that managerial actions diverge from shareholder value maximization. Many institutional investors are aggressive in protecting and enhancing their investments. They are shifting from traders to owners.

They are assuming the role of permanent shareholders and rigorously analyzing issues of corporate governance. In the process they are

reinventing systems of corporate monitoring and accountability.

Managerial Rewards and Incentives As we discussed earlier in the chapter, incentive systems must be designed to help a company

achieve its goals.86 From the perspective of governance, one of the most critical roles of the board of directors is to create incentives that

align the interests of the CEO and top executives with the interests of owners of the corporation—long-term shareholder returns. Shareholders rely on CEOs to adopt policies and strategies that maximize the value of their shares. A combination of three basic policies may create the right monetary incentives for CEOs to maximize the value of their companies:

1. Boards can require that the CEOs become substantial owners of company stock.
2. Salaries, bonuses, and stock options can be structured so as to provide rewards for superior performance and penalties for poor

performance.

3. Dismissal for poor performance should be a realistic threat.