What’s This About Chemistry?
Phone: +1 832 748 1900
Businesses with a well developed strategy make better business decisions. And that goes from strategic decisions, like whether or not to expand into new geographic areas, to tactical decisions, like what to serve in the company cafeteria.
But developing strategies is a complicated process. An effective strategy takes into consideration all the factors that impact your business – your customers, your competitors, the general business environment and your own strengths and weaknesses. So developing effective strategies is like a chemical process. It mixes your customers’ needs and desires with your competitors' strengths and weaknesses, along with an honest assessment of your own skills and capabilities, and transforms that stuff into a plan of action that adds value to your business by making it more competitive.
And to take the strategic plan to the ultimate level, throw in a crystal ball that predicts the future, so that you remain competitive, and reach that elusive state that many have talked about but few have realized - the Sustainable Competitive Advantage!
We can provide the strategic chemistry to help you better understand yourself, your customers, your competitors and your environment to make better decisions and create value for your stakeholders.
Value and Risk - Which way is the future?
Business schools teach that the best measure of the value of a business is the cash that’s generated by the business. This is usually defined as the net present value (NPV), or the current value of the cash flow the business will generate in the future. So according to the textbooks, selecting between strategic options is easy. You simply pick the one that generates the highest NPV, because that’s the one that maximizes the value of the business. But here’s the problem - We don’t know for sure the cash flow the business will generate in the future, because we don’t know for sure what the future will look like.
That’s why it’s important to understand risk and uncertainty, and to test strategies against alternative views of the future.
A detailed, robust financial model based in Excel or some other spreadsheet or financial software is a valuable tool for evaluating strategic options and monitoring business performance. A well constructed model can allow you to isolate key business drivers and use statistical techniques to assess the relative risk of strategic options.
Let’s say you want to expand your plant, but there are too many variables you can’t predict to make you comfortable with the decision. The cost of steel and other materials has skyrocketed, and you’re worried about cost over-runs. You’re concerned about how your competition will respond, and worried that you may have to reduce prices to expand sales. You’re also concerned about rising fuel costs, because your key competitor is located in an oil producing country that regulates energy prices to support local industry, and you have to pay market prices. A plant expansion would improve fuel efficiency, but will it save enough to offset investment costs and potentially lower margins? You’ve had an analysis done based on your “best guess”, and both the expansion and non expansion options yield the same NPV.
The chart below is an example of a statistical tool that can help you make the decision.
This is a “Cumulative Probability” chart that shows NPV calculations for each option based on a range of possible outcomes for major uncertainties. In this case, the major uncertainties include investment costs, energy costs, and margins. For each uncertainty the project team selects high, low and medium probability values, so that they are 90% confident that the actual outcome will fall within the selected range. So instead of making the strategic decision of whether or not to expand based on the best guess of one value for each key uncertainty, you can make your decision based on a range of possible outcomes that factor in the risk associated with all identified uncertainties. The red line shows that the “Expand” option has a 50% probability of yielding a better outcome than the “Don’t Expand” option. However, it has a 20% chance of yielding a negative NPV, or actually reducing the value of the business. The blue line shows that the “Don’t Expand” option yields a top end NPV about $50 MM below the “Expand” option. But it also has a 50% probability of yielding a better outcome than the “Expand” option. Most importantly, it has a zero probability of yielding a negative NPV and destroying value. Which option would you choose?
To find out more about how we can help you with your analysis and strategic decision making email or give us a call at +1 832 748 1900.
What's a Sustainable Competitive Advantage, and how do I get one?
Simply put, a Sustainable Competitive Advantage provides superior business results versus competition through greater efficiency and/or a valuable, differentiated customer offer. It has to be durable, so it lasts over time, and it has to be difficult to imitate, so the competition can’t easily copy it. It often results from continuous innovation, so that by the time your competitors have figured out how you do it, you’re doing something different, and they are always a step behind.
When you get right down to it, achieving a Sustainable Competitive Advantage is about using and developing competencies – assets, knowledge and skills – to create unique and significant value for yourself and your customers in ways that your competition cannot match or copy. The key is focus – focus on customer needs and industry trends to understand how to use your competencies to create value. This covers the entire business - the products you offer, how you market and distribute them, communicate externally and internally, how you source raw materials and manufacture products, use technical and R&D support, and how you chose which markets and geography to serve. Focus is also about choosing what you don’t do, which activities don’t add value, and which customers and markets you can’t efficiently serve.
The funny bubble chart is what we call a “Competency Map”. This is useful in understanding how you use your competencies to create a Sustainable Competitive Advantage. The key is to identify and map how the various elements of your business link together to create unique value. Done honestly and openly, this is a great tool in discussing and debating your strategy internally, and can help you identify gaps that could be opportunities to strengthen your competitive position in the future.
To find out more email us or give us a call at +1 832 748 1900.
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