bradley economics and strategy - 19-10-11
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Economics and StrategyA presentation to the LSE MSc in Management and Strategy
Richard Bradley
19 October 2011
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2 Frontier Economics
Using economics for business strategy
Theprinciples
Thepractice
How does economics help strategic thinking?
An example: UK supermarkets
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3 Frontier Economics
Economics provides tools for thinking through problems
How do customersmake decisions?
Consumer theory
How do firms makedecisions?
Producer theory
How do marketswork?
IO and game theory
Business Strategy:How do I build a sustainable andsuccessful business?
Competition/regulation/policyShould policy seek to changethe market outcome, and how?
in a consistent wayto set up and test empirical hypotheses
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The most powerful law in economics
Unless there are barriers to entry and expansion,
marginal firms will earn the industry cost of capitalon the replacement cost of their assets.
Competitive advantage is about earning more thanthis market rate of return: economic profit
Scarcity matters
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A very useful question for finding scarcity
Why cant I do that?
Things that may be hard to copy
Networks or patents
Costs and scale Access to customers
Brand and reputation
Knowledge
Coordination and management
Its only scarce until someone copies it
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Economicprofit
No. offirms
Positioning
?
?
A typical industry
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A simple example - acting
Tom Hanks has grossed $3.3bn over32 movies and almost 30 years
His brother might have earned $10mover this period
Toms economic profit is thus over
$100m per year
And there are lots of other rich actors
Have you made a career error?
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Acting/music/sport/the lottery
Economicprofit
No. ofplayers
Thereality
The
dream
Winner takes all small differences in capability, big differences in reward
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Another example Airlines
Lots of entry and exits recently
And lots of losses
Probably none earning economic profits
Is it all to do with the oil price? Or recession? Or lack ofconsolidation?
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Airlines a revealing story
In March 2005, Alpha One Airlines waslaunched by an 18 year old from Oxford
The plan was to fly between Oxford andCambridge for 49 return
He had a pilots licence, leased the planes(and a crew), built a website and paidairport charges
He was hailed at the next Richard
Branson
It failed. He tried again. And again
Rumour has it he now flies as a cabinattendant on Virgin Atlantic
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Airlines the economics
Entry is easy few sunk costs, capacitycan be moved, access to skills
Lots of entry hundreds of newroute/operators in the past decade
Limited scale effects bigger is not moreprofitable
Hard to differentiate can customers seea difference?
So, economics tells us that
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profits have never been good for airlines
Economic profit(Adjusted ROI less WACC)
30%
9%
0% 0%
-4%
2%
-1%
19%
7%
5%
2%
-2%-3%
-6%
16%
4% 4%
-2%
-4%-5%
-4%
20%
2% 2%
-1% -2%
-6%-7%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
Ryanair easyJet Iberia Air France BA KLM Lufthansa
FY00
FY01
FY02
FY03
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Airlines the future?
This industry is crying out for consolidation.
Weve too much capacity and the future will
be 3-4 large players in Europe.
Is this right?
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Airlines the future?
This industry is crying out for consolidation.
Weve too much capacity and the future will
be 3-4 large players in Europe.
Is this right?
(The quote is from the Chairman of BA in
1981)
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Lesson #1: Exploiting scarcity
Its not always obvious
Positioning is important
drives day-to-day profitability
explains short/medium term success
But doesnt tell us:
why companies can position in the way they do
why others cannot copy success
what determines long-term success
The key is build something that supports the
right positioning and is difficult to replicate
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16 Frontier Economics
Using economics for business strategy
Theprinciples
Thepractice
How does economics help strategic thinking?
An example: UK supermarkets
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The history of the market
Twenty years ago, Sainsburys was the largest supermarket
Tesco now has roughly twice the share of Asda/JSwith Morrisons fourth
Asda was acquired by Wal-Mart in 1999
0%
5%
10%
15%
20%
25%
30%
35%
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Tesco Sainsbury Asda Morrisons/Safeway Somerfield
20 years ofoutperformance
by Tesco
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Profits dont follow scale
Source: Supermarket Inquiry, Competition Commission
8%
10%
12%
14%
16%
18%
20%
22%
1993 1994 1995 1996 1997 1998 1999
Returnoncapitalemployed Morrisons
Tesco
Asda
Sainsbury
Safeway
Source: Supermarket Inquiry, Competition Commission
They didnt in the
1990s
and they still
dont today
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External views on why Tesco has been successful
Theyve got huge scale benefits in buying
Theyre cheap
Its all the stores theyve got
Theyve got the best stores
Its Clubcard
The brand is fantastic
All that non food must make a difference
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External views on why Tesco has been successful
Theyve got huge scale benefits in buying
Theyre cheap
Its all the stores theyve got
Theyve got the best stores
Its Clubcard
The brand is fantastic
All that non-food must make a difference
Why cant I do that?
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A broad church for customers
0
100
200
300
400
500
600
700
800
Tesco
Sains
bury's
Walm
art/Asd
a
Valuerangesizes
0
100
200
300
400
500
600
700
800
Tesc
o
Sains
bury'
s
Walm
art/Asd
a
Finestrangesizes
0-10k10,001-20k
20,001-30k
30,001-40k
40,001-50k
50,001-60k
60,001-80k
80,001+
Store Size
(sq ft)
Value range Finest rangeSource: Information Resources Ltd based on sales from 2003
backed by top class operational management
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from a diverse store base
212 Extras 470 superstores
186 metros 1285 Express
New store formats
Match shopping habits
Site assembly
Strong operating model
Logistics support
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Management and culture
Clubcard
One in front
Small store formats
No quibble guarantees
Longer opening hours
Home delivery 1 hour
Carbon labelling
Follow the customer
Evidenced decisions
Challenge beliefs
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Lesson #2. Tescos UK success is hard to copy
because it is deep in the organisation
Every Little Helps has a deeper meaning
Tesco has taken decisions differently
balanced and stable objectives (Steering Wheel)
good toolkits (insight)
learnings (risk) constant stream of small ideas (innovation)
This is valuable because it supports the positioning
And even when you know this, its hard to copy
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Growing beyond grocery retailing in the UK
UK, 22,344m
Asia, 5,275m
US, 247mEurope ,
5,048m
UK, 1,347m
Asia, 228m
US, -95m
Europe , 212m
Revenue
s
Profits
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and expanding into non-food, and non-grocery
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Creating sustainable advantage elsewhere
As Tesco moves away from UK grocery:
is there scarcity? can Tesco exploit it?
What is the real competitive advantage that translatesacross from UK retailing?
What does every little helps mean elsewhere?
How can it stay ahead by taking better decisions?
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ANNEX
Additional material notplanned for presentation
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Is it scale?
The single biggest overestimated effect in any industry
Where is the positive scale effect?
On buying, CC found no difference for small suppliers, and smalldifferences across large retailers (but even here JS had 48% of linescheaper), and how do we know this is scale rather than skill?
What about scale diseconomies:
how spread is the best talent and do you feel there is some duplication, lackof hunger, etc.?
how many times are there problems in outsourced systems, etc.?
Some facts from history:
Morrisons has consistently performed better, and Asda/Wal-Mart is bigger
Tesco overcame Sainsburys (and the leader used to be the
Co-op)
T&S bought lots of lines better than Tesco!
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Is it sites and stores?
Something in the thought that it takes time to acquire but
Why did Tesco carry on when others stopped expanding?
Why does Tesco have the strongest (and most innovative)pipeline?
Why can Tesco afford to pay more (from better trading)?
Its not: because of the stores it already has (not incumbency)
because it has deeper pockets
a scale effect
And it doesnt explain LfL performance Or why Tesco gets uplifts when it buys competitor stores
So is this really an explanation or partly a symptom of somethingelse?
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Could it be management/culture?
Does it look different? (To me as an outside, absolutely.)
How easy is it to replicate
can you describe what it is?
what would be involved?
how long would it take?
Where you see it? Customer insight (Why?)
Steering Wheel
ELH
High quality people (Why?) Senior management culture (constant challenge without politics)
Can we see the feed into site development, commercial,marketing, innovation, etc.?
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