THE PROCESS OF STRATEGIC MANAGEMENT

ENVIRONMENTAL SCANNINGEXTERNAL THREATS & OPPORTUNITIES

MACRO (Society), TASK (Industry), COMPETITIVE

INTERNAL STRENGTHS & WEAKNESSESRESOURCES, STRUCTURE, FINANCIAL PERFORMANCE TRENDS

STRATEGY FORMULATIONMISSIONOBJECTIVESSTRATEGIES

IMPLEMENTATIONBUDGETSASSIGNMENTSTACTICAL PLANS

EVALUATION & CONTROLCRITERIA & ASSESSMENT TOOLSREPORTS & FEEDBACK DEVICESADJUSTMENT MECHANISMS

THE MACRO ENVIRONMENT(PEST)

POLITICALSUPPORTS GOVERNMENT STABILITYCONTROLS ANTI-TRUST, EPA, TAX LAWSPENDING LEGISLATION ATTITUDES TOWARD FOREIGN FIRMS

ECONOMICINFLATION INTEREST RATESUNEMPLOYMENT ENERGY AVAILABILITY & COSTDISPOSABLE INCOME PRODUCTIVITY, GROWTH, GDP

SOCIO-CULTURALGEOGRAPHIC SHIFTS CONSUMER ACTIVISMCUSTOMS & VALUES LIFESTYLE CHANGESDEMOGRAPHICS BIRTHRATES & LIFE EXPECTANCIES

TECHNOLOGICALBASIC RESEARCH R & D SPENDING (Gvmt & Industry)NEW PRODUCTS/SERVICES PATENT PROTECTIONPROCESS IMPROVEMENTS COMPUTER HACKING

EIGHT SOCIO-CULTURAL TRENDS IN NORTH AMERICA

ENVIRONMENTAL AWARENESS

Conservation, Recycling, Landfills

GROWING HEALTH CONSCIOUSNESS

Personal Fitness, Nutrition, Genetically Altered Foods, AIDS & Bird Flu

BABY BOOMERS NEAR RETIREMENT (77 Million)

Companionship, Pets, Retirement Communities, Vacations, Senior Services

IMPACT OF “GENERATION Y” BOOMLET (70 Million)

Born between 1978 and 1994, Crowded Schools, Youth Markets

DECLINING MASS MARKET

Customized, Targeted - no generic products, Cars to Magazines

CHANGING PACE AND LOCATION OF LIFE

Instant Communication (e-mail, computers, etc), Telecommuting Possibilities

CHANGING HOUSEHOLDS

Singles, Partners, Couples with no Children (DINKS)

INCREASING DIVERSITY OF WORKFORCE AND MARKETS

Growth of Hispanic and Asian Groups, Immigrants (legal and illegal)

RECENT BREAKTHROUGH DEVELOPMENTS IN TECHNOLOGY

PORTABLE INFORMATION DEVICES AND NETWORKING

Connectivity, Phones, TVs, Stereos, and Computers becoming obsolete

FUEL CELLS AND ALTERNATIVE ENERGY SOURCES

Wind, Geothermal, Hydroelectric, Solar, Biomass – 30% by 2010

PRECISION FARMING

Corporate Farming, Computerized Crop Management

VIRTUAL PERSONAL ASSISTANTS

Smart computers that monitor e-mail, voice mail, can write letters, etc.

GENETICALLY ALTERED ORGANISMS

Plants and animals that are resistant to disease, grow faster, yield more

SMART MOBILE ROBOTS

Perform sophisticated factory work, do housework, assist the disabled

THE INTERNATIONAL DIMENSION TO THE MACRO (SOCIETIAL) ENVIRONMENT

POLITICALPOLITICAL IDEOLOGY REGULATION OF FOREIGN OWNERSHIPGOVERNMENT STABILITY STRENGTH OF OPPOSITION GROUPSPROTECTIONIST SENTIMENT TERRORIST ACTIVITYLEGAL SYSTEM FOREIGN POLICIES

ECONOMICECONOMIC DEVELOPMENT PER CAPITA INCOME & WAGE LEVELSUNEMPLOYMENT LEVELS GDP TRENDS CURRENCY CONVERTIBILITY OUTSOURCING CAPABILITY

SOCIO-CULTURALLANGUAGES SPOKEN LIFE EXPECTANCIESCUSTOMS & VALUES RELIGIOUS BELIEFSLITERACY LEVEL ATTITUDES TOWARD FOREIGNERS

TECHNOLOGICALINTERNET AVAILABILITY REGULATION ON TECHNOL TRANSFERSKILL LEVEL OF WORKFORCE PATENT & TRADEMARK PROTECTIONTRANSPORTATION NETWORK NATURAL RESOURCE AVAILABILITY

THE TASK ENVIRONMENT(INDUSTRY)

ENTITIES THAT DIRECTLY “TOUCH” THE ORGANIZATION

CUSTOMERS

SUPPLIERS

CREDITORS

GOVERNMENT AGENCIESFEDERAL

STATE

LOCAL

UNIONS

STOCKHOLDERS

COMMUNITIES

SPECIAL INTEREST GROUPS

EXAMINE EACH ENVIRONMENTAL SEGMENT FOR:

COMPLEXITYHOW MANY ENTITIES DOES THE FIRM DEAL WITH?

DYNAMISMHOW FREQUENTLY DO THESE ENTITIES CHANGE?

IMPORTANCE (Significance)WHAT IS THE IMPACT OF THIS SEGMENT ON THE ORGANIZATION?

PREDICTABILITYCAN THE FIRM FORSEE PENDING SHIFTS AND CHANGES?

CONTROLCAN THE FIRM MANIPULATE OR CONTROL THIS SEGMENT?

STRATEGICALLY…

1 - HOW CAN THE FIRM MONITOR EACH IMPORTANT SEGMENT?

2 - HOW DO WE CONTROL OR INFLUENCE EACH IMPORTANT SEGMENT?

3 - HOW SHOULD THE FIRM STRUCTURE ITSELF TO ACCOMPLISH THIS?

ENVIRONMENTAL UNCERTAINTYDUNCAN (72)

COMPLEXITYSIMPLE

COMPLEX

STATIC - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

LOW MODERATELY

UNCERTAINTY LOW

UNCERTAINTY

DYNAMISM - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

(CHANGE)

MODERATELY HIGH

HIGH UNCERTAINTY

UNCERTAINTY

DYNAMIC - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

COMPLEXITY = # of Entities the Firm must deal with?

DYNAMISM = How Frequently do these entities (or their demands) change?

ENVIRONMENTAL UNCERTAINTYSCHWAB (80)

THREE ISSUES TO ADDRESS:

IMPORTANCE (Significance)

What is the impact of this environmental segment on the firm?PREDICTABILITY

Can the firm anticipate pending shifts and changes in this segment?CONTROL (Influence)

Can the firm manipulate or control this environmental segment?

PREDICTABILITYHIGH LOW

HIGH - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

LOW MODERATELY UNCERTAINTY LOW

UNCERTAINTYCONTROL - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

(INFLUENCE) MODERATELY HIGH HIGH UNCERTAINTY UNCERTAINTY

LOW - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

The firm only concerns itself with Important segments of it’s task environment.The most difficult environments are those which are Unpredictable and Uncontrollable

IDENTIFYING EXTERNAL STRATEGIC FACTORSCAMPBELL 84

AN ISSUES PRIORITY MATRIX

IMPACT ON THE FIRM

MAJOR MODERATE MINIMAL 100% - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

HIGH HIGH MEDIUM

PRIORITY PRIORITY PRIORITY

PROBABILITY - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

OF 50% HIGH MEDIUM LOW

OCCURRENCE PRIORITY PRIORITY PRIORITY- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

MEDIUM LOW LOWPRIORITY PRIORITY PRIORITY

VIRTUALLY 0% - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

EVALUATE THE EMERGENT TRENDS IN THE MACRO & TASK ENVIRONMENTSWHAT IS THE PROBABILITY OF EACH ENVIRONMENTAL TREND?WHAT IS THE LIKELY IMPACT OF EACH TREND ON THE CORPORATION?HIGH PRIORITY TRENDS = OPPORTUNITIES & THREATS FACED BY THE FIRM

SEVEN QUESTIONS TO ANSWER WHEN CONDUCTING AN INDUSTRY & COMPETITIVE ANALYSIS

1--WHAT ARE THE INDUSTRY’S DOMINANT ECONOMIC TRAITS?

2--WHAT ARE THE COMPETITIVE FORCES IN THE INDUSTRY AND HOW STRONG ARE THEY?

3--WHAT ARE THE DRIVING FORCES FOR CHANGE IN THE INDUSTRY?

4--WHICH RIVAL COMPANIES ARE IN THE STRONGEST & WEAKEST COMPETITIVE POSITIONS?

5--WHO SHOULD BE MONITORED AND WHAT STRATEGIC MOVES ARE THEY MOST LIKELY TO TAKE?

6--WHAT ARE THE KEY SUCCESS FACTORS IN THIS INDUSTRY?

7--HOW ATTRACTIVE IS THIS INDUSTRY IN TERMS OF ITS PROSPECTS FOR ABOVE-AVERAGE PROFITABILITY?

IDENTIFYING THE INDUSTRY’S DOMINANT ECONOMIC TRAITS

MARKET SIZE & FRAGMENTATION

NUMBER OF COMPETITORS AND THEIR RELATIVE SIZES

SCOPE OF RIVALRY –Local, Regional, National, Global

MARKET GROWTH RATE & STAGE OF DEVELOPMENT

EASE OF ENTRY AND EXIT

CAPITAL REQUIREMENTS

NUMBER OF CUSTOMERS & THEIR AVERAGE DEMAND

PREVALENCE OF VERTICAL INTEGRATION

PRODUCT/SERVICE CHARACTERISTICS –Differentiated or Generic?

SCALE ECONOMIES & EXPERIENCE CURVE EFFECTS

RATE OF CHANGE & INNOVATION IN PRODUCTS & PROCESSES

INDUSTRY PROFITABILITY

INDUSTRY CAPACITY SURPLUSES & SHORTAGES

POTENTIAL DRIVING FORCES IN THE ENVIRONMENT

MAJOR INNOVATIONS IN…EMERGING TECHNOLOGIES PRODUCT DESIGN PRODUCTION PROCESSES SERVICE DESIGN AND DELIVERYMARKETING AND ADVERTISING

SIGNIFICANT CHANGES IN…THE INDUSTRY’S GROWTH RATEWHO BUYS THE PRODUCT AND HOW THEY USE ITDEMAND FOR MORE (OR LESS) DIFFERENTIATED PRODUCTSPRODUCTION/DELIVERY COSTS AND EFFICIENCIESTHE NUMBER OF MAJOR COMPETITORSTHE GLOBALIZATION OF THE INDUSTRYREGULATORY POLICIES AND GOVERNMENTAL CONTROLSSOCIETAL CONCERNS, ATTITUDES, AND LIFESTYLESUNCERTAINTY AND BUSINESS RISK

COMPETITIVE FORCESPORTER 80

INTENSITY OF COMPETITION…HOW DIFFICULT IS IT TO SUCCEED IN THIS BUSINESS?

COMPETITIVE RIVALRY

Competition among existing firms

BARRIERS TO ENTRY

Ease of entry into and exit from the industry

SUBSTITUTE GOODS & SERVICES

Price, quality, and switching costs

POWER OF CUSTOMERS

Number, size, and relative clout

POWER OF SUPPLIERS

Number, size, and relative clout

POWER OF OTHER STAKEHOLDERS (Freeman)

Government,Unions,Communities, Special Interest Groups, etc

RIVALRY IS INCREASED WHEN…

THE MARKET IS GROWING VERY SLOWLY

PRODUCTS OR SERVICES ARE WEAKLY DIFFERENTIATED

THE NUMBER OF COMPETITORS INCREASE

COMPETITORS ARE EQUAL IN SIZE

IT COSTS A LOT TO LEAVE THE BUSINESS

THERE ARE BIG ADVANTAGES TO FIRST MOVERS

FIXED COSTS ARE HIGH AND VARIABLE COSTS ARE LOW

FIRMS DEAL WITH PERISHABLE PRODUCTS

“MAVERICKS” ARE COMPETING

BARRIERS TO ENTRY

SIGNIFICANT ECONOMIES OF SCALE EXIST

LEARNING AND EXPERIENCE CURVE EFFECTS

STRONG BRAND PREFERENCES AND CUSTOMER LOYALTY

SIGNIFICANT CAPITAL REQUIREMENTS

OTHERS HOLD PATENTS, THE MOST FAVORABLE LOCATIONS, OR HAVE ACCESS TO CHEAP RAW MATERIALS OR CAPITAL

ACCESS TO DISTRIBUTION CHANNELS, DEALERS, AND RETAIL OUTLETS

GOVERNMENTAL REGULATORY AGENCIES AND POLICIES

TARIFFS AND INTERNATIONAL TRADE RESTRICTIONS

SUBSTITUTE GOODS & SERVICES

POTENTIAL SUBSTITUTES

1. PRICE AND AVAILABILITY OF SUBSTITUTES PUTS A CEILING ON PRICES AND PROFITS

2. UNLESS PRODUCTS ARE DIFFERENTIATED FROM SUBSTITUTES, LOW GROWTH AND PROFITS WILL RESULT

3. HOW EASILY CAN BUYERS "SWITCH OVER" TO A SUBSTITUTE?

THE MOST INTENSE COMPETITIVE PRESSURES ARE FELT WHEN:

--THE PRICE OF SUBSTITUTES IS LOW

--SUBSTITUTES ARE HIGH IN QUALITY AND PERFORMANCE

--SWITCHING COSTS ARE LOW

CUSTOMER POWER IS HIGH WHEN…

THERE ARE JUST A FEW CUSTOMERS

THEY PURCHASE IN VERY LARGE AMOUNTS OR LOTS

THERE ARE MANY SELLERS OR SUPPLIERS

ALL OF THE SELLERS ARE RELATIVELY SMALL

PRODUCTS OR SERVICES ARE STANDARDIZED

THE PURCHASED ITEM OR SERVICE IS NOT AN IMPORTANT INPUT TO THE CUSTOMER

THE PURCHASED ITEM OR SERVICE DOES NOT SAVE THE CUSTOMER MONEY

CUSTOMERS PURCHASE FROM SEVERAL SUPPLIERS RATHER THAN ONE

CUSTOMERS COULD INTEGRATE BACKWARD

SUPPLIERS ARE UNLIKELY TO INTEGRATE FORWARD

POWER OF SUPPLIERS IS HIGH WHEN…

SUPPLIES ARE CRUCIAL TO THE BUYER

THERE ARE JUST A FEW LARGE SUPPLIERS, AND THEY DON’T COMPETE AGGRESSIVELY

IT IS DIFFICULT OR COSTLY TO SWITCH SUPPLIERS

WHEN BUYERS AREN’T SEEN BY SUPPLIERS AS IMPORTANT CUSTOMERS

WHEN THERE ARE NO READY SUBSTITUTES

WHEN SUPPLIERS COULD INTEGRATE FORWARD

WHEN BUYERS ARE UNLIKELY TO INTEGRATE BACKWARD

MAPPING COMPETITIVE POSITIONS OF RIVAL FIRMS

POSSIBLE DIMENSIONS

PRICE/QUALITY[High, Medium, Low]

GEOGRAPHIC COVERAGE[Local, Regional, National, Global]

PRODUCT LINE BREADTH[Wide, Narrow]

DEGREE OF SERVICE[No-frills, Limited, Full Service]

DEGREE OF VERTICAL INTEGRATION[None, Partial, Full]

DISTRIBUTION CHANNELS[One, Some, All]

USE TWO DIMENSIONS THAT AREN’T HIGHLY CORRELATEDDEVELOP AT LEAST TWO DIFFERENT MAPS (WITH DIFFERENT DIMENSIONS)STRONGEST COMPETITION IS LIKELY WHEN FIRMS ARE CLOSE TOGETHER

STRATEGIC COMPETITOR “TYPES”MILES & SNOW 78

COMPETING FIRMS IN A COMMON INDUSTRY ARE LIKELY TO TAKE ON ONE OF FOUR BASIC STRATEGIC ORIENTATIONS…

DEFENDERS -- PROVIDES A LIMITED PRODUCT LINE

FOCUSES ON EFFICIENCY (COST) OF CURRENT OPERATIONS

NOT LIKELY TO INNOVATE

PROSPECTORS -- OFFERS A BROAD PRODUCT LINEFOCUSES ON PRODUCT INNOVATION & MARKET OPPORTUNITIES

SOMEWHAT INEFFICIENT

ANALYZERS -- OPERATES IN TWO MARKETS (one stable, one variable)EMPHASIZES EFFICIENCY IN STABLE AREAS

EMPHASIZES INNOVATION IN VARIABLE AREAS

REACTORS LACKS A CONSISTENT STRATEGY/CULTURERESPONSES TO THE ENVIRONMENT ARE OFTEN INEFFECTIVE

TENDS TO MAKE PIECEMEAL STRATEGIC CHANGES

TYPES OF KEY SUCCESS FACTORS

TECHNOLOGY MARKETING

Research Expertise Well-trained, Effective Sales Force

Product Innovation Quick, Dependable Customer Service

Process Innovation Customer Guarantees and Warranties

Attractive Styling and Packaging

MANUFACTURING Breadth of Product Line

Low-Cost Production Efficiency

High Utilization of Fixed Assets

High Quality of Manufacture OTHER

Low-Cost Facilities Superior Talent, Highly-Skilled Staff

High Labor Productivity Quality Control Know-How

Flexible Manufacturing Facilities Design Expertise

Convenient Locations

DISTRIBUTION Superior Information Systems

Strong Network of Distributors Quick Response to Market Shifts

Ample Shelf Space Favorable Image/Reputation with Buyers

Company-owned Retail Outlets Pleasant, Courteous Employees

Low Distribution Costs Access to Financial Capital

Fast Delivery

COMPETITIVE STRENGTH ASSESSMENTS

OUR Rival Rival Rival

KEY SUCCESS FACTORS FIRM # 1 # 2 # 3

LOW-COST PRODUCTION 7 10 8 6

PRODUCT QUALITY 9 4 6 9

DISTRIBUTION NETWORK 5 5 7 8

CUSTOMER SERVICE 6 8 7 10

FINANCIAL RESOURCES 6 4 8 8

1 = Very Weak, 10 = Very Strong

UNDERSTANDING YOUR COMPETITORSKENDRICK & BLACKMORE 2001

COMPETITIVE INTELLIGENCE QUESTIONS

Why do your competitors exist? Do they exist to make profits or just to support another unit?

Where do they add customer value? Do they offer higher quality, lower price, better service, or excellent credit terms?

Which customers are your competitors most interested in?Do they seek your best customers, the ones you don’t want, or do they go for everyone?

What is their cost base and liquidity?How much cash and working capital do they have?

Are their suppliers better than yours? Are they less exposed with their suppliers than your firm?

What do they intend to do in the future?Do they have a your market segments targeted? Are they committed to growth?

How will their activity affect your strategies?Should you adjust your plans and operations?

Do either of you have a competitive advantage in the marketplace?How much better than your competitor do you have to be to attract customers?

Will new competitors emerge over the next few years?Who is a potential new entrant?

If you were a customer, would you choose your product over those offered by others?What irritates your current customers?

DRAWING CONCLUSIONS ABOUT OVERALL INDUSTRY ATTRACTIVENESS

FACTORS WHICH MAKE THE INDUSTRY ATTRACTIVE?

FACTORS WHICH MAKE THE INDUSTRY UNATTRACTIVE?

SPECIAL ISSUES AND PROBLEMS WHICH ARE UNIQUE TO THIS INDUSTRY?

IMPACT, PROBABILITY, SEVERITY

THE PROFIT OUTLOOK

ABOVE OR BELOW AVERAGE?

DEGREE OF RISK & UNCERTAINTY IN THE INDUSTRY’S FUTURE

ENVIRONMENTAL SCENARIOS

WHAT ARE YOUR ASSUMPTIONS ABOUT THE ENVIRONMENT?WHAT ARE THE POSSIBLE “STATES OF NATURE” IN THE FUTURE?

WHAT ARE THE MOST IMPORTANT ENVIRONMENTAL OPPORTUNITIES AND THREATS IN YOUR INDUSTRY?

WHAT IS THE PROBABILITY THAT EACH OF THESE TRENDS WILL OCCUR IN THE NEXT 5 –7 YEARS? (Assign a probability)

DEVELOP A PARAGRAPH WHICH INTEGRATES THESE TRENDS INTO A “MOST LIKELY” SCENARIO.

WRITE AT LEAST TWO MORE PARAGRAPHS WHICH DESCRIBE OTHER POSSIBLE, PROBABLE, OR FAIRLY LIKELY FUTURE ENVIRONMENTS (Optimistic, Pessimistic, Etc).

USING ENVIRONMENTAL SCENARIOS

WHAT ARE OUR SCENARIOS? ENVIRONMENTAL EVENTS WE CAN’T CONTROLIT IS REASONABLE TO ASSUME THAT EACH EVENT COULD OCCUR

WHAT STRATEGIC ALTERNATIVES DO WE HAVE?WE HAVE SEVERAL OPTIONS WE CAN PURSUETHE ORGANIZATION CAN MAKE A CHOICE

WHAT OUTCOMES OR RESULTS ARE POSSIBLE? WHAT RESULTS ARE LIKELY WHEN A SPECIFIC ENVIRONMENTAL SCENARIO COMBINES WITH A CHOSEN ALTERNATIVE?

HOW CERTAIN ARE WE OF EACH OUTCOME?VIRTUALLY CERTAIN? …WHAT IS THE PROBABILITY?

A PAYOFF TABLE ILLUSTRATIONUNDER TOTAL UNCERTAINTY

EXPECTED PROFITS $ / ACRE

STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS NORMAL WET DRY VIOLENT

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

CORN $ 900 450 -800 250

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

POTATOES 800 -300 400 500

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

HAY/GRASS 300 500 0 100

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 1. MAXI-MAX (Optimist) *Corn 900, Potato 800, Hay 500

2. MAXI-MIN (Pessimist) Corn -800, Potato -300, *Hay 0

3. MINI-MAX (Regret) Regrets..Corn 1200, Potato 800, *Hay 600

4. AVERAGE (Rational) Ex Value…Corn 200, *Potato 350, Hay 225

BUILDING A REGRET MATRIX

EXPECTED PROFITS $ / ACRESTATES OF NATURE / ENVIRONMENTAL SCENARIOS

ORIGINAL MATRIXALTERNATIVE CROPS NORMAL WET DRY VIOLENT

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -CORN $ 900 450 -800 250POTATOES 800 -300 400 500HAY/GRASS 300 500 0 100

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

REGRET MATRIX

CORN 0 50 1200 250POTATOES 100 800 0 0HAY/GRASS 600 0 400 400

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

MINIMIZE THE MAXIMUM REGRETSCorn = 1200, Potatoes = 800, Hay = 600**

A PAYOFF TABLE ILLUSTRATIONUNDER RISK (ASSIGNED PROBABILITY)

EXPECTED PROFITS $ / ACRE

PROBABILITIES COME FROM “GOOD” GUESSES. CALCULATE THE EXPECTED VALUES

INDIAN JOE’S ESTIMATES = Normal 30%, Wet 25%, Dry 20%, Violent 25%

STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS NORMAL WET DRY VIOLENT EXPECTED

WEIGHTS .30 .25 .20 .25 VALUES

= = = = = = = = = = = = = = = = = = = = = = =

CORN $ 900 450 -800 250 $ 285

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

POTATOES 800 -300 400 500 370**

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

HAY/GRASS 300 500 0 100 240= = = = = = = = = = = = = = = = = = = = = = = == =

You should PLANT POTATOES EVERY YEAR. In any one year you’ll either make 800, lose 300, make 400, or make 500 …but over the years, you’ll average $370 of profits.

A PAYOFF TABLE ILLUSTRATIONUNDER RISK (FACTUAL PROBABILITY)

EXPECTED PROFITS $ / ACRE

PROBABILITY INFORMATION COMES FROM RELIABLE (FACTUAL) SOURCESWEATHER BUREAU HISTORY = Normal 35%, Wet 30%, Dry 15%, Violent 20%

STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS NORMAL WET DRY VIOLENT EXPECTED

WEIGHTS .35 .30 .15 .20 VALUES = = = = = = = = = = = = = = = = = = = = = = =

CORN $ 900 450 -800 250 $ 380**- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

POTATOES 800 -300 400 500 350- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

HAY/GRASS 300 500 0 100 275= = = = = = = = = = = = = = = = = = = = = = =

You should PLANT CORN EVERY YEAR. In any one year you’ll either make 900, make 450, lose 800 or make 250 …but over the years, you’ll average $380 of profits.

A PAYOFF TABLE ILLUSTRATIONUNDER RISK (WHAT IS THE VALUE OF PERFECT INFORMATION?)

WE KNOW ONLY GOD CONTROLS THE WEATHER, BUT IF WE HAD PERFECT PREDICTION EACH YEAR, WE’D KNOW EXACTLY WHAT THE WEATHER WOULD BE AND WHAT WE SHOULD PLANT. WE’D HAVE NORMAL CONDITIONS 35% OF THE TIME, AND DURING THOSE TIMES, WE’D PLANT CORN. 30% OF THE TIME IT WOULD BE WET AND WE’D PLANT HAY, ETC.

STATES OF NATURE / ENVIRONMENTAL SCENARIOS

ALTERNATIVE CROPS NORMAL WET DRY VIOLENT EXPECTED

WEIGHTS .35 .30 .15 .20 VALUES = = = = = = = = = = = = = = = = = = = = = = =

CORN $ 900 450 -800 250 $ 380**POTATOES 800 -300 400 500 350HAY/GRASS 300 500 0 100 275

= = = = = = = = = = = = = = = = = = = = = = =Expected Profits given Perfect Information (EPPI) = $625.Expected Value of Perfect Information (EVPI) = EPPI – EV = $625 –380 = $

245Therefore, you can increase your profits by up to $245 if you have a perfect

weather forecast each spring.