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

[email protected]

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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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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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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