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THE PROCESS OF STRATEGIC MANAGEMENT

ENVIRONMENTAL SCANNING
  EXTERNAL THREATS & OPPORTUNITIES
      MACRO (Society), TASK (Industry), COMPETITIVE
  INTERNAL STRENGTHS & WEAKNESSES
      RESOURCES, STRUCTURE, FINANCIAL PERFORMANCE TRENDS


STRATEGY FORMULATION
  MISSION
  OBJECTIVES
  STRATEGIES

IMPLEMENTATION
  BUDGETS
  ASSIGNMENTS
  TACTICAL PLANS

EVALUATION & CONTROL
  CRITERIA & ASSESSMENT TOOLS
  REPORTS & FEEDBACK DEVICES
  ADJUSTMENT MECHANISMS
THE MACRO ENVIRONMENT
                          (PEST)

POLITICAL
  SUPPORTS                 GOVERNMENT STABILITY
  CONTROLS                 ANTI-TRUST, EPA, TAX LAWS
  PENDING LEGISLATION      ATTITUDES TOWARD FOREIGN FIRMS

ECONOMIC
  INFLATION                INTEREST RATES
  UNEMPLOYMENT             ENERGY AVAILABILITY & COST
  DISPOSABLE INCOME        PRODUCTIVITY, GROWTH, GDP

SOCIO-CULTURAL
  GEOGRAPHIC SHIFTS        CONSUMER ACTIVISM
  CUSTOMS & VALUES         LIFESTYLE CHANGES
  DEMOGRAPHICS             BIRTHRATES & LIFE EXPECTANCIES

TECHNOLOGICAL
  BASIC RESEARCH           R & D SPENDING (Gvmt & Industry)
  NEW PRODUCTS/SERVICES    PATENT PROTECTION
  PROCESS IMPROVEMENTS     COMPUTER HACKING
EIGHT SOCIO-CULTURAL TRENDS IN
                   NORTH AMERICA
ENVIRONMENTAL AWARENESS
   Conservation, Recycling, Landfills
GROWING HEALTH CONSCIOUSNESS
   Personal Fitness, Nutrition, Genetically Altered Foods, AIDS & Bird Flu
BABY BOOMERS NEAR RETIREMENT (77 Million)
   Companionship, Pets, Retirement Communities, Vacations, Senior Services
IMPACT OF “GENERATION Y” BOOMLET (70 Million)
   Born between 1978 and 1994, Crowded Schools, Youth Markets
DECLINING MASS MARKET
   Customized, Targeted - no generic products, Cars to Magazines
CHANGING PACE AND LOCATION OF LIFE
   Instant Communication (e-mail, computers, etc), Telecommuting Possibilities
 CHANGING HOUSEHOLDS
   Singles, Partners, Couples with no Children (DINKS)
INCREASING DIVERSITY OF WORKFORCE AND MARKETS
   Growth of Hispanic and Asian Groups, Immigrants (legal and illegal)
RECENT BREAKTHROUGH DEVELOPMENTS IN
                 TECHNOLOGY
PORTABLE INFORMATION DEVICES AND NETWORKING
  Connectivity, Phones, TVs, Stereos, and Computers becoming obsolete

FUEL CELLS AND ALTERNATIVE ENERGY SOURCES
  Wind, Geothermal, Hydroelectric, Solar, Biomass – 30% by 2010

PRECISION FARMING
  Corporate Farming, Computerized Crop Management

VIRTUAL PERSONAL ASSISTANTS
   Smart computers that monitor e-mail, voice mail, can write letters, etc.

GENETICALLY ALTERED ORGANISMS
  Plants and animals that are resistant to disease, grow faster, yield more

SMART MOBILE ROBOTS
  Perform sophisticated factory work, do housework, assist the disabled
THE INTERNATIONAL DIMENSION TO THE MACRO
          (SOCIETIAL) ENVIRONMENT
POLITICAL
  POLITICAL IDEOLOGY         REGULATION OF FOREIGN OWNERSHIP
  GOVERNMENT STABILITY       STRENGTH OF OPPOSITION GROUPS
  PROTECTIONIST SENTIMENT    TERRORIST ACTIVITY
  LEGAL SYSTEM               FOREIGN POLICIES

ECONOMIC
  ECONOMIC DEVELOPMENT       PER CAPITA INCOME & WAGE LEVELS
  UNEMPLOYMENT LEVELS        GDP TRENDS
  CURRENCY CONVERTIBILITY    OUTSOURCING CAPABILITY

SOCIO-CULTURAL
  LANGUAGES SPOKEN           LIFE EXPECTANCIES
  CUSTOMS & VALUES           RELIGIOUS BELIEFS
  LITERACY LEVEL             ATTITUDES TOWARD FOREIGNERS

TECHNOLOGICAL
  INTERNET AVAILABILITY      REGULATION ON TECHNOL TRANSFER
  SKILL LEVEL OF WORKFORCE   PATENT & TRADEMARK PROTECTION
  TRANSPORTATION NETWORK     NATURAL RESOURCE AVAILABILITY
THE TASK ENVIRONMENT
                     (INDUSTRY)

ENTITIES THAT DIRECTLY “TOUCH” THE ORGANIZATION


CUSTOMERS
SUPPLIERS
CREDITORS
GOVERNMENT AGENCIES
  FEDERAL
  STATE
  LOCAL
UNIONS
STOCKHOLDERS
COMMUNITIES
SPECIAL INTEREST GROUPS
EXAMINE EACH ENVIRONMENTAL SEGMENT FOR:

COMPLEXITY
  HOW MANY ENTITIES DOES THE FIRM DEAL WITH?
DYNAMISM
  HOW FREQUENTLY DO THESE ENTITIES CHANGE?
IMPORTANCE (Significance)
  WHAT IS THE IMPACT OF THIS SEGMENT ON THE ORGANIZATION?
PREDICTABILITY
  CAN THE FIRM FORSEE PENDING SHIFTS AND CHANGES?
CONTROL
  CAN THE FIRM MANIPULATE OR CONTROL THIS SEGMENT?

STRATEGICALLY…
1 - HOW CAN THE FIRM MONITOR EACH IMPORTANT SEGMENT?
2 - HOW DO WE CONTROL OR INFLUENCE EACH IMPORTANT SEGMENT?
3 - HOW SHOULD THE FIRM STRUCTURE ITSELF TO ACCOMPLISH THIS?
ENVIRONMENTAL UNCERTAINTY
                              DUNCAN (72)


                                      COMPLEXITY
                          SIMPLE                             COMPLEX
                 STATIC   ---------------------------------------------
                            LOW                      MODERATELY
                            UNCERTAINTY              LOW
                                                     UNCERTAINTY
DYNAMISM                  ---------------------------------------------
(CHANGE)
                            MODERATELY               HIGH
                            HIGH                     UNCERTAINTY
                            UNCERTAINTY
               DYNAMIC    ---------------------------------------------


COMPLEXITY = # of Entities the Firm must deal with?
DYNAMISM = How Frequently do these entities (or their demands) change?
ENVIRONMENTAL UNCERTAINTY
                                         SCHWAB (80)
THREE ISSUES TO ADDRESS:
    IMPORTANCE (Significance)
         What is the impact of this environmental segment on the firm?
    PREDICTABILITY
         Can the firm anticipate pending shifts and changes in this segment?
    CONTROL (Influence)
         Can the firm manipulate or control this environmental segment?

                                                   PREDICTABILITY
                                    HIGH                                     LOW
                        HIGH        ---------------------------------------------
                                      LOW                               MODERATELY
                                      UNCERTAINTY                       LOW
                                                                        UNCERTAINTY
CONTROL                             ---------------------------------------------
(INFLUENCE)                           MODERATELY                        HIGH
                                      HIGH                              UNCERTAINTY
                                      UNCERTAINTY
                         LOW        ---------------------------------------------


The firm only concerns itself with Important segments of it’s task environment.
The most difficult environments are those which are Unpredictable and Uncontrollable
IDENTIFYING EXTERNAL STRATEGIC FACTORS
                            CAMPBELL 84

AN ISSUES PRIORITY MATRIX
                                IMPACT ON THE FIRM

                       MAJOR             MODERATE         MINIMAL
               100%    ---------------------------------------------
                       HIGH             HIGH              MEDIUM
                       PRIORITY         PRIORITY          PRIORITY
PROBABILITY            ---------------------------------------------
OF              50%    HIGH             MEDIUM            LOW
OCCURRENCE             PRIORITY         PRIORITY          PRIORITY
                       ---------------------------------------------
                       MEDIUM           LOW               LOW
                       PRIORITY         PRIORITY          PRIORITY
       VIRTUALLY 0%    ---------------------------------------------

EVALUATE THE EMERGENT TRENDS IN THE MACRO & TASK ENVIRONMENTS
WHAT IS THE PROBABILITY OF EACH ENVIRONMENTAL TREND?
WHAT IS THE LIKELY IMPACT OF EACH TREND ON THE CORPORATION?
HIGH PRIORITY TRENDS = OPPORTUNITIES & THREATS FACED BY THE FIRM
SEVEN QUESTIONS TO ANSWER WHEN CONDUCTING AN
          INDUSTRY & COMPETITIVE ANALYSIS

1--WHAT ARE THE INDUSTRY’S DOMINANT ECONOMIC TRAITS?

2--WHAT ARE THE COMPETITIVE FORCES IN THE INDUSTRY AND
   HOW STRONG ARE THEY?

3--WHAT ARE THE DRIVING FORCES FOR CHANGE IN THE INDUSTRY?

4--WHICH RIVAL COMPANIES ARE IN THE STRONGEST & WEAKEST
   COMPETITIVE POSITIONS?

5--WHO SHOULD BE MONITORED AND WHAT STRATEGIC MOVES ARE
   THEY MOST LIKELY TO TAKE?

6--WHAT ARE THE KEY SUCCESS FACTORS IN THIS INDUSTRY?

7--HOW ATTRACTIVE IS THIS INDUSTRY IN TERMS OF ITS PROSPECTS
   FOR ABOVE-AVERAGE PROFITABILITY?
IDENTIFYING THE INDUSTRY’S DOMINANT ECONOMIC
                        TRAITS


MARKET SIZE & FRAGMENTATION
NUMBER OF COMPETITORS AND THEIR RELATIVE SIZES
SCOPE OF RIVALRY –Local, Regional, National, Global
MARKET GROWTH RATE & STAGE OF DEVELOPMENT
EASE OF ENTRY AND EXIT
CAPITAL REQUIREMENTS
NUMBER OF CUSTOMERS & THEIR AVERAGE DEMAND
PREVALENCE OF VERTICAL INTEGRATION
PRODUCT/SERVICE CHARACTERISTICS –Differentiated or Generic?
SCALE ECONOMIES & EXPERIENCE CURVE EFFECTS
RATE OF CHANGE & INNOVATION IN PRODUCTS & PROCESSES
INDUSTRY PROFITABILITY
INDUSTRY CAPACITY SURPLUSES & SHORTAGES
POTENTIAL DRIVING FORCES IN THE ENVIRONMENT


MAJOR INNOVATIONS IN…
EMERGING TECHNOLOGIES
PRODUCT DESIGN
PRODUCTION PROCESSES
SERVICE DESIGN AND DELIVERY
MARKETING AND ADVERTISING
SIGNIFICANT CHANGES IN…
THE INDUSTRY’S GROWTH RATE
WHO BUYS THE PRODUCT AND HOW THEY USE IT
DEMAND FOR MORE (OR LESS) DIFFERENTIATED PRODUCTS
PRODUCTION/DELIVERY COSTS AND EFFICIENCIES
THE NUMBER OF MAJOR COMPETITORS
THE GLOBALIZATION OF THE INDUSTRY
REGULATORY POLICIES AND GOVERNMENTAL CONTROLS
SOCIETAL CONCERNS, ATTITUDES, AND LIFESTYLES
UNCERTAINTY AND BUSINESS RISK
COMPETITIVE FORCES
                                    PORTER 80

INTENSITY OF COMPETITION…HOW DIFFICULT IS IT TO SUCCEED
   IN THIS BUSINESS?


COMPETITIVE RIVALRY
  Competition among existing firms
BARRIERS TO ENTRY
  Ease of entry into and exit from the industry
SUBSTITUTE GOODS & SERVICES
  Price, quality, and switching costs
POWER OF CUSTOMERS
  Number, size, and relative clout
POWER OF SUPPLIERS
  Number, size, and relative clout

   POWER OF OTHER STAKEHOLDERS (Freeman)
       Government,Unions,Communities, Special Interest Groups, etc
RIVALRY IS INCREASED WHEN…
THE MARKET IS GROWING VERY SLOWLY

PRODUCTS OR SERVICES ARE WEAKLY DIFFERENTIATED

THE NUMBER OF COMPETITORS INCREASE

COMPETITORS ARE EQUAL IN SIZE

IT COSTS A LOT TO LEAVE THE BUSINESS

THERE ARE BIG ADVANTAGES TO FIRST MOVERS

FIXED COSTS ARE HIGH AND VARIABLE COSTS ARE LOW

FIRMS DEAL WITH PERISHABLE PRODUCTS

“MAVERICKS” ARE COMPETING
BARRIERS TO ENTRY

SIGNIFICANT ECONOMIES OF SCALE EXIST

LEARNING AND EXPERIENCE CURVE EFFECTS

STRONG BRAND PREFERENCES AND CUSTOMER LOYALTY

SIGNIFICANT CAPITAL REQUIREMENTS

OTHERS HOLD PATENTS, THE MOST FAVORABLE LOCATIONS,
  OR HAVE ACCESS TO CHEAP RAW MATERIALS OR CAPITAL

ACCESS TO DISTRIBUTION CHANNELS, DEALERS, AND RETAIL
  OUTLETS

GOVERNMENTAL REGULATORY AGENCIES AND POLICIES

TARIFFS AND INTERNATIONAL TRADE RESTRICTIONS
SUBSTITUTE GOODS & SERVICES

POTENTIAL SUBSTITUTES
1.   PRICE AND AVAILABILITY OF SUBSTITUTES PUTS A CEILING ON
     PRICES AND PROFITS

2.   UNLESS PRODUCTS ARE DIFFERENTIATED FROM SUBSTITUTES,
     LOW GROWTH AND PROFITS WILL RESULT

3.   HOW EASILY CAN BUYERS "SWITCH OVER" TO A SUBSTITUTE?


THE MOST INTENSE COMPETITIVE PRESSURES ARE FELT WHEN:
     --THE PRICE OF SUBSTITUTES IS LOW

     --SUBSTITUTES ARE HIGH IN QUALITY AND PERFORMANCE

     --SWITCHING COSTS ARE LOW
CUSTOMER POWER IS HIGH WHEN…

THERE ARE JUST A FEW CUSTOMERS
THEY PURCHASE IN VERY LARGE AMOUNTS OR LOTS
THERE ARE MANY SELLERS OR SUPPLIERS
ALL OF THE SELLERS ARE RELATIVELY SMALL
PRODUCTS OR SERVICES ARE STANDARDIZED
THE PURCHASED ITEM OR SERVICE IS NOT AN IMPORTANT
  INPUT TO THE CUSTOMER
THE PURCHASED ITEM OR SERVICE DOES NOT SAVE THE
  CUSTOMER MONEY
CUSTOMERS PURCHASE FROM SEVERAL SUPPLIERS RATHER
  THAN ONE
CUSTOMERS COULD INTEGRATE BACKWARD
SUPPLIERS ARE UNLIKELY TO INTEGRATE FORWARD
POWER OF SUPPLIERS IS HIGH WHEN…


SUPPLIES ARE CRUCIAL TO THE BUYER
THERE ARE JUST A FEW LARGE SUPPLIERS, AND THEY DON’T
   COMPETE AGGRESSIVELY
IT IS DIFFICULT OR COSTLY TO SWITCH SUPPLIERS
WHEN BUYERS AREN’T SEEN BY SUPPLIERS AS IMPORTANT
   CUSTOMERS
WHEN THERE ARE NO READY SUBSTITUTES
WHEN SUPPLIERS COULD INTEGRATE FORWARD
WHEN BUYERS ARE UNLIKELY TO INTEGRATE BACKWARD
MAPPING COMPETITIVE POSITIONS OF RIVAL FIRMS

POSSIBLE DIMENSIONS
PRICE/QUALITY
  [High, Medium, Low]
GEOGRAPHIC COVERAGE
  [Local, Regional, National, Global]
PRODUCT LINE BREADTH
  [Wide, Narrow]
DEGREE OF SERVICE
  [No-frills, Limited, Full Service]
DEGREE OF VERTICAL INTEGRATION
  [None, Partial, Full]
DISTRIBUTION CHANNELS
  [One, Some, All]

USE TWO DIMENSIONS THAT AREN’T HIGHLY CORRELATED
DEVELOP AT LEAST TWO DIFFERENT MAPS (WITH DIFFERENT DIMENSIONS)
STRONGEST COMPETITION IS LIKELY WHEN FIRMS ARE CLOSE TOGETHER
STRATEGIC COMPETITOR “TYPES”
                         MILES & SNOW 78

COMPETING FIRMS IN A COMMON INDUSTRY ARE LIKELY TO TAKE ON ONE
  OF FOUR BASIC STRATEGIC ORIENTATIONS…


DEFENDERS -- PROVIDES A LIMITED PRODUCT LINE
  FOCUSES ON EFFICIENCY (COST) OF CURRENT OPERATIONS
  NOT LIKELY TO INNOVATE


PROSPECTORS -- OFFERS A BROAD PRODUCT LINE
  FOCUSES ON PRODUCT INNOVATION & MARKET OPPORTUNITIES
  SOMEWHAT INEFFICIENT


ANALYZERS -- OPERATES IN TWO MARKETS (one stable, one variable)
  EMPHASIZES EFFICIENCY IN STABLE AREAS
  EMPHASIZES INNOVATION IN VARIABLE AREAS


REACTORS LACKS A CONSISTENT STRATEGY/CULTURE
  RESPONSES TO THE ENVIRONMENT ARE OFTEN INEFFECTIVE
  TENDS TO MAKE PIECEMEAL STRATEGIC CHANGES
TYPES OF KEY SUCCESS FACTORS

TECHNOLOGY                            MARKETING
   Research Expertise                 Well-trained, Effective Sales Force
   Product Innovation                 Quick, Dependable Customer Service
   Process Innovation                 Customer Guarantees and Warranties
                                      Attractive Styling and Packaging
MANUFACTURING                         Breadth of Product Line
  Low-Cost Production Efficiency
  High Utilization of Fixed Assets
  High Quality of Manufacture         OTHER
  Low-Cost Facilities                 Superior Talent, Highly-Skilled Staff
  High Labor Productivity             Quality Control Know-How
  Flexible Manufacturing Facilities   Design Expertise
                                      Convenient Locations
DISTRIBUTION                          Superior Information Systems
   Strong Network of Distributors     Quick Response to Market Shifts
   Ample Shelf Space                  Favorable Image/Reputation with Buyers
   Company-owned Retail Outlets       Pleasant, Courteous Employees
   Low Distribution Costs             Access to Financial Capital
   Fast Delivery
COMPETITIVE STRENGTH ASSESSMENTS

                           OUR Rival        Rival   Rival
KEY SUCCESS FACTORS        FIRM # 1         #2      #3

LOW-COST PRODUCTION          7         10    8       6

PRODUCT QUALITY              9          4    6       9

DISTRIBUTION NETWORK         5          5    7       8

CUSTOMER SERVICE             6          8    7       10

FINANCIAL RESOURCES          6          4    8       8

     1 = Very Weak, 10 = Very Strong
UNDERSTANDING YOUR COMPETITORS
                                 KENDRICK & BLACKMORE 2001

COMPETITIVE INTELLIGENCE QUESTIONS
Why do your competitors exist?
    Do they exist to make profits or just to support another unit?
Where do they add customer value?
    Do they offer higher quality, lower price, better service, or excellent credit terms?
Which customers are your competitors most interested in?
    Do they seek your best customers, the ones you don’t want, or do they go for everyone?
What is their cost base and liquidity?
    How much cash and working capital do they have?
Are their suppliers better than yours?
    Are they less exposed with their suppliers than your firm?
What do they intend to do in the future?
    Do they have a your market segments targeted? Are they committed to growth?
How will their activity affect your strategies?
    Should you adjust your plans and operations?
Do either of you have a competitive advantage in the marketplace?
    How much better than your competitor do you have to be to attract customers?
Will new competitors emerge over the next few years?
    Who is a potential new entrant?
If you were a customer, would you choose your product over those offered by others?
    What irritates your current customers?
DRAWING CONCLUSIONS ABOUT OVERALL
         INDUSTRY ATTRACTIVENESS

FACTORS WHICH MAKE THE INDUSTRY ATTRACTIVE?

FACTORS WHICH MAKE THE INDUSTRY UNATTRACTIVE?

SPECIAL ISSUES AND PROBLEMS WHICH ARE UNIQUE TO THIS
  INDUSTRY?
            IMPACT, PROBABILITY, SEVERITY


THE PROFIT OUTLOOK
            ABOVE OR BELOW AVERAGE?


DEGREE OF RISK & UNCERTAINTY IN THE INDUSTRY’S
  FUTURE
ENVIRONMENTAL SCENARIOS


WHAT ARE YOUR ASSUMPTIONS ABOUT THE ENVIRONMENT?
WHAT ARE THE POSSIBLE “STATES OF NATURE” IN THE FUTURE?

  WHAT ARE THE MOST IMPORTANT ENVIRONMENTAL
  OPPORTUNITIES AND THREATS IN YOUR INDUSTRY?

  WHAT IS THE PROBABILITY THAT EACH OF THESE TRENDS
  WILL OCCUR IN THE NEXT 5 –7 YEARS? (Assign a probability)

  DEVELOP A PARAGRAPH WHICH INTEGRATES THESE
  TRENDS INTO A “MOST LIKELY” SCENARIO.

  WRITE AT LEAST TWO MORE PARAGRAPHS WHICH
  DESCRIBE OTHER POSSIBLE, PROBABLE, OR FAIRLY
  LIKELY FUTURE ENVIRONMENTS (Optimistic, Pessimistic, Etc).
USING ENVIRONMENTAL SCENARIOS


WHAT ARE OUR SCENARIOS?
 ENVIRONMENTAL EVENTS WE CAN’T CONTROL
 IT IS REASONABLE TO ASSUME THAT EACH EVENT COULD OCCUR


WHAT STRATEGIC ALTERNATIVES DO WE HAVE?
 WE HAVE SEVERAL OPTIONS WE CAN PURSUE
 THE ORGANIZATION CAN MAKE A CHOICE


WHAT OUTCOMES OR RESULTS ARE POSSIBLE?
 WHAT RESULTS ARE LIKELY WHEN A SPECIFIC ENVIRONMENTAL
 SCENARIO COMBINES WITH A CHOSEN ALTERNATIVE?


HOW CERTAIN ARE WE OF EACH OUTCOME?
 VIRTUALLY CERTAIN? …WHAT IS THE PROBABILITY?
A PAYOFF TABLE ILLUSTRATION
                        UNDER TOTAL UNCERTAINTY

EXPECTED PROFITS $ / ACRE
                            STATES OF NATURE / ENVIRONMENTAL SCENARIOS


ALTERNATIVE CROPS           NORMAL       WET        DRY      VIOLENT
                            --------------------------------
       CORN                 $ 900      450    -800     250
                            --------------------------------
       POTATOES               800     -300     400     500
                            --------------------------------
       HAY/GRASS              300      500      0      100
                            --------------------------------
1.   MAXI-MAX (Optimist)    *Corn 900, Potato 800, Hay 500
2.   MAXI-MIN (Pessimist)    Corn -800, Potato -300, *Hay 0
3.   MINI-MAX (Regret)    Regrets..Corn 1200, Potato 800, *Hay 600
4.   AVERAGE (Rational) Ex Value…Corn 200, *Potato 350, Hay 225
BUILDING A REGRET MATRIX
EXPECTED PROFITS $ / ACRE
                            STATES OF NATURE / ENVIRONMENTAL SCENARIOS
ORIGINAL MATRIX
ALTERNATIVE CROPS           NORMAL       WET        DRY      VIOLENT
                            --------------------------------
      CORN                  $ 900      450    -800     250
      POTATOES                800     -300     400     500
      HAY/GRASS               300      500      0      100
                            --------------------------------
REGRET MATRIX

      CORN           0            50          1200        250
      POTATOES      100          800            0          0
      HAY/GRASS     600           0            400        400
                   ------------------------------------
MINIMIZE THE MAXIMUM REGRETS
                   Corn = 1200, Potatoes = 800, Hay = 600**
A PAYOFF TABLE ILLUSTRATION
                            UNDER RISK (ASSIGNED PROBABILITY)

EXPECTED PROFITS $ / ACRE
       PROBABILITIES COME FROM “GOOD” GUESSES. CALCULATE THE EXPECTED VALUES
       INDIAN JOE’S ESTIMATES = Normal 30%, Wet 25%, Dry 20%, Violent 25%

                               STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS              NORMAL       WET          DRY     VIOLENT EXPECTED
 WEIGHTS                         .30       .25   .20     .25  VALUES
                               =======================
       CORN                    $ 900      450    -800     250   $ 285
                               --------------------------------
       POTATOES                  800     -300     400     500     370**
                               --------------------------------
       HAY/GRASS                 300      500       0     100     240
                            = = = = = = = = = = = = = = = = = = = = = = = == =
You should PLANT POTATOES EVERY YEAR. In any one year you’ll either make 800,
     lose 300, make 400, or make 500 …but over the years, you’ll average $370 of profits.
A PAYOFF TABLE ILLUSTRATION
                        UNDER RISK (FACTUAL PROBABILITY)

EXPECTED PROFITS $ / ACRE
      PROBABILITY INFORMATION COMES FROM RELIABLE (FACTUAL) SOURCES
      WEATHER BUREAU HISTORY = Normal 35%, Wet 30%, Dry 15%, Violent 20%

                            STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS           NORMAL       WET        DRY     VIOLENT EXPECTED
 WEIGHTS                   .35         .30        .15         .20    VALUES
                         =======================
     CORN                $ 900        450         -800         250    $ 380**
                         --------------------------------
     POTATOES              800       -300          400         500      350
                         --------------------------------
     HAY/GRASS             300        500            0         100      275
                         =======================
You should PLANT CORN EVERY YEAR. In any one year you’ll either make 900,
     make 450, lose 800 or make 250 …but over the years, you’ll average $380 of
     profits.
A PAYOFF TABLE ILLUSTRATION
          UNDER RISK (WHAT IS THE VALUE OF PERFECT INFORMATION?)

     WE KNOW ONLY GOD CONTROLS THE WEATHER, BUT IF WE HAD PERFECT
     PREDICTION EACH YEAR, WE’D KNOW EXACTLY WHAT THE WEATHER
     WOULD BE AND WHAT WE SHOULD PLANT. WE’D HAVE NORMAL
     CONDITIONS 35% OF THE TIME, AND DURING THOSE TIMES, WE’D PLANT
     CORN. 30% OF THE TIME IT WOULD BE WET AND WE’D PLANT HAY, ETC.

                          STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS         NORMAL        WET         DRY     VIOLENT EXPECTED
 WEIGHTS                     .35           .30       .15         .20    VALUES
                          =======================
     CORN                 $ 900           450        -800         250     $ 380**
     POTATOES               800          -300         400         500        350
     HAY/GRASS              300           500           0         100        275
                          =======================
Expected Profits given Perfect Information (EPPI) = $625.
Expected Value of Perfect Information (EVPI) = EPPI – EV = $625 –380 = $
     245
Therefore, you can increase your profits by up to $245 if you have a perfect
     weather forecast each spring.

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B689 w03

  • 1. THE PROCESS OF STRATEGIC MANAGEMENT ENVIRONMENTAL SCANNING EXTERNAL THREATS & OPPORTUNITIES MACRO (Society), TASK (Industry), COMPETITIVE INTERNAL STRENGTHS & WEAKNESSES RESOURCES, STRUCTURE, FINANCIAL PERFORMANCE TRENDS STRATEGY FORMULATION MISSION OBJECTIVES STRATEGIES IMPLEMENTATION BUDGETS ASSIGNMENTS TACTICAL PLANS EVALUATION & CONTROL CRITERIA & ASSESSMENT TOOLS REPORTS & FEEDBACK DEVICES ADJUSTMENT MECHANISMS
  • 2. THE MACRO ENVIRONMENT (PEST) POLITICAL SUPPORTS GOVERNMENT STABILITY CONTROLS ANTI-TRUST, EPA, TAX LAWS PENDING LEGISLATION ATTITUDES TOWARD FOREIGN FIRMS ECONOMIC INFLATION INTEREST RATES UNEMPLOYMENT ENERGY AVAILABILITY & COST DISPOSABLE INCOME PRODUCTIVITY, GROWTH, GDP SOCIO-CULTURAL GEOGRAPHIC SHIFTS CONSUMER ACTIVISM CUSTOMS & VALUES LIFESTYLE CHANGES DEMOGRAPHICS BIRTHRATES & LIFE EXPECTANCIES TECHNOLOGICAL BASIC RESEARCH R & D SPENDING (Gvmt & Industry) NEW PRODUCTS/SERVICES PATENT PROTECTION PROCESS IMPROVEMENTS COMPUTER HACKING
  • 3. EIGHT SOCIO-CULTURAL TRENDS IN NORTH AMERICA ENVIRONMENTAL AWARENESS Conservation, Recycling, Landfills GROWING HEALTH CONSCIOUSNESS Personal Fitness, Nutrition, Genetically Altered Foods, AIDS & Bird Flu BABY BOOMERS NEAR RETIREMENT (77 Million) Companionship, Pets, Retirement Communities, Vacations, Senior Services IMPACT OF “GENERATION Y” BOOMLET (70 Million) Born between 1978 and 1994, Crowded Schools, Youth Markets DECLINING MASS MARKET Customized, Targeted - no generic products, Cars to Magazines CHANGING PACE AND LOCATION OF LIFE Instant Communication (e-mail, computers, etc), Telecommuting Possibilities CHANGING HOUSEHOLDS Singles, Partners, Couples with no Children (DINKS) INCREASING DIVERSITY OF WORKFORCE AND MARKETS Growth of Hispanic and Asian Groups, Immigrants (legal and illegal)
  • 4. RECENT BREAKTHROUGH DEVELOPMENTS IN TECHNOLOGY PORTABLE INFORMATION DEVICES AND NETWORKING Connectivity, Phones, TVs, Stereos, and Computers becoming obsolete FUEL CELLS AND ALTERNATIVE ENERGY SOURCES Wind, Geothermal, Hydroelectric, Solar, Biomass – 30% by 2010 PRECISION FARMING Corporate Farming, Computerized Crop Management VIRTUAL PERSONAL ASSISTANTS Smart computers that monitor e-mail, voice mail, can write letters, etc. GENETICALLY ALTERED ORGANISMS Plants and animals that are resistant to disease, grow faster, yield more SMART MOBILE ROBOTS Perform sophisticated factory work, do housework, assist the disabled
  • 5. THE INTERNATIONAL DIMENSION TO THE MACRO (SOCIETIAL) ENVIRONMENT POLITICAL POLITICAL IDEOLOGY REGULATION OF FOREIGN OWNERSHIP GOVERNMENT STABILITY STRENGTH OF OPPOSITION GROUPS PROTECTIONIST SENTIMENT TERRORIST ACTIVITY LEGAL SYSTEM FOREIGN POLICIES ECONOMIC ECONOMIC DEVELOPMENT PER CAPITA INCOME & WAGE LEVELS UNEMPLOYMENT LEVELS GDP TRENDS CURRENCY CONVERTIBILITY OUTSOURCING CAPABILITY SOCIO-CULTURAL LANGUAGES SPOKEN LIFE EXPECTANCIES CUSTOMS & VALUES RELIGIOUS BELIEFS LITERACY LEVEL ATTITUDES TOWARD FOREIGNERS TECHNOLOGICAL INTERNET AVAILABILITY REGULATION ON TECHNOL TRANSFER SKILL LEVEL OF WORKFORCE PATENT & TRADEMARK PROTECTION TRANSPORTATION NETWORK NATURAL RESOURCE AVAILABILITY
  • 6. THE TASK ENVIRONMENT (INDUSTRY) ENTITIES THAT DIRECTLY “TOUCH” THE ORGANIZATION CUSTOMERS SUPPLIERS CREDITORS GOVERNMENT AGENCIES FEDERAL STATE LOCAL UNIONS STOCKHOLDERS COMMUNITIES SPECIAL INTEREST GROUPS
  • 7. EXAMINE EACH ENVIRONMENTAL SEGMENT FOR: COMPLEXITY HOW MANY ENTITIES DOES THE FIRM DEAL WITH? DYNAMISM HOW FREQUENTLY DO THESE ENTITIES CHANGE? IMPORTANCE (Significance) WHAT IS THE IMPACT OF THIS SEGMENT ON THE ORGANIZATION? PREDICTABILITY CAN THE FIRM FORSEE PENDING SHIFTS AND CHANGES? CONTROL CAN THE FIRM MANIPULATE OR CONTROL THIS SEGMENT? STRATEGICALLY… 1 - HOW CAN THE FIRM MONITOR EACH IMPORTANT SEGMENT? 2 - HOW DO WE CONTROL OR INFLUENCE EACH IMPORTANT SEGMENT? 3 - HOW SHOULD THE FIRM STRUCTURE ITSELF TO ACCOMPLISH THIS?
  • 8. ENVIRONMENTAL UNCERTAINTY DUNCAN (72) COMPLEXITY SIMPLE COMPLEX STATIC --------------------------------------------- LOW MODERATELY UNCERTAINTY LOW UNCERTAINTY DYNAMISM --------------------------------------------- (CHANGE) MODERATELY HIGH HIGH UNCERTAINTY UNCERTAINTY DYNAMIC --------------------------------------------- COMPLEXITY = # of Entities the Firm must deal with? DYNAMISM = How Frequently do these entities (or their demands) change?
  • 9. ENVIRONMENTAL UNCERTAINTY SCHWAB (80) THREE ISSUES TO ADDRESS: IMPORTANCE (Significance) What is the impact of this environmental segment on the firm? PREDICTABILITY Can the firm anticipate pending shifts and changes in this segment? CONTROL (Influence) Can the firm manipulate or control this environmental segment? PREDICTABILITY HIGH LOW HIGH --------------------------------------------- LOW MODERATELY UNCERTAINTY LOW UNCERTAINTY CONTROL --------------------------------------------- (INFLUENCE) MODERATELY HIGH HIGH UNCERTAINTY UNCERTAINTY LOW --------------------------------------------- The firm only concerns itself with Important segments of it’s task environment. The most difficult environments are those which are Unpredictable and Uncontrollable
  • 10. IDENTIFYING EXTERNAL STRATEGIC FACTORS CAMPBELL 84 AN ISSUES PRIORITY MATRIX IMPACT ON THE FIRM MAJOR MODERATE MINIMAL 100% --------------------------------------------- HIGH HIGH MEDIUM PRIORITY PRIORITY PRIORITY PROBABILITY --------------------------------------------- OF 50% HIGH MEDIUM LOW OCCURRENCE PRIORITY PRIORITY PRIORITY --------------------------------------------- MEDIUM LOW LOW PRIORITY PRIORITY PRIORITY VIRTUALLY 0% --------------------------------------------- EVALUATE THE EMERGENT TRENDS IN THE MACRO & TASK ENVIRONMENTS WHAT IS THE PROBABILITY OF EACH ENVIRONMENTAL TREND? WHAT IS THE LIKELY IMPACT OF EACH TREND ON THE CORPORATION? HIGH PRIORITY TRENDS = OPPORTUNITIES & THREATS FACED BY THE FIRM
  • 11. SEVEN QUESTIONS TO ANSWER WHEN CONDUCTING AN INDUSTRY & COMPETITIVE ANALYSIS 1--WHAT ARE THE INDUSTRY’S DOMINANT ECONOMIC TRAITS? 2--WHAT ARE THE COMPETITIVE FORCES IN THE INDUSTRY AND HOW STRONG ARE THEY? 3--WHAT ARE THE DRIVING FORCES FOR CHANGE IN THE INDUSTRY? 4--WHICH RIVAL COMPANIES ARE IN THE STRONGEST & WEAKEST COMPETITIVE POSITIONS? 5--WHO SHOULD BE MONITORED AND WHAT STRATEGIC MOVES ARE THEY MOST LIKELY TO TAKE? 6--WHAT ARE THE KEY SUCCESS FACTORS IN THIS INDUSTRY? 7--HOW ATTRACTIVE IS THIS INDUSTRY IN TERMS OF ITS PROSPECTS FOR ABOVE-AVERAGE PROFITABILITY?
  • 12. IDENTIFYING THE INDUSTRY’S DOMINANT ECONOMIC TRAITS MARKET SIZE & FRAGMENTATION NUMBER OF COMPETITORS AND THEIR RELATIVE SIZES SCOPE OF RIVALRY –Local, Regional, National, Global MARKET GROWTH RATE & STAGE OF DEVELOPMENT EASE OF ENTRY AND EXIT CAPITAL REQUIREMENTS NUMBER OF CUSTOMERS & THEIR AVERAGE DEMAND PREVALENCE OF VERTICAL INTEGRATION PRODUCT/SERVICE CHARACTERISTICS –Differentiated or Generic? SCALE ECONOMIES & EXPERIENCE CURVE EFFECTS RATE OF CHANGE & INNOVATION IN PRODUCTS & PROCESSES INDUSTRY PROFITABILITY INDUSTRY CAPACITY SURPLUSES & SHORTAGES
  • 13. POTENTIAL DRIVING FORCES IN THE ENVIRONMENT MAJOR INNOVATIONS IN… EMERGING TECHNOLOGIES PRODUCT DESIGN PRODUCTION PROCESSES SERVICE DESIGN AND DELIVERY MARKETING AND ADVERTISING SIGNIFICANT CHANGES IN… THE INDUSTRY’S GROWTH RATE WHO BUYS THE PRODUCT AND HOW THEY USE IT DEMAND FOR MORE (OR LESS) DIFFERENTIATED PRODUCTS PRODUCTION/DELIVERY COSTS AND EFFICIENCIES THE NUMBER OF MAJOR COMPETITORS THE GLOBALIZATION OF THE INDUSTRY REGULATORY POLICIES AND GOVERNMENTAL CONTROLS SOCIETAL CONCERNS, ATTITUDES, AND LIFESTYLES UNCERTAINTY AND BUSINESS RISK
  • 14. COMPETITIVE FORCES PORTER 80 INTENSITY OF COMPETITION…HOW DIFFICULT IS IT TO SUCCEED IN THIS BUSINESS? COMPETITIVE RIVALRY Competition among existing firms BARRIERS TO ENTRY Ease of entry into and exit from the industry SUBSTITUTE GOODS & SERVICES Price, quality, and switching costs POWER OF CUSTOMERS Number, size, and relative clout POWER OF SUPPLIERS Number, size, and relative clout POWER OF OTHER STAKEHOLDERS (Freeman) Government,Unions,Communities, Special Interest Groups, etc
  • 15. RIVALRY IS INCREASED WHEN… THE MARKET IS GROWING VERY SLOWLY PRODUCTS OR SERVICES ARE WEAKLY DIFFERENTIATED THE NUMBER OF COMPETITORS INCREASE COMPETITORS ARE EQUAL IN SIZE IT COSTS A LOT TO LEAVE THE BUSINESS THERE ARE BIG ADVANTAGES TO FIRST MOVERS FIXED COSTS ARE HIGH AND VARIABLE COSTS ARE LOW FIRMS DEAL WITH PERISHABLE PRODUCTS “MAVERICKS” ARE COMPETING
  • 16. BARRIERS TO ENTRY SIGNIFICANT ECONOMIES OF SCALE EXIST LEARNING AND EXPERIENCE CURVE EFFECTS STRONG BRAND PREFERENCES AND CUSTOMER LOYALTY SIGNIFICANT CAPITAL REQUIREMENTS OTHERS HOLD PATENTS, THE MOST FAVORABLE LOCATIONS, OR HAVE ACCESS TO CHEAP RAW MATERIALS OR CAPITAL ACCESS TO DISTRIBUTION CHANNELS, DEALERS, AND RETAIL OUTLETS GOVERNMENTAL REGULATORY AGENCIES AND POLICIES TARIFFS AND INTERNATIONAL TRADE RESTRICTIONS
  • 17. SUBSTITUTE GOODS & SERVICES POTENTIAL SUBSTITUTES 1. PRICE AND AVAILABILITY OF SUBSTITUTES PUTS A CEILING ON PRICES AND PROFITS 2. UNLESS PRODUCTS ARE DIFFERENTIATED FROM SUBSTITUTES, LOW GROWTH AND PROFITS WILL RESULT 3. HOW EASILY CAN BUYERS "SWITCH OVER" TO A SUBSTITUTE? THE MOST INTENSE COMPETITIVE PRESSURES ARE FELT WHEN: --THE PRICE OF SUBSTITUTES IS LOW --SUBSTITUTES ARE HIGH IN QUALITY AND PERFORMANCE --SWITCHING COSTS ARE LOW
  • 18. CUSTOMER POWER IS HIGH WHEN… THERE ARE JUST A FEW CUSTOMERS THEY PURCHASE IN VERY LARGE AMOUNTS OR LOTS THERE ARE MANY SELLERS OR SUPPLIERS ALL OF THE SELLERS ARE RELATIVELY SMALL PRODUCTS OR SERVICES ARE STANDARDIZED THE PURCHASED ITEM OR SERVICE IS NOT AN IMPORTANT INPUT TO THE CUSTOMER THE PURCHASED ITEM OR SERVICE DOES NOT SAVE THE CUSTOMER MONEY CUSTOMERS PURCHASE FROM SEVERAL SUPPLIERS RATHER THAN ONE CUSTOMERS COULD INTEGRATE BACKWARD SUPPLIERS ARE UNLIKELY TO INTEGRATE FORWARD
  • 19. POWER OF SUPPLIERS IS HIGH WHEN… SUPPLIES ARE CRUCIAL TO THE BUYER THERE ARE JUST A FEW LARGE SUPPLIERS, AND THEY DON’T COMPETE AGGRESSIVELY IT IS DIFFICULT OR COSTLY TO SWITCH SUPPLIERS WHEN BUYERS AREN’T SEEN BY SUPPLIERS AS IMPORTANT CUSTOMERS WHEN THERE ARE NO READY SUBSTITUTES WHEN SUPPLIERS COULD INTEGRATE FORWARD WHEN BUYERS ARE UNLIKELY TO INTEGRATE BACKWARD
  • 20. MAPPING COMPETITIVE POSITIONS OF RIVAL FIRMS POSSIBLE DIMENSIONS PRICE/QUALITY [High, Medium, Low] GEOGRAPHIC COVERAGE [Local, Regional, National, Global] PRODUCT LINE BREADTH [Wide, Narrow] DEGREE OF SERVICE [No-frills, Limited, Full Service] DEGREE OF VERTICAL INTEGRATION [None, Partial, Full] DISTRIBUTION CHANNELS [One, Some, All] USE TWO DIMENSIONS THAT AREN’T HIGHLY CORRELATED DEVELOP AT LEAST TWO DIFFERENT MAPS (WITH DIFFERENT DIMENSIONS) STRONGEST COMPETITION IS LIKELY WHEN FIRMS ARE CLOSE TOGETHER
  • 21. STRATEGIC COMPETITOR “TYPES” MILES & SNOW 78 COMPETING FIRMS IN A COMMON INDUSTRY ARE LIKELY TO TAKE ON ONE OF FOUR BASIC STRATEGIC ORIENTATIONS… DEFENDERS -- PROVIDES A LIMITED PRODUCT LINE FOCUSES ON EFFICIENCY (COST) OF CURRENT OPERATIONS NOT LIKELY TO INNOVATE PROSPECTORS -- OFFERS A BROAD PRODUCT LINE FOCUSES ON PRODUCT INNOVATION & MARKET OPPORTUNITIES SOMEWHAT INEFFICIENT ANALYZERS -- OPERATES IN TWO MARKETS (one stable, one variable) EMPHASIZES EFFICIENCY IN STABLE AREAS EMPHASIZES INNOVATION IN VARIABLE AREAS REACTORS LACKS A CONSISTENT STRATEGY/CULTURE RESPONSES TO THE ENVIRONMENT ARE OFTEN INEFFECTIVE TENDS TO MAKE PIECEMEAL STRATEGIC CHANGES
  • 22. TYPES OF KEY SUCCESS FACTORS TECHNOLOGY MARKETING Research Expertise Well-trained, Effective Sales Force Product Innovation Quick, Dependable Customer Service Process Innovation Customer Guarantees and Warranties Attractive Styling and Packaging MANUFACTURING Breadth of Product Line Low-Cost Production Efficiency High Utilization of Fixed Assets High Quality of Manufacture OTHER Low-Cost Facilities Superior Talent, Highly-Skilled Staff High Labor Productivity Quality Control Know-How Flexible Manufacturing Facilities Design Expertise Convenient Locations DISTRIBUTION Superior Information Systems Strong Network of Distributors Quick Response to Market Shifts Ample Shelf Space Favorable Image/Reputation with Buyers Company-owned Retail Outlets Pleasant, Courteous Employees Low Distribution Costs Access to Financial Capital Fast Delivery
  • 23. COMPETITIVE STRENGTH ASSESSMENTS OUR Rival Rival Rival KEY SUCCESS FACTORS FIRM # 1 #2 #3 LOW-COST PRODUCTION 7 10 8 6 PRODUCT QUALITY 9 4 6 9 DISTRIBUTION NETWORK 5 5 7 8 CUSTOMER SERVICE 6 8 7 10 FINANCIAL RESOURCES 6 4 8 8 1 = Very Weak, 10 = Very Strong
  • 24. UNDERSTANDING YOUR COMPETITORS KENDRICK & BLACKMORE 2001 COMPETITIVE INTELLIGENCE QUESTIONS Why do your competitors exist? Do they exist to make profits or just to support another unit? Where do they add customer value? Do they offer higher quality, lower price, better service, or excellent credit terms? Which customers are your competitors most interested in? Do they seek your best customers, the ones you don’t want, or do they go for everyone? What is their cost base and liquidity? How much cash and working capital do they have? Are their suppliers better than yours? Are they less exposed with their suppliers than your firm? What do they intend to do in the future? Do they have a your market segments targeted? Are they committed to growth? How will their activity affect your strategies? Should you adjust your plans and operations? Do either of you have a competitive advantage in the marketplace? How much better than your competitor do you have to be to attract customers? Will new competitors emerge over the next few years? Who is a potential new entrant? If you were a customer, would you choose your product over those offered by others? What irritates your current customers?
  • 25. DRAWING CONCLUSIONS ABOUT OVERALL INDUSTRY ATTRACTIVENESS FACTORS WHICH MAKE THE INDUSTRY ATTRACTIVE? FACTORS WHICH MAKE THE INDUSTRY UNATTRACTIVE? SPECIAL ISSUES AND PROBLEMS WHICH ARE UNIQUE TO THIS INDUSTRY? IMPACT, PROBABILITY, SEVERITY THE PROFIT OUTLOOK ABOVE OR BELOW AVERAGE? DEGREE OF RISK & UNCERTAINTY IN THE INDUSTRY’S FUTURE
  • 26. ENVIRONMENTAL SCENARIOS WHAT ARE YOUR ASSUMPTIONS ABOUT THE ENVIRONMENT? WHAT ARE THE POSSIBLE “STATES OF NATURE” IN THE FUTURE? WHAT ARE THE MOST IMPORTANT ENVIRONMENTAL OPPORTUNITIES AND THREATS IN YOUR INDUSTRY? WHAT IS THE PROBABILITY THAT EACH OF THESE TRENDS WILL OCCUR IN THE NEXT 5 –7 YEARS? (Assign a probability) DEVELOP A PARAGRAPH WHICH INTEGRATES THESE TRENDS INTO A “MOST LIKELY” SCENARIO. WRITE AT LEAST TWO MORE PARAGRAPHS WHICH DESCRIBE OTHER POSSIBLE, PROBABLE, OR FAIRLY LIKELY FUTURE ENVIRONMENTS (Optimistic, Pessimistic, Etc).
  • 27. USING ENVIRONMENTAL SCENARIOS WHAT ARE OUR SCENARIOS? ENVIRONMENTAL EVENTS WE CAN’T CONTROL IT IS REASONABLE TO ASSUME THAT EACH EVENT COULD OCCUR WHAT STRATEGIC ALTERNATIVES DO WE HAVE? WE HAVE SEVERAL OPTIONS WE CAN PURSUE THE ORGANIZATION CAN MAKE A CHOICE WHAT OUTCOMES OR RESULTS ARE POSSIBLE? WHAT RESULTS ARE LIKELY WHEN A SPECIFIC ENVIRONMENTAL SCENARIO COMBINES WITH A CHOSEN ALTERNATIVE? HOW CERTAIN ARE WE OF EACH OUTCOME? VIRTUALLY CERTAIN? …WHAT IS THE PROBABILITY?
  • 28. A PAYOFF TABLE ILLUSTRATION UNDER TOTAL UNCERTAINTY EXPECTED PROFITS $ / ACRE STATES OF NATURE / ENVIRONMENTAL SCENARIOS ALTERNATIVE CROPS NORMAL WET DRY VIOLENT -------------------------------- CORN $ 900 450 -800 250 -------------------------------- POTATOES 800 -300 400 500 -------------------------------- HAY/GRASS 300 500 0 100 -------------------------------- 1. MAXI-MAX (Optimist) *Corn 900, Potato 800, Hay 500 2. MAXI-MIN (Pessimist) Corn -800, Potato -300, *Hay 0 3. MINI-MAX (Regret) Regrets..Corn 1200, Potato 800, *Hay 600 4. AVERAGE (Rational) Ex Value…Corn 200, *Potato 350, Hay 225
  • 29. BUILDING A REGRET MATRIX EXPECTED PROFITS $ / ACRE STATES OF NATURE / ENVIRONMENTAL SCENARIOS ORIGINAL MATRIX ALTERNATIVE CROPS NORMAL WET DRY VIOLENT -------------------------------- CORN $ 900 450 -800 250 POTATOES 800 -300 400 500 HAY/GRASS 300 500 0 100 -------------------------------- REGRET MATRIX CORN 0 50 1200 250 POTATOES 100 800 0 0 HAY/GRASS 600 0 400 400 ------------------------------------ MINIMIZE THE MAXIMUM REGRETS Corn = 1200, Potatoes = 800, Hay = 600**
  • 30. A PAYOFF TABLE ILLUSTRATION UNDER RISK (ASSIGNED PROBABILITY) EXPECTED PROFITS $ / ACRE PROBABILITIES COME FROM “GOOD” GUESSES. CALCULATE THE EXPECTED VALUES INDIAN JOE’S ESTIMATES = Normal 30%, Wet 25%, Dry 20%, Violent 25% STATES OF NATURE / ENVIRONMENTAL SCENARIOS ALTERNATIVE CROPS NORMAL WET DRY VIOLENT EXPECTED WEIGHTS .30 .25 .20 .25 VALUES ======================= CORN $ 900 450 -800 250 $ 285 -------------------------------- POTATOES 800 -300 400 500 370** -------------------------------- HAY/GRASS 300 500 0 100 240 = = = = = = = = = = = = = = = = = = = = = = = == = You should PLANT POTATOES EVERY YEAR. In any one year you’ll either make 800, lose 300, make 400, or make 500 …but over the years, you’ll average $370 of profits.
  • 31. A PAYOFF TABLE ILLUSTRATION UNDER RISK (FACTUAL PROBABILITY) EXPECTED PROFITS $ / ACRE PROBABILITY INFORMATION COMES FROM RELIABLE (FACTUAL) SOURCES WEATHER BUREAU HISTORY = Normal 35%, Wet 30%, Dry 15%, Violent 20% STATES OF NATURE / ENVIRONMENTAL SCENARIOS ALTERNATIVE CROPS NORMAL WET DRY VIOLENT EXPECTED WEIGHTS .35 .30 .15 .20 VALUES ======================= CORN $ 900 450 -800 250 $ 380** -------------------------------- POTATOES 800 -300 400 500 350 -------------------------------- HAY/GRASS 300 500 0 100 275 ======================= You should PLANT CORN EVERY YEAR. In any one year you’ll either make 900, make 450, lose 800 or make 250 …but over the years, you’ll average $380 of profits.
  • 32. A PAYOFF TABLE ILLUSTRATION UNDER RISK (WHAT IS THE VALUE OF PERFECT INFORMATION?) WE KNOW ONLY GOD CONTROLS THE WEATHER, BUT IF WE HAD PERFECT PREDICTION EACH YEAR, WE’D KNOW EXACTLY WHAT THE WEATHER WOULD BE AND WHAT WE SHOULD PLANT. WE’D HAVE NORMAL CONDITIONS 35% OF THE TIME, AND DURING THOSE TIMES, WE’D PLANT CORN. 30% OF THE TIME IT WOULD BE WET AND WE’D PLANT HAY, ETC. STATES OF NATURE / ENVIRONMENTAL SCENARIOS ALTERNATIVE CROPS NORMAL WET DRY VIOLENT EXPECTED WEIGHTS .35 .30 .15 .20 VALUES ======================= CORN $ 900 450 -800 250 $ 380** POTATOES 800 -300 400 500 350 HAY/GRASS 300 500 0 100 275 ======================= Expected Profits given Perfect Information (EPPI) = $625. Expected Value of Perfect Information (EVPI) = EPPI – EV = $625 –380 = $ 245 Therefore, you can increase your profits by up to $245 if you have a perfect weather forecast each spring.