University Notes - Senior Year, 2nd Semester

Table of Contents
Keith Parker’s Notes from USC

Volume 5 of 5
Senior Year, Second Semester

Page Content
BUAD-497: Strategic Management
1 Syllabus
11 Course Documents
25 Assignments
37 Class Notes
63 Group Project
89 Powerpoint Slides
FBE-440: Trading and Exchanges

179 Syllabus
190 Course Documents
214 Assignments
228 Class Notes
243 Exam Things
FBE-462: International Trade and Commercial

Trade
272 Syllabus
277 Course Documents
282 Handouts
286 Homework
300 Class Notes
315 Group Project
MOR-492: Global Strategy

401 Syllabus
412 Discussion Help
413 Reading Notes
417 Class Notes
435 Projects
BUAD-497: Syllabus
University of Southern California
Page 1 Marshall School of Business
BUAD 497: STRATEGIC MANAGEMENT

Spring 2007
Instructor: Peer C. Fiss, Ph.D.
Office: Bridge Hall 303-B
Phones: Office: 1-213-821-1471
Email: fiss@marshall.usc.edu
Sections: Section 15102R – T/TH 12-1:50pm ACC 201
Section 15107R – T/TH 2-3:50pm HOH 304
Section 15112R – T/TH 6-7:50pm ACC 201
Office Hours: Wed 2:00pm – 4:00pm and by Appointment
Prerequisites: Successful completion of all core business requirements
COURSE DESCRIPTION
This course introduces the concepts, tools, and first principles of strategy formulation and competitive analysis.
You will learn about why some firms survive and prosper while others do not, and develop the critical analysis and
communication skills necessary to create and implement firm strategy. The course focuses on the information,
analyses, organizational processes, and skills and business judgment managers must use to design strategies,
position their businesses and assets, and define firm boundaries, to maximize long-term profits in the face of
uncertainty and competition.
Strategic Management (BUAD 497) is an integrative and interdisciplinary course in two important respects:
1. The course assumes a broad view of the environment that includes buyers/consumers, suppliers,
technology, economics, capital markets, competitors, government, and global forces and it assumes that
the external environment is dynamic and characterized by uncertain changes. In studying strategy, this
course draws together and builds on all the ideas, concepts, and theories from your functional courses
such as Accounting, Economics, Finance, Marketing, Organizational Behavior, and Statistics. However,
it is much more than a mere integration of the functional specialties within a firm.
2. The course takes a general management perspective. It views the firm as a whole, and examines how
policies in each functional area are integrated into an overall competitive strategy. We designed this
course to develop the “general management point of view” among participants. This point of view is the
best vantage point for making decisions that lead to sustainable business performance. The key strategic
business decisions of concern in this course involve determining and shaping organizational purpose to
evolving opportunities, creating competitive advantages, choosing competitive strategies, securing and
defending sustainable market positions, and allocating critical resources over long periods. Decisions
such as these can only be made effectively by viewing a firm holistically, and over the long term.
This course is intended to help you develop skills for formulating strategy. These skills will help you in whatever
job you take after graduation as well as in your personal investing and choice of employment. The strategy
formulation process demands the mastery of a body of analytical tools and the ability to take an integrative point of
view. You will develop these skills through:
• In-depth analysis of industries and competitors

• Prediction of competitive behavior
• Techniques for analyzing how firms can develop and sustain competitive advantages over time
NOTE: BUAD 497 is a core course taught by several instructors. Policies regarding assignments
and grading may be different for each instructor. Be sure to refer ONLY to this syllabus.
Keith Parker, University of Southern California

BUAD-497: Syllabus
Page 2
EDUCATIONAL OBJECTIVES
Theory and Concepts. The central concept of this course is that of competitive strategy. Definitions abound, but
they all share some sense of the allocation of critical resources over relatively long periods in pursuit of specific
goals and objectives. Successful strategies exploit external conditions, entrepreneurial insights, and internal
resources, seeking configurations of prices, preferences, technologies, and information that offer opportunities for
sustainable competitive advantage. Strategy can be usefully thought of as the comprehensive alignment of an
organization with its future environment.
Success, however, depends not only on the soundness of the strategy, but also on its effective implementation
through appropriate organizational and administrative choices. In the end, unforeseen external factors may cause a
well-conceived and executed strategy to fail, in spite of its initial wisdom -- but a poor strategy badly executed
increases the chances of failure. Opportunities to act strategically often do not come labeled as “strategic” and
occur infrequently. If missed, or mismanaged, they can prove disastrous for any firm.
Understanding the concept of competitive strategy formulation is a primary educational objective of this course.
This will involve mastering an array of economic, strategic, and organizational concepts and theories, and acquiring
an integrative general manager’s point of view. The course will cover theories for in-depth industry and competitor
analysis, for anticipating and predicting future industry developments, and for examining the impact of change (in
technologies, tastes, government regulations, global competition, and other important environmental forces) on
competition and industry evolution. The course will also examine the economic underpinnings of competitive
advantages, and the fundamental conditions that allow firms to conceive, develop, and sustain, advantageous
strategic positions. While our primary focus will be on mastering strategy formulation at the business unit or
competitive level, the course will also examine corporate and global strategy issues such as diversification, vertical
integration, economies of scope across related businesses, the transfer of technology and core competencies, and
international expansion and growth.
Analytical Skills. Theoretical concepts are a great aid to understanding, but by themselves, they do not help
resolve real business problems or challenges. Also needed are analytical skills and techniques that can be applied to
the data to "fill in" the facts and premises assumed in the theories. A second educational objective is further to
increase each student’s inventory of useful analytical skills and tools. Some of the tools are quantitative --
analyzing financial statements, computing comparative buyer costs, and calculating the effects of scale and learning
on production costs, for example -- while others are qualitative. Learning how to apply these techniques, and, more
importantly, when to apply them is a key objective of the course.
In learning to size-up a business and its problems or opportunities, this course will require you to conduct "full
blown" strategic analyses. That is, identifying firms’ strategies and testing them for consistency, recognizing
potential entrepreneurial opportunities and strategic challenges/problems, selecting and establishing competitively
protected market niches, identifying competitive advantages and shaping defenses to circumvent the advantages of
rivals, formulating and implementing internally consistent business strategies, and designing efficient and effective
organizations.
Rhetorical Skills. The best analysis in the world will have little effect if it cannot be communicated to others.
Managers must be able to articulate their views coherently and persuasively, and they must be skilled at
understanding and analyzing other points of view. Management is a "verbal sport;" perhaps 90% of a typical
manager's day is consumed by oral communication. Time is often scarce. You must learn to make convincing
arguments and to make them quickly, or the merits of their ideas are likely to become simply irrelevant. This skill
takes practice, and we will place a great deal of emphasis on it in class.
Wisdom. Much of the knowledge that successful managers and consultants employ consists of "rules of thumb"
about what issues are likely to be important in certain kinds of business situations. These rules of thumb, or
heuristics, are often implicit in the thinking of people who have never bothered to articulate them explicitly. A
fourth goal of this course is to help you build up your set of useful "stories" and heuristics for your future
managerial careers.
In this course, we are as much interested in developing an appreciation for the art of management as we are in
understanding the science of management. Tools alone will not a strategist make. While the ability to master
2
BUAD-497: Syllabus
Page 3
analytical models, frameworks, and tools is essential, ultimate success is more strongly predicated on prescient
judgment, entrepreneurial insight, iconoclastic vision, and a willingness to act forcefully with conviction.
COURSE FORMAT AND THE CASE DISCUSSION METHOD
In order to achieve the objectives of the course, we will devote the majority of our class time to the analysis and
discussion of selected management, competitive strategy, and business policy cases. I will use lectures to elaborate
on key theoretical models and frameworks or to reinforce crucial concepts. These lectures, however, will be
subordinate to the case analysis. Cases provide a natural "test-bed" for theory and provide vivid examples that aid
memory of concepts. While nothing can surpass first hand personal industry and managerial experience as a basis
for analysis and decision-making, case analysis is an indispensable proxy for the kind of knowledge that can only be
gained through years of experience and research. I have selected a mix of old and new business cases on a range of
companies from a variety of industry settings. Each case is intended to teach us something specific, yet each can
teach many things. We will not attempt to exhaust each case of all its learning experiences, but rather build up a
"tool kit" of analytical tools, skills and insights, progressively over all the selected cases.
There are other reasons for employing the case discussion method of instruction. First, it allows you to develop
skills at problem definition in addition to problem solving. Cases typically do not have an obvious set of tasks
whose performance will lead to mastery. Rather, they force you to sift through a mass of information, some of it
irrelevant or contradictory, in order to identify the important or strategic issues. Second, the case method gives you
a chance to deal with ambiguity. Most cases do not have obvious "right" answers. Managers must be able to
function in situations where the right answer is not known, without falling into the trap of assuming that any answer
is as good as another. Some analyses and proposed strategies are clearly wrong, and some are clearly better than
others are. A popular phrase in case analysis classes is "There are no right answers, but there are wrong
answers." Case discussion techniques provide a chance to learn the meaning of analytical rigor in situations other
than open-and-shut problems.
These rationales are offered because the case method is unfamiliar to most of you and frequently causes initial
confusion. There will be many times when I will not reveal my own opinions about a particular issue, and there will
be many cases that do not end up neatly packaged with an "answer." You may discover that your preparation
"misses" key points of a case, especially at first. This is a normal part of the learning experience.
While we will direct class discussions, the quality of your learning experience will be directly determined by: (1)
your degree of preparation, active listening, and participation, and (2) your classmates' preparation, listening, and
participation. Some will not agree with you, and you may be asked to defend your argument or change your mind.
So long as criticism is directed at arguments and not at individuals, is relevant to the issues at hand and coherently
argued, it is very much welcomed.
Case Preparation Because this course relies heavily on case material, extensive before class preparation and in
class participation are required to ensure the class' success. (1) Preparation for a case discussion should begin
with a rapid reading of the assigned case and other materials. (2) Then, it is worthwhile to review the discussion
questions provided for clues as to what issues require special attention. (3) The next step is normally to re-read the
case carefully, taking notes which sort information, facts, and observations under a number of relevant headings.
Try to formulate theories or hypotheses about what is going on as you read ("the company loses money on small
orders"), modifying or rejecting them as new information surfaces ("Table 2 shows that shipping costs per unit are
higher for small orders, but only for long-distance shipments"). Push yourself to reach definitive conclusions before
you come to class. (4) You should perform quantitative analyses, “crunching” whatever numbers are available. It is
also very important to provide quantitative support wherever possible, particularly when exploring various
hypotheses as to the nature and importance of certain phenomena. (If the requisite data are not available in the case,
a precise description of what data are missing often triggers ideas for making creative use of the information that is
available.) It is usually worthwhile to identify trends in the firm or industry, preferably with a quantitative
measurement. Some of these trends, often very important ones, will not be flagged in the text of the case. (5)
Finally, preparation will include notes that can be used to guide your interventions in class discussions.
You will probably want to, and I strongly encourage you to form study groups that regularly meet to share insights
and ideas about the assigned cases. While this is voluntary, experience shows that satisfactory performance in this
course, and a good grade, depend on it.
3
BUAD-497: Syllabus
Page 4
WARNING! There is a good chance that you will feel a bit confused or overwhelmed during the first
module, or two, of the course. This is a byproduct of the peculiar structure of the strategy course that does not build
up linearly by successively adding components of knowledge week by week. Rather, every case in a sense contains
all the material in the entire course. Furthermore, the early theoretical concepts will gain in meaning to you once
you have worked through a few cases. As a result, there is no logical way to begin except by immersion. So
remember:
SOME CONFUSION IS NORMAL AT FIRST. You will gain experience as we progress through the course.
COURSE EVALUATION
Course grades will be determined by individual and group activities:
Course contribution and participation 15%

Individual mini case analysis 10
Individual midterm exam 20
Group project presentation 10
Group project writeup 20
Individual final exam 25
100%
In order to pass this course successfully, a passing grade (> 50%) must be achieved in the group and in the
combined average of the individual components.
Please note that if your individual performance in the course is unsatisfactory, it will not be brought up by a
good group grade.
The distribution of grades will closely follow the guidelines of the Marshall School of Business (an average class
GPA of 3.0 for required courses).
Course Contribution and Participation. Managers must often “sell” their ideas to others in order to get their
acceptance and support. In this course, the classroom provides a laboratory in which you can test your ability to
convince your peers of the appropriateness of your approach to complex management problems. Furthermore, it
tests your ability to carefully listen to others’ perspectives and understand why they may reach a different
conclusion. Before you can effectively sell your ideas to others, you must understand what is motivating them, what
issues they feel are important, and what assumptions they are making that may be different from your own.
When evaluating your contribution to the class discussion, then, I will consider how effectively you put forth your
own arguments, as well as how well you listen to, understand, and build upon (or refute) the arguments of others. In
all cases, I will look for high quality (which is frequently not the same as high quantity) arguments, analyses and
questions that improve the class’ collective understanding of the case issues. While I encourage you to speak up at
any time, keep in mind that comments that are redundant, tangential or seemingly irrelevant to the case discussion at
hand or attempts to dominate class discussion will have a negative impact on your participation grade. I will use the
following criteria when determining class contribution grades:
• Has the student attended and made significant contributions to each class discussion?
• Does the student show evidence of careful case analysis by using facts and evidence from the case?
• Does the student draw valid conclusions from the facts presented in the case?
• Does the student contribute interesting examples? Does the student make effective comparisons among
different cases situations, as well as between case situations and real life cases?
• Do the ideas suggested by the student push us to consider an aspect of the case that is not necessarily obvious at
the outset? Do they go beyond the surface and get into core issues?
• Is the student is an active listener? Do his/her comments fit in with the flow of the class discussion? Do his/her
comments demonstrate listening to and reflection on points suggested by others? Does the student interact with,
challenge, question, and extend comments of other participants, or are all comments directed towards the
instructor?
• Does the student engage in constructive debate that challenges the opinions expressed by others without
diminishing the value of their contribution?
4
BUAD-497: Syllabus
Page 5
I realize that some of you may be shy about speaking up in a large class like this. Therefore, I offer you the
opportunity to somewhat compensate by participating in the class’s online discussion group. The same evaluation
criteria apply here as for in-class discussion. However, keep in mind that this can never fully substitute for in-class
discussion.
Please remember that your classmates and I expect you to attend and be well prepared for each class, having read
the required conceptual material and analyzed the assigned case study ahead of time. We also expect you to play an
active role in class discussion. If all class members prepare for and actively participate in each class discussion, your
experience will be all the better for it. I will ask you to speak even if you have not volunteered, so please be ready
for discussion every class.
Individual Mini Case Analysis. For this assignment, I will ask you to analyze a recent event in the business press
using the tools we have discussed in class. The analysis should not exceed four (4) double-spaced pages with 1"
margins and 12 point font. I will post more information on this assignment on the course website. This assignment
will be due on Tuesday, February 6.
Individual Midterm Exam. For this assignment, I will provide you with specific questions regarding a company
case, and your answers should be confined primarily to the facts as presented in the case. You are expected to use
both the concepts and the terminology presented in this course in your write-ups. For the mid-term analysis, the
analysis should not exceed six (6) double-spaced typewritten pages, with 1" margins and 12 point font).
Your analysis will be evaluated equally on the following criteria:
• How well (i.e., thoroughly and concisely) do you describe the environmental context and internal factors that
are important to the problem?
• Accurate and thorough use of course concepts
• Integration of course concepts with information about the company and problem
• How well do you integrate course concepts with information about the problem to illuminate the problem in a
way that leads to solutions?
• Extent to which recommendations are consistent with analysis
• Feasibility and specificity of recommendations
• Quality of written analysis
The individual midterm exam will be a take-home exam. It will be due on Tuesday, March 6, at the beginning of
class.
Please put your name and student number ON THE BACK OF YOUR EXAM ONLY, NOT ON THE FRONT. I
don’t want to see your name while I grade these assignments. As always, you should not discuss the case itself with
any other student.
Group Project Presentation and Writeup. For this group project, you will self-select into groups of 4-6
members. It is your responsibility to form teams. All team members must be from the same section. The project
requires you to examine strategic challenges or an issue of concern at real organizations. The purpose of the project
is to give your team an opportunity to apply what has been learned in the course to strategic problems faced by real-
world organizations.
In terms of the topics for your analysis, groups can choose from a menu of topics including the organizational
development of a firm over its entire history, an analysis of a firms’ responses to the internet, an analysis of the
growth pattern of a successful and an unsuccessful firm, or a successful and unsuccessful radical repositioning of
two companies. Your team should identify one or more public, private, or not-for-profit organizations to study. You
may select an organization in which one or more of the team members has worked or been a member. I would
suggest that you be selective in choosing an issue or problem to analyze, as a lack of background on the issue itself
will not be an acceptable excuse for a lack of depth in the analysis.
1. an e-mail with the names an addresses of your group members, a team name, and a brief statement that
outlines your proposed project (see below)
5
BUAD-497: Syllabus
Page 6
2. a written analysis and data appendix (20% of course grade) and
3. an oral presentation to the class (10% of course grade)
4. completing a peer evaluation form within 24 hours of the presentation
You will conduct original research on your organization(s) and will supplement this information with data from the
media, the organization(s)’ own literature, and other secondary sources. You should focus your analysis on applying
concepts from the course. Although it is acceptable to incorporate several concepts from the course, please aim for
depth rather than breadth regarding the use of course concepts. In my experience, papers that aim to apply a bunch
of concepts end up being shallow in their analysis and don’t do well.
The project proposal e-mail will be due by midnight on Wednesday, January 31. This e-mail should include:
1. The team name and names of all team members

2. A brief description (roughly 400 words) of your topic.
The written analysis should not exceed fifteen (15) double-spaced typewritten pages, with 1" margins and 12 point
font. I will only read the first 15 pages of text, so please stay within the page limit. The limit does not include
appendices, which you can use to provide charts, figures, or other background material, but should be no longer
than five (5) pages. Appendices which are not directly referenced in the text will not be read. The appendix is not a
catch-all for anything that might be relevant, but is to be used carefully to support your points. Always include page
numbers. Staple papers only, (no binding, folders, clips, or anything other than plain paper).
This written document is due at noon on Friday, April 6 for all teams.
Oral presentations will be given during the final 4 class sessions. Each presentation should be 25-30 minutes in
length, and additional time will be set aside for questions from other teams after the presentation. Both the oral
presentation and written document should cover all of the key elements of your analysis. For grading purposes, it
will not be sufficient to orally present an aspect of your analysis that does not appear in the written document.
The in-class presentation of your paper is worth 10% of the course grade. Half of these 10% will come from your
peers, who will attend your presentation and afterwards score it, while the other half will come from my evaluation.
It is therefore imperative that you both do well on these presentations and also attend the presentations of your
peers, as you will have to post grades for them online. Also, I do not expect but welcome non-traditional forms
of presentation. I expect that at this time of your USC career, you know how to give a professional presentation, so
this may be a good opportunity to play around with the format. However, please remember that presentations that
neglect content in favor of form are not likely to score well.
Finally, each team is free to structure itself as it wishes. However, at the conclusion of the project, each member of
the group will be asked to evaluate every other group member anonymously on the last day of class using a peer
evaluation form that will be available on the course website. All team members must complete the form within 24
hours of their presentation. The goal of this evaluation is to discourage free-riding. If any students receives
unsatisfactory ratings from their group, their grade will be marked down accordingly.
Individual Final Exam. A final exam will be given during the exam time specified by the University. The exam
will consist of questions on an exam case passed out to you one week prior to the exam. The format is similar to
case presentations and discussions (e.g., you will be asked to diagnose the problem and make recommendations for
action based on all the materials covered in this course). The anticipated times are listed in the course schedule
attached at the back of the syllabus. However, you are responsible for confirming this date and time in the
university schedule of classes.
COURSE POLICIES
Attendance. Attendance at all class sessions is expected. Because learning in this course occurs primarily through
interactions with other participants during class, every effort should be made to attend each class. There is no
substitute for being present, prepared, and participating in the class discussion. While I recognize that from time to
time absences may be unavoidable, absences necessarily limit your class contribution (you can’t gain participation
points if you are not there…) and hence can influence your grade. Please notify me by email at least a day in
6
BUAD-497: Syllabus
Page 7
advance if you must miss a class. If you do miss class, it will be your responsibility to get notes, find out
what was discussed, etc. from one of your classmates.
Participation Cards. At the end of each case discussion, students who actively participated in the discussion
should turn in a Participation Card. These cards should list your name, the date, the case discussed that day, and a
synopsis of your contributions during that day’s discussion. The Participation Cards will be used in combination
with my own daily evaluations to determine your participation grade for the day. For this purpose, please purchase a
package of 3x5 index cards and bring them to each class.
Please turn off all Communication and Entertainment Devices. Your classmates and I expect your full
attention, so please keep your laptops closed unless we use them for an assignment. Also, please be sure your cell
phones, pagers, Blueberries, phasers, tricorders, or other devices are turned off during class.
Other Stuff:
• Do not wait until the end of the semester to see me regarding problems with your performance. Your
performance in this class is important to me, so please see me early.
• Written assignments must be submitted on time. As managers, you will not be afforded the luxury of missing
deadlines (think of deadlines as “windows of opportunity”). The discount rate for late assignments is steep.
• If you can convey your thoughts more succinctly in your written assignments, please do so! Suggested paper
lengths are only upper limits.
• Like managers executing actual strategies, we may find that the course syllabus must be amended slightly as the
semester progresses. Please be sure to check the course webpage before class for study questions and
further information on the readings and cases!
COURSE MATERIAL
Case Package: The assigned cases for this course are available from the University Book Store. When
necessary, I will place additional materials on the course website for you.
Text: There is no required textbook for this course. However, if you would like to use a textbook to
extend your understanding, you are welcome to come by my office and browse my collection
and pick my brain about them (i.e. which ones to buy, which ones to avoid…)
3x5 Cards: Please bring a deck of 3x5 cards to every class to record your participation (see above
description).
COURSE COMMUNICATION: BLACKBOARD SYSTEM
I have posted the course syllabus to the 497 folder for your section in Blackboard. I will also post additional course
lecture notes/materials, further details on assignments, and general course announcements to this folder throughout
the semester. You should develop the habit of checking the course folder on a daily basis. You can access
Blackboard either by going to http://totale.usc.edu/webapps/portal/frameset.jsp or by going through the “My
Marshall” portal http://mymarshall.usc.edu. You will need your UNIX password for either site.
IMPORTANT:
(1) Since e-mails sent to the class originate from the Blackboard system, it is your responsibility to make sure
your e-mail is set up to forward your messages to your preferred internet provider (IP) account such as
EarthLink, AOL, Hotlink, etc.
(2) Be certain that you include a recent digital color photograph of yourself within the personal information
section, as I will use these to learn your names (important for your participation grade).
ACADEMIC INTEGRITY
The following information on academic integrity, dishonesty, and the grading standard are placed here at the
recommendation of the School of Business Administration Faculty and are taken from the Faculty Handbook.
7
BUAD-497: Syllabus
Page 8
Additional statements about academic integrity may be found in SCampus handbook available at the Topping
Student Center and online at http://www.usc.edu/go/scampus. Further information may be obtained from the Office
of Student Judicial Affairs and Community Standards at http://www.usc.edu/student-affairs/SJACS/index.
“The University, as an instrument of learning, is predicated on the existence of an environment of integrity. As

members of the academic community, faculty, students, and administrative officials share the responsibility for
maintaining this environment. Faculty has the primary responsibility for establishing and maintaining an
atmosphere and attitude of academic integrity such that the enterprise may flourish in an open and honest way.
Students share this responsibility for maintaining standards of academic performance and classroom behavior
conducive to the learning process. Administrative officials are responsible for the establishment and maintenance of
procedures to support and enforce those academic standards. Thus, the entire University community bears the
responsibility for maintaining an environment of integrity and for taking appropriate action to sanction individuals
involved in any violation. When there is a clear indication that such individuals are unwilling or unable to support
these standards, they should not be allowed to remain in the University.” (Faculty Handbook, 1994: 20)
Academic dishonesty includes: (Faculty Handbook, 1994: 21-22)
1. Examination behavior - any use of external assistance during an examination shall be considered academically
dishonest unless expressly permitted by the teacher.
2. Fabrication - any intentional falsification or invention of data or citation in an academic exercise will be
considered a violation of academic integrity.
3. Plagiarism - the appropriation and subsequent passing off another’s ideas or words as one’s own. If the words
or ideas of another are used, acknowledgment of the original source must be made through recognized
referencing practices.
4. Other Types of Academic Dishonesty - submitting a paper written by or obtained from another, using a paper or
essay in more than one class without the teacher’s express permission, obtaining a copy of an examination in
advance without the knowledge and consent of the teacher, changing academic records outside of normal
procedures and/or petitions, using another person to complete homework assignments or take-home exams
without the knowledge or consent of the teacher.
The use of unauthorized material, communication with fellow students during an examination, attempting to benefit
from the work of another student, and similar behavior that defeats the intent of an examination or other class work
is unacceptable to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior
resulting from the nervous tensions accompanying examinations. Where a clear violation has occurred, however,
the instructor may disqualify the student’s work as unacceptable and assign a failing mark on the paper.
STUDENTS WITH DISABILITIES

Any student requesting academic accommodations based on a disability is required to register with Disability
Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained
from DSP. Please be sure the letter is delivered to me as early in the semester as possible. DSP is located in STU
301 and is open 8:30 a.m. – 5:00 p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.
8
BUAD-497: Syllabus
Page 9
COURSE SCHEDULE
Tu – Th Schedule for Fall, 2006

Days of
the
Dates Week Session Topic
Introduction
1/09 Tuesday 1 Introduction
Thursda
1/11 y 2 Preview Case: Intel Corporation
Industry and Firm Analysis
1/16 Tuesday 3 Industry Analysis I
Thursda
1/18 y 4 Industry Analysis II: CF Motorfreight
1/23 Tuesday 5 Industry Analysis III: Apple Inc.: iPods and iTunes
Thursda
1/25 y 6 Firm Competencies I
1/30 Tuesday 7 Firm Competencies II: Pepsico Restaurants
Team project proposal e-mail due by midnight on Wednesday, January 31
Thursda
2/01 y 8 Firm Competencies III: WalMart
2/06 Tuesday 9 Complementarities and Fit
Individual mini case analysis due at the beginning of class
Thursda
2/08 y 10 Fit Applied I: Progressive Corporation
2/13 Tuesday 11 Fit Applied II: Airborne Express
Competitive Dynamics and Positioning
Thursda
2/15 y 12 Competitor Analysis
2/20 Tuesday 13 Competitor Analysis Applied: Ryanair
Thursda
2/22 y 14 Competitor Analysis Applied: Leadership Online (A): Barnes and Noble versus Amazon.com
2/27 Tuesday 15 Creating Competitive Advantage: Harnischfeger Industries
Thursda
3/01 y 16 Sustaining Competitive Advantage: Saturn
9
BUAD-497: Syllabus
Page 10
3/06 Tuesday 17 Standards and Network Externalities I

Individual midterm exam due at the beginning of class
Thursda
3/08 y 18 Standards and Network Externalities II: The Browser Wars
3/13 Tuesday -- Spring Break
Thursda
3/15 y -- Spring Break
Strategy Implementation
3/20 Tuesday 19 Strategy Formulation and Implementation I: Honda A
Thursda
3/22 y 20 Strategy Formulation and Implementation II: Honda B
3/27 Tuesday 21 Implementation and Change I: Lehman Brothers A
Thursda
3/29 y 22 Implementation and Change II: Lehman Brothers B
4/03 Tuesday 23 Managing with Networks and Power I
Thursda
4/05 y 24 Managing with Networks and Power II: Abelli and Savotti
Team written projects due by noon on Friday, April 6
4/10 Tuesday 25 Performance and Governance I
Thursda
4/12 y 26 Performance and Governance II: Bausch and Lomb
Group Project Presentations

4/17 Tuesday 27 Team presentations
Thursda
4/19 y 28 Team presentations
4/24 Tuesday 29 Team presentations
Thursda
4/26 y 30 Team presentations and wrap up
10
BUAD-497: Course Documents
Porter’s 5-force framework:
Page 11 • Assesses competitive position of a firm within an industry
• 5 variables measure competitive advantage
• Assumes continuous downward pressure of competition
• Points to interdependencies between factors (i.e. interaction, substitution)
Competition…
Threat of entry: ease of ability to enter new markets
Impacted by: absolute cost advantages, government policy, economies of scale, and brand identity
(minimum efficient scale)
Patents, tariffs, quotas, licensing, geographical locations, language/cultural
Buyer power: size and concentration of customers
Impacted by: concentration, switching costs, backwards integration
Powerful…large and concentrated, backwards integration
Weak…fragmented, producer’s supply critical parts
Supplier power: differentiation and switching costs
Impacted by: # of suppliers, switching costs and presence of substitute inputs
Powerful…concentrated and significant switching costs
Weak…standard product and concentrated purchasers
Rivalry: intense rivalry reduces average profitability
Impacted by: growth, differentiation, # of competitors, diversity and exit barriers
Concentration ratio, Herfindahl Index (monopoly, perfect competition)
Threat of substitutes: price/performance ratios, switching costs and sub. improvement
Impacted by: products in other industries ability to constrain the raising of prices
*Great framework for industry dynamics…but complimentors and government influence missing!
PEST:
Political: tax policy, employment laws, environmental regulations, trade restrictions, tariffs and political
stability.
Economic: growth, interest rates, exchange rates and inflation.
Socio-cultural: health consciousness, population growth rate, age distribution, career attitudes and safety.
Technological: barriers to entry, MES and outsourcing decisions (R&D, automation).
*Useful for understanding market growth/decline, business positions, potential direction for operations.
Overview of various macroenvironmental factors in firm’s particular environment. These factors = external
opportunities and threats in SWOT!!!
SWOT:
Strengths: internal asset
Weaknesses: internal liability
Opportunities: external asset
Threats: external liability
*Unfortunately, most strengths have corresponding weaknesses and all future events are both opportunities
and threats…thus, SWOT = introspective analysis of company, not the industry or competitive environment
Porter’s Generic Strategies:

Strategy: unique position for a firm
not doing the same activities better, rather doing them differently or doing different activities.
Strategy involves trade-offs
Due to incompatible product features, inconsistencies in image, limits of coordination, motivation,
management, etc.
Strategy = achieving high degree of fit between internal activities and external environ.
Operational effectiveness is not strategy
*Strategy key tension…control and flexibility!!!
Hambrick and Fredrickson: BUAD-497: Course Documents
Strategy: central, integrated, externally oriented concept of how to achieve objectives. Page 12
Arenas: where will we be active? (geographically, industry, markets, segments/positions)
Vehicles: how will we get there? (joint ventures, subsidiaries, LLP, corporations)
Differentiators: how will we compete? (quality, quantity, cost, service, efficiency, safety)
Staging: what speed and sequence of moves? (monthly, quarterly, annually, saturate markets, slow
introduction, across entire continents, select countries)
Economic Logic: where will profits come from? (premium prices, superior product, etc.)
*does strategy…fit environment? Exploit key resources? Sustain differentiators? Internally consistent?
Enough resources to pursue in long term?
*Elements of firm must reinforce strategy!!!
Boston Consulting Group Matrix:

Stars: (high Market share, high Growth) Aggressive investment to support continued growth and
consolidate competitive position of firm
Question Marks: (low Market Share, high Growth) Selective investments: divestitures for weak firms
or those with uncertain prospect for strategic fit.
Cash Cows: (high Market Share, low Growth) Investments sufficient to maintain competitive position:
excess cash used to nurture stars and select question marks.
Dogs: (low Market Share, low Growth) Divestiture, harvesting or liquidation and exit.
*Measures market share against growth
McKinsey Matrix:
Industry Attractiveness (comp. position-good, medium, poor):
Low: profit producer, loser, loser
Medium: winner, average business, loser
High: winner, winner, question mark
Core Competencies:
Core competencies combine resources and capabilities to create a competitive advantage.
Resources: tangible (factories, products) and intangible (reputation, loyalty) assets to firm in the form
of: financial, physical, human, org.
Capabilities: proficiencies enabling firm to take full advantage of resources (marketing and
cooperative relationships).
Portfolio of Competencies: existing and new

Existing: opportunity to improve existing position in markets by leveraging current core
competencies…new products to be created from a different configuration of existing resources.
New: new products required to protect and expand brand in current markets…the markets of the
future.
Resource Based View (RBV) of Corporation:

2 critical assumptions: Resource Heterogeneity (differences in resources among existing firms) and Resource
Immobility (costly for firms to acquire)…have something someone doesn’t and can’t get, then a sustainable
competitive advantage is created.
*Internal focus on idiosyncratic strategies (not external with identical)…resources not highly mobile,
therefore possession directly correlated to competitive advantage.
VRIO:
Value: resource enables firm to exploit opportunity (increase revenue) or neutralize threat (decrease costs).
Rare: if not rare, perfect competition observed: no competitive advantage…must have scarcity among firms
to enjoy rarity and competitive advantage.
*Valuable and rare…competitive advantage
*Valuable and not rare…competitive parity
*not Valuable…competitive BUAD-497:
disadvantage Course Documents
PageImitability:
13 cost disadvantage in imitating valuable and rare resources = sustainable competitive advantage:
intangible and bundles of resources more costly to imitate.
• Unique historical conditions: first mover advantage, path dependence
• Casual ambiguity: bundling fogs actual casual links
• Social complexity: unable to duplicate relationships exactly
• Patents: periods of legal protection
Organization: align structure and control mechanisms to exploit resources and compliment other resources
within firm (3M rewards innovation and risk taking).
* Valuable, Rare, Imitate, Organized resources = sustainable competitive advantage.
Greiner’s model of Org. Growth:

Phase 1: growth by creativity…crisis by style of management
Phase 2: growth by tight management…crisis by autonomy
Phase 3: growth by delegation…crisis by control
Phase 4: growth by coordination…crisis by bureaucracy
Phase 5: growth by team spirit…crisis by unknown factors
*Firm grows as organization evolves…each new phase sparked by revolutionary infusion
Organizational Structures:
Simple: low revenue base, simple product-market scope.
Functional: increase in revenues, engage in vertical integration.
Cost Leadership: operations = main function. Process engineering > R&D. Large centralized staff,
formal procedures, and highly structured job roles.
Differentiation: marketing = main function. R&D, decentralization emphasized. Foster change and
promote new ideas with organic, less structured job roles.
Divisional: expand into new/related product markets and/or geographic areas.
More autonomy for divisions: corporate staff relegated to logistical and general strategic oversight.
Divisions are solely responsible for functionality. *Decentralized structure (i.e. Nucor).
Matrix: expand internationally: extension of divisional concept to project level.
Mintzberg’s Organizational Theory:

5 Basic Elements
Operating Core: employees perform basic work related to organization’s product.
Strategic Apex: corporate executives responsible for running entire organization.
Middle Line: managers transfer information between higher and lower levels of organizational hierarchy.
Technostructure: organizational specialists responsible for standardizing various aspects of organization’s
activities.
Support Staff: individuals provide indirect support services to organization.
5 Organizational Structures:
The Simple Structure: young, small; nonsophisticated technical system; simple, dynamic environment. (Key:
strategic apex)
Machine Bureaucracy: old, larger; regulating, nonautomated technical system; simple, stable envir. (Key:
technostructure)
The Divisionalized Form: diversified markets (esp. products & services); old, large. (Key: Market grouping,
performance control, limited vertical decentralization)
The Professional Bureaucracy: complex, stable envir. Nonregulating, nonsophisticated technical system:
(Key: Operating Core).
The Adhocracy: complex, dynamic envir.; sophisticated and often automated technical system (Key: Support
Staff)
*The Idea Organization: Value-based organizations, public/religious organizations…Jehovas Witnesses,
Greenpeace, Al-Qaeda, IRA
Activity Systems:
Configurations exhibit high BUAD-497:
degrees of internalCourse
fit. InterplayDocuments
of complementarities and trade-offs across
Pageand
multiple activities is critical to success...equifinal (different, yet equally effective methods). Must extend 14
strengthen fit among activities according to strategic position.
What is strategy? Unique position, tailored activities, clear tradeoffs, continuity of position with
consistent improvement and integrated system of activities with fit.
What is not strategy? Best practices, learning, agility, flexibility, restructuring, mergers/consolidation,
alliances or the Internet.
Game Theory:
1. Structure of games:
• Players – any number of persons
• Rules – determined by the number of options/alternatives in the play of the game. Structure of
play off matrix is a function of the rules of the game.
• Payoff Structure
1. Zero sum: one side must get less if the other gets more
2. Non-zero sum: not an equal trade off of +/-
• Strategies
1. Minimax – to minimize the maximum loss; defensive strategy
2. Maximin – to maximize the minimum gain; offensive strategy
3. Tit-for-Tat – always respond in kind
4. Tat-for-Tit – always respond conflictually to cooperation and cooperatively towards
conflict
2. Moves to change the game played:

• Players: can bring in customers, bring in suppliers, bring in complementors, or bring in
competitors.
• Added Value: can limit the supply, raise amount of consumers are willing to pay, or lower
competitors’ value.
• Rules of the Game: can change the rules to benefit you
• Tactics employed: can make the game more transparent or opaque, depending on which
benefits you
• Scope of the Game: you can link games to other games or de-couple the game from other
games.
3. Basic games:
Prisoners’ Dilemma – The result of using a minimax strategy. It assumes no communication. Strategies
can be altered if there is sufficient trust between the players. Both confess at the saddle point.
Characterized by T > R > P > S
• Temptation: desire to double- cross other player
• Reward: cooperate with the other player
• Punishment: from playing it safe
• Sucker’s pay off: for the player who is double-crossed
Chicken – there is no saddle point. No matter what one player choose, the other player can change for
some advantage. It is unstable and the outcome cannot be predicted, but credible commitment can
persuade the other player to back down
Dilemma of the Commons – the problem of the unregulated use of a public good. Someone takes
advantage of a shared good and profits himself but reduces the overall capacity of the market, hurting the
rest of the group.
Competitor profiling
PageComplements
15 game theory w/ competitor profiling to work around restrictive assumptions on which game theory is built
Behavioral perspective
• Focus on competitors’ predispositions
• What competitors really want given beliefs, blind spots, and historical gathering
Why Competitor Profiling Matters

• Goals may not be fully rational
• Differences in an organizations’ charter (public, non-profit, family-owned)
• Beliefs—see the world differently
• Mental models may differ (diff. in functional backgrounds)
• Agency problems (top-management’s interests may be different)
• Irrationality (pride, jealousy, fairness)
• Routines may constrain opportunities for action

• inertia due to size/family/maturity/complexity/strong culture/bureaucratization
Integrating game theory and competitor profiling

• Think Broadly about the set of strategic options
• Variables (organization, customers, pricing)
• Asymmetric
• Commitment postures
• Information
• Augment your toolkit for dynamic Analysis
• Scenario analysis (role-playing/devils advocate)
• Market testing
• Sequenced rollout
• Match analytics and industry/company context
• Do general assumptions hold in the industry/company?
• But: question industry logics/orthodoxies
Value chain analysis, including value creation, value division, value added, the value net
Value added chain analysis (Harnishfeger Case)
• Why Value Creation?

• Before who gets what, determine what there is to get
• Assessing=
• Who are the players?
• Customers willing to pay?
• Suppliers’ opportunity costs?
Value Chain
• Production Flow
SUPPLIER resource or input BUSINESS product/output CUSTOMER
Monetary flow ($)

•
CUSTOMER BUSINESS SUPPLIER
Value Creation
SELLER (indifferent)
Opportunity cost
Cost BUAD-497: Course Documents
(profit) Page 16
Price
Willingness to pay
BUYERS
Value Created = buyer’s willingness to pay – supplier’s opportunity costs
• Price measures the division between business and the customer

• Cost measures the division of value between business and supplier
Value Added = total value with you – total value w/o you
• What you bring to others
| Cost
| Price
| (positive bargaining zone)
| Willingness to pay
Size of the pie = willingness to pay – opportunity cost
Division of the pie = value added
Value net
Customers
/ | \
Competitors Company Complement
\ | /
Suppliers
Standards/network externalities and their role in strategy (open/closed, tactics etc..)
Standards matter whenever products depend on compatibility
Strategies
• Hold back product launch
• Adopt a simple, undifferentiated, standard design
• Encourage imitation by other manufactures
• Lower prices to maximize early sales
• Sony vs. JVC

•
Standards introduce network effects
Page 17 • Benefits that come from having a large installed base of users
• Classic examples are literal networks
• Telephone
• Fax
• Internet
• Number of possible connections grow rapidly w/ number of users – “network externalities”
• System w/ one user is of little users
• System w/ all customers on is very valuable
• Windows vs. Mac
Wins and looses

• Consumers
• Better off
• Reduced uncertainty
• More users, more value
• Decrease in variety
• Complementars
• Generally better off
• Brokering role
Key Points
• Understand the positions and interests of all pates involved in the standards competition
• Strength of position – 7 key assets
1. Control over an installed based
2. Intellectual property rights
3. Ability to innovate
4. First-mover advantages
5. Manufacturing
6. Strength in complements
7. Reputation and brand name
• Preemption
• New technologies require champions to invest early to build
• Being first can back fire if there are better technologies arriving soon
Expectations Management
• Engage in aggressive marketing, make early announcements of new products, assemble allies, make visible
commitments to your technology
• Self-fulfilling prophecies can overrule technical advantage
• Leapfrogging
Open
• No one firm controls
• Specs are public – anyone can build compatible products
• May require license fee
• May not help firm that invented
Closed
• One firm
• Systems can be controlled, so benefits don’t flow to a competitor
• Leapfrogging may occur
•

Dynamic industries and their effect on strategy Page 18
• Competitive advantages erode quickly

• Established rules are broken
• Industry boundaries are breached
• Customer loyalty is fickle
• Sustainable competitive advantages becomes a series of shorter unsustainable competitive advantages
• Internet Explorer vs. Netscape

• Internet Explorer vs. Mozilla
Judo and Hardball strategies
Judo Strategy
Target your opponents weakness and use it as leverage
Hardball Strategy
Use “unfair” advantage
Design vs. Learning schools in strategy (fallacies, deliberate vs. emergent etc..)
Design School
• Ex-ante analysis, thinking and reasoning
• Assumes all relevant factors can be objectively analyzed
• Assumes that this analysis precedes and dominates action – implementation follows as a separate stage
• Separates thinking from doing and often implies a hierarchy – senior managements thinks – others implement
• Option appraisal is conducted logically on the basis of analysis
Learning School
• Strategy making takes place w/in an unpredictable world
• Creates the necessity for the flexible strategic approaches
• Serendipity (accidental discoveries, luck, etc) is required for effective performance
• Strategy is often made by lower-level managers – strategy evolves through autonomous action
• Strategy has both intended and emergent components
Mintzberg’s 3 fallacies of strategic planning

1. fallacy of predetermination – future is unknown
2. fallacy of detachment – impossible to detach formulation from implementation
3. fallacy of formation – inhibits flexibility, spontaneity, intuition, and learning
= GRAND FALLACY – “because analysis is not synthesis, strategic planning is not strategy formulation”
Deliberate vs. Emergent Strategies

Intended Strategy + unrealized strategy Deliberate realized strategy + emergent strategy = sustained superior
strategy
Robust action
Allows a company to rapidly take advantage of opportunities as they occur

Enables various levels and functions w/in the organization to contribute to the emerging strategies

PageThe
19 public company and its strengths/weaknesses
The public company faces pressure from various angles including:

Wall Street – investor expectations, earnings growth, and quarterly pressures
Executive Compensation – increase in overall level, use of stock options
Economic Cycles
Cyclical Industry
The above pressures are offset by the following methods of control:

Compliance Department
Disclosure
Governance
Ethics and integrit of participants
Strengths/Weaknesses of the Public Company

Strengths
Ability to raise enourmous amounts of capital and spread risk
Transparency – financing acitivites are visible and information readily available. Poor performance
results in lower share values
Corporation are disciplined both by their internal governance systems and by competition in product
and factor markets.
Weaknesses
Separation of ownership and control results in an agency problem
Lack of powerful and informed monitors results when the shareholders are widely dispersed
Entrenchment incentives – management may invest in protecting their jobs rather than creating value
Excessive mandated information disclosure lowers value of proprietary product and strategic
information.
Agency Theory
Risk bearking specialist (principal) pays compensation to a managerial decision-making specialist (agent)
“The essence of the Agency Theory is that the Principal has inferior information to the Agent.
Moral Hazzard: the principal and agent share the same information up to the point at which the agent takes an
action, but thereafter the principal is only able to observe the outcomes.
Adverse Selection: the principle does not know some information which is relevant to the action (such as the
ability of the agent to perform the task), whereas the agent can make use of this information to his own
advantage.
Example: any time someone hires an outside consultant or contractor to perform a service for which the
principal has no real input/influence that can alter the outcome aside from the directions given to the Agent.
Financial Advisor or contractor (construction),
Diversification and differences in risk preferences
….
The role of the board of directors (formally and actually)
The Board of Directors is responsible for hiring, firing, monitoring, and setting compensation of the firm’s
managers.
They have broad discretion to direct the company’s affairs and is supposed to ensure that the firm in
managed in the best interest of shareholders.
Shareholder votes are alsoBUAD-497:
required to approveCourse Documents
corporate mergers, to authorize the sale of major assets, to
amend the firm’s bylaws, and to authorize the issuance of new equity issues. Page 20
Directors are frequently selected by management and are beholden to them for their jobs
CEO’s are often on the Board which can create accountability problems.
Boards too often have poor procedures of evaluation in place, both regarding management and their won
performance. As a result, Board’s of Directors often exercise rather little control.
Disclosure and shareholder control (formally and actually)
Publicly-traded companies are required annually to disclose a great deal of information about corporate
earnings, executive compensation, and the ownership of the company’s voting shares.
Firms are also required to hold annual shareholders’ meetings that are open to all owners of common stock
Prior to these meetings, corporations send out proxy statements to shareholders that describes:
The meeting agenda
Spells out precisely which issues are to be voted on by shareholders
Provides a form for shareholders to use either to vote personally at the meeting or to assign their right
to vote to someone else.
How corporate control is really exercised…

Most corporate elections are usually staid affairs where shareholders are asked to vote for or withhold
their vote for single slate of company directors
Proxy fights occur when a rival group of shareholders nominate a slate of alternative directors who do
not support the current management team.
-This is relatively rare due to the expense to shareholders
As a result, shareholders often have little opportunity or incentive to actively engage in corporate
control.
Compensation and stock options (formal and actually)
In 2006, avg total compensation of chief executives of S&P 500 companies was $14.78 million. This
represented a 9.4% increase in CEO pay over 2005
Performance and compensation have a cloudy connection when it comes to CEO’s
Compensation on average was comprised of:
Salary (cash): 20%
Short term incentive plans (bonus): 20%....usually tied to specific performance measures such as ROI
or net profits
Long term incentive plans (stock options): 60%
Other benefits (insurance, legal, pension…)
Underwater options and indexed options
Underwater option: an option in which the strike price (price you can purchase stock at) is higher than the
current stock price. No reason to exercise option until this situation is reversed.
Indexed Options:
Indexed options balance a company's relative stock market performance against its absolute gains.
Because indexed stock options pay primarily for out performance, they are highly leveraged. This means they
require more shares to deliver the same value as traditional stock options
Indexed Options strip out market effects. They link an option's strike price to a benchmark such as the S&P
500 or an industry index. Executives are rewarded only for beating the benchmark

The Market for CorporateBUAD-497: Course
Control and Takeover Defense Documents
Page 21 • Board of directors is supposed to act in the interest of shareholders; they decide things such as the
hiring and firing of upper-level management. Shareholders must vote on things such as major sales of
assets, mergers et cetera
• How the corporation controls this: Directors are selected by management, and owe them for their
jobs; CEO are very often the head of the boards of directors, causing accountability problems
• Boards of directors therefore usually have very little power over companies
• Stockholder meeting are usually set up by companies to be intimidating, hard for stockholders to ask
questions or make any comments
• Voting for directors is usually ‘yes or no’ for a proposed slate of new directors
• Shareholders are too fragmented to really put up any fight against current management
• The market thus operates when firms face the risk of takeover when they are operated inefficiently.
Many firms begin to operate more efficiently as a result of the “threat” of takeover. Hence, the market
allegedly acts as an important source of discipline over managerial incompetence and waste
• However, it’s an expensive last resort...and often doesn’t work!
Predictable Surprise
• The learning school theory: remember that you can’t just depend on one core competency and ignore
changes in the environment, things change
• Externalities will have many effects on business operations, predicting these surprises is an important
part of strategic thinking
Corporate Crime and Strategic Control Systems, Warning Signs, and how to control it (KPMG guidelines)
• White collar crime is a very big problem, yet it is seldom investigated
• Most companies aren’t doing very much about the threat of fraud in the business world
• Managers often feel enormous pressure to meet financial expectations, and will do a lot to try to meet
these numbers, even if some of it is unethical
• Company culture has a large effect on the amount of white-collar crime going on
• Some warning signs: Kill the messenger attitude in the company; low confidence in accounting
statements; employees seldom refer to ethical conduct codes when making decisions; top
management ethical statements seem to be just for the public; people who ignore ethics but produce
good numbers are promoted
• How to control crime: find out what the risks are in your company, address these specifically; make
views on fraud known; create a culture that looks down on corporate crime; ensure that internal
controls are effective; develop a response plan when fraud comes up; be strict on fraud when it is
found
• Good news: The majority of consumers will switch to brands/ stores when they are found to be ethical
BUAD 497 Final Study Guide- Scott Exner
I. 7-S Framework
The 7-S framework is a management model used for internal analysis describing the 7 interconnected factors
to:
• Organize a company in a holistic and effective way (create alignment among depts.)
• Determine “doablility” of strategies
• Examine the effects of change on the Org.
• Examine functional/dysfunctional aspects of the Org.
• Strategy – a plan of action to maintain competitive advantage over the competition

• Systems – measures and actions which accommodate the execution of daily activities
• Structure – the way the organization is structured, who reports to whom
• Style – how do you lead? Personal style?
• Shared Values – company culture, work ethics etc
•
BUAD-497:
Staff – company employees Course Documents
and their capabilities
• Skills – core competencies of the company as well as that of its staff Page 22
• Successful strategy implementation requires the alignment of all the seven S’s—fit is just as
important inside as outside!
II. Beer’s formula for organizational change and…
Δ = f(D•M•P) – C
Δ is the effectiveness of change, a positive function of D (dissatisfaction), M (model, or vision), and P

(change process) that need to be greater than C (cost of change).
III.…Leading organizational transformations
When implementing a new strategy, start with the hard part of operational improvement! Only then make the
transition to improving the work environment.
IV.Five forces of management and strategy execution
I couldn’t find any info relevant to the graphic provided by Peaches in slides of online.
• Many excellent strategies fail because of poor execution

• Good execution accepts the role of communication and politics
• Good execution is flexible enough to roll with the punches and builds options into the process è
robust action
V. Small world effects, direct/indirect ties, strong/weak ties, and the strength of weak ties
• Small World Effects: People know neighbors, distant people, and people at random Small
World of Connections (i.e. 6 degrees of Kevin Bacon). The first five random links reduce the
path length of the network by half!--> Small World Networks should be everywhere!!!
• Can be seen in Al Qaeda, Marketing, Connections amongst industry leaders
• We tend to use “weak ties” (Granovetter) and also friends-of-friends, because they are more
likely to have non-redundant information
• Direct and indirect ties are positively related to innovation
• Alliance Networks: Access to know-how, contacts, resources expands the size of radar screen
and make you detect technological discontinuities, emergent markets, new designs. The
position of the firm in the alliance network also determines the propensity to collaborate.
VI.Network foundations of social capital

Social capital is a “useful metaphor,” explaining “how people do better because they are somehow better
connected with other people- What mechanisms form foundations of?
• When focused on a single person, the network is fragile!
• As structural cohesion increases, fewer nodes are able to control resource flow within the
network.
• Power, Information, Norms and Values, Informal Social Control is more uniform for better
foundation, less freeriding (Community Character)
Page 23
VII.Structural holes, brokerage and closure, strategic network expansion
Structural Holes are contact disconnects- create social capital via brokerage opportunities.
Structural holes provide important benefits.
• Brokers occupying structural holes earn bigger bonuses
• Managers located in structural holes are promoted earlier in their careers
• People located in structural holes often have “better ideas” than others
Combine Brokerage and Closure:
Strategic Network Expansion was just this lame graphic, basically means build contacts from contacts in
different industries I think…
Takeaways:
• It is the diversity of contacts that generates social capital—strength in weak ties
• Network centrality and structural holes are important for determining power and knowledge flows—
both for firms and for your personal experience. Brokers do better!
• Social capital and power come from bridges that person can build between others!

Page 24
BUAD 497: Strategic Management

Informal Cheat Sheet for the Final Exam Spring 2007
Listed in chronological order:
Porter’s 5-Force framework, PEST and SWOT frameworks

Porter’s Generic Strategies
Hambrick & Fredrickson framework (from “Are you sure you have a strategy?”)
BCG and McKinsey matrices
Core competency and resource-based view of the corporation
VRIO framework
Greiner’s model of org. growth and classic growth patterns of firms
Organizational structures (simple, functional, divisional etc.) and their relation to strategy
Mintzberg’s approach to org. structure
Activity Systems and strategy as positioning/configuration/fit
Complementarities, tradeoffs, equifinality, fit
Game theory, the structure of games, moves to change the game played
Basic games such as PD, Chicken, the Dilemma of the Commons
Competitor profiling
Value chain analysis, including value creation, value division, value added, the value net
Standards/network externalities and their role in strategy (open/closed, tactics etc..)
Dynamic industries and their effect on strategy
Judo and Hardball strategies
Design vs. Learning schools in strategy (fallacies, deliberate vs. emergent etc..)
Robust action
7-S Framework
Beer’s formula for organizational change and leading organizational transformations
Five forces of management and strategy execution
Small world effects, direct/indirect ties, strong/weak ties, and the strength of weak ties
Network foundations of social capital
Structural holes, brokerage and closure, strategic network expansion
The public company and its strengths/weaknesses
Agency theory, moral hazard, adverse selection (think of examples!)
Diversification and differences in risk preferences
The role of the board of directors (formally and actually)
Disclosure and shareholder control (formally and actually)
Compensation and stock options (formal actually)
Underwater options and indexed options
The market for corporate control and takeover defenses
Predictable surprise
Corporate crime and Strategic control systems
Warning signs of deviant org. cultures
KPMG’s recommendations on deterring employee fraud

BUAD-497: Assignments
Page 25
Professor Fiss
Individual Mini Case Analysis
BUAD-497: Tuesday-Thursday 12-1:50 PM
ID#6390.4899.77

Page 26
1) The sales growth in McDonalds Coffee of thirty percent over the past year since the
introduction of McCafe has reinforced Sgro’s belief that a bold move into a more dedicated
retail coffee offering in McDonalds’ restaurants provides value. Nonetheless, this is not to say
that the current success of McCafe has completely solved the problem of McDonald’s
lackluster breakfast offering. First, to tackle the issues facing McDonald’s breakfast sales, one
must look at the value that these breakfast items bring to the quick-serve breakfast industry.
Clearly, McDonalds is an industry leader in providing good-quality products quickly at a low
price. The restaurant had continued to offer this value in their breakfast menu, but hadn’t
vigorously sought innovative new breakfast items or changes in the menu to match changes
occurring in the industry. As a result of this oversight in McDonald’s product management,
the fast-food leader was quickly losing ground in breakfast sales to its competitors, namely
Tim Hortons. As McCafe brings value to McDonald’s breakfast menu by turning McDonalds
into a one-stop-shop for breakfast and coffee, something valued in the industry as seen by the
melding of Wendy’s and Tim Hortons as well as others, McCafe does not solve the
McDonalds’ breakfast menu’s lack of dynamism.
2) If McCafe were to be introduced years before the case date, it may have been much
more rare than it actually was at its introduction. The ‘McCafe’ concept had become more of
an industry trend than an exception, with many major quick-service retailers offering similar
value to McDonald’s McCafe integration. At the time, Tim Hortons had already begun to
broaden its breakfast offerings, essentially offering similar value to that provided by a
McDonald’s with a McCafe. The advantage McDonalds would have over Tim Hortons in this
arena would have been its historically efficient operations; Tim Hortons, though, has
challenged this advantage after being purchased by Wendy’s, another quick-service chain that

Page 27
has brought its operating efficiency to Tim Hortons coffee houses. Furthermore, Tricon Global
Restaurants, which includes KFC, Pizza Hut, and Taco Bell, had already begun to offer menus
from these three restaurants in different combinations under one roof, the success of which has
further strengthened the idea that combination restaurants are appealing to consumers.
Concurrently, there is strong evidence that multiple offerings under one roof, such as
McDonalds and McCafe, are more attractive to consumers than a restaurant that serves only a
menu similar to McCafe’s. Nonetheless, McDonalds is not a first mover in implementing this
idea, as the industry has already been busy making a trend out of this concept.
3) McCafe is imitable, to an extent. For the most part, as mentioned in the above
paragraph, Tim Hortons in collaboration with Wendy’s has largely already implemented this
concept in their international operations. Other restaurants in the quick-serve industry cannot
imitate McDonald’s strategy in a very important way, though. McDonald’s brand image is
arguably stronger than any other restaurant, especially the “Mc” branding. Further, McCafe
has attempted to differentiate itself with its coffee delivery. While its competitors take a few
minutes to make each cup of specialty coffee, McCafe’s machines take only seconds to brew
up the same coffee. While this speedy delivery may prove to differentiate McCafe enough for
some gain in market share, its competitors are sure to react quickly to this strategy. Other
coffee and breakfast providers, such as Tim Hortons, are likely to either switch to these faster
machines or advertise that their coffee is made the ‘right’ or ‘original’ way, and that it is
somehow more genuine than the mass-produced McCafe coffee. Further, Wendy’s may
further promote the strategy they have been using largely in their international restaurants,
melding Tim Hortons and Wendy’s together in one restaurant, by bringing this strategy to the
Canadian market. While McDonalds’ McCafes may help the restaurant chain to regain some

Page 28
market share in the quick-serve breakfast market, competitors are likely to respond with similar
offerings or strong product differentiation.
4) The McCafe concept falls directly in line with McDonald’s organizational structure.
McDonalds has been organized to depend on low-cost largely unskilled labor, quick service, a
strong brand image, and overall low product cost to consumers. Further, McDonalds allows
consumers to enjoy their orders in a variety of ways: take-out, eat-in, and drive-through. The
new McCafes took advantage of these operating efficiencies by utilizing new coffee
technology that allows for unskilled workers to quickly brew premium coffee at a low cost to
the consumer as per McDonalds’ trademark efficiency. In tandem, customers can order their
premium coffee with take-out, drink-in, and drive through, all on the same receipt as their
McDonalds breakfast order. As McCafe so closely follows McDonalds organizational
structure, the restaurant will have the knowledge in operating efficiency to be a cost leader in
the premium coffee industry in Canada. While others, such as Tim Hortons and Wendys, may
have similar restaurant structures with menus similar to McDonalds and McCafe, they may not
be able to achieve the operating efficiency of McDonalds that allows for such low prices.
Therefore, McDonalds will be able to achieve a sustainable competitive advantage in the low-
cost quick-serve premium-coffee market that also serves a breakfast menu as a result of its
historically strong operating efficiency and strong brand image. Nonetheless, competitors may
be able to capture market share by differentiating themselves as more genuine premium coffee
servers that don’t use mass-produced machine-made coffee. Further, if Wendy’s were to
further integrate Tim Hortons into its operations, it may be able to achieve the operating
efficiency of McDonalds and McCafe, therefore diminishing the McCafe competitive
advantage.

Page 29
Professor Fiss
Take-Home Midterm
BUAD-497: Tuesday-Thursday 12-1:50 PM
ID#6390.4899.77

Page 30
1) An analysis of the steel industry based on Porter’s five forces model reveals that
rivalry is high, due not only to the basic five forces in the industry but also to powerful
changes in the global steel market. To begin, the threat of entrants into the steel industry
is low. The primary reason for this threat level is due to the high costs of entry. Steel
manufacturing mills are extremely expensive to build and maintain, leading to a low level
of new entrants into the market, especially given the state of the industry today. Namely,
the industry has been blanketed with over-capacity in the United States while it has been
experiencing little growth. Therefore, there is little incentive for new players to enter the
market, as providing more capacity in the industry would be of little value to buyers.
Buyer power, alternatively, is relatively high in some respects but low in others.
Overall, buyer power is rated to be medium. On one hand, there are few possibilities for
differentiation in the steel industry, lending buyers the power to bid competing steel
manufacturers against each other for the lowest possible price. Further, buyers arrive one
at a time for purchases, in a sense. In other words, when a buyer is interested in placing
an order for steel, steel manufacturers line up all at the same time to bid on supplying the
product to the buyer. Therefore, buyers can easily force these undifferentiated steel
manufacturers into a bidding war that drives margins down for manufacturers. As H.
Aycock, former Nucor chairman and CEO, said, “The key to making a profit when
selling a product with no aesthetic value, or a product that you really can’t differentiate
from your competitors, is cost.” On the other hand, some companies in the industry have
shown an ability to differentiate their steel product in some ways. Although this has been
limited, manufacturers such as Nucor have offered services along with their product such
as in-house engineering that provides the buyer with a product that is uniquely designed
2
Page 31
for their use of the product. Conversely, the high transportation costs of steel products
lowers buyers ability to bid manufacturers against each other, as the number of
manufacturers that can be bid against each other is limited to those within a reasonable
proximity of the buyer. Finally, the ability of buyers to backward integrate is limited due
to the high barriers to entry into the steel manufacturing industry mentioned earlier.
The threat of substitutes in this industry is relatively high. The largest threats are
lighter metals and stronger alloys as well as plastics and synthetics. As technology
develops, these types of products have been used more and more in applications typically
reserved solely for steel, such as the side paneling of new cars. Further, many other
consumer products, such as bicycles, are being made from these new materials. While
the steel industry clearly has a future with stable purchasers, such as the construction
industry, technology has allowed substitute products to become more of a threat to the
steel industry than what the industry has seen in past decades.
The power of suppliers, like buyers, is rated at a medium level. First, suppliers of
the minerals and scrap steel required for steel production aren’t able to demand a very
high margin on their products. While the steel itself makes up a significant portion of
costs in this industry (sixty percent in the case of Nucor), the mini-mill developed by
Nucor has allowed backward integration to eliminate suppliers in some cases and cause
low supplier margins in other cases due to the threat of backward integration. The
industry’s other primary supplier, employees, have high bargaining power. Many of
those employed in this industry are members of unions that demand high wages and
benefits, while others who aren’t unionized are paid high wages and given steep benefits
in order to compensate for harsh working conditions. The power of employees in this
3
Page 32
industry becomes clear after reviewing their incredibly high wages, which is usually
double the average wage in the manufacturing industry in the United States.
Rivalry among firms is very high. There are a variety of reasons for this. First,
foreign competition made a strong entrance onto the US steel-manufacturing scene and
had more of an impact on domestic competitors than it should have. It was found that
many of these new entrants were being unfairly subsidized by foreign governments or
were ‘dumping’ into the United States. Secondly, the industry has been burdened with
overcapacity, leading to intense rivalry among firms. Further compiling on top of this
overcapacity are barriers to exiting the industry. These barriers of exit keep firms in the
industry that are under bankruptcy protection or that aren’t making a profit on their goods
sold. Third, the industry growth rate has been slow in many of the developed nations of
the world that are home to competitive multi-national steel manufacturers, leading to
intense global competition. All of these factors contribute to the intense rivalry seen in
this industry. Overall, the industry is not very attractive in the state that it is currently in.
To compete in this type of industry, a firm will do best to challenge the tough
powers working against it. Namely, in order to combat supplier power a firm can
backwards integrate and automate the production process to reduce necessary manpower.
In order to combat threat of substitutes and buyer power, a firm might find a way to
differentiate its product by bundling other services with it. To combat intense rivalry, a
firm could take advantage of its excess capacity by expanding into developing markets
with a higher industry growth rate.
2) Central to Nucor’s activity system is low cost. As mentioned in the previous
pages, H. Aycock can be directly quoted in saying that cost leadership is essential to the
Nucor activity system. Leading to this low cost advantage first is Nucor’s lean
4
Page 33
organizational structure. Nucor puts a very strong emphasis on keeping executive
management limited, with a total corporate staff of less than twenty-five when 1999
began. This is achieved by having a decentralized management system, where very little
corporate oversight is present. Managers of individual mills and manufacturing plants
are given nearly full autonomy of operations, and operations such as engineering and
software development are operated independently in each facility. Further, executives
within the company don’t receive the traditional perks usually associated with their
position, such as private jets and plush corporate offices. This lends to employee loyalty,
lower costs, and a lean company culture.
Also important to Nucor’s activity system is their unique incentive-based
employee compensation system. With this system, employees are given bonuses based
on the amount of production that is reached in a week that is above a standardized
production rate. This system leads to increased employee loyalty, decreased employee
turnover rates, and more satisfied employees who don’t demand unionization. Although
they pay their employees more per hour than the industry average, Nucor’s incentive
system leads to a more productive employee base and a strong company culture. This
productivity leads to lower product costs, and their more self-reliant employees are able
to self-manage in Nucor’s decentralized management structure.
Further strengthening Nucor’s activity system, technological innovation adds
value to the entire organization. Nucor’s emphasis on technological innovation is
strengthened by in-house engineering in each individual facility that caters to the
different demands of customers in different regions and industries, which is supported by
the decentralized management structure explained earlier. Further, innovation in the firm
led to the development of he mini-mill system of manufacturing, which allowed for
5
Page 34
backwards integration and lower costs. Other technological innovations included the
placement of electric arc furnaces in their mini-mills to increase efficiency and, again,
lower costs.
In an industry where low costs and local innovations are key to success, Nucor’s
activity system has provided these values enough to become a major competitor in the
steel manufacturing industry. The four core elements of Nucor’s activity system, an
incentive-based employee structure, technological innovation, a lean organizational
structure, and low costs, lend to a product that provides a great value to buyers. (See
Appendix #1: Nucor Activity System)
3) One change in Nucor’s organizational structure involved the overcapacity of the
steel manufacturing industry in the United States. As capacity utilization was about
seventy-five percent, opening new plants and adding to this over-capacity would not be
beneficial. Although Nucor had traditionally opened Greenfield plants, this structure had
lost its effectiveness in the current state of the industry. Thus, the firm’s executives
decided that they would move towards mergers and acquisitions.
The other relevant move by the management of Nucor was the decision to add a
level of management to the corporate office staff: four new Executive Vice Presidents
and two specialist jobs in strategic and steel technology. The reasoning for this change,
as stated by Aycock, was to enable corporate headquarters to get back in touch with
independent facilities. Although this move appears to be a clear departure from the
companies tried-and-true activity system, it actually falls neatly into their strategy.
Specifically, as competition increased and Nucor grew in size, the small corporate office
staff began to lose touch with independent facilities. Thus, the entire organizational
structure was deteriorating, which led the organizational structure to be not lean but,
6
Page 35
more accurately, non-existent. In order to keep the ‘lean organizational structure’
element of their activity system intact, it was necessary for Nucor to keep communication
intact and expand the number of employees in corporate operations.
4) Nucor’s options for future strategies include the option of doing more of the same.
That is, keeping their newly altered organizational structure with a slightly larger
corporate staff. Further, mergers and acquisitions would lead their development in the
United States. Yet another option for Nucor would be to focus more on expansion
overseas, in markets where the steel industry is growing much quicker than in developed
markets. This option would allow for Nucor to utilize some of its excess capacity
without trying competing in the over-saturated US market. A third option would be to
focus on technological innovations that would lower costs and allow for a lower cost to
the buyer.
I would recommend a combination of two of these strategies. The best option for
Nucor is to continue with mergers and acquisitions of other steel-manufacturing firms in
the United States, but place more of an emphasis on technological development that
would reduce their costs of steel manufacturing. This is best because it allows Nucor to
sustain one of its primary and more important competitive advantages as a company: a
very productive self-reliant workforce that is able to manage itself. This advantage might
not travel internationally, thus Nucor must focus on the domestic market. In order to
compete in the domestic market, price must be lowered by technological innovation.
Further, in order to grow as a company, mergers and acquisitions must continue in order
to develop the company but not add to the over capacity of the US market.
7
Appendix 1: Nucor Activity System
Low Cost Lean Organizational

Structure
More productive No Traditional

and Self Reliant Customized
Perks for Executives
Employees Products
Decentralized Management
Incentive-Based In-House
Engineering Technological
Employee Compensation Custom to Market Innovation
Electric Arc
Allows for Furnaces
Company Culture Backwards
Develops Employee Loyalty Integration
Non-Unionized
Workers Mini-Mill System

Page 36
BUAD-497: Class Notes
Page 37

Page 38

Page 39

Page 40

Page 41

Page 42

Page 43

Page 44

Page 45

Page 46

Page 47

Page 48

Page 49

Page 50

Page 51

Page 52

Page 53

Page 54

Page 55

Page 56

Page 57

Page 58

Page 59

Page 60

Page 61

Page 62

BUAD-497: Group Project
Page 63
1: Extremist Religious Ideology

Al-Qaeda Defined
Al-Qaeda is a radical political group driven by an interpretive religious ideology.
Literally meaning “the base,” al-Qaeda is the core of an international network of Islamic
terrorist organizations. Its goals include eliminating foreign influence in the Muslim
world, especially American forces in Saudi Arabia, eradicating those deemed to be
infidels, recapturing Jerusalem, and establishing a new Islamic caliphate. Ultimately, it
hopes to create Islamic states and build a formidable army with nuclear capabilities to
wage war on the Western world.1 Led by Osama bin Laden and Ayman al-Zawahiri, the
evolution from a brick and mortar organization to a decentralized global network is
transforming terrorism. Appendix ‘A’ provides a timeline of al-Qaeda’s significant
events. Their popular ideology makes them a performance and networking leader.
Technology is the vehicle inspiring believers to become recruits, willing to sacrifice
everything because of a steadfast dedication to the message of al-Qaeda’s ideology.
Radical Influence
Al-Qaeda’s ideology is a Sunni Islamist movement using the mujahadeen to
pursue jihad against the influence of the West. Although the literal meaning of jihad is
not directly correlated with the popularized definition as a holy war, the influence of
radical religious factions removes all but this military context from the word. The six
rules of jihad and the Koran clearly state that deliberate killing of noncombatants is
forbidden unless they are conspirators.2 However, modern Islamists, including bin Laden
and al-Qaeda’s ideological leader, al-Zawahiri, extend the religious boundaries of
interpretation to generate support for their political agenda. They select elements of
tradition and modernity to create a unique religious perspective. Al-Qaeda’s leadership
1
Page 64
understands the significance of its ideology as the fundamental core of its global strategy.
Implementing a broad platform that appeals to the greater cause of martyrdom rather than
targeting specific rules is instrumental to understanding why al-Qaeda is the world’s
leader in terrorism.
It is important to note that al-Qaeda was conceptualized by Abdullah Azzam, not
bin Laden. Azzam was not a proponent of resorting to terrorist tactics because of the
grave implications on future negotiations and hopes of peace.3 After his assassination, an
act some believe to have been ordered by bin Laden himself, al-Qaeda was free to
broaden the appeal of their ideology to attract the widest possible support base. With al-
Zawahiri and other religious scholars at his side, bin Laden used Qutbism and takfir to
create an indiscriminate brand of Islam closely resembling the unifying philosophy of
Salafism.4 Strong anti-US and anti-Israeli rhetoric engenders a vast support structure
across all spectrums of radical Islam, including the second largest Islamist group
Hezbollah, a Shia organization. While many terrorist organizations have short life spans
due to their specific convictions and confinement to territorial campaigns, al-Qaeda’s
underlying goal to bridge the ethnic, cultural and secular divides between Shia and Sunni
Muslims for the greater good applies to every Islamist struggle.5 Uniting Muslims as one
coherent force fighting the tyranny of the West, al-Qaeda is instilling a locally rooted, yet
globally inspired attitude to develop its global influence.
Religious Justification
Al-Qaeda engenders support from non-radical Muslims because it establishes
religious justification for its actions. Bin Laden constantly refers to the will of Allah in
both his writings and speeches, leading many to believe that he is carrying out His divine
2
Page 65
requests. As the loudest voice in many areas of the Muslim world, he maximizes
effectiveness through expansive awareness of al-Qaeda’s mission. Bin Laden released
two fatwa’s, one in 1996 and another in 1998 that clearly describe his disgust of
American occupation in several Muslim countries and their unilateral support of Israel.
More importantly, he provides religious authorization for the indiscriminate killing of
Americans and Jews everywhere. 6 Although bin Laden is not a religious scholar worthy
of issuing such official Islamic decrees, he rejects the authority of contemporary Islamic
leaders and assumes responsibility for directing the jihad against the West.
The strength of this ideology lies in its overwhelming acceptance by Muslims of
all social classes. Al-Qaeda is the best at reinforcing the glory of martyrdom because of
the time and effort spent on training and preparing its operators for the reward of
sacrifice. Believing that sacrifice is the ultimate act of allegiance, suicide operators view
death as an appealing opportunity to drive fear into the enemy.7 The robust capacity for
regeneration is directly attributable to the widespread sympathy and belief in their
ideology. However, the most compelling aspect of their religious legitimization is the
danger it poses to civilization at large. Widespread politicization of radical ideas allows
al-Qaeda to dramatically influence both non-radical Muslims and the West.
Spectrum of Islamist Groups

The Spectrum of Islamist Groups is a framework separating terrorist organizations
by their goals and methods. It highlights the role al-Qaeda’s ideology plays in making it
the most feared and powerful terror network in Islamism.8 Unlike other terrorist
organizations, al-Qaeda is evolving from segment to segment as it increases its global
capabilities and presence. While their core values are revolutionary and ideological, its
3
Page 66
progression from a utopian to an apocalyptic group following the attacks on 9/11 leaves it
the world’s foremost authority of terror. The only other group exhibiting such force is the
Armed Islamic Group of Algeria (GIA), an organization even bin Laden denounces for its
extreme methods. But al-Qaeda’s leveraging its ideology to validate the dramatic
escalation of violence opposed to the sheer terror the GIA is inflicting intentionally.9 Just
as Hezbollah politicized its popular national movement in Lebanon, al-Qaeda is doing so
on the global stage through its complex organization and operations. This carefully
crafted ideology threatens both Western and Islamic societies on a scale that reaches far
beyond that of traditional terrorism.
2: Decentralized Organizational Structure

Vertical Leadership
Al-Qaeda’s decentralized organizational structure is guided by strong leadership,
the only vertically integrated segment. Bin Laden is al-Qaeda’s emir-general, or head of
operations. He provides spiritual council, financial governance and oversees all strategic
objectives. Next is the shura majlis who act as the organization’s board of directors. With
twenty to thirty members, including the chief lieutenant al-Zawahiri, they monitor
strategic, operational and religious issues.10 Al-Qaeda’s leadership are the lines of
authority responsible for coordination and guidance. Their insight keeps the organization
on a goal-oriented, big picture approach focusing on furthering their ideology.
Compartmentalized Operational Committees

Below the council are the four operational committees, each led by an emir who
reports directly to the shura majlis. These groups include: military, finance and business,
Islamic study and fatwa, and media and publicity. It is the duty of the committees and
4
Page 67
regional networks to oversee day-to-day operations and implement al-Qaeda’s specific
operations
Military
The military committee trains, recruits and acquires military resources without
disrupting their decentralized structure. Current estimates indicate Al Qaeda camps have
trained more than 100,000 Islamist militants, with over 120 camps operating in
Afghanistan at the time of 9/11, although they retain only “a small number of militants
under direct orders.”11 Organizational success requires constant attention to internal and
external changes within an organization’s environment. As Al Qaeda grows, its
leadership has reconciled the challenges faced by expansion through self-sufficient and
independent terrorist cells. Al-Qaeda created precise training resources, namely the Al
Qaeda Field Manual, Encyclopedia of Afghanistan Jihad and the Declaration of Jihad
Against the Country Tyrant’s.12 These comprehensive training manuals cover everything
from doctrinal values, military principles, recruiting and the importance of teamwork.
Discussing issues ranging from assassinating enemy personnel to qualifications for
becoming members, these manuals lay out exact directions for how to live a life free from
conceptual problems and full of religious principle.
Finance/Business
Although al-Qaeda is popularly seen as an illegitimate organization, much of its
financing is quite legitimate. With many terrorist organizations resorting to illegal
activities, including kidnapping and drug trafficking, al-Qaeda focuses on genuine
businesses like diamond trading, import/export, construction, manufacturing, transport
and financial services. Nonetheless, some funding has been tracked to fraud, currency
5
Page 68
counterfeiting, document forging and wealthy individual supporters through infiltration
of various charities and non-governmental organizations (NGO’s). Al Qaeda's financial
network is valued at approximately three-hundred million dollars, with annual dispersion
between thirty and forty million a year. Organizing collection and distribution are
members of al-Qaeda’s finance committee. Professional bankers, accountants, and
financiers control the large and diverse supply of funding. An operational doctrine
teaches operatives frugal financial behavior, self-sustaining financial tools, deception and
denial.13 The entire financial network is built on a base of operationally strong terrorists
and networked financiers, allowing it to be extremely adaptive and flexible. Its means of
sourcing, hiding, and distributing funds are numerous and complex. Although the US has
had some success in freezing funds, the complexity of the organization minimizes the
pervasive effect on al-Qaeda as a whole. As of 2004, every Al Qaeda cell carrying out a
successful terrorist attack has received its funding from a different source.14
Al-Qaeda’s primary objective is to carry out financial activities that limit record
keeping and potential tracking. Focusing on discretion and decentralization, operatives
are trained to manage finances, forge documents, participate in credit card scams and
hack into accounts. Many cells are expected to be almost fully self-reliant in terms of
funding, a slight change in structure that followed the World Trade Center bombing of
1993.15 Al Qaeda cells were required to be too self-sufficient; the operative involved in
this attack didn't have sufficient funds for buying enough explosives to do substantial
damage to the trade center, nor did they have the funding needed to fly out of America
(leading one of the operatives to foolishly return to the dealership for a deposit refund on
the van carrying the explosives). Thereafter, a portion of funds raised by individual sects
6
Page 69
is pooled for redistribution to groups planning major attacks. As described in Al Qaeda's
military training manual Declaration of Jihad Against the Country's Tyrants, the
commander of each cell also divides remaining funds into those needed for operational
activity and those to be invested for financial return.
Through international banking, the Islamic banking system and the underground
hawala network, al-Qaeda easily hides funding sources and distribution channels.
International banking does not have heavy regulations or authorities to pursue potential
terrorist activity. The Islamic banking system suffers from even weaker oversight due to
the poor economic state of most developing countries using this construct. Finally, the
hawala network is widespread, even in the US, and has no records of transactions or
financial systems. The business environment in which Al Qaeda operates contributes
greatly to their ability to conceal their methods. 16 Through these frameworks, al-Qaeda
raises substantial amounts of funding and redistributes them across the globe, all under
the watchful eye of seemingly powerless anti-terrorist organizations and governments.
Islamic Law
The Islamic Law committee serves as the lightning rod for growth and creating
cohesion between its decentralized units. Combining their intangible ideology with
various resources, especially human capital, has far reaching effects on expansion. The
many “loosely-organized and widely-disbursed movement or ideology comprised of
many small and localized "self-generating" terrorist cells and individuals”17 responsible
for the bulk of al-Qaeda activities are linked by religious foundations in Islamic Law. Al-
Qaeda roots its battle on the West in the Sharia, or Islamic Divine Law, illustrated by the
fatwas placed upon the West. Maintaining a low profile in its role in global terrorism
7
Page 70
without wavering its ideology allows al-Qaeda to maximize its effectiveness. 18
Legitimizing their actions as a struggle for social justice in combination with the power
of religious indoctrination is providing al-Qaeda with both rapid growth and continued
success.
Media and PR
This committee molds al-Qaeda’s public image, aiming to garner support
throughout the Muslim world and further insight ill-will against the West. Their strategy
and methods are discussed in detail in Part 3: Strategic Use of Digital Technologies.
Expansive Global Network

The remainder of al-Qaeda exists in an intricate global network of independent
cells and affiliates. Al-Qaeda’s strong leadership provides financial, logistical, and
strategic guidance to an estimated six to seven million radical Muslims worldwide,
roughly 120,000 of them willing to resort to violence.19 The ability to draw on countless
independent operators at any time makes their options limitless. Using an arms-length
network with some strong ties, al-Qaeda’s decentralized structure acts like that of a
consulting firm or holding company facilitating communications with its subsidiaries.
Most members of al-Qaeda are actually associates without inside access to the
organization. Only a special few whose devotion is constantly tested make up the strong
ties within the network. Maintaining maximum security and integrity within the
organization is the driving force behind this specialized arms-length approach.
Much like the compartmentalized committees, cells are designed to be completely
self-sustaining and independent of one another. The “family” idea developed in their
training camps is the basic construct for members. Each family represents a separate
8
Page 71
nationality. From these families, cells ranging from two to twenty people are organized
for specific missions. Whether its surveillance, active reconnaissance or a suicide
bombing, these teams are well prepared and fully aware of their objectives. The level of
trust remains high even among members from different families because of their common
bond of being strict believers in the brotherhood of Islam above all else.20 With a
horizontally integrated global network, dissemination of information through different
groups is done only on a need to know basis, making it very difficult for intelligence
agencies to procure tangible amounts of reliable information. As globalization diversifies
the world, al-Qaeda understands the need for interconnectivity, but does so only when
necessary to maximize efficiency and effectiveness without sacrificing protection.
Appendix ‘B’ illustrates al-Qaeda’s organizational structure in a flow chart.
3: Strategic Use of Digital Technologies

Technological Web of al-Qaeda
Al-Qaeda’s strategy is continuous reinforcement of their ideology while
remaining decentralized and anonymous. Utilizing advances in modern technology, al-
Qaeda delivers an unweaving devotion to a universal brand strategy: communicating a
single message to all myriad units. They are ahead of the curve in using digital media,
namely the internet and satellite broadcasting. Computer technologies and the internet
allow the jihadist networks to communicate, spread their ideology, and recruit new
members.21 “Terrorist websites have exploded in numbers from a dozen in 1998 to more
than 4,800 today. Modern terrorist organizations exploit the internet to raise funds, recruit
members, and execute attacks.”22 Because al-Qaeda is so decentralized with vast
networks, the use of the internet explains their superior functionality. They stay
connected in complicated webs of networks with minimal risk. Many encrypted internet
9
Page 72
sites facilitate communication and interaction with security and privacy, leaving little to
no paper trail.
As the internet and digital media are developing a 360º approach, making it
available everywhere, on every device, at anytime, it is becoming the cornerstone of
modern strategic implementation. Such versatile vehicles, al-Qaeda is constantly pushing
their ideology on users at every level. Only a computer with internet access is needed to
watch and listen to bin Laden himself. The ease and speed of communication is
remarkable, especially when considering they are able to raise funds, spread propaganda,
recruit members, and execute attacks online. Be it financing, active involvement or mere
sympathy, al-Qaeda’s militaristic strategy is deeply impeded in an ideology successfully
communicated through digital media. Adoption of these digital communication networks
and methods greatly enhance al-Qaeda’s capabilities. Trying to connect an organization’s
strategy and structure through a virtual system is an abstract concept. Al-Qaeda is
currently deeply rooted in social networking sites, portable programs, and Massively
Multiplayer Online Role-Playing Games (MMORPGs).
Social Networking
Social networking sites enable al-Qaeda to recruit through propaganda of their
ideology. Children growing up with computers and the internet are exposed to jihadist
sites dedicated to rearing them on violence and hatred towards the US. They also show
graphic images of war casualties, video executions, and leader statements. This
generation of internet users is more likely to believe in conspiracies and the ideologies of
al-Qaeda because of the psychosomatic interaction between the internet and the jihad
10
Page 73
ideology.23 Furthermore, user accessibility is increased through free communication
services on the internet like Skype and Voice-Over-Internet Protocol (VoIP).
Portable Programs
Al-Qaeda’s use of technology is nothing short of staggering, especially with the
recent discovery of Mujahadeen Secrets by iDefense/VeriSign. Mujahadeen Secrets is a
portable program utilizing USB and pen drive technology that does not require
installation of applications, allowing them to operate at internet or computer cafés. 24 It is
nearly impossible to trace usage of such programs beyond the café itself. The programs
are very popular because they are written in native languages, rather than English based
sites like YouTube.com. This language system increases user comfort, trust, and
understanding, ultimately allowing for easier acceptance of al-Qaeda’s ideology.
MMORPGs
Extensive research is developing the functionality of MMORPGs in business and
military arenas. MMORPGs are a virtual world where users can live in the game almost
as realistically as in real life: design their own characters, team with groups, purchase
land and other goods, and socialize through VoIPs. Popular MMORPGs are World of
War Craft and Second Life. Second Life is more “realistic” than the fantasy-warrior
planet of War Craft. “Second Life is a 3-D virtual world entirely built and owned by its
residents. Since opening to the public in 2003, it has grown explosively and today is
inhabited by a total of 5,231,598 people from around the globe.”25 The threat comes from
virtual terrorism. Extreme activists can connect online and implement 3D plans of
attacks, gather intelligence, recruit more members, and perform other aspects of
communication and networking. Essentially, Second Life allows for an entire world
11
Page 74
without law or prosecution. Extremist groups “activity has included attempts to infiltrate
[other] groups, use of virtual weapons, and mass protest rallies.”26 Al-Qaeda seeks to
gain the advantage of this technology’s massive global networking capabilities and
virtual scenario executions.
Al-Zawraa TV
On November 14, 2006, al-Zawraa, a 24-hour insurgent station began
broadcasting throughout the Middle East.27 This strategically important information
outlet is overloaded with propaganda, audio messages from leaders, violence against the
Iraq government, and military footage. It is broadcast on a satellite owned by Egypt as a
“purely commercial arrangement.”28 On January 26, the signal started broadcasting from
a satellite somewhere in Saudi-Arabia. With these types of satellite collaborations,
shutting down this station is highly unlikely making the jihad ideology difficult to tune
out. The stations long term effects have yet to be measured however its content is viewed
as highly credible.29 Importantly, this is another strong communication of al-Qaeda’s
ideology and unifying strategy.
Craigslist and Decentralization

An interesting parallel is the United States concentration on Craigslist as a model
for al-Qaeda. Craigslist is merely an online bulletin board that astonishingly receives over
five billion hits a month with only 24 employees.30 This is an exemplary model of a
decentralized agency whose unifying-internal-message statement has led to vast success.
Founder Craig Newmark states: “Decentralized organizations can be more effective and
resilient. People who are passionate and can work independently can get more done than
a centralized organization.” Key to al-Qaeda’s operations, the leadership does not require
12
Page 75
sub cells to report back, rather they are given a strong up front mission (ideology) and are
expected to perform independently. The combination of ideology and devotion is so
strong that each sub cell functions extraordinarily well. Bin Laden’s message to
followers: “I want to kill people and wreak havoc. Don’t check with me, or they will find
me. We’ll send money.” Not reporting back also ensures more secrecy and confidentiality
of the leaders.31 Like Craigslist, other user-generated sites provide interesting leverage
for communication between strangers. Groups sharing an ideology can develop wikis,
post videos, and join blogs. There is almost no limit to the ability of a small group to
communicate. With the extensive decentralization of Al-Qaeda, they have truly advanced
the art of military communication borrowed from innovative business models.
4: Countering al-Qaeda’s Strategy

Western Response
Following 9/11, the West intensified efforts to capture and destroy al-Qaeda. The
invasion of Afghanistan left the Taliban and al-Qaeda’s infrastructure destroyed.
Although nearly two-thirds of al-Qaeda’s leadership has been neutralized, failure to
capture bin Laden or al-Zawahiri combined with al-Qaeda’s technological prowess leaves
them a major threat. The West’s inability to secure quality counterintelligence through
state-of-the-art technology underscores the need for a more inclusive strategy. A military
campaign alone will not destroy al-Qaeda. The use of satellite imagery, intercepting
communications and direct countermeasures to the digital media devices being employed
by al-Qaeda is inadequate because of their decentralization, popular ideology and
technical abilities. Focusing on these core elements rather than the peripherals of how
they spread their ideology is the only way to defeat them. A successful strategy must be a
13
Page 76
fluid and dynamic approach that challenges their ideology and attacks their financial
supporters directly.
Challenge the Ideology

Discrediting their ideology is the most essential element to destroying al-Qaeda.
Undercutting their religious legitimacy by revealing their political motivations and
hypocritical actions will tarnish their movement. Damaging their reputations as religious
figures fighting for Islam will weaken their massive global support structure and create
widespread dissension. By working with legitimate leaders of Islam to inform the Muslim
world of the true extent of al-Qaeda’s actions, the West will be able to use Islam against
them. Unable to undermine their technology, al-Qaeda’s ideology is becoming deeply
engrained into the Muslim world. Western forces must challenge this key differentiator in
the global arena in order to halt this rapid progression. Until their fundamental ideology
is attacked, their cause will always have believers carrying on the fight.
Attack Financial Supporters

Attacking those that sponsor terrorism through financing or protection is the next
phase of reducing al-Qaeda’s global strength. As Colonel Gadaffi told the American’s
post 9/11, “If you want to combat terrorism, bomb London and Riyadh.”32 With various
individuals donating over $1.6 million a day to Islamic causes via charities and
investments in Saudi Arabia, the time to go after those behind terrorism is now. London
is the home to many Islamist offices and anonymous financial contributors. Moreover,
support from the governments of Iran, Syria and the Sudan to name a few, must be
stopped in order to achieve substantial military success. Al-Qaeda must be destroyed
from within by attacking their core strengths. Challenging al-Qaeda’s ideology and
14
Page 77
eliminating their major financing and protection sponsors will erode their global network,
not to mention helping locate bin Laden and al-Zawahiri. With technology helping to
further their decentralization and spread their ideology, a cohesive strategy confronting
these crucial aspects simultaneously is the path leading to the ultimate destruction of al-
Qaeda in its entirety.
15
Page 78
Appendix ‘A’: Timeline of Significant Events
 ‘80s: Maktab al Khadamat (MAK), led by Abdullah Azzam and Osama bin Laden, is a
mujahadeen financing organization used during the anti-Soviet revolt in
Afghanistan begins evolving into the organization al-Qaeda.
 ’88: al-Qaeda is officially formed under Azzam and bin Laden in response to an outcry
for expanding assistance to Islamist struggles throughout the world.
 ’89: Azzam is assassinated and al-Qaeda consolidates remaining MAK members that
share bin Laden’s point of view.
 ’90: bin Laden returns to Saudi Arabia to find the country’s wealthy oil fields
vulnerable to Saddam Hussein’s military, who recently invaded Kuwait. Bin
Laden offers his mujahadeen army to protect these natural resources, but the
Saudi royal family instead allows American forces to deploy from Saudi Arabia.
 ’91: bin Laden’s public outcry against the Saudi royal family for allowing them to
profane the sacred soil in the land of the two mosques forces him into exile to the
Sudan.
 ’92: al-Qaeda builds a solid financial infrastructure through legitimate business

(construction firms, import/export companies, and farms) and through banking
operations to facilitate unfettered growth for several years.
 ’93: World Trade Center (WTC) bombing kills six and injures over one thousand.
 ’96: bin Laden returns to Afghanistan amidst heavy foreign pressure on the Sudanese
government to extradite him. This is when al-Qaeda establishes alliance with
Taliban, whose similar outlook on world relations and isolation from the Western
world provides them safe haven for training recruits and solidifying the
organization’s operations. Issues first fatwa denouncing the American occupation
of Saudi Arabia and their support of Israel.
 ’98: bin Laden creates World Islamic Front Against the Jews and Crusaders to issue a
fatwa authorizing the indiscriminate killing of Americans and Jews across the
globe. US embassy bombings in Tanzania and Kenya kill over three hundred.
 ’00: suicide attack on the USS Cole stationed in Yemen kills seventeen.
 ’01: suicide attack on WTC and the Pentagon on 9/11 kill three thousand people. US
led coalition enters Afghanistan and begins attacking Taliban and al-Qaeda.
 ’04: over two-thirds of al-Qaeda leadership has been either captured or killed and much
of their physical infrastructure is destroyed, but bin Laden and al-Zawahiri remain
at large.
16
Page 79
Appendix ‘B’: Organizational Structure Flow Chart
Osama bin Laden

Emir-General/Senior
Operations Chief
Shura-Majlis
Advisory Council
Finance and Business Fatwa and Islamic Military Committee Media and Publicity
Committee Study Committee Committee
Training Camp Administration

Subcommittee Subcommittee
Islamic Army (Affiliate Organizations)
17
Page 80
Appendix ‘C’: Glossary
Terms:
Caliphate: the only form of government fully approved by Islamic theology. It represents the political unity
and leadership of the Muslim world.
Emir-general: high title of nobility traditionally used in Islamic nations; literally meaning commander or
general.
Fatwa: a legal pronouncement made by a mufti, a scholar capable of making judgments on Islamic law.
Usually made when fiqh (Islamic jurisprudence) is unclear.
Families: each family denotes a different country. At the basic level, cells are organized by nationality.
Recruitment is made through family, friends or trusted acquaintances. However, for specific operations,
families sometimes merge or recruit outside their nationality (i.e. the 9/11 attacks predominantly used the
Saudi family, but were led by Muhammad Atta of the Egyptian family).
Hawala: informal value transfer system based on performance and honor of a huge network of money
brokers. Via a network of hawaladars, or money brokers, customers transfer a sum of money to recipients is
other cities under a promise to repay the debt at a later date. There is no legal interference (or protection)
and no records of individual transactions.
Infidel: one who denies Allah or the Islamic prophet Muhammad; literally meaning “unbeliever” or “one
without faith.”
Islamism: the idea that Islam is also a political system, as well as a religion. It also refers to groups
violently opposed to Western encroachment on their way of life.
Jihad: the exertion of one’s utmost effort in order to attain a goal or to repel something detestable in a
variety of contexts, ranging from personal to military conflicts.
Mujahadeen: term for Muslim fighting in a war or involved in any other struggle; literally meaning
“struggler.”
Qutbism: radical strain of Islamic ideology and activism inspired by Sayyid Qubt, a leading Egyptian
ideologue who believed only followers of his strain of Islam were true Muslims and that furthering the
Middle East required the removal of Israel and the Jews.
Salafism: a universalistic vision of classic Islam. Viewing Islam in totality, it has no bias against conflicting
sects. Its goal is to return Islam to the sublime nature described in the Koran.
Sharia: body of Islamic law, it’s the legal framework within the public and some private aspects of life are
regulated for those living in a legal system based on Muslim principles of jurisprudence.
Shura majlis: a term used by many Sunni terrorist organizations for their top leadership; literally meaning
consultative council.
Six rules of jihad:

1. jihad is for the sake of Allah, not for the sake of wealth, goods, fame, glory or power
2. obedience to the imam (Arabic for “leader”)
3. avoid misappropriating booty
4. respect pledges of protection
5. manifest endurance under attack
6. avoid corruption
18
Page 81
Spectrum of Islamist Groups: 4 segments of radical Islamic factions:

1. Revolutionary – seek to legitimize violence by advocating and practicing collective decision
making, drawing selectively on the Qutbist ideology. (i.e. Egyptian Islamic Jihad, Hamas)
2. Ideological – have a coherent discourse of political violence. (i.e. Hezbollah)
3. Utopian – seek to destroy existing order. (i.e. Abu Sayyaf Group, Libyan Islamic Fighting Group)
4. Apocalyptic – use collective violence but are indiscriminate. (i.e. GIA)
Takfir: in Islamic law, the practice of declaring those previously known as Muslims as actual kafirs, or non-
believers.
People/Organizations:
Abdullah Azzam: Palestinian by birth, he was a central figure in the global development of the Islamist
militant movement. As a religious scholar, he created an ideology and paramilitary operation to further the
cause of oppressed Muslims. His practical approach to recruitment and training combined with his ideology
left a lasting impression of bin Laden and was instrumental in establishing al-Qaeda.
Armed Islamic Group of Algeria (GIA): Islamic terrorist organization that seeks to replace the existing
Algerian government with an Islamic state. Notorious for extreme violence, their methods during the ‘90s
resulted in many fellow terrorist organizations, including the Libyan Islamic Fighting Group, Egyptian
Islamic Jihad and bin Laden to denounce their overly aggressive actions. However, they stop short of
denouncing their ambitions for an Islamic Algerian state.
Ayman al-Zawahiri: Egyptian by birth, he is a poet, physician, author and former head of the militant group
Egyptian Islamic Jihad. Fluent in English, French and Arabic, he merged his organization with al-Qaeda in
’98 and is a high ranking member of the shura council. It is believed he is the chief lieutenant to bin Laden
and also his physician. Al-Zawahiri is credited with much of al-Qaeda’s ideological ideas and military
operations.
Colonel Gadaffi: although he holds no public office, he is the de facto leader of Libya. Government
officials refer to him as the “Brother Leader and Guide to the Revolution.”
Hezbollah: a Shia Islamic political and paramilitary group based in Lebanon. It shares similar goals with al-
Qaeda, including the eradication of Western influence and the establishment of an Islamic government in
Lebanon. As the second largest recognized terrorist organization, their expertise in bombing buildings has
been tapped by al-Qaeda through their unique and truly rare tactical alliance.
Osama bin Laden: Saudi Arabian by birth, he is the leader of al-Qaeda. As a member of the prestigious and
wealthy bin Laden family, he inherited between $25-30 million following his father’s death. A careful
financial planner and shrewd businessman, bin Laden’s skills have guided al-Qaeda to become a powerful
multinational organization. His methods are revolutionary, changing the Islamist movement to pursue a
global strategy against the West that is justified by two fatwa’s he issued in ’96 and in ’98. One of the
FBI’s Ten Most Wanted, bin Laden remains the most renowned terrorist in the world.
19
Page 82
Notes
1
"Al Qaeda." wikipedia Encyclopedia. Jan 2007. 29 Mar 2007
<http://en.wikipedia.org/wiki/Al-Qaeda>.
2
Rohan Gunartna, Inside Al Qaeda: Global Network of Terror (New York: Columbia University Press,
2002), p.120-122
3
2002), p. 134
4
2002), p.124
5
Hayes , Laura. "Al Qaeda: Bin Laden's Network of Terror." infoPlease. 29 Mar 2007
<http://www.infoplease.com/spot/al-qaeda-terrorism.html>.
6
"fatwa." wikipedia Encyclopedia. Jan 2007. 29 Mar 2007
<http://en.wikipedia.org/wiki/fatwa>.
7
2002), p.112-126
8
2002), p.112-126
9
2002), p.72
10
2002), p.55
11
12
Sympathy for al-Qaeda Soars in Pakistan, Frontier Star, January 23, 2006. Monday, 350 words
13
2002), p.60-69
14
Basile, Mark, ‘Going to the Source: Why Al Daeda’s Financial Network is Likely to Withstand the
Current War on Terrorist Financing’, Studies in Conflict & Terrorism, 27:3, 169-185
15
Committee on Banking, Housing, and Urban Affairs, Subcommittee on International Trade and Finance,
Hawala and Underground Terrorist Financiang Mechanisms: Hearing before the Subcommittee on
International Trade and Finance. 107th Congress., 1st sess., 14 November 2001
16
Schramm, Matthias and Markus Taube, Evolution and institutional foundation of the hawala financial
system, International Review of Finincial Analysis, Vol. 12 Issue 4, Pages 405-420
17
Signs Point To a Surviving Terror Network, The Washington Post, August 11, 2006 Friday, Final
Edition, A Section; A01, 1214 words, Karen DeYoung, Washington Post Staff Writer
<LexisNexus>
20
Page 83
18
19
2002), p.13-14
20
2002), p.21-71
21
Bernard, Jerome. "Weakened Military, al-Qaeda Fights On-line." Agence France Presse 19 Feb 2007
22
McKenna, Brian. "Sinister Links to a Deadly Network." Times Higher Education Supplement 06 Oct
2006: 25.
23
McKenna, Brian. "Sinister Links to a Deadly Network." Times Higher Education Supplement 06 Oct
2006: 25.
24
Cochran, Andrew. "Internet Security Company Cracks Special Jihadist Software." Internet Blog 26 Jan
2007 02 Apr 2007 <http://counterterrorismblog.org/mt/pings.cgi/3583>.
25
"What is Second Life?." Second Life. 2 Apr 2007 <http://secondlife.com/whatis/ >.
26
Cochran, Andrew. "Part II of ‘MetaTerror: The Potential Use of MMORPGs by Terrorists”." Internet
Blog 12 Mar 2007 02 Apr 2007 <http://counterterrorismblog.org/mt/pings.cgi/3583>.
27
Grace, Nick. "Al Qaeda TV." Daily Standard 03 Jan 2007:
28
Cochran, Andrew. "Arabsat Begins to Broadcast Insurgent Propaganda Station." Internet Blog 12 Mar
29
Cochran, Andrew. "Arabsat Begins to Broadcast Insurgent Propaganda Station." Internet Blog 12 Mar
30
Jones, Del. "Can Small Businesses Help Win the War?." USA Today - Final Edition 3 Jan 2007: 1B.
31
Jones, Del. "Can Small Businesses Help Win the War?." USA Today - Final Edition 3 Jan 2007: 1B.
32
2002), p.192
21
Page 84
AL QAEDA
Decentralization and the Technological
Evolution of Global Terrorism
5: PEACHES
Scott Exner · Lizzy Friedman · Keith Parker
Mark Kimbrough · Bryan Neff · Matt Zimmerman
1
Page 85
AGENDA 1: EXTREMIST RELIGIOUS IDEOLOGY

1: Extremist Religious 3: Strategic Use of Digital Al-Qaeda: a radical political group driven by an
Ideology Technologies
Al-Qaeda Defined Technological Web of al- interpretive religious ideology.
Radical Influence Qaeda
Religious Justification Social Networking
Spectrum of Islamist Groups Portable Programs Goals:
2: Decentralized MMORPGs  eliminate foreign influence in the Muslim
Organizational Structure Al-Zawraa TV
world
Vertical Leadership Craigslist and
Expansive Global Network Decentralization  eradicate those deemed to be infidels
Compartmentalized 4: Countering al-Qaeda’s
Strategy  establish a new Islamic caliphate
Operational Committees
2
Page 86
1: EXTREMIST RELIGIOUS IDEOLOGY 1: EXTREMIST RELIGIOUS IDEOLOGY
Extremist Ideology: Sunni Islamist movement Maximize effectiveness through expansive

pursuing jihad against the West. awareness
 Fatwas, video messages, etc.
Core of Ideology
 Locally rooted…globally inspired Robust capacity for regeneration  glory of
 Fundamental rhetoric martyrdom
 Extend religious boundaries  Spectrum of Islamist Groups
2: DECENTRALIZED ORGANIZATIONAL 2: DECENTRALIZED ORGANIZATIONAL

STRUCTURE STRUCTURE
Vertical Leadership
 Emir-General = Osama bin Laden Compartmentalized Operational Committees
 Shura Majlis (20-30 members)  Finance/Business
– Includes: Ayman al-Zawahiri  Military
– Oversees strategic, operational, and religious  Islamic Law
issues
 Media and PR
 Lines of authority = goal-oriented

STRUCTURE STRUCTURE
Finance and Business
 Sophisticated financial network
Expansive Global Network – Professional Finance Committee
 Intricate global network of independent cells – Strict operational doctrine; self-reliant
– Adaptive and flexible
and affiliates
 Limit record keeping and potential tracking
 Arms-length network with some strong ties – Frugal financial behavior
– “family” construct – Self-sustaining financial tools
– Deception and denial
– Limited upward communication/ financing
– Difficulties with this structure
3
Page 87

STRUCTURE STRUCTURE
Military
Finance and Business
 Military Committee
 Redistribution Channels
 Trains,recruits and acquires military resources
– International banking: fewer regulations &
policing authorities  Decentralized management through Literature
– Islamic banking system: weaker than and Ideology
international banking
 Self-sufficient and independent terrorist cells
– Hawala network: no records!
 Purposefully make unnecessarily high number
of money transfers
STRATEGIC USE OF DIGITAL

2: DECENTRALIZED ORGANIZATIONAL
TECHNOLOGIES
STRUCTURE
Social Portable
Islamic Law Networking Programs
 Rooted in “Sharia”- Islamic Divine Law Ideology Alignment
 Lightning rod for growth

Unified Brand
 Cohesion between decentralized units Al-Zawraa TV
Strategy
MMORPG’s
Autonomy Networks
Media and PR
 Molds public image of itself and the West Craigslist &
Decentralization
 Garner support in Muslim populations

Technological Web of al-Qaeda
SOCIAL NETWORKING PORTABLE PROGRAMS
Propaganda of Ideology
“Mujahadeen Secrets”
Graphic images, videos, and leader Program on USB –

statements No installation required
Internet cafés
Skype &
Voice-Over-Internet Protocol (VoIP)
Impossible to trace
Children target sites

Native language
4
Page 88
MMORPG’S AL-ZAWRAA TV
5,231,598+ global users November 14, 2006, al-Zawraa, a
24-hour insurgent station
Virtual Terrorism
Violence against the Iraq
government & military footage
Scenario Executions
January 26, 2007 – satellite
somewhere in Saudi-Arabia
Recruiting
Long term effects have yet to be

World without laws measured however its content is
viewed as highly credible
CRAIGSLIST &
4: COUNTERING AL-QAEDA’S
DECENTRALIZATION STRATEGY
Online bulletin board - five billion  Western Response thus far
hits a month with 24 Employees
 Strategy for Future Success
Decentralized internet organization
– Challenge the Ideology
with a strong internal message – Attack Financial Supporters
Autonomy – no reporting back
User-generation: build wikis and

blog
QUESTIONS?
5
BUAD-497: Powerpoints
Page 89
BUAD 497: Strategic Management Class 1: Introduction to Strategy
 Class Introductions
 Prof. Peer C. Fiss
 Office: Bridge Hall 303-B  Who am I
 Telephone: (213) 821-1471
 Email: fiss@marshall.usc.edu  Why this class
 Office Hours: Wednesdays 2-4 pm, or by  What will you learn
appointment
 How will we operate
 Sections 15102, 15107, 15112

 What is Strategy?
My Own Background Why this class?
German citizen Strategic Management is intended to be a

Worked for a number
Where I grewof
up…companies, including challenging and exciting capstone
Mannesmann and DPD
The primary objective of this course is to
Ph.D. in Management and Sociology from Northwestern
introduce you to the analysis and formulation of
University (Kellogg School of Management)
strategic problems and decisions facing managers
Appointments at Queen’s University and USC
and leaders.
Published in a variety of top academic journals
Taught courses on strategy and corporate governance at
The material in this course is designed to be as
the undergraduate, MBA, and executive level “real world,” relevant, and interesting as possible.
Some of my research interests I hope this course will be one of the most useful
 Corporate governance you have ever had and that it will be instrumental
 Executive compensation in helping to make you more successful in your
 Strategic change career
What will I teach? How will we operate?
 Mix of theory and cases

 Current events
This class will focus both on the
 Performance evaluation
making and implementation of  Contribution to class discussion (15 %)
business strategy  Individual mini case analysis (10%)
 Individual midterm case analysis (20 %)
 Group project presentation (10%)
 Group project writeup (20%)
 Individual final exam (25%)
 Course packet available from Campus Bookstore
– there is no textbook
 Come prepared
1
Page 90
Other Administrative Stuff… What is Strategy…?
 A preliminary definition:
 A company‘s strategy is the ‚game plan‘
management has for positioning the
company in its chosen market arena,
competing successfully, pleasing
customers, and achieving good business
performance. (Thompson/Strickland 1998)
 Strategy-making efforts must aim at
producing a good fit between a
company‘s resource capability and its
external situation
Why is strategic management

Basics of Strategic Management important?
 Four aspects that set strategic

management apart
Makes a difference in performance levels
 Interdisciplinary
 capstone course
 External focus Provides systematic approach to

 Competition and the nature of the business landscape uncertainties and business challenges
 Internal focus
 Firm competencies, strengths and weaknesses
Coordinates and focuses employees
 Future direction
 Where are we going and how is the marketplace developing?
Who does strategy? A Short History of Strategy
 The Role of the Board of Directors HBS requires a class in Business Policy in 1912
 Elected representatives of the company’s stockholders
Adam Smith’s “invisible hand” (the market) gives
 Legally obligated to represent and protect
stockholder’s way to Alfred Sloan (GM CEO from 1923-1946)
 The Role of Top Management concept of the “visible hand”—middle manager
 Responsible for decisions and action of every Chester Bernard influential book “The Executive”
employee argues that managers should pay attention to
 Providing effective leadership
“strategic factors”
 Other Organizational Employees
 Implement—put the strategies into action and Ronald Coase’s 1937 article “why firms exist”
monitor performance (Nobel Prize in economics) and Joseph
 Evaluate—do the actual evaluations and take Schumpter’s concept of “disruptive technologies”
necessary actions
written in 1942 bring in organizational economics
2
Page 91
Historical Overview: Historical Overview:

From Planning to SM From Planning to SM

Phase: Planning (1945-1960)  2. Phase: Long-Range Planning
 Only budgeting. If you focus on financial (1960-1973)
aspects and controlling, you will be able to  Operations researchers aim to integrate the
plan and forecast. firm into one single model
 But then…main external shock: Oil crisis of
 Order optimization 1973, increases demand for forecasts
 Operations research

 3. Phase: Strategic Planning (1973-1980)  4. Phase: Strategic Management (1980- about

now)
 Before: Main focus on past and extrapolation
to the future.  Globalization strengthens the customer‘s
position.
 Now: What can we learn from the oil crisis? Do
we have to accept such external shocks? Are  Interconnections between firm and environment
we able to predict them? are getting more and more intensive. In many
industries, there is a necessity for permanent
 Change of perspective: How can we analyze
change and innovation.
future chances and risks?
 Focus on social sciences and “human factor”: A
 Oil shock was located outside the company,
company can only implement a strategy if it is
therefore main focus changed to the
accepted by all members.
environment. What is the environment asking
for?  So called “soft factors” are more Important:
personnel, organization, culture.
 Are we able to handle and to meet these
requirements?  The organization has to be more open for
cooperation and integration. Congruence model
 Important Research: Strategic Issue
becomes dominant.
Management, Strategic Surprise Management  (1980: Strategic Management Journal and Journal of Business Strategy)
(Early Warning Systems by Krystek/Müller-
Stewens / Weak Signals by Ansoff)
 5. Phase: New Organizational  A Central Idea of Strategic Management:

Types…?  “Fit” between the elements of the system
(Intra-System-Fit), focus on structure, culture,
 “Knowledge workers” and behavior.
 “Complexity science”  Chandler (1962): Strategy and Structure >
 “Virtual organizations”
„Structure follows strategy“
 “Network forms of organizing”  Ansoff (1965): Corporate Strategy > “System-
 “Adaptive teams”
Environment-Fit“
 “Virtual markets”  Basic hypothesis: environment, external
strategic behavior, and the internal ‚structure‘
 “Boundariless organizations”
are interrelated
3
Page 92
Strategic Management Process Key Takeaways
Analyzing
Current
Deciding
on
Putting
Strategies
Evaluating and
Changing Fast Paced Class…come prepared!
Situation Strategies in Action Strategies
Situation Strategy Strategy Strategy Where strategy came from
Analysis Formulation Implementation Evaluation
What strategy is
Know the basic strategic management
process
Preview for Class 2
Preview Case of interaction between firm

actions and industry landscape
Prepare the assigned readings (Porter, Intel
case; see syllabus and course website)
Fill out the personal information sheet on
the course website
4
Page 93
BUAD 497: Session 2 Agenda for today
• Administrative items
• Case Discussion: Intel Corporation
Preview Case
Learning goals for this session Intel Corporation: 1968-1997
• Understand how the industry landscape

influences a firm’s opportunities for growth • What was Intel’s strategy in DRAMs?
• See how strategic choices at the firm level
matter • What accounts for Intel’s dramatic decline in
• Examine the nature of the competitive market share in DRAMs between 1974- 1984?
landscape and how it can be shaped
• Connect strategy and the creation of value for
firms
Intel Corporation: 1968-1997 Up Through 286 386 and Later

Licensee PC
Manufacturer
Licensee
PC
• What strategy did Intel use to gain a Manufacturer
competitive advantage in microprocessors?

Intel IBM Intel PC
Manufacturer
Licensee
PC
Manufacturer
Licensee
PC
Manufacturer
1
Page 94
Intel Corporation: 1968-1997 Intel Corporation: 1968-1997
• What threats has Intel faced in sustaining this • Why has Intel been able to sustain its
competitive advantage? advantage in microprocessors, but not in
• How did Intel deal with each threat? DRAMs?
Intel Corporation: 1968-1997 Key Takeaways
• Industry landscape strongly influences a firm’s

opportunities for profit—microprocessors are a more
fertile landscape to achieve high profits
• Intel and Internet: New Challenges • Strategic choices at the firm level matter—Intel
exploited that landscape to its benefit
• Firms can shape the landscape—Intel shows how firms

can affect the competitive landscape
• Strategy is about value appropriation as well as value

generation—you have to capture value or someone
else will
• Capabilities as a source of sustainable competitive
advantage
Next session: Industry Analysis I
• Prepare Porter “The structural

analysis of industries”
• Prepare Hambrick and Fredrickson

“Are you sure you have a strategy?”
2
Page 95
Industry Analysis: Issues and

BUAD 497: Session3
Tools
 Learning goals for this session

 Know how industry analysis fits into strategy
formulation
 Know the general tools for industry analysis—
 Industry Analysis I be an informed consumer
 Know Porter’s model for industry analysis
and be able to apply it on your own
 Understand Hambrick & Fredrickson’s model
of strategy and be able to apply it on your own
Profitability Differences Across

Industry and competitive analysis Selected Industries (Ghemawat, Rivkin, 1999)
 “When an industry with a reputation

for difficult economics meets a
manager with a reputation for
excellence, it is usually the industry
that keeps its reputation intact.”
(Warren Buffet)
Profitability Differences Within the Profitability Differences Within the

Pharmaceutical Industry Airline Industry
(Ghemawat & Rivkin, 1998) (Ghemawat & Rivkin, 1998)
1
Page 96
A Three-Dimensional Business What is causing the industry to

Landscape (Ghemawat, 2001) change? An Example
 "An Update on Moore’s Law“

 The observation made in 1965 by
Gordon Moore, co-founder of Intel,
that the number of transistors per
square inch on integrated circuits
had doubled every year since the
integrated circuit was invented. This
is the current definition of Moore's
Law, which Moore himself has
blessed. Most experts, including
Moore himself, expect Moore's Law
to hold for at least another two
decades.
Industry Importance:
Moore’s Law Empirical Evidence
 Rumelt, R. (1991). How much does industry

matter? Strategic Management Journal, 12: 167-
185.
 "To the extent that accounting returns measure the

presence of economic rents, the results obtained here
imply that by far the most important sources of rents in
… manufacturing businesses are due to resources or
market positions that are specific to particular business-
units rather than to corporate resources or to
membership in an industry. Put simply, business units
within industries differ from one another a great deal
more than industries differ from one another.”
How much does industry matter? Industry Importance: Empirical

Rumelt (1991) Evidence
 McGahan, A., Porter, M. (1997). How much

Approximate Effects on Variance in does industry matter, really? Strategic
Return on Capital: Management Journal, v18, pp. 15-30.
Variable % of Variance
Explained  “We also find that the importance of the effects
Corporate Effects 0.8% differ substantially across broad economic sectors.
Industry effects account for a smaller portion of
Stable Business Effects 8.3% profit variance in manufacturing but a larger portion
in lodging/ entertainment, services, wholesale/retail
Stable Business-Unit Effects 46.4% trade, and transportation.”
2
Page 97
How much does industry matter? Industry Analysis: Basic Issues

Porter & McGahan (1997)
Approximate Effects on Variance in

Return on Capital:
 What does this industry look like?
Variable % of Variance Explained  What are the major competitive forces?
 What are the trends?
Year 2%
Industry 19%
 What does it take to do better than average
in this industry?
Corporate Parent 4%  What are the sources of sustainable competitive
advantage?
Business Specific Effects 32%
Porter’s Five Forces
 Framework used to assess the competitive

 Michael E. Porter is the Bishop William position of a firm within an industry
Lawrence Professor Professor, based
at Harvard Business School where he  Uses five forces or variables to measure
leads the Institute for Strategy and competitive advantage
Competitiveness  Assumes continuous downward pressure of
competition
 (1980): Competitive Strategy, Free Press, New  Points to interdependencies between factors
York  Interaction
 (1990): What is Strategy?, Harvard Business  Substitution
Review
Industry Rivalry
Porter’s Five Forces Model
 Intense rivalry among firms in an industry
reduces average profitability.
Threat of Entry
 Rivalry is impacted by
 industry growth
 product differentiation
 number of competitors
Supplier Power Rivalry Buyer Power  competitor diversity
 exit barriers
Threat of Substitutes
3
Page 98
What causes rivalry to be strong What causes rivalry to be strong

or weak? or weak?
 Number and relative size of  Herfindahl Index - a measure of the

competitors balance in an industry
 Concentration ratio = % of total industry sales

accounted by the 4 largest firms
 Example: 3 firms with market shares of 0.50, 0.25, 0.25
 Logging = 18%  H = ((0.50)2+(0.25)2+(0.25)2) = 0.25 + 0.0625 + 0.0625 =

0.375
 Cigarettes = 85%
 H of 0 ➔ Perfectly Competitive
 H of 1 ➔ Monopoly
 H > 0.18 ➔ Relatively high concentration, i.e. industries with
reduced rivalry
2. Buyer Power Buyer Power
 Size and concentration of customers  The power of buyers is determined by factors

such as buyer concentration, switching costs,
and backward integration
 Buyers are powerful if
 Buyers are large and concentrated (government
purchases from defense contractors)
 Credible threat of backward integration (large auto
manufacturers and small parts suppliers—classic Fisher
auto body case)
 Buyers are weak if
 Buyers are fragmented (most consumer products)
 Producers supply critical parts (Intel’s relationship w/
PC manufacturers)
3. Supplier Power Supplier Power
 Differentiation  Bargaining power is based on factors such as

 Switching Costs number of suppliers, switching costs, and
presence of substitute inputs
 Suppliers are powerful if
 Suppliers are concentrated (drug industry’s relationship
with hospitals)
 Significant cost to switch suppliers (Microsoft’s
relationship with PC manufacturers)
 Suppliers are weak if
 Standardized product with many competitive suppliers
(tire industry’s relationship with auto manufacturers)
 Concentrated purchasers (garment industry’s
relationship to major department stores)
4
Page 99
4. Threat of Substitutes Threat of Substitutes
 Price to Performance Ratios  In Porter’s model, substitute products refer to

 Switching Costs products in other industries (Pepsi is not a
substitute for Coke!)
 A close substitute constrains the ability of firms
to raise prices (e.g. aluminum can maker is
constrained by price of glass bottles, steel cans,
and plastic containers)
 Factors that affect substitutes:

 Price/Performance tradeoff
 Switching costs
 Substitute improvement
5. Threat of Entry Threat of New Entrants
 Ability of new firms to enter market is

determined by factors such as:
 absolute cost advantages
 government policy
 economies of scale
 brand identity
Minimum Efficient Scale Entry Barriers
 Patents - pharmaceuticals
 Licensing - physicians, lawyers physicians,
Unit
Costs
lawyers
 Laws - product standards, corporate crime
 Tariffs
 Geographic advantages - Panama or Suez
canal
Entry MES Volume  Language or culture - publishing in many
Point countries
5
Page 100
So, what’s missing from Porter’s A Toolkit fir Industry Analysis

model…? (from Macro to Micro)
PEST (or STEP)

Threat of Entry  Political/Economic/Socio-cultural/Technological
Porter’s Five Forces
SWOT
Supplier Power Rivalry Buyer Power  Strengths/Weaknesses/Opportunities/Threats
Value Chain Analysis
Threat of Substitutes
SWOT But how well does SWOT work?
 SWOT stands for Strengths,  Research has shown that managers view
Weaknesses, Opportunities, and Threats opportunities and threats differently
 But almost any future event can be framed
Now/Internal Future/External
as either an opportunity or a threat.
 Likewise, most strengths entail
Assets Strength Opportunity corresponding weaknesses, and vice versa.
 Thus, SWOT mostly tells you about
yourself, not your environment…
Liabilities Weakness Threat
Hambrick & Fredrickson: Do you An Example: GE Transportation Systems --

have a strategy? Locomotives
 Strategy: “central, integrated, externally Staging Arenas
oriented concept of how we will achieve 1: • New Model X by Year 2

• Push very aggressively in Latin
• Diesel
• Emphasize long and heavy hauls
our objectives” America and Asia
• Sign Eastern Europe JVs
Arenas
(including industrial and mining)
· Americas, Asia, Middle East,
 Five elements: 2: • New Model XX by Year 4 Staging Economic

Africa
Vehicles · Limited defensive position in
• Push aggressively in Africa Logic Europe
 Where will we be active? (arenas)
Throughout: • 5% annual
 How will we get there? (vehicles) productivity
gains
Differentiators
Vehicles
• Wholly-owned subs
 How will we compete? (distinctive properties) • Wait-and-see in
Western Europe with extensive service sites
Differentiators • Selective JVs in Europe
 What speed and sequence of moves? (staging) (including Eastern/Central)
Economic Logic • Service
 Where will profits come from? (economic logic) • Mileage/operating efficiency
• Premium prices for superior product and service • Safety
• Lowest diesel manufacturing costs (Erie factory) • Operator comfort/ergonomics
6
Page 101
Hambrick & Fredrickson: Key Key takeaways – Industry

Evaluation Criteria analysis
1. Does your strategy fit with what’s  Industry matters; know your toolkit for
going on in the environment? understanding the constraints it poses upon
2. Does your strategy exploit your key you
resources?  Porter’s model is useful for making sense of
3. Will your envisioned differentiators industry dynamics, but it has important
be sustainable? shortcomings; know the blind spots
4. Are the elements of your strategy  Don’t take your industry for granted—the
internally consistent? definition matters!
5. Do you have enough resources to  Make sure you have a strategy and that its
pursue this strategy? elements reinforce each other
Next class
 Prepare CF Motorfreight Case

 Be sure to have handed in the complete
personal information sheet (w/ your
picture…)
7
Page 102
BUAD 497: Session 4 Administrative Stuff
 Group projects
Industry Analysis II  Other stuff…
Learning goals for this session CF MotorFreight in 1992
 Apply the tools for industry analysis

to a classic industry
 Why is it so difficult to make money in the
 Build a deeper understanding of LTL trucking business?
industry dynamics
 Connect this to strategy formulation
CF MotorFreight in 1992 CF MotorFreight in 1992
 How well positioned is CFMF in the LTL  As Bob Lawrence and Don Moffitt, what
business? How should we evaluate their are your options for solving these
strategy for this industry? competitive problems?
1
Page 103
CF MotorFreight: Update
What matters
Price
most…!
 CF spun off its unionized trucking business and Unit
called it CFC Margins
 Performance continued to deteriorate Cost
 CFC’s competitors such as Roadway Express, Net
Yellow, and Arkansas Best remained profitable Income Times
 The regional trucking units kept cannibalizing Market

CFC’s business Return On Divided Share
Investment By
Unit
 In May 2002, the board replaced the CEO with a
turnaround specialist Volumes
Assets Market
 CFC filed for bankruptcy September 3, 2002 Managed Size
Your Essential Choice Product Innovation Key Takeaways

of Strategies Price
Product Quality
Strategies
Marketing Effort
Margin
Process Innovation  Industry analysis is a powerful tool for analyzing
Cost
Functional Efficiency
strategy; it can show what opportunities exist in
Strategies the environment
Integration
Net Income  A deeper understanding of industry dynamics
Marketing Effort
protects you from simplistic strategies that often
Market Share
Strategies
Customer Value get you into trouble
Barriers to Entry
Volume
New Products
Market Size
New Markets
Strategies
More Useage
Next session: Industry Analysis III
 Prepare Apple Inc.: iPods and iTunes case

 Begin planning for your group projects
2
Page 104
BUAD 497: Session 5 Learning goals for this session
 Use several tools for industry analysis

in a dynamic industry
Industry Analysis III  Examine factors that contribute to
dynamic industry change
 Begin to think about strategy
formulation under uncertainty
Apple Computer Inc: iPods and iTunes Apple Computer Inc: iPods and iTunes
 How attractive was the music industry

traditionally for the recording companies?
 How has the attractiveness of the industry  What was Napster’s strategy and how did
changed with the entry of Napster? it evolve over time?
1
Page 105
 What was Apple’s strategy as it relates to  As Apple, what should be your strategy
the music industry? going forward?
Four Levels of Uncertainty in Strategic Planning Key Takeaways

Clear-Enough Alternate A Range of True
Future Futures Futures Ambiguity
What can A single, A few discrete A range of No basis to

be known? forecast precise solutions that possible forecast the  Companies must look broadly at the economics and
enough for define the outcomes, but future forces of the industry. Think about the power
strategy future no natural
scenario constellations and how they are likely to change
Analytic Classic industry Decision Latent- Analogies and
 Good strategies are coherent, build on existing
Tools and strategy analysis; Game demand pattern advantages, and exploit industry landscape. That’s
analysis tools Theory; Option search; recognition; what Apple did
valuation Scenario Nonlinear
models planning dynamic models  There is a big difference between having a product
advantage and having a competitive advantage.
Examples Strategy against Entry into Entry into Entry into the
entrant in the deregulated emerging Russian market Product advantages alone are difficult to sustain
mining industry local phone markets such in 1992  Uncertainty is critical to strategy making, and there
market as India
are tools to deal with different levels of uncertainty
Source: Courtney et al, Strategy under Uncertainty, HBR 1997
Next session: Firm Competencies I
 Prepare Hill and Jones chapter “Internal

Analysis”
 Go to the USC and Marshall homepages
and study the strategic framework for
USC and the Dean’s message for Marshall
2
Page 106
 Examine the RBV and role of core

competencies in building competitive
advantage
 Firm Competencies I
 Understand how a Resource-based View
(RBV) of the firm works and how it differs
from the IO view
 Apply both frameworks to conduct a
strategic analysis of USC and Marshall
A Comparison: GTE vs. NEC in And eight years later… GTE vs.
1980 NEC in 1988
 GTE  NEC  GTE  NEC

 Sales 9.98B  Sales 3.8B  Sales – 16.46B  Sales – 21.89B
 Closed down semi-  World leader in semi-
 Active in  No telecom
conductors conductors
telecommunications experience
 Divested much of  First tier player in
 Positioned in  Comparable their display business telecommunications
display technologies technological base  Telephone operating  Included lifestyle
 Net cash flow 1.73B company products – mobile
 Moved other areas phones, fax,
into joint ventures notebooks
GTE’s Strategy: A Portfolio of NEC’s view of changes in the

Businesses 1980s
 NEC identified three interrelated streams of

 No clear strategic intent or commitment technological and market evolution
 Significant work to identify key  Computing would evolve from Main Frame to
distributed processing
technologies, but little coordination
 Components from ICs to VLSI
among business units
 Communications from mechanical to digital
 Decentralization and outsourcing made
GTE increasingly dependent on outsiders  → Semi-conductors would become the
for critical skills ‘Core Product’
1
Page 107
NEC’s Strategy: A Portfolio of

GTE vs. NEC
Competencies
 Exploit the convergence of computing and

communications – C&C
 Communicated its intent to the whole Portfolio of Portfolio of
vs.
organization Businesses Competencies
 Shifted resources between units to support
components and processors
The Strategic Implications of the BCG

The BCG Portfolio Matrix Matrix
 Stars
 Aggressive investments to support continued growth and
consolidate competitive position of firms
 Question marks
 Selective investments; divestiture for weak firms or those
with uncertain prospects and lack of strategic fit
 Cash cows
 Investments sufficient to maintain competitive position.
Cash surpluses used in developing and nurturing stars and
selected question mark firms
 Dogs
 Divestiture, harvesting, or liquidation and industry exit
The McKinsey/GE Matrix The Corporation as a Portfolio

of Core Competencies
Source: G. Hamel and C. K. Prahalad, Competing for the

Future (Cambridge, Mass.: Harvard Business Sc hool Press,
1994), p. 227.
2
Page 108
Core Competencies and the RBV:

Two Concepts of the Corporation
What is the company good at?
Portfolio of Businesses Portfolio of Competencies

 Core competencies are a source of competitive
advantage
Basis for competition Product competition based on Interfirm competition to build
today’s products competencies  They make a company distinctive
Corporate structure Portfolio of businesses related Portfolio of competencies, core

 Competencies = Resources and Capabilities
in product-market terms products and businesses  Resources
 tangible and intangible assets of a firm
Status of the business unit Autonomy is central; the SBU SBU is a potential reservoir of
“owns” all resources other than core competencies
» tangible: factories, products intangible: reputation
cash  four general categories: financial, physical, human, organization
Resource allocation Discrete businesses are the Businesses and competencies  Capabilities
unit of analysis; capital is are the unit of analysis; top
allocated business by business management allocates capital  proficiencies that that enable a firm to take full advantage of
and talent other resources
Value added of top Optimizing corporate returns Building strategic architecture » marketing skills, cooperative relationships
management through capital allocation trade- and competencies to secure
offs among businesses the future
Examples: Competencies At Marks & Spencer

Distinctive Competencies
 Toyota, Honda, Nissan

 Low-cost, high-quality manufacturing capability and
short design-to-market cycles Marks &
Spencer
 Intel
 Ability to design and manufacture ever more powerful
microprocessors for PCs
 Motorola
 Defect-free manufacture (six-sigma quality) of cell
phones
Adapted from Exhibit 3.5 M arks & Spencer: How Resources and Capabilities Lead to Advantages, with permission of Harvard Business
Review: Exhibit from “Competing on Resources: Strategy in the 1990’s” by D. J. Collis and C. M ontgomery, 73, no. 4 (1995).
The Resource Based View (RBV) IO vs. RBV
Industrial Organization (IO) Resource Based View

 Two critical assumptions of RBV: (RBV)
 Resource Heterogeneity Some Porter, Rumelt Barney, Wernerfelt
 differences in resources among similar firms Authors:
 Resource Immobility
Focus: External—describes Internal—describes
 costly for firms to acquire
environmental conditions firm’s internal
favoring high levels of firm characteristics and
 What do these assumptions mean? performance performance
 If one firm has resources that are valuable and Assumptions: Firms within an industry have Firms have idiosyncratic,
other firms don’t AND if other firms can’t imitate identical strategic resources not identical strategic
resources
these resources without incurring high costs, THEN
Resources are highly mobile Resources are not
the firm possessing the valuable resources will likely perfectly mobile and
(easily bought and sold) and
gain a sustained competitive advantage therefore homogeneous therefore heterogeneous
3
Page 109
The VRIO Framework Applying the VRIO Framework
The Question of Value

If a firm has resources that are…
 In theory: Does the resource enable the firm
• valuable, to exploit an external opportunity or neutralize
• rare, and an external threat?
• costly to imitate, and…  The practical: Does the resource result in an

increase in revenues, a decrease in costs, or
• the firm is organized to exploit these resources,
some combination of the two?
…then the firm can expect to enjoy a sustained Levi’s reputation allows it to charge a premium
competitive advantage for its Docker’s pants
Applying the VRIO Framework Applying the VRIO Framework
The Question of Rarity

Valuable and Rare
 If a resource is not rare, then perfect competition
dynamics are likely to be observed (i.e., no
If a firm’s resources are… …the firm can expect:
competitive advantage, no above normal profits)
 A resource must be rare enough that perfect Not Valuable Competitive Disadvantage
competition has not set in
 Thus, there may be other firms that possess the Valuable, but Not Rare Competitive Parity
resource, but still few enough that there is scarcity
Several pharmaceuticals sell cholesterol-lowering Competitive Advantage
Valuable and Rare
drugs, but the drugs are still scarce—look at prices (at least temporarily)
Applying the VRIO Framework Costs of Imitation
The Question of Imitability  Unique Historical Conditions

 First mover advantages
 The temporary competitive advantage of valuable  Path dependence
and rare resources can be sustained only if
competitors face a cost disadvantage in imitating  Causal Ambiguity
the resource  Causal links between resources and competitive advantage may not
be understood
 Bundles of resources fog these causal links
 intangible resources are usually more costly to
imitate than tangible resources and bundles of  Social Complexity
resources are more costly than single resources  The social relationships entailed in resources may be so complex that
managers cannot really manage or replicate them
Harley-Davidson’s styles may be easily imitated,
but its reputation cannot  Patents
 Offer a period of protection if the firms is able to defend its patent
rights
 Can be a two-edged sword as firms disclosure may decrease costs of
imitation by other firms
4
Page 110
Applying the VRIO Framework The VRIO Framework
The Question of Organization Costly to Exploited by Competitive Economic

Valuable? Rare? Imitate? Organization? Implications Implications
 A firm’s structure and control mechanisms
must be aligned so as to give people ability No No Disadvantage Below
Normal
and incentive to exploit the firm’s resources
 Examples: formal and informal reporting structures, Yes No Parity Normal
management controls, compensation policies,
relationships, etc.
Temporary Above
 These structure and control mechanisms complement Yes Yes No Advantage Normal
other firm resources—taken together, they can help a
firm achieve sustained competitive advantage Sustained Above
Yes Yes Yes Yes
Advantage Normal
3M Company – rewards innovation and risk-taking Source; Adapted from J. Barney, “Firm Resources a Sustained Competitive Advantage, ‘ Journal of
Management 17 (1991), pp. 99-120.
Competitive Dynamics
Case Study: USC/Marshall
of Resource Imitation
Competitive Dynamics
 The strategic decisions and actions of firms in
response to the strategic decisions and actions
of other firms
Firm B’s Possible Responses
Firm A No Response
(strategy decisions
Change Tactics
lead to competitive
advantage) Change Strategy
Key Takeaways Next class: Firm Competencies II
 While traditional factors used to be important,

knowledge-based core competencies are increasingly
important in the new business landscape  Examine the role of corporate
 Internal strategic analysis aims to integrate the firm’s headquarters in acquiring and
specific strengths to maximize advantage developing competencies
 Know the VRIO framework for understanding how to  Prepare PepsiCo case
achieve and sustain competitive advantage
 Core competencies can become core rigidities
5
Page 111
BUAD 497: Session 7 Learning goals for this case
 Use the RBV to understand what PepsiCo

should do
Firm Competencies II  Examine how we can achieve coordination
among businesses to exploit competencies
 Examine the relationship between
corporate vs. business unit strategy and
trade-offs between autonomy and
coordination
PepsiCo’s Restaurants PepsiCo’s Restaurants
 Should PepsiCo acquire CoC and CPK?
PepsiCo’s Restaurants PepsiCo’s Restaurants
 Given PepsiCo’s strategic goals, where  How could PepsiCo be re-structured to

should CoC and CPK be placed in the improve coordination and synergy?
PepsiCo structure?
1
Page 112
PepsiCo Restaurants: Update PepsiCo Restaurants: Update (Cont’d)
 Pepscio made both acquisitions. They took a  However, 1994 operating profits from restaurants fell 6%
51% ownership with agreements to buy out the  Pepsico Vice-Chairman Roger Enrico’s goals are to return
to profitable growth by tying together business functions
rest over time, conditional on performance. across the chains, including accounting, billing, and
 CPK and CoC were left as independent purchasing to cut costs, and reducing the number of
company owned stores.
companies reporting to VP Strategic Planning
 In 1997, PepsiCo spun off its restaurants as Tricon,
(Ken Stevens) and one or two restaurant renamed Yum! in 2002.
presidents  Yum! focused on generating concentrated efficiencies
 CoC was reconceived as a design and marketing under a single brand, sometimes placing two or three
company, with production outsourced brands into a single restaurant; sales have increased
considerably, though still less than at McDonalds
 CPK has rolled out more stores nationwide, using  Growth has been impressive in China, with operating
the funding from PepsiCo profits rising from $20m to $200m from 1998 to 2005
Key Takeaways Next class: Firm Competencies III
 Be able to analyze what actions create

competencies and how they affect corporate
strategy
 PepsiCo: clear example of benefits of sharing and  Prepare Wal-Mart Case and skim the business
coordination at the corporate level (you can’t get press on current developments around Wal-
much more related than three fast food Mart
restaurants…!)  Remember that group emails are due by
 But even here: tradeoff between autonomy and midnight on Wednesday, the 31st
growth!
 You can create value through fairly independent
divisions—the question is, can coordination
create even more?
2
Page 113
 Continue analyzing the sources of a firm’s

competitive advantage and how they relate
to competency
Firm Competencies III
 Examine the sustainability of this
competitive advantage
 Analyze the transferability of competitive
advantage and what factors matter when
moving into different environments
Wal-Mart Stores Inc. Wal-Mart Stores Inc.
 What are Wal-Mart’s sources of

competitive advantage?
Wal-Mart Stores Inc. Wal-Mart Stores Inc.
 What are the issues involved with Wal-

 How sustainable is Wal-Mart’s position? Mart diversifying into foreign countries?
1
Page 114
Next class: Complementarities and Fit
 Prepare readings
 Milgrom and Roberts, “Complementarities
and Design Decisions”
 Grant, “Alternative Structural Forms”
 Mini case analysis due at beginning of
class
2
Page 115
BUAD 497: Session 9 Learning Goals
 Understand the importance of organizational

structure and configurations for designing and in
implementing strategies
 Understand the tension between differentiation
Fit and Complementarities and integration in organizing
 Know the relative advantages and disadvantages
of the most common organizational structures
(functional, divisional, matrix)
 Examine different views of organizations, such as
Mintzberg’s approach and a view of firms as
activity systems
Why Understand Organizational

Organizational Structure and Design
Configurations and Structure?
 Organizational Structure
 Internal fit of organizational configurations is  The formal configuration between individuals
and groups with respect to the allocation of
essential for achieving sustainable competitive tasks, responsibilities, and authorities within
advantage organizations
 Understanding configurations and structures is  Organizational Design
important for your career. What activities are  The process of coordinating the structural
core? Where do you fit in? What organization do elements of an organization in the most
appropriate manner
you want to be in? Formal vs. informal?
Centralized vs. decentralized? Entrepreneurial vs.  Three approaches:
 Classical Organization Design
rule-guided?
 Mintzberg’s Framework
 Activity Systems
Part I: The Classical Approach The history of a hostel that grew

too fast…
Husband
Children Wife
Midlevel manager Midlevel manager Midlevel manager
It-technician Caretaker Chef Dishwashers
Cleaning aid Receptionist Waiter
Guests
1
Page 116
Greiner’s Model of Organizational

Graphic Description The
The circularity of formalisation
Basic Problem of Organizing
Growth
Phase 1 Phase 2 Phase 3 Phase 4 Phase 5

Growth by
Team Spirit
Growth by The problem is how to find
= Evolution
= Revolution Growth by
Coordination
Crisis
Controlthe right balance and not let the
Flexibility
Growth by Delegation organisation drown in complexity
Tight by what?
Size of Organisation
Growth by
Creativity Management
Crisis by
Bureaucracy
Crisis by
Control
 ”After the task has been divided into specialist subtasks, the problem is
Crisis by Crisis by to integrate the subtasks around the completion of the global task. This
Style of Autonomy is the problem of organisation design.”
Management Jay Galbraith (1974), Organization Design – An Information Processing View
Age of Organisation
Growth Patterns of Firms Functional Structure
Phase 1
Strategy: Low revenue base; simple product-market scope
Structure: Simple Chief Executive
Officer or President
Phase 2
Strategy: Increase in revenues; engage in vertical integration
Structure: Functional
Phase 3
Strategy: Expand into new, related product-markets and/or Manager Manager Manager Manager Manager Manager
geographical areas Production Engineering Marketing R&D Personnel Accounting
Structure: Divisional
Phase 4
Strategy: Expand into international markets Lower-level managers, specialists, and operating personnel
Structure: International Division, Geographic Area, Worldwide
Product Division, Worldwide Functional, or
Worldwide Matrix
Structure for Cost Leadership

Functional Structure
Strategy
Advantages Disadvantages • Operations is main function Office of the President
 Pooling of specialists  Differences in functional • Process engineering is
enhances coordination orientations impede
communication and emphasized over R&D
and control • Large centralized staff
coordination
 Centralized decision  Tendency for specialists • Formalized procedures
making enhances an Centralized Staff
to develop a short-term • Structure is mechanical, job
organizational perspective perspective and a narrow roles highly structured
across functions functional orientation
 Efficient use of talent  Functional area conflicts
 Career paths and may overburden top level
decision makers Engineering Operations Accounting
professional development
in specialized areas are  Difficult to establish
uniform performance
facilitated standards Marketing Personnel
2
Page 117
Structure for a Differentiation Strategy Divisional Structure
President and
Limited Staff Chief Executive
Officer or
President
R&D Marketing
Corporate S taff
New Product
R&D Marketing Finance Division A Division B Division C
General Manager General Manager General Manager
Operations Human
Resources Manager Manager Manager Manager Manager Manager
Production Engineering Marketing R&D Personnel Accounting
• Marketing is the main function for tracking new product ideas

• New product R&D is emphasized Lower-level managers, specialists, and operating personnel
• Most functions are decentralized

Organized Organized
similarly to similarly to
• Formalization is limited to foster change and promote new ideas Division 1 Division 1
• Overall structure is organic; job roles are less structured
Divisional Structure Multi-Divisional Structure (A)
Advantages Disadvantages
 Increases strategic and  Increased costs incurred Chief Executive Officer
operational control, through duplication of
permits executives to personnel, operations, Corporate Office (Staff)
address strategic issues and investment
 Quick response to  Dysfunctional
environmental changes competition among North
Europe Asia
Latin
Africa Australi
divisions may detract America America
 Increased focus on a
products and markets from corporate
performance
 Minimizes problems
associated with sharing  Difficulty in maintaining Product A Product B Product C Product D
resources across functions uniform corporate image
 Facilitates development of  Overemphasis on short- A structure based on geographic lines usually
general managers term performance implies a multi-domestic international strategy
Matrix Structure
Multi-Divisional Structure (B)
Chief Executive Officer

Chief Executive
Officer or
Corporate Office (Staff) President Corporate
Staff
Product A Product B Product C Product D Manager Manager Manager Manager Manager Manager Public
Administration Projects Manufacturing Engineering Marketing Relations
and Human
Resources
Project A
Project B
A structure based on product lines usually
implies a global international strategy Project C
Project D
3
Page 118
Matrix Structure Restructuring Leo Burnett
Advantages Disadvantages
 Increases market  Dual reporting relationships
responsiveness through can result in uncertainty
collaboration and regarding accountability
synergies  Intense power struggles
 Allows more efficient may lead to increased
utilization of resources levels of conflict
 Improves flexibility,  Working relationships may
coordination, and be more complicated and
communication resources duplicated
 Increases professional  Excessive reliance on
development through teamwork may impede
broader responsibilities timely decision making
Part II: Mintzberg’s Approach Henry Mintzberg: Five Basic Elements
 Operating Core: Employees who perform the

basic work related to an organization’s product or
service.
 Strategic Apex: Top-level executives responsible
for running an entire organization.
 Middle Line: Managers who transfer information
between higher and lower levels of the
organizational hierarchy.
 Technostructure: Organizational specialists
responsible for standardizing various aspects of
an organization’s activities.
 Support Staff: Individuals who provide indirect
support services to an organization.
Mintzberg’s Five Organizational Forms
4
Page 119
Five Organizational Forms (1) Five Organizational Forms (2)
The Simple Structure: young, small; The Professional Bureaucracy:

nonsophisticated technical system; complex, stable envir. Nonregulating,
simple, dynamic environment. nonsophisticated technical system:
Key: strategic apex Key: Operating Core.
Machine Bureaucracy: old, larger; The Adhocracy: complex, dynamic

regulating, nonautomated technical envir.; sophisticated and often automated
system; simple, stable envir. technical system
Key: technostructure Key: Support Staff
The Divisionalized Form: diversified The Idea Organization: Value-based

markets (esp. products & services); old, organizations, public/religious
large. organizations…Jehovas Witnesses,
Key: Market grouping, performance Greenpeace, Al Quada, IRA
control, limited vertical decentralization
Part III: Organizations as Activity

Summary of Mintzberg Systems
The Underlying View: Strategy as A Different View:

Positioning (Porter, 1996) Firms as Activity Systems
 Operational effectiveness is not strategy

 Operational effectiveness is a given  Activity Systems form configurations that
 Strategy is a unique position for the firm need to exhibit a high degree of internal fit
 Strategy is not doing the same activities better, rather
doing them differently or doing different activities  Interplay of complementarities and trade-
 Strategy involves trade-offs offs across multiple activities is critical to
 Due to incompatible product features, inconsistencies success
in image, limits of coordination, motivation,  Different configurations can be equifinal,
management, etc.
i.e. equally effective (“many best ways to
 Strategy means achieving a high degree of fit
between internal activities/resources and the
organize”)
external environment
5
Page 120
IKEA’s Activity System
Self-
High-traffic
Explanatory T ransport by
Suburban Store layout
Catalogues, customers
Informative Location More
Displays and With ample Impulse
labels parking buying
Limited
S elf-selection
Customer
by Customers
Ease of S ervice Most
T ransport and Limited Items in
assembly Sales inventory
staffing
Self-assembly Ample
By customers Inventory
On site
Increased
“ knock-down” Likelihood of
Year-round
Kit packaging Future
stocking
purchase
Modular Low
Furniture Manufacturing
Design Cost
In-house
Design focused
Wide variety 100%
On cost of
With ease of Sourcing from
manufacturing
manufacturing Long-term
suppliers
Equifinal Activity Systems with

Internal Fit: Wine Industry
Robert Mondavi E.&J. Gallo
 Premium wine producer  Large-volume, low-price
producer
 Long-term contracts with
outside growers, also owns  Grapes purchased at arms-
vineyards length from outside growers,
 Established relationships, often also imported
extensive knowledge-sharing  Highly automated production
 Extensive use of hand- methods
methods to ensure highest  Aging in stainless steel tank
quality farms
 Aging in small oak barrels  Heavy use of advertising
(leading advertiser among
 Heavy use of tastings, PR,
wine tours California wineries)
Equifinal Activity Systems with

Internal Fit: Home Improvement Implications: Strategy and Fit
Retailing
Home Depot Lowe’s  Taylor many activities to the strategic
 Huge stores with no-frills  Slightly smaller, more
design attractive stores position
 Widest selection of items  Greater emphasis on  Strengthen the fit among activities
 High ceilings allow large fashion, kitchen, decorating
inventories on store shelves  The strategic value of outsourcing depends
 Lower ceilings with more
 No warehouses or distribution attractive shelving on fit
centres; direct deliveries from
limited number of vendors  Regional distribution  Outsourcing tends to make activities generic
 Goods delivered go directly on centres with hub-and-  Tailor suppliers to strategy
selling floor on palettes spoke system
 Well-trained employees to  Contractors are served by  Improve the strategy (and counter your
advise mostly DIYs and small separate corporate divisions rivals’ moves) in ways that extend and
contractors
 Low prices
 Higher proportion of strengthen fit
unique and fashion items
w/ higher prices
6
Page 121
Summary: Strategy as Configuration Key Takeaways
 Structure and configuration need to follow strategy

What is a Strategy? What is not a Strategy?
 There is a key tension in organizational structures
 Unique position  Best practice improvement
between control and flexibility; know which one is
 Tailored activities  Learning
more important for your situation
 Activities fit together in an  Agility
integrated system  Organizations go through growth cycles; know
 Flexibility
 Clear tradeoffs which one you are in and recognize the symptoms
 Restructuring
 Continuity of position but  Mergers/Consolidation  Know the main organizational structures and their
consistent improvement  Alliances/Partnering advantages and disadvantages
 The Internet  Formal structures are only half the story—know
how a firm’s activity systems are configured and
how this supports/hinders the firm’s strategy
Next Session: Fit Applied
 Prepare Progressive Case
7
Page 122
 Get experience applying the activity

system framework
 Fit Applied I  Examine trade-offs of strategic positions
 Understand the model of strategy that
underlies the configurations approach
Average Industry Ratios 1995-

Progressive Corporation
1998
Alternative Views of Strategy Key Takeaways
 Strategy as “One  Strategy as Fit

Best Way”  Competitive advantage emerges out of the entire
 One ideal competitive position in  Unique competitive position system of a firm’s activities
the industry for the company
 Activities tailored to the firm’s  Fit among activities reduces cost or increases
 Benchmarking of all activities
and achieving best practices strategy differentiation
 Clear trade-offs and choices
 Aggressive outsourcing and
vis-à-vis competitors
 Relying on complex activity systems decreases
partnering to gain efficiencies
 Advantages rest on a few key  Advantages arise from fit the threat of imitation by competitors
success factors, critical across activities  The most viable strategic positions are those
resources, core competencies  Sustainability comes from the
activity system, not the parts
whose activity systems are incompatible because
 Flexibility and rapid responses to
competitive and market changes of tradeoffs
1
Page 123
Next Session: Fit Applied II
 Continue with analysis of activity

systems
 Prepare Airborne Express case
2
Page 124
 Compare different positions within an

industry and understand the strategies
that go with them
Fit Applied II
 Examine the effect of cost position on
strategy
 Be able to identify priorities based on
total and marginal relative costs
Airborne Express Airborne Freight Stock Price
Update Update (cont’d)
 Airborne continued to prosper in 1997 and 1998  In March 2003, DHL announced it would acquire
(net income 1996: $28m, 1997: $120m, 1998: Airborne for about $1.2 billion.
137m).  Since 2003, DHL has committed extensive funds
 However, in 1999 Airborne began to falter. FedEx to catch up with FedEx and UPS in the US. DHL’s
moved further into ground operations. Both brand has replaced Airborne’s and is trying to
FedEx and UPS exploited the online shopping establish itself as a “third force” in the express
boom of the late 1990s, but Airborne struggled. mail industry
 After 1999, Airborne’s profits were meager with
losses in some quarters
1
Page 125
Key Takeaways Next Session: Fit Applied II
 Greater interactions between decisions tend to

lead to internally consistent but mutually
exclusive positions
 Even a small firm can carve out a long-viable  Continue with analysis of activity
position in an inhospitable environment by
exploiting a distinct position systems
 Successful strategies tailor a large number of  Prepare Airborne Express case
activities in mutually reinforcing ways to create
this position
 However, even the best fit is not invulnerable to
competitive moves that take away positional
advantages
2
Page 126
Understand how game theory applies to business

and helps us to analyze strategic moves by our
competitors
Competitor Analysis Know the main elements of games and their basic
forms
Examine how firms can change the rules of a game
to capture more value for themselves
See how competitor profiling can complement game
theory
What is Game Theory? Games We Play
“No man is an island” Group projects Free riding and reputation

Poker Credibility
Analysis of rational behavior in Traffic Congestion
interactive or interdependent situations Dating Information manipulation
The bad news… Dining out Coordination
…knowing game theory does not guarantee
winning
The good news…
…very useful framework for thinking about
strategic interaction
Decision Theory vs. Game Theory Restaurant Decision-Making
May I recommend that with the

Bleu Cheese for ten dollars more?
Ten of you go to a restaurant
Sure!
If each of you pays for your own meal…
…this is a decision problem
It is only
a dollar
If you all agree to split the bill... more
for me!
…now, this is a game
A check splitting policy changes incentives:
they depend now on the moves of other players…
1
Page 127
Games Businesses Play Components of a Game
Market entry Commitment

Supply chains Auctions Games have the following characteristics:
Corporate takeovers Winner’s curse
Fishing Congestion
Patent races Game of chicken  Players
OPEC output Collusion & enforcement  Rules
 Payoffs
 Strategies
Games as Defined by the Number

Games as Defined by the Rules
of Players
Rules determine the number of options/alternatives

1-person (or game against nature) in the play of the game.
2-person The payoff matrix has a structure (independent of
value) that is a function of the rules of the game
n-person (3-person & up) Thus many games have a 2x2 structure due to 2
alternatives for each player
Games as Defined by the Payoff

Generic Strategies
Structure
Zero-sum In simple games, it is natural to suppose that one
 Classic games: Chess, checkers, tennis, poker. player will attempt to anticipate what the other
 Business games: Sales negotiations (often) player will do
 Minimax: to minimize the maximum loss; a defensive
strategy
Non-zero sum  Maximin: to maximize the minimum gain; an
offensive strategy
 Classic games: Monopoly
 Business games: Market entry, research investment
Games can also have sequential play, which leads
to more complex strategies
 Tit-for-tat: always respond in kind
 Tat-for-tit: always respond conflictually to
cooperation and cooperatively towards conflict
2
Page 128
Game or Nash Equilibria (1) The Prisoner’s Dilemma
Games also often have solutions or equilibrium Prisoner A
points Should you ~ Confess Confess

These games, owing to the selection of particular confess?
reasonable strategies, will result in a determined
outcome
~ Confess Six months Free
A Nash Equilibrium is that point
where it is not to either player’s Six months Ten years
advantage to unilaterally Prisoner B
change his or her mind Confess Ten years Two years
Free Two years

John F. Nash (1928-)
What makes a Game a Prisoner’s

What is the Outcome of a PD?
Dilemma?
The saddle point is where both confess

We can characterize the set of choices in a PD as: This is the result of using a minimax strategy.
 Temptation (desire to double-cross other player) Two aspects of the game can make a difference.
 Reward (cooperate with other player)  The game assumes no communication
 Punishment (play it safe)  The strategies can be altered if there is sufficient
trust between the players
 Sucker’ pay off (for the player who is double-crossed)
Examples in Business: two companies deciding on
A game is a Prisoner’s Dilemma whenever: whether to start an advertising campaign; Boeing
T>R>P>S vs. Airbus in VLAs; research investments, …
Free > Six months > Two years > Ten years
(2) The Game of Chicken Chicken is an Unstable game
Driver A There is no saddle point in the game.

~ Swerve Swerve No matter what one player chooses, the other
player can unilaterally change for some advantage
Chicken is therefore unstable
~ Swerve -20 -1 We cannot predict the outcome
BUT: Credible commitment can persuade the other
-20 +1 player to back down
Driver B
Swerve +1 0
Examples in Business: Patent races, Microsoft vs.
-1 0 Linux, etc.
3
Page 129
(3) Tragedy of the Commons Cow Carrying Capacity
Describes the problem of the unregulated use of a

public good Each cow produces 500 lbs of meat & dairy per year
Take a village with 10 families up to or at carrying capacity of the pasture.
Each family has 10 cows which just exactly provide 10 families X 10 Cows X 500 lbs = 50,000 lbs of
the food they need food at carrying capacity
The village commons …and then Farmer Symthe’s wife has triplets…
has a carrying capacity
of 100 cows
One more cow… Reduced Capacity
So Farmer Smythe decides he really needs With the overgrazing, each cow will now produce
only 490 lbs of food.
one more cow
101 Cows X 490 lbs = 49,490 lbs of food at carrying
And there is no one to tell him “No!” because capacity
the commons is an unregulated public good Each family gets 4900 lbs of meat & dairy, instead
 Some modern commons are forests, oceans, of 5000
public roadways, air quality, Internet (no Except Farmer Smythe, who gets 5390 lbs
spamming), markets with limited carrying Even with the reduced carrying capacity,
capacity, etc.. it is still to his advantage to
add the extra cow
Applying Game Theory to

Looks familiar…?
Business: Toys “R” Us
Look at the situation: Competitive Landscape

 N players  Toy & department stores
 Equilibrium solution is to ~cooperate  Do not compete with TRU on price (50% markups)
 General discounters (Wal-Mart, Target)
 Joint optimal outcome is to cooperate  Cannot compete with TRU on selection (9% markups)
 This is an n-person,  Toys exhibit high product differentiation
collective Prisoner’s dilemma  Specialized discounters (only TRU)

 Enjoyed 20% market share nationally
 Warehouse clubs (Costco, Pace)
 Introduced in the 1980s
 By 1989, about 200 items in competition
 Cause of concern for Toys “R” Us!
4
Page 130
Toys “R” Us (continued) Toys “R” Us (continued)
Market research into the future of warehouse Manufacturers agreed to TRU deal
clubs  Really they had little choice given the uncertainty about
 Manufacturers estimated 3-5% annual growth rate the future
 Toys “R” Us conducted comprehensive but proprietary
study Warehouse club toy sales decreased
 Manufacturers were aware of the study, but not its  Pre-agreement growth of 51% per year
results
 Overall growth of clubs of over 10% per year
 Toys “R” Us expected warehouse clubs to grow quite
fast… Toys “R” Us kept its market
Idea! Issue statement to manufacturers:
 “You may not sell to warehouse clubs without losing
Toys “R” Us as a customer.”
 Effectively, choose between a $5 billion market (TRU) and a
less than $500M market (warehouse clubs)
The Toys “R” Us Example Changing the Game…
Sequential timing
 Threat of Manufacturer’s decisions
How will my opponents react?
Simultaneous timing
 Manufacturer’s decisions
What is my opponent doing right now?
Information
 Future profitability of warehouse clubs
What can I infer from the actions of others?
Agreements
 Enforceability of contracts & agreements
What happens if someone breaks the agreement?
What game is being played? How can the game be changed?
Who are the key players?

 duopoly game; oligopoly game; etc… The game can be changed by changing…
What options are open to the players?
 pricing game; advertising game; etc.  Players
What goals are the players pursuing  Added value
 market share? profits?..
 Rules of the game
Are goals complementary or conflicting?  Tactics employed
 issues the players agree on, sources of conflict, etc..
 Scope of the game
What is the time structure of the game?
 one shot, repeated, simultaneous, sequential…
5
Page 131
Changing the players Change the added value
Bring in customers Limit your supply

 Pay customers (esp. early adopters) to play (Samples, Netscape)  DeBeers and diamonds; Nintendo & video games
 Subsidize some customers, other full paying customers will follow  Downside: Shrinks the pie today; leaves entry opportunity open
(Initial discount to lower risk)
Raise amount consumers are willing to pay
Bring in suppliers  Policies that build loyalty (frequent flier miles) increase willingness
 Holland Sweetener Co./NutraSweet and Coca-Cola to pay - GM / Ford credit cards
Bring in complementors Lower competitors’ value
 Do it yourself. Nintendo - both h/w & s/w  Softsoap - by cornering the supply of pumps
 Pay complementors to play (at least initially)
Bring in competitors
 Create a second source to encourage buyers to adopt technology
Changing tactics Changing the scope
Make the game more transparent or opaque What is the current scope of the game?
 depending on which benefits you  Games are often linked across geographic and product
To establish credibility (clear the fog) markets
 Absorb uncertainty (e.g. accept a pay-for-performance contract) Do you want to link the game to other games?
 Offer guarantees or advertise  Would a multi-market contract be beneficial to you?
 Ask others to demonstrate their credibility to you
Do you want to de-couple the game from
To establish uncertainty (preserve the fog) other games?
 Create complexity (long distance calling rates)
 Leave a market to stop competing head-on with
 Bluff: Ask yourself whether you will be believed and under what
circumstances another firm
 Ask what others stand to gain by preserving the fog, and what they
could be bluffing about
Beyond Game Theory:

Why Competitor Profiling?
Competitor Profiling
Game Theory takes an economic perspective

 Focus on incentives and interactions among moves
 Assumption of rationality; what competitors should do
if they behaved rationally
Competitor Profiling takes a behavioral
perspective
 Focus on competitors’ predispositions
 What do competitors really want given their beliefs,
blind spots, and historical tendencies
6
Page 132
How to Integrate Both Game

Why Competitor Profiling Matters
Theory and Competitor Profiling
Goals may not be fully rational due to Think broadly about the set of strategic options
- Difference in an organizations’ charter (public, non-  Variables (organization, customers, pricing…)
profit, family-owned…)  Asymmetries
- Agency problems (top management’s interest may be  Commitment postures
different)  Information
- Irrationality (pride, jealousy, fairness…) Augment you toolkit for dynamic analysis
Beliefs may lead them to see the world differently  Scenario analysis (role-playing/devil’s advocate)
 Market testing
- Mental models may differ (e.g. due to differences in
functional backgrounds)  Sequenced rollout
Routines may constrain opportunities for action Match analytics and industry/company context
 Do general assumptions hold in this industry/company?
- Inertia due to size/maturity/complexity/strong
 But: question industry logics/orthodoxies
culture/bureaucratization etc.
Key Takeaways Next Session
Game theory is a powerful tool for analyzing

competitive moves—know the typical games and
be able to anticipate your rival’s response
 Get experience applying game
Logics can often be changed so a new game is
theory and competitor analysis
played—use this to your advantage
Never assume your opponent’s behavior is fixed!  Prepare Ryanair case
Predict their reaction to your behavior
Complement game theory with competitor profiling
to work around the restrictive assumptions on
which game theory is built
7
Page 133
BUAD 497: Session 13 Learning Objectives
 Get experience applying competitor

Competitor Analysis analysis
Applied I  Examine market entry and the threat of
retaliation
Ryanair Ryanair: What Happened…
 Even before Ryanair initiated service in May

1986, Air Lingus and BA reduced their lowest,
restricted round-trip fare to £95!
 Ryanair countered with an unrestricted fair of
£94.99
 By 1989, customers could find fares as low as £70
 Ryanair’s initial performance was promising
 almost 100% seats sold
 great PR for “taking on the big guys”
Ryanair: What Happened…

Ryanair reborn!
(Con’d)
 The airline cut costs radically

 Ryanair soon grew to serve 27 routes (Dublin,  dropped all loss-making routes
Manchester, Liverpool, Glasgow etc.)  removed all in-flight amenities (coffee, snacks, etc.)
 Passenger volume grew rapidly  promoted duty-free sales
 renegotiated labor contracts
 But…the company began to accumulate large
losses  Ryanair remodeled itself completely on Southwest
 I£6 Million in 1988, I£4.5 Million in 1989 Airlines
 Expansion strained the firm’s management system  2002-2003: 30% operating profit margin vs.
British Airway’s 3.8%
 January 1991, Ryanair was hours away from
bankruptcy…  2003: market capitalization of $5b – compared to
$3b for BA and $2.7b for Air France
1
Page 134
Mini Case Analysis Notes and

Key Takeaways Comments
 Combining game theory analysis with competitor

profiling is essential; you need to examine both
sides of the story
 Retaliation is extremely unattractive when the
entrant is small, the incumbent large, and across-
the-board price cuts necessary to retain customers
 But: the ability to retaliate in a targeted way
makes retaliation more attractive and likely
 Credible commitment is often difficult
Next Session
 Continue with applying competitor analysis

 Case: Leadership Online—Barnes and
Nobles vs. Amazon
2
Page 135
 Examine competitive moves in the new

economy of online selling
Competitor Analysis  Understand how positioning analysis—the
analysis of willingness to pay and of
Applied II cost—matters in the context of online
selling
 Explore the substitution threat to
competitive advantages in this new
business landscape
Cost Comparison of Online vs. Offline

Leadership Online Business Models
vs.
What B&N brings to the table… Amazon vs. Barnes & Noble
 The B&N annual report of 1996 read as follows:
 “The competitive advantages we bring to this

business are enormous, as is our ability to
leverage pre-existing assets. They include [the]
distribution center, [the] 2.5 million title data
base, special order processing, direct marketing
expertise, name recognition and franchise value,
international reputation, excellent partnerships
(Firefly, AOL, etc), [and] bookselling expertise.”
1
Page 136
Update on the Online Battle Key Takeaways
 Amazon in 2004:  Competitor analysis is valuable across various

 $588m net income on revenues of $6,921m business landscapes and can show the differences
 about 70% of the online book market resulting from differing ability to digitize products
 market cap of $18 billion
 Barnes & Noble in 2004:
 There is usually a continuum of competitive
 $143m net income on revenues of $4,874 responses—consider all and select the one that
 about 15% of the online book market best works with your capabilities and is hardest to
 market cap of $2.3 billion imitate
 By 2005, Amazon had become the world’s largest online  The sustainability of competitive advantage is
retailer with 47 million accounts. It had moved from often complicated in virtual contexts. Online and
books into other media (CDs, DVDs…) and then into
electronics and a dozen other categories offline competition can coexist and interact
 Amazon added operations in the UK (1998), Germany  The threat of imitation for online business models
(1998), France (2000), Japan (2000), Canada (2000), and is frequently overblown, but such business likely
China (2004)
have to deal with new threats to sustainability
Next Session
 Focus on creating value and competitive

advantage
 Case: Harnischfeger Industries
2
Page 137
 Enhance our understanding of value creation,

Creating Competitive value appropriation, and value added
Advantage  See how value creation and appropriation
relate to competitive moves
 Apply these concepts to the Harnischfeger case
Why Care About Value Creation? Assessing Value Creation
 Who are the players?

 In any market, before considering  What are customers willing to pay for
who gets what it is important to the good or service?
understand what there is to get  What are suppliers’ opportunity costs
 What determines total value created? of providing the good or service?
The Value Chain Value Creation
1
Page 138
Value Creation Value Division
Value created =
Buyer’s willingness-to-pay
minus
Supplier’s opportunity cost
This is the value that can be

appropriated
Value Added Value Added - A Simple Game
Imagine there are 30 students in this class. A black

card is passed out to each student.
 Price measures the division of value
between business and customer
 Cost measures the division of value
between business and supplier
 What determines these divisions of
value?
 Added Value
Added Value - A Simple Game Added Value - A Simple Game
Imagine the instructor holds 30 red cards. The Dean has agreed to pay $100 for each pair (1
black + 1 red) of cards.
$100
2
Page 139
Added Value –
Added Value - A Simple Game
A Slight Modification
How much would you be willing to accept for your Imagine the same game except now the instructor
black card? Imagine the instructor offered you only has 27 red cards. There are still 30 black
$20. Would you accept this offer? cards for 30 students. How much would you
accept for your black card?
Added Value in the card game = Added Value in the card game =
When the instructor is in the game, the value When there are 30 black and 27 red cards,
of the game is $3,000. When the the instructor has an added value of
instructor is not in the game the value of $2,700 and an individual student has an
the game is $0. added value of $0. Since 3 students will
end up without a match, no one student is
essential to the game.
When there are 30 black and 30 red cards,
each student has an added value of $100 The total value of the game with 30 students
because without each student a match is $2,700.
cannot be made and $100 is lost. The total value of the game with 27 students
is also $2,700.
What you get is based on your

What is your added value?
added value
Added value = Ask yourself the following question:

total value with you
minus If I enter this game, what do I add?
total value without you
That is how much you can bargain for…
It’s what you bring to others
(Brandenburger and Nalebuff, Coopetition, 1996)
3
Page 140
Summary Harnischfeger Industries
 The size of the pie

 Willingness-to-Pay minus Opportunity Cost
 The division of the pie:
 Added Value
 The next step: what happens if you

cannot cooperate to maximize value
created?
Update on Harnischfeger… The Value Net
 Bob Hale of Harnischfeger chose to do battle with

Kranco
 In July 1992, Kranco filed for Chapter 11
bankruptcy after its biggest lender cut off the funds
 In January 1993, Kone announced that it had
acquired Kranco’s operating assets, including the
rights to designs and trade names, for $3.5 million
 This was about the worst possible outcome from
Harnischfeger’s perspective
 In January 1998, Harnischfeger sold its crane unit
to an investment firm and left the market for
overhead cranes
 Value creation and value division are both

important aspects of strategy
 If you only consider the competitive battle,  Move from creating to sustaining
you may miss the larger opportunities that competitive advantage
come from creating value!
 Case: Saturn—A Different Kind of Car
 Added value largely determines the division Company
of the pie
 Expanding the game by bringing in new
players may frequently be your best bet at
capturing more value (i.e. more of the pie)
4
Page 141
 Examine how to create competitive advantage

Sustaining as a de novo entrant in a mature industry
 Understand the challenges of sustaining
Competitive Advantage
competitive advantage
 See how Saturn has used the configuration of
its value chain to secure its competitive position
Saturn: A Different Kind of Car Company Key Takeaways
 As a de novo entrant in a mature industry, you

can only achieve competitive advantage by
creating value in a new way
 The likely way of creating new value is through
reconfiguring the value chain to achieve novel
product attributes
 Sustaining competitive advantage may rest on a
narrow set of interlinked activities
 Taking actions to secure and protect competitive
advantage can be a two-edged sword: it can
prevent imitation but may also make knowledge
transfer to the corporate parent more difficult
Next Session
 Strategy in a world of standards and

network externalities
 Reading: Shapiro and Varian, “The Art of
Standard Wars”
 Also: Check out the Blue-Ray/HD-DVD
battle going on right now
1
Page 142
 Understand the role of standards in

strategy and implementation
Standards and Network  Know the rules of standards strategy and
the politics of standard setting
Externalities I
 Apply these concepts to a current real-
life example
Standards Require Different

Winning with Standards
Strategies
 The elements of the generic “Porter Style”

 Standards are central to business strategy, strategy:
yet are often not well understood  get in the market early
 differentiate the product
 Standards matter wherever products  protect it from imitation
depend on compatibility (software, CDs, video  charge premium prices
tapes, lamp batteries, razor blades, typewriter keyboards,
ski bindings, credit card systems…)  With standards, successful strategies often
 Standards change the game and the work differently. It may be smarter to…
required different strategies  hold back the product launch
 adopt a simple, undifferentiated, standard design
 encourage imitation by other manufacturers
 lower prices to maximize early sales
An Example… Sony vs. JVC
 Sony launches its Betamax videotape recording system in

1974
 Two years later, JVC introduces its Video Home System
(VHS), an incompatible alternative to Betamax
 By that time, more than 100,000 Betamax machines had
already been sold
versus  BUT: JVC adopts a more “open” policy for partners,
sharing information about the technology…
 By 1984, the JVC “family” has 40 companies, including
Grundig, Hitachi, Matsushita, Philips, RCA, and Sharp,
some of the biggest manufacturers in Japan, Europe, and
North America. The Betamax group has only about a
dozen members
1
Page 143
Sony vs. JVC: Number of Units Sold Sony vs. JVC: Share of VCR Market
Understanding Standards and

Sony vs. JVC
Network Externalities
 Sources of JVC’s success:

 “Bandwagon” of supporting firms
 Consumer confidence
 Faster pace of product improvement at moment of choice
 Larger scale lowers costs
 Network externalities for consumers
 The Result: by 1988, Sony conceded and began

production of VHS recorders; the war was
officially over
How Standards Change the Game How Standards Change the Game
 Standards introduce network effects

 Positive feedback strengthens widely used
“Demand side Economies of Scale”
platforms
 Benefits that come from having a large installed  Example: Windows vs. Mac
base of users
 Windows has more users, therefore
 Classic examples are literal networks  More retailers sell Windows PCs
 telephone network (“natural monopoly”)  More software producers write for Windows
 fax machines
 Windows documents can easily be exchanged with
 Internet others
 Number of possible connections grows rapidly  More IT staff specialize in Windows
with number of users – “network externalities”  Therefore, still more people switch to Windows
 system with one user is of little use
 system with all customers on is very valuable
2
Page 144
Network effects are not based on

efficient production The Evolution of a Standard War
 Microsoft products are not necessarily better

 Some quality benefits from huge sales, but not crucial
 “Popularity adds value”
 Switching costs can be considerable
 Legacy systems can create path dependencies
 Where no clear winner exists yet
 Customer expectations for future will decide winner
 Need to lure developers and users in early stages
(win “mindshare”)
Who Wins and Who Loses From

Open versus Closed Standards
Standard Adoption?
 Consumers  Some technological standards are open (WiFi networks,
 Generally better off Ethernet, TCP/IP)
 Reduced uncertainty; no need to wait  no one firm controls them
 More users, more value  specifications are public, anyone can build compatible products
 may require license fee
 But variety may decrease
 Some standards are closed, controlled by one firm (e.g.
 Complementors most of Windows)
 Generally better off
 Important tradeoffs here:
 May serve in a brokering role (DVD)
 Openness helps technology become dominant
 Incumbents  But success of a technology may not help the firm that devised
 May be a threat it (e.g. IBM and desktops)
 Strategies  Closed systems can be controlled, so benefits don’t flow to a
 Deny backward compatibility competitor
 Introduce its own standard  But development may be stifled and leapfrogging may occur
 Ally itself with new standard
Strategies for New Standards: Part One: Tactics in Formal

Open vs. Closed Standard Setting
Control Open
 Don’t automatically participate
 If you do you have to license
Compatible Controlled Open Migration
 Keep up momentum
Migration (Many vendors)
Windows 98, Fax machines,  Continue R&D while negotiating
Pentium, some modems
Software
 Look for logrolling
upgrades  Trading technologies and votes
Incompatible Performance Discontinuity
Play (Many vendors)
Palm Pilot, CD audio, 3.5” disks
Iomega Zip
3
Page 145
Part One: Tactics in Formal Part Two: Tactics in Standard

Standard Setting Wars
 Be creative about deals

 Second sourcing, licensing, hybrids, etc.  Standard wars emerge when two
 Beware of vague promises incompatible technologies struggle to
 Definition of “reasonable royalties” become a de facto standard
 Search carefully for blocking patents  These wars usually end in
 Also patents held by non-participants
 truce (56 k modems)
 Preemptively build an installed base  duopoly (video games)
 fight to death (VCRs)
Two Basic Tactics for

Key Assets for Standard Wars Standard Wars
 Preemption
 Control over an installed base  New technologies require champions willing to invest
early to build an installed base
 Intellectual property rights  Being first to market can backfire if superior technology
 Ability to innovate will soon arrive
 First-mover advantages  Expectations management

 Engage in aggressive marketing, make early
 Manufacturing announcements of new products, assemble allies,
make visible commitments to your technology
 Strength in complements
 Reputation and brand name
Blu-ray vs. HD-DVD Strategies after you win a war
 Staying on your guard

 Offer your customers a migration path to fend off
challenges from upstarts
 Leverage your installed base and
commoditize complementary products
vs.  But enter adjacent markets only if integration adds
value for consumers
 Competing with your own installed base
 You need improvements to drive upgrade sales
4
Page 146
Strategies after you win a war Strategies if you fall behind
 Protecting your position  Adapters and interconnection

 Offer ongoing attractive terms to important  Target a market niche or interconnect with the larger
complementors network (American Express with Visa)
 Stay ahead  Survival pricing
 Develop proprietary extensions to improve your  It doesn’t work
technology
 Legal approaches
 If all else fails, sue!
Key Takeaways Next Class
 Understand the positions and interests of all

parties involved in a standards competition
 The strength of your position in standards  Apply standard strategy to the
competitions depends on seven key assets marketplace
 Preemption is a critical tactic, but there are ways  Prepare Browser Wars Case
around it
 Expectations management is critical; self-fulfilling
prophecies can overrule technical advantage
 Once you’ve won the war, don’t rest; beware of
leapfrogging
5
Page 147
 Analyze fast-moving competition in an

Standards and Network industry with network externalities
Externalities II  Understand the dynamics of a small firm
taking on a much larger rival
Competition in Dynamic Industry New Rules of Competitive

Environments Engagement
 Don’t cling to competitive advantages—create

new ones
 Competitive advantages erode quickly
 Entry barriers are easily overcome
 Established rules are broken  Consistency and logical thinking make your firm
 Industry boundaries are breached predictable, so think outside the box
 Customer loyalty is fickle  Long term planning only prepares you to sustain
and exploit existing advantages, so work to create
 Sustainable competitive advantages
new competencies and advantages
becomes a series of shorter unsustainable
 Consistently attacking your competitor’s main
competitive advantages weakness forces them to become stronger, so
attack a range of weaknesses
(D’A veni--Hypercompetition )
The Browser Wars Mike Homer—Netscape
 Held Senior Positions at

Netscape as well as
other firms such as
vs. Apple and AOL
 Graduate of University
of California at Berkeley
1
Page 148
Usage Share of Major Web

The Next Challenger: Firefox
Browsers
vs.
Source: Wikipedia.org
Current Market Share Key Takeaways
 The winning strategy in the Browser War

 Get market share (give the product away)
 Innovate constantly
 Adopt open standards; but not too open
 “Judo Strategy”: target your opponents weakness
and use it as leverage
 Netscape exploiting its competitors’ retail sales and
revenue streams
 Microsoft doing the same to Netscape
 “Hardball Strategy”: use “unfair” advantage
 Microsoft exploiting its Windows advantage
End of the course’s first part
 Move on to strategy implementation

 Prepare Honda (A) case
Have a great break!
2
Page 149
BUAD 497: Session 19 Second Part of the Course
 How do good strategies get implemented?

Strategy Formulation and  What can managers do to foster good
Implementation I strategies?
The Honda Case (A) Next Class
 Prepare Honda (B) case

 Read Eccles and Nohria: “Strategy as a
Language Game”
1
Page 150
BUAD 497: Session 20 Understanding Strategy
 Honda (A) and (B):

 Two versions of a story that
Strategy Formulation and emphasize the differences between
Implementation II planned and emergent strategies
Where we left off… Where we left off…
…and what Honda did

with it!
What  Changed market
motorcycles perception of the
used to be definition of a motorcycle
about in the
1950s…  Drove rapid increase in
overall U.S. market for
motorcycles
 Grew from ~ 0% in 1959
July 21st, 1947 Life
Magazine Photo
to 43% of total market in
1974
BCG’s View of Honda’s Entrance into The Inside View of Honda’s

the US Motorcycle Market Honda (A) Entrance Honda (B)
 Made strong investments in R&D

 Used extensive vertical integration
 Aggressive low price strategy for entry into USA.
Soichiro Honda on
 Market strategies expanded and redefined the market the assembly line
segment – “You meet the Nicest People on a Honda”, (circa 1950s)
through pricing, distribution and advertising.
 Progressive expansion of market from region to region
(West to East) over a six year period
 Construction of plant with a capacity 10x demand
 Low cost producer with high volumes and high
productivity based on capital intensive automated
techniques to exploit economies of scale; focus on long-
term profitability & share
1
Page 151
Two Views of Strategy The Design School in Strategy
 Ex-ante analysis, thinking and reasoning.

 Assumes all relevant factors can be objectively
analysed
 Assumes that this analysis precedes and
dominates action – implementation follows as a
separate stage.
 Separates thinking from doing and often implies a
hierarchy – senior management thinks – others
implement.
 Option appraisal is conducted logically on the
basis of analysis
The Classic Planning Process
Identify
Mission,
Goals, &
Strategies
Analyze the Opportunities
Environment and Threats Reassess
Objectives
Analyze Strengths and
Resources Weaknesses
Evaluate Formulate
Results Strategies
Implement
Strategies
The Learning School in Strategy
 Strategy making takes place within an

unpredictable world
 Creates the necessity for flexible strategic approaches
 Serendipity (accidental discoveries, luck, etc.) is
required for effective performance
 Strategy is often made by lower-level managers
 Strategy evolves through autonomous action
 Strategy has both intended and emergent
components
 Realized strategies are combinations of intended and
emergent strategies
2
Page 152
Mintzberg’s Three Fallacies of

Deliberate versus Emergent Strategies
Strategic Planning
In
 Fallacy of predetermination S t te n d
ra e d
te
The future is unknown gy
 Fallacy of detachment Deli

ber
a te
Impossible to detach formulation from implementation S tra
te g
y
 Fallacy of formalization Sustained
Inhibits flexibility, spontaneity, intuition, and learning Realized Superior
Unrealized Strategy Performance
All three contribute to the “Grand Fallacy”: Strategy
"Because analysis is not synthesis, strategic Emergent Strategy

planning is not strategy formation"
(Mintzberg 1994, “The Rise and Fall…”, p. 321) Adapted from: Mintzberg, H. “The Strategy Concept I: Five Ps for Strategy” California Management Review. Volume 30
Number1, Fall 1987.
Eccles and Nohria Robust Action is…
 Acting without certitude

 Strategy as  Constantly preserving flexibility
 Being politically savvy
Robust Action
 Having a keen sense of timing
 Judging the situation at hand
 Using rhetoric effectively
 Working multiple agendas
Eccles & Nohria, Beyond the Hype
What, then, is the role of

Key Takeaways
strategic planning?
 Effective strategies combine both deliberate and
1. Provide a structured mechanism for analysis and emergent elements; both are important
thinking about complex strategic problems  Strategic planning processes should really be
2. It involves people in strategy process giving them viewed as strategic learning processes
ownership  Use strategy language to build consensus on mission,
3. Planning helps communicate the strategy objectives, and strategic alternatives
4. Planning assists control by requiring regular  Plans and processes must be robust enough to…
review of performance  …allow a company to rapidly take advantage of
opportunities as they occur
5. Assist in presentation of alternative and possible
radical ways of considering strategic issues  …enable various levels and functions within the
organization to contribute to the emerging strategies
–“thinking outside the box”
3
Page 153
Next Session
 Continue with implementation and

change inside the firm
 Prepare Lehman Brothers (A) case
4
Page 154
BUAD 497: Session 21 Session Objectives
 Examine strategy implementation up

close and personal
Implementation  Understand the key ingredients in
and Change I successful strategy implementation
 Understand what it takes to
successfully manage change
The Rise of Lehman Brothers’ Equity

Lehman Brothers (A) Research Department, 1987-1990
The 7-S Framework The 7-S Framework
 A tool for determining the “doability” of strategies

 Used for internal analysis of a company
 Analyze strategic characteristics of a company
 Aims to create alignment among various
departments of an organization
 Allows to examine the effect of change on a
company
 Analyze the successful and dysfunctional aspects
of an organization
1
Page 155
The 7-S Framework: “Hard S” The 7-S Framework: “Soft S”
 Style – how do you lead? Personal style?

 Strategy – a plan of action to maintain
competitive advantage over the competition  Shared Values – company culture, work ethics
etc
 Systems – measures and actions which
accommodate the execution of daily activities  Staff – company employees and their capabilities
 Structure – the way the organization is  Skills – core competencies of the company as
structured, who reports to whom well as that of its staff
Beer’s Formula of Organizational Leading Organizational

Change Transformation
Desired State
Ineffective transformation path
Δ = f(D•M•P) - C
Work environment
Δ is the effectiveness of change, which is a

Effective transformation path
positive function of D (dissatisfaction), M
(model, or vision), and P (change process)
that need to be greater than C (cost of Existing State
change). Operational efficiency
(Michael Beer, “Leading Change,” HBS Press, 1988)
The Five Forces of Management Key Takeaways
 Successful strategy implementation requires the alignment

Up of all the seven S’s—fit is just as important inside as
outside!
 Know Beer’s formula of organizational change: it’s a
function of Dissatisfaction, Model, and Process
 When implementing a new strategy, start with the hard
Across Self Out part of operational improvement! Only then make the
transition to improving the work environment. But do
make it!
 Success in playing a game changes the game. Failure to
appreciate the consequences of one’s success and tenacity
Down
Down
in playing the old game are what tragedies are made of!
2
Page 156
Next Session
 Continue with implementation and

change
 Prepare Lehman Brothers (B) case
3
Page 157
BUAD 497: Session 22 Session Objectives
 Examine the factors that lead to the

Implementation decline of Lehman Brothers
 Understand the challenges of strategy
and Change II implementation and staying on top
 The role of leadership in strategy
execution
Lehman Brothers (B): The Story The Rise and Fall of Lehman Brothers’
Equity Research Department, 1987-
Continues… 1995
The 7-S Framework: What’s not Leading Organizational

aligned now…? Transformation
Ineffective
Effective
Global Coordination
Ineffective
Local Autonomy
1
Page 158
How Much Do You Want to Rely on

People?
“More than anything else,

management cut the analysts’
emotional ties by ejecting the
nucleus of the department, Jack
and Fred” (Dean Eberling, 1993)
What Happened Next… Back on top…but at what price?
 Firm-wide change, 1997-2001: Employees up more than

44% since 1997, as Lehman bulks up in banking, equity
research, and sales & trading
− 2001: 2/3 of Lehman’s revenues from trading and underwriting,
with the balance from bonds; in 1997, it was opposite
− 2001: Lehman’s 150th anniversary; average tenure of upper
ranks: 22 years; “no splashy acquisitions, no managerial coups,
no lay-offs; employees own 35% of the firm
 “2001 was Lehman’s year…” Posted the best ROE of any
securities firm; top tier of corporate debt underwriting;
almost doubled its equity underwriting market
 “It wasn’t what happened in 2001. It takes years to create
change” (Fuld)
 No plans to downsize; “Now is the time to build market share”
(Fuld, 2002)
How They Did It Again Back on top…but at what price?
 In 1999, analyst Steve Hash is Lehman’s new

equity research head
 Hash gets senior leadership’s mandate to rebuild
the equity research department
 He consults with Fraenkel and reintroduces
several of Rivkin & Fraenkel’s processes to the
department
 Training sessions
 Weekly meetings
 Hash later reflects that he had taken “all that
Jack and Fred had done” and did it again—and An industry expert estimated it cost Lehman close to
the formula had again succeeded $100 million in additional expenses to get back to #1
2
Page 159
Why Many Strategies fail…the

Leadership
John Chambers
Styles
and Jack Welch
Importance of Execution
 “We had a failure in communication and execution, not in
planning…” (Chris Pettit, August 1995)
 Common mistakes in execution:
 The strategy is not made by those responsible for its execution
 Pursuing too many initiatives concurrently
 Failure to appreciate the weaknesses of the assumptions and
develop contingency plans
 Successful execution involves both communication and
politics. It entails…
 Jointly setting goals
 Following through and holding people accountable
 Learning from how reality deviates from the plan.
 “Execution…it’s the leader’s most important job.” (Bossidy
and Charan, 2002)
 Effective leadership is key to execution
Seven Critical Aspects of Seven Critical Leadership

Successful Execution Attributes
1. Know your people and your business 5. Reward the doers
Can you trust the information you get or has it Do you have a process in place that rewards high-
been extensively filtered? performers objectively, fairly, and openly?
2. Insist on realism 6. Expand people’s capabilities
Can you clearly articulate the organization’s Do you spend enough time directly coaching,
problems and weaknesses? providing feedback, and cultivating people?
3. Set clear goals and priorities 7. Know yourself
Are the business priorities few in number and Can you be honest with yourself, deal objectively
focused in a constructive way? with business and organization realities, and give
4. Follow through people direct and forthright assessments?
How many meetings have you attended in which
a good idea surfaced, but never got done?
 Many excellent strategies fail because of poor

execution
 Managing with networks and power
 Good execution keeps the 7 S’s aligned—fit
rules!  Burt, “Structural Holes: Introduction”
 Good execution accepts the role of  Reading: Cross, Borgatti, and Parker,
communication and politics “Making Invisible Work Visible”
 Good execution is flexible enough to roll with
the punches and builds options into the process
 robust action
3
Page 160
 Understand how and why networks matter

 Know the different characteristics of
Managing with networks and network positions
Networks and Power I  Know the basic concepts tools for analyzing
your firm’s and your own position in a
network
What is “Six Degrees”? The Kevin Bacon Game
 Invented by Albright College

students in 1994
 Goal: Connect any actor to
Kevin Bacon, by linking actors
“Six degrees of separation between us who have acted in the same
and everyone else on this planet” movie.
 Oracle of Bacon website uses
John Guare (1990) Internet Movie Database
(IMDB.com) to find shortest
link between any two actors
http://oracleofbacon.org/
The Kevin Bacon Game: Not Quite the

An Example Kevin Bacon Game…
Kevin Mystic River (2003) Kevin The Big Picture (1989)
Bacon Bacon
Tim Code 46 (2003) Teri Desperate
Housewives (2004)
Robbins Hatcher
Om Puri Larry Shaw Is the brother of…
Yuva (2004)
Rani Mukherjee Lynda Mansson

Is the aunt-in-law of…
Black (2005)
Amitabh Bachchan Peer Fiss

Source: Kentaro Toyama, Microsoft Research India
1
Page 161
Another Fun Example: The Erdős

The Science Behind “Six Degrees”
Number
 Number of links required to

connect scholars to Paul Erdős, The Small World Experiment
via co-authorship of papers (Milgram, 1967)
 Erdős wrote 1500+ papers with
507 co-authors.  A single “target” (stock broker in Boston)
 Jerry Grossman’s (Oakland Univ.)
 Random ”senders” chosen in Nebraska
website allows mathematicians to
compute their Erdos numbers:  Each sender asked to forward a packet to a
Stanley Milgram
http://www.oakland.edu/enp/ (1933-1984)
friend who was “closer” to the target
 Connecting path lengths, among  All friends got the same instructions
mathematicians only:  64 packets reached the target via different
Paul Erdős (1913-1996)
 average is 4.65 “chains”
 maximum is 13  Typical length of chain?  Six…
Society as a Graph Society as a Graph
People are People are

represented as represented as
nodes nodes
Relationships are
represented as
edges (lines)
(Relationships may be
friendship, colleagues,
business contacts etc.)
The Small World Effect

Watts and Strogatz (1998)
Fully Connected graph

Ring graph
b=0 b = 0.125 b=1

Random graph
People know People know People know
their neighbors. their neighbors, others at
and a few distant people. random.
Power Law Graph Clustered, but Clustered and Not clustered,

not a “small world” “small world” but “small world”
2
Page 162
The Small World Effect But Who Cares…?

Watts and Strogatz (1998)
First five random links reduce

the average path length of the
network by half, regardless of Why do networks matter?
N!
Normalized path length

Clustering coefficient /
So what would it take for any
world at all to be small?
It turns out: not much…
Some source of “order”
The tiniest amount of randomness
Clustering coefficient (C) and average
path length (L) plotted against b Why is Six Degrees interesting?
So: Small World Networks
should be everywhere!
The 9/11 Hijackers and Their Business ties in US Biotech-

Associates Industry: 1988
Nodes: investment
pharma
research labs
public
biotechnology
Links: financial
R&D collab.
Source: http://ecclectic.ss.uci.edu/~drwhite/Movie
Business ties in US Biotech-

Industry: 1991 Viral and Buzz Marketing
Nodes: investment
pharma
research labs black: opinion leaders
public purple: influenced
green: uninfluenced
grey: undecided
biotechnology
Links: financial
R&D collab.
Source: http://ecclectic.ss.uci.edu/~drwhite/Movie Source: http://www.orgnet.com
3
Page 163
Typical Small Interfirm Production

Network in NYC Garment Industry Example 1: Finding a Job
 Contrary to economic theory, many labor

markets rely on personal contacts
 We ask family, friends, colleagues for help
 In particular, we tend to use “weak ties”
(Granovetter) and also friends-of-friends,
because they are more likely to have non-
redundant information
 Hence, the “Strength of Weak Ties”
Source: Uzzi, ASQ 1997
Example 2: Making Business

Contacts
Sarah
Ralph
Jane
Peter
Example 3: Mapping Email Flow to Find

„Hidden“ Communities of Experts Example 4: Alliance Networks
 Access to know-how, contacts, resources expands the

size of radar screen and make you detect
technological discontinuities, emergent markets, new
colors refer to
department affiliation designs
 Direct and indirect ties are positively related to
innovation (Ahuja 2000)
 Experience and centrality in the network are related to
success—the relevant knowledge is widely distributed
outside the firm (Powell et al. 1996)
 The position of the firm in the alliance network also
determines the propensity to collaborate (Stuart 1998)
sourc e : http://www.orgnet.c om
4
Page 164
Networks and Social Capital Network Foundations of Social Capital
Ron Burt argues that social capital is a “useful A collectivity is structurally cohesive to the extent that
metaphor,” explaining “how people do better the social relations of its members hold it together
because they are somehow better connected
with other people,” and that we need to “cut
beneath the metaphor to reason from concrete
network mechanisms responsible for social
capital” (Burt 2005)
 What are the “concrete network mechanisms”

that create advantage for communities &
organizations?
 How do individual membership patterns shape
community cohesion?
LOW Cohesiveness
Network Foundations of Social Capital Network Foundations of Social Capital
Add more ties ….
But when focused on a single person, the network is fragile!
Network Foundations of Social Capital Network Foundations of Social Capital
Remove that one person and the whole network Solution: Spreading relations around the structure makes
disintegrates… Problem! it robust to node removal
5
Page 165
Network Foundations of Social Capital A Key Feature: Structural Holes

(Burt 1992)
As structural cohesion increases, fewer nodes are able to  Structural Holes are disconnects between contacts that
control resource flow within the network create social capital via brokerage opportunities
 Ego actor gains earlier access to flows of valuable
 Power is more evenly distributed because nobody information
controls access to network resources  Ego fills structural holes by forging new ties linking its
unconnected alters, extract “commission” or “fee” for
 Information flows more uniformly across the network
providing brokerage services
 Norms & values tend to be more uniform  Information and control benefits mean better performance,
 Informal Social Control is uniform as there are fewer which mean higher return on human capital
opportunities to free ride  Ego maximizes its self-interests by controlling & exploiting
information, playing one actor against another (“tertius
The collectivity should take on a community character gaudens”)
Structural Holes and the Social

How Network Position Matters
Structure of Competition
Structural holes provide important benefits.

Redundant contact
For example…
 Brokers occupying structural holes earn bigger
A bonuses
?  Managers located in structural holes are
Non-redundant contact
promoted earlier in their careers
D
Structural Holes
Filled by “You”
 People located in structural holes often have
YOU B
“better ideas” than others
C
(Burt 1992; 2003)
How Network Position Matters Strategic Network Expansion
You You
You
Network A’ Network B’ Network C’
6
Page 166
Exercise: Assessing YOUR

Combining Brokerage and Closure
Network
Ask yourself the following questions…

 Academic matters
 Who are the people with whom you have discussed important
projects and assignments?
 Job Search
 What people have been most helpful in your job search so far?
 Friends
 Who are your closest friends?
 Professional development during your time at USC
 What people have contributed most significantly to your professional
development during the last year?
© 2004 Ronald Burt. Brokerage and Closure, Cambridge University Press 2005.
 Network centrality and structural holes are

important for determining power and knowledge
flows—both for firms and for your personal
experience. Brokers do better!
 Social capital and power come from the bridges  Prepare case: Abelli and Savotti at
that a person can build between others Banca Commerciale Italiana (A)
 It is the diversity of contacts that generates social
capital—strength lies in weak ties
 Network effectively; what does a new contact
add to your network? What do YOU contribute to
their network?
7
Page 167
 Get experience applying tools of network

Managing with analysis
Networks and Power II  Examine the role of power and influence in
interorganizational and interpersonal
networks
Another Example: The German

Abelli & Saviotti at BCI
Network of Crossholdings
Cross-shareholdings—March 1999 Cross-shareholdings—March 1999

3.3% 3.3%
3.2% Compart 1.7% Banc a di Banc a d’Italia 3.2% Compart 1.7% Banc a di Banc a d’Italia
8.1% 8.1%
Italmobiliare Roma Italmobiliare Roma
14.5% 14.5%
3% 3%
2% 7.6% 2% 7.6%
4.5% 3.1% 13.1% 4.5% 3.1% 13.1%
2% 2%
2% 8.2% Banc a Intesa 2% 8.2% Banc a Intesa
HdP 2% Mediobanc a HdP 2% Mediobanc a
13.2% 1.9% 9.2% 13.2% 1.9%

9.4%
0.4% 2% 0.4% 9.4% 9.2%
2%
3.4% 3.4%
12.5% 4.7% 4.7%
SAI 2.1% SAI 2.1% 12.5%
Lazard Lazard
6.2% 4.8% 6.2% 4.8%
14.2% 4.5% 14.2% 4.5% Generali
Generali 10% 10%
Burgo 21% Burgo 21%
2.7% 2.7% 5%
5% 5% 5%
2.2% 1.2% 2.2% 1.2%
1.4% 2.2% 0.6% Commerzbank 1.4% 2.2% 0.6% 4.9% Commerzbank
0.7% 4.9% 0.7%
11.7% 11.7%
Banc a Commerc iale Italiana 1% Banc a Commerc iale Italiana 1%
2% 2%
Pirelli 4.9% Pirelli 4.9%
1% 1%
6% 6%
0.4% 0.4%
5.7% 5.7%
3.3% 4.5% Unic redito 3.3% 4.5% Unic redito
0.8% 0.8%
Italiano Italiano
2.9% 2.9%
3.1% 3.1%
FIAT Paribas Deutsc he Bank FIAT Paribas Deutsc he Bank
1
Page 168
Director Interlocks—March 1999 Influence Matrix for BCI Case
Compart Banca di Banca d’I talia

Italmobiliare Roma
Lucchini
Banca Intesa
HdP Mediobanca
Gutty Lucchini Desiata

Sav iotti
SAI Sav iotti
Lazard
Gutty Generali
Rondelli
Burgo
Lucchini
Gutty
v Ruedorf err Commerzbank
Sozzani Banca Commerciale Italiana

Pirelli
Unicredito
Rondelli Italiano
Gutty F.-Poncet
FIAT Paribas Deutsche Bank
BCI: What Happened Next… What Happened Next… (Cont’d)
 May 12, 1999: BCI chairman Luccini calls a general

shareholders meeting for June 21 • June 21, 1999: The general assembly the next day
 May 15, 1999: Under pressure from the Mediobanca appoints a new board that duly reflects Mediobanca’s
coalition, the BCI board rejects the Unicredito proposal control over BCI. Fausti is appointed honorary chairman
 June 17, 1999: The BCI board convenes to asses Banca • June 23, 1999: The governor of Banca d’Italia (the
Intesa’s offer (70% stake, BCI to remain a separate entity central bank) publicly states his approval of the Banca
within Banca’s group) Intesa deal
 June 20, 1999: Abelli and Saviotti resign with the entire • End of June, 1999: BCI and Banca Intesa seal a
BCI board except for Luccini and one other board member takeover deal; by September, Banca Intesa has complete
control of BCI
A Comparison of the Banca

Intesa and Unicredito Italiano What Happened Next… (Cont’d)
Offers
So Mediobanca seems to have prevailed…?
 April 2000: Banca Intesa severs its ties with

Mediobanca! Moreover, the reorganization of IntesaBCI
turns BCI into a direct competitor of Mediobanca
 June 2000: Mediobanca Honorary Chairman, Enrico
Cuccia, dies
 2001 and after: Mediobanca’s influence over Italy’s
corporate world continues to decline. By 2003, its
shareholders agree to restrain the banks management
from using its holdings as a means of control over
corporate Italy
Source: Morgan Stanley Dean Witter Research

estimates, MSDW Equity Research, 09/01/1999
2
Page 169
(Some) Key Takeaways Next Week
 Understanding power and influence in complex

networks is an important advantage; as both A&S
and Cuccia found out, you have to know the
territory  Last topic relating to strategy
 There is a lot more to power than authority and implementation: Performance and
competence; often power is best exercised Governance
indirectly through intermediaries
 Sharon Oster “Organizational Goals:
 There is considerable value in building
interdependent relationships with key players Politics and Power in Organizations”
over time that can be leveraged when needed in  Prepare Monks and Minow on “Arthur
the future Andersen”
3
Page 170
BUAD 497: Session 25 Goals for this Session
 Examine challenges to implementing

Performance and strategy and the essential problem of the
public company
Governance I  Know the various mechanisms for
exercising corporate governance
 Examine problems at Arthur Anderson
Strategy, Performance, and Arthur Andersen’s Houston

Integrity Branch Office
 A critical function of managers is to create strong
competitive strategies that enable the company to
meet financial goals without compromising
integrity
 BUT: Today’s business environment is
extraordinarily complex
 Less staff forces organizations to do more with less
 Expense reductions continue to be major way
companies increase EPS
 Earnings growth continues to be core focus
 Unrealistic performance goals can pressure those who “…perhaps nothing can bring a company down with such
must make them work amazing speed as misconduct.”
 Reward and compensation systems can expose M. Ingebretsen, Why Companies Fail: The 10 Big Reasons Businesses Crumble, and How to
Keep Yours Strong and Solid. (2003)
employees to ethical compromises
The Paradox of Operating as a An Example: The “Walk-down to

Public Company Earnings Game”
Pressures Offsetting  Analysts are “systematically optimistic” regarding earnings

forecasts at the beginning of the fiscal reporting period
Controls
 Aware of these tendencies, company financial officers give
 Wall Street Influence “guidance” to analysts (usually in the form of discretionary
 Investor expectations
 Earnings growth  Compliance (Enron) information disclosures” suggesting the analysts lower
 Quarterly pressures their estimates)
 Exec. Compensation  As analysts lower their estimates towards the end of the
 Disclosure (Worldcom)
 Increase in overall level, period
stock options
 The company releases its official reported earnings at a
 Economic Cycle  Governance (Tyco) level that “beats” the analyst estimates
 Cyclical Industry  The analysts issue “strong buy” recommendations
 Ethics and integrity of  If the game is played right, the company’s stock
participants (Arthur will rise sharply on the day it announces its earnings
Andersen)
1
Page 171
The Public Company Conundrum A historical example…
Strengths On a boat trip up China’s Yangtze River in the 19th

 Ability to raise enormous amounts of capital and spread risk Century, a titled English woman complained to her host
 Transparency - financing activities are visible and information of the cruelty to the oarsmen. One burly coolie stood
readily available / Poor performance results in lower share values over the rowers with a whip, making sure there were no
 Corporations are disciplined both by their internal governance laggards.
systems and by competition in product and factor markets
Weaknesses Her host explained that the boat was

 Separation of ownership and control results in an agency problem jointly owned by the oarsmen, and
 Lack of powerful, informed monitors results when the that they hired the man responsible
shareholdings are widely dispersed for flogging!
 Entrenchment incentives - management may invest in protecting
their jobs rather than creating value
 Excessive mandated information disclosure lowers value of Why would such an organizational arrangement arise
proprietary product and strategic information voluntarily?
Agency Relationship: Owners and Basic Problems of Information

Managers Asymmetry
The essence of the Agency Theory is that the

Shareholders Principal has inferior information to the Agent.
(Principals)
• Firm owners  Moral Hazard: the principal and agent share the
same information up to the point at which the agent
Managers takes an action, but thereafter the principal is only able
• Decision makers to observe the outcomes
(Agents)
 Adverse Selection: the principal does not know some

• Risk bearing specialist information which is relevant to the action (such as the
(principal) pays compensation to An Agency ability of the agent to perform the task), whereas the
• A managerial decision-making Relationships agent can make use of this information to his own
specialist (agent) advantage
The Tradeoff Between Profitability Manager and Shareholder Risk and

and Revenue Growth Rates Diversification
Shareholder Managerial
(business) (employment)
risk profile risk profile
Risk
A B
Dominant Related Related Unrelated
Business Constrained Linked Businesses
Diversification
2
Page 172
How is Corporate Control How is Corporate Control

Exercised Exercised (really…)
The Board of Directors  Directors are frequently selected by management
 The elected B of D is responsible for hiring, firing, and are beholden to them for their jobs
monitoring, and setting the compensation of the firm’s  CEOs are all to often also the chairs of the boards,
managers
which creates all kinds of accountability problems
 The B of D has broad discretion to direct the company’s
 This is the case in about 75% of S&P 500 firms in the
affairs and is supposed to ensure that the firm is managed
US (McKinsey & Company US Directors Survey,2002)
in the best interest of shareholders
 Shareholder votes are also required  Boards too often have poor procedures of
to approve corporate mergers, evaluation in place, both regarding management
to authorize the sale of major and their own performance
assets, to amend the firm’s bylaws,
and to authorize the issuance
of new equity issues As a result, BoDs often exercise rather little
control…
How is Corporate Control

Exercised
Disclosure and Shareholder Meetings
 Publicly-traded companies are required to annually disclose
a great deal of information about corporate earnings,
executive compensation, and the ownership of the
company’s voting shares
 Further, these firms are also required to hold annual
shareholders’ meetings, which is open to all owners of
even a single share of common stock
 In announcing these meetings, corporations send every
shareholder a proxy statement that describes:
 the meeting agenda,
 spells out precisely which issues are to be voted on by shareholders,
 and provides a form for shareholders to use either to vote
personally at the meeting, via www, via telephone or to assign the
right to vote the shares they own to someone else
How is Corporate Control Flow of Authority in Corporate

Exercised (really…) Governance
 Most corporate elections are usually staid affairs

where shareholders are asked to vote for or
withhold their vote for single slate of company
directors
 “Proxy fights” occur when a rival group of
shareholders nominate a slate of alternative
directors who do not support the current
management team.
 However, these are relatively rare due to expense
to shareholders
 As a result, shareholders often have little
opportunity or incentive to actively engage in
corporate control
© 2006 The McGraw-Hill Companies
3
Page 173
How is Corporate Control Compensation and Corporate

Exercised Earnings (Bebchuck & Grinstein, 2006)
Compensation and Incentives
 In 2006, the average total compensation of chief
executives of S&P 500 corporations was $14.78 million,
including salaries, bonuses, and incentive plans
 That’s a 9.4% increase in CEO pay over 2005
 The connection between superior performance and pay is
rather tenuous
 CEOs Henry McKinnell of Pfizer and Robert Nardelli of Home Depot
both received exit packages of more than $200 million. Both firms
underperformed during their tenures
 Compensation on average consisted of
 Salary (cash): ~20%
 Short term incentive plans (bonus): ~20%, usually tied so specific
measures (ROI, net profits…)
 Long term incentive plans (stock option plans etc): ~60%
 Other benefits (insurance, legal, pension etc.)
Source: Bebchuck & Grinstein, The Growth of Executive Compensation (2005)
Market Downturn and the An External Mechanism: The

Dilemma with Stock Options Market for Corporate Control
 To the extent that managers do not act in the best
The problem of “underwater” options… interest of shareholders, the stock price of the firm will be
less than what it would have been if the managers
focused on maximizing shareholder wealth.
 The market thus operates when firms face the risk of
takeover when they are operated inefficiently. Many firms
begin to operate more efficiently as a result of the
Why take action? “threat” of takeover.
 Hence, the market allegedly acts as an important source
of discipline over managerial incompetence and waste
Why NOT take action?  However, it’s an expensive last resort…and often
doesn’t work!
Impediments to the Market for The Full Picture on Corporate

Corporate Control Control…
 Entrenched insider groups frequently fight these bids
using:
 Various court actions  Boards of Directors have a fiduciary duty to
 Staggered boards shareholders to monitor management, but…
 Poison pills
 Amendments to the corporate charter
 Principals (i.e. shareholders) may engage in
 Greenmail monitoring behavior to assess the activities and
 Selling off “crown jewels” (aka “scorched earth”) decisions of managers, but…
 Searching for white knights
 Any other strategy designed to discourage the bidder from
 Executive Compensation can be used to align
pursuing the target further the incentives of managers and owners, but…
 Firms frequently succeed in fending off takeover bids even  The Market for Corporate Control can
when they would yield the target firm shareholders very
large share premiums discipline ineffective management, but…
4
Page 174
Arthur Andersen Arthur Andersen Background Info
 Arthur Andersen was an accounting and

consulting service that operated businesses
throughout the US & world.
 The 89 year old company was part of the “Big 5”
accounting firms.
 Main headquarters in Chicago, Illinois and
Houston, Texas.
 Enron, the large energy corporation, was a client
of Andersen’s for 16 years up until Enron’s 2001
bankruptcy.
Timeline of the Scandal Timeline (cont’d)
 In the summer and fall of 2001, Arthur Andersen  October, 2001- Enron informs Andersen to
foresaw government litigations and investigations destroy all paper documents and emails
against Andersen and Enron. concerning Enron.
 Shortly after, the SEC starts an investigation of
 October 16th,2001- Enron issued a press release the two companies.
announcing the company’s $618m net loss for the  Lawyers defending Arthur Andersen argued that
3rd quarter of 2001. shredding documents was a routine practice.
 On the same day, Enron reduced shareholder’s  Eventually, Andersen was charged with
equity in the stock and the stock price obstruction of justice for destroying the
plummeted. documents before the collapse of the energy
giant.
 August 31, 2002- Arthur Andersen dissolves
 Know (and be able to “speak”) Agency Theory;

it is the most dominant theory today in
corporate governance and likely to remain so in
the future
 Also know the limits of Agency Theory; it has  Prepare Bausch & Lomb Case
little to say about trust, dominant social,
political, or organizational culture. These
matter! (and may differ considerably…)
 All the different mechanisms of internal and
external governance as currently on the books
have their weaknesses—know and avoid them!
5
Page 175
BUAD 497: Session 26 Session Goals
 Examine what factors contribute to

Performance and unethical conduct in organizations
Governance II  Understand what went wrong at Bausch
& Lomb
Corporate or “White Collar” Crime Corporate or “White Collar” Crime
 “…crime committed by a person of respectability and high

social status in the course of his occupation” (Sutherland  In the U.S., the cost of corporate crime such as price-
1939) fixing and unsafe or illegal practices is estimated at up to
 Encompasses a variety of non-violent crimes usually $200 billion annually
committed in commercial situations for financial gain,  Employee theft is 10 times as big a problem as street
including theft, white collar crime is 2-10 times as big a problem as
employee theft
antitrust violations, computer/internet fraud,  White collar criminals are far less likely to be investigated,
credit card fraud, phone/telemarketing fraud,
bankruptcy fraud, healthcare fraud, environmental
arrested or prosecuted than other types of offenders
law violations, insurance fraud, mail fraud,  White-collar crime is especially
government fraud, tax evasion, financial fraud, dangerous because of opportunities
securities fraud, insider trading, bribery, for large-scale thefts; large enough
kickbacks, counterfeiting, public corruption, to sink even a large company
money laundering, embezzlement, economic
espionage, trade secret theft etc…
Companies reporting fraud by Fraudster’s relation to the

industry sector (Global) company
45% of companies
worldwide
reported being
victims of
economic crime in
the last 2 years
Typical profile
male (80%), between 31 and
41 years (34%), educated with
degree or higher (48%)
Source: PWC Global Economic Crime Survey 2005

1
Page 176
How are companies responding

Reasons for committing fraud
to the threat of fraud…?
KPMG’s survey of large companies in 2002
found that
 10% admitted fraud is “something we have not really

thought about”
 17% said fraud risk management is not adequately
addressed
 55% said they needed to improve channels for reporting
Almost a quarter of acts suspicion of fraud
committed by senior
management  More than 80% said the person with overall responsibility
for fraud prevention and detection is either the CEO or CFO
KPMG Fraud and Misconduct Diagnostic Survey 2002

Bausch & Lomb: Pressure to Perform Bausch & Lomb: Missing the Mark
Essential Elements of Strategic

Control Systems Update: Bausch & Lomb
 Between 1994 and 1995, the value of the company’s

shares sank by about a third
Boundaries  Daniel Gill retired in late 1995 in response to increasingly
angry shareholders
 A later SEC inquiry cleared Gill personally but stated that
“Bausch & Lomb violated the anti-fraud, reporting and
record keeping, and internal control provisions of the
Exchange Act.”
 Bausch & Lomb struggled to develop a viable long-term
Culture Rewards strategy, resulting in the restructuring of the company in
late 2001 and early 2002, which included the loss of some
700 jobs.
2
Page 177
Update: Bausch & Lomb Again in Bausch & Lomb: Not the
Trouble (cont’d) Exception…
 In October, 2005, Bausch & Lomb disclosed that an  Managers often feel enormous pressure to do whatever it
accounting fraud problem in its Brazilian subsidiary may takes to deliver good financial performance
require the company to postpone filing its quarterly
financial report due to problems with its books and records  Actions often taken by managers
Cut costs wherever savings show up immediately
 On March 17, 2006, B&L announced it would delay its Squeeze extra sales out of early deliveries
2005 annual report by about 6 weeks to make adjustments
Engage in short-term maneuvers to make the numbers
following internal investigations
Stretch the rules further and further, until
 Bausch & Lomb also said its ongoing investigation into limits of ethical conduct are overlooked
South Korean vision joint venture BL Korea has found  Executives feel pressure to hit performance targets since
evidence of improper sales practices from 2002 to 2005. their compensation depends heavily on company
 On March 23, 2006, Moody's Investors Service announced performance
it considering lowering its "Baa3" rating on B&L’s $544
million of unsecured debt (that’s just one notch above junk)  Fundamental problem with a “make the numbers”
syndrome: The company does not serve its customers or
 Bausch & Lomb is currently still working on its 2006
financial statements and plans to file them by April 30 shareholders well by placing top priority on the bottom line!
Warning Signs of a Deviant Warning Signs of a Deviant

Organizational Culture Organizational Culture (con’d)
1. There is a "kill the messenger" ethos in the 6. Top management's stated concern for ethics
organisation -- justifies distortion and appears to be mainly for public relations
concealment of information 7. Managers (while basically truthful) are willing to
2. There is a low degree of confidence in the deceive in order to accomplish organizational or
accuracy of internal reports personal goals
3. Despite claims to doing the right thing, in the last 8. Managers do not believe there is an obligation to
analysis, top management does the most be candid where it could harm personal or
expedient thing organizational goals
4. Employees do not know of 9. People who ignore ethics
or refer to written ethics policies but produce bottom line results
5. The operative value of the organisation get promoted
is: if it's legal it's ethical
KPMG: How to Deter Employee KPMG: How to Deter Employee

Fraud Fraud
 Know the risks in your business  Make certain that personnel policies are
 What areas are most at risk? Where do you need to concentrate effective
your efforts?
 Check applicant’s information and references thoroughly,
 Make your views on fraud known particularly for risk areas. Establish an employee hotline for
 Set the tone, establish clear guidelines, make clear your intention reporting fraud.
to investigate vigorously. Nothing is a better deterrent than a
history of investigation  Review disciplinary policy
 Create a culture that frustrates fraud  Be tough on fraud; it can put your entire
business at risk and damage its reputation
 Lead by example and avoid gray areas in rules, including receiving
or giving gifts, entertainment, commissions, conflict of interest as well as yours. A firm response to fraud will
be your best protection against future fraud.
 Ensure that your internal controls are
effective
 Be alert for indicators of fraud. Develop a fraud response plan so
you know what to do. Set up an audit committee or expand the
role of the BoD’s audit committee
3
Page 178
But there’s also good news..! Next Class
 76% of customers will switch to brands or

stores based on ethics & societal issues
(Cone/Roper, 1997)
 88% of consumers are more likely to buy
from a socially responsible firm (Walker Next….YOUR Turn Presenting!
Research, 1998)
 Sales growth, profits, and ROI are
correlated with corporate citizenship
(Maignan, 1997)
Ethical strategy and business = profits!
4
FBE-440: Syllabus
Page 179
Professor Larry Harris FBE 440

Marshall School of Business Courses 15355R (MW) & 15356R (TTh)
University of Southern California Spring 2007
TRADING AND EXCHANGES

Course Syllabus
Course Objectives
This course will introduce you to the theory and practice of securities and contract trading
at exchanges and in dealer networks. We will examine
• why and how people trade,
• the principals of proprietary trading,
• why market institutions are organized as they are,
• how markets are changing in response to innovations in information technologies,
• the origins of liquidity, volatility, price efficiency, and trading profits, and
• the role of public policy in the markets.
To address these questions, we must understand why and how institutions, dealers, and
individuals trade. Understanding trader behavior thus is a primary course objective.
At the end of this course, you should be able to
• solve various trading problems,
• recognize various trading styles,
• judge whether you would be a successful trader,
• evaluate and motivate brokers,
• design markets, and
• effectively lobby policy-makers on market issues.
Target Audience
I designed this course for anyone who wants to understand how markets work and how
traders trade. The reading assignments and the class lectures are appropriate for
students who have no market experience.
Experienced traders will also find this course to be valuable. Although you may already
know much about market institutions, the economic perspectives that you will learn in this
course will greatly improve your understanding of why some people make money while
others lose money. Many brokers and dealers have greatly appreciated taking this course.
Students with substantial market experience have little advantage over other students other
than initial familiarity with the jargon and institutions.
Prerequisites
This course has no prerequisites. Familiarity with Investments, Microeconomics,
Corporate Finance, Information Technologies, and Statistics is helpful but not necessary.

FBE-440: Syllabus
Page 180
You will not be lost if you have not yet studied these subjects, but you may have to work
harder than students who are already familiar with their principle concepts.
Addresses and Telephone Numbers

Professor Larry Harris (213) 740-6496 office
Fred V. Keenan Chair in Finance (323) 933-0888 home
USC Marshall School of Business (323) 244-1154 mobile
Hoffman Hall 600G
Los Angeles, CA 90089-1427 You may call me at home or on
my cell, but not before 7:00 AM,
LHarris@USC.edu after 9:30 PM, on Friday night,
LarryHarris.com or on Saturday.
How to Reach Me
1. Drop in during office hours—no appointment is necessary. My office is in Hoffman
600G. My office hours this semester are:
Mondays 1:00-2:00 PM
Thursdays 9:45-10:45 AM
2. Arrange to meet me by appointment.
3. Just drop in. I am in my office most days. It is best (but not necessary) to call ahead to
make sure I am available and not occupied. I am obviously unavailable when I am
teaching. I teach MW 10-12, TTh 8-10, and TTh 11-12:30.
4. Call me on the telephone. If you leave a message, please speak slowly and clearly
when you give your phone number. You may call me at home or on my cell phone, but
please not before 7:00 AM, after 9:30 PM, on Friday night, or on Saturday.
5. Arrange to dine with me before or after class. Consider inviting your classmates too.
6. Send me e-mail at LHarris@USC.edu. While I am always happy to take questions
about course topics, I prefer to respond orally rather than by e-mail. The opportunity to
listen and respond generally produces more effective learning.
Electronic Notices
I post assignments and information of interest to this class on Blackboard. The web
address for BlackBoard is http://blackboard.usc.edu.
I may use a password to protect some documents. If so, the password will be TradeOn.
The password is case sensitive.
2
FBE-440: Syllabus
Page 181
Grades and Examinations

I will base the course grade on two midterm examinations, many small homework projects
(see below) and on a final examination. Their relative weights in the course grade are as
follows:
2 midterm examinations at 20 percent per midterm 40%
Homework projects / class participation 25%
Final examination 35%
Total 100%
The examinations are scheduled as follows:
MW Class TTh Class
Midterm 1 Wednesday, February 14 Thursday, February 15
Midterm 2 Wednesday, April 4 Tuesday, April 3
Final Exam Monday, May 7, 8:00 - 10:00 AM Wednesday, May 9, 8:00 - 10:00 AM
The midterm and final examination dates will not change. Please check now to see that
you do not have any conflicts.
The second midterm will cover primarily topics covered since the first midterm. Since you
cannot fully understand some topics without understanding earlier topics, you may wish to
review earlier topics before the second midterm.
The final examination will be a cumulative examination. Topics covered after the second
midterm, however, may be somewhat over-represented.
When assigning grades, I compute the weighted sum of examination and homework
numeric scores using the weights above. Since the in-class variance of scores typically
varies across exams and homework, the influence of a given score may be different from
the weights presented above. In the past, the greatest in-class variation has been in
homework scores and in essay exam scores. These exercises therefore have had a
greater influence on the final grade than the above weights would suggest.
Grading Standards
The Marshall School uses (and I adhere to) the following standards for undergraduate
grading:
A Excellent quality work
B Good quality work
C Fair quality work
D Work of minimum passing quality
F This grade is awarded to any undergraduate student failing to meet the
minimum standards for passing the course. The grade of F indicates that the
student failed at the end of the semester or was doing failing work and
stopped attending the course after the twelfth week of the semester.
3
FBE-440: Syllabus
Page 182
Plus/minus grading (A, A-, B+, B, B-, C+, C, C-, D+, D, D-, F) increases the basic five
grades to a total of twelve possible levels of performance.
I interpret these standards as follows:
A Mastery of course concepts, tools, and techniques, plus a solid
understanding of implications, applications, and interrelationships. Ability to
apply and express that understanding with meaningful oral and written
language.
B Solid understanding of course concepts, tools, and techniques, plus

knowledge of or awareness of implications, applications, and
interrelationships. Capability to converse effectively in the terminology of the
course.
C Knowledge of course fundamentals. Basic understanding or awareness of

finer points of course and discipline. Meets normal expectations of course
input criteria.
D Barely grasps the essentials of the course with little or no understanding of

the finer points.
F Unable to communicate an understanding of the basic concepts, tools, or

techniques of the course. A failure to measure up to the basic course output
goals.
Class Participation and Homework Projects

Class participation is an important part of the learning experience of this course. The
richness of the learning experience depends upon the degree of preparation by all students
before each class session. Your classmates and I expect you to prepare for all classes
and to actively participate in class discussions. I may call upon you at any time during
class discussions to summarize insights from readings and class discussions, to analyze
problems, or to opine on the value of what you are learning.
Many concepts that we will discuss in the class sessions do not appear in the textbook. We
also will discuss many topics more thoroughly and from different perspectives than does
the textbook. Accordingly, class attendance also is an important component of the learning
experience for this course.
I generally will assign a short homework project for you to do before each class session.
The homework usually will challenge you to think deeply about topics of interest to this
course. It often will provide a foundation for an in-class discussion.
The project will be due at the beginning of the class session. To encourage on-time
attendance, I do not accept late projects. You must personally turn-in your homework
projects. On days when no homework is due, I may pass an attendance signup sheet
which will serve as a substitute for the homework.
4
FBE-440: Syllabus
Page 183
To encourage you to attend the entire class session, I may call upon you at anytime until I
dismiss the class. If you do not respond when I call your name, you will not receive credit
for the homework assignment, even if you turned it in.
I designed these homework collection procedures to encourage you to attend class. I have
taught this course without these procedures and have observed that students who did not
attend class typically learned much less than those who did. Since I adopted these
procedures, I have observed that students come to class better prepared and that they
learn more.
Take the homework assignments seriously. You may fail the course if you do not
receive credit for enough assignments. Regrettably, I have failed students who
did not obtain credit for enough homework assignments.
To ensure that these policies are not too burdensome to you, you may miss three
homework assignments during the semester with no negative effect on your grade. For
example, if I assign 25 homework projects during the course, you will have a perfect
homework/participation score if I accept at least 22 adequately prepared assignments
from you. Although I will not award extra credit if you complete all the assignments, I
strongly encourage you to do so.
After you have missed three assignments, you may request permission to be absent. I will
grant permission entirely at my discretion and only under the most severe circumstances.
You should avoid missing homework assignments early in the semester because you may
need to miss them later if you get sick or need to attend an interview or a funeral.
Since I expect that missing homework will be a rare occurrence, and since you will always
know when you have missed an assignment or have left class early, I will not post my
records of completed assignments. I will notify you if your work has not been acceptable.
To obtain complete credit for a homework project,
• it must be turned in on time, as noted above,
• you must be present if I call your name, as noted above,
• your paper must represent your sincere effort to address the assignment,
• the paper should be properly formatted, and
• your name and social security number must be legibly written in the upper right hand
corner of the paper.
I will judge the sincerity of your effort by whether your written presentations are thoughtfully
prepared and/or by your ability to discuss your work in class. If I have accepted your
homework and I have not contacted you to tell you that your assignment was not adequately
prepared, you may assume that you obtained full credit for the assignment.
Given the very large number of homework papers that I will receive, our time would be
poorly spent returning your homework papers to you in class. I therefore will not return your
homework papers to you unless I have specific comments to give you. You therefore may
want to keep a copy for yourself.
Adequately completing the homework assignments will primarily require that you be
disciplined and that you make an honest effort to complete the assignment. To trade
5
FBE-440: Syllabus
Page 184
effectively requires good personal discipline. In a course about trading, asking you to
exercise personal discipline is very reasonable.
The Fine Print on Grades

These rules protect you and me should unexpected events occur.
You generally will receive no credit for tests that you miss. If you secure prior permission from me to
miss a test, or if you have a valid medical excuse, I will make a special arrangement for you. At my
sole discretion, I will allow you take the test (or a similar test) at another time, or I will arrange to give
more weight to your other test results.
To prove illness, you must submit your doctor’s note stating the nature of the illness and your doctor’s
name, address, and telephone number. To prove that you were sent out of town on business, you must
submit a copy of your airline and motel receipts, plus the name, address, and telephone number of your
superior. I will not excuse you unless I receive all documentation listed above. I reserve the right to
contact your doctor, superior, etc.
USC strongly discourages incomplete grades, except in dire circumstances. Consequently, I will not
give a grade of “Incomplete.” I will only make an exception to this rule if you have taken the
examinations when scheduled, but missed the final examination due to illness or to a required out-of-
town business trip for which you give prior written notice. You cannot pass the course without taking
the final examination. Students who do not complete all required work, and do not receive a grade of
“incomplete” will fail.
To receive a final grade in the unlikely event of an “Incomplete,” you may either take the final exam that I
administer to my next “Trading and Exchanges” class (which could be years from now) or take the final
of another professor teaching an equivalent class (which is not likely as I have been the only professor
teaching this class).
Register in this class only if you are willing to abide by these rules. Your registration will be
your confirmation that you agree to abide by these rules.
Academic Integrity
Academic integrity is an important component of the optimal learning environment that
USC seeks to maintain. General principles of academic integrity include the concept of
respect for the intellectual property of others, the expectation that individual work will be
submitted unless otherwise allowed by an instructor, and the obligations both to protect
one’s own academic work from misuse by others as well as to avoid using another’s work
as one’s own. All students are expected to understand and abide by these principles.
SCAMPUS, the Student Guidebook, contains the Student Conduct Code in Section 11.00;
recommended sanctions appear in Appendix A.
http://www.usc.edu/dept/publications/SCAMPUS/gov/
I do not expect academic dishonesty to be a problem in this course. However, should any
suspicion of academic dishonesty arise, students will be referred to the Office of Student
Judicial Affairs and Community Standards for further review. The review process appears
at: http://www.usc.edu/student-affairs/SJACS/.
6
FBE-440: Syllabus
Page 185
Disability Services
Any student requesting academic accommodations based on a disability must register
with Disability Services and Programs (DSP) each semester. You can obtain a letter of
verification for approved accommodations from DSP. Deliver the letter to me as early in
the semester as possible. DSP is located in STU 301 and is open 8:30 AM - 5:00 PM,
Monday through Friday. The phone number for DSP is (213) 740-0776.
Returned Papers
To protect the confidentiality of your work, you must pick up your own graded paperwork. I
will not give your papers to anyone else. Students who miss class sessions when
paperwork is returned must arrange for an appointment to retrieve the material. I will
discard graded paperwork unclaimed by a student after four weeks.
Disputes over graded material must be brought to my attention as soon as possible.
Technology Use in Class Sessions

Communication devices such as cell phones, Blackberries, etc. capable of sending or
receiving electronic communication and all entertainment devices such as iPods or other
MP3 players must be turned off and kept off throughout the class session. Receiving or
sending communication or entertainment during class disrupts the learning environment
and is rude to those around you.
You may use laptops for taking notes, but I may revoke this privilege on an individual or
global basis if I find that it is disruptive. You may use laptops for other purposes only with
my expressed permission. In all events, you may not connect to the Internet unless I
specifically permit it. You may not use laptops during examinations.
Your Responsibilities
• Read assigned readings before coming to class and come prepared to discuss them.
If you are uncertain of the assignment, consult the course web pages at
http://blackboard.usc.edu.
The readings and our discussions are an integral part of the course.
• Read the financial press every day. Come to class prepared to discuss current events
in the markets. At a minimum, read the front page of the Money & Investing section of
The Wall Street Journal. You also should read the Los Angeles Times business
section. The business sections of the New York Times, The Financial Times and
Investor’s Daily are even better. Try reading the finance section of The Economist and
any relevant special reports. Best of all, read Traders Magazine or Securities Week, if
you can get a copy.
Serious professionals follow current events in their industry. Be a securities industry professional, if
only for the next seventeen weeks. Reading the news will help you get more out of this class.
7
FBE-440: Syllabus
Page 186
• Come to class on time.

If you are late, enter quietly. If it is raining, remember that you will need more travel time. If you are
habitually late, think about why you are not excited about coming to class. If I can improve things,
please tell me. If you are simply not interested, drop the class for your sake—you must have better
things to do than to attend a class that does not interest you.
• Help your classmates study and prepare for class.

The best way to learn is to teach. Teach each other, and you will learn quickly and thoroughly. Also,
your classmates may become your professional colleagues. Start forming your professional networks
by getting to know them now.
• Express yourself.
This is your class. Express your opinions, your problems, your reservations, your suggestions, and
your interests. Make this class work for you. Help me improve the course. There are no dumb
questions. If you do not understand something, many of your classmates also probably do not
understand it either. Please ask the question.
• Initiate.
Do not limit yourself only to the resources I assemble for the course. If you want to learn something we
do not cover, find a source (I can help) and study.
Required Text
Larry Harris, Trading and Exchanges: Market Microstructure for Practitioners, Oxford
University Press, 2003.
I am offering a one-dollar bounty for each new error in the book that you bring to my attention. To earn
this reward, you must be the first to identify the error. I am interested in typos, grammatical problems,
factual inaccuracies, and any other objective issues that are the responsibility of the author. I will be
the sole arbiter of what qualifies and I reserve the right to cancel this offer at anytime. An errata sheet
appears at http://www.tradingandexchanges.com.
A Very Useful Book

John Downes and Jordan Elliot Goodman, editors, Dictionary of Finance and Investment
Terms, 7th Edition (New York: Barron’s Educational Series, 2006, ISBN 978-
0764134166)
This inexpensive dictionary is very useful for quickly defining financial jargon and concepts.
A Strong Recommendation
Edwin Lefèvre, Reminiscences of a Stock Operator, (New York: John Wiley and Sons,
Inc., Reprinted 1993, ISBN 0-47105970-6, first published in 1923)
Reminiscences is a ghostwritten autobiography of Jesse Livermore. Livermore was a very successful
stock and commodity speculator who traded in the late 19th and early 20th centuries. The author, Edwin
Lefèvre, was a financial reporter who spent two months interviewing Livermore for this project. The result
is presented as a first-person narrative by a character called Larry Livingston, who clearly represents
Jesse Livermore. The book is full of market wisdom and human wisdom. It is easy to read, engaging,
and covers many of the topics of this course.
8
FBE-440: Syllabus
Page 187
Rev: 1/4/07
9
Professor Larry Harris FBE-440: Syllabus
Trading and Exchanges USC Spring 2007
Page 188
FBE 440 TTh Class Schedule
The examinations indicated on this schedule will take place as scheduled. Otherwise, this
is a tentative schedule that I may modify in response to the needs and interests of the
class. As the course evolves, I will post the topics to be covered in the next lecture (and
associated reading assignments) on BlackBoard. The topics below correspond to
chapters in the textbook. Please read them before coming to class.
I will not attend class on March 27 (Q Group Conference) and April 10 (Passover holiday). I
hope to arrange for outside speakers on those days.
Date Topic
Jan 9 Tu 1 Introduction
Jan 10 Th 2 Trading Stories
3 The Trading Industry
4 Orders and Order Properties
Jan 16 Tu 5 Market Structures
Jan 18 Th 6 Order Driven Markets
Jan 23 Tu 6 Order Driven Markets (continued)
Jan 25 Th 7 Brokers
Jan 30 Tu 8 Why Do People Trade?
Feb 1 Th 9 Good Markets
Feb 6 Tu 10 Informed Traders and Market Efficiency
Feb 8 Th 11 Order Anticipators
Feb 13 Tu 12 Bluffing and Price Manipulation
Feb 15 Th Midterm Examination
Feb 20 Tu 13 Dealers
Feb 22 Th 14 Bid/Ask Spreads
Feb 27 Tu 15 Block Trading
Mar 1 Th 16 Value-motivated Traders

Professor Larry Harris FBE-440: Syllabus
Trading and Exchanges USC Spring 2007
Page 189
Date Topic
Mar 6 Tu 17 Arbitrageurs
Mar 7 Th 18 Buy-side Traders
Mar 13 Tu Spring Recess Holiday
Mar 15 Th Spring Recess Holiday
Mar 20 Tu 19 Liquidity
20 Volatility
Mar 22 Th 21 Liquidity and Transaction Cost Measurement
Mar 27 Tu No Class
Mar 29 Th 22 Performance Evaluation and Prediction

Apr 3 Tu Midterm Examination
Apr 5 Th 23 Index and Portfolio Markets

Apr 10 Tu No Class
Apr 12 Th 24 Specialists
Apr 17 Tu 25 Internalization, Preferencing, and Crossing
Apr 19 Th 26 Competition within and among Markets
Apr 24 Tu 27 Bubbles, Crashes, and Circuit Breakers
Apr 26 Th 28 Floor versus Automated Trading Systems
29 Insider Trading
May 9 W Final Examination, 8:00 AM - 10:00 AM
May 11 F University Commencement
2
Professor Larry Harris FBE-440:
TradingCourse Documents
and Exchanges USC Spring 2007
Page 190
Techniques for Learning Efficiently
You will learn more in less time if you learn efficiently. You then will have more time for other
activities. Consider the following suggestions to make your learning quicker and more
effective.
The General Principle

You learn most effectively when you force yourself to use what you must learn. You must put
new information and concepts into your own words. Then you must organize, manipulate and
use them.
Specific Suggestions
When studying, imagine that you will have to teach others what you have learned. Think
carefully about how you would do this. This objective is more real than you might imagine.
When people hire you for what you know, they expect you to share your knowledge. You soon
will be educating your supervisors, colleagues and employees.
Practice teaching the course material to your classmates in study sessions.
If you have a copy of a speaker’s lecture notes, do not use them when you attend the lecture.
You will learn most effectively if you take notes yourself and then later compare your notes to
the speaker’s notes. If no speaker’s notes are available, trade lecture notes with your
classmates and discuss the differences among them. Do this even if the speaker’s notes are
available.
Highlighting and underlining may help you identify what you need to learn, but they are not
efficient learning techniques. At best, they help you understand what other people have
written. To remember your studies, you must put them into your own words. People like to
highlight and underline because these tangible activities make them feel productive. Do not
mistake activity for productivity. If you ever catch yourself highlighting and underlining on
autopilot, you know what I am talking about.
You learn most effectively by taking notes. If you do not feel like writing, consider dictating
your notes into a tape recorder. Both methods work well. In either event, do it in your words.
Do not copy what others have written. You learn more from composing your notes than from
studying them. Spend more time composing.
Compose notes after you finish reading a section or a chapter. It is best to wait a few hours.
Recompose your lecture notes after a lecture, preferably without looking at your original notes.
To remember something, you have to practice remembering. If you know that you will later
compose and recompose, you will remember more.
When you review your studies, start by trying to remember what you want to review. Then go
back to your notes, see what you forgot, and study just that. It is inefficient to study what you
already know. If necessary, return to the original sources.

FBE-440: Course Documents
Page 191
To prepare for tests, practice taking old tests if they are available. Take the tests before you
read the answers. Being able to recognize a correct answer is not the same thing as being
able to provide the correct answer. Practice providing, not recognizing.
If you cannot understand an important passage in your readings, go back and review. Good
texts are organized so that you should not have to read forward to understand an earlier
passage. You accomplish little by plowing through confusion. Unlike snow, confusion usually
piles up in front instead of being pushed to the side. Not all texts are well written, however,
and even the best texts may have some weak sections. Sometimes it is best to do a quick
first pass over the material so you can see where it is going. Then go back and read it
carefully.
If you are lost in a lecture, tell your instructor. Many others may be lost too. The true object of
a lecture is to transmit knowledge, not to finish a set of topics. Instructors that finish their
lectures without conveying information have wasted your time and their time. Come to class
prepared to minimize the chance that you will get lost.
Everyone gets frustrated when they are confused about something that they believe they must
know. Frustration is an emotion that makes learning less effective. It can cause you to
overestimate the time necessary to accomplish your objectives and lead to feelings of failure
that would become self-reinforcing if you quit. Managing frustration therefore is essential to
effective learning.
You can prevent frustration by not allowing yourself to get confused. When you do not
understand what you are reading, go back and review. When you do not understand a point
made in lecture, ask the instructor to explain it again differently.
When you do become frustrated (everyone does at some point), deal with it immediately by
taking action to control this emotion instead of letting it control you. If you are studying, stop
and do something else for a while. If you are in a lecture or a meeting, ask a question. Do not
waste time in an emotional state that is not productive. Instead, recognize your emotion and
deal with it.
Do not eat a heavy meal before you attend class or plan to study. It is easier to learn when
you do not have to fight the natural inclination of your body to doze on a full stomach.
Most peoples’ minds slow down in the early afternoon (if they keep normal sleeping hours).
Try to avoid studying and taking classes when your mind is not active.
If you are too tired to learn effectively, get some sleep and return to your studies when you are
more rested. Otherwise you will waste your time and be even more tired.
Study somewhere where you will have few distractions. You only have one CPU in your head.
Multitasking is inefficient because keeping track of tasks and switching among them
consumes energy and time. You can accomplish more in less time by devoting your full
attention to one task at a time than if you try to do several at the same time.
If you review a little bit every now and then, you will learn more than if you spend the same
amount of time cramming before an exam.
2
Page 192
A Final Note of Encouragement

Although these suggestions may seem as though they are difficult, they will allow you to learn
more in less time. Learning effectively will give you more time to do other things. Time is our
most scarce resource. Use it wisely.
3
FBE-440: Course
Name _____________________________ Documents
Page 193 Last, First
Professor Larry Harris Trading and Exchanges USC Spring 2005
FBE 440 MW Midterm 1

Write your name on the exam now. Each question can be answered with a short answer.
Please use a pen and write legibly. If most fourth grade students could not read your
cursive script, please write in block print. Take your time and do well. Please ask me if
you have trouble with spelling or grammar.
Since knowing that you do not know something is a valuable form of knowledge, I give half
credit for blank answers. A completely wrong answer, of course, will receive no credit.
Good luck!
Very Short Answers (five points each)

1. What kind of option does a buy limit order
represent? __________________________
2. What common order type has the greatest market

impact? __________________________
3. What benefit do commodity hedgers expect to

obtain from trading? __________________________
Simple One Sentence Answers (5 points each)

4. In what sense are exchanges and brokers the same?
5. What is the primary conflict of interest within an SRO?

Page 194
6. What is the main advantage of a call market over a continuous trading market?
7. Why is price priority self-enforcing?
8. The pricing rule used in the bucket and bucketering shops that Jesse Livermore traded
in is a derivative pricing rule. Why have I classified it as such?
Slightly Harder One Sentence Answers (10 points each)

9. Why do mutual fund management companies like soft dollars commissions?

FBE-440: Course
Name _____________________________ Documents
10. Of what benefit is orthogonality to a well-informed trader?
11. Consider a sealed bid auction in which the highest bidder wins and pays the average of
the highest and second highest bid prices. Explain why bidders should or should not
bid their reservation prices in this auction.
12. Provide one example of how informative prices in the secondary capital markets
(trading of seasoned securities) help make production in our economy more efficient.

Page 196
Computation Questions (10 points each)

13. Suppose that the following orders are submitted to a call market that conducts a single
price auction using price-time precedence rule at 10:15. What will be the market
clearing price and the total volume of trade? (Please do not double-count the volume.)
Trader Arrival time Side Price Size

A 9:30 Buy 11 10
B 9:40 Sell 11 10
C 9:45 Buy 9 20
D 9:50 Sell 9 10
E 10:00 Buy 12 5
Price _____________ Volume _____________
14. Mark submits a market order to sell 9 to a continuous market with the following order
book:
Trader Bid Size Price Offer Size

Ann 15 80.0
Jack 3 80.3
Steve 80.4 5
Beth 80.6 10
At what average price will Mark’s order be filled? __________________________

FBE-440: Course
Name _____________________________ Documents
FBE 440 TTH Midterm 1

Since knowing that you do not know something is a valuable form of knowledge, I give half
credit for blank answers. A completely wrong answer, of course, will receive no credit.
Good luck!
Very Short Answers (5 points each)

1. Price is currently at 50. What order should a trader
use if she wants to sell if the price falls to 30? __________________________
2. What limits the trading profits of informed traders? __________________________

3. Who or what is on the “buy-side?”
4. What is the difference between a broker and a dealer?

Page 198
5. What benefit do members of an SRO obtain by subjecting themselves to its regulation?
6. Ignoring labor costs, what is the most important argument against opening the NYSE an
hour earlier to accommodate European traders?
8. Rational investors expect to lose on average to well-informed traders. Why are they still
willing to trade?

FBE-440: Course
Name _____________________________ Documents

10. Why is a large tick (minimum price variation) necessary to make secondary
precedence rule such as time precedence economically meaningful?
11. How do informative prices in the primary (new issue) capital markets help make
production in our economy more efficient?
12. How might gamblers in the financial markets benefit the economy as a whole?

Page 200

13. An ECN that organizes a continuous pure price-time auction opens with an empty limit
order book. It then receives the following orders:
Trader Arrival time Side Pric Size

e
A 9:30 Buy 10 10
B 9:40 Sell 11 10
C 9:45 Buy 9 20
D 9:50 Sell 8 15
E 10:00 Buy 10 5
List the trades, if any, that the ECN arranges:
Trade # Time Buyer Seller Price Size

1
2
3
4
5
14. Consider the following order book for a single price auction:
Aggregate Aggregate
Bid Sizes Price Offer Sizes
15 12.0
35 12.1
15 12.2 5
5 12.3 10
5 12.4
12.5
12.6 10
12.7 15
12.8
12.9 15
13.0 10
What will be the market clearing price and the total volume of trade? (Please do not
double-count the volume.)

FBE-440: Course
Name _____________________________ Documents
Price _____________ Volume _____________

Page 202
FBE 440 MW Midterm 1 Answers

1. What kind of option does a buy limit order represent?

A put option.
2. What common order type has the greatest market impact?

Large market orders
3. What benefit do commodity hedgers expect to obtain from trading?

Risk reduction
4. In what sense are exchanges and brokers the same?

They both arrange trades for their clients.
5. What is the primary conflict of interest within an SRO?

An SRO is managed by the members that it regulates. The
SRO thus may place the members’ interests before the
public’s interests.
6. What is the main advantage of a call market over a continuous trading market?
The call market reduces search costs by concentrating
liquidity at a single point in time and space.
7. Why is price priority self-enforcing?

Traders always seek the best prices.
Bucket and bucketering shops obtain (derive) their
contract prices from prices printed at other venues.
9. Why do mutual fund management companies like soft dollars commissions?

Soft dollar commissions allow fund management companies
to pay for goods and services with their customers’
assets.

Page 203
10. Of what benefit is orthogonality to a well-informed trader?

Orthogonality increases the liquidity available to well-
informed traders by decreasing the probability that they
will compete with other informed traders for the same
liquidity.
Bidders should bid slightly less than their reservation
prices because their bids determine to some extent the
prices that they will pay if they win.
12. Provide one example of how informative prices in the secondary capital markets
(trading of seasoned securities) help make production in our economy more efficient.
Informative secondary prices help allocate managers to
existing capital by pricing how well they use the
resources available to them. Informative secondary
prices also allow shareholder to motivate their managers
with stock options.

Page 204


A 9:30 Buy 11 10
B 9:40 Sell 11 10
C 9:45 Buy 9 20
D 9:50 Sell 9 10
E 10:00 Buy 12 5
The sorted order book is
Bid Price Offer

Size Size
20 9 10
10 11 10
5 12
The 5 to buy at 12 are matched with 5 of the 10 to sell at 9

leaving 5 to sell at 9. The remaining 5 to sell at 9 are
matched with the 10 to buy at 11 leaving 5 to buy at 11. The
remaining 5 to buy at 11 are matched with 5 of the 10 to sell
at 11. No further trades can be arranged because the next
best buyer is only willing to pay 9. The single price is 11
and the volume is 15.
14. Mark submits a market order to sell 9 to a continuous market with the following order
book:

Ann 15 80.0
Jack 3 80.3
Steve 80.4 5
Beth 80.6 10
At what average price will Mark’s order be filled?

3 trade at 80.3 and 6 trade at 80.0 so that the average
price is 80.1.

Page 205
FBE 440 TTH Midterm 1 Answers

1. Price is currently at 50. What order should a trader use if she wants to sell if the price
falls to 30?
A stop order at 30.
2. What limits the trading profits of informed traders?

Liquidity
3. Who or what is on the “buy-side?”

Institutions and individuals that manage money.
4. What is the difference between a broker and a dealer?

A dealer trades for his own account whereas a broker
trades as agent for other accounts.
A dealer fills orders from his own account whereas a
broker fills orders by finding a trader to take the other
side.
5. What benefit do members of an SRO obtain by subjecting themselves to its regulation?

SROs regulate their members to decrease the costs that
members may impose upon each other. The costs may result
from bad business practices or from the loss of
reputation suffered by all when some members cheat the
public.
6. Ignoring labor costs, what is the most important argument against opening the NYSE an
hour earlier to accommodate European traders?
It will dilute liquidity by further spreading it through
time.
Bucket and bucketering shops obtain (derive) their
contract prices from prices printed at other venues.
8. Rational investors expect to lose on average to well-informed traders. Why are they still
willing to trade?
They benefit by using the markets to move money from the
present to the future.

Page 206
Bidders should bid slightly less than their reservation
prices because their bids determine to some extent the
prices that they will pay if they win.
precedence rules such as time precedence economically meaningful?
A small tick allows traders to cheaply obtain precedence
through price priority.
11. How do informative prices in the primary (new issue) capital markets help make
production in our economy more efficient?
They make it impossible or expensive for entrepreneurs to
obtain capital for bad investment projects and make it
easy for entrepreneurs to obtain capital for good
projects.
12. How might gamblers in the financial markets benefit the economy as a whole?
They make prices more efficient in the long run by making
markets more liquid for informed traders.

13. An ECN that organizes a continuous pure price-time auction opens with an empty limit
order book. It then receives the following orders:

A 9:30 Buy 10 10
B 9:40 Sell 11 10
C 9:45 Buy 9 20
D 9:50 Sell 8 15
E 10:00 Buy 10 5
List the trades, if any, that the ECN arranges:
Trade # Time Buyer Seller Price Size

1 9:50 A D 10 10
2 9:50 C D 9 5
3
4
5

Page 207
14. Consider the following order book for a single price auction:
Aggregate Aggregate
15 12.0
35 12.1
15 12.2 5
5 12.3 10
5 12.4
12.5
12.6 10
12.7 15
12.8
12.9 15
13.0 10
What will be the market clearing price and the total volume of trade? (Please do not
double-count the volume.)
Match 5 bid at 12.4 with 5 offered at 12.2. Match the 5 bid

at 12.3 with 5 of the 10 offered at 12.3. No more trades are
possible. The only price that works for all is 12.3. The
total volume is 10.

Professor Larry HarrisFBE-440: Course
Trading Documents
and Exchanges USC Spring 2007
Page 208
Homework Assignment 7 - Answers
Using the following orders, please complete the following tables taken from Chapter 6.
Table 6-1-New. Example Orders
Time Trader Order side Size Price
10:01 Bea Buy 3 30.0

10:05 Sam Sell 2 30.1
10:08 Ben Buy 4 30.2
10:09 Sol Sell 2 30.3
10:10 Stu Sell 5 30.3
10:15 Bif Buy 4 market
10:18 Bob Buy 3 30.2
10:20 Sue Sell 4 30.0
10.27 Sun Sell 3 30.2
10:29 Bud Buy 3 30.3
Assume that Bif’s true reservation price is 30.5.
Table 6-2. Example Order Book
Sellers Buyers
Trader Size Order price Size Trader
30.0 3 Bea
Sue 4 30.0
Sam 2 30.1
Sun 3 30.2
30.2 3 Bob
30.2 4 Ben
30.3 3 Bud
Sol 2 30.3
Stu 5 30.3
Market 4 Bif

Page 209
Please conduct a single price call market auction and present the re sults:
Table 6-3. Call Market Trades
Match Seller Buyer Quantity
1 Sue Bif 4
2 Sam Bud 2
3 Sun Bud 1
4 Sun Ben 2
Total: 9
What is the single uniform price? 30.2
Table 6-7. Trader Surpluses in the Single Price Auction Example
Filled Filled Trade Assumed

Trader Order sales buys price value Trader surpluses
Sue Sell 5 limit 30.0 4 30.2 30.0 (30.2 − 30.0) × 4 = 0.8

Sam Sell 2 limit 30.1 2 30.2 30.1 (30.2 − 30.1) × 2 = 0.2
Sun Sell 3 limit 30.2 3 30.2 30.2 (30.2 − 30.2) × 3 = 0.0
Bif Buy 4 at market 4 30.2 30.5 (30.5 − 30.2) × 4 = 1.2
Bud Buy 3 limit 30.3 3 30.2 30.3 (30.3 − 30.2) × 3 = 0.3
Ben Buy 4 limit 30.2 2 30.2 30.2 (30.2 − 30.2) × 2 = 0.0
Totals 9 9 2.6
2
Page 210
Please conduct a continuous market auction using the same orders from Table 6-1-New
above and present the results:
Order Book after First Order Arrives
Sellers Buyers
30.0 3 Bea
The market is 30.0 bid for 3
Order Book after Two Orders
Sellers Buyers
30.0 3 Bea
Sam 2 30.1
The market is 30.0–30.1 3 x 2.
Order Book after Three Orders
Sellers Buyers
30.0 3 Bea
30.2 2 Ben
The market is 30.2 bid for 2
3
Page 211
Order Book after Four Orders
Sellers Buyers
30.0 3 Bea
30.2 2 Ben
Sol 2 30.3
Order Book after Five Orders
Sellers Buyers
30.0 3 Bea
30.2 2 Ben
Sol 2 30.3
Stu 5 30.3
Order Book after Six Orders
Sellers Buyers
30.0 3 Bea
30.2 2 Ben
Stu 3 30.3
4
Page 212
Order Book after Seven Orders
Sellers Buyers
30.0 3 Bea
30.2 3 Bob
30.2 2 Ben
Stu 3 30.3
Order Book after Eight Orders
Sellers Buyers
30.0 3 Bea
30.2 1 Bob
Stu 3 30.3
Order Book after Nine Orders
Sellers Buyers
30.0 3 Bea
Sun 2 30.2
Stu 3 30.3
5
Page 213
Order Book after Ten Orders
Sellers Buyers
30.0 3 Bea
Stu 2 30.3
Table 6-8. Trades in the Continuous Auction Example
Time Seller Buyer Price Quantity
10:08 Sam Ben 30.1 2

10:15 Sol Bif 30.3 2
10:15 Stu Bif 30.3 2
10:20 Sue Ben 30.2 2
10:20 Sue Bob 30.2 2
10:27 Sun Bob 30.2 1
10:29 Sun Bud 30.2 2
10:29 Stu Bud 30.3 1
Total: 14
Table 6-9. Trader Surpluses in the Continuous Auction Example
Filled Filled Average Assumed

Trader Order sales buys trade price value Trader surplus
Sam Sell 2 limit 30.1 2 30.1 30.1 (30.1 − 30.1) × 2 = 0.0

Sol Sell 2 limit 30.3 2 30.3 30.3 (30.3 − 30.3) × 2 = 0.0
Sue Sell 4 limit 30.0 4 30.2 30.0 (30.2 − 30.0) × 4 = 0.8
Sun Sell 3 limit 30.2 3 30.2 30.2 (30.2 − 30.2) × 3 = 0.0
Stu Sell 5 limit 30.3 3 30.3 30.3 (30.3 − 30.3) × 3 = 0.0
Ben Buy 4 limit 30.2 4 30.15 30.2 (30.2 − 30.15) × 4 = 0.2
Bif Buy 4 at market 4 30.3 30.5 (30.5 − 30.3) × 4 = 0.8
Bob Buy 3 limit 30.2 3 30.2 30.2 (30.2 − 30.2) × 3 = 0.0
Bud Buy 3 limit 30.3 3 30.233 30.3 (30.3 − 30.233) × 3 = 0.2
Totals 14 14 2.0
6
FBE-440: Assignments
Page 214
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
WSJ Article Summary

From Tuesday, January 9th, Print edition of the WSJ
“Same Crowd Behind Oil Rise Now Sells Out”
Many people expected investors to continue to put more money into crude oil and to
continue to buy futures in the commodities market. Many analysts don’t believe this to
be completely true, as returns have slowed and the costs of holding investments in this
market have increased significantly. If the large cost of holding onto an investment in the
crude oil market continues, investors may not be willing to buy. Further, oil futures have
fallen 27 percent since their peak in July of last year. This article is important to the class
largely because it demonstrates that an investment that provides a return may not be
attractive to investors if the cost of holding onto said investment is too high.

Page 215
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
Discussion on SRO’s self-regulation and its implications

For Thursday, January 18th
While there are clearly ways in which for-profit stock exchanges that list
themselves on their own exchange could manipulate the regulations applicable to buying
and selling stock, I do not believe that this would happen in today’s market. The most
prominent reason for this is the industry’s focus on such a thing happening. Further,
because the idea that a for-profit organization regulating itself seems to many to be ill-
fated, there follows the idea that there will be intense scrutiny of discrepancies and
manipulations of self-imposed regulations that might be aimed at the increase of profits
for said exchange. As a result of this scrutiny that is likely to occur over these
organizations’ self-regulations, it would be too risky for such exchanges with long-
standing reputations (such as the NYSE or NASDAQ) to take part in self-regulation
manipulations for fear of being caught.
As far as regulatory problems that could occur go, there are a few possibilities.
First, an exchange such as the NYSE or NASDAQ could manipulate the time it takes for
their own stock to update in electronic trading systems to work in their advantage when
trading of their stock is taking place. Further, when buyers purchase their own stock at
low prices, these exchanges could artificially make it appear that prices are low for a
period of time; this would result in more stocks being sold than if the price were allowed
to rise, as regulations require.

Page 216
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
WSJ Article Brief

The Most Important Traders in the Stock Market
For Tuesday, January 30th
In the stock market the most important traders are speculators, particularly the
informed traders within this group. This is true because the price of stock for a certain
company in the stock market should represent as best it can the true value of that firm.
Informed traders act on information about the fundamental values of a firm, thus their
trades balance out to an equilibrium price that is the nearly true value of the firm,
according to what is known in the market. This ‘close-to-true’ value is based on trades
from value traders who extensively research the worth of the company, as well as news
traders who keep the stock price up-to-date by acting on the most recent news relevant to
the organization. Nonetheless, the price of a stock usually doesn’t represent the true
worth of a firm, as noise traders whose trade is based on factors outside of standard
information and news cause the price of a stock to vary widely from its real value.
Essentially, informed traders are important to the stock market because they act as a
counter-balance to the noise created by ‘noise traders’ (essentially all traders who are not
‘informed traders’).

Page 217
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
What Is The Optimal eBay Bidding Strategy?

For Thursday, January 25th
In order to receive an item for the lowest possible price through the online bidding
site eBay, a user is best served by not bidding at all until as close to the auction end as
they can get, then entering their bid limit. EBay is essentially an English auction.
Further, the eBay system automatically enters a bid for one’s item at a set bidding
increment above the previous bidder’s bid limit, up to the price of one’s bid limit. As a
result of this, a user needs not constantly sit at his or her computer outbidding somebody
else up to their bid limit, they can merely enter their bid limit and let the eBay system do
the rest. Secondly, it is best to enter one’s bid limit as close to the end of the auction as
possible. The reason for this is as follows. If users enter their bid limits early in the
auction, the current bid price will rise and other users may reconsider their bid limit,
raising their limit to a higher amount than it would have previously been. This will result
in a higher cost of the item. The exception here is an item with many substitutes or listed
by many sellers. In this case, bidding early will raise the bid price enough to cause other
users to look elsewhere and not bid on the item at all.

Page 218
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
WSJ Article Brief

The Most Important Traders in the Stock Market
For Tuesday, January 30th
In the stock market the most important traders are speculators, particularly the
informed traders within this group. This is true because the price of stock for a certain
company in the stock market should represent as best it can the true value of that firm.
Informed traders act on information about the fundamental values of a firm, thus their
trades balance out to an equilibrium price that is the nearly true value of the firm,
according to what is known in the market. This ‘close-to-true’ value is based on trades
from value traders who extensively research the worth of the company, as well as news
traders who keep the stock price up-to-date by acting on the most recent news relevant to
the organization. Nonetheless, the price of a stock usually doesn’t represent the true
worth of a firm, as noise traders whose trade is based on factors outside of standard
information and news cause the price of a stock to vary widely from its real value.
Essentially, informed traders are important to the stock market because they act as a
counter-balance to the noise created by ‘noise traders’ (essentially all traders who are not
‘informed traders’).

Page 219

Page 220

Page 221

Page 222

Page 223

Page 224

Page 225
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
New York Times Article Brief

S.E.C. is Looking at Stock Trading
For Thursday, February 8th
The SEC has begun an investigation that will attempt to reveal which banks on
Wall Street, if any, have been engaging in front running. Front running is when a bank
tells valuable clients about a major trade before the trade actually happens. This allows
the client to make a risk-free trade on said stock. Some banks may have been allowing
front running a little differently than it has happened in the past; banks may be giving
their valuable clients information about trades in advance of large trades, after which
these clients would go to a different bank to make the trade. The SEC has demanded all
stock and option trading data for the last two weeks of September from Major Wall Street
Banks. Concerns have arisen from studies that show unusual amounts of trading
occurring before major deals are carried out. Further, the growing dominance of Hedge
funds on Wall Street, which now account for 30 to 50 percent of trading on most major
markets, has fed concerns of insider trading. The SEC has reported that any information
regarding insider trading will be immediately investigated as usual.

Page 226
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
Bidding for CBOT

For Thursday, March 23rd
Although ICE may be offering a higher bid price for CBOT (over one billion
dollars higher), the shareholders will benefit more from the acceptance of the CME bid.
The underlying reason for this is compatibility. The nature of the futures trading markets,
that futures can only be traded within their exchanges (unlike stocks which can be moved
from exchange to exchange), it is important to build market share. Most importantly, a
merger between CBOT and CME will provide customers with more liquidity. CBOT
should accept the lower bid offer and through this provide a better service with more
liquidity, thus providing more value to their shareholders.

Page 227
Keith Parker
ID#6390.4899.77
kaparker@usc.edu
Jim Cramer on Market Manipulation

For Thursday, March 29th
It seemed to me that Jim Cramer, when speaking of things that would manipulate
the market illegally, wasn’t as concerned as much about the legality of such moves as he
was whether or not such actions were commonplace and accepted as standard in the
market. His insights into the way in which markets could be manipulated were
interesting though. His comments in regards to short-selling companies such as Apple
and RIM (Research in Motion), then leaking rumors that the near futures of those
companies weren’t looking very good in order to lower stock price in order to make a
profit were also a clear indication that market manipulation and corruption were more
routine than many people might think. Some comments in the video, such as it ‘only’
costing 10 or 15 million dollars to manipulate the market in some ways, made it clear that
market manipulation is often a very expensive game to play.

FBE-440: Class Notes
Page 228

Page 229

Page 230

Page 231

Page 232

Page 233

Page 234

Page 235

Page 236

Page 237

Page 238

Page 239

Page 240

Page 241

Page 242

FBE-440: Exam Things
Page 243
FBE-440 Review 2/9/07 2:13 PM
Traders often use whole numbers more often than fractions, et cetera
Some questions will come from boxes in the book
What are the benefits of a call market?

• Bring people together at the same place and time, creating and
offering more liquidity
• What’s the role of time and place when we think about Call
markets? Liquidity
How do order-driven markets arrange trades

• Market uses a set of rules, order precedence rules, to match buyers
to sellers, and use pricing rules to determine price
Do brokers work for their clients or for themselves? Obviously, they work
for themselves, though the nature of their work is that they are working for
other people
Of what value is a large entertainment budget to a broker?

• Brokers are most valuable when they have many clients
Soft dollars, what are they? Soft dollars paid towards research from one
account might benefit another account, this could be a problem here
What agency regulates options trading? The SEC
Find out what a deep-discount broker is
Activities that may appear in the back office of a brokerage firm?
Why is it important to have a poker face in a physically convened market?

This is negotiating prices face-to-face
Why do traders care about trustworthiness? Don’t ramble on when

answering questions like these, just answer it very straightforward

Page 244
Things from the book that weren’t in class?

• Does it appear in the list of important points in the chapter?
• Was it highlighted in some way in the book?
• Was an example provided to make it more clear?
• Were there questions on it at the end of the book?
Will get more credit for not writing something on the exam that you know
you don’t know, rather than making something up
What do brokers do?

• Help their clients arrange trades, provide more value when they
have more clients
Figure out what payment for order flow is

• What is payment for order flow, why are regulators concerned
about it, and what affect does it have on commissions?
What markets would you expect to see the greatest market efficiency? What
makes prices informative?
In what way is market structure like the rules of the game? It determines
who has power, et cetera
Lecture notes on blackboard represent at least one outline for going through
the course; basically an abbreviated form of the book with the important
stuff; often professor looks at lecture notes when writing exam
A couple of questions might be on current events in the trading arena

Page 245
Continuous Auction
Time Trader Order Side Size Price
10:01 Bea Buy 3 30
Sam Sell 2 30.1
Ben Buy 4 30.2
Sol Sell 2 30.3
Stu Sell 5 30.3
Bif Buy 4 Market
Bob Buy 3 30.2
Sue Sell 4 30
Sun Sell 3 30.2
10:29 Bud Buy 3 30.3
Trades
Buyer Seller Price Quantity
Ben Sam 30.1 2
Bip Sol 30.3 2
Bif Stu 30.3 2
Ben Sue 30.2 2
Bob Sue 30.2 2
Bob Sun 30.2 1
Bud Sun 30.2 2
Bud Stu 30.3 1
Order Book
Buyer side Sellers side
Buyer Price Quantity Seller Price Quantity
Ben 30.2 2 Sam 30.1 2
Bob 30.2 3 1 Sun 30.2 2
Bea 30 3 Sol 30.3 2
Stu 30.3 532
Buyers' Surplus Seller Surplus

Surplus Reservation Surplus Reservation
(30.2-30.1)2 30.2 Ben (30.1-30.1)2 30.1 Sue
List goes on List goes on
When calculating suplus for Bud, who traded at two prices, you have to
calculated his weighted average trading price

Page 246

1. Suppose the market is 100 bid, offered at 101. What would be the limit price of a limit
buy order if it were placed at the market?
100
2. The following orders are in a market:

Order A: Buy 10 for 18
Order B: Buy 15 for 19
Order C: Buy 5 for 20
Order D: Sell 5 at 21
Order E: Sell 25 at 22
Order F: Sell 20 at 23
What is the best bid?

Order C: Buy 5 for 20 (The highest priced buy order.)
3. An order book in a continuous auction contains only one limit order. It is a buy order
with a limit price of 5. A limit sell order with a limit price of 4 arrives. At what price will a
trade be arranged, if any?
5
4. In the extreme, a market sell order is like what kind of limit order?
A limit order with a zero price.
5. In what direction is price moving when a limit sell order placed at the market fails to
execute?
Down
6. What do you expect will happen to bid/ask spreads if volatility increases?

Spreads will increase.
7. Suppose a buyer buys 5 contracts for 40 using a limit order priced at 42. Given this
information only, what is a reasonable lower bound for his trader’s surplus?
(42-40)*5=10
8. Who makes payments for order flow?

Dealers

Page 247
9. How can a buyer who does not have time-precedence at $25 acquire order
precedence?
Raise her bid.
10. The market in a continuous trading auction is 100 bid, offered at 101. An IOC order to
buy, limit 100.5 arrives. What happens?
Nothing. The order does not fill and it cancels
automatically.
11. Why do traders only want to trade with creditworthy counterparts?

They want to be sure that their counterparts are able to
settle their trades.
12. Why would it be difficult to enforce the uniform pricing rule in a continuous trading
market?
Traders will break their orders into pieces to price
discriminate.
13. In this course, what is the difference between an investor and a speculator?
An investor trades to move money from one point in time
to another. A speculator trades to profit from unique
information.

Page 248
14. Consider the following summary order book for a single price auction.
Aggregate Aggregate
Market Sell 2
15 12
20 12.1 2
15 12.2
10 12.3 7
7 12.4 4
5 12.5 4
1 12.6 10
1 12.7 15
12.8 30
12.9 15
13 10
4 Market Buy
At what price should the single price auction be conducted?
What total quantity will trade?

The single price auction price will be 12.4. The market
buy orders are matched with the market sell orders
leaving 2 unmatched on the buy side. These are matched
with the sell orders placed at 12.1. The sell orders
placed at 12.3 are matched with the buy orders placed at
12.7, 12.6 and 12.5. The sell orders place at 12.4 are
matched with 4 of the buy orders placed at 12.4, leaving
3 unfilled on the buy side. No further trade is
possible. The clearing price of 12.4 maximizes the total
volume. The volume, counted on the buy side is 4 + 1 +
1+ 5 + 4 = 15. Counted on the sell side it is 2 + 2 + 7
+ 4 = 15.
15. Mark submits a market order to buy 9 to a continuous market with the following order
book:

Ann 15 80.0
Jack 3 80.3
Steve 80.4 6
Beth 80.7 10

Page 249

price is 80.5.

Page 250

1. In what direction is price moving when a limit buy order placed at the market fails to
execute?
Up
2. Whose trading would a public order precedence rule restrict?

The members of an exchange
3. The following orders are standing in a market:

Order A: Buy 10 for 18
Order B: Buy 15 for 19
Order C: Buy 5 for 20
Order D: Sell 5 at 21
Order E: Sell 25 at 22
Order F: Sell 20 at 23
What is the best offer?

Order D: Sell 5 at 21 (The lowest priced sell order).
4. Suppose a seller sells 8 bonds for 95 using a limit order priced at 93. Given this
information only, what is a good lower bound for her trader’s surplus?
(95-93)*8=16 or 1600 if you remember the bond pricing
convention.
5. An order book in a continuous auction contains only one limit order. It is a buy order
with a limit price of 5. A limit sell order with a limit price of 4 arrives. At what price will a
trade be arranged, if any?
5
6. Which type of informed trader typically profits when values change but prices do not
change?
News trader
7. The market at a continuous trading auction is 100 bid, offered at 101. A day order to
buy, limit 100.5 arrives. What happens?
The order is placed into the book on the buy side at
100.5 to await execution.

Page 251
8. What makes a market transparent?

A transparent market publishes its quotes, orders and
trades in a timely fashion.

precedence rules such as time precedence economically meaningful?
A small tick allows traders to cheaply obtain precedence
through price priority.
10. Why would it be difficult to enforce the uniform pricing rule in a continuous trading
market?
Traders will break their orders into pieces to price
discriminate.
11. What effect does liquidity have on price efficiency?

Prices should be more efficient in liquid markets because
informed traders need liquidity to profit.
12. Why are uninformed traders willing to lose to informed traders?

Uninformed traders are willing to lose to informed
traders because they obtain some other benefit from
trading besides trading profits. These benefits may come
from investing, hedging, gambling or asset exchanging.

Page 252
Order Arrival Time Side Limit Price Size

A 9:30 Sell 50 25
B 10:00 Buy Market 25
C 10:15 Buy 51 10
D 10:31 Sell 50 5
E 10:35 Buy 49 10
F 10:38 Sell 51 20
What is the market clearing price?
First sort the orders into an order book as follows:
Order Arrival Time Side Limit Price Size

A 9:30 Sell 50 25
D 10:31 Sell 50 5
F 10:38 Sell 51 20
B 10:00 Buy Market 25

C 10:15 Buy 51 10
E 10:35 Buy 49 10
In a single price auction, all of Order A (25) is first

matched with Order B and both are completely filled. All
of Order D is then matched with 5 of Order C. The
remaining 5 of Order C are matched with part of Order F.
No further trades are possible because Order E is only
willing to pay 49 but Order F wants 51.
The uniform price for this auction is 51 since 51 is the

only price at which a trade can be arranged between Order
C and Order F.
What total quantity will trade?

The total volume is 25 + 5 + 5 = 35.

Page 253
14. Mark submits a market order to buy 9 to a continuous market with the following order
book:

Ann 15 80.0
Jack 3 80.3
Steve 80.4 6
Beth 80.7 10

price is 80.5.

Page 254
Midterm #2 Review FBE-440 3/30/07 2:17 PM
Arbitragers provide liquidity – connects people who arrive in different places

and time, provide an example of a speculative arbitrage
Recognize pure and speculative arbitrages
It is speculative for sure if you can image some factor that would cause the
arbitrage spread to forever move apart
All arbitragers are risky
Discuss the risks of doing an arbitrage, implementation risks, risks of

engaging in a speculative arbitrage
Market manipulation
• Potential for bluffing imposes a discipline
• The price impact per share, when your buying you typically raise
prices
• If the price impact per share of buying is higher, than you could
just buy a bunch to push prices up and then sell them
Understand that brokers end up staking their reputation on the quality of

information that they produce
Order anticipation chapter, if you go around telling everybody that you’re

going to trade, people will front run you- control the exposure of your order
Dark liquidity pool: a trading system where people can’t see who is willing to
trade
Explain why firms with crummy ideas have a hard time selling capital
• If you have a bad idea, you have to sell a lot of shares and this
dilutes the values of the shares, which is just transferring the cost
of the new venture to the shareholders, which isn’t good
Know a lot about adverse selection, and where it arises in trading markets
• Bid-Ask spreads, et cetera

Page 255
What determines a bid-ask spread?
Why is it unlikely that a liquid market would ever develop around

somebody’s pizza parlor? There would be too much asymmetric information
Two models of the bid-ask spread: the equilibrium spread model talked
about in class should be known
• The implications of free entry and exit
• People are deciding whether to, if you are selling, to take a bid or
make an offer, and, if you are buying, whether to take a bid or
make an offer
Who is going to be doing the best with arbitrage?
The arbitrage portfolio, the high frequency arbitrage is going to tend to be

done with high something
Fundamental volatility is due to changes in actual value; transitory volatility

is the volatility due to everything else (effects of uninformed traders, et
cetera) Transitory volatility has a strong link with transaction costs
When is a value motivated trader able to trade?

• If price is below (or above) fundamental value
o This can happen for two reasons: prices changed and values
didn’t (uninformed traders), or vice versa (news trader)
o Value motivated trader is a supplier of liquidity
Winner’s curse
• Why it arises (valuation errors)
• When bidding in an auction, must be careful because, as a buyer,
the highest bidder is the one who wins. It is likely that the highest
bidder is the guy who probably overvalued the thing being bid on

Page 256
FBE 440 MW Midterm 2

Since knowing that you do not know something is a valuable form of knowledge, I will give
40 percent credit for blank answers. A completely wrong answer, of course, will receive no
credit.
Good luck!
Short Answers: These questions can be answered with one or two sentences.
(10 points each)
1. Order anticipators, informed traders, and dealers all profit from other traders.
Which of these traders are parasitic traders and why?
2. Why are momentum traders especially vulnerable to bluffers?
3. How do dealers learn about value from their order flow?

Page 257
4. Under what conditions would you expect adverse selection spreads to be large?
5. Why do block brokers prefer to serve uninformed traders rather than informed
traders?
6. How do we know that value traders are the ultimate suppliers of liquidity?
7. Arbitrageurs and dealers both match buyers to sellers. How do their methods
differ?
Keith Parker, University2 of Southern California

FBE-440: Exam
Name _____________________________ Things
Last, First Page 258
8. How do exchanges simplify bilateral searches?
9. What distinguishing characteristics of fundamental volatility and transitory volatility

allow us to discriminate between them?
10. Suppose that transaction costs for a trader are evaluated relative to an opening
price benchmark. The trader fills orders for a portfolio manager who trades on
momentum. Will the trader’s estimated transaction costs be unbiased?

Page 259

Page 260
FBE 440 TTH Midterm 2

Since knowing that you do not know something is a valuable form of knowledge, I will give
40 percent credit for blank answers. A completely wrong answer, of course, will receive no
credit.
Good luck!
Short Answers: These questions can be answered with one or two sentences.
(10 points each)
1. How do the strategies used to front-run a market order and a standing limit order
differ? (Assume the orders are buy orders.)
2. Why do bluffers fear value traders?
3. Suppose that an uninformed trader trades only with dealers who only know about
market values but nothing about fundamental values. Do the uninformed trader’s
trading profits depend on the number of informed traders in the market? Why or
why not?

Page 261
4. If the value of all traders’ time increased, what would you expect would happen to
bid/ask spreads? Why?
5. Why do large liquidity suppliers want to know whether the traders who seek to trade
with them will want to trade more of the same security in the future?
6. You plan to bid in an auction for an item for which the value is uncertain. You set
your bid assuming that there will only be ten bidders. Before submitting your bid,
you learn that 100 people will bid on the item. Should you change your bid? Why?
7. Do arbitrageurs and dealers compete with each other for trading profits? Why or
why not?

FBE-440: Exam
Name _____________________________ Things
Last, First Page 262
8. What is liquidity?
9. How is transitory volatility related to transaction costs?
10. Suppose that transaction costs for a trader are evaluated relative to a closing price
benchmark. The trader fills orders for a portfolio manager who tends to be well
informed. Will the trader’s estimated transaction costs be unbiased?

Page 263

Page 264

Short Answers (10 points each)
1. Order anticipators, informed traders, and dealers all profit from other traders. Which of
these traders are parasitic traders and why?
The order anticipators are parasitic traders because
their trading neither makes markets more liquid nor
prices more informative.
2. Why are momentum traders especially vulnerable to bluffers?

Since momentum traders follow trends, bluffers can cause
them to trade unwisely by manipulating prices.
3. How do dealers learn about value from their order flow?

A surplus of buy order volume over sell order volume
suggests to them that informed traders may be present so
that values are probably higher then current prices, and
vice versa for a surplus of sell order volume.
4. Under what conditions would you expect adverse selection spreads to be large?
When many informed traders are in the order flow or when
the information that informed traders tend to have is
highly material (i.e. price is very different from
value).
5. Why do block brokers prefer to serve uninformed traders rather than informed traders?
The clients with whom the block brokers match block
initiators do not want to lose to informed traders. If
they burn these clients, they won’t be able to do more
business with them.
6. How do we know that value traders are the ultimate suppliers of liquidity?
Value traders trade when price departs from value, which
usually happens when uninformed traders are moving prices
away from values. They thus supply liquidity in response
to the demands from these uninformed traders.

Page 265
7. Arbitrageurs and dealers both match buyers to sellers. How do their methods differ?
Arbitrageurs use their hedge portfolios to match buyers
to sellers at the same time but in different places.
Dealers use their inventories to match buyers to sellers
in the same market buy who arrive at different times.
8. How do exchanges simplify bilateral searches?

They reduce the costs of searching by creating systems
that allow buyers and sellers to quickly find the best
trading opportunities.
9. What distinguishing characteristics of fundamental volatility and transitory volatility allow

us to discriminate between them?
Price changes due to fundamental volatility are
unpredictable whereas those due to transitory volatility
tend to reverse (are mean-reverting).
10. Suppose that transaction costs for a trader are evaluated relative to an opening price
benchmark. The trader fills orders for a portfolio manager who trades on momentum.
Will the trader’s estimated transaction costs be unbiased?
The estimated transaction costs will be upward biased
because momentum managers buy when prices are rising and
sell when prices are following so that the trader will
tend to buy when price is above the open and sell when
price is below the open.

Page 266

1. How do the strategies used to front-run a market order and a standing limit order differ?
(Assume the orders are buy orders.)
To front run the market order, you buy first and then
sell when the price impact of the market order moves
prices up. To front run a standing limit order, you buy
first. You then sell to the standing limit order if you
believe that prices will fall.
2. Why do bluffers fear value traders?

Value traders can stop a bluff by supplying all the
liquidity that the bluffer is demanding when the bluffer
is trying to move prices.
3. Suppose that an uninformed trader trades only with dealers who only know about
market values but nothing about fundamental values. Do the uninformed trader’s
trading profits depend on the number of informed traders in the market? Why or why
not?
The uninformed trader’s profits are reduced by adverse
selection spreads that the dealers must charge to recover
from them what the dealers lose to the well informed
traders.
4. If the value of all traders’ time increased, what would you expect would happen to
bid/ask spreads? Why?
Bid/ask spreads would widen to compensate traders who
offer liquidity for the additional value of their time
committed to do so.
5. Why do large liquidity suppliers want to know whether the traders who seek to trade
with them will want to trade more of the same security in the future?
They do not want to offer liquidity to price
discriminators.
6. You plan to bid in an auction for an item for which the value is uncertain. You set your
bid assuming that there will only be ten bidders. Before submitting your bid, you learn
that 100 people will bid on the item. Should you change your bid? Why?
You should lower your bid because if you win the auction,
you will learn that your estimate was higher than 100
people rather than just 10—you probably over estimated
value.

Page 267
7. Do arbitrageurs and dealers compete with each other for trading profits? Why or why
not?
Arbitrageurs and dealers compete to match buyers to
sellers. If either were not in the market, the other
would be more profitable.
8. What is liquidity?
1. The ability to trade quickly when you want at low
cost.
2. The successful outcome of a bilateral search in which
buyers look for sellers and vice versa.
9. How is transitory volatility related to transaction costs?

The price impacts of trades are both transaction costs
and contributors to transitory volatility.
10. Suppose that transaction costs for a trader are evaluated relative to a closing price
benchmark. The trader fills orders for a portfolio manager who tends to be well
informed. Will the trader’s estimated transaction costs be unbiased?
The estimated transaction costs will tend to
underestimate the actual transaction costs because the
trader will tend to buy at a price below the close
because his manager is well informed.

Page 268

1. Which type of informed trader typically profits when prices change but values do not
change?
Value-motivated trader
2. When deliberately moving prices, bluffers hope that other traders will identify them as
what kind of trader?
Informed trader
3. When selling has more price impact than buying, should a bluffer buy first or sell first?
Sell first.
4. Name an important way that dealers attract order flow.

Quote aggressive prices
Quote substantial sizes
Purchase order flow
Advertise
5. Dealer Jack quotes a market of 20 bid, 21 offered. Dealer Jill quotes 20.5 bid, 21
offered. Dealer Julia quotes 20 bid, 20.75 offered. What is the inside market quote?
20.5 bid, offered at 20.75
6. Name the two most important risks that concern traders who offer liquidity to large
traders.
Risk of trading with an informed trader (Adverse selection
risk)
Risk that the large trader will trade more size
7. Name an important risk that an arbitrager faces when he engages in a pure arbitrage.
Poor implementation (poor trading)
Model risk (winner’s curse)- Failure to properly understand
the relative value relation.
8. Is the outside spread generally wider or narrower than a typical dealer’s spread?
Wider

Page 269
Very Short Essays (20 points each)
9. In what sense can we identify arbitrageurs as producers and recyclers of financial

instruments?
Many arbitrages involve trading of nearly identical risks
that appear in different forms. When an arbitrageur buys
one instrument and sells the others, he or she in effect
transforms the risk from one from to another. The process
can be viewed as producing or recycling financial
instruments. For example, when an arbitrageur buys the 500
S&P 500 stocks and sells the S&P 500 futures contract, the
arbitrageur effectively creates the futures contract. The
arbitrageur would do this when the futures contract gets
expensive relative to the cash index, which typically will
happen when demand for the futures form of the S&P 500
equity risk rises relative to demand for the cash form of
the risk.
10. What causes the winner’s curse and how do traders avoid it when bidding for an item?
The winner’s curse arises because traders cannot perfectly
value the instruments that they trade. When they overvalue
them, they tend to bid too high and win the auctions at
prices above values. Traders avoid the winner’s curse by
considering what they learn when they are the highest
bidder. In particular, if they are the highest bidder, they
likely overvalued the item. They avoid the winner’s curse by
lowering their bids to reflect the fact that, if they win,
they will learn that everyone else likely had a lower
valuation. The amount that they lower their bid increases
with the number of other bidders and with the uncertainty in
their estimates of value.
11. Describe how a sentiment-oriented technical trader might identify profitable trading
strategies.
A sentiment-oriented technical trader tries to anticipate
the trades that uninformed traders will do. He or she would
do this by considering why uninformed traders trade. If the
reasons can be predicted, the technical trader can front-run
the uninformed traders. For example, suppose that
uninformed traders tend to buy whatever stocks are featured
on CNBC. A sentiment-oriented technical trader would watch
CNBC and immediately buy on the first indication that a
stock will be featured on the show.

Page 270

1. When buying has more price impact per contract than selling, should a bluffer buy first
or sell first?
Buy first.
2. To which type of trader do bluffers most commonly lose?

Value-motivated traders
3. Name an important way that dealers attract order flow.

Quote aggressive prices
Quote substantial size
Purchase order flow
Advertise
4. What do you expect would happen to bid/ask spreads if gamblers traded more often in
the instruments in which dealers make markets?
Spread would narrow because gamblers are uninformed traders.
5. How does large trade size affect the adverse selection spread component?
It increases it because people fear that large traders are
well informed.
6. Name the two most important risks that concern traders who offer liquidity to large
traders.
Risk of trading with an informed trader (Adverse selection
risk)
Risk that the large trader will trade more size
7. What trader type can ultimately supply the most liquidity to a market?
Value-motivated traders
8. In a pure order-driven market, how would an increase in the value of all traders’ time
affect bid/ask spreads?
Bid/ask spreads would increase.

Page 271
Very Short Essays (20 points each)
9. Why do we expect a liquid market to have more informative prices?

The liquidity would make informed trading more profitable
since the informed traders would have less impact on price
when trading. They then would acquire more costly
information and put it into the price.
10. A slow trader has issued a large standing buy limit order at the market. How could a
clever fast trader profit from this situation?
Place a buy order at a slightly better price and hope that
it executes. If values subsequently rise, the clever trader
profits without bound. If values fall, the clever trader
will sell to the large buyer for a small loss. This
strategy is profitable if the slow trader is not likely to
cancel his order after the clever trader’s order is filled.
This strategy effectively extracts the option value of the
put that the buyer granted to the market.
11. How do arbitrageurs and dealers compete with each other?

Dealers use their inventories to move liquidity through time
by connecting a buyer who arrives at one point in time with
a seller who arrives at a different point in time, both in
the same market. Arbitrageurs use their hedge portfolios to
move liquidity from one market to another by connecting a
buyer who arrives at one market to a seller who arrives at a
different market, both at the same time. Since dealers and
arbitrageurs both can satisfy demands for liquidity, they
are competitors.

FBE-462: Syllabus
Page 272
International Trade and

Commercial Trade
(FBE 462)
Department of Finance
Marshall School of Business
Fall 2007 Professor Baizhu Chen

740-7558 HOH701C
email: baizhu@marshall.usc.edu
http://www-rcf.usc.edu/~baizhu/
Office Hours: M 4:00 – 6:00pm
TTH 2:00 – 3:00pm
or by appointment
The post-war period has been a remarkable era of growth in trade. As a result economies in general have
become more open. Countries are more interconnected through international trade. Firms are now more and
more facing competitions from other countries. Many aspects of trade relations are now headline news - for
example the bilateral trade conflict between U.S. and Japan; alleged unfair trading practices of Japan,
Korea, Taiwan, and now increasingly China and others; the Super 301 provisions; restrictions on U.S.
multinationals; newly negotiated voluntary restraint agreements; liberalization in Eastern Europe and other
formal socialist countries; Human rights and trade; the Uruguay Round of GATT negations;
NAFTA，WTO and so on. U.S. policy on these and other issues is of crucial importance to global
prosperity in the 1990s. Firms' competitive strategies are increasingly influenced by the trade policies of
U.S. and other countries. A firm without a global view will not be competitive in a global economy in
which competitions come not only from domestic competitors but also from competitors located in
different countries.
COURSE OBJECTIVES:
This course surveys the major topics in the theory of international trade. Like all branches of economics,
this course is concerned with decision making with respect to the use of scarce resources to meet desired
economic objectives. It is consequently concerned with how international transactions influence such things
as social welfare, income distribution, employment, growth, and the possible ways public policy can affect
the outcomes. We will focus on such questions as:
(1). What determines the basis for trade?

(2). What are the effects of trade?
(3). What determines the value and the volume of trade?
(4). What factors impede trade flows?
(5). What is the impact of public policy that attempts to alter the pattern of trade?
We will cover most basic trade theories and their policy implications. In this course, we will analyze
various trade and industrial policies, for instance, tariff, quota, VER, anti-dumping, customs union. We
will also discuss the U.S. trade law, institutional framework of WTO/GATT, the Uruguay Round
negotiations, the Multi-Fiber Agreement, and NAFTA. This course is concerned mainly with the non-
monetary aspect of international economics. The monetary and balance of payments issues are only
marginally discussed.
COURSE REQUIREMENTS:

FBE-462: Syllabus
Page 273
Thomas A. Pugel, International Economics, 12th edition, Irwin McGraw-Hill, 2004
Reading Packet
Wall Street Journal is required
Lecture notes will be posted in the BLACKBOARD system under the course number for downloading.
You should be able to access the BLACKBOARD by typing your userid and password of your UNIX
account. For more information of the BLACKBOARD, please contact the Keck Center.
COURSE EVALUATION:
Requirements for the course include one project (25%), three examinations (45%), three homework
assignments (each 5%) and class participation (15%). Class participation may alter your grade by as much
as one level. The final grade is based on a “curve.” I adhere roughly to the school guidelines: An average
grade of 3.30 out of 4.00 for undergraduate elective courses. This translates loosely into something like 30-
35% A, 45-50% B, 15-20% C, and 0-10% D&E. I do not assign letter grades to individual exams and
homework assignments. However, I will give you complete distributions for each grade and you can apply
the scale indicated above.
Project 25%
Examinations 45%
Homework 15%
Class Participation 15%
Examinations will consist of multiple choice questions, numerical problems, and in some cases short
essays. All exams are closed-book, closed-notes. Each exam will cover the required readings from the text
and all the material covered in class.
Students should turn in their homework assignments before the due dates. Generally the homework
assignment should be turned in at the beginning of the lecture on the due date. Should he or she for any
reasons turn in the homework assignment after the due dates, his or her scores will be discounted 10% for
every hour the homework is overdue up to a maximum of 50% discount.
Violations of academic integrity standards will be treated seriously. "The use of unauthorized materials,
communication with fellow students during an examination, attempting to benefit from the work of another
student, and similar behavior that defeats the intent of an examination or other class work is unacceptable
to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior
resulting from the nervous tensions that accompany examinations. Where a clear violation has occurred,
however, the instructor may disqualify the student's work as unacceptable and assign a failing mark on the
paper."
Make-up Exams: Current department policy to which I adhere is “No makeup midterm and final
exams will be allowed.” If you have an extenuating circumstance that prevents you from taking the exams,
discuss your reasons with me BEFORE the time of the exam. Current department policy is that a student
may not be given a make-up exam unless he or she has obtained written permission from the course
instructor in advance. In addition, you must be able to document your extenuating circumstance.
Any student requesting academic accommodations based on a disability is required to register with
Disability Services and Programs (DSP) each semester. A letter of verification for approved
accommodations can be obtained from DSP. Please be sure the letter is delivered to me (or my TA) as

FBE-462: Syllabus
Page 274
early in the semester as possible. DSP is located in STU 301 and is open 8:30 a.m. - 5:00 p.m. Monday
through Friday. The phone number for DSP is (213) 740-0776
Team Project: We will arrange a field trip to Maquiladoras of Mexico. The trip date is tentatively
scheduled on March 1-4, 2005. We will leave in the evening of March 1, Thursday, and return on March 4,
Sunday. We will visit several Maquiladoras in Tijuana and other places in Mexico. Students are asked to
conduct preliminary research on these Maquiladoras before the trip. After the field trip, students are
required to complete a team research paper, which is to be presented at the end of the semester.
Disclaimer
This syllabus is an invitation to you to engage in an exciting and interactive study international trade. It is
my goal to provide a collaborative and supportive learning environment where students will learn from one
another both inside and outside of the classroom. To that end, modifications to this syllabus may be
warranted as I assess the learning needs of this particular class.
This is a contract for this course between you and me. If you want a grade from this class, implicitly you
have to follow this contract.
COURSE OUTLINE:
1/9 Introduction
1/11 Global Trade Overview International Economics (TP), ch. 1, p1-11, p33
1/16 Is Trade A Zero-Sum Game? International Economics (TP), ch. 2, p15-28
1/16- Why Nations Trade (I)? International Economics (TP), ch. 3, p31-43
/18
“The Halo Effect”, The Economist, Sept. 30, 2004
“Trade Disputes,” The Economist, Sept. 16, 2004
Case Discussion: Free Trade vs. Protectionism: the Great Corn

Laws Debate, HBR Case 9-701-080, Feb. 20, 2001
1/23 Why Nations Trade (II)? International Economics (TP), ch.3, p48-57, ch.4, p68-72
1/25
“A forbidden fruit in Europe: Latin bananas face hurdles”,
The New York Times, April 5, 1993
“Working Man’s Dread”, The Economist, October 1, 1994.
“The Sucking Sound from the East”, the Economist, July 26,
2003
1/25 Why Nations Trade (III) ? International Economics (TP), 5

1/30
2/1 Growth and Trade International Economics (TP), ch.5

“Korea is overthrown as sneaker champ”,

FBE-462: Syllabus
Page 275
the Wall Street Journal, October 7, 1993
2/6 Examination 1
2/8 Tariff International Economics (TP), ch. 7
2/13 Tariff Case Discussion: Can Florida Orange Growers Survive

Globalization?, HBR Case 9-904-415, March 8, 2004
2/15 Non-tariff Barriers International Economics (TP), ch. 8

“U.S. import rights: going once, going twice...”
Business Week, March 9, 1997
“China Trade Policy’s Ripple Effect,” the Washington Post,
November 11, 2003
2/20- Protect or Not To Protect International Economics (TP), ch. 9

2/22 “Argument against free trade when market fails,” Notes (to be
provided in class)
“How Countries Go High-tech,” the Economist, November 8,
2001
Case Discussion: Brazil on Wheel, HBR Case 9-804-080, May

25, 2004
2/27- Pushing Exports International Economics (TP), ch. 10
“How to beggar your neighbor” the Economist, February 3,

1996
3/1 No Class (Preparation for Mexico trip)
3/1-4 Trip to Mexico
3/6 Pushing Exports International Economics (TP), ch. 10
“How to beggar your neighbor” the Economist, February 3,

1996
3/8 Examination 2
3/12- No Classes (Spring Break)

3/16

FBE-462: Syllabus
Page 276
3/20- Trade Blocs and Trade Blocks International Economics (TP), ch. 11
3/22
“Regionalism and trade, the right direction?” the Economist,
September 16, 1995
“Building blocks or stumbling blocks”, the Economist,
October 31, 1992
“Everybody’s Doing It,” the Economist, February 26, 2004
3/27- GATT/WTO, US Trade Laws Case Discussion:

3/29
Creating the International Trade Organization, HBS, Case, 9-
798-057, Feb. 1998
David Moss and Nick Barlett, The World Trade

Organization, Sept. 2002, HBR Case, 9-703-015
4/3- Trade and Environment International Economics (TP), ch. 12

4/5
“Trading Hot Air”, the Economist, October 17, 2002
“Tax or Trade”, the Economist, February 14, 2002
Case Discussion: the Sweat Serpent of the South-East Asia,

the Economist, Dec. 30, 2003
4/10 Trade in Factors International Economics (TP), ch. 14
4/12 Review/Catch up
4/17 No Class (Preparation for Project)
4/19 Project Due

Project Presentation
4/24 Project Presentation
4/26 Examination 3

Page 277
Midterm Examination
International Trade and Commercial Policies
(FBE 462)
Spring 2007 Professor Baizhu Chen

740-7558 HOH701C
II. Please answer each question in the space provided. Do not feel compelled to fill the entire space.
Complete but concise answers are appreciated.
1. (8 points) The following table shows the labor costs of producing cloth and wheat in England and Poland
Poland England
Wheat 4 1
Cloth 2 1.5
Both countries use only labor to produce each product. Labor can move between the two industries. Each
country is endowed with 100 units of labor.
a. Which country is more productive in producing wheat? What is its labor productivity in wheat?
Which country is more productive in producing cloth? What is its labor productivity in cloth?
Answer:
England more productive in both wheat (productivity: 1) and cloth (productivity: 2/3)
b. Write out the full employment condition for each nation. Draw it in the following diagram. What
is the autarky relative price of cloth in Poland?
W W
100
25
50 C 66.7 C
Poland England

Page 278
4W+2C=100 W+1.5C=100
c. Which country has a higher wage? Why?

1*WE = Pw
2*WP=Pc
Pw = Pc => W E =2*WP

Page 279
2. (5 points) The following table shows the factor endowments of several countries.
3. (4 points) In article "Working Man's Dread" published in The Economist, October 1, 1994, in the
reading packet, it says:
- Trade => price of skilled labor intensive goods goes up and price of unskilled labor intensive goods
goes down => unskilled labor wage goes down while skilled labor wage goes up => gap increases
- technological change => demand for skilled labor increases while demand for unskilled labor
decrease
4. (11 points) In the great Corn-Laws debate, many arguments have been made to support or
against the repeal of Corn Laws in Britain in the mid-19 century. These arguments are listed in
the following table. In the column “Effect”, enter R if you believe that the argument is for
repealing the Corn Laws. Enter N if the argument is not for repealing.
5. (4 points) BANANA question
(a). Answer: these factors are possibly the reasons – weather, cheaper land and cheaper labor
(b). Answer: benefiting American consumers

Page 280
International Trade and Commercial Policies, FBE 462
Group Project
This group project is to be completed by a group of no more than 5 students. It is due on

April 19, 2007. The project needs to be typed with double space. Total pages should not exceed
20, including tables, reference, footnotes, executive summary and title page. You will present
your findings at the end of this term. Any report exceeding the page upper limit will be penalized.
There is no minimum page requirement.
Each group will choose one of the companies visited as your target company. One
company can be selected by multiple groups. Discussions between different groups are not
allowed.
Your project write-up should contain an executive summary, a body of analysis, and a
conclusion. You should also include references and footnotes, if necessary. You should collect as
much data/evidence as possible to support your statements in your project. Ideally, you should
utilize as much as possible in your report the knowledge, terms, models/frameworks, and
techniques that you have learnt in this class.
You should use your target company as a sample to study the industry. You should
address the broad question if the industry in Mexico has a comparative advantage. The overall
aim of your report is to develop a detailed industry report, focusing on the strategic challenges
and opportunities in your industry in Mexico today and in the next five or so years. It should
emphasize analyses instead of description. Descriptive information should be discussed to set the
stage and context for the situation facing your industry but the analyses of the situation should
receive much greater emphasis. Your team should think critically about the industry and should
develop your own perspective on the situation facing the industry now and in the future.
The intended audience should be managers in the industry who are interested in Mexico,
both local and foreign managers. Thus, it should read like a report prepared for an industry
association or set of players in the industry. Any company in the industry, foreign or local, should
be interested in the report as it should discuss the basic structural information of this industry.
In analyzing your industry, think back to frameworks, concepts, tools, theories, models,
and other material learned in this class, as well as in other classes of your undergraduate
curriculum. Use appropriate frameworks, concepts, tools, theories, and models you learned earlier
in the undergraduate program for analyzing and drawing conclusions about your industry. A well
developed industry analysis is interdisciplinary in nature, drawing upon strategic, marketing,
operational, financial, economic, and management perspectives. Therefore, you should apply and
integrate appropriate material from earlier courses in preparing your industry report.
Issues to Address
1) Conclusions and recommendations about opportunities for foreign companies

to compete in the industry in Mexico over the next five years
2) Conclusions and recommendations about opportunities for local Mexican
companies to compete domestically and globally over the next five years

Page 281
In analyzing your industry, the following are some possible areas you may wish to consider.
However, the following list is NOT meant to be a template of areas that you must cover for the
report. You should think about what kinds of analyses are appropriate to analyzing the situation
facing your industry in your target country and include those relevant analyses in your report.
You should define the areas of analyses that are relevant to your report.
1) Evolution of the industry over time – forecasts of growth, future trends, upcoming
opportunities and challenges, etc.
2) Competitive analysis of local players in the industry in Mexico – strengths and
weaknesses of domestic participants in the industry, the strategies pursued by various
players, the relative levels of success and profitability of various players, the likelihood
of new domestic entrants into the industry over the next five years, etc.
3) Competitive analysis of foreign players in the industry in Mexico – strengths and
weaknesses of foreign participants in the industry, the strategies they are pursuing, the
relative levels of success and profitability of these players, the likelihood of new foreign
entrants into the industry over the next five years, the relative comparative advantages of
foreign vs. local players in this industry, etc.
4) Strategic marketing analysis – assessment of the dynamics of customers, viable target
segments, market potential in the target country, marketing opportunities and challenges,
etc.
5) Cost structures of the industry – what are the major components of the cost? Is it mainly
the labor cost, or capital cost? How does regulations affect the cost structure?
6) Strategic operational analysis – assessment of the challenges, opportunities, and critical
success factors for carrying out effective operations in the country, advantages and
disadvantages of local production, etc.
7) Environmental analysis of Mexico – assessment of the impact of the economic, political,
cultural, and technological environment of Mexico on the industry, the implications of
these environment factors for being successful in the industry, etc.
8) Policy analysis – assess the impact of various government policies on your industry. You
may want to address how NAFTA or China’s entry of WTO influences the competitive
structure of this industry.
9) Ethical issues confronting companies in your industry in Mexico – assessment of the
ethical challenges faced by managers in your industry doing business in Mexico, the
implications of these ethical challenges for competition and for being successful in the
industry, etc.
10) Comparison of the characteristics and strategic challenges of the industry in Mexico with
that of the industry in other countries, particularly the U.S. or China – assessment of the
similarities and differences in your industry Mexico and other countries in areas such as
competitive environment, customer environment, opportunities and challenges, key
success factors, etc.
11) Strategic importance of the country in regard to global competition in the industry –
importance of the country in the global context of the industry in terms of market
opportunities, access to factors of production, access to new innovations, competitive
positioning, as a base for exporting to other countries, etc.
12) Conclusions and recommendations about opportunities for foreign companies to compete
in the industry in Mexico – motivations for foreign companies to participate in the
industry in Mexico, likelihood of new foreign entry into the industry, etc.
13) Conclusions and recommendations about opportunities for local companies domestically
and globally

FBE-462: Handouts
Page 282

FBE-462: Handouts
Page 283

FBE-462: Handouts
Page 284

FBE-462: Handouts
Page 285

FBE-462: Homework
Page 286

FBE-462: Homework
Page 287

FBE-462: Homework
Page 288

FBE-462: Homework
Page 289

FBE-462: Homework
Page 290

FBE-462: Homework
Page 291

FBE-462: Homework
Page 292

FBE-462: Homework
Page 293

FBE-462: Homework
Page 294

FBE-462: Homework
Page 295

FBE-462: Homework
Page 296

FBE-462: Homework
Page 297

FBE-462: Homework
Page 298

FBE-462: Homework
Page 299

Page 300
FBE-462 1/11/07 10:12 AM
Globalization and global trade overview

• People same
• Communicate (transaction cost goes down)
• Trade freer
o Goods and services
o Capitals and labors
• Interdependence
o Factors of production
• Technology
• Conflict
• Trade is more regional
o 49% of Asian exports go to Asia, if you add 20% to that (the
amount that goes to North America), you see that over 70%
of Asian trade is within Asia

Page 301
FBE-462 1/16/07 10:01 AM
Basic mercantilist idea assumes that the more precious metals a country
has, the wealthier it is
• This promotes exports, and dissuades from high imports
• Agriculture was always the heavily protected industry protected
back then, during this period
Is trade a zero-sum game?

• Barriers still exist in trade among countries
• As long as there are barriers, there is arbitrage
• Globalization process creates winners and losers, more social
stratification, some countries are becoming worse off than they
were before
Wealth of a nation should be measured by the amount of goods and services

that can be produced, not by the amount of gold
• This is less convenient than gold, but better
• Today, we see gold as just another good, like anything else
• Many people still think that export is better than import, without
any preconditions
• Section 301 is a trade law that says that any foreign country that
has an excessive trade imbalance with the US, the US will enter
into trade negotiations with that state to attempt to eliminate this
imbalance
o This was targeted at Japan when it was first introduced
• Consumer surplus
• Utility curve for consumers, indifference curve, the shit learned last
semester in Econ for business – the more of a good one has, the
less it is worth to them
• Marginal willingness to pay for a good or service
• Consumer surplus is $2 if the consumer is willing to pay $8 for a
service, but only has to pay $6
• Selling Apples, market price is $10 but you are willing to sell them
for $8, producer surplus is thus $2
Autarky to open economy

• Supply equals demand

Page 302
• What is the total wealth of this country?

• Total welfare of a nation is consumer surplus plus producer surplus
(CS+PS=Total Welfare)
• North Korea is a close example of this, China before 1978
• In the slide, the difference (e) is exports, when price is above the
market equilibrium of demand and supply
• CS=c, PS=d
• Total welfare in this case is c=d=e, so by engaging in trade, a small
country will benefit (the total welfare of that country is higher with
trade)
• Consider two countries, one is the home country the other is foreign
o One is importing the other is exporting
o World market price is determined by the equilibrium of the
export supply and the import demand
o The smaller the country is, the more relative gains you will
receive from trade from other countries
o We see this, small countries have applied more free trade
policies because of the benefits that come to these countries
from this free trade
o NAFTA set up an emergency fund to compensate those
countries that will be negatively affected by the opening of
trade
o In exporting country, consumers will suffer and producers will
gain, while this is vise-versa in importing country
General Equilibrium Approach

• Production possibility frontier
• There is a line tangent to the production frontier that shows world
relative price, this line meets consumer utility curve
• Relative price of cloth, versus relative cost of wheat
• Suppose in a world market, cloth is more expensive than wheat
• The world market price line (in the slide) will be steeper
• Price of exports divided by Price of imports = relative price of
exports or TOT (terms of trade)
• When terms of trade increases, line gets steeper and country can
get more of relative product for each product being exported

Page 303
• China, long history of China

• Chinese have small bananas, while the US has very big bananas

Page 304
FBE-462 1/18/07 10:06 AM
Why nations trade?
Going over handout given in class
“The halo Effect” article from the economist
Benefits
• Change in relative prices will be good for developed countries
Downsides
• Hurts developing countries who are competing with China in
industries attractive to developing nations
For a developed country, TOT (terms of trade) will improve because of this
effect in China, with 200 million unskilled workers
“One man’s junk is another man’s treasure” article for today

• Scrap metals, papers
• Trash is the number one export from the US to China
• This is based on relative prices, exports of scrap metals, papers, et
cetera are cheaper as raw materials in China than getting these
products in others ways from within China
Another example of how demand affects imports and exports

• Chicken breast exported to the US from China, more demand for it
here than there
• Chicken slaughtering in China
Case Analysis
• Corn law- protecting agriculture industry within the UK (not just
corn, many other agricultural products as well)
• Case is about Britain thinking about appealing the corn law and
opening free trade of agriculture
• Pros of this proposition
o Price of agricultural goods in the UK will go down

Page 305
o Trade relations with countries supplying these goods might be

improved
o Better usage of land within the UK, instead of subsidized
agriculture
o Shifting resources to other industries, reduce strain on
government funds to subsidize farmers
o Solve certain food shortage problems
o More varieties of goods available in the country
• Cons
o Farmers’ wages will decrease
o Increase dependence on other countries for agricultural
products
o Other countries may not reciprocate
o Will the economy be able to absorb the shock?
o Losing political support from farmers
o Loss of revenue and fairness

Page 306
FBE-462 1/23/07 10:01 AM
Why Nations Trade?

• What determines supply and what determines demand?
• Substitutes, et cetera
• Article brings up concerns of Southeast Asian countries of whether
or not they will have a competitive advantage over China in
industries that might benefit these nations
• Ricardo’s Theory of Competitive Advantage
Both productivity and wage are very important

• Outsourcing
• Starting to outsource white-collar jobs has caused dispute
Ricardo model
• Requires a high degree of specialization
• Competitive advantage
o If a country has a lower opportunity cost of producing good A,
the country has a comparative advantage in that trade
• The line in the graph is usually not straight in the real world, it is
curved
• Japan is smaller than the US in all respects

Page 307
FBE-462 1/30/07 10:01 AM
Dogswell presentation
Why nations trade
Resource-based trade
Labor-based trade
Chile trade article

• Farming products, most notably fruits, made in Chile (their summer
is our winter)
• Chilean wines are now becoming more competitive in other
countries
• In their winter, we sell them fruits
Brazilian article
• Covering the agriculture sector in Brazil
o Oranges are very competitive, especially orange juice
o Sugar, Coffee, Soy beans
 Growth rate of soy bean exports in Brazil is very high
• Why do they have a competitive advantage in growing?
o Good growing conditions, tropical weather
o Vast amounts of land, it’s a land-abundant country
• Prices of these commodities have gone up (such as orange juice
prices)
Who wins and who loses?

• Everybody doesn’t always win, creates larger income gaps
• For simplicity, assume that production technologies are constant
Article “Working Man’s Dread”

• What happened to the real wage in America since 1973?
o It has gone up at a slower rate than other wages
• Wage is price for labor
• Demand is determined by labor productivity
• Labor for tech jobs has increased, as demand for technology
increases

Page 308
Article “The Sucking Sound From The East”

• Mexico
• Low-skilled manufacturing demand has gone down in Mexico
• They are less competitive, can’t compete with labor costs in China
• Also, Mexico has high energy costs
• Energy sector in Mexico is a monopoly, and has reduced the
competitiveness of their low-skilled work force
• This work force isn’t as productive as China’s work force
• Unions of labor forces in Mexico makes them less competitive

Page 309
FBE-462 2/1/07 10:15 AM
Exam on Tuesday will be similar to class discussions and homework

• There will be a couple of questions on the articles read for the class,
but these questions will be preceded by an excerpt from the article
• Structure of exam will be similar to homework, but a bit longer and
with questions from cases and articles
Who is most likely to benefit from free trade and who is most likely to be
hurt from free trade?
Labor
C W Price of cloth relative to wheat will go up
Land
• Exporting cloth
o Labor will be better off and land owner will be worse off (as
cloth is labor intensive, and price relative to wine will increase
as the country exports cloth)
• US is capital abundant, US will export capital
o Capital owners will likely vote for free trade, and will benefit
from it, labor will be worse off from free trade as labor prices
relative to capital will go down
• Will the two groups always vote against each other on the issue of
free trade?
o It depends on which industry one is in, those in industries
who don’t have a competitive advantage will be protectionist,
those in industries with an advantage will be pre-free trade
o Boeing all voted for a most-favored nation status for China
Section 5: Economies of Scale and Trade

• Intra-Industry trade
o US imports and exports cars
o US sells soybeans, buys shoes from China
Economies of scale
• External economies of scale (EES)
o Prices go down when the entire industry gets bigger

Page 310
• Internal economies of scale (IES)

o Prices go down as the size of operations within the firm
increases
• C = F + a*X
• AC = (C/X) = (F/X) + A
• The more a firm produces, the less the fixed costs per unit are
Perfect Competition Monopoly
Monopolistic Competition Oligopoly
• Companies often merge if the fixed costs factor is high enough, this
way Internal Economies of Scale come into effect
o Examples here are car manufacturers and banks
• Monopolistic competition: Each firm is a monopoly in its own
product, but competes with similar products
Scale economies and product differentiation

• Two countries that are exactly the same
o Instead on each country making some expensive cars and
some cheap cars, these nations will benefit from economies of
scale if one nation produces cheap cars only and the other
country produces expensive cars only

Page 311
FBE-462 2/13/07 10:19 AM
Dutch disease
• Currency appreciation
• Direct result of the resource-based trade model
• Immiserizing growth: Even though there is a harvest of coffee,
because of price drops some coffee producers are worse off than if
they had not increased production
o In a small country, growth is always good
o Balanced growth for a large country is usually good
o Growth biased towards export sector of a large country, may
be worse off- prices of export drop, country gets less of
import product for each unit of export product
• Economic growth can also affect the TOT
• When export growth occurs in a large country, world price may
decrease and effect TOT so much that the country is worse off (with
a small country, world price may not be affected as much)
• ISI strategies (He calls is Import Substitution Strategy)
Product cycle theory

• Dynamics of comparative advantage
• Comparative advantage changes over time because of economic
growth
o South Korea and the shoe-making market
• Countries will gain competitive advantage, and other will lose it, its
all part of a cycle
• Difficult to figure out when a country will lose its competitive
advantage, took about 20 years for South Korea to lose its
competitive advantage in sneakers
Tariffs – Section 7

Page 312
FBE-462 2/15/07 10:03 AM
Tariffs – Basics
• NAFTA- trade should be duty free by 2015
• Preferential duties
• GSP (Generalized System of Preferences)
• Weighted average of tariff rates- weighted average based on dollar
amount of trade of each product/service
Welfare of import duty

• Small nation: its TOT is given
• Tariff has no effect on its TOT
• Gain or loss?
• For large countries, when tariff is imposed the world market price
drops and P-star (P*) declines, making the Tariff more than it would
be for a small country

Page 313
FBE-462 3/20/07 10:17 AM
Dumping and Anti-dumping

• The product is sold in another country at lower than the fair market
value
o How does one determine the fair market value?
o Compare to other similar products or prices of same or similar
products in other countries
o If you can’t do this, base it on the cost of production
• The case of China and shrimp dumping
o There is a 112% import duty on shrimp from China
o Even though price is lower in China, this can’t be used for
comparison in determining fair market price because Chinese
are commies
o The US just makes excuses why it can’t use local price for
comparing shrimp prices in the US (i.e., in Thailand they eat
fresh shrimp so its OK that the price for shrimp there is lower
than the price for Thai shrimp in the US)
• Conditions for dumping to occur
o Imperfect markets
o Segmented markets
• Types of dumping
o Predatory dumping
 Very difficult to do this, because after you raise prices
back up, more competitors will enter
o Cyclical dumping
 Dumping Christmas trees at low prices after Christmas
is over
o Persistent dumping
Export subsidy and countervailing duties

• China is the largest cotton producer, with US coming in second and
India coming in third
• US cotton subsidy is $2 billion
• Divide that out, you get $120,000 to produce cotton in the United
States

Page 314
FBE-462 3/22/07 10:07 AM
Export subsidies
• Consumers lose welfare
• Producers gain welfare
• Government must pay for subsidy
• Results in a deadweight loss
• Country will always lose if implementing a export subsidy, whether
the country is large or small
• European agricultural industry
o Agriculture goods are more expensive in Europe
o Land for farming is limited in Europe, makes it hard for them
to compete in the world market
o World price is $10 for farm goods, EU set a price floor at $15,
at one point 75% of the EU budget was for buying Europe’s
excess supply
o EU implemented an export subsidy of $5, so farmers had
incentive to export their excess production to foreign
countries (this way they wouldn’t have to spend so much
buying and storing excess production)
o Many reasons for the original protection of the agriculture
industry

FBE-462: Group Project
Page 315
Mexican Wine Industry Analysis

Prepared by:
Eric Chen
Cyrus Chini
Alex Daly
Shelley Goto
Keith Parker
FBE 462 – International Trade and Commercial Policy

April 19, 2007

Page 2 of 17Page 316
Executive Summary
This report on the Mexican wine industry is intended to serve as a resource for both domestic
wineries and foreign wine companies considering Mexico as a potential investment opportunity.
As a truly global industry, we had to center our analysis of Mexico’s wine industry within the
context of this international market. What we found on a global level is a $90 billion industry
undergoing a serious transition, with New World producers reinventing the way that wine is
produced, distributed, and marketed, and challenging the traditional vintners of Europe
worldwide. Scale economies and cost efficiency, consistent quality, and aggressive branding
campaigns have replaced esteemed terroir as the success factors for wineries. Tariff barriers and
regulations are falling, allowing almost any wine-producer to compete worldwide.
Turning to Mexico, we will examine the $230 million wine industry in terms of its factor
endowment advantages and infrastructural and customer base shortcomings. There is very little
foreign investment in the industry, and the largest domestic wineries have done little to break
into export markets. An analysis of the environment facing Mexican wineries highlights the
favorable political and economic policies in place but also the striking lack of experience with
viticulture and interest in wine within the country.
Looking ahead to opportunities and challenges, wineries worldwide will continue to compete
aggressively for the sole growth segments of premium and super-discount wines. Innovative
branding and access to solid distribution channels will continue to be essential. In the end, we
offer the following recommendations:
o Mexican wineries must place much more emphasis on these marketing concepts and
strongly push the export of their premium and super-premium wines.
o Due to existing global oversupply and the many challenges impeding successful
operations in Mexico, we do not believe that any foreign wine companies should look to
invest in the Mexican industry.

Page 317 Page 3 of 17
Mexican Wine Industry Analysis
A Global Overview
The global wine industry is currently undergoing a drastic transition. In the past 30 to 40 years,
this $90 billion industry has changed from a European agricultural product based on centuries of
tradition to a globally competitive, marketing-centric industry. New World producers in
Australia, the United States, and South America have turned the conventions of wine-making
upside down, utilizing huge plots of fertile land, implementing advanced agro-industrial
techniques, and aggressively pushing the exports of strongly branded wines.
Major Players
Though their hold over the market is declining, the largest wine exporters are still the traditional
countries of France, Italy and Spain, followed by the United States and Australia. However,
even though France and Italy produce far more wine than New World countries, the two largest
wine companies are from the U.S. and Australia. A 2003 merger between Constellation of the
U.S. and BRL hardy from Australia formed the world’s largest wine producer, just passing E&J
Gallo of California. These conglomerates have achieved economies of scale in both production
and distribution that far exceed any current competitors in Europe.
Consumption Patterns
Wine consumption is still concentrated in Europe, with France, Italy and Spain being the three
largest wine markets in the world, but per capita consumption is rapidly declining in these
traditional wine regions – from over 100 liters per capita in 1966 to under 60 liters today. At
the same time, wine consumption is steadily increasing in North America, Australia, and most
rapidly in totally new markets such as Asia and Africa. Across all markets, demand for higher
quality wine is actually still growing, leading to an emphasis on quality, not quantity. Trend-

wise, red wines are on the upswing, and younger consumers especially look for new, more
exciting wines than the traditional Chardonnays of the 1980s. With their open acreage for
planting and more consistent production, New World wineries are much more capable of
adjusting to these changing trends than European competitors.
New World Innovations
Australian, American, and South American entrepreneurs have fully taken advantage of their
ability to carve a domestic industry out of nothing – to completely reinvent wine-making.
Utilizing resource factors such as abundant land, a warmer climate, and capital intensive
technology, New World producers are now challenging European wine makers in almost every
market and at every price segment. The use of irrigation, trellis growing systems, scientific
experimentation, stainless steel fermentation tanks has all but eliminated the annual quality
variations that affect the consistency of European wines. New marketing techniques such as half
gallon bottles, screw off tops, and boxed wines have also proven very attractive to consumers, in
addition to reducing shipping and storage costs.
The Rise of Australian Wines
“Australia is the driving force in the global wine industry.”1 This quote would have been
unheard of just 30 years, but since Australia is now the largest wine exporter to the United
Kingdom, it is probably fitting. Due to their relatively small domestic market, Australian
wineries had to combine their new production methods with an aggressive marketing campaign
to establish themselves on the international stage. Companies such as BRL Hardy and Southcorp
vastly improved the accessibility of wine by simplifying their denomination systems and
1
The Economist. “Blended.” http://economist.com 23 June 2003.

establishing strong brand identities that could carry over from one varietal to the next. Their
methods have obviously worked, as Britain, long considered a key import market due to its lack
of domestic production, now sells more Australian wine than French wine. Showing how much
the industry has changed, a recent study shows that British consumers choose their wines based
on previous purchases, price, country and occasion, in that order – nothing to do with the region
or variety, which are two areas often focused on by traditional wine-makers. 2
South American Experiences
Of particular interest to the Mexican winemakers may be the successes of the wine industry in
Chile and Argentina. Argentina is the world’s fifth biggest wine producer, most of which is
consumed domestically, and Chile is one of the most competitive wine exporters. Argentina has
all the natural endowments necessary for wine production, and its exports have increased
dramatically during the past seven years of domestic stability – many of its signature varietals
are especially popular with American consumers.3 Chile, on the other hand, has followed
Australia’s model of strongly branding its wines and even promotes its exports through the use
of overseas wine trade groups. Chile has been further aided by its existing free trade agreements
with countries including the United States, Japan, and South Korea.
Cost Structure of the Industry
New World wine producers launched their immensely successful growth based on their
efficiency and ability to essentially mass produce what was once considered an artisan’s product.
While the quality of wine exported by countries such as Australia and Chile has greatly
2
Campbell, Gwyn and Nathalie Guibert. “Introduction.” The British Food Journal 108:4 233-39.
3
The Economist. “Vino’s Twin Peaks.” http://economist.com 15 Mar 2007.

improved, a large part of their competitive advantage still stems from lower production costs, of
which there are four major components:
• Grape costs per case
• Crush and Capitol costs
• Barrel Costs (corks, labels, etc.)
• Dry goods costs per case
Grape Costs
Depending on the quality of wine produced, this cost sees the most variability. For Basic quality
wines, grape costs are usually around 8% the total cost of production. On the other end of the
spectrum, for Ultra-Premium quality wines, the cost of grapes range from around 65%-85% of
the total cost of production. Of greater importance, however, is the fact that the amount of
grapes needed for a 9L case of Ultra-Premium Australian wine can be produced for $45.45 as
opposed to $104.55 in France.
Crush and Capitol Costs
This category includes the cost of the machinery and labor used to produce the wine. These costs
are usually fixed and do not see much variability between the different qualities of wine nor
between the different wine-producing countries. Costs range from $13-20 for each 9L case
produced.
Barrel Costs
These costs are relatively 0% for lower quality wines and only reach up to about 2% of the total
cost of producing higher quality wines.

Dry Goods Costs
The costs remain less than 1% of the production per case regardless of the quality of the wine or
the country. But when all of the production costs are added together, New World wineries are
able to achieve significantly higher margins than European producers across every market
segment and most notably with their Super-Premium and Ultra-Premium wines. In these
segments, Australian winery margins of 17% and 50%, respectively, far outshine the 4% and
18% of their French counterparts. Further downstream profits are also available for companies
who have vertically integrated enough to own their own marketing and distribution channels.
Regulations
The historical status of wine production in Europe plays a major role in the cost structure of the
wine industry. Heavy fines may be imposed if guidelines are not properly met, and many
countries that produce wine, mostly in Europe, have restrictions placed on grape varieties in
particular regions. Other regulations may include the amount of sugar content in the wine, the
amount of time spent aging the wine, and the geographic origin of the oak used for barreling.
These sorts of limits hurt certain countries when there are shifts in demand. For example, if the
market demand shifts to a drier red wine, there may be restrictions holding back wineries in
certain German regions from producing what the market demands. With their non-traditional,
more market-based approach, New World producers are largely free from these constraints and
can quickly adapt to market preferences.
Tariffs
The tariffs applied to the imports of wine vary greatly from country to country. The United
States charged a tariff of $0.063 per liter of wine in 2002, which is one of the lowest in the

world.4 Other import tariffs range from $0.11 per liter in Europe, to 4% ad valorem in Mexico,
to 60% ad valorem in Hong Kong. A 2002 Mutual Acceptance Agreement (MAA) on
Oenological Practices signed by the U.S., Canada, Chile, Australia, and New Zealand sought to
promote the international wine trade and ease barriers.5
Strategic Market Analysis
Wineries have two main customers:
Wholesalers
Retailers such as grocery stores, liquor stores, etc. obtain the wine they sell from their
wholesalers or wine merchants, who have previously purchased cases from the wineries
themselves. Wine retailing has undergone a shift in recent years, as large, powerful grocery
chains or wholesale stores such as CostCo have exerted more influence on their distributors.
These chains are able to demand a large scale and scope from their distributors, meaning the
most successful wine producers will often be those who are able to provide their distributor (or
retailer if the winery owns their distribution) with enough variety to stock an entire grocery shelf.
And of course, the wine conglomerates of Australia, Chile and the United States are in a much
better position to do this than the independent vintners of Bordeaux.
End Consumers
Wine drinkers can also purchase their wine directly from the winery but this method is often
inconvenient, and largely relegated to small, local wineries that are unable to gain access to
broader distribution channels. End consumers are much more likely to purchase their wine at a
local retailer. To reach more consumers, producers strive to create a diverse product line to
4
Penn, Cyril. “Wine Gaining Ground in US Trade Outlook.” Wine Business Monthly
5
Penn.

appeal to all palates. For example, German wineries do their best, with respect to regulations, to
respond to the market demand in sweeter wines by producing their own brand of dessert wine.
These shifts in ‘fashion’ are one of the biggest challenges wineries are faced with. Strict
regulations prohibit many Old World wineries from quickly meeting the new demands.
Competitive Analysis of Mexico’s Wine Industry
With this understanding of the global wine industry, we can now turn specifically to Mexico. In
2005 the Mexican wine industry generated revenues of $230.2 million, and growth is expected to
accelerate in the coming years, with the market reaching $313.6 million by 2010.6 The industry
centers around the city of Ensenada in Baja California, which accounts for 90% of the quality
wine produced in the country. Other major winegrowing regions include Guadalupe, Calafia,
San Vicente and Santo Tomas Valleys. Although Mexico is not a global leader in the wine
industry, one advantage it has over many other countries is its weather. Baja California lies
above the 30th parallel on the Pacific Coast and has the perfect climate of hot days and cool
nights needed for winegrowing, allowing grapes to develop their sugar without a corresponding
drop in acidity.
Challenges for the Industry
Even though Mexico has this ideal weather for producing high quality grapes, the Mexican wine
industry still faces many barriers, one of which is the relative shortage of wine drinkers.
Traditionally, wine is not the primary choice of alcoholic beverage for Mexican people, who tend
to prefer beer and tequila. Domestic consumption is further discouraged by the fact that the
Mexican government put a 40% tax on each bottle of wine, making it harder for wine to compete
with the more traditional Mexican beverages. A more complicated challenge for the Mexican
6
Datamonitor Industry Market Research. “Mexico – Wine.”

wine industry is the water supply, specifically the management of water use in the winegrowing
areas. Controlled water stress has worked well for Mexican wineries in the past, but due to the
proliferation of new wineries, many Mexican vineyards that require irrigation are not getting
enough water supply. On top of that, the fact that the city of Ensenada is growing rapidly results
in even less water available for the vines, leading Josef Backhoff to argue that “if the region were
to have no problem with water, without a doubt we would be growing 10 times faster."
The Market Leader – L.A. Cetto
There is very little foreign involvement in the Mexican wine industry, but there are a few
domestic companies that have enjoyed some success both domestically and internationally. The
largest producer is L.A. Cetto. L.A. Cetto is a family owned company that has a large vineyard
in the Guadalupe Valley and Sonora and annual sales of 1.8 million liters. The winery divides its
wine into three different levels, commercial blends, the single varietal series, and the "Limited
Reserve". In addition to the more common wines, it also sells wines that acknowledge their
Italian heritage, such as Nebbiolo and Passito dessert wine, as well as the Californian specialties
of Zinfandel and Petite Syrah. Overall, L.A. Cetto enjoys a great deal of success; it has a large
market share of 9.9% within Mexico, and exports about 40% of its total wine production.
Other Mexican Wineries
The second biggest producer in Mexico is Bodegas de Santo Tomas, with an 8.8% market share
and sales of 1.6 million liters in 2005. Another winery that is doing fairly well is Monte Xanic.
Monte Xanic is smaller than L.A. Cetto, but it is a proud winner of numerous prizes, including
the bronze medal at the 2000 Challenge International Du Vin in Blaye-Bourg, France for the
1998 Monte Xanic Chardonnay. Strategically speaking, Monte Xanic chooses to differentiate
itself by concentrating on Bordeaux varietals and Chardonnay.

Environmental Analysis for Mexico’s Wine Industry
Economic Environment
Despite primary and secondary education being free and mandatory, 47% of the population live
below the poverty line.7 This provides an abundance of cheap, disposable labour, which is
especially useful in a seasonal, labor-intensive industry as is wine. Since the growing and
harvesting season only comprises about a third of the year, the ability to pick up seasonal
workers is very important to the industry, and Mexico can provide that. The relative abundance
of labor along with the shortage of available jobs for low-skilled employment allows the winery
to freely hire and fire as many workers as it needs, allowing them to keep wages down and profit
maximized.
The second important dimension of the economic environment is overall macroeconomic
stability. While the economic and financial crises that Mexico experienced in the 1980s and
1990s may seem to be distant memories, in terms of wine-growing this really is not that long at
all. To produce top quality wines, vintners must wait as long as 20 years to really see their
investment mature, which helps explain why wine production and exports in the more stable
Chile have grown so much more rapidly than in Argentina.
Cultural Environment
From our first-hand experiences in Mexico, it was apparent that Mexico has a very small
domestic market for wine. The alcohol sector is dominated by beer and tequila, because those
are the more traditional drinks. This means that if wineries and the industry want to expand, they
will have to export a good portion of their product.
7
Ed. Starr, Pamela K.. Challenges for a Postelection Mexico: Issues for US Policy. Council on Foreign Relations.
Council special report no. 17, November 2006

Political Environment
Mexico is very open to trade; they have free trade agreements with about 40 different countries.8
Also, as the NAFTA transition periods progress, and US-Mexico trade becomes more and more
open, whatever tariffs exist on liquors and wines will be dropped along with the rest of the agri-
business sector.9 This will give Mexican wineries a large market in the US that allows low
transportation costs, and a favorable market. This would give them a larger target market and
allow them to expand beyond the capacity of the domestic market.
Technological Environment
Mexico, unlike the more traditional wine-producing regions like France and other European
states, lacks the rules and regulations regarding the traditions in wine production. Therefore, it
can utilize technological advances like steel vats for brewing white wines, as we observed at L.A.
Cetto. This gives the Mexican wineries an advantage in the cheaper-grade or boxed wine
industries that can be produced en masse.
Policy Analysis
NAFTA’s effect on the industry
About 90% of all Mexican imports go to either the US or Canada, both of which have an
appreciation for imported wine and cheap wine.10 Also, the lower trade barriers allow for the
Mexican wineries to take advantage of lower transportation costs to the US and Canada as
opposed to overseas. Also, as the NAFTA countries continue to integrate, Mexico will have
8
Ed Starr.
9
Adams, John A., Jr.. Bordering the Future: The Impact of Mexico on the United States. Praeger Publishers:
Westport, Connecticut. 2006
10
Starr.

freer and freer access to the North American markets, allowing them to expand their wine
exports.
Border Control
Since there is a 1 liter limit on how much alcohol private citizens can bring across the border
from Mexico to the US, Mexican wineries can mark up the prices of wine they import based on
supply and demand. Since the US consumers can therefore really only get Mexican wines
domestically as opposed to buying in bulk while south of the border and bringing it back, the
wineries can up the price that they charge distributors in the states to reflect that exclusivity.
In addition to this, the increased security at the border is draining California wineries of their
supply of seasonal workers. The migrant workers that used to pick the wineries’ grapes during
the relatively short harvesting season can no longer go to the US from Mexico as easily. This
restriction on the international mobility of labor gives Mexico a comparative advantage over the
US wineries, since the labor is much cheaper and more readily available in Mexico.
China’s Effect on the Industry
Although China is the world’s sixth largest producer of wine, it consumes most of it domestically,
and does not rank among the top ten wine exporting countries.11 In the future, however, China
may become a threat to the Mexican wine industry, especially as the country becomes more open
to western cultures and consumables. Analytically speaking, China has the climate, the
resources and the land for wine production, it just hasn’t taken off because wine in the
conventional sense is not traditionally a part of Chinese culture. Right now, in the wine and beer
sectors, Mexico exports over 200 times as much as China does to the US.12 Mexico, as well as
11
FAOSTAT. Food and Agriculture Organisation of the United Nations. http://faostat.fao.org. 12 April 2007.
12
USDA Foreign Agricultural Service (FAS). United States Department of Agriculture: Foreign Agricultural
Service. http://www.fas.usda.gov. 12 April 2007

any other wine-producing country, will continue to benefit from China staying out of this export
market.
Competitive Environment
The domestic array of wine producing competitors in Mexico is very limited, due to its status as
a relatively under-developed market for wine production. Competition from imports poses a
very strong risk to any potential wineries in Mexico, though. Established foreign wine producing
markets have years of experience in making high quality wine in bulk at low prices, most notably
the California and Australian markets. Further, European wineries have long produced premium
wine brands and still hold a large portion of the world wine market, despite the problems they
have had in recent decades. In order to develop as an effective world wine-producing competitor,
Mexico would first have to develop its own domestic wine market. Currently, Mexico makes
up .7 percent of the wine market for the Americas.13 With such a small market, it would be
difficult to establish the image of desirability so needed in this competitive industry. Further,
wine making has been making a move from a labor-intensive business to a capital intensive
business, as evidenced by the emergence of very large mass-producing wine companies such as
E&J Gallo, who recently posted a US$4 Billion revenue intake. While California is known for
its abundance of Capital, Mexico is not.14 These conditions paint a clear picture of the
difficulties Mexico would face in emerging as a competitive force in the world wine industry.
13
“Wine Industry Overview.” Business and Company Resource Center, 11 April 2007
14
“Business: Blended; Wine Industry Mergers.” The Economist, 25 January 2003

Customer Environment
When looking at consumer trends in the wine industry in Mexico, the picture is a little brighter.
While US wine sales growth has slowed from its record-breaking numbers in the 90s, Mexican
consumers’ demand has seen recent sharp increases. Wine sales in Mexico are expected to have
a compound annual growth rate of 6.2 percent, compared with similar markets such as Brazil
who have seen growth slide to 1.9 percent.15
Opportunities and Challenges
The vast majority of growth in the wine industry has been in the premium wines and super-
discount wines. The market for wines between these two extremes has seen very little growth,
and often market shrinkage. As the Mexican wine industry is fairly under-developed, wine
producers in this market have little opportunity to achieve the scale needed for the production of
super-discount wines, the opportunity in this market lies in premium brands. This actually
coincides nicely with the wine-growing conditions in Mexico, as the Mexican climate and soil
are said to be very conducive to premium grape growing. Also, when looking at the target
market for wine consumption in Mexico, the focus will quickly fall to the upper-middle to higher
income population. This segment, and specifically urban professionals with travel experience
and greater discretionary spending, will be the people most likely to venture away from the
traditional choices of beer and tequila. An opportunity for Super-Premium and Ultra-Premium
wines exists here as a status symbol.
Furthermore, as mentioned earlier, the lack of domestic competitiveness leads to a lack of
pressure for innovation and improvement in quality; conversely, the highly developed wine
producing regions around the world are constantly under pressure from competitors to improve
15

quality and to rapidly innovate. A major boost from foreign investors with agricultural,
technological, and most importantly marketing experience would probably be needed to really
raise the Mexican wine industry up to the standards of even Chile or Argentina, but the problem
lies in attracting these investors.
Conclusions and Recommendations
With this understanding of the global wine industry, the economics of wine production, the
history of the industry in Mexico, the overall business environment in Mexico, and the ongoing
development of the wine market in Mexico, it is possible to make some concluding
recommendations for both local wineries and foreign companies considering expanding to
Mexico.
Domestic Producers
For a domestic winery such as LA Cetto to be grow and be successful both domestically and
internationally, we strongly believe the emphasis must be placed on quality and branding, due to
the fact that the only segments that continue to grow in sales on a global basis are the premium
wines. The primary challenge in entering the market as a high quality brand is the development
of a strong brand image. In order to compete in the premium wine segment, a Mexican wine
producer would need to develop a brand image that could compete with well established and
respected brand name labels from Australia, California, France, Italy, and others. Given the fact
that Mexico has no history of wine-making, this could prove especially challenging. However,
since there have already been a few wineries such as Monte Xanic experiencing success
internationally, perhaps the Mexican government could consider export subsidies for the wine

industry, or at least looking into MAA’s such as the one signed in 2002 to promote their
involvement in the international wine trade.
Foreign Companies
In the final evaluation, we do not believe that the Mexican wine industry is a desirable
investment opportunity for foreign wine companies looking to expand. As mentioned above, the
infrastructure in Mexico is still lacking, especially in regards to irrigation and water supply, but
also concerning financial and economic stability. The domestic market for wine is also very
small, meaning a new foreign producer would have to focus almost entirely back on their home
market, limiting the advantages to be gained from economies of scale. This need to focus almost
entirely on exports would cause problems of its own due to the fact that there is very little
recognition of Mexican wines worldwide. With no wine heritage, it would be very hard for a
new Mexican wine to compete with the established vintners of Europe, the US, Australia, or
even Chile. Furthermore, success in the wine industry is currently being driven by marketing
and quality, and while foreign investors could bring their branding experience to Mexico, they
would have a very difficult time establishing a competitive image for Mexican wines. Finally,
and perhaps most fundamentally, there is currently a huge global oversupply of grapes for every
type of wine except specialties such as champagne and port. In the face of declining global
consumption and falling prices for grape growers, there is simply no reason for a foreign firm to
make the huge investment necessary to jumpstart the Mexican wine industry.

Page 332
Comparison of markets
Competitive Environment
The domestic array of wine producing competitors in Mexico is very limited, due
to its status as a relatively under-developed market for wine production. Competition
from imports poses a very strong risk to any potential wineries in Mexico, though.
Established foreign wine producing markets have years of experience in making high
quality wine in bulk at low prices, most notably the California and Australian markets.
Further, European wineries have long produced premium wine brands and still hold a
large portion of the world wine market, despite the problems they have had in recent
decades. In order to develop as an effective world wine-producing competitor, Mexico
would first have to develop its own domestic wine market. Currently, Mexico makes up
.7 percent of the wine market for the Americas.1 With such a small market, it would be
difficult to establish the image of desirability so needed in this competitive industry.
Further, wine making has been making a move from a labor-intensive business to a
capital intensive business, as evidenced by the emergence of very large mass-producing
wine companies such as E&J Gallo, who recently posted a US$4 Billion revenue intake.
While California is known for its abundance of Capital, Mexico is not.2 These conditions
paint a clear picture of the difficulties Mexico would face in emerging as a competitive
force in the world wine industry.
Customer Environment
When looking at consumer trends in the wine industry in Mexico, the picture is a
little brighter. While US wine sales growth has slowed from its record-breaking numbers
1
2
“Business: Blended; Wine Industry Mergers.” The Economist, 25 January 2003

Page 333
in the 90s, Mexican consumers’ demand has seen recent sharp increases. Wine sales in
Mexico are expected to have a compound annual growth rate of 6.2 percent, compared
with similar markets such as Brazil who have seen growth slide to 1.9 percent.3
Opportunities and Challenges
The far majority of growth in the wine industry has been in the premium wines
and super-discount wines. The market for wines between these two extremes has seen
very little growth, and often market shrinkage. As the Mexican wine industry is fairly
under-developed, wine producers in this market have little opportunity to achieve the
scale needed for the production of super-discount wines, the opportunity in this market
lies in premium brands. This actually coincides nicely with the wine-growing conditions
in Mexico, as the Mexican climate and soil are said to be very conducive to good grape
growing. The primary challenge in entering the market as a premium brand is the
development of a strong brand image. In order to compete in the premium wine segment,
a Mexican wine producer would need to develop a brand image that could compete with
well established and respected brand name labels from Australia, California, France,
Italy, and others. Further, as mentioned earlier, the lack of domestic competitiveness
lends to a lack of pressure for innovation and improvement in quality; conversely, the
highly developed wine producing regions of the world are constantly under pressure from
competitors to improve quality and to rapidly innovate.
3

Page 334
Agenda
Entering the Mexican • Global Wine Industry Overview
Wine Industry • Industry Cost Structure
• Overview of Mexican Wine Market
Professor Chen
FBE-462 • Analysis of market externalities
Yu Chen
Cyrus Chini
• Opportunities and Challenges
Alexander Daly • Conclusion and Recommendations
Shelley Goto
Keith Parker
The Reshaping of the Competitive

Global Wine Industry Overview Environment
• $90 billion industry in 2002 • The decline in European
• Largest national producers and exporters dominance
– France, Italy, Spain, United States, Australia – Falling consumption rates
• Key import markets – New World production methods and
innovation
– Germany, United Kingdom, United States, France
– Oversupply of grapes
• Major wineries/conglomerates
– Constellation, LVMH, E&J Gallo, Southcorp, • The rise of Australian exports
Seagram
• The South American experience
Cost Structure of the Industry Market Analysis

• Production
– Grape Costs
– Crush and Capitol Costs
– Barrel Costs Winery Wholesaler Retailer End Consumer
– Dry Goods Costs
• Non Production
– Regulation Fines
– Tariffs
– Marketing, Shipping, and Distribution
1
Page 335
Advantages and Disadvantages of

The Mexican Wine Industry
the Mexican Wine Industry
Weather
• Centered in Ensenada
Water Supply
• Guadalupe, Calafia, San Vicente and
Santo Tomas Valleys
Number of Wine Lovers
Main Wine Producers Environmental Analysis

in Mexico • Economic
– Abundance of cheap, low-skilled labor
– Favors the seasonal nature of the wine
L.A. Cetto industry
– Possibility of macroeconomic instability
• Political
Monte Xanic – Free trade agreements
– NAFTA
Environmental Analysis Policy Analysis

• Cultural • Border Control: mobility of goods
– Small domestic market – Limited amounts may be brought across the
– Expansion opportunities lie in exports border
– Marketing necessary to increase domestic – Can sell for a higher price to reflect exclusivity
consumption • Border Control: mobility of labor
• Technological – US lack of cheap seasonal labor
– Lacks traditional wine-making regulations – Give Mexican producers an advantage
– Cheap mass production possible
2
Page 336
Policy Analysis Competitive Analysis

• NAFTA • Domestic Wine Competition
– Take advantage of US markets – Very Limited
– Continuing integration promises less profit • International Wine Competition
loss to tariffs – Very large and established
• China – Have reached Economies of Scale and Scope
– Large producer, but not exporter – Competitors have established images
– Has the resources to take market share • Very hard to develop
away, but less cultural incentive • Mexico currently doesn’t have the right image
Opportunities and Challenges Conclusions and Recommendations
• Overall Industry Growth • Domestic Firms

– On the extremes – Focus on branding – creating a Mexican identity
– Mexican entrants should focus on Premium – Expand exports, especially within premium segments
• Establishing a Premium Brand • Foreign Companies – NOT attractive
– Good Terroir in Mexico – Infrastructure not in place
– Would compete with established name brands – Domestic market too small
– Lack of significant domestic competition – Lack of a national wine heritage, limited branding
• Less innovation possibilities
• Less pressure for higher quality – Global oversupply
Thank You
Questions?
3
Business & Company Resource Center -- Market Research Display Page http://msbapps02.marshall.usc.edu:2059/servlet/BCRC?locID=usoc...
Page 337
Business & Company Resource Center
Datamonitor Industry Market Research, Nov 15, 2006 pNA
Mexico - Wine.
(L.A. Cett)(Industry overview)
Full Text: COPYRIGHT 2006 Datamonitor

MarketDefinition
The wine market consists of fortified wine, sparkling wine and still wine.
The market is valued according to retail selling price (RSP) and includes
any applicable taxes. Any currency conversions used in the creation of this
report have been calculated using constant 2005 annual average exchange
rates.
For the purpose of this report, the Americas comprises the US, Canada,
Brazil and Mexico.
ResearchHighlights
*The Mexican wine market generated total revenues of $230.2 million in

2005, this representing a compound annual growth rate (CAGR) of 5.6%
for the five-year period spanning 2001-2005.
*Market consumption volumes increased with a CAGR of 2.5% between

2001-2005, to reach a total of 18.2 million liters in 2005.
*The performance of the market is forecast to accelerate, with an

anticipated CAGR of 6.4% for the five-year period 2005-2010 expected to
drive the market to a value of $313.6 million by the end of 2010.
MarketAnalysis
The Mexican wine market has posted steady rates of growth throughout
2001-2005 and is expected to grow at an even faster pace in the
forthcoming five year period. Similarly to wine markets in Brazil and
Canada, Mexico benefits primarily from the sale of still wines.
The Mexican wine market generated total revenues of $230.2 million in

2005, this representing a compound annual growth rate (CAGR) of 5.6%
for the five-year period spanning 2001-2005. In comparison, the Canadian
and Brazilian markets grew with CAGRs of 4.1% and 1.9% over the same
period, to reach respective values of $4257.8 million and $2235.7 million
in 2005.
Market consumption volumes increased with a CAGR of 2.5% between

2001-2005, to reach a total of 18.2 million liters in 2005. The market's
volume is expected to rise to 19.4 million liters by the end of 2010, this
1 of 6 4/1/07 6:56 PM
Page 338
representing a CAGR of 1.3% for the 2005-2010 period.
Still wines sales proved the most lucrative for the Mexican wine market in
2005, generating total revenues of $183.7 million, equivalent to 79.8% of
the market's overall value. In comparison, sales of sparkling wines
generated revenues of $33.4 million in 2005, equating to 14.5% of the
market's aggregate revenues.
The performance of the market is forecast to accelerate, with an anticipated

CAGR of 6.4% for the five-year period 2005-2010 expected to drive the
market to a value of $313.6 million by the end of 2010. Comparatively, the
Canadian and Brazilian markets will grow with CAGRs of 3.4% and 3.8%
respectively over the same period, to reach respective values of $5026.1
million and $2,697.7 million in 2010.
Value
The Mexican wine market grew by 5.1% in 2005 to reach a value of

$230.2 million.
The compound annual growth rate of the market in the period 2001-2005
was 5.6%.
Mexico Wine Market Value

Unit: USD
Year Value Growth

2001 185300000
2002 197100000 6.4%
2003 207200000 5.1%
2004 219000000 5.7%
2005 230200000 5.1%
CAGR 2001-2005 5.6%
Volume
The Mexican wine market grew by 2.1% in 2005 to reach a volume of 18.2
million liters.
The compound annual growth rate of the market volume in the period
2001-2005 was 2.5%.
Mexico Wine Market Volume

Unit: Liters
Year Volume Growth

2001 16500000
2002 17000000 3.3%
2003 17400000 2%
2004 17800000 2.5%
2005 18200000 2.1%
CAGR 2001-2005 2.5%
2 of 6 4/1/07 6:56 PM
Page 339
Segmentation
Sales of still wine accounts for 79.8% of the Mexican wine market's value.
In comparison, sparkling wine generates a further 14.5% of the market's

revenues.
Mexico Wine Market Segmentation
Year: 2005
Category Percentage
Still wine 79.8%
Sparkling wine 14.5%
Fortified wine 5.7%
Segmentation
The Mexican wine market accounts for 0.7% of the Americas market
value.
In comparison, Brazil generates 7.3% of the market's value.

Mexico Wine Market Segmentation
Year: 2005
Geography Percentage
United States 78.1%
Canada 13.9%
Brazil 7.3%
Mexico 0.7%
Share
L.A. Cetto accounts for 9.9% of the Mexican wine market's volume.
In comparison, Bodegas de Santo Tomas generates a further 8.8%.

Mexico Wine Market Share
Year: 2005
Company Percentage
L.A. Cetto 9.9%
Bodegas de Santo Tomas 8.8%
Pernod Ricard 1.1%
Serena 0.5%
Other 79.7%
CompetitiveLandscape
L.A. Cetto leads the Mexican wine market, with sales in 2005 amounting
to 1.8 million liters, this accounting for 9.9% of the markets volume. Other
significant players include: Bodegas de Santa Tomas, whose sales of 1.6
million liters comprise 8.8% of the markets volume, and Pernod Ricard,
which has sales of 0.2 million liters and a volume share of 1.1% of the
market.
3 of 6 4/1/07 6:56 PM
Page 340
Supermarkets & hypermarkets form the most significant distribution
channel for wine sales in Mexico, accounting for 35.7%. On-trade sales
account for an additional 28% of the market.
This section contains brief overviews of the leading companies in the

Mexican wine market.
Company
L.A. Cett
L.A. Cetto is based in Chapultepec, Mexico. It primarily produces Cava

and exports to 27 countries.
No recent financial data is available.
Company
Pernod Ricard
Pernod Ricard is the second largest manufacturer of spirits and fourth

largest manufacturer of wines globally. It manufactures and distributes
wines and spirits under more than 65 brand names. The company operates
in the Americas, Europe and the Asia Pacific. It is headquartered in Paris,
France and employed about 12,250 people as of December 2003.
The company recorded revenues of $6.5 billion during the fiscal year
ended December 2005, an increase of 46.9% over 2004. The operating
profit of the company during fiscal 2005 was $1.3 billion. The net profit
was $800.5 million during fiscal year 2004, an increase of 22% over 2004.
Supermarkets & hypermarkets are the most important distribution channel,

with 35.7% of the market's volume distributed via this channel.
On-trade accounts for a further 28%.

Mexico Wine Market Distribution
Year: 2005
Channel Percentage
Supermarkets/hypermarkets 35.7%
On-trade 28%
Specialist Retailers 24.7%
Other 11.6%
ForecastValue
In 2010, the Mexican wine market is forecast to have a value of $313.6

million, an increase of 7.3% since 2005.
The compound annual growth rate of the market in the period 2005-2010 is
predicted to be 6.4%.
Mexico Wine Market Value Forecast
4 of 6 4/1/07 6:56 PM
Page 341
Unit: USD
Year Value Growth

2005 230200000 5.1%
2006 242100000 5.2%
2007 255900000 5.7%
2008 275500000 7.7%
2009 292200000 6.1%
2010 313600000 7.3%
CAGR 2005-2010 6.4%
ForecastVolume
In 2010, the Mexican wine market is forecast to have a volume of 19.4

million liters, an increase of 6.6% since 2005.
The compound annual growth rate of the market volume in the period
2005-2010 is predicted to be 1.3%.
Mexico Wine Market Volume Forecast

Unit: Liters
Year Volume Growth

2005 18200000 2.1%
2006 18400000 1.3%
2007 18600000 1.1%
2008 18900000 1.4%
2009 19200000 1.4%
2010 19400000 1.3%
CAGR 2005-2010 1.3%
MacroeconomicData
Population
Mexico Size of Population

Unit: Population
Year Value Growth

2001 101200000
2002 102500000 1.2%
2003 103700000 1.2%
2004 105000000 1.2%
2005 106200000 1.2%
GDP
Mexico GDP
Unit: Real GDP (1995=100)
Year Value Growth

2001 130.2
2002 131.5 1%
5 of 6 4/1/07 6:56 PM
Page 342
2003 133.4 1.4%
2004 137.7 3.2%
2005 142.6 3.5%
Inflation
Mexico Inflation
Unit: Inflation Rate %
Year Value
2001 0.044
2002 0.057
2003 0.04
2004 0.04
2005 0.033
Exchange Rate
Unit: Exchange Rate
Year Value
2001 0.001
2002 0.001
2003 0.001
2004 0.001
2005 0.001
Article A156814249
© 2007 by The Gale Group, Inc.
6 of 6 4/1/07 6:56 PM
Business & Company Resource Center -- Industry Overview Display...
http://msbapps02.marshall.usc.edu:2059/servlet/BCRC?locID=usoc...
Page 343
Business & Company Resource Center
Wines, Brandy, and Brandy Spirits

SIC Code(s) Covered
2084-Wines, Brandy & Brandy Spirits
NAICS Code(s) Covered

312130-Wineries
Industry Snapshot
Although the first commercial wine venture in the United States was in Pennsylvania in
1793, the majority of modern American wineries have been located in California, with
Washington and New York coming in a distant second and third, respectively.
California and its 1,300 wineries has accounted for more than 90 percent of all U.S.
wine production and more than 70 percent of all wine sold in the United States. If
viewed as a nation, California would rank fourth in worldwide wine production,
following Italy, France, and Spain. In the mid-2000s Gallo was the dominant wine
producer in the country, as well as the leading exporter.
In the mid-2000s Americans purchased 627 million gallons of wine, with a retail value
of approximately $23 billion. Eighty-eight percent of the total was table wine, 7 percent
was dessert wine, and 4 percent was sparkling wine or champagne. Table wine has
been the most popular kind of wine sold in the United States. Varietals, table wines
made predominately of one kind of grape, grew in popularity in the past decade. In
2004, 40.5 percent of wine sold in supermarkets was red, 40.4 percent was white, and
19.1 percent was blush.
Organization and Structure
All winemakers must sell their products through wholesalers and retailers to
accommodate various federal, state, and local regulations regarding the sale of alcoholic
beverages. The Federal Alcohol Administration Act (FAA) was established after the
13-year Prohibition Era ended in 1933. The Bureau of Alcohol, Tobacco, and Firearms
(ATF) is responsible for administering and enforcing the FAA, including qualifying
winemakers, collecting producer and wholesaler occupational taxes, and regulating trade
practices, advertising, and labeling. Beyond the uniformity of the FAA, regulations vary
greatly among the 50 states.
1 of 13 4/1/07 7:11 PM
Page 344
States can sell wine in one of two ways, either in a controlled environment or using an
open, licensed method. "Open" states have licensed retailers and wholesalers that handle
the distribution and sale of alcoholic beverages. Thirty-two states and the District of
Columbia are open states. The other 18 states operate under the control method, in
which each state government buys and sells alcoholic beverages at the wholesale and
retail levels. In addition to federal regulations, some states have set up their own
independent agencies that are responsible for the administration, licensing, and
enforcement of state laws and the collection of state revenues. Some state legislatures
even have created their own alcoholic beverage control (ABC) agencies with
rule-making power, and 32 states allow their citizens to vote for or against the sale of
liquor on a city or county-wide basis.
Background and Development
California winemaking began in 1769 when Father Junipero Serra planted vines at
Mission San Diego. In September 1772, the grapes were harvested and pressed,
creating California's first vintage. These early wines were produced for sacramental
purposes and personal consumption at the missions.
The commercial era of wine production began in 1830 with the efforts of Frenchman
Jean Louis Vignes from Bordeaux, France. His vineyard was located in what is now
downtown Los Angeles. The wine industry boomed as an ancillary result of the
discovery of gold in California in 1848. A surge of Europeans came to the state seeking
their fortune. Immigrants from Italy, France, and Germany who had no luck finding
gold turned to a trade they already knew--winemaking.
Between 1860 and 1880, the industry grew rapidly as numerous wineries were
established. By 1890, several of the state's famous wine regions already had taken
shape and the industry was producing 25 million gallons of wine per year. After
suffering losses from a vine pest called phylloxera, the industry virtually disappeared
with the passage of Prohibition in 1919. The repeal of Prohibition in 1933, however,
prompted the industry to rebuild. Growth was steady between 1949 and 1960, with
annual output increasing from 117 million gallons to 129 million gallons. By the 1970s,
the demand for California table wines had doubled.
As the industry evolved, so did consumer preferences. From 1933 to 1967, dessert
wine was the most popular kind of wine in the United States. During the 1970s, generic
table wines, like California Chablis and California Burgundy, dominated sales. By the
late 1980s, varietal wines, those labeled with the name of the grape, had taken over.
After posting a 6.5 percent loss in 1993, wine sales in the United States continued to
rise, while per capita consumption remained steady at 1.8 gallons. According to the San
Francisco-based Wine Institute, consumer demand for premium varietal wines spurred a
5 percent increase in California table wine sales in 1994--the strongest performance in
more than a decade.
While most of the largest wine producers reported record sales, and consumer tastes
moved upscale to more expensive wines, 1994 was noted as the best year for the wine
industry since the late 1980s. "The end of the drought, the waning of phylloxera root
2 of 13 4/1/07 7:11 PM
Page 345
louse problems and increased consumer demand all have winemakers singing a new
tune," reported Clifford Carlsen of The San Francisco Business Times.
Total U.S. production again rose in 1995, up 10.3 percent at 437 million gallons.
According to wine industry analyst Jon Frederickson of San Francisco-based
Gomberg, Fredrickson and Associates, wine sales increased 8 percent in 1995 to a
record $4.4 billion. Increased consumer demand and a relatively strong supply of fruit
contributed to the industry's continued strong growth.
Following record wine sales and all-time high prices for grapes in 1995, the industry
experienced another banner year in 1996. In fact, many North Coast wineries, with
sales increases of 30 to 40 percent, did not have enough wine to meet the staggering
demand.
The improved economy and continuing news reports about the health benefits of
moderate wine consumption fueled the continued growth of the industry. A 1991
broadcast of 60 Minutes reported a link between moderate wine consumption and a
reduced risk of heart attack. Called the French Paradox, two scientists found that despite
similar fat intake, France's heart attack rate was one-third that of the United States. A
key factor they attributed to this was the French custom of drinking wine with meals.
Red wine sales increased more than 75 percent after that 1991 report.
Champagne sales continued to drop despite increases of specific brands. From a peak of
18.2 million 9 liter cases of sparkling wine and champagne in the United States in 1986,
consumption fell to 12.3 million 9 liter cases in 1995. Causes for the decline were high
prices for champagne, high taxes, high cost of shipping, and lack of consistent,
high-profile marketing programs.
Wine sales were expected to continue their increase as the federal government took an
unprecedented step in advocating moderate consumption. When the U.S. government
issued new dietary guidelines in 1996, it acknowledged, for the first time, the benefits
of moderate wine consumption. Previously, the government had warned that even small
amounts of alcohol had "no net health benefit."
"Writing that language into the dietary guidelines was an extraordinary statement of
public policy change in the United States. It's a foundation we can build on into the next
century," said John De Luca, president of the Wine Institute, the trade association for
the wine industry. He added that the revised guidelines culminated five years of work to
redefine the image of wine, "putting it back on the dining room table where it's been for
2,000 years."
Leading the pack in wine sales have been the varietals. Relatively new to the industry, a
"fighting" varietal has been defined as a value-priced, cork-finished, 750 ml varietal
wine. The leader in fighting varietals has been Glen Ellen, followed by Fetzer's Bel
Arbors, Sebastiani's Country Wines and Swan Cellar label, Beringer's Napa Valley, and
Robert Mondavi's Woodbridge. Tim Wallace, a Glen Ellen executive, told Beverage
Dynamics that "fighting varietals are the foundation for the American wine industry in
the future."
In the late 1990s, fruit-flavored varietal wines became popular. Canadaigua introduced
Arbor Mist in 1998 in flavors such as peach and tropical fruits chardonnay and exotic
fruits and sangria zinfandel. Other producers followed suit, including Sutter Home's
Portico, Earnest & Julio Gallo's Wild Vines, and the Wine Group's Lyrica.
3 of 13 4/1/07 7:11 PM
Page 346
The introduction of fruit-flavored varietals caused a minor uproar among wine purists in
the industry. Because these wines contain less than 7 percent alcohol, they are regulated
for the Federal Drug Administration (FDA), which does not issue designation
requirements for varietals.
At the end of the twentieth century, U.S. producers of champagne and sparkling wine
commanded a 70 percent share of the domestic market. Growth continued to be slow. In
1997, shipments of champagne rose 1 percent for the first time since the 1980s, but they
fell by 3 percent the following year. These losses were attributed to consumers'
abandonment of the less expensive charmat producers in favor of the higher-end
method champenoise varieties.
The good news was that the quality of champagne, both domestic and imported, was
rising. Those producing champagne began to make a product that was more suited to
American tastes. Improvements in champagne production were forged mainly in
Carneros, Mendocino County, California, as well as on the central coast. In return,
these domestic producers saw consumers move to brands that offered high quality at
affordable prices.
The sale of wine over the Internet stirred a heated debate between the U.S. Congress
and the wine industry. Spurred by a rash of student-led violence in the nation's schools,
legislators created a bill on youth crime and gun control. An amendment to the bill gave
states the power to use federal courts to enforce local laws governing the interstate
alcohol trade. Proponents said that the amendment's purpose was to prevent underage
drinking. Many in the wine industry believed that it would restrict their business. A
survey of 176 California vintners, conducted by the Wine Institute, found that nine out
of ten shipped their products to out-of-state customers and 50 percent used Web sites to
sell their products.
Production.
The making of wine begins with the grape harvest, which generally occurs from August
through November, depending on the grape variety and the weather. The grapes are
placed in a crusher that separates the stems from the fruit and breaks up the berries. The
stems are then discarded, leaving a combination of juice, seeds, pulp, and skins, called
"must." Juice from red or white wine grapes is colorless.
To make white wine, the skins and seeds usually are removed from the must after a few
hours. The remaining juice is called "free-run." The discarded skins also are pressed to
extract the "press juice." Both juices then are filtered, placed in storage, and given yeast
to facilitate the fermentation process. White wine fermentation can last anywhere from
three days to three weeks. Upon completion, the wine is filtered for solids or remaining
yeast. The wine then is aged for a period of one week to a year in stainless steel, oak, or
redwood containers. It also can be aged in the bottle. After aging, the wine can be
blended with other wines to create a desired style or can be sent to be finished, a
process that stabilizes and filters the wine before bottling.
Production of red wine is slightly different than the process of making white wine. Red
wine is fermented at warmer temperatures than white wine. For red wine production,
the skins are fermented with the crushed juice to give it color and flavor. The skins float
to the top and are moistened regularly with juice to extract color and flavor. Red wine
usually is fermented for five to ten days and then is filtered, clarified, and preserved
with sulfites. Red wine commonly is aged in oak barrels for one to two years.
4 of 13 4/1/07 7:11 PM
Page 347
Champagne is made in one of two ways: by method champenoise or the charmat
process. In method champenoise, still wine is blended with a mixture (called triage) of
still wine, yeast, and a sugar substance. This blend is resealed in bottles where it is
fermented for a second time and aged. Carbon dioxide collects in the bottles, which is
released in a rush of bubbles when the bottles are uncorked. In the charmat, or bulk,
process, the still wine, yeast, and sugar are fermented in a pressurized tank rather than
in bottles.
Types of Wines.
Wines sold in the United States generally are divided into the following categories:
champagne, aperitif, dessert wine, table wine, and varietal wine. Also included in this
discussion are brandy and other fortified wines. Wines can be named one of four ways:
by variety, which tells the predominant type of grape; by a generic name describing the
color, such as blush; by the region that originally inspired the wine, such as Chablis; or
by a proprietary name, which is a label created by the winery.
Champagne and sparkling wines are names used interchangeably in the United States
for wines with effervescence. These wines range from very dry (natural), to dry (brut),
to slightly sweet (extra dry), to sweet (sec and demi-sec). Aperitifs are appetizer wines
usually served prior to a meal and can include champagnes and sherries. Dessert wines
are officially classified as those with an alcohol content of 17 percent to 21 percent.
They can be sweet or dry and include sherries and ports.
Table wine is a term commonly used to describe all red, white, blush, and rose wines
that contain 7 to 14 percent alcohol. These wines are still rather effervescent and are
served mainly with meals. Table wines can be made from any grape or combination of
grapes and in any style that the winemaker chooses. Varietal wines are table wines that
are made from a minimum of 75 percent of a particular grape variety; they carry the
name of the grape variety from which they are produced, such as Chardonnay or
Merlot.
The red table wine category has been led by Cabernet Sauvignon, a full-bodied, rich,
intense wine with noticeable tannins. A leading prestigious varietal, Cabernet
Sauvignon has been one of the most widely available wines from California. Other red
varietals include Merlot, Petite Sirah, and Zinfandel. Merlot is a medium- to full-bodied
wine that originally was made for the sole purpose of blending with Cabernet
Sauvignon. Petite Sirah is a wine with deep color, full body, and a fresh-berry taste.
Zinfandel, known as the classic California wine, is known too for its versatility, range
of style, and raspberry-spicy aroma and flavor.
White table wines have been dominated by Chardonnay, which is the most widely
planted variety of grape in California, making up more than 56,000 acres. It is a dry
wine that has a balance of fruit, acidity, and texture. Depending on what the winemaker
uses for storage, Chardonnay can range from clean and crisp wines to rich, complex,
oak-aged wines.
Other white varietals include French Columbard, Sauvignon Blanc, Johannisberg

Reisling, Gewurztraminer, and Pinot Blanc. French Columbard is generally fresh and
fruity, ranging from light to medium in body. Sauvignon Blanc has been one of the
fastest growing varietals in California; sometimes called Fume Blanc, it is best known
for its grassy, herbal flavors and is often consumed with fish and shellfish.
Johannisberg Riesling, from the German Riesling grape, is aromatic, delicate, and
slightly sweet. Late Harvest Rieslings are good accompaniments for dessert.
5 of 13 4/1/07 7:11 PM
Page 348
Gewurztraminer offers spicy aromas and flavors and a slight wisp of residual
sweetness. Often this wine goes well with Asian food. Pinot Blanc is a unique, dry
white wine, with styles ranging from bold, oak-aged to crisp and medium-bodied.
Brandy is "burnt wine" or fruit wine that is boiled and aged in wood. Virtually any type
of fruit can be used to make brandy, although grapes have been the most common.
Brandy has been produced primarily in Spain, Italy, and France, and most recently in
the United States. Cognac has been considered to be the best of all brandies. Cognac's
discerning characteristic has been its blending, often created from a number of different
cognacs coupled carefully to achieve an appropriate mixture.
Fortified wines were the creation of the Spanish and Portuguese and included port,
sherry, and Madeira. Sherry is made by blending younger sherries with older sherries
in oak casks. It varies in dryness levels and in hues. Harvey's Bristol Cream, imported
by Hiram Walker & Sons, has been the top-selling sherry in the United States, with a
nearly 41 percent market share. The best-seller is a blend of aged oloroso, a fortified
full-bodied sherry, and Pedro Ximines grapes, which sweetens the mixture.
Port is red wine fortified with grape brandy. It was created unintentionally in the
seventeenth century when Portugal tried to ship its table wine to England. In order to
stabilize the wine during its voyage across the Atlantic, the wine needed the addition of
grape brandy. England has remained the most popular market for port.
Madeira comes from a tropical island of the same name and is a raisiny, sweet wine.
Madeira has been closely linked with the history of the United States, according to the
New York Times Magazine. It was considered to be the wine of choice for American
Revolutionary notables such as Thomas Jefferson, George Washington, and Ben
Franklin. Unlike other wines that soured during the long, hot voyage across the
Atlantic, Madeira was the only wine known to improve dramatically with the
introduction of heat.
After a time of record growth throughout the 1990s, U.S. winemakers began seeing
wine sales flatten in the early 2000s. With a shaky economy made all the more so by the
attacks of September 11, 2001, the wine industry, like many U.S. industries, was
affected by the decrease in consumer spending on travel and recreation, which is tied in
to wine drinking. Another factor in the state of the wine industry from 2000 to 2003
was the overproduction of grapes and the ensuing drop in grape prices by as much as
75 percent in 2001 and 2002. Wine prices dropped during this time while sales
flattened. Retail sales of wine in the United States were $19.8 billion in 2001, a 4
percent increase over 2000's sales of $19.0 billion. By 2002, sales of California wine
dropped in all categories for the first time in more than a decade. Finally, the
proliferation of high quality, inexpensive imported wine caused further woes for U.S.
winemakers. Imports rose 17 percent in 2002, accounting for 25 percent of total wine
sales in the United States.
White wine continued to be popular, owning 40 percent of the wine market in 2001,
with red not far behind, growing from 17 percent in 1991 to a strong 37 percent of
market share in 2001. The MKF Wine Trends Report noted that the leading California
table wine varietals, Chardonnay, Cabernet Sauvignon, Merlot, and White
Zinfandel/Blush, accounted for about 76 percent of all retail sales by value of California
wine in 2001. Chardonnay continued its leading spot with a 29 percent dollar market
share, followed by Cabernet with 19 percent, Merlot with 15 percent, and White
Zinfandel/Blush holding 13 percent of the market by value. Secondary red varietals,
including Syrah, Pinot Noir, and Red Zinfandel, all were up more than 30 percent in
6 of 13 4/1/07 7:11 PM
Page 349
revenues for California wineries. There was a surge in popularity of Pinot Grigio,
which the Wine Spectator reported had sales increasing faster that any other white wine
in supermarkets. Wine coolers, once popular in the late 1990s, were less so as the new
millennium dawned.
In a climate of more cautious consumer spending, wines priced at $50 and higher were
selling far less than in the robust 1990s, noted Charles Krug Winery co-proprietor Peter
Mondavi in a July 2002 interview with Beverage Industry. "The wines that are $35 or
so are still going through the roof. So we're having great success in that category," he
added. With prices falling to record lows, consumers were indeed enjoying bargains in
the early 2000s. Indeed, California chain Trader Joe's seemed to be leading the bargain
trend, offering the Charles Shaw line of Merlots, Cabernets, and Chardonnays for
$1.99 in late 2002 and early 2003. In those six months, wine industry analysts Jon
Fredrikson estimates the company sold about 1 million cases of the generally good
quality wine that was dubbed, "Two-Buck Chuck."
Current Conditions
By the mid-2000s the U.S. wine industry was picking up. California wineries shipped a
record amount of products, with approximately 428 million gallons shipped
domestically, from a total 522 million gallons shipped worldwide. While so-called
"extreme value" varieties continued to sell well, the expensive premium wines also were
seeing increases, accounting for 64 percent of industry revenues. Following the trend
across nearly all American retail industries, the middle variety sales were flat, with the
majority of the industry growth occurring at either extreme end of the price spectrum. In
2004 sales of red outpaced white for the first time in years.
To ensure that California sustained its fertile winegrowing land, the Wine Institute and
the California Association of Winegrape Growers launched the "Code of Sustainable
Winegrowing Practices" in 2002, which in 2004 received a $475,000 USDA grant for
support of sustainable winegrowing practices. The program for vintners and growers
was a voluntary and helpful tool for conserving natural resources, protecting the
environment, and enhancing relationships with neighbors, local communities, and
employees.
A new trend in the mid-2000s was that of bringing winemaking to the masses with
make-your-own wineries and classes springing up in Florida, New York, California,
and Texas, to name just a few of the locations. While the majority of these operations,
which were not affiliated with any particular winery, allowed customers to simply
choose grapes, add yeast, and design labels, some of the larger operations, such as the
Bacchus School of Wine, were truly teaching the winemaking process in less than a
year, starting students from the very beginning.
Other relevant trends included more vintners moving to plastic corks. Although
considered "tacky" by some, more and more winemakers worldwide were seeing the
benefits to the move, as costlier, traditional corks were increasingly blamed for ruining
bottles with sediment, mustiness, or leakage. This negative cork performance costs
vineyards money, as they absorb the cost of returned bottles. Other winemakers made a
move to organics, as Fetzer Vineyards announced that it intended to grow and use 100
percent organic grapes for all of its wine by the 2010 harvest.
7 of 13 4/1/07 7:11 PM
Page 350
Industry Leaders
As dominant as the state of California is in the wine industry, so too are the wineries of
California winemakers Ernest & Julio Gallo (E & J Gallo). Controlling nearly 40
percent of the U.S. wine market, E & J Gallo Wineries led every wine category in
which it competed. According to the Wine Spectator, one out of every three bottles of
wine made in America is a Gallo product. The world's largest winemaker, E & J Gallo
Wineries had annual sales of more than $3 billion in 2004.
In 1933 the original Ernest and Julio Gallo brothers winery was founded in Modesto,
California. Unable to obtain bank financing, the company bought crushing and
fermenting equipment on 90-day terms and rented a warehouse to make its first
commercial wine. Using pamphlets on winemaking from the local library and grapes
bought on a promise to pay from eventual sales, the two brothers made their first batch
of wine. By 1993 Gallo owned five separate vineyards totaling more than 2,000 acres.
The company remained a private, family-owned business (two of Julio Gallo's
great-grandchildren, Matt and Gina, are actively involved in the company's winemaking
operations) and was one of the largest organic farms in the United States.
The company's success was due in part to the partnership of the Gallo brothers; Ernest
marketed the wine that Julio made. Another part of Gallo's success was its quest for
improving the quality of the wine it produced. To this end, Gallo replanted its vineyard
in Livingston in 1946 using grape varieties that had not been previously grown in the
area. Various viticultural techniques were experimented with, and in 1947 a formal
research program was established to evaluate the results. Specific standards were
developed for winemaking and were used thereafter.
In 1965 Julio Gallo established the first Growers Relations Department and shared
research findings with area growers. In 1967 Gallo offered long-term contracts to
selected growers, giving economic security and incentive to replant vineyards with the
better grape varieties recommended by Gallo. During the 1970s, the winery shifted to
producing premium varietal wines, and in 1991 it introduced its first ultra-premium
wine, 1991 Sonoma Estate Chardonnay. Leading brands for E & J Gallo Wineries have
been Gallo, Andre, Bartles & James, and Carlo Rossi.
Constellation Brands, the former Canadaigua Wine Company, became the number-two
seller in the U.S. wine market in 1995 with the acquisition of the Almaden and
Inglenook wine labels (in 1994) from Heublein for $130.5 million. Although the
company name may not be well known, its products such as Almaden, Inglenook,
Taylor California Wines, and Paul Masson Wines are household names. Constellation
had sales of $3.6 billion in 2004.
The company is a father-and-son operation located in upstate New York, started in

1945 by Marvin Sands, who bought a sauerkraut factory and turned it into a winery for
$60,000. For ten years, Canandaigua Industries sold fruit wines in bulk to local bottlers
who then sold them under their own brand names. In 1954 Sands turned away from
bulk wines and created a brand for himself--Richards Wild Irish Rose, a blended red
dessert wine. During the 1960s Wild Irish Rose represented nearly all of the company's
sales.
8 of 13 4/1/07 7:11 PM
Page 351
Working from that base, Sands slowly expanded, acquiring 11 small wineries through
1984. Then the company entered the wine cooler market with its Country Wine Coolers.
Although the company suffered an operating loss of $20 million in 1987 and 1988 due
to expensive advertising, Sands realized the power of the company's distribution
network and began looking for established brands.
In 1991 Canadaigua made its first major purchase with Cook's Champagne for $60
million. Then came additional purchases in 1993, 1994, 1998, and 1999. By the end of
the twentieth century, Canadaigua was posting annual sales of $740 million. In 2004,
the company had more than 200 brands of wine, beer, and spirits on the market.
Workforce
In 2003, the beverage manufacturing industry as a whole employed more than 169,000
workers. In total, as of the early 2000s, the winemaking industry employed more than
17,000 workers. The majority of wineries were family-owned, were located in
California, and had a tremendous impact on that state's economy. Los Angeles-based
Recon Research Corporation reported that the California wine industry contributed
nearly $1.5 billion annually to the Sonoma County economy, employing more than
3,600 people and creating secondary industrial employment of an additional 2,500 jobs.
America and the World
U.S. wine companies' efforts to establish joint ventures in Europe were not as
successful as they had hoped. Controlled by small producers and cooperatives,
experiences there led U.S. companies, in the early 2000s, to the more successful,
growing trend of teaming with Australian companies, who were more than willing to
establish a greater foothold in the United States. However, overseas planting of
premium varietals elsewhere had been growing at a fast pace and was expected to be a
significant new source of wine for U.S. consumers. In fact, California wineries bought
unprecedented amounts of overseas wine to meet consumer demand for low-priced
everyday wine and to expand their existing line of products in the mid-1990s.
For example, in 1996 Robert Mondavi began importing a Chilean line of wines, the
Caletara brand, priced in the $6 to $9 range. A second brand, Edwardo Chadwick, was
introduced in the $12 to $15 range, followed by a brand in an even higher price range.
In 1995 the winery also launched a line of Italian varietals.
Demand for Australian wine in the United States skyrocketed as American consumers
enjoyed the Australian style of wine. Its worldwide trademark of generous flavors, soft
tannins, and accessible fruit made this wine easier to like when young, a perfect style of
wine for Americans. In 1990 the Australians shipped only 578,000 cases of wine to the
United States. By the decade's end, the Australian Wine Bureau reported that more than
4 million cases of Australian wine would be shipped to the United States by 2001, and
by 2026 shipments should total more than 10 million cases with an estimated value of
9 of 13 4/1/07 7:11 PM
Page 352
$440 million. Chilean wine became popular in the late 1990s and early 2000s as well,
with Chilean exports up 15.6 percent, but falling prices earned them only 1.4 percent
more money. Exports of Chilean wine to the United States fell 1.8 percent in 2001.
South African wines, meanwhile, grew faster than projected, growing by 29 percent
and increasing 133 percent in value, based on 1999 sales figures.
In late 2001, the United States, Canada, Australia, Chile, and New Zealand signed the
Mutual Acceptance Agreement on Oenological Practices. The wine trade agreement was
a significant development in promoting international wine commerce and would loosen
trade restrictions for U.S. wines. John De Luca, president and CEO of the Wine
Institute in San Francisco exclaimed, "This agreement is a breakthrough for the world
wine trade that recognizes the effectiveness of other country's regulatory and
enforcement systems for assuring that producers comply with its country's standards."
Argentina and South Africa had the option to sign the agreement prior to March 2002.
According to the Department of Commerce, U.S. wine exports totaled $541 million in
2001. The largest market was the United Kingdom, which grew by 32 percent in
volume with values of exports rising 20 percent to $170 million in that market. Other
leading markets included Canada, with $95 million; the Netherlands, with $69 million;
Japan, with $57 million; Belgium, with $28 million; the Federal Republic of Germany,
with $14 million; Ireland, with $14 million; France, with $7.1 million; Sweden, with
$6.6 million; and Denmark, with $6.2 million. Champagne and sparkling wine exports
totaled 25 million gallons valued at $31 million, down from a high of 37 million gallons
in 1999 due to consumers stocking up for millennium celebrations. Dessert wine
exports were $31 million, and grape must and other fermented beverage exports stood
at $22 million in 2001. In total, the United Stats shipped 1 percent less wine in 2001
than the previous year. Mexico was expected to be an important market in the
twenty-first century because, according to the North American Free Trade Agreement
(NAFTA), the 16 percent tariff on American wine sales to that country would be lifted
around the year 2004.
Further Readings
Baker, Deborah J., ed. Ward's Business Directory of U.S. Private and Public
Companies. Detroit: Thomson Gale, 2003.
"Bottled Perfection." Entrepreneur, February 2005.
"Business: Blended; Wine Industry Mergers." The Economist, 25 January 2003.
"California Vintners Getting Stomped After a Decade of Growth." The San

Diego Union-Tribune, 7 January 2003.
Carlsen, Clifford. "Full-bodied Sales Make 1994 Vintage Year for Wineries."
San Francisco Business Times, 4 August 1995.
------. "Robust Year of Sales Gives Wine Makers a Healthy Glow." San
10 of 13 4/1/07 7:11 PM
Page 353
Francisco Business Times, 15 November 1996.
Ceausu, Joel. "US: Winegrowing Study Results Revealed." Entrepreneur,

February 2005.
Cioletti, Jeff. "Three Markets in One." Beverage World, 15 February 2005.
"Crisp Pinot Grigio at Last Gets Chance to Sparkle as Chardonnay Alternative."

Nation's Restaurant News, 10 February 2003.
"Fetzer Vineyards." Beverage Industry, 18 November 2002.
George, Jason. "An Italian Tradition Moves from the Cellar to the Classroom."
The New York Times, 27 September 2004.
"GP Life: Drink." GP, 5 July 2004.
Hallett, Vicky. "Vintage Me, 2004." U.S. News & World Report, 27 September
2004.
"Hoover's Company Capsules." Hoover's Online, 2005. Available from

http://www.hoovers.com.
Lazich, Robert S., ed. Market Share Reporter. Detroit: Thomson Gale, 2005.
"Plastic Corks Coming of Age; Low Cost Appeals to Vintners." South Florida
Sun-Sentinel, 6 February 2003.
"Seeing Red: Changing Preferences Make U.S. Wineries Happy to be 'In the
Red.'" Beverage Industry, July 2002.
"Too Many Bottles, Not Enough Buyers; Wine Industry Souring." Seattle Times,
24 January 2003.
"Up Close with Peter Mondavi, Jr." Beverage Industry, July 2002.
U.S. Department of Labor. Industry-Specific Occupational Employment

Statistics, 17 February 2005. Available from http://www.bls.gov.
11 of 13 4/1/07 7:11 PM
Page 354
Whitley, Robert. "Big Cult Is Swallowing $1.99 Wine." The San Diego
Union-Tribune, 25 February 2003.
Wine Institute. "California Vintners and Growers Introduce Code of Sustainable

Winegrowing Guidelines," October 2001. Available from
http://www.wineinstitute.org.
------. "California Wine Industry Statistical Highlights," December 2004.

Available from http://www.wineinstitute.org.
------. "Despite Economic Conditions, September 11 and the Strong Dollar 2001
California Wine Shipments Up One Percent," April 2002. Available from
------. "New Ground-Breaking Report Documents California Sustainable

Winegrowing Practices," 6 October 2004. Available from
------. "Strong Sales Growth in 2004 for California Wine as Shipments Reached
New High," 5 April 2004. Available from http://www.wineinstitute.org.
------. "United States, Canada, Australia, Chile and New Zealand Sign Mutual
Acceptance Agreement on Oenological Practices," December 2001. Available
from http://www.wineinstitute.org.
------. "U.S. House and Senate Approve Limited Direct Wine Shipments for
Winery Visitors," October 2002. Available from http://www.wineinstitute.org.
------. "U.S. Wine Exports Up Three Percent in Volume, Strong Dollar

Contributes to One Percent Decrease in Revenues," May 2002. Available from
Source Citation: "Wines, Brandy, and Brandy Spirits." Encyclopedia of American

Industries. Online Edition. Thomson Gale, 2006. Reproduced in Business and
Company Resource Center. Farmington Hills, Mich.:Gale Group. 2007.
http://galenet.galegroup.com/servlet/BCRC
Document Number: I2501400038
12 of 13 4/1/07 7:11 PM
Page 355
© 2007 by The Gale Group, Inc.
13 of 13 4/1/07 7:11 PM
FBE-462: Powerpoints
Page 356
Overview Questions
 Discussion of Globalization
Section 1. Globalization &
 List some stylized facts about the world
Global Trade Overview trade
Professor Baizhu Chen  What is Mercantilism?
FBE462
1 2
1. Globalization Globalization
International Interdependence, % import of GDP

 Product Market – Trade Flow
Export of G&S 1970 1998
World Merchandise export as % of GDP
United States 6% 12%
9
United Kingdom 23 29
8
7
Japan 11 10
6 Netherlands 42 56
5
Germany 21 27
4
3 Singapore 102 170
2 China 3 22
1
0
Belgium 52 73
1889 1913 1929 1950 1960 1970 1980 1990 2000
3
Korea 14 28 4
Globalization Globalization
Destination of Merchandise Export, 2003

destination North Latin Western CIS/ Africa Middle Asia
origin America America Europe CE Europe East
North America 40.5 15.4 18.1 0.8 1.2 2.1 22.0
Latin America 57.8 15.6 13.6 1.2 1.4 1.2 7.6
Western Europe 9.5 1.8 67.7 6.8 2.5 2.6 7.9
C.E Europe/CIS 4.6 1.7 56.8 24.5 1.1 2.3 7.6
Africa 18.9 2.5 48.4 0.6 10.2 1.5 17.7
Middle East 15.5 0.9 16.0 0.8 3.5 7.3 48.6
Asia 22.5 2.2 16.8 1.7 1.7 3.0 49.9
World 19.8 4.4 41.7 4.9 2.2 2.7 22.6
5 6
1
Page 357
transaction costs are lower but still exist
Baldwin & Martin NBER 6904

7 8
Globalization  Product Market – LOOP

Baldwin & Martin NBER 6904
9 10
 Factor Market – FDI World FDI Stock as a % of World Output
1914 1938 1960 1980 1985 1990 1995 1997
France 21.1 27.8 6.8 2.7 6 9.2 12 13.6

Germany 11.1 0.8 1.1 5.3 9.7 9.2 11.1 14.4
Japan 0.8 9.9 1.2 1.9 3.3 6.9 4.7 6.5
UK 52.3 38.5 15 15 21.9 23.8 28.3 29.1
US 7.2 8.5 6.2 8.1 6.2 7.9 10 10.6
Outward FDI Stock as a % of GDP
11 12
2
Page 358
Correlation between domestic savings Foreign securities held by Pension, % of total assets
and domestic investment
US Japan UK
13 14
Globalization Overview of World Trade

Share of U.S. Population That is Foreign-Born
 Factor Market – Labor
1900-2000
percentage
20
15
10
0
1900 1920 1940 1960 1980 2000
Source: Department of Commerce Historical Statistics of the US Colonial Times to 1970, US
Statistical Abstract 2000 15 16
Overview of World Trade Overview of World Trade

Country Export Share Country Import Share Country Export Share Country Import Share
Germany 10.0 US 16.8 US 16.0 US 12.8
US 9.6 Germany 7.7 UK 8.0 Germany 9.6
Japan 6.3 China 5.3 Germany 6.4 UK 6.6
China 5.8 UK 5.0 France 5.5 Japan 6.2
France 5.2 France 5.0 Spain 4.2 France 4.7
UK 4.1 Japan 4.9 Italy 4.0 Italy 4.2
Netherlands 3.9 Italy 3.7 Japan 3.9 Netherlands 3.6
Italy 3.9 Netherlands 3.4 Netherlands 3.5 China 3.1
Canada 3.6 Canada 3.2 China 2.6 Ireland 2.8
Belgium 3.4 Belgium 3.0 HK, China 2.5 Canada 2.8
Total World $7.5T Total World $7.7T World Total $1.8T World Total $1.8T
2003, leading merchandise exporters and importers 17 2003, leading service exporters and importers 18
3
Page 359

Share of China and other Asian countries in US merchandise imports, 1990-03 (%)
Merchandise/2004 出口比例占全球进口占全球比例
D eveloped N ations 65.4％ 70％

U S & C anada 12.5 19.0
E urope 45.3 44.8
Japan 6.4 4.8
A ustralia/N ew Z ealand 1.2 1.4
D eveloping N ations 34.6％ 30％
C hina 6.5 5.9
B razil 1.1 0.7
India 0.8 1.1
6 E conom ies in E .A sia 9.7 8.5
19 20

Meat 7
Foods & Beverage 45 Soybeans 5
Intra-regional trade of major RTAs, share in world exports Corn 5
Chemicals 26
Industry Supplies 148 plastic 13
others 13
Capital Goods 300

semiconductor 42
Computer accessories 34
Telecom equipment 26
Auto & Parts 69 Civilian aircraft 25
Consumer Goods 83
Pharmaceutical preparations 15
Apparel, textiles7
Others 32
21
Total 676 US Export (Jan – Nov 2001, billion) 22
Overview of World Trade

fish 9
Foods & Beverage 43 meat 6
wine 4
Crude oil 70
Industry Supplies 258 Chemical 18
Natural gas 16
US Trade Deficits (Quarterly)
Capital Goods 276 Computer accessories 57
Semiconductor 29
Telecom equipment 22
Auto & Parts 174 Electronic apparatus 22
Consumer Goods 262 Apparel 64

Pharmaceutical preparations 30
Toys 20
Others 44
Total 1057 US Import (Jan – Nov 2001, billion)

23 24
4
Page 360
2. Mercantilism
 Assumption: the wealth of the nation is

measured by the nation’s stock of precious
metals
 export goods to other nations => receive
precious metals from other nations
 import goods from other nations => pay
precious metals to other nations
25 26
- Mercantilism - Mercantilism
 If a nation’s export exceeds its import =>  Policy implication based on Mercantilism:
its stock of precious metals increase  a nation’s wealth can be accumulated through
 => wealth increases export rather than import
 trade is a zero-sum game
 If a nation’s export exceeds its export =>
its stock of precious metals decrease  trade policy should be used to promote export
 => wealth decreases  trade policy should be used to restrict import
27 28
5
Page 361
1. Overview Questions
 What is consumer’s surplus?

Section 2. Is Trade A Zero-  What is producer’s surplus?
Sum Game?  Will a small nation gain from trade?
Professor Baizhu Chen  Is trade a zero-sum game?
FBE462
1 2
2. Demand - Demand
 Consumer decision: max U(q1,q2)  Consumer surplus:

 Budget constraint: F(q1,q2, p1, p2, I) = 0  measures the amount a consumer gains from a
purchase by the difference between the price
 Demand function: qi=qi(p1, p2, I)
he actually pays and the price he would have
been willing to pay
p
q
3 4
- Demand - Supply
 In the diagram, the consumer surplus of  Producer’s decision: max pq-c(q)

consuming 10 units of apple is given by a  the cost function c(q) depends on factor
prices and techniques of production (# of
p factors required to produce one unit output)
 supply function: qs=qs(p, …)
a p
12
b
q q
10
5 6
1
Page 362
- Supply - Supply
 Producer surplus:  In the diagram, the producer surplus of

 measures the amount a producer gains from a selling 10 units of apple is a
sale by the difference between the price he
p
actually receives and the price he would have
been willing to accept
b p
10
7 8
3. From Autarky To Open - From Autarky To Open

Economy Economy
 Autarky  Small country: price is taken as given
 total welfare of this nation = ?  welfare with trade = ?
p D  gains = ?
c
a p* e
d
b S
9 10
- From Autarky To Open - From Autarky To Open

Economy Economy
 Large country: price is endogenous  world market price: determined by the world
 Two countries: Home and Foreign demand and supply
 ==> gains from trade
H
F export
supply  In Home country, anyone worse off?
p c p* c*
e H import F  Income distribution: across nations, within
d e*
demand
d* the same nation
11 12
2
Page 363
4. General Equilibrium Approach General Equilibrium Approach
 General equilibrium Wheat

 General equilibrium Wheat
analysis analysis
 Two goods  World relative price – p*
 Production – B
 Autarky equilibrium – A C
 Consumption – C
 Relative price of cloth - p
A
 Country gains from trade A●
 Gains are not distributed
evenly ●B
 Trade creates winners

P
and losers P
P*
Cloth Cloth
13 14
Gains From Trade
 Terms of trade (TOT)

Wheat
 Relative price of
D
export to import B
 When TOT improves,

the country is better
off A●
C●
P*
Cloth
15
3
Page 364
Overview Questions
 Know the determinants of trade pattern

Section 3. Why Nations Trade (I)?  What is comparative advantage?
 What is absolute advantage?
Professor Baizhu Chen
FBE462
1 2
Determinants of Trade Determinants of Trade
 Countries trade with each other because  Supplies are different

they are different Pc/Pw
(Sc/S w)h
 Demands are different
Pc/Pw
(Sc/S w)h= (Sc /S w)f (Pc/P w)h
(Sc/S w)f
(Pc/P w)h
(Pc/P w)f
(Pc/P w)f (Dc /D w)h = (Dc/Dw)f
(Dc /D w)h
(Dc /D w)f
C/W
C/W 3 4
Ricardo’s Theory of
Determinants of Trade
Comparative Advantage
 Demands are different because tastes differ  Consider a simple situation:
 it is hard to explain the difference in tastes  two countries, two goods produced by labor,
 What cause the difference in supply?  labor fully mobile domestically not
 labor cost or labor productivity internationally, full employment
 no trade barrier, perfect competition
 factor endowments
 Will Mexico be able to export?
Labor cost to make In Mexico In the US

1 bushel of Wheat 4 hours 1 hours
1 yard of cloth 2 hours 1.5 hour
5 6

Page 365
Ricardo’s Theory of Ricardo’s Theory of

Comparative Advantage Comparative Advantage
 If no trade between them, the opportunity  Comparative Advantage:
cost of producing cloth  If a country has a lower opportunity cost of
 in Mexico: 0.5 bushel of wheat per yard producing good A, the country has a
 in US: 1.5 bushel of wheat per per yard
comparative advantage in producing A
One bushel of wheat

 A country will export the good in which it
Mexico US has a comparative advantage
One yard of cloth  In Ricardo’s Theory: opportunity cost of
Save 0.5 bushel
production is determined by the relative labor
Get 0.5 more
of wheat cost
bushel of wheat
7 8
Ricardo’s Theory of Ricardo’s Theory of

Comparative Advantage Comparative Advantage
 If each country has 100 labor hour  Countries gain from trade if trade is based
 still assume the free-trade relative price of on comparative advantage
wheat is one per yard of cloth (terms of trade)  Trade is a positive sum game
wheat wheat US
Mexico 100 S*1  Mercantilism: Trade is a zero sum game
50
80
C*  Direct comparison of the absolute labor
76
S*0 cost of production is irrelevant for trade
25
20 S0
C  The country that has an absolute advantage
S1
15
in labor cost has a higher wage
16 20 66.7
20 30 50 Cloth Cloth
9 10
Ricardo’s Theory of
Extension from Ricardo
Comparative Advantage
 Ricardian model implies extremely high wheat wheat
degree of specialization
 Ricardian model implies that trade will
benefit everyone
C
C S0
S1
S0
S1 Cloth
Cloth
11 12

Page 366
Extension from Ricardo
 Gains from trade with increasing cost of

production
wheat
wheat
S0
C
C
S1
S0 S1
Cloth Cloth 13

Page 367
Module Objectives
 To explain why countries with similar

technologies trade
 Income distribution effect of trade
Section 4. Why Nations Trade (II)
1 2
Factor Endowments Factor Endowments

How to explain this trade pattern?
 Consider a simple situation:
 Two factors of production: labor and capital
 factors can freely move domestically but not
internationally, full employment
 technologies of production are the same for all
countries (two countries)
 no trade barriers, perfect competition
 countries differ in their endowments
3 4
Will A Less Resource Nation Be

They Have the Same Technology
Able to Export?
 Japan endowments: Land=10, Labor=8  US is said to be land abundant and Japan is

 US endowments: Land=20, Labor=10 labor abundant
 Cloth is said to be labor intensive, and
Japan
 3W + C =10 Land Wheat is land intensive
 W + 3C = 8 3 1  Will Japan be able to find anything to
export?
Wheat Cloth
US
3W + C = 20
1 3
W + 3C = 10
Labor
5 6
1
Page 368
Which Country Relatively

Production Possibility Frontier
Supply More?
W
Japan 8  More general, production possibility
3W + C = 10
frontiers in these countries
W + 3C = 8
 which country relatively supply cloth more at
10/3 C
any given relative price?
W 8/3 10 W W
10 Japan US
US
 3W + C = 20 20/3
 W + 3C = 10
C
10/3 20 7 C C 8
Factor Endowments Determine Comparison of Factor Endowments
 Countries export the products that use their

abundant factors intensively
 Heckscher-Ohlin Theory
 To know your advantage:
 Which factors are abundant?
 Does your industry use the abundant factor
intensively?
9 10
Who Wins and Who Loses? - Who Wins and Who Loses?
 For simplicity, assume that production  Assume the prices are:

technologies are constant  Wheat: Pw = $14
 W is land intensive, C is labor intensive  Cloth: Pc = $10
 capital-labor ratio: Land  Perfect competitive conditions:
3 1 MC of producing cloth = MR of selling cloth
 W: 1/3 
 C: 3 W C  MC of producing wheat = MR of selling wheat
1 3
labor
11 12
2
Page 369
- Who Wins and Who Loses? - Who Wins and Who Loses?
 3r + w = $14  Suppose Pc increases by 20%

 r+ 3w = $10  3r + w = $14
 ==> equilibrium factor prices  r + 3w = $12
r
 r = $4  r = $3.75 Pc
r  w = $2.75
 w = $2 Pc
Pw
Pw w
w
13 14
- Who Wins and Who Loses? - Who Wins and Who Loses?
 ==> %Δr = -6.25%  Application: Suppose U.S. has export and

 ==> %Δw = 37.5% import sectors. Assume export sector is
 %Δr < 0 = %ΔP w < %ΔPc =20% < %Δw high-skill labor intensive and import is low-
 those factors intensively used in sectors skill labor intensive. U.S. is high-skill labor
with prices increase will be better off abundant
 those factors not intensively used in sectors  who will support freer trade in U.S.?
with prices increase will be worse off
 Stolper-Samuelson Theorem
15 16
3
Page 370
Module Objectives
 To explain the scale economies

Section 5 Economies of Scale  To explain trade that is not based on the
and Trade standard assumptions
1 2
Patterns of Trade of US Inter- versus Intra-Industry Trade
 How to explain intra-industry trade?

 A country exports and imports goods of the same
industry
 Can difference in labor cost and factor
endowments explain intra-industry trade?
 Inter-industry trade
 a country exports goods in some industries and
imports goods in other industries.
3 4
Economies of Scale Economies of Scale
 External economies of scale (EES)  Examples of EES?

 average production cost of a firm is lower if  What kinds of market structures are
the whole industry at a particular location is consistent with EES?
larger but does not depend on the size of the
firm  If EES is significant, history, luck,
coincidence, or government policy play
 Internal economies of scale (IES)
important role in determining the pattern of
 average production cost of a firm is lower if
trade
the firm size is larger
 Policy implications?
5 6
1
Page 371
Scale Economies and

Economies of Scale
Monopolistic Competition
 What can lead to Internal Economies of Scale?  Consider
 differentiated product - products that are
 What kinds of market structures are consistent seemingly the same good but that are perceived by
with IES? consumer to have real or imagined difference
 consumers value varieties
 monopolistic competition - a producer has a
monopolistic power on his brand; but compete
with other brands
 scale economies - size of the firm increases
reduces the cost of production (two types of scale
7
economies) 8
Scale Economies and Product

Differentiation
Countries Are Identical
 Two nations: US and UK, two types of car  Assume U.S. and UK were identical, and
 cheap car expensive car each has 35 labors
 labor output labor output  Assume in autarky, each produce 10 cheap
 10 5 20 5 cars and 5 expensive cars
 15 10 25 10
 20 15 30 15
 25 20 35 20
 30 25 40 25
 35 30 45 30
9 10
Gains From Trade Gains From Trade, Again
 If U.S. and UK can trade with each other,  U.S. uses 35 labors produce expensive car and
consider the following two situations: UK uses 35 labors produce cheap car => how
many cheap and expensive cars total?
 U.S. uses 35 labors produce cheap car and UK
uses 35 labors produce expensive car => how
many cheap and expensive cars total?
11 12
2
Page 372
Scale Economies and

Why Trade Benefits?
Monopolistic Competition
 With economies of scale and product  How to describe the pattern of trade?
differentiation, nations with similar  Japan - capital abundant
characteristics will still trade with each  Canada - land abundant
other  Two goods: manufacturing (capital intensive)
 to explore the scale of the market and food (land intensive)
 to satisfy the diversified needs of consumer  differentiated products in manufacturing with
increasing returns to scale
13 14
Patterns of Trade What If Market Sizes Differ?
 If nations have different sizes of markets

Canada and trade has to incur transportation costs,
what kind of pattern of trade will it be?
 => country with a larger demand for a good
Food
Manufacturing will likely to be the export of this good, if scale
products economies are present
Japan
15 16
3
Page 373
 What is the Rybczynski Theorem?

Section 6. Growth and Trade  What is the “Dutch Disease”?
 Under what circumstances the
immiserizing growth will more likely
occur?
 What is the product cycle theory?
1 2
2. Rybczynski Theorem - Rybczynski Theorem
 Two factors of production: labor and capital  Consider only two goods: wheat and cloth
 factors can freely move domestically but
not internationally
 all factors are fully employed L
 technologies of production are the same for
all countries W C
 no natural and man-made trade barriers
K
 perfect competition
3 4
- Rybczynski Theorem - Rybczynski Theorem
 For simplicity, first assume that production  Home country endowments:

technologies are constant  Labor: 10
 W is labor intensive, C is capital intensive  capital: 14
 capital-labor ratio: L  full employment condition: W
3 1 3W + C = 10
 W: 1/3  14
K
 C: 3  W + 3C = 14
W C
 A: (W,C)=(2,4) 10/3
3 A L C
1
K 10
14/3
5 6

Page 374
- Rybczynski Theorem - Rybczynski Theorem
 Suppose L increases by 20%  If one factor endowment increases, the industry

uses the factor intensive will grow, the other
 A: (W,C) = (2.75, 3.25) industry will decline
 W↑by 37.5%, C↓ by 18.75%
 “Dutch Disease”
 The deindustrialization of an economy as a result of the
W discovery of a natural resource. So named because it
14 occurred in Holland after the discovery of North Sea gas; it
K has also been applied to the UK since the discovery of
North Sea oil. The discovery of such a resource lifts the
value of the country's currency, making manufactured
10/3 goods less competitive; exports therefore decline and
A L imports rise.
C Ÿ Dictionary of Business, Oxford University Press
14/3 10
7 8
3. Immiserizing Growth - Immiserizing Growth
 For a small country, growth is always good.  Balanced growth for a large country
 The country tends to be better off
W W
C C
9 10
- Immiserizing Growth - Immiserizing Growth
 Growth biased toward to the import sector  Growth biased toward to the export sector
for a large country => better off for a large country => maybe worse off
W W
C C
11 12

Page 375
- Immiserizing Growth - Immiserizing Growth
 Two effects when a large country grows  Conditions that growth causes TOT worsens
 growth effect => tends to make it better off such that immiserizing growth occurs:
 TOT effect
 growth strongly biased toward to the export sector
 if growth biased toward to import sector =>TOT
 world demand for the export good is very inelastic
improves
 if growth biased toward to export sector => TOT  the country is heavily dependent on the export
worsens sector (heavily involved in trade) before growth

 If TOT worsens so much that dominates the  the country must be a large economy
growth effects => growth is immiserizing

13 14
4. Product Cycle Theory Product Cycle Theory
 Dynamics of Comparative Advantage  New Product Stage

 comparative advantage changes overtime  high income countries (US) produce and
because of economic growth consume new product
 firmsneed to familiarize the products and to detect
consumer response
 high R&D cost, high cost in advertising, sales
promotion, marketing, etc.
 demand is local
 almost no international trade
15 16
Product Cycle Theory Product Cycle Theory
 Maturing Product Stage  Standardized Product Stage

 standards begin to emerge and large-scale  product is familiar to consumers
production is adopted  production processes can be easily learnt
 economies of scale begin to realize  laborcosts play an important role
 firsthigh income countries (US) exports to medium  developed countries busy introducing other new
income nations (Spain) products
 later medium income nations (Spain) export to high  production shifts to developing counties
income countries (US)
 developed countries become the importer
 foreign direct investment occurs, and MNCs emerge
17 18

Page 376
Product Cycle Theory

Production,
consumption of
a product U.S.
Consumption
imports
exports
U.S. Production
t0 t1 t2
New product Maturing Standardized
stage product stage product stage 19

Page 377
 What are different types of tariffs?

Section 7. Tariff  What happens to terms of trade when a
small country imposes a tariff? a large
country?
 What is the effective rate of protection?
 What is the optimal tariff rate?
1 2
2. Basics of Tariff Basics of Tariff
 tax on import or export

 ad valorem tariff: P = P* (1+t)
 specific tariff: P = P* + t
Source: http://www.usitc.gov/tata/hts/bychapter/index.htm
3 4
Basics of Tariff Basics of Tariff
 Tariff structures can be quite complicated

 wristwatches with case of precious metal or of Tariff Rates in China, 1995
metal clad with precious metal: with
mechanical display only, having no jewels or
only one jewel in the movement
 MFN: 51c each +6.25% on the case & strap, band
or bracelet +5.3% on the battery
 Non-MFN: $2.25 each +45% on the case+80% on
strap, band or bracelet +35% on the battery
5 6

Page 378
- Basics of Tariff - Basics of Tariff
 Preferential duties  Measurement of tariff rates

 tariff rates applied to an import according to its  unweighted average tariff rate
geographical source; a country that is given  10% on Good A, 15% on good B, 20% on good C
 unweighted average tariff rate = 15%
preferential treatment pays a lower tariff
 overstate the height of the country’s average tariff if the
 e.g., British Commonwealth, EU, NAFTA country imports mostly good A
weighted average tariff rate
 GSP (generalized system of preferences) 
 value of A import $500, B $200, C$100

 developed countries permit duty-free entry of a  weighted average tariff rate = 12.5%
selected list of products if those products are  What is the problem of using weighted average tariff rate as a
measure of degree of protection?
imported from particular developing countries
7 8
3. Welfare of Import Duty - Welfare of Import Duty
 small nation: its TOT is given  large nation: tariff affects its TOT
 tariff has no effect on its TOT  gain or loss?
 gain or loss? D D
P S P S
a a
b b
P*+ t P*+ t
c e c g
d f f h
P* P* d
i
P* e
Q 9
Q 10
- Welfare of Import Duty - Welfare of Import Duty
 Effects of tariff  tariff=consumption tax+production subsidy

 consumption effect  e.g. $10 shirt, 50% tariff => P = $15,
 production effect government collects $5
 trade effect  This is equivalent to a 50% consumption tax +
 revenue effect 50% production subsidy
 redistribution effect
 terms of trade effect
11 12

Page 379
- Welfare of Import Duty - Welfare of Import Duty
 Optimal tariff  A country has both tariffs on its car imports

 the tariff rate that maximizes the welfare of the and auto engine imports. The country
tariff-imposing nation produces cars using imported auto engine.
 what is the optimal tariff of a small nation? As the pressure of trade liberalization rises,
 what is the optimal tariff of a large nation? the country pledges to move toward freer
 Why U.S. does not impose the optimal tariff? trade by eliminating the tariff on engine
imports. Evaluate the country’s policy.
13 14
- Welfare of Import Duty 4. Welfare of Export Duty
 effective rate of tariff  examples of export tax:

 when there are different levels of production,  cocoa (Ghana)
and at each level, there is a tariff imposed, how  coffee (Brazil and Colombia)
to measure the degree of protection?
 jute (Pakistan)
 rice (Burma and Thailand)
 timber (Ivory Coast and Liberia)
 tea (Sri Lanka)
 tin (Malaysia)
15 16
- Welfare of Export Duty
 small country: export duty $25
Pw=60 S
b d
a c
P=35
20
17

Page 380
 What are the effects of an export tariff?

Section 8. Non-tariff Barriers  What are the differences and similarities of
a tariff, quota, and VER?
 Name some other non-tariff barriers
1 2
2. Quota and VER - Quota and VER
 Tariff, Quota and VER  Quota versus Tariff

 What if it is a large nation?  With increasing foreign competition, quota
P
offers more protection to domestic industries
than tariff
 Quotas provide bureaucrats more power
12  quotas are more likely to create a domestic

a
b
c d monopoly than tariff
10
q3 q1 q2 q4 Q 3 4
- Quota and VER 3. Other Barriers
 MFA: multifiber arrangement (1974)  Local content requirement

 iron and steel  technical, administrative and other
 sugar (quota + tariff) regulations
 1989, US sugar price $0.2281/lb, World price  health and technical regulations
$0.1445, equivalent tariff rate of 58%  Government procurement policies
 Japanese car  “Buy America” act
 1981, 1.68 million cars (VER) to U.S.  Fed government agencies must buy from home U.S.
firms unless the price is 6% abover foreigners’
 84-85, increased to 1.85 million cars
 for Department of Defense, this figure is 12%
5 6

Page 381
- Other Barriers - Other Barriers
 Reclassification  Foreign exchange controls

 Restrictions on services trade  exporters are required to sell their foreign
 restrictions on foreign insurance companies exchange earnings to the central bank, which
in term parcels out to importers selectively
 foreign ships not allowed from carrying cargo
 Advance deposit requirement
between purely domestic ports (U.S., etc.)
 license to import is awarded only if the
 landing rights for foreign aircraft limited (open
space? Canada, EU versus US) importing firm deposits with the government
specific funds
7 8
9 10

Page 382
 What is market failure?

Section 9 Protect or Not to Protect  What is the implication to trade when
market fails
 What is the Coase Theorem?
 What is the industrial policy?
1 2
2. For and Against Free Trade -For and Against Free Trade
 Arguments for free trade  Arguments against free trade

 efficiency  optimal tariff theory
 scale economy
 Revenue
 Income Distribution/welfare policy
 transfer of technology
 Political and strategic objectives
 reducing social cost (e.g. rent-seeking cost)
 market failure
 free
trade no longer optimal=> policy need to be
used to correct market failure
3 4
5 6

Page 383
7 8
3. What if market fails? - What if market fails?
 Market fails if there is monopoly, or  If the market fails to compensate the

increasing returns to scale, or, … producer for the extra benefits generated
 When market fails, the price no longer Spr=MCpr
reflects the opportunity cost of producing p
this good
 When market fails, producer’s surplus or Sso =MCso
consumer surplus does not fully capture the

benefit of producing or consuming a good Q
9 10
- What if market fails? - What if market fails?
 What is the first-best policy to correct  What is the first-best policy to correct
market failure? - a positive externality market failure? - a negative externality
Sso
Spr Spr
p p
Sso
h
12 pw=10
a b c a c e g
pw=10 d 8 b d f
e
Q Q
q1 q3 q4 q2 11
q1 q3 q4 q2 12

Page 384
 The first-best policy is always the one  An alternative to impose policies, specify
which can directly correct the market failure the property rights
 The second-best policy is the one which is  Coase Theorem
most closely targeted to the market failure  Ifcostless negotion is possible, rights are well-
specified, and redistribution does not affect
though cannot directly correct it. marginal values, then
 A general rule: Ÿ the allocation of resources will be identical whatever the
allocation of legal rights, and
 The closer a policy is targeted to the problem, Ÿ the allocation will be efficient, so there is no problem of
the better it is (requires to identify the externality, further more
problem!) Ÿ if additional policy (tax/subsidy) is imposed in such a
13 situation, efficiency will be lost. 14
 Purse-seine fishing of tuna fish results in  The African elephant population was cut in
drowning of dolphin (similarly the sea half within a span of 8 yrs in 1980s due to
turtles killed trapping in the nets with poaching
shrimp)  Public pressure from affluent countries to
save the elephants intensified in late 1980s
 What is the source of problems? and early 1990s
 What are the policy options?  What is the source of problem?
 What are the policy options?
15 16
4. Industrial Policy - Industrial Policy
 Government policy to channel resources to  Consider using industrial policy for the
particular industries, generally those followings:
industries that government views as  industries with high value-added per worker
important to future economic growth  upstream industries
 Instruments used to channel resources:  industries with future growth potential
 tariff, direct production subsidy, government  high-tech industries
procurement, free R&D, cheap credit, etc...

 Should or should not use industrial policy?
17 18

Page 385
 What is dumping?
Section 10. Pushing Export  What is countervailing duty?
 Explain the strategic trade policy
1 2
2. Dumping and Anti-dumping - Dumping and Anti-dumping
 The product is sold in another country at a  dumping if the good is selling below “fair
price less than fair value. market value”
 less than the price of the like product in the  how to calculate the “fair market value”
exporting country
 Conditions for dumping to occur:
 or (in the absence of such domestic price) less
 imperfect market
than the highest comparable price of the like
product selling in any third country  segmented markets
 or less than the cost of production in the
country of origin
3 4
- Dumping and Anti-dumping - Dumping and Anti-dumping
 types of dumping  Persistent Dumping

 predatory dumping  perfect competition in foreign market
 cyclical dumping
 monopoly domestic P
 persistent dumping
MC
Dfor=MRfor
MRdom Ddom
5 Q 6

Page 386
 antidumping duty can be imposed if  Negotiate

settlemen
 dumping occurred (selling at less than fair
t
value)
 ITAof Commerce Dept. determines if dumping Petitio ITA ITC ITA
occurs n
If not below
 dumping causing material injury to plaintiff LTFV
If no injury
 ITC determines if material injury occurs Impose

penalty
Case Case
dismissed dismissed
7 8
 Numbers of antidumping investigations in  Target industries of U.S. antidumping

U.S. investigations
 1980 37 1985 63  Chemicals 58
 1981 15 1986 71  Food 16
 1982 65 1987 15  Iron and Steel 201
 1983 46 1988 42  Machinery 8
 1984 74 1989 23  Textiles and apparel 15
 Total 1980-1989: 451  others 153
 Total 1980-1989: 451
9 10
 Target countries of U.S. antidumping  U.S. cases 1980 1982 1985 total(80-85)
investigations, 1980-1989  duties 10(27%) 13(20%) 25(40%) 82(27%)
 Japan 58 Brazil 24  rejected 9(24%) 21(32%) 20(32%) 104(35%)
 Germany 29 France 22
 withdrawn 18(49%) 31(48%) 18(29%) 114(38%)
 Korea 27 UK 18
 total cases 37 65 63 300
 Italy 26 China 17
 Canada 25
 U.S. International Trade Commission Annual Report
11 12

Page 387
3. Export Subsidy and - Export Subsidy and

Countervailing Duty Countervailing Duty
 welfare cost of export subsidy  European Common Agriculture Policy
 what if it is a large nation? (CAP)
P  EC members: Germany, France, Italy,
ps Belgium, Netherlands, Luxembourg, UK,
a c Ireland, Denmark, Greece, Spain, Portugal.
b d
Pw
13 14
- Export Subsidy and - Export Subsidy and

 According to GATT/WTO, export subsidy
is to be condemned (except farm subsidy)
 Countervailing duty is permitted
Million T Million T
 if export subsidy is found
 if the subsidized export cause or threaten to
cause material injury to domestic firms
15 16
- Export Subsidy and - Export Subsidy and

 Numbers of CVD investigations in U.S.  Target countries of U.S. CVD
 1980 69 1985 63 investigations, 1980-1989
 1981 17 1986 71  Japan 17 Brazil 36
 1982 116 1987 15  Germany 18 France 28
 1983 8 1988 42  Korea 17 UK 18
 1984 26 1989 23  Italy 24 China --
 Total 1980-1989: 301  Canada 18
17 18

Page 388
4. Strategic Trade Policy - Strategic Trade Policy
 Government may encourage exporters to  Airbus v.s. Boeing

form cartel to extract rents from foreign  If Boeing starts produce first
countries
OPEC, MITI Airbus
 P NP
-5 0
 An importing country facing a foreign P
cartel may tax the import to extract back Boeing -5 100
part of the monopoly rents. 100 0
NP
0 0
19 20
- Strategic Trade Policy - Strategic Trade Policy
 Airbus v.s. Boeing  Airbus v.s. Boeing

 If Europe subsidizes Airbus $25  If Europe and US both subsidy their firms
Airbus Airbus
P NP P NP
20 0 20 0
P P
Boeing -5 100 Boeing 20 120
125 0 120 0
NP NP
0 0 0 0
21 22
- Strategic Trade Policy - Strategic Trade Policy
 Suppose the payoff matrix is the following  What lessons we learn from these?
 What if EC $25 subsidy  strategic trade policy is a beggar-thy-neighbor
policy
Airbus
P NP  strategic trade policy could be used to increase
P -20 0 the welfare of the nation imposing the policy

 it is not clear that strategic trade policy will
Boeing 5 125
always increase the welfare of the nation
100 0  if foreign nation retaliates, all nations may be
NP
0 worse off in this non-cooperative game
0
23 24

Page 389
1. Trade Blocs
 Free-trade-area
Section 11. Trade Blocs and  countries abolish all import duties on their
Trade Blocks mutual trade in all goods, but each country has
its own tariffs for the rest of the world
 Andean Group
Ÿ Bolivia, Colombia, Ecuador, Peru, Venezuela
 European Free Trade Association (EFTA)
Ÿ Austria, Finland, Iceland, Liechtenstein, Norway,
Sweden and Switzerland
 NAFTA
1  transshipment and rules of origin 2
- Trade Blocs - Trade Blocs
 Customs Union  Common Market

 a free-trade-area with a common external tariff  a customs union with mobility of factors of
toward the rest of the world production
 Benelux (1947, later absorbed into EC in 1958)  EC (European Community, 1958, Treaties of Rome)
Ÿ Belgium, Netherlands, and Luxembourg  MERCOSUR (Southern Cone Common Market)
 ASEAN (loose association-moving toward Ÿ Argentina, Brazil, Paraguay, Uruguay
customs union)  Central American Common Market
Ÿ Brunei, Indonesia, Malaysia, Philippines, Singapore, Ÿ Costa Rica, El Salvador, Guatemala, Honduras,
Thailand Nicaragua
 no transshipment problem
3 4
 Economic Union  Is a FTA always welfare improving?

 a common market with unified fiscal,  tariff $4
monetary and socioeconomic policies
 European Union
Ÿ Belgium, Denmark, France, Germany, Greece, Ireland, 15 SUS
Italy, Luxembourg, Netherlands, Portugal, Spain and UK
14
12 SM
10 SK
5 6

Page 390
 If U.S. and Korea form a FTA, US better  FTA improves welfare if Trade Creation
off? dominates Trade Diversion
 If U.S. and Mexico form a FTA, U.S. better  What kind of FTA likely improves welfare?
off?  more trade originally (large trade partner)
15
15 a SUS  low tariffs among members before FTA
relative to external tariff
14 b c
d e f  member nations complement with each others
12 SM
g h i j  more members and larger size of economies
10 SK
 if transportation => closer geographically
A B C D 7 8
- Discuss:When Can Sanctions

- Trade Blocs
Succeed
 NAFTA  Give some successful examples of
 Benefits of being in NAFTA for each of the economic sanction
following nations?  Give some unsuccessful examples of
 U.S., Mexico, and Canada economic sanction
 EC  Under what conditions economic sanctions
 Difference between EC and NAFTA? will be more successful?
 PAFTA? (Pacific-Asia Free Trade Area)
 APEC
9 10

Page 391
History of WTO
 1944 Bretton Woods

Section 12. WTO  IMF, World Bank and ITO (GATT)
 GATT suppose to be temporary
 GATT function
 lists
code of conduct
 dispute settlement
 multilateral negotiation
1 2
Principles of WTO GATT/WTO negotiations
 non-discrimination (MFN, Article I)

 yr nations $
 trade liberalization
 reciprocity
 Kennedy Round: 62-67 48 40b
 any new tariff or increase in tariff must be offset by  Tokyo Round: 73-79 99 155b
cuts in other tariffs
 Uruguay Round: 86-93 108 1,000b
 no unilateral quotas on imports, except threaten
“market disruption”
 no unfair encouragement for exports
 no export subsidy, except agricultural goods
 transparency
 protect through tariff 3 4
US Tariff Rates Exemptions
 Exemptions from GATT/WTO rules

Smoot-Hawley (1930)
 antidumping and countervailing duties (VI)
% of of dutiable  safeguard arrangements (XIX)
 BOP and Economic Development (XII, XVIII)
Kennedy Round  free trade areas (XXIV)

Tokyo Round
 general exemptions (XX, XXI)
% of total import
5 6

Page 392
US Tariff and Non-tariff

GATT problems
Barriers
 “gray area”: VER
 abuse antidumping and CVD exemptions
Tariff (% of dutiable)
 traditional issues: agriculture, T&C
 new issues: service, & IPR

Equivalent tariff rate of non-tariff barriers
 free-trade-area
 weak GATT institution
7 8
- GATT negotiations The Uruguay Round
 Accomplishment of Uruguay Round

 GATT Rounds resulted tariff reduction  40% reduction in tariffs
 % of nations’ trade subject to nontariff  agreement of all nations to recognize IPR
barriers 1966 1986  agreement among developed nations on starting to
convert nontariff to tariff barriers on Textile &
 US 36% 45% Clothing (over 10 years) and then cut tariff rate
Subsidies in agriculture be cut over six years by 20%,
 EU 21% 54% 
non-tariff barriers be converted to tariffs and cut by
 Japan 31% 43% 36%
 more formalized institution (WTO) to monitor tariff
 All DC 25% 48% reductions and resolve disputes
 Laird & Yeats, Weltwirtschaftliches Archiv, 1990, 126, 2:299-326  No agreements on financial services and
9
telecommunications yet, but talks continue 10
Achievement of WTO
 Dispute settlement mechanism is working

 104 disputes submitted in less than 2 years (compare
with 196 cases to GATT in 50 years)
 Case of Kodak v.s. Fuji
 Case of Costa Rica lingerie case v.s. US
 Telecommunications Agreements (Feb. 1997)
 68 nations (account for 90% of the revenue) pledged
 US, EU, and Japan fully liberalized by Jan 1, 1998
 Financial Service Agreement (Dec. 1997)
 102 nations (over 95% market) pledged
 US, EU fully open to foreign banks, insurance and
11 securities with minor exceptions 12

Page 393
Unresolved Issues Some U.S. Trade Policies
 Substantial trade barriers remain in some sectors  US Trade Laws

 Financial, entertainment, and publishing
 Environmental concerns
 Worker’s rights
 Foreign Direct Investment
 Local content requirement, local ownership rules,
outright prohibition
 Abusive use of antidumping
13 14
Case: China’s Entry of WTO Case: China’s Entry of WTO
 Agriculture
 average tariff reduced to 17%, duty on US
major agri-export to 14.5%
 grace period to 2004
 accept USDA certification
 tariff once lowered, cannot be increased
 tariff-rate quota (TRQ)

 low tariff rate if within quota (1-3%), but high tariff exceeding
the quota
Ÿ soybean oil: TRQ currently 1.7 million cubic ton, increases to
3.3 million cubic ton in 2005, TRQ to be abolished in 2006
15 16
Export from US to China
17 18

Page 394
 Industrial Products
 average duty lower from 24.6% to 9.44% after WTO,
 Services
key products to 7.1%  permitting grandfathering the provincial
 high tech products duty lower from 13.3% to 0, no agreement
requirement of technological transfer  abolish restrictions on domestic distribution
 lowered duty cannot be adjusted within 3-5 years
 2/3 of products grace period to 2003, majority of others
 restrictions on leasing, warehouse, advertising,
to 2005
packaging, air shipping, inspections abolished
 no quotas on major US products (fertilizer, fiber
optical cable, etc.), grace period 5 years within 3-4 years
 if there is a quota, increase 15% per year
 car quota 6 million, abolish by 2005 19 20
 Telecommunication  Insurance
 abolish geographical restriction  abolish geographical restriction with 5 years
 paging - within 4 years  foreign insurance firms can do group
 mobile - within 5 years insurance, health insurance and pension
 foreign investment after 4 years can be 49%  life insurance firms can choose their own
(51% in paging) domestic venture partner, can take 50% share
 adopt CDMA protocol after WTO and increase to 51% after one year
 non-life firm can take 51% share after WTO,
can be WOFE after 2 years.
21 22
Case: China’s Entry of WTO
 Banking and Security

 retail banking will be opened for WOFE banks
by 2005
 banking on RMB business allowed by 2005
 only joint venture is allowed in security,

foreign firms can take up to 33% (???)
23

Page 395
What are the differences?

Income Numbers Population (b) Income Range Average
(1999) per person ($) Income per
Section 13. Environmental and person ($)
Labor Standards Low 58 2.4 100-754 410
Lower 49 2.1 755-2995 1200

middle
Upper 27 0.6 2996-9265 4900

middle
High 27 0.9 9266+ 25730

1 2
What are the differences? Setting Standards

Income Infant Deaths % children CO2 Annual deforest.
(1999) per 100,000 of 10-14y Emissions square kilom per  Harmonization of standards
birth works Metric Tons 100,000 person
per person  Mutual recognition of standards
Low 68 19 100-754 1.8  Separate standards
Lower 35 7 755-2995 1.2
middle
Upper 26 6 2996-9265 7.2

middle
High 6 <1 9266+ -1.3

3 4
Labor Standards Child Labor
 International Labor Organization (ILO) % of its children

20%
 Prohibition of forced labor
 Freedom of association
40%
 The right to organize and bargain collectively
 An end to the exploitation of child labor

18%
 Nondiscrimination in employment
US Child Labor 300,000 – 800,000

5 6

Page 396
Trade and Environmental Issues How to attack externalities?
 Non Transboundary Environmental Issues  impose tax to force producer to pay extra
 Difference in environmental standards social cost
P MC of waste
 Pollution havens  Problems? dumping to Austria
 Transboundary Environmental Issues  second-best D
400 B
Germany’s MB of
dumping waste
C
A
7
80 8
- How to attack externalities? Cases
 Coase Theorem  CFC’s and Ozone

 if costless negotiation is possible, property  what is the policy used?
rights are well-specified, and redistribution  is the policy working?
does not affect marginal values, then
 why the policy is (or not) successful?
 the allocation of resources will be identical,
whatever the allocation of legal rights
 the allocation will be efficient, so there is no
problem of externality
 if a tax is imposed in such a situation, efficiency
will be lost
9 10
- Cases - Cases
 Dolphins and Tuna  Elephants and Ivory

 what is the policy for U.S?  what is the policy?
 Is the policy working?  Is the policy working?
 why the policy is (or not) successful?  why the policy is (or not) successful?
11 12

Page 397
- Cases
 Brazilian Rain Forests

 what is the policy?
 Is the policy working?
 why the policy is (or not) successful?
13

Page 398
International Capital Flow
 foreign portfolio investment

Section 14. Trade in Factors  Stocks and bonds
 No direct management and control
Professor Baizhu Chen  foreign direct investment

 Often involves control and management
FBE462
 In the U.S., owns more than 10% shares to be
counted as FDI for accounting purpose.
1 2
FDI
 Firm factors
Inbound FDI  What unique advantage the firm has over local firms?
 Local factors
 What factors in local are attractive? Is it cheaper labor
or land? Or is it the market? Or else?
 Policy factors
 Is the local policy encouraging FDI? Legal structures
are favorable?
 Competitive factors
 Scale economy? Competitors there already? Can we
keep our competitiveness?
3 4
FDI FDI
5 6

Page 399
FDI – China Case FDI – China Case
7 8
FDI – China Case FDI – China Case

2003 Nation Accumulated $B
01 HK 24.63
55%
02 Cayman Is 3.691
% of asset overseas
03 Virgin Is 0.533
56%
04 U.S. 0.502 46% 74%
4% 57%
05 Macau 0.446
15% 26%
16% 2% 10% 1%
06 Australia 0.416
07 Korea 0.235
08 Singapore 0.165
09 Thailand 0.151
10 Zambia 0.144 9 Source: UNCTAD 10
FDI – China Case FDI – Why Go Global?

Company Target US$ million
2001 Haier Menghetti Spa 7
2002 CNOOC Repsol-YPE 592  Domestic competition
2002 SinoPec Oil fields Algeria 394  Diversification v.s. globalization
2002 CNOOC 5% interests Northwest Shelf Venture 320
2002 CNOOC BP’s refinery assets 275  Technology & know-how
2002 Petrol China Devon’s oil field 262
2002 TCL Schneider Electronics AG 9.8
 Global brand
2003
2004
BOE
Minmetals
Hynix TFT-LCD unit
Noranda
650
7000*
 Protectionism
2005 Lenovo IBM PC 1750  Exchange Rate
2005 SAIC Ssangyong Motors 520
2005 Haier Maytag 1275*  Government policies
2005 CNOOC Unocal 18500*
2006 CIMC Burg 130
11 12

Page 400
Immigration Immigration
MPLR
MPLS F
DS DR
A
WR WR
E c a
B
WE WE
d b
C
WS WS
0S LE L1 0R
13 14
Immigration
MPLR
MPLS F
DS G
WR WR
A L
W’R W’R
E c a
B M
WE WE
d b
C N
WS WS
DR
H
0S LE L1 L2 0R
If L1 L2 in S country is unemployed
15

MOR-492: Syllabus
Page 401

MOR 492: GLOBAL STRATEGY

Spring 2006
Professor: Carl W. Voigt, Ph.D.
Office: Bridge Hall 303-E
Phone: Direct: (213) 740-0764
Department of Management and Organization Office: (213) 740-0728
Email: cvoigt@marshall.usc.edu [Note: I do not check email sent to cvoigt@usc.edu!!!]
Office Hours: MW 11:00-12:00 noon, 1:30-2:00 pm, immediately after class, and by appointment
COURSE DESCRIPTION
Business enterprise in today’s environment increasingly involves crossing national borders and, more generally,
engaging in business activities in numerous countries that are often very different from each other. Changes in
technology, transportation, communications, and political alliances have significantly internationalized business.
Increasingly, firms are required to compete in multiple foreign markets at both the product and supply-chain levels.
Understanding the management, marketing, financial, and operational challenges associated with global business
activity, and developing skills in these areas, have become essential requirements for success. The Global Strategy
course is designed to provide students with the skills, knowledge, and sensitivity required to create, maintain, and
renew sustainable competitive advantage within a global environment.
Global Strategy will explore international business issues from an integrated firm-level perspective. The course will
adopt a strategic perspective and will highlight the following topics from this perspective: the analysis of industry
and environmental forces, the competitive context in which companies operate in global industries, creating and
sustaining global competitive advantage, the characteristics of global, multi-domestic and transnational strategies,
international entry strategies, global strategic alliances, the role of global organizational structures, and the
importance of global strategic control. Case studies used in this course will help you develop your analytical and
decision-making skills and also highlight the reality of environmental uncertainties influencing decision making in
the global context. Cases also seek to develop your capacity to identify issues, to reason carefully through various
options and improve your ability to manage the organizational process by which decisions get formed and executed.
In addition to case analyses we will also read and discuss additional articles on strategic issues relevant to operating
in a global context. Thus, students will develop both, historical and current, and theoretical and practical,
perspectives on operating in a global context.
This course has two broad objectives and will be taught simultaneously at two levels. First, this course is designed
to teach students “about” international business issues. That is, the course intends to help students understand how
business practices vary widely across regions and countries. Secondly, this course is designed to teach students
“how to” formulate and evaluate winning global strategies. In a very real sense, this course is designed for students
who seek to work in, or with, firms that operate in many different countries, or which operate outside the US.
By the end of the course, students should be able to: perform country, region, industry and firm analyses in an
international setting, evaluate the effectiveness and sustainability of international and global corporate strategies,
analyze the benefits and shortcomings of various multinational organizational structures, compare the relative merits
of different modes of global market entry, and understand the underlying conditions of the international economy
that influence global competitive behavior activity such as economic, legal, political and cultural differences,
exchange rates, comparative national advantage, national economic policy, the role of international agreements and
customs unions, and balance of trade and payments.

MOR-492: Syllabus
MOR 492 Syllabus 2
Page 402
COURSE EVALUATION
Course grades will be determined by students’ relative performance on the following course components:
Course Contribution (participation and unannounced quizzes) 20%

Individual Case Analysis (one) 10
Group Case Analysis (one) 10
Doing Business with Mexico Group Project and Presentation 25
First Mid-term Exam 15
Second Mid-term Exam 20
100%
In order to successfully pass this course, a passing grade (> 50%) must be achieved in each individual course
component. Missed mid-terms and/or assignments severely reduce a students grade. Plus and minus shades will be
assigned to those immediately above or below grade cutoff points. The distribution of grades will closely follow
the guidelines of the Marshall School of Business (an average class GPA of 3.3).
ATTENDANCE POLICY
Class attendance is absolutely essential. All missed classes will be noted. The policy on missed classes is to allow
each student three (3) absences, no questions asked, no penalty. All further absences over the limit will reduce the
student's participation grade, no questions asked, no excuses of any kind expected or accepted. Students with an
excessive number of absences are at risk of failing the course. Only Official University engagements, such as
scheduled debating events, sports events, are excepted from this policy. Job interviews, etc., are not excused, so
choose your absences carefully. Habitual lateness (and leaving class early), for whatever reason, will be noted as
evidence of low course commitment, and penalized. Simply put, you cannot learn for our class discussions, and
your classmates cannot learn from you, if you are not present.
COURSE CONTRIBUTION
Since this course is principally a case and seminar class, your overall commitment and attitude toward this course,
and your daily active verbal participation (speaking and listening) in classroom discussions, will be closely
monitored. In grading class participation, we will look at both the quantity and quality of your class
contributions/interventions. Class participation is obviously a function of preparation, skills, attitude, and a
willingness to actively commit yourself in front of your instructor and colleagues. A classroom is a cost-free
environment for experimenting and learning to "play the game." Make use of it. Shyness is no excuse.
With regard to quality, the dimensions that we look for include:

Relevance -- does the comment bear on the subject at hand? Comments that do not link up with what the discussion
is focusing on can actually detract from the learning experience.
Causal Linkage -- are the logical antecedents or consequences of a particular argument traced out? Comments that
push the implications of a fact or idea as far as possible are generally superior.
Responsiveness -- does the comment react in an important way to what someone else has said? Analysis -- is the
reasoning employed consistent and logical?
Evidence -- have data from the case, from personal experience, from general knowledge been employed to support
the assertions made?
Importance -- does the contribution further our understanding of the issues at hand? Is a connection made with other
cases we have analyzed?
Clarity -- is the comment succinct and understandable? Does it stick to the subject or does it wander?
All students will be formally called on, at random, to take the lead in various aspects of class discussions at least
once or twice during the semester. If the student called upon is not present, is late, or is not sufficiently prepared to
make a substantial contribution to the class discussion, he/she will lose points for class contribution. If the student
makes helpful comments, he/she will accumulate points for class contribution. Since it is unlikely that there will be
MOR 492 GLOBAL STRATEGY Spring, 2006

MOR-492: Syllabus
Page 403
MOR 492 Syllabus 3
enough opportunities to call on each student more than once or twice, be warned that failure to be thoroughly
prepared, on all occasions, can be devastating to your overall grade.
Each student will receive a score for participation at the end of each lecture/discussion and case discussion session.
No Credit Students, though present, who make no contributions, will receive no credit.
A Little Credit The simple recitation of facts from the case will receive some credit toward the student’s class
contribution score.
More Credit Comments that do more than simply recite case facts will receive significantly greater credit
towards a student’s class contribution score. For example, comments that provide synthesis or raise counterintuitive
points, will add much more to a student’s class contribution score.
Gold-Star Credit Students who substantially advance the learning of the whole class by providing non-intuitive
analyses, profound insights, or “over the top” quantitative analyses, will receive maximum credit.
Negative Credit Comments that contain factual misstatements, demonstrate lack of adequate preparation, or are
distracting because they come too late in the discussion, will be penalized. Attempts to dominate class discussion
rarely result in consistent and significant contributions.
Participation Cards: At the end of each case discussion, students who actively participated in the discussion will
be asked to turn in a “Participation Card”. These cards should list your name, the date, the case discussed that day,
and a synopsis of your contributions during that day’s discussion. The Participation Cards will be used in
combination with the instructor’s own daily evaluations to determine your participation grade for the day. For this
purpose, please purchase a package of 3x5 index cards and bring them to each class.
Group Article Presentations and Critiques: On days when additional articles have been assigned one group
will be given the task of reviewing and critiquing each article. Groups should creatively think of ways to help the
other students in class learn the assigned materials. These presentations will be evaluated and will factor into
determining a students overall course contribution grade.
Unannounced Quizzes: Short unannounced quizzes may be given at any time during the course to test the level
of student preparation for lecture and case discussions. Multiple choice and short answer questions may be given at
the beginning of classes where a case is assigned for class discussion. No make-up opportunities will be given to
students who are absent or late. Student performance on these pop-quizzes will be used to determine a student’s
participation grade.
INDIVIDUAL CASE ANALYSIS
Students must select a case and prepare a comprehensive external, competitive, and internal analysis, and provide
appropriate strategic recommendations and implementation plans. The individual case analysis should include a
“consulting format” report with a carefully prepared one page executive brief (attached to the front) containing the
essence of the critical issues, analysis and strategic recommendations which have detailed in your report. A
“consulting format” report should contain powerpoint slides which are essentially visual in appearance. Examples
of reports will be presented in class. Please note carefully those cases which can be prepared as an individual
analysis. They are designated by an “ica.” More detail will be given in class. The individual case analysis is 10
percent of the course grade.
Students must be present in class to submit individual assignments, and they must be submitted at the beginning of
class. Unfortunately, late individual assignments will not be accepted. Students may submit a second individual
case assignment if they are not satisfied with the first grade received. The better of the two individual assignments
will be used in determining your final course grade.
GROUP CASE ANALYSIS
I will assist all students in forming groups. I will attempt to ensure a proportional distribution of women and men in
each group. In forming groups I will also ensure that no group has more than two non-native English speakers.
Additionally, international students will be distributed across groups so as to ensure within-group diversity.

MOR-492: Syllabus
MOR 492 Syllabus 4
Page 404
The group case analysis should include a carefully prepared report with a two-page executive brief. Your report
should be in “consulting format”. Please note carefully those cases that can be prepared as a group case analysis.
They are designated by a “gca” on the course schedule. More detail will be given in class. The group case analysis
is 10 percent of the course grade.
Note: Each group must submit a GCA, in Modules I or II, before the first Mid-term Exam which is
scheduled for Wednesday, February 14th.
Late group case analyses will not be accepted. Groups may submit a second group case assignment if they are not
satisfied with the grade received on the first. The better of the two grades will be used in determining the final
course grade for all group members.
INTERNATIONAL FIELD TRIP TO MEXICO
This course includes a MANDATORY field trip to Tijuana and Ensenada, Mexico. The dates and length of the
international field trip are still to be determined but are likely to be March 1-3. We are planning a two-day trip
(Friday and Saturday) where we will study local Mexican businesses, Maquiladoras (multinational companies with
facilities in Mexico which benefit from free trade agreements), meet with local Mexican government officials, and
study local culture and business practices. The cost of the trip will be subsidized by USC’s CIBER (Center for
International Business Education and Research) and the USC Marshall Undergrad Program, but will require students
to contribute to the cost of the trip. The trip will require students to make arrangements to miss classes, and/or work
obligations on those days. You should ask your professors and employers for permission to be absent now.
Participation on the field trip to Mexico is mandatory.
You must have a valid passport for this trip. If you DO NOT have a passport, you must apply for one
IMMEDIATELY.
DOING BUSINESS WITH MEXICO GROUP REPORT AND PRESENTATION
Assignment: If you were advising a global company not already present in Mexico (or another
country such as China), would you advise them to enter the “x” business sector? Why or Why
not? If yes, How? If not, what would change your decision? Your analysis should consider how
you would enter and market products to the lowest tiers for the consumer sector. [Where “x”
represents an industrial, retail, financial, or service sector of your choice. For example, automotive sector, textile
sector, tourism sector, electronics, retail, etc.]
Creativity in framing your project is encouraged. While the primary assignment is to take a U.S. business (not
currently doing business in Mexico) to Mexico and enter all segments of the Mexican market, you may structure
your assignment differently. You could consider bringing a Mexican company to the US. Or you could consider
taking a U.S. company to another global market instead of Mexico. Or you could consider bringing a non-US
business to Mexico. Any variation on the topic should be outlined in a short memo and be presented in advance of
all deadline to me for feedback and acceptance.
Assess the opportunity for an existing global corporation, typically a U.S. firm in the same sector but not already
present in Mexico. Prepare your report as if you were going to present your findings to the top management
executive team of the global company. Your report should examine the challenges of entering all segments of the
Mexican market place. You must consider how to enter the fourth and “fifth” tiers of the consumer market place.
If you choose to enter, why and how do you enter this sector, i.e., a recommended entry strategy for the global firm
including an analysis of which segment of the sector you would enter, the mode of entry you would choose. If not,
why not? Is this decision contingent on some factors, and what are these factors?
Regardless of whether you chose to enter or not to enter, what would make you change your decision? What
indicators do you look for to change your decision?

MOR-492: Syllabus
Page 405
MOR 492 Syllabus 5
To support your recommendation, the following key dimensions should be addressed

(Whenever possible, you should collect data and use statistical analysis to support your
arguments. These data should be presented clearly in tables and figures both in the report
and the presentation):
1) Market Potential: For example: Importance of sector to economy in terms of absolute size and percentage of
the sector in the economy, employment and any other dimensions, growth rate of sector, profitability in then
sector, foreign investment in sector, sources of foreign investment.
2) Competition in the Sector: For example: who are the players, their market shares, what types of strategies
are they following, domestic players and multi-national players, countries of origin of key multi-national
players, who are the major investors in the sector—domestic and multi-nationals, what are the primary ways in
which they compete, sources of competitive advantage of key players, value chain configurations of key
players.
3) Strategic Importance to Mexico of the Sector: For example: does Mexico have factor endowment
advantages in this sector, is Mexico a lead market for trends and developments in the sector, are there related
and supporting industries that support the development of this industry in the country, how important is Mexico
in the global competitive battles among major international players in this sector, how important is this market
as a platform for expansion into surrounding countries.
4) Profitability and Growth rates: For example: current profitability of the sector as a whole, differences in
the profitability of different strategies of competitors, attractive competitive positions of incumbents, potentially
attractive strategic positions for new entrants.
5) Key Institutional Forces / Institutional Voids (Economic, Political, Legal, Technological, and
Social Context) affecting Sector including any barriers to entry: For example: Economic policies,
Political forces, Regulatory framework, Technological forces, Social changes; focus should be on laying out the
current context and what is changing; focus should be on only the major issues not a laundry list; in particular,
you should address key impediments or barriers to entry faced by foreign firms seeking to enter Mexico
especially with respect to this particular sector.
6) Marketing Analysis: For example: what are the primary target markets, what are the needs and preferences
of the target markets regarding the sector, what are customer attitudes and perceptions of the sector, what are
the key trends in customer demand and behavior impacting the sector, how satisfied are customers with the
sector, what products and services are typically offered, and how are the products and services priced, promoted
and positioned relative to the competition. How is the consumer market segmented? What are lowest tiers of
the consumer market like?
7) Comparison of Key Characteristics of Sector with Same Sector in the U.S. Economy: For
example: a comparison of the key characteristics and features of the sector with the same sector in the U.S.; in
particular, you may compare the structure of the industry, key operating characteristics, cost and quality
competitiveness of the sector or key players in the sector; value chain configurations and so on.
8) Sector Evolution: For example: How is the sector likely to evolve in the future and why so; what key
indicators of evolution should an analysis focus on to understand the changes in the industry; how is the
structure of the sector likely to change?
9) Entry Strategy: For example: If you choose to enter the market, how does your entry strategy address the
entry barriers described in section 5 and the evolution of the sector described in section 8? If you chose not to
enter the market, come up with a strategy that would reduce the risk of entry if a U.S. company decided to enter
the market in spite of your recommendations.
Page Limit You should limit your report to 2 pages of executive summary, and up to 10-15 pages of appropriate
“consulting format” presentation slides. Fewer pages would be better if you can more effectively present the data in

MOR-492: Syllabus
MOR 492 Syllabus 6
Page 406
diagrams and tables (and Powerpoint slides). Make use of tables and charts to present as much information as
parsimoniously as possible. You will not have enough time to be able to provide a full comprehensive treatment of
the assignment, so focus on the most important issues in each area outlined above. Please note: Cases are not good
models for your group project because they are intendedly descriptive, and, on purpose lack substantive analysis.
Your project should be long on analysis and short on description.
The report and presentation is 25 percent of the course grade. Late projects will be penalized 10 percent per day
late, including weekends. The 25 percent report grade will be divided into 15 percent for the written report, which I
will assign, and 10 percent for the class presentation. The class presentation grade will be determined by the class as
a whole. Member of the class will be required to rank all the group presentations. Your average presentation
ranking will determine your presentation grade. The top ranked group will receive an A, the bottom ranked group
will received a B-.
In preparing your Doing Business in Mexico presentation you should carefully consider your audience; your
classmates. Be sure to prepare your verbal/oral presentation in a way that teaches them something new and
interesting. It is difficult to educate without entertaining, although it is easier to entertain without educating. Be
careful to get the education part right. Your written reports should necessarily be more comprehensive, including all
appropriate detailed analyses. However, an oral presentation, to your classmates who have also prepared similar
reports, will necessarily be different than your written report.
MID-TERM EXAMS
Two mid-term exams have been scheduled for this course. These mid-terms will cover all the assigned readings,
course lectures, and case studies in the modules preceding the mid-terms. The mid-term exams will consist of
multiple choice questions, short answer and short essay questions on all assigned readings and cases. Students who
miss mid-terms without prior arrangement will receive a grade of zero. See Course Schedule for the dates of the
mid-term exams.
COURSE MATERIAL
A series of cases and readings have been assigned for this course. They are available through University Partners in
the University Book Store. When necessary, your instructors may place additional materials in the bookstore for
you to purchase.
COURSE COMMUNICATION: BLACKBOARD
An “Electronic Folder” has been created for this course in BLACKBOARD. You should begin the habit of
checking the BLACKBOARD folder on a very regular basis. The course syllabus, case discussion and assignment
information have been posted to the MOR 492 folder. Additional course lecture notes/materials, further details on
assigned cases and the group projects, and general course announcements, will be posted to the folder throughout the
semester.
STUDENT REPRESENTATIVE
You will be asked to elect a Section Representative during our first session. The selected student representative will
act as a liaison between the section and the instructor to provide informal feedback and communication, particularly
on issues that individual students may not wish to raise personally with the instructor.
OFFICE HOURS AND APPOINTMENTS

MOR-492: Syllabus
Page 407
MOR 492 Syllabus 7
I have set aside the hour before lunch on Monday and Wednesday for “open” office hours, and 30 minutes before
the afternoon class, for those who would like/need to discuss specific issues related to the course. I will also make
appointments for those who cannot meet me during the “open” office hours.
ACADEMIC INTEGRITY
The following information on academic integrity, dishonesty, and the grading standard are placed here at the
recommendation of the School of Business Administration Faculty and are taken from the Faculty Handbook.
“The University, as an instrument of learning, is predicated on the existence of an environment of integrity. As

members of the academic community, faculty, students, and administrative officials share the responsibility for
maintaining this environment. Faculty have the primary responsibility for establishing and maintaining an
atmosphere and attitude of academic integrity such that the enterprise may flourish in an open and honest way.
Students share this responsibility for maintaining standards of academic performance and classroom behavior
conducive to the learning process. Administrative officials are responsible for the establishment and maintenance of
procedures to support and enforce those academic standards. Thus, the entire University community bears the
responsibility for maintaining an environment of integrity and for taking appropriate action to sanction individuals
involved in any violation. When there is a clear indication that such individuals are unwilling or unable to support
these standards, they should not be allowed to remain in the University.” (Faculty Handbook, 1994: 20)
Academic dishonesty includes: (Faculty Handbook, 1994: 21-22)
1. Examination behavior - any use of external assistance during an examination shall be considered academically
dishonest unless expressly permitted by the teacher.
2. Fabrication - any intentional falsification or invention of data or citation in an academic exercise will be
considered a violation of academic integrity.
3. Plagiarism - the appropriation and subsequent passing off of another’s ideas or words as one’s own. If the
words or ideas of another are used, acknowledgment of the original source must be made through recognized
referencing practices.
4. Other Types of Academic Dishonesty - submitting a paper written by or obtained from another, using a paper or
essay in more than one class without the teacher’s express permission, obtaining a copy of an examination in
advance without the knowledge and consent of the teacher, changing academic records outside of normal
procedures and/or petitions, using another person to complete homework assignments or take-home exams
without the knowledge or consent of the teacher.
The use of unauthorized material, communication with fellow students for course assignments, or during a mid-term
examination, attempting to benefit from work of another student, past or present, and similar behavior that defeats
the intent of an assignment or mid-term examination is unacceptable to the University. It is often difficult to
distinguish between a culpable act and inadvertent behavior resulting from the nervous tensions accompanying
examinations. Where a clear violation has occurred, however, the instructor may disqualify the student’s work as
unacceptable and assign a failing mark on the paper.
STUDENTS WITH DISABILITIES
Any student requesting academic accommodations based on a disability is required to register with Disability
Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained
from DSP. Please be sure the letter is delivered to me as early in the semester as possible. Your letter must be
specific as to the nature of any accommodations granted. DSP is located in STU 301 and is open 8:30 am to 5:00
pm, Monday through Friday. The telephone number for DSP is (213) 740-0776.

MOR-492: Syllabus
MOR 492 Syllabus 8
Page 408
RETURNED COURSEWORK
Returned paperwork, unclaimed by a student, will be discarded after 4 weeks and hence, will not be available should
a grade appeal be pursued following receipt of his/her grade.
ABOUT YOUR PROFESSOR
Carl Voigt is an Associate Professor of Strategy (Clinical) in the Management and Organization Department. He
also received his Ph.D. from the Anderson School at UCLA in strategy and organization. He is a native New
Zealander, although he completed his undergraduate work at Avondale College in New South Wales, Australia.
Dr Voigt specializes in teaching competitive and global strategy, and management courses in both the undergraduate
and MBA programs here at USC. His academic interests are in business, corporate and global strategy, and in
particular in entrepreneurship.
Dr. Voigt has consulted with firms and organizations in the entertainment, food processing, tourism, health care,
engineering, telecommunications, defense, and not-for-profit sectors. He has also conducted numerous seminars for
teams of managers in the areas of management and strategy. He is an academic consultant with the F.T.C. Line of
Business program.
Initially, Dr. Voigt began his career as a high school teacher. His first job was teaching high school business
subjects on Guadalcanal in the Solomon Islands. During that time he also served as Chair of the Business Studies
Curriculum Development Committee and a member of the National Secondary School Curriculum Committee for
the Solomon Island government.
Dr. Voigt has been awarded two Marshall’s Golden Apple teaching awards: one from the Marshall MBA students in
2001, and one from the Marshall undergrads in 2005. Dr. Voigt has previously been an Associate Dean of our
Marshall Undergrad Program, MBA.PM and EMBA Programs, and Marshall MBA Program. He has also
successfully coached several teams of Marshall undergraduates to world prominence in different case competitions.
In April 2001 he helped coach four Marshall undergraduates to first place in McGill’s international case
competition. In February 2000 he coached Marshall’s team to first place in the Marshall International Case
Competition. And he also coached Marshall undergraduate teams to a second place finish in 1998, and a final four
finish in 1999.
In a “past” life, he was heavily involved in coaching basketball; having coached at the high school, college and
international levels. While in the Solomon Islands he coached their national basketball team for 2 ½ years. Today,
he is first and foremost a father. He spends most of his free time, now, organizing and coaching and refereeing in
recreational programs for his children (He has three sons: 22, 17 and 13 years old, and a 12 year old daughter). Dr.
Voigt’s wife, Diane, teaches grades 7-10.
TENTATIVE COURSE SCHEDULE**

** Please note that this is a tentative course schedule. Changes may be necessary relative to coordinating our
International Field Trip to Mexico. Additionally, some cases may be changed by the instructor.
For those without a current valid passport, you must apply for a Passport. You will need
this for our field trip to Mexico in March. You must expedite your passport
Session Date Case / Topic Course Deliverable

MOR-492: Syllabus
Page 409
MOR 492 Syllabus 9
1 1/8 Course Introduction

Lecture/Discussion: What is Globalization and the Global Marketplace, really?
Read: Gupta and Govindarajan. “Managing Global Expansion: A Conceptual
Framework”
I. COMPETING IN THE GLOBAL MARKETPLACE
2 1/10 Review/Introduction: First Principles and Core Concepts of Strategy Photo and Bio
Read: Siegel, Introduction to Global Strategy
1/15 MLK HOLIDAY
3 1/18 Case: Jollibee Food Corporation: International Expansion Immigration

Documents
4 1/22 Case: Global Wine Wars: New World Challenges Old (A) gca/ica
5 1/24 Case: BRL Hardy: Globalizing an Australian Wine Company gca/ica

Read: Ghemawat, “Regional Strategies for Global Leadership”
II. GLOBALIZATION IN CONTEXT
6 1/29 Lecture/Discussion: Global Environmental Analysis: Frameworks for Analyzing

Global Regions, Countries, Industries and Markets
Read: Ghemawat, “Distance Still Matters: The Hard Reality of Global Expansion
Note on Political Risk Analysis
7 1/31 Case: Toys “R” Us Japan ica

Read: Prahalad and Lieberthal, “The End of Corporate Imperialism”
8 2/5 Lecture/Discussion: Country Analysis: Analyzing Opportunities and Challenges

Case: Mexico: Unfinished Business
Read: “Country Analysis”
Selection of economic sector and focal company for doing business in Mexico project due ***
9 2/7 Case: The Competitive Advantage of China

Read: Porter, “The Competitive Advantage of Nations”
10 2/12 Case: AmorePacific: From Local to Global Beauty gca/ica
11 2/14 FIRST MID-TERM EXAM
2/19 P R E S I D E N T S’ D A Y H O L I D A Y
III. CREATING GLOBAL COMPETITIVE ADVANTAGES
12 2/21 Lecture/Discussion: Global Strategy: Creating Global Advantages and

Building Strategic Multinational Capabilities
Read: Ghemawat, “The Forgotten Strategy”
13 2/26 Case: S.A. Chupa Cups ica

MOR-492: Syllabus
MOR 492 Syllabus 10
Page 410
Read: Bartlett and Ghoshal, “Going Global: Lessons from Late Movers”
14 2/28 Case: The Globalization of CEMEX gca

Read: MacMillan, van Putten, McGrath, “Global Gamesmanship”
3/1-3 INTERNATIONAL TRIP TO MEXICO Mandatory
15 3/5 Case: Haier: Taking a Chinese Company Global ica
IV. GLOBAL ENTRY STRATEGIES AND STRATEGIC ALLIANCES
16 3/7 Lecture/Discussion: Global Entry Strategies: Exporting,

Foreign Direct Investments, Joint Ventures and Strategic Alliances
Read: Hamel, Doz and Prahalad, “Collaborate with Your Competitors – and win”
Working Outline, with designation of individual responsibilities, of “Doing Business in

Mexico” course group project due. ***
3/10-18 S P R I N G B R E A K
17 3/19 No Class Work on your “Doing Business in Mexico Project”
18 3/21 Case: Louis Vuitton Moet Hennessy: Expanding Brand Dominance in Asia ica
19 3/26 Case: Hong Kong Disney (A): The Walt Disney Perspective ica
20 3/28 Case: Flextronics International, Ltd. gca
V. MANAGING AND ORGANIZING MULTINATIONAL CORPORATIONS
21 4/2 Lecture/Discussion: Global Business Management: Designing and Managing

Multinational Corporations
Read: Bartlett and Ghoshal, “What is a Global Manager?”
22 4/4 Case: P&G Japan: The SK-II Globalization Project ica
23 4/9 Case: Timberland: Commerce & Justice
24 4/11 SECOND MID-TERM EXAM
25 4/16 No Class: Work on Doing Business in Mexico Group Assignment **
VI. DOING BUSINESS IN MEXICO PROJECT PRESENTATIONS
26 4/18 Final Presentations: Doing Business in Mexico Report Due
27 4/23 Final Presentations
28 4/25 Final Presentations
FINAL EXAM PERIOD (see Spring Schedule of Classes for date)

MOR-492: Syllabus
Page 411
MOR 492 Syllabus 11
Scheduled Feedback Sessions on Presentations and Report
Please Note:
Submitting Group Case Analyses
All groups must submit a group case analysis (gca) before the first Mid-Term Exam. I will assist you with a
within-group peer performance appraisal. You should plan on using this group peer evaluation intervention to give
open, honesty, and constructive feedback to each other based on performance to this point in our class. It is better to
deal with within-group issues earlier rather than later!
Submitting Individual Case Analyses
ica/gca: In modules I & II, you may submit an individual case analysis (ica), if your group choose not to prepare
and submit a gca. Note, however, that you may not submit an ica at the same time your group submits a gca.
Submit Photo and Bio by January 10 (Session 2)
Please prepare a 5 x 7 inch card with a picture of yourself (depicted anyway you like so long as you are
recognizable), with some brief information about yourself such as country of origin, languages you speak, your
major, your short-term and long-term career goals, hobbies, eccentricities, and anything else that is interesting about
yourself that you would like to share with me.
Immigration Documents by January 18 (Session 3)
You will need legal documents for our trip to Mexico in October. A current passport is required and/or alien
resident card. As of January U.S. citizen must travel to and from Mexico with a valid passport. Please turn in a
clear photocopy of your passport, alien resident card, or a copy of you application for a passport, on Wednesday,
January 18th.
Note: All cases and articles are in the Case Package available from the University Book Store.

MOR-492: Discussion Help
Page 412
Session 3: International Expansion:

Global Strategy & Management Challenges Wednesday, 1/18
The Jollibee case traces the international expansion of Jollibee Foods Corporation, a Philipines based fast food
company led by entrepreneur Tony Tan Caktiong (or TTC) that is expanding within Asia, and now beyond. The
case begins with Noli Tingzon, the new general manager of the international division, facing three investment
decisions. He has opportunities to expand into Papua New Guinea (PNG), Hong Kong, or the United States, and
recognizes that his decision on which project to back will probably shape the broader strategic agenda and
organizational model that the company’s international operations will follow.
The Jollibee case will also give us practice at identifying a competitive strategy, drawing a business model,
evaluating the sustainability of competitive advantages, and thinking critically about how far a company’s strategy
can “travel” without modification.
Read Gupta and Govindarajan. “Managing Global Expansion: A Conceptual

Framework”
Seigel “Introduction to Global Strategy”
Case Jollibee Foods Corporation: International Expansion
Discussion
Questions
1. How was Jollibee able to build its dominant position in fast food in the Philippines? What sources
of competitive advantage was it able to develop against McDonald’s in its home market?
2. How would you evaluate Tony Kitchner’s effectiveness as the first head of Jollibee’s international
division? Does his broad strategic thrust make sense? How effectively did he develop the
organization to implement his priorities?
3. As Noli Tingzon, how would you deal with the three options described at the end of the case?
How would you implement your decision?
4. Provide advice to the top management team at Jollibee. What should Tingzon do to ensure global
success? Which option should he select? What competitive advantages does he have to build on?
What global competitive advantages can Tingzon exploit to improve its global position?
No formal turn-in assignment

This is our first case and we will use it to get used to doing a case analysis.
Reminder: Immigration Documents

Please bring to class one of the following: (1) a clear photo copy of the information page from your passport (the
copy of your photo should be recognizable), or (2) a copy of your birth certificate and one government issued photo
ID. If you are an international student or an international exchange student (that is, a student on any type of visa),
we need a copy of your visa, too.

MOR-492: Reading Notes
Page 413
The Forgotten Strategy

By Pankaj Ghemawat
• In many if not most cases, companies see globalization as a matter of taking a superior business model and
extending it geographically, with necessary modifications, to maximize the firm’s economies of scale
• The key strategic challenge is simply to determine how much to adapt the business model – how much to
standardize from country to country versus how much to localize to respond to local differences
• Many companies have moved toward more localization and less standardization
• All companies that view global strategy in this way focus on similarities across countries, and the potential
for the scale economies that such commonalities unlock, as their primary source of added value
• In their rush to exploit the similarities across borders, multinationals have discounted the original global
strategy: arbitrage, the strategy of difference
• If they are to get their global strategies right in the long term, many companies will have to find ways to
combine the two approaches, despite the very real tensions between them
The Strategy of Differences
• Arbitrage has been around for a very long time

• Many of the industries in which arbitrage has historically been applied – farming, mining, and textiles – are
regarded as low-tech and mature
• There is also the sense that well-run global enterprises have already reaped what competitive advantage
they can from arbitraging such generic factors of production as capital or labor, which, as one leading
management guru has put it, can now be sourced efficiently with the click of a mouse
• The scope of arbitrage is as wide as the differences that remain among countries, which continue to be
broad and deep
o Cultural Arbitrage
 Claims that the scope for cultural arbitrage is decreasing over time are clearly not true for
all countries and product categories
 Reduction in other dimensions of difference – tariffs or transport costs, for instance – can
also increase the viability of cultural arbitrage
o Administrative Arbitrage
 Legal, institutional, and political differences from country to country open up a host of
strategic arbitrage opportunities
 Tax differentials are an obvious example (NewsCorp)
 Few managers explicitly treat tax or other administrative arbitrages as a strategic tool,
despite their potential
 Executives are reluctant to draw attention to such arrangements for fear that they might
be outlawed
 In some cases, administrative arbitrageurs are actually breaking the law
 Many forms of administrative arbitrage involve working with or around given rules
 In some cases, companies can leverage political power to try and change the rules
 The potential for using government influence to create administrative arbitrage
opportunities remains high
o Geographic Arbitrage
 Transportation and communication costs have dropped sharply in the last few decades
 But the drop does not necessarily translate into a decrease in the scope of geographic
arbitrage strategies
 Although communication costs have dropped more sharply than transportation costs,
there are cases in the telecom sector where returns earned by focusing on residual
distance have been higher than those gained by building or exploiting global connectivity
 The geographic arbitrageurs that have lost some ground in recent decades are the great
general trading companies of the past, which traditionally took advantage of large
international variations in prices for a broad array of products by getting them from
market A to market B

Page 414
o Economic Arbitrage
 Refers to the exploitation of specific economic factors that don’t derive directly from a
country’s culture, geography, or administrative context
 These factors include differences in the costs of labor and capital, as well as variations in
more industry-specific inputs such as knowledge or the availability of complementary
products, technologies, and infrastructures
 The best-known type of economic arbitrage is the exploitation of cheap labor, which is
common in labor-intensive, capital-light industries like clothing
 Labor arbitrage can be applied to R&D as well as to ongoing operations, as Emraer also
demonstrates
 One might argue that labor arbitrage is an unsustainable strategy in knowledge industries
because labor costs quickly rise to match demand
 Capital cost differentials would seem to offer slimmer pickings than labor cost
differences; they are measured in single percentage points rather than multiples of ten or
twenty
 The subtlest forms of economic arbitrage involve the exploitation of knowledge
differentials
Reconciling Difference and Similarity
• One would think that companies that try to exploit differences would not find it easy to exploit similarities
as well
• Fundamental tensions between pursuing scale economies and playing the spreads exists
• The data indicates that there is some merit to classifying companies according to the primary way they add
value through their international operations over long periods of time
• For a start, it’s possible to apply different strategies to different elements of a business
• The branded business grew to significant volumes but continued to generate losses because the competitive
environment was particularly tough for a late mover
• The future of globalization process is by no means obvious
• Markets may integrate further once economic conditions improve
• Some argue that the process could actually shift into reverse, toward even greater economic isolation, if the
experience between the two World Wars is any precedent
• The differences that make arbitrage valuable as well as the similarities that create scale economies will
remain with us for the foreseeable future

Page 415
Going Global: Lessons from Late Movers

By Christopher A. Bartlett and Sumantra Ghoshal
• Companies from developing countries have entered the game too late
• They don’t have the resources; they can’t hope to compete against giants
• There is plenty of evidence that the above is not true
• The writers studied 12 emerging multinationals in depth
o They operate in wide range of businesses, but they are all based in countries that have not
produced many successful multinationals
• The evolution into more-profitable product segments can be clearly tracked on what we call the value curve
o All industries can be seen as a collection of product market segments
o The value curve is a tool used to differentiate the various segments
o The more profitable the segment, the more sophisticated are the capabilities needed to compete in
it – in R&D, distribution, or marketing
A Model of Success
• Indian pharmaceutical company Ranbaxy

o Moving into large markets like China and Russsia – required building new customer relationships,
a strong brand image, and different distribution channels
o U.S. and European markets – the company needed to meet much more stringent regulatory
requirements
o Their immediate challenge was to break out of the mind-set that they couldn’t compete
successfully on the global stage
o Once freed of that burden, they had to find strategies in which being a late moves was a source of
competitive advantage rather than a disadvantage
o They had to also develop a culture of continual cross-border learning
Breaking Out of the Marginal Mind-Set
• Companies from peripheral countries can fall into several traps, which we call liabilities of origin
• Some companies feel as though they are locked in a prison of local standards because of the gap between
technical requirements and design norms at home and world-class standards abroad
• If demand at home is strong, managers then can reasonably postpone the investments needed to comply
with international standards
• Sometimes, management is either unaware of the company’s global potential or too debilitated by self-
doubt to capitalize on it
• There are a few companies for which the liability of origin derives from a limited exposure to global
competition, leaving them overconfident in their abilities or blind to potential dangers
• Our emerging multinationals started to overcome them by creating a push from home and a pull from
abroad
o Push from home
 Management’s greatest challenge is to shock or challenge the company to push it from its
nest
 Samsung example
 Another way to create a push from home requires a leap of faith more than a shock of
recognition
 These leaps can be dramatic, and they are always risky, like performing on a trapeze
without a net
 Some CEO’s do this by investing far ahead of demand, even if doing so reduces the
company’s responsiveness to its successful home market
o Pull from abroad
 Organizations need an engaged trading post, not just a passive listening post

Page 416
 Companies need offshore champions who can provide the young, overseas organization
with credibility and confidence, both internally and externally
 Singh from Ranbaxy created an organization in which managers from other parts of the
world had a seat at the table on key corporate decisions
Devising Strategies for Late Movers
• The next major challenge is to choose a strategy to enter the global marketplace
• Benchmark and sidestep
o Emerging multinationals can learn how to compete against the players in foreign markets simply
by adapting and responding to those players as they enter the home market
o They benchmark the established global players and then maneuver around them, often by
exploiting niches that the larger companies have overlooked
o Jollibee example
• Confront and challenge
o When companies use their newcomer status to challenge the rules of the game, capitalizing on the
inflexibilities in the existing players’ business models
o A more radical strategy is to introduce new business models that challenge the industry’s
established rules of competition
o Though risky, this approach can be very effective in industries deeply embedded with tradition or
comfortably divided among an established oligopoly
o The typical business model in these industries has become inflexible
o BRL Hardy example
Learning How to Learn
• The global marketplace is information based and knowledge intensive

• To survive in this environment you must learn how to learn: its is the central skill that allows a company to
move up the value curve
• Protect the past
o Too many companies become so focused on where they are going that they forget where they are
coming from
o With the Jollibee example, the new manager broke down the barriers between the international
and domestic organizations and began building relationships that acknowledged his respect for
their success and dependence on the home country’s expertise
• Build the future
o Entering a new market requires considerably more than simply tweaking the home-market formula
o Often companies lack the expertise needed to tailor the product or strategy to the new environment
o So many emerging multinationals try to take a shortcut to learning by entering into a partnership
with a foreign company
o In theory, companies can sidestep the disadvantages of partnering by buying the necessary
capabilities
o After the false start, Hardy realized that in international business new capabilities cannot simply
be installed; they must be developed and internalized
Having the Right Stuff
• Moving from the periphery into the mainstream of global competition is such a big leap that it was always
led from the top
• The emerging multinationals always have leaders who drive them relentlessly up the value curve
• Their commitment to global entrepreneurialism was rooted in an unshakable belief that their company
would succeed internationally
• Their operation expanded, they all exhibited a remarkable openness to new ideas that would facilitate
internationalism – even when those ideas challenged established practice and core capabilities
• These leaders are models for the heads of thousands of marginal companies in peripheral economies that
have the potential to become legitimate global players

MOR-492: Class Notes
Page 417
MOR-492 1/10/07 2:04 PM
General Strategy
• Managing the future
Risk premiums, sustainable/renewable above normal returns

• ROA: Return on Assets
• ROIC
• EVA: Economic Value added
• Government no risk
• More risks with businesses
Willingness to buy
• Marketing, placement of staples in grocery stores
• Willingness to pay: Hospitals, we don’t shop around for the
cheapest emergency room
• Harley Davidson tattoos, you can charge them whatever you want
Cost minimization
• Fixed costs stay the same, economies of scale doesn’t affect fixed
costs
• Economies of scope, sharing fixed costs, so one item carries less of
a burden
o Trucking, want to fill up lorries so there is less cost on each
product
Not often is it possible to have both high volume and high margins
• It’s not true at all that high market share equals high profit
• There are two winning strategies
• One emphasize low price and high volume
Business Models
• Very important to know the business model, for direction in
decisions
• Investment goes into uniqueness
o Usually, some exceptions (R&D to lower costs)
When you have a good thing in business, people will try to copy you

Page 418
• Rivals
o Entrants
o Buyers
o Substitutes
o Supply
• If there are many of these in some market, it is not attractive
• To solve this
• Barrier to entry to block entrants
Targeting
• Low Cost – Broad market focus: Ivory, Dial et cetera
• Low Cost – Focused market focus: The stuff you get in a hotel
• Differentiated – Broad:
Drug industry can charge a lot, because insurance covers it

• Most Pharmaceuticals are patent protected
• Huge barrier to entry when getting into this industry
Shocks and trends can have enormous affects on industries
Attractive products
• Valuable
• Rare
• (non)Imitable
• Organization
Strategy is your idea for making money

• How to sustain it over time
• Competitive threats, how to build up a defensible market position

Page 419

Page 420

Page 421

Page 422

Page 423

Page 424

Page 425

Page 426

Page 427

Page 428

Page 429

Page 430

Page 431

Page 432

Page 433

Page 434

MOR-492: Projects
Page 435
Global Expansion
Nan Wang
Whitney Stambler
Keith Parker
Kerry MacDonald
Gary Lilardi
February 12, 2007 Chen Kang “CK” Hsu
Group 5 “The Seven Samurai” Mark Davenport
Decision Tree - Strategic Approach

Vision: To become a top 10
company with $4 billion in
sales by increases overseas
sales from $100m to $1.2b.

MOR-492: Projects
Page 436
Cosmetics – An Expanding Industry

• AmorePacific is involved in 49%
of the potential cosmetics product
scope (green shaded slices).
•Europe makes up the largest
market followed by Asia with the
US closely behind in third.
Expected expansion of
cosmetics industry by 2009:
$180 Billion
Projected Performance
From this analysis, AmorePacific is facing an overall medium competitive global cosmetic industry.
Porter’s 5 Forces
• Low barriers to entry

Threat of • L’Oreal, The Procter & Gamble, Unilever
•Low restrictive regulation New Entrants PLC, Shiseido Co. Ltd., The Estee Lauder
(FDA) Cos. Inc., Avon Products, Beiersdorf AG,
• Low capital requirements - High Johnson & Johnson, Alberto-Culver Co.,
Kao Corp.
•Similarity among brands
•Increasing global concentration
Bargaining Rivalry Bargaining

power of among power of
Suppliers - competitors - Buyers –
Low High High/Medium
• Large selection of other
• Many suppliers
labels
• Fragmented
• Low switching costs Threat of • Low switching costs
•Fragmented market
Substitutes - • Some degree of customer
loyalty
• Oral supplements
Low
• Tattooed make-up
• Plastic/dermatology surgery
• Spa treatments

MOR-492: Projects
Page 437
CAGE Framework
Distance between Korea and other countries
Korea vs. China Korea vs. U.S

Culture Distance Culture Distance
•Different languages •Different languages
•Korean herbal medicine system was based on China’s •Different religions and Value, Norms, and ethnicity
•Common Confucian tradition, colonial ties •Korean based business on personal contact
Administrative Distance Administrative Distance
•World Trade Organization •World Trade Organization
•China open to foreign investment and competition •Korean government has heavy influence on economy
Geographic Distance •Relatively unstable political climate due to North Korea
•Land borders Geographic Distance
•Northeast China is accessible from Korea, and shares •Long Distance
much history and culture •Korea has multiple American military bases
Economic Distance Economic Distance
•Korea is a developed country, China is a developing •Rich-Rich: Replication
country •Korea has complicated social and distribution network
Korea vs. France

Culture Distance : - Different languages
- Different religions and Value, Norms, and ethnicity
- France has a relatively lax work environment
Administrative Distance - World Trade Organization
- France has strict socialist labor laws
- France has relatively unfriendly political environment for commerce
Geographic Distance - Long Distance
Economic Distance - Rich-Rich: Replication
Macro-Environment Analysis
Political Environment Economic Environment
United States: United States:
• Open trade • Capitalist Economy
• FDA approval required for most cosmetic products
China:
China: •1980s and 1990s became more open to foreign
•Law banning door-to-door sales in 1996 investment and competition
•Shares much history and culture with Korea • High GDP growth rate
France: France:
• Labor Union activity can affect production costs •Strong currency (EU)
P.E.S.T. Analysis
Social Environment Technological Environment
United States: United States:
•Mixed cultural environment • High cosmetics R&D
• Rapidly expanding Internet based economy
China:
•Common Confucian tradition, colonial ties, and Korean China:
herbal medicine systems comes from China •Evolving e-commerce
•Growing popularity on South Korean culture
France:
France: • Advanced cosmetic industry R&D infrastructure
•Prefer “Made in France” products
•“the home of cosmetics”
AmorePacific wants to expand their product line internationally. Therefore, the company needs to
determine the right place to sell the maximum amount of their products to earn the highest profit. Even
though there are cultural gaps between Korea the United States, China , and France, AmorePacific
should be able to make a profit in these different regions through thorough research of where to enter the
market in order to reach the widest consumer base.

MOR-492: Projects
Page 438
Business Model
As a cosmetics company, AmorePacific relies on Differentiation-based model to attract customers and build
consumer loyalty.
Loyal Door to Door

Quality Personal Selling
Consumers
Brand Reputation Extra Premium

Marketing Profits Prices
R&D
Increased
Margins
Value Chain
AmorePacific serves a wide range of customers by offering products of different quality and levels of
innovation. Furthermore, AmorePacific’s unique culture of adaptability and unity has given more market
sensibility. Combined with their strong home base, high levels of innovation, successful marketing
strategy, expansive knowledge base, and a wide range of personalized products, AmorePacific is able to
obtain its current success.
R&D Raw Materials Manufacturing Distribution Marketing Retail
•Location •location •S cope of •Differentiatio •Customer

•Experience
production line n relationship
•botanicals •technology
•Knowledge •Brand
•transportation •Changing of
•chemicals •consolidation marketing
•Designated consumer’s
national taste
research lab
by Korean •Door to door
government personalized
selling
•Nano
structure •High-end
technologies retail
distribution

MOR-492: Projects
Page 439
Opportunities & Attractiveness

US
• Another world leader in
cosmetic product development
• Large number of Korean
immigrants
• High discretionary income
France
China
• World center for cosmetic
Benefits
• Market Size and Growth product development

• Growth potential, unsaturated • Strong demand for cosmetics
• Entry costs are high,
• Joined the WTO
especially in high profile
targeted locations
• Overcoming association with
• Reluctance to buy from newly
‘newly developed country’
• Access to majority of developed country
origins
Costs
population is limited
• Trouble reaching mid-priced
• Door-to-door sales illegal pharmacy channel
• Brand confusion, with low-end

• Different cosmetic product products and high end offerings
• Political stability
preferences
Risks
• Reaching the non-immigrant

• Economic freedom lacking
•Flagship product, a fragrance, market
• Unemployment levels high has low loyalty levels
• Highly regulated market
Well Equipped for High-End Market

Unique Packaging
•Designed in multiple layers
•Protect products from light,
heat, cold, and time
•Packaging is the “shape of
devotion”
New Products Distribution

•Quick launch of high-end
DIFFERENTIATION •Single brand booths
brands STRATEGY •High-tech door-to-door sales
•Innovative and research-based
•Hue Place
products
R&D Center Exclusive Ingredients

•Among the largest of any •Only available in Korean farms
cosmetics company worldwide
•Hand picked rare ginseng
•Exclusive “Nano Delivery aged precisely 6 years
System”, 1/1000th the size of a
•Unmatched perfect
skin cell
microclimate
•Maximizes nurturing at the
•Green tea extract harvested by
cellular level
hand during 1 st week of April
•First in sector designated
“National Research Lab”

MOR-492: Projects
Page 440
Success Factors
Amore Pacific’s success is the contribution of several factors that helped them establish their brand in
the Korean cosmetics market. Factors such as product quality, their market familiarity, and luck enables
them to become Korea’s leading producer of skin-care and cosmetic producs.
Market Familiarity Product Quality

•Understand Korean • High quality products
women and their that works.
needs. •Access to rare and
•AmorePacific is a quality ingredients.
local Korean company •Beauty professionals Reputation
with majority of their to provide customer
employees Korean. service through spas,
Hence, they are able to department store
better understand their booths, etc.
market’s needs.
Luck
•AmorePacific is the first company to provide skin-care and cosmetic products to the
Korean market.
•Korean Economic crisis and depression creates a larger entry barrier for large
international competitior to enter Korea and enables AmorePacific to take advantage of their
market dominance.
Global Strategy
In order to understand AmorePacific’s strategy for going global, and what they wanted to achieve in their
global businesses, close attention should be paid to their levels of local responsiveness and global
coordination through this model.
High
AmorePacific’s goal is to
Transnational compete with the best
international brands in the global
Global Coordination
Global cosmetic market. To do this,

AmorePacific they must appeal to the different
(Tomorrow) global consumer needs while
keeping their costs at a minimum
Multi-Domestic One solution for this is to move
into a Transnational-type
company. This would mean high
International AmorePacific product differentiation for each
(Now) regional market (scope) while
keeping high global coordination
to take advantage of economies
scale.
Local Responsiveness
Low High

MOR-492: Projects
Page 441
Initial Entry Strategy

AmorePacific’s entry strategy for each of their global market were different to suit the heterogeneousity of
consumer preference. These differentiations included: Marketing strategy (target market and entry market),
Product lines, and Distribution/retail points.
Entry Market: Low-M edium

Entry Market: High-M edium Asian Entry Market: High-M edium Income
market Income
Products: Full line Skin-care and Products: Exclusive to Fragrances Products: Skin-care and Cosmetics
Cosmetics Marketing S trategy:
Marketing S trategy:
Marketing S trategy: •“Bottom-up” strategy
•“M ade in France” Fragrances to
• Target the Asian market within the create an exclusive image •Used Korean marketing strategy
US because they had more brand because of similar market
awareness •Different brand name to better environmet. (eg.Korean M odels)
appeal to the local’s preference
•High priced skin-care products to
promote youthfulness
Recommendations
• Strongest emphasis on the US market, large
potential for high investment returns.
United •Top Down Approach.

•Focus on High-End department stores and
retailers.
States •Diversify marketing towards non-Asian and

Korean consumers in US.
• Second strongest push for development in the

French market, strategically necessary location for
cosmetic companies.
France •Retain separation from Corporate to allow local

decision making for the French market.
•Expand product line to build from the foothold of
fragrances. Bundle skincare products.
• Emerging market offers strong potential for high market

share, but many barriers still exists low-end targeting
could influence global brand image
China •Retain “Made in Korea” to ride the “Korean Wave.”

•Introduce higher-end products but retain accessibility to
Tier 3 consumers.

MOR-492: Projects
Page 442
Implementation
France China
•Exploit strong perfume market, but avoid cosmetics for •Continue bottom up penetration
the near-term •Huge mass market opportunities in the lower tiers
•Sophisticated demand in perfume market can provide through low-end niches
knowledge for introducing quality products for markets •Emphasize “Made in Korea” to appeal to
in other countries All Global Markets young popular culture
•Avoid “Made in Korea” concept •Management should avoid reducing resource
•Emphasize quality commitments because this will hinder goals to
increase worldwide market share. The strong
financial position currently doesn’t necessitate
reductions.
•Continue to pursue organic growth. Inorganic
growth through acquisitions or joint ventures can
lead to inconsistencies in operations and
damage AmorePacfic’s global image.
•Diverse entry strategies are necessary because
of differences between cosmetic market maturity
and consumer preferences by country.
United States
•Potential for highest returns because of profit premiums on high-
end product lines with emphasis on research & technology
•Resources should be dedicated to securing premium distribution
channels for market introduction (i.e. Saks Fifth Avenue, Bergdorf-
Goodman, Neiman Marcus, etc.)
•Penetrate top down by catering to 1st & 2nd tier customers
Conclusion
• The United States would offer the highest returns on investments of
resources and managerial emphasis.
• France is strategically important in the global cosmetics market, as an
industry focal point.
• By moving from the multi-domestic to transnational approach, Suh
Kyung-Bae should be concerned with maintaining local
responsiveness and increasing global coordination.
• Joint ventures and acquisitions could be considered, but not at the
expense of losing control or sacrificing the company image.

MOR-492: Projects
Page 443

MOR-492: Projects
Page 444

MOR-492: Projects
4 N Q\ r UFu k» u D
scanR scanner scanr document scan scans doc documents doc@scanR.com
eurokeith@gmail.com
Tuesday, February 06, 2007 Tuesday, February 06 07 Tue, Feb 6 Tue, Feb 6, 2007
02/06/2007 06/02/2007 2007/02/06 02/2007 02-06-2007 06-02-2007 2007-02-06 02-2007 02/06/07 06/02/07 07/02/06 02/07 02-06-07 06-02-07 07-02-06 02-07
[MOR 492] White Board
Page 445

MOR-492: Projects
Page 446
P&G in Japan: The SK-II Globalization Project

Individual Case Analysis
Keith Parker
ID#6390.4899.77

MOR-492: Projects
Page 447
In deciding upon which markets to enter, two factors are important to consider.
First, the individual country factors must be analyzed and compared with the core
competencies of the P & G organization. Second, and just as important, one must
understand the effects that entering either or both of these countries will have on the
newly created strategic organizational structure of P & G’s entire group.
In analyzing a potential move into the English market, it has become clear that
many of the core competencies that SK-II holds in Japan do not travel to the European
market. First, the four to six-step face washing program might be too intense for the
casual European woman. Further, service at the point of sale, one of AK-II’s strong
points, must be able to travel in order to ensure success. England, with its high minimum
wage, does not provide the most attractive market for such a sales model.
The consideration of entering the high-end Chinese market appears to be much
more appealing than the entry into the English market. While the overall Chinese market
may not be able to afford such expensive luxuries as the SK-II product line, the more
sophisticated inner-city markets with a high discretionary income appear to be a great
match for entry by SK-II. Olay has already done some of the work in testing the waters
by borrowing the service-based sales model and putting it into practice in China. This
model was highly successful, which lends to the idea that one of SK-II’s most important
core competencies will travel to the Chinese market.
Moving into the Chinese market seams to be a good move from most angles.
When taking into account the new organizational structure of P & G, which emphases the
firms’ ability to take successful products from separate GBUs and spread them across the
globe, a move into the English market seems to be a good test of this organizational
structure and may help newly appointed managers find their place in the organization.

MOR-492: Projects
Page 448
Bringing SK-II into Europe

ID#6390.4899.77
and China
Keith Parker

Overview

• The core competencies of SK-II travel best to the Asian
Market
• The European market has different preferences than the
Asian market and very different competitive conditions
MOR-492: Projects
• Market share of SK-II is still low in Asia, and with its

promise of success as shown by large growth in Japan,
the market in Asia that might best be known for being
home to some of Asia’s most sophisticated beauty
product consumers, so growth should be focused in this
region
• Nonetheless, with the new organizational structure of
Proctor and Gamble supporting the widespread sale of
successful P & G products, a weary entry into the English
market might provide clues as to the potential for further
expansion into other western markets
Page 449
Page 450
SK-II Sources of Success

•Well researched and developed product; provides the multi-step
process desired in the sophisticated beauty product market of
Japan
•Service at the counter is strong, leading to customer loyalty
MOR-492: Projects
•Innovative advertising appealed to Japanese market

Research and Service at
Manufacturing Advertising Distribution
Development Counter
Advertising methods Distribution High labor
Will Likely travel to should travel well to methods may costs in the UK
China, where China, but may need adjustment will make this
preferences are require different for Europe, but very difficult to
similar. In Europe, mediums. In P&G’s travel, though
though, Will Likely Europe, TV ads are knowledge with in China the
preferences differ travel too expensive- may distribution in opposite is
to the extent that successfully be too difficult to this market true, as labor
products may not to both establish recognition should make for is much
travel well to this China and and build market a smooth cheaper than
area Europe share transition in Japan
Industry Analysis

•Firms compete
heavily for market
share
Threat of Entry •There are many
•Mostly a marketing-based industry, which requires heavy use of capital to gain a players in the beauty
significant market share products game,
increasing rivalry; this
•Large amount of capital also required for research and development is especially true in
•Boutique entrants may find niche markets, but in order to gain a significant saturated markets
MOR-492: Projects
market share it is important to be established and have a large capital base

Low
Supplier Buyer Power
Power Medium- •Buyers are customers at the end
of the line
•Suppliers are High Rivalry High •These customers have a fairly
employees along the
large amount of buying power, as
entire value chain, High beauty products are usually sold
chemical suppliers,
and suppliers of selling near competing beauty products
space so it is easy for the customer to
•Those in control of walk away
selling space have a Medium
large amount of power
as there is limited Substitutes
space and many •Depending on the market, substitutes may be common or rare In China,
people competing for it women may chose to instead use simple soap and water. In Japan, though,
•Other suppliers don’t consumer sophistication lends to the idea that there is little substitution for
have very much power beauty products
Page 451
Page 452
Possible Entry Considerations

Cost and Volume Drivers Location Drivers
By expanding operations,
movement along the learning National Non-market
curve will increase economies differences will be strategies are not
of replication limiting in Europe, substantial in this
MOR-492: Projects
but no so much in case

entering China
Global learning will With the size of P
As with economies As initial expansion be seen most in
into these markets & G’s operations in
of replication, and entering Europe, other and similar
increase in total will only include one and will be an
product line (SK-II), industries, the firm
units sold after important test of will be able to
entering either of operations will not be the new
benefited by provide some of
these markets will organizational the flexibility
lead to benefit from economies of scope structure of P & G needed in entering
economies of scale Europe and China
Region analysis

MOR-492: Projects
Japan
England
China Japan’s market is
Clearly, there are large sophisticated, has on
cultural differences between China’s top-tier market is more average a relatively
the Asian beauty market and similar to Japan’s market. large amount of
the European beauty market. Although the overall market discretionary income,
While Japan may be the may differ, the target market and has proven that
sophisticated market of Asia, (I.e. those in the big cities with SK-II, along with the
where large amounts of large discretionary income) will services and
development within the most likely buy SK-II products. marketing that
industry occur, France is the Evidence of this has arisen accompany the
equivalent of Europe. from Olay’s use of SK-II’s product, can succeed
Without being in France, SK- Japanese tactics in China in in markets similar to
II won’t be able to effectively order to justify the price this
compete with other European premium for their products.
Beauty suppliers in England. This has been wildly successful.
Page 453
Page 454
Entering England

• Although Europe may not be ideally suited as a potential location for
expansion of the SK-II line, entry into this market may provide strategic
benefit
• As most large beauty product companies are global in scale, SK-II can
reap the benefits of knowledge transfer, economies of scope, et cetera
MOR-492: Projects
• If SK-II is to become a globally competitive brand, it must test the waters

and make a presence in the western world
• England, with its concentrated department store channels that would allow
limited high-cost service staff but similar service quality, would be a good
choice
• While losses may occur, this is necessary in order to gain a strategic
position in the world market
• Further, although SK-II’s premium positioning doesn’t fit well with P & G’s
volume-based strategy, it will compliment Olay’s lower-cost volume
strategy and provide economies of scope as well as stronger bargaining
power with England’s very powerful concentrated retailers
• Further, as brand image and service quality are essential to the success
of SK-II in the British market, ownership of these components should be
as full as possible. A partner in entering this market would be a good idea
for the other components of business operation, though, so as to minimize
risk and provide for a smoother exit strategy
Entering China

• The Chinese market, though on average quite a bit different
from the Japanese market in terms of personal spending power
and sophisticated preferences, can still provide SK-II with a
large amount of success in the Asian market
• In the largest, wealthies cities of China reside those who have
MOR-492: Projects
preferences similar to the Japanese and the buying power to

purchase items marked up as high as SK-II
• As service is such a large part of SK-II’s overall product offering
and strategy, the ability to hire service workers at an extremely
low price in China adds great appeal to entering the market
• Olay borrowed the service-based idea from SK-II and put it to
work in China, to huge success; this alone is proof that one of
SK-II’s strongest core competencies will travel into the Chinese
market and meet success
• China’s potential for growth and profit is strong enough for one
to suggest that P & G enter into the market without a partner in
order to maximize profit (I.e. China is not a very risky entry)
Page 455
Page 456
How Does This Fit Into The

Organizational Structure?
•As this case analysis may have provided more
concrete reasons to NOT enter England than vice
versa, when taking into account P & G’s new
MOR-492: Projects
organizational structure one finds that this is clearly

not the case
•One of the core competencies of the new
organizational structure of P & G is its ability to take
a good idea from one GBU and mass market the
same technology in different ways throughout the
world; SK-II is the perfect product to challenge this
new organizational structure and allow all of the
newly appointed managers to establish their role in
the organization
Page 457
The Wahaha Group

Mexican Expansion
MOR-492: Projects
Presented by
Mark Davenport, C.K. Hsu, Gary Lilardi, Kerry MacDonald,
Keith Parker, Whitney Stambler, Nan Wang

Executive Summary
Wahaha’s Company Background
Wahaha is the leading beverage producer in C hina. Founded by Zong Qingou in 1989, the company has
grown into a billion dollar industry. Wahaha has begun a limited expansion abroad by entering the United
States and putting its products on shelves in New York and Los Angeles. Part of Wahaha’s strategy is to find
markets with high growth opportunities.
Mexico’s Attractiveness to Wahaha

The Mexican soft drink market is an extremely attractive market for Wahaha. C urrently, Mexico is ranked
the world’s second largest soft drink market. Within the soft drink industry, carbonated beverage category
dominates with huge revenues representing over 60% of the market. C arbonates are particularly popular in
Mexico due to the hot climate, compatibility with Mexican food, and the wide market penetration. In fact,
carbonated drinks have become part of Mexican culture; “many Mexicans would find it difficult to imagine a
gathering with friends without carbonates.”[1] Over the next few years, the soft drink market is expected to
be valued at $20.3 billion, an increase of 27% since 2005. Meanwhile, sales volume is expected to increase
by 28.6% to 49.6 billion liters. Wahaha should take advantage of the opportunity to enter in this growing
economy.
Wahaha’s target customers are similar to who the company appeals to in C hina. The company will aim at the
lower tiers of the market (tiers 3 and 4) where consumers are more price-sensitive. In Mexico, this target
MOR-492: Projects
market represents a large percentage of the overall Mexican market (approximately 64%).
How to Enter into Mexico

There are many options for Wahaha to consider before entering Mexico. However, out of the many possible
paths the best choice is to joint venture with Groupe Danone. Wahaha and Danone have an existing
relationship that was formed in 1996. C urrently, Danone owns 51% of Wahaha. With Danone's assistance,
Wahaha was able to invest in advanced production lines, improve efficiency, and production doubled from
1996 to 1997. Danone has been operating in Mexico for over 30 years. With Danone’s experience in Mexico,
Wahaha can use its knowledge of the market to have a greater chance at success. Wahaha will need to build
a bottling plant, but with the high growth of the market, the breakeven should occur during the second year.
Also, Danone already has a wide distribution and manufacturing network that can be used to distribute
Wahaha products. Wahaha will be able to enter Mexico and know that they have a trustworthy partner with
them.

When entering into this new market, Wahaha should implement its old business model, but make some
necessary small adaptations. In C hina, Wahaha targets the lower tiers in rural regions, but in Mexico, these
areas are not as populated and population in rural areas continues to decline Therefore Wahaha will need
Page 458
Page 459
Executive Summary Continued

Competitors Wahaha Will Face
Wahaha faces major competition in Mexico. The largest are C oke and Pepsi who dominate the market with
63% combined market share. However, Wahaha will not be directly competing with these two companies.
Instead, Wahaha will look to grab some of the market that the smaller brands reach. Big C ola is one of the
smaller brands that Wahaha will be competing with and matching the price they put on its products. Market
trends indicate that much of the increase in consumption volumes in Mexico is driven by low-price
carbonates that are more affordable for consumers. In this sense, Wahaha will not be stealing market share
from competitors as much, but expanding the market.
Barriers to Wahaha’s Success in Mexico

While Mexico holds great potential for Wahaha, there are factors that may hinder the success of the
company. There are relatively high political risks and corruption within Mexico. There are also cultural
distances because of the difference in language and Mexicans do not favor Asian products. However, by
joint venturing with Danone, Wahaha can mitigate these cultural distances by learning from Danone’s
experience and responding to these differences in the market.
How to Succeed in Mexico

MOR-492: Projects
In order to succeed in the Mexican carbonated drinks industry, Wahaha needs to build its global competitive
advantage. In order to do this, the company can take advantage of its knowledge in creating economies of
scale and scope that improved tremendously with their joint venture with Danone. Additionally, the way that
Wahaha advertises will help spread its brand image. Wahaha will replicate the marketing strategy that it
uses in C hina and use commercials, print ads, and celebrity endorsements. Danone’s 30-year experience in
Mexico will also help Wahaha succeed in this new market and capture a portion of the soft drink industry.

[1 ] “S oft D rinks – M exic o.” E uromonitor I nternational. A ugus t 2 0 0 6 .
MOR-492: Projects
Page 460
Company Information

Page 461
Who is Wahaha?
“Wahaha” in Chinese refers to the sound kids make when they

are happy and laughing
Found by Zong Qinghou in 1989
Private-owned company and biggest beverage producer in China
Manufactures non-alcoholic beverages and non-beverage goods

including clothes, snacks, etc.
Responsible for 15.6% of China's total beverage production

MOR-492: Projects
RMB 4.65 billion in total assets
JV ownership: Zong Qinghou holds 49% and Danone holds 51%
Looking for growth opportunities

How Wahaha Should Enter Mexico
T here are s everal entry s trategy options
available for Wahaha for their move into Direct investment
M exic o. T he mos t c apital intens ive without any
inves tment would be a wholly-owned strategic alliances
s ubs idiary. A lthough this would give the
c ompany c omplete c ontrol over their
operations , this mode of entry is not
advis able as Wahaha lac ks experienc e in A cquisition of a
expanding its bus ines s internationally. local brand
Rather than building their operations , Wahaha

c ould ac quire a M exic an brand that is a Mexico
direc t c ompetitor to Wahaha, but this c omes Joint Venture with
with the ris k of failing to integrate the existing f irm in
c ompanies or overpaying for the c ompany. Mexico
(Danone)
Wahaha c ould c ons ider a s trategic allianc e
s uc h as a joint venture with D anone or a
partners hip with a loc al bottler/dis tributor Partnership with
s uc h as A RC A . local bottler
MOR-492: Projects
or distributor
A ll of thes e are viable entry s trategies . (A RCA )
H owever, Wahaha needs to c arefully weigh
the pros and c ons of eac h option to ens ure
s uc
A c es
fter c ons entry into
s fulidering all of
M the o.
exicoptions , we rec ommend that Wahaha enter the M exic an market through a
joint venture with D anone. Wahaha’s exis ting relations hip with D anone mitigates muc h of the ris k of a
partner holding up Wahaha bec aus e D anone is financ ially tied to Wahaha’s s uc c es s . Furthermore,
Wahaha c ould take advantage of D anone’s already es tablis hed dis tribution c hannels in M exic o.
D anone firs t entered M exic o in the 7 0 ’s as a wholly owned international s ubs idiary, and now has an
extens ive network of dis tributors , retailers , and s upporting indus tries under its belt. T his would, in
effec t, make Wahaha’s dis tribution in loc al s upermarkets and mom and pop s tores muc h eas ier than if
they go in M exic o by thems elves .
With D anone owning 5 1 % of Wahaha in C hina, the c ompanies ’ c los e relations hip would provide

Wahaha an eas ier and more effec tive entry s trategy. I t allows them to be c ompetitive with loc al
brands that are c ompeting in the low-c os t, high-volume s oft drink produc t.
Page 462
Page 463
Wahaha’s Business Model

The ex hibit below is a depiction of W ahaha’s business m odel. The m ain focus of W ahaha is increasing
sales volum e in creative and effective ways. Success in their m odel is driven by quality, R&D, advertising,
and econom ies of scale.
W ahaha ’s business m odel is transferable but sm all adaptations are necessary. In China, W ahaha
targets the lower tiers in rural areas. However, in Mex ico, the rural areas are not as populated and the
population in these areas is declining. For this reason, they m ust alter their strategy to reach the lower
tiers in urban and suburban areas as well.
Quality
Volume
Num ber of visits
And repeating
visits
Advertising
MOR-492: Projects
R&D Improve brand Economies

Innovation and awareness and use
pull marketing to
Of scales
creativity for new Price
tastes and products increase WTP
Extra Increased Low Unit

Margin Cost

Profits
Critical Success Factors
Advertising
When entering a
new market,
advertising is Brand Image
essential to building Many carbonated
consumer drinks taste
awareness about similar. Brand
Sales
the product. image will drive
Increased increased sales
Volume
awareness can also and market share
lead to an in the long run.
increased
willingness-to-pay
MOR-492: Projects
and higher profit

margins. Distribution
There are many determinants for the success of a
Wahaha’s target market
company. In the case of Wahaha, the most
important factor is sales volume which is essential includes people living in tiers 3
to generating income. With volume being the focus, & 4, and these customers often
there are other factors that are supplementary. buy soda from among the many
Advertising can increase brand equity and mom and pop stores in Mexico.
consumers’ willingness-to-pay. Good advertising It is imperative that Wahaha
builds a strong brand image, which drives volume.
finds a way to distribute
The channels for distribution are also extremely

important—particularly in Mexico where it is a effectively to these scattered
challenge to reach customers with so many small locations.
Page 464
MOR-492: Projects
Page 465
Industry and Country Analysis

Competitive Advantage & Location Drivers
This diagram of Volum e and Location drivers allows for an in-depth analysis of W ahaha’s
operations and the advantages / disadvantages of m oving into another location. This will lead to a
better understanding of the com pany’s com parative advantage.
•Location Advantages: High
Wahaha’s product takes
volume of low-middle income
advantage of economies
consumers who are very price
of replication as soft •More than 90% of trade
sensitive
drinks are standardized under free trade
and are manufactured •Language barrier that might agreements
through a fixed affect the brand name •Member of WTO,
production process. therefore subject to
•Different consumer taste and
Therefore, they require regulations
preference might affect sales.
little modification and are
simple to produce.
Economies of National Non-Market
Replication Differences Strategy
MOR-492: Projects
Economies of Economies of
Scale Scope
Learning Flexibility
Economies of scale are crucial for We recommend that
Wahaha as cost savings from scale Wahaha limits their product •Very little flexibility as
•Learns crucial information
effect is critical to stay competitive in line when entering Mexico. entering a new market in
about the Mexican market
the soft drink industry. By competing This is because one of the this industry requires very
(consumer preference,
with high volume & low margin critical success factors for high capital costs.
cultural differences,
products, Wahaha has to have low cost the industry is scale
distribution channel •Risks may be reduced if
of production to support the low prices advantage and not scope.
effectiveness, etc.) bottling or other operations
that they charge Therefore, once they have
established the scale they •Strategic alliance with can be outsourced to a local
In order to be successful in Mexico, it is partner.
needed, then they should Danone would provide them
imperative that Wahaha take full
start considering expansion with a better understanding of

advantage of economies of scale.
to create scope. their market
Page 466
Page 467
Why Go To Mexico?
Mexico is the world’s 2nd largest soft drink market
•Carbonate sales proved to be the m ost lucrative in Mex ico, generating revenues of US$9.7 billion, or
60.6% of the soft drink m ark et
•Bottled water generates another 27.4% of sales of soft drink s in Mexico
•PepsiCo and Coca-Cola are both pursuing aggressive cam paigns to gain m ark et share in Mex ico,
recognizing the high value of the m ark et
•By 2010, the Mex ican soft drink m ark et is ex pected to be valued
at $20.3 billion, an increase of 27% since 2005
Compound A nnual Growth Rate
•In this sam e tim e period, sales volum e is ex pected to increase
by 28.6% to 49.6 billion liters
•In 2002, the Mexican governm ent approved a 20 percent tax on
soft drink m anufacturers who use fructose sweeteners, in order to
help stim ulate the dom estic sugar industry
MOR-492: Projects
Global Soft Drink Sales (In billions US$)

The Key to Successful Market Entrance
Porter’s diam ond analysis of com petitive factors allows us to analyze W ahaha’s com petitive
advantages when the com pany m ak es the m ove. W ith good dem and conditions and supporting
industries, we can conclude that there are significant factors that can potentially allow them to
succeed in Mex ico.
Firm Strategy,
Structure, Rivalry
•Rivalry from local colas
(Big Cola) and leading
cola brands (Coke, Pepsi).
Chance •Low-cost, High Volume
strategy.
•Targets middle-low
income groups
Demand Conditions
•Growing market for soft
Factor Conditions drink industry in Mexico
•Wahaha has the
MOR-492: Projects
•Demand for low cost soft

experience of doing drink is high due to lower
business in a developing purchasing power of
country. consumer
•Mexico is suited for their
business model because
of similar market.
Related and
Supporting Industry
•Danon could provide
distribution channels for
Wahaha Government
•Large supermarket

chains around the
company to act as
potential distributor
(Calimax)
Page 468
Page 469
How Attractive is the Industry?

Heavy rivalry and a high threat of substitutes offsets the low ratings for the other factors for new
entrants. Low supplier and buyer power m ak e the industry attractive for established com petitors
and those with large capital sources.
Threat of Entry - Low

•Mostly a m ark eting-based industry, which requires heavy use of capital to gain a significant
m ark et share
•O nly in the energy drink category do we see fragm entation
•Fairly sim ple to enter as there are m any bottlers to contract with, but difficult to gain m ark et
share without advertising capital
Supplier Rivalry- Medium-

High Buyer Power - Low
Power –
•Advertising is heavy •The buyers are bottling
Medium / Low from the m ajor com panies and/or
•Suppliers for retailers
MOR-492: Projects
com petitors, rivalry for

sugar and other m ark et share is very •Threat of forward
raw m aterials high integration: m any large
are m ostly The m arket has been com panies are buying
undifferentiated recognized by m ajor the bottlers they used to
and have little players as a growing sell to
power m ark et, spurning •Bottlers are
•Em ployee are heavy investm ent to undifferentiated, can
back ed by capture growth easily be substituted with
unions •Pepsi, Cok e, Big Cola another bottler in the area
Substitutes - High

•Many substitutes for soft drink s: W ater, juices, alcohol, and energy drink s
•Private labels show threat within the soft drink m ark et (i.e. store-brand labels or ‘spin-offs’)
Competition in Mexico
While Coke and Pepsi dominate the market, Wahaha will not be directly competing with
them. Instead, Wahaha will focus on grabbing some of the market that the smaller
brands reach. Therefore, Wahaha will be priced lower than Coke and Pepsi.
Soft Drinks Market Share
•There are about 43 soft drink

com panies in Mex ico, though
70% of sales cam e from the top
8 com panies
•Pepsi and Cok e historically split
up Mex ico into regions, where
each would dom inate the
m ark et; this has changed in
recent years, increasing
MOR-492: Projects
com petition
•In 2004, Coca-Cola em ployed 86,000 people in Mex ico
•PepsiCo considers Mex ico its second m ost im portant m ark et outside of the US; in early 2002,
PepsiCo announced its goal to invest m ore than US$1.2 billion in Mex ico by 2006
•Bottlers in Mex ico have been consolidating operations, leading to a possible strengthening of buyer
power
•In the past, Cok e and Pepsi tried to prevent sm aller com panies from entering the m arket, but this

behavior is no longer being tolerated. in 2005, the Mexican governm ent fined 15 Coke bottlers and
distributors $15 m illion for anti-com petitive practices. The dealers “unfairly pressured m om -and-pop
retailers not to carry Big Cola by threatening to stop Cok e deliveries and yank from their tiny stores
Page 470
Page 471
Main Competitor:
Wahaha will be directly competing with Big Cola, a Peruvian entrant into Mexico. Both share the same target market
and will be competing fiercely to come out with the lowest prices in order to attract the price-sensitive consumers
Background Facts
– Bottled and marketed by Ajemax, a subsidiary of Peruvian firm Kola
Real
– Entered Mexican market in 2002
– Presently accounts for 5% of the Mexican drink market
– Investment stands at $40 million in 2004
Target Market
– 3rd & 4th tier of the pyramid, similar to Wahaha
– “Tastes good as long as it is cold,” according to a consumer
– Sold for $1.13, sometimes as low as 87 cents
MOR-492: Projects
– Forced PepsiCo to lower prices

Distribution
– Considered a “counter-brand”
– Only 28 distribution centers and sells to small grocery stores
– Business model based on economics along value chain
– Savings passed along to consumers
– Uses freelance vendors who open up new markets for Big Cola

Institutional Voids Analysis
The most important challenges for Wahaha will be developing a on-site water purification system and working with the
local government to ensure a regular water supply at their bottling plant. Moreover, Wahaha will need to rely on an
established partner for adequate distribution. Building their own distribution channel will be too costly and time
consuming.
Hard Infrastructure
•Poor sanitation
•Inadequate waste
disposal facilities
•Contaminated water
•55% of Mexican
households with
access to piped
Soft water received
MOR-492: Projects
Infrastructure services on an
• Logistical intermittent basis
intermediaries – Country Factor Endowments
distribution •Unstable political
channels are environment
limited in rural
areas
•Legal system

Page 472
Page 473
Mexico’s Macro Environment

The economic conditions in Mexico make this an attractive market for Wahaha to enter.
Although there are negative political and economic aspects in the Mexican market,
Wahaha can mitigate these factors by implementing an appropriate entry strategy and,
ultimately, lower the political risk and benefit from the growing economy.
P.E.S.T. Analysis
Political Environment Economic Environment
•Federal Republic •Tourism in Mexico is a large industry,
•Commercial and financial dependence on the ranked third in importance
US •Free market economy
•Part of WTO, subject to regulations •13th largest economy in the world
•Ranked as number 63 for index of economic •Established as an upper middle-income
freedom country
•Mixture of US constitutional theory and civil •GDP - per capita: $10,600
MOR-492: Projects
law system •Unemployment rate: 3.2%

•Blue collar work force is up to a 6-day, 48- •Underemployment of about 25%
hour work week •Foreign Debt: $178.3 billion
•Mexican Federal Labor Law prevents unsafe •Low labor wages
working conditions •Stable inflation rate 5.4%
•Foreigners are not allowed to own land in the •Growth rate 1.16%
restricted
Social zone
Environment Technological Environment
•Mainly speak Spanish, and some English •Use modern technology
depending on area •Weak infrastructure in certain areas
•Literacy rate was at 92.2% •Average water transportation
•No official religion

•Dress and grooming are status symbols
Wahaha’s Distance Barriers
Based on this analysis, W ahaha should m ainly focus on how they will get their products to be as
close as possible to the lower tiers because of the lim ited m obility. Their product is already priced
low to appeal to the lower m ark et, so the financial situation in Mex ico should not be a m ajor hurdle
to overcom e. W ahaha should be able to overcom e the m obility problem because they face the
sam e situation in China when distributing to the lower tiers of the m ark et. Also, a partnership with
a com pany that has been in Mexico for a while can help W ahaha learn and respond as necessary
to the differences in the Mex ican m ark et.
Cultural Administrative Geographic Economic
Do not favor High corruption Water Ranked 9th most
Asian products and political risk contamination impoverished out
Market Weak law Distribution of 102 developing
dominated enforcement mobility is limited countries
products: Coke in rural areas 17.6% of the
and Pepsi population is in
extreme poverty
MOR-492: Projects
Majority of
stores are small Severe
scale (Mom & Pop) underemployment
Different for much of the
language population
Different tastes Consumers are
& preferences price sensitive

Page 474
Page 475
Benefits Outweigh Costs & Risks

Although there are obvious costs and risks (both market and non-market forces)
involved in entering into Mexico’s soft drink market, the lucrative market offers
tremendous benefits for a company to capitalize on, as a growing domestic demand
makes it more worthwhile for new entrants into the industry.
BENEFITS COSTS
• Carbonate sales • Highly fragm ented
com m and and
lucrative in Mex ico, com m unication structure
generating revenues A TTRA CTIVENESS
of US$9.7 billion • Mobility lim ited in rural
• PepsiCo and Coca- areas
Cola pursuing
aggressive • Lim ited purchasing power
of 40% Mex ican
cam paigns to gain households
MOR-492: Projects
m ark et share,
recognizing the high
value of the m ark et
• By 2010, Mex ican soft
drink m ark et to be
valued at $20.3 RISKS
billion, an increase of • Mex ican drink ers m ay not
27% since 2005 want to purchase a new drink
from a Chinese corporation
• By 2010, sales
volum e is to increase • May not be able to penetrate
by 28.6% to 49.6 m ark et dom inated by Coca-
Cola and Pepsi

billion liters
MOR-492: Projects
Page 476
Entry Strategy

Page 477
Distribution Channels in Mexico

Whichever distribution method Wahaha chooses, it must be able to effectively reach the
channels shown in the chart below.
Goals for Distribution Hot weather in Northern Mexico

Must establish a method to reach increases importance of Single
the mom and pop stores Serve format and Coolers,
Existing transportation Stable Pricing Environment
infrastructure can pose
challenges to overcome Prices do not fluctuate
Access to bottling facilities which High Demand per Capita
are geographically disbursed
Access to water
MOR-492: Projects

Possible Ways to Distribute
Based on the pros and cons in this analysis, it com es down to deciding between contracting with ARCA or
a JV with Danone. Therefore, a closer look at these two choices is needed to m ak e a final decision on
which strategy to use.
Contract w ith an Existing JV Partnership w ith Acquire an Existing Build Ow n Distribution
Distributor - ARCA Danone Distributor Netw ork
Low-cost Less financial risk Gain control over Com plete control
Utilize ex isting Because have distribution over entire
e x pertise partial ownership of Can focus on distribution process
Relationships with W ahaha, they are W ahaha brand instead Can concentrate on
stores already m ore aligned with of com peting with W ahaha brand only
established their core values others Ability to set up new
Distribution Have a previously Distribution channels with rural
infrastructure will built relationship Infrastructure will locations
already be in place with distributors already be in place
Access to water Share shelf space Can leverage
rights is responsibility in stores ex isting relationships
Advantages
with stores
MOR-492: Projects
of partner
Easy ex it strategy Can leverage
ex isting relationships
Lack of control over May not want to High initial entry cost Ex trem ely high entry
with consum ers
distribution have a JV with Must m aintain cost
Partner m ay not W ahaha infrastructure Must secure access
prioritize brand Less control over More difficult ex it to water and other
Must share shelf- distribution strategy resources
space with the big Lim ited More financial risk if Must m aintain entire
brands. distribution to the acquire a distributor infrastructure
Their plants are rural areas Very difficult ex it
only in the Northern strategy
Disadvantages
region of Mex ico

W ill have to work to
establish new
relationships with
stores
Page 478
Page 479
ARCA Distribution Partnership

Second-Largest bottler in Latin America serving 16 million consumers and over 214,000
points-of-sale.
• Resulting from • Seeking opportunities

the merger of three to diversify portfolio
of the oldest bottlers • Recent new
product launches:
in Mexico – Argos,
• Ciel
Arma and Procor- Aquarius,
Embotelladoras Arca, Minute Maid,
it was created in Purified
2001. Water.
• Expansion to
• The Company distributes its West Coast
MOR-492: Projects
products in northern • Increase

Mexico, mainly in the states Advertising
of Nuevo Leon, Coahuila, • Retailer Loyalty
Sonora, Sinaloa, Baja Programs
California, Baja California
Sur, and Tamaulipas.
Currently, ARCA has 14
bottling plants and 61
distribution centers.

: Using An Existing Relationship
As there is already a history of successful cooperation between W ahaha and Danone in China,
W ahaha can approach Danone in Mex ico and try to replicate their joint venture project. Having
spent 30 years operating in Mex ico, Danone will be able to provide W ahaha with a solid foothold in
the m ark et as they already have a wide distribution and m anufacturing network . In this way,
W ahaha will be able to enter the new m ark et of Mex ico k nowing that they have a reputable and
trustworthy partner to back them up.
History of Cooperation
W ahaha form ed a Joint Venture in China with Groupe Danone SA in 1996
Invested in advanced production lines and im proved efficiency
Production doubled in just one year Danone’s Market Share Growth
Danone currently owns 51% of W ahaha
30 Years of Presence in Mexico
Entrance in 1976 “1 st Danone Com pany outside Europe ”
Pioneer in Corporate Social Responsibility
Mark et share leader in their industry (41.3% in 2006)
Excellence in Execution
MOR-492: Projects
Shelf space leader

33.5% share of shelf spaces in leading superm arket chains
(including Calim ax )
10,000 PO S to cater to rural areas by 12/2007

Page 480
Page 481
Adaptation & Political Risks Dictate Entry

After successfully m oving into Mex ico to com pete in the carbonated drink s m ark et, W ahaha can
later introduce their other drink s including juices, tea, and sport drink s.
H H
i i Wahaha
Global & Danone
JV
Econ. Opportunity
MOR-492: Projects
Global Coordination
International
L L
o o
L Local Responsiveness H L Political Risk H
Exporting o i o i
W ahaha will alter their entry strategy into There are high political and financial risk s
Mex ico by shipping the soda concentrate to entering the m ark et as a wholly-owned
to Danone. Danone will bottle and subsidiary. Therefore, to m itigate these
distribute the product. W ahaha will avoid risk s, W ahaha will J.V. with Danone.
shipping bottled soda because of the low

value-to-weight ratio which m ak es it
im practical.
Our Target Market
Rather than competing head-to-head with Coca-Cola and Pepsi, Wahaha will aim for
the lower tiers of the market with more price sensitive consumers. This represents a
very large percentage of the overall Mexican market. However, our target market also
cares about image, which is why Wahaha will use limited advertising to build a brand
and differentiate from our key competitor, Big Cola.
Mexican Population (in millions)
Wahaha will target Tier 1 & 2

tiers 3 & 4 which
includes 65.7 million
people Tier 3
MOR-492: Projects
Tier 4
Tier 5

Page 482
Page 483
Marketing Strategy Replication

As Mexico possess a similar demographic to C hina, a similar marketing campaign can be instilled
in the new market. The budget will be smaller, adjusted to the difference in population between
the two countries. The marketing campaign can “kick-off” during the C opa Americas, which is
the most watched television event in Mexico, similar to the rollout of Wahaha’s TV
advertisements during the World C up of 2006.
Successful Marketing Strategy in China

- Centralized marketing campaign
- High cash investment (USD$60.5 Million)
- TV: Brand awareness & recognition
- Print Ads: Product functionality & promotions
- 1st Chinese company to use celebrities’ endorsements
MOR-492: Projects
Target Market
- Urban, Suburban, and Rural areas
- Mass market potential

- Priced lower than known comparable products

- Similar to Chinese market
- GDP per capita higher and median age lower
Wahaha’s Value Chain
Wahaha will manufacture the syrup concentrate at the factories in China and export it
to Danone’s bottling plant. Danone will then bottle and distribute the soda using their
pre-existing distribution network. Wahaha will manage marketing efforts with input
from Danone’s local management. A combination push and pull marketing will be used
to gain shelf space at retail locations. Danone will use its clout and leverage to
negotiate with retailers and Wahaha’s creative advertising will create a draw in
demand by customers.
Manufacture
Bottling Distribution Marketing Retail
Concentrate
MOR-492: Projects
Wahaha Danone Danone Wahaha Various

Page 484
Page 485
Financial Analysis
Pro Forma Income Statement (millions of USD)
2008E 2009E 2010E

Volum e (in m illions of
liters) 440.6 935.0 1488.0
149.8
Revenue 1 317.89 505.92
CO GS 77.90 165.30 263.08
Gross Margin 71.91- 152.59 242.84

Depreciation (Bottling
1
Plant) 20.00 20.00 20.00 Assumptions:
SG&A (including 3
•Retail price: $0.34/liter
m ark eting) 65.00-. 20.00 20.00
0 •Market share: 1% in 2008, 2% in 2009, 3% in 2010
1 •Market growth (in v olume): 6.1% CAGR
O perating Incom e (EBIT) 9 112.59 202.84
3 •Tax rate: 30% (same as Coca-Cola FEMSA)
•Depreciation: $60M bottling plant straight-line depr.
Tax es 0.00. 33.78 60.85
MOR-492: Projects
0- ov er 3 y rs
•No interest expense (all-equity f irm)
Net Incom e 9
1 78.81 141.99
2- Total
1. NPV Retail Price Per Liter
1-
1 Com parison (USD)
1.
NPV (8% discount rate) 2 67.57 112.72 168.16
1
9 Coca-cola $0.53
NPV (10% discount rate) 0. 65.13 106.68 159.91
6
Pepsi $0.38
NPV (12% discount rate) 9 62.83 101.07 152.20
Big Cola $0.34
Expected Breakeven in 2ND Year!

Wahaha $0.34
Possible Exit Strategies
Sell off the bottling plant to Coca Cola, Pepsi, Big

Cola, ARCA, or another company
Discount remaining inventory until all is sold off
Worst case scenario, liquidate all remaining

assets in Mexico
MOR-492: Projects

Page 486
Page 487
References
CIA – The W orld Factbook – Mex ico, https://www.cia.gov/cia/publications/factbook /index .htm l
Coca-Cola FEMSA, S.A.B. de C.V. 2006 Financial Results (Mex ican Stock Ex change tick er KO FL)
Dick erson, Marla. “Upstart firm in Peru tak ing fizz out of cola giants: Cok e, Pepsi face unlik ely
challenger.” Los Angeles Times. 30 Decem ber 2005. http://www.sfgate.com /cgi-
bin/article.cgi?file=/chronicle/archive/2005/12/30/BUGV3GEUE41.DTL&type=business
“Soft Drink s – Mex ico.” Eurom onitor International. August 2006.
Hoovers.com
Hum an Developm ent Report 2006, Hum an Developm ent Indicators: Country Fact Sheets,
http://hdr.undp.org/hdr2006/statistics/countries/country_fact_sheets/cty_fs_MEX.htm l
Index of Econom ic Freedom , http://www.heritage.org/research/features/index/country
Index Mundi – Mex ico, http://www.index m undi.com /

MOR-492: Projects
ISI Em erging Mark ets
JP Morgan Equity Conference – Mex ico City, August 2006
Mex ico Connect, http://www.m ex connect.com /m ex _/laborlaw.htm l#SALARY
Mex ico - Factfile & Statistics, http://www.m ex ico-child-link .org/m ex ico-factile-statistics.htm
“Mex ico – Soft Drink s.” Datam onitor Industry Mark et Research. January 2002.
W ahaha, http://en.wahaha.com .cn

MOR-492: Projects
Page 488
AGENDA COMPANY ANALYSIS ENTRY FINANCIAL CONCLUSION

INFORMATION STRATEGY ANALYSIS
• Company Information
The Wahaha Group
Mexican Expansion • Country & Industry Analysis
• Entry Strategy
• Financial Analysis
Presented by
Mark Davenport, C.K. Hsu, Gary Lilardi, Kerry MacDonald,
Keith Parker, Whitney Stambler, Nan Wang
• Conclusion
AGENDA COMPANY ANALYSIS ENTRY FINANCIAL CONCLUSION AGENDA COMPANY ANALYSIS ENTRY FINANCIAL CONCLUSION
INFORMATION STRATEGY ANALYSIS INFORMATION STRATEGY ANALYSIS
Who is Wahaha?
• Private-owned company and biggest beverage producer (15.6% of total
production) in China
• Found by Mr. Zong Qinghou in 1989
“Wahaha” in Chinese is the sound happy kids make when they are
Company Information •
laughing
• Non-alcoholic beverages and non-beverage goods
• $600M USD in total assets
• JV ownership with Danone
• Looking for growth opportunities
Wahaha’s Business Model

Quality
Volume
Num be r o f visits
And re pe a ting
visits
Advertising Economies
R&D Im pro ve bra nd
Inno va tio n a nd
cre a tivity fo r ne w
ta ste s a nd pro ducts
a wa re ne ss a nd use
pull m a rk e ting to
incre a se W TP
Price
Of scales Country & Industry Analysis
Extra Increased Low Unit
Profits Margin Cost
Critical Success Factors

Sales
Advertising Brand Image Distribution
Volume

MOR-492: Projects
Page 489
Why, or Why Not, Go to Mexico? How Attractive is the Industry?

• Why?
– Market Size
– Market Value
Market Growth
Threat of Entry: Low
– Market Growth
Supplier
• Why Not? Rivalry: Buyer
– Aggressive Competitor Campaigns Power:
– Government Imposed Tax Medium/ Power:
Medium/
• Competitors High Low
– Market Concentration Low
– Pepsi and Coca Cola
– Recent Anti-competitive practices
– Wahaha will compete more directly with more fragmented, smaller
competitors
Substitutes: High
Wahaha’s Target Market Main Competitor: Big Cola

Wahaha will be directly competing with Big Cola in the same target market
Wahaha will Tiers 1 & 2 •Background Facts

target tiers 3 & 4
Tier 3 –Bottled and marketed by Ajemax, a subsidiary of Peruvian firm Kola Real
which includes
–Entered Mexican market in 2002
65.7 million people
–Presently accounts for 5% of the Mexican drink market
Tier 4 •Target Market

–3rd & 4th tier of the pyramid, similar to Wahaha
–Sold for $1.13, sometimes as low as 87 cents
–Forced PepsiCo to lower prices
Tier 5 •Distribution
–Considered a “counter-brand”
–Business model based on economics along value chain
–Uses freelance vendors who open up new markets for Big Cola
Wahaha’s Distance Barriers

Cultural Administrative Geographic Economic
•Do not favor Asian •High corruption and •Water contamination •Ranked 9th most
products political risk •Distribution mobility is impoverished out of
•Market dominated •Weak law enforcement limited in rural areas 102 developing
products: Coke and countries
Pepsi
•Majority of stores are
small scale (Mom &
•17.6% of the
population is in
extreme poverty
Entry Strategy
Pop) •Severe
•Different language underemployment for
•Different tastes & much of the population
preferences •Consumers are price
sensitive
Partnership with a company that has been in Mexico for a while can help Wahaha learn
and respond as necessary to the differences in the Mexican market.

MOR-492: Projects
Page 490
Entering Mexico – How? Distribution Channels in Mexico

Goals for Distribution
• Must establish a method to reach the Mom and Pop stores
Direct investment
Without any • Existing transportation infrastructure can pose challenges to overcome
Strategic alliances • Access to bottling facilities which are geographically disbursed
• Access to water
Acquisition of a local
Brand
Mexico Partnership with local
bottler/distribution
(ARCA)
Joint Venture with
Existing firms in Mexico
(Danone)
Distribution Options : Utilizing an Existing Relationship

• History of Cooperation
Contracting with ARCA JV Partnership with Danone – Wahaha formed a Joint Venture in China with Groupe Danone SA in 1996
– Invested in advanced production lines and improved efficiency
•Low-cost • Less financial risk
– Production doubled in just one year Danone’s Market Share Growth
•Utilize existing expertise •Because have partial ownership of
Advantages
•Relationships with stores already established Wahaha, they are more aligned with their • 30 Years of Presence in Mexico
core values
•Distribution infrastructure will already be in – Market share leader in their industry (41.3% in 2006)
place •Have a previously built relationship with
•Access to water rights is responsibility of distributors • Excellence in Execution
partner •Share shelf space in stores – 33.5% share of shelf space in leading supermarket chains
•Easy exit strategy
Disadvantages
•Lack of control over distribution •May not want to have a JV with Wahaha
•Partner may not prioritize brand •Less control over distribution
•Must share shelf-space with the big brands. •Limited distribution to the rural areas – 10,000 POS to cater to rural areas by 12/2007
•Their plants are only in the Northern region
of Mexico
Adaptation & Political Risks Dictate Entry

H Hi
i Global Wahaha &
Danone JV
Coordination
Opportunity
Econ.
Global
L
International
L Financial Analysis
o L Local Responsiveness H o L Political Risk H
E o i o i
Manufacture
Concentrate Bottling Distribution Marketing Retail
Wahaha Danone Danone Wahaha Various

MOR-492: Projects
Page 491
Financial Analysis
Capital Investments: $60M bottling plant, $60.5M advertising
Exit Strategies & Conclusion

Retail Price Per Liter
Comparison (USD)
Coca-cola $0.53
Pepsi $0.38
Big Cola $0.34
Wahaha $0.34
Expected Breakeven in 2ND Year!
Possible Exit Strategies Conclusion
Sell off the bottling plant to Coca Cola, Pepsi, •Enter Mexico
Big Cola, ARCA, or another company
•JV with Danone
Discount remaining inventory until all is sold off
•Target tiers 3 & 4
Worst case scenario, liquidate all remaining
•Start with carbonated products and
assets in Mexico
later add teas, juices, etc.
Insure it, burn it, and move to New Zealand!
AGENDA COMPANY ANALYSIS ENTRY FINANCIAL CONCLUSION

INFORMATION STRATEGY ANALYSIS
Financial Analysis
Pro Forma Income Statement (millions of USD)
2008E 2009E 2010E
Thank you! Volume (in millions of liters)
Revenue
440.6
149.81
935.0
317.89
1488.0
505.92
Xie Xie
COGS 77.90 165.30 263.08
Gross Margin 71.91 152.59 242.84

Assumptions:
Depreciation (Bottling Plant) 20.00 20.00 20.00 •Retail pric e: $0.34/liter
•Market share: 1% in 2008, 2% in 2009, 3% in 2010
SG&A (including marketing) 65.00 20.00 20.00 •Market growth (in volume): 6.1% CAGR
Operating Income (EBIT) -13.09 112.59 202.84 •T ax rate: 30% (same as Coc a-Cola FEMSA)
Questions? Taxes
Net Income
0.00
-13.09
33.78
78.81
60.85
141.99
•Deprec iation: $60M bottling plant straight-line
deprec iation over 3 years
•No interest expense (all-equity firm)
Total NPV Retail Price Per Liter Comparison (USD)
NPV (8% discount rate) -12.12 67.57 112.72 168.16

Coc a-c ola $0.53
NPV (10% discount rate) -11.90 65.13 106.68 159.91
NPV (12% discount rate) -11.69 62.83 101.07 152.20 Pepsi $0.38
Big Cola $0.34

Expected Breakeven in 2 ND Year! Wahaha $0.34

MOR-492: Projects
Page 492
Plantronics, Inc. (NYSE: PLT)
Headquarters Mexico (dba Plamex, S.A. de C.V.)

Address: 345 Encinal St. Address: Avenida Produccion, #12
Santa Cruz, CA 95060 USA Parque Industrial Internacional Tijuana
Tel: 831-426-5858 Mesa de Otay
Toll Free: 800-544-4660 Tijuana, Baja California 22390, Mexico
Fax: 831-426-6098 Tel: +52 664-682-2798
Web: http://www.plantronics.com Fax: +52 66-822796
Overview
Plantronics, Inc. engages in the design, manufacture, and marketing of lightweight
communications headsets, telephone headset systems, and accessories for the business and
consumer markets under the Plantronics brand worldwide. It also manufactures and markets
computer and home entertainment sound systems, portable audio products, and a line of
headsets, headphones, and microphones for personal digital media under Altec Lansing brand.
In addition, the company offers specialty telephone products, such as telephones for the
hearing impaired, and other related products for people with special communication needs
under Clarity brand. Further, Plantronics provides audio enhancement solutions to consumers,
audio professionals, and businesses under Volume Logic brand. It distributes its products
through a network of distributors, original equipment manufacturers, wireless carriers, retailers,
and telephony service providers. (Yahoo Finance, 2007)
Finances (2006) Miscellaneous

Sales: $750.4M Founded: 1961
1 yr sales growth: 34% Top competitors: GN Netcom, Logitech, Motorola
Net Income: $81.2M Total employees: 7,300
People
Chairman: Marvin Tseu
President, CEO, & Director: S. Kenneth Kannappan
SVP, Finance & Administration, CFO: Barbara Scherer
SVP, Chief Marketing Officer: Mark Breier
SVP, Operations: Terry Walters
Operations in Mexico
Plantronics opened Plamex in Tijuana, Mexico, 35 years ago and since then the facility has
been recognized worldwide for its commitment to quality and progressive employee
programs. Plamex has won nine international manufacturing awards over the past two years,
and was recognized twice by Mexico president Vicente Fox Quesada for its technology and
quality leadership. Plamex is also the only manufacturing facility in the world to win both the
Ibero American Quality Award and Asia-Pacific Quality Award for large manufacturing
organizations. PLAMEX's 3,600 associates contribute to Plantronics' worldwide success by
manufacturing more than 8,000 different models of headset products.

MOR-492: Powerpoints
Page 493
Overarching Goal
COMPETITIVE • Above Normal Returns
STRATEGY
• Strategic Competitiveness
• Sustainable/Renewable
A Primer
Sustainable/Renewable
Above Normal Returns &
Willingness to Buy
Strategic Competitiveness
Profits = Q (R-C) X Time

Margin
Q Quantity
• Fast food – Size of the ticket

• Discount Stores – volume purchasing
• Aggressive Competition (all 5 forces) • Staples are at the back of the store
• Uncertain turbulent future • Impulse buys
• ADVERTISING!!!/POINT OF PURCHASE
Willingness to Pay Cost Minimization
R Price/Revenue
C
• Scales
Costs
• Design
• Premium prices
• Branding • Scope • Productivity
• Monopoly situations – broken arm • Location • Capacity Utilization
• Lifecycle costs of a product
• Experience • HR Productivity
• Customer loyalty – Harley Davidson tattoos
1
Page 494
Business Models: The

Sustainability
Core of a Strategy
TIME
• A firm’s choice of relationship
among these variables is its
business model
•Competitive imitation • Focus and tradeoffs among
variables
•Substitution
•Technological Obsolescence • Two generic business models:
• Cost-based
•Organizational Slack
• Differentiation-based
Illustration of tradeoffs in Market Share-Profitability Relationship:

Q*Margin “Porter’s Bucket”
Margin High
n
ve Differentiation- Low Cost
a based Strategies Leadership
He Strategies
Hi
in
Profitability
e
ad
M
Stuck-in-the-Middle
Lo
Low
Low High
Market Share (Quantity)

Lo Hi Volume
Business Models Business Models

Quality Volume Quality Loyal
Consumers
Price
R&D Economies R&D Premium
Brand Reputation
Advertising of Scale Prices
Mktg Extra
Profits
Increased Low Unit Investments

Extra Margins Cost Uniqueness Increased
Profits Margins
2
Page 495
Value Chains for Cost Advantage

Porter's Generic Strategies and Differentiation Advantage
Firm A: Firm A has a
Strategic Advantage Price
Price cost advantage
Strategic Target
Uniqueness Perceived Low Cost Position Firm B:

by the Customer
Price
OVERALL
Industrywide DIFFERENTIATION COST
LEADERSHIP Firm C has a
Firm C: differentiation
Price
advantage
Particular
Segment Only FOCUS Firm B:
Total cost to buyer

Producer’s cost Producer’s margin Buyer’s cost
Source: Porter (1980)
Distribution of Industry Returns

Average Return on Equity in US Industries, 1982-1993
Great 100
11.7%
13.8%
16.5%
90
Sources Industries 80
70
Fourth Quartile
Average
First Quartile
Average
22.2%
9.3%
of Above Number 60
of
Industries
50
Normal 40
30
Average = 14.7%
Median = 13.8%
Return 20
Great 10
0
Strategies
4%
6%
12%
18%
24%
30%
8%
10%
14%
16%
20%
22%
26%
28%
32%
2%
Return on Equity (Percent)

Source: Jan W. Rivkin’s Analysis Note: Return on Equity = Net Inc ome / Year End
Based on Dun and Bradstreet Data Shareholders’ Equity; Analysis based on sample of 593
industries
Profitability Differences Across

Selected Industries
Superior Profitability
Pharmaceuticals
GATEWAY
Prepackaged software
Semiconductors
Women's clothing stores
Dental equipment HP
Eating places
Drug stores LENOVO???
Petroleum / natural gas
Race track operations
COMMODORE DELL
WHY?
Trucking except local
Engineering services
Computer system design
Cable TV service
WANG
Motor vehicles
Scheduled airlines
0 5 10 15 20 25
Source: Jan W. Rivkin
based on Compustat Operating Income / Assets, 1988-95 (%)
3
Page 496
Determinants of Superior Porter’s Five Forces Analysis

Performance Threat of New Entry
• Economies of scale • Capital requirements
• Profits earned are determined by:

• Proprietary product • Access to distribution
differences • Absolute cost advantages
• Brand identity • Government policy
• Willingness-to-Pay: the value of the product/service to Bargaining Power
• Switching costs • Expected retaliation
Bargaining Power
customers of Suppliers of Customers
• Differentiation of inputs • Buyer concentration
• Intensity of Competition • Switching costs
Rivalry Among • Buyer volume
• Presence of substitute Existing Competitors • Buyer switching costs
• the relative Bargaining Power at different levels in the inputs
• Supplier concentration
• Industry growth • Switching costs •
•
Buyer information
Ability to integrate
• Fixed costs / value • Concentration and balance
production chain • Importance of volume to
supplier
added • Informational complexity
•
backward
Substitute products
• Overcapacity • Diversity of competitors
• Cost relative to total • Price / total purchases
• Sources of profits above competitive level are purchases
• Product differences
• Brand identity
•
•
Corporate stakes
Exit barriers • Product differences
• Impact of inputs on cost • Brand identity
determined by: or differentiation
• Threat of forward
• Impact of quality /
performance
integration • Buyer profits
• Industry attractiveness Threat of Substitutes
• Relative price performance of substitutes
• Strategic group attractiveness • Switching costs
• Buyer propensity to substitute
• Competitive position attractiveness
Source: Michael E. Porter, Competitive Advantage (New York: Free Press, 1985)
SUPPLIER POWER SUPPLIER POWER

LOW DRUG HIGH
Airline
INDUSTRY •strong labor unions
•concentrated aircraft makers Industry
(ROE=28%) (ROE=-1%)
THREAT OF ENTRY THREAT OF ENTRY
LOW INDUSTRY HIGH INDUSTRY
COMPETITIVENESS COMPETITIVENESS
•economies of scale LOW THREAT OF •entrants have cost HIGH THREAT OF
•capital requirements SUBSTITUTES advantages •many companies SUBSTITUTES
for R&D and clinical •high concentration LOW •low capital requirements •little product MEDIUM
trials •product differentiation •little product differentiation
•product differentiation •patent protection No substitutes. differentiation •excess capacity •autos for short distance
•control of distribution •steady demand growth (Changing as managed care •deregulation of •high fixed/variable costs travel
channels •no cyclical fluctuations encourages generics.) governmental barriers •cyclical fluctuations of
•patent protection of demand demand
BUYER POWER BUYER POWER

LOW MEDIUM/HIGH
Physician as buyer: Buyers extremely price sensitive
Not price sensitive Good access to information
No bargaining power. Low switching costs
(Changing with managed care.)
30 31
Issues with the Five-Forces

Neutralizing the Five Competitive
Framework
Forces • Industry definition
Force Method for Neutralizing Force • Completeness (e.g., import competition)
Entry Erecting barriers (isolating • Consistency (e.g., import strategic variety)
mechanisms) create exploit economies of scale, • Duplication (e.g., switching costs)
aggressive deterrence, design in switching costs, etc
• Symmetry (e.g., buyer substitution vs. supplier
Rivalry Compete on nonprice dimensions: substitution, complements)
cost leadership, differentiation, cooperation, etc
Substitutes • The role of informational conditions
Improve attractiveness compared to
substitutes: better service, more features, etc • The need for macroenvironmental analysis
Buyers Reduce buyer uniqueness: forward • Long-run focus vs. change
integrate, differentiate product, new customers, etc • shocks
Suppliers • cycles
Reduce supplier uniqueness: backward • trends
integrate, obtain minority position, second source, etc
• Product rather than resource focus
4
Page 497
Coopetition and the Value Continually Changing

Net
A player is your competitor with A player is your complementor
Industry Conditions
respect to customers if customers Customers with respect to customers if
value your product less when customers value your product more • Exogenous Changes
they have the other player’s when they have the other player’s
product as well product as well • Shocks and Trends
Competitors Firm Complementors

• TINAs
• Endogenous Changes
• New innovations
A player is your competitor with A player is your complementor
respect to suppliers if it is less with respect to suppliers if it is
attractive for a supplier to Suppliers more attractive for a supplier to
provide resources to you when it provide resources to you when it • New business models
is also supplying the other player is also supplying the other player
• New Supply chains
Source: Adam Brandenburger and Barry Nalebuff, Co-operation (New York: Currency Doubleday, 1996)
• Etc.
Shocks and Trends External “Triggers”

 Technology
• “Triggering” shifts, shocks and trends, even in adjacent
 Consumer markets, may create uncertainties that allow/force firms to

Tastes Laws, change their strategies
Tax Policy,
• Shocks and Trends
Regulations
• changes in consumer tastes
• changes in technology
Inventions & Uncertainty &
Discoveries Market Ignorance • changes in relative prices of inputs
• changes in laws, regulations, and tax policy
• inventions and discoveries
• changes in global supply and demand conditions

Global Supply &
Demand
 Relative Prices
of Inputs
• Uncertainty and market ignorance create/produce the
opportunity for firms to reformulate their strategies
Conditions
Aggregating Demand in New

Ways
Examples of Intelligent
and Threatening
Competitors
5
Page 498
New Product Concept &

New Types of Arbritage
New Business Model
Narayana Hrudayalaya Heart Hospital, India
Closing the “Global New Customer Segments

Distance”
Complementary
New Strategic Groups Products/Services
6
Page 499
Strategic Map of the United States Airline Industry

The Late 1970s
International Laker
Pan
T WA Am
World
Strategic Group
North
Braniff
west
Geographic Scope
Eastern
Analysis
United
Delta
National American
Companies may take different Continental
approaches to competing in Western

Republic Ozark
the same industry

USAir Piedmont
AirCal
South- Frontier
west
Regional T exas Int’l
PSA
No Full Service
Frills Quality of Service
Strategic Map of the United States Airline Industry Strategic Map of the United States Airline Industry
The Early 1980s The Mid 1980s
International Pan International North
X
T WA Am
west
United
American
X North
west
Eastern T WA
Geographic Scope
Geographic Scope
Eastern
United Delta
Delta
American
National National
Continental
Continental
Republi Ozark
Western c
Republic Ozark
USAir Piedmon
South- South- t
USAir Piedmont
west west AirCa
Frontie
l
AirCal r
Frontier
PSA
New
Regional New PSA Regional Entrants
Entrants
No Full Service No Full Service
Frills Quality of Service Frills Quality of Service
Strategic Map of the United States Airline Industry Strategic Map of the United States Airline Industry
The Late 1980s The Early 1990s
International International
American American
United United
North North
west west
Delta Delta
Geographic Scope
Geographic Scope
T WA T WA
Continental Continental
National USAir National USAir
South- South- Mobility Barriers

west west
Americ Americ
a a
West West
Kiwi
Regional MGM
Gran
Regional Reno
Others
X
d
No Full Service No Full

Frills Quality of Service Frills Quality of ServiceService
7
Page 500
The U.S. Auto Industry’s Profit Pool
Operating Margin
Finding New Profit
Pools within Industries
Profits earned in different parts
of the industry production chain
0% 100%
can change over time Share of Industry Revenue
Source: Gadiesh & Gilbert, 1998
A Three-Dimensional Business
Competitive Advantages Landscape: Great Positions!!!
Protected
Competitive
Positions
Great
Strategies
Valuable
Resources
&
Capabilities
Sources of Competitive Advantage Sustainability of Superior Performance

Based on Impediments to Imitation
Competitive Attractive Industry
Advantages protected by Entry Barriers
(Sources of Rates of Profit in
Excess of the Competitive Level)
AND/OR
Attractive Strategic Groups

Avoid Be Better Than (within Industry) protected
by Mobility Barriers
Competitors Competition
(Position) (Capability) AND/OR
Get in first, Better, Attractive Competitive

Positions (within Strategic Group)
Keep others out Faster, protected by Isolating
Mechanisms
Cheaper
8
Page 501
Isolating Mechanisms
• Information Impactedness
• Response Lags
• Economies of Scale and Scope COMPETENCIES & CAPABILITIES:
• Producer Learning
Outperforming Competitors
• Buyer Switching Costs
• Reputation Building and Renewing
Distinctive Competencies &
• Buyer Evaluation Costs
Organizational Capabilities
• Advertising and Channel Crowding
Sourc e: Ric hard Rumelt, 1987
Building Cost and Differentiation Cost Drivers

Strategies
• Economies of • Integration
Differentiation scale • Timing
Cost Reduction
• Economies of • Policies
Total Quality Management
scope
Just-In-Time • Cheaper • Location
• Learning
• Better
Time Management
• Institutional
Geographic Location
• Pattern of factors
Business Re-engineering • Faster capacity utilization
Mass Customization
etc.
• Linkages
etc.
• Interrelationships
Source: Michael E. Porter, Competitive Advantage (New York: Free Press, 1985)
The Nature of Differentiation The Sources of

“Differentiation means providing something unique that is valuable Differentiation Advantage
to the buyer beyond simply offering a low price.” (M. Porter)
THE KEY IS CREATING VALUE FOR THE CUSTOMER
TANGIBLE INTANGIBLE • Observable Goods:

DIFFERENTIATION – Buyer Learning
DIFFERENTIATION – Buyer Switching Costs
Observable product characteristics:
Unobservable and subjective – Advertising Economies
• size, color, materials, etc.
characteristics relating to • Experience Goods:
• performance
image status, exclusively, – Reputation
• packaging
identity. – Credibility
• complementary services
• Communication Goods:
– Relative Base
TOTAL CUSTOMER RESPONSIVENESS: Differentiation not just
about the product, it embraces the whole relationship between the
supplier and the customer.
9
Page 502
The Value Chain as a Framework The Porter Value Chain

for Creating Competitive Firm Infrastructure
Advantages
Human Resource Management
Technology Development
The McKinsey Business System Procurement
Inbound Outbound Marketing

Operations Service
Logistics Logistics & Sales
TECHNOLOGY PRODUCT DESIGN MANUFACTURING MARKETING DISTRIBUTION SERVICE
Sales Sales
Marketing Adv ertising Technical
Management Force Force Promotion
Literature
Administration Operations
Source: Michael E. Porter, Competitive Advantage, 1985.
Using The Value Chain To Stages In Value Chain

Analyze Costs Analysis
Value Cost Cost • Disaggregate firm into separate activities
Chain Analysis Advantage • Establish relative importance of activities
• Identify cost drivers
• Identify • Assign costs, • Cost position • Identify linkages
activities assets of competitors
• Identify cost • Control drivers

• Examine scope for reducing costs
drivers
• Change chain
• Competitive
scope
Source: Susan Polk, 1991
Southwest Airlines’ Activity

Be Better Than Competitors
System
No baggage
(1) In individual elements of value chain No meals transfers
Limited No
No seat passenger connections
assignments
amenities with other
airlines
Short-haul,
Frequent, point-to-point
Limited use routes between
reliable 15-minute of travel Standardized
(2) In coordinating elements of value chain departures gate agents fleet of 737
midsize cities
and secondary
turnarounds aircraft airports
Automatic
ticketing
Lean, highly machines
High
productive Very low
compensation
ground and ticket prices
of employees
gate crews
(3) In selecting elements of value chain (make vs. buy)
High level High “Southwest,

Flexible
of employee aircraft
X X
union the low-fare
stock utilization airline”
contracts
ownership
Source: Michael E. Porter “What is Strategy” Harvard Business Review, Nov-Dec 1966
10
Page 503
Reversion to the Mean Four Threats to Sustainability

40 Imitation Substitution
30
Added
Value
ROI%
20
Appropriated
Value
10
0 Slack Holdup
1 2 3 4 5 6 7 8 9 10
Year
Source: Pankaj Ghemawat, Commitment (New York: The Free Press, 1991)
Responding to the Threats to

Sustainability
Responses to Responses to
Imitation Substitution
Building Barriers • Not responding
• Economies of scale and • Fighting
• Switching
Strategic Renewal
scope
• Learning/private • Recombining
• Straddling
information Added • Harvesting
• Contracts and relationships
• Network externalities Value
• Threats of retaliation
• Time lags Appropriated Responses to
• Strategic complexity
• Upgrading Value Holdup
• Contracting
Responses to Slack • Integrating
• Gathering information • Building bargaining
• Monitoring behavior power
• Offering performance • Bargaining hard
incentives • Reducing asset-
• Shaping norms specificity
• Bonding resources • Building relationships
• Changing governance • Developing trust
• Mobilizing for change
The Strategic Task The Strategic Task

Keep developing new sources of competitive advantage!
EXTENT OF EXTENT OF
ADVANTAGE ADVANTAGE
HIGH HIGH
LOW LOW
TIME TIME
Sourc e: Marvin Lieberman, 1997 Sourc e: Marvin Lieberman, 1997
11
Page 504
The Hexagon of Competitive Advantage:

Potential Sources for Creating Advantages
Customer
/ Market
Scale Product
/ / Service
Scope Competitive
Advantage
Competitor
/ Partner Business System
Interaction / Value Chain
Assets /
Resources
Sourc e: George Yip,
1997
12
Marshall
Page 505 School of Business Voigt, Spring 2007
Department of Management and Organization
Country Analysis Framework
Session Agenda
Country Analysis  Analyzing the “Meet” Dimension
 Country Analysis
 Institutional Differences & “Voids”

Analyzing the Attractiveness of
Analysis
Regions, Economies, Industrial Sectors,
 Getting to Know the Data Workshop
and Markets for Global Business
GSBA 582: GLOBE MOR 492: Global Strategy 2
Meet Question? Meet question?

Country Analysis Framework Country Analysis Framework
Analyzing the Global Market:

What will the firm meet? Country Analysis
Regional Analysis  Global Economics of Region
 ASEAN, NAFTA, APEC, etc.
Country Analysis
 Macroeconomic Policies
Industrial Sector Competitiveness Analysis  Political Agenda
 Fiscal & Monetary Policies
Industry Analysis  Policies toward foreign investments & control
Feasibility Market Potential Analysis Profitability  Political Risk Analysis
Analysis Analysis  Institutional Voids Analysis
Competitor Analysis
MOR 492: Global Strategy 3 MOR 492: Global Strategy 4
Meet Question? Meet Question?

Diamond of Global Competitiveness
Chance Firm Strategy,
Examining Relevant “Distances”
Structure, and
Rivalry  CAGE Framework (Ghemawat)
 Cultural Distance
 Administrative Distance
Factor Demand
Conditions Conditions  Geographic Distance
 Economic Distance
• Global strategy must exploit/mitigate relative
Related and
Supporting “distance” between the firm and the global market
Industries
Government • CAGE can be applied at the Country level, industrial
Source: Porter (1990) sector, industry, and firm level
GSBA 582: GLOBE 1

Marshall School of Business Voigt, Spring Page
2007 506
Business “Context” Country Analysis

Business Strategy
Framework
& Operations
Comparing and Contrasting
Opportunities and Differences
Professions, Debt & Equity Spec ialized
“Soft” Logistics Consultants
Credentialing Markets, Ac c ountants
Infrastructure Intermediaries Search Firms Venture Capital & Legal System
“Hard” Schools, Physical & Banks & Financial Functioning

Roads, Rail
Universities, Property Institutions, Independent
Infrastructure & Ports Training Rights Security Regulators Legal System
Country Factor Capital Political &

Endowments Land Labor Markets Social Systems
Why Country Analysis? Country Effects Matter

 Countries continue to achieve remarkably  Nation States make the “rules” by which businesses
different rates of economic growth must abide
 Countries differ in size, geographic location,  Country “Institutions” (courts, laws, capital
resource endowments, historical experiences, markets, law & order enforcement, unions,
cultures and income levels, and these governments, etc) create the context for business
and markets
difference are important for global strategy
decisions  Countries “do” compete with each other for
resources
 The profit performance of similar industries
 Countries do have “strategies” too
differs widely from one country to another
 Governments do play an active role
 “Country effects” matter
 Country borders (degree of openness) do matter
Country Borders Matter Foreign Direct Investment Distribution

 Within countries, economic forces  Theory suggests that capital should flow to
where the arbitrage opportunities are
work efficiently to bring convergence greatest
 Across countries, global economic  However, low wages may be offset by institutional
forces are impeded by barriers to voids which raise overall costs
trade, capital flows and immigration  In reality, most FDI is between “rich”
countries, and a select group of emerging
and convergence is mitigated economies (e.g. China, Brazil, Mexico,
Singapore, Indonesia, Malaysia, Saudi
Arabia, Argentina)
GSBA 582: GLOBE 2

Marshall
Institutional Voids Country Analysis Framework

 Institutional voids are the absence of intermediaries
between buyers and sellers  Identification
 Examples:  Strategy
Venture Capital Firms
Finance Private Equity Providers Context Strategy Performance
Mutual Funds  Context
Banks
Auditors  Performance
Management Business Schools
 Evaluation
Certification Agencies
Talent Headhunting Firms
Relocation Services  Prediction
Products Certification Agencies
Consumer Reports
Regulatory Authorities
Extra-judicial dispute resolution
Performance Strategy
 Formal economy, grey market, black market
 Vision – guiding motivating values
 Economic Performance Measures
 Output  Community solidarity vs. individual achievement
 Prices  Goals
 Employment
 Savings  Policies – policy mix
 Investment  Foreign/Defense Policies
 Productivity
 Wages increases  Fiscal Policy
 Unit labor costs  Spending priorities, types of taxes, balanced/ deficit/
 Utilization of capital surplus budgets
 Distribution of income
 Net inflows vs outflows of capital, labor, etc.
Strategy (continued) Context

 Monetary Policy  International Context
 Income Policies  Trading Blocs
 Redistribution of incomes  Historical ties
 Foreign Trade and Investment Policies  Domestic Context
 Import vs. Export Orientation  Political – strong or weak governments, ability to
bring about reform
 Industrial Policy
 Institutional Context – Government, legal, financial,
 Social Policies agricultural, transportation, energy, infrastructure.
 Education, Population, Health Care, Religion Other institutions like union, religions
GSBA 582: GLOBE 3

Marshall School of Business Voigt, Spring Page
2007 508
Context (Continued) Context (Continued)

 Ideological Context  Resources – The equipment and
 Rights vs. Obligations recruiting system
 Individual vs. Group (minority rights  Human capital, physical capital, natural
protection) resource wealth, and technological skills
 International Context  The Players in the Game
 GATT, WTO, IMF  Firms, government actors, and non-
government organizations

FRAMEWORK FOR COUNTRY ANALYSIS
Strategy Context Performance
Context (Continued) Goals

Higher per-capita income lev el and growth,
equality of income, stability , autonomy ,
def ense, etc.
National Resources
Labor, capital, natural resources, technology ,
geography
Economic
GNP
The Rules of the Game

National income accounts
 Policies Players in the Games Prices
 Written and unwritten rules of conduct Fiscal & monetary policies

Exchange rate policies
Firms
Gov ernment actors
Inf lation
Unemploy ment
 Formal Trade and inv estment policies Non-state organizations:

Unions, employer associations, religious groups, political
Social
 Laws, property-rights Sectoral policies parties, etc.
Industrial policies Income distribution

 Informal Constitutional ref orm Rules of the Game Fertility , mortality , literacy , etc.
 Business practices which come for culture heritage Formal rules
Rules define what is possible and what is not

economic (e.g. property rights, contract law), political ( e.g.
 federal system, separation of powers), treaties Political
International Dimension
Inf ormal rules Political stability , political f reedom, etc.
 - conventions, culture, religious beliefs, ideology
 Role of multinational corporations International

International
Balance of pay ments
 International organizations like IMF, World Bank, WTO Location Exchange rates
International Organizations Tarif f s, quotas
Treaties on Trade and Inv estment, International

MOR 492: Global Strategy 21 MOR 492: Global Strategy Monetary Sy stem
22
Country Analysis Framework
Framework for Analyzing the

Institutional Voids Analysis “Fitness” of Emerging Markets
 The creation or replication of a global business
strategy in a new market presupposes the
existence of supporting “infrastructure” and
Examining the Institutional complementary “institutions”
Physical infrastructure, specialized intermediaries, legal
Context for Business in New

support, contract-enforcing mechanisms, dispute
mediation, regulatory systems, etc.
and Emerging Markets  Firms have three choices:
 Adapt to local “institutional voids” and market conditions
 Change the local markets and “fix” the institutional voids
 Stay out of the market altogether
GSBA 582: GLOBE MOR 492: Global Strategy 24
GSBA 582: GLOBE 4

Marshall
Spotting Institutional Voids:

Business “Context” Hard Infrastructure
 Political and Social System
 Role of government in supporting/controlling business/market
Business Strategy activities
 Transparency in regulatory environment
& Operations  Physical Infrastructure
 Quality of ports, roads, rail
Professions, Debt & Equity Spec ialized  Energy, water, housing stock, etc.
“Soft” Logistics Consultants
Infrastructure Intermediaries
Credentialing
Search Firms
Markets,
Venture Capital
Ac c ountants
& Legal System
 Personal and Property Protection
Schools, Banks & Financial Functioning  Personal safety – atmosphere of security, law & order
“Hard” Roads, Rail Physical &
Infrastructure & Ports

Universities, Property Institutions, Independent  Health care
Training Rights Security Regulators Legal System
 Legal protection of personal property, intellectual property, etc.
Country Factor Capital Political &
Endowments Land Labor Markets Social Systems
Spotting Institutional Voids: Spotting Institutional Voids:

Hard Infrastructure “Soft” Infrastructure
 Openness  Product Markets
 Role of media, non-government institutions, churches, social  Existence of reliable data on consumer behavior
groups, etc.
 Access to quality raw materials, local manufacturing of
 Restrictions on foreign investment, repatriation of profits, etc. components
 Restrictions on foreign intermediaries (e.g. auditing firms, ad
agencies, consulting firms, banks, insurance, etc.  Quality of retail sector
 Free trade agreements (WTO compliant, FTAs, RTAs)  Consumer credit (credit cards, cheques, etc.)
 Freedoms on business activities – restrictions on where and in  Regulation of quality standards, product content, etc.
what sectors foreign businesses are allowed to invest  Environment and safety standards
 Freedom of foreigners and locals to travel within, and into and
out of country  Supply Chain Intermediaries
 Logistics and transportation specialists
 Distribution channels, wholesale markets, warehousing
Spotting Institutional Voids: Spotting Institutional Voids:

“Soft” Infrastructure “Soft” Infrastructure
 Labor Markets  Capital Markets
 Quality of basic and specialized education  Prevalence and effectiveness of banks, insurance companies,
 Technical and professional training savings & loan institutions
 Accreditation of education  Access to banking for consumers, businesses
 Prevalence of “English” (Int’l language of Business)  Transparency in Banking practices
 Free movement of employees  Debt & equity raising, venture capital
 Compensation practices (merit pay, seniority based, stock options)  Standards of financial reporting, protection for stockholders,
 Enforcement of labor contracts bankruptcy laws/protections
 Workers’ rights, Unions  Market for acquisitions/takeovers
 Regulations on layoffs, etc.
GSBA 582: GLOBE 5

Marshall School of Business Page 510
Department of Management and Organization Mayer & Voigt, Term IV, 2001
Geographic Scope Geographic Scope
Geographic Scope of Competition

Geographic Scope  Effective geographic
scope of competition
 Geographic Scope
is influenced by:
of Competition and 

Local
Regional


Economics
Politics
Strategy 

National
International
 Corporate Strategy
 global
MOR 492 Global Strategy 1 MOR 492 Global Strategy 2
Geographic Scope of Competition Drivers of Change in Scope

 Geographic scope of competition  Exogeneous drivers
tends to expand with:  Changes in government policies
 Increases in economies of scale, scope, and  Reductions in trade barriers
learning  Endogeneous drivers:
 Reductions in logistical constraints  New technologies
 Reductions in the distinctiveness of local  Adoption of strategies requiring large fixed
markets – differences in consumers tastes investments
 Reductions in barriers to competition  Decisions to enter new markets
Geographic Scope of Strategy Geographic Scope Choices

 Firms choose:  Geographically-  Advantage
focused  Strong local responsiveness
 Overall geographic scope of firm’s strategy  Strong differentiated market
 Serving local markets
 The markets to compete in position
 Distinct products/services  Dangers
 The location of important activities
 Localized marketing  Scale, scope and learning
 The organization and coordination of these  Satisfying local advantages of global
activities competitors may overtake
regulatory requirements
local advantages
 Local distribution
GSBA 515 GLOBAL STRATEGY 1

Marshall
Page 511 School of Business
Department of Management and Organization Mayer & Voigt, Term IV, 2001
Configuration and Coordination

Geographic Scope Choices of Firm Activities
 Global Strategy  Advantage  Location of firm activities are influenced by:
 Serving universal needs  Exploit scale, scope, and  Market conditions
across borders learning economies
 Same product everywhere  Capture global low-cost  Regulatory barriers
 Global customers leadership position  Tax regimes
 Global product varieties –  Dangers  Wages rates
slightly modified for local Inability to compete with
markets requirements

 Locations of specific pockets of expertise
locally responsive
 Global marketing approach differentiated firms  Firms can choose to locate activities in
single or disperse locations
Configuration and Coordination Competitive Interaction

of Firm Activities and Multi-market Competition
 Two extremes  The scope of competition may expand
Tight coordination

 Important decisions centrally managed from home
globally as firms match/mirror the
nation moves of rivals
 Loose coordination
 Important decisions decentralized to many nations
 Firms feel compelled to match the
 The appropriate form of coordination will rivals to avoid cross-subsidization

depend on the relative importance of
pressures for global coordination and
pressures for local responsiveness
GSBA 515 GLOBAL STRATEGY 2

Marshall School of Business Voigt, Fall, Page
2000512
Strategic Alliances Strategic Alliances
THE COLLABORATIVE CHALLENGE: STRATEGIC ALLIANCES

JOINT VENTURES AND STRATEGIC ALLIANCES
STRATEGIC CHALLENGE
 Pre 1980s
 Protectprofits from erosion through
competition/bargaining
“Companies are just beginning to learn what
nations have always known -- in a complex,  1980s and 1990s
uncertain world filled with dangerous  Pursue multiple sources of competitive advantage
opponents, it is best not to go it alone.”
 Simultaneous reliance on competition and
collaboration [Coopetition]
Kenichi Ohmae, McKinsey - Japan
STRATEGIC ALLIANCES TYPES OF STRATEGIC ALLIANCES

QUESTIONS  JOINT VENTURES
 What types of arrangements are most  New entity jointly owned by two or more firms
appropriate? Shared or 50-50 ventures
Dominant ventures
 What can we learn from the experience of
others?  INFORMAL
 Cooperation without any formal contractual
 How do we successfully manage these obligations
alliances?
STRATEGIC ALLIANCES TYPES OF STRATEGIC ALLIANCES

Foreign company offers
Access to business system:
 MINORITY INVESTMENTS
Know -how:
Customers; distribution;
Technology; concept
manufacturing  Firm buys stock in another
 Often access to resources for capital
Know Alliances offering
how Joint development access to markets  Stronger mutual commitment
Local in return for technology
company  TWO-WAY INVESTMENTS
offers
Access to  Reciprocal equity stakes/cross-ownership
Traditional Exchange of access
business
 Less concern about dominance
Joint Venture
system
MOR 492 GLOBAL STRATEGY 1

Marshall
Page 513 School of Business Voigt, Fall, 2000
WHY STRATEGIC ALLIANCES? WHY STRATEGIC ALLIANCES?

TRADITIONAL REASONS EMERGING REASONS
 Sharing of resources and risks  Learning from one another
 Host government requirements  Attain global scale economies
 Overcoming strong nationalistic sentiments  Raw material/ Component supply
 Marketing and distribution
 Quicker entry
 Rising R&D costs and technological interdependence
 Benefit from partner’s local knowledge
 Short product life cycles
 Industry convergence
STRATEGIC ALLIANCES –
WHY STRATEGIC ALLIANCES? POTENTIAL RISKS
Industry Globalization and Global Competition
 Partner opportunism and loss of competitive
 Improved market access
edge
 Stronger product line
 Strategic and organizational complexity
 Superior timing
 Conflict of interest problems
 Shaping competitive rivalry
 Keeping key competitors at bay  Decreasing partner commitment
 Reduced transaction and other costs
MAKING STRATEGIC ALLIANCES WORK MAKING STRATEGIC ALLIANCES WORK

ASSESSING NEED DEFINING GOALS AND OBJECTIVES
 Do you need a partner? How big is the payoff?  Clarify and resolve separate interests
 How likely is success?  Develop mutual trust and understanding
PARTNER SELECTION DESIGNING AN ALLIANCE

 Does the partner share your goals and objectives?  Define role of each partner
 Does strategic synergy exist?  Define venture boundaries
 Is the partner compatible?  Identifying champion(s)

 Trust versus legal considerations
 Allow for termination

2000514

MANAGING THE ALLIANCE
MANAGING THE ALLIANCE
 Achieving operating momentum  Managing cultural differences
 Recognize alliance needs  Flexibility

 Policies  Assuring continued commitments
 Resources (inc. human resources)
 Increasing willingness to learn
 Overcoming reluctance to give up autonomy
 Avoiding bottleneck dependence
Strategic Alliances
STRUCTURING ALLIANCES TO REDUCE

OPPORTUNISM
Walling off
Critical technology
Establishing
Probability of
contractual
Opportunism by
safeguards
Alliance Partner
Reduced By
Agreeing to swap
valuable skills and
technologies
Seeking credible
commitments
MOR 492 Global Strategy 15

Marshall
Generic Global Strategies Generic Global Strategies
Generic Global Strategies FOUR BASIC STRATEGIES
GLOBAL TRANS-
NATIONAL
 Multidomestic strategy
 Global strategy Efficiency
 Choice -- Global versus Multidomestic
benefits MULTI-
INTERNA-
from global TIONAL DOMESTIC
 Transition -- Multidomestic to Global integration
 Transnational strategy
Benefits from national
MOR 492 Global Strategy MOR 492 Global Strategy
responsiveness
1 2

Location and Coordination Issues PRESSURES: NATIONAL
LOCATION COORDINATION RESPONSIVENESS
 Production facilities  Networking of
international plants  Differences in consumer preferences
 Product line, market
selection  Commonality of brand
name, similarity of  Infra-structural differences
 Location of service channels etc.
organization  Government demands
 Similarity of service
Number and location standards
 New manufacturing technology

of R&D centers  Coordination of pricing
 Location of  Coordination of  Organizational limitations
purchasing function suppliers
 Managerial resistance
MULTIDOMESTIC STRATEGY MULTIDOMESTIC STRATEGY

 Customized product Unit 1
 Countries -- selected on their stand-

alone potential
 Units independent HQ
 Low coordination; high dispersion
Unit 2 Unit 3
 Few inter-subsidiary transfers

2000516

INDUSTRY GLOBALIZATION POTENTIAL
MULTIDOMESTIC STRATEGY MARKET DRIVERS
Competitive advantage from
 Local responsiveness
COST DRIVERS COMPETITIVE DRIVERS
Industry
 Goodwill -- local government, Globalization
customers Potential
 Lower costs -- avoiding shipping costs

and tariffs
GOVERNMENT DRIVERS
 Quick response to local market
situations
PRESSURES: GLOBAL INTEGRATION PRESSURES: GLOBAL INTEGRATION

 COST DRIVERS
 Economies of scale  MARKET DRIVERS
 Economies of scope  Homogenization of product needs
 Decreased transportation costs  Global customers
 Improved product quality
 Learning and experience
 Reduced adaptation costs
 Lower communication costs
 GOVERNMENT DRIVERS  COMPETITIVE DRIVERS
 Reduced tariffs, quotas  Global competitors
 Compatible technical standards  Increased formation of global alliances
GLOBAL STRATEGY GLOBAL STRATEGY

 Central control over country operations Unit 1
 Central surveillance of resource allocation
and performance
 Standardized products
 Extensive transshipments HQ
 Cross-subsidization
Unit 2 Unit 3
 Activities located in country(ies) providing
comparative advantage

Marshall
GLOBAL STRATEGY TRANSITION: MULTIDOMESTIC TO GLOBAL

Competitive advantage from
 Determine where the benefits of
 Lower cost structure globalization lie
 Economies of scale
 Less duplication of activities  Establish mandate for each subsidiary
 Lower inventories  Reduce strategic autonomy of subsidiaries
 Improved quality
 Rotate country managers to help them
 Increased competitive leverage
develop a global vision
 Greater bargaining power
 Quick response -- R&D concentration
 Change reward and evaluation system to fit
the mandate
MULTIDOMESTIC AND GLOBAL Generic Global Strategies Generic Global Strategies

STRATEGIES
MULTIDOMESTIC GLOBAL
Strategic Arena  Selected Target
Countries
 Most countries which
constitute critical markets
CONSUMER ELECTRONICS
Business Strategy  Custom strategies;  Same basic strategy Matsushita
little coordination worldwide
Product-line strategy Adapted to local Standardized products

Global
 
needs
Production Strategy  Plants scattered  Plants located on the Integration Philips

across many host basis of competitive
countries advantage
General Electric
Sources of supply  Suppliers in host  Attractive suppliers from
country preferred anywhere
Marketing  Adapted to local  Worldwide coordination;

practices and culture minor adaptation
Organization  Autonomy Local Responsiveness

 Central control
“You want to be able to optimize a CONSUMER ELECTRONICS:

business globally -- to specialize TRANSITION TO TRANSNATIONALITY
in the production of components,
Matsushita
to drive economies of scale as
far as you can ....But you also
want to have deep local roots Global
everywhere you operate ... If you Integration Philips
build such an organization, you
create a business advantage
that’s damn difficult to copy.”
Percy Barnevik, CEO, ABB Local Responsiveness


2000518
TRANSNATIONAL STRATEGY TRANSNATIONAL STRATEGY

 Greater emphasis on differentiated products than in Unit 1
“pure” global industries
 Greater demand for global efficiency and lower
costs than in “pure” multidomestic industries
 Greater sensitivity to governmental demands
HQ
 Units coordinate activities with HQ and with one
another
Unit 2 Unit 3
 Units may adapt to special circumstances only they
face
TRANSNATIONAL CORPORATION FOUR BASIC STRATEGIES

 Each national unit is a source of ideas and
competencies that can be harnessed for the
benefit of the corporation GLOBAL TRANS-
NATIONAL
 National units achieve global scale by making

them the company’s world source for particular Efficiency
product, component or activity benefits MULTI-
INTERNA-
from global TIONAL DOMESTIC
 New, highly-complex managing roles which integration
coordinates relationships between units in a
flexible way Benefits from national
responsiveness
21 22

Marshall
Department of Management and Organization Voigt, Fall, 2003
Global Competitive Advantage Global Competitive Advantage
Creating Competitive Advantage

Creating Global
 Most markets have local, regional, and
Competitive Advantage global aspects
Building Multinational Competencies  Example
National Industry Global Industry
Characteristics Characteristics
• Differentiated markets • Interdependent markets
• National scale economies • Extra-national scale
• Local competition • Cross-market competition

Strategies for Globalization
Exploit similarities
across countries Logic of Global Advantages
Aggregation
 Arbitrage
Globalization
Localization
 Adaptation/Replication
Local Global
Customization Adaptation Standardization  Aggregation
 Transformation
Arbitrage (“ARAT” Model)
Exploit differences
MOR 492 Global Strategy across countries 3 MOR 492 Global Strategy From Ghemawat, “ Global Advantage…” 4
Arbitrage Three Kinds of Arbitrage

 Taking advantage of supply and demand
mismatches
 Classic Trading Arbitrage
 Taking advantage of national differences
 Relocation Arbitrage
 Factor endowments
 Production Integration Arbitrage
 Industry clusters, etc.
 Unique consumer demand
 Consolidated and coordinated global
operations

Classic Trading Arbitrage Relocation Arbitrage

 Taking advantage of supply and demand  Taking advantage of differences in endowments
mismatches through trading through activity relocation
 Taking advantage of national differences in  Activity location depends on country
supply and demand prices and qualities differences:
 Factor endowments: Raw materials, Labor  Cost and quality of inputs and processes
 Unique consumer demand: US Surfboards in Japan,  Porter’s Diamond Factors
 Unique production capability: Japanese textiles,  Risks and Uncertainties
French and Belgian goldsmithing  Transport costs
 Tariffs
Production Integration as
Arbitrage Integration and the Value Chain
 Economies of scale or scope across
countries/regions/globe REMEMBER:
 Where integrating and trading outperforms Integration can take place at any
replication point in the value chain:
 Localselling, global sourcing
 TENSION between scale/scope economies on
the one hand and commitment, tariffs, and  Global selling, local sourcing
transport costs on the other  Global selling, global sourcing
Integration and Extensibility Other Forms of Arbitrage

Deciding Tradeoffs in Activity Integration  Cultural arbitrage
 Examples: French Culture, US Culture, Brazilian
Local National Regional Global lifestyle
 Administrative arbitrage
Activity 1  Examples: tax differentials, smuggling
 Geographic arbitrage
Activity 2  Examples: international flower markets
 Economic arbitrage
Activity 3  Examples: lower cost labor, cheaper capital

Marshall
Replication (with Adaptation) Adaptation

 Applying a successful model in multiple national
environments; “transfering DNA”  “Think Global, act local (and adjust)”
 Taking advantage of similarities among nations  Strategic action on both the global and
 Product Segment similarity
 Value Chain similarity local levels
 Customization/Standardization tension
 Replication will almost always require some
adaptation to local market conditions
 Multi-divisional organization in order to focus on
national organizations
Forms of Adaptation Transformation

 Decentralization – moving decision-making from HQ to
the field  Trying to simultaneously take advantage
 Partitioning – separating choice elements of differences and similarities among
 Modularization – separating and designing standard nations
interfaces
 Recombination – melding elements of the parent  Utilize arbitrage strategies where nations have
business model with new possibilities different and strategically significant
 Innovation – deliberate local-for-local innovations characteristics (e.g., differences in production
 Transformation of context – reduce the need for costs or natural resources)
adaptation by changing tastes
 Utilize replication strategies to capitalize on
 Scope selection – reduce need for adaptation by
focusing on a narrow geographic area similar to what has worked in other settings
domestic market

Economic Implications of
Arbitrage and Replication
Strategies Aggregation
Arbitrage Replication  Finding scale and scope opportunities in
Cost International differences International economies new markets/nations
Drivers in absolute costs of scale and/or scope  Aggregation mechanisms that operate at
levels intermediate to one country and the
Benefit Country-of-origin Nature, amount, & effects
effects of standardization whole world.
Drivers
 Like a transnational mentality
Key Metrics Spread/Margin Volume/Market Share  Deals with the integration-responsiveness
trade-off
Risk Mgmt Spreading risks
Hedging (e.g., Enron) across markets
MOR 492 Global Strategy From Ghemawat, “ Global Advantage…” 17 MOR 492 Global Strategy 18

Bases for Creating Global Advantage Location Drivers

Economies
of
Replication National Non-Market
National Non-Market Differences Strategies
Differences Strategies
Global Global Global Global

Learning Flexibility Learning Flexibility
Economies Economies
© Voigt, Mayer & Liebeskind, 2006 of Scale of Scope © Voigt, Mayer & Liebeskind, 2006
Economies
Cost and Volume Drivers of
Replication
Economies of National Non-Market
Replication
Global Global
Learning Flexibility
Economies Economies Economies

Economies
of Scale of Scope
of Scale of Scope
MOR 492 Global Strategy © Voigt, Mayer & Liebeskind, 2006 21 MOR 492 Global Strategy © Voigt, Mayer & Liebeskind, 2006 22
National Differences Economies of Scale

 Comparative advantage  Economies of scale
 Natural factor endowments and Societal endowments  Expand output in order to achieve lower production costs
 Scarce or abundant resources  Lowering costs by expanding in one area
 Cost differences in factors of production  Experience or learning effects

 Lower labor costs, lower cost of capital, tax advantages,  Higher volume helps firms exploit benefits of accumulated
availability of land, etc. learning
 Differences in consumer demand  Value-added Chain

 “Relatively “ high willingness-to-pay  Selecting components of chain to specialize in, and exploiting
coordination benefits across activities
 Location advantages
 Lower transportation costs, etc.

Marshall
Examples of Scope Economies

Economies of Scope Multi-Product Multi-Market
Economies of scope Scope Advantages Scope Advantages
Expand into different activities in order to maximize A factory that can produce
Shared
utilization of resources and lower total costs Global brand name
Physical several different products or
Lowering costs by expanding into different areas (Coca-Cola)
Assets product variations (e.g., Ford)
Sharing investments and costs across the same or
different value chains Shared Using common distribution Servicing multinational
External channels for multiple products
Sources Relations (e.g., Matsushita)
customers worldwide
(e.g., Citibank)
Shared physical activities
Shared external relations Shared Shared R&D across multiple Pooling knowledge
Shared learning Learning products (e.g., NEC computer developed in different
& communications LOBs) markets (e.g., P&G)
MOR 492 Global Strategy 25 MOR 492 Global Strategy From Bartlett and Ghoshal, “ T ransnational Management” 26
Economies of Replication Global Learning & Innovation

 Transfer of learning & innovations across markets
 Duplicating successful profit-making  From the center to the subsidiaries
 From the periphery to the center
activities in new locations  Throughout the network of locations
 May also involve learning advantages  Organizational challenges

– costing of replicating a business may  Putting the right incentives and processes in place
 Decentralize collection of knowledge
fall with cumulative experience  Centralize processes for sharing knowledge across markets
and divisions
 Local loyalties, turf protections, NIH (not-invented here)
 Intelligence gathering
 Identification of market opportunities
Creating Worldwide Innovations Global Flexibility and Adaptiveness

 Capture external diversity  Managing diversity and volatility across
 Worldwide stimuli as potential source of markets – manage the risk/exploit the opportunities
competitive information advantage  Portfolio of national and product markets
 Need to convert “delivery pipelines” into
 Minimize impact of adverse conditions (political or
“sensory feelers”
economic) in a single market
 Leverage internal variety  Competitive actions
 Worldwide human resources and capabilities as  Cross-parrying, multi-market retaliation, etc.
potential sources of competitive advantage
 Cross-market subsidization (e.g. cross-market cash-flows)
 Opportunity to leverage central and local innovations
 Create true global innovations by linking sensing,
 Internal markets for resources
response and implementation capabilities  Labor, capital, etc.

Global Flexibility Non-Market Strategies

 Macroeconomic Risks  Taking advantage of government
Shocks and major trends in macro-environment

protection, subsidies, tax holidays,
 Political Risks interest-free loans, etc.
 Actions of national governments
 Taking advantage of government rule-
 Competitive Risks
 Uncertainties of competitors actions & reactions making that creates barriers for new
 Resource Risks competitors
 Scarcity of strategic resources
Global Strategy Perspectives The Four Strategies and ART

High Trans-
Global GLOBAL TRANSNATIONAL
Global National
Product Replication; Transformation:
Coordination, Value Chain Arbitrage Products and Value
Integration International Multi- through integration Chain
Low Domestic INTERNATIONAL MULTIDOMESTIC
Arbitrage through Product And Value Chain
Low National High exporting Arbitrage through RDI
Differentiation,
MOR 492 Global Strategy
Responsiveness MOR 492 Global Strategy
33 34
Global Competitive Advantage
The Four Strategies:

Replicating Versus Responding
REPLICATE RESPOND
Global Strategy Transnational Strategy
International Strategy Multidomestic Strategy

Marshall
Department of Management and Organization Voigt
Global Context Global Context
Overview
Globalization
 Analyzing the Global External
Environment
 Globalization and “Distance”
in Context  National Competitiveness: Competitive

and Comparative Advantage of Nations
 Non-Market Strategy
 Political Risk
Global Context
Country’s Overall Attractiveness

BENEFITS
• Size of market
COSTS
• Political factors
Macro-environmental
• Growth rate
• Economic
System
ATTRACTIVENESS • Economic
underdevelopment Analysis
• Legal system
Analyzing Similarities and

RISKS
Differences
• Political
• Economic
MOR 492 Global Strategy • Legal GSBA 492 Global Strategy
3
Global External Environment Political Environment

First Cut Analysis
 Macro-environmental (PEST) Analysis  Type of Government
 Political Environment  Stability
 Economic Environment  Political goals/agenda
 Social Environment  Succession and transfer of power
 Technological Environment  Political Alliances
 Competitive and Competitor Analysis  Legal Infrastructure
 Similarities, Differences, and Rate/Velocity  Contract enforcement
of Change  Nature and extent of Regulation
 Shocks and Trends

Political Environment Legal Environment

 Business-government relationships  Property Rights
 Intellectual Property Rights - Patent,
 Role of business in political agenda trademark, copyright laws
 Role of Public Sector  Contract Law – common law and civil law
 Privatization  Tariffs, quotas and trade barriers
 Restrictive trade practices legislation
 Influence Activities
 Taxation
 Lobbying  Product liability, civil and criminal laws
 Bribery/corruption  Labor laws
 Laws governing business practices
Political Systems Political Environment

Political System – the system of government in a nation POLITICAL SYSTEMS
 Democracy – representative democracy
Collectivism Individualism  Totalitarianism
 Communist
• Socialism • Individual Freedom &
• Communism Self-Expression  Theocratic
• Social Democracy • Economic Self-  Tribal
interest (invisible
hand)  Right-wing
 Others (e.g., Oligarchy)
Economic Environment Economic Systems

 Economic growth; stage of economic development  Market Economy
 Free interplay of demand and supply
 GDP per capita (income)
 No restrictions on supply
 Financial Institutions – stock exchanges, banks, etc.
 Monitoring Institutions  Central Command
 SEC, Auditors, GAAP  Government moderates the activities of different economic systems –
quantity produced and prices charged set by government
 Money supply and monetary stability
 Balance of payments; foreign debt  Mixed
 Combination of market and command economies – both private
 “Hard” currency reserves ownership and free markets and government planning
 Exchange rate fluctuations
 State-Directed Economy
 Fiscal policies, interest rates, taxation  State plays a significant role in directing the investment activities of
 Unemployment levels private enterprise through “industrial policy” and other wise regulating
business activity in accordance with national goals

Marshall
Social/Cultural Environment Culture : Silent Language

Language  Time
 Meaning of delays, deadlines, schedules
Norms, Value
Systems, Attitudes Education
 Space
and Beliefs  Size, conversation distance
 Things
CULTURE  Material possessions, language of money
 Friendships
 Meanings of “friends”, expectations
Social structure Work Place  Agreements
Values
 “Verbal” versus “written” agreements
Religion
Global Context
Demographic Environment
 Population
 Education
growth
and literacy
CAGE Framework
 Age distribution and changes Pankaj Ghemawat,
“Globalization and Distance”
 Population shifts
MOR 492 Global Strategy 15 GSBA 492 Global Strategy
Country Level Influences on Bilateral Trade Flows CAGE Framework for Thinking about
Distance(Closeness) at Country Level
 Economic Size: GDP (1% increase) +0.8%  Cultural Distance
 Income Level: GDP per capita +0.7%  Cultural attributes of society that are sustained by general social
 Distance: 1% increase -1.1% interaction
 Geographic size -0.2%
 Landlockedness -50%
 Administrative Distance
 Common Land Border +80%  Administrative attributes encompass laws, policies and
 Common Language +200%
institutions that emerge from the political process
 Common Regional Trading Bloc +330%  Geographic Distance
 Colony/Colonizer +900%  Geographic attributes include natural constraints and physical
 Common Colonizer +190% differences
 Common Polity +300%  Economic Distance
 Common Currency +340%  Economic Factors

Cultural Distance Administrative Distance

 Common (Different) Languages  Common (Lack) Colonial Ties
Example: Spanish companies invest more in South America

which is geographically further away than Asia
 Shared Regional Trading Agreements
 NAFTA, Mercosur, ASEAN, European Union
 Common (Different) Ethnicity
 Lack of connective ethnic or social networks
 Common Currencies
 Immigrant populations can substitute for language-related links  Political Climate (hostility)
 Common (Different) Religions  Examples: Pakistan vs. India, Pariah States
 Common (Different) Values, Norms, and Dispositions  Others:

 restrictions on foreign trade & investment,
 Examples: values (Confucian vs Western), norms (insiders vs
outsiders), average disposition (materialism, individualism, or  discrimination against foreign companies,
risk-taking)  limits on currency convertibility/remittance,
 Other:  poor institutional quality – bribery/corruption
 Insularity, traditionalism  poor contract enforcement
Geographic Distance Economic Distance

 Physical Distance
 Rich/Poor Differences
 Land Borders  80% of the trade/FDI of high-income countries is
 Differences in Climates/Disease Environments directed at other high-income countries
 Others:  Rich-Rich is “replication”, Rich-Poor is “arbitrage”
 landlockness  Others:
 lack of internal navigability
 factor endowments
 geographic size
 infrastructure
 absolute remoteness
 advanced factors
Global Context
Comparative Advantages:
Factor Endowments
National  Natural Resources
 Land, climate, mineral resources, water,
Competitiveness
demographics, location, etc.
 National Infrastructure
 Ports, transportation system, energy,
telecommunications, banking system, etc.
Comparative and  Labor Productivity
 Education levels, skill levels, labor costs, etc.
Competitive Advantages  Advanced Factors
 Research facilities, technical know-how, court system
etc.
GSBA 492 Global Strategy MOR 492 Global Strategy 24

Marshall
Global Context Determinants of National Competitive Global Context

Advantage of Nations: Porter’s Complete System
Competitive Advantage of Nations Chance Firm Strategy,
Structure, and
Rivalry
 What explains:
 Japan Inc., Taiwan Dragon, “The German Machine”
etc.
 Why Competitive Clusters? Factor
Conditions
Demand
Conditions
 Silicon Valley, French Wines, Italian Ceramics, UK
Formula I Racing, etc.
 Why do some nations have such negative
inertia? Related and
Supporting
 India, Mexico, Russia, China, etc. Industries
Government
Porter’s Five Forces Framework Global Context
SUPPLIERS
Government
as Supplier
Non-Market
Bargaining power
of suppliers
Threat of
MARKET
new entrants
Strategy
COMPETITORS
POTENTIAL
SUBSTITUTES
ENTRANTS
Rivalry among
existing firms Threat of substitute
products or services
Non-market Influences on Bargaining power

of customers
Global Economic Activities Government

BUYERS
as Buyer
GSBA 492 Global Strategy MOR 492 Global Strategy 28
Government as a Sixth Force Global Context Global Context
SUPPLIERS
Disaggregating Non-Market Influences
Bargaining power
of suppliers
Threat of
 Government Roles
MARKET
new entrants
COMPETITORS  Transactor (Government entities) vs. Rulemaker
POTENTIAL
SUBSTITUTES
ENTRANTS  National vs. Regional vs. Local Government
Rivalry among
Threat of substitute
 Politicians vs. Bureaucrats
existing firms
products or services
Government:
Bargaining power
of customers
 Stakeholders
Player and/or  Regulators, partners, competitors, unions, media,
Rulemaker BUYERS consumers, communities, interest groups/activists

Government as a Rulemaker Government as a Rulemaker

 Taxes and subsidies  Local ownership/partnership requirements
 Price/profit restrictions  Competition policy
 Disclosure requirements and other financial  Restrictions on entry/expansion
regulations
 Patent law
 Product/process regulation
 Intellectual property right recognition and
 Local content requirements enforcement
 Trade/industrial policy  Technology transfer policies
 Governmental ownership by statute
Global Context
Non-market Strategy Responses



Lobbying
Political Contributions, bribery Political Risk
 Advocacy advertising
 Public exposure Analysis
 Constituency influence
 Collegial persuasion
 Litigation
 Collective organizing
 Official testimony
MOR 492 Global Strategy 33 GSBA 492 Global Strategy
Political Risk
US Intelligence Sources (1985)  Political Risk arises from the vagaries of
governmental action:
estimated that 80 percent of  Policy changes
foreign contracts for large scale  Leadership changes
 Nationalization of private property
capital projects were won by  Expropriation of foreign holdings
firms paying bribes.  Civil strife
 Currency inconvertibility
 War
 Etc.

Marshall
Political Risks -- Macro Political Risks -- Micro

Causes Form Causes Form
 Competing  Changing social  High inflation,
 Confiscation, values
political currency instability
philosophies national
 Unstable economic
expropriation conditions  Breach/revision of
 Armed conflicts
contracts
and rebellion  Damage to  Vested interests
 Social unrest and property, persons  Quasi-political  Discrimination

disorders  Local business
 Loss of transfer  Operating
 New international  Latent hostility
freedoms restrictions
alliances towards foreigners
Political Risk -- Vulnerability Political Risk -- Defensive Strategies

 Stay ahead -- technical and managerial
 “Critical” industries
HIGHER capabilities
 Entirely foreign or entirely local
management  Multiple sourcing of products
 Control over foreign firm’s access to  Raise political costs of intervention
market, raw materials etc.  JVs with politically connected local
companies
 Maximize debt investment from local sources
 Globally, integrated firm
High technology firm
 Significant exports
LOWER 
 “Good citizen” -- public services
Political Risk Forecasting Political Risk Rating Agencies

 Internal stability  Business Environment Risk Intelligence:
 Prospects of domestic violence BERI Index
 Demonstrations, riots, strikes  Bank of America World Information
 Terrorisms, assassinations Services: Country Risk Monitor Rankings
 Economist Intelligence Unit (EIU): Country
 External political relations
Risk Ratings
 Prospects of border warfare
 Euromoney: Country Risk Ratings
 Regional political alliances
 Trade disputes and economic warfare  Institutional Investor: Country Credit Ratings

Example: Business Environment Risk Intelligence

Example: The Economist Rankings (BERI) Political Risk Index
 Politics (50 points) Society (17 points)  Internal Causes of Political Risk
 Being near a superpower or troublemaker  Pace of urbanization  Political fractionalization
 Authoritarianism  Islamic fundamentalism  Ethnic fractionalization
 Longevity of regime Coercive measures required for retaining power
 Corruption 
 Illegitimacy Mentality, including xenophobia, nationalism, corruption, nepotism
 Ethnic tension 
 General in power  Social conditions, including population density and wealth distribution
 War/armed insurrection  Radical left
 Economics (33 points)  External Causes of Political Risk
 Falling GDP per capita
 Importance of hostile major power
 High inflation  Negative regional influences
 Capital flight
 Symptoms of Political Risk
 High and rising foreign debt as a proportion
 Societal conflict involving demonstrating, strikes, and street violence
of GDP
 Instability as perceived by non-constitutional changes, assassinations, and
 Decline in food production per capita
guerilla wars
 Raw material as a high percent of exports
Global Context
Country’s Overall Attractiveness

BENEFITS COSTS
• Size of market • Political factors
• Growth rate ATTRACTIVENESS • Economic
• Economic underdevelopment
System • Legal system
RISKS
• Political
• Economic
MOR 492 Global Strategy • Legal
45

Page 533
COMPETITIVE
ADVANTAGE OF NATIONS
This is presentation is based on

Michael E. Porter’s book:
The Competitive Advantage of Nations, Free Press, 1990
Source: The presentation slides were prepared by George Yip,

UCLA
Porter’s
Competitive Advantage of Nations
Extends and modifies traditional theory of
comparative advantage to take into account the
following factors:
 Competitive advantage is about companies -- the
importance of the national environment is providing a
home base for the company
 Sustained competitive advantage depends upon dynamic
factors -- innovation and upgrading of firm’s resources
and capabilities
 The critical role of the national environment is its
influence upon the dynamics of innovation and upgrading
MOR 492 Porter on Global Strategy 2

Voigt, 2002
1
Page 534
The Determinants of
National Advantage
Firm Strategy,
Structure, and
Rivalry
Factor Demand
Conditions Conditions
Related and
Supporting
Industries
Source: Porter (1990) MOR 492 Porter on Global Strategy 3

Voigt, 2002
Factor Conditions

Voigt, 2002
2
Page 535
Demand Conditions

Voigt, 2002
Related and Supporting Industries
Leather
Footwear
Parts of Design
Footwear Services
Leather Processed
Working Leather
Machinery
Source: Porter (1990) MOR 492 Porter on Global Strategy 6

Voigt, 2002
3
Page 536
Internationally Competitive
Related Industries

Voigt, 2002
Firm Strategy, Structure and Rivalry

Voigt, 2002
4
Page 537
Estimated Number of Japanese Rivals

in Selected Industries, 1987

Voigt, 2002
The Complete System

Structure, and
Rivalry
Factor Demand
Related and
Supporting
Industries
Government

Source: Porter (1990) Voigt, 2002
5
Page 538
Company Strategy

Voigt, 2002
Competitive Advantage in
International Competition
1. Competitive advantage grows fundamentally out of improvement,

innovation, and change.
2. Competitive advantage involves the entire value system.
3. Competitive advantage is sustained only through relentless
improvement.
4. Sustaining advantage demands that its sources be upgraded.
5. Sustaining advantage ultimately requires a global approach to
strategy.

Voigt, 2002
6
Page 539
Pressures For Innovation

Voigt, 2002
Perceiving Industry Change

Voigt, 2002
7
Page 540
Predicting the Behavior of Foreign Rivals Firm

Strategy, Structure and Rivalry

Voigt, 2002
Predicting the Behavior of

Foreign Rivals, cont.
FACTOR CONDITIONS
What is the direction of industry-related research

in the nation and the types of training received by
new employees?
How will pressures from selective factor
disadvantages modify strategies?

Voigt, 2002
8
Page 541
Predicting the Behavior of Foreign

Rivals, cont.
DEMAND CONDITIONS
Which industry segments are likely to be

emphasized because of their importance
domestically?
What trends in domestic buyer needs will
shape competitor perceptions of new product
directions?

Voigt, 2002
Predicting the Behavior of

Foreign Rivals, cont.
RELATED AND SUPPORTING INDUSTRIES
How will developments in local supplier industries

skew the direction of technical development?
How will entry from related industries redefine the nature

of domestic rivalry or pressure firms to change?

Voigt, 2002
9
Page 542
Choosing Industries and Segments For Which

the Nation is a Favorable Home Base

Voigt, 2002

the Nation is a Favorable Home Base, cont.

Voigt, 2002
10
Page 543


Voigt, 2002


Voigt, 2002
11
2005544
Introduction: What is Globalization? Introduction: What is Globalization?
What is Globalization and Outline

the Global Marketplace,  What is Globalization?
really?  Drivers of Globalization
 The Changing Demographics of the

Global Economy
 The Globalization Debate: Prosperity
or Improverishment?
 Managing in the Global Marketplace
Definition of Globalization What is Globalization?

 The Globalization of Markets
 Globalization is the trend toward a
more integrated global economic  The merging of historically distinct and
separate national markets into one huge global
system
market place
 Examples: telecommunications,  Convergence of consumer tastes and
automobiles, computers, credit cards, preferences
fast food, etc.  Citicorp credit cards, Coca-Cola, Levis, Sony Walkman,
Nintendo, McDonalds, etc.
 Globalization of Markets (Continued)  Globalization of Production

 The most global of markets are for industrial  The tendency of firms to source goods and
services from different locations around the
goods and materials
globe to take advantage of national
 Markets for Commodities differences in the cost and quality factors or
aluminum, oil, wheat

production (such as labor, energy, land, and
 Markets for Industrial Products capital)
 microprocessors, DRAMs, commercial jet aircraft
 Global web of suppliers
 Markets for Financial Assets
 Almost irrelevant to speak about American
 T-bills, Eurobonds, futures
products, Chinese products, Japanese
 Same multinationals compete with each other products, Italian products
in multiple national markets

Marshall
Semi-Globalization Drivers of Globalization

 Declining Trade (tariffs) and
 Globalization vs Semi-Globalization
Investment Barriers
 Semi-Globalization is a state between
 General Agreement on Tariffs and Trade (GATT)
completely integrated markets and  World Trade Organization (WTO)
completely independent localized  The lowering of trade and investment barriers
markets has allowed firms to locate production
 Regionalization – NAFTA, EU, Mercosur optimally almost anywhere in the world
 “Home” markets are now under attack from
foreign competitors
 The Role of Technological Change  The Role of Technological Change

(continued)
 Microprocessors and Telecommunications
 Transportation Technology
 As costs of telecommunications fall, so do the
costs of coordinating and controlling global  Development of commercial aircraft and
organizations superfreighters
 Containerization (simplifying transshipments)
 Internet and the World Wide Web
 Commercial jet travel (reducing time to travel)
 Information backbone of the global economy
 Greatly increased across-border transaction
 Location, scale and time no longer become
major competitive advantages
 Implications for the Globalization of

Production
 Containerization
 Development of commercial aircraft and
superfreighters
 Containerization (simplifying transshipments)
 Commercial jet travel (reducing time to travel)
 Information Technology
 Real costs of info processing and
communication have fallen dramatically
 Ability to manage globally dispersed production
systems

2005546
 Implications for the Globalization of Changing Demographics of the

Markets Global Economy
 Containerization and Low-cost Transportation
 In the 1960s world stylized facts
 Economical to ship products around world
characterized the demographics of the
 Low-cost Global Communication global economy:
 eCommerce 1. US dominance of the world economy and world trade
2. US dominance of world foreign direct investment
 Low-cost Jet Travel 3. Dominance of international business by large US
 mass movement of people between countries multinational corporations
 reduced cultural distance between countries 4. Approximately half of the world was under the control
 creating a worldwide culture of centrally-planned communist economies which were
off-limits to US businesses
 Emergence of global markets for consumer
products

The Changing Pattern of World Output and Trade
 Changing World Output and World Country Share of World Share of World Share of World
Trade Patterns Output, 1963 Output, 1997+ Exports, 1998
United States 40.3% 20.8% 12.7%
Japan 5.5 8.3 7.26

 Decline of US of world output (and other
Germany* 9.7 4.8 10
traditionally dominant economies) relative to
France 6.3 3.5 5.7
emerging economies such as Asia
United Kingdom 6.5 3.2 5.1
 Decline of US as leading exporter relative to
Italy 3.4 3.2 4.5
Japan, Germany, South Korea, China, etc.
Canada 3 1.7 4.0
 Emerging regions and economies such as
China++ NA 11.3 3.4
those of South America, Eastern Europe, and
South Korea NA 1.7 2.45
Asian Pacific have further eroded US position *1963 figure for Germany refers to the former West Germany.
+ Output is measured by gross national product. The 1997 estimates are based on purchasing power parity (PPP) statistics that adjust GNP for differences in prices (the cost of
living) between countries.
++ The Chinese figures are somewhat suspect. When calculated using unadjusted GNP data, China's share of world output shrinks to 3.1 percent. Thus, China's high share of
world output on a PPP basis is partly due to the relatively low cost of living in China.
Source: Export data from World Trade Organization, A nnual Report, 1999 and Statistics, 1996 (Geneva: WTO, 1996). World output data from CIA factbook, 1999.
 Changing Foreign Direct Investment  Changing Nature of the Multinational

Picture Enterprise
 Relative decline to US foreign direct  Definition: A multinational corporation (MNC)
investment is any business that has productive activities
 Emergence of non-US firms investing across- in two or more countries
borders  Two important trends:
 Emergence of non-US MNCs
 Japanese and European MNCs
 Growth of mini-MNCs
 Medium and small businesses with as few as 25
employees

Marshall
The National Composition of the

 Changing World Order
Largest Multinationals
Of the Top 260 in 1973 Of the Top 500 in 1997

United States 126 (48.5%) 162 (32.4%)
 Between 1989-1991 a series of democratic
revolutions swept the communist world
Japan 9 (3.5) 126 (25.2)
 Collapse of the Soviet Union
Britain 49 (18.8) 34 (6.8)
 Numerous European and Asian countries with
France 19 (7.3) 42 (8.4) a commitment to free-markets creates
Germany 21 (8.1) 41 (8.2) international business opportunities
 Quieter revolutions in China and Latin
Source: The 1973 figures from Hood and Young, The Economics of the Multinational Enterprise (New
York: Longman, 1979). The 1997 figures from "The Global 500," Fortune, August 4, 1997, pp. 130-31.
America
 The Global Economy of the 21st

 The Global Economy of the 21st Century
Century (Continued)
 Barriers to the free flow of goods, services, and  Widespread adoption of liberal economic
capital have come down policies
 The volume of cross-border trade and  privatization of state-owned businesses
investment grew more than global output  deregulation
 indicates national economies are becoming more  removal tariffs and other barriers
closely integrated into a single, interdependent,
global economic system
 New countries are expected to build powerful
market economies
 More nations have joined the ranks of the
 Czech Republic, Poland, Brazil, China, South
developed world Africa
 e.g. Korea, Taiwan
 The Global Economy of the 21st The Globalization Debate:

Century (Continued) Prosperity or Impoverishment
 Russia appears to be backing away from a
 Pros:
market economy
 Lower prices for goods or services
 Financial crises such as the Asian crisis of
1998 spread very quickly across borders,  Economic growth resulting in increased
household incomes
driving economies to recession
 Job creation from international trade
 Some South American countries seem to be
 Countries that conduct a lot of trade together
reversing course usually don’t go to “war” with each other
 Promotes cross-cultural understanding

2005548
The Globalization Debate: The Globalization Debate:

Prosperity or Impoverishment (Continued) Prosperity or Impoverishment (Continued)
 Cons:  Cons:
 Destroys manufacturing jobs in developed  Movement of manufacturing facilities of
countries advanced nations to developing countries
 Wages rates of unskilled workers in  exploitation of labor and environmental abuse
developed countries have declined in developing countries
 “fleeing” to avoid perceived burdensome
 Growing inequality between skilled and
unskilled workers wages regulations
 Economic power and sovereignty is being
challenged by supranational organizations
 WTO, EU, UN
Managing in the Global Marketplace Managing in the Global Marketplace

 International Business and MNCs  Strategic Questions
 Definition of international business  Where in the world to produce to minimize
 Any firm that engages in international trade or cost and maximize added-value?
investment  How to best coordinate and control the
 Managerial Challenges globally dispersed production activities?
 Profound and enduring differences in  Which foreign to enter and which to avoid?
cultures, political systems, economic  What mode of entry?
systems, legal systems,and levels of
 Export? License? Joint Venture? Wholly-
economic development owned subsidiary?
 International business must vary practices
country by country 27 28
Managing in the Global Marketplace Managing in the Global Marketplace

 Across-border financial transaction  Differences between international
challenges business and domestic business
 Government restrictions on international 1. Countries are different
2. The range of problems confronted by a manager in an
trade and investment international business is wider and the problems are
 Foreign exchange rate movements more complex
3. An international business must find ways to work within
 Restrictions on the repatriation of profits the limits imposed by government intervention in the
international trade and investment system
4. International transactions involve converting money
into different currencies

Marshall
Introduction: What is Globalization?
Who is us?
AND
Who is them?

Global Entry Mode
Modes of OVERVIEW: ENTRY STRATEGIES
Global Market
 EXPORT ENTRY
 Direct and indirect exporting
Entry
 CONTRACTUAL ENTRY
 Licensing/franchising, technical agreements
 Contract manufacturing, turnkey projects
 STRATEGIC ALLIANCES
 INVESTMENT ENTRY
 Wholly owned subsidiaries
GSBA 492 Global Strategy GSBA 492 Global Strategy 2
Global Entry Mode
Choice of International Entry Mode
EXPORT
TRANSACTIONS DIRECT INVESTMENT
JOINT VENTURE FULLY OWNED
EXPORTING: EXPORTING: EXPORTING: LICENSING FRANCH
SUBSIDIARY
Spot with with TECHN- -ISING
STRATEGIES
Transactions OLOGY
Long-term foreign
contracts distributor/ag and Market Market
Fully Fully
ent -ing & -ing &
inte- inte-
TRDAE- Dist’n Dist’n
grated grated
MARKS only only
Key Issues:
Is the firm’s competitive advantages based upon firm-specific or country-specific
resources and capabilities
Is the product tradable and what are the barriers to/costs of trade?
Does the firm possess the full range of resources and capabilities needed to
serve the overseas market?
GSBA 492 Global Strategy 3 GSBA 492 Global Strategy
Global Entry Mode Global Entry Mode
EXPORT - APPROACHES EXPORT - ADVANTAGES

DIRECT  Lower per unit cost
 Firm handles entire export operations itself  Economies of scale
 Better capacity utilization
INDIRECT
 Overcome domestic market size limitations
 Exports using
 Manufacturers' export agents
 Offset market cyclicality
 Export commission agents
 Low asset exposure to political risk
 Export merchants  Flexibility of switching the geographical
direction of products
GSBA 492 Global Strategy 5 GSBA 492 Global Strategy 6

Marshall
EXPORT -- DISADVANTAGES EXPORT -- QUESTIONS

 Costs associated with trade barriers  Will there be sustainable competitive
 Lower control over market advantage in export markets? Why?
 Local government objections  What exports markets and segments will

value our products sufficiently?
 Transportation costs
 Standard product with standard marketing
 Costs associated with locating and mix or tailored products?
maintaining relationships with importer(s)  What trade barriers impede export?
 Conflicts-- exporters’ and importers’ goals  What are the appropriate channels for
distribution?
Global Entry Mode
LICENSING: ADVANTAGES
LICENSING
 Extends product life cycle
 Allows penetration of small markets
 Helps build goodwill for MNC’s products
 Limited exposure to political risks
 Reduces loss due to “piracy”
 Requires limited resources
 Quick entry
LICENSING: DISADVANTAGES LICENSING PROCESS

 Lost control over technology
 Difficulty in maintaining quality standards
Assessing Finding Building a
Government restrictions/ high taxes on royalties Negotiating

potential suitable working
a licensing
 Development of potential competitors in target licensing partnership
agreement
market candidates with
 Opportunity costs licensee
 Post-agreement costs
 Protecting industrial property
 Backup services

Global Entry Mode
WHEN IS LICENSING EMPLOYED?
CONTRACT
 Firm lacks capital, managerial resources or
knowledge of foreign markets
 Testing and developing a market that can be

later exploited by direct investment
Technology involved is not central to the
licensor’s core business
MANUFACTURING
 Prospects of “technology feedback” are high
 Host-country government restricts imports or FDI
 Licensee unlikely to become a future competitor
 Pace of technological change is rapid
Beamish (1994)
CONTRACT MANUFACTURING GLOBAL SOURCING STRATEGY

ADVANTAGES DISADVANTAGES
 Limited commitment  Time and effort required
to develop manufacturer
DOMESTIC
of resources Domestic purchasing agreement
 Adverse sentiment
 Quick entry
domestically
 Avoids ownership
 Potential loss in
problems flexibility and control OUTSOURCING
 Cost reduction  Expense -- negotiating,
 Access to technology maintaining and
enforcing contracts FOREIGN
 Creation of future Offshore outsourcing
competitor
Global Entry Mode
STRATEGIC ALLIANCES
• Enable firms to shares risks and resources to expand
STRATEGIC into international ventures

• Most joint ventures (JVs) involve a foreign company
ALLIANCES
with a new product or technology and a host
company with access to distribution or knowledge
of local customs, norms or politics
• May experience difficulties in merging disparate
cultures
• May not understand the strategic intent of partners
or experience divergent goals

Marshall
WHY STRATEGIC ALLIANCES? WHY STRATEGIC ALLIANCES?

EMERGING REASONS
TRADITIONAL REASONS
 Learning from one another
 Sharing of resources and risks
 Attain global scale economies
 Host government requirements
 Raw material/ Component supply
 Overcoming strong nationalistic sentiments  Marketing and distribution
 Quicker entry  Rising R&D costs and technological interdependence
 Benefit from partner’s local knowledge  Short product life cycles
 Industry convergence
WHY STRATEGIC ALLIANCES? RISKS OF STRATEGIC ALLIANCES

Industry Globalization and Global Competition  Partner opportunism and loss of
 Improved market access competitive edge
 Stronger product line
 Strategic and organizational complexity
 Superior timing
 Shaping competitive rivalry
 Conflict of interest problems
 Keeping key competitors at bay  Decreasing partner commitment
 Reduced transaction and other costs

ASSESSING NEED DEFINING GOALS AND OBJECTIVES
 Clarify and resolve separate interests
 Do you need a partner? How big is the payoff?
 Develop mutual trust and understanding
 How likely is success?
PARTNER SELECTION DESIGNING AN ALLIANCE

 Does the partner share your goals and  Define role of each partner
objectives?  Define venture boundaries
 Identifying champion(s)
 Does strategic synergy exist?
 Trust versus legal considerations
 Is the partner compatible?
 Allow for termination

MAKING STRATEGIC ALLIANCES WORK MAKING ALLIANCES WORK

MANAGING THE ALLIANCE MANAGING THE ALLIANCE
 Achieving operating momentum  Managing cultural differences

 Recognize alliance needs  Flexibility
 Policies  Assuring continued commitments
 Resources (inc. human resources)
 Increasing willingness to learn
 Overcoming reluctance to give up autonomy
 Avoiding bottleneck dependence
Global Entry Mode
STRUCTURING ALLIANCES TO
REDUCE OPPORTUNISM
Walling off
Critical technology DIRECT
Probability of
Opportunism by
Establishing
contractual
safeguards
INVESTMENT
STRATEGIES
Alliance Partner
Reduced By
Agreeing to swap
valuable skills and
technologies
Seeking credible
commitments
FULLY-OWNED SUBSIDIARIES: FULLY-OWNED SUBSIDIARIES:

GREENFIELD INVESTMENTS ACQUISITIONS
 Total control  Host government objections  Total control  Acquisitions difficult to
 Lack of partner  Large investment required  Quick entry evaluate
commitment not a  Post-acquisition assimilation
 Labor union objections
concern
problems
 Vulnerability to political risk
 Greater learning about  Vulnerability to political risk
foreign markets  Time required to establish
competitive advantage  Can be considered as “anti-
 No loss of technology social”

Marshall
Global Entry Mode
ENTRY STRATEGIES
Level of
GLOBAL MARKET
Investment
Risk High
WHOLLY OWNED
ENTRY CHOICES
SUBSIDIARY
Medium STRATEGIC ALLIANCES
LICENSING
Limited EXPORTING
Limited Medium High

Ownership and control of foreign operations
RESPONSE TO
ENTRY STRATEGY: CHOICE GOVERNMENTAL BARRIERS
EXTERNAL FACTORS
TRADE BARRIERS BUSINESS RESPONSE
 Target country environment
 Tariffs and quotas  Establish manufacturing
 Government policies/regulations
 Domestic content operations in country
 Economy
restrictions  Acquire local firm
 Socio-cultural factors
 Government  Subcontract or purchase
 Institutional voids
procurement locally
 Political risk
restrictions  Develop products jointly
 Market factors
 Shift to higher-priced
 Size/attractiveness of markets
exports (for quotas)
 Competitive structure
 Marketing infrastructure
RESPONSE TO
GOVERNMENTAL BARRIERS ENTRY STRATEGY: CHOICE
INVESTMENT BARRIERS BUSINESS RESPONSE INTERNAL FACTORS
 Limits on foreign  Enter into a JV  Technology and product characteristics
ownership  Franchising/ licensing  Product factors
 Restrictions on agreements  Pre and post purchase services
repatriation of earning  Set up affiliate  Technological intensity
 Fear of expropriation relationships with local  Minimum efficient scale
 Tax barriers firms  Resource and commitment factors
 Shift high value-added  Resource availability
activities to low-tax  Willingness to take risks
nations  Corporate goals

Firm Capability
CHOICE OF
ENTRY ENTRY STRATEGY SELECTION

 Firm Size; Multinational Experience
 Industry Factors STRATEGY

 Industry growth; Global industry • Joint Venture • Joint Venture
concentration; Technical intensity; High • Wholly owned • Contract manufacturing
Advertising intensity
ENTRY MODES
subsidiaries • Exporting
Location-specific Factors AND DEGREE ECONOMIC

 Country risk; Cultural distance;

Market potential; Market Knowledge OF CONTROL OPPORTUNITY
• Licensing • Licensing
 Venture-specific Factors Low • Exporting • Contract manufacturing
 Contractual risk; Venture size; Tacit • Exporting
nature of know-how
 Strategic Factors Low High

Global strategic motivation; Global
POLITICAL RISK

synergy
Global Entry Mode
ENTRY STRATEGY SELECTION

Export
High Wholly Owned
Delay Entry
RISK OF Subsidiary
HOLD-UP Get Creative
BY TRADING
PARTNER Market Joint Venture/
Low
Transaction Strategic Alliance
Low High
POLITICAL RISK
GSBA 492 Global Strategy 39

Marshall
The Global Organization and OVERVIEW

Management Challenge:
Organizational Design,  Control: Essence of Implementation
Coordination, and Control  Global Managers
 Organization Design
 Organization Systems
 Organization Culture
Global Managers Four Basic Global Strategies

High
 The Business Manager (Global scale & competitiveness)
 Strategist+Architect+Coordinator GLOBAL TRANS-
Efficiency, NATIONAL
 The Country Manager (Local responsiveness & flexibility) Global Scale,
 Sensor+Builder+Contributor Low Cost,
Global
 The Functional Manager (Linking functions worldwide) Integration
 Scanner+Cross-Pollinator+Champion
INTERNA- MULTI-
 The Corporate Manager (Transnational mission) TIONAL DOMESTIC
 Leader+Talent Scout+Developer
Low
EXPORT Low High
-ING Importance of Local Responsiveness
Aligning Managers Responsibility and Decision-making

Four Basic Global Organizational Designs Discretion with Organizational Arrangements
High
High
CENTRALIZED GBU Manager Networked
GLOBAL GLOBAL Dominant
Efficiency, Team
Efficiency, BUSINESS NETWORKS
UNITS Global Scale,
Global Scale,
Low Cost,
Low Cost,
Global
Global
Integration
Integration International
DECENTRAL- Functional Country
INTERNA-
IZED Manager Manager
TIONAL
AREA- Dominant Dominant
FUNCTIONAL
FOCUSED
Low
Low
EXPORT Low High
EXPORT Low High -ING Importance of Local Responsiveness

2004558
Successful Multinational Execution Global Strategy Prescriptions

 Important but not sufficient – Formal Control  Locate each value-added activity in the country that has
Mechanisms the least cost for the factor that activity uses most
 Incentives, compensation, monitoring systems, rewards & intensely
punishments  Dexterously shift capital and resources across national
 Due Process in Global Strategic Decision-making markets, cross-subsidizing global units
 Head office is familiar with subsidiaries local situation  Institutionalize fully standardized product offerings,
 Two-way communication exists in the global strategy-making marketing approaches, and commonly used distribution
process systems worldwide to allow maximum global efficiencies
 Head office is relatively consistent in making decisions across  Consciously consolidate worldwide knowledge,
subsidiaries
technology, marketing and production skills to build
 Subsidiary units can legitimately challenge HQ views and
decisions reservoirs of distinctive core competencies that can act
 Subsidiary units receive an explanation for final strategic as engines for continuous new business development,
decisions innovation and enhanced customer value
CONTROL
How do you execute them? IMPEDIMENTS
 Historical
evolution of headquarters-
 Increasing sacrifice of subsystem for system
priorities and considerations subsidiary relationship
 Swift actions in a globally coordinated manner  HQ managers may lack understanding
 Effective and efficient exchange relations of skills and limitations involved in
among the nodes of the multinational’s global operating in dissimilar environments
network
Multinational enterprises need subsidiary  Presence of JV partners
managers with a sense of commitment, trust
and social harmony  Host governments like to influence
- compulsory vs. voluntary execution
strategy at subsidiary level
ORGANIZATION STRUCTURE EXPORT ORGANIZATION

Name
Title
Disadvantages
 International Export manager may have insufficient clout
Name Name Name
Title Title Title 
 Worldwide Area Name

Title
Name
Title
 Export orders may receive low priority
 Global Product Division  Domestically oriented organization not

supportive of foreign market requirements
 Matrix
 Network

Marshall
TRADITIONAL SOLUTION:
INTERNATIONAL DIVISION
STRUCTURAL MERRY-GO-ROUND CEO/
PRESIDENT
Worldwide Global
Product Matrix
Division
DOMESTIC DOMESTIC DOMESTIC
DIVISION DIVISION DIVISION INTERNATIONAL
A B C DIVISION
FOREIGN PRODUCT
DIVERSITY Area
International Division
Division
Germany Japan Brazil

FOREIGN SALES AS
PERCENTAGE OF TOTAL SALES
INTERNATIONAL DIVISION
ADVANTAGES DISADVANTAGES WORLDWIDE AREA
CEO/
· Focus on · International- PRESIDENT
international domestic split
opportunities · Domestic North South
Europe Asia
· Greater “weight” divisions exert America America
in hierarchy greater power
Country
· Establishment of · Manager needs to Manager: U.S. Germany Brazil India
understand
formal control product market Canada Spain Argentina Japan
procedures strategies of all
divisions
WORLDWIDE AREA
WORLDWIDE PRODUCT DIVISION
CEO/
PRESIDENT
· Local sensitivity · Country
considerations
· More efficient dominate over global Product Product Product Product
use of resources Division A Division B Division C Division D
within country · Country managers Area Product Area Product Area Product Area Product
may not have
· Motivated adequate knowledge
Manager: U.S. Manager: U.S. Manager: U.S. Manager: U.S.
country of all products Area Product

Manager: Japan
Area Product
Manager: Japan
Area Product
Manager: Japan
Area Product
Manager: Japan
managers
· Duplication at HQ

2004560
WORLDWIDE PRODUCT DIVISION PORTFOLIO- WORDWIDE

BUSINESS MANAGER
Worldwide
· Better · Duplication at
coordination Business
country level Manager
within product
groups · Coordination across Country Country
product groups 5
· Global view of 1
competition · Less subsidiary

initiative
· Facilitates Country
2 Country
Country
4
technology 3
transfer across
country border
PORTFOLIO- COUNTRY
MANAGER GLOBAL MATRIX
CEO/
Country PRESIDENT
Manager
Product Product Product
Business Business Division A Division B Division C
1 5
Subs. Mgr.
Manager A Manager B Manager C
Japan
Business Business Subs. Mgr.

2 Business 4 Germany
3
ORGANIZATIONAL IMPLICATIONS:
THE INTEGRATED NETWORK
GLOBAL MATRIX
· Combines · Dual reporting can CENTRALIZED

DECENTRALIZED
FEDERATION
positives of cause confusion HUB
product and · Slow decision

area structures making
· May be · Requires high THE INTEGRATED NETWORK
suitable for horizontal and
transnational vertical
strategies coordination
MOR 492 Global Strategy 23 MOR 492 Global Strategy COORDINATED FEDERATION 24

Marshall
NETWORK
TRANSNATIONAL MANAGEMENT
Business Business
manager manager BUILDING AND MANAGING THE
TRANSNATIONAL
Business
Business Corporate
manager
manager Management
Business Business
manager manager
MOR 492 Global Strategy 25 MOR 492 Global Strategy
STRATEGIC CAPABILITY OF THE TRANSNATIONAL: Developing Transnational Organization

The New Multi-layered Game
 Sensitivity, flexibility, and responsiveness
 Building an organization -
to local needs
More than Installing a Structure
 Global scale efficiency and competitive

response capability  Requires an integrated approach
- Building the Transnational Anatomy
 Worldwide innovation skills and learning - Shaping the Transnational Physiology
capabilities - Moulding the Transnational Psychology
Building and Managing the Transnational

BUILDING AND MANAGING THE TRANSNATIONAL:
A Biological Metaphor - Don’t manage like the United Nations:
Differentiate roles and responsibilities
 A new structural anatomy
* Redistributing assets and responsibilities - Don’t let a single perspective dominate:
Legitimize business, area and functional
 A new process physiology management
* Redefining information flows and relationships
- Don’t search for a standard coordination process:
Develop and apply different tools to different tasks
 A new cultural psychology
* Readjusting mentalities and beliefs - Focus beyond structure and systems:
Build a matrix in managers’ minds

2004562
Building and Maintaining Multiple Strategic Capabilities

Require Protecting the Legitimacy of Multiple Management Tasks
The New Organizational Roles and GLOBAL

Responsibilities EFFICIENCY
BUSINESS
MANAGEMENT
Company Business Function Geography
Research
M atsushita M edical Taiwan UK
Purchasing Singapore
FUNCTIONAL
Telecom
Development MANAGEMENT NATIONAL
France RESPONSIVENESS
GE Consumer Production
Electronics
M arketing Australia
Brazil
Phillips Sales
Lighting Service India
WORLDWIDE AREA
INNOVATION AND MANAGEMENT
LEARNIING
Building and Balancing Multiple Transnational Coordinate

Organizational Perspectives
Mechanisms
- Build legitimacy and credibility of nondominant groups:
Coopt specific individuals
Provided required mandate - Intense cross-border flows
- Provide access to information channels - Goods: Materials, components, products
Modify existing channels - Resources: Financial, human
- Knowledge: Technology, expertise, Intelligence
Create new channels
- Create influence in decision processes
Use micro-structural tools - Administrative heritage influences coordination
Use both visible and invisible hands - Centralization in Japanese centralized hubs
- Maintain balance over time - Formalization in American coordinated federations
- Socialization in European decentralized federations
Manage ambiguity and flux
Develop fit and flexibility
Transnational Coordination Mechanisms Traditional Solution: Structural Merry-Go-Round

Portfolio of tools, selectively applied
- Goods flows: Formalized coordination Structure and systems
- Resource flows: Centralized coordination - Blunt instrument of change
- Knowledge flows: Socialized coordination
- Deny, oversimplify or compartmentalize
With flexibility to match roles and tasks complexity
- Leaders and black holes: Socialization dominates

- Reinforce parochial, hierarchical, adversarial
- Contributors: Centralization dominates
mentality
- Implementers: Formalization dominates

Marshall
INSTALLING THE TRANSNATIONAL

STRUCTURE LIMITS OF TRADITIONAL
CHANGING ATTITUDES AND BEHAVIORS: CHANGE MODELS
The Foundation Stone of Change
 Developing shared values and purpose •Classic change process driven by structural reconfiguration
* Clarity, Continuity, Consistency Assumptions of change model:
Change in formal structure/responsibilities

 Building multi-dimensional perspectives, capabilities
reshapes
* Expand career paths, assignments, education
Organizational processes/relationships
 Helping the organization embrace, not deny,
redefines
complexity
* “Create a matrix in managers’ minds”
Individuals attitude/mentalities
BUILDING THE TRANSNATIONAL ORGANIZATION:

The Alternative Approach
• Recognizes structures as a blunt instrument of change
* Simultaneous changes organization's anatomy,

Physiology, psychology
Modify individual attitudes/mentalities

(Psychology)
Develop new processes/relationships
(Physiology)
Confirm with redefined structures/responsibilities
(Anatomy)

Marshall School of Business Voigt, Term Iv, Page
2006564
WBMH Framework
The “Radio” Model Framework
WBMH Framework W Why go global? What is the motivation,

goals, intended end outcomes?
What does the firm bring (and what will
An Overview Framework for B “travel”) to the global market opportunity?
Global Strategy Analysis
M What will/should/can the firm expect to
meet when it goes global?
H How should the firm enter the global

market? How should it organize itself?
MOR 492 Global Strategy MOR 492 Global Strategy Sourc e: WBMH is built on idea from Porter
2
Why? WBMH Framework Why? WBMH Framework
Motivations/Imperatives Motivations/Imperatives (Continued)

for “Becoming” Global
 Growth
 Imperative: pursuing new sources of  Knowledge Imperative: continuous learning
volume by finding “Q” in new global markets markets change,
 “Replication” of existing business model in new consumer’s tastes and needs change,
location  competitors innovate and adapt,
 technology “jumps”
 Efficiency Imperative:
 Globalization of Customers: when customers
 pursuing low cost raw materials, labor, etc. start to go global, firms must keep pace with them
 “Arbitrage” is using involved in some way or lose overseas and domestic business to new
 economies of scale and scope rivals
 Minimum efficient scale may be bigger than any single  Globalization of Competitors:
market
 Rivals may capture global first mover advantages
 reducing distribution costs, inventory costs, etc  Rival may be able to use multi-market presence to
cross-subsidize
MOR 492 Global Strategy an attack on a firm’s home market 4
Bring? WBMH Framework Bring? WBMH Framework
Transferring Competitive Advantages, Core

Competencies and Capabilities across Borders Global “Generic” Strategies
 What “travels” from a firm’s strategy  Source of Global Strategies are in two
(business model) to the new global market? areas:
 What can the firm “take” with it?  Arbitrage
 What can the firm replicate in the local market?  Replication
 What can the firm adapt to the local market?  Transformation (third area which combines first two)
 What resources and skills will not travel?
Asking and answering the “Taco Stand” question is
critical to determining what the firm can “bring” global
GSBA 519b Corporate & Global Strategy 1

Marshall
Page 565 School of Business Voigt, Term Iv, 2006
Bring? WBMH Framework Meet? WBMH Framework
Bases for Global Advantage Analyzing the Global Market:

Economies
What will the firm meet?
of Regional Analysis
Replication
National Non-Market Country Analysis
Industrial Sector Competitiveness Analysis
Industry Analysis
Global Global
Feasibility Market Potential Analysis Profitability
Learning Flexibility Analysis Analysis
Economies Economies Competitor Analysis
© Voigt, Mayer & Liebeskind, 2006 of Scale of Scope
Meet? WBMH Framework Meet? WBMH Framework
Country Analysis Global Competitiveness

 Global Economics of Region  Relative competitiveness of “Country”
 Macroeconomic Policies  Relative competitiveness of “Industries”
 Political Agenda  Use Porter’s Diamond of Global Competitive
 Fiscal & Monetary Policies Advantage
 Policies toward foreign investments & control
 Political Risk Analysis Also important to examine sources leading to
 Institutional Voids Analysis
“un”competitiveness of country or industry
Meet? WBMH Framework Meet? WBMH Framework
Diamond of Global Competitiveness

Examining Relevant “Distances”
Structure, and
Rivalry
 CAGE Framework (Ghemawat)
 Cultural Distance
Factor Demand  Administrative Distance
 Geographic Distance
 Economic Distance
Related and
Supporting Global strategy must exploit/mitigate relative
Industries
Government “distance” between the firm and the global market

Marshall School of Business Voigt, Term Iv, Page
2006566
How? WBMH Framework How? WBMH Framework
“How” to Become Global? Four Basic Global Strategies

High
 Choice of Global Strategy
TRANS-
 Choice of Entry Mode Efficiency,
GLOBAL
NATIONAL
Global Scale,
 Choice of Organizational Structure Low Cost,
Global
Integration
INTERNA- MULTI-
TIONAL DOMESTIC
Low
EXPORT Low High
Traditional Solution:
Choice of International Entry Mode Structural “Merry-go-round”
TRANSACTIONS DIRECT INVESTMENT
Worldwide Global
JOINT VENTURE FULLY OWNED
EXPORTING: EXPORTING: EXPORTING: LICENSING FRANCH
SUBSIDIARY
Product Matrix
Spot with with TECHN- -ISING
Transactions OLOGY
Division
Long-term foreign
contracts distributor/ag and Market Market
Fully Fully
ent -ing & -ing &
inte- inte-
TRDAE- Dist’n Dist’n
grated grated
MARKS only only FOREIGN PRODUCT
DIVERSITY Area
Key Issues: International Division
Division
Is the firm’s competitive advantages based upon firm-specific or country-specific
resources and capabilities
Is the product tradable and what are the barriers to/costs of trade?
Does the firm possess the full range of resources and capabilities needed to FOREIGN SALES AS
serve the overseas market? PERCENTAGE OF TOTAL SALES
International Division
CEO/
Worldwide Area
PRESIDENT CEO/
PRESIDENT
DOMESTIC DOMESTIC DOMESTIC

DIVISION DIVISION DIVISION INTERNATIONAL North South
Europe Asia
A B C DIVISION America America
Country
Manager: U.S. Germany Brazil India
Canada Spain Argentina Japan

Germany Japan Brazil

Marshall
Page 567 School of Business Voigt, Term Iv, 2006
Worldwide Product Division Global Matrix

CEO/
CEO/
PRESIDENT
PRESIDENT
Product Product Product Product Product Product Product

Division A Division B Division C Division D Division A Division B Division C
Area Product Area Product Area Product Area Product Subs. Mgr.
Manager: U.S. Manager: U.S. Manager: U.S. Manager: U.S. Manager A Manager B Manager C
Japan
Area Product Area Product Area Product Area Product
Manager: Japan Manager: Japan Manager: Japan Manager: Japan Subs. Mgr.
Germany
How? WBMH Framework How? Organizational Implications: WBMH Framework

The Integrated Network
Network
Business Business
manager manager
DECENTRALIZED
CENTRALIZED FEDERATION
HUB
Business
Business Corporate
manager
manager Management
THE INTEGRATED NETWORK
Business Business
manager manager
MOR 492 Global Strategy 21 MOR 492 Global Strategy COORDINATED FEDERATION 22


University Notes - Senior Year, 2nd Semester

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

University Notes - Senior Year, 2nd Semester

Uploaded by

Copyright:

Available Formats

Table of Contents

Keith Parker’s Notes from USC

Senior Year, Second Semester

FBE-440: Trading and Exchanges

FBE-462: International Trade and Commercial

MOR-492: Global Strategy

BUAD 497: STRATEGIC MANAGEMENT

• In-depth analysis of industries and competitors

Keith Parker, University of Southern California

COURSE FORMAT AND THE CASE DISCUSSION METHOD

Course grades will be determined by individual and group activities:

Course contribution and participation 15%

Your analysis will be evaluated equally on the following criteria:

1. The team name and names of all team members

COURSE COMMUNICATION: BLACKBOARD SYSTEM

“The University, as an instrument of learning, is predicated on the existence of an environment of integrity. As

Academic dishonesty includes: (Faculty Handbook, 1994: 21-22)

STUDENTS WITH DISABILITIES

Tu – Th Schedule for Fall, 2006

3/06 Tuesday 17 Standards and Network Externalities I

Group Project Presentations

Porter’s Generic Strategies:

Boston Consulting Group Matrix:

Portfolio of Competencies: existing and new

Resource Based View (RBV) of Corporation:

Greiner’s model of Org. Growth:

Mintzberg’s Organizational Theory:

2. Moves to change the game played:

Why Competitor Profiling Matters

• Routines may constrain opportunities for action

Integrating game theory and competitor profiling

Value added chain analysis (Harnishfeger Case)

• Why Value Creation?

Monetary flow ($)

Value Created = buyer’s willingness to pay – supplier’s opportunity costs

• Price measures the division between business and the customer

Size of the pie = willingness to pay – opportunity cost

Division of the pie = value added

Competitors Company Complement

Standards/network externalities and their role in strategy (open/closed, tactics etc..)

Standards matter whenever products depend on compatibility

• Sony vs. JVC

Keith Parker, University of Southern California

• Windows vs. Mac

Wins and looses

Keith Parker, University of Southern California

• Competitive advantages erode quickly

• Internet Explorer vs. Netscape

Judo and Hardball strategies

Mintzberg’s 3 fallacies of strategic planning

Deliberate vs. Emergent Strategies

Allows a company to rapidly take advantage of opportunities as they occur

Keith Parker, University of Southern California

The public company faces pressure from various angles including:

The above pressures are offset by the following methods of control:

Strengths/Weaknesses of the Public Company

Diversification and differences in risk preferences

Disclosure and shareholder control (formally and actually)

How corporate control is really exercised…

Compensation and stock options (formal and actually)

Underwater options and indexed options

Keith Parker, University of Southern California

BUAD 497 Final Study Guide- Scott Exner