In the previous webcast, you learned how to estimate the growth option value from stock prices. In this webcast, you'll learn to understand why some firms have valuable growth options and other firms have not. So you'll learn to understand the value creation behind growth options. Actually, financial markets have difficulties at times in valuing growth options. Consider for instance the stock price of a company like Amazon.com. Amazon.com is by far the pioneer in Internet retailing. And by 1997 it went public, with a share price of $18. By 1999, the share price rose to over $100, along with other new companies. But it became clear at that time that the new companies in general could not meet their expectations, the share price made a free fall. And as you can see here, subsequently, Amazon.com developed itself as a world class retailer. Financial markets at some times have difficulties in valuing the growth opportunities of firms. In this webcast, you'll learn to understand why some firms have these valuable growth opportunities. To understand that, we consider two approaches. One set of approaches considers the firm from its external environment. So the external environment of the company: the industry structure, the strategic position, and other external factors determine the profitability of the firm. Another view, another set approaches, approach this problem from internal. The internal capabilities and the internal resources of the firm determine why some firms are more profitable than others. And the leveraging of these, or the use of these internal capabilities, that determines the profitability of firms. We're going to discuss them both. So the first external framework. The first external framework we're going to discuss is Porter's five forces analysis. According to Porter's five forces analysis, the profitability of a company depends on its external environment and the intensity of rivaly within the industry. Direct competition in Porter's framework comes from rivals, and they determine the competition and the profitability of the new growth opportunities of the company. But on top of that, there are other forces that influence this competition. The intensity of rivalry and competition within the industry is also influenced by four forces. It can be influenced by the bargaining powers towards suppliers and customers. And on the other hand, it can be influenced by the threat of entry of other rivals and the threat substitutes. And all these factors influence the intensity of competition in the industry and the ability of the firm to earn more than opportunity cost of capital on their existing assets or on their new growth opportunities. Consider for instance a private equity investor that enters an industry with a retail chain. The average profitability of the investment depends obviously on the average profitability of the industry. But as the investor acquires more companies, its bargaining power towards suppliers also grows. And therefore, it's probably more profitable for this investor, for the larger investor, to buy an additional acquisition, than for smaller rival. Just because of the increased bargaining power towards suppliers. In this way, you can use Porter's framework to analyze strategic investments. So next to the competitive forces analysis, there's another external approach, and that external approach is based on game theory. And game theory looks at strategic interactions between firms. So the profitability of the firm depends on how it plays the game in its external environment against rivals. For instance, a strategic bidding situation for a company in an acquisition. That can be analyzed with game theory. In industry situations, game theory can actually be analyzed if there's not too many competitors and the alternatives can be readily ascertained. For instance, Coca-Cola and Pepsi Cola, or Procter & Gamble and Unilever, or Boeing and Airbus. In these situations, one action of one firm directly influences the profitability of another firm. While game theory understands that the external environment, and how it plays the game in an external environment, obviously is a important determinant of profitability. It doesn't analyze so much the differences between firms. For instance, the strategic conflict and game theory approach does not recognize that the accumulation of unique resources and unique capabilities is also an important determinant of profitability. And these internal factors that influence the profitability of the firm and their future growth opportunities are discussed next. So the main strand of internal based approaches is the resource based view. And the resource based view states that the accumulation of unique resources, and capabilities are the source of competitive advantage. So resources are actually the basic input in the the production process, and they add to the strengths and weaknesses of the firm. So for instance, it can be their trade contracts or it can be the technical knowledge or know how. A capability is a capacity to perform certain tasks in the production process, we also speak of core capabilities. Examples of a core capability is for instance: Tesla's know how in the electrification of cars, or Canon's know how in optics. And these add to the value creation of these firms. To be a source of competitive advantage, these resources and capabilities should have several characteristics. First, they should be relevant to be a source of competitive advantage. Second, it should be hard and durable, so it will be difficult to imitate and for rivals to replicate the strategy. And three, the value created by the resource should be appropriable by the firm. If these conditions are met, the firm can expect to earn more than the opportunity cost of capital that adds to the value assets in place or can expect valuable growth opportunities. An important step in understanding the resource based view is distinguish those resources that are truly unique, from those that can readily be acquired in the marketplace. If somebody can readily acquire resources in the marketplace, it is unlikely to yield an excess profit, because everybody can replicate it. So only those unique resources that are truly relevant help the firm to create an excess profit above the opportunity cost of capital. Microsoft's dominant position has been based on its unique capability of programming its operating system, which allows it to stay in the lead of other products, with programs such as Word and Excel. Coca-Cola's dominant position has been based on the capability of its brand name and its advertising. Its well-known brand name, which allows it to ask a premium on their products. Another internal strand that adds additional insights is the dynamic capability approach. That looks at how firms can renew their competencies in response to a changing environment. Actually if a firm cannot buy unique resources, it must be built up gradually. So history matters. So the historical path and relationship and the accumulation of assets determines the strategic position of the firm, and therefore, the future growth opportunities. So to understand this path dependency, consider your own career path. You'll probably get a bachelor's degree, and that allows you to follow a master's degree and that leads you to your first job and your second job. So actually the history, your historical path, your historical interest and your accumulated knowledge determines your future opportunities over time. This is the same way as the dynamic capabilities explain that the accumulation of unique resources, your accumulation of relationship and technology and so forth, allows them to exercise their future opportunities. So actually, history matters. And the accumulation, the assets in place in the valuation, actually determine the future growth opportunities. To summarize: actually if we look at financial markets, we know that we can back out growth option value, but financial markets at times have difficulties in estimating accurately this growth option value. There are several strategic frameworks that helps you better understand why some firms have valuable growth options, and other firms haven't. One group of paradigms that analyze these growth options, look at this from an external perspective: industry's five forces and game theory. They consider that the industry, the strategic position of the industry, and how firms play this game against rivals, is an important determinant for having valuable growth opportunities. Another approach, a set of approaches, looks from within the firm, internally from within the firm, and that's the resource based view and the dynamic capabilities. They state that unique capabilities or the unique brand name, and the unique resources of the firm and accumulation of the unique resources, allows them to have valuable opportunities that other firms haven't. And that's why they can create value. Why don't you look at financial markets and different companies and try to identify unique capabilities and unique resource of these firms and their external environment. And then you can better explain why some firms have these valuable growth options and other firms haven't. In the next week, we're going actually to look how we can actually value these growth opportunities from bottom up. So we can actually go to quantify the different options. I hope to see you next week. Do your work.