PIMS

Basic

80% of the difference in ROI = ƒ the characteristics of

Served Market

Business

Competition

20% = ƒ of skill or luck

More important to do the right thing than to do it well.

Nine Influences constitute most of the 80% (in order of importance)

Investment intensity

negative %ROI & Cash Flow

High amount of value over cost of material/components per employee

more profitable

Share of served market

has positive impact on profit & net cash flow

Growth of served market

Favorable to $ measure of profit

Indifferent to % measure of profit

Negative to all measure of net cash flow

Favorable customer evaluation of product/service package to that of competitors

Favorable impact on all measures of financial performance.

Extensive actions (Aggressive Market Strategies) taken by a business

In the areas of

New product introduction

R&D

Marketing effort

Generally produce positive effect if business has a strong market position to begin.

Verticle Integration

Favorable in mature, stable markets

Unfavorable in growing, declining, otherwise changing

Cost Increases

Complex

Depends on:

The current direction of change of any of the above factors

usually has the opposite effect on

Good operating management

A favorable factor

When the fundamentals change

Profitability & net cash flow move in the direction of the norm of the new position

Performance moves toward the norm for its fundamentals

Cost of making a move vs the benefits of having made it.

Pamphlets

could cross reference

Strategic Determinants of Cash Flow

Generation of Cash Flow
Long term:
Market Share +
Investment Intensity -
Short term:
Rate of new products -
Mkt expense growth -
--------------------------------------------
Use of Cash Flow
Real Mkt growth -
Selling price growth -
% change in share -
point ∆ in inv/sales -

Business Portfolio

Mature Business Trap

New High growth area with no prior experience

Resource Drain: Old to new

Old becomes weak

Back to Basics

Corp Strength

Balance Resources

Slow growth : generates resources

Rapid growth: utilizes

Realistic Projections

Effective Monitoring of Progress

Surprise

∆ of portfolio role: from user to generator

Morale : impact of these labels

Relatedness (Diversification Mgt)

Buys from/sells to: no impact

Shares production facilities: only consumer products

Same customers : only consumer products more profitable

Shared marketing pgms: only consumer products more profitable

Marketing (cross Ref to Mkt Folder)

Market Position: Build, Hold or Harvest #3

Some of the major considerations which should be kept in mind while planning a mkt share strategy
Served market=the specific segment of the total business which is making a serious competitive attempt, by offering a product or service that is suitable for that segment and by addressing its maketing effort to that segment.

Positive Relationship between Market Share and ROI

Strong market position achieved by

Becoming large

Segmenting your market

Selecting an attractive portion of the total potential market for special emphasis

& by concentrating your efforts and resources on that portion

winning a larger % of the segment than you previously had of the market as a whole

Why does Market Position Improve Profitability

Economies of Scale

The Experience Curve

Bargaining Power

Where Strong Position is Especially Valuable

High market growth rate

Early in the industry life cycle

Technology requires a high degree of verticle integration (ratio of make/buy)

Employees not highly unionized

Lack patent protection

Distribution requires high market expense

If position is weak

Minimize R&D efforts

Avoid expensive marketing approaches

Keep capacity loaded

Be cautious with verticle integration investments

Be an adroit follower

What to Do?

The cost/benefits of increments of added position must be weighted.

The cash cost of improving market position is steep when:

Market is growing rapidly

Attempt to do it by discounting

Initial product line is standard or substandard

If the cost/benefit ratio for building market share is

Favorable

Do it

Unless an even better investment elsewhere & not enough cash for both

Unfavorable

Investigate the possibility of harvesting

Exchanging points of the market share for higher short term cash flow/profits

Pricing High, Spending Low or Both

The conditions that make harvesting likely to be productive

A mature (but not declining market)

At least averge product quality (relative to the three largest competitors)

Equal or high current relative price.

Determining an appropriate market-share strategy comes down to a matter of careful calculation

Aggressive expansion

How?

How Much?

Harvest

How?

How much?

Hold

Until something important changes drastically

Careful calculation is most urgently required

Signal conflict

Fairly extensive restructuring is indicated

swapping a large number of weak position for a few more concentrated.

The overall company has a cash or profit problem

needs to sacrifice some individual businesses diliberately

WHERE & HOW LARGE?

Market Share Strategy: Beliefs vs Actions #9

Beliefs

about Large Share Firms

Find it easy to gain additional share

Possess advantages in

Resource Availability

Strategic position

Visibility

In Rapid Growth markets

Should pursue a share gaining strategy

about Weak Share Firms

Observed Behavior

Large share lose share in rapid growth

Large share fare worse in negative mkt growth situations

Causes

Short time horizon

Management by exception

May fear wreaking havoc in the market

Need a strong corp strategy

Should couple strategy with reward system to induce managers to follow that strategy

The Dispute About High-Share Businesses #19

Conclusion

The higher profitability of high share businesses does not come from

higher prices but does come from lower costs.

See Discussion that could be used in antitrust studies

Product Quality #4

How to Measure - see p11

Superior, Equilavent, Inferior to those of leading competitors

What % of its total dollar sales falls into each category

Quality Index = % Superior less the % inferior

Characteristics of the … to the customer

Object or substance sold

but also Service rendered

speed of delivery

application

Businesses selling Hi quality products & services are generally more profitable

than those with lower quality offering

Impact is greatest at the extremes

High share & high quality usually go together but the correlation is not perfect

High quality seems to pay off in terms of ROI in virtually all circumstances

Almost all kinds of products & Market situations

Businesses with high quality products tend to gain share

especially in markets that are growing slowly.

Quality leaders usually entered their markets early and

frequently were pioneers in developing them

Result of innovation

Quality Improvement usually leads to increased market share, but

at a cost in terms of reduced short term profitability

High Quality producers usually charge premium prices.

These businesses can typically attain greater growth, however, by combining

premium quality with

moderate price premium

over major competitors

Pricing High Quality Products #5

High product quality leads to higher gains in market share regardless of pricing

Lower Pricing allows quality to be translated into greater market share gains

There in no profit penalty if prices are low

The Value of Value

Caveats

When Value Helps #18

Value (determined by the competition)

Actual Quality > the quality expected for a given price

Actual Price is below the expected price for a given level of quality.

Under certain cirmustances it is particularly important

Value & the product life cycle

Benefits come in the middle to late stages of PLC

or Slow growth markets

Late Entrants must offer value

Value is particularly helpful to those with Weak Share

Value helps to offset Capital Intensity

The Robustness of Value

Must weigh the costs & benefits since value is a strategic characteristic

How Price Premiuns and Discounts Affect Performance #7

Intro

The level of price relative to competition has little to do with the tradeoff between

New product introductions, marketing expenditures and R&D directed at product quality are all ways to gain market share at the expense of current profits. But relative price is not.

current profits and market share gains

For Some businesses … is right (higher profits & mkt share gains)

Premium - Price Strategy

Discount-price strategy

Opportunities for Premium Pricing

Heavy spending on advertising and promotion

Distinctive product line

High finished goods inventory

Opportunities for Discount Pricing

Little or no unionization

High product quality

Opportunities for Price Differentiation (avoid equivalent price when)

Strong market position

Late market entry

Commodity product

Brand Awareness and Profitability #24

The connection between BA and ROI

Improved BA creates an improved potential for market share.

Higher MS creates a potential for higher ROI

Scale

Learning Curve

Bargaining Power

Brand Awareness and Market Share are positively correlated

Study revealed a 1 to 1 correlation

Exceptions

Companies that reported a significant number of related products for a given market

tended to have a higher awareness than market share

At the extreme this seep6 for opp

How to increase Brand awareness

Aggresive (Above-Par) Marketing efforts relative to competitors

The decay factor

Awarness, like market share, tends to decay

See dynamics p 7.Leaders

Advertising & Promotion appear to be effective

Converting BA into MS

Benefits

Higher Ms = higher roi

Leads to higher BA that presents the opportunity for future gains in BA

Firms that failed to convert tended to experience a decline in BA

Factors associated with The conversion

Having or developing adequate manufacturing capacity

Building a differentiation of product and business characteristics from competition

Product quality

Breadth of product line

Tactical efforts

Implications & guidance

For businesses that want to "build" (expand their market position)

For businesses that want to "Harvest"

Observation

Many businesses with strong market positions understress their mkt efforts

How Much R&D to Spend #13

Observations

0, .4, 1.2, 2.2, 3.9% and above

Many businesses have R&D levels that depress ROI without producing offsetting gains in market share.

High R&D spenders are generally less profitable than moderate R&D spenders.

Frequently have other characteristics which in turn cause low ROI

Normal Spending

Factors Normally Low Normally High
Avg .5% of sales Avg 4% of sales
---------- ---------- ----------
Lifecycle Stage Mature Growth
Real Market Growth Average > Average
Vertical Integration Low > Average
Investment Intensity < Average > Average
New-Product Introductions Average High
New Products Relative
to Competitors < Average High
Market Share Average > Average

Determined by businesses in similar circumstances

It is not relative to competitors

Overspending : 1% of sales or more

Underspending: 1% of sales or more

R&D Spending Strategies

Deliberate overspending

Focused on creating :

Deliberate Underspending

Managers are unwilling to forego current profits.

Managers have taken advantage of opportunities to

increase quality

or reduce cost without the aid of R&D

See p 6

Both can work. However several factors affect the likelihood of success.

Overspending is a risky strategy for weak mkt share businesses.

New Product Introductions

New Products are important tools for a strategy of building market share.

Underspending can be successful and cheap way to gain share if

there is a source of new-product ideas other than R&D

Copying

Market Research

Overspenders

Are less dependent upon

the absolute level of new products

at least partly because

their more aggressive stratey includes

higher (and rising) levels of marketing

and partly because their

more intense R&D efforts

result in

innovative products that are not easily copied.

Growth Markets

Guidelines on spending

Normal Spending is usually the best strategy

If possible, it may be more profitable to copy than to innovate

Market-share growth is hurt by an underspending strategy if there is no alternative source of new products

High share businesses risk less by overspending than do low-share businesses

Growth markets are less favorable to overspending than stable or contracting markets

Entry of New Competitors: How safe is your industry? #17

Competition is attracted to

Industry growth

Incumbent profitability

Popular barriers are often not deterrants

Industry concentration

Advertising intensity

Investment intensity

The Unprofitability of "Modern" Technology and What to Do About it #2

Investment intensity has a negative impact on profits in relation to both:

investment

sales

The major reasons lies in the :

changed competitive climate produced by such technology

inability to realize savings in labor and other costs.

Market strategies that will minimize the damage or in $ terms make the inv. int. move more profitable.

Concentrate on served market to obtain high share.

Having a wider product line than competitors.

Obtain adequate productivity improvement for the increased investment.

Good Productivity vs Bad Productivity (Value Added per employee) #11

Observations

ROI Increases as Value added per employee increases

ROI declines as Investment/value added increases

Value Added per employee is essentially flat as Investment/value added increases

Value Added per employee increases as Investment per employee increases.

Bad productivity

is that which costs too much.

Increases in investment without substantially reducing labor intensity

Good productivity

Increase in labor productivity without much increase in investment

by such devices as improved morale

improved employee training

improved work practices

Need to focus on reducing the labor content of value added.

Productivity Benchmarks #21

Picture

Intro

Simple or partial measures often miss key aspects of productivity & can lead to

Partial Productivity Ratios

Physical Measures of Output

Ratio of Outputs in physical terms ÷ Inputs in physical terms

Unit measures are not comparable over time.
It omits the marketing and finance perspectives:
What do customers want?
What are they willing to pay and pay for?
It tends to turn the product line away from differentiated, high value added, high margin products to low margin, commodity products.
The linkage between strategy & functional operating plans tend to become uncoupled.

One should not let a focus on physical productivity lead to operating or product-mix decisions that cause prices or margins to fall.

Value Measures of Output

Labor Productivity = Value Added÷#of Employees

Capital Productivity = Pretax Income ÷ Investment

Pretax income ÷ Value added

Whats wrong with partial measures

They do not indicate the productivity or effectiveness of a particular input

Total Factor productivity ratios

difficult to interpret

difficult to implement

What is needed is a benchmark

Labor-productivity benchmark that take capital inputs and other relevant factors fully into account.

Need a benchmark of value added per employee that reflects

the amount of value added that is "normal" given

Level & composition of investment per employee

The strategic position of the business.

The most powerful determinants of output per employee are

Factors Impact
------------------ ----------
• Fixed Capital / Employee (+)
• Working Cap / Employee (+)
• Capacity Utilization (+)
• Market Share &
Relative Market Share (+)
• % of Employees Unionized (-)
• % of Sales from
New Products (-)
• Customized Products (+)
• Real Market Growth (+)
• Total Employee Cost
per Employee (+)
(A measure of human capital
after accounting for the effects of
the above factors

The level & mix of capital per employee

Plant & equipment per employee

Working capital

Relative market share

The positive effect of investment on value added is greater when market share is

large than when it is small

What form should productivity improvement take

A measure of operating effectiveness relative to other businesses

Distributions

Low to High PAR

Above or Below Par

Separating Actual Value added into its "par" & "difference from par" components

helps indicate the kinds of action that management should take to

improve labor productivity

Traditional shop level productivity

Improve managerial effectiveness

Worker Motivation

Strategic Fundamentals

Any Labor Productivity Ratio Should Be Assessed Against a Benchmark that reflects Capital Inputs.

Union and Profits #6

High union (above 35%) businesses suffer in their profitability by being

relatively less productive.

What to do:

Don't automatically raise investment intensity

Invest selectively in those areas where

even with a reduced % ROI

the $ amount will go up.

Bargain harder on matters relating to productivity.

Social Benefit and Profitability #16

Intro

Highly profitable businesses tend to confer more "social benefits" than less profitable ones.

When there is a conflict between social benefit and private profitability

deconcentration may aggravate the conflict rather than ease.

Social Benefit Index

Customers

High Product Quality

Low Prices

Low rate of price increase

Employee

High Wages

High Salaries

Community at large

High Industry Growth Rate

High R&D/Sales

Private Benefit Index

Return on Investment

Rate of Sales Growth

Harmony of Interest

High Market Share

Growing labor productivity

Conflict of Interest

High Investment Intensity

High R&D Spending

Opportunities for more harmony

The Need for "Social Benefit Action"

Government encouragement of concentration

Recession: Who gets hurt? How to Cope? #14

Defined

For a particualr served market

Mild 4-10% below its long term trend line

Severe >10%

There need not be an actual decline in volume

Who Gets Hurt?

Everyone

Some worse than others

because

The dip in their own specific market is more severe than the average and/or

Given the magnitude of the dip, the profit damage is more severe than average

Businesses which are already weak in some major respect suffer the most severe further damage

Low market share

Low product quality

Low labor productivity

High Investment Intensity

Highly vertically integrated business suffer less than thinly integrated ones

The time to guard against recession damage is before the recession starts

How to Cope?

Actions taken during the recession

In many areas of cost and investment cut back roughly proportional to volumne

Marketing Expense

R&D Expense

Inventories

Receivables

The wisest thing to do is to overreact rather than underreact

Cutbacks don't damage the business.

Decision Areas:

Don't cut prices to protect volumne. Retain competitive pricing position

Don't cut product quality or service.

Introduce new products if recession is mild

Cut the work force to a degree roughly proportional to the decline in volumne

Opportunities

May be a time to accomplish some long-term good for the business.

To do some pruning that would probably be a good idea anyway.

Reducing inventories proportional to volumne reduction plus a little.

Value added per employee

Marketing/Sales

Percentage of products inferior to competition.

However not the time to keep going with long-term plans and damn the torpedos

An Important Warning

Consider the impact of actions on customer service

Impact on cash flow

Inflation:

Inflation & ROI#22

How Inflation Distorts ROI

Fixed Capital

Inventories

The Magnitude of Distortion

What Strategic Diference does it make?

Conclusions

Coping With Double-Digit Inflation#23

Appearance vs Reality

Who Beats Inflation

Some Get Caught Unaware

…But Strategy Change is not the answer

How To Adapt

Improving Productivity

Profitable Productivity

Recommended Steps

How Price Controls Affect Business

Measurements

Performance Measures

Discounted Net Income

Discounted Cash Flow

Discounted Cash Flow Yield rate

Average Return on Investment

Discounted Cash Flow plus residual

ROI

Pre-tax net income ÷

including special non-recurring costs

minus corporate overhead costs

Average Investment

including fixed and working capital at book value

but excluding corp investment not particular to this business

Factors

Industry Growth -long run SIC (10 years)

Real Market Growth (short run)

Industry Concentration Ratio

Revenues of 4 largest firms ÷ total industry

Immediate Customer Fragmentation

Total # of immediate customers accounting for 50% of total sales.
Example: if 5 of 100 customers represent 50% then the % is 5

Purchase Amount of Immediate Customers

Market Positions

Market Share

Relative Market Share

Market Share Instability

Averge percent difference from trend

Selling Price Growth Rate

Price Relative to Competion

Standard vs Customized (designed to order) Products/Services

Relative Product Qualtity

Market Expense ÷ Sales

New products sales ÷ total sales

R&D Expense ÷ Sales

Investment intensity index a factor combining

Investment ÷sales

Investment may be measured in any of the following ways

Net book value of P&E + Working Capital

Equity Plus long term debt

Total assets employed minus current liabilites attributed to the business

Investment ÷adjusted value added

Value Added - .5(Net income-Pims Mean Roi* Investment)

Fixed Capital Intensity

Gross Book Value of plant & equipment ÷

Original Value of buildings, real estate, manufacturing & trans equip

Sales

Newness of Plant & Equipment (NBV÷GBV)

Capacity Utilization

Average % of standard capacity utilized during the year

Standard Capacity

Sales Value of maximum output this business can sustain with

Facilities normally in operation

For mfg this in normally 2shifts, 5 days per week

For process businesses 3 shifts, 6 days per week

Current constraints

Technology

Work Rules

Labor Practices

Inventory ÷ Sales

net of reserve for losses

Vertical Integration

Relative Backward Integration

Relavtive Fowared Integration

Relative Compensation

Employee unionzed %

Value Added per employee

Investment per employee

Fifo Valuation