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Strategic Management for the
Capstone Business Simulation® and
Comp-XM® and Global DNA®
Michael L. Pettus, Ph.D.
7th Edition
ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced or
used in any form or by any means- graphic, electronic, or mechanical, including photocopying, recording,
taping, Web distribution, or information storage and retrieval systems without the written permission of the
author, Michael L. Pettus. Susquehanna University
Copyright 2015
® is a registered trademark of Management Simulations, Inc.
mailto:mpettus@millikin.edu
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“This text is excellent as a strategic management text which uses the Capstone
simulation and cases to explain the linkages of strategic management concepts to
real world business problems.”
Joseph Mahoney, Ph.D.
Caterpillar Chair in Strategic Management
University of Illinois
Associate Editor, Strategic Management Journal
“If you use the Capstone simulation this strategic management text must be used.
No other strategic management text can drive the concepts of strategic management
into a real world based simulation.”
Peter Wright, Ph.D.
Free Enterprise Chair in Strategic Management
University of Memphis
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Acknowledgments
I would like to thank many people for their hard work and dedication to the
construction of this book. First, I would like to thank Dan Smith, founder of the
Capstone Business Simulation, for giving me the opportunity to prepare the book.
Second, I would like to thank all the students who spent hundreds of hours
word processing this book: Karen Knight and Tim Wiggenbach deserve special
recognition. Amanda Walker was especially helpful in the construction of this
second edition. Denisa Smaldone was very helpful in the development of the third
edition. Victoria Dudleston was instrumental in the constructing of the fourth
edition. Kelsey Lee was very important, and made significant contributions, in the
construction of the 5 th
edition. Audra Davis was crucial in terms of assistance of the
updated 5 th
edition. Maddison Harner was outstanding in terms of assistance in
creating the 6th edition. Kelsey Armstrong was very helpful in the construction of
this 7th edition. Someday all of you will walk with industry giants.
Third, there are two people who were vital to the construction of this book:
May Zelner of Capstone Business Simulation and Hans Royal-Hedinger of Millikin
University. Without the hard work of these individuals, this book would never have
been accomplished. If I were to pick a number of individuals to start a business,
May and Hans would be among my ten top picks in the world! Someday both of
you will walk with captains of industry.
Fourth, I would like to thank Eddie Schwertz of Webster University for his
review of the 6th edition.
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Michael L. Pettus earned a PhD in strategic management from the University of
Illinois in 1997 and has more than 40 years of global experience in airline, airfreight
and trucking industries. He is published in the Academy of Management Journal, the
Strategic Management Journal, and many leading practitioner journals. He is the
author of Growth from Chaos (2003: Praeger) which explores corporate growth in
deregulated transportation industries. This book, Strategic Management for the
Capstone Business Simulation and Comp - XM, which is now in its 7th edition,
explains how the content of strategic management is integrated into business
simulations.
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This book is dedicated to all the wonderful
professors who use it.
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Summary Table of Contents Forward……………….................................................................................17
Inside the Mind of the Global CEO; an Interview with Doug
Oberhelman, CEO and Chairman of the Board of Directors of
Caterpillar Inc.............................................................................................. 17
Chapter 1 ..................................................................................................... 25
Managing Environmental Turbulence ...................................................... 25 Chapter 2 ..................................................................................................... 49
Industry Analysis and Industry Evolution for the 21 st
Century ............. 49
Chapter 3 ..................................................................................................... 73
Utilizing Internal Analysis to Build Competitive Advantage Over
Rivals ............................................................................................................ 73
Chapter 4 ..................................................................................................... 93
Business Level Strategy .............................................................................. 93
Chapter 5......................................................................................................107
Applying Game Theory to Collective Bargaining and Competitive
Dynamics......................................................................................................107
Chapter 6 ................................................................................................... 125
Analysis of Markets and Positioning ......................................................... 125
Chapter 7 ................................................................................................... 149
Growth by Internal Development ............................................................ 149
Chapter 8 ................................................................................................... 169
Corporate Level Strategies and Restructuring....................................... 169
Chapter 9 ................................................................................................... 199
Growth Via Strategic Alliances ................................................................ 199
Chapter 10 ................................................................................................. 227
Acquisition Strategies ............................................................................... 227
Chapter 11 ................................................................................................. 249
International Strategies ............................................................................ 249
Chapter 12....................................................................................................277
Global DNA..................................................................................................277
Chapter 13 ................................................................................................. 303
Strategic Leadership Decision Making ...................................................... 303
Chapter 14 ................................................................................................. 329
Wealth Creation ........................................................................................ 329
Chapter 15 ................................................................................................. 347
Conducting Case Analysis: An Exercise in Wealth Creation ................. 347
Chapter 16 ................................................................................................. 359
Comp-XM® .................................................................................................... 359
Major Cases………………………………………………………………379
Appendix .................................................................................................... 436
8
Glossary ...................................................................................................... 438
Index ........................................................................................................... 444
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Detailed Table of Contents Forward……………………………………………………………………………………………….....17
Inside the Mind of the Global CEO; an Interview with Doug Oberhelman
CEO and Chairman of the Board of Directors of Caterpillar Inc……….....17
Chapter 1 ...................................................................................................... ..25
Managing Environmental Turbulence ............................................................... 25 Learning and Assessment Goals ..................................................................................... 26
U.S. Economic Collapse ................................................................................................... 33
U.S. Government Stimulus Plan ..................................................................................... 35
U.S. Auto Industry ........................................................................................................... 35
International Recession ................................................................................................... 36 The "Secret" Global Bailout ........................................................................................... 38
The Economic Recovery..................................................................................................38
Discussion Questions ....................................................................................................... 43
References ......................................................................................................................... 44
L’Oréal Mini Case..............................................................................................................47
Chapter 2 ..................................................................................................... 49
Industry Analysis and Industry Evolution for the 21 st
Century ............. 49 Learning and Assessment Goals ..................................................................................... 51
The Competitive Environment in the 21 st
Century ....................................................... 52
Industry Structure ........................................................................................................... 54
Industry Classification ..................................................................................................... 54
Porter’s Five Forces ......................................................................................................... 56
Potential Entrants (Threat of New Entrants) ............................................................. 57 Bargaining Power of Suppliers ................................................................................. 57
Bargaining Power of Buyers ..................................................................................... 57
Threat of Substitutes ................................................................................................. 58
Degree of Rivalry ...................................................................................................... 58
Industry Analysis Using Porter’s Five Forces Model ................................................... 59
Industry Evolution ........................................................................................................... 60
Introduction Stage ..................................................................................................... 61 Growth Stage............................................................................................................. 61
Maturity Stage ........................................................................................................... 61
Decline Stage ............................................................................................................ 62
Industry Life Cycle.......................................................................................................64
Discussion Questions ....................................................................................................... 69
References ......................................................................................................................... 70
Intel Mini Case ................................................................................................................. 72
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Chapter 3 ..................................................................................................... 73
Utilizing Internal Analysis to Build Competitive
Advantage Over Rivals ................................................................................... 73 Learning and Assessment Goals .....................................................................................75
The Resource-Based View ...............................................................................................76
Criteria for Competitive Advantage .......................................................................... 77
Value Chain Analysis ......................................................................................................78
Technology Development ......................................................................................... 83 Human Resource Management ................................................................................. 84
Firm Infrastructure .................................................................................................... 84
Procurement .............................................................................................................. 85
Inbound and Outbound Logistics .............................................................................. 85
Operations ................................................................................................................. 85
Marketing and Sales .................................................................................................. 86
Service ....................................................................................................................... 86
Global Outsourcing ..........................................................................................................87
Discussion Questions .......................................................................................................89
References .........................................................................................................................90
Ryder Mini Case ..............................................................................................................92
Chapter 4 ..................................................................................................... 93
Business Level Strategy .............................................................................. 93 Learning and Assessment Goals .....................................................................................95
Key Success Factors .........................................................................................................96 Determining Key Success Factors ............................................................................. 96
Utilizing Key Success Factors over Time ................................................................. 97
Generic Business Level Strategies ..................................................................................97 Cost leadership .......................................................................................................... 98
Focused low cost ....................................................................................................... 98
Differentiation ........................................................................................................... 98
Focused differentiation .............................................................................................. 99
Walmart Expansion ................................................................................................. 101
Discussion Questions .....................................................................................................104
References .......................................................................................................................105
Dell Mini Case ................................................................................................................106
Chapter 5......................................................................................................107
Applying Game Theory to Collective Bargaining and Completive
Dynamics......................................................................................................107 Learning and Assessment Goals.....................................................................................109
Competitive Dynamics.....................................................................................................115
SWOT Analysis................................................................................................................115
Strengths....................................................................................................................115
Weaknesses................................................................................................................115
Opportunities............................................................................................................116
Threats.......................................................................................................................116
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Competitive Dynamics Over Time.................................................................................118
Discussion Questions.......................................................................................................122
References........................................................................................................................123
Eli Lilly Mini Case……………………...........................................................................124
Chapter 6 ................................................................................................... 125
Analysis of Markets and Positioning ......................................................... 125 Learning and Assessment Goals ...................................................................................127
Market Segmentation ....................................................................................................128
Market Segmentation of the Airline Industry…………………….……………128
Product Positioning…………………………………………………………………130
Sales Forecasting ............................................................................................................ 132 Sales Forecasting Methods ...................................................................................... 132
Sales Forecasting and Capstone Simulation ................................................................133
Marketing Mix Variables ..............................................................................................139
Product Variable ...................................................................................................... 139 Price Variable .......................................................................................................... 140
Promotion Variable ................................................................................................. 140
Distribution Variable ............................................................................................... 142
Branding..........................................................................................................................143
Discussion Questions .....................................................................................................145
References .......................................................................................................................146
Embraer Mini Case .......................................................................................................147
Chapter 7 ................................................................................................... 149
Growth by Internal Development ............................................................ 149 Learning and Assessment Goals ...................................................................................150
Internal Development Strategies...................................................................................151
Market Penetration .................................................................................................. 151 Market Development ............................................................................................... 153
Product Development .............................................................................................. 155
Diversification ......................................................................................................... 157
Competition ....................................................................................................................157
Internal Development and Capstone Simulation ........................................................158
Growth by Market Penetration ................................................................................ 158 Growth by Market Development ............................................................................ 159
Growth by Product Development............................................................................ 161
Growth by Diversification ....................................................................................... 163
Discussion Questions .....................................................................................................164
References .......................................................................................................................165
Starbucks Mini Case ......................................................................................................167
Chapter 8 ................................................................................................... 169
Corporate Level Strategies and Restructuring....................................... 169 Learning and Assessment Goals ...................................................................................170
Diversification.................................................................................................................171
Diversification and Performance ............................................................................. 171
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Diversification and Value Chain Analysis .............................................................. 173
Same Industry Diversification ......................................................................................174
Related Industry Diversification ..................................................................................175
Unrelated Industry Diversification ...............................................................................176
Diversification and Risk .......................................................................................... 176
Business Strengths and Industry Attractiveness .........................................................177
Industry Attractiveness ............................................................................................ 179 Business Strength .................................................................................................... 180
Restructuring ..................................................................................................................181
Downsizing ............................................................................................................. 182 Downscoping .......................................................................................................... 184
Realignment ............................................................................................................ 185
Restructuring and the Capstone Simulation ...............................................................186
Discussion Questions .....................................................................................................192
References .......................................................................................................................193
General Electric (G.E.) Mini Case ................................................................................198
Chapter 9 ................................................................................................... 199
Growth Via Strategic Alliances ................................................................ 199 Learning and Assessment Goals ...................................................................................201
Trust ................................................................................................................................203
Scale of Coverage ...........................................................................................................204
Relationship-Specific Assets ..........................................................................................204
Complementary Capabilities ........................................................................................204
Interfirm Knowledge Sharing .......................................................................................204
Scale Alliances ................................................................................................................205
Link Alliances .................................................................................................................207
Joint Ventures ................................................................................................................209
The Downside of Strategic Alliances and Joint Ventures ...........................................212
Strategic Alliances and the Recession...........................................................................212
The Future of Strategic Alliances .................................................................................213
Strategic Alliances and Capstone Simulation ..............................................................214
Discussion Questions .....................................................................................................217
References .......................................................................................................................218
Oneworld Airline Strategic Alliance Mini Case ..........................................................224
TNK & BP Mini Case………………………………………………………………....225
Chapter 10 ................................................................................................. 227
Acquisition Strategies ............................................................................... 227 Learning and Assessment Goals ...................................................................................228
Attributes of Successful Acquisitions ...........................................................................231
Access to International Markets .............................................................................. 231 Synergies Resulting from Economies of Scale ....................................................... 232
Synergies Resulting from Economies of Scope ...................................................... 232
Reduce Costs of New Product Development .......................................................... 232
Entry into More Attractive Industries ..................................................................... 233
Problems with Acquisitions ...........................................................................................233
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Paying Too Much .................................................................................................... 233 Inability to Achieve Synergies ................................................................................ 233
Failure to Retain Key Personnel .............................................................................. 234
Too Much Debt ....................................................................................................... 234
Invest in Mature Industries ...................................................................................... 235
Process for Achieving Successful Acquisitions ............................................................236
Due Diligence ......................................................................................................... 236 Engage in Friendly Acquisitions ............................................................................. 236
Maximize Resource Utilization .............................................................................. 236
Diversify Into Firms That Have Strong Brand Names ............................................ 237
Acquire High Growth Firms ................................................................................... 238
Hostile Acquisitions .......................................................................................................238
Are Acquisitions Beneficial? .........................................................................................239
Acquisitions as a Source of Innovation ........................................................................241
Discussion Questions .....................................................................................................242
References .......................................................................................................................243
Proctor and Gamble Mini Case ....................................................................................246
Chapter 11 ................................................................................................. 249
International Strategies ............................................................................ 249 Learning and Assessment Goals ...................................................................................250
Factors Encouraging International Expansion ...........................................................251
Innovation in Domestic Market ....................................................................................255
Determining International Country Attractiveness ....................................................255
Role of Government.......................................................................................................256
Determination of International Industry Attractivness .............................................258
Determination of Firms’ Business Strengths ...............................................................261
Adaptation Versus Standardization .............................................................................263
Determination of International Modes of Entry .........................................................263
Exporting ...................................................................................................................... 263
Licensing/Franchising ............................................................................................. 265
Strategic Alliances .................................................................................................. 266
Acquisitions ............................................................................................................ 266
Foreign Direct Investment ....................................................................................... 267
Competition within International Markets Intensifies ...............................................268
Relocate to Low Cost Markets ......................................................................................268
New Innovation in Home Markets ...............................................................................268
Emerging Markets..........................................................................................................269
Discussion Questions .....................................................................................................271
References .......................................................................................................................272
IKEA Mini Case .............................................................................................................275
Chapter 12 ................................................................................................. 277
Global DNA..................................................................................................277 Learning and Assessment Goals......................................................................................279
Competitive Landscape....................................................................................................280
Financial Overview...........................................................................................................283
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Internal Analysis...............................................................................................................285
Regional Sales and Profitability......................................................................................287
Key Buying Criteria..........................................................................................................288
Budget Segment Analysis..................................................................................................289
Performance Segment Analysis........................................................................................292
Firm Level Decision Making.............................................................................................294
Discussion Questions..........................................................................................................302
Chapter 13....................................................................................................303
Strategic Leadership Decision Making ..................................................... 303 Learning and Assessment Goals ...................................................................................305
Strategic Leadership ......................................................................................................306
Ethics..................................................................................................................................307
Most Ethical Firms...........................................................................................................308
Least Ethical Firms..........................................................................................................308
Ethics Scenario..................................................................................................................309
Customers .......................................................................................................................311
Employees .......................................................................................................................312
Collective Bargaining Organizations ............................................................................313
Shareholders ...................................................................................................................313
Board of Directors ..........................................................................................................314
Investment Community .................................................................................................315
Senior Managers and Ethical Decision Making ..........................................................315
Strategic Leadership and Growth ………………………………………………. .... 317
Scandals and Strategic Leadership ...............................................................................319
Industry Evolution and Strategic Leadership .............................................................321
Introduction ............................................................................................................. 321 Growth .................................................................................................................... 322
Maturity................................................................................................................... 322
Decline .................................................................................................................... 323
Discussion Questions .....................................................................................................324
References .......................................................................................................................325
Hershey Mini Case .........................................................................................................327
Chapter 14 ................................................................................................. 329
Wealth Creation ........................................................................................ 329 Learning and Assessment Goals ...................................................................................331
Balanced Scorecard and Wealth Creation ...................................................................332
Customer Wealth ...........................................................................................................334
Consumer Costs ...................................................................................................... 335 Firm Costs ............................................................................................................... 335
Shareholder Wealth .......................................................................................................336
Liquidity Ratios ....................................................................................................... 337 Asset Management Ratios ....................................................................................... 337
Debt Management Ratios ........................................................................................ 338
Profitability Ratios .................................................................................................. 338
Economic Value Added (EVA) and Market Value Added (MVA) ........................ 339
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Employee Wealth ...........................................................................................................340
Positioning for Future Wealth ......................................................................................341
Capstone Simulation Measures of Wealth Creation ...................................................344
Discussion Questions .....................................................................................................345
References …………………………………………………………………………..346
Chapter 15 ................................................................................................. 347
Conducting Case Analysis: An Exercise in Wealth Creation ................. 347 Industry Structure .........................................................................................................351
Competitive Dynamics for the Capstone Simulation ..................................................354
Wealth Creation Measures ............................................................................................355
Conclusion ......................................................................................................................356
Recommendations ..........................................................................................................358
Chapter 16 ................................................................................................. 359
Comp-XM® .................................................................................................... 359 Balanced Scorecard........................................................................................................366
Board Query Questions .................................................................................................374
Major Cases................................................................................................379 Airbus A380 vs. Boeing 787...........................................................................................380
Amazon.com....................................................................................................................386
Archer Daniels Midland (ADM)....................................................................................388
BNSF Railroad.................................................................................................................394
Chevron.............................................................................................................................401
Disney................................................................................................................................408
G.M....................................................................................................................................411
Global Steel Industry.......................................................................................................414
Louis Vuitton Moet Hennessey.......................................................................................422
McDonald’s......................................................................................................................428
Oracle...............................................................................................................................431
Appendix .................................................................................................... 436 U.S. Domestic Data Sources ..........................................................................................436 International Data Sources ............................................................................................437
Glossary ...................................................................................................... 438
Index ........................................................................................................... 444
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Inside the Mind of the Global CEO
This article highlights an interview with the CEO and Chairman of the Board of Directors of
Caterpillar, Douglas R. Oberhelman. Caterpillar is one of the thirty (30) firms that make up the
Dow Jones Industrial Average. The company is viewed by many analysts as a barometer of the
health of the global economy.
This interview provides helpful insights into how emerging markets may develop in the future.
Oberhelman’s responses contain the thought processes and values of a successful corporate leader.
His responses showcase viewpoints as well as an agenda for success in important developing
markets (e.g. BRIC) and other markets of future importance. Oberhelman discusses not only what
markets are emerging but also, how and why firms should conduct business in these emerging
markets. This interview provides us a unique opportunity to go “inside the mind” of a truly global
CEO.
The person who conducted the interview was Michael Pettus, an Associate Professor of
Management at the Tabor School of Business at the Millikin University in Illinois.
Pettus : Why do you think a discussion of strategies for emerging markets is important?
Oberhelman : I could sum it up in one word—growth. The developed markets will continue to be
important, but when it comes to new customers and new opportunities there are tremendous
possibilities in the emerging markets. Just look at income as an example. For about 10 years, U.S.
discretionary income has been flat while worldwide discretionary income has grown like no time in
history. The result is higher growth in emerging markets, and lower growth in developed markets.
Pettus : You graduated from Millikin University in 1975 with a degree in finance and then
you went to work for Caterpillar. Your first international assignment was in Uruguay. That
would not appear to be a usual starting point for a new graduate. Can you tell us what
happened?
Oberhelman : I had a choice of living in Argentina or Uruguay. Looking back, it was a tremendous
experience, but back then in the early 1980’s, both countries were pretty dangerous. They were
under martial law and sometimes people would just disappear from those countries and other
countries during this time period. In the late 70’s, oil prices spiked and gasoline went from about 30
cents a gallon to over a dollar a gallon. The resulting recycling of those petrol dollars around the
world had a tremendous impact in Latin America. Mexico was the first country to devalue its
currency in 1982 and many other Latin American countries followed. This was the first real
currency crisis in emerging countries. I saw many countries go nearly bankrupt, and I saw the
impact that had on businesses, communities and individuals.
I learned a great deal about international finance, currency movements, and banking. I remember
staying at the Sheridan Hotel in Argentina and every day my rate would go up because inflation was
out of control. When I got there it was something like 20 pesos to the dollar; when I left it was
more like four million pesos to the dollar. This was similar to the German inflation in the 1930’s.
Pettus : A lot of the academic community and practitioners feel that the BRIC countries
(Brazil, Russia, India & China) are going to be growth engines for the future. Do you share
that view? Whether you do or don’t, could you contrast and compare those countries?
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Oberhelman: Yes, I do believe that, but I also think that we need to look beyond just BRIC (as a
block of countries) and look at each on its own merit. Every one of those countries is completely
different. And we shouldn’t forget there’s another set of emerging countries, and I would put
Indonesia right at the top.
When we graduated from college in the 1970’s there were probably 3 ½ billion people on the Earth.
There were probably only a billion or so living in countries open for international business. Russia
was a largely closed market in the 1970s due to the Cold War. India was basically closed. China
was completely closed. Viet Nam was just emerging in Southeast Asia from a terrible destructive
war situation.
Today, with the seven billion people on the planet, there are probably only 500,000 million that we
can’t sell due to U.S. government policy. All of these 6½ billion people want to live as
progressively and modern as we do. Therefore, multinational firms have many more international
growth opportunities today. There are three factors which will be important over the next 15 years:
(1) discretionary incomes rising, (2) the growing middle class, and (3) the rapidly growing
population.
Most of the growth will be in emerging markets. They are expected to grow three to four times
quicker than the developed world in the coming decade, and they bounce back from downturns
faster than the highly indebted parts of the developed world. This has just been witnessed from the
recent recession.
Every one of those BRIC, plus Indonesia, the Middle East, and a couple countries in Africa will
provide firms tremendous opportunities. China’s had problems sustaining growth at 12% and they
may likely never see that again, but with growth at around 8%, China remains an excellent
opportunity. Brazil has stumbled a little bit, but it is a great opportunity. It seems like every year
that India is 3 steps forward and 2 steps back. However, it’s still a key market.
Russia is a great opportunity, but it’s a small country in terms of population (approximately 142
million people) but presents large opportunities from a resource standpoint. The CIS as a whole is
about 228 million people. When compared to China, the CIS is small, but in comparison with
Brazil, the CIS has a larger population and more natural resources.
As for the Middle East, Caterpillar has had a long-term presence. We have dealer relationships of
more than 60 years, a Caterpillar Marketing and Product Support organization in territory, and the
recently opened parts distribution center in Dubai to better serve our customers in the region.
Despite some political turmoil in this region, there are good reasons why we believe in sustainable
growth. This region has important natural resources, a young population and huge consumer needs.
For example, with the relative high oil prices, the region is running a high current account surplus.
About 40 percent of the world's crude oil reserves are controlled by countries in the Middle East.
To keep pace with the growing population as well as an increasing urbanization, especially in
countries like Saudi Arabia, the UAE (United Arab of Emirates) and for that matter also Africa,
these countries are increasingly directing funds towards infrastructure development with a focus on
education, healthcare, transportation and power generation. Our product range is well suited for the
region as it has important needs for infrastructure such as road, irrigation power networks and
boasts a significant oil and gas activity – all segments we play in.
19
So when you talk about emerging markets, it’s really a country by country analysis. Every one of
those countries has different problems and challenges but great opportunities in the future.
Pettus : You mentioned Brazil, can you talk a little bit about that?
Oberhelman : In the 80s, military-controlled Brazil was deep in debt crisis. Today, Brazil is a
modern, but still an emerging market. Firms in Brazil have had their balance sheets completely
restored and they have positive reserves. These firms’ currency strengthened during the early 2000s
until the global recession hit. But there are about 200 million people there and the political system
has been relatively stable now for about 10 years. Growth is occurring. There are a number of
activities occurring in Brazil, such as the Olympics and the World Cup games, which provide
additional opportunities. Brazil is becoming a much more developed market. However, a great deal
of infrastructure investments will be required to support these developments.
Pettus : I think that China may be a step or two ahead of the other emerging markets based
upon the fact that they’ve got infrastructure already in place. Virtually everybody that I talk
to wants to establish a position in China.
Oberhelman : Earlier this year (2013), I met with the Premier Li Keqiang, about half his new
ministers, and other vice ministers. I was pleased with what I’ve heard. They’ve really reformed
government. China is going to be a force to reckon with for a very long time. Today Caterpillar has
about 100 competitors inside China and at least a handful of those aspire to expand beyond China
and compete in international markets (including the United States). And I would say that every big
multi-national company from around the world will have greater competition from these firms.
Pettus : How much infrastructure is in place within China?
Oberhelman : We’ve seen rapid infrastructure development, and there is still much more to come.
The rate of urbanization in China has essentially doubled in 30 years. The forecast is that in the
next 40 years it will go to 80%, which would be similar to Europe and North America. If that
happens, that’s another 400-600 million people going into urbanization. An intensive infrastructure
will be needed to develop and support this growth. While there has been a lot of development in
parts of China, the infrastructure in the Western part of the country looks like the U.S. in the 1950’s.
Over the next 15 years China is forecast to build 5 million new buildings and 50,000 skyscrapers,
equivalent to building two cities the size of Chicago every year. The massive migration from rural
areas to urban areas will create multiple mega-cities with populations exceeding 25 million, and
many more with populations exceeding 1 million. These megacities will be home to China’s
growing middle classes, creating consumer markets larger than today’s Japan and Spain,
respectively. In China, the number of urban middle class households will quintuple. China has the
potential to revolutionize mass transit. It already has plans for building new metros, highways, and
high-speed trains in its top 170 cities. This represents massive opportunities for developers and
construction companies. In addition, massive increases in demand for electricity will be driven by
this growth, requiring investments in coal fired, hydropower, nuclear, wind powered, and renewable
energy sources.
Pettus : In the emerging markets, is the government a constraint or an accelerator?
Oberhelman : As an example, in my experience in China the government is open for investment.
But, we’ve worked for many years on building relationships. To be successful, you have to find a
way to communicate with, or work with the government.
20
We’ve had a similar experience with the Brazilian government, and really, most emerging
countries. As I said before, every country is different, but they often try to protect their domestic
markets in three ways: : (1) Many of these countries don’t always want foreign investment, (2) they
often restrict foreign investment, or (3) they don’t want foreign imports. It can be a challenge, but
just like we do here in the United States, we try to educate on the benefits of open trade.
Pettus : There has been a recent development in Venezuela, Do you think the death of Hugo
Chavez will help or hurt our relationship with that country?
Oberhelman : Yes, I think it will definitely help, but it’s going to take some time. I think their
biggest challenges come in managing their huge oil reserve. The new government must use this
resource to support the Venezuelan people. I believe that this will happen.
Pettus : How do you think the Chinese government views the US?
Oberhelman : Well I think they view us a lot like we view them—they see the opportunities that
can come from working together, but they are skeptical. For example, they admire the American
entrepreneurial system but they don’t like capitalism. I clearly think their goal is to be the primary
world power in the future, and they are prepared for the long haul. At the same time, I think they are
very worried about social problems inside China.
And they’ve got to be very cautious how they manage their economy. Frankly, I don’t know how
you can centrally control an economy that will essentially double in a relatively short time frame.
I think U.S.-China relations will continue to develop, but it’s going to be gradual. Our two countries
need each other, so we need to find a way to manage the relationship—socio-economically,
politically and militarily.
Pettus : How about with India, is that a different kind of challenge?
Oberhelman : Completely different. I don’t see India challenging the U.S. or China as a
competitive power. They have a great educational system. However, there is a significant social
system inside India that holds them back.
Pettus : How about Russia? How would they view the U.S. government?
Oberhelman: It’s a complex relationship. Russia still wants to see itself as a superpower, though it
doesn’t have the economic power and the population to be one. There is still a lot of suspicion, but
on the other hand, it is a dynamic economy with a lot happening and with a huge potential. We see a
lot of opportunities for trade and business. And that is what brings countries together. The more
investment, business and social ties we can create between both countries will be a tremendous
benefit for both countries. And that will help us learn to work together.
Pettus : Do you see the CIS as an integrated block?
Oberhelman: The CIS is pretty much what it says, a number of independent states who cooperate in
some fields, but can pursue totally different policies in other fields. It is certainly not as integrated
as the European Union is today.
Pettus : That’s going to make it a lot tougher then.
21
Oberhelman: The Russian Federation is the largest country in the CIS and the relation between
Russia and the other CIS-members is also complex. I do not see a consensus to go beyond the
current cooperation in intra CIS trade.
Pettus : How does the Brazilian government view the U.S.?
Oberhelman: I think the view is favorable. They want to be a primary trading partner for the United
States. I think they respect our system and like what we’ve done.
Pettus : How did Caterpillar build the international infrastructure they have now?
Oberhelman : Post-WWI & II, the world needed infrastructure and we were about the only firm who
had the equipment to build it. So we had a name and we had distributors all over the world. We
started constructing plants overseas and this development has continued for decades. This
construction is really in the DNA of our company. This is important because 2/3 to 3/4 of our
business is outside the U.S.
Pettus : Do you see that percentage increasing?
Oberhelman : I think that percentage is probably about where it is going to stay.
Pettus : How do you see outsourcing?
Oberhelman : Well, outsourcing has an unfair negative connotation … everybody has
outsourcing. Firms generally outsource because it is not a core competency which they have.
Pettus : Do you have assets in highly volatile countries like North Korea and Syria?
Oberhelman : Countries like Syria, North Korea, Iran and Cuba do not have political stability. Even
if we weren’t prohibited from doing business in these countries – which we are per U.S. export
control and economic sanctions laws and regulations – political stability is a big risk factor that we
consider when we look at investing internationally in markets which are volatile.
Pettus : One of the things that you did is you bought a pretty large company in Milwaukee.
How has that helped your international posturing?
Oberhelman : We purchased a mining company called Bucyrus. You could find Bucyrus
equipment in virtually every mine on the planet. From Zambia to Australia to Madagascar to
Canada to the US – you name it – they are there. You can also find Cat equipment in those same
mines. We didn’t necessarily expand our footprint with that acquisition, but we expanded our
product line. The Bucyrus products really complemented our mining business.
Pettus : Do you look at industries first or countries first?
Oberhelman : Industries. When I became CEO almost four years ago, we updated our corporate
strategy. A big part of that involved looking at the industries we are in. We tried to identify highly
attractive industries and allocate our resources accordingly. That’s where you start.
Pettus : Do you have your own people who do that on a country by country basis?
22
Oberhelman: We have a tremendous strategic team at Caterpillar that looks at industries and
countries—all while considering the needs of our customers. Most of the issues we address start
within our internal team, but we also use some external advisors.
Pettus : What would you like me to tell the academic community? The topic is “success in
emerging markets” – if you could just tell us one thing.
Oberhelman: Nothing beats actually traveling to the emerging markets we are talking about. Call
on or visit a university and talk to their professors and maybe spend a semester there. That’s what I
tell our people here about international markets: don’t tell me about it if you’ve never been there. If
you’re going to teach students about Brazil’s economy – go down there and see how business is
done..
Pettus : I guess the only market that we haven’t talked about is Southeast Asia – do you have
any thoughts on those markets?
Oberhelman: Yes, I’ve mentioned Indonesia is a strong market. There is vast demand for
infrastructure projects in Indonesia, and the Indonesian government has issued a new economic
“master plan” with an emphasis on infrastructure projects. Indonesia’s ports are overstretched, its
electrical grid inadequate, and its road system is one of the least developed in the region. The
government has pledged US$150 billion on infrastructure spending in the next five years, although
two-thirds of this figure is expected to come from private investors.
From a market perspective, Thailand, Vietnam, and Malaysia are also emerging markets. When
China’s strengthens again, these markets are going to be favorable places to invest.
In addition, Myanmar is a growth market. Their population of more than 60 million is buying
everything from cell phones to bulldozers.
Pettus : Have we missed anything?
Oberhelman : We’ve missed Africa. But do you know who hasn’t missed Africa? China. China is
very actively and purposefully seizing the opportunities in Africa. Many African countries have
tremendous mineral and energy resources. And they are starting to realize that money invested in
these industries will benefit their own people.
China is short on resources, so they are looking at Africa as an opportunity. We are seeing all kinds
of Chinese investment, Chinese equipment, Chinese money, and Chinese workers going to Africa to
develop it. It should be very healthy for Africa, and for China. I’m not sure how healthy it’s going
to be for U.S. We are missing opportunities. As an example, we are starting to see some significant
infrastructure development within Africa.
Six of the 10 fastest growing countries in the world are in Africa (measured in GDP growth
between 2010 and 2016). Gains are to be expected across the board: banking and finance, consumer
goods, natural resources, agriculture and infrastructure. In 2012, South Africa launched a $430
billion, 15-year National Infrastructure Plan with 18 specific integrated strategic projects for
transport, energy, water, and sanitation, with aims to create jobs, green the economy, and strengthen
the delivery of basic services. South Africa aims to unlock mining development in Limpopo, North
23
West, and Northern Cape provinces.
There is also the trans-Algerian highway which will run 1200 km across the north of Algeria, from
the border with Morocco in the west to the Tunisian border, passing through 24 provinces. In
addition the Algerian government has earmarked a budget of $15 billion dollars for expanding the
country’s railway and road transport infrastructure over the coming five years.
These are just a few examples, but Africa is definitely making some progress.
Pettus : Are we behind in Africa?
Oberhelman : We (the U.S.) aren’t behind—we aren’t even in the game. I understand that Africa
has a lot of instability. We aren’t in the game because a lot of it is political risk, and our government
is disjointed in its approach to Africa. It’s risky. But Caterpillar has been involved in international
markets for years. In Africa in particular, we can build on a great legacy of 24 dealers with an
average of about 50 years Caterpillar experience.
And fortunately, in many cases, other U.S.-based businesses have been able to get in early and gain
a foothold, which is important. It’s much easier to establish relationships and gain customers early
on when you don’t have many competitors. It’s much more difficult when you are late to the party.
Right now, China is establishing relationships and gaining customers.
Pettus : Anything else that you would like to tell the academic community?
Oberhelman : Yes, I have come to the conclusion that there are not enough Americans that really
understand emerging markets. I admire you for taking this on because the emerging markets of
today are significantly different than they were even five years ago. Growth is occurring like
we’ve never seen in this country (U.S.). It’s just happening everywhere – the internet has opened it
up; the accessibility to capital has opened it up.
Students that graduate from college today better understand there’s competition in emerging
markets. And emerging markets are in every corner of the world! I can’t stress enough the
importance of learning about these countries, understanding what drives them and even more
importantly appreciating the opportunities for everyone if we learn to work together.
24
25
Chapter 1
Managing Environmental Turbulence
26
Learning and Assessment Goals
1. Understand why we moved into a recession within the U.S.
2. Understand why a global recession has occurred.
3. Understand the role the U.S. Government is playing to improve economic conditions with its economic stimulus plan.
4. Understand the economic state of affairs as of 2015.
5. Understand, at the firm level, how to grow in turbulent economic environments.
6. Understand how firms can maintain competitive positions in times of economic turbulence.
27
This book is about strategic management. It has two fundamental objectives. First, to
integrate all content from your discipline specific courses. This text will provide you with
knowledge to be able to understand how these content pieces are integrated between
themselves. Second, this text will show you how to use this integration, to establish
competitive advantage over time.
Strategic management is defined as the ability to achieve competitive advantage over
rivals over time1. To understand how this competitive advantage is achieved over time, we
use a business simulation. Simulations provide a risk-free environment in which to make
strategic decisions in response to changes in customers, competitors, and the environment.
The book is designed to explain strategic concepts and to show how these concepts are
integrated over time. This is the only complete strategic management text designed to be
used with the Capstone simulation. The flow chart on the next page shows how the
textbook integrates the Capstone simulation over time.
28
Figure 1
Strategic Management for the Capstone Business
Simulation
THEORY
PRACTICE
Figure 1
Strategic Management for the Capstone Business
Simulation (continued)
THEORY
PRACTICE
Chapter 5
Game Theory,
Labor Negotiating
and Competitive
Dynamics
Chapter 3
Utilizing Internal
Analysis to Build
Competitive Advantage
Over Rivals
Chapter 2
Industry Analysis and
Industry Evolution
for the 21st Century
Simulation
1) Using the
electronic sensor
industry as an
example, an industry
analysis will be
conducted.
2) Understand
industry evolution.
Chapter 1
Managing
Environmental
Turbulence
Chapter 7
Growth by Internal
Development
Chapter 6
Analysis of
Markets
and Positioning
Chapter 4
Business Level
Strategy
Simulation
1) Understand
how firms create
competitive
advantage
2) Understand
competitive
dynamics
Simulation
1) Understand how to
conduct an
environmental
assessment
2) Understand how to
conduct this
assessment over time
3) Understand decision
making to changing
conditions over time
Simulation
1) Integrate decision
making across all
functional levels of the
firm.
2) Understand the
impact of these
decisions upon
performance
Simulation
1) Understanding
sales forecasting
2) Understand the
application of
marketing
variables
Simulation
1) Understand how
to design internal
development
strategies
2) Understand how
internal
development
strategies are
implemented.
Simulation
1) Understanding
sales forecasting
2) Understand
decision making
when faced with
different outcomes
important to
different
shareholder groups
29
Figure 1
Strategic Management for the Capstone Business
Simulation (continued)
THEORY
PRACTICE
Figure 1
Strategic Management for the Capstone Business
Simulation (continued)
THEORY
PRACTICE
Chapter 10
Acquisition
Strategies
Chapter 9
Growth Via
Strategic
Alliances
Chapter 8
Corporate Level
Strategy and
Restructuring
Simulation
1) Develop an
understanding of
how strategic
alliances could be
integrated into the
simulation.
Chapter
13
Strategic
Leadership
Decision
Making
Simulation
1) Understand
the
components
of wealth
creation.
2) Understand
how wealth is
created and
destroyed.
Chapter 11
International
Strategies
Simulation
1) Strategic
leadership and
ethics
2) Understand
how strategic
leaders meet the
needs of various
stakeholders.
3) Understand
how strategic
leaders integrate
corporate and
business level
strategies.
Chapter 15
Conducting
Case Analysis:
An Exercise in
Wealth Creation
Chapter
14
Wealth
Creation
Chapter
16
Comp-
XM®
Simulation
1) By treating each market
segment as an industry,
understand which segments
a firm should develop.
2) Understand how firms
can restructure their
portfolio of businesses to
achieve competitive
advantage
Simulation
1)
Determine
wealth
creation for
Capstone
Simulation
teams.
Simulation
1) Assessment
1) Design of
global strategy
2) Understand
how competitive
advantage can
be achieved in a
global
environment
Chapter 12
Simulation
1) Decision
making
under
conditions of
international
uncertainty
2) Sales
forecasting
ramifications
Global DNA
30
For decades strategic management textbooks have been focused upon translating
theory into practice. A key concept is viewing strategic management as streams of decisions
over time2. This dynamic component is important because firms do not make static
decisions. In addition, a firm’s environment change over time. As such, a firm’s strategy
must evolve over time. Dynamic firm decision making is required for firm growth in the
long run.
In general, the Capstone simulation, is based upon decision making over time. The
simulation begins as an industry moving from a regulated to a deregulated environment.
The transition of an industry from a regulated a deregulated industry represents a
“Schumpeterian shock3” The simulation uses a “hypothetical electric sensor industry” as the
industry which has been deregulated. Chapters 1 and 2 of the text are focused upon
managing environmental uncertainty and conducting industry analysis under changing
conditions.
While a clear understanding of the industry the firm is competing in is of significant
importance, a firm’s relative position via competitors is of crucial importance. The firm
uses its resources and capabilities to achieve and sustain a competitive position within the
industry. Resources and capabilities provide the basis upon which the firm’s builds
competitive advantage. It is not the resources and capabilities themselves with dictate
competitive advantage, it is how these recourses and capabilities are used which allows the
firm to grow and sustain advantages over time4. Chapters 3 & 4 address this important
topic.
The U.S. economy is gradually moving towards economic recovery. However, this
recovery has been very slow. The recession hit the entire global community hard. Emerging
markets have been growing more quickly than fully developed economies. One reason is
because many developing markets have many industries which are state owned. By “state owned,” I mean that the primary stakeholder is the government.
With one decision maker, it makes it easier for firms in an industry to do business
because price and profits are government controlled5. The government of these markets can
also prevent competition from outside the industry by maintaining barriers to entry.
A topic which has not been fully developed in many strategic management texts is
how the firm can develop accurate sales forecasting in the current time period and beyond.
The simulation shows why this concept is important. If a firm sales forecast is too
aggressive, the firm will generate excess inventory. Excess inventory leads to higher
inventory carrying costs. Higher carrying cost can lead to emergency loans. These loans
must be paid back which could hurt financial performance (eg. net income) in the year in
which the loan was incurred and in future years.
Sales forecasts which are too pessimistic lead to customers lost customers. The
firms’ customers may buy product(s) from competitors who can meet their demand.
In addition, a firm’s knowledge of strategic industry factors in all segments is of
crucial importance. The simulation refers to these factors as key buying criteria. An
understanding of these factors is important in the current time period, but also as the
industry evolves over time6. The firm must build resources and capabilities to serve market
segments in the current time period and over time based upon accurate sales forecasting.
The firm has many stakeholders. One group of stakeholders could be the firm’s
collective bargaining organization. Competitive dynamics helps us to understand the
strategic decisions the firm makes over time. These decisions have a direct impact upon the
financial indicators of the firm and its competitors over time. This analysis is the foundation
31
of the firms and competitors position over time. This discussion is reviewed in Chapter 5,
Game Theory, Labor Negotiating and Competitive Dynamics.
Chapter 6, Analysis of Markets and Positioning. A central concept which in
discussion is sales forecasting. Without relatively accurate sales forecasts, a firm will not be
able to implement its designed strategy. It is also important to understand critical
components of marketing because it is these components which interface with the existing
and future customer base.
Firms have four general options in terms of how they can grow: Chapter 7-
Internal Development, Chapter 8- Corporate Level Strategies and Restructuring,
Chapter 9- Strategic Alliances, and Chapter 10 Acquisitions. The primary focus of the
simulation is upon growth by internal development. Strategic alliances and acquisitions are
discussed in Chapters 9 and 10.
The simulation has begun to incorporate international development. This is quite
important. Of the 30 companies which make up the Dow Jones averages, most generate
more international revenue than domestic revenues. International strategies are discussed in
Chapter 11. Chapter 12: Global DNA discusses how international strategy can be
successfully implemented in various global environmental conditions.
The simulation has incorporated the important concept of ethics. Firms have many
stakeholders and each of the needs of these stakeholders must be met by a firm’s senior
management team. How the needs of each stakeholder group can be met ethically is
discussed in Chapter 13. A key takeaway from the chapter is that if senior managers are
attempting to maximize their own wealth, this takes time away from meeting stakeholders’
needs.
In general, this means that a firms’ wealth creation Chapter 14 is not being
achieved. The text addresses wealth creation from a modified balanced scorecard
perspective. A key limitation of the balanced scorecard is that it’s focused upon historical financial performance. These indicators do not necessarily predict future performance. The
following elements of the balanced scorecard are discussed: (1) shareholder wealth (2)
customer wealth (3) employee wealth (4) positioning for future wealth.
The simulation is a crucial aspect of any students learning. It examines the growth and profitability of a firm in a competitive setting over time. Case study analysis is also
important because students must understand what will happen to a specific firm over time.
Cases provide a rich and detailed history of how a specific firm has grown revenue and/or
(profit)/(losses) over time. Chapter 15 provides a guide which includes how a case analysis
could be conducted. While your professor will provide you with specifics, the chapter
provides general aspects of case analysis which may be important.
The founder and CEO of the simulation has been on the Board of Directors of the
AACSB. In his role, he has focused upon “assurance of learning” from a student
perspective. “Assurance of learning” is a concept which is difficult to measure. His firm
developed COMP-XM as an assessment vehicle to measure “assurance of learning”.
Chapter 16 is the COMP-XM chapter in the text. The examples used are taken from actual
simulation rounds. The questions at the end of the chapter are designed to provide for
“assurance of learning” as has been discussed by the AACSB.
This completes the overview.
32
We live in a chaotic, changing world. The economic ramifications of 2007-2010
have had a negative economic impact on most emerging and fully developed countries
throughout the world. The United States has been very significantly impacted by this
economic downturn. Some economists believe that the 2007-2010 time period
represented a depression rather than a recession.
Are the 1930’s depression conditions upon us during 2007-2010? The Great
Depression of the 1930’s may have a more modern version. This chapter will address
ways of dealing with current economic conditions. If firms are to be successful in
current economic times, a number of decisions will need to be made which address
conditions specific to modern times. The first question that needs to be raised is, “Are
we in a depression or a recession?” In the United States, the Business Cycle Dating
Committee of the National Bureau of Economic Research (NBER) is generally seen as
the authority for dating U.S. recessions. The NBER defines an economic recession as:
“a significant decline in [the] economic activity spread across the country, lasting more
than a few months, normally visible in a reduction in real GDP growth, real personal
income, employment (non-farm payrolls), industrial production, and wholesale-retail
sales7.” Academics, economists, policy makers, and businesses defer to the
determination measurement by the NBER for the precise dating of a recession’s onset
and end8. A depression is a severe economic downturn that results in a decline in real
GDP exceeding 10% and is a recession lasting three or more years9. Table 1.1 identifies
the conditions in the Great Depression of the 1930’s and the (2007-2010) economic
condition.
Table 1.1 Comparison of the Great Depression (1930s) to the
Current (2007-2010) Economic Conditions
Factor 2007-2010 1930’s
GDP Less than 5% Down 30%
Unemployment 5-10% 25-30%
Consumer prices Fairly stable Down 20-30%
During the 1930’s depression gross domestic product fell by over 30 %10. Since
2007 gross domestic product has fallen by less than 5 %. While in 2007-2010
unemployment hovered about 5-10 %, unemployment during the 1930’s depression was
approximately 25-30 %. In the 2007-2010 time period, consumer prices have held fairly
stable; however, during the Great Depression there was between a 20-30 % reduction in
consumer prices. Fortunately, this economic downturn does indeed appear to be a
recession as opposed to a depression. However, the U.S. economy experienced its worst
economic conditions since the Great Depression11. The U.S. Government has played a
very significant role (e.g. Chrysler and G.M.) throughout this period of recession.
In essence, the government has been regulating economic conditions (e.g.
economic stimulus package). As the government reduces its regulatory role, firms will
33
need to learn how to adjust to the new economic environment. These economic
conditions (2007-2010) have had a significant impact upon industries and firms. Let us
begin with what caused the current (2007-2009) economic crisis.
U.S. Economic Collapse What happened was caused by a combination of two factors. The first factor was
people losing their jobs causing them not to be able to pay their mortgages. In the U.S.,
significant job losses have been going on since December 2007 and accelerated in
September 2008. In 2008, 2.6 million jobs were lost. From January through April of
2009, 2.6 million jobs were also lost.
The rise of advanced economies in Russia, Brazil, India, and China increased the
total global labor pool dramatically. Recent improvements in communication and
education in these countries has allowed workers to compete more effectively with
workers in traditionally strong economies, such as the United States. This surge in labor
supply has provided downward pressure on wages and contributed to unemployment.
The second factor that has contributed to the challenging economic conditions is
falling housing prices in the U.S. Historically, the U.S. housing market has been very
strong. From the mid-1990 to 2005, housing prices grew. During the same period of
time, the U.S. gross domestic product (GDP) per capita was rising.
Housing prices stopped increasing in 2006, started to decrease in 2007, decreased
in 2008 and have fallen about 25% from the peak in 20059. During 2007-2010, the
decline in prices meant that homeowners had more difficulty refinancing their mortgage
rates. This action caused delinquencies and defaults of mortgages to increase sharply,
especially among subprime borrowers. Sub-prime loans were made to customers who
had spotty credit histories. In 2006, it was estimated that over half of the loans were sub-
prime. Banks who had financed these mortgages tried to sell the loans to other banking
institutions. In order to sell the loans, these institutions had to lower the price. These actions made the initial bank and the bank who acquired the loans worse off. In general,
this is what led to the demise of Bear Stearns and Lehman Brothers. Many other firms
were also dramatically affected. From Table 1.2, the top U.S. bankruptcy filings of all
times included six firms in the United States.
34
Table 1.2
Top 10 U.S. Bankruptcy Filings of all Time
Company
Bankruptcy
Date
Assets ($ billions)
1. Lehman Brothers 6/15/2009 691
2. Washington Mutual 9/26/2008 328
3. Worldcom Inc. 7/21/2002 104
4. General Motors 6/1/2009 91
5. Enron 12/2/2001 66
6. Conseco Inc. 12/17/2002 61
7. Chrysler 4/30/2009 39
8. Thornburg Mortgage 5/1/2009 36
9. Pacific Gas and Electric 4/6/2009 35
10. Texaco Inc. 4/12/1987 34
Although the economic crisis started in the home mortgage market, it spread to
commercial real estate, corporate junk bonds, and other forms of debt. Total losses to
U.S. banks reached as high as one-third of the total bank capital. The crisis has led to a
sharp reduction in bank lending, which in turn caused a severe recession in the U.S.
economy10. How mortgages were affected needs to be discussed. Borrowers were given low mortgage rates from banks for the first two to three
years (these initial low rates were called “teaser rates”) 12. The strategy was that by the time the teaser rates expired and the rates were to be adjusted upward, the value of their homes would have increased enough so that a new mortgage could be taken out and the
old mortgage paid off. However, this strategy worked only as long as housing prices
were increasing.
When housing prices stopped increasing in 2006, this strategy no longer worked13.
Old mortgages could no longer be refinanced, so the borrowers were stuck with higher
mortgage rates that they could not afford, and the default rates started to increase. From
the first quarter of 2006 to the third quarter of 2008, the percentage of mortgages in
foreclosure more than doubled from 4.5 % to 10 %14. This foreclosure rate was the
highest since the Great Depression. According to data from Bankruptcy Data.com, a division of New Generation
Research, Inc., bankruptcy filings among publicly traded companies surged 74 % in 200815. There were 136 bank bankruptcy filings in 2008, compared with 78 in 2007. While the year-over-year growth in bankruptcies rose quickly, the value of the firms seeking protection grew much faster. The 136 banks seeking bankruptcy protection in 2008 had about $1.16 trillion in assets, compared with just $70.5 billion in assets for banks filing for bankruptcy protection in 200716.
35
U.S. Government Stimulus Plan The U. S. government tried to stabilize this economic crisis. President Obama’s
economic stimulus package, $787 billion, has been an attempt to get the economy back
on track. On February 10, 2009, the Senate voted 61-37 to approve President Obama’s
economic stimulus bill. The first piece of the plan would create one or more banks that
would rely on taxpayer and private money to purchase and hold the banks’ bad assets17.
In the credit markets, the administration and the Fed are proposing to expand a lending
program that would spend as much as $1 trillion to make up for the $1.2 trillion decline
created between 2006 and 2009 by issuing securities backed primarily by consumer
loans18.
The second major component of the plan gave banks capital with which to lend.
Banks that receive new government assistance cut the salaries and perks of their
executives and sharply limited dividends and some corporate acquisitions19. The third piece of the plan uses the last $350 billion that the Treasury has
allocated for the bailout to rely on the Federal Reserve’s ability to create money. The Fed’s money enabled the government to become involved in the management of markets and banks20.
By comparing the first six months of 2006 with the first six months of 2009,
results were not promising. Retail sales have decreased from $360 billion in 2006 to
$340 billion in 200921. Construction of new homes has declined from approximately 2
million in 2006 to less than 500,000 in 200922. The purchasing managers’ index shows
the manufacturing sector activity has declined significantly since 2006. Orders for
nondefense capital goods decreased from over $60 billion in 2006 to less than $50
billion in 200923. Jobless claims increased from 300,000 to over 600,000. In 2009, the
number of people who are receiving jobless benefits rose to 670,000 million individuals.
This is the highest total since 196724. The impact of the recession upon the
U.S. auto industry has been especially severe.
U.S. Auto Industry G.M. and Chrysler received billions of dollars in government funds to try to
return to profitability. As of mid-2009, nothing positive had happened. Chrysler
emerged from Chapter 11 bankruptcy (7 th
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