Eddielogic

– Thoughts on Strategy and Management

September 20, 2008
by Oliver
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Specific aspects of financial crisis

The last two days can be described as a dramatic change in terms of the global financial crisis. Not so long ago – or to be more specific: last weekend – a liberal approach seem to rule governmental measures how to tackle the financial crisis. Lehman Brothers did not receive a public backup. But at the end of this week we could observe an enormous change: US authorities moved towards an agreement on a program of government intervention in financial markets. The German regulator BaFin (as well as other regulators) bans short selling transactions of 11 financial institutions in Germany (Aareal Bank, Allianz, AMB Generali Holding, Commerzbank, Deutsche Bank, Deutsche Börse, Deutsche Postbank , Hannover Rückversicherung, Hypo Real Estate (HRE), MLP and Münchener Rückversicherungs-Gesellschaft). The BaFin’s move was part of a massive measure by global regulators on short selling aimed at calming the turmoil in global markets. So, let’s have a look at an interesting issue: Is this the end of the financial crisis?

Unfortunately this is likely not to be the case. A key role is given to real estate market in the United States. As long as we see a decline in real estate prices, we cannot expect a total stabilization in US financial markets, US economy or US financial system. Declining prices for real estate does not only reduce the wealth of US consumers. It also reduces the value of mortgages and therefore the values of structured financial products and bonds that are linked with the value of these mortgages. How long may it take before we see the bottom line in terms of house prices? The ratio between real estate prices and rents can be used as an indicator (some sort of price-earnings ratio for real estate). Until the year 2000 this ratio was quite stable. The strong price increase for real estate did change this ratio after 2000. Taking into account the development of the Case/Shiller Index –which shows a 16 % decline per year for 10 selected cities – as well as rent increase, it would take several months (until 2010!) before the ratio has reached it long term median. Of course, everything (different to this) is possible. But considering this ratio it can be assumed that real estate prices will be under pressure in 2009, too.

Since the beginning of the financial crisis US banks had to write down 260 billion USD. But they were just able to raise 184 billion USD in terms of new equity to stabilize their capital base. Due to an ongoing decline in real estate prices it can be expected that this disproportion will continue. Even if the US government’s plan to buy bad securities from banks can be described as a right step, the pressure for the US banking system will keep high. Do we face the risk to end in a situation like Japan in the early 90’s? Probably this won’t be the case. The US economy can be characterized by extremely flexible labor- and commodity markets. First and foremost US banks have started to write downs their mortgages and securities more quickly compared to Japanese banks at the early 90’s. Furthermore the US government seems to accept a more active role to stabilize the markets. In sum it cannot be recommended to put US situation on a level with the situation in Japan.

September 14, 2008
by Oliver
2 Comments

The worse is yet to come

Last we were informed about US government’s decision to rescue Freddie Mac and Fannie Mae. Both mortgage lenders are under special regulatory supervision now, the so called conservatorship. This event can be described in two sentences, but there are some major implications. We have found the following data that illustrate the size of this public rescue measure:

  • All CDS positions (CDS = credit default swaps) have to be cleared and processed. Their sum has been estimated about 1400 to 1600 billion USD. (The total market size is 62000 billion USD).
  • The total of mortgage based securities (e.g. mortgage backed securities) that have been issued from Freddie Mac and Fannie Mae counts for 5500 billion USD. This is nearly 50 % of the US market, which counts for 12000 billion USD.
  • The US government is ready to invest 200 billion USD in preferred shares. The sum of all public spending was 2700 billion USD in 2007.
  • The month the US government will spend 5 billion USD for bond issues of Freddie and Fannie.
  • Two month ago the Congressional Budget Office estimated the financial burden resulting to rescue Freddie Mac and Fannie Mae. The forecast was 25 billion USD.
  • Indeed the cost of this rescue measure will account for 300 billion USD (outcome of a new forecast). This amount would nearly twice the number in terms of US net raising of credit in 2007.

In sum it will be a very expensive rescue measure for the public budget. But alternatives – doing nothing – could be second best solutions, furthermore they bear the risks to become far more expansive due to avalanche impact chains.

September 7, 2008
by Oliver
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Sticky factors

In this post we will have a brief look at a specific phenomenon of strategic management. Turn back time is in interesting concept in terms of movies or sci-fi literature, but in terms of chosen strategic directions an easy way out often does not exist. So let’s look at this issue – given the example of competitive advantages and investment activities to achieve those advantages.

Competitive advantages exist when an organization has a specific resource structure in comparison to other firms. Such a differentiation in terms of resource structure can be achieved and protected by investment activities (e.g. by R&D activities; establishing a new plant with a very efficient production line that creates a cost advantage). Due to incomplete information and a future perspective investment activities are always linked with uncertainty. No matter how good your analysis and forecasting have been, you always deal with the future and hence there is no guarantee that you receive your expected returns. But this uncertainty is not the only critical issue. Another attribute for an investment activity is its irreversibility. This irreversibility occurs due to the impossibility to reverse an investment without consequences. Typical consequences are sunk costs (see this old post concerning sunk cost dilemma). Could one reverse investment activities without cost, every investment activity could be made without any kind of risks.

Another critical issue is commitment that can be defined as to stick to a chosen strategic direction. In corporate practice this stick is called “commitment” very often. Reasons to stick are called “sticky factors”; four different types of these sticky factors can be distinguished.

  • The first factor is an exit barrier which creates a lock-in situation. It is established by composition of everlasting and specialized factors which make it difficult to turn back to the starting point. Sunk cost and the loss of intangible assets represent the most critical issues.
  • Barriers for a re-entry. An exit from a specific strategic direction can be inappropriate since a re-entry to this direction might be difficult or impossible afterwards.
  • The time lag between strategy implementation and observation of results is another issue. During this time an organization will stick to selected strategic direction.
  • Organizational idleness arises from different psychological or sociological reasons, e.g. that a project promoter does not want to accept a failure. This factor has its share that an organization sticks to a selected strategy, too.

Choosing the right strategic direction is a hard business. When identifying the need to change this direction you have to keep in mind that there are sticky factors which create barriers to shift to a new direction.

August 28, 2008
by Oliver
1 Comment

The Price of knowledge

How important is education? Well, we know that education (as process) and knowledge gained (as a result) has become an important factor to differentiate organizations and to establish (or at least to support) competitive advantages. Today knowledge can have the same meaning as a commodity. Information, knowledge and learning have a huge impact on capabilities of the organization and influence organizational performance. Internationalization, globalization, acceleration of change in the business environment, increasing uncertainty, and fast technological progress challenge both the learning ability and the viability of an organization. In this term it is very interesting to see, how “organizations” tackle those issues.

As an example and as a small contribution to the knowledge of our international readers about Germany I will present some very interesting figures concerning German understanding about the value of knowledge and education. German understanding is (unfortunately) different to understanding / perception in the Anglo American world. Students protest against study fees of the universities, but not for an extension of the scholarship system. Education / Knowledge is not allowed to become an asset. (Note: Transfer this perception to the bookstore next to you, and you should get all literature for free). Politicians of all segments agree on education equity – but accept that the very first education (neonatal training in kindergarten) has to be paid. Okay, that won’t be a strategic issue in terms of organizational management…anyway I found those numbers quite interesting.

  • Daily entertainment consumption (TV, Internet, Computer games) of 10 year kid in North Germany within an immigration family on weekend: 340 minutes
  • Daily entertainment consumption (TV, Internet, Computer games) of 10 year kid in South Germany within an German family (at least one parent has a high school degree) on weekend: 54 minutes
  • Annual fee for a private kindergarten (5 star quality) near Berlin: 11.760 EUR
  • Annual fee for a public kindergarten in a rich town in South Germany for a 4 year kid (parent’s income is under 45.000 EUR): 0 EUR
  • Annual fee for a public kindergarten in a “not so rich town” in North Germany for a 4 year kid (parent’s income is under 45.000 EUR): 1.752 EUR
  • Study fees for the public university in the same town in North Germany within the first 14 terms: 0 EUR

(Data Source: The world in Numbers (Brand eins Journal, vol. 5, 2008).

August 18, 2008
by Oliver
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Brand overstressing

Brand management is an important tool when it comes to segment markets and to leverage positive perceptions (of a specific brand). But sometimes brand management can confuse customers and your company will receive very negative feedbacks. To illustrate this statement I have a brief example from the car industry.

General Motors (GM) operates the brand Chevrolet that can be described as a maker of automotive icons like Corvette sports car or Blazer jeep. Daewoo, a South Korean car maker, also belongs to the GM Empire. Due to an idea of GM, Chevrolet also transfers its large brand to small Daewoo cars like the Aveo. Once upon a time the Chevrolet Aveo was the Daewoo Kalos, than it became a Chevy car.

© GM Media; Source: Press information by Chevrolet Deutschland GmbH

Well, in the case that you buy a Chevrolet you will not be happy about those kind of statements from a current German newspaper: …Indeed it is hard to find superior attributes within the Aveo…”. That is not a good feedback, but at the end of the article an interesting mixture of feedback and humor creates a very sticky summary: what is left after 14 days of testing? “…we got a parking ticket…and a memory of the most lamely engine since an Opel Diesel car in 1990…”

I cannot believe that GM brand managers will be happy about this type of feedback. In the South Korean market the Chevrolet Aveo is still a Daewoo car, hence it would be helpful to transfer this approach to other markets and to protect the Chevrolet brand.

July 29, 2008
by Oliver
1 Comment

The nature of strategic risks

A couple of days ago I participated in a discussion concerning risk management systems. A specific emphasis was given on strategic risks and their management. Identification and delimitation were described as two major problems when starting to manage this risk type.

Well, that is basically not an unusual situation within an organization. Before managing a specific risk type it is essential to define this type to ensure that every involved participant within the organization does understand what this risk is and what it is not. So how can we distinguish strategic risks from other risk types?

To distinguish strategic risks and operative risks the two attributes scope of risk effects and level of uncertainty can be used. I have to explain that this is an initial idea that can be used as a good starting point for a discussion in your organization. In general the level of uncertainty for strategic risks is higher, since the time frame for risks impact is bigger than for operational risks. In terms of the scope concerning risks effects strategic risks have a general potential for a larger scope than operational risks.

But the attribute scope of risk effects to distinguish risk types has some disadvantages, too. Other risk types, e.g. interest rate related risks, can have a huge impact on the survivability of an organization. Furthermore time frame that has to be considered to classify risks is not sufficient enough to offer a clear definition, too. Given the example of a long term credit approval a bank has made a long term decision; however this decision is part of the organization’s day-to-day business and does not a strategic decision. On the other side an organization can made a strategic acquisition of another organization but does not hold the shares for a long time. Both attributes “scope of risks effects” and “time frame” help to make a differentiation between strategic risks and operational risks. But both attributes are not able to distinguish strategic risks and operational risks in all situations. Hence an additional specification is needed. To achieve this specification the concepts of strategy and strategic management should be taken into account from your organization.

Continue Reading →

June 29, 2008
by Oliver
6 Comments

Mergers and acquisitions in the banking industry

The subprime crisis of us-American mortgages (and its primary and secondary impacts on the financial system) has increased the pressure for mergers and acquisitions in the European financial services market. In particular in Germany major transactions are likely to occur: Postbank and Citibank are on Sale. Some Federal State banks (former Sachsen LB and West LB) have demonstrated their problems to manage risk related issues or did enter business segments outside their business model and faced financial losses. Daily news are full with ideas, recommendations and hypotheses which bank could or should be involved in M&A transactions. Everything seems to be fine, isn’t it?

The issue with all those concepts and recommendations is the performance of the new organization in the future. We have to have in mind that most large mergers and acquisitions have difficulties to achieve the expected synergies. Nearly a decade ago (01.1999) the Economist reported study results of mergers: Two of three M&A transactions did not work. In 2003 a study by Merrill Lynch reported that not only most mergers cannot deliver their promised value / return. Furthermore large transactions follow the trend to “perform worse compared to small transactions. ML found out that at least 50 % of important transactions (time frame since 1990) did reduce shareholder returns and hence organizational value.

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May 23, 2008
by Oliver
2 Comments

Problems and barriers to strategic planning and proposals for solutions

OliverAs you might have noticed from one of my blog posts I am an external PhD-student of the Warsaw School of Economics / Institute for Organization and Management in Industry. My research topic focuses on the strategic planning of European retail banks. As part of my studies I was given the opportunity to present some of my research findings in the institute’s journal “Economics and Organization of Enterprise”. My last paper was titled “Problems and barriers to strategic planning”.

In my paper I analyze and summarize the existing problems and barriers related to the strategic planning process. In the last two decades a large number of articles and books related to this matter have been published. Taking the number of publications into consideration it could be argued that the relevance of strategic planning process is unquestioned and would need no further explanation. But still research results – including new ones – from different studies express that a “duality” of strategic planning still exits. On one side the relevance of the strategic planning process for developing organization’s strategy is described as very important. On the other side a number of concerns and problems when running that process can be found. Identified problem areas include in particular strategy implementation, communication of strategic planning results and monitoring of strategy execution.

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May 11, 2008
by Oliver
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Risks of innovations

OliverA couple of weeks ago I discussed four major benefit criteria of innovation in this post. Now it is time to look on the other side of innovation. Yes, there are not only benefits; in the case that your organization starts to focus on innovation you should have in mind to face some disadvantages. You can also refer them as risks when entering an unknown field (of business). I won’t argue that you should not use innovation. But it will helpful to anticipate and to understand these risks in order to prepare yourself.

Innovations always involve particular risks for the organization. A company that searches for new ways, processes and types of organization is confronted frequently with the risk to land in a dead end. Another disadvantages of a “we are innovators”-approach is the need to review strategy more often; hence structural adaptations which are linked to strategy can take place more often, too. An organization has to consider further five typical disadvantages: Continue Reading →

May 4, 2008
by Oliver
1 Comment

Consulting classics

Last week I received a newsletter from McKinsey concerning some selected articles. The major purpose was to present some thoughts around the 7 S Framework. Furthermore the newsletter suggested some other publications from The McKinsey Quarterly; some of them have the premium status (which means you have to pay in order to have access).

Since these are very interesting articles which might help your organization to survive (or at least to manage) current uncertain times, I recommend to consider their findings. You can find the articles on the following websites:

As a very interesting collection I would recommend this edition of the McKinsey Quarterly Reader that puts an emphasis on strategy in an uncertain world. You can find the full paper (39 pages) on this website for free.