Lecture 10 – “The Big Finish”

Lecture 10 – “The Big Finish” Steve Montgomery

Introduction To The Business Environment • What to do when someone’s not telling you what to do • Topics covered: • Course introduction and Overview of corporate structure (1 session) • Fundamentals of business strategy (2 sessions) • Introduction to Marketing (2 sessions) • Overview of Accounting and Finance (2 sessions) • Project Valuation and ROI (2 sessions) • Putting it all together (1 session)

Lecture 10 • Guest Speaker: Kristena Louie, Microsoft Corp. • Course wrap-up and summary

Homework, cont. • What is Cummins’ tax rate? • What is Cummins’ WACC? • What is the minimum initial price you need to charge to make this a positive NPV? • How does this change if your ASP did NOT decline year on year? • What steps could Cummins take to preserve the ASP? (Put your strategy hat back on) • Assume the minimum IRR for Cummins is 12%. What does the initial price need to be to meet this goal? • What is the NPV for this price level? • Headcount = $125,000/year • Interest rate on debt = 6% • Final year growth rate = 2% • Risk free i = 5.3%, Stock premium = 6.4% • $50/hour labor rate

Cummins Info: • Source: Yahoo Finance • One mistake: Free cash flow • Remember the formula! • Take out Capex, and NWC from net income and add back in depreciation

Point of this course? • As future technical leaders, you will need: • An ability to evangelize your ideas and rally support/resources • An understanding/grasp of business topics and strategy • An ability to communicate your ideas to senior management • The ability to pick projects that maximize your business, promote your career, and promote the careers of those on your team • All the tools here are applicable on a number of levels: • Your firm • Your business group • Your own career

Course Wrap-Up

Goal of Any Business – • Identify external threats and undue influences • Maximize own influence • Minimize negative influences • Create differentiation • By maximizing/minimizing influence, and creating differentiation you get pricing power (assuming there is a market) • If there isn’t an existing market, and it makes sense to do so, create one!

Strategic Thinking • As future leaders, you need to keep the following ideas in mind: • What incentives do the programs that I observe create? • What behaviors do these incentives drive? • Are these behaviors good or bad? Why? • What metrics best reflect value creation? • And how do you use them to your benefit? • Everybody else plays checkers. You should play chess.

Incentives • Simple rule of human behavior: • Rational human beings respond to incentives • Knowing what incentives are out there allows you to predict a lot of behavioral patterns: • Incentives can be positive or negative • Incentives can be emotional or factual in nature • Incentives can result from corp. structure, metrics of measurement, or strategic directives • Also intangibles like paranoia, but that’s another class

Corporate Goals • Any corporation in business today (for profit, obviously) has the following goals: • Survival • Profitability • Survival can mean many things: • Staying in business • Returning value to shareholders • Pushing the state of the art • Pursuing a mission and a set of values

Survival • To survive, companies seek to minimize inefficiencies and streamline processes • Organizations are grouped to streamline tasks, allocate resources, and unify functions • Analyzing an org chart can tell you a lot about what a company values • …and is a gateway to understanding the overall strategy and business model

What Is Differentiation? • Differentiation is achieving the ability to deliver a product or service that customers perceive to be unique or distinct in some important way • Differentiation doesn’t need to be tangible - Examples: • Nordstrom’s – known for customer service above all else, even on similar merchandise to rivals • Mercedes, BMW – Perceived status of owning a Bimmer or a Benz vs. an equivalent car • Brand image plays a huge role in determining perceived value • Can be based on cost as well

Differentiators: Nordstrom’s Rolex Porsche Prada Broad differentiators: Intel Samsung Sony Ford Toyota GE Differentiation (Higher costs, higher prices) Cost leaders: Wal-Mart Generic drug man’f Southwest Airlines Costco Cost leadership (Low costs, low prices) Differentiation, cont.

Differentiation Summary: • Firms make choices on which factors to promote or ignore (we’ll explore this more in Lecture 3) • When you achieve differentiation, either hard (features you have the competition doesn’t) or soft (brand perception), you can charge a higher price • Key is delivering perceived value to customers • Intangibles can be harder to imitate: • Me-too products can be reverse engineered • Intangibles often reflect execution, which is harder to match • BUT, intangibles often are a function of consumer trust. If that’s ever lost, may be difficult to get back (GM?)

SWOT Scorecard: The New GM

SWOT Summary • Is a good technique to get the strategy discussion going – puts a lot of high-level information in context • Use it to assess situations and think more deeply about tactical moves • If the SWOT picture looks really misaligned with the market/your firm, can tell you that your overall strategy should be reassessed • Is only as good as the thinking that went into it

Porter’s Five Forces Model • Five Forces Model: A framework for shaping competitive strategy • Like SWOT, gives a repeatable set of criteria to judge a situation by

Five Forces Summary • Is a good generic framework; is as detailed as you make it • Curious treatment of the government – should there be a 6th force? • Complementary products can make or break an offering – • iPod example • Cars are pretty useless without roads or gas stations • Airlines irrelevant without airports • Does not tell you how to exploit a market, just helps ID the forces driving it • There are other strategies for that • Industry structure changes: Another item to watch for • Example: Newspapers. News is available 24/7 on the web. Is print dead? • Does it make sense for big city newspapers to have foreign bureaus? • Like other tools, is applicable up and down the chain

How These Tools Relate To You • Using SWOT and Five Forces in tandem allows you to: • Identify the strategic environment • Make an assessment of your strength relative to other players • If you’re thorough in gathering information and disciplined in its presentation, the right answer can leap off the page • Apply these tools to: • Your company • Your business unit • Your organization • Your team • You • Strategy is a mindset!

The Idea Career Highlights • “Hit ‘em where they ain’t” • The business variant of this is Blue Ocean Strategy Baseball’s #2 dead-ball era hitter • Some strategies are universal: • Baseball or armored warfare 3rd Army rampaged across Europe

Reduce: What current items aren’t generating value in proportion to the effort? New Value Creation Eliminate: Which current items are considered frivolous or unnecessary? Create: New features? New combinations? New segments? Raise: Which items are substandard? Four Actions Strategy: In General Divert Resources Divert Resources

Steps in BOS: Strategy Canvas • First: Analyze your industry • Chart common factors that outline areas of value: • For example, Wine • Common to all competitors will be taste, cost, image, selection of types, etc. • Gyms: • Common to all will be price, class offerings, instructors, workout equipment, features, location, etc. • Plot each of these values on a graph showing “high” offering levels and “low” offering levels • Note that “high” in one category can be good while “low” in another is also desired, e.g. cost

Construct a graph – product attributes on x, “offering level” on y Goodness /= high. High price, for example, is bad Badness /= low. Low price, for example, is good. Chart the target firm and its competition in these terms. Where do they line up? Where are there gaps? The Strategy Canvas Level of Offering: Low to High Product or Industry Attribute

Steps in BOS, cont. • Next: Change the rules • “6 Paths” Framework: • Look across alternative industries • Check for products/services that have similar functions but different purpose • Example: NetJets and fractional plane ownership, Worldmark and flexible time shares • Look across strategic groups within industries • Why do people trade up or down between products? • What makes someone choose one thing over another? • Figure out a way to have cake and eat it, too • Example: Lexus: Mercedes, BMW quality at Cadillac prices • Look across the chain of buyers • Buyers may not be the end users • Example – pharma. Doctors buy, but patients use. Big Pharma now markets directly to patients • Intel Inside is the most famous example of this • What is the buying chain in your industry? If you shift this group, can you unlock more demand?

Steps in BOS, cont. • Look across complementary offerings • Are there complimentary products that make it easier to sell yours? • What’s the total solution that buyers are looking for? • What are people ‘hiring’ your product to do? • Example: Bookstores have added lounges, coffee shops, couches • Differentiate between functional and emotional appeal – switch your product • If you compete on emotional appeal, how can you make it appeal to functionality? • If you compete on functionality, how can you make it appeal to emotion? • Example: Swatch watches. People bought them for the fashion statement, not to tell time (Transformed a functional product into an emotional one) • Example: Starbucks: Changed getting a cup of coffee into a social experience

Steps in BOS, cont. 6. Look across time • What trends are developing that affect your products? • Can you affect these trends? • Example: Apple’s iTunes (capitalized on electronic file sharing), CNN’s 24/7 news (capitalized on growing need for 24/7 information and spread of cable TV), Kraft Mac & Cheese (families eating healthier)

Summary of BOS • Provides a framework, out of which you can visualize your market position • Attack the market with the strategy that presents itself • “Value Innovation” • Sometimes, by looking at the data objectively, you can innovate and deliver unique value in a crowded marketspace • Remember to try and break the rules by looking for opportunities: • Are you even thinking of yourself in the right way? Look across industries • Look across strategic groups within industries. Look for underserved groups. • Look across buyers. Where are the eyeballs? Where are the real users? • Look at trends and exploit them • Look at complementary products. Is there a side product you can offer that enhances your main offering? • Try and differentiate between emotional and functional appear • Your competition gets a vote • Anything you do, most of the time, they can do it, too • JetBlue vs. SWA. Honda et al. vs. Toyota

Summary of BOS, cont. • Also applies to you as a leader • What skills can you give yourself to create your own personal blue ocean at work? • How can you “value innovate” your career? • Same frameworks and toolsets apply • In any case: Hit ‘em where they ain’t • The best ways to win fights are: • Attack with your strengths against their weaknesses • Attack where they aren’t • Continually improve and differentiate: always add new wrinkles

Limitations of BOS • BOS doesn’t guarantee a timeframe • Here today, gone tomorrow • You have to watch out for fads • Example: Swatch. Are they getting the press they used to in the 80’s? Sketchers? • Strategy frameworks are good, but garbage in/garbage out applies • Measure the right things or you’ll misread your market • You can have great strategy, but if your execution is off… • Be mindful of introducing radical change in your organization, unless you can manage it

What Is Marketing? • Marketing is a design process: • Subject to assumptions, boundary conditions, safety factors, costs and specifications • Just like every other design problem, the above factors must be balanced and aligned with the overall program goals • Good marketing mixes math, customer focus, and human psychology in equal parts

What Is Being Designed? • What is being designed? • A message, with the aim of imparting positive imagery in a target buyer’s consciousness • Why design a message? • Because, as we’ve seen: • The best technical design doesn’t always win • Customers make buying decisions based on perceived value • What does the design target? • The sensory and retention systems of one of the most complex machines on the planet, the human brain Ideally: Product and message are co-designed so as to optimize *both*

Marketing = More Than Advertising • One perception is that marketing is just the process of designing ads • NO! Marketing: • …helps identify the needs/wants of customers • …used properly, influences the design process of the product • …creates additional value by establishing the vital perceived value of products • …determines the value a customer assigns to a product, and thus sets the price • …and many more • In short, marketing is a core component of your overall strategic plan. It’s the voice you use to communicate with the outside world (i.e., your customers)

End Purpose of Marketing? • Just to repeat: • “Create, communicate and deliver unique value to customers so that the organization can capture a portion back in the exchange” – D.J. Turner, UW Assoc. Dean • Also: • “Customers have money. Organizations want it. And marketing—at its essence—is the approach to getting it.” – D.J. Turner • And: • Marketing is “Achieving organizational goals by discovering and influencing the needs and wants of consumers and delivering the desired benefits more effectively than competitors.” – E. Stearns, UW Foster Business School.

How Does This Relate To You? • Your companies have to sell the technology you develop • If you’re not working on things you’re company can’t/won’t make money on… • As current or future program/project leaders, your job is simple: • Marshal resources and secure funding & support for your programs and ideas • One of your primary roles is the program’s evangelist • If your programs are misaligned with your company’s strategy –or– you can’t communicate their intent to management, you will fail

Subject of Today’s Discussion The Big PictureHow Can I Make ‘Better’ Marketing Decisions? Source: Dan Turner, UW

The 5 C’s of Marketing Context Customers Competitors Company & Collaborators

Zooming In… Customers Get paid here Money Lost Here Competition intense here Company & Collaborators Competitors

Align your offering with exactly what your customers want – maximizing the exchange for you Create a local monopoly (by offering much more than anyone else) Your offering delivers real and perceived value Essence of Blue Ocean Strategy = differentiation Ideally… Context Customers, Company & Collaborators Competitors

The 5 C’s: Summarized • The 5 C’s represent your collective intelligence on: • What you’re building • Why you’re selling it • Who you’re selling it to • What environment you’re selling it into • Where you’d sell your product • And also provides insight into: • Engineering decisions you’ll make • How you’ll approach the market with your offering

The 4 P’s • The 4P’s are: • Product • Price • Place • Promotion • The 4P’s represent the ‘Marketing Mix’ • Or, in other words, once you’ve identified context, customer, company & collaborators, and competitors, how do you actually take the product to market? • What is your market implementation strategy?

Summary, cont. • Why should you care about Marketing? • Marketing, used properly, becomes another set of inputs and boundary conditions for your product design team • Products that aren’t designed correctly, placed to draw the most eyeballs, priced out of reach of potential customers (or too low), and inadequately promoted either fail or leave $$$ on the table • The right marketing strategy promotes and enforces your company’s overall strategy • Use strategic marketing to feed data into the your strategic toolsets (i.e. BOS, SWOT, etc.) to help create localized monopolies, i.e. Blue Oceans

Summary, cont. • Why should you care about Marketing? • You’re in charge of a product or a technology. You have two responsibilities: • First, management needs to understand it and give your resources to execute it (short term) • Secondly, somebody needs to consume your product/technology and you need to understand how to incorporate anything that will affect your design earlier rather than later (long term) • The principles of marketing are the same no matter whom it is you’re facing. Only the audience and the relative parameters (context, collaborators, etc.) change. • If you understand how your company markets its existing products, you can gauge how well received your technology will be

Simple: The Pomelo, cont. • Now consider this description: • “A pomelo is basically a supersized grapefruit with a very thick and soft rind.” • Notice the brevity! • This message takes advantage of an existing association • The mental imagery was already there; this description merely linked to it • Concept is similar to “A picture is worth a thousand words” (that you don’t have to say) • Corollary here: “An existing mental association is a thousand descriptions you don’t have to make” Bottom line on Simple: Pack as much information as possible into as little space as possible!

Unexpected, summarized • The gap theory hinges on being able to teach people what they don’t know • You’ve caught they’re attention. Now create a new mental association (schema) for recall later • One way to look at it is moving from “What info do I need to convey?” to “What questions do I want my audience to ask?” • Once you’ve reached this point, your audience is much more engaged • Set the context and give enough details to almost fill a knowledge gap – then let curiosity take over: The idea of the Unexpected Idea • Roone Arledge at ABC Sports Unexpected: Deliver a calculated surprise to hold the viewers attention, then insert a new schema with the association you want

Concrete, Summarized • People remember concepts that are firmly defined: • Firm, fixed numbers and concepts • Or nouns that conjure mental images • Concrete helps focus the brain into relevant subsets of the world – more resources are activated • Remember the Curse of Knowledge – it’s easy to forget that people don’t know what we know Concrete ideas create a “shared ‘turf’ on which people can collaborate”

Credibility, Summarized • Summary: • Credibility can be created through a number of pathways: Statistics, personal experience (antiauthorities), authority figures, testimonials of trusted people • The key idea is to pass the believability test. Is the authority trustworthy? • Vivid details can really help • Draw on multiple sources for credibility Credibility comes from tangibility, and relating this to your target. Think of credibility as “try before you buy”

Emotion - Summary • Emotional appeals won’t work when people are thinking analytically – • Studies show that when people are confronted with statistics and numbers, their thinking is driven by analytics rather than emotions • Make your target care: • If they don’t care, they won’t act • Appeal to self-interest, but also to identities • Create empathy for individuals and/or associations that people already care about/have a connection to Emotional appeals need to make people care – appeal to more than Maslow’s Basement (Because everyone else always goes there first)

Stories, summarized • Stories are mental simulation – the target brain will activate more sections that they story itself would suggest • Use this simulation time to evoke emotion – give the story plenty of velcro in the form of vivid details • Stories tend to contain a lot of SUCCES all on their own, and given enough detail, can really touch on unexpected and concrete • Make sure the story you’re telling is reflective of your agenda – in other words, get to the point! Stories are like mental flight simulators. Your audience gets to fly along with you.

Made To Stick, Summarized • Remember SUCCES • Simple, Unexpected, Concrete, Credible, Emotional, Stories • In engineering, can we always tell an emotional story? • No, but we can ‘talk shop’ and create new schemas that didn’t exist before – like Ingersoll Rand

Lecture 10 – “The Big Finish”