Written Assignment #1 – Apple’s Strategy
Refer to Assurance of Learning Exercise #1 (Apple) in Chapter One of your Thompson (2022) text. Read “Apple Inc: Exemplifying a Successful Strategy” in Illustration Capsule 1.1.
Incorporate our course (Thompson text) work for the week and Develop your analysis by responding to the following questions:
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CRAFTING AND
EXECUTING
STRATEGY
The Quest for
Competitive
Advantage
Concepts and Cases
page iii
CRAFTING AND EXECUTING
STRATEGY
The Quest for Competitive
Advantage
Concepts and Cases | 23RD EDITION
Arthur A.
Thompson
Margaret
A. Peteraf
The University of
Alabama
Dartmouth
College
John E.
Gamble
Texas A&M
University–Corpus
Christi
A.J.
Strickland
III
The University
of Alabama
page iv
CRAFTING & EXECUTING STRATEGY: CONCEPTS AND CASES
Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10121. Copyright
©2022 by McGraw Hill LLC. All rights reserved. Printed in the United States of America. No part of
this publication may be reproduced or distributed in any form or by any means, or stored in a
database or retrieval system, without the prior written consent of McGraw Hill LLC, including, but
not limited to, in any network or other electronic storage or transmission, or broadcast for distance
learning.
Some ancillaries, including electronic and print components, may not be available to customers
outside the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 LWI 24 23 22 21
ISBN 978-1-265-02824-4
MHID 1-265-02824-9
Cover Image: Image Source/Getty Images
All credits appearing on page or at the end of the book are considered to be an extension of the
copyright page.
The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a
website does not indicate an endorsement by the authors or McGraw Hill LLC, and McGraw Hill
LLC does not guarantee the accuracy of the information presented at these sites.
mheducation.com/highered
http://mheducation.com/highered
page v
To our families and especially our spouses:
Hasseline, Paul, Heather, and Kitty.
page vi
About the Authors
Courtesy of Arthur A. Thompson, Jr.
Arthur A. Thompson, Jr., earned his BS and PhD degrees in economics
from The University of Tennessee, spent three years on the economics
faculty at Virginia Tech, and served on the faculty of The University of
Alabama’s College of Commerce and Business Administration for 24 years.
In 1974 and again in 1982, Dr. Thompson spent semester-long sabbaticals
as a visiting scholar at the Harvard Business School.
His areas of specialization are business strategy, competition and market
analysis, and the economics of business enterprises. In addition to
publishing over 30 articles in some 25 different professional and trade
publications, he has authored or co-authored five textbooks and six
computer-based simulation exercises. His textbooks and strategy
simulations have been used at well over 1,000 college and university
campuses worldwide.
Dr. Thompson and his wife of 58 years have two daughters, two
grandchildren, and a Yorkshire Terrier.
Courtesy of Margaret A. Peteraf
Margaret A. Peteraf is the Leon E. Williams Professor of Management
Emerita at the Tuck School of Business at Dartmouth College. She is an
internationally recognized scholar of strategic management, with a long list
of publications in top management journals. She has earned myriad honors
and prizes for her contributions, including the 1999 Strategic Management
Society Best Paper Award recognizing the deep influence of her work on
the field of Strategic Management. Professor Peteraf is a fellow of the
Strategic Management Society and the Academy of Management. She
served previously as a member of the Board of Governors of both the
Society and the Academy of Management and as Chair of the Business
Policy and Strategy Division of the Academy. She has also served in
various editorial roles and on numerous editorial boards, including the
Strategic Management Journal, the Academy of Management Review, and
Organization Science. She has taught in Executive Education programs in
various programs around the world and has won teaching awards at the
MBA and Executive level.
Professor Peteraf earned her PhD, MA, and MPhil at Yale University and
held previous faculty appointments at Northwestern University’s Kellogg
Graduate School of Management and at the University of Minnesota’s
Carlson School of Management.
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Courtesy of Richard’s Photography, LLC.
John E. Gamble is a Professor of Management and Dean of the College of
Business at Texas A&M University–Corpus Christi. His teaching and
research for 25 years has focused on strategic management at the
undergraduate and graduate levels. He has conducted courses in strategic
management in Germany since 2001, which have been sponsored by the
University of Applied Sciences in Worms.
Dr. Gamble’s research has been published in various scholarly journals
and he is the author or co-author of more than 75 case studies published in
an assortment of strategic management and strategic marketing texts. He
has done consulting on industry and market analysis for clients in a diverse
mix of industries.
Professor Gamble received his PhD, MA, and BS degrees from The
University of Alabama and was a faculty member in the Mitchell College of
Business at the University of South Alabama before his appointment to the
faculty at Texas A&M University–Corpus Christi.
Courtesy of Dr. A. J. (Lonnie) Strickland
Dr. A. J. (Lonnie) Strickland is the Thomas R. Miller Professor of
Strategic Management at the Culverhouse School of Business at The
University of Alabama. He is a native of north Georgia, and attended the
University of Georgia, where he received a BS degree in math and physics;
Georgia Institute of Technology, where he received an MS in industrial
management; and Georgia State University, where he received his PhD in
business administration.
Lonnie’s experience in consulting and executive development is in the
strategic management arena, with a concentration in industry and
competitive analysis. He has developed strategic planning systems for
numerous firms all over the world. He served as Director of Marketing and
Strategy at BellSouth, has taken two companies to the New York Stock
Exchange, is one of the founders and directors of American Equity
Investment Life Holding (AEL), and serves on numerous boards of
directors. He is a very popular speaker in the area of strategic management.
Lonnie and his wife, Kitty, have been married for over 49 years. They
have two children and two grandchildren. Each summer, Lonnie and his
wife live on their private game reserve in South Africa where they enjoy
taking their friends on safaris.
B
page viii
Preface
y offering the most engaging, clearly articulated, and conceptually
sound text on strategic management, Crafting and Executing Strategy
has been able to maintain its position as the leading textbook in strategic
management for over 35 years. With this latest edition, we build on this
strong foundation, maintaining the attributes of the book that have long
made it the most teachable text on the market, while updating the content,
sharpening its presentation, and providing enlightening new illustrations
and examples.
The distinguishing mark of the 23rd edition is its enriched and enlivened
presentation of the material in each of the 12 chapters, providing an as up-
to-date and engrossing discussion of the core concepts and analytical tools
as you will find anywhere. As with each of our new editions, there is an
accompanying lineup of exciting new cases that bring the content to life and
are sure to provoke interesting classroom discussions, deepening students’
understanding of the material in the process.
While this 23rd edition retains the 12-chapter structure of the prior
edition, every chapter—indeed every paragraph and every line—has been
reexamined, refined, and refreshed. New content has been added to keep the
material in line with the latest developments in the theory and practice of
strategic management. In other areas, coverage has been trimmed to keep
the book at a more manageable size. Scores of new examples have been
added, along with many new Illustration Capsules, to enrich understanding
of the content and to provide students with a ringside view of strategy in
action. The result is a text that cuts straight to the chase in terms of what
students really need to know and gives instructors a leg up on teaching that
material effectively. It remains, as always, solidly mainstream and balanced,
mirroring both the penetrating insight of academic thought and the
pragmatism of real-world strategic management.
A standout feature of this text has always been the tight linkage between
the content of the chapters and the cases. The lineup of cases that
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accompany the 23rd edition is outstanding in this respect—a truly appealing
mix of strategically relevant and thoughtfully crafted cases, certain to
engage students and sharpen their skills in applying the concepts and tools
of strategic analysis. Many involve high-profile companies that the students
will immediately recognize and relate to; all are framed around key
strategic issues and serve to add depth and context to the topical content of
the chapters. We are confident you will be impressed with how well these
cases work in the classroom and the amount of student interest they will
spark.
For some years now, growing numbers of strategy instructors at business
schools worldwide have been transitioning from a purely text-case course
structure to a more robust and energizing text-case-simulation course
structure. Incorporating a competition-based strategy simulation has the
strong appeal of providing class members with an immediate and engaging
opportunity to apply the concepts and analytical tools covered in the
chapters and to become personally involved in crafting and executing a
strategy for a virtual company that they have been assigned to manage and
that competes head-to-head with companies run by other class
members. Two widely used and pedagogically effective online
strategy simulations, The Business Strategy Game and GLO-BUS, are
optional companions for this text. Both simulations were created by Arthur
Thompson, one of the text authors, and, like the cases, are closely linked to
the content of each chapter in the text. The Exercises for Simulation
Participants, found at the end of each chapter and integrated into the
Connect package for the text, provide clear guidance to class members in
applying the concepts and analytical tools covered in the chapters to the
issues and decisions that they have to wrestle with in managing their
simulation company.
To assist instructors in assessing student achievement of program
learning objectives, in line with AACSB requirements, the 23rd edition
includes a set of Assurance of Learning Exercises at the end of each chapter
that link to the specific learning objectives appearing at the beginning of
each chapter and highlighted throughout the text. An important instructional
feature of the 23rd edition is its more closely integrated linkage of selected
chapter-end Assurance of Learning Exercises and cases to Connect™. Your
students will be able to use Connect™ to (1) complete chapter-specific
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activities, including selected Assurance of Learning Exercises appearing at
the end of each of the 12 chapters as well as video and comprehension
cases, (2) complete chapter-end quizzes, (3) complete suggested assignment
questions for 14 of the 27 cases in this edition and (4) complete assignment
questions for simulation users. All Connect exercises are automatically
graded (with the exception of select Exercises for Simulation Participants),
thereby enabling you to easily assess the learning that has occurred.
In addition, both of the companion strategy simulations have a built-in
Learning Assurance Report that quantifies how well each member of your
class performed on nine skills/learning measures versus tens of thousands of
other students worldwide who completed the simulation in the past 12
months. We believe the chapter-end Assurance of Learning Exercises, the
all-new online and automatically graded Connect™ exercises, and the
Learning Assurance Report generated at the conclusion of The Business
Strategy Game and GLO-BUS simulations provide you with easy-to-use,
empirical measures of student learning in your course. All can be used in
conjunction with other instructor-developed or school-developed scoring
rubrics and assessment tools to comprehensively evaluate course or
program learning outcomes and measure compliance with AACSB
accreditation standards.
Taken together, the various components of the 23rd edition package and
the supporting set of instructor resources provide you with enormous course
design flexibility and a powerful kit of teaching/learning tools. We’ve done
our very best to ensure that the elements constituting the 23rd edition will
work well for you in the classroom, help you economize on the time needed
to be well prepared for each class, and cause students to conclude that your
course is one of the very best they have ever taken—from the standpoint of
both enjoyment and learning.
DIFFERENTIATING FEATURES OF
THE 23RD EDITION
Nine standout features strongly differentiate this text and the accompanying
instructional package from others in the field:
1. We provide the clearest discussion of business models to be found
anywhere. By introducing this often-misunderstood concept right in the
first chapter and defining it precisely, we give students a leg up on
grasping this important concept. Follow-on discussions in the next eight
chapters drive the concept home. Illustration capsules and cases show
how a new business model can enable a company to compete
successfully even against well-established rivals. In some cases, a new
business model can even be the agent for disrupting an existing industry.
2. Our integrated coverage of the two most popular perspectives on
strategic management— positioning theory and resource-based theory—
is unsurpassed by any other leading strategy text. Principles and concepts
from both the positioning perspective and the resource-based perspective
are prominently and comprehensively integrated into our coverage of
crafting both single-business and multibusiness strategies. By
highlighting the relationship between a firm’s resources and capabilities
to the activities it conducts along its value chain, we show explicitly how
these two perspectives relate to one another. Moreover, in Chapters 3
through 8 it is emphasized repeatedly that a company’s strategy must be
matched not only to its external market circumstances but also to its
internal resources and competitive capabilities.
3. With this new edition, we provide the clearest, easiest to understand
presentation of the value-price-cost framework. In recent years, this
framework has become an essential aid to teaching students how
companies create economic value in the course of conducting business.
We show how this simple framework informs the concept of the business
model as well as the all-important concept of competitive advantage. In
Chapter 5, we add further clarity by showing in pictorial fashion how the
value-price-cost framework relates to the different sources of competitive
advantage that underlie the five generic strategies.
4. Our coverage of cooperative strategies and the role that
interorganizational activity can play in the pursuit of competitive
advantage is similarly distinguished. The topics of the value net,
ecosystems, strategic alliances, licensing, joint ventures, and other types
of collaborative relationships are featured prominently in a number of
chapters and are integrated into other material throughout the text. We
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show how strategies of this nature can contribute to the success of single-
business companies as well as multibusiness enterprises, whether with
respect to firms operating in domestic markets or those operating in the
international realm.
5. The attention we give to international strategies, in all their dimensions,
make this textbook an indispensable aid to understanding strategy
formulation and execution in an increasingly connected, global world.
Our treatment of this topic as one of the most critical elements of the
scope of a company’s activities brings home to students the connection
between the topic of international strategy with other topics concerning
firm scope, such as multibusiness (or corporate) strategy, outsourcing,
insourcing, and vertical integration.
6. With a standalone chapter devoted to these topics, our coverage of
business ethics, corporate social responsibility, and environmental
sustainability goes well beyond that offered by any other leading strategy
text. Chapter 9, “Ethics, Corporate Social Responsibility, Environmental
Sustainability, and Strategy,” fulfills the important functions of (1)
alerting students to the role and importance of ethical and socially
responsible decision making and (2) addressing the accreditation
requirement of the AACSB International that business ethics be
visibly and thoroughly embedded in the core curriculum. Moreover,
discussions of the roles of values and ethics are integrated into portions
of other chapters, beginning with the first chapter, to further reinforce
why and how considerations relating to ethics, values, social
responsibility, and sustainability should figure prominently into the
managerial task of crafting and executing company strategies.
7. Long known as an important differentiator of this text, the case collection
in the 23rd edition is truly unrivaled from the standpoints of student
appeal, teachability, and suitability for drilling students in the use of the
concepts and analytical treatments in Chapters 1 through 12. The 27
cases included in this edition are the very latest, the best, and the most on
target that we could find. The ample information about the cases in the
Instructor’s Manual makes it effortless to select a set of cases each term
that will capture the interest of students from start to finish.
8. The text is now optimized for hybrid and online delivery through robust
assignment and assessment content integrated into Connect™. This will
enable professors to gauge class members’ prowess in accurately
completing (a) additional exercises and selected chapter-end exercises,
(b) chapter-end quizzes, (c) exercises for simulation participants, and (d)
exercises for 14 of the cases in this edition.
9. Two cutting-edge and widely used strategy simulations—The Business
Strategy Game and GLO-BUS—are optional companions to the 23rd
edition. These give you an unmatched capability to employ a text-case-
simulation model of course delivery.
ORGANIZATION, CONTENT, AND
FEATURES OF THE 23RD-EDITION
TEXT CHAPTERS
Chapter 1 serves as a brief, general introduction to the topic of strategy,
focusing on the central questions of “What is strategy?” and “Why is it
important?” As such, it serves as the perfect accompaniment for your
opening-day lecture on what the course is all about and why it matters.
Using the example of Apple, Inc., to drive home the concepts in this
chapter, we introduce students to what we mean by “competitive
advantage” and the key features of business-level strategy. Describing
strategy making as a process, we explain why a company’s strategy is
partly planned and partly reactive and why a strategy tends to co-evolve
with its environment over time. As part of this strategy making process,
we discuss the importance of ethics in choosing among strategic
alternatives. We introduce the concept of a business model and offer a
clear definition along with an illustration capsule that provides examples
from the real world of business. We explain why a viable business model
must provide both an attractive value proposition for the company’s
customers and a formula for making profits for the company. A key
feature of this chapter is a depiction of how the value-price-cost
framework can be used to frame this discussion. We show how the mark
of a winning strategy is its ability to pass three tests: (1) the fit test (for
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internal and external fit), (2) the competitive advantage test, and (3) the
performance test. And we explain why good company performance
depends not only upon a sound strategy but upon solid strategy execution
as well.
Chapter 2 presents a more complete overview of the strategic
management process, covering topics ranging from the role of vision,
mission, and values to what constitutes good corporate governance. It
makes a great assignment for the second day of class and provides a
smooth transition into the heart of the course. It introduces
students to such core concepts as strategic versus financial
objectives, the balanced scorecard, strategic intent, and business-level
versus corporate-level strategies. It explains why all managers are on a
company’s strategy-making, strategy- executing team and why a
company’s strategic plan is a collection of strategies devised by different
managers at different levels in the organizational hierarchy. The chapter
concludes with a section on the role of the board of directors in the
strategy-making, strategy-executing process and examines the conditions
that have led to recent high-profile corporate governance failures. The
illustration capsule on Volkswagen’s emissions scandal brings this section
to life.
The next two chapters introduce students to the two most fundamental
perspectives on strategy making: the positioning view, exemplified by
Michael Porter’s classic “five forces model of competition,” and the
resource-based view. Chapter 3 provides what has long been the clearest,
most straightforward discussion of the five forces framework to be found
in any text on strategic management. It also offers a set of complementary
analytical tools for conducting competitor analysis, identifying strategic
groups along with the mobility barriers that limit movement among them,
and demonstrates the importance of tailoring strategy to fit the
circumstances of a company’s industry and competitive environment. The
chapter includes a discussion of the value net framework, which is useful
for conducting analysis of how cooperative as well as competitive moves
by various parties contribute to the creation and capture of value in an
industry.
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Chapter 4 presents the resource-based view of the firm, showing why
resource and capability analysis is such a powerful tool for sizing up a
company’s competitive assets. It offers a simple framework for
identifying a company’s resources and capabilities and explains how the
VRIN framework can be used to determine whether they can provide the
company with a sustainable competitive advantage over its competitors.
Other topics covered in this chapter include dynamic capabilities, SWOT
analysis, value chain analysis, benchmarking, and competitive strength
assessments, thus enabling a solid appraisal of a company’s cost position
and customer value proposition vis-á-vis its rivals. An important feature
of this chapter is a table showing how key financial and operating ratios
are calculated and how to interpret them. Students will find this table
handy in doing the number crunching needed to evaluate whether a
company’s strategy is delivering good financial performance.
Chapter 5 sets forth the basic approaches available for competing and
winning in the marketplace in terms of the five generic competitive
strategies— broad low-cost, broad differentiation, best-cost, focused
differentiation, and focused low cost. It demonstrates pictorially the link
between generic strategies, the value-price-cost framework, and
competitive advantage. The chapter also describes when each of the five
approaches works best and what pitfalls to avoid. Additionally, it explains
the role of cost drivers and uniqueness drivers in reducing a company’s
costs and enhancing its differentiation, respectively.
Chapter 6 focuses on other strategic actions a company can take to
complement its competitive approach and maximize the power of its
overall strategy. These include a variety of offensive or defensive
competitive moves, and their timing, such as blue-ocean strategies and
first-mover advantages and disadvantages. It also includes choices
concerning the breadth of a company’s activities (or its scope of
operations along an industry’s entire value chain), ranging from
horizontal mergers and acquisitions, to vertical integration, outsourcing,
and strategic alliances. This material serves to segue into the scope issues
covered in the next two chapters on international and diversification
strategies.
Chapter 7 takes up the topic of how to compete in international markets.
It begins with a discussion of why differing market conditions across
countries must necessarily influence a company’s strategic choices about
how to enter and compete in foreign markets. It presents five major
strategic options for expanding a company’s geographic scope and
competing in foreign markets: export strategies, licensing, franchising,
establishing a wholly owned subsidiary via acquisition or “greenfield”
venture, and alliance strategies. It includes coverage of topics such as
Porter’s Diamond of National Competitive Advantage, multi-market
competition, and the choice between multidomestic, global, and
transnational strategies. This chapter explains the impetus for sharing,
transferring, or accessing valuable resources and capabilities across
national borders in the quest for competitive advantage, connecting the
material to that on the resource-based view from Chapter 4. The chapter
concludes with a discussion of the unique characteristics of competing in
developing-country markets.
Chapter 8 concerns strategy making in the multibusiness company,
introducing the topic of corporate-level strategy with its special focus on
diversification. The first portion of this chapter describes when and why
diversification makes good strategic sense, the different means of
diversifying a company’s business lineup, and the pros and cons of
related versus unrelated diversification strategies. The second part of the
chapter looks at how to evaluate the attractiveness of a diversified
company’s business lineup, how to decide whether it has a good
diversification strategy, and what strategic options are available for
improving a diversified company’s future performance. The evaluative
technique integrates material concerning both industry analysis and the
resource-based view, in that it considers the relative attractiveness of the
various industries the company has diversified into, the company’s
competitive strength in each of its lines of business, and the extent to
which its different businesses exhibit both strategic fit and resource fit.
Although the topic of ethics and values comes up at various points in this
textbook, Chapter 9 brings more direct attention to such issues and may
be used as a stand-alone assignment in either the early, middle, or late
part of a course. It concerns the themes of ethical standards in business,
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approaches to ensuring consistent ethical standards for companies with
international operations, corporate social responsibility, and
environmental sustainability. The contents of this chapter are sure to give
students some things to ponder, rouse lively discussion, and help to make
students more ethically aware and conscious of why all companies should
conduct their business in a socially responsible and sustainable manner.
The next three chapters (Chapters 10, 11, and 12) comprise a module on
strategy execution that is presented in terms of a 10-step action
framework. Chapter 10 provides an overview of this framework and then
explores the first three of these tasks: (1) staffing the organization with
people capable of executing the strategy well, (2) building the
organizational capabilities needed for successful strategy execution, and
(3) creating an organizational structure supportive of the strategy
execution process.
Chapter 11 discusses five additional managerial actions that advance the
cause of good strategy execution: (1) allocating resources to enable the
strategy execution process, (2) ensuring that policies and procedures
facilitate rather than impede strategy execution, (3) using process
management tools and best practices to drive continuous improvement in
the performance of value chain activities, (4) installing information and
operating systems that help company personnel carry out their
strategic roles, and (5) using rewards and incentives to
encourage good strategy execution and the achievement of performance
targets.
Chapter 12 completes the 10-step framework with a consideration of the
importance of creating a healthy corporate culture and exercising
effective leadership in promoting good strategy execution. The recurring
theme throughout the final three chapters is that executing strategy
involves deciding on the specific actions, behaviors, and conditions
needed for a smooth strategy-supportive operation and then following
through to get things done and deliver results. The goal here is to ensure
that students understand that the strategy-executing phase is a make-
things-happen and make-them-happen-right kind of managerial exercise
—one that is critical for achieving operating excellence and reaching the
goal of strong company performance.
In this latest edition, we have put our utmost effort into ensuring that the
12 chapters are consistent with the latest and best thinking of academics and
practitioners in the field of strategic management and provide the topical
coverage required for both undergraduate and MBA-level strategy courses.
The ultimate test of the text, of course, is the positive pedagogical impact it
has in the classroom. If this edition sets a more effective stage for your
lectures and does a better job of helping you persuade students that the
discipline of strategy merits their rapt attention, then it will have fulfilled its
purpose.
THE CASE COLLECTION
The 27-case lineup in this edition is flush with interesting companies and
valuable lessons for students in the art and science of crafting and executing
strategy. There’s a good blend of cases from a length perspective—about
two-thirds of the cases are under 15 pages yet offer plenty for students to
chew on; and the remainder are detail-rich cases that call for more sweeping
analysis.
At least 25 of the 27 cases involve companies, products, people, or
activities that students will have heard of, know about from personal
experience, or can easily identify with. The lineup includes at least 20 cases
that will deepen student understanding of the special demands of competing
in industry environments where product life cycles are short and
competitive maneuvering among rivals is quite active. Twenty-three of the
cases involve situations in which company resources and competitive
capabilities play as large a role in the strategy-making, strategy executing
scheme of things as industry and competitive conditions do. Scattered
throughout the lineup are 20 cases concerning nonU.S. companies, globally
competitive industries, and/or cross-cultural situations. These cases, in
conjunction with the globalized content of the text chapters, provide
abundant material for linking the study of strategic management tightly to
the ongoing globalization of the world economy. You’ll also find 8 cases
dealing with the strategic problems of family-owned or relatively small
entrepreneurial businesses and 24 cases involving public companies and
situations where students can do further research on the Internet.
page xv
The “Guide to Case Analysis” follows the last case. It contains sections
on what a case is, why cases are a standard part of courses in strategy,
preparing a case for class discussion, doing a written case analysis, doing an
oral presentation, and using financial ratio analysis to assess a company’s
financial condition. We suggest having students read this guide before the
first class discussion of a case.
A number of cases have accompanying YouTube video segments which
are listed in Section 3 of the Instructor’s Manual, in a separate Video
Library within the Instructor’s Resources, and in the Teaching Note for each
case.
THE TWO STRATEGY SIMULATION
SUPPLEMENTS: THE BUSINESS
STRATEGY GAME AND GLO-BUS
The Business Strategy Game and GLO-BUS: Developing Winning
Competitive Strategies— two competition-based strategy simulations that
are delivered online and that feature automated processing and grading of
performance—are being marketed by the publisher as companion
supplements for use with the 23rd edition (and other texts in the field).
The Business Strategy Game is the world’s most popular strategy
simulation, having been used by nearly 3,600 different instructors for
courses involving close to one million students at 1,300 university
campuses in 76 countries. It features global competition in the athletic
footwear industry, a product/market setting familiar to students
everywhere and one whose managerial challenges are easily grasped. A
freshly updated and much-enhanced version of The Business Strategy
Game was introduced in August 2018.
GLO-BUS, a newer and somewhat simpler strategy simulation first
introduced in 2004 and freshly revamped in 2016 to center on
competition in two exciting product categories—wearable miniature
action cameras and unmanned camera-equipped drones suitable for
multiple commercial purposes, has been used by 2,100 different
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instructors for courses involving nearly 360,000 students at 800+
university campuses in 53 countries.
How the Strategy Simulations Work
In both The Business Strategy Game (BSG) and GLO-BUS, class members
are divided into teams of one to five persons and assigned to run a company
that competes head-to-head against companies run by other class members.
In both simulations, companies compete in a global market arena, selling
their products in four geographic regions— Europe-Africa, North America,
Asia-Pacific, and Latin America. Each management team is called upon to
craft a strategy for their company and make decisions relating to production
operations, workforce compensation, pricing and marketing, social
responsibility/citizenship, and finance.
Company co-managers are held accountable for their decision making.
Each company’s performance is scored on the basis of earnings per share,
return-on-equity investment, stock price, credit rating, and image rating.
Rankings of company performance, along with a wealth of industry and
company statistics, are available to company co-managers after each
decision round to use in making strategy adjustments and operating
decisions for the next competitive round. You can be certain that the market
environment, strategic issues, and operating challenges that company co-
managers must contend with are very tightly linked to what your class
members will be reading about in the text chapters. The circumstances that
co-managers face in running their simulation company embrace the very
concepts, analytical tools, and strategy options they encounter in the text
chapters (this is something you can quickly confirm by skimming through
some of the Exercises for Simulation Participants that appear at the end of
each chapter).
We suggest that you schedule one or two practice rounds and anywhere
from four to 10 regular (scored) decision rounds (more rounds are better
than fewer rounds). Each decision round represents a year of company
operations and will entail roughly two hours of time for
company co-managers to complete. In traditional 13-week,
semester-long courses, there is merit in scheduling one decision round per
week. In courses that run five to 10 weeks, it is wise to schedule two
decision rounds per week for the last several weeks of the term ( sample
course schedules are provided for courses of varying length and varying
numbers of class meetings).
When the instructor-specified deadline for a decision round arrives, the
simulation server automatically accesses the saved decision entries of each
company, determines the competitiveness and buyer appeal of each
company’s product offering relative to the other companies being run by
students in your class, and then awards sales and market shares to the
competing companies, geographic region by geographic region. The unit
sales volumes awarded to each company are totally governed by
How its prices compare against the prices of rival brands.
How its product quality compares against the quality of rival brands.
How its product line breadth and selection compare.
How its advertising effort compares.
And so on, for a total of 11 competitive factors that determine unit sales
and market shares.
The competitiveness and overall buyer appeal of each company’s product
offering in comparison to the product offerings of rival companies is all-
decisive—this algorithmic feature is what makes BSG and GLO-BUS
“competition-based” strategy simulations. Once each company’s sales and
market shares are awarded based on the competitiveness and buyer appeal
of its respective overall product offering vis-à-vis those of rival companies,
the various company and industry reports detailing the outcomes of the
decision round are then generated. Company co-managers can access the
results of the decision round 15 to 20 minutes after the decision deadline.
The Compelling Case for Incorporating Use of a Strategy
Simulation
There are three exceptionally important benefits associated with using a
competition-based simulation in strategy courses taken by seniors and MBA
students:
A three-pronged text-case-simulation course model delivers significantly
more teaching-learning power than the traditional text-case model. Using
page xvii
both cases and a strategy simulation to drill students in thinking
strategically and applying what they read in the text chapters is a stronger,
more effective means of helping them connect theory with practice and
develop better business judgment. What cases do that a simulation cannot
is give class members broad exposure to a variety of companies and
industry situations and insight into the kinds of strategy-related problems
managers face. But what a competition-based strategy simulation does far
better than case analysis is thrust class members squarely into an active,
hands-on managerial role where they are totally responsible for assessing
market conditions, determining how to respond to the actions of
competitors, forging a long-term direction and strategy for their company,
and making all kinds of operating decisions. Because they are held fully
accountable for their decisions and their company’s performance, co-
managers are strongly motivated to dig deeply into company operations,
probe for ways to be more cost-efficient and competitive, and ferret out
strategic moves and decisions calculated to boost company performance.
Consequently, incorporating both case assignments and a
strategy simulation to develop the skills of class members in
thinking strategically and applying the concepts and tools of strategic
analysis turns out to be more pedagogically powerful than relying solely
on case assignments—there’s stronger retention of the lessons learned
and better achievement of course learning objectives.
To provide you with quantitative evidence of the learning that occurs
with using The Business Strategy Game or GLO-BUS, there is a built-in
Learning Assurance Report showing how well each class member
performs on nine skills/learning measures versus tens of thousands of
students worldwide who have completed the simulation in the past 12
months.
The competitive nature of a strategy simulation arouses positive energy
and steps up the whole tempo of the course by a notch or two. Nothing
sparks class excitement quicker or better than the concerted efforts on the
part of class members at each decision round to achieve a high industry
ranking and avoid the perilous consequences of being outcompeted by
other class members. Students really enjoy taking on the role of a
manager, running their own company, crafting strategies, making all
kinds of operating decisions, trying to outcompete rival companies, and
getting immediate feedback on the resulting company performance. Lots
of back-and-forth chatter occurs when the results of the latest simulation
round become available and co-managers renew their quest for strategic
moves and actions that will strengthen company performance. Co-
managers become emotionally invested in running their company and
figuring out what strategic moves to make to boost their company’s
performance. Interest levels climb. All this stimulates learning and causes
students to see the practical relevance of the subject matter and the
benefits of taking your course.
As soon as your students start to say, “Wow! Not only is this fun but I
am learning a lot,” which they will, you have won the battle of engaging
students in the subject matter and moved the value of taking your course
to a much higher plateau in the business school curriculum. This
translates into a livelier, richer learning experience from a student
perspective and better instructor-course evaluations.
Use of a fully automated online simulation reduces the time instructors
spend on course preparation, course administration, and grading. Since
the simulation exercise involves a 20- to 30-hour workload for student
teams (roughly two hours per decision round times 10 to 12 rounds, plus
optional assignments), simulation adopters often compensate by trimming
the number of assigned cases from, say, 10 to 12 to perhaps 4 to 6. This
significantly reduces the time instructors spend reading cases, studying
teaching notes, and otherwise getting ready to lead class discussion of a
case or grade oral team presentations. Course preparation time is further
cut because you can use several class days to have students bring their
laptops to class or meet in a computer lab to work on upcoming decision
rounds or a three-year strategic plan (in lieu of lecturing on a chapter or
covering an additional assigned case). Not only does use of a simulation
permit assigning fewer cases, but it also permits you to eliminate at least
one assignment that entails considerable grading on your part. Grading
one less written case or essay exam or other written assignment saves
enormous time. With BSG and GLO-BUS, grading is effortless and takes
only minutes; once you enter percentage weights for each assignment in
your online grade book, a suggested overall grade is calculated for you.
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You’ll be pleasantly surprised—and quite pleased—at how little time it
takes to gear up for and administer The Business Strategy Game or GLO-
BUS.
In sum, incorporating use of a strategy simulation turns out to be a
win–win proposition for both students and instructors. Moreover, a very
convincing argument can be made that a competition-based strategy
simulation is the single most effective teaching/ learning tool that
instructors can employ to teach the discipline of business and competitive
strategy, to make learning more enjoyable, and to promote better
achievement of course learning objectives.
A Bird’s-Eye View of The Business Strategy Game
The setting for The Business Strategy Game (BSG) is the global athletic
footwear industry (there can be little doubt in today’s world that a globally
competitive strategy simulation is vastly superior to a simulation with a
domestic-only setting). Global market demand for footwear grows at the
rate of seven to nine percent annually for the first five years and five to
seven percent annually for the second five years. However, market growth
rates vary by geographic region—North America, Latin America, Europe-
Africa, and Asia-Pacific.
Companies begin the simulation producing branded and private-label
footwear in two plants, one in North America and one in Asia. They have
the option to establish production facilities in Latin America and Europe-
Africa. Company co-managers exercise control over production costs on the
basis of the styling and quality they opt to manufacture, plant location
(wages and incentive compensation vary from region to region), the use of
best practices and Six Sigma programs to reduce the production of defective
footwear and to boost worker productivity, and compensation practices.
All newly produced footwear is shipped in bulk containers to one of four
geographic distribution centers. All sales in a geographic region are made
from footwear inventories in that region’s distribution center. Costs at the
four regional distribution centers are a function of inventory storage costs,
packing and shipping fees, import tariffs paid on incoming pairs shipped
from foreign plants, and exchange rate impacts. At the start of the
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simulation, import tariffs average $4 per pair in North America, $6 in
Europe-Africa, $8 per pair in Latin America, and $10 in the Asia-Pacific
region. Instructors have the option to alter tariffs as the game progresses.
Companies market their brand of athletic footwear to footwear retailers
worldwide and to individuals buying online at the company’s website. Each
company’s sales and market share in the branded footwear segments hinge
on its competitiveness on 13 factors: attractive pricing, footwear styling and
quality, product line breadth, advertising, use of mail-in rebates, appeal of
celebrities endorsing a company’s brand, success in convincing footwear
retailers to carry its brand, number of weeks it takes to fill retailer orders,
effectiveness of a company’s online sales effort at its website, and brand
reputation. Sales of private-label footwear hinge solely on being the low-
price bidder.
All told, company co-managers make as many as 57 types of decisions
each period that cut across production operations (up to 11 decisions per
plant, with a maximum of four plants), the addition of facility space,
equipment, and production improvement options (up to eight decisions per
plant), worker compensation and training (up to six decisions per plant),
shipping and distribution center operations (five decisions per geographic
region), pricing and marketing (up to nine decisions in four geographic
regions), bids to sign celebrities (two decision entries per bid), financing of
company operations (up to eight decisions), and corporate social
responsibility and environmental sustainability (up to eight decisions). Plus,
there are 10 entries for each region pertaining to assumptions about the
upcoming-year actions and competitive efforts of rival companies that
factor directly into the forecasts of a company’s unit sales, revenues, and
market share in each of the four geographic regions.
Each time company co-managers make a decision entry, an
assortment of on-screen calculations instantly shows the projected effects
on unit sales, revenues, market shares, unit costs, profit, earnings per share,
ROE, and other operating statistics. The on-screen calculations help team
members evaluate the relative merits of one decision entry versus another
and put together a promising strategy.
Companies can employ any of the five generic competitive strategy
options in selling branded footwear—low-cost leadership, differentiation,
best-cost provider, focused low cost, and focused differentiation. They can
pursue essentially the same strategy worldwide or craft slightly or very
different strategies for the Europe-Africa, Asia-Pacific, Latin America, and
North America markets. They can strive for competitive advantage based
on more advertising, a wider selection of models, more appealing
styling/quality, bigger rebates, and so on.
Any well-conceived, well-executed competitive approach is capable of
succeeding, provided it is not overpowered by the strategies of competitors
or defeated by the presence of too many copycat strategies that dilute its
effectiveness. The challenge for each company’s management team is to
craft and execute a competitive strategy that produces good performance on
five measures: earnings per share, return on equity investment, stock price
appreciation, credit rating, and brand image.
All activity for The Business Strategy Game takes place at www.bsg-
online.com.
A Bird’s-Eye View of GLO-BUS
In GLO-BUS, class members run companies that are in a neck-and-neck
race for global market leadership in two product categories: (1) wearable
video cameras smaller than a teacup that deliver stunning video quality and
have powerful photo capture capabilities (comparable to those designed and
marketed by global industry leader GoPro and numerous others) and (2)
sophisticated camera-equipped copter drones that incorporate a company
designed and assembled action-capture camera and that are sold to
commercial enterprises for prices in the $850 to 2,000+ range. Global
market demand for action cameras grows at the rate of six to eight percent
annually for the first five years and four to six percent annually for the
second five years. Global market demand for commercial drones grows
briskly at rates averaging 18 percent for the first two years, then gradually
slows over eight years to a rate of four to six percent.
Companies assemble action cameras and drones of varying designs and
performance capabilities at a Taiwan facility and ship finished goods
directly to buyers in North America, Asia-Pacific, Europe-Africa, and Latin
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America. Both products are assembled usually within two weeks of being
received and are then shipped to buyers no later than two to three days after
assembly. Companies maintain no finished goods inventories and all parts
and components are delivered by suppliers on a just-in-time basis (which
eliminates the need to track inventories and simplifies the accounting for
plant operations and costs).
Company co-managers determine the quality and performance features of
the cameras and drones being assembled. They impact production costs by
raising/lowering specifications for parts/components and expenditures for
product R&D, adjusting work force compensation, spending more/less on
worker training and productivity improvement, lengthening/shortening
warranties offered (which affects warranty costs), and how cost-efficiently
they manage assembly operations. They have options to manage/ control
selling and certain other costs as well.
Each decision round, company co-managers make some 50 types of
decisions relating to the design and performance of the company’s two
products (21 decisions, 10 for cameras and 11 for drones), assembly
operations and workforce compensation (up to eight decision
entries for each product), pricing and marketing (seven decisions
for cameras and five for drones), corporate social responsibility and
citizenship (up to six decisions), and the financing of company operations
(up to eight decisions). In addition, there are 10 entries for cameras and
seven entries for drones involving assumptions about the competitive
actions of rivals; these entries help company co-managers to make more
accurate forecasts of their company’s unit sales (so they have a good idea of
how many cameras and drones will need to be assembled each year to fill
customer orders). Each time co-managers make a decision entry, an
assortment of on-screen calculations instantly shows the projected effects
on unit sales, revenues, market shares, total profit, earnings per share, ROE,
costs, and other operating outcomes. All of these on-screen calculations
help co-managers evaluate the relative merits of one decision entry versus
another. Company managers can try out as many different decision
combinations as they wish in stitching the separate decision entries into a
cohesive whole that is projected to produce good company performance.
Competition in action cameras revolves around 11 factors that determine
each company’s unit sales/market share:
1. How each company’s average wholesale price to retailers compares
against the all-company average wholesale prices being charged in each
geographic region.
2. How each company’s camera performance and quality compares against
industry-wide camera performance/quality.
3. How the number of week-long sales promotion campaigns a company
has in each region compares against the regional average number of
weekly promotions.
4. How the size of each company’s discounts off the regular wholesale
prices during sales promotion campaigns compares against the regional
average promotional discount.
5. How each company’s annual advertising expenditures compare against
regional average advertising expenditures.
6. How the number of models in each company’s camera line compares
against the industry-wide average number of models.
7. The number of retailers stocking and merchandising a company’s brand
in each region.
8. Annual expenditures to support the merchandising efforts of retailers
stocking a company’s brand in each region.
9. The amount by which a company’s expenditures for ongoing
improvement and updating of its company’s website in a region is
above/below the all-company regional average expenditure.
10. How the length of each company’s camera warranties compare against
the warranty periods of rival companies.
11. How well a company’s brand image/reputation compares against the
brand images/ reputations of rival companies.
Competition among rival makers of commercial copter drones is more
narrowly focused on just nine sales-determining factors:
1. How a company’s average retail price for drones at the company’s
website in each region compares against the all-company regional
average website price.
2. How each company’s drone performance and quality compares against
the all- company average drone performance/quality.
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3. How the number of models in each company’s drone line compares
against the industry-wide average number of models.
4. How each company’s annual expenditures to recruit/support third-party
online electronics retailers in merchandising its brand of drones in each
region compares against the regional average.
5. The amount by which a company’s price discount to third-party online
retailers is above/below the regional average discounted price.
6. How well a company’s expenditures for search engine advertising in a
region compares against the regional average.
7. How well a company’s expenditures for ongoing improvement and
updating of its website in a region compares against the regional average.
8. How the length of each company’s drone warranties in a region compares
against the regional average warranty period.
9. How well a company’s brand image/reputation compares against the
brand images/ reputations of rival companies.
Each company typically seeks to enhance its performance and build
competitive advantage via its own custom-tailored competitive strategy
based on more attractive pricing, greater advertising, a wider selection of
models, more appealing performance/ quality, longer warranties, a better
image/reputation, and so on. The greater the differences in the overall
competitiveness of the product offerings of rival companies, the bigger the
differences in their resulting sales volumes and market shares. Conversely,
the smaller the overall competitive differences in the product offerings of
rival companies, the smaller the differences in sales volumes and market
shares. This algorithmic approach is what makes GLO-BUS a “competition-
based” strategy simulation and accounts for why the sales and market share
outcomes for each decision round are always unique to the particular
strategies and decision combinations employed by the competing
companies.
As with BSG, all the various generic competitive strategy options—low-
cost leadership, differentiation, best-cost provider, focused low-cost, and
focused differentiation—are viable choices for pursuing competitive
advantage and good company performance. A company can have a strategy
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aimed at being the clear market leader in either action cameras or drones or
both. It can focus its competitive efforts on one or two or three geographic
regions or strive to build strong market positions in all four geographic
regions. It can pursue essentially the same strategy worldwide or craft
customized strategies for the Europe-Africa, Asia-Pacific, Latin America,
and North America markets. Just as with The Business Strategy Game, most
any well-conceived, well-executed competitive approach is capable of
succeeding, provided it is not overpowered by the strategies of competitors
or defeated by the presence of too many copycat strategies that dilute its
effectiveness.
The challenge for each company’s management team is to craft and
execute a competitive strategy that produces good performance on five
measures: earnings per share, return on equity investment, stock price
appreciation, credit rating, and brand image.
All activity for GLO-BUS occurs at www.glo-bus.com.
Special Note: The time required of company co-managers to complete each
decision round in GLO-BUS is typically about 15 to 30 minutes less than
for The Business Strategy Game because
(a
) there are only 8 market segments (versus 12 in BSG),
(b
) co-managers have only one assembly site to operate (versus
potentially as many as four plants in BSG, one in each
geographic region), and
(c
) newly assembled cameras and drones are shipped directly to
buyers, eliminating the need to manage finished goods
inventories and operate distribution centers.
Administration and Operating Features of the Two
Simulations
http://www.glo-bus.com/
The Internet delivery and user-friendly designs of both BSG and GLO-BUS
make them incredibly easy to administer, even for first-time users. And the
menus and controls are so similar that you can readily switch between the
two simulations or use one in your undergraduate class and the other in a
graduate class. If you have not yet used either of the two simulations, you
may find the following of particular interest:
Setting up the simulation for your course is done online and takes about
10 to 15 minutes. Once setup is completed, no other administrative
actions are required beyond those of moving participants to a different
team (should the need arise) and monitoring the progress of the
simulation (to whatever extent desired).
Participant’s Guides are delivered electronically to class members at the
website— students can read the guide on their monitors or print out a
copy, as they prefer.
There are two to four minute Video Tutorials scattered throughout the
software (including each decision screen and each page of each report)
that provide on-demand guidance to class members who may be uncertain
about how to proceed.
Complementing the Video Tutorials are detailed and clearly written Help
sections explaining “all there is to know” about (a) each decision entry
and the relevant cause-effect relationships, (b) the information on each
page of the Industry Reports, and (c) the numbers presented in the
Company Reports. The Video Tutorials and the Help screens allow
company co-managers to figure things out for themselves, thereby
curbing the need for students to ask the instructor “how things work.”
Team members running the same company who are logged in
simultaneously on different computers at different locations can click a
button to enter Collaboration Mode, enabling them to work
collaboratively from the same screen in viewing reports and making
decision entries, and click a second button to enter Audio Mode, letting
them talk to one another and hold an online meeting.
When in “Collaboration Mode,” each team member sees the same
screen at the same time as all other team members who are logged in
and have joined Collaboration Mode. If one team member chooses
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to view a particular decision screen, that same screen appears on the
monitors for all team members in Collaboration Mode.
Each team member controls their own color-coded mouse pointer
(with their first-name appearing in a color-coded box linked to their
mouse pointer) and can make a decision entry or move the mouse to
point to particular on-screen items.
A decision entry change made by one team member is seen by all, in
real time, and all team members can immediately view the on-screen
calculations that result from the new decision entry.
If one team member wishes to view a report page and clicks on the
menu link to the desired report, that same report page will
immediately appear for the other team members engaged in
collaboration.
Use of Audio Mode capability requires that each team member work
from a computer with a built-in microphone (if they want to be heard
by their team members) and speakers (so they may hear their
teammates) or else have a headset with a microphone that they can
plug into their desktop or laptop. A headset is recommended for best
results, but most laptops now are equipped with a built-in
microphone and speakers that will support use of our new voice chat
feature.
Real-time VoIP audio chat capability among team members who
have entered both the Audio Mode and the Collaboration Mode is a
tremendous boost in functionality that enables team members to go
online simultaneously on computers at different locations and
conveniently and effectively collaborate in running their simulation
company.
In addition, instructors have the capability to join the online session
of any company and speak with team members, thus circumventing
the need for team members to arrange for and attend a meeting in the
instructor’s office. Using the standard menu for administering a
particular industry, instructors can connect with the company
desirous of assistance. Instructors who wish not only to talk but also
to enter Collaboration (highly recommended because all attendees
are then viewing the same screen) have a red-colored mouse pointer
linked to a red box labeled Instructor.
Without a doubt, the Collaboration and Voice-Chat capabilities are
hugely valuable for students enrolled in online and distance-learning
courses where meeting face-to-face is impractical or time-consuming.
Likewise, the instructors of online and distance-learning courses will
appreciate having the capability to join the online meetings of particular
company teams when their advice or assistance is requested.
Both simulations work equally well for online courses and in-person
classes.
Participants and instructors are notified via e-mail when the results are
ready (usually about 15 to 20 minutes after the decision round deadline
specified by the instructor/game administrator).
Following each decision round, participants are provided with a complete
set of reports—a six-page Industry Report, a Competitive Intelligence
report for each geographic region that includes strategic group maps and a
set of Company Reports (income statement, balance sheet, cash flow
statement, and assorted production, marketing, and cost statistics).
Two “open-book” multiple-choice tests of 20 questions are built into each
simulation. The quizzes, which you can require or not as you see fit, are
taken online and automatically graded, with scores reported
instantaneously to participants and automatically recorded in the
instructor’s electronic grade book. Students are automatically provided
with three sample questions for each test.
Both simulations contain a three-year strategic plan option that you can
assign. Scores on the plan are automatically recorded in the instructor’s
online grade book.
At the end of the simulation, you can have students complete online peer
evaluations (again, the scores are automatically recorded in your online
grade book).
Both simulations have a Company Presentation feature that enables each
team of company co-managers to easily prepare PowerPoint slides for use
in describing their strategy and summarizing their company’s
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performance in a presentation to either the class, the instructor, or an
“outside” board of directors.
A Learning Assurance Report provides you with hard data concerning
how well your students performed vis-à-vis students playing the
simulation worldwide over the past 12 months. The report is based on
nine measures of student proficiency, business know-how, and decision-
making skill and can also be used in evaluating the extent to which your
school’s academic curriculum produces the desired degree of student
learning insofar as accreditation standards are concerned.
For more details on either simulation, please consult
Section 2 of the Instructor’s Manual accompanying this text or register as
an instructor at the simulation websites (www.bsg-online.com and
www.glo-bus.com) to access even more comprehensive information. You
should also consider signing up for one of the webinars that the simulation
authors conduct several times each month (sometimes several times
weekly) to demonstrate how the software works, walk you through the
various features and menu options, and answer any questions. You have an
open invitation to call the senior author of this text at (205) 722-9145 to
arrange a personal demonstration or talk about how one of the simulations
might work in one of your courses. We think you’ll be quite impressed with
the cutting-edge capabilities that have been programmed into The Business
Strategy Game and GLO-BUS, the simplicity with which both simulations
can be administered, and their exceptionally tight connection to the text
chapters, core concepts, and standard analytical tools.
RESOURCES AND SUPPORT
MATERIALS FOR THE 23RD EDITION
For Students
Key Points Summaries At the end of each chapter is a synopsis
of the core concepts, analytical tools, and other key points discussed in the
chapter. These chapter-end synopses, along with the core concept
http://www.bsg-online.com/
http://www.glo-bus.com/
page xxv
definitions and margin notes scattered throughout each chapter, help
students focus on basic strategy principles, digest the messages of each
chapter, and prepare for tests.
Two Sets of Chapter-End Exercises Each chapter
concludes with two sets of exercises. The Assurance of Learning Exercises
are useful for helping students prepare for class discussion and to gauge
their understanding of the material. The Exercises for Simulation
Participants are designed expressly for use in class which incorporate the
use of a simulation. These exercises explicitly connect the chapter content
to the simulation company the students are running. Even if they are not
assigned by the instructor, they can provide helpful practice for students as
a study aid.
Connect™ The 23rd edition takes full advantage of Connect™, a
personalized teaching and learning tool. The Connect™ package for this
edition includes several robust and valuable features that simplify the task
of assigning and grading three types of exercises for students:
Autograded chapter quizzes that students can take to measure their grasp
of the material presented in each of the 12 chapters.
A variety of interactive exercises for each of the 12 chapters that drill
students in the use and application of the concepts and tools of strategic
analysis, including selected Assurance of Learning Exercises and newly
integrated Exercises for Simulation Participants.
Case Exercises for 14 of the 27 cases in this edition that require students
to work through answers to a select number of the assignment questions
for the case. These exercises have multiple components and are tailored
to match the circumstances presented in each case, calling upon students
to do whatever strategic thinking and strategic analysis are
called for to arrive at pragmatic, analysis-based action
recommendations for improving company performance.
All Connect™ exercises are automatically graded (with the exception of
a few select Exercises for Simulation Participants that entail answers in the
form of short essays), thereby simplifying the task of evaluating each class
member’s performance and monitoring the learning outcomes. The
progress-tracking function built into Connect™ enables you to
View scored work immediately and track individual or group
performance with assignment and grade reports.
Access an instant view of student or class performance relative to
learning objectives.
Collect data and generate reports required by many accreditation
organizations, such as AACSB International.
SmartBook 2.0® SmartBook 2.0 is the first and only adaptive
reading experience designed to change the way students read and learn. It
creates a personalized reading experience by highlighting the most
impactful concepts a student needs to learn at that moment in time. As a
student engages with SmartBook, the reading experience continuously
adapts by highlighting content based on what the student knows and doesn’t
know. This ensures that the focus is on the content he or she needs to learn,
while simultaneously promoting long-term retention of material. Use
SmartBook’s real-time reports to quickly identify the concepts that require
more attention from individual students–or the entire class. The end result?
Students are more engaged with course content, can better prioritize their
time, and come to class ready to participate.
For Instructors
Assurance of Learning Aids Each chapter begins with a set of
Learning Objectives, which are tied directly to the material in the text
meant to address these objectives with helpful signposts. At the conclusion
of each chapter, there is a set of Assurance of Learning Exercises that can
be used as the basis for class discussion, oral presentation assignments,
short written reports, and substitutes for case assignments. Similarly, there
is a set of Exercises for Simulation Participants that are designed expressly
for use by adopters who have incorporated use of a simulation and want to
go a step further in tightly and explicitly connecting the chapter content to
the simulation company their students are running. New to this edition is
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the incorporation of these assignable Exercises for Simulation Participants
within Connect. The questions in both sets of exercises (along with those
Illustration Capsules that qualify as “mini-cases”) can be used to round out
the rest of a 75- minute class period should your lecture on a chapter last for
only 50 minutes.
Instructor Library The Connect Instructor Library is your
repository for additional resources to improve student engagement in and
out of class. You can select and use any asset that enhances your lecture.
Instructor’s Manual The accompanying IM contains:
A section on suggestions for organizing and structuring your course.
Sample syllabi and course outlines.
A set of lecture notes on each chapter.
Answers to the chapter-end Assurance of Learning Exercises.
A test bank for all 12 chapters.
A comprehensive case teaching note for each of the 27 cases. These
teaching notes are filled with suggestions for using the case effectively,
have very thorough, analysis-based answers to the suggested assignment
questions for the case, and contain an epilogue detailing any important
developments since the case was written.
Test Builder The accompanying Test Bank, which contains over 900
multiple choice and short answer/essay questions, is available in Connect™
via Test Builder.
Test Builder is a cloud-based tool that enables instructors to format tests
that can be printed or administered within an LMS. Test Builder offers a
modern, streamlined interface for easy content configuration that matches
course needs, without requiring a download. Test Builder provides a secure
interface for better protection of content and allows for just-in-time updates
to flow directly into assessments.
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PowerPoint Slides To facilitate delivery preparation of your
lectures and to serve as chapter outlines, you’ll have access to
approximately 500 colorful and professional-looking slides displaying core
concepts, analytical procedures, key points, and all the figures in the text
chapters.
CREATE™ is McGraw-Hill’s custom-publishing program where
you can access full-length readings and cases that accompany Crafting and
Executing Strategy: The Quest for a Competitive Advantage
(http://create.mheducation.com/thompson). Through Create™, you will
be able to select from 30 readings that go specifically with this textbook.
These include cases and readings from Harvard, MIT, and much more! You
can assemble your own course and select the chapters, cases, and readings
that work best for you. Also, you can choose from several ready-to-go,
author-recommended complete course solutions. Among the pre-loaded
solutions, you’ll find options for undergrad, MBA, accelerated, and other
strategy courses.
The Business Strategy Game and GLO-BUS Online
Simulations Using one of the two companion simulations is a
powerful and constructive way of emotionally connecting students to the
subject matter of the course. We know of no more effective way to arouse
the competitive energy of students and prepare them for the challenges of
real-world business decision making than to have them match strategic wits
with classmates in running a company in head-to-head competition for
global market leadership.
ACKNOWLEDGMENTS
We heartily acknowledge the contributions of the case researchers whose
case-writing efforts appear herein and the companies whose cooperation
made the cases possible. To each one goes a very special thank-you. We
cannot overstate the importance of timely, carefully researched
http://create.mheducation.com/thompson
cases in contributing to a substantive study of strategic management issues
and practices.
A great number of colleagues and students at various universities,
business acquaintances, and people at McGraw-Hill provided inspiration,
encouragement, and counsel during the course of this project. Like all text
authors in the strategy field, we are intellectually indebted to the many
academics whose research and writing have blazed new trails and advanced
the discipline of strategic management. In addition, we’d like to thank the
following reviewers who provided seasoned advice and splendid
suggestions over the years for improving the chapters:
Robert B. Baden, Edward Desmarais, Stephen F. Hallam, Joy Karriker,
Wendell Seaborne, Joan H. Bailar, David Blair, Jane Boyland, William J.
Donoher, Stephen A. Drew, Jo Anne Duffy, Alan Ellstrand, Susan Fox-
Wolfgramm, Rebecca M. Guidice, Mark Hoelscher, Sean D. Jasso, Xin
Liang, Paul Mallette, Dan Marlin, Raza Mir, Mansour Moussavi, James
D. Spina, Monica A. Zimmerman, Dennis R. Balch, Jeffrey R. Bruehl,
Edith C. Busija, Donald A. Drost, Randall Harris, Mark Lewis
Hoelscher, Phyllis Holland, James W. Kroeger, Sal Kukalis, Brian W.
Kulik, Paul Mallette, Anthony U. Martinez, Lee Pickler, Sabine Reddy,
Thomas D. Schramko, V. Seshan, Charles Strain, Sabine Turnley, S.
Stephen Vitucci, Andrew Ward, Sibin Wu, Lynne Patten, Nancy E.
Landrum, Jim Goes, Jon Kalinowski, Rodney M. Walter, Judith D.
Powell, Seyda Deligonul, David Flanagan, Esmerlda Garbi, Mohsin
Habib, Kim Hester, Jeffrey E. McGee, Diana J. Wong, F. William
Brown, Anthony F. Chelte, Gregory G. Dess, Alan B. Eisner, John
George, Carle M. Hunt, Theresa Marron-Grodsky, Sarah Marsh, Joshua
D. Martin, William L. Moore, Donald Neubaum, George M. Puia, Amit
Shah, Lois M. Shelton, Mark Weber, Steve Barndt, J. Michael Geringer,
Ming-Fang Li, Richard Stackman, Stephen Tallman, Gerardo R. Ungson,
James Boulgarides, Betty Diener, Daniel F. Jennings, David Kuhn,
Kathryn Martell, Wilbur Mouton, Bobby Vaught, Tuck Bounds, Lee
Burk, Ralph Catalanello, William Crittenden, Vince Luchsinger, Stan
Mendenhall, John Moore, Will Mulvaney, Sandra Richard, Ralph
Roberts, Thomas Turk, Gordon Von Stroh, Fred Zimmerman, S. A.
Billion, Charles Byles, Gerald L. Geisler, Rose Knotts, Joseph
page xxviii
Rosenstein, James B. Thurman, Ivan Able, W. Harvey Hegarty, Roger
Evered, Charles B. Saunders, Rhae M. Swisher, Claude I. Shell, R.
Thomas Lenz, Michael C. White, Dennis Callahan, R. Duane Ireland,
William E. Burr II, C. W. Millard, Richard Mann, Kurt Christensen, Neil
W. Jacobs, Louis W. Fry, D. Robley Wood, George J. Gore, and William
R. Soukup.
We owe a debt of gratitude to Professors Catherine A. Maritan, Jeffrey A.
Martin, Richard S. Shreve, and Anant K. Sundaram for their helpful
comments on various chapters. We’d also like to thank the following
students of the Tuck School of Business for their assistance with the
revisions: Alen A. Ameni, Dipti Badrinath, Stephanie K. Berger, Courtney
D. Bragg, Katie Coster, Jacob Crandall, Robin Daley, Kathleen T. Durante,
Shawnda Lee Duvigneaud, Isaac E. Freeman, Vedrana B. Greatorex,
Brittany J. Hattingh, Sadé M. Lawrence, Heather Levy, Margaret W.
Macauley, Ken Martin, Brian R. McKenzie, Mathew O’Sullivan, Sara
Paccamonti, Byron Peyster, Jeremy Reich, Carry S. Resor, Edward J.
Silberman, David Washer, and Lindsey Wilcox. And we’d like to
acknowledge the help of Dartmouth students Avantika Agarwal, Charles K.
Anumonwo, Maria Hart, Meaghan I. Haugh, Artie Santry, as well as Tuck
staff member Doreen Aher.
As always, we value your recommendations and thoughts
about the book. Your comments regarding coverage and contents will be
taken to heart, and we always are grateful for the time you take to call our
attention to printing errors, deficiencies, and other shortcomings. Please e-
mail us at athompso@cba.ua.edu,
margaret.a.peteraf@tuck.dartmouth.edu, john.gamble@tamucc.edu, or
astrickl@cba.ua.edu.
Arthur A. Thompson
Margaret A. Peteraf
John E. Gamble
A. J. Strickland
mailto://athompso@cba.ua.edu
mailto://margaret.a.peteraf@tuck.dartmouth.edu
mailto://john.gamble@tamucc.edu
mailto://astrickl@cba.ua.edu
page xxix
The Business Strategy Game or
GLO-BUS Simulation Exercises
The Business Strategy Game or GLO-BUS Simulation Exercises
Either one of these text supplements involves teams of students
managing companies in a head-to-head contest for global market
leadership. Company co-managers have to make decisions relating to
product quality, production, workforce compensation and training,
pricing and marketing, and financing of company operations. The
challenge is to craft and execute a strategy that is powerful enough to
deliver good financial performance despite the competitive efforts of
rival companies. Each company competes in North America, Latin
America, Europe-Africa, and Asia-Pacific.Fanatic Studio/Getty Images
page xxx
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page xxxiii
page xxxii
Brief Contents
PART
1 Concepts and Techniques for Crafting
and Executing Strategy
Section A: Introduction and Overview
1 What Is Strategy and Why Is It Important?
2
2 Charting a Company’s Direction 20
Section B: Core Concepts and Analytical Tools
3 Evaluating a Company’s External
Environment 50
4 Evaluating a Company’s Resources,
Capabilities, and Competitiveness 90
Section C: Crafting a Strategy
5 The Five Generic Competitive Strategies
126
6 Strengthening a Company’s
Competitive Position 156
7 Strategies for Competing in International
Markets 186
8 Corporate Strategy 222
9 Ethics, Corporate Social Responsibility,
Environmental Sustainability, and Strategy
266
Section D: Executing the Strategy
10 Building an Organization Capable of Good
Strategy Execution 296
11 Managing Internal Operations 328
12 Corporate Culture and Leadership 352
PART
2 Cases in Crafting and Executing
Strategy
Section A: Crafting Strategy in Single-Business
Companies
1 Airbnb in 2020 C2
2 Competition in the Craft Beer Industry in
2020 C7
3 Costco Wholesale in 2020: Mission,
Business Model, and Strategy C18
4 Ford Motor Company: Will the Company’s
Strategic Moves Restore its
Competitiveness and Financial
Performance? C43
5 Macy’s, Inc.: Will Its Strategy Allow It to
Survive in the Changing Retail Sector?
C51
6 TOMS Shoes: Expanding Its Successful
One For One Business Model C59
7 lululemon athletica’s Strategy in 2020: Is
the Recent Growth in Retail Stores,
Revenues, and Profitability Sustainable?
C68
8 Under Armour’s Strategy in 2020: Can It
Revive Sales and Profitability in Its Core
North American Market? C86
9 Spotify in 2020: Can the Company Remain
Competitive? C112
10 Beyond Meat, Inc. C124
11 Netflix’s 2020 Strategy for Battling Rivals in
the Global Market for Streamed Video
Subscribers C140
12 Twitter Inc. in 2020 C161
13 Yeti in 2020: Can Brand Name and
Innovation Keep it Ahead of the
Competition? C173
14 GoPro in 2020: Have its Turnaround
Strategies Failed? C184
15 Publix Super Markets: Its Strategy in the
U.S. Supermarket and Grocery Store
Industry C198
16 Tesla’s Strategy in 2020: Can It Deliver
Sustained Profitability? C212
17 Unilever’s Purpose-led Brand Strategy:
Can Alan Jope Balance Purpose and
Profits? C238
18 Domino’s Pizza: Business Continuity
Strategy during the Covid-19 Pandemic
C249
19 Burbank Housing: Building from the Inside
Out C260
20 Boeing 737 MAX: What Response Strategy
is Needed to Ensure Passenger Safety and
Restore the Company’s Reputation? C273
21 The Walt Disney Company: Its
Diversification Strategy in 2020 C279
22 Robin Hood C293
Section B: Crafting Strategy in Diversified Companies
23 Southwest Airlines in 2020: Culture, Values,
and Operating Practices C295
24 Uber Technologies in 2020: Is the Gig
Economy Labor Force Working for Uber?
C315
Section C: Implementing and Executing Strategy
25 Starbucks in 2020: Is the Company on
Track to Achieve Attractive Growth and
Operational Excellence? C325
page xxxiv
26 Nucor Corporation in 2020:
Pursuing Efforts to Grow Sales and Market
Share Despite Tough Market Conditions
C354
27 Eliminating Modern Slavery from Supply
Chains: Can Nestlé Lead the Way? C389
Guide to Case Analysis CA-1
INDEXES Company I-1
Name I-9
Subject I-15
page xxxv
Contents
PART
1 Concepts and Techniques for Crafting
and Executing Strategy 1
Section A: Introduction and Overview
1 What Is Strategy and Why Is It Important? 2
WHAT DO WE MEAN BY STRATEGY? 4
Strategy Is about Competing Differently 4
Strategy and the Quest for Competitive Advantage 5
Why a Company’s Strategy Evolves over Time 8
A Company’s Strategy Is Partly Proactive and Partly Reactive 9
Strategy and Ethics: Passing the Test of Moral Scrutiny 9
A COMPANY’S STRATEGY AND ITS BUSINESS MODEL
11
WHAT MAKES A STRATEGY A WINNER? 12
WHY CRAFTING AND EXECUTING STRATEGY ARE
IMPORTANT TASKS 14
Good Strategy + Good Strategy Execution = Good Management 15
THE ROAD AHEAD 15
ILLUSTRATION CAPSULES
1.1 Apple Inc.: Exemplifying a Successful Strategy 7
1.2 Pandora, SiriusXM, and Over-the-Air Broadcast Radio: Three Contrasting
Business Models 13
2 Charting a Company’s Direction 20
WHAT DOES THE STRATEGY-MAKING, STRATEGY-
EXECUTING PROCESS ENTAIL? 22
STAGE 1: DEVELOPING A STRATEGIC VISION,
MISSION STATEMENT, AND SET OF CORE VALUES
24
page xxxvi
Developing a Strategic Vision 24
Communicating the Strategic Vision 25
Expressing the Essence of the Vision in a Slogan 27
Why a Sound, Well-Communicated Strategic Vision Matters 27
Developing a Company Mission Statement 27
Linking the Vision and Mission with Company Values 28
STAGE 2: SETTING OBJECTIVES 31
Setting Stretch Objectives 31
What Kinds of Objectives to Set 31
The Need for a Balanced Approach to Objective Setting 32
Setting Objectives for Every Organizational Level 34
STAGE 3: CRAFTING A STRATEGY 35
Strategy Making Involves Managers at All Organizational Levels 35
A Company’s Strategy-Making Hierarchy 36
Uniting the Strategy-Making Hierarchy 39
A Strategic Vision + Mission + Objectives + Strategy = A Strategic Plan
39
STAGE 4: EXECUTING THE STRATEGY 40
STAGE 5: EVALUATING PERFORMANCE AND
INITIATING CORRECTIVE ADJUSTMENTS 41
CORPORATE GOVERNANCE: THE ROLE OF THE
BOARD OF DIRECTORS IN THE STRATEGY-
CRAFTING, STRATEGY-EXECUTING PROCESS 41
ILLUSTRATION CAPSULES
2.1 Examples of Strategic Visions—How Well Do They Measure Up? 26
2.2 TOMS Shoes: A Mission with a Company 30
2.3 Examples of Company Objectives 33
2.4 Corporate Governance Failures at Volkswagen 44
Section B: Core Concepts and Analytical Tools
3 Evaluating a Company’s External Environment 50
ASSESSING THE COMPANY’S INDUSTRY AND
COMPETITIVE ENVIRONMENT 52
ANALYZING THE COMPANY’S MACRO-ENVIRONMENT
53
ASSESSING THE COMPANY’S INDUSTRY AND
COMPETITIVE ENVIRONMENT 57
page xxxvii
The Five Forces Framework 57
Competitive Pressures Created by the Rivalry among Competing Sellers
57
The Choice of Competitive Weapons 61
Competitive Pressures Associated with the Threat of New Entrants 61
Whether Entry Barriers Are High or Low 62
The Expected Reaction of Industry Members in Defending against New Entry
63
Competitive Pressures from the Sellers of Substitute Products 64
Competitive Pressures Stemming from Supplier Bargaining Power 67
Competitive Pressures Stemming from Buyer Bargaining Power and Price
Sensitivity 69
Whether Buyers Are More or Less Price-Sensitive 71
Is the Collective Strength of the Five Competitive Forces Conducive to
Good Profitability? 72
Matching Company Strategy to Competitive Conditions 73
COMPLEMENTORS AND THE VALUE NET 73
INDUSTRY DYNAMICS AND THE FORCES DRIVING
CHANGE 74
Identifying the Forces Driving Industry Change 75
Assessing the Impact of the Forces Driving Industry Change 78
Adjusting the Strategy to Prepare for the Impacts of Driving Forces 78
STRATEGIC GROUP ANALYSIS 78
Using Strategic Group Maps to Assess the Market Positions of Key
Competitors 78
The Value of Strategic Group Maps 79
COMPETITOR ANALYSIS AND THE SOAR
FRAMEWORK 81
Current Strategy 82
Objectives 82
Resources and Capabilities 82
Assumptions 83
KEY SUCCESS FACTORS 83
THE INDUSTRY OUTLOOK FOR PROFITABILITY 84
ILLUSTRATION CAPSULES
3.1 The Differential Effects of the Coronavirus Pandemic of 2020 56
3.2 Comparative Market Positions of Selected Companies in the Pizza Chain
Industry: A Strategic Group Map Example 80
3.3 Business Ethics and Competitive Intelligence 84
page xxxviii
4 Evaluating a Company’s Resources, Capabilities,
and Competitiveness 90
QUESTION 1: HOW WELL IS THE COMPANY’S
PRESENT STRATEGY WORKING? 92
QUESTION 2: WHAT ARE THE COMPANY’S
STRENGTHS AND WEAKNESSES IN RELATION TO
THE MARKET OPPORTUNITIES AND EXTERNAL
THREATS? 95
Identifying a Company’s Internal Strengths 96
Identifying Company Internal Weaknesses 97
Identifying a Company’s Market Opportunities 97
Identifying External Threats 97
What Do the SWOT Listings Reveal? 99
QUESTION 3: WHAT ARE THE COMPANY’S MOST
IMPORTANT RESOURCES AND CAPABILITIES, AND
WILL THEY GIVE THE COMPANY A LASTING
COMPETITIVE ADVANTAGE? 100
Identifying the Company’s Resources and Capabilities 100
Types of Company Resources 101
Identifying Organizational Capabilities 102
Assessing the Competitive Power of a Company’s Resources and
Capabilities 103
The Four Tests of a Resource’s Competitive Power 103
A Company’s Resources and Capabilities Must Be Managed Dynamically
105
The Role of Dynamic Capabilities 105
QUESTION 4: HOW DO VALUE CHAIN ACTIVITIES
IMPACT A COMPANY’S COST STRUCTURE AND
CUSTOMER VALUE PROPOSITION? 106
The Concept of a Company Value Chain 106
Comparing the Value Chains of Rival Companies 108
A Company’s Primary and Secondary Activities Identify the Major
Components of Its Internal Cost Structure 108
The Value Chain System 109
Benchmarking: A Tool for Assessing the Costs and Effectiveness of Value
Chain Activities 111
Strategic Options for Remedying a Cost or Value Disadvantage 113
Improving Internally Performed Value Chain Activities 113
Improving Supplier-Related Value Chain Activities 114
Improving Value Chain Activities of Distribution Partners 114
Translating Proficient Performance of Value Chain Activities into
Competitive Advantage 115
How Value Chain Activities Relate to Resources and Capabilities 115
QUESTION 5: IS THE COMPANY COMPETITIVELY
STRONGER OR WEAKER THAN KEY RIVALS? 116
Strategic Implications of Competitive Strength Assessments 118
QUESTION 6: WHAT STRATEGIC ISSUES AND
PROBLEMS MERIT FRONT-BURNER MANAGERIAL
ATTENTION? 119
ILLUSTRATION CAPSULES
4.1 The Value Chain for Everlane, Inc. 109
4.2 Benchmarking in the Solar Industry 112
4.3 Benchmarking and Ethical Conduct 113
Section C: Crafting a Strategy
5 The Five Generic Competitive Strategies 126
TYPES OF GENERIC COMPETITIVE STRATEGIES
128
BROAD LOW-COST STRATEGIES 129
The Two Major Avenues for Achieving a Cost Advantage 129
Cost-Efficient Management of Value Chain Activities 129
Revamping of the Value Chain System to Lower Costs 132
Examples of Companies That Revamped Their Value Chains to Reduce Costs
132
The Keys to a Successful Broad Low-Cost Strategy 134
When a Low-Cost Strategy Works Best 134
Pitfalls to Avoid in Pursuing a Low-Cost Strategy 135
BROAD DIFFERENTIATION STRATEGIES 136
Managing the Value Chain in Ways that Enhance Differentiation 136
Revamping the Value Chain System to Increase Differentiation 138
Delivering Superior Value via a Broad Differentiation Strategy 139
When a Differentiation Strategy Works Best 140
Pitfalls to Avoid in Pursuing a Differentiation Strategy 141
FOCUSED (OR MARKET NICHE) STRATEGIES 142
A Focused Low-Cost Strategy 142
A Focused Differentiation Strategy 144
page xxxix
When a Focused Low-Cost or Focused Differentiation Strategy Is
Attractive 144
The Risks of a Focused Low-Cost or Focused Differentiation
Strategy 146
BEST-COST (HYBRID) STRATEGIES 146
When a Best-Cost Strategy Works Best 147
The Risk of a Best-Cost Strategy 149
THE CONTRASTING FEATURES OF THE GENERIC
COMPETITIVE STRATEGIES 149
Successful Generic Strategies Are Resource-Based 149
Generic Strategies and the Three Different Approaches to Competitive
Advantage 151
ILLUSTRATION CAPSULES
5.1 Vanguard’s Path to Becoming the Low-Cost Leader in Investment
Management 133
5.2 Clinícas del Azúcar’s Focused Low-Cost Strategy 143
5.3 Canada Goose’s Focused Differentiation Strategy 145
5.4 Trader Joe’s Focused Best-Cost Strategy 148
6 Strengthening a Company’s Competitive Position
156
LAUNCHING STRATEGIC OFFENSIVES TO IMPROVE A
COMPANY’S MARKET POSITION 158
Choosing the Basis for Competitive Attack 158
Choosing Which Rivals to Attack 160
Blue-Ocean Strategy—a Special Kind of Offensive 160
DEFENSIVE STRATEGIES—PROTECTING MARKET
POSITION AND COMPETITIVE ADVANTAGE 161
Blocking the Avenues Open to Challengers 162
Signaling Challengers That Retaliation Is Likely 163
TIMING A COMPANY’S STRATEGIC MOVES 163
The Potential for First-Mover Advantages 163
The Potential for Late-Mover Advantages or First-Mover Disadvantages
166
To Be a First Mover or Not 166
STRENGTHENING A COMPANY’S MARKET POSITION
VIA ITS SCOPE OF OPERATIONS 167
page xl
HORIZONTAL MERGER AND ACQUISITION
STRATEGIES 168
Why Mergers and Acquisitions Sometimes Fail to Produce Anticipated
Results 169
VERTICAL INTEGRATION STRATEGIES 171
The Advantages of a Vertical Integration Strategy 171
Integrating Backward to Achieve Greater Competitiveness 171
Integrating Forward to Enhance Competitiveness 172
The Disadvantages of a Vertical Integration Strategy 173
Weighing the Pros and Cons of Vertical Integration 174
OUTSOURCING STRATEGIES: NARROWING THE
SCOPE OF OPERATIONS 176
The Risk of Outsourcing Value Chain Activities 177
STRATEGIC ALLIANCES AND PARTNERSHIPS 177
Capturing the Benefits of Strategic Alliances 179
The Drawbacks of Strategic Alliances and Their Relative Advantages
180
How to Make Strategic Alliances Work 181
ILLUSTRATION CAPSULES
6.1 Etsy’s Blue Ocean Strategy in Online Retailing of Handmade Crafts 162
6.2 Tinder Swipes Right for First-Mover Success 165
6.3 Walmart’s Expansion into E-Commerce via Horizontal Acquisition 170
6.4 Tesla’s Vertical Integration Strategy 175
7 Strategies for Competing in International Markets
186
WHY COMPANIES DECIDE TO ENTER FOREIGN
MARKETS 188
WHY COMPETING ACROSS NATIONAL BORDERS
MAKES STRATEGY MAKING MORE COMPLEX 189
Home-Country Industry Advantages and the Diamond Model 189
Demand Conditions 189
Factor Conditions 190
Related and Supporting Industries 191
Firm Strategy, Structure, and Rivalry 191
Opportunities for Location-Based Advantages 191
page xli
The Impact of Government Policies and Economic Conditions in Host
Countries 192
The Risks of Adverse Exchange Rate Shifts 193
Cross-Country Differences in Demographic, Cultural, and Market
Conditions 195
STRATEGIC OPTIONS FOR ENTERING
INTERNATIONAL MARKETS 196
Export Strategies 196
Licensing Strategies 197
Franchising Strategies 197
Foreign Subsidiary Strategies 198
Alliance and Joint Venture Strategies 199
The Risks of Strategic Alliances with Foreign Partners 200
INTERNATIONAL STRATEGY: THE THREE MAIN
APPROACHES 201
Multidomestic Strategies—a “Think-Local, Act-Local” Approach 202
Global Strategies—a “Think-Global, Act-Global” Approach 203
Transnational Strategies—a “Think-Global, Act-Local” Approach 204
INTERNATIONAL OPERATIONS AND THE QUEST FOR
COMPETITIVE ADVANTAGE 206
Using Location to Build Competitive Advantage 207
When to Concentrate Activities in a Few Locations 207
When to Disperse Activities across Many Locations 208
Sharing and Transferring Resources and Capabilities across Borders to
Build Competitive Advantage 208
Benefiting from Cross-Border Coordination 210
CROSS-BORDER STRATEGIC MOVES 210
Waging a Strategic Offensive 210
Defending against International Rivals 211
STRATEGIES FOR COMPETING IN THE MARKETS OF
DEVELOPING COUNTRIES 212
Strategy Options for Competing in Developing-Country Markets 212
DEFENDING AGAINST GLOBAL GIANTS: STRATEGIES
FOR LOCAL COMPANIES IN DEVELOPING
COUNTRIES 214
ILLUSTRATION CAPSULES
7.1 Walgreens Boots Alliance, Inc.: Entering Foreign Markets via Alliance
Followed by Merger 200
7.2 Four Seasons Hotels: Local Character, Global Service 206
7.3 WeChat’s Strategy for Defending against International Social Media Giants
in China 216
8 Corporate Strategy 222
WHAT DOES CRAFTING A DIVERSIFICATION
STRATEGY ENTAIL? 224
WHEN TO CONSIDER DIVERSIFYING 224
BUILDING SHAREHOLDER VALUE: THE ULTIMATE
JUSTIFICATION FOR DIVERSIFYING 225
APPROACHES TO DIVERSIFYING THE BUSINESS
LINEUP 226
Diversifying by Acquisition of an Existing Business 226
Entering a New Line of Business through Internal Development 227
Using Joint Ventures to Achieve Diversification 227
Choosing a Mode of Entry 228
The Question of Critical Resources and Capabilities 228
The Question of Entry Barriers 228
The Question of Speed 228
The Question of Comparative Cost 229
CHOOSING THE DIVERSIFICATION PATH: RELATED
VERSUS UNRELATED BUSINESSES 229
DIVERSIFICATION INTO RELATED BUSINESSES 229
Identifying Cross-Business Strategic Fit along the Value Chain 232
Strategic Fit in Supply Chain Activities 234
Strategic Fit in R&D and Technology Activities 234
Manufacturing-Related Strategic Fit 234
Strategic Fit in Sales and Marketing Activities 234
Distribution-Related Strategic Fit 235
Strategic Fit in Customer Service Activities 235
Strategic Fit, Economies of Scope, and Competitive Advantage 235
From Strategic Fit to Competitive Advantage, Added Profitability, and Gains
in Shareholder Value 236
DIVERSIFICATION INTO UNRELATED BUSINESSES
238
Building Shareholder Value via Unrelated Diversification 238
The Benefits of Astute Corporate Parenting 240
Judicious Cross-Business Allocation of Financial Resources 241
Acquiring and Restructuring Undervalued Companies 241
page xlii
The Path to Greater Shareholder Value through Unrelated
Diversification 242
The Drawbacks of Unrelated Diversification 242
Demanding Managerial Requirements 242
Limited Competitive Advantage Potential 243
Misguided Reasons for Pursuing Unrelated Diversification 243
COMBINATION RELATED–UNRELATED
DIVERSIFICATION STRATEGIES 244
EVALUATING THE STRATEGY OF A DIVERSIFIED
COMPANY 244
Step 1: Evaluating Industry Attractiveness 245
Calculating Industry-Attractiveness Scores 246
Interpreting the Industry-Attractiveness Scores 247
Step 2: Evaluating Business Unit Competitive Strength 248
Calculating Competitive-Strength Scores for Each Business Unit 248
Interpreting the Competitive-Strength Scores 249
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness
and Competitive Strength 249
Step 3: Determining the Competitive Value of Strategic Fit in Diversified
Companies 252
Step 4: Checking for Good Resource Fit 252
Financial Resource Fit 253
Nonfinancial Resource Fit 255
Step 5: Ranking Business Units and Assigning a Priority for Resource
Allocation 256
Allocating Financial Resources 256
Step 6: Crafting New Strategic Moves to Improve Overall Corporate
Performance 257
Sticking Closely with the Present Business Lineup 257
Broadening a Diversified Company’s Business Base 257
Retrenching to a Narrower Diversification Base 259
Restructuring a Diversified Company’s Business Lineup 260
ILLUSTRATION CAPSULES
8.1 Examples of Companies Pursuing a Related Diversification Strategy
233
8.2 The Kraft–Heinz Merger: Pursuing the Benefits of Cross-Business
Strategic Fit 237
8.3 Examples of Companies Pursuing an Unrelated Diversification Strategy
239
8.4 Restructuring Strategically at VF Corporation 261
page xliii
9 Ethics, Corporate Social Responsibility,
Environmental Sustainability, and Strategy 266
WHAT DO WE MEAN BY BUSINESS ETHICS? 268
WHERE DO ETHICAL STANDARDS COME FROM—ARE
THEY UNIVERSAL OR DEPENDENT ON LOCAL
NORMS? 268
The School of Ethical Universalism 268
The School of Ethical Relativism 269
The Use of Underage Labor 269
The Payment of Bribes and Kickbacks 270
Why Ethical Relativism Is Problematic for Multinational Companies 271
Ethics and Integrative Social Contracts Theory 271
HOW AND WHY ETHICAL STANDARDS IMPACT THE
TASKS OF CRAFTING AND EXECUTING STRATEGY
272
DRIVERS OF UNETHICAL BUSINESS STRATEGIES
AND BEHAVIOR 273
Faulty Oversight, Enabling the Unscrupulous Pursuit of Personal Gain and
Self-Interest 273
Heavy Pressures on Company Managers to Meet Short-Term Performance
Targets 275
A Company Culture That Puts Profitability and Business Performance Ahead
of Ethical Behavior 276
WHY SHOULD COMPANY STRATEGIES BE ETHICAL?
277
The Moral Case for an Ethical Strategy 277
The Business Case for Ethical Strategies 277
STRATEGY, CORPORATE SOCIAL RESPONSIBILITY,
AND ENVIRONMENTAL SUSTAINABILITY 279
The Concepts of Corporate Social Responsibility and Good Corporate
Citizenship 280
Corporate Social Responsibility and the Triple Bottom Line 282
What Do We Mean by Sustainability and Sustainable Business Practices?
285
Crafting Corporate Social Responsibility and Sustainability Strategies
287
The Moral Case for Corporate Social Responsibility and Environmentally
Sustainable Business Practices 289
page xliv
The Business Case for Corporate Social Responsibility and
Environmentally Sustainable Business Practices 289
ILLUSTRATION CAPSULES
9.1 Ethical Violations at Uber and their Consequences 274
9.2 How PepsiCo Put Its Ethical Principles into Practice 279
9.3 Warby Parker: Combining Corporate Social Responsibility with Affordable
Fashion 283
9.4 Unilever’s Focus on Sustainability 288
Section D: Executing the Strategy
10 Building an Organization Capable of Good Strategy
Execution 296
A FRAMEWORK FOR EXECUTING STRATEGY 298
The Principal Components of the Strategy Execution Process 298
What’s Covered in Chapters 10, 11, and 12 299
BUILDING AN ORGANIZATION CAPABLE OF GOOD
STRATEGY EXECUTION: THREE KEY ACTIONS
300
STAFFING THE ORGANIZATION 302
Putting Together a Strong Management Team 302
Recruiting, Training, and Retaining Capable Employees 303
DEVELOPING AND BUILDING CRITICAL RESOURCES
AND ORGANIZATIONAL CAPABILITIES 305
Three Approaches to Building and Strengthening Organizational
Capabilities 306
Developing Organizational Capabilities Internally 306
Acquiring Capabilities through Mergers and Acquisitions 307
Accessing Capabilities through Collaborative Partnerships 308
The Strategic Role of Employee Training 309
Strategy Execution Capabilities and Competitive Advantage 309
MATCHING ORGANIZATIONAL STRUCTURE TO THE
STRATEGY 310
Deciding Which Value Chain Activities to Perform Internally and Which to
Outsource 311
Aligning the Firm’s Organizational Structure with Its Strategy 313
Making Strategy-Critical Activities the Main Building Blocks of the
Organizational Structure 314
page xlv
Matching Type of Organizational Structure to Strategy Execution
Requirements 314
Determining How Much Authority to Delegate 317
Centralized Decision Making: Pros and Cons 318
Decentralized Decision Making: Pros and Cons 319
Capturing Cross-Business Strategic Fit in a Decentralized Structure 320
Providing for Internal Cross-Unit Coordination 320
Facilitating Collaboration with External Partners and Strategic Allies 322
Further Perspectives on Structuring the Work Effort 322
ILLUSTRATION CAPSULES
10.1 Management Development at Deloitte Touche Tohmatsu Limited 304
10.2 Zara’s Strategy Execution Capabilities 310
10.3 Which Value Chain Activities Does Apple Outsource and Why? 312
11 Managing Internal Operations 328
ALLOCATING RESOURCES TO THE STRATEGY
EXECUTION EFFORT 330
INSTITUTING POLICIES AND PROCEDURES THAT
FACILITATE STRATEGY EXECUTION 331
EMPLOYING BUSINESS PROCESS MANAGEMENT
TOOLS 333
Promoting Operating Excellence: Three Powerful Business Process
Management Tools 333
Business Process Reengineering 333
Total Quality Management Programs 334
Six Sigma Quality Control Programs 335
The Difference between Business Process Reengineering and Continuous-
Improvement Programs Like Six Sigma and TQM 337
Capturing the Benefits of Initiatives to Improve Operations 338
INSTALLING INFORMATION AND OPERATING
SYSTEMS 339
Instituting Adequate Information Systems, Performance Tracking, and
Controls 340
Monitoring Employee Performance 341
USING REWARDS AND INCENTIVES TO PROMOTE
BETTER STRATEGY EXECUTION 341
Incentives and Motivational Practices That Facilitate Good Strategy
Execution 342
Striking the Right Balance between Rewards and Punishment 343
Linking Rewards to Achieving the Right Outcomes 345
Additional Guidelines for Designing Incentive Compensation Systems 346
ILLUSTRATION CAPSULES
11.1 Charleston Area Medical Center’s Six Sigma Program 337
11.2 How Wegmans Rewards and Motivates its Employees 344
11.3 Nucor Corporation: Tying Incentives Directly to Strategy Execution 347
12 Corporate Culture and Leadership 352
INSTILLING A CORPORATE CULTURE CONDUCIVE TO
GOOD STRATEGY EXECUTION 354
Identifying the Key Features of a Company’s Corporate Culture 355
The Role of Core Values and Ethics 355
Embedding Behavioral Norms in the Organization and Perpetuating the
Culture 356
The Role of Stories 357
Forces That Cause a Company’s Culture to Evolve 357
The Presence of Company Subcultures 358
Strong versus Weak Cultures 358
Strong-Culture Companies 358
Weak-Culture Companies 359
Why Corporate Cultures Matter to the Strategy Execution Process 360
Healthy Cultures That Aid Good Strategy Execution 361
High-Performance Cultures 361
Adaptive Cultures 362
Unhealthy Cultures That Impede Good Strategy Execution 363
Change-Resistant Cultures 364
Politicized Cultures 364
Insular, Inwardly Focused Cultures 364
Unethical and Greed-Driven Cultures 365
Incompatible, Clashing Subcultures 365
Changing a Problem Culture 365
Making a Compelling Case for Culture Change 366
Substantive Culture-Changing Actions 367
Symbolic Culture-Changing Actions 368
How Long Does It Take to Change a Problem Culture? 368
LEADING THE STRATEGY EXECUTION PROCESS
369
Staying on Top of How Well Things Are Going 370
Mobilizing the Effort for Excellence in Strategy Execution 371
page xlvi
Leading the Process of Making Corrective Adjustments 372
A FINAL WORD ON LEADING THE PROCESS OF
CRAFTING AND EXECUTING STRATEGY 373
ILLUSTRATION CAPSULES
12.1 PUMA’s High-Performance Culture 362
12.2 Driving Cultural Change at Goldman Sachs 369
PART
2 Cases in Crafting and Executing
Strategy
Section A: Crafting Strategy in Single-
Business Companies
1 Airbnb in 2020 C2
John D. Varlaro, Johnson & Wales University
John E. Gamble, Texas A&M University-Corpus Christi
2 Competition in the Craft Beer Industry
in 2020 C7
John D. Varlaro, Johnson & Wales University
John E. Gamble, Texas A&M University–Corpus Christi
3 Costco Wholesale in 2020: Mission,
Business Model, and Strategy C18
Arthur A. Thompson Jr., The University of Alabama
4 Ford Motor Company: Will the
Company’s Strategic Moves Restore
its Competitiveness and Financial
Performance? C43
Marlene M. Reed, Baylor University
Rochelle R. Brunson, Baylor University
5 Macy’s, Inc.: Will Its Strategy Allow It
to Survive in the Changing Retail
Sector? C51
Alen Badal, University of Liverpool
John E. Gamble, Texas A&M University-Corpus Christi
6 TOMS Shoes: Expanding Its
Successful One For One Business
Model C59
Margaret A. Peteraf, Tuck School of Business at Dartmouth
Sean Zhang and Carry S. Resor, Research Assistants,
Dartmouth College
7 lululemon athletica’s Strategy in
2020: Is the Recent Growth in Retail
Stores, Revenues, and Profitability
Sustainable? C68
Arthur A. Thompson, The University of Alabama
Randall D. Harris, Texas A&M University-Corpus Christi
8 Under Armour’s Strategy in 2020:
Can It Revive Sales and Profitability in
page xlvii
Its Core North American Market?
C86
Arthur A. Thompson, The University of Alabama
9 Spotify in 2020: Can the Company
Remain Competitive? C112
Diana R. Garza, University of the Incarnate Word
10 Beyond Meat, Inc. C124
Arthur A. Thompson, The University of Alabama
11 Netflix’s 2020 Strategy for Battling
Rivals in the Global Market for
Streamed Video Subscribers C140
Arthur A. Thompson, The University of Alabama
12 Twitter Inc. in 2020
C161
David L. Turnipseed, University of South Alabama
13 Yeti in 2020: Can Brand Name and
Innovation Keep it Ahead of the
Competition? C173
Diana R. Garza, University of the Incarnate Word
David L. Turnipseed, University of South Alabama
14 GoPro in 2020: Have its Turnaround
Strategies Failed? C184
David L. Turnipseed, University of South Alabama
John E. Gamble, Texas A&M University–Corpus Christi
15 Publix Super Markets: Its Strategy in
the U.S. Supermarket and Grocery
Store Industry C198
Gregory L. Prescott, University of West Florida
David L. Turnipseed, University of South Alabama
16 Tesla’s Strategy in 2020: Can It
Deliver Sustained Profitability?
C212
Arthur A. Thompson, The University of Alabama
17 Unilever’s Purpose-led Brand
Strategy: Can Alan Jope Balance
Purpose and Profits? C238
Syeda Maseeha Qumer, ICFAI Business School Hyderabad
Debapratim Purkayastha, ICFAI Business School Hyderabad
18 Domino’s Pizza: Business Continuity
Strategy during the Covid-19
Pandemic C249
Debapratim Purkayastha, IBS Hyderabad
Hadiya Faheem, IBS Hyderabad
19 Burbank Housing: Building from the
Inside Out C260
Christy Anderson, MBA Student, Sonoma State University
Armand Gilinsky Jr., Sonoma State University
page xlviii
20 Boeing 737 MAX: What Response
Strategy is Needed to Ensure
Passenger Safety and Restore the
Company’s Reputation? C273
Rochelle R. Brunson, Baylor University
Marlene M. Reed, Baylor University
21 The Walt Disney Company: Its
Diversification Strategy in 2020
C279
John E. Gamble, Texas A&M University-Corpus Christi
22 Robin Hood C293
Joseph Lampel, Alliance Manchester Business School
Section B: Crafting Strategy in
Diversified Companies
23 Southwest Airlines in 2020: Culture,
Values, and Operating Practices
C295
Arthur A. Thompson, The University of Alabama
John E. Gamble, Texas A&M University—Corpus Christi
24 Uber Technologies in 2020: Is the Gig
Economy Labor Force Working for
Uber? C315
Emily Farrell, MBA Candidate, Sonoma State University
Armand Gilinsky, Jr., Sonoma State University
Section C: Implementing and
Executing Strategy
25 Starbucks in 2020: Is the
Company on Track to Achieve
Attractive Growth and Operational
Excellence? C325
Arthur A. Thompson, The University of Alabama
26 Nucor Corporation in 2020: Pursuing
Efforts to Grow Sales and Market
Share Despite Tough Market
Conditions C354
Arthur A. Thompson, The University of Alabama
27 Eliminating Modern Slavery from
Supply Chains: Can Nestlé Lead the
Way? C389
Syeda Maseeha Qumer, ICFAI Business School, Hyderabad
Debapratim Purkayastha, ICFAI Business School, Hyderabad
Guide to Case Analysis CA-1
INDEXES Company I-1
Name I-9
Subject I-15
page 1
PART 1
Concepts and
Techniques for
Crafting and
Executing
Strategy
page 2
chapter 1
What Is Strategy and Why Is It
Important?
Learning Objectives
After reading this chapter, you should be able to:
LO 1-1 Understand what is meant by a company’s strategy and
why it needs to differ from competitors’ strategies.
LO 1-2 Grasp the concept of a sustainable competitive
advantage.
LO 1-3 Identify the five most basic strategic approaches for
setting a company apart from its rivals.
LO 1-4 Understand why a company’s strategy tends to evolve.
LO 1-5 Identify what constitutes a viable business model.
LO 1-6 Identify the three tests of a winning strategy.
page 3
Gary Waters/Ikon Images/Superstock
Strategy is about setting yourself apart from the competition.
Michael Porter—Professor and consultant
Strategy means making clear-cut choices about how to compete.
page 4
Jack Welch—Former CEO of General Electric
I believe that people make their own luck by great preparation and good strategy.
Jack Canfield—Corporate trainer and entrepreneur
According to The Economist, a leading publication on business, economics, and
international affairs, “In business, strategy is king. Leadership and hard work are all very
well and luck is mighty useful, but it is strategy that makes or breaks a firm.”1 Luck and
circumstance can explain why some companies are blessed with initial, short-lived
success. But only a well-crafted, well-executed, constantly evolving strategy can explain
why an elite set of companies somehow manage to rise to the top and stay there, year
after year, pleasing their customers, shareholders, and other stakeholders alike in the
process. Companies such as Apple, Disney, Starbucks, Alphabet (parent company of
Google), Berkshire Hathaway, General Electric, and Amazon come to mind—but long-
lived success is not just the province of U.S. companies. Diverse kinds of companies,
both large and small, from many different countries have been able to sustain strong
performance records, including Denmark’s Lego Group, the United Kingdom’s HSBC (in
banking), Dubai’s Emirates Airlines, Switzerland’s Rolex China Mobile (in
telecommunications), and India’s Tata Steel.
In this opening chapter, we define the concept of strategy and describe its many
facets. We introduce you to the concept of competitive advantage and explore the tight
linkage between a company’s strategy and its quest for competitive advantage. We will
also explain why company strategies are partly proactive and partly reactive, why they
evolve over time, and the relationship between a company’s strategy and its business
model. We conclude the chapter with a discussion of what sets a winning strategy apart
from others and why that strategy should also pass the test of moral scrutiny. By the
end of this chapter, you will have a clear idea of why the tasks of crafting and executing
strategy are core management functions and why excellent execution of an excellent
strategy is the most reliable recipe for turning a company into a standout performer over
the long term.
WHAT DO WE MEAN BY STRATEGY?
• LO 1-1
Understand what is
meant by a
company’s strategy
and why it needs to
differ from
competitors’
strategies.
A company’s strategy is the set of coordinated actions that its managers take
in order to outperform the company’s competitors and achieve superior
profitability. The objective of a well-crafted strategy is not merely temporary
competitive success and profits in the short run, but rather the sort of lasting
success that can support growth and secure the company’s future over the
long term. Achieving this entails making a managerial commitment to a
coherent array of well-considered choices about how to compete.2 These
include
How to position the company in the marketplace.
How to attract customers.
How to compete against rivals.
How to achieve the company’s performance targets.
How to capitalize on opportunities to grow the business.
How to respond to changing economic and market conditions.
CORE
CONCEPT
A company’s
strategy is the set
of coordinated
actions that its
managers take in
order to outperform
the company’s
competitors and
achieve superior
profitability.
In most industries, companies have considerable freedom in choosing the
hows of strategy.3 Some companies strive to achieve lower costs than rivals,
while others aim for product superiority or more personalized customer
service dimensions that rivals cannot match. Some companies opt for wide
product lines, while others concentrate their energies on a narrow product
lineup. Some deliberately confine their operations to local or regional
markets; others opt to compete nationally, internationally (several countries),
or globally (all or most of the major country markets worldwide). Choices of
how best to compete against rivals have to be made in light of the firm’s
resources and capabilities and in light of the competitive approaches rival
companies are employing.
Strategy Is about Competing Differently
Mimicking the strategies of successful industry rivals—with either copycat
product offerings or maneuvers to stake out the same market position—rarely
works. Rather, every company’s strategy needs to have some distinctive
element that draws in customers and provides a competitive edge. Strategy, at
its essence, is about competing differently—doing what rival firms don’t do
or what rival firms can’t do.4 This does not mean that the key elements of a
company’s strategy have to be 100 percent different, but rather that they must
differ in at least some important respects. A strategy stands a better chance of
succeeding when it is predicated on actions, business approaches, and
competitive moves aimed at (1) appealing to buyers in ways that set a
company apart from its rivals and (2) staking out a market position that is not
crowded with strong competitors.
A company’s strategy provides direction and guidance, in terms of not only
what the company should do but also what it should not do. Knowing what
not to do can be as important as knowing what to do, strategically. At best,
making the wrong strategic moves will prove a distraction and a waste of
company resources. At worst, it can bring about unintended long-term
consequences that put the company’s very survival at risk.
Strategy is about
competing differently
from rivals—doing
what competitors
don’t do or, even
page 5
better, doing what
they can’t do!
Figure 1.1 illustrates the broad types of actions and approaches that often
characterize a company’s strategy in a particular business or industry. For a
more concrete example, see Illustration Capsule 1.1 describing the elements
of Apple, Inc.’s successful strategy.
FIGURE 1.1 Identifying a Company’s Strategy—What to
Look For
Strategy and the Quest for Competitive
Advantage
page 6
• LO 1-2
Grasp the concept of
a sustainable
competitive
advantage.
The heart and soul of any strategy are the actions in the marketplace that
managers take to gain a competitive advantage over rivals. A company has a
competitive advantage whenever it has some type of edge over rivals in
attracting buyers and coping with competitive forces. A competitive
advantage is essential for realizing greater marketplace success and higher
profitability over the long term.
There are many routes to competitive advantage, but they all
involve one of two basic mechanisms. Either they provide the customer with
a product or service that the customer values more highly than others (higher
perceived value), or they produce their product or service more efficiently
(lower costs). Delivering superior value or delivering value more efficiently
—whatever form it takes—nearly always requires performing value chain
activities differently than rivals and building capabilities that are not readily
matched. In Illustration Capsule 1.1, it is evident that Apple, Inc. has gained a
competitive advantage over its rivals in the technological device industry
through its efforts to create “must-have,” exciting new products, that are
beautifully designed, technologically advanced, easy to use, and sold in
appealing stores that offer a fun experience, knowledgeable staff, and
excellent service. By differentiating itself in this manner from its competitors
Apple has been able to charge prices for its products that are well above those
of its rivals and far exceed the low cost of its inputs. Its expansion policies
have allowed the company to make it easy for customers to find an Apple
store in almost any high-quality mall or urban shopping district, further
enhancing the brand and cementing customer loyalty. A creative distinctive
strategy such as that used by Apple is a company’s most reliable ticket for
developing a competitive advantage over its rivals. If a strategy is not
distinctive, then there can be no competitive advantage, since no firm would
be meeting customer needs better or operating more efficiently than any
other.
If a company’s competitive edge holds promise for being sustainable (as
opposed to just temporary), then so much the better for both the strategy and
the company’s future profitability. What makes a competitive advantage
sustainable (or durable), as opposed to temporary, are elements of the
strategy that give buyers lasting reasons to prefer a company’s products or
services over those of competitors—reasons that competitors are unable to
nullify, duplicate, or overcome despite their best efforts. In the case of Apple,
the company’s unparalleled name recognition, its reputation for technically
superior, beautifully designed, “must-have” products, and the accessibility of
the appealing, consumer-friendly stores with knowledgeable staff, make it
difficult for competitors to weaken or overcome Apple’s competitive
advantage. Not only has Apple’s strategy provided the company with a
sustainable competitive advantage, but it has made Apple, Inc. one of the
most admired companies on the planet.
CORE
CONCEPT
A company achieves
a competitive
advantage when it
provides buyers with
superior value
compared to rival
sellers or offers the
same value at a
lower cost to the
firm. The advantage
is sustainable if it
persists despite the
best efforts of
competitors to
match or surpass
this advantage.
Five of the most frequently used and dependable strategic approaches to
setting a company apart from rivals, building strong customer loyalty, and
gaining a competitive advantage are
page 7
• LO 1-3
Identify the five most
basic strategic
approaches for
setting a company
apart from rivals.
1. A low-cost provider strategy—achieving a cost-based advantage over
rivals. Walmart and Southwest Airlines have earned strong market
positions because of the low-cost advantages they have achieved over their
rivals. Low-cost provider strategies can produce a durable competitive
edge when rivals find it hard to match the low-cost leader’s approach to
driving costs out of the business.
2. A broad differentiation strategy—seeking to differentiate the company’s
product or service from that of rivals in ways that will appeal to a broad
spectrum of buyers. Successful adopters of differentiation strategies
include Apple (innovative products), Johnson & Johnson in baby products
(product reliability), Rolex (luxury and prestige), and BMW (engineering
design and performance). One way to sustain this type of competitive
advantage is to be sufficiently innovative to thwart the efforts of clever
rivals to copy or closely imitate the product offering.
ILLUSTRATION
CAPSULE 1.1 Apple Inc.:
Exemplifying a Successful Strategy
Apple Inc. is one of the most profitable companies in the world, with revenues of more
than $265 billion. For more than 10 consecutive years, it has ranked number one on
Fortune’s list of the “World’s Most Admired Companies.” Given the worldwide popularity
of its products and services, along with its reputation for superior technological innovation
and design capabilities, this is not surprising. The key elements of Apple’s successful
strategy include:
Designing and developing its own operating systems, hardware, application software,
and services. This allows Apple to bring the best user experience to its customers
through products and solutions with innovative design, superior ease-of-use, and
seamless integration across platforms. The ability to use services like iCloud across
devices incentivizes users to join Apple’s technological ecosystem and has been
critical to fostering brand loyalty.
Continuously investing in research and development (R&D) and frequently introducing
products. Apple has invested heavily in R&D, spending upwards of $11 billion a year,
to ensure a continual and timely injection of competitive products, services, and
technologies into the marketplace. Its successful products and services include the
Mac, iPod, iPhone, iPad, Apple Watch, Apple TV, and Apple Music. It is currently
investing in an Apple electric car and Apple solar energy.
Strategically locating its stores and staffing them with knowledgeable personnel. By
operating its own Apple stores and positioning them in high-traffic locations, Apple is
better equipped to provide its customers with the optimal buying experience. The
stores’ employees are well versed in the value of the hardware and software
integration and demonstrate the unique solutions available on its products. This high-
quality sale and after-sale supports allows Apple to continuously attract new and retain
existing customers.
Expanding Apple’s reach domestically and internationally. Apple operates more than
500 retail stores across 24 countries. During fiscal year 2019, 60 percent of Apple’s
revenue came from international sales.
PUGUN SJ/Shutterstock
Maintaining a quality brand image, supported by premium pricing. Although the
computer industry is incredibly price competitive, Apple has managed to sustain a
competitive edge by focusing on its inimitable value proposition and deliberately
keeping a price premium—thus creating an aura of prestige around its products.
page 8
Committing to corporate social responsibility and sustainability through supplier
relations. Apple’s strict Code of Conduct requires its suppliers to comply with several
standards regarding safe working conditions, fair treatment of workers, and
environmentally safe manufacturing.
Cultivating a diverse workforce rooted in transparency. Apple believes that diverse
teams make innovation possible and is dedicated to incorporating a broad range of
perspectives in its workforce. Every year, Apple publishes data showing the
representation of women and different race and ethnicity groups across functions.
Note: Developed with Shawnda Lee Duvigneaud
Sources: Apple 10-K, Company website.
3. A focused low-cost strategy—concentrating on a narrow buyer segment (or
market niche) and outcompeting rivals by having lower costs and thus
being able to serve niche members at a lower price. Private-label
manufacturers of food, health and beauty products, and nutritional
supplements use their low-cost advantage to offer supermarket buyers
lower prices than those demanded by producers of branded
products. IKEA’s emphasis on modular furniture, ready for
assembly, makes it a focused low-cost player in the furniture market.
4. A focused differentiation strategy—concentrating on a narrow buyer
segment (or market niche) and outcompeting rivals by offering buyers
customized attributes that meet their specialized needs and tastes better
than rivals’ products. Lululemon, for example, specializes in high-quality
yoga clothing and the like, attracting a devoted set of buyers in the process.
Tesla, Inc., with its electric cars, LinkedIn specializing in the business and
employment aspects of social networking, and Goya Foods in Hispanic
specialty food products provide some other examples of this strategy.
5. A best-cost provider strategy—giving customers more value for the money
by satisfying their expectations on key quality features, performance,
and/or service attributes while beating their price expectations. This
approach is a hybrid strategy that blends elements of low-cost provider and
differentiation strategies; the aim is to have lower costs than rivals while
simultaneously offering better differentiating attributes. Target is an
example of a company that is known for its hip product design (a
reputation it built by featuring limited edition lines by designers such as
Rodarte, Victoria Beckham, and Jason Wu), as well as a more appealing
shopping ambience for discount store shoppers. Its dual focus on low costs
as well as differentiation shows how a best-cost provider strategy can offer
customers great value for the money.
Winning a sustainable competitive edge over rivals with any of the
preceding five strategies generally hinges as much on building competitively
valuable expertise and capabilities that rivals cannot readily match as it does
on having a distinctive product offering. Clever rivals can nearly always copy
the attributes of a popular product or service, but for rivals to match the
experience, know-how, and specialized capabilities that a company has
developed and perfected over a long period of time is substantially harder to
do and takes much longer. The success of the Swatch in watches, for
example, was driven by impressive design, marketing, and engineering
capabilities, while Apple has demonstrated outstanding product innovation
capabilities in digital music players, smartphones, and e-readers. Hyundai has
become the world’s fastest-growing automaker as a result of its advanced
manufacturing processes and unparalleled quality control systems.
Capabilities such as these have been hard for competitors to imitate or best.
Why a Company’s Strategy Evolves over Time
• LO 1-4
Understand why a
company’s strategy
tends to evolve.
The appeal of a strategy that yields a sustainable competitive advantage is
that it offers the potential for a more enduring edge than a temporary
advantage over rivals. But sustainability is a relative term, with some
advantages lasting longer than others. And regardless of how sustainable a
competitive advantage may appear to be at a given point in time, conditions
change. Even a substantial competitive advantage over rivals may crumble in
the face of drastic shifts in market conditions or disruptive innovations.
Therefore, managers of every company must be willing and ready to modify
the strategy in response to changing market conditions, advancing
technology, unexpected moves by competitors, shifting buyer needs,
page 9
emerging market opportunities, and new ideas for improving the strategy.
Most of the time, a company’s strategy evolves incrementally as management
fine-tunes various pieces of the strategy and adjusts the strategy in response
to unfolding events.5 However, on occasion, major strategy shifts are called
for, such as when the strategy is clearly failing or when industry
conditions change in dramatic ways. Industry environments
characterized by high-velocity change require companies to repeatedly adapt
their strategies.6 For example, companies in industries with rapid-fire
advances in technology like 3-D printing, shale fracking, and genetic
engineering often find it essential to adjust key elements of their strategies
several times a year. When the technological change is drastic enough to
“disrupt” the entire industry, displacing market leaders and altering market
boundaries, companies may find it necessary to “reinvent” entirely their
approach to providing value to their customers.
Regardless of whether a company’s strategy changes gradually or swiftly,
the important point is that the task of crafting strategy is not a one-time event
but always a work in progress. Adapting to new conditions and constantly
evaluating what is working well enough to continue and what needs to be
improved are normal parts of the strategy-making process, resulting in an
evolving strategy.7
Changing
circumstances and
ongoing
management efforts
to improve the
strategy cause a
company’s strategy
to evolve over time
—a condition that
makes the task of
crafting strategy a
work in progress,
not a one-time
event.
A Company’s Strategy Is Partly Proactive and
Partly Reactive
The evolving nature of a company’s strategy means that the typical company
strategy is a blend of (1) proactive, planned initiatives to improve the
company’s financial performance and secure a competitive edge and (2)
reactive responses to unanticipated developments and fresh market
conditions. The biggest portion of a company’s current strategy flows from
previously initiated actions that have proven themselves in the marketplace
and newly launched initiatives aimed at edging out rivals and boosting
financial performance. This part of management’s action plan for running the
company is its deliberate strategy, consisting of proactive strategy elements
that are both planned and realized as planned (while other planned strategy
elements may not work out and are abandoned in consequence)—see Figure
1.2.8
A company’s
strategy is shaped
partly by
management
analysis and choice
and partly by the
necessity of
adapting and
learning by doing.
FIGURE 1.2 A Company’s Strategy Is a Blend of Proactive
Initiatives and Reactive Adjustments
But managers must always be willing to supplement or modify the
proactive strategy elements with as-needed reactions to unanticipated
conditions. Inevitably, there will be occasions when market and competitive
conditions take an unexpected turn that calls for some kind of strategic
reaction. Hence, a portion of a company’s strategy is always developed on the
fly, coming as a response to fresh strategic maneuvers on the part of rival
firms, unexpected shifts in customer requirements, fast-changing
technological developments, newly appearing market opportunities, a
changing political or economic climate, or other unanticipated happenings in
the surrounding environment. These adaptive strategy adjustments make up
the firm’s emergent strategy. A company’s strategy in toto (its realized
strategy) thus tends to be a combination of proactive and reactive elements,
with certain strategy elements being abandoned because they have become
obsolete or ineffective. A company’s realized strategy can be observed in the
pattern of its actions over time, which is a far better indicator than any of its
strategic plans on paper or any public pronouncements about its strategy.
CORE
CONCEPT
page 10
A company’s
deliberate strategy
consists of proactive
strategy elements
that are planned; its
emergent strategy
consists of reactive
strategy elements
that emerge as
changing conditions
warrant.
A strategy cannot be
considered ethical
just because it
involves actions that
are legal. To meet
the standard of
being ethical, a
strategy must entail
actions and behavior
that can pass moral
scrutiny in the sense
of not being
deceitful, unfair or
harmful to others,
disreputable, or
unreasonably
damaging to the
environment.
Strategy and Ethics: Passing the Test of Moral
Scrutiny
In choosing among strategic alternatives, company managers are well advised
to embrace actions that can pass the test of moral scrutiny. Just keeping a
company’s strategic actions within the bounds of what is legal does not mean
the strategy is ethical. Ethical and moral standards are not fully
governed by what is legal. Rather, they involve issues of “right”
versus “wrong” and duty—what one should do. A strategy is ethical only if it
does not entail actions that cross the moral line from “can do” to “should not
do.” For example, a company’s strategy definitely crosses into the “should
not do” zone and cannot pass moral scrutiny if it entails actions and
page 11
behaviors that are deceitful, unfair or harmful to others, disreputable, or
unreasonably damaging to the environment. A company’s strategic actions
cross over into the “should not do” zone and are likely to be deemed
unethical when (1) they reflect badly on the company or (2) they adversely
impact the legitimate interests and well-being of shareholders, customers,
employees, suppliers, the communities where it operates, and society at large
or (3) they provoke public outcries about inappropriate or “irresponsible”
actions, behavior, or outcomes.
Admittedly, it is not always easy to categorize a given strategic behavior as
ethical or unethical. Many strategic actions fall in a gray zone and can be
deemed ethical or unethical depending on how high one sets the bar for what
qualifies as ethical behavior. For example, is it ethical for advertisers of
alcoholic products to place ads in media having an audience of as much as 50
percent underage viewers? Is it ethical for companies to employ
undocumented workers who may have been brought to the United States as
children? Is it ethical for Nike, Under Armour, and other makers of athletic
wear to pay a university athletic department large sums of money as an
“inducement” for the university’s athletic teams to use their brand of
products? Is it ethical for pharmaceutical manufacturers to charge higher
prices for life-saving drugs in some countries than they charge in others? Is it
ethical for a company to ignore the damage done to the environment by its
operations in a particular country, even though they are in compliance with
current environmental regulations in that country?
Senior executives with strong ethical convictions are generally
proactive in linking strategic action and ethics; they forbid the pursuit of
ethically questionable business opportunities and insist that all aspects of
company strategy are in accord with high ethical standards. They make it
clear that all company personnel are expected to act with integrity, and they
put organizational checks and balances into place to monitor behavior,
enforce ethical codes of conduct, and provide guidance to employees
regarding any gray areas. Their commitment to ethical business conduct is
genuine, not hypocritical lip service.
The reputational and financial damage that unethical strategies and
behavior can do is substantial. When a company is put in the public spotlight
because certain personnel are alleged to have engaged in misdeeds, unethical
page 12
behavior, fraudulent accounting, or criminal behavior, its revenues and stock
price are usually hammered hard. Many customers and suppliers shy away
from doing business with a company that engages in sleazy practices or turns
a blind eye to its employees’ illegal or unethical behavior. Repulsed by
unethical strategies or behavior, wary customers take their business elsewhere
and wary suppliers tread carefully. Moreover, employees with character and
integrity do not want to work for a company whose strategies are shady or
whose executives lack character and integrity. Consequently, solid business
reasons exist for companies to shun the use of unethical strategy elements.
Besides, immoral or unethical actions are just plain wrong.
A COMPANY’S STRATEGY AND ITS
BUSINESS MODEL
• LO 1-5
Identify what
constitutes a viable
business model.
At the core of every sound strategy is the company’s business model. A
business model is management’s blueprint for delivering a valuable product
or service to customers in a manner that will generate revenues sufficient to
cover costs and yield an attractive profit.9 The two elements of a company’s
business model are (1) its customer value proposition and (2) its profit
formula. The customer value proposition lays out the company’s approach to
satisfying buyer wants and needs at a price customers will consider a good
value. The profit formula describes the company’s approach to determining a
cost structure that will allow for acceptable profits, given the pricing tied to
its customer value proposition. Figure 1.3 illustrates the elements of the
business model in terms of what is known as the value-price-cost
framework.10 As the framework indicates, the customer value
proposition can be expressed as V − P, which is essentially the
customers’ perception of how much value they are getting for the money. The
profit formula, on a per-unit basis, can be expressed as P − C. Plainly, from a
customer perspective, the greater the value delivered (V) and the lower the
price (P), the more attractive is the company’s value proposition. On the
other hand, the lower the costs (C), given the customer value proposition (V −
P), the greater the ability of the business model to be a moneymaker. Thus,
the profit formula reveals how efficiently a company can meet customer
wants and needs and deliver on the value proposition. The nitty-gritty issue
surrounding a company’s business model is whether it can execute its
customer value proposition profitably. Just because company managers have
crafted a strategy for competing and running the business does not
automatically mean that the strategy will lead to profitability—it may or it
may not.
CORE
CONCEPT
A company’s
business model
sets forth the logic
for how its strategy
will create value for
customers and at
the same time
generate revenues
sufficient to cover
costs and realize a
profit.
FIGURE 1.3 The Business Model and the Value-Price-Cost
Framework
Aircraft engine manufacturer Rolls-Royce employs an innovative “power-
by-the-hour” business model that charges airlines leasing fees for engine use,
maintenance, and repairs based on actual hours flown. The company retains
ownership of the engines and is able to minimize engine maintenance costs
through the use of sophisticated sensors that optimize maintenance and repair
schedules. Gillette’s business model in razor blades involves selling a
“master product”—the razor—at an attractively low price and then making
money on repeat purchases of razor blades that can be produced cheaply and
sold at high profit margins. Printer manufacturers like Hewlett-Packard,
Canon, and Epson pursue much the same business model as Gillette—selling
printers at a low (virtually break-even) price and making large profit margins
on the repeat purchases of ink cartridges and other printer supplies.
McDonald’s invented the business model for fast food—providing value to
customers in the form of economical quick-service meals at clean, convenient
locations. Its profit formula involves such elements as standardized cost-
efficient store design, stringent specifications for ingredients, detailed
operating procedures for each unit, sizable investment in human resources
and training, and heavy reliance on advertising and in-store promotions to
drive volume. Illustration Capsule 1.2 describes three contrasting business
models in radio broadcasting.
WHAT MAKES A STRATEGY A
WINNER?
• LO 1-6
Identify the three
tests of a winning
strategy.
Three tests can be applied to determine whether a strategy is a winning
strategy:
1. The Fit Test: How well does the strategy fit the company’s situation? To
qualify as a winner, a strategy has to be well matched to industry and
competitive conditions, a company’s best market opportunities, and other
pertinent aspects of the business environment in which the company
operates. No strategy can work well unless it exhibits good external fit
with respect to prevailing market conditions. At the same time, a winning
strategy must be tailored to the company’s resources and competitive
capabilities and be supported by a complementary set of functional
activities (i.e., activities in the realms of supply chain management,
operations, sales and marketing, and so on). That is, it must also exhibit
internal fit and be compatible with a company’s ability to execute the
strategy in a competent manner. Unless a strategy exhibits good fit with
both the external and internal aspects of a company’s overall situation, it is
likely to be an underperformer and fall short of producing winning results.
Winning strategies also exhibit dynamic fit in the sense that they evolve
over time in a manner that maintains close and effective alignment with the
company’s situation even as external and internal conditions change.11
To pass the fit test, a
strategy must exhibit
fit along three
dimensions: (1)
external, (2) internal,
and (3) dynamic.
page 13
ILLUSTRATION
CAPSULE 1.2 Pandora, SiriusXM,
and Over-the-Air Broadcast Radio: Three
Contrasting Business Models
Vivien Killilea/Stringer/Getty Images
Pandora SiriusXM Over-the-Air RadioBroadcasters
Pandora SiriusXM Over-the-Air RadioBroadcasters
Customer
value
proposition
Through free-
of-charge
Internet radio
service, allowed
PC, tablet
computer, and
smartphone
users to create
up to 100
personalized
music and
comedy
stations.
Utilized
algorithms to
generate
playlists based
on users’
predicted music
preferences.
Offered
programming
interrupted by
brief,
occasional ads;
eliminated
advertising for
Pandora One
subscribers.
For a monthly
subscription fee,
provided
satellite-based
music, news,
sports, national
and regional
weather, traffic
reports in limited
areas, and talk
radio
programming.
Also offered
subscribers
streaming
Internet
channels and
the ability to
create
personalized
commercial-free
stations for
online and
mobile listening.
Offered
programming
interrupted only
by brief,
occasional ads.
Provided free-
of-charge music,
national and
local news, local
traffic reports,
national and
local weather,
and talk radio
programming.
Included
frequent
programming
interruption for
ads.
page 14
Pandora SiriusXM Over-the-Air RadioBroadcasters
Profit
formula
Revenue
generation:
Display, audio, and
video ads targeted
to different
audiences and
sold to local and
national buyers;
subscription
revenues
generated from an
advertising-free
option called
Pandora One.
Cost structure:
Fixed costs
associated with
developing
software for
computers, tablets,
and smartphones.
Fixed and variable
costs related to
operating data
centers to support
streaming network,
content royalties,
marketing, and
support activities.
Profit margin:
Profitability
dependent on
generating
sufficient
advertising
revenues and
subscription
revenues to cover
costs and provide
attractive profits.
Revenue
generation:
Monthly
subscription fees,
sales of satellite
radio equipment,
and advertising
revenues.
Cost structure:
Fixed costs
associated with
operating a
satellite-based
music delivery
service and
streaming Internet
service.
Fixed and variable
costs related to
programming and
content royalties,
marketing, and
support activities.
Profit margin:
Profitability
dependent on
attracting a
sufficiently large
number of
subscribers to
cover costs and
provide attractive
profits.
Revenue
generation:
Advertising sales to
national and local
businesses.
Cost structure:
Fixed costs
associated with
terrestrial
broadcasting
operations. Fixed
and variable costs
related to local
news reporting,
advertising sales
operations, network
affiliate fees,
programming and
content royalties,
commercial
production
activities, and
support activities.
Profit margin:
Profitability
dependent on
generating
sufficient
advertising
revenues to cover
costs and provide
attractive profits.
A
winning strategy
must pass three
tests:
1. The fit test
2. The competitive
advantage test
3. The performance
test
2. The Competitive Advantage Test: Is the strategy helping the company
achieve a competitive advantage? Is the competitive advantage likely to be
sustainable? Strategies that fail to achieve a competitive advantage over
rivals are unlikely to produce superior performance. And unless the
competitive advantage is sustainable, superior performance is unlikely to
last for more than a brief period of time. Winning strategies enable a
company to achieve a competitive advantage over key rivals that is long-
lasting. The bigger and more durable the competitive advantage, the more
powerful it is.
3. The Performance Test: Is the strategy producing superior company
performance? The mark of a winning strategy is strong company
performance. Two kinds of performance indicators tell the most about the
caliber of a company’s strategy: (1) competitive strength and market
standing and (2) profitability and financial strength. Above-average
financial performance or gains in market share, competitive position, or
profitability are signs of a winning strategy.
Strategies—either existing or proposed—that come up short on one or
more of the preceding tests are plainly less desirable than strategies passing
all three tests with flying colors. New initiatives that don’t seem to match the
company’s internal and external situations should be scrapped before they
come to fruition, while existing strategies must be scrutinized on a regular
basis to ensure they have good fit, offer a competitive advantage, and are
contributing to above-average performance or performance improvements.
Failure to pass one or more of the three tests should prompt managers to
make immediate changes in an existing strategy.
page 15
WHY CRAFTING AND EXECUTING
STRATEGY ARE IMPORTANT TASKS
Crafting and executing strategy are top-priority managerial tasks for two big
reasons. First, a clear and reasoned strategy is management’s prescription for
doing business, its road map to competitive advantage, its game plan for
pleasing customers, and its formula for improving performance. High-
performing enterprises are nearly always the product of astute, creative, and
proactive strategy making. Companies don’t get to the top of the industry
rankings or stay there with flawed strategies, copycat strategies, or timid
attempts to try to do better. Only a handful of companies can boast of hitting
home runs in the marketplace due to lucky breaks or the good
fortune of having stumbled into the right market at the right time
with the right product. Even if this is the case, success will not be lasting
unless the companies subsequently craft a strategy that capitalizes on their
luck, builds on what is working, and discards the rest. So there can be little
argument that the process of crafting a company’s strategy matters—and
matters a lot.
Second, even the best-conceived strategies will result in performance
shortfalls if they are not executed proficiently. The processes of crafting and
executing strategies must go hand in hand if a company is to be successful in
the long term. The chief executive officer of one successful company put it
well when he said
In the main, our competitors are acquainted with the same fundamental concepts and techniques
and approaches that we follow, and they are as free to pursue them as we are. More often than not,
the difference between their level of success and ours lies in the relative thoroughness and self-
discipline with which we and they develop and execute our strategies for the future.
Good Strategy + Good Strategy Execution =
Good Management
Crafting and executing strategy are thus core management tasks. Among all
the things managers do, nothing affects a company’s ultimate success or
failure more fundamentally than how well its management team charts the
company’s direction, develops competitively effective strategic moves, and
pursues what needs to be done internally to produce good day-in, day-out
page 16
strategy execution and operating excellence. Indeed, good strategy and good
strategy execution are the most telling and trustworthy signs of good
management. The rationale for using the twin standards of good strategy
making and good strategy execution to determine whether a company is well
managed is therefore compelling: The better conceived a company’s strategy
and the more competently it is executed, the more likely the company will be
a standout performer in the marketplace. In stark contrast, a company that
lacks clear-cut direction, has a flawed strategy, or can’t execute its strategy
competently is a company whose financial performance is probably suffering,
whose business is at long-term risk, and whose management is sorely
lacking.
THE ROAD AHEAD
Throughout the chapters to come and in Part 2 of this text, the spotlight is on
the foremost question in running a business enterprise: What must managers
do, and do well, to make a company successful in the marketplace? The
answer that emerges is that doing a good job of managing inherently requires
good strategic thinking and good management of the strategy-making,
strategy-executing process.
How well a company
performs is directly
attributable to the
caliber of its strategy
and the proficiency
with which the
strategy is executed.
The mission of this book is to provide a solid overview of what every
business student and aspiring manager needs to know about crafting and
executing strategy. We will explore what good strategic thinking entails,
describe the core concepts and tools of strategic analysis, and examine the ins
and outs of crafting and executing strategy. The accompanying cases will
help build your skills in both diagnosing how well the strategy-making,
strategy-executing task is being performed and prescribing actions
for how the strategy in question or its execution can be improved.
The strategic management course that you are enrolled in may also include a
strategy simulation exercise in which you will run a company in head-to-head
competition with companies run by your classmates. Your mastery of the
strategic management concepts presented in the following chapters will put
you in a strong position to craft a winning strategy for your company and
figure out how to execute it in a cost-effective and profitable manner. As you
progress through the chapters of the text and the activities assigned during the
term, we hope to convince you that first-rate capabilities in crafting and
executing strategy are essential to good management.
As you tackle the content and accompanying activities of this book, ponder
the following observation by the essayist and poet Ralph Waldo Emerson:
“Commerce is a game of skill which many people play, but which few play
well.” If your efforts help you become a savvy player and better equip you to
succeed in business, the time and energy you spend here will indeed prove
worthwhile.
KEY POINTS
1. A company’s strategy is the set of coordinated actions that its managers
take in order to outperform its competitors and achieve superior
profitability.
2. The success of a company’s strategy depends upon competing differently
from rivals and gaining a competitive advantage over them.
3. A company achieves a competitive advantage when it provides buyers with
superior value compared to rival sellers or produces its products or services
more efficiently. The advantage is sustainable if it persists despite the best
efforts of competitors to match or surpass this advantage.
4. A company’s strategy typically evolves over time, emerging from a blend
of (1) proactive deliberate actions on the part of company managers to
improve the strategy and (2) reactive emergent responses to unanticipated
developments and fresh market conditions.
5. A company’s business model sets forth the logic for how its strategy will
create value for customers and at the same time generate revenues
sufficient to cover costs and realize a profit. Thus, it contains two crucial
elements: (1) the customer value proposition—a plan for satisfying
customer wants and needs at a price customers will consider good value,
and (2) the profit formula—a plan for a cost structure that will enable the
LO 1-1, LO 1-2, LO
1-3
LO 1-4, LO 1-6
page 17
company to deliver the customer value proposition profitably. These
elements are illustrated by the value-price-cost framework.
6. A winning strategy will pass three tests: (1) fit (external, internal, and
dynamic consistency), (2) competitive advantage (durable competitive
advantage), and (3) performance (outstanding financial and market
performance).
7. Ethical strategies must entail actions and behavior that can pass the test of
moral scrutiny in the sense of not being deceitful, unfair or harmful to
others, disreputable, or unreasonably damaging to the environment.
8. Crafting and executing strategy are core management functions. How well
a company performs and the degree of market success it enjoys are directly
attributable to the caliber of its strategy and the proficiency with which the
strategy is executed.
ASSURANCE OF LEARNING EXERCISES
1. Based on your experiences and/or knowledge of
Apple’s current products and services, does Apple’s
strategy (as described in Illustration Capsule 1.1)
seem to set it apart from rivals? Does the strategy
seem to be keyed to a cost-based advantage,
differentiating features, serving the unique needs of
a niche, or some combination of these? What is
there about Apple’s strategy that can lead to
sustainable competitive advantage?
2. Elements of Amazon’s strategy have evolved in
meaningful ways since the company’s founding in
1994. After reviewing the company’s history and all
of the links at the company’s investor relations site
ir.aboutamazon.com prepare a one- to two-page
report that discusses how its strategy has evolved.
Your report should also assess how well Amazon’s
strategy passes the three tests of a winning strategy.
http://ir.aboutamazon.com/
LO 1-5
LO 1-1
LO 1-6
LO 1-3
3. Go to investor.siriusxm.com and check whether
Sirius XM’s recent financial reports indicate that its
business model is working. Are its subscription fees
increasing or declining? Are its revenue stream
advertising and equipment sales growing or
declining? Does its cost structure allow for
acceptable profit margins?
EXERCISES FOR SIMULATION PARTICIPANTS
Three basic questions must be answered by managers of
organizations of all sizes as they begin the process of crafting strategy:
What is our present situation?
Where do we want to go from here?
How are we going to get there?
After you have read the Participant’s Guide or Player’s Manual for the
strategy simulation exercise that you will participate in during this academic
term, you and your co-managers should come up with brief one- or two-
paragraph answers to these three questions prior to entering your first set of
decisions. While your answer to the first of the six questions can be
developed from your reading of the manual, the remaining questions will
require a collaborative discussion among the members of your company’s
management team about how you intend to manage the company you have
been assigned to run.
1. Your company’s strategy in the business simulation
for this course should include choices about what
types of issues?
2. What is your company’s current situation? A
substantive answer to this question should cover the
following issues:
Does your company appear to be in sound financial condition?
What problems does your company have that need to be addressed?
3. Why will your company matter to customers? A
complete answer to this question should say
http://investor.siriusxm.com/
LO 1-5
LO 1-6
LO 1-1, 1-2, 1-6
page 18
something about each of the following: How will
you goals or aspirations do you have for your
company?
How will you create customer value?
What will be distinctive about the company’s products or services?
How will capabilities and resources be deployed to deliver customer
value?
4. What are the primary elements of your company’s
business model?
Describe your customer value proposition.
Discuss the profit formula tied to your business model.
What level of revenues is required for your company’s business model to
become a moneymaker?
5. How will you build and sustain competitive
advantage?
Which of the basic strategic and competitive approaches discussed in this
chapter do you think makes the most sense to pursue?
What kind of competitive advantage over rivals will you try to achieve?
How do you envision that your strategy might evolve as you react to the
competitive moves of rival firms?
Does your strategy have the ability to pass the three tests of a winning
strategy? Explain.
6. Why will strategy execution be important to your
company’s success?
ENDNOTES
1 B. R, “Strategy,” The Economist, October 19, 2012, www.economist.com/blogs/schumpeter/2012/10/z-business-
quotations-1 (accessed January 4, 2014).
2 Jan Rivkin, “An Alternative Approach to Making Strategic Choices,” Harvard Business School case 9-702-433, 2001.
3 Michael E. Porter, “What Is Strategy?” Harvard Business Review 74, no. 6 (November–December 1996), pp. 65–67.
4 Ibid.
5 Eric T. Anderson and Duncan Simester, “A Step-by-Step Guide to Smart Business Experiments,” Harvard Business
Review 89, no. 3 (March 2011).
6 Shona L. Brown and Kathleen M. Eisenhardt, Competing on the Edge: Strategy as Structured Chaos (Boston, MA:
Harvard Business School Press, 1998).
http://www.economist.com/blogs/schumpeter/2012/10/z-business-quotations-1
page 19
7 Cynthia A. Montgomery, “Putting Leadership Back into Strategy,” Harvard Business Review 86, no. 1 (January 2008).
8 Henry Mintzberg and J. A. Waters, “Of Strategies, Deliberate and Emergent,” Strategic Management Journal 6 (1985);
Costas Markides, “Strategy as Balance: From ‘Either-Or’ to ‘And,’ ” Business Strategy Review 12, no. 3 (September
2001).
9 Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann, “Reinventing Your Business Model,” Harvard
Business Review 86, no. 12 (December 2008); Joan Magretta, “Why Business Models Matter,” Harvard Business Review
80, no. 5 (May 2002).
10 A. Brandenburger and H. Stuart, “Value-Based Strategy,” Journal of Economics and Management Strategy 5 (1996),
pp. 5–24; D. Hoopes, T. Madsen, and G. Walker, “Guest Editors’ Introduction to the Special Issue: Why Is There a
Resource-Based View? Toward a Theory of Competitive Heterogeneity,” Strategic Management Journal 24 (2003), pp.
889–992; M. Peteraf and J. Barney, “Unravelling the Resource-Based Tangle,” Managerial and Decision Economics 24
(2003), pp. 309–323.
11 Rivkin, “An Alternative Approach to Making Strategic Choices.”
page 20
chapter 2
Charting a Company’s Direction
Its Vision, Mission, Objectives, and
Strategy
Learning Objectives
After reading this chapter, you should be able to:
LO 2-1 Understand why it is critical for managers to have a
clear strategic vision of where the company needs
to head.
LO 2-2 Explain the importance of setting both strategic and
financial objectives.
LO 2-3 Explain why the strategic initiatives taken at various
organizational levels must be tightly coordinated.
LO 2-4 Recognize what a company must do to execute its
strategy proficiently.
LO 2-5 Comprehend the role and responsibility of a company’s
board of directors in overseeing the strategic
management process.
page 21
Pamela Hamilton/Getty Images
Sound strategy starts with having the right goal.
Michael Porter—Professor and consultant
Purpose must be deliberately conceived and chosen, and then pursued.
page 22
Clayton Christensen—Professor and consultant
A vision without a strategy remains an illusion.
Lee Bolman—Author and leadership consultant
Crafting and executing strategy are the heart and soul of managing a business
enterprise. But exactly what is involved in developing a strategy and executing it
proficiently? What goes into charting a company’s strategic course and long-term
direction? Is any analysis required? Does a company need a strategic plan? What are
the various components of the strategy-making, strategy-executing process and to what
extent are company personnel—aside from senior management—involved in the
process?
This chapter presents an overview of the ins and outs of crafting and executing
company strategies. The focus is on management’s direction-setting responsibilities—
charting a strategic course, setting performance targets, and choosing a strategy
capable of producing the desired outcomes. We explain why strategy-making is a task
for a company’s entire management team and which kinds of strategic decisions tend to
be made at which levels of management. The chapter concludes with a look at the roles
and responsibilities of a company’s board of directors and how good corporate
governance protects shareholder interests and promotes good management.
WHAT DOES THE STRATEGY-MAKING,
STRATEGY-EXECUTING PROCESS
ENTAIL?
Crafting and executing a company’s strategy is an ongoing process that
consists of five interrelated stages:
1. Developing a strategic vision that charts the company’s long-term
direction, a mission statement that describes the company’s purpose, and a
set of core values to guide the pursuit of the vision and mission.
2. Setting objectives for measuring the company’s performance and tracking
its progress in moving in the intended long-term direction.
3. Crafting a strategy for advancing the company along the path management
has charted and achieving its performance objectives.
4. Executing the chosen strategy efficiently and effectively.
5. Monitoring developments, evaluating performance, and initiating
corrective adjustments in the company’s vision and mission statement,
objectives, strategy, or approach to strategy execution in light of actual
experience, changing conditions, new ideas, and new opportunities.
Figure 2.1 displays this five-stage process, which we examine next in some
detail. The first three stages of the strategic management process involve
making a strategic plan. A strategic plan maps out where a company is
headed, establishes strategic and financial targets, and outlines the basic
business model, competitive moves, and approaches to be used in achieving
the desired business results.1 We explain this more fully at the conclusion of
our discussion of stage 3, later in this chapter.
CORE
CONCEPT
A strategic
inflection point is
the point at which
the extent of
industry change
requires
management to
consider changing
the company’s
strategic vision.
FIGURE 2.1 The Strategy-Making, Strategy-Executing
Process
The five-stage process model illustrates the need for management to
evaluate a number of external and internal factors in deciding upon a strategic
direction, appropriate objectives, and approaches to crafting and executing
strategy (see Table 2.1). Management’s decisions that are made in the
strategic management process must be shaped by the prevailing economic
conditions and competitive environment and the company’s own internal
resources and competitive capabilities. These strategy-shaping conditions
will be the focus of Chapters 3 and 4.
TABLE 2.1 Factors Shaping Decisions in the Strategy-
Making, Strategy-Execution Process
External Considerations
Does sticking with the company’s present strategic course present attractive
opportunities for growth and profitability?
What kind of competitive forces are industry members facing, and are they acting to
enhance or weaken the company’s prospects for growth and profitability?
What factors are driving industry change, and what impact on the company’s
prospects will they have?
How are industry rivals positioned, and what strategic moves are they likely to make
next?
page 23
page 24
What are the key factors of future competitive success, and does the industry offer
good prospects for attractive profits for companies possessing those capabilities?
Internal Considerations
Does the company have an appealing customer value proposition?
What are the company’s competitively important resources and capabilities, and are
they potent enough to produce a sustainable competitive advantage?
Does the company have sufficient business and competitive strength to seize market
opportunities and nullify external threats?
Are the company’s costs competitive with those of key rivals?
Is the company competitively stronger or weaker than key rivals?
The model shown in Figure 2.1 also illustrates the need for management to
evaluate the company’s performance on an ongoing basis. Any indication that
the company is failing to achieve its objectives calls for corrective
adjustments in one of the first four stages of the process. The company’s
implementation efforts might have fallen short, and new tactics must be
devised to fully exploit the potential of the company’s strategy. If
management determines that the company’s execution efforts are sufficient, it
should challenge the assumptions underlying the company’s business model
and strategy, and make alterations to better fit competitive conditions and the
company’s internal capabilities. If the company’s strategic approach to
competition is rated as sound, then perhaps management set overly ambitious
targets for the company’s performance.
The evaluation stage of the strategic management process shown in Figure
2.1 also allows for a change in the company’s vision, but this should be
necessary only when it becomes evident to management that the industry has
changed in a significant way that renders the vision obsolete. Such occasions
can be referred to as strategic inflection points. When a company reaches a
strategic inflection point, management has tough decisions to make about the
company’s direction because abandoning an established course
carries considerable risk. However, responding to unfolding
changes in the marketplace in a timely fashion lessens a company’s chances
of becoming trapped in a stagnant or declining business or letting attractive
new growth opportunities slip away.
STAGE 1: DEVELOPING A STRATEGIC
VISION, MISSION STATEMENT, AND
SET OF CORE VALUES
• LO 2-1
Understand why it is
critical for managers
to have a clear
strategic vision of
where the company
needs to head.
Very early in the strategy-making process, a company’s senior managers must
wrestle with the issue of what directional path the company should take. Can
the company’s prospects be improved by changing its product offerings, or
the markets in which it participates, or the customers it aims to serve?
Deciding to commit the company to one path versus another pushes
managers to draw some carefully reasoned conclusions about whether the
company’s present strategic course offers attractive opportunities for growth
and profitability or whether changes of one kind or another in the company’s
strategy and long-term direction are needed.
Developing a Strategic Vision
Top management’s views about the company’s long-term direction and what
product-market-customer business mix seems optimal for the road ahead
constitute a strategic vision for the company. A strategic vision delineates
management’s aspirations for the company’s future, providing a panoramic
view of “where we are going” and a convincing rationale for why this makes
good business sense. A strategic vision thus points an organization in a
particular direction, charts a strategic path for it to follow, builds commitment
to the future course of action, and molds organizational identity. A clearly
articulated strategic vision communicates management’s aspirations to
stakeholders (customers, employees, stockholders, suppliers, etc.) and helps
steer the energies of company personnel in a common direction. The vision of
Google’s cofounders Larry Page and Sergey Brin “to organize the world’s
information and make it universally accessible and useful” provides a good
example. In serving as the company’s guiding light, it has captured the
imagination of stakeholders and the public at large, served as the basis for
crafting the company’s strategic actions, and aided internal efforts to mobilize
and direct the company’s resources.
CORE
CONCEPT
A strategic vision
describes
management’s
aspirations for the
company’s future
and the course and
direction charted to
achieve them.
Well-conceived visions are distinctive and specific to a particular
organization; they avoid generic, feel-good statements like “We will become
a global leader and the first choice of customers in every market we serve.”2
Likewise, a strategic vision proclaiming management’s quest “to be the most
innovative” or “to be recognized as the best company in the industry” offers
scant guidance about a company’s long-term direction or the kind of
company that management is striving to build.
A surprising number of the vision statements found on company websites
and in annual reports are vague and unrevealing, saying very little about the
company’s future direction. Some could apply to almost any company in any
industry. Many read like a public relations statement—high-sounding words
that someone came up with because it is fashionable for companies to have
an official vision statement.3 An example is Hilton Hotel’s vision “to fill the
earth with light and the warmth of hospitality,” which simply borders on the
incredulous. The real purpose of a vision statement is to serve as a
management tool for giving the organization a sense of direction.
An effectively
communicated
page 25
vision is a valuable
management tool for
enlisting the
commitment of
company personnel
to actions that move
the company in the
intended long-term
direction.
For a strategic vision to function as a valuable management tool, it must
convey what top executives want the business to look like and provide
managers at all organizational levels with a reference point in making
strategic decisions and preparing the company for the future. It must say
something definitive about how the company’s leaders intend to position the
company beyond where it is today. Table 2.2 provides some dos
and don’ts in composing an effectively worded vision statement.
Illustration Capsule 2.1 provides a critique of the strategic visions of several
prominent companies.
TABLE 2.2 Wording a Vision Statement—the Dos and
Don’ts
The Dos The Don’ts
Be graphic. Paint a clear picture of where
the company is headed and the market
position(s) the company is striving to
stake out.
Don’t be vague or incomplete. Never
skimp on specifics about where the
company is headed or how the company
intends to prepare for the future.
Be forward-looking and directional.
Describe the strategic course that will help
the company prepare for the future.
Don’t dwell on the present. A vision is
not about what a company once did or
does now; it’s about “where we are
going.”
Keep it focused. Focus on providing
managers with guidance in making
decisions and allocating resources.
Don’t use overly broad language. Avoid
all-inclusive language that gives the
company license to pursue any
opportunity.
page 26
page 27
The Dos The Don’ts
Have some wiggle room. Language that
allows some flexibility allows the
directional course to be adjusted as
market, customer, and technology
circumstances change.
Don’t state the vision in bland or
uninspiring terms. The best vision
statements have the power to motivate
company personnel and inspire
shareholder confidence about the
company’s future.
Be sure the journey is feasible. The
path and direction should be within the
realm of what the company can
accomplish; over time, a company should
be able to demonstrate measurable
progress in achieving the vision.
Don’t be generic. A vision statement that
could apply to companies in any of
several industries (or to any of several
companies in the same industry) is not
specific enough to provide any guidance.
Indicate why the directional path
makes good business sense. The
directional path should be in the long-term
interests of stakeholders (especially
shareholders, employees, and suppliers).
Don’t rely on superlatives. Visions that
claim the company’s strategic course is
the “best” or “most successful” usually
lack specifics about the path the company
is taking to get there.
Make it memorable. A well-stated vision
is short, easily communicated, and
memorable. Ideally, it should be reducible
to a few choice lines or a one-phrase
slogan.
Don’t run on and on. A vision statement
that is not concise and to the point will
tend to lose its audience.
Sources: John P. Kotter, Leading Change (Boston: Harvard Business School Press, 1996);
Hugh Davidson, The Committed Enterprise (Oxford: Butterworth Heinemann, 2002); Michel
Robert, Strategy Pure and Simple II (New York: McGraw-Hill, 1992).
Communicating the Strategic Vision
A strategic vision offers little value to the organization unless it’s effectively
communicated down the line to lower-level managers and employees. A
vision cannot provide direction for middle managers or inspire and energize
employees unless everyone in the company is familiar with it and can
observe senior management’s commitment to the vision. It is particularly
important for executives to provide a compelling rationale for a dramatically
new strategic vision and company direction. When company
personnel don’t understand or accept the need for redirecting
organizational efforts, they are prone to resist change. Hence,
explaining the basis for the new direction, addressing employee concerns
head-on, calming fears, lifting spirits, and providing updates and progress
reports as events unfold all become part of the task in mobilizing support for
the vision and winning commitment to needed actions.
ILLUSTRATION
CAPSULE 2.1 Examples of Strategic Visions
—How Well Do They Measure Up?
Philip Arno Photography/Shutterstock
Vision Statement Effective Elements Shortcomings
Vision Statement Effective Elements Shortcomings
Whole Foods
Whole Foods Market is a dynamic
leader in the quality food business. We
are a mission-driven company that aims
to set the standards of excellence for
food retailers. We are building a
business in which high standards
permeate all aspects of our company.
Quality is a state of mind at Whole
Foods Market.
Our motto—Whole Foods, Whole
People, Whole Planet—emphasizes
that our vision reaches far beyond just
being a food retailer. Our success in
fulfilling our vision is measured by
customer satisfaction, team member
happiness and excellence, return on
capital investment, improvement in the
state of the environment and local and
larger community support.
Our ability to instill a clear sense of
interdependence among our various
stakeholders (the people who are
interested and benefit from the success
of our company) is contingent upon our
efforts to communicate more often,
more openly, and more
compassionately. Better communication
equals better understanding and more
trust.
Forward-
looking
Graphic
Focused
Makes good
business
sense
Long
Not
memorable
Keurig Dr. Pepper
A leading producer and distributor of hot
and cold beverages to satisfy every
consumer need, anytime and anywhere.
Easy to
communicate
Focused
Not distinctive
Not forward-
looking
Nike
NIKE, Inc. fosters a culture of invention.
We create products, services and
experiences for today’s athlete* while
solving problems for the next
generation.
*If you have a body, you are an athlete.
Forward-
looking
Flexible
Vague
Not focused
Note: Developed with Frances C. Thunder.
Source: Company websites (accessed online February 12, 2016).
Winning the support of organization members for the vision nearly always
requires putting “where we are going and why” in writing, distributing the
statement organizationwide, and having top executives personally explain the
vision and its rationale to as many people as feasible. Ideally, executives
should present their vision for the company in a manner that reaches out and
grabs people. An engaging and convincing strategic vision has enormous
motivational value—for the same reason that a stonemason is more inspired
by the opportunity to build a great cathedral for the ages than a house. Thus,
executive ability to paint a convincing and inspiring picture of a company’s
journey to a future destination is an important element of effective strategic
leadership.
Expressing the Essence of the Vision in a Slogan The task of effectively
conveying the vision to company personnel is assisted when management can
capture the vision of where to head in a catchy or easily remembered slogan.
A number of organizations have summed up their vision in a brief phrase.
Instagram’s vision is “Capture and share the world’s moments,” while
Charles Schwab’s is simply “Helping investors help themselves.” Habitat for
Humanity’s aspirational vision is “A world where everyone has a decent
place to live.” Even Scotland Yard has a catchy vision, which is to “make
London the safest major city in the world.” Creating a short slogan to
illuminate an organization’s direction and using it repeatedly as a reminder of
“where we are headed and why” helps rally organization members to
maintain their focus and hurdle whatever obstacles lie in the company’s path.
Why a Sound, Well-Communicated Strategic Vision Matters A well-
thought-out, forcefully communicated strategic vision pays off in several
respects: (1) It crystallizes senior executives’ own views about the firm’s
long-term direction; (2) it reduces the risk of rudderless decision making; (3)
it is a tool for winning the support of organization members to help make the
vision a reality; (4) it provides a beacon for lower-level managers in setting
departmental objectives and crafting departmental strategies that are in sync
with the company’s overall strategy; and (5) it helps an organization prepare
for the future. When top executives are able to demonstrate significant
page 28
progress in achieving these five benefits, the first step in organizational
direction setting has been successfully completed.
Developing a Company Mission Statement
The defining characteristic of a strategic vision is what it says about the
company’s future strategic course—“the direction we are headed and the
shape of our business in the future.” It is aspirational. In contrast, a mission
statement describes the enterprise’s present business and purpose—“who we
are, what we do, and why we are here.” It is purely descriptive. Ideally, a
company mission statement (1) identifies the company’s products and/or
services, (2) specifies the buyer needs that the company seeks to satisfy and
the customer groups or markets that it serves, and (3) gives the company its
own identity. The mission statements that one finds in company annual
reports or posted on company websites are typically quite brief; some do a
better job than others of conveying what the enterprise’s current business
operations and purpose are all about.
The distinction
between a strategic
vision and a mission
statement is fairly
clear-cut: A
strategic vision
portrays a
company’s
aspirations for its
future (“where we
are going”), whereas
a company’s
mission describes
the scope and
purpose of its
present business
(“who we are, what
we do, and why we
are here”).
Consider, for example, the mission statement of FedEx
Corporation, which has long been known for its overnight shipping service,
but also for pioneering the package tracking system now in general use:
The FedEx Corporation offers express and fast delivery transportation services, delivering an
estimated 3 million packages daily all around the globe. Its services include overnight courier,
ground, heavy freight, document copying, and logistics services.
Note that FedEx’s mission statement does a good job of conveying “who
we are, what we do, and why we are here,” but it provides no sense of “where
we are headed.” This is as it should be, since a company’s vision statement is
that which speaks to the future.
Another example of a well-stated mission statement with ample specifics
about what the organization does is that of St. Jude Children’s Research
Hospital: “to advance cures, and means of prevention, for pediatric
catastrophic diseases through research and treatment. Consistent with the
vision of our founder Danny Thomas, no child is denied treatment based on
race, religion or a family’s ability to pay.” Twitter’s mission statement, while
short, still captures the essence of what the company is about: “To give
everyone the power to create and share ideas and information instantly,
without barriers.” An example of a not-so-revealing mission statement is that
of JetBlue: “To inspire humanity—both in the air and on the ground.” It says
nothing about the company’s activities or business makeup and could apply
to many companies in many different industries. A person unfamiliar with
JetBlue could not even discern from its mission statement that it is an airline,
without reading between the lines. Coca-Cola, which markets more than 500
beverage brands in over 200 countries, also has an uninformative mission
statement: “to refresh the world; to inspire moments of optimism and
happiness; to create value and make a difference.” The usefulness of a
mission statement that cannot convey the essence of a company’s business
activities and purpose is unclear.
All too often, companies couch their mission in terms of making a profit,
like Dean Foods with its mission “To maximize long-term stockholder
value.” This, too, is flawed. Profit is more correctly an objective and a result
of what a company does. Moreover, earning a profit is the obvious intent of
every commercial enterprise. Companies such as Gap, Inc., Edward Jones,
Honda, The Boston Consulting Group, Citigroup, DreamWorks Animation,
and Intuit are all striving to earn a profit for shareholders; but plainly the
fundamentals of their businesses are substantially different when it comes to
“who we are and what we do.” It is management’s answer to “make a profit
doing what and for whom?” that reveals the substance of a company’s true
mission and business purpose.
To be well worded, a
company mission
statement must
employ language
specific enough to
distinguish its
business makeup
and purpose from
those of other
enterprises and give
the company its own
identity.
Linking the Vision and Mission with Company
Values
Companies commonly develop a set of values to guide the actions and
behavior of company personnel in conducting the company’s business and
pursuing its strategic vision and mission. By values (or core values, as they
are often called) we mean certain designated beliefs, traits, and behavioral
norms that management has determined should guide the pursuit of its vision
and mission. Values relate to such things as fair treatment, honor and
integrity, ethical behavior, innovativeness, teamwork, a passion for top-notch
quality or superior customer service, social responsibility, and community
citizenship.
CORE
CONCEPT
A company’s values
are the beliefs,
traits, and
behavioral norms
that company
personnel are
expected to display
in conducting the
company’s business
and pursuing its
page 29
strategic vision and
mission.
Most companies articulate four to eight core values that company
personnel are expected to display and that are supposed to be mirrored in how
the company conducts its business. Build-A-Bear Workshop, with
its cuddly Teddy bears and stuffed animals, credits six core values
with creating its highly acclaimed working environment: (1) Reach, (2)
Learn, (3) Di-bear-sity (4) Colla-bear-ate, (5) Give, and (6) Cele-bear-ate.
Zappos prides itself on its 10 core values, which employees are expected to
embody:
1. Deliver WOW Through Service
2. Embrace and Drive Change
3. Create Fun and a Little Weirdness
4. Be Adventurous, Creative, and Open-Minded
5. Pursue Growth and Learning
6. Build Open and Honest Relationships with Communication
7. Build a Positive Team and Family Spirit
8. Do More with Less
9. Be Passionate and Determined
10. Be Humble
Do companies practice what they preach when it comes to their professed
values? Sometimes no, sometimes yes—it runs the gamut. At one extreme
are companies with window-dressing values; the values are given lip service
by top executives but have little discernible impact on either how company
personnel behave or how the company operates. Such companies have value
statements because they are in vogue and make the company look good. The
limitation of these value statements becomes apparent whenever corporate
misdeeds come to light. Prime examples include Volkswagen, with its
emissions scandal, and Uber, facing multiple allegations of misbehavior and a
criminal probe of illegal operations. At the other extreme are companies
whose executives are committed to grounding company operations on sound
values and principled ways of doing business. Executives at these companies
deliberately seek to ingrain the designated core values into the corporate
culture—the core values thus become an integral part of the company’s DNA
page 30
and what makes the company tick. At such values-driven companies,
executives “walk the talk” and company personnel are held accountable for
embodying the stated values in their behavior.
At companies where the stated values are real rather than cosmetic,
managers connect values to the pursuit of the strategic vision and mission in
one of two ways. In companies with long-standing values that are deeply
entrenched in the corporate culture, senior managers are careful to craft a
vision, mission, strategy, and set of operating practices that match established
values; moreover, they repeatedly emphasize how the value-based behavioral
norms contribute to the company’s business success. If the company changes
to a different vision or strategy, executives make a point of explaining how
and why the core values continue to be relevant. Few companies with sincere
commitment to established core values ever undertake strategic moves that
conflict with ingrained values. In new companies, top management has to
consider what values and business conduct should characterize the company
and then draft a value statement that is circulated among managers and
employees for discussion and possible modification. A final value statement
that incorporates the desired behaviors and that connects to the vision and
mission is then officially adopted. Some companies combine their vision,
mission, and values into a single statement or document, circulate it to all
organization members, and in many instances post the vision, mission, and
value statement on the company’s website. Illustration Capsule 2.2 describes
how the success of TOMS Shoes has been largely driven by the nature of its
mission, linked to the vision and core values of its founder.
ILLUSTRATION
CAPSULE 2.2 TOMS Shoes: A Mission with
a Company
TOMS Shoes was founded in 2006 by Blake Mycoskie after a trip to Argentina where he
witnessed many children with no access to shoes in areas of extreme poverty. Mycoskie
returned to the United States and founded TOMS Shoes with the purpose of matching
every pair of shoes purchased by customers with a new pair of shoes to give to a child in
need, a model he called One for One®. In contrast to many companies that begin with a
product and then articulate a mission, Mycoskie started with the mission and then built a
company around it. Although the company has since expanded their product portfolio, its
mission remains essentially the same:
With every product you purchase, TOMS will help a person in need. One for One.®
TOMS’s mission is ingrained in their business model. While Mycoskie could have set
up a nonprofit organization to address the problem he witnessed, he was certain he didn’t
want to rely on donors to fund giving to the poor; he wanted to create a business that
would fund the giving itself. With the one-for-one model, TOMS built the cost of giving
away a pair of shoes into the price of each pair they sold, enabling the company to make
a profit while still giving away shoes to the needy.
Much of TOMS’s success (and ability to differentiate itself in a competitive
marketplace) is attributable to the appeal of its mission and origin story. Mycoskie first got
TOMS shoes into a trendy store in LA because he told them the story of why he founded
the company, which got picked up by the LA Times and quickly spread. As the company
has expanded communication channels, they continue to focus on leading with the story
of their mission to ensure that customers know they are doing more than just buying a
product.
As TOMS expanded to other products, they stayed true to the one-for-one business
model, adapting it to each new product category. In 2011, the company launched TOMS
Eyewear, where every purchase of glasses helps restore sight to an individual. They’ve
since launched TOMS Roasting Co. that helps support access to safe water with every
purchase of coffee, TOMS Bags where purchases fund resources for safe birth, and
TOMS High Road Backpack Collection where purchases provide training for bullying
prevention.
Shutterstock/Teresa Schaeffer
By ingraining the mission in the company’s business model, TOMS has been able to
truly live up to Mycoskie’s aspiration of a mission with a company, funding giving through
page 31
a for-profit business. TOMS even ensured that the business model will never change;
when Mycoskie sold 50 percent of the company to Bain Capital in 2014, part of the
transaction protected the one-for-one business model forever. TOMS is a successful
example of a company that proves a commitment to core values can spur both revenue
growth and giving back.
Note: Developed with Carry S. Resor
Sources: TOMS Shoes website, accessed February 2018, http://www.toms.com/about-
toms; Lebowitz, Shana, Business Insider, “TOMS Blake Mycoskie Talks Growing a
Business While Balancing Profit with Purpose,” June 15, 2016,
http://www.businessinsider.com/toms-blake-mycoskie-talks-growing-a-business-
while-balancing-profit-with-purpose-2016-6; Mycoskie, Blake, Harvard Business
Review, “The Founder of TOMS on Reimaging the Company’s Mission,” from January-
February 2016 issue, https://hbr.org/2016/01/the-founder-of-toms-on-reimagining-
the-companys-mission.
STAGE 2: SETTING OBJECTIVES
• LO 2-2
Explain the
importance of setting
both strategic and
financial objectives.
The managerial purpose of setting objectives is to convert the vision and
mission into specific performance targets. Objectives reflect management’s
aspirations for company performance in light of the industry’s prevailing
economic and competitive conditions and the company’s internal capabilities.
Well-stated objectives must be specific, as well as quantifiable or
measurable. As Bill Hewlett, cofounder of Hewlett-Packard, shrewdly
observed, “You cannot manage what you cannot measure. . . . And what gets
measured gets done.”4 Concrete, measurable objectives are managerially
valuable for three reasons: (1) They focus organizational attention and align
actions throughout the organization, (2) they serve as yardsticks for tracking a
company’s performance and progress, and (3) they motivate employees to
expend greater effort and perform at a high level. For company objectives to
http://www.toms.com/about-toms
http://www.businessinsider.com/toms-blake-mycoskie-talks-growing-a-business-while-balancing-profit-with-purpose-2016-6
https://hbr.org/2016/01/the-founder-of-toms-on-reimagining-the-companys-mission
serve their purpose well, they must also meet three other criteria: they must
contain a deadline for achievement and they must be challenging, yet
achievable.
CORE
CONCEPT
Objectives are an
organization’s
performance targets
—the specific results
management wants
to achieve.
Well-chosen
objectives are:
specific
measurable
time-limited
challenging
achievable
Setting Stretch Objectives
The experiences of countless companies teach that one of the best ways to
promote outstanding company performance is for managers to set
performance targets high enough to stretch an organization to perform at its
full potential and deliver the best possible results. Challenging company
personnel to go all out and deliver “stretch” gains in performance pushes an
enterprise to be more inventive, to exhibit more urgency in improving both its
financial performance and its business position, and to be more intentional
and focused in its actions. Employing stretch goals can help create an
exciting work environment and attract the best people. In many cases, stretch
objectives spur exceptional performance and help build a firewall against
contentment with modest gains in organizational performance.
CORE
CONCEPT
Stretch objectives
set performance
page 32
targets high enough
to stretch an
organization to
perform at its full
potential and deliver
the best possible
results. Extreme
stretch goals are
warranted only
under certain
conditions.
There is a difference, however, between stretch goals that are clearly
reachable with enough effort, and those that are well beyond the
organization’s current capabilities, regardless of the level of effort. Extreme
stretch goals, involving radical expectations, fail more often than not. And
failure to meet such goals can kill motivation, erode employee confidence,
and damage both worker and company performance. CEO Marissa Mayer’s
inability to return Yahoo to greatness is a case in point.
Extreme stretch goals can work as envisioned under certain circumstances.
High profile success stories at companies such as Southwest Airlines, 3M,
SpaceX, and General Electric provide evidence. But research suggests that
success of this sort depends upon two conditions being met: (1) the company
must have ample resources available, and (2) its recent performance must be
strong. Under any other circumstances, managers would be well advised not
to pursue overly ambitious stretch goals.5
What Kinds of Objectives to Set
Two distinct types of performance targets are required: those relating to
financial performance and those relating to strategic performance. Financial
objectives communicate management’s goals for financial performance.
Strategic objectives are goals concerning a company’s marketing standing
and competitive position. A company’s set of financial and strategic
objectives should include both near-term and longer-term performance
targets. Short-term (quarterly or annual) objectives focus attention
on delivering performance improvements in the current period and
satisfy shareholder expectations for near-term progress. Longer-term targets
(three to five years off) force managers to consider what to do now to put the
company in position to perform better later. Long-term objectives are critical
for achieving optimal long-term performance and stand as a barrier to a
nearsighted management philosophy and an undue focus on short-term
results. When trade-offs have to be made between achieving long-term
objectives and achieving short-term objectives, long-term objectives should
take precedence (unless the achievement of one or more short-term
performance targets has unique importance). Examples of commonly used
financial and strategic objectives are listed in Table 2.3. Illustration Capsule
2.3 provides selected financial and strategic objectives of three prominent
companies.
CORE
CONCEPT
Financial
objectives
communicate
management’s goals
for financial
performance.
Strategic
objectives lay out
target outcomes
concerning a
company’s market
standing,
competitive position,
and future business
prospects.
TABLE 2.3 Common Financial and Strategic Objectives
Financial Objectives Strategic Objectives
Financial Objectives Strategic Objectives
An x percent increase in annual
revenues
Annual increases in after-tax profits of
x percent
Annual increases in earnings per share
of x percent
Annual dividend increases of x percent
Profit margins of x percent
An x percent return on capital
employed (ROCE) or return on
shareholders’ equity (ROE) investment
Increased shareholder value in the
form of an upward-trending stock price
Bond and credit ratings of x
Internal cash flows of x dollars to fund
new capital investment
Winning an x percent market share
Achieving lower overall costs than
rivals
Overtaking key competitors on product
performance, quality, or customer
service
Deriving x percent of revenues from
the sale of new products introduced
within the past five years
Having broader or deeper
technological capabilities than rivals
Having a wider product line than rivals
Having a better-known or more
powerful brand name than rivals
Having stronger national or global
sales and distribution capabilities than
rivals
Consistently getting new or improved
products to market ahead of rivals
The Need for a Balanced Approach to Objective
Setting
The importance of setting and attaining financial objectives is obvious.
Without adequate profitability and financial strength, a company’s long-term
health and ultimate survival are jeopardized. Furthermore, subpar earnings
and a weak balance sheet alarm shareholders and creditors and put the jobs of
senior executives at risk. In consequence, companies often focus most of their
attention on financial outcomes. However, good financial performance, by
itself, is not enough. Of equal or greater importance is a company’s strategic
performance—outcomes that indicate whether a company’s market position
and competitiveness are deteriorating, holding steady, or improving. A
stronger market standing and greater competitive vitality—especially when
accompanied by competitive advantage—is what enables a company to
improve its financial performance.
Moreover, financial performance measures are really lagging indicators
that reflect the results of past decisions and organizational activities.6 But a
company’s past or current financial performance is not a reliable indicator of
page 33
page 34
its future prospects—poor financial performers often turn things around and
do better, while good financial performers can fall upon hard
times. The best and most reliable leading indicators of a
company’s future financial performance and business prospects are strategic
outcomes that indicate whether the company’s competitiveness and market
position are stronger or weaker. The accomplishment of strategic objectives
signals that the company is well positioned to sustain or improve its
performance. For instance, if a company is achieving ambitious strategic
objectives such that its competitive strength and market position are on the
rise, then there’s reason to expect that its future financial
performance will be better than its current or past performance. If
a company is losing ground to competitors and its market position is slipping
—outcomes that reflect weak strategic performance—then its ability to
maintain its present profitability is highly suspect.
ILLUSTRATION
CAPSULE 2.3 Examples of Company
Objectives
JETBLUE
Produce above average industry margins by offering a quality product at a competitive
price; generate revenues of over $6.6 billion, up 3.4 percent year over year; earn a net
income of $759 million, an annual increase of 12.0 percent; further develop fare options,
a co-branded credit card, and the Mint franchise; commit to achieving total cost savings
of $250 to $300 million by 2020; kickoff multi-year cabin restyling program; convert all
core A321 aircraft from 190 to 200 seats; target growth in key cities like Boston, plan to
grow 150 flights a day to 200 over the coming years; grow toward becoming the carrier of
choice in South Florida; organically grow west coast presence by expanding Mint offering
to more transcontinental routes; optimize fare mix to increase overall average fare.
LULULEMON ATHLETICA, INC.
Optimize and strategically grow square footage in North America; explore new concepts
such as stores that are tailored to each community; build a robust digital ecosystem with
key investments in customer relationship management, analytics, and capabilities to
elevate guest experience across all touch points; continue to expand the brand globally
through international expansion, open 11 new stores in Asia and Europe, which include
the first stores in China, South Korea, and Switzerland—operating a total of 50+ stores
across nine countries outside of North America; increase revenue $4 billion by 2020;
increase total comparable sales, which includes comparable store sales and direct to
consumer, by 6 percent increase gross profit as a percentage of net revenue, or gross
margin, by 51.2 percent; increase income from operations for fiscal 2016 by 14 percent.
Eric Broder Van Dyke/Shutterstock
GENERAL MILLS
Generate low single-digit organic net sales growth and high single-digit growth in
earnings per share. Deliver double-digit returns to shareholders over the long term. To
drive future growth, focus on Consumer First strategy to gain a deep understanding of
consumer needs and respond quickly to give them what they want; more specifically: (1)
grow cereal globally with a strong line-up of new products, including new flavors of iconic
Cheerios, (2) innovate in fast growing segments of the yogurt category to improve
performance and expand the yogurt platform into new cities in China; (3) expand
distribution and advertising for high performing brands, such as Häagen-Dazs and Old El
Paso; (4) build a more agile organization by streamlining support functions, allowing for
more fluid use of resources and idea sharing around the world; enhancing e-commerce
know-how to capture more growth in this emerging channel; and investing in strategic
revenue management tools to optimize promotions, prices and mix of products to drive
sales growth.
Note: Developed with Kathleen T. Durante
Sources: Information posted on company websites.
Consequently, it is important to use a performance measurement system
that strikes a balance between financial and strategic objectives.7 The most
widely used framework of this sort is known as the Balanced Scorecard.8
This is a method for linking financial performance objectives to specific
strategic objectives that derive from a company’s business model. It maps out
the key objectives of a company, with performance indicators, along four
dimensions:
Financial: listing financial objectives
Customer: objectives relating to customers and the market
Internal process: objectives relating to productivity and quality
Organizational: objectives concerning human capital, culture,
infrastructure, and innovation
CORE
CONCEPT
The Balanced
Scorecard is a
widely used method
for combining the
use of both strategic
and financial
objectives, tracking
their achievement,
and giving
management a more
complete and
balanced view of
how well an
organization is
performing.
CORE
CONCEPT
The four dimensions
of a Balanced
Scorecard:
1. Financial
2. Customer
3. Internal Process
4. Organizational
(formerly called
Growth and
Learning)
Done well, this can provide a company’s employees with clear guidelines
about how their jobs are linked to the overall objectives of the organization,
so they can contribute most productively and collaboratively to the
achievement of these goals. The balanced scorecard methodology continues
to be ranked as one of the most popular management tools.9 Over 50 percent
of companies in the United States, Europe, and Asia report using a balanced
scorecard approach to measuring strategic and financial performance.10
Organizations that have adopted the balanced scorecard approach include 7-
Eleven, Ann Taylor Stores, Allianz Italy, Wells Fargo Bank, Ford Motor
Company, Verizon, ExxonMobil, Pfizer, DuPont, Royal Canadian Mounted
Police, U.S. Army Medical Command, and over 30 colleges and
universities.11 Despite its popularity, the balanced scorecard is not without
limitations. Importantly, it may not capture some of the most important
priorities of a particular organization, such as resource acquisition or
partnering with other organizations. Further, as with most strategy tools, its
value depends on implementation and follow through as much as on
substance.
Setting Objectives for Every Organizational Level
Objective setting should not stop with top management’s establishing
companywide performance targets. Company objectives need to be broken
down into performance targets for each of the organization’s separate
businesses, product lines, functional departments, and individual work units.
Employees within various functional areas and operating levels will be
guided much better by specific objectives relating directly to their
departmental activities than broad organizational-level goals. Objective
setting is thus a top-down process that must extend to the lowest
organizational levels. This means that each organizational unit must take care
to set performance targets that support—rather than conflict with or negate—
the achievement of companywide strategic and financial objectives.
The ideal situation is a team effort in which each organizational unit strives
to produce results that contribute to the achievement of the company’s
performance targets and strategic vision. Such consistency signals that
organizational units know their strategic role and are on board in helping the
company move down the chosen strategic path and produce the desired
results.
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STAGE 3: CRAFTING A STRATEGY
• LO 2-3
Explain why the
strategic initiatives
taken at various
organizational levels
must be tightly
coordinated.
As indicated in Chapter 1, the task of stitching a strategy together entails
addressing a series of “hows”: how to attract and please customers, how to
compete against rivals, how to position the company in the marketplace, how
to respond to changing market conditions, how to capitalize on attractive
opportunities to grow the business, and how to achieve strategic and financial
objectives. Choosing among the alternatives available in a way that coheres
into a viable business model requires an understanding of the basic principles
of strategic management. Fast-changing business environments demand
astute entrepreneurship searching for opportunities to do new things or to do
existing things in new or better ways.
In choosing among opportunities and addressing the hows of strategy,
strategists must embrace the risks of uncertainty and the discomfort that
naturally accompanies such risks. Bold strategies involve making difficult
choices and placing bets on the future. Good strategic planning is not about
eliminating risks, but increasing the odds of success.
This places a premium on astute entrepreneurship searching for
opportunities to do new things or to do existing things in new or better
ways.12 The faster a company’s business environment is changing, the more
critical it becomes for its managers to be good entrepreneurs in diagnosing
the direction and force of the changes underway and in responding with
timely adjustments in strategy. Strategy makers have to pay attention to early
warnings of future change and be willing to experiment with dare-to-be-
different ways to establish a market position in that future. When obstacles
page 36
appear unexpectedly in a company’s path, it is up to management to adapt
rapidly and innovatively. Masterful strategies come from doing things
differently from competitors where it counts—out-innovating them, being
more efficient, being more imaginative, adapting faster—rather than running
with the herd. Good strategy making is therefore inseparable from good
business entrepreneurship. One cannot exist without the other.
Strategy Making Involves Managers at All
Organizational Levels
A company’s senior executives obviously have lead strategy-making roles
and responsibilities. The chief executive officer (CEO), as captain of the ship,
carries the mantles of chief direction setter, chief objective setter, chief
strategy maker, and chief strategy implementer for the total enterprise.
Ultimate responsibility for leading the strategy-making, strategy-executing
process rests with the CEO. And the CEO is always fully accountable for the
results the strategy produces, whether good or bad. In some enterprises, the
CEO or owner functions as chief architect of the strategy, personally deciding
what the key elements of the company’s strategy will be, although he or she
may seek the advice of key subordinates and board members. A CEO-
centered approach to strategy development is characteristic of small owner-
managed companies and some large corporations that were founded by the
present CEO or that have a CEO with strong strategic leadership skills. Elon
Musk at Tesla Motors and SpaceX, Mark Zuckerberg at Facebook, Jeff Bezos
at Amazon, Jack Ma of Alibaba, Warren Buffett at Berkshire Hathaway, and
Marillyn Hewson at Lockheed Martin are examples of high-profile corporate
CEOs who have wielded a heavy hand in shaping their company’s strategy.
In most corporations, however, strategy is the product of more
than just the CEO’s handiwork. Typically, other senior executives—business
unit heads, the chief financial officer, and vice presidents for production,
marketing, and other functional departments—have influential strategy-
making roles and help fashion the chief strategy components. Normally, a
company’s chief financial officer is in charge of devising and implementing
an appropriate financial strategy; the production vice president takes the lead
in developing the company’s production strategy; the marketing vice
president orchestrates sales and marketing strategy; a brand manager is in
charge of the strategy for a particular brand in the company’s product lineup;
and so on. Moreover, the strategy-making efforts of top managers are
complemented by advice and counsel from the company’s board of directors;
normally, all major strategic decisions are submitted to the board of directors
for review, discussion, perhaps modification, and official approval.
But strategy making is by no means solely a top management function, the
exclusive province of owner-entrepreneurs, CEOs, high-ranking executives,
and board members. The more a company’s operations cut across different
products, industries, and geographic areas, the more that headquarters
executives have little option but to delegate considerable strategy-making
authority to down-the-line managers in charge of particular subsidiaries,
divisions, product lines, geographic sales offices, distribution centers, and
plants. On-the-scene managers who oversee specific operating units can be
reliably counted on to have more detailed command of the strategic issues for
the particular operating unit under their supervision since they have more
intimate knowledge of the prevailing market and competitive conditions,
customer requirements and expectations, and all the other relevant aspects
affecting the several strategic options available. Managers with day-to-day
familiarity of, and authority over, a specific operating unit thus have a big
edge over headquarters executives in making wise strategic choices for their
unit. The result is that, in most of today’s companies, crafting and executing
strategy is a collaborative team effort in which every company manager plays
a strategy-making role—ranging from minor to major—for the area he or she
heads.
In most companies,
crafting and
executing strategy is
a collaborative team
effort in which every
manager has a role
for the area he or
she heads; it is
rarely something
that only high-level
managers do.
page 37
Take, for example, a company like General Electric, a $213 billion global
corporation with nearly 300,000 employees, operations in over 180 countries,
and businesses that include jet engines, lighting, power generation, medical
imaging and diagnostic equipment, locomotives, industrial automation,
aviation services, and financial services. While top-level headquarters
executives may well be personally involved in shaping GE’s overall strategy
and fashioning important strategic moves, they simply cannot know enough
about the situation in every GE organizational unit to direct every strategic
move made in GE’s worldwide organization. Rather, it takes involvement on
the part of GE’s whole management team—top executives, business group
heads, the heads of specific business units and product categories, and key
managers in plants, sales offices, and distribution centers—to craft the
thousands of strategic initiatives that end up composing the whole of GE’s
strategy.
The larger and more
diverse the
operations of an
enterprise, the more
points of strategic
initiative it has and
the more levels of
management that
have a significant
strategy-making
role.
A Company’s Strategy-Making Hierarchy
In diversified companies like GE, where multiple and sometimes strikingly
different businesses have to be managed, crafting a full-fledged strategy
involves four distinct types of strategic actions and initiatives. Each of these
involves different facets of the company’s overall strategy and calls for the
participation of different types of managers, as shown in Figure 2.2.
FIGURE 2.2 A Company’s Strategy-Making Hierarchy
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As shown in Figure 2.2, corporate strategy is orchestrated by the
CEO and other senior executives and establishes an overall strategy for
managing a set of businesses in a diversified, multibusiness company.
Corporate strategy concerns how to improve the combined performance of
the set of businesses the company has diversified into by capturing cross-
business synergies and turning them into competitive advantage. It addresses
the questions of what businesses to hold or divest, which new markets to
enter, and how to best enter new markets (by acquisition, creation of a
strategic alliance, or through internal development, for example). Corporate
strategy and business diversification are the subjects of Chapter 8, in which
they are discussed in detail.
CORE
CONCEPT
Corporate strategy
establishes an
overall game plan
for managing a set
of businesses in a
diversified,
multibusiness
company. Business
strategy is primarily
concerned with
strengthening the
company’s market
position and building
competitive
advantage in a
single-business
company or in a
single business unit
of a diversified
multibusiness
corporation.
Business strategy is concerned with strengthening the market position,
building competitive advantage, and improving the performance of a single
line of business. Business strategy is primarily the responsibility of business
unit heads, although corporate-level executives may well exert strong
influence; in diversified companies it is not unusual for corporate officers to
insist that business-level objectives and strategy conform to corporate-level
objectives and strategy themes. The business head has at least two other
strategy-related roles: (1) seeing that lower-level strategies are well
conceived, consistent, and adequately matched to the overall business
strategy; and (2) keeping corporate-level officers (and sometimes the board
of directors) informed of emerging strategic issues.
Functional-area strategies concern the approaches employed in managing
particular functions within a business—like research and development
(R&D), production, procurement of inputs, sales and marketing, distribution,
customer service, and finance. A company’s marketing strategy, for example,
represents the managerial game plan for running the sales and marketing part
of the business. A company’s product development strategy represents the
game plan for keeping the company’s product lineup in tune with what
buyers are looking for.
Functional strategies flesh out the details of a company’s business strategy.
Lead responsibility for functional strategies within a business is normally
delegated to the heads of the respective functions, with the general manager
of the business having final approval. Since the different functional-level
strategies must be compatible with the overall business strategy and with one
another to have beneficial impact, there are times when the general business
manager exerts strong influence on the content of the functional strategies.
Operating strategies concern the relatively narrow approaches for
managing key operating units (e.g., plants, distribution centers, purchasing
centers) and specific operating activities with strategic significance (e.g.,
quality control, materials purchasing, brand management, Internet sales). A
plant manager needs a strategy for accomplishing the plant’s objectives,
carrying out the plant’s part of the company’s overall manufacturing game
plan, and dealing with any strategy-related problems that exist at the plant. A
company’s advertising manager needs a strategy for getting maximum
audience exposure and sales impact from the ad budget. Operating strategies,
while of limited scope, add further detail and completeness to functional
strategies and to the overall business strategy. Lead responsibility for
operating strategies is usually delegated to frontline managers, subject to the
review and approval of higher-ranking managers.
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Even though operating strategy is at the bottom of the strategy-making
hierarchy, its importance should not be downplayed. A major plant that fails
in its strategy to achieve production volume, unit cost, and quality targets can
damage the company’s reputation for quality products and undercut the
achievement of company sales and profit objectives. Frontline managers are
thus an important part of an organization’s strategy-making team.
One cannot reliably judge the strategic importance of a given
action simply by the strategy level or location within the managerial
hierarchy where it is initiated.
A company’s
strategy is at full
power only when its
many pieces are
united.
In single-business companies, the uppermost level of the strategy-making
hierarchy is the business strategy, so a single-business company has three
levels of strategy: business strategy, functional-area strategies, and operating
strategies. Proprietorships, partnerships, and owner-managed enterprises may
have only one or two strategy-making levels since it takes only a few key
people to craft and oversee the firm’s strategy. The larger and more diverse
the operations of an enterprise, the more points of strategic initiative it has
and the more levels of management that have a significant strategy-making
role.
Uniting the Strategy-Making Hierarchy
The components of a company’s strategy up and down the strategy hierarchy
should be cohesive and mutually reinforcing, fitting together like a jigsaw
puzzle. Anything less than a unified collection of strategies weakens the
overall strategy and is likely to impair company performance.13 It is the
responsibility of top executives to achieve this unity by clearly
communicating the company’s vision, mission, objectives, and major strategy
components to down-the-line managers and key personnel. Midlevel and
frontline managers cannot craft unified strategic moves without first
understanding the company’s long-term direction and knowing the major
components of the corporate and/or business strategies that their strategy-
making efforts are supposed to support and enhance. Thus, as a general rule,
strategy making must start at the top of the organization, then proceed
downward from the corporate level to the business level, and then from the
business level to the associated functional and operating levels. Once
strategies up and down the hierarchy have been created, lower-level strategies
must be scrutinized for consistency with and support of higher-level
strategies. Any strategy conflicts must be addressed and resolved, either by
modifying the lower-level strategies with conflicting elements or by adapting
the higher-level strategy to accommodate what may be more appealing
strategy ideas and initiatives bubbling up from below.
A Strategic Vision + Mission + Objectives +
Strategy = A Strategic Plan
Developing a strategic vision and mission, setting objectives, and crafting a
strategy are basic direction-setting tasks. They map out where a company is
headed, delineate its strategic and financial targets, articulate the basic
business model, and outline the competitive moves and operating approaches
to be used in achieving the desired business results. Together, these elements
constitute a strategic plan for coping with industry conditions, competing
against rivals, meeting objectives, and making progress along the chosen
strategic course.14 Typically, a strategic plan includes a commitment to
allocate resources to carrying out the plan and specifies a time period for
achieving goals.
CORE
CONCEPT
A company’s
strategic plan lays
out its direction,
business model,
competitive strategy,
and performance
targets for some
specified period of
time.
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In companies that do regular strategy reviews and develop explicit
strategic plans, the strategic plan usually ends up as a written document that
is circulated to most managers. Near-term performance targets are the part of
the strategic plan most often communicated to employees more generally and
spelled out explicitly. A number of companies summarize key elements of
their strategic plans in the company’s annual report to
shareholders, in postings on their websites, or in statements
provided to the business media; others, perhaps for reasons of competitive
sensitivity, make only vague, general statements about their strategic plans.15
In small, privately owned companies it is rare for strategic plans to exist in
written form. Small-company strategic plans tend to reside in the thinking
and directives of owner-executives; aspects of the plan are revealed in
conversations with company personnel about where to head, what to
accomplish, and how to proceed.
STAGE 4: EXECUTING THE STRATEGY
• LO 2-4
Recognize what a
company must do to
achieve operating
excellence and to
execute its strategy
proficiently.
Managing the implementation of a strategy is easily the most demanding and
time-consuming part of the strategic management process. Converting
strategic plans into actions and results tests a manager’s ability to direct
organizational change, motivate company personnel, build and strengthen
competitive capabilities, create and nurture a strategy-supportive work
climate, and meet or beat performance targets. Initiatives to put the strategy
in place and execute it proficiently must be launched and managed on many
organizational fronts.
Management’s action agenda for executing the chosen strategy emerges
from assessing what the company will have to do to achieve the financial and
page 41
strategic performance targets. Each company manager has to think through
the answer to the question “What needs to be done in my area to execute my
piece of the strategic plan, and what actions should I take to get the process
under way?” How much internal change is needed depends on how much of
the strategy is new, how far internal practices and competencies deviate from
what the strategy requires, and how well the present work culture supports
good strategy execution. Depending on the amount of internal change
involved, full implementation and proficient execution of the company
strategy (or important new pieces thereof) can take several months to several
years.
In most situations, managing the strategy execution process includes the
following principal aspects:
Creating a strategy-supporting structure.
Staffing the organization to obtain needed skills and expertise.
Developing and strengthening strategy-supporting resources and
capabilities.
Allocating ample resources to the activities critical to strategic success.
Ensuring that policies and procedures facilitate effective strategy execution.
Organizing the work effort along the lines of best practice.
Installing information and operating systems that enable company
personnel to perform essential activities.
Motivating people and tying rewards directly to the achievement of
performance objectives.
Creating a company culture conducive to successful strategy execution.
Exerting the internal leadership needed to propel implementation forward.
Good strategy execution requires diligent pursuit of operating excellence.
It is a job for a company’s whole management team. Success hinges on the
skills and cooperation of operating managers who can push for needed
changes in their organizational units and consistently deliver good results.
Management’s handling of the strategy implementation process
can be considered successful if things go smoothly enough that
the company meets or beats its strategic and financial performance targets
and shows good progress in achieving management’s strategic vision. In
Chapters 10, 11, and 12, we discuss the various aspects of the strategy
implementation process more fully.
STAGE 5: EVALUATING
PERFORMANCE AND INITIATING
CORRECTIVE ADJUSTMENTS
The fifth component of the strategy management process—monitoring new
external developments, evaluating the company’s progress, and making
corrective adjustments—is the trigger point for deciding whether to continue
or change the company’s vision and mission, objectives, strategy, business
model and/or strategy execution methods.16 As long as the company’s
strategy continues to pass the three tests of a winning strategy discussed in
Chapter 1 (good fit, competitive advantage, strong performance), company
executives may decide to stay the course. Simply fine-tuning the strategic
plan and continuing with efforts to improve strategy execution are sufficient.
But whenever a company encounters disruptive changes in its
environment, questions need to be raised about the appropriateness of its
direction and strategy. If a company experiences a downturn in its market
position or persistent shortfalls in performance, then company managers are
obligated to ferret out the causes—do they relate to poor strategy, poor
strategy execution, or both?—and take timely corrective action. A company’s
direction, objectives, business model, and strategy have to be revisited
anytime external or internal conditions warrant.
Likewise, managers are obligated to assess which of the company’s
operating methods and approaches to strategy execution merit continuation
and which need improvement. Proficient strategy execution is always the
product of much organizational learning. It is achieved unevenly—coming
quickly in some areas and proving troublesome in others. Consequently, top-
notch strategy execution entails vigilantly searching for ways to improve and
then making corrective adjustments whenever and wherever it is useful to do
so.
A company’s vision,
mission, objectives,
strategy, and
page 42
approach to strategy
execution are never
final; reviewing
whether and when
to make revisions is
an ongoing process.
CORPORATE GOVERNANCE: THE
ROLE OF THE BOARD OF DIRECTORS
IN THE STRATEGY-CRAFTING,
STRATEGY-EXECUTING PROCESS
• LO 2-5
Comprehend the
role and
responsibility of a
company’s board of
directors in
overseeing the
strategic
management
process.
Although senior managers have the lead responsibility for crafting and
executing a company’s strategy, it is the duty of a company’s board of
directors to exercise strong oversight and see that management performs the
various tasks involved in each of the five stages of the strategy-making,
strategy-executing process in a manner that best serves the interests of
shareholders and other stakeholders, including the company’s customers,
employees, and the communities in which the company operates.17 A
company’s board of directors has four important obligations to fulfill:
1. Oversee the company’s financial accounting and financial reporting
practices. While top executives, particularly the company’s CEO and CFO
(chief financial officer), are primarily responsible for seeing that
the company’s financial statements fairly and accurately report the
results of the company’s operations, board members have a legal
obligation to warrant the accuracy of the company’s financial reports and
protect shareholders. It is their job to ensure that generally accepted
accounting principles (GAAP) are used properly in preparing the
company’s financial statements and that proper financial controls are in
place to prevent fraud and misuse of funds. Virtually all boards of directors
have an audit committee, always composed entirely of outside directors
(inside directors hold management positions in the company and either
directly or indirectly report to the CEO). The members of the audit
committee have the lead responsibility for overseeing the decisions of the
company’s financial officers and consulting with both internal and external
auditors to ensure accurate financial reporting and adequate financial
controls.
2. Critically appraise the company’s direction, strategy, and business
approaches. Board members are also expected to guide management in
choosing a strategic direction and to make independent judgments about
the validity and wisdom of management’s proposed strategic actions. This
aspect of their duties takes on heightened importance when the company’s
strategy is failing or is plagued with faulty execution, and certainly when
there is a precipitous collapse in profitability. But under more normal
circumstances, many boards have found that meeting agendas become
consumed by compliance matters with little time left to discuss matters of
strategic importance. The board of directors and management at Philips
Electronics hold annual two- to three-day retreats devoted exclusively to
evaluating the company’s long-term direction and various strategic
proposals. The company’s exit from the semiconductor business and its
increased focus on medical technology and home health care resulted from
management-board discussions during such retreats.18
3. Evaluate the caliber of senior executives’ strategic leadership skills. The
board is always responsible for determining whether the current CEO is
doing a good job of strategic leadership (as a basis for awarding salary
increases and bonuses and deciding on retention or removal).19 Boards
must also exercise due diligence in evaluating the strategic leadership
skills of other senior executives in line to succeed the CEO. When the
incumbent CEO steps down or leaves for a position elsewhere, the board
must elect a successor, either going with an insider or deciding that an
page 43
outsider is needed to perhaps radically change the company’s strategic
course. Often, the outside directors on a board visit company facilities and
talk with company personnel personally to evaluate whether the strategy is
on track, how well the strategy is being executed, and how well issues and
problems are being addressed by various managers. For example,
independent board members at GE visit operating executives at each major
business unit once a year to assess the company’s talent pool and stay
abreast of emerging strategic and operating issues affecting the company’s
divisions. Home Depot board members visit a store once per quarter to
determine the health of the company’s operations.20
4. Institute a compensation plan for top executives that rewards them for
actions and results that serve stakeholder interests, and most especially
those of shareholders. A basic principle of corporate governance is that the
owners of a corporation (the shareholders) delegate operating authority and
managerial control to top management in return for compensation. In their
role as agents of shareholders, top executives have a clear and unequivocal
duty to make decisions and operate the company in accord with
shareholder interests. (This does not mean disregarding the
interests of other stakeholders—employees, suppliers, the communities in
which the company operates, and society at large.) Most boards of
directors have a compensation committee, composed entirely of directors
from outside the company, to develop a salary and incentive compensation
plan that rewards senior executives for boosting the company’s long-term
performance on behalf of shareholders. The compensation committee’s
recommendations are presented to the full board for approval. But during
the past 10 years, many boards of directors have done a poor job of
ensuring that executive salary increases, bonuses, and stock option awards
are tied tightly to performance measures that are truly in the long-term
interests of shareholders. Rather, compensation packages at many
companies have increasingly rewarded executives for short-term
performance improvements—most notably, for achieving quarterly and
annual earnings targets and boosting the stock price by specified
percentages. This has had the perverse effect of causing company
managers to become preoccupied with actions to improve a company’s
near-term performance, often motivating them to take unwise business
risks to boost short-term earnings by amounts sufficient to qualify for
multimillion-dollar compensation packages (that many see as obscenely
large). The focus on short-term performance has proved damaging to long-
term company performance and shareholder interests—witness the huge
loss of shareholder wealth that occurred at many financial institutions
during the banking crisis of 2008–2009 because of executive risk-taking in
subprime loans, credit default swaps, and collateralized mortgage
securities. As a consequence, the need to overhaul and reform executive
compensation has become a hot topic in both public circles and corporate
boardrooms. Illustration Capsule 2.4 discusses how weak governance at
Volkswagen contributed to the 2015 emissions cheating scandal, which
cost the company billions of dollars and the trust of its stakeholders.
CORE
CONCEPT
A company’s
stakeholders
include its
stockholders,
employees,
suppliers, the
communities in
which the company
operates, and
society at large.
Every corporation should have a strong independent board of directors that
(1) is well informed about the company’s performance, (2) guides and judges
the CEO and other top executives, (3) has the courage to curb management
actions the board believes are inappropriate or unduly risky, (4) certifies to
shareholders that the CEO is doing what the board expects, (5) provides
insight and advice to management, and (6) is intensely involved in debating
the pros and cons of key decisions and actions.21 Boards of directors that lack
the backbone to challenge a strong-willed or “imperial” CEO or that rubber-
stamp almost anything the CEO recommends without probing inquiry and
debate abdicate their fiduciary duty to represent and protect shareholder
interests.
Effective corporate
governance requires
page 44
the board of
directors to oversee
the company’s
strategic direction,
evaluate its senior
executives, handle
executive
compensation, and
oversee financial
reporting practices.
ILLUSTRATION
CAPSULE 2.4 Corporate
Governance Failures at Volkswagen
In 2015, Volkswagen admitted to installing “defeat devices” on at least 11 million vehicles
with diesel engines. These devices enabled the cars to pass emission tests, even though
the engines actually emitted pollutants up to 40 times above what is allowed in the United
States. Current estimates are that it will cost the company at least €7 billion to cover the
cost of repairs and lawsuits. Although management must have been involved in
approving the use of cheating devices, the Volkswagen supervisory board has been
unwilling to accept any responsibility. Some board members even questioned whether it
was the board’s responsibility to be aware of such problems, stating “matters of technical
expertise were not for us” and “the scandal had nothing, not one iota, to do with the
advisory board.” Yet governing boards do have a responsibility to be well informed, to
provide oversight, and to become involved in key decisions and actions. So what caused
this corporate governance failure? Why is this the third time in the past 20 years that
Volkswagen has been embroiled in scandal?
The key feature of Volkswagen’s board that appears to have led to these issues is a
lack of independent directors. However, before explaining this in more detail it is
important to understand the German governance model. German corporations operate
two-tier governance structures, with a management board, and a separate supervisory
board that does not contain any current executives. In addition, German law requires
large companies to have at least 50 percent supervisory board representation from
workers. This structure is meant to provide more oversight by independent board
members and greater involvement by a wider set of stakeholders.
In Volkswagen’s case, these objectives have been effectively circumvented. Although
Volkswagen’s supervisory board does not include any current management, the
chairmanship appears to be a revolving door of former senior executives. Ferdinand
Piëch, the chair during the scandal, was CEO for 9 years prior to becoming chair in 2002.
Martin Winterkorn, the recently ousted CEO, was expected to become supervisory board
page 45
chair prior to the scandal. The company continues to elevate management to the
supervisory board even though they have presided over past scandals. Hans Dieter
Poetsch, the newly appointed chair, was part of the management team that did not inform
the supervisory board of the EPA investigation for two weeks.
Vytautas Kielaitis/Shutterstock
VW also has a unique ownership structure where a single family, Porsche, controls
more than 50 percent of voting shares. Piëch, a family member and chair until 2015,
forced out CEOs and installed unqualified family members on the board, such as his
former nanny and current wife. He also pushed out independent-minded board members,
such as Gerhard Cromme, author of Germany’s corporate governance code. The
company has lost numerous independent directors over the past 10 years, leaving it with
only one non-shareholder, non-labor representative. Although Piëch has now been
removed, it is unclear that Volkswagen’s board has solved the underlying problem.
Shareholders have seen billions of dollars wiped away and the Volkswagen brand
tarnished. As long as the board continues to lack independent directors, change will likely
be slow.
Note: Developed with Jacob M. Crandall.
Sources: “Piëch under Fire,” The Economist, December 8, 2005; Chris Bryant and
Richard Milne, “Boardroom Politics at Heart of VW Scandal,” Financial Times, October 4,
2015; Andreas Cremer and Jan Schwartz, “Volkswagen Mired in Crisis as Board
Members Criticize Piech,” Reuters, April 24, 2015; Richard Milne, “Volkswagen: System
Failure,” Financial Times, November 4, 2015.
KEY POINTS
The strategic management process consists of five interrelated and integrated
stages:
1. Developing a strategic vision of the company’s future, a mission statement
that defines the company’s current purpose, and a set of core values to
guide the pursuit of the vision and mission. This stage of strategy making
provides direction for the company, motivates and inspires company
personnel, aligns and guides actions throughout the organization, and
communicates to stakeholders management’s aspirations for the company’s
future.
2. Setting objectives to convert the vision and mission into performance
targets that can be used as yardsticks for measuring the company’s
performance. Objectives need to spell out how much of what kind of
performance by when. Two broad types of objectives are required:
financial objectives and strategic objectives. A balanced scorecard
approach for measuring company performance entails setting both
financial objectives and strategic objectives. Stretch objectives can spur
exceptional performance and help build a firewall against complacency
and mediocre performance. Extreme stretch objectives, however, are only
warranted in limited circumstances.
3. Crafting a strategy to achieve the objectives and move the company along
the strategic course that management has charted. A single business
enterprise has three levels of strategy—business strategy for the company
as a whole, functional-area strategies (e.g., marketing, R&D, logistics), and
operating strategies (for key operating units, such as manufacturing plants).
In diversified, multibusiness companies, the strategy-making task involves
four distinct types or levels of strategy: corporate strategy for the company
as a whole, business strategy (one for each business the company has
diversified into), functional-area strategies within each business, and
operating strategies. Thus, strategy making is an inclusive collaborative
activity involving not only senior company executives but also the heads
of major business divisions, functional-area managers, and operating
managers on the frontlines.
4. Executing the chosen strategy and converting the strategic plan into action.
Management’s agenda for executing the chosen strategy emerges from
LO 2-1
page 46
assessing what the company will have to do to achieve the targeted
financial and strategic performance. Management’s handling of the
strategy implementation process can be considered successful if things go
smoothly enough that the company meets or beats its strategic and
financial performance targets and shows good progress in achieving
management’s strategic vision.
5. Monitoring developments, evaluating performance, and initiating
corrective adjustments in light of actual experience, changing conditions,
new ideas, and new opportunities. This stage of the strategy management
process is the trigger point for deciding whether to continue or change the
company’s vision and mission, objectives, business model strategy, and/or
strategy execution methods.
The sum of a company’s strategic vision, mission, objectives, and strategy
constitutes a strategic plan for coping with industry conditions, outcompeting
rivals, meeting objectives, and making progress toward aspirational goals.
Boards of directors have a duty to shareholders as well as other
stakeholders to play a vigilant role in overseeing management’s handling of a
company’s strategy-making, strategy-executing process. This entails four
important obligations: (1) Ensure that the company issues accurate financial
reports and has adequate financial controls; (2) critically appraise the
company’s direction, strategy, and strategy execution; (3) evaluate the caliber
of senior executives’ strategic leadership skills; and (4) institute a
compensation plan for top executives that rewards them for actions and
results that serve stakeholder interests, most especially those of shareholders.
ASSURANCE OF LEARNING EXERCISES
1. Using the information in Table 2.2, critique the
adequacy and merit of the following vision
statements, listing effective elements and
shortcomings. Rank the vision statements from best
to worst once you complete your evaluation.
LO 2-2
page 47
Vision Statement EffectiveElements ShortcomingsVision Statement
Effective
Elements Shortcomings
American Express
We work hard every day to make American
Express the world’s most respected service
brand.
Hilton Hotels Corporation
Our vision is to be the first choice of the world’s
travelers. Hilton intends to build on the rich heritage
and strength of our brands by:
Consistently delighting our customers
Investing in our team members
Delivering innovative products and services
Continuously improving performance
Increasing shareholder value
Creating a culture of pride
Strengthening the loyalty of our constituents
MasterCard
A world beyond cash.
BASF
We are “The Chemical Company” successfully
operating in all major markets.
Our customers view BASF as their partner of
choice.
Our innovative products, intelligent solutions and
services make us the most competent worldwide
supplier in the chemical industry.
We generate a high return on assets.
We strive for sustainable development.
We welcome change as an opportunity.
We, the employees of BASF, together ensure
our success.
Sources: Company websites and annual reports.
2. Go to the company investor relations websites for
Starbucks (investor.starbucks.com), Pfizer
(www.pfizer.com/investors), and Salesforce
http://investor.starbucks.com/
http://www.pfizer.com/investors
LO 2-4
LO 2-5
LO 2-5
LO 2-1
(investor.salesforce.com) to find examples of
strategic and financial objectives. List four
objectives for each company, and indicate which of
these are strategic and which are financial.
3. Go to the investor relations website for Walmart
(investors.walmartstores.com) and review past
presentations Walmart has made during various
investor conferences by clicking on the Events
option in the navigation bar. Prepare a one- to two-
page report that outlines what Walmart has said to
investors about its approach to strategy execution.
Specifically, what has management discussed
concerning staffing, resource allocation, policies and
procedures, information and operating systems,
continuous improvement, rewards and incentives,
corporate culture, and internal leadership at the
company?
4. Based on the information provided in Illustration
Capsule 2.4, describe the ways in which Volkswagen
did not fulfill the requirements of effective corporate
governance. In what ways did the board of directors
sidestep its obligations to protect shareholder
interests? How could Volkswagen better select its
board of directors to avoid mistakes such as the
emissions scandal in 2015?
EXERCISES FOR SIMULATION PARTICIPANTS
1. Which of the five stages of the strategy formulation,
strategy execution process apply to your company in
the simulation?
2. Meet with your co-managers and prepare a strategic
vision statement for your company. It should be at
least one sentence long and no longer than a brief
paragraph. When you are finished, check to see if
your vision statement meets the conditions for an
http://investor.salesforce.com/
http://investors.walmartstores.com/
LO 2-2
LO 2-3
LO 2-4
page 48
effectively worded strategic vision set forth in Table
2.2. If not, then revise it accordingly. What would be
a good slogan that captures the essence of your
strategic vision and that could be used to help
communicate the vision to company personnel,
shareholders, and other stakeholders?
3. What are your company’s financial objectives?
What are your company’s strategic objectives?
4. What are the three to four key elements of your
company’s strategy?
5. The strategy execution process for your company in
the business simulation includes which principle
aspects?
ENDNOTES
1 Gordon Shaw, Robert Brown, and Philip Bromiley, “Strategic Stories: How 3M Is Rewriting Business Planning,” Harvard
Business Review 76, no. 3 (May–June 1998); David J. Collis and Michael G. Rukstad, “Can You Say What Your Strategy
Is?” Harvard Business Review 86, no. 4 (April 2008) pp. 82–90.
2 Hugh Davidson, The Committed Enterprise: How to Make Vision and Values Work (Oxford: Butterworth Heinemann,
2002); W. Chan Kim and Renée Mauborgne, “Charting Your Company’s Future,” Harvard Business Review 80, no. 6
(June 2002), pp. 77–83; James C. Collins and Jerry I. Porras, “Building Your Company’s Vision,” Harvard Business
Review 74, no. 5 (September–October 1996), pp. 65–77; Jim Collins and Jerry Porras, Built to Last: Successful Habits of
Visionary Companies (New York: HarperCollins, 1994); Michel Robert, Strategy Pure and Simple II: How Winning
Companies Dominate Their Competitors (New York: McGraw-Hill, 1998).
3 Davidson, The Committed Enterprise, pp. 20 and 54.
4 As quoted in Charles H. House and Raymond L. Price, “The Return Map: Tracking Product Teams,” Harvard Business
Review 60, no. 1 (January–February 1991), p. 93.
5 Sitkin, S., Miller, C. and See, K., “The Stretch Goal Paradox”, Harvard Business Review, 95, no. 1
(January–February, 2017, pp. 92–99.
6 Robert S. Kaplan and David P. Norton, The Strategy-Focused Organization (Boston: Harvard Business School Press,
2001); Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston:
Harvard Business School Press, 1996).
7 Kaplan and Norton, The Strategy-Focused Organization; Kaplan and Norton, The Balanced Scorecard; Kevin B.
Hendricks, Larry Menor, and Christine Wiedman, “The Balanced Scorecard: To Adopt or Not to Adopt,” Ivey Business
Journal 69, no. 2 (November–December 2004), pp. 1–7; Sandy Richardson, “The Key Elements of Balanced Scorecard
Success,” Ivey Business Journal 69, no. 2 (November–December 2004), pp. 7–9.
8 Kaplan and Norton, The Balanced Scorecard.
9 Ibid.
10 Ibid.
11 Information posted on the website of the Balanced Scorecard Institute, balancedscorecard.org (accessed October,
2015).
12 Henry Mintzberg, Bruce Ahlstrand, and Joseph Lampel, Strategy Safari: A Guided Tour through the Wilds of Strategic
Management (New York: Free Press, 1998); Bruce Barringer and Allen C. Bluedorn, “The Relationship between
Corporate Entrepreneurship and Strategic Management,” Strategic Management Journal 20 (1999), pp. 421–444; Jeffrey
G. Covin and Morgan P. Miles, “Corporate Entrepreneurship and the Pursuit of Competitive Advantage,”
Entrepreneurship: Theory and Practice 23, no. 3 (Spring 1999), pp. 47–63; David A. Garvin and Lynne C. Levesque,
http://balancedscorecard.org/
page 49
“Meeting the Challenge of Corporate Entrepreneurship,” Harvard Business Review 84, no. 10 (October 2006), pp. 102–
112.
13 Joseph L. Bower and Clark G. Gilbert, “How Managers’ Everyday Decisions Create or Destroy Your Company’s
Strategy,” Harvard Business Review 85, no. 2 (February 2007), pp. 72–79.
14 Gordon Shaw, Robert Brown, and Philip Bromiley, “Strategic Stories: How 3M Is Rewriting Business Planning,”
Harvard Business Review 76, no. 3 (May–June 1998), pp. 41–50.
15 David Collis and Michael Rukstad, “Can You Say What Your Stratgey Is?” Harvard Business Review, May 2008, pp.
82–90.
16 Cynthia A. Montgomery, “Putting Leadership Back into Strategy,” Harvard Business Review 86, no. 1 (January 2008),
pp. 54–60.
17 Jay W. Lorsch and Robert C. Clark, “Leading from the Boardroom,” Harvard Business Review 86, no. 4 (April 2008),
pp. 105–111.
18 Ibid.
19 Stephen P. Kaufman, “Evaluating the CEO,” Harvard Business Review 86, no. 10 (October 2008), pp. 53–57.
20 Ibid.
21 David A. Nadler, “Building Better Boards,” Harvard Business Review 82, no. 5 (May 2004), pp. 102–105; Cynthia A.
Montgomery and Rhonda Kaufman, “The Board’s Missing Link,” Harvard Business Review 81, no. 3 (March 2003), pp.
86–93; John Carver, “What Continues to Be Wrong with Corporate Governance and How to Fix It,” Ivey Business Journal
68, no. 1 (September–October 2003), pp. 1–5. See also Gordon Donaldson, “A New Tool for Boards: The Strategic
Audit,” Harvard Business Review 73, no. 4 (July–August 1995), pp. 99–107.
page 50
chapter 3
Evaluating a Company’s External
Environment
Learning Objectives
After reading this chapter, you should be able to:
LO 3-1 Recognize the factors in a company’s broad macro-
environment that may have strategic significance.
LO 3-2 Use analytic tools to diagnose the competitive conditions
in a company’s industry.
LO 3-3 Map the market positions of key groups of industry rivals.
LO 3-4 Determine whether an industry’s outlook presents a
company with sufficiently attractive opportunities for
growth and profitability.
page 51
Fanatic Studio/Getty Images
No matter what it takes, the goal of strategy is to beat the competition.
Kenichi Ohmae—Consultant and author
Companies that solely focus on competition will die. Those that focus on value creation will thrive.
Edward de Bono—Author and consultant
Continued innovation is the best way to beat the competition.
Thomas A Edison—Inventor and Businessman
In Chapter 2, we learned that the strategy formulation, strategy execution process begins
with an appraisal of the company’s present situation. Two facets of a company’s situation
are especially pertinent: (1) its external environment—most notably, the competitive
page 52
conditions of the industry in which the company operates; and (2) its internal environment
—particularly the company’s resources and organizational capabilities.
Insightful diagnosis of a company’s external and internal environments is a prerequisite
for managers to succeed in crafting a strategy that is an excellent fit with the company’s
situation—the first test of a winning strategy. As depicted in Figure 3.1, strategic thinking
begins with an appraisal of the company’s external and internal environments (as a basis
for deciding on a long-term direction and developing a strategic vision). It then moves
toward an evaluation of the most promising alternative business models, and strategies
and finally culminates in choosing a specific strategy.
FIGURE 3.1 From Analyzing the Company’s Situation to
Choosing a Strategy
This chapter presents the concepts and analytic tools for zeroing in on those aspects of
a company’s external environment that should be considered in making strategic choices.
Attention centers on the broad environmental context, the specific market arena in which
a company operates, the drivers of change, the positions and likely actions of rival
companies, and key success factors. In Chapter 4, we explore the methods of evaluating
a company’s internal circumstances and competitive capabilities.
ASSESSING THE COMPANY’S
INDUSTRY AND COMPETITIVE
page 53
ENVIRONMENT
Thinking strategically about a company’s industry and competitive
environment entails using some well-validated concepts and analytical tools to
get clear answers to seven questions:
1. Do macro-environmental factors and industry characteristics offer sellers
opportunities for growth and attractive profits?
2. What kinds of competitive forces are industry members facing, and how
strong is each force?
3. What forces are driving industry change, and what impact will these changes
have on competitive intensity and industry profitability?
4. What market positions do industry rivals occupy—who is strongly
positioned and who is not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors of competitive success?
7. Does the industry outlook offer good prospects for profitability?
Analysis-based answers to these questions are prerequisites for a strategy
offering good fit with the external situation. The remainder of this chapter is
devoted to describing the methods of obtaining solid answers to these seven
questions.
ANALYZING THE COMPANY’S MACRO-
ENVIRONMENT
• LO 3-1
Recognize the
factors in a
company’s broad
macro-environment
that may have
strategic
significance.
page 54
A company’s external environment includes the immediate industry and
competitive environment and a broader “macro-environment” (see Figure 3.2).
This macro-environment comprises six principal components: political factors;
economic conditions in the firm’s general environment (local, country,
regional, worldwide); sociocultural forces; technological factors;
environmental factors (concerning the natural environment); and
legal/regulatory conditions. Each of these components has the potential to
affect the firm’s more immediate industry and competitive environment,
although some are likely to have a more important effect than others. An
analysis of the impact of these factors is often referred to as PESTEL analysis,
an acronym that serves as a reminder of the six components involved
(Political, Economic, Sociocultural, Technological, Environmental,
Legal/regulatory).
FIGURE 3.2 The Components of a Company’s Macro-
Environment
CORE
CONCEPT
PESTEL analysis
can be used to
assess the strategic
relevance of the
six principal
components of the
macro-environment:
Political, Economic,
Social,
Technological,
Environmental, and
Legal/Regulatory
forces.
Since macro-economic factors affect different industries in different ways
and to different degrees, it is important for managers to determine which of
these represent the most strategically relevant factors outside the firm’s
industry boundaries. By strategically relevant, we mean important enough to
have a bearing on the decisions the company ultimately makes about its long-
term direction, objectives, strategy, and business model. The impact of the
outer-ring factors depicted in Figure 3.2 on a company’s choice of strategy can
range from big to small. Those factors that are likely to a bigger impact deserve
the closest attention. But even factors that have a low impact on the company’s
business situation merit a watchful eye since their level of impact may change.
CORE
CONCEPT
The macro-
environment
encompasses the
broad environmental
context in which a
company’s industry
is situated.
For example, when stringent new federal banking regulations are announced,
banks must rapidly adapt their strategies and lending practices to be in
compliance. Cigarette producers must adapt to new antismoking ordinances,
the decisions of governments to impose higher cigarette taxes, the growing
cultural stigma attached to smoking and newly emerging e-cigarette
technology. The homebuilding industry is affected by such macro-influences as
trends in household incomes and buying power, rules and regulations that make
it easier or harder for homebuyers to obtain mortgages, changes in mortgage
interest rates, shifting preferences of families for renting versus owning a
home, and shifts in buyer preferences for homes of various sizes, styles, and
price ranges. Companies in the food processing, restaurant, sports, and fitness
industries have to pay special attention to changes in lifestyles, eating habits,
leisure-time preferences, and attitudes toward nutrition and fitness in
fashioning their strategies. Table 3.1 provides a brief description of the
components of the macro-environment and some examples of the industries or
business situations that they might affect.
page 55
TABLE 3.1 The Six Components of the Macro-Environment
Component Description
Political
factors
Pertinent political factors include matters such as tax policy, fiscal
policy, tariffs, the political climate, and the strength of institutions such
as the federal banking system. Some political policies affect certain
types of industries more than others. An example is energy policy,
which clearly affects energy producers and heavy users of energy
more than other types of businesses.
Economic
conditions
Economic conditions include the general economic climate and specific
factors such as interest rates, exchange rates, the inflation rate, the
unemployment rate, the rate of economic growth, trade deficits or
surpluses, savings rates, and per-capita domestic product. Some
industries, such as construction, are particularly vulnerable to
economic downturns but are positively affected by factors such as low
interest rates. Others, such as discount retailing, benefit when general
economic conditions weaken, as consumers become more price-
conscious.
Sociocultural
forces
Sociocultural forces include the societal values, attitudes, cultural
influences, and lifestyles that impact demand for particular goods and
services, as well as demographic factors such as the population size,
growth rate, and age distribution. Sociocultural forces vary by locale
and change over time. An example is the trend toward healthier
lifestyles, which can shift spending toward exercise equipment and
health clubs and away from alcohol and snack foods. The
demographic effect of people living longer is having a huge impact on
the health care, nursing homes, travel, hospitality, and entertainment
industries.
Tec
hnological
factors
Technological factors include the pace of technological change and
technical developments that have the potential for wide-ranging effects
on society, such as genetic engineering, nanotechnology, and solar
energy technology. They include institutions involved in creating new
knowledge and controlling the use of technology, such as R&D
consortia, university-sponsored technology incubators, patent and
copyright laws, and government control over the Internet.
Technological change can encourage the birth of new industries, such
as drones, virtual reality technology, and connected wearable devices.
They can disrupt others, as cloud computing, 3-D printing, and big data
solution have done, and they can render other industries obsolete (film
cameras, music CDs).
Component Description
Environmental
forces
These include ecological and environmental forces such as weather,
climate, climate change, and associated factors like flooding, fire, and
water shortages. These factors can directly impact industries such as
insurance, farming, energy production, and tourism. They may have an
indirect but substantial effect on other industries such as transportation
and utilities. The relevance of environmental considerations stems
from the fact that some industries contribute more significantly than
others to air and water pollution or to the depletion of irreplaceable
natural resources, or to inefficient energy/resource usage, or are
closely associated with other types of environmentally damaging
activities (unsustainable agricultural practices, the creation of waste
products that are not recyclable or biodegradable). Growing numbers
of companies worldwide, in response to stricter environmental
regulations and also to mounting public concerns about the
environment, are implementing actions to operate in a more
environmentally and ecologically responsible manner.
Legal and
regulatory
factors
These factors include the regulations and laws with which companies
must comply, such as consumer laws, labor laws, antitrust laws, and
occupational health and safety regulation. Some factors, such as
financial services regulation, are industry-specific. Others affect certain
types of industries more than others. For example, minimum wage
legislation largely impacts low-wage industries (such as nursing homes
and fast food restaurants) that employ substantial numbers of relatively
unskilled workers. Companies in coal-mining, meat-packing, and steel-
making, where many jobs are hazardous or carry high risk of injury, are
much more impacted by occupational safety regulations than are
companies in industries such as retailing or software programming.
As the events surrounding the coronavirus pandemic of 2020 made
abundantly clear, there is a class of macro-level external factors that is not
included as part of PESTEL analysis. This is the set of factors that occurs more
irregularly and unpredictably, unlike the categories within PESTEL that can be
expected to affect firms in an ongoing and more foreseeable manner. This
additional set of factors can be thought of as societal shocks to the macro-
environment; they include terrorism (whether by domestic or foreign agents),
civil war, foreign invasion or occupation, and epidemics and pandemics.
Societal shocks such as these also affect different industries and companies to
varying degrees, but they are much harder for companies to anticipate and
prepare for since they often begin with little warning. The coordinated terrorist
attacks by al-Qaeda against the United States now referred to as 9/11 (since
they occurred on September 11, 2001) offer an example. These attacks had a
significant economic impact, not only within the United States, but on world
page 56
markets as well. New York City’s businesses suffered enormously, particularly
those located within and nearby the World Trade Center complex.
Industries suffering an outsized effect include the airline industry,
which had to cut back travel capacity by nearly 20%, and the export industry.
Illustration Capsule 3.1 illustrates how another such societal shock—the
coronavirus pandemic of 2020—affected industries, businesses, geographies,
and countries differentially.
ILLUSTRATION
CAPSULE 3.1 The Differential Effects of the
Coronavirus Pandemic of 2020
While the world had suffered through a number of other pandemics, including the Spanish
Flu (which caused somewhere between 20 to 50 million deaths in 1918–1919), the
Coronavirus pandemic of 2020 was predicted to be even more devastating. Not only was
the world now more interconnected due to globalization, but the disease causing the
pandemic, known as Covid-19, was easily transmissible. By April 1, 2020, there were
already more than 31,000 deaths worldwide, despite the fact that the disease had not yet
peaked in some of the world’s most populous countries.
The virus was new to the world and identified as such in early January, 2020. First
appearing in Wuhan, a Chinese city of 11 million, it spread around the globe rapidly,
reaching at least 170 countries by the end of March. Different countries were affected by
the pandemic at different rates and handled the crisis in different ways. Nations that were
particularly hard hit by Covid-19 include China, Italy (with 1/3 of the deaths as of April 1,
2020), Spain, France, Iran, and the United States. Italy’s high death rate may be explained
in part due to demographics, since its much older population was more susceptible to the
disease. But in contrast to South Korea, which utilized extensive testing to identify and
control the spread of the disease, Italy failed to test widely. The United States also found
itself with insufficient test kits to implement South Korea’s strategy, a situation exacerbated
by the Trump administration’s downplaying the seriousness of the threat until March.
Shutterstock / theskaman306
The economic impact of the pandemic was catastrophic, despite a $2 trillion U.S. fiscal
stimulus package and similar measures elsewhere designed to combat its economic
consequences. Emerging markets seemed destined to absorb much of the hit, as
international investment dried up, tourism collapsed, and demand for commodities fell. But
even wealthy nations were not immune from dire consequences, although different sectors
and industries were affected to varying degrees. In the United States, the hospitality and
transportation industries were hard hit, along with retail, oil and gas, live sports and other
forms of entertainment. Small businesses and low-margin industries, with little ability to
weather a significant downturn, were particularly vulnerable. Some industries, such as
health care, online retail, and delivery services found themselves facing demand in excess
of their capabilities, especially in light of supply chain breakdowns. A number of large
companies responded to the crisis by switching to the production of supplies needed for
managing the crisis. GM, Ford, and other automakers aided the efforts to produce critically
needed ventilators, while distilleries such as Tito’s Handmade Vodka and Dillon’s Distillery
began making hand sanitizers. Fashion companies, such as Inditex (with its Zara brand)
and Los Angeles Apparel, turned their production capabilities toward making hospital
gowns and face masks. Virtually no company was unaffected by the pandemic, but those
which quickly adopted practices to remain nimble, control costs, minimize job losses,
support their workers and suppliers, and join in the effort to combat the crisis were best
positioned to weather it.
Sources: “Timeline: How the new coronavirus spread, Aljazeera news, March 29, 2020;
“These companies are switching gears to help address coronavirus shortages”, by Chloe
Hadavas, Slate, March 23, 2020; SlateStatista.com (accessed April 1, 2020).
http://slatestatista.com/
page 57
As company managers scan the external environment, they must
be alert for potentially important outer-ring developments (whether in the form
of societal shocks or among the components of PESTEL analysis), assess their
impact and influence, and adapt the company’s direction and strategy as
needed. However, the factors in a company’s environment having the greatest
strategy-shaping impact typically pertain to the company’s immediate industry
and competitive environment. Consequently, it is on a company’s industry and
competitive environment (depicted in the center of Figure 3.2) that we
concentrate the bulk of our attention in this chapter.
ASSESSING THE COMPANY’S
INDUSTRY AND COMPETITIVE
ENVIRONMENT
• LO 3-2
Use analytic tools to
diagnose the
competitive
conditions in a
company’s industry.
After gaining an understanding of the industry’s general economic
characteristics, attention should be focused on the competitive dynamics of the
industry. This entails using some well-validated concepts and analytic tools.
These include the five forces framework, the value net, driving forces, strategic
groups, competitor analysis, and key success factors. Proper use of these
analytic tools can provide managers with the understanding needed to craft a
strategy that fits the company’s situation within their industry environment.
The remainder of this chapter is devoted to describing how managers can use
these tools to inform and improve their strategic choices.
The Five Forces Framework
The character and strength of the competitive forces operating in an industry
are never the same from one industry to another. The most powerful and widely
used tool for diagnosing the principal competitive pressures in a market is the
five forces framework.1 This framework, depicted in Figure 3.3, holds that
competitive pressures on companies within an industry come from five
sources. These include (1) competition from rival sellers, (2) competition from
potential new entrants to the industry, (3) competition from producers of
substitute products, (4) supplier bargaining power, and (5) customer bargaining
power.
FIGURE 3.3 The Five Forces Model of Competition: A Key
Analytic Tool
Sources: Adapted from M. E. Porter, “How Competitive Forces Shape Strategy,” Harvard
Business Review 57, no. 2 (1979), pp. 137–145; M. E. Porter, “The Five Competitive Forces
That Shape Strategy,” Harvard Business Review 86, no. 1 (2008), pp. 80–86.
Using the five forces model to determine the nature and strength of
competitive pressures in a given industry involves three steps:
Step 1: For each of the five forces, identify the different parties involved,
along with the specific factors that bring about competitive pressures.
Step 2: Evaluate how strong the pressures stemming from each of the five
forces are (strong, moderate, or weak).
Step 3: Determine whether the five forces, overall, are supportive of high
industry profitability.
Competitive Pressures Created by the Rivalry
among Competing Sellers
The strongest of the five competitive forces is often the rivalry for buyer
patronage among competing sellers of a product or service. The intensity of
rivalry among competing sellers within an industry depends on a number of
identifiable factors. Figure 3.4 summarizes these factors, identifying those that
intensify or weaken rivalry among direct competitors in an industry. A brief
explanation of why these factors affect the degree of rivalry is in order:
FIGURE 3.4 Factors Affecting the Strength of Rivalry
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Rivalry increases when buyer demand is growing slowly or
declining. Rapidly expanding buyer demand produces enough new
business for all industry members to grow without having to draw customers
away from rival enterprises. But in markets where buyer demand is slow-
growing or shrinking, companies eager to gain more business are likely to
engage in aggressive price discounting, sales promotions, and other tactics to
increase their sales volumes at the expense of rivals, sometimes to the point
of igniting a fierce battle for market share.
Rivalry increases as it becomes less costly for buyers to switch brands. The
less costly (or easier) it is for buyers to switch their purchases from one seller
to another, the easier it is for sellers to steal customers away from rivals.
When the cost of switching brands is higher, buyers are less prone to
brand switching and sellers have protection from rivalrous moves.
Switching costs include not only monetary costs but also the time,
inconvenience, and psychological costs involved in switching brands. For
example, retailers may not switch to the brands of rival manufacturers
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because they are hesitant to sever long-standing supplier relationships or
incur the additional expense of retraining employees, accessing technical
support, or testing the quality and reliability of the new brand. Consumers
may not switch brands because they become emotionally attached to a
particular brand (e.g. if you identify with the Harley motorcycle brand and
lifestyle).
Rivalry increases as the products of rival sellers become less strongly
differentiated. When the offerings of rivals are identical or weakly
differentiated, buyers have less reason to be brand-loyal—a condition that
makes it easier for rivals to convince buyers to switch to their offerings.
Moreover, when the products of different sellers are virtually identical,
shoppers will choose on the basis of price, which can result in fierce price
competition among sellers. On the other hand, strongly differentiated product
offerings among rivals breed high brand loyalty on the part of buyers who
view the attributes of certain brands as more appealing or better suited to
their needs.
Rivalry is more intense when industry members have too much
inventory or significant amounts of idle production capacity,
especially if the industry’s product entails high fixed costs or high storage
costs. Whenever a market has excess supply (overproduction relative to
demand), rivalry intensifies as sellers cut prices in a desperate effort to cope
with the unsold inventory. A similar effect occurs when a product is
perishable or seasonal, since firms often engage in aggressive price cutting to
ensure that everything is sold. Likewise, whenever fixed costs account for a
large fraction of total cost so that unit costs are significantly lower at full
capacity, firms come under significant pressure to cut prices whenever they
are operating below full capacity. Unused capacity imposes a significant
cost-increasing penalty because there are fewer units over which to spread
fixed costs. The pressure of high fixed or high storage costs can push rival
firms into offering price concessions, special discounts, and rebates and
employing other volume-boosting competitive tactics.
Rivalry intensifies as the number of competitors increases and they become
more equal in size and capability. When there are many competitors in a
market, companies eager to increase their meager market share often engage
in price-cutting activities to drive sales, leading to intense rivalry. When
there are only a few competitors, companies are more wary of how their
rivals may react to their attempts to take market share away from them. Fear
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of retaliation and a descent into a damaging price war leads to restrained
competitive moves. Moreover, when rivals are of comparable size and
competitive strength, they can usually compete on a fairly equal footing—an
evenly matched contest tends to be fiercer than a contest in which one or
more industry members have commanding market shares and substantially
greater resources than their much smaller rivals.
Rivalry becomes more intense as the diversity of competitors increases in
terms of long-term directions, objectives, strategies, and countries of origin.
A diverse group of sellers often contains one or more mavericks willing to
try novel or rule-breaking market approaches, thus generating a more volatile
and less predictable competitive environment. Globally competitive markets
are often more rivalrous, especially when aggressors have lower costs and
are intent on gaining a strong foothold in new country markets.
Rivalry is stronger when high exit barriers keep unprofitable firms from
leaving the industry. In industries where the assets cannot easily be sold or
transferred to other uses, where workers are entitled to job protection, or
where owners are committed to remaining in business for personal reasons,
failing firms tend to hold on longer than they might otherwise—even when
they are bleeding red ink. Deep price discounting typically ensues, in a
desperate effort to cover costs and remain in business. This sort of rivalry can
destabilize an otherwise attractive industry.
The previous factors, taken as whole, determine whether the rivalry in an
industry is relatively strong, moderate, or weak. When rivalry is strong, the
battle for market share is generally so vigorous that the profit margins of most
industry members are squeezed to bare-bones levels. When rivalry is moderate,
a more normal state, the maneuvering among industry members, while lively
and healthy, still allows most industry members to earn acceptable profits.
When rivalry is weak, most companies in the industry are relatively well
satisfied with their sales growth and market shares and rarely undertake
offensives to steal customers away from one another. Weak rivalry means that
there is no downward pressure on industry profitability due to this particular
competitive force.
The Choice of Competitive Weapons
Competitive battles among rival sellers can assume many forms that extend
well beyond lively price competition. For example, competitors may resort to
such marketing tactics as special sales promotions, heavy advertising, rebates,
or low-interest-rate financing to drum up additional sales. Rivals may race one
another to differentiate their products by offering better performance features
or higher quality or improved customer service or a wider product selection.
They may also compete through the rapid introduction of next-generation
products, the frequent introduction of new or improved products, and efforts to
build stronger dealer networks, establish positions in foreign markets, or
otherwise expand distribution capabilities and market presence. Table 3.2
displays the competitive weapons that firms often employ in battling rivals,
along with their primary effects with respect to price (P), cost (C), and value
(V)—the elements of an effective business model and the value-price-cost
framework, discussed in Chapter 1.
TABLE 3.2 Common “Weapons” for Competing with Rivals
Types of Competitive
Weapons Primary Effects
Discounting prices,
holding clearance sales
Lowers price (P), increases total sales volume and market
share, lowers profits if price cuts are not offset by large
increases in sales volume
Offering coupons,
advertising items on
sale
Increases sales volume and total revenues, lowers price (P),
increases unit costs (C), may lower profit margins per unit sold
(P – C)
Advertising product or
service characteristics,
using ads to enhance a
company’s image
Boosts buyer demand, increases product differentiation and
perceived value (V), increases total sales volume and market
share, but may increase unit costs (C) and lower profit
margins per unit sold
Innovating to improve
product performance
and quality
Increases product differentiation and value (V), boosts buyer
demand, boosts total sales volume, likely to increase unit
costs (C)
Introducing new or
improved features,
increasing the number
of styles to provide
greater product
selection
Increases product differentiation and value (V), strengthens
buyer demand, boosts total sales volume and market share,
likely to increase unit costs (C)
Increasing
customization of
product or service
Increases product differentiation and value (V), increases
buyer switching costs, boosts total sales volume, often
increases unit costs (C)
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Types of Competitive
Weapons Primary Effects
Building a bigger, better
dealer network
Broadens access to buyers, boosts total sales volume and
market share, may increase unit costs (C)
Improving warranties,
offering low-interest
financing
Increases product differentiation and value (V), increases unit
costs (C), increases buyer switching costs, boosts total sales
volume and market share
Competitive Pressures Associated with the Threat
of New Entrants
New entrants into an industry threaten the position of rival firms since they will
compete fiercely for market share, add to the number of industry rivals, and
add to the industry’s production capacity in the process. But even the threat of
new entry puts added competitive pressure on current industry members and
thus functions as an important competitive force. This is because credible
threat of entry often prompts industry members to lower their prices and
initiate defensive actions in an attempt to deter new entrants. Just how
serious the threat of entry is in a particular market depends on (1)
whether entry barriers are high or low, and (2) the expected reaction of existing
industry members to the entry of newcomers.
Whether Entry Barriers Are High or Low The strength of the threat of
entry is governed to a large degree by the height of the industry’s entry
barriers. High barriers reduce the threat of potential entry, whereas low barriers
enable easier entry. Entry barriers are high under the following conditions:2
There are sizable economies of scale in production, distribution, advertising,
or other activities. When incumbent companies enjoy cost advantages
associated with large-scale operations, outsiders must either enter on a large
scale (a costly and perhaps risky move) or accept a cost disadvantage and
consequently lower profitability.
Incumbents have other hard to replicate cost advantages over new entrants.
Aside from enjoying economies of scale, industry incumbents can have cost
advantages that stem from the possession of patents or proprietary
technology, exclusive partnerships with the best and cheapest suppliers,
favorable locations, and low fixed costs (because they have older facilities
that have been mostly depreciated). Learning-based cost savings can also
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accrue from experience in performing certain activities such as
manufacturing or new product development or inventory management. The
extent of such savings can be measured with learning/experience curves. The
steeper the learning/experience curve, the bigger the cost advantage of the
company with the largest cumulative production volume. The microprocessor
industry provides an excellent example of this:
Manufacturing unit costs for microprocessors tend to decline about 20 percent each time cumulative
production volume doubles. With a 20 percent experience curve effect, if the first 1 million chips cost
$100 each, once production volume reaches 2 million, the unit cost would fall to $80 (80 percent of
$100), and by a production volume of 4 million, the unit cost would be $64 (80 percent of $80).3
Customers have strong brand preferences and high degrees of loyalty to
seller. The stronger the attachment of buyers to established brands, the harder
it is for a newcomer to break into the marketplace. In such cases, a new
entrant must have the financial resources to spend enough on advertising and
sales promotion to overcome customer loyalties and build its own clientele.
Establishing brand recognition and building customer loyalty can be a slow
and costly process. In addition, if it is difficult or costly for a customer to
switch to a new brand, a new entrant may have to offer a discounted price or
otherwise persuade buyers that its brand is worth the switching costs. Such
barriers discourage new entry because they act to boost financial
requirements and lower expected profit margins for new entrants.
Patents and other forms of intellectual property protection are in place. In a
number of industries, entry is prevented due to the existence of intellectual
property protection laws that remain in place for a given number of years.
Often, companies have a “wall of patents” in place to prevent other
companies from entering with a “me too” strategy that replicates a key piece
of technology.
There are strong “network effects” in customer demand. In industries where
buyers are more attracted to a product when there are many other users of the
product, there are said to be “network effects,” since demand is higher the
larger the network of users. Video game systems are an example because
users prefer to have the same systems as their friends so that they can play
together on systems they all know and can share games. When
incumbents have a large existing base of users, new entrants with
otherwise comparable products face a serious disadvantage in attracting
buyers.
Capital requirements are high. The larger the total dollar investment needed
to enter the market successfully, the more limited the pool of potential
entrants. The most obvious capital requirements for new entrants relate to
manufacturing facilities and equipment, introductory advertising and sales
promotion campaigns, working capital to finance inventories and customer
credit, and sufficient cash to cover startup costs.
There are difficulties in building a network of distributors/dealers or in
securing adequate space on retailers’ shelves. A potential entrant can face
numerous distribution-channel challenges. Wholesale distributors may be
reluctant to take on a product that lacks buyer recognition. Retailers must be
recruited and convinced to give a new brand ample display space and an
adequate trial period. When existing sellers have strong, well-functioning
distributor–dealer networks, a newcomer has an uphill struggle in squeezing
its way into existing distribution channels. Potential entrants sometimes have
to “buy” their way into wholesale or retail channels by cutting their prices to
provide dealers and distributors with higher markups and profit margins or
by giving them big advertising and promotional allowances. As a
consequence, a potential entrant’s own profits may be squeezed unless and
until its product gains enough consumer acceptance that distributors and
retailers are willing to carry it.
There are restrictive regulatory policies. Regulated industries like cable TV,
telecommunications, electric and gas utilities, radio and television
broadcasting, liquor retailing, nuclear power, and railroads entail
government-controlled entry. Government agencies can also limit or even bar
entry by requiring licenses and permits, such as the medallion required to
drive a taxicab in New York City. Government-mandated safety regulations
and environmental pollution standards also create entry barriers because they
raise entry costs. Recently enacted banking regulations in many countries
have made entry particularly difficult for small new bank startups—
complying with all the new regulations along with the rigors of competing
against existing banks requires very deep pockets.
There are restrictive trade policies. In international markets, host
governments commonly limit foreign entry and must approve all foreign
investment applications. National governments commonly use tariffs and
trade restrictions (antidumping rules, local content requirements, quotas, etc.)
to raise entry barriers for foreign firms and protect domestic producers from
outside competition.
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The Expected Reaction of Industry Members in Defending against New
Entry A second factor affecting the threat of entry relates to the ability and
willingness of industry incumbents to launch strong defensive maneuvers to
maintain their positions and make it harder for a newcomer to compete
successfully and profitably. Entry candidates may have second thoughts about
attempting entry if they conclude that existing firms will mount well-funded
campaigns to hamper (or even defeat) a newcomer’s attempt to gain a market
foothold big enough to compete successfully. Such campaigns can include any
of the “competitive weapons” listed in Table 3.2, such as ramping up
advertising expenditures, offering special price discounts to the very customers
a newcomer is seeking to attract, or adding attractive new product features (to
match or beat the newcomer’s product offering). Such actions can raise a
newcomer’s cost of entry along with the risk of failing, making the prospect of
entry less appealing. The result is that even the expectation on the part of new
entrants that industry incumbents will contest a newcomer’s entry may
be enough to dissuade entry candidates from going forward. Microsoft
can be counted on to fiercely defend the position that Windows enjoys in
computer operating systems and that Microsoft Office has in office
productivity software. This may well have contributed to Microsoft’s ability to
continuously dominate this market space.
However, there are occasions when industry incumbents have nothing in
their competitive arsenal that is formidable enough to either discourage entry
or put obstacles in a newcomer’s path that will defeat its strategic efforts to
become a viable competitor. In the restaurant industry, for example, existing
restaurants in a given geographic market have few actions they can take to
discourage a new restaurant from opening or to block it from attracting enough
patrons to be profitable. A fierce competitor like Nike was unable to prevent
newcomer Under Armour from rapidly growing its sales and market share in
sports apparel. Furthermore, there are occasions when industry incumbents can
be expected to refrain from taking or initiating any actions specifically aimed at
contesting a newcomer’s entry. In large industries, entry by small startup
enterprises normally poses no immediate or direct competitive threat to
industry incumbents and their entry is not likely to provoke defensive actions.
For instance, a new online retailer with sales prospects of maybe $5 to $10
million annually can reasonably expect to escape competitive retaliation from
much larger online retailers selling similar goods. The less that a newcomer’s
entry will adversely impact the sales and profitability of industry incumbents,
the more reasonable it is for potential entrants to expect industry incumbents to
refrain from reacting defensively.
Even high entry
barriers may not
suffice to keep out
certain kinds of
entrants: those with
resources and
capabilities that
enable them to leap
over or bypass the
barriers.
Figure 3.5 summarizes the factors that cause the overall competitive pressure
from potential entrants to be strong or weak. An analysis of these factors can
help managers determine whether the threat of entry into their industry is high
or low, in general. But certain kinds of companies—those with sizable
financial resources, proven competitive capabilities, and a respected brand
name—may be able to hurdle an industry’s entry barriers even when they are
high.4 For example, when Honda opted to enter the U.S. lawn-mower market in
competition against Toro, Snapper, Craftsman, John Deere, and others, it was
easily able to hurdle entry barriers that would have been formidable to other
newcomers because it had long-standing expertise in gasoline engines and a
reputation for quality and durability in automobiles that gave it instant
credibility with homeowners. As a result, Honda had to spend relatively little
on inducing dealers to handle the Honda lawn-mower line or attracting
customers. Similarly, Samsung’s brand reputation in televisions, DVD players,
and other electronics products gave it strong credibility in entering the market
for smartphones—Samsung’s Galaxy smartphones are now a formidable rival
of Apple’s iPhone.
FIGURE 3.5 Factors Affecting the Threat of Entry
It is also important to recognize that the barriers to entering an industry can
become stronger or weaker over time. For example, once key patents
preventing new entry in the market for functional 3-D printers expired, the way
was open for new competition to enter this industry. On the other hand, new
strategic actions by incumbent firms to increase advertising, strengthen
distributor–dealer relations, step up R&D, or improve product quality can erect
higher roadblocks to entry.
High entry barriers
and weak entry
threats today do not
always translate into
high entry barriers
and weak entry
threats tomorrow.
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Competitive Pressures from the Sellers of
Substitute Products
Companies in one industry are vulnerable to competitive pressure from the
actions of companies in a closely adjoining industry whenever buyers view the
products of the two industries as good substitutes. Substitutes do not include
other brands within your industry; this type of pressure comes from
outside the industry. Substitute products from outside the industry are
those that can perform the same or similar functions for the consumer as
products within your industry. For instance, the producers of eyeglasses and
contact lenses face competitive pressures from the doctors who do corrective
laser surgery. Similarly, the producers of sugar experience competitive
pressures from the producers of sugar substitutes (high-fructose corn syrup,
agave syrup, and artificial sweeteners). Internet providers of news-related
information have put brutal competitive pressure on the publishers of
newspapers. The makers of smartphones, by building ever better cameras into
their cell phones, have cut deeply into the sales of producers of handheld
digital cameras—most smartphone owners now use their phone to take pictures
rather than carrying a digital camera for picture-taking purposes.
As depicted in Figure 3.6, three factors determine whether the
competitive pressures from substitute products are strong or weak. Competitive
pressures are stronger when
FIGURE 3.6 Factors Affecting Competition from Substitute
Products
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1. Good substitutes are readily available and attractively priced. The presence
of readily available and attractively priced substitutes creates competitive
pressure by placing a ceiling on the prices industry members can charge
without risking sales erosion. This price ceiling, at the same time, puts a lid
on the profits that industry members can earn unless they find ways to cut
costs.
2. Buyers view the substitutes as comparable or better in terms of quality,
performance, and other relevant attributes. The availability of substitutes
inevitably invites customers to compare performance, features, ease of use,
and other attributes besides price. The users of paper cartons constantly
weigh the price-performance trade-offs with plastic containers and
metal cans, for example. Movie enthusiasts are increasingly
weighing whether to go to movie theaters to watch newly released movies or
wait until they can watch the same movies streamed to their home TV by
Netflix, Amazon Prime, cable providers, and other on-demand sources.
3. The costs that buyers incur in switching to the substitutes are low. Low
switching costs make it easier for the sellers of attractive substitutes to lure
buyers to their offerings; high switching costs deter buyers from purchasing
substitute products.
Some signs that the competitive strength of substitute products is increasing
include (1) whether the sales of substitutes are growing faster than the sales of
the industry being analyzed, (2) whether the producers of substitutes are
investing in added capacity, and (3) whether the producers of substitutes are
earning progressively higher profits.
But before assessing the competitive pressures coming from substitutes,
company managers must identify the substitutes, which is less easy than it
sounds since it involves (1) determining where the industry boundaries lie and
(2) figuring out which other products or services can address the same basic
customer needs as those produced by industry members. Deciding on the
industry boundaries is necessary for determining which firms are direct rivals
and which produce substitutes. This is a matter of perspective—there are no
hard-and-fast rules, other than to say that other brands of the same basic
product constitute rival products and not substitutes. Ultimately, it’s simply the
buyer who decides what can serve as a good substitute.
Competitive Pressures Stemming from Supplier
Bargaining Power
Whether the suppliers of industry members represent a weak or strong
competitive force depends on the degree to which suppliers have sufficient
bargaining power to influence the terms and conditions of supply in their favor.
Suppliers with strong bargaining power are a source of competitive pressure
because of their ability to charge industry members higher prices, pass costs on
to them, and limit their opportunities to find better deals. For instance,
Microsoft and Intel, both of which supply PC makers with essential
components, have been known to use their dominant market status not only to
charge PC makers premium prices but also to leverage their power over PC
makers in other ways. The bargaining power of these two companies over their
customers is so great that both companies have faced antitrust charges on
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numerous occasions. Prior to a legal agreement ending the practice, Microsoft
pressured PC makers to load only Microsoft products on the PCs they shipped.
Intel has defended itself against similar antitrust charges, but in filling orders
for newly introduced Intel chips, it continues to give top priority to PC makers
that use the biggest percentages of Intel chips in their PC models. Being on
Intel’s list of preferred customers helps a PC maker get an early allocation of
Intel’s latest chips and thus allows the PC maker to get new models to market
ahead of rivals.
Small-scale retailers often must contend with the power of manufacturers
whose products enjoy well-known brand names, since consumers expect to
find these products on the shelves of the retail stores where they shop. This
provides the manufacturer with a degree of pricing power and often the ability
to push hard for favorable shelf displays. Supplier bargaining power is also a
competitive factor in industries where unions have been able to organize the
workforce (which supplies labor). Air pilot unions, for example, have
employed their bargaining power to increase pilots’ wages and benefits in the
air transport industry. The growing clout of the largest healthcare union in the
United States has led to better wages and working conditions in nursing homes.
As shown in Figure 3.7, a variety of factors determine the
strength of suppliers’ bargaining power. Supplier power is stronger when
FIGURE 3.7 Factors Affecting the Bargaining Power of
Suppliers
Demand for suppliers’ products is high and the products are in short supply.
A surge in the demand for particular items shifts the bargaining power to the
suppliers of those products; suppliers of items in short supply have pricing
power.
Suppliers provide differentiated inputs that enhance the performance of the
industry’s product. The more valuable a particular input is in terms of
enhancing the performance or quality of the products of industry members,
the more bargaining leverage suppliers have. In contrast, the suppliers of
commodities are in a weak bargaining position, since industry members have
no reason other than price to prefer one supplier over another.
It is difficult or costly for industry members to switch their purchases from
one supplier to another. Low switching costs limit supplier bargaining power
by enabling industry members to change suppliers if any one supplier
attempts to raise prices by more than the costs of switching. Thus, the higher
the switching costs of industry members, the stronger the bargaining power
of their suppliers.
The supplier industry is dominated by a few large companies and it is more
concentrated than the industry it sells to. Suppliers with sizable market
shares and strong demand for the items they supply generally have sufficient
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bargaining power to charge high prices and deny requests from industry
members for lower prices or other concessions.
Industry members are incapable of integrating backward to self-
manufacture items they have been buying from suppliers. As a rule,
suppliers are safe from the threat of self-manufacture by their customers until
the volume of parts a customer needs becomes large enough for the customer
to justify backward integration into self-manufacture of the component.
When industry members can threaten credibly to self-manufacture suppliers’
goods, their bargaining power over suppliers increases proportionately.
Suppliers provide an item that accounts for no more than a small fraction of
the costs of the industry’s product. The more that the cost of a particular part
or component affects the final product’s cost, the more that industry members
will be sensitive to the actions of suppliers to raise or lower their prices.
When an input accounts for only a small proportion of total input costs,
buyers will be less sensitive to price increases. Thus, suppliers’ power
increases when the inputs they provide do not make up a large proportion of
the cost of the final product.
Good substitutes are not available for the suppliers’ products. The lack of
readily available substitute inputs increases the bargaining power of suppliers
by increasing the dependence of industry members on the suppliers.
Industry members are not major customers of suppliers. As a rule, suppliers
have less bargaining leverage when their sales to members of the industry
constitute a big percentage of their total sales. In such cases, the well-being
of suppliers is closely tied to the well-being of their major customers, and
their dependence upon them increases. The bargaining power of suppliers is
stronger, then, when they are not bargaining with major customers.
In identifying the degree of supplier power in an industry, it is important to
recognize that different types of suppliers are likely to have different amounts
of bargaining power. Thus, the first step is for managers to identify the
different types of suppliers, paying particular attention to those that provide the
industry with important inputs. The next step is to assess the bargaining power
of each type of supplier separately.
Competitive Pressures Stemming from Buyer
Bargaining Power and Price Sensitivity
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Whether buyers are able to exert strong competitive pressures on industry
members depends on (1) the degree to which buyers have bargaining power
and (2) the extent to which buyers are price-sensitive. Buyers with strong
bargaining power can limit industry profitability by demanding price
concessions, better payment terms, or additional features and services that
increase industry members’ costs. Buyer price sensitivity limits the profit
potential of industry members by restricting the ability of sellers to raise prices
without losing revenue due to lost sales.
As with suppliers, the leverage that buyers have in negotiating favorable
terms of sale can range from weak to strong. Individual consumers seldom
have much bargaining power in negotiating price concessions or other
favorable terms with sellers. However, their price sensitivity varies by
individual and by the type of product they are buying (whether it’s a necessity
or a discretionary purchase, for example). Similarly, small businesses usually
have weak bargaining power because of the small-size orders they place with
sellers. Many relatively small wholesalers and retailers join buying groups to
pool their purchasing power and approach manufacturers for better terms than
could be gotten individually. Large business buyers, in contrast, can have
considerable bargaining power. For example, large retail chains like
Walmart, Best Buy, Staples, and Home Depot typically have
considerable bargaining power in purchasing products from manufacturers, not
only because they buy in large quantities, but also because of manufacturers’
need for access to their broad base of customers. Major supermarket chains like
Kroger, Albertsons, Hannaford, and Aldi have sufficient bargaining power to
demand promotional allowances and lump-sum payments (called slotting fees)
from food products manufacturers in return for stocking certain brands or
putting them in the best shelf locations. Motor vehicle manufacturers have
strong bargaining power in negotiating to buy original-equipment tires from
tire makers such as Bridgestone, Goodyear, Michelin, Continental, and Pirelli,
partly because they buy in large quantities and partly because consumers are
more likely to buy replacement tires that match the tire brand on their vehicle
at the time of its purchase. The starting point for the analysis of buyers as a
competitive force is to identify the different types of buyers along the value
chain—then proceed to analyzing the bargaining power and price sensitivity of
each type separately. It is important to recognize that not all buyers of an
industry’s product have equal degrees of bargaining power with sellers, and
some may be less sensitive than others to price, quality, or service differences.
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Figure 3.8 summarizes the factors determining the strength of buyer power
in an industry. The top of this chart lists the factors that increase buyers’
bargaining power, which we discuss next. Note that the first five
factors are the mirror image of those determining the bargaining
power of suppliers.
FIGURE 3.8 Factors Affecting the Power of Buyers
Buyer bargaining power is stronger when
Buyer demand is weak in relation to the available supply. Weak or declining
demand and the resulting excess supply create a “buyers’ market,” in which
bargain-hunting buyers have leverage in pressing industry members for
better deals and special treatment. Conversely, strong or rapidly growing
market demand creates a “sellers’ market” characterized by tight supplies or
shortages—conditions that put buyers in a weak position to wring
concessions from industry members.
Industry goods are standardized or differentiation is weak. In such
circumstances, buyers make their selections on the basis of price, which
increases price competition among vendors.
Buyers’ costs of switching to competing brands or substitutes are relatively
low. Switching costs put a cap on how much industry producers can raise
prices or reduce quality before they will lose the buyer’s business.
Buyers are large and few in number relative to the number of sellers. The
larger the buyers, the more important their business is to the seller and the
more sellers will be willing to grant concessions.
Buyers pose a credible threat of integrating backward into the business of
sellers. Beer producers like Anheuser Busch InBev SA/NV (whose brands
include Budweiser, Molson Coors, and Heineken) have partially integrated
backward into metal-can manufacturing to gain bargaining power in
obtaining the balance of their can requirements from otherwise powerful
metal-can manufacturers.
Buyers are well informed about the product offerings of sellers (product
features and quality, prices, buyer reviews) and the cost of production (an
indicator of markup). The more information buyers have, the better
bargaining position they are in. The mushrooming availability of product
information on the Internet (and its ready access on smartphones) is giving
added bargaining power to consumers, since they can use this to find or
negotiate better deals. Apps such as ShopSavvy and BuyVia are now making
comparison shopping even easier.
Buyers have discretion to delay their purchases or perhaps even not make a
purchase at all. Consumers often have the option to delay purchases of
durable goods (cars, major appliances), or decline to buy discretionary goods
(massages, concert tickets) if they are not happy with the prices offered.
Business customers may also be able to defer their purchases of certain
items, such as plant equipment or maintenance services. This puts pressure
on sellers to provide concessions to buyers so that the sellers can keep their
sales numbers from dropping off.
Whether Buyers Are More or Less Price-Sensitive Low-income and
budget-constrained consumers are almost always price-sensitive; bargain-
hunting consumers are highly price-sensitive by nature. Most consumers grow
more price-sensitive as the price tag of an item becomes a bigger fraction of
their spending budget. Similarly, business buyers besieged by weak sales,
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intense competition, and other factors squeezing their profit margins are price-
sensitive. Price sensitivity also grows among businesses as the cost of an item
becomes a bigger fraction of their cost structure. Rising prices of frequently
purchased items heighten the price sensitivity of all types of buyers. On the
other hand, the price sensitivity of all types of buyers decreases the more that
the quality of the product matters.
The following factors increase buyer price sensitivity and result
in greater competitive pressures on the industry as a result:
Buyer price sensitivity increases when buyers are earning low profits or have
low income. Price is a critical factor in the purchase decisions of low-income
consumers and companies that are barely scraping by. In such cases, their
high price sensitivity limits the ability of sellers to charge high prices.
Buyers are more price-sensitive if the product represents a large fraction of
their total purchases. When a purchase eats up a large portion of a buyer’s
budget or represents a significant part of his or her cost structure, the buyer
cares more about price than might otherwise be the case.
Buyers are more price-sensitive when the quality of the product is not
uppermost in their considerations. Quality matters little when products are
relatively undifferentiated, leading buyers to focus more on price. But when
quality affects performance, or can reduce a business buyer’s other costs (by
saving on labor, materials, etc.), price will matter less.
Is the Collective Strength of the Five Competitive
Forces Conducive to Good Profitability?
Assessing whether each of the five competitive forces gives rise to strong,
moderate, or weak competitive pressures sets the stage for evaluating whether,
overall, the strength of the five forces is conducive to good profitability. Is any
of the competitive forces sufficiently powerful to undermine industry
profitability? Can companies in this industry reasonably expect to earn decent
profits in light of the prevailing competitive forces?
The most extreme case of a “competitively unattractive” industry occurs
when all five forces are producing strong competitive pressures: Rivalry among
sellers is vigorous, low entry barriers allow new rivals to gain a market
foothold, competition from substitutes is intense, and both suppliers and buyers
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are able to exercise considerable leverage. Strong competitive pressures
coming from all five directions drive industry profitability to unacceptably low
levels, frequently producing losses for many industry members and forcing
some out of business. But an industry can be competitively unattractive without
all five competitive forces being strong. In fact, intense competitive pressures
from just one of the five forces may suffice to destroy the conditions for good
profitability and prompt some companies to exit the business.
As a rule, the strongest competitive forces determine the extent of the
competitive pressure on industry profitability. Thus, in evaluating the strength
of the five forces overall and their effect on industry profitability, managers
should look to the strongest forces. Having more than one strong force will not
worsen the effect on industry profitability, but it does mean that the industry
has multiple competitive challenges with which to cope. In that sense, an
industry with three to five strong forces is even more “unattractive” as a place
to compete. Especially intense competitive conditions due to multiple strong
forces seem to be the norm in tire manufacturing, apparel, and commercial
airlines, three industries where profit margins have historically been thin.
CORE
CONCEPT
The strongest of the
five forces
determines the
extent of the
downward pressure
on an industry’s
profitability.
In contrast, when the overall impact of the five competitive forces is
moderate to weak, an industry is “attractive” in the sense that the average
industry member can reasonably expect to earn good profits and a nice return
on investment. The ideal competitive environment for earning superior profits
is one in which both suppliers and customers have limited power, there are no
good substitutes, high barriers block further entry, and rivalry among present
sellers is muted. Weak competition is the best of all possible worlds
for also-ran companies because even they can usually eke out a
decent profit—if a company can’t make a decent profit when competition is
weak, then its business outlook is indeed grim.
Matching Company Strategy to Competitive
Conditions
Working through the five forces model step by step not only aids strategy
makers in assessing whether the intensity of competition allows good
profitability but also promotes sound strategic thinking about how to better
match company strategy to the specific competitive character of the
marketplace. Effectively matching a company’s business strategy to prevailing
competitive conditions has two aspects:
1. Pursuing avenues that shield the firm from as many of the different
competitive pressures as possible.
2. Initiating actions calculated to shift the competitive forces in the company’s
favor by altering the underlying factors driving the five forces.
A company’s
strategy is
strengthened the
more it provides
insulation from
competitive
pressures, shifts the
competitive battle in
the company’s favor,
and positions the
firm to take
advantage of
attractive growth
opportunities.
But making headway on these two fronts first requires identifying
competitive pressures, gauging the relative strength of each of the five
competitive forces, and gaining a deep enough understanding of the state of
competition in the industry to know which strategy buttons to push.
COMPLEMENTORS AND THE VALUE
NET
Not all interactions among industry participants are necessarily competitive in
nature. Some have the potential to be cooperative, as the value net framework
demonstrates. Like the five forces framework, the value net includes an
analysis of buyers, suppliers, and substitutors (see Figure 3.9). But it differs
from the five forces framework in several important ways.
First, the analysis focuses on the interactions of industry participants with a
particular company. Thus, it places that firm in the center of the framework, as
Figure 3.9 shows. Second, the category of “competitors” is defined to include
not only the focal firm’s direct competitors or industry rivals but also the
sellers of substitute products and potential entrants. Third, the value net
framework introduces a new category of industry participant that is not found
in the five forces framework—that of “complementors.” Complementors are
the producers of complementary products, which are products that enhance the
value of the focal firm’s products when they are used together. Some examples
include snorkels and swim fins or shoes and shoelaces.
CORE
CONCEPT
Complementors
are the producers of
complementary
products, which are
products that
enhance the value
of the focal firm’s
products when they
are used together.
FIGURE 3.9 The Value Net
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The inclusion of complementors draws particular attention to the fact that
success in the marketplace need not come at the expense of other industry
participants. Interactions among industry participants may be cooperative in
nature rather than competitive. In the case of complementors, an increase in
sales for them is likely to increase the sales of the focal firm as well. But the
value net framework also encourages managers to consider other forms of
cooperative interactions and realize that value is created jointly by all industry
participants. For example, a company’s success in the marketplace depends on
establishing a reliable supply chain for its inputs, which implies the need for
cooperative relations with its suppliers. Often a firm works hand in
hand with its suppliers to ensure a smoother, more efficient
operation for both parties. Newell-Rubbermaid, and Procter & Gamble for
example, work cooperatively as suppliers to companies such as Walmart,
Target, and Kohl’s. Even direct rivals may work cooperatively if they
participate in industry trade associations or engage in joint lobbying efforts.
Value net analysis can help managers discover the potential to improve their
position through cooperative as well as competitive interactions.
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INDUSTRY DYNAMICS AND THE
FORCES DRIVING CHANGE
While it is critical to understand the nature and intensity of competitive and
cooperative forces in an industry, it is equally critical to understand that the
intensity of these forces is fluid and subject to change. All industries are
affected by new developments and ongoing trends that alter industry
conditions, some more speedily than others. The popular hypothesis that
industries go through a life cycle of takeoff, rapid growth, maturity, market
saturation and slowing growth, followed by stagnation or decline is but one
aspect of industry change—many other new developments and emerging trends
cause industry change.5 Any strategies devised by management will therefore
play out in a dynamic industry environment, so it’s imperative that managers
consider the factors driving industry change and how they might affect the
industry environment. Moreover, with early notice, managers may be able to
influence the direction or scope of environmental change and improve the
outlook.
Industry and competitive conditions change because forces are
enticing or pressuring certain industry participants (competitors, customers,
suppliers, complementors) to alter their actions in important ways. The most
powerful of the change agents are called driving forces because they have the
biggest influences in reshaping the industry landscape and altering competitive
conditions. Some driving forces originate in the outer ring of the company’s
macro-environment (see Figure 3.2), but most originate in the company’s more
immediate industry and competitive environment.
CORE
CONCEPT
Driving forces are
the major underlying
causes of change in
industry and
competitive
conditions.
Driving-forces analysis has three steps: (1) identifying what the driving
forces are; (2) assessing whether the drivers of change are, on the whole, acting
to make the industry more or less attractive; and (3) determining what strategy
changes are needed to prepare for the impact of the driving forces. All three
steps merit further discussion.
Identifying the Forces Driving Industry Change
Many developments can affect an industry powerfully enough to qualify as
driving forces. Some drivers of change are unique and specific to a particular
industry situation, but most drivers of industry and competitive change fall into
one of the following categories:
Changes in an industry’s long-term growth rate. Shifts in industry growth up
or down have the potential to affect the balance between industry supply and
buyer demand, entry and exit, and the character and strength of competition.
Whether demand is growing or declining is one of the key factors
influencing the intensity of rivalry in an industry, as explained earlier. But
the strength of this effect will depend on how changes in the industry growth
rate affect entry and exit in the industry. If entry barriers are low, then growth
in demand will attract new entrants, increasing the number of industry rivals
and changing the competitive landscape.
Increasing globalization. Globalization can be precipitated by such factors as
the blossoming of consumer demand in developing countries, the availability
of lower-cost foreign inputs, and the reduction of trade barriers, as has
occurred recently in many parts of Latin America and Asia. Significant
differences in labor costs among countries give manufacturers a strong
incentive to locate plants for labor-intensive products in low-wage countries
and use these plants to supply market demand across the world. Wages in
China, India, Vietnam, Mexico, and Brazil, for example, are much lower than
those in the United States, Germany, and Japan. The forces of globalization
are sometimes such a strong driver that companies find it highly
advantageous, if not necessary, to spread their operating reach into more and
more country markets. Globalization is very much a driver of industry
change in such industries as energy, mobile phones, steel, social media,
public accounting, commercial aircraft, electric power generation equipment,
and pharmaceuticals.
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Emerging new Internet capabilities and applications. Mushrooming use of
high-speed Internet service and Voice-over-Internet-Protocol (VoIP)
technology, growing acceptance of online shopping, and the exploding
popularity of Internet applications (“apps”) have been major drivers of
change in industry after industry. The Internet has allowed online discount
stock brokers, such as E*TRADE, and TD Ameritrade to mount a strong
challenge against full-service firms such as Edward Jones and Merrill Lynch.
The newspaper industry has yet to figure out a strategy for surviving the
advent of online news.
Massive open online courses (MOOCs) facilitated by
organizations such as Coursera, edX, and Udacity are profoundly affecting
higher education. The “Internet of things” will feature faster speeds, dazzling
applications, and billions of connected gadgets performing an array of
functions, thus driving further industry and competitive changes. But Internet-
related impacts vary from industry to industry. The challenges are to assess
precisely how emerging Internet developments are altering a particular
industry’s landscape and to factor these impacts into the strategy-making
equation.
Shifts in who buys the products and how the products are used. Shifts in
buyer demographics and the ways products are used can greatly alter
competitive conditions. Longer life expectancies and growing percentages of
relatively well-to-do retirees, for example, are driving demand growth in
such industries as cosmetic surgery, assisted living residences, and vacation
travel. The burgeoning popularity of streaming video has affected broadband
providers, wireless phone carriers, and television broadcasters, and created
opportunities for such new entertainment businesses as Hulu and Netflix.
Technological change and manufacturing process innovation. Advances in
technology can cause disruptive change in an industry by introducing
substitutes or can alter the industry landscape by opening up whole new
industry frontiers. For instance, revolutionary change in autonomous system
technology has put Google, Tesla, Apple, and every major automobile
manufacturer into a race to develop viable self-driving vehicles.
Product innovation. An ongoing stream of product innovations tends to alter
the pattern of competition in an industry by attracting more first-time buyers,
rejuvenating industry growth, and/or increasing product differentiation, with
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concomitant effects on rivalry, entry threat, and buyer power. Product
innovation has been a key driving force in the smartphone industry, which in
an ever more connected world is driving change in other industries. Philips
Lighting Hue bulbs now allow homeowners to use a smartphone app to
remotely turn lights on and off, blink if an intruder is detected, and create a
wide range of white and color ambiances. Wearable action-capture cameras
and unmanned aerial view drones are rapidly becoming a disruptive force in
the digital camera industry by enabling photography shots and videos not
feasible with handheld digital cameras.
Marketing innovation. When firms are successful in introducing new ways to
market their products, they can spark a burst of buyer interest, widen
industry demand, increase product differentiation, and lower unit costs—any
or all of which can alter the competitive positions of rival firms and force
strategy revisions. Consider, for example, the growing propensity of
advertisers to place a bigger percentage of their ads on social media sites like
Facebook and Twitter.
Entry or exit of major firms. Entry by a major firm thus often produces a new
ball game, not only with new key players but also with new rules for
competing. Similarly, exit of a major firm changes the competitive structure
by reducing the number of market leaders and increasing the dominance of
the leaders who remain.
Diffusion of technical know-how across companies and countries. As
knowledge about how to perform a particular activity or execute a particular
manufacturing technology spreads, products tend to become more
commodity-like. Knowledge diffusion can occur through scientific journals,
trade publications, onsite plant tours, word of mouth among suppliers and
customers, employee migration, and Internet sources.
Changes in cost and efficiency. Widening or shrinking differences in the
costs among key competitors tend to dramatically alter the state of
competition. Declining costs of producing tablets have enabled price cuts and
spurred tablet sales (especially lower-priced models) by making
them more affordable to lower-income households worldwide.
Lower cost e-books are cutting into sales of costlier hardcover books as
increasing numbers of consumers have laptops, iPads, Kindles, and other
brands of tablets.
Reductions in uncertainty and business risk. Many companies are hesitant to
enter industries with uncertain futures or high levels of business risk because
it is unclear how much time and money it will take to overcome various
technological hurdles and achieve acceptable production costs (as is the case
in the solar power industry). Over time, however, diminishing risk levels and
uncertainty tend to stimulate new entry and capital investments on the part of
growth-minded companies seeking new opportunities, thus dramatically
altering industry and competitive conditions.
Regulatory influences and government policy changes. Government
regulatory actions can often mandate significant changes in industry
practices and strategic approaches—as has recently occurred in the world’s
banking industry. New rules and regulations pertaining to government-
sponsored health insurance programs are driving changes in the health care
industry. In international markets, host governments can drive competitive
changes by opening their domestic markets to foreign participation or closing
them to protect domestic companies.
Changing societal concerns, attitudes, and lifestyles. Emerging social issues
as well as changing attitudes and lifestyles can be powerful instigators of
industry change. Growing concern about the effects of climate change has
emerged as a major driver of change in the energy industry. Concerns about
the use of chemical additives and the nutritional content of food products
have been driving changes in the restaurant and food industries. Shifting
societal concerns, attitudes, and lifestyles alter the pattern of competition,
favoring those players that respond with products targeted to the new trends
and conditions.
The most important
part of driving-forces
analysis is to
determine whether
the collective impact
of the driving forces
will increase or
decrease market
demand, make
competition more or
less intense, and
lead to higher or
lower industry
profitability.
page 78
While many forces of change may be at work in a given industry, no more
than three or four are likely to be true driving forces powerful enough to
qualify as the major determinants of why and how the industry is changing.
Thus, company strategists must resist the temptation to label every change they
see as a driving force. Table 3.3 lists the most common driving forces.
TABLE 3.3 The Most Common Drivers of Industry Change
Changes in the long-term industry growth rate
Increasing globalization
Emerging new Internet capabilities and applications
Shifts in buyer demographics
Technological change and manufacturing process innovation
Product and marketing innovation
Entry or exit of major firms
Diffusion of technical know-how across companies and countries
Changes in cost and efficiency
Reductions in uncertainty and business risk
Regulatory influences and government policy changes
Changing societal concerns, attitudes, and lifestyles
Assessing the Impact of the Forces Driving
Industry Change
The second step in driving-forces analysis is to determine whether the
prevailing change drivers, on the whole, are acting to make the industry
environment more or less attractive. Three questions need to be answered:
1. Are the driving forces, on balance, acting to cause demand for the industry’s
product to increase or decrease?
2. Is the collective impact of the driving forces making competition more or
less intense?
3. Will the combined impacts of the driving forces lead to higher or lower
industry profitability?
The real payoff of
driving-forces
analysis is to help
managers
understand what
strategy changes
are needed to
prepare for the
impacts of the
driving forces.
Getting a handle on the collective impact of the driving forces requires
looking at the likely effects of each factor separately, since the driving forces
may not all be pushing change in the same direction. For example, one driving
force may be acting to spur demand for the industry’s product while another is
working to curtail demand. Whether the net effect on industry demand is up or
down hinges on which change driver is the most powerful.
Adjusting the Strategy to Prepare for the Impacts
of Driving Forces
The third step in the strategic analysis of industry dynamics—where the real
payoff for strategy making comes—is for managers to draw some conclusions
about what strategy adjustments will be needed to deal with the impacts of the
driving forces. But taking the “right” kinds of actions to prepare for the
industry and competitive changes being wrought by the driving forces first
requires accurate diagnosis of the forces driving industry change and the
impacts these forces will have on both the industry environment and the
company’s business. To the extent that managers are unclear about the drivers
of industry change and their impacts, or if their views are off-base, the chances
of making astute and timely strategy adjustments are slim. So driving-forces
analysis is not something to take lightly; it has practical value and is basic to
the task of thinking strategically about where the industry is headed and how to
prepare for the changes ahead.
STRATEGIC GROUP ANALYSIS
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• LO 3-3
Map the market
positions of key
groups of industry
rivals.
Within an industry, companies commonly sell in different price/quality ranges,
appeal to different types of buyers, have different geographic coverage, and so
on. Some are more attractively positioned than others. Understanding which
companies are strongly positioned and which are weakly positioned is an
integral part of analyzing an industry’s competitive structure. The best
technique for revealing the market positions of industry competitors is
strategic group mapping.
CORE
CONCEPT
Strategic group
mapping is a
technique for
displaying the
different market or
competitive
positions that rival
firms occupy in the
industry.
Using Strategic Group Maps to Assess the Market
Positions of Key Competitors
A strategic group consists of those industry members with similar competitive
approaches and positions in the market. Companies in the same strategic group
can resemble one another in a variety of ways. They may have
comparable product-line breadth, sell in the same price/quality range,
employ the same distribution channels, depend on identical technological
approaches, compete in much the same geographic areas, or offer buyers
essentially the same product attributes or similar services and technical
assistance.6 Evaluating strategy options entails examining what strategic
groups exist, identifying the companies within each group, and determining if a
competitive “white space” exists where industry competitors are able to create
and capture altogether new demand. As part of this process, the number of
strategic groups in an industry and their respective market positions can be
displayed on a strategic group map.
CORE
CONCEPT
A strategic group is
a cluster of industry
rivals that have
similar competitive
approaches and
market positions.
The procedure for constructing a strategic group map is straightforward:
Identify the competitive characteristics that delineate strategic approaches
used in the industry. Typical variables used in creating strategic group maps
are price/quality range (high, medium, low), geographic coverage (local,
regional, national, global), product-line breadth (wide, narrow), degree of
service offered (no frills, limited, full), use of distribution channels (retail,
wholesale, Internet, multiple), degree of vertical integration (none, partial,
full), and degree of diversification into other industries (none, some,
considerable).
Plot the firms on a two-variable map using pairs of these variables.
Assign firms occupying about the same map location to the same strategic
group.
Draw circles around each strategic group, making the circles proportional to
the size of the group’s share of total industry sales revenues.
This produces a two-dimensional diagram like the one for the U.S. pizza
chain industry in Illustration Capsule 3.2.
Several guidelines need to be observed in creating strategic group maps.
First, the two variables selected as axes for the map should not be highly
correlated; if they are, the circles on the map will fall along a diagonal and
reveal nothing more about the relative positions of competitors than would be
revealed by comparing the rivals on just one of the variables. For instance, if
companies with broad product lines use multiple distribution channels while
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companies with narrow lines use a single distribution channel, then looking at
the differences in distribution-channel approaches adds no new information
about positioning.
Second, the variables chosen as axes for the map should reflect important
differences among rival approaches—when rivals differ on both variables, the
locations of the rivals will be scattered, thus showing how they are positioned
differently. Third, the variables used as axes don’t have to be either quantitative
or continuous; rather, they can be discrete variables, defined in terms of distinct
classes and combinations. Fourth, drawing the sizes of the circles on the map
proportional to the combined sales of the firms in each strategic group allows
the map to reflect the relative sizes of each strategic group. Fifth, if more than
two good variables can be used as axes for the map, then it is wise to draw
several maps to give different exposures to the competitive positioning
relationships present in the industry’s structure—there is not necessarily one
best map for portraying how competing firms are positioned.
The Value of Strategic Group Maps
Strategic group maps are revealing in several respects. The most important has
to do with identifying which industry members are close rivals and which are
distant rivals. Firms in the same strategic group are the closest rivals; the next
closest rivals are in the immediately adjacent groups. Often, firms in
strategic groups that are far apart on the map hardly compete at all.
For instance, Walmart’s clientele, merchandise selection, and pricing points are
much too different to justify calling Walmart a close competitor of Neiman
Marcus or Saks Fifth Avenue. For the same reason, the beers produced by
Yuengling are really not in competition with the beers produced by Pabst.
Strategic group
maps reveal which
companies are close
competitors and
which are distant
competitors.
ILLUSTRATION
CAPSULE 3.2 Comparative Market Positions
of Selected Companies in the Pizza Chain
Industry: A Strategic Group Map Example
Note: Circles are drawn roughly proportional to the sizes of the chains, based on revenues.
The second thing to be gleaned from strategic group mapping is that not all
positions on the map are equally attractive.7 Two reasons account for why
some positions can be more attractive than others:
1. Prevailing competitive pressures from the industry’s five forces may cause
the profit potential of different strategic groups to vary. The profit prospects
of firms in different strategic groups can vary from good to poor because of
differing degrees of competitive rivalry within strategic groups, differing
pressures from potential entrants to each group, differing degrees of
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exposure to competition from substitute products outside the industry, and
differing degrees of supplier or customer bargaining power from group to
group. For instance, in the ready-to-eat cereal industry, there are
significantly higher entry barriers (capital requirements, brand loyalty, etc.)
for the strategic group comprising the large branded-cereal makers
than for the group of generic-cereal makers or the group of small
natural-cereal producers. Differences among the branded rivals versus the
generic cereal makers make rivalry stronger within the generic-cereal
strategic group. Among apparel retailers, the competitive battle between
Marshall’s and TJ MAXX is more intense (with consequently smaller profit
margins) than the rivalry among Prada, Burberry, Gucci, Armani, and other
high-end fashion retailers.
2. Industry driving forces may favor some strategic groups and hurt others.
Likewise, industry driving forces can boost the business outlook for some
strategic groups and adversely impact the business prospects of others. In the
energy industry, producers of renewable energy, such as solar and wind
power, are gaining ground over fossil fuel-based producers due to
improvements in technology and increased concern over climate change.
Firms in strategic groups that are being adversely impacted by driving forces
may try to shift to a more favorably situated position. If certain firms are
known to be trying to change their competitive positions on the map, then
attaching arrows to the circles showing the targeted direction helps clarify
the picture of competitive maneuvering among rivals.
Some strategic
groups are more
favorably positioned
than others because
they confront
weaker competitive
forces and/or
because they are
more favorably
impacted by industry
driving forces.
Thus, part of strategic group map analysis always entails drawing
conclusions about where on the map is the “best” place to be and why. Which
companies/strategic groups are destined to prosper because of their positions?
Which companies/strategic groups seem destined to struggle? What accounts
for why some parts of the map are better than others? Since some strategic
groups are more attractive than others, one might ask why less well-positioned
firms do not simply migrate to the more attractive position. The answer is that
mobility barriers restrict movement between groups in the same way that
entry barriers prevent easy entry into attractive industries. The most profitable
strategic groups may be protected from entry by high mobility barriers.
CORE
CONCEPT
Mobility barriers
restrict firms in one
strategic group from
entering another
more attractive
strategic group in
the same industry.
COMPETITOR ANALYSIS AND THE
SOAR FRAMEWORK
Unless a company pays attention to the strategies and situations of competitors
and has some inkling of what moves they will be making, it ends up flying
blind into competitive battle. As in sports, scouting the opposition is an
essential part of game plan development. Gathering competitive intelligence
about the strategic direction and likely moves of key competitors allows a
company to prepare defensive countermoves, to craft its own strategic moves
with some confidence about what market maneuvers to expect from rivals in
response, and to exploit any openings that arise from competitors’ missteps.
The question is where to look for such information, since rivals rarely reveal
their strategic intentions openly. If information is not directly available, what
are the best indicators?
Studying
competitors’ past
behavior and
preferences
provides a valuable
assist in anticipating
what moves rivals
page 82
are likely to make
next and
outmaneuvering
them in the
marketplace.
Michael Porter’s SOAR Framework for Competitor Analysis points to
four indicators of a rival’s likely strategic moves and countermoves. These
include a rival’s Strategy, Objectives, Assumptions about itself and the industry,
and Resources and capabilities, as shown in Figure 3.10. A strategic profile of
a competitor that provides good clues to its behavioral proclivities can be
constructed by characterizing the rival along these four dimensions. By
“behavioral proclivities,” we mean what competitive moves a rival is likely to
make and how they are likely to react to the competitive moves of your
company—its probable actions and reactions. By listing all that you
know about a competitor (or a set of competitors) with respect to
each of the four elements of the SOAR framework, you are likely to gain some
insight about how the rival will behave in the near term. And knowledge of this
sort can help you to predict how this will affect you, and how you should
position yourself to respond. That is, what should you do to protect yourself or
gain advantage now (in advance); and what should you do in response to your
rivals next moves?
FIGURE 3.10 The SOAR Framework for Competitor Analysis
page 83
Current Strategy To succeed in predicting a competitor’s next moves,
company strategists need to have a good understanding of each rival’s current
strategy, as an indicator of its pattern of behavior and best strategic options.
Questions to consider include: How is the competitor positioned in the market?
What is the basis for its competitive advantage (if any)? What kinds of
investments is it making (as an indicator of its growth trajectory)?
Objectives An appraisal of a rival’s objectives should include not only its
financial performance objectives but strategic ones as well (such as those
concerning market share). What is even more important is to consider the
extent to which the rival is meeting these objectives and whether it is under
pressure to improve. Rivals with good financial performance are likely to
continue their present strategy with only minor fine-tuning. Poorly performing
rivals are virtually certain to make fresh strategic moves.
Resources and Capabilities A rival’s strategic moves and countermoves are
both enabled and constrained by the set of resources and capabilities the rival
has at hand. Thus, a rival’s resources and capabilities (and efforts to acquire
new resources and capabilities) serve as a strong signal of future strategic
actions (and reactions to your company’s moves). Assessing a rival’s
resources and capabilities involves sizing up not only its strengths in this
respect but its weaknesses as well.
Assumptions How a rival’s top managers think about their strategic
situation can have a big impact on how the rival behaves. Banks that believe
they are “too big to fail,” for example, may take on more risk than is
financially prudent. Assessing a rival’s assumptions entails considering its
assumptions about itself as well as about the industry it participates in.
Information regarding these four analytic components can often be gleaned
from company press releases, information posted on the company’s website
(especially the presentations management has recently made to securities
analysts), and such public documents as annual reports and 10-K filings. Many
companies also have a competitive intelligence unit that sifts through the
available information to construct up-to-date strategic profiles of rivals.8
Doing the necessary detective work can be time-consuming, but scouting
competitors well enough to anticipate their next moves allows managers to
prepare effective countermoves (perhaps even beat a rival to the punch) and to
take rivals’ probable actions into account in crafting their own best course of
action. Despite the importance of gathering such information, these activities
should never cross the bounds of ethical impropriety (see Illustration Capsule
3.3).
KEY SUCCESS FACTORS
An industry’s key success factors (KSFs) are those competitive factors that
most affect industry members’ ability to survive and prosper in the
marketplace: the particular strategy elements, product attributes, operational
approaches, resources, and competitive capabilities that spell the difference
between being a strong competitor and a weak competitor—and between profit
and loss. KSFs by their very nature are so important to competitive success that
all firms in the industry must pay close attention to them or risk becoming an
industry laggard or failure. To indicate the significance of KSFs another way,
how well the elements of a company’s strategy measure up against an
industry’s KSFs determines whether the company can meet the basic criteria
for surviving and thriving in the industry. Identifying KSFs, in light of the
prevailing and anticipated industry and competitive conditions, is therefore
always a top priority in analytic and strategy-making considerations. Company
page 84
strategists need to understand the industry landscape well enough to separate
the factors most important to competitive success from those that are less
important.
CORE
CONCEPT
Key success
factors are the
strategy elements,
product and service
attributes,
operational
approaches,
resources, and
competitive
capabilities that are
essential to
surviving and
thriving in the
industry.
Key success factors vary from industry to industry, and even from time to
time within the same industry, as change drivers and competitive conditions
change. But regardless of the circumstances, an industry’s key success factors
can always be deduced by asking the same three questions:
1. On what basis do buyers of the industry’s product choose between the
competing brands of sellers? That is, what product attributes and service
characteristics are crucial?
2. Given the nature of competitive rivalry prevailing in the marketplace, what
resources and competitive capabilities must a company have to be
competitively successful?
3. What shortcomings are almost certain to put a company at a significant
competitive disadvantage?
ILLUSTRATION
CAPSULE 3.3 Business Ethics and
Competitive Intelligence
Those who gather competitive intelligence on rivals can sometimes cross the fine line
between honest inquiry and unethical or even illegal behavior. For example, calling rivals to
get information about prices, the dates of new product introductions, or wage and salary
levels is legal, but misrepresenting one’s company affiliation during such calls is unethical.
Pumping rivals’ representatives at trade shows is ethical only if one wears a name tag with
accurate company affiliation indicated.
Avon Products at one point secured information about its biggest rival, Mary Kay
Cosmetics (MKC), by having its personnel search through the garbage bins outside MKC’s
headquarters. When MKC officials learned of the action and sued, Avon claimed it did
nothing illegal since a 1988 Supreme Court case had ruled that trash left on public property
(in this case, a sidewalk) was anyone’s for the taking. Avon even produced a videotape of
its removal of the trash at the MKC site. Avon won the lawsuit—but Avon’s action, while
legal, scarcely qualifies as ethical.
Only rarely are there more than five key factors for competitive success.
And even among these, two or three usually outrank the others in importance.
Managers should therefore bear in mind the purpose of identifying key success
factors—to determine which factors are most important to competitive success
—and resist the temptation to label a factor that has only minor importance as a
KSF.
In the beer industry, for example, although there are many types of buyers
(wholesale, retail, end consumer), it is most important to understand the
preferences and buying behavior of the beer drinkers. Their purchase decisions
are driven by price, taste, convenient access, and marketing. Thus, the KSFs
include a strong network of wholesale distributors (to get the company’s brand
stocked and favorably displayed in retail outlets, bars, restaurants, and
stadiums, where beer is sold) and clever advertising (to induce beer drinkers to
buy the company’s brand and thereby pull beer sales through the established
wholesale and retail channels). Because there is a potential for strong buyer
power on the part of large distributors and retail chains, competitive success
depends on some mechanism to offset that power, of which advertising (to
create demand pull) is one. Thus, the KSFs also include superior product
differentiation (as in microbrews) or superior firm size and branding
capabilities (as in national brands). The KSFs also include full utilization of
page 85
brewing capacity (to keep manufacturing costs low and offset the high costs of
advertising, branding, and product differentiation).
Correctly diagnosing an industry’s KSFs also raises a company’s chances of
crafting a sound strategy. The key success factors of an industry point to those
things that every firm in the industry needs to attend to in order to retain
customers and weather the competition. If the company’s strategy cannot
deliver on the key success factors of its industry, it is unlikely to earn enough
profits to remain a viable business.
THE INDUSTRY OUTLOOK FOR
PROFITABILITY
• LO 3-4
Determine whether
an industry’s outlook
presents a company
with sufficiently
attractive
opportunities for
growth and
profitability.
Each of the frameworks presented in this chapter—PESTEL, five forces
analysis, driving forces, strategy groups, competitor analysis, and key success
factors—provides a useful perspective on an industry’s outlook for future
profitability. Putting them all together provides an even richer and more
nuanced picture. Thus, the final step in evaluating the industry and
competitive environment is to use the results of each of the analyses
performed to determine whether the industry presents the company with strong
prospects for competitive success and attractive profits. The important factors
on which to base a conclusion include
How the company is being impacted by the state of the macro-environment.
Whether strong competitive forces are squeezing industry profitability to
subpar levels.
Whether the presence of complementors and the possibility of cooperative
actions improve the company’s prospects.
Whether industry profitability will be favorably or unfavorably affected by
the prevailing driving forces.
Whether the company occupies a stronger market position than rivals.
Whether this is likely to change in the course of competitive interactions.
How well the company’s strategy delivers on the industry key success
factors.
As a general proposition, the anticipated industry environment is
fundamentally attractive if it presents a company with good opportunity for
above-average profitability; the industry outlook is fundamentally unattractive
if a company’s profit prospects are unappealingly low.
However, it is a mistake to think of a particular industry as being equally
attractive or unattractive to all industry participants and all potential entrants.9
Attractiveness is relative, not absolute, and conclusions one way or the other
have to be drawn from the perspective of a particular company. For instance, a
favorably positioned competitor may see ample opportunity to capitalize on the
vulnerabilities of weaker rivals even though industry conditions are otherwise
somewhat dismal. At the same time, industries attractive to insiders may be
unattractive to outsiders because of the difficulty of challenging current market
leaders or because they have more attractive opportunities elsewhere.
The degree to which
an industry is
attractive or
unattractive is not
the same for all
industry participants
and all potential
entrants.
When a company decides an industry is fundamentally attractive and
presents good opportunities, a strong case can be made that it should invest
aggressively to capture the opportunities it sees and to improve its long-term
competitive position in the business. When a strong competitor concludes an
industry is becoming less attractive, it may elect to simply protect its present
position, investing cautiously—if at all—and looking for opportunities in other
page 86
industries. A competitively weak company in an unattractive industry may see
its best option as finding a buyer, perhaps a rival, to acquire its business.
KEY POINTS
Thinking strategically about a company’s external situation involves probing
for answers to the following questions:
1. What are the strategically relevant factors in the macro-environment, and
how do they impact an industry and its members? Industries differ
significantly as to how they are affected by conditions and developments in
the broad macro-environment. Using PESTEL analysis to identify which of
these factors is strategically relevant is the first step to understanding how a
company is situated in its external environment.
2. What kinds of competitive forces are industry members facing, and how
strong is each force? The strength of competition is a composite of five
forces: (1) rivalry within the industry, (2) the threat of new entry
into the market, (3) inroads being made by the sellers of substitutes,
(4) supplier bargaining power, and (5) buyer power. All five must be
examined force by force, and their collective strength evaluated. One strong
force, however, can be sufficient to keep average industry profitability low.
Working through the five forces model aids strategy makers in assessing
how to insulate the company from the strongest forces, identify attractive
arenas for expansion, or alter the competitive conditions so that they offer
more favorable prospects for profitability.
3. What cooperative forces are present in the industry, and how can a company
harness them to its advantage? Interactions among industry participants are
not only competitive in nature but cooperative as well. This is particularly
the case when complements to the products or services of an industry are
important. The Value Net framework assists managers in sizing up the
impact of cooperative as well as competitive interactions on their firm.
4. What factors are driving changes in the industry, and what impact will they
have on competitive intensity and industry profitability? Industry and
competitive conditions change because certain forces are acting to create
incentives or pressures for change. The first step is to identify the three or
four most important drivers of change affecting the industry being analyzed
(out of a much longer list of potential drivers). Once an industry’s change
page 87
drivers have been identified, the analytic task becomes one of determining
whether they are acting, individually and collectively, to make the industry
environment more or less attractive.
5. What market positions do industry rivals occupy—who is strongly positioned
and who is not? Strategic group mapping is a valuable tool for understanding
the similarities, differences, strengths, and weaknesses inherent in the market
positions of rival companies. Rivals in the same or nearby strategic groups
are close competitors, whereas companies in distant strategic groups usually
pose little or no immediate threat. The lesson of strategic group mapping is
that some positions on the map are more favorable than others. The profit
potential of different strategic groups may not be the same because industry
driving forces and competitive forces likely have varying effects on the
industry’s distinct strategic groups. Moreover, mobility barriers restrict
movement between groups in the same way that entry barriers prevent easy
entry into attractive industries.
6. What strategic moves are rivals likely to make next? Anticipating the actions
of rivals can help a company prepare effective countermoves. Using the
SOAR Framework for Competitor Analysis is helpful in this regard.
7. What are the key factors for competitive success? An industry’s key success
factors (KSFs) are the particular strategy elements, product attributes,
operational approaches, resources, and competitive capabilities that all
industry members must have in order to survive and prosper in the industry.
For any industry, they can be deduced by answering three basic questions:
(1) On what basis do buyers of the industry’s product choose between the
competing brands of sellers, (2) what resources and competitive capabilities
must a company have to be competitively successful, and (3) what
shortcomings are almost certain to put a company at a significant
competitive disadvantage?
8. Is the industry outlook conducive to good profitability? The last step in
industry analysis is summing up the results from applying each of the
frameworks employed in answering questions 1 to 7: PESTEL, five forces
analysis, Value Net, driving forces, strategic group mapping, competitor
analysis, and key success factors. Applying multiple lenses to the
question of what the industry outlook looks like offers a more
robust and nuanced answer. If the answers from each framework, seen as a
whole, reveal that a company’s profit prospects in that industry are above-
average, then the industry environment is basically attractive for that
LO 3-2
LO 3-3
LO 3-1, LO 3-4
company. What may look like an attractive environment for one company
may appear to be unattractive from the perspective of a different company.
Clear, insightful diagnosis of a company’s external situation is an essential
first step in crafting strategies that are well matched to industry and
competitive conditions. To do cutting-edge strategic thinking about the external
environment, managers must know what questions to pose and what analytic
tools to use in answering these questions. This is why this chapter has
concentrated on suggesting the right questions to ask, explaining concepts and
analytic approaches, and indicating the kinds of things to look for.
ASSURANCE OF LEARNING EXERCISES
1. Prepare a brief analysis of the organic food industry
using the information provided by the Organic Trade
Association at www.ota.com and the Organic Report
magazine at theorganicreport.com. That is, based on
the information provided on these websites, draw a
five forces diagram for the organic food industry and
briefly discuss the nature and strength of each of the
five competitive forces.
2. Based on the strategic group map in Illustration
Capsule 3.2, which pizza chains are Hungry Howie’s
closest competitors? With which strategic group does
California Pizza Kitchen compete the least, according
to this map? Why do you think no Pizza chains are
positioned in the area above the Pizza Hut’s strategic
group?
3. The National Restaurant Association publishes an
annual industry fact book that can be found at
www.restaurant.org. Based on information in the
latest report, does it appear that macro-environmental
factors and the economic characteristics of the
industry will present industry participants with
attractive opportunities for growth and profitability?
Explain.
http://www.ota.com/
http://theorganicreport.com/
http://www.restaurant.org/
LO 3-1
LO 3-2
LO 3-3
LO 3-4
page 88
LO 3-2
LO 3-3
LO 3-4
EXERCISES FOR SIMULATION PARTICIPANTS
1. Which of the factors listed in Table 3.1 might have the
most strategic relevance for your industry?
2. Which of the five competitive forces is creating the
strongest competitive pressures for your company?
3. What are the “weapons of competition” that rival
companies in your industry can use to gain sales and
market share? See Table 3.2 to help you identify the
various competitive factors.
4. What are the factors affecting the intensity of rivalry
in the industry in which your company is competing?
Use Figure 3.4 and the accompanying discussion to
help you in pinpointing the specific factors most
affecting competitive intensity. Would you
characterize the rivalry and jockeying for better
market position, increased sales, and market share
among the companies in your industry as fierce, very
strong, strong, moderate, or relatively weak? Why?
5. Are there any driving forces in the industry in which
your company is competing? If so, what
impact will these driving forces have? Will
they cause competition to be more or less intense?
Will they act to boost or squeeze profit margins? List
at least two actions your company should consider
taking in order to combat any negative impacts of the
driving forces.
6. Draw a strategic group map showing the market
positions of the companies in your industry. Which
companies do you believe are in the most attractive
position on the map? Which companies are the most
weakly positioned? Which companies do you believe
are likely to try to move to a different position on the
strategic group map?
7. What do you see as the key factors for being a
successful competitor in your industry? List at least
three.
LO 3-4
page 89
8. Does your overall assessment of the industry suggest
that industry rivals have sufficiently attractive
opportunities for growth and profitability? Explain.
ENDNOTES
1 Michael E. Porter, Competitive Strategy (New York: Free Press, 1980); Michael E. Porter, “The Five Competitive Forces
That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008), pp. 78–93.
2 J. S. Bain, Barriers to New Competition (Cambridge, MA: Harvard University Press, 1956); F. M. Scherer, Industrial
Market Structure and Economic Performance (Chicago: Rand McNally, 1971).
3 Ibid.
4 C. A. Montgomery and S. Hariharan, “Diversified Expansion by Large Established Firms,” Journal of Economic Behavior &
Organization 15, no. 1 (January 1991).
5 For a more extended discussion of the problems with the life-cycle hypothesis, see Porter, Competitive Strategy, pp. 157–
162.
6 Mary Ellen Gordon and George R. Milne, “Selecting the Dimensions That Define Strategic Groups: A Novel Market-Driven
Approach,” Journal of Managerial Issues 11, no. 2 (Summer 1999), pp. 213–233.
7 Avi Fiegenbaum and Howard Thomas, “Strategic Groups as Reference Groups: Theory, Modeling and Empirical
Examination of Industry and Competitive Strategy,” Strategic Management Journal 16 (1995), pp. 461–476; S. Ade
Olusoga, Michael P. Mokwa, and Charles H. Noble, “Strategic Groups, Mobility Barriers, and Competitive Advantage,”
Journal of Business Research 33 (1995), pp. 153–164.
8 Larry Kahaner, Competitive Intelligence (New York: Simon & Schuster, 1996).
9 B. Wernerfelt and C. Montgomery, “What Is an Attractive Industry?” Management Science 32, no. 10 (October 1986), pp.
1223–1230.
page 90
chapter 4
Evaluating a Company’s Resources,
Capabilities, and Competitiveness
Learning Objectives
After reading this chapter, you should be able to:
LO 4-1 Evaluate how well a company’s strategy is working.
LO 4-2 Assess the company’s strengths and weaknesses in light of
market opportunities and external threats.
LO 4-3 Explain why a company’s resources and capabilities are
critical for gaining a competitive edge over rivals.
LO 4-4 Understand how value chain activities affect a company’s
cost structure and customer value proposition.
LO 4-5 Explain how a comprehensive evaluation of a company’s
competitive situation can assist managers in making critical
decisions about their next strategic moves.
page 91
PhotoDisc Imaging/Getty Images
Crucial, of course, is having a difference that matters in the industry.
Cynthia Montgomery—Professor and author
If you don’t have a competitive advantage, don’t compete.
Jack Welch—Former CEO of General Electric
Organizations succeed in a competitive marketplace over the long run because they can do certain things
their customers value better than can their competitors.
Robert Hayes, Gary Pisano, and David Upton—Professors and consultants
page 92
Chapter 3 described how to use the tools of industry and competitor analysis to assess a
company’s external environment and lay the groundwork for matching a company’s strategy to
its external situation. This chapter discusses techniques for evaluating a company’s internal
situation, including its collection of resources and capabilities and the activities it performs
along its value chain. Internal analysis enables managers to determine whether their strategy
is likely to give the company a significant competitive edge over rival firms (given external
conditions). Combined with external analysis, it facilitates an understanding of how to
reposition a firm to take advantage of new opportunities and to cope with emerging
competitive threats. The analytic spotlight will be trained on six questions:
1. How well is the company’s present strategy working?
2. What are the company’s strengths and weaknesses in relation to the market opportunities
and external threats?
3. What are the company’s most important resources and capabilities, and will they give the
company a lasting competitive advantage over rival companies?
4. How do a company’s value chain activities impact its cost structure and customer value
proposition?
5. Is the company competitively stronger or weaker than key rivals?
6. What strategic issues and problems merit front-burner managerial attention?
In probing for answers to these questions, five analytic tools—resource and capability
analysis, SWOT analysis, value chain analysis, benchmarking, and competitive strength
assessment—will be used. All five are valuable techniques for revealing a company’s
competitiveness and for helping company managers match their strategy to the company’s
particular circumstances. Accordingly, this will enable the company to pass the first of the
three tests of a winning strategy (the Fit Test), as discussed in Chapter 1.
QUESTION 1: HOW WELL IS THE
COMPANY’S PRESENT STRATEGY
WORKING?
• LO 4-1
Evaluate how well a
company’s strategy
is working.
Before evaluating how well a company’s present strategy is working, it is best to
start with a clear view of what the strategy entails. The first thing to examine is the
company’s competitive approach. What moves has the company made recently to
attract customers and improve its market position—for instance, has it cut prices,
improved the design of its product, added new features, stepped up advertising,
entered a new geographic market, or merged with a competitor? Is it striving for a
competitive advantage based on low costs or a better product offering? Is it
concentrating on serving a broad spectrum of customers or a narrow market niche?
The company’s functional strategies in R&D, production, marketing, finance,
human resources, information technology, and so on further characterize company
strategy, as do any efforts to establish alliances with other enterprises. Figure 4.1
shows the key components of a single-business company’s strategy.
FIGURE 4.1 Identifying the Components of a Single-Business
Company’s Strategy
A determination of the effectiveness of this strategy requires a more in-depth
type of analysis. The two best indicators of how well a company’s strategy is
working are (1) whether the company is recording gains in financial strength and
profitability, and (2) whether the company’s competitive strength and market
standing are improving. Persistent shortfalls in meeting company performance
page 93
targets and weak marketplace performance relative to rivals are reliable warning
signs that the company has a weak strategy, suffers from poor strategy
execution, or both. Specific indicators of how well a company’s
strategy is working include
Trends in the company’s sales and earnings growth.
Trends in the company’s stock price.
The company’s overall financial strength.
The company’s customer retention rate.
The rate at which new customers are acquired.
Evidence of improvement in internal processes such as defect rate, order
fulfillment, delivery times, days of inventory, and employee productivity.
The stronger a company’s current overall performance, the more likely it has a
well-conceived, well-executed strategy. The weaker a company’s financial
performance and market standing, the more its current strategy must be questioned
and the more likely the need for radical changes. Table 4.1 provides a compilation
of the financial ratios most commonly used to evaluate a company’s financial
performance and balance sheet strength.
Sluggish financial
performance and
second-rate market
accomplishments
almost always signal
weak strategy, weak
execution, or both.
TABLE 4.1 Key Financial Ratios: How to Calculate Them and
What They Mean
Ratio How Calculated What It Shows
Profitability ratios
1. Gross profit
margin
Shows the
percentage of
revenues available to
cover operating
expenses and yield a
profit.
Ratio How Calculated What It Shows
2. Operating
profit margin
(or return on
sales) or
Shows the
profitability of current
operations without
regard to interest
charges and income
taxes. Earnings
before interest and
taxes is known as
EBIT in financial and
business accounting.
3. Net profit
margin (or
net return on
sales)
Shows after-tax
profits per dollar of
sales.
4. Total return
on assets
A measure of the
return on total
investment in the
enterprise. Interest is
added to after-tax
profits to form the
numerator, since
total assets are
financed by creditors
as well as by
stockholders.
5. Net return on
total assets
(ROA)
A measure of the
return earned by
stockholders on the
firm’s total assets.
6. Return on
stockholders’
equity (ROE)
The return
stockholders are
earning on their
capital investment in
the enterprise. A
return in the 12% to
15% range is
average.
page 94
Ratio How Calculated What It Shows
7. Return on
invested
capital
(ROIC)—
sometimes
referred to
as return on
capital
employed
(ROCE)
A measure of the
return that
shareholders are
earning on the
monetary capital
invested in the
enterprise. A higher
return reflects
greater bottom-line
effectiveness in the
use of long-term
capital.
Liquidity ratios
1. Current ratio Shows a firm’s ability
to pay current
liabilities using
assets that can be
converted to cash in
the near term. Ratio
should be higher
than 1.0.
2. Working
capital
Current assets − Current liabilities The cash available
for a firm’s day-to-
day operations.
Larger amounts
mean the company
has more internal
funds to (1) pay its
current liabilities on a
timely basis and (2)
finance inventory
expansion, additional
accounts receivable,
and a larger base of
operations without
resorting to
borrowing or raising
more equity capital.
Leverage ratios
Ratio How Calculated What It Shows
1. Total debt-to-
assets ratio
Measures the extent
to which borrowed
funds (both short-
term loans and long-
term debt) have
been used to finance
the firm’s operations.
A low ratio is better
—a high fraction
indicates overuse of
debt and greater risk
of bankruptcy.
2. Long-term
debt-to-
capital ratio
A measure of
creditworthiness and
balance sheet
strength. It indicates
the percentage of
capital investment
that has been
financed by both
long-term lenders
and stockholders. A
ratio below 0.25 is
preferable since the
lower the ratio, the
greater the capacity
to borrow additional
funds. Debt-to-
capital ratios above
0.50 indicate an
excessive reliance
on long-term
borrowing, lower
creditworthiness, and
weak balance sheet
strength.
Ratio How Calculated What It Shows
3. Debt-to-
equity ratio
Shows the balance
between debt (funds
borrowed both short
term and long term)
and the amount that
stockholders have
invested in the
enterprise. The
further the ratio is
below 1.0, the
greater the firm’s
ability to borrow
additional funds.
Ratios above 1.0 put
creditors at greater
risk, signal weaker
balance sheet
strength, and often
result in lower credit
ratings.
4. Long-term
debt-to-
equity ratio
Shows the balance
between long-term
debt and
stockholders’ equity
in the firm’s long-
term capital
structure. Low ratios
indicate a greater
capacity to borrow
additional funds if
needed.
5. Times-
interest-
earned (or
coverage)
ratio
Measures the ability
to pay annual
interest charges.
Lenders usually
insist on a minimum
ratio of 2.0, but ratios
above 3.0 signal
progressively better
creditworthiness.
Activity ratios
1. Days of
inventory
Measures inventory
management
efficiency. Fewer
days of inventory are
better.
page 95
Ratio How Calculated What It Shows
2. I
n
ventory
turnover
Measures the
number of inventory
turns per year.
Higher is better.
3. Average
collection
period
or
Indicates the
average length of
time the firm must
wait after making a
sale to receive cash
payment. A shorter
collection time is
better.
Other important measures of financial performance
1. Dividend
yield on
common
stock
A measure of the
return that
shareholders receive
in the form of
dividends. A “typical”
dividend yield is 2%
to 3%. The dividend
yield for fast-growth
companies is often
below 1%; the
dividend yield for
slow-growth
companies can run
4% to 5%.
2. Price-to-
earnings
(P/E) ratio
P/E ratios above 20
indicate strong
investor confidence
in a firm’s outlook
and earnings growth;
firms whose future
earnings are at risk
or likely to grow
slowly typically have
ratios below 12.
3. Dividend
payout ratio
Indicates the
percentage of after-
tax profits paid out
as dividends.
Ratio How Calculated What It Shows
4. Internal cash
flow
After-tax profits + Depreciation A rough estimate of
the cash a
company’s business
is generating after
payment of operating
expenses, interest,
and taxes. Such
amounts can be
used for dividend
payments or funding
capital expenditures.
5. Free cash
flow
After-tax profits + Depreciation − Capital
expenditures − Dividends
A rough estimate of
the cash a
company’s business
is generating after
payment of operating
expenses, interest,
taxes, dividends, and
desirable
reinvestments in the
business. The larger
a company’s free
cash flow, the
greater its ability to
internally fund new
strategic initiatives,
repay debt, make
new acquisitions,
repurchase shares of
stock, or increase
dividend payments.
QUESTION 2: WHAT ARE THE
COMPANY’S STRENGTHS AND
WEAKNESSES IN RELATION TO THE
MARKET OPPORTUNITIES AND
EXTERNAL THREATS?
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• LO 4-2
Assess the
company’s strengths
and weaknesses in
light of market
opportunities and
external threats.
An examination of the financial and other indicators discussed previously can tell
you how well a strategy is working, but they tell you little about the underlying
reasons—why it’s working or not. The simplest and most easily applied tool for
gaining some insight into the reasons for the success of a strategy or lack thereof is
known as SWOT analysis. SWOT is an acronym that stands for a
company’s internal Strengths and Weaknesses, market Opportunities, and
external Threats. Another name for SWOT analysis is Situational Analysis. A
first-rate SWOT analysis can help explain why a strategy is working well (or not)
by taking a good hard look a company’s strengths in relation to its weaknesses and
in relation to the strengths and weaknesses of competitors. Are the company’s
strengths great enough to make up for its weaknesses? Has the company’s strategy
built on these strengths and shielded the company from its weaknesses? Do the
company’s strengths exceed those of its rivals or have they been overpowered?
Similarly, a SWOT analysis can help determine whether a strategy has been
effective in fending off external threats and positioning the firm to take advantage
of market opportunities.
CORE
CONCEPT
SWOT analysis, or
Situational Analysis,
is a popular, easy-
to-use tool for sizing
up a company’s
strengths and
weaknesses, its
market
opportunities, and
external threats.
SWOT analysis has long been one of the most popular and widely used
diagnostic tools for strategists. It is used fruitfully by organizations that range in
type from large corporations to small businesses, to government agencies to non-
profits such as churches and schools. Its popularity stems in part from its ease of
use, but also because it can be used not only to evaluate the efficacy of a strategy,
but also as the basis for crafting a strategy from the outset that capitalizes on the
company’s strengths, overcomes its weaknesses, aims squarely at capturing the
company’s best opportunities, and defends against competitive and macro-
environmental threats. Moreover, a SWOT analysis can help a company with a
strategy that is working well in the present determine whether the company is in a
position to pursue new market opportunities and defend against emerging threats to
its future well-being.
Basing a company’s
strategy on its most
competitively
valuable strengths
gives the company
its best chance for
market success.
Identifying a Company’s Internal Strengths
An internal strength is something a company is good at doing or an attribute that
enhances its competitiveness in the marketplace.
One way to appraise a company’s strengths is to ask: What activities does the
company perform well? This question directs attention to the company’s skill level
in performing key pieces of its business—such as supply chain management,
R&D, production, distribution, sales and marketing, and customer service. A
company’s skill or proficiency in performing different facets of its operations can
range from the extreme of having minimal ability to perform an activity (perhaps
having just struggled to do it the first time) to the other extreme of being able to
perform the activity better than any other company in the industry.
When a company’s proficiency rises from that of mere ability to perform an
activity to the point of being able to perform it consistently well and at acceptable
cost, it is said to have a competence—a true capability, in other words. If a
company’s competence level in some activity domain is superior to that of its
rivals it is known as a distinctive competence. A core competence is a
proficiently performed internal activity that is central to a company’s strategy and
is typically distinctive as well. A core competence is a more competitively
valuable strength than a competence because of the activity’s key role in the
company’s strategy and the contribution it makes to the company’s market success
and profitability. Often, core competencies can be leveraged to create new markets
page 97
or new product demand, as the engine behind a company’s growth. Procter and
Gamble has a core competence in brand management, which has led to an ever-
increasing portfolio of market-leading consumer products, including Charmin,
Tide, Crest, Tampax, Olay, Febreze, Luvs, Pampers, and Swiffer. Nike
has a core competence in designing and marketing innovative athletic
footwear and sports apparel. Kellogg has a core competence in developing,
producing, and marketing breakfast cereals.
CORE
CONCEPT
A competence is an
activity that a
company has
learned to perform
with proficiency.
A distinctive
competence is a
capability that
enables a company
to perform a
particular set of
activities better than
its rivals.
CORE
CONCEPT
A core competence
is an activity that a
company performs
proficiently and that
is also central to its
strategy and
competitive success.
Identifying Company Internal Weaknesses
An internal weakness is something a company lacks or does poorly (in comparison
to others) or a condition that puts it at a disadvantage in the marketplace. It can be
thought of as a competitive deficiency. A company’s internal weaknesses can
relate to (1) inferior or unproven skills, expertise, or intellectual capital in
competitively important areas of the business, or (2) deficiencies in competitively
important physical, organizational, or intangible assets. Nearly all companies have
competitive deficiencies of one kind or another. Whether a company’s internal
weaknesses make it competitively vulnerable depends on how much they matter in
the marketplace and whether they are offset by the company’s strengths.
CORE
CONCEPT
A company’s
strengths represent
its competitive
assets; its
weaknesses are
shortcomings that
constitute
competitive
liabilities.
Table 4.2 lists many of the things to consider in compiling a company’s
strengths and weaknesses. Sizing up a company’s complement of strengths and
deficiencies is akin to constructing a strategic balance sheet, where strengths
represent competitive assets and weaknesses represent competitive liabilities.
Obviously, the ideal condition is for the company’s competitive assets to outweigh
its competitive liabilities by an ample margin!
TABLE 4.2 What to Look for in Identifying a Company’s
Strengths, Weaknesses, Opportunities, and Threats
Strengths and Competitive Assets Weaknesses and Competitive Deficiencies
Strengths and Competitive Assets Weaknesses and Competitive Deficiencies
Ample financial resources to grow the
business
Strong brand-name image or reputation
Distinctive core competencies
Cost advantages over rivals
Attractive customer base
Proprietary technology, superior
technological skills, important patents
Strong bargaining power over suppliers or
buyers
Superior product quality
Wide geographic coverage and/or strong
global distribution capability
Alliances and/or joint ventures that provide
access to valuable technology,
competencies, and/or attractive
geographic markets
No distinctive core competencies
Lack of attention to customer needs
Inferior product quality
Weak balance sheet, too much debt
Higher costs than competitors
Too narrow a product line relative to rivals
Weak brand image or reputation
Lack of adequate distribution capability
Lack of management depth
A plague of internal operating problems or
obsolete facilities
Too much underutilized plant capacity
Market Opportunities External Threats
Meet sharply rising buyer demand for the
industry’s product
Serve additional customer groups or
market segments
Expand into new geographic markets
Expand the company’s product line to
meet a broader range of customer needs
Enter new product lines or new
businesses
Take advantage of falling trade barriers in
attractive foreign markets
Take advantage of an adverse change in
the fortunes of rival firms
Acquire rival firms or companies with
attractive technological expertise or
competencies
Take advantage of emerging technological
developments to innovate
Enter into alliances or other cooperative
ventures
Increased intensity of competition
Slowdowns in market growth
Likely entry of potent new competitors
Growing bargaining power of customers or
suppliers
A shift in buyer needs and tastes away
from the industry’s product
Adverse demographic changes that
threaten to curtail demand for the
industry’s product
Adverse economic conditions that
threaten critical suppliers or distributors
Changes in technology—particularly
disruptive technology that can undermine
the company’s distinctive competencies
Restrictive foreign trade policies
Costly new regulatory requirements
Tight credit conditions
Rising prices on energy or other key
inputs
Identifying a Company’s Market Opportunities
Market opportunity is a big factor in shaping a company’s strategy. Indeed,
managers can’t properly tailor strategy to the company’s situation without first
identifying its market opportunities and appraising the growth and profit potential
each one holds. Depending on the prevailing circumstances, a company’s
opportunities can be plentiful or scarce, fleeting or lasting, and can range from
wildly attractive to marginally interesting or unsuitable.
Newly emerging and fast-changing markets sometimes present stunningly big or
“golden” opportunities, but it is typically hard for managers at one company to
peer into “the fog of the future” and spot them far ahead of managers at other
companies.1 But as the fog begins to clear, golden opportunities are nearly always
seized rapidly—and the companies that seize them are usually those that have been
staying alert with diligent market reconnaissance and preparing themselves to
capitalize on shifting market conditions swiftly. Table 4.2 displays a sampling of
potential market opportunities.
Identifying External Threats
Often, certain factors in a company’s external environment pose threats to its
profitability and competitive well-being. Threats can stem from such factors as the
emergence of cheaper or better technologies, the entry of lower-cost competitors
into a company’s market stronghold, new regulations that are more burdensome to
a company than to its competitors, unfavorable demographic shifts, and political
upheaval in a foreign country where the company has facilities.
Simply making lists
of a company’s
strengths,
weaknesses,
opportunities, and
threats is not
enough; the payoff
from SWOT analysis
comes from the
conclusions about a
company’s situation
and the implications
for strategy
improvement that
flow from the four
lists.
External threats may pose no more than a moderate degree of adversity (all
companies confront some threatening elements in the course of doing business), or
page 98
page 99
they may be imposing enough to make a company’s situation look tenuous. On
rare occasions, market shocks can give birth to a sudden-death threat that throws a
company into an immediate crisis and a battle to survive. Many of the
world’s major financial institutions were plunged into unprecedented
crisis in 2008–2009 by the aftereffects of high-risk mortgage lending, inflated
credit ratings on subprime mortgage securities, the collapse of housing prices, and
a market flooded with mortgage-related investments (collateralized debt
obligations) whose values suddenly evaporated. It is management’s job to identify
the threats to the company’s future prospects and to evaluate what strategic actions
can be taken to neutralize or lessen their impact.
What Do the SWOT Listings Reveal?
SWOT analysis involves more than making four lists. In crafting a new strategy, it
offers a strong foundation for understanding how to position the company to build
on its strengths in seizing new business opportunities and how to mitigate external
threats by shoring up its competitive deficiencies. In assessing the effectiveness of
an existing strategy, it can be used to glean insights regarding the company’s
overall business situation (thus the name Situational Analysis); and it can help
translate these insights into recommended strategic actions. Figure 4.2 shows the
steps involved in gleaning insights from SWOT analysis.
FIGURE 4.2 The Steps Involved in SWOT Analysis: Identify the
Four Components of SWOT, Draw Conclusions,
Translate Implications into Strategic Actions
page 100
The beauty of SWOT analysis is its simplicity; but this is also its primary
limitation. For a deeper and more accurate understanding of a company’s situation,
more sophisticated tools are required. Chapter 3 introduced you to a set of tools for
analyzing a company’s external situation. In the rest of this chapter, we look more
deeply at a company’s internal situation, beginning with the company’s resources
and capabilities.
QUESTION 3: WHAT ARE THE
COMPANY’S MOST IMPORTANT
RESOURCES AND CAPABILITIES, AND
WILL THEY GIVE THE COMPANY A
LASTING COMPETITIVE ADVANTAGE?
• LO 4-3
Explain why a
company’s
resources and
capabilities are
critical for gaining a
competitive edge
over rivals.
An essential element of a company’s internal environment is the nature of
resources and capabilities. A company’s resources and capabilities are its
competitive assets and determine whether its competitive power in the
marketplace will be impressively strong or disappointingly weak. Companies with
second-rate competitive assets nearly always are relegated to a trailing position in
the industry.
CORE
CONCEPT
A company’s
resources and
capabilities
represent its
competitive assets
and are
determinants of its
competitiveness and
ability to succeed in
the marketplace.
Resource and capability analysis provides managers with a powerful tool for
sizing up the company’s competitive assets and determining whether they can
provide the foundation necessary for competitive success in the marketplace. This
is a two-step process. The first step is to identify the company’s resources and
capabilities. The second step is to examine them more closely to ascertain which
are the most competitively important and whether they can support a sustainable
competitive advantage over rival firms.2 This second step involves applying the
four tests of a resource’s competitive power.
Resource and
capability analysis
is a powerful tool for
sizing up a
company’s
competitive assets
and determining
whether the assets
can support a
sustainable
competitive
advantage over
market rivals.
Identifying the Company’s Resources and
Capabilities
A firm’s resources and capabilities are the fundamental building blocks of its
competitive strategy. In crafting strategy, it is essential for managers to know how
to take stock of the company’s full complement of resources and capabilities. But
before they can do so, managers and strategists need a more precise definition of
these terms.
In brief, a resource is a productive input or competitive asset that is owned or
controlled by the firm. Firms have many different types of resources at their
disposal that vary not only in kind but in quality as well. Some are of a higher
quality than others, and some are more competitively valuable, having greater
potential to give a firm a competitive advantage over its rivals. For example, a
company’s brand is a resource, as is an R&D team—yet some brands such as
Coca-Cola and Xerox are well known, with enduring value, while others have little
more name recognition than generic products. In similar fashion, some R&D teams
are far more innovative and productive than others due to the outstanding talents of
the individual team members, the team’s composition, its experience, and its
chemistry.
A capability (or competence) is the capacity of a firm to perform some internal
activity competently. Capabilities or competences also vary in form, quality, and
competitive importance, with some being more competitively valuable than others.
American Express displays superior capabilities in brand management and
marketing; Starbucks’s employee management, training, and real estate capabilities
are the drivers behind its rapid growth; Microsoft’s competences are in developing
operating systems for computers and user software like Microsoft Office®.
Organizational capabilities are developed and enabled through the deployment of
a company’s resources.3 For example, Nestlé’s brand management capabilities for
its 2,000 + food, beverage, and pet care brands draw on the knowledge of the
company’s brand managers, the expertise of its marketing department, and the
page 101company’s relationships with retailers in nearly 200 countries. W. L.
Gore’s product innovation capabilities in its fabrics and medical and
industrial product businesses result from the personal initiative, creative talents,
and technological expertise of its associates and the company’s culture that
encourages accountability and creative thinking.
CORE
CONCEPT
A resource is a
competitive asset
that is owned or
controlled by a
company; a
capability (or
competence) is the
capacity of a firm to
perform some
internal activity
competently.
Capabilities are
developed and
enabled through the
deployment of a
company’s
resources.
Types of Company Resources A useful way to identify a company’s resources
is to look for them within categories, as shown in Table 4.3. Broadly speaking,
resources can be divided into two main categories: tangible and intangible
resources. Although human resources make up one of the most important parts of a
company’s resource base, we include them in the intangible category to emphasize
the role played by the skills, talents, and knowledge of a company’s human
resources.
TABLE 4.3 Types of Company Resources
Tangible resources
page 102
Tangible resources
Physical resources: land and real estate; manufacturing plants, equipment, and/or
distribution facilities; the locations of stores, plants, or distribution centers, including the
overall pattern of their physical locations; ownership of or access rights to natural resources
(such as mineral deposits)
Financial resources: cash and cash equivalents; marketable securities; other financial assets
such as a company’s credit rating and borrowing capacity
Technological assets: patents, copyrights, production technology, innovation technologies,
technological processes
Organizational resources: IT and communication systems (satellites, servers, workstations,
etc.); other planning, coordination, and control systems; the company’s organizational design
and reporting structure
Intangible resources
Human assets and intellectual capital: the education, experience, knowledge, and talent of
the workforce, cumulative learning, and tacit knowledge of employees; collective learning
embedded in the organization, the intellectual capital and know-how of specialized teams
and work groups; the knowledge of key personnel concerning important business functions;
managerial talent and leadership skill; the creativity and innovativeness of certain personnel
Brands, company image, and reputational assets: brand names, trademarks, product or
company image, buyer loyalty and goodwill; company reputation for quality, service, and
reliability; reputation with suppliers and partners for fair dealing
Relationships: alliances, joint ventures, or partnerships that provide access to technologies,
specialized know-how, or geographic markets; networks of dealers or distributors; the trust
established with various partners
Company culture and incentive system: the norms of behavior, business principles, and
ingrained beliefs within the company; the attachment of personnel to the company’s ideals;
the compensation system and the motivation level of company personnel
Tangible resources are the most easily identified, since tangible resources are
those that can be touched or quantified readily. Obviously, they include various
types of physical resources such as manufacturing facilities and mineral resources,
but they also include a company’s financial resources, technological resources,
and organizational resources such as the company’s communication and control
systems. Note that technological resources are included among tangible resources,
by convention, even though some types, such as copyrights and trade secrets,
might be more logically categorized as intangible.
Intangible resources are harder to discern, but they are often among the most
important of a firm’s competitive assets. They include various sorts of human
assets and intellectual capital, as well as a company’s brands, image, and
reputational assets. While intangible resources have no material
existence on their own, they are often embodied in something material.
Thus, the skills and knowledge resources of a firm are embodied in its managers
and employees; a company’s brand name is embodied in the company logo or
product labels. Other important kinds of intangible resources include a company’s
relationships with suppliers, buyers, or partners of various sorts, and the company’s
culture and incentive system.
Listing a company’s resources category by category can prevent managers from
inadvertently overlooking some company resources that might be competitively
important. At times, it can be difficult to decide exactly how to categorize certain
types of resources. For example, resources such as a work group’s specialized
expertise in developing innovative products can be considered to be technological
assets or human assets or intellectual capital and knowledge assets; the work ethic
and drive of a company’s workforce could be included under the company’s
human assets or its culture and incentive system. In this regard, it is important to
remember that it is not exactly how a resource is categorized that matters but,
rather, that all of the company’s different types of resources are included in the
inventory. The real purpose of using categories in identifying a company’s
resources is to ensure that none of a company’s resources go unnoticed when sizing
up the company’s competitive assets.
Identifying Organizational Capabilities Organizational capabilities are more
complex entities than resources; indeed, they are built up through the use of
resources and draw on some combination of the firm’s resources as they are
exercised. Virtually all organizational capabilities are knowledge-based, residing in
people and in a company’s intellectual capital, or in organizational processes and
systems, which embody tacit knowledge. For example, Amazon’s speedy delivery
capabilities rely on the knowledge of its fulfillment center managers, its
relationship with the United Parcel Service, and the experience of its
merchandisers to correctly predict inventory flow. Bose’s capabilities in auditory
system design arise from the talented engineers that form the R&D team as well as
the company’s strong culture, which celebrates innovation and beautiful design.
Because of their complexity, organizational capabilities are harder to categorize
than resources and more challenging to search for as a result. There are, however,
two approaches that can make the process of uncovering and identifying a firm’s
capabilities more systematic. The first method takes the completed listing of a
firm’s resources as its starting point. Since organizational capabilities are built
from resources and utilize resources as they are exercised, a firm’s resources can
provide a strong set of clues about the types of capabilities the firm is likely to
have accumulated. This approach simply involves looking over the firm’s
resources and considering whether (and to what extent) the firm has built up any
related capabilities. So, for example, a fleet of trucks, the latest RFID tracking
technology, and a set of large automated distribution centers may be indicative of
page 103
sophisticated capabilities in logistics and distribution. R&D teams composed of
top scientists with expertise in genomics may suggest organizational capabilities in
developing new gene therapies or in biotechnology more generally.
The second method of identifying a firm’s capabilities takes a functional
approach. Many organizational capabilities relate to fairly specific functions; these
draw on a limited set of resources and typically involve a single department or
organizational unit. Capabilities in injection molding or continuous casting or
metal stamping are manufacturing-related; capabilities in direct selling,
promotional pricing, or database marketing all connect to the sales and marketing
functions; capabilities in basic research, strategic innovation, or new product
development link to a company’s R&D function. This approach
requires managers to survey the various functions a firm performs to
find the different capabilities associated with each function.
A problem with this second method is that many of the most important
capabilities of firms are inherently cross-functional. Cross-functional capabilities
draw on a number of different kinds of resources and are multidimensional in
nature—they spring from the effective collaboration among people with different
types of expertise working in different organizational units. Warby Parker draws
from its cross-functional design process to create its popular eyewear. Its design
capabilities are not just due to its creative designers, but are the product of their
capabilities in market research and engineering as well as their relations with
suppliers and manufacturing companies. Cross-functional capabilities and other
complex capabilities involving numerous linked and closely integrated competitive
assets are sometimes referred to as resource bundles.
CORE
CONCEPT
A resource bundle
is a linked and
closely integrated
set of competitive
assets centered
around one or more
cross-functional
capabilities.
It is important not to miss identifying a company’s resource bundles, since they
can be the most competitively important of a firm’s competitive assets. Resource
bundles can sometimes pass the four tests of a resource’s competitive power
(described below) even when the individual components of the resource bundle
cannot. Although PetSmart’s supply chain and marketing capabilities are matched
well by rival Petco, the company continues to outperform competitors through its
customer service capabilities (including animal grooming and veterinary and day
care services). Nike’s bundle of styling expertise, marketing research skills,
professional endorsements, brand name, and managerial know-how has allowed it
to remain number one in the athletic footwear and apparel industry for more than
20 years.
Assessing the Competitive Power of a Company’s
Resources and Capabilities
To assess a company’s competitive power, one must go beyond merely identifying
its resources and capabilities to probe its caliber.4 Thus, the second step in
resource and capability analysis is designed to ascertain which of a company’s
resources and capabilities are competitively superior and to what extent they can
support a company’s quest for a sustainable competitive advantage over market
rivals. When a company has competitive assets that are central to its strategy and
superior to those of rival firms, they can support a competitive advantage, as
defined in Chapter 1. If this advantage proves durable despite the best efforts of
competitors to overcome it, then the company is said to have a sustainable
competitive advantage. While it may be difficult for a company to achieve a
sustainable competitive advantage, it is an important strategic objective because it
imparts a potential for attractive and long-lived profitability.
CORE
CONCEPT
Recall that a
competitive
advantage means
that you can
produce more value
(V) for the customer
than rivals can, or
the same value at
lower cost (C). In
other words, your V-
C is greater than the
V-C of competitors.
V-C is what we call
the Total Economic
Value produced by a
company.
page 104
The Four Tests of a Resource’s Competitive Power The competitive power of
a resource or capability is measured by how many of four specific tests it can
pass.5 These tests are referred to as the VRIN tests for sustainable competitive
advantage—VRIN is a shorthand reminder standing for Valuable, Rare,
Inimitable, and Nonsubstitutable. The first two tests determine whether a resource
or capability can support a competitive advantage. The last two determine whether
the competitive advantage can be sustained.
CORE
CONCEPT
The VRIN tests for
sustainable
competitive
advantage ask
whether a resource
is valuable, rare,
inimitable, and
nonsubstitutable.
1. Is the resource or organizational capability competitively Valuable? To be
competitively valuable, a resource or capability must be directly relevant to the
company’s strategy, making the company a more effective competitor. Unless
the resource or capability contributes to the effectiveness of the company’s
strategy, it cannot pass this first test. An indicator of its effectiveness is
whether the resource enables the company to strengthen its business
model by improving its customer value proposition and/or profit formula (see
Chapter 1). Google failed in converting its technological resources and software
innovation capabilities into success for Google Wallet, which incurred losses of
more than $300 million before being abandoned in 2016. While these resources
and capabilities have made Google the world’s number-one search engine, they
proved to be less valuable in the mobile payments industry.
CORE
CONCEPT
The Total
Economic Value
produced by a
company is equal to
V-C. It is the
difference between
the buyer’s
perceived value
regarding a product
or service and what
it costs the company
to produce it.
2. Is the resource or capability Rare—is it something rivals lack? Resources and
capabilities that are common among firms and widely available cannot be a
source of competitive advantage. All makers of branded cereals have valuable
marketing capabilities and brands, since the key success factors in the ready-to-
eat cereal industry demand this. They are not rare. However, the brand strength
of Oreo cookies is uncommon and has provided Kraft Foods with greater market
share as well as the opportunity to benefit from brand extensions such as Golden
Oreos, Oreo Thins, and Mega Stuf Oreos. A resource or capability is considered
rare if it is held by only a small percentage of firms in an industry or specific
competitive domain. Thus, while general management capabilities are not rare
in an absolute sense, they are relatively rare in some of the less developed
regions of the world and in some business domains.
3. Is the resource or capability Inimitable—is it hard to copy? The more difficult
and more costly it is for competitors to imitate a company’s resource or
capability, the more likely that it can also provide a sustainable competitive
advantage. Resources and capabilities tend to be difficult to copy when they are
unique (a fantastic real estate location, patent-protected technology, an
unusually talented and motivated labor force), when they must be built over
time in ways that are difficult to imitate (a well-known brand name, mastery of a
complex process technology, years of cumulative experience and learning), and
when they entail financial outlays or large-scale operations that few industry
members can undertake (a global network of dealers and distributors). Imitation
is also difficult for resources and capabilities that reflect a high level of social
complexity (company culture, interpersonal relationships among the managers or
R&D teams, trust-based relations with customers or suppliers) and causal
ambiguity, a term that signifies the hard-to-disentangle nature of the complex
resources, such as a web of intricate processes enabling new drug discovery.
Hard-to-copy resources and capabilities are important competitive assets,
contributing to the longevity of a company’s market position and offering the
potential for sustained profitability.
CORE
CONCEPT
Social complexity
and causal
page 105
ambiguity are two
factors that inhibit
the ability of rivals to
imitate a firm’s most
valuable resources
and capabilities.
Causal ambiguity
makes it very hard
to figure out how a
complex resource
contributes to
competitive
advantage and
therefore exactly
what to imitate.
4. Is the resource or capability Nonsubstitutable—is it invulnerable to the threat of
substitution from different types of resources and capabilities? Even resources
that are competitively valuable, rare, and costly to imitate may lose much of
their ability to offer competitive advantage if rivals possess equivalent substitute
resources. For example, manufacturers relying on automation to gain a cost-
based advantage in production activities may find their technology-based
advantage nullified by rivals’ use of low-wage offshore manufacturing.
Resources can contribute to a sustainable competitive advantage only when
resource substitutes aren’t on the horizon.
The vast majority of companies are not well endowed with standout resources or
capabilities, capable of passing all four tests with high marks. Most firms have a
mixed bag of resources—one or two quite valuable, some good, many satisfactory
to mediocre. Resources and capabilities that are valuable pass the first of the four
tests. As key contributors to the effectiveness of the strategy, they are relevant to
the firm’s competitiveness but are no guarantee of competitive advantage. They
may offer no more than competitive parity with competing firms.
Passing both of the first two tests requires more—it requires
resources and capabilities that are not only valuable but also rare. This is a much
higher hurdle that can be cleared only by resources and capabilities that are
competitively superior. Resources and capabilities that are competitively superior
are the company’s true strategic assets. They provide the company with a
competitive advantage over its competitors, if only in the short run.
To pass the last two tests, a resource must be able to maintain its competitive
superiority in the face of competition. It must be resistant to imitative attempts and
efforts by competitors to find equally valuable substitute resources. Assessing the
availability of substitutes is the most difficult of all the tests since substitutes are
harder to recognize, but the key is to look for resources or capabilities held by
other firms or being developed that can serve the same function as the company’s
core resources and capabilities.6
Very few firms have resources and capabilities that can pass all four tests, but
those that do enjoy a sustainable competitive advantage with far greater profit
potential. Costco is a notable example, with strong employee incentive programs
and capabilities in supply chain management that have surpassed those of its
warehouse club rivals for over 35 years. Lincoln Electric Company, less well
known but no less notable in its achievements, has been the world leader in
welding products for over 100 years as a result of its unique piecework incentive
system for compensating production workers and the unsurpassed worker
productivity and product quality that this system has fostered.
A Company’s Resources and Capabilities Must Be Managed Dynamically
Even companies like Costco and Lincoln Electric cannot afford to rest on their
laurels. Rivals that are initially unable to replicate a key resource may develop
better and better substitutes over time. Resources and capabilities can depreciate
like other assets if they are managed with benign neglect. Disruptive changes in
technology, customer preferences, distribution channels, or other competitive
factors can also destroy the value of key strategic assets, turning resources and
capabilities “from diamonds to rust.”7
Resources and capabilities must be continually strengthened and nurtured to
sustain their competitive power and, at times, may need to be broadened and
deepened to allow the company to position itself to pursue emerging market
opportunities.8 Organizational resources and capabilities that grow stale can impair
competitiveness unless they are refreshed, modified, or even phased out and
replaced in response to ongoing market changes and shifts in company strategy.
Management’s challenge in managing the firm’s resources and capabilities
dynamically has two elements: (1) attending to the ongoing modification of
existing competitive assets, and (2) casting a watchful eye for opportunities to
develop totally new kinds of capabilities.
A company requires
a dynamically
evolving portfolio of
resources and
capabilities to
sustain its
competitiveness and
help drive
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improvements in its
performance.
The Role of Dynamic Capabilities Companies that know the importance of
recalibrating and upgrading their most valuable resources and capabilities ensure
that these activities are done on a continual basis. By incorporating these activities
into their routine managerial functions, they gain the experience necessary to be
able to do them consistently well. At that point, their ability to freshen and renew
their competitive assets becomes a capability in itself—a dynamic capability. A
dynamic capability is the ability to modify, deepen, or augment the company’s
existing resources and capabilities.9 This includes the capacity to improve existing
resources and capabilities incrementally, in the way that Toyota aggressively
upgrades the company’s capabilities in fuel-efficient hybrid engine technology and
constantly fine-tunes its famed Toyota production system. Likewise, management
at BMW developed new organizational capabilities in hybrid engine design that
allowed the company to launch its highly touted i3 and i8 plug-in hybrids. A
dynamic capability also includes the capacity to add new resources and
capabilities to the company’s competitive asset portfolio. One way to do
this is through alliances and acquisitions. An example is General Motor’s
partnership with Korean electronics firm LG Corporation, which enabled GM to
develop a manufacturing and engineering platform for producing electric vehicles.
This enabled GM to beat the likes of Tesla and Nissan to market with the first
affordable all-electric car with good driving range—the Chevy Bolt EV.
CORE
CONCEPT
A dynamic
capability is an
ongoing capacity of
a company to modify
its existing
resources and
capabilities or create
new ones.
QUESTION 4: HOW DO VALUE CHAIN
ACTIVITIES IMPACT A COMPANY’S COST
STRUCTURE AND CUSTOMER VALUE
PROPOSITION?
• LO 4-4
Understand how
value chain activities
can affect a
company’s cost
structure and
customer value
proposition.
Company managers are often stunned when a competitor cuts its prices to
“unbelievably low” levels or when a new market entrant introduces a great new
product at a surprisingly low price. While less common, new entrants can also
storm the market with a product that ratchets the quality level up so high that
customers will abandon competing sellers even if they have to pay more for the
new product. This is what seems to have happened with Apple’s iPhone 7 and
iMac computers.
Regardless of where on the quality spectrum a company competes, it must
remain competitive in terms of its customer value proposition in order to stay in
the game. Patagonia’s value proposition, for example, remains attractive to
customers who value quality, wide selection, and corporate environmental
responsibility over cheaper outerwear alternatives. Since its inception in 1925, the
New Yorker’s customer value proposition has withstood the test of time by
providing readers with an amalgam of well-crafted and topical writing.
Recall from our discussion of the Customer Value Proposition in Chapter 1: The
value (V) provided to the customer depends on how well a customer’s needs are
met for the price paid (V-P). How well customer needs are met depends on the
perceived quality of a product or service as well as on other, more tangible
attributes. The greater the amount of customer value that the company can offer
profitably compared to its rivals, the less vulnerable it will be to competitive
attack. For managers, the key is to keep close track of how cost-effectively the
company can deliver value to customers relative to its competitors. If it can deliver
the same amount of value with lower expenditures (or more value at the same
cost), it will maintain a competitive edge.
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The greater the
amount of customer
value that a
company can offer
profitably relative to
close rivals, the less
competitively
vulnerable the
company becomes.
Two analytic tools are particularly useful in determining whether a company’s
costs and customer value proposition are competitive: value chain analysis and
benchmarking.
The higher a
company’s costs are
above those of close
rivals, the more
competitively
vulnerable the
company becomes.
The Concept of a Company Value Chain
Every company’s business consists of a collection of activities undertaken in the
course of producing, marketing, delivering, and supporting its product or service.
All the various activities that a company performs internally combine to form a
value chain—so called because the underlying intent of a company’s activities is
ultimately to create value for buyers.
CORE
CONCEPT
A company’s value
chain identifies the
primary activities
and related support
activities that create
customer value.
As shown in Figure 4.3, a company’s value chain consists of two broad
categories of activities: the primary activities foremost in creating value for
customers and the requisite support activities that facilitate and enhance the
performance of the primary activities.10 The kinds of primary and
secondary activities that constitute a company’s value chain vary
according to the specifics of a company’s business; hence, the listing
of the primary and support activities in Figure 4.3 is illustrative rather than
definitive. For example, the primary activities at a hotel operator like Starwood
Hotels and Resorts mainly consist of site selection and construction, reservations,
and hotel operations (check-in and check-out, maintenance and housekeeping,
dining and room service, and conventions and meetings); principal support
activities that drive costs and impact customer value include hiring and training
hotel staff and handling general administration. Supply chain management is a
crucial activity for Boeing and Amazon but is not a value chain component at
Facebook, WhatsApp, or Goldman Sachs. Sales and marketing are dominant
activities at GAP and Match.com but have only minor roles at oil-drilling
companies and natural gas pipeline companies. Customer delivery is a crucial
activity at Domino’s Pizza and Blue Apron but insignificant at Starbucks and
Dunkin Donuts.
FIGURE 4.3 A Representative Company Value Chain
http://match.com/
Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free
Press, 1985), pp. 37–43.
With its focus on value-creating activities, the value chain is an ideal tool for
examining the workings of a company’s customer value proposition and business
model. It permits a deep look at the company’s cost structure and ability to offer
low prices. It reveals the emphasis that a company places on activities that enhance
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differentiation and support higher prices, such as service and marketing. It also
includes a profit margin component (P-C), since profits are necessary to
compensate the company’s owners and investors, who bear risks and provide
capital. Tracking the profit margin along with the value-creating activities is
critical because unless an enterprise succeeds in delivering customer value
profitably (with a sufficient return on invested capital), it can’t survive for long.
Attention to a company’s profit formula in addition to its customer value
proposition is the essence of a sound business model, as described in Chapter 1.
Illustration Capsule 4.1 shows representative costs for various value chain
activities performed by Everlane, Inc., an American clothing retailer that sells
primarily online.
Comparing the Value Chains of Rival Companies Value chain analysis
facilitates a comparison of how rivals, activity by activity, deliver value to
customers. Even rivals in the same industry may differ significantly in terms of the
activities they perform. For instance, the “operations” component of the value
chain for a manufacturer that makes all of its own parts and components and
assembles them into a finished product differs from the “operations” of a rival
producer that buys the needed parts and components from outside suppliers and
performs only assembly operations. How each activity is performed may affect a
company’s relative cost position as well as its capacity for differentiation. Thus,
even a simple comparison of how the activities of rivals’ value chains differ can
reveal competitive differences.
A Company’s Primary and Secondary Activities Identify the Major
Components of Its Internal Cost Structure The combined costs of all the
various primary and support activities constituting a company’s value chain define
its internal cost structure. Further, the cost of each activity contributes to whether
the company’s overall cost position relative to rivals is favorable or unfavorable.
The roles of value chain analysis and benchmarking are to develop the data for
comparing a company’s costs activity by activity against the costs of key rivals and
to learn which internal activities are a source of cost advantage or disadvantage.
Evaluating a company’s cost-competitiveness involves using what accountants
call activity-based costing to determine the costs of performing each value chain
activity.11 The degree to which a company’s total costs should be broken down into
costs for specific activities depends on how valuable it is to know the
costs of specific activities versus broadly defined activities. At the
very least, cost estimates are needed for each broad category of primary and
support activities, but cost estimates for more specific activities within each broad
category may be needed if a company discovers that it has a cost disadvantage vis-
à-vis rivals and wants to pin down the exact source or activity causing the cost
disadvantage. However, a company’s own internal costs may be insufficient to
assess whether its product offering and customer value proposition are competitive
with those of rivals. Cost and price differences among competing companies can
have their origins in activities performed by suppliers or by distribution allies
involved in getting the product to the final customers or end users of the product,
in which case the company’s entire value chain system becomes relevant.
A company’s cost-
competitiveness
depends not only on
the costs of
internally performed
activities (its own
value chain) but also
on costs in the value
chains of its
suppliers and
distribution-channel
allies.
ILLUSTRATION
CAPSULE 4.1 The Value Chain for Everlane,
Inc.
Everlane, Inc. prides itself on producing casual clothing, designed to last, in ethically managed
factories, under a policy of what they call “radical transparency”. From the start, they have made
their cost and margin breakdowns readily available on their website. Below is such a breakdown
for a pair of their slim-fit denim jeans:
M4OS Photos/Alamy Stock Photo
Materials (11 oz. denim – 98% cotton; 2% elastane $12.78
Hardware (metal fasteners, trim) 2.15
Labor 7.50
Cost of Goods 22.43
Shipping 1.90
Import Duties 3.70
Total Cost 28.03
Everlane Retail Price 68.00
Everlane Profit Margin (Retail Price – Total Cost) 39.97
Average Traditional Retailer’s Price 140.00
Source: Everlane.com/about (accessed 2/08/20).
The Value Chain System
A company’s value chain is embedded in a larger system of activities that includes
the value chains of its suppliers and the value chains of whatever wholesale
distributors and retailers it utilizes in getting its product or service to end users.
This value chain system (sometimes called a vertical chain) has implications that
extend far beyond the company’s costs. It can affect attributes like product quality
that enhance differentiation and have importance for the company’s customer
http://everlane.com/about
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value proposition, as well as its profitability.12 Suppliers’ value chains are relevant
because suppliers perform activities and incur costs in creating and delivering the
purchased inputs utilized in a company’s own value-creating activities. The costs,
performance features, and quality of these inputs influence a company’s own costs
and product differentiation capabilities. Anything a company can do to
help its suppliers drive down the costs of their value chain activities or
improve the quality and performance of the items being supplied can enhance its
own competitiveness—a powerful reason for working collaboratively with
suppliers in managing supply chain activities.13 For example, automakers have
encouraged their automotive parts suppliers to build plants near the auto assembly
plants to facilitate just-in-time deliveries, reduce warehousing and shipping costs,
and promote close collaboration on parts design and production scheduling.
Similarly, the value chains of a company’s distribution-channel partners are
relevant because (1) the costs and margins of a company’s distributors and retail
dealers are part of the price the ultimate consumer pays and (2) the quality of the
activities that such distribution allies perform affect sales volumes and customer
satisfaction. For these reasons, companies that don’t sell directly to the end
consumer work closely with their distribution allies (including their direct
customers) to perform value chain activities in mutually beneficial ways. For
instance, motor vehicle manufacturers have a competitive interest in working
closely with their automobile dealers to promote higher sales volumes and better
customer satisfaction with dealers’ repair and maintenance services. Producers of
kitchen cabinets are heavily dependent on the sales and promotional activities of
their distributors and building supply retailers and on whether distributors and
retailers operate cost-effectively enough to be able to sell at prices that lead to
attractive sales volumes.
As a consequence, accurately assessing a company’s competitiveness entails
scrutinizing the nature and costs of value chain activities throughout the entire
value chain system for delivering its products or services to end-use customers. A
typical value chain system that incorporates the value chains of suppliers, business
buyers, and other forward-channel allies (if any) is shown in Figure 4.4. As was
the case with company value chains, the specific activities constituting value chain
systems vary significantly from industry to industry. The primary value chain
system activities in the pulp and paper industry (timber farming, logging, pulp
mills, and papermaking) differ from the primary value chain system activities in
the home appliance industry (parts and components manufacture, assembly,
wholesale distribution, retail sales) and yet again from the computer software
industry (programming, disk loading, marketing, distribution). Some value chains
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may also include strategic partners whose activities may likewise affect both the
value and cost of the end product.
FIGURE 4.4 A Representative Value Chain System
Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive
Advantage (New York: Free Press, 1985), p. 35.
Benchmarking: A Tool for Assessing the Costs and
Effectiveness of Value Chain Activities
Benchmarking entails comparing how different companies perform various value
chain activities—how materials are purchased, how inventories are managed, how
products are assembled, how fast the company can get new products to market,
how customer orders are filled and shipped—and then making cross-company
comparisons of the costs and effectiveness of these activities.14 The comparison is
often made between companies in the same industry, but benchmarking can also
involve comparing how activities are done by companies in other industries. The
objectives of benchmarking are simply to identify the best means of performing an
activity and to emulate those best practices. It can be used to benchmark the
activities of a company’s internal value chain or the activities within an entire
value chain system.
CORE
CONCEPT
Benchmarking is a
potent tool for
improving a value
chain activities that
is based on learning
how other
companies perform
them and borrowing
their “best
practices.”
A best practice is a method of performing an activity or business process that
consistently delivers superior results compared to other approaches.15 To qualify as
a legitimate best practice, the method must have been employed by at least one
enterprise and shown to be consistently more effective in lowering costs, improving
quality or performance, shortening time requirements, enhancing safety, or
achieving some other highly positive operating outcome. Best practices thus
identify a path to operating excellence with respect to value chain activities.
CORE
CONCEPT
A best practice is a
method of
performing an
activity that
consistently delivers
superior results
compared to other
approaches.
Xerox pioneered the use of benchmarking to become more cost-competitive,
quickly deciding not to restrict its benchmarking efforts to its office equipment
rivals but to extend them to any company regarded as “world class” in performing
any activity relevant to Xerox’s business. Other companies quickly picked up on
Xerox’s approach. Toyota managers got their idea for just-in-time inventory
deliveries by studying how U.S. supermarkets replenished their shelves. Southwest
Airlines reduced the turnaround time of its aircraft at each scheduled stop by
studying pit crews on the auto racing circuit. More than 80 percent of Fortune 500
companies reportedly use benchmarking for comparing themselves against rivals
on cost and other competitively important measures. Illustration Capsule 4.2
describes benchmarking practices in the solar industry.
The tough part of benchmarking is not whether to do it but, rather, how to gain
access to information about other companies’ practices and costs. Sometimes
benchmarking can be accomplished by collecting information from published
reports, trade groups, and industry research firms or by talking to knowledgeable
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industry analysts, customers, and suppliers. Sometimes field trips to the facilities
of competing or noncompeting companies can be arranged to observe how things
are done, compare practices and processes, and perhaps exchange data on
productivity and other cost components. However, such companies, even if they
agree to host facilities tours and answer questions, are unlikely to share
competitively sensitive cost information. Furthermore, comparing two companies’
costs may not involve comparing apples to apples if the two companies employ
different cost accounting principles to calculate the costs of particular activities.
However, a third and fairly reliable source of benchmarking information has
emerged. The explosive interest of companies in benchmarking costs and
identifying best practices has prompted consulting organizations (e.g., Accenture,
A. T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC)
and several associations (e.g., the QualServe Benchmarking Clearinghouse, and
the Strategic Planning Institute’s Council on Benchmarking) to gather
benchmarking data, distribute information about best practices, and provide
comparative cost data without identifying the names of particular companies.
Having an independent group gather the information and report it in a manner that
disguises the names of individual companies protects competitively
sensitive data and lessens the potential for unethical behavior on the
part of company personnel in gathering their own data about competitors. The
ethical dimension of benchmarking is discussed in Illustration Capsule 4.3.
Benchmarking the
costs of company
activities against
those of rivals
provides hard
evidence of whether
a company is cost-
competitive.
ILLUSTRATION
CAPSULE 4.2 Benchmarking in the Solar
Industry
The cost of solar power production is dropping rapidly, leading to lower solar power prices for
consumers and an expanding market for solar companies. According to the Solar Energy
Industries Association, over 11 gigawatts (GW) of solar serving electric utilities were installed in
2016—enough to supply power for approximately 1.8 million households. Simultaneously, the
solar landscape is becoming more competitive. As of 2017, 46 firms had installed a cumulative
total of over 45 GW of solar serving electric utilities in the United States.
As competition grows, benchmarking plays an increasingly critical role in assessing a solar
company’s relative costs and price positioning compared to other firms. This is often measured
using the all-in installation and production costs per kilowatt hour generated by a solar asset,
called the “Levelized Cost of Energy” (LCOE). Kilowatt hours are the units of electricity that are
sold to consumers.
In 2008, SunPower—one of the largest solar firms in the United States—used benchmarking
to target a 50 percent decrease in its solar LCOE by 2012. This early benchmarking strategy
helped the company to defend against new market entrants offering lower prices. But in the
ensuing years, between 2009 and 2014, the overall industry solar LCOE fell by 78 percent,
leading the company to conclude that an even more aggressive approach was needed to
manage downward pricing pressure. Over the course of 2017, SunPower’s quarterly earnings
calls highlighted efforts to compete on benchmark prices by simplifying its company structure;
divesting from non-core assets; and diversifying beyond the low-cost, large-scale utility solar
market and into residential and commercial solar where it could compete more easily on price.
Geniusksy/Shutterstock
Continuing to anticipate and adapt to falling solar prices requires reliable industry data on
benchmark costs. The National Renewable Energy Laboratory (NREL) Quarterly U.S. Solar
Photovoltaic System Cost Benchmark breaks down industry solar costs by inputs, including
solar modules, structural hardware, and electrical components, as well as soft costs like labor
and land expenses. This enables firms like SunPower to assess how their component costs
compare to benchmarks and informs SunPower’s outlook for how solar prices will continue to
fall over time.
For solar to play a major role in U.S. power generation, costs must keep decreasing. As solar
companies race toward lower costs, benchmarking will continue to be a core strategic tool in
determining pricing and market positioning.
Note: Developed with Mathew O’Sullivan.
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Sources: Solar Power World, “Top 500 Solar Contractors” (2017); SunPower, “The Drivers of
the Levelized Cost of Electricity for Utility-Scale Photovoltaics” (2008); Lazard, “Levelized Cost
of Energy Analysis, Version 8.0” (2014).
Industry associations are another source of data that may be used for
benchmarking purposes. In the cement industry, for example, the Portland Cement
Association publishes key plant level data for the industry that enables companies
to understand whether their own plants are cost leaders or laggards. Benchmarking
data is also provided by some government agencies; data of this sort plays an
important role in electricity pricing, for example.
ILLUSTRATION
CAPSULE 4.3 Benchmarking and Ethical
Conduct
Because discussions between benchmarking partners can involve competitively sensitive data,
conceivably raising questions about possible restraint of trade or improper business conduct,
the Strategic Planning Institute’s Council on Benchmarking and the Global Benchmarking
Network urge all individuals and organizations involved in benchmarking to abide by a code of
conduct grounded in ethical business behavior. The code is based on the following principles:
Principle of Legality. Avoid discussions or actions that might lead to or imply an interest in
restraint of trade: market or customer allocation schemes, price fixing, dealing arrangements,
bid rigging, bribery, or misappropriation. Do not discuss costs with competitors if costs are an
element of pricing.
Principle of Exchange. Be willing to provide the same level of information that you request, in
any benchmarking exchange.
Principle of Confidentiality. Treat benchmarking interchange as something confidential to the
individuals and organizations involved. Information obtained must not be communicated
outside the partnering organizations without prior consent of participating benchmarking
partners. An organization’s participation in a study should not be communicated externally
without their permission.
Principle of Use. Use information obtained through benchmarking partnering only for the
purpose of improvement of operations within the partnering companies themselves. External
use or communication of a benchmarking partner’s name with their data or observed
practices requires permission of that partner. Do not, as a consultant or client, extend one
company’s benchmarking study findings to another without the first company’s permission.
Principle of First Party Contact. Initiate contacts, whenever possible, through a benchmarking
contact designated by the partner company. Obtain mutual agreement with the contact on
any hand off of communication or responsibility to other parties.
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Principle of Third Party Contact. Obtain an individual’s permission before providing their
name in response to a contact request.
Principle of Preparation. Demonstrate commitment to the efficiency and effectiveness of the
benchmarking process with adequate preparation at each process step; particularly, at initial
partnering contact.
Source: BPIR.com (Business Performance Improvement Resource),
https://www.bpir.com/benchmarking-code-of-conduct-bpir.com/menu-id-56.html
(accessed 2/08/20).
Strategic Options for Remedying a Cost or Value
Disadvantage
The results of value chain analysis and benchmarking may disclose cost or value
disadvantages relative to key rivals. Such information is vital in crafting strategic
actions to eliminate any such disadvantages and improve profitability. Information
of this nature can also help a company find new avenues for enhancing its
competitiveness through lower costs or a more attractive customer value
proposition. There are three main areas in a company’s total value chain system
where company managers can try to improve its efficiency and effectiveness in
delivering customer value: (1) a company’s own internal activities, (2) suppliers’
part of the value chain system, and (3) the forward-channel portion of the value
chain system.
Improving Internally Performed Value Chain Activities Managers can
pursue any of several strategic approaches to reduce the costs of internally
performed value chain activities and improve a company’s cost-competitiveness.
They can implement best practices throughout the company, particularly for high-
cost activities. They can redesign the product and/or some of its components to
eliminate high-cost components or facilitate speedier and more economical
manufacture or assembly. They can relocate high-cost activities (such as
manufacturing) to geographic areas where they can be performed more
cheaply or outsource activities to lower-cost vendors or contractors.
To improve the effectiveness of the company’s customer value proposition and
enhance differentiation, managers can take several approaches. They can adopt
best practices for quality, marketing, and customer service. They can reallocate
resources to activities that address buyers’ most important purchase criteria,
which will have the biggest impact on the value delivered to the customer. They
can adopt new technologies that spur innovation, improve design, and enhance
http://bpir.com/
https://www.bpir.com/benchmarking-code-of-conduct-bpir.com/menu-id-56.html
creativity. Additional approaches to managing value chain activities to lower costs
and/or enhance customer value are discussed in Chapter 5.
Improving Supplier-Related Value Chain Activities Supplier-related cost
disadvantages can be attacked by pressuring suppliers for lower prices, switching
to lower-priced substitute inputs, and collaborating closely with suppliers to
identify mutual cost-saving opportunities.16 For example, just-in-time deliveries
from suppliers can lower a company’s inventory and internal logistics costs and
may also allow suppliers to economize on their warehousing, shipping, and
production scheduling costs—a win–win outcome for both. In a few instances,
companies may find that it is cheaper to integrate backward into the business of
high-cost suppliers and make the item in-house instead of buying it from outsiders.
Similarly, a company can enhance its customer value proposition through its
supplier relationships. Some approaches include selecting and retaining suppliers
that meet higher-quality standards, providing quality-based incentives to suppliers,
and integrating suppliers into the design process. Fewer defects in parts from
suppliers not only improve quality throughout the value chain system but can
lower costs as well since less waste and disruption occur in the production
processes.
Improving Value Chain Activities of Distribution Partners Any of three
means can be used to achieve better cost-competitiveness in the forward portion of
the industry value chain:
1. Pressure distributors, dealers, and other forward-channel allies to reduce their
costs and markups.
2. Collaborate with them to identify win–win opportunities to reduce costs—for
example, a chocolate manufacturer learned that by shipping its bulk chocolate in
liquid form in tank cars instead of as 10-pound molded bars, it could not only
save its candy bar manufacturing customers the costs associated with unpacking
and melting but also eliminate its own costs of molding bars and packing them.
3. Change to a more economical distribution strategy, including switching to
cheaper distribution channels (selling direct via the Internet) or integrating
forward into company-owned retail outlets.
The means to enhancing differentiation through activities at the forward end of the
value chain system include (1) engaging in cooperative advertising and promotions
with forward allies (dealers, distributors, retailers, etc.), (2) creating exclusive
arrangements with downstream sellers or utilizing other mechanisms that increase
their incentives to enhance delivered customer value, and (3) creating and
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enforcing standards for downstream activities and assisting in training channel
partners in business practices. Harley-Davidson, for example, enhances the
shopping experience and perceptions of buyers by selling through retailers that sell
Harley-Davidson motorcycles exclusively and meet Harley-Davidson standards.
The bottlers of Pepsi and Coca Cola engage in cooperative promotional activities
with large grocery chains such as Kroger, Publix, and Safeway.
Translating Proficient Performance of Value Chain
Activities into Competitive Advantage
A company that does a first-rate job of managing the activities of its value chain or
value chain system relative to competitors stands a good chance of profiting from
its competitive advantage. A company’s value-creating activities can offer a
competitive advantage in one of two ways (or both):
1. They can contribute to greater efficiency and lower costs relative to competitors.
2. They can provide a basis for differentiation, so customers are willing to pay
relatively more for the company’s goods and services.
Achieving a cost-based competitive advantage requires determined management
efforts to be cost-efficient in performing value chain activities. Such efforts have to
be ongoing and persistent, and they have to involve each and every value chain
activity. The goal must be continuous cost reduction, not a one-time or on-again–
off-again effort. Companies like Dollar General, Nucor Steel, Irish airline Ryanair,
T.J.Maxx, and French discount retailer Carrefour have been highly successful in
managing their value chains in a low-cost manner.
Ongoing and persistent efforts are also required for a competitive advantage
based on differentiation. Superior reputations and brands are built up slowly over
time, through continuous investment and activities that deliver consistent,
reinforcing messages. Differentiation based on quality requires vigilant
management of activities for quality assurance throughout the value chain. While
the basis for differentiation (e.g., status, design, innovation, customer service,
reliability, image) may vary widely among companies pursuing a differentiation
advantage, companies that succeed do so on the basis of a commitment to
coordinated value chain activities aimed purposefully at this objective. Examples
include Rolex (status), Braun (design), Room and Board (craftsmanship), Zappos
and L.L. Bean (customer service), Salesforce.com and Tesla (innovation), and
FedEx (reliability).
http://salesforce.com/
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How Value Chain Activities Relate to Resources and Capabilities There is a
close relationship between the value-creating activities that a company performs
and its resources and capabilities. An organizational capability or competence
implies a capacity for action; in contrast, a value-creating activity initiates the
action. With respect to resources and capabilities, activities are “where the rubber
hits the road.” When companies engage in a value-creating activity, they do so by
drawing on specific company resources and capabilities that underlie and enable
the activity. For example, brand-building activities depend on human resources,
such as experienced brand managers (including their knowledge and expertise in
this arena), as well as organizational capabilities in advertising and marketing.
Cost-cutting activities may derive from organizational capabilities in inventory
management, for example, and resources such as inventory tracking systems.
Because of this correspondence between activities and supporting resources and
capabilities, value chain analysis can complement resource and capability analysis
as another tool for assessing a company’s competitive advantage. Resources and
capabilities that are both valuable and rare provide a company with what it takes
for competitive advantage. For a company with competitive assets of this sort, the
potential is there. When these assets are deployed in the form of a value-creating
activity, that potential is realized due to their competitive superiority. Resource
analysis is one tool for identifying competitively superior resources and
capabilities. But their value and the competitive superiority of that value can be
assessed objectively only after they are deployed. Value chain analysis
and benchmarking provide the type of data needed to make that
objective assessment.
Value chain analysis
and benchmarking
provide the type of
data needed to
assess objectively
whether a
company’s
resources and
capabilities are
competitively
superior.
Performing value
chain activities with
capabilities that
permit the company
to either outmatch
rivals on
differentiation or
beat them on costs
will give the
company a
competitive
advantage.
There is also a dynamic relationship between a company’s activities and its
resources and capabilities. Value-creating activities are more than just the
embodiment of a resource’s or capability’s potential. They also contribute to the
formation and development of organizational capabilities. The road to competitive
advantage begins with management efforts to build organizational expertise in
performing certain competitively important value chain activities. With consistent
practice and continuous investment of company resources, these activities rise to
the level of a reliable organizational capability or a competence. To the extent that
top management makes the growing capability a cornerstone of the company’s
strategy, this capability becomes a core competence for the company. Later, with
further organizational learning and gains in proficiency, the core competence may
evolve into a distinctive competence, giving the company superiority over rivals in
performing an important value chain activity. Such superiority, if it gives the
company significant competitive clout in the marketplace, can produce an
attractive competitive edge over rivals. Whether the resulting competitive
advantage is on the cost side or on the differentiation side (or both) will depend on
the company’s choice of which types of competence-building activities to engage
in over this time period.
QUESTION 5: IS THE COMPANY
COMPETITIVELY STRONGER OR
WEAKER THAN KEY RIVALS?
• LO 4-5
Explain how a
comprehensive
evaluation of a
company’s
competitive situation
can assist managers
in making critical
decisions about their
next strategic
moves.
Using resource analysis, value chain analysis, and benchmarking to determine a
company’s competitiveness on value and cost is necessary but not sufficient. A
more comprehensive assessment needs to be made of the company’s overall
competitive strength. The answers to two questions are of particular interest: First,
how does the company rank relative to competitors on each of the important
factors that determine market success? Second, all things considered, does the
company have a net competitive advantage or disadvantage versus major
competitors?
An easy-to-use method for answering these two questions involves developing
quantitative strength ratings for the company and its key competitors on each
industry key success factor and each competitively pivotal resource, capability, and
value chain activity. Much of the information needed for doing a competitive
strength assessment comes from previous analyses. Industry and competitive
analyses reveal the key success factors and competitive forces that separate
industry winners from losers. Benchmarking data and scouting key competitors
provide a basis for judging the competitive strength of rivals on such factors as
cost, key product attributes, customer service, image and reputation, financial
strength, technological skills, distribution capability, and other factors. Resource
and capability analysis reveals which of these are competitively important, given
the external situation, and whether the company’s competitive advantages are
sustainable. SWOT analysis provides a more general forward-looking picture of
the company’s overall situation.
Step 1 in doing a competitive strength assessment is to make a list of the
industry’s key success factors and other telling measures of competitive strength or
weakness (6 to 10 measures usually suffice). Step 2 is to assign weights to each of
the measures of competitive strength based on their perceived importance. (The
sum of the weights for each measure must add up to 1.) Step 3 is to calculate
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page 118
weighted strength ratings by scoring each competitor on each strength
measure (using a 1-to-10 rating scale, where 1 is very weak and 10 is
very strong) and multiplying the assigned rating by the assigned weight. Step 4 is
to sum the weighted strength ratings on each factor to get an overall measure of
competitive strength for each company being rated. Step 5 is to use the overall
strength ratings to draw conclusions about the size and extent of the company’s net
competitive advantage or disadvantage and to take specific note of areas of
strength and weakness.
Table 4.4 provides an example of competitive strength assessment in which a
hypothetical company (ABC Company) competes against two rivals. In the
example, relative cost is the most telling measure of competitive
strength, and the other strength measures are of lesser importance. The
company with the highest rating on a given measure has an implied competitive
edge on that measure, with the size of its edge reflected in the difference between
its weighted rating and rivals’ weighted ratings. For instance, Rival 1’s 3.00
weighted strength rating on relative cost signals a considerable cost advantage over
ABC Company (with a 1.50 weighted score on relative cost) and an even bigger
cost advantage over Rival 2 (with a weighted score of 0.30). The measure-by-
measure ratings reveal the competitive areas in which a company is strongest and
weakest, and against whom.
TABLE 4.4 A Representative Weighted Competitive Strength
Assessment
Competitive Strength Assessment(rating scale: 1 = very weak, 10 = very strong)
ABC Co. Rival 1 Rival 2
Key Success
Factor/Strength
Measure
Importance
Weight
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Quality/product
performance 0.10 8 0.80 5 0.50 1 0.10
Reputation/image 0.10 8 0.80 7 0.70 1 0.10
Manufacturing
capability 0.10 2 0.20 10 1.00 5 0.50
Technological skills 0.05 10 0.50 1 0.05 3 0.15
Dealer
network/distribution
capability
0.05 9 0.45 4 0.20 5 0.25
Competitive Strength Assessment(rating scale: 1 = very weak, 10 = very strong)
ABC Co. Rival 1 Rival 2
Key Success
Factor/Strength
Measure
Importance
Weight
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
New product
innovation
capability
0.05 9 0.45 4 0.20 5 0.25
Financial
resources 0.10 5 0.50 10 1.00 3 0.30
Relative cost
position 0.30 5 1.50 10 3.00 1 0.30
Customer service
capabilities 0.15 5 0.75 7 1.05 1 0.15
Sum of importance
weights 1.00
Overall weighted
competitive
strength rating
5.95 7.70 2.10
The overall competitive strength scores indicate how all the different strength
measures add up—whether the company is at a net overall competitive advantage
or disadvantage against each rival. The higher a company’s overall weighted
strength rating, the stronger its overall competitiveness versus rivals. The bigger
the difference between a company’s overall weighted rating and the scores of
lower-rated rivals, the greater is its implied net competitive advantage. Thus, Rival
1’s overall weighted score of 7.70 indicates a greater net competitive advantage
over Rival 2 (with a score of 2.10) than over ABC Company (with a score of 5.95).
Conversely, the bigger the difference between a company’s overall rating and the
scores of higher-rated rivals, the greater its implied net competitive disadvantage.
Rival 2’s score of 2.10 gives it a smaller net competitive disadvantage against
ABC Company (with an overall score of 5.95) than against Rival 1 (with an
overall score of 7.70).
High-weighted
competitive strength
ratings signal a
strong competitive
position and
possession of
competitive
advantage; low
ratings signal a
weak position and
competitive
disadvantage.
Strategic Implications of Competitive Strength
Assessments
In addition to showing how competitively strong or weak a company is relative to
rivals, the strength ratings provide guidelines for designing wise offensive and
defensive strategies. For example, if ABC Company wants to go on the offensive
to win additional sales and market share, such an offensive probably needs to be
aimed directly at winning customers away from Rival 2 (which has a lower overall
strength score) rather than Rival 1 (which has a higher overall strength score).
Moreover, while ABC has high ratings for technological skills (a 10 rating), dealer
network/distribution capability (a 9 rating), new product innovation capability (a 9
rating), quality/product performance (an 8 rating), and reputation/image (an 8
rating), these strength measures have low importance weights—meaning that ABC
has strengths in areas that don’t translate into much competitive clout in the
marketplace. Even so, it outclasses Rival 2 in all five areas, plus it enjoys
substantially lower costs than Rival 2 (ABC has a 5 rating on relative cost position
versus a 1 rating for Rival 2)—and relative cost position carries the highest
importance weight of all the strength measures. ABC also has greater competitive
strength than Rival 3 regarding customer service capabilities (which carries the
second-highest importance weight). Hence, because ABC’s strengths are in the
very areas where Rival 2 is weak, ABC is in a good position to attack Rival 2.
Indeed, ABC may well be able to persuade a number of Rival 2’s customers to
switch their purchases over to its product.
A company’s
competitive strength
scores pinpoint its
strengths and
weaknesses against
rivals and point
directly to the kinds
of offensive and
defensive actions it
can use to exploit its
competitive
strengths and
reduce its
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competitive
vulnerabilities.
But ABC should be cautious about cutting price aggressively to win customers
away from Rival 2, because Rival 1 could interpret that as an attack by ABC to
win away Rival 1’s customers as well. And Rival 1 is in far and away the best
position to compete on the basis of low price, given its high rating on relative cost
in an industry where low costs are competitively important (relative cost carries an
importance weight of 0.30). Rival 1’s strong relative cost position vis-
à-vis both ABC and Rival 2 arms it with the ability to use its lower-
cost advantage to thwart any price cutting on ABC’s part. Clearly ABC is
vulnerable to any retaliatory price cuts by Rival 1—Rival 1 can easily defeat both
ABC and Rival 2 in a price-based battle for sales and market share. If ABC wants
to defend against its vulnerability to potential price cutting by Rival 1, then it
needs to aim a portion of its strategy at lowering its costs.
The point here is that a competitively astute company should utilize the strength
scores in deciding what strategic moves to make. When a company has important
competitive strengths in areas where one or more rivals are weak, it makes sense to
consider offensive moves to exploit rivals’ competitive weaknesses. When a
company has important competitive weaknesses in areas where one or more rivals
are strong, it makes sense to consider defensive moves to curtail its vulnerability.
QUESTION 6: WHAT STRATEGIC ISSUES
AND PROBLEMS MERIT FRONT-BURNER
MANAGERIAL ATTENTION?
The final and most important analytic step is to zero in on exactly what strategic
issues company managers need to address—and resolve—for the company to be
more financially and competitively successful in the years ahead. This step
involves drawing on the results of both industry analysis and the evaluations of the
company’s internal situation. The task here is to get a clear fix on exactly what
strategic and competitive challenges confront the company, which of the
company’s competitive shortcomings need fixing, and what specific problems
merit company managers’ front-burner attention. Pinpointing the specific issues
that management needs to address sets the agenda for deciding what actions to
take next to improve the company’s performance and business outlook.
The “priority list” of issues and problems that have to be wrestled with can
include such things as how to stave off market challenges from new foreign
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competitors, how to combat the price discounting of rivals, how to reduce the
company’s high costs, how to sustain the company’s present rate of growth in light
of slowing buyer demand, whether to correct the company’s competitive
deficiencies by acquiring a rival company with the missing strengths, whether to
expand into foreign markets, whether to reposition the company and move to a
different strategic group, what to do about growing buyer interest in substitute
products, and what to do to combat the aging demographics of the company’s
customer base. The priority list thus always centers on such concerns as “how to
. . . ,” “what to do about . . . ,” and “whether to . . .” The purpose of the priority list
is to identify the specific issues and problems that management needs to address,
not to figure out what specific actions to take. Deciding what to do—which
strategic actions to take and which strategic moves to make—comes later (when it
is time to craft the strategy and choose among the various strategic alternatives).
Compiling a “priority
list” of problems
creates an agenda
of strategic issues
that merit prompt
managerial
attention.
A good strategy
must contain ways
to deal with all the
strategic issues and
obstacles that stand
in the way of the
company’s financial
and competitive
success in the years
ahead.
If the items on the priority list are relatively minor—which suggests that the
company’s strategy is mostly on track and reasonably well matched to the
company’s overall situation—company managers seldom need to go much beyond
fine-tuning the present strategy. If, however, the problems confronting the
company are serious and indicate the present strategy is not well suited for the road
ahead, the task of crafting a better strategy needs to be at the top of management’s
action agenda.
KEY POINTS
There are six key questions to consider in evaluating a company’s ability to
compete successfully against market rivals:
1. How well is the present strategy working? This involves evaluating the strategy
in terms of the company’s financial performance and market standing. The
stronger a company’s current overall performance, the less likely the need for
radical strategy changes. The weaker a company’s performance, the more its
current strategy must be questioned.
2. What is the company’s overall situation, in terms of its internal strengths and
weaknesses in relation to its market opportunities and external threats? The
answer to this question comes from performing a SWOT analysis. A company’s
strengths and competitive assets are strategically relevant because they are the
most logical and appealing building blocks for strategy; internal weaknesses are
important because they may represent vulnerabilities that need correction.
External opportunities and threats come into play because a good strategy
necessarily aims at capturing a company’s most attractive opportunities and at
defending against threats to its well-being.
3. What are the company’s most important resources and capabilities and can they
give the company a sustainable advantage? A company’s resources can be
identified using the tangible/intangible typology presented in this chapter. Its
capabilities can be identified either by starting with its resources to look for
related capabilities or looking for them within the company’s different
functional domains.
The answer to the second part of the question comes from conducting the four
tests of a resource’s competitive power—the VRIN tests. If a company has
resources and capabilities that are competitively valuable and rare, the firm will
have a competitive advantage over market rivals. If its resources and capabilities
are also hard to copy (inimitable), with no good substitutes (nonsubstitutable),
then the firm may be able to sustain this advantage even in the face of active
efforts by rivals to overcome it.
4. Are the company’s cost structure and value proposition competitive? One telling
sign of whether a company’s situation is strong or precarious is whether its costs
are competitive with those of industry rivals. Another sign is how the company
compares with rivals in terms of differentiation—how effectively it delivers on
its customer value proposition. Value chain analysis and benchmarking are
essential tools in determining whether the company is performing particular
functions and activities well, whether its costs are in line with those of
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LO 4-1
competitors, whether it is differentiating in ways that really enhance customer
value, and whether particular internal activities and business processes need
improvement. They complement resource and capability analysis by providing
data at the level of individual activities that provide more objective evidence of
whether individual resources and capabilities, or bundles of resources and linked
activity sets, are competitively superior.
5. On an overall basis, is the company competitively stronger or weaker than key
rivals? The key appraisals here involve how the company matches up against
key rivals on industry key success factors and other chief determinants of
competitive success and whether and why the company has a net competitive
advantage or disadvantage. Quantitative competitive strength assessments, using
the method presented in Table 4.4, indicate where a company is competitively
strong and weak and provide insight into the company’s ability to defend or
enhance its market position. As a rule, a company’s competitive strategy should
be built around its competitive strengths and should aim at shoring up areas
where it is competitively vulnerable. When a company has important
competitive strengths in areas where one or more rivals are weak, it
makes sense to consider offensive moves to exploit rivals’ competitive
weaknesses. When a company has important competitive weaknesses in areas
where one or more rivals are strong, it makes sense to consider defensive moves
to curtail its vulnerability.
6. What strategic issues and problems merit front-burner managerial attention?
This analytic step zeros in on the strategic issues and problems that stand in the
way of the company’s success. It involves using the results of industry analysis
as well as resource and value chain analysis of the company’s competitive
situation to identify a “priority list” of issues to be resolved for the company to
be financially and competitively successful in the years ahead. Actually
deciding on a strategy and what specific actions to take is what comes after
developing the list of strategic issues and problems that merit front-burner
management attention.
Like good industry analysis, solid analysis of the company’s competitive situation
vis-à-vis its key rivals is a valuable precondition for good strategy making.
ASSURANCE OF LEARNING EXERCISES
1. Using the financial ratios provided in Table 4.1 and
following the financial statement information presented
page 122
for Urban Outfitters, Inc., calculate the following ratios
for Urban Outfitters for both 2018 and 2019:
a. Gross profit margin
b. Operating profit margin
c. Net profit margin
d. Times-interest-earned (or coverage) ratio
e. Return on stockholders’ equity
f. Return on assets
g. Debt-to-equity ratio
h. Days of inventory
i. Inventory turnover ratio
j. Average collection period
Based on these ratios, did Urban Outfitter’s financial
performance improve, weaken, or remain about the same
from 2018 to 2019?
Consolidated Income Statements for Urban Outfitters, Inc.,
2018–2019 (in thousands, except per share data)
2018 2019
Net sales (total revenue) $3,616,014 $3,950,623
Cost of sales 2,440,507 2,603,911
Selling, general, and administrative 915,615
965,399
Operating income $259,892 $381,313
Other income (expense)
Other expenses (4,840) (6,325)
Interest income and other, net 6,314 10,565
Income before income taxes 261,366 385,553
Provision for income taxes 153,103 87,550
Net income $108,263 $298,003
Basic earnings per share $ 0.97 $ 2.75
Diluted earnings per share $ 0.96 $ 2.72
Source: Urban Outfitters, Inc., 2019.
page 123
Consolidated Balance Sheets for Urban Outfitters, Inc., 2018–
2019 (in thousands, except per share data)
January 31, 2018 January 31, 2019
Assets
Current Assets
Cash and cash equivalents $ 282,220 $ 358,260
Short-term investments 165,125 279,232
Receivables, net 76,962 80,461
Merchandise inventories 351,395 370,507
Prepaid expenses and other current assets 103,055 114,296
Total current assets 978,757 1,202,756
Net property and equipment 813,768 796,029
Deferred income taxes and Other assets 160,255 161,730
Total assets $1,952,780 $2,160,515
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable $ 128,246 $ 144,414
Accrued salaries and benefits 36,058 54,799
Accrued expenses and Other current liabilities 195,910 187,431
Total current liabilities 360,214
$ 386,644
Long-term debt 0 0
Deferred rent and other liabilities 284,773 291,663
Total liabilities 671,417 651,877
Commitments and Contingencies
Equity
Preferred stock $.0001 par value; 10,000,000 shares
authorized; no shares issued and outstanding 0 0
Common stock $.0001 par value; 200,000,000 shares
authorized; 105,642,283 and 108,248,568 shares
issued and outstanding
11 11
Additional paid-in capital $ 0 $ 684
Retained earnings 1,489,087 1,300,208
Total stockholders’ equity 1,489,098 1,300,90
LO 4-2, LO 4-3
LO 4-4
LO 4-5
January 31, 2018 January 31, 2019
Total Liabilities and Equity $2,160,515 $1,952,780
Source: Urban Outfitters, Inc., 2019 10-K.
2. Cinnabon, famous for its cinnamon rolls, is an American
chain commonly located in high traffic areas, such as
airports and malls. They operate more than 1,200 bakeries
in more than 48 countries. How many of the four tests of
the competitive power of a resource does the store
network pass? Using your general knowledge of this
industry, perform a SWOT analysis. Explain your
answers.
3. Review the information in Illustration Capsule 4.1
concerning Everlane’s average costs of producing and
selling a pair of denim jeans, and compare this with the
representative value chain depicted in Figure 4.3. Then
answer the following questions:
a. Which of the company’s costs correspond to the
primary value chain activities depicted in Figure 4.3?
b. Which of the company’s costs correspond to the support
activities described in Figure 4.3?
c. What value chain activities might be important in
securing or maintaining Everlane’s advantage? Explain
your answer.
4. Using the methodology illustrated in Table 4.3 and your
knowledge as an automobile owner, prepare a competitive
strength assessment for General Motors and its rivals
Ford, Chrysler, Toyota, and Honda. Each of the five
automobile manufacturers should be evaluated on the key
success factors and strength measures of cost-
competitiveness, product-line breadth, product quality
and reliability, financial resources and profitability, and
customer service. What does your competitive strength
assessment disclose about the overall competitiveness of
each automobile manufacturer? What factors account
most for Toyota’s competitive success? Does Toyota have
competitive weaknesses that were disclosed by your
analysis? Explain.
LO 4-1
LO 4-1
LO 4-1
LO 4-2, LO 4-3
LO 4-2, LO 4-3
LO 4-4
page 124
EXERCISES FOR SIMULATION PARTICIPANTS
1. Using the formulas in Table 4.1 and the data in your
company’s latest financial statements, calculate the
following measures of financial performance for your
company:
a. Operating profit margin
b. Total return on total assets
c. Current ratio
d. Working capital
e. Long-term debt-to-capital ratio
f. Price-to-earnings ratio
2. On the basis of your company’s latest financial statements
and all the other available data regarding your company’s
performance that appear in the industry report, list the
three measures of financial performance on which your
company did best and the three measures on which your
company’s financial performance was worst.
3. What hard evidence can you cite that indicates your
company’s strategy is working fairly well (or perhaps not
working so well, if your company’s performance is
lagging that of rival companies)?
4. What internal strengths and weaknesses does your
company have? What external market opportunities for
growth and increased profitability exist for your
company? What external threats to your company’s future
well-being and profitability do you and your co-managers
see? What does the preceding SWOT analysis indicate
about your company’s present situation and future
prospects—where on the scale from “exceptionally
strong” to “alarmingly weak” does the attractiveness of
your company’s situation rank?
5. Does your company have any core competencies? If so,
what are they?
6. What are the key elements of your company’s value
chain? Refer to Figure 4.3 in developing your answer.
LO 4-5
page 125
7. Using the methodology presented in Table 4.4, do a
weighted competitive strength assessment for your
company and two other companies that you and your co-
managers consider to be very close competitors.
ENDNOTES
1 Donald Sull, “Strategy as Active Waiting,” Harvard Business Review 83, no. 9 (September 2005), pp. 121–126.
2 Birger Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5, no. 5 (September–October 1984),
pp. 171–180; Jay Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17, no. 1 (1991),
pp. 99–120.
3 R. Amit and P. Schoemaker, “Strategic Assets and Organizational Rent,” Strategic Management Journal 14 (1993).
4 Jay B. Barney, “Looking Inside for Competitive Advantage,” Academy of Management Executive 9, no. 4 (November 1995), pp.
49–61; Christopher A. Bartlett and Sumantra Ghoshal, “Building Competitive Advantage through People,” MIT Sloan
Management Review 43, no. 2 (Winter 2002), pp. 34–41; Danny Miller, Russell Eisenstat, and Nathaniel Foote, “Strategy from
the Inside Out: Building Capability-Creating Organizations,” California Management Review 44, no. 3 (Spring 2002), pp. 37–54.
5 M. Peteraf and J. Barney, “Unraveling the Resource-Based Tangle,” Managerial and Decision Economics 24, no. 4 (June–July
2003), pp. 309–323.
6 Margaret A. Peteraf and Mark E. Bergen, “Scanning Dynamic Competitive Landscapes: A Market-Based and Resource-Based
Framework,” Strategic Management Journal 24 (2003), pp. 1027–1042.
7 C. Montgomery, “Of Diamonds and Rust: A New Look at Resources,” in C. Montgomery (ed.), Resource-Based and
Evolutionary Theories of the Firm (Boston: Kluwer Academic, 1995), pp. 251–268.
8 Constance E. Helfat and Margaret A. Peteraf, “The Dynamic Resource-Based View: Capability Lifecycles,” Strategic
Management Journal 24, no. 10 (2003).
9 D. Teece, G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” Strategic Management Journal 18, no.
7 (1997), pp. 509–533; K. Eisenhardt and J. Martin, “Dynamic Capabilities: What Are They?” Strategic Management
Journal 21, no. 10–11 (2000), pp. 1105–1121; M. Zollo and S. Winter, “Deliberate Learning and the Evolution of
Dynamic Capabilities,” Organization Science 13 (2002), pp. 339–351; C. Helfat et al., Dynamic Capabilities: Understanding
Strategic Change in Organizations (Malden, MA: Blackwell, 2007).
10 Michael Porter in his 1985 best seller Competitive Advantage (New York: Free Press).
11 John K. Shank and Vijay Govindarajan, Strategic Cost Management (New York: Free Press, 1993), especially chaps. 2–6, 10,
and 11; Robin Cooper and Robert S. Kaplan, “Measure Costs Right: Make the Right Decisions,” Harvard Business Review 66,
no. 5 (September–October, 1988), pp. 96–103; Joseph A. Ness and Thomas G. Cucuzza, “Tapping the Full Potential of ABC,”
Harvard Business Review 73, no. 4 (July–August 1995), pp. 130–138.
12 Porter, Competitive Advantage, p. 34.
13 Hau L. Lee, “The Triple-A Supply Chain,” Harvard Business Review 82, no. 10 (October 2004), pp. 102–112.
14 Gregory H. Watson, Strategic Benchmarking: How to Rate Your Company’s Performance against the World’s Best (New York:
Wiley, 1993); Robert C. Camp, Benchmarking: The Search for Industry Best Practices That Lead to Superior Performance
(Milwaukee: ASQC Quality Press, 1989); Dawn Iacobucci and Christie Nordhielm, “Creative Benchmarking,” Harvard Business
Review 78 no. 6 (November–December 2000), pp. 24–25.
15 www.businessdictionary.com/definition/best-practice.html (accessed December 2, 2009).
16 Reuben E. Stone, “Leading a Supply Chain Turnaround,” Harvard Business Review 82, no. 10 (October 2004), pp. 114–121.
http://www.businessdictionary.com/definition/best-practice.html
page 126
chapter 5
The Five Generic Competitive Strategies
Learning Objectives
After reading this chapter, you should be able to:
LO 5-1 Understand what distinguishes each of the five generic strategies and explain
why some of these strategies work better in certain kinds of competitive
conditions than in others.
LO 5-2 Recognize the major avenues for achieving a competitive advantage based on
lower costs.
LO 5-3 Identify the major avenues to a competitive advantage based on differentiating a
company’s product or service offering from the offerings of rivals.
LO 5-4 Explain the attributes of a best-cost strategy—a hybrid of low-cost and
differentiation strategies.
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page 128
Roy Scott/Media Bakery
It’s all about strategic positioning and competition.
Michele Hutchins—Consultant
Strategic positioning means performing different activities from rivals or performing similar activities in different ways.
Michael E. Porter—Professor, author, and cofounder of Monitor Consulting
I learnt the hard way about positioning in business, about catering to the right segments.
Shaffi Mather—Social entrepreneur
A company can employ any of several basic approaches to gaining a competitive advantage over rivals, but they all
involve delivering more value to customers than rivals or delivering value more efficiently than rivals (or both). More value
for customers can mean a good product at a lower price, a superior product worth paying more for, or a best-value offering
that represents an attractive combination of price, features, service, and other appealing attributes. Greater efficiency
means delivering a given level of value to customers at a lower cost to the company. But whatever approach to delivering
value the company takes, it nearly always requires performing value chain activities differently than rivals and building
competitively valuable resources and capabilities that rivals cannot readily match or outdo.
This chapter describes the five generic competitive strategy options. Each of the five generic strategies represents a
distinctly different approach to competing in the marketplace. Which of the five to employ is a company’s first and foremost
choice in crafting an overall strategy and beginning its quest for competitive advantage.
TYPES OF GENERIC COMPETITIVE STRATEGIES
• LO 5-1
Understand what
distinguishes each
of the five generic
strategies and
explain why some of
these strategies
work better in certain
kinds of competitive
conditions than in
others.
A company’s competitive strategy lays out the specific efforts of the company to position itself in the
marketplace, please customers, ward off competitive threats, and achieve a particular kind of competitive
advantage. The chances are remote that any two companies—even companies in the same industry—will
employ competitive strategies that are exactly alike in every detail. However, when one strips away the
details to get at the real substance, the two biggest factors that distinguish one competitive strategy from
another boil down to (1) whether a company’s market target is broad or narrow and (2) whether the
company is pursuing a competitive advantage linked to lower costs or differentiation. These two factors
give rise to four distinct competitive strategy options, plus one hybrid option, as shown in Figure 5.1 and
listed next.1
FIGURE 5.1 The Five Generic Competitive Strategies
Source: This is an expanded version of a three-strategy classification discussed in Michael E. Porter, Competitive Strategy (New
York: Free Press, 1980).
1. A broad, low-cost strategy—striving to achieve broad lower overall costs than rivals on comparable
products that attract a broad spectrum of buyers, usually by underpricing rivals.
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2. A broad differentiation strategy—seeking to differentiate the company’s product offering from rivals’
with attributes that will appeal to a broad spectrum of buyers.
3. A focused low-cost strategy—concentrating on the needs and requirements of a narrow buyer segment
(or market niche) and striving to meet these needs at lower costs than rivals (thereby being able to
serve niche members at a lower price).
4. A focused differentiation strategy—concentrating on a narrow buyer segment (or market niche) and
offering niche members customized attributes that meet their tastes and requirements better than rivals’
products.
5. A best-cost strategy—striving to incorporate upscale product attributes at a lower cost than rivals.
Being the “best-cost” producer of an upscale, multifeatured product allows a company to give
customers more value for their money by underpricing rivals whose products have similar upscale,
multifeatured attributes. This competitive approach is a hybrid strategy that blends elements of the
previous four options in a unique and often effective way. It may be focused or broad in its appeal.
The remainder of this chapter explores the ins and outs of these five generic competitive strategies and
how they differ.
BROAD LOW-COST STRATEGIES
• LO 5-2
Recognize the major
avenues for
achieving a
competitive
advantage based on
lower costs.
Striving to achieve lower costs than rivals targeting a broad spectrum of buyers is an especially effective
competitive approach in markets with many price-sensitive buyers. A company achieves low-cost
leadership when it becomes the industry’s lowest-cost producer rather than just being one of perhaps
several competitors with comparatively low costs. But a low-cost producer’s foremost strategic objective
is meaningfully lower costs than rivals—not necessarily the absolutely lowest possible cost. In striving for
a cost advantage over rivals, company managers must incorporate features and services that buyers
consider essential. A product offering that is too frills-free can be viewed by consumers as offering little
value regardless of its pricing.
CORE
CONCEPT
The essence of a
broad, low-cost
strategy is to
produce goods or
services for a broad
base of buyers at a
lower cost than
rivals.
A company has two options for translating a low-cost advantage over rivals into superior profit
performance. Option 1 is to use the lower-cost edge to underprice competitors and attract price-sensitive
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buyers in great enough numbers to increase total profits. Option 2 is to maintain the present price, be
content with the present market share, and use the lower-cost edge to raise total profits by earning a
higher profit margin on each unit sold.
While many companies are inclined to exploit a low-cost advantage by using option 1 (attacking rivals
with lower prices), this strategy can backfire if rivals respond with retaliatory price cuts (in order to
protect their customer base and defend against a loss of sales). A rush to cut prices can often trigger a
price war that lowers the profits of all price discounters. The bigger the risk that rivals will respond with
matching price cuts, the more appealing it becomes to employ the second option for using a low-cost
advantage to achieve higher profitability.
The Two Major Avenues for Achieving a Cost Advantage
To achieve a low-cost edge over rivals, a firm’s cumulative costs across its overall value chain must be
lower than competitors’ cumulative costs. There are two major avenues for accomplishing this:2
1. Perform internal value chain activities and/or value chain system activities more cost-effectively than
rivals.
2. Revamp the firm’s overall value chain to eliminate or bypass some cost-producing activities.
A low-cost
advantage over
rivals can translate
into superior
profitability through
lower price and
higher market share
or higher profit
margins.
Cost-Efficient Management of Value Chain Activities For a company to do a more cost-effective job
of managing its value chain than rivals, managers must diligently search out cost-saving opportunities in
every part of the value chain. No activity can escape cost-saving scrutiny, and all company
personnel must be expected to use their talents and ingenuity to come up with innovative and
effective ways to keep down costs. Particular attention must be paid to a set of factors known as cost
drivers that have a strong effect on a company’s costs and can be used as levers to lower costs. Figure 5.2
shows the most important cost drivers. Cost-cutting approaches that demonstrate an effective use of the
cost drivers include
CORE
CONCEPT
A cost driver is a
factor that has a
strong influence on
a company’s costs.
FIGURE 5.2 Cost Drivers: The Keys to Driving Down Company Costs
page 131
Source: Adapted from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York:
Free Press, 1985).
1. Capturing all available economies of scale. Economies of scale stem from an ability to lower unit costs
by increasing the scale of operation. Economies of scale may be available at different points along a
company’s value chain (both internally and elsewhere along its value chain system). Often, a large
plant is more economical to operate than a small one, particularly if it can be operated round the clock
robotically. Economies of scale may be available due to a large warehouse operation on the input side
or a large distribution center on the output side. In global industries, selling a mostly standard product
worldwide tends to lower unit costs as opposed to making separate products (each at lower scale) for
each country market. There are economies of scale in advertising as well. For example, Anheuser-
Busch InBev SA/NV could afford to pay the $5.6 million cost of a 30-second Super Bowl ad in 2020
because the cost could be spread out over the hundreds of millions of units of Budweiser that the
company sells.
2. Taking full advantage of experience and learning-curve effects. The cost of performing an activity can
decline over time as the learning and experience of company personnel build. Learning and experience
economies can stem from debugging and mastering newly introduced technologies, using the
experiences and suggestions of workers to install more efficient plant layouts and assembly procedures,
and the added speed and effectiveness that accrues from repeatedly picking sites for and building new
plants, distribution centers, or retail outlets.
3. Operating facilities at full capacity. Whether a company is able to operate at or near full capacity has a
big impact on unit costs when its value chain contains activities associated with substantial fixed costs.
Higher rates of capacity utilization allow depreciation and other fixed costs to be spread over a larger
unit volume, thereby lowering fixed costs per unit. The more capital-intensive the business and the
higher the fixed costs as a percentage of total costs, the greater the unit-cost penalty for operating at
less than full capacity.
4. Improving supply chain efficiency. Partnering with suppliers to streamline the ordering and purchasing
process, to reduce inventory carrying costs via just-in-time inventory practices, to economize on
shipping and materials handling, and to ferret out other cost-saving opportunities is a much-used
approach to cost reduction. A company with a distinctive competence in cost-efficient supply chain
management, such as Colgate-Palmolive or Unilever (leading consumer products companies), can
sometimes achieve a sizable cost advantage over less adept rivals.
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5. Substituting lower-cost inputs wherever there is little or no sacrifice in product quality or performance.
If the costs of certain raw materials and parts are “too high,” a company can switch to using lower-cost
items or maybe even design the high-cost components out of the product altogether.
6. Using the company’s bargaining power vis-à-vis suppliers or others in the value chain system to gain
concessions. Home Depot, for example, has sufficient bargaining clout with suppliers to win price
discounts on large-volume purchases.
7. Using online systems and sophisticated software to achieve operating efficiencies. For example,
sharing data and production schedules with suppliers, coupled with the use of enterprise resource
planning (ERP) and manufacturing execution system (MES) software, can reduce parts inventories,
trim production times, and lower labor requirements.
8. Improving process design and employing advanced production technology. Often, production costs can
be cut by (1) using design for manufacture (DFM) procedures and computer-assisted design (CAD)
techniques that enable more integrated and efficient production methods, (2) investing in highly
automated robotic production technology, and (3) shifting to a mass-customization production process.
Dell’s highly automated PC assembly plant in Austin, Texas, is a prime example of the use of advanced
product and process technologies. Many companies are ardent users of total quality management
(TQM) systems, business process reengineering, Six Sigma methodology, and other business process
management techniques that aim at boosting efficiency and reducing costs.
9. Being alert to the cost advantages of outsourcing or vertical integration. Outsourcing the performance
of certain value chain activities can be more economical than performing them in-house if outside
specialists, by virtue of their expertise and volume, can perform the activities at lower cost. On the
other hand, there can be times when integrating into the activities of either suppliers or distribution-
channel allies can lower costs through greater production efficiencies, reduced transaction
costs, or a better bargaining position.
10. Motivating employees through incentives and company culture. A company’s incentive system can
encourage not only greater worker productivity but also cost-saving innovations that come from worker
suggestions. The culture of a company can also spur worker pride in productivity and continuous
improvement. Companies that are well known for their cost-reducing incentive systems and culture
include Nucor Steel, which characterizes itself as a company of “20,000 teammates,” Southwest
Airlines, and DHL Express (rival of FedEx).
Revamping of the Value Chain System to Lower Costs Dramatic cost advantages can often emerge
from redesigning the company’s value chain system in ways that eliminate costly work steps and entirely
bypass certain cost-producing value chain activities. Such value chain revamping can include
Selling direct to consumers and bypassing the activities and costs of distributors and dealers. To
circumvent the need for distributors and dealers, a company can create its own direct sales force, which
adds the costs of maintaining and supporting a sales force but may be cheaper than using independent
distributors and dealers to access buyers. Alternatively, they can conduct sales operations at the
company’s website, since the costs for website operations and shipping may be substantially cheaper
than going through distributor-dealer channels). Costs in the wholesale and retail portions of the value
chain frequently represent 35 to 50 percent of the final price consumers pay, so establishing a direct
sales force or selling online may offer big cost savings.
Streamlining operations by eliminating low-value-added or unnecessary work steps and activities. At
Walmart, some items supplied by manufacturers are delivered directly to retail stores rather than being
routed through Walmart’s distribution centers and delivered by Walmart trucks. In other instances,
Walmart unloads incoming shipments from manufacturers’ trucks arriving at its distribution centers and
loads them directly onto outgoing Walmart trucks headed to particular stores without ever moving the
goods into the distribution center. Many supermarket chains have greatly reduced in-store meat
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butchering and cutting activities by shifting to meats that are cut and packaged at the meatpacking plant
and then delivered to their stores in ready-to-sell form.
Reducing materials-handling and shipping costs by having suppliers locate their plants or warehouses
close to the company’s own facilities. Having suppliers locate their plants or warehouses close to a
company’s own plant facilitates just-in-time deliveries of parts and components to the exact workstation
where they will be used in assembling the company’s product. This not only lowers incoming shipping
costs but also curbs or eliminates the company’s need to build and operate storerooms for incoming
parts and to have plant personnel move the inventories to the workstations as needed for assembly.
Illustration Capsule 5.1 describes the path that Vanguard has followed in achieving its position as the
low-cost leader of the investment management industry.
ILLUSTRATION
CAPSULE 5.1 Vanguard’s Path to Becoming the Low-Cost
Leader in Investment Management
Vanguard is now one of the world’s largest investment management companies. It became an industry giant by leading the
way in low-cost passive index investing. In active trading, an investment manager is compensated for making an educated
decision on which stocks to sell and which to buy. This incurs both transactional and management fees. In contrast, passive
index portfolios aim to mirror the movements of a major market index like the S&P 500, Dow Jones Industrial Average, or
NASDAQ. Passive portfolios incur fewer fees and can be managed with lower operating costs. A measure used to compare
operating costs in this industry is known as the expense ratio, which is the percentage of an investment that goes toward
expenses. In 2019, Vanguard’s expense ratio was less than 14 percent of the industry’s average expense ratio. Vanguard
was the first to capitalize on what was at the time an underappreciated fact: over long horizons, well-managed index funds,
with their lower costs and fees, typically outperform their actively trading competitors.
Vanguard provides low-cost investment options for its clients in several ways. By creating funds that track index(es) over
a long horizon, the client does not incur transaction and management fees normally charged in actively managed funds.
Possibly more important, Vanguard was created with a unique client-owner structure. When you invest with Vanguard you
become an owner of Vanguard. This structure effectively cut out traditional shareholders who seek to share in profits. Under
client ownership, any returns in excess of operating costs are returned to the clients/investors.
Vanguard keeps its costs low in several other ways. One notable one is its focus on its employees and organizational
structure. The company prides itself on low turnover rates (8 percent) and very flat organizational structure. In several
instances Vanguard has been able to capitalize on being a fast follower. They launched several product lines after their
competitors introduced those products. Being a fast follower allowed them to develop superior products and reach scale
more quickly—both further lowering their cost structure.
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Keith Srakocic/AP Images
The low-cost structure has not come at the expense of performance. Vanguard now has 410 funds, over 30 million
investors, has surpassed $5.5 trillion in AUM (assets under management), and is growing faster than all its competitors
combined. When Money published its January 2020 list of recommended investment funds, 44 percent of the funds listed
were Vanguard funds.
Vanguard’s low-cost strategy has been so successful that industry experts now refer to The Vanguard Effect. This refers
to the pressure that this investment management giant has put on competitors to lower their fees in order to compete with
Vanguard’s low-cost value proposition.
Note: Developed with Vedrana B. Greatorex.
Sources: https://www.nytimes.com/2017/04/14/business/mutfund/vanguard-mutual-index-funds-growth.html;
https://investor.vanguard.com; Sunderam, A., Viceira, L., & Ciechanover, A. (2016) The Vanguard Group, Inc. in 2015:
Celebrating 40. HBS No. 9-216-026. Boston, MA: Harvard Business School Publishing; Money.com; About
Vanguard.com/Fast Facts About Vanguard.
Examples of Companies That Revamped Their Value Chains to Reduce Costs Nucor Corporation,
the most profitable steel producer in the United States and one of the largest steel producers worldwide,
drastically revamped the value chain process for manufacturing steel products by using relatively
inexpensive electric arc furnaces and continuous casting processes. Using electric arc furnaces to melt
recycled scrap steel eliminated many of the steps used by traditional steel mills that made their steel
products from iron ore, coke, limestone, and other ingredients using costly coke ovens, basic oxygen blast
furnaces, ingot casters, and multiple types of finishing facilities—plus Nucor’s value chain system
required far fewer employees. As a consequence, Nucor produces steel with a far lower capital
investment, a far smaller workforce, and far lower operating costs than traditional steel mills. Nucor’s
strategy to replace the traditional steelmaking value chain with its simpler, quicker value chain
approach has made it one of the world’s lowest-cost producers of steel, allowing it to take a
huge amount of market share away from traditional steel companies and earn attractive profits. This
approach has allowed the company to remain steadily profitable even as a flood of illegally subsidized
imports wreaked havoc on the rest of the North American steel market.
Success in
achieving a low-cost
edge over rivals
comes from out-
managing rivals in
finding ways to
perform value chain
activities faster,
more accurately, and
more cost-
effectively.
Southwest Airlines has achieved considerable cost savings by reconfiguring the traditional value chain
of commercial airlines, thereby permitting it to offer travelers lower fares. Its mastery of fast turnarounds
at the gates (about 25 minutes versus 45 minutes for rivals) allows its planes to fly more hours per day.
This translates into being able to schedule more flights per day with fewer aircraft, allowing Southwest to
generate more revenue per plane on average than rivals. Southwest does not offer assigned seating,
baggage transfer to connecting airlines, or first-class seating and service, thereby eliminating all the cost-
producing activities associated with these features. The company’s fast and user-friendly online
reservation system facilitates e-ticketing and reduces staffing requirements at telephone reservation
centers and airport counters. Its use of automated check-in equipment reduces staffing requirements for
terminal check-in. The company’s carefully designed point-to-point route system minimizes connections,
delays, and total trip time for passengers, allowing about 75 percent of Southwest passengers to fly
nonstop to their destinations and at the same time reducing Southwest’s costs for flight operations.
https://investor.vanguard.com/
http://money.com/
http://vanguard.com/Fast
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The Keys to a Successful Broad Low-Cost Strategy
While broad, low-cost companies are champions of frugality, they seldom hesitate to spend aggressively
on resources and capabilities that promise to drive costs out of the business. Indeed, having competitive
assets of this type and ensuring that they remain competitively superior is essential for achieving
competitive advantage as a broad, low-cost leader. Walmart, for example, has been an early adopter of
state-of-the-art technology throughout its operations; however, the company carefully estimates the cost
savings of new technologies before it rushes to invest in them. By continuously investing in complex,
cost-saving technologies that are hard for rivals to match, Walmart has sustained its low-cost advantage
for over 45 years.
A low-cost producer
is in the best
position to win the
business of price-
sensitive buyers, set
the floor on market
price, and still earn a
profit.
Uber and Lyft, employing a formidable low-cost provider strategy and an innovative business model,
have stormed their way into hundreds of locations across the world, totally disrupting and seemingly
forever changing competition in the taxi markets where they have a presence. And, most significantly, the
ultra-low fares charged by Uber and Lyft have resulted in dramatic increases in the demand for taxi
services, particularly those provided by these two low-cost providers. Other companies noted for their
successful use of broad low-cost strategies include Spirit Airlines, EasyJet, and Ryanair in airlines; Briggs
& Stratton in small gasoline engines; Huawei in networking and telecommunications equipment; Bic in
ballpoint pens; Stride Rite in footwear; and Poulan in chain saws.
When a Low-Cost Strategy Works Best
A low-cost strategy becomes increasingly appealing and competitively powerful when
1. Price competition among rival sellers is vigorous. Low-cost leaders are in the best position to compete
offensively on the basis of price, to gain market share at the expense of rivals, to win the business of
price-sensitive buyers, to remain profitable despite strong price competition, and to survive price wars.
2. The products of rival sellers are essentially identical and readily available from many eager sellers.
Look-alike products and/or overabundant product supply set the stage for lively price competition; in
such markets, it is the less efficient, higher-cost companies whose profits get squeezed the most.
3. There are few ways to achieve product differentiation that have value to buyers. When the differences
between product attributes or brands do not matter much to buyers, buyers are nearly always sensitive
to price differences, and industry-leading companies tend to be those with the lowest-priced brands.
4. Buyers incur low costs in switching their purchases from one seller to another. Low switching costs
give buyers the flexibility to shift purchases to lower-priced sellers having equally good products or to
attractively priced substitute products. A low-cost leader is well positioned to use low price to induce
potential customers to switch to its brand.
5. Buyers are price-sensitive or have the power to bargain down prices. When buyers are focused
primarily on price or have substantial bargaining power, then a low-cost strategy becomes something of
a necessity!
Pitfalls to Avoid in Pursuing a Low-Cost Strategy
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Perhaps the biggest mistake a low-cost producer can make is getting carried away with overly aggressive
price cutting. Higher unit sales and market shares do not automatically translate into higher profits.
Reducing price results in earning a lower profit margin on each unit sold. Thus, reducing price improves
profitability only if the lower price increases unit sales enough to offset the loss in revenues due to the
lower per unit profit margin. A simple numerical example tells the story: Suppose a firm selling
1,000 units at a price of $10, a cost of $9, and a profit margin of $1 opts to cut price 5 percent to $9.50—
which reduces the firm’s profit margin to $0.50 per unit sold. If unit costs remain at $9, then it takes a 100
percent sales increase to 2,000 units just to offset the narrower profit margin and get back to total profits
of $1,000. Hence, whether a price cut will result in higher or lower profitability depends on how big the
resulting sales gains will be and how much, if any, unit costs will fall as sales volumes increase.
A second pitfall is relying on cost reduction approaches that can be easily copied by rivals. If rivals
find it relatively easy or inexpensive to imitate the leader’s low-cost methods, then the leader’s advantage
will be too short-lived to yield a valuable edge in the marketplace.
Reducing price does
not lead to higher
total profits unless
the added gains in
unit sales are large
enough to offset the
loss in revenues due
to lower margins per
unit sold.
A third pitfall is becoming too fixated on cost reduction. Low costs cannot be pursued so zealously that
a firm’s offering ends up being too feature-poor to generate buyer appeal. Furthermore, a company
driving hard to push down its costs has to guard against ignoring declining buyer sensitivity to price,
increased buyer interest in added features or service, or new developments that alter how buyers use the
product. Otherwise, it risks losing market ground if buyers start opting for more upscale or feature-rich
products.
Even if these mistakes are avoided, a low-cost strategy still entails risk. An innovative rival may
discover an even lower-cost value chain approach. Important cost-saving technological breakthroughs
may suddenly emerge. And if a low-cost producer has heavy investments in its present means of
operating, then it can prove costly to quickly shift to the new value chain approach or a new technology.
A low-cost
producer’s product
offering must always
contain enough
attributes to be
attractive to
prospective buyers
—low price, by itself,
is not always
appealing to buyers.
BROAD DIFFERENTIATION STRATEGIES
• LO 5-3
Identify the major
avenues to a
competitive
advantage based on
differentiating a
company’s product
or service offering
from the offerings of
rivals.
Differentiation strategies are attractive whenever buyers’ needs and preferences are too diverse to be fully
satisfied by a standardized product offering. Successful product differentiation requires careful study to
determine what attributes buyers will find appealing, valuable, and worth paying for.3 Then the company
must incorporate a combination of these desirable features into its product or service that will be different
enough to stand apart from the product or service offerings of rivals. A broad differentiation strategy
achieves its aim when a wide range of buyers find the company’s offering more appealing than that of
rivals and worth a somewhat higher price.
CORE
CONCEPT
The essence of a
broad
differentiation
strategy is to offer
unique product
attributes that a wide
range of buyers find
appealing and worth
paying more for.
Successful differentiation allows a firm to do one or more of the following:
Command a premium price for its product.
Increase unit sales (because additional buyers are won over by the differentiating features).
Gain buyer loyalty to its brand (because buyers are strongly attracted to the differentiating features
and bond with the company and its products).
Differentiation enhances profitability whenever a company’s product can command a sufficiently
higher price or generate sufficiently bigger unit sales to more than cover the added costs of achieving the
differentiation. Company differentiation strategies fail when buyers don’t place much value on the brand’s
uniqueness and/or when a company’s differentiating features are easily matched by its rivals.
Companies can pursue differentiation from many angles: a unique taste (Red Bull, Listerine); multiple
features (Microsoft Office, Apple Watch); wide selection and one-stop shopping (Home Depot,
Alibaba.com); superior service (Ritz-Carlton, Nordstrom); spare parts availability (John Deere; Morgan
Motors); engineering design and performance (Mercedes, BMW); high fashion design (Prada, Gucci);
product reliability (Whirlpool, LG, and Bosch in large home appliances); quality manufacture (Michelin);
technological leadership (3M Corporation in bonding and coating products); a full range of services
(Charles Schwab in stock brokerage); and wide product selection (Campbell’s soups; Frito-Lay snack
foods.).
http://alibaba.com/
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Managing the Value Chain in Ways that Enhance Differentiation
Differentiation is not something in marketing and advertising departments, nor is it limited to the catchalls
of quality and service. Differentiation opportunities can exist in activities all along a company’s value
chain and value chain system. The most systematic approach that managers can take, however, involves
focusing on the value drivers, a set of factors—analogous to cost drivers—that are particularly effective
in creating differentiation. Figure 5.3 contains a list of important value drivers. Ways that managers can
enhance differentiation based on value drivers include the following:
CORE
CONCEPT
A value driver is a
factor that is
particularly effective
in creating
differentiation.
FIGURE 5.3 Value Drivers: The Keys to Creating a Differentiation Advantage
Source: Adapted from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York:
Free Press, 1985).
1. Create product features and performance attributes that appeal to a wide range of buyers. The physical
and functional features of a product have a big influence on differentiation, including features such as
added user safety or enhanced environmental protection. Styling and appearance are big differentiating
factors in the apparel and motor vehicle industries. Size and weight matter in binoculars and mobile
devices. Most companies employing broad differentiation strategies make a point of
incorporating innovative and novel features in their product or service offering, especially
those that improve performance and functionality.
2. Improve customer service or add extra services. Better customer services, in areas such as delivery,
returns, and repair, can be as important in creating differentiation as superior product features.
Examples include superior technical assistance to buyers, higher-quality maintenance services, more
and better product information provided to customers, more and better training materials for end users,
better credit terms, quicker order processing, and greater customer convenience.
3. Invest in production-related R&D activities. Engaging in production R&D may permit custom-order
manufacture at an efficient cost, provide wider product variety and selection through product
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“versioning,” or improve product quality. Many manufacturers have developed flexible manufacturing
systems that allow different models and product versions to be made on the same assembly line. Being
able to provide buyers with made-to-order products can be a potent differentiating capability.
4. Strive for innovation and technological advances. Successful innovation is the route to more frequent
first-on-the-market victories and is a powerful differentiator. If the innovation proves hard to replicate,
through patent protection or other means, it can provide a company with a first-mover advantage that is
sustainable.
5. Pursue continuous quality improvement. Quality control processes reduce product defects, prevent
premature product failure, extend product life, make it economical to offer longer warranty coverage,
improve economy of use, result in more end-user convenience, or enhance product
appearance. Companies whose quality management systems meet certification standards,
such as the ISO 9001 standards, can enhance their reputation for quality with customers.
6. Increase marketing and brand-building activities. Marketing and advertising can have a tremendous
effect on the value perceived by buyers and therefore their willingness to pay more for the company’s
offerings. They can create differentiation even when little tangible differentiation exists otherwise. For
example, blind taste tests show that even the most loyal Pepsi or Coke drinkers have trouble telling one
cola drink from another.4 Brands create customer loyalty, which increases the perceived “cost” of
switching to another product.
7. Seek out high-quality inputs. Input quality can ultimately spill over to affect the performance or quality
of the company’s end product. Starbucks, for example, gets high ratings on its coffees partly because it
has very strict specifications on the coffee beans purchased from suppliers.
8. Emphasize human resource management activities that improve the skills, expertise, and knowledge of
company personnel. A company with high-caliber intellectual capital often has the capacity to generate
the kinds of ideas that drive product innovation, technological advances, better product design and
product performance, improved production techniques, and higher product quality. Well-designed
incentive compensation systems can often unleash the efforts of talented personnel to develop and
implement new and effective differentiating attributes.
Revamping the Value Chain System to Increase Differentiation Just as pursuing a cost advantage
can involve the entire value chain system, the same is true for a differentiation advantage. Activities
performed upstream by suppliers or downstream by distributors and retailers can have a meaningful effect
on customers’ perceptions of a company’s offerings and its value proposition. Approaches to enhancing
differentiation through changes in the value chain system include
Coordinating with downstream channel allies to enhance customer value. Coordinating with
downstream partners such as distributors, dealers, brokers, and retailers can contribute to differentiation
in a variety of ways. Methods that companies use to influence the value chain activities of their channel
allies include setting standards for downstream partners to follow, providing them with templates to
standardize the selling environment or practices, training channel personnel, or cosponsoring
promotions and advertising campaigns. Coordinating with retailers is important for enhancing the
buying experience and building a company’s image. Coordinating with distributors or shippers can
mean quicker delivery to customers, more accurate order filling, and/or lower shipping costs. The Coca-
Cola Company considers coordination with its bottler-distributors so important that it has at times taken
over a troubled bottler to improve its management and upgrade its plant and equipment before releasing
it again.5
Coordinating with suppliers to better address customer needs. Collaborating with suppliers can also be
a powerful route to a more effective differentiation strategy. Coordinating and collaborating with
suppliers can improve many dimensions affecting product features and quality. This is particularly true
for companies that engage only in assembly operations, such as Dell in PCs and Ducati in motorcycles.
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Close coordination with suppliers can also enhance differentiation by speeding up new product
development cycles or speeding delivery to end customers. Strong relationships with suppliers can also
mean that the company’s supply requirements are prioritized when industry supply is insufficient to
meet overall demand.
Delivering Superior Value via a Broad Differentiation Strategy
Differentiation strategies depend on meeting customer needs in unique ways or creating new needs
through activities such as innovation or persuasive advertising. The objective is to offer customers
something that rivals can’t—at least in terms of the level of satisfaction. There are four basic routes to
achieving this aim:
The first route is to incorporate product attributes and user features that lower the buyer’s overall costs
of using the company’s product. This is the least obvious and most overlooked route to a differentiation
advantage. It is a differentiating factor since it can help business buyers be more competitive in their
markets and more profitable. Producers of materials and components often win orders for their products
by reducing a buyer’s raw-material waste (providing cut-to-size components), reducing a buyer’s
inventory requirements (providing just-in-time deliveries), using online systems to reduce a buyer’s
procurement and order processing costs, and providing free technical support. This route to differentiation
can also appeal to individual consumers who are looking to economize on their overall costs of
consumption. Making a company’s product more economical for a consumer to use can be done by
incorporating energy-efficient features (energy-saving appliances and lightbulbs help cut buyers’ utility
bills; fuel-efficient vehicles cut buyer costs for gasoline) and/or by increasing maintenance intervals and
product reliability to lower buyer costs for maintenance and repairs.
A second route is to incorporate tangible features that increase customer satisfaction with the product,
such as product specifications, functions, and styling. This can be accomplished by including attributes
that add functionality; enhance the design; save time for the user; are more reliable; or make the product
cleaner, safer, quieter, simpler to use, more portable, more convenient, or longer-lasting than rival brands.
Smartphone manufacturers are in a race to introduce next-generation devices capable of being used for
more purposes and having simpler menu functionality.
A third route to a differentiation-based competitive advantage is to incorporate intangible features that
enhance buyer satisfaction in noneconomic ways. Toyota’s Prius and GM’s Chevy Bolt appeal to
environmentally conscious motorists not only because these drivers want to help reduce global carbon
dioxide emissions but also because they identify with the image conveyed. Bentley, Ralph Lauren, Louis
Vuitton, Burberry, Cartier, and Coach have differentiation-based competitive advantages linked to buyer
desires for status, image, prestige, upscale fashion, superior craftsmanship, and the finer things in life.
Intangibles that contribute to differentiation can extend beyond product attributes to the reputation of the
company and to customer relations or trust.
Differentiation can
be based on
tangible or intangible
attributes.
The fourth route is to signal the value of the company’s product offering to buyers. The value of certain
differentiating features is rather easy for buyers to detect, but in some instances buyers may have trouble
assessing what their experience with the product will be. Successful differentiators go to great lengths to
make buyers knowledgeable about a product’s value and employ various signals of value. Typical signals
of value include a high price (in instances where high price implies high quality and performance), more
appealing or fancier packaging than competing products, ad content that emphasizes a product’s standout
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attributes, the quality of brochures and sales presentations, and the luxuriousness and ambience of a
seller’s facilities. The nature of a company’s facilities are important for high-end retailers and other types
of companies whose facilities are frequented by customers; they make potential buyers aware of the
professionalism, appearance, and personalities of the seller’s employees and/or make
potential buyers realize that a company has prestigious customers. Signaling value is
particularly important (1) when the nature of differentiation is based on intangible features and is
therefore subjective or hard to quantify, (2) when buyers are making a first-time purchase and are unsure
what their experience with the product will be, (3) when repurchase is infrequent, and (4) when buyers are
unsophisticated.
Regardless of the approach taken, achieving a successful differentiation strategy requires, first, that the
company have capabilities in areas such as customer service, marketing, brand management, and
technology that can create and support differentiation. That is, the resources, competencies, and value
chain activities of the company must be well matched to the requirements of the strategy. For the strategy
to result in competitive advantage, the company’s competencies must also be sufficiently unique in
delivering value to buyers that they help set its product offering apart from those of rivals. They must be
competitively superior. There are numerous examples of companies that have differentiated themselves
on the basis of distinctive capabilities. Health care facilities like M.D. Anderson, Mayo Clinic, and
Cleveland Clinic have specialized expertise and equipment for treating certain diseases that most
hospitals and health care providers cannot afford to emulate. When a major news event occurs, many
people turn to Fox News and CNN because they have the capabilities to get reporters on the scene
quickly, break away from their regular programming (without suffering a loss of advertising revenues
associated with regular programming), and devote extensive air time to newsworthy stories.
The most successful approaches to differentiation are those that are difficult for rivals to duplicate.
Indeed, this is the route to a sustainable competitive advantage based on differentiation. While resourceful
competitors can, in time, clone almost any tangible product attribute, socially complex intangible
attributes such as company reputation, long-standing relationships with buyers, and image are much
harder to imitate. Differentiation that creates switching costs that lock in buyers also provides a route to
sustainable advantage. For example, if a buyer makes a substantial investment in learning to use one type
of system, that buyer is less likely to switch to a competitor’s system. (This has kept many users from
switching away from Microsoft Office products, despite the fact that there are other applications with
superior features.) As a rule, differentiation yields a longer-lasting and more profitable competitive edge
when it is based on a well-established brand image, patent-protected product innovation, complex
technical superiority, a reputation for superior product quality and reliability, relationship-based customer
service, and unique competitive capabilities.
Easy-to-copy
differentiating
features cannot
produce sustainable
competitive
advantage.
When a Differentiation Strategy Works Best
Differentiation strategies tend to work best in market circumstances where
Buyer needs and uses of the product are diverse. Diverse buyer preferences allow industry rivals to set
themselves apart with product attributes that appeal to particular buyers. For instance, the diversity of
consumer preferences for menu selection, ambience, pricing, and customer service gives restaurants
exceptionally wide latitude in creating a differentiated product offering. Other industries with diverse
buyer needs include magazine publishing, automobile manufacturing, footwear, and kitchen appliances.
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There are many ways to differentiate the product or service that have value to buyers. Industries in
which competitors have opportunities to add features to products and services are well suited
to differentiation strategies. For example, hotel chains can differentiate on such features as
location, size of room, range of guest services, in-hotel dining, and the quality and luxuriousness of
bedding and furnishings. Similarly, cosmetics producers are able to differentiate based on prestige and
image, formulations that fight the signs of aging, UV light protection, exclusivity of retail locations, the
inclusion of antioxidants and natural ingredients, or prohibitions against animal testing. Basic
commodities, such as chemicals, mineral deposits, and agricultural products, provide few opportunities
for differentiation.
Few rival firms are following a similar differentiation approach. The best differentiation approaches
involve trying to appeal to buyers on the basis of attributes that rivals are not emphasizing. A
differentiator encounters less head-to-head rivalry when it goes its own separate way in creating value
and does not try to out-differentiate rivals on the very same attributes. When many rivals base their
differentiation efforts on the same attributes, the most likely result is weak brand differentiation and
“strategy overcrowding”—competitors end up chasing much the same buyers with much the same
product offerings.
Technological change is fast-paced and competition revolves around rapidly evolving product features.
Rapid product innovation and frequent introductions of next-version products heighten buyer interest
and provide space for companies to pursue distinct differentiating paths. In smartphones and wearable
Internet devices, drones for hobbyists and commercial use, automobile lane detection sensors, and
battery-powered cars, rivals are locked into an ongoing battle to set themselves apart by introducing the
best next-generation products. Companies that fail to come up with new and improved products and
distinctive performance features quickly lose out in the marketplace.
Pitfalls to Avoid in Pursuing a Differentiation Strategy
Differentiation strategies can fail for any of several reasons. A differentiation strategy keyed to product or
service attributes that are easily and quickly copied is always suspect. Rapid imitation means that no rival
achieves differentiation, since whenever one firm introduces some value-creating aspect that strikes the
fancy of buyers, fast-following copycats quickly reestablish parity. This is why a firm must seek out
sources of value creation that are time-consuming or burdensome for rivals to match if it hopes to use
differentiation to win a sustainable competitive edge.
Any differentiating
feature that works
well is a magnet for
imitators.
Differentiation strategies can also falter when buyers see little value in the unique attributes of a
company’s product. Thus, even if a company succeeds in setting its product apart from those of rivals, its
strategy can result in disappointing sales and profits if the product does not deliver adequate perceived
value to buyers. Anytime many potential buyers look at a company’s differentiated product offering with
indifference, the company’s differentiation strategy is in deep trouble.
The third big pitfall is overspending on efforts to differentiate the company’s product offering, thus
eroding profitability. Company efforts to achieve differentiation nearly always raise costs—often
substantially, since marketing and R&D are expensive undertakings. The key to profitable differentiation
is either to keep the unit cost of achieving differentiation below the price premium that the differentiating
attributes can command (thus increasing the profit margin per unit sold) or to offset thinner profit margins
per unit by selling enough additional units to increase total profits. If a company goes overboard in
pursuing costly differentiation, it could be saddled with unacceptably low profits or even losses.
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Other common mistakes in crafting a differentiation strategy include
Offering only trivial improvements in quality, service, or performance features vis-à-vis rivals’
products. Trivial differences between rivals’ product offerings may not be visible or important to
buyers. If a company wants to generate the fiercely loyal customer following needed to earn superior
profits and open up a differentiation-based competitive advantage over rivals, then its strategy must
result in strong rather than weak product differentiation. In markets where differentiators do no better
than achieve weak product differentiation, customer loyalty is weak, the costs of brand switching are
low, and no one company has enough of a differentiation edge to command a price premium over rival
brands.
Over-differentiating so that product quality, features, or service levels exceed the needs of most buyers.
A dazzling array of features and options not only drives up product price but also runs the risk that
many buyers will conclude that a less deluxe and lower-priced brand is a better value since they have
little occasion to use the deluxe attributes.
Charging too high a price premium. While buyers may be intrigued by a product’s deluxe features, they
may nonetheless see it as being overpriced relative to the value delivered by the differentiating
attributes. A company must guard against turning off would-be buyers with what is perceived as “price
gouging.” Normally, the bigger the price premium for the differentiating extras, the harder it is to keep
buyers from switching to the lower-priced offerings of competitors.
Over-differentiating
and overcharging
are fatal
differentiation
strategy mistakes. A
low-cost strategy
can defeat a
differentiation
strategy when
buyers are satisfied
with a basic product
and don’t think
“extra” attributes are
worth a higher price.
FOCUSED (OR MARKET NICHE) STRATEGIES
What sets focused strategies apart from broad low-cost and broad differentiation strategies is concentrated
attention on a narrow piece of the total market. The target segment, or niche, can be in the form of a
geographic segment (such as New England), or a customer segment (such as young urban creatives or
“yuccies”), or a product segment (such as a class of models or some version of the overall product type).
Community Coffee, the largest family-owned specialty coffee retailer in the United States, has a
geographic focus on the state of Louisiana and communities across the Gulf of Mexico. Community holds
only a small share of the national coffee market but has recorded sales in excess of $100 million and has
won a strong following in the Southeastern United States. Examples of firms that concentrate on a well-
defined market niche keyed to a particular product or buyer segment include Zipcar (hourly and daily car
rental in urban areas), Airbnb and HomeAway (owner of VRBO) (by-owner lodging rental), Fox News
Channel and HGTV (cable TV), Blue Nile (online jewelry), Tesla Motors (electric cars), and CGA, Inc. (a
specialist in providing insurance to cover the cost of lucrative hole-in-one prizes at golf tournaments).
Microbreweries, local bakeries, bed-and-breakfast inns, and retail boutiques have also scaled their
operations to serve narrow or local customer segments.
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A Focused Low-Cost Strategy
A focused low-cost strategy aims at securing a competitive advantage by serving buyers in the target
market niche at a lower cost (and usually lower price) than those of rival competitors. This strategy has
considerable attraction when a firm can lower costs significantly by limiting its customer base to a well-
defined buyer segment. The avenues to achieving a cost advantage over rivals also serving the target
market niche are the same as those for broad low-cost leadership—use the cost drivers to perform value
chain activities more efficiently than rivals and search for innovative ways to bypass
nonessential value chain activities. The only real difference between a broad low-cost strategy
and a focused low-cost strategy is the size of the buyer group to which a company is appealing—the
former involves a product offering that appeals to almost all buyer groups and market segments, whereas
the latter aims at just meeting the needs of buyers in a narrow market segment.
ILLUSTRATION
CAPSULE 5.2 Clinícas del Azúcar’s Focused Low-Cost
Strategy
Though diabetes is a manageable condition, it is the leading cause of death in Mexico. Over 14 million adults (14 percent of
all adults) suffer from diabetes, 3.5 million cases remain undiagnosed, and more than 80,000 die due to related
complications each year. The key driver behind this public health crisis is limited access to affordable, high-quality care.
Approximately 90 percent of the population cannot access diabetes care due to financial and time constraints; private care
can cost upwards of $1,000 USD per year (approximately 45 percent of Mexico’s population has an annual income less
than $2,000 USD) while average wait times alone at public clinics surpass five hours. Clinícas del Azúcar (CDA), however,
is quickly scaling a solution that uses a focused low-cost strategy to provide affordable and convenient care to low-income
patients.
By relentlessly focusing only on the needs of its target population, CDA has reduced the cost of diabetes care by more
than 70 percent and clinic visit times by over 80 percent. The key has been the use of proprietary technology and a
streamlined care system. First, CDA leverages evidence-based algorithms to diagnose patients for a fraction of the costs of
traditional diagnostic tests. Similarly, its mobile outreach significantly reduces the costs of supporting patients in managing
their diabetes after leaving CDA facilities. Second, CDA has redesigned the care process to implement a streamlined
“patient process flow” that eliminates the need for multiple referrals to other care providers and brings together the
necessary professionals and equipment into one facility. Consequently, CDA has become a one-stop shop for diabetes
care, providing every aspect of diabetes treatment under one roof.
Rob Marmion/Shutterstock
The bottom line: CDA’s cost structure allows it to keep its prices for diabetes treatment very low, saving patients both time
and money. Patients choose from three different care packages, ranging from preventive to comprehensive care, paying an
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annual fee that runs between approximately $70 and $200 USD. Given this increase in affordability and convenience, CDA
estimates that it has saved its patients over $2 million USD in medical costs and will soon increase access to affordable,
high-quality care for 10 to 80 percent of the population. These results have attracted investment from major funders
including Endeavor, Echoing Green, and the Clinton Global Initiative. As a result, CDA and others expect CDA to grow from
five clinics serving approximately 5,000 patients to more than 50 clinics serving over 100,000 patients throughout Mexico by
2020.
Note: Developed with David B. Washer.
Sources: www.clinicasdelazucar.com; “Funding Social Enterprises Report,” Echoing Green, June 2014; Jude Webber,
“Mexico Sees Poverty Climb Despite Rise in Incomes,” Financial Times online, July 2015,
www.ft.com/intl/cms/s/3/98460bbc-31e1-11e5-8873-775ba7c2ea3d.html#axzz3zz8grtec; “Javier Lozano,” Schwab
Foundation for Social Entrepreneurship online, 2016, www.schwabfound.org/content/javier-lozano.
Budget motel chains, like Motel 6, Sleep Inn, and Super 8, cater to price-conscious travelers who just
want to pay for a clean, no-frills place to spend the night. Illustration Capsule 5.2 describes how Clinícas
del Azúcar’s focus on lowering the costs of diabetes care is allowing it to address a major health issue in
Mexico.
Focused low-cost strategies are fairly common. Costco, BJ’s, and Sam’s Club sell large
lots of goods at wholesale prices to small businesses and bargain-hunters. Producers of private-label
goods are able to achieve low costs in product development, marketing, distribution, and advertising by
concentrating on making generic items imitative of name-brand merchandise and selling directly to retail
chains wanting a low-priced store brand. The Perrigo Company Plc has become a leading manufacturer of
over-the-counter health care products and self-care, with 2018 sales of nearly $5 billion, by focusing on
producing private-label brands for retailers such as Walmart, CVS, Walgreens, Rite Aid, and Safeway.
A Focused Differentiation Strategy
Focused differentiation strategies involve offering superior products or services tailored to the unique
preferences and needs of a narrow, well-defined group of buyers. Successful use of a focused
differentiation strategy depends on (1) the existence of a buyer segment that is looking for special product
or service attributes and (2) a firm’s ability to create a product or service offering that stands apart from
that of rivals competing in the same target market niche.
Companies like Molton Brown in bath, body, and beauty products, Bugatti in high-performance
automobiles, and Four Seasons Hotels in lodging employ successful differentiation-based focused
strategies targeted at upscale buyers wanting products and services with world-class attributes. Indeed,
most markets contain a buyer segment willing to pay a big price premium for the very finest items
available, thus opening the strategic window for some competitors to pursue differentiation-based focused
strategies aimed at the very top of the market pyramid. Whole Foods Market, which was acquired by
Amazon in 2017, became the largest organic and natural foods supermarket chain in the United States by
catering to health-conscious consumers who prefer organic, natural, minimally processed, and locally
grown foods. Whole Foods prides itself on stocking the highest-quality organic and natural foods it can
find; the company defines quality by evaluating the ingredients, freshness, taste, nutritive value,
appearance, and safety of the products it carries. Illustration Capsule 5.3 describes how Canada Goose has
become a popular winter apparel brand with a focused differentiation strategy.
When a Focused Low-Cost or Focused Differentiation Strategy Is
Attractive
A focused strategy aimed at securing a competitive edge based on either low costs or differentiation
becomes increasingly attractive as more of the following conditions are met:
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http://www.ft.com/intl/cms/s/3/98460bbc-31e1-11e5-8873-775ba7c2ea3d.html#axzz3zz8grtec
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The target market niche is big enough to be profitable and offers good growth potential.
Industry leaders have chosen not to compete in the niche—in which case focusers can avoid battling
head to head against the industry’s biggest and strongest competitors.
It is costly or difficult for multisegment competitors to meet the specialized needs of niche buyers and
at the same time satisfy the expectations of their mainstream customers.
The industry has many different niches and segments, thereby allowing a focuser to pick the niche best
suited to its resources and capabilities. Also, with more niches there is room for focusers to concentrate
on different market segments and avoid competing in the same niche for the same customers.
Few if any rivals are attempting to specialize in the same target segment—a condition that reduces the
risk of segment overcrowding.
ILLUSTRATION
CAPSULE 5.3 Canada Goose’s Focused Differentiation
Strategy
Open up a winter edition of People and you will probably see photos of a celebrity sporting a Canada Goose parka.
Recognizable by a distinctive red, white, and blue arm patch, the brand’s parkas have been spotted on movie stars like
Emma Stone and Bradley Cooper, on New York City streets, and on the cover of Sports Illustrated. Lately, Canada Goose
has become extremely successful thanks to a focused differentiation strategy that enables it to thrive within its niche in the
$1.2 trillion fashion industry. By targeting upscale buyers and providing a uniquely functional and stylish jacket, Canada
Goose can charge nearly $1,000 per jacket and never need to put its products on sale.
While Canada Goose was founded in 1957, its recent transition to a focused differentiation strategy allowed it to rise to
the top of the luxury parka market. In 2001, CEO Dani Reiss took control of the company and made two key decisions.
First, he cut private-label and non-outerwear production in order to focus on the branded outerwear portion of Canada
Goose’s business. Second, Reiss decided to remain in Canada despite many North American competitors moving
production to Asia to increase profit margins. Fortunately for him, these two strategy decisions have led directly to the
company’s current success. While other luxury brands, like Moncler, are priced similarly, no competitor’s products fulfill the
promise of handling harsh winter weather quite like a Canada Goose “Made in Canada” parka. The Canadian heritage, use
of down sourced from rural Canada, real coyote fur (humanely trapped), and promise to provide warmth in sub-25°F
temperatures have let Canada Goose break away from the pack when it comes to selling parkas. The company’s distinctly
Canadian product has made it a hit among buyers, which is reflected in the willingness to pay a steep premium for
extremely high-quality and warm winter outerwear.
Galit Rodan/Bloomberg/Getty Images
Since Canada Goose’s shift to a focused differentiation strategy, the company has seen a boom in revenue and appeal
across the globe. Prior to Reiss’s strategic decisions in 2001, Canada Goose had annual revenue of about $3 million.
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Within a decade, the company had experienced over 4,000 percent growth in annual revenue; by the end of 2019,
revenues from purchases in more than 50 countries had exceeded $830 million. At this pace, it looks like Canada Goose
will remain a hot commodity as long as winter temperatures remain cold.
Note: Developed with Arthur J. Santry.
Sources: Drake Bennett, “How Canada Goose Parkas Migrated South,” Bloomberg Businessweek, March 13, 2015,
www.bloomberg.com; Hollie Shaw, “Canada Goose’s Made-in-Canada Marketing Strategy Translates into Success,”
Financial Post, May 18, 2012, www.financialpost.com; “The Economic Impact of the Fashion Industry,” The Economist,
June 13, 2015, www.maloney.house.gov; and company website (accessed January 26, 2020).
The advantages of focusing a company’s entire competitive effort on a single market niche are
considerable, especially for smaller and medium-sized companies that may lack the breadth and depth of
resources to tackle going after a broader customer base with a more complex set of needs. YouTube
became a household name by concentrating on short video clips posted online. Papa John’s, Little
Caesars, and Domino’s Pizza have created impressive businesses by focusing on the home delivery
segment.
The Risks of a Focused Low-Cost or Focused Differentiation
Strategy
Focusing carries several risks. One is the chance that competitors outside the niche will find effective
ways to match the focused firm’s capabilities in serving the target niche—perhaps by coming up with
products or brands specifically designed to appeal to buyers in the target niche or by developing expertise
and capabilities that offset the focuser’s strengths. In the lodging business, large chains like Marriott and
Hilton have launched multibrand strategies that allow them to compete effectively in several lodging
segments simultaneously. Hilton has flagship hotels with a full complement of services and amenities that
allow it to attract travelers and vacationers going to major resorts; it has Waldorf Astoria, Conrad Hotels
& Resorts, Hilton Hotels & Resorts, and DoubleTree hotels that provide deluxe comfort and service to
business and leisure travelers; it has Homewood Suites, Embassy Suites, and Home2 Suites designed as a
“home away from home” for travelers staying five or more nights; and it has nearly 700 Hilton Garden
Inn and 2,100 Hampton by Hilton locations that cater to travelers looking for quality lodging at an
“affordable” price. Tru by Hilton is the company’s newly introduced brand focused on value-conscious
travelers seeking basic accommodations. Hilton has also added Curio Collection, Tapestry Collection, and
Canopy by Hilton hotels that offer stylish, distinctive decors and personalized services that appeal to
young professionals seeking distinctive lodging alternatives. Multibrand strategies are attractive to large
companies such as Hilton precisely because they enable a company to enter a market niche and siphon
business away from companies that employ a focus strategy.
A second risk of employing a focused strategy is the potential for the preferences and needs of niche
members to shift over time toward the product attributes desired by buyers in the mainstream portion of
the market. An erosion of the differences across buyer segments lowers entry barriers into a focuser’s
market niche and provides an open invitation for rivals in adjacent segments to begin competing for the
focuser’s customers. A third risk is that the segment may become so attractive that it is soon inundated
with competitors, intensifying rivalry and splintering segment profits. And there is always the risk for
segment growth to slow to such a small rate that a focuser’s prospects for future sales and profit gains
become unacceptably dim.
BEST-COST (HYBRID) STRATEGIES
To profitably employ a best-cost strategy, a company must have the capability to incorporate upscale
attributes into its product offering at a lower cost than rivals. When a company can incorporate more
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appealing features, good to excellent product performance or quality, or more satisfying customer service
into its product offering at a lower cost than rivals, then it enjoys “best-cost” status—it is the low-cost
provider of a product or service with upscale attributes. A best-cost producer can use its low-cost
advantage to underprice rivals whose products or services have similarly upscale attributes and still earn
attractive profits. As Figure 5.1 indicates, best-cost strategies are a hybrid of low-cost and differentiation
strategies, incorporating features of both simultaneously. They may address either a broad or narrow
(focused) customer base. This permits companies to aim squarely at the sometimes great mass of value-
conscious buyers looking for a better product or service at a somewhat lower price. Value-conscious
buyers frequently shy away from both cheap low-end products and expensive high-end
products, but they are quite willing to pay a “fair” price for extra features and functionality they
find appealing and useful. The essence of a best-cost strategy is giving customers more value for the
money by satisfying buyer desires for appealing features and charging a lower price for these attributes
compared to rivals with similar-caliber product offerings.6
CORE
CONCEPT
Best-cost
strategies are a
hybrid of low-cost
and differentiation
strategies,
incorporating
features of both
simultaneously.
A best-cost strategy is different from a low-cost strategy because the additional attractive attributes
entail additional costs (which a low-cost producer can avoid by offering buyers a basic product with few
frills). Moreover, the two strategies aim at a distinguishably different market target. The target market for
a best-cost producer is value-conscious buyers—buyers who are looking for appealing extras and
functionality at a comparatively low price, regardless of whether they represent a broad or more focused
segment of the market. Value-hunting buyers (as distinct from price-conscious buyers looking for a basic
product at a bargain-basement price) often constitute a very sizable part of the overall market for a
product or service. A best-cost strategy differs from a differentiation strategy because it entails the ability
to produce upscale features at a lower cost than other high-end producers. This implies the ability to
profitably offer the buyer more value for the money.
Best-cost producers need not offer the highest end products and services (although they may); often the
quality levels are simply better than average. Positioning of this sort permits companies to aim squarely at
the sometimes great mass of value-conscious buyers looking for a better product or service at an
economical price. Value-conscious buyers frequently shy away from both cheap low-end products and
expensive high-end products, but they are quite willing to pay a “fair” price for extra features and
functionality they find appealing and useful. The essence of a best-cost strategy is the ability to provide
more value for the money by satisfying buyer desires for better quality while charging a lower price
compared to rivals with similar-caliber product offerings.
Toyota has employed a classic best-cost strategy for its Lexus line of motor vehicles. It has designed an
array of high-performance characteristics and upscale features into its Lexus models to make them
comparable in performance and luxury to Mercedes, BMW, Audi, Jaguar, Cadillac, and Lincoln models.
To signal its positioning in the luxury market segment, Toyota established a network of Lexus dealers,
separate from Toyota dealers, dedicated to providing exceptional customer service. Most important,
though, Toyota has drawn on its considerable know-how in making high-quality vehicles at low cost to
produce its high-tech upscale-quality Lexus models at substantially lower costs than other luxury vehicle
makers have been able to achieve in producing their models. To capitalize on its lower manufacturing
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costs, Toyota prices its Lexus models below those of comparable Mercedes, BMW, Audi, and Jaguar
models to induce value-conscious luxury car buyers to purchase a Lexus instead. The price differential
has typically been quite significant. For example, in 2017, a well-equipped Lexus RX 350 (a midsized
SUV) had a sticker price of $54,370, whereas the sticker price of a comparably equipped Mercedes GLE-
class SUV was $62,770 and the sticker price of a comparably equipped BMW X5 SUV was $66,670.
When a Best-Cost Strategy Works Best
• LO 5-4
Explain the
attributes of a best-
cost strategy—a
hybrid of low-cost
and differentiation
strategies.
A best-cost strategy works best in markets where product differentiation is the norm and an attractively
large number of value-conscious buyers can be induced to purchase midrange products rather than cheap,
basic products or expensive, top-of-the-line products. In markets such as these, a best-cost producer needs
to position itself near the middle of the market with either a medium-quality product at a below-
average price or a high-quality product at an average or slightly higher price. But as the Lexus
example shows, a firm with the capabilities to produce top-of-the-line products more efficiently than its
rivals, would also do well to pursue a best-cost strategy. Best-cost strategies also work well in
recessionary times, when masses of buyers become more value-conscious and are attracted to
economically priced products and services with more appealing attributes. However, unless a company
has the resources, know-how, and capabilities to incorporate upscale product or service attributes at a
lower cost than rivals, adopting a best-cost strategy is ill-advised. Illustration Capsule 5.4 describes how
Trader Joe’s has applied the principles of a focused best-cost strategy to thrive in the competitive grocery
store industry.
ILLUSTRATION
CAPSULE 5.4 Trader Joe’s Focused Best-Cost Strategy
Over the last 50 years, Trader Joe’s has built a cult-like following by offering a limited selection of highly popular private-
label products at great prices, under the Trader Joe’s brand. By pursuing a focused best-cost strategy, Trader Joe’s has
been able to thrive in the notoriously low-margin grocery business. Today, Trader Joe’s earns over $2,000 of annual sales
per square foot— nearly double that of Whole Foods.
One key to Trader Joe’s success, and a major part of its strategy, is its unique approach to product selection. By selling
mainly private label goods under its own brand, Trader Joe’s keeps its costs low, enabling it to offer lower prices. By being
very selective about the particular products that it carries, it has also managed to ensure that its brand is associated with
very high quality. The company’s policy is to swiftly replace any product that does not prove popular with another more
appealing product. This has paid off: when you ask U.S. consumers which grocery store represents quality, Trader Joe’s
tops the list. On a recent YouGov Brand Index poll, nearly 40 percent of consumers ranked Trader Joe’s best for quality—
the highest among its competitors. While Trader Joe’s offers far fewer stock-keeping units (SKUs) than a typical grocery
store—only 4,000 SKUs as compared to 50,000 + in a Kroger or Safeway—the upside for customers is that this also helps
to keep costs and prices low. It results in higher inventory turns (a key measure of efficiency in retail), lower inventory costs,
and lower rents since stores in any given location can be smaller.
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Ken Wolter/Shutterstock
Trader Joe’s also intentionally locates its stores in areas with value-focused customers who appreciate quality. Trader
Joe’s identifies potential sites for expansion by evaluating demographic information. This enables Trader Joe’s to focus on
serving young educated singles and couples who may not be able to afford more expensive groceries but prefer organics
and ready-to-eat products. Given that it occupies smaller sized retail spaces, Trader Joe’s can locate in walkable areas and
urban centers, the very same neighborhoods in which its chosen customer base lives. Because of its focused best-cost
strategy, it is unlikely that the company’s loyal customers will quit lining up to buy its tasty corn salsa or organic cold brew
coffee any time soon.
Note: Developed with Stephanie K. Berger.
Sources: Company website; Beth Kowitt, “Inside the Secret World of Trader Joe’s,” Fortune (August 2010); Elain Watson,
“Quirky, Cult-life, Aspirational, but Affordable: The Rise and Rise of Trader Joes,” Food Navigator USA (April 2014; Janie
Ryan, “The Surprising Secrets Behind Trader Joe’s Supply Chain”, Elementum.com, (December 13, 2018).
The Risk of a Best-Cost Strategy
A company’s biggest vulnerability in employing a best-cost strategy is getting squeezed between the
strategies of firms using low-cost and high-end differentiation strategies. Low-cost producers may be able
to siphon customers away with the appeal of a lower price (despite less appealing product attributes).
High-end differentiators may be able to steal customers away with the appeal of better product attributes
(even though their products carry a higher price tag). Thus, to be successful, a firm employing a best-cost
strategy must achieve significantly lower costs in providing upscale features so that it can outcompete
high-end differentiators on the basis of a significantly lower price. Likewise, it must offer buyers
significantly better product attributes to justify a price above what low-cost leaders are charging. In other
words, it must offer buyers a more attractive customer value proposition.
THE CONTRASTING FEATURES OF THE GENERIC
COMPETITIVE STRATEGIES
Deciding which generic competitive strategy should serve as the framework on which to hang the rest of
the company’s strategy is not a trivial matter. Each of the five generic competitive strategies positions the
company differently in its market and competitive environment. Each establishes a central theme for how
the company will endeavor to outcompete rivals. Each creates some boundaries or guidelines for
http://elementum.com/
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maneuvering as market circumstances unfold and as ideas for improving the strategy are debated. Each
entails differences in terms of product line, production emphasis, marketing emphasis, and means of
maintaining the strategy, as shown in Table 5.1.
A company’s
competitive strategy
should be well
matched to its
internal situation and
predicated on
leveraging its
collection of
competitively
valuable resources
and capabilities.
Thus, a choice of which generic strategy to employ spills over to affect many aspects of how the
business will be operated and the manner in which value chain activities must be managed. Deciding
which generic strategy to employ is perhaps the most important strategic commitment a company makes
—it tends to drive the rest of the strategic actions a company decides to undertake.
Successful Generic Strategies Are Resource-Based
For a company’s competitive strategy to succeed in delivering good performance and gain a competitive
edge over rivals, it has to be well matched to a company’s internal situation and underpinned by an
appropriate set of resources, know-how, and competitive capabilities. To succeed in employing a low-cost
strategy, a company must have the resources and capabilities to keep its costs below those of its
competitors. This means having the expertise to cost-effectively manage value chain activities better than
rivals by leveraging the cost drivers more effectively, and/or having the innovative capability to bypass
certain value chain activities being performed by rivals. To succeed in a differentiation strategy, a
company must have the resources and capabilities to leverage value drivers more effectively than rivals
and incorporate attributes into its product offering that a broad range of buyers will find appealing.
Successful focus strategies (both low cost and differentiation) require the capability to do an outstanding
job of satisfying the needs and expectations of niche buyers. Success in employing a best-cost strategy
requires the resources and capabilities to incorporate upscale product or service attributes at a lower cost
than rivals. For all types of generic strategies, success in sustaining the competitive edge depends on
having resources and capabilities that rivals have trouble duplicating and for which there are no good
substitutes.
TABLE 5.1 Distinguishing Features of the Five Generic Competitive Strategies
Broad Low-Cost BroadDifferentiation Focused Low-Cost
Focused
Differentiation Best-Cost
Strategic
target
A broad
cross-
section of
the market.
A broad
cross-section
of the
market.
A narrow
market niche
where buyer
needs and
preferences
are
distinctively
different.
A narrow
market niche
where buyer
needs and
preferences
are
distinctively
different.
A broad or narrow
range of value-
conscious buyers.
Broad Low-Cost BroadDifferentiation Focused Low-Cost
Focused
Differentiation Best-Cost
Basis of
competitive
strategy
Lower
overall
costs than
competitors.
Ability to
offer buyers
something
attractively
different from
competitors’
offerings.
Lower overall
cost than
rivals in
serving niche
members.
Attributes that
appeal
specifically to
niche
members.
Ability to
incorporate upscale
features and
attributes at lower
costs than rivals.
Product
line
A good
basic
product with
few frills
(acceptable
quality and
limited
selection).
Many
product
variations,
wide
selection;
emphasis on
differentiating
features.
Features and
attributes
tailored to the
tastes and
requirements
of niche
members.
Features and
attributes
tailored to the
tastes and
requirements
of niche
members.
Items with
appealing attributes
and assorted
features; better
quality, not
necessarily best.
Production
emphasis
A
continuous
search for
cost
reduction
without
sacrificing
acceptable
quality and
essential
features.
Build in
whatever
differentiating
features
buyers are
willing to pay
for; strive for
product
superiority.
A continuous
search for
cost
reduction for
products that
meet basic
needs of
niche
members.
Small-scale
production or
custom-made
products that
match the
tastes and
requirements
of niche
members.
Build in appealing
features and better
quality at lower cost
than rivals.
Marketing
emphasis
Low prices,
good value.
Try to make
a virtue out
of product
features
that lead to
low cost.
Tout
differentiating
features.
Charge a
premium
price to
cover the
extra costs of
differentiating
features.
Communicate
attractive
features of a
budget-priced
product
offering that
fits niche
buyers’
expectations.
Communicate
how product
offering does
the best job
of meeting
niche buyers’
expectations.
Emphasize delivery
of best value for the
money.
Keys to
maintaining
the
strategy
Strive to
manage
costs down,
year after
year, in
every area
of the
business.
Stress
continuous
improvement
in products
or services
and constant
innovation to
stay ahead
of imitative
competitors.
Stay
committed to
serving the
niche at the
lowest overall
cost; don’t
blur the firm’s
image by
entering other
market
segments or
adding other
products to
widen market
appeal.
Stay
committed to
serving the
niche better
than rivals;
don’t blur the
firm’s image
by entering
other market
segments or
adding other
products to
widen market
appeal.
Stress continuous
improvement in
products or
services and
constant innovation,
along with
continuous efforts
to improve
efficiency.
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Broad Low-Cost BroadDifferentiation Focused Low-Cost
Focused
Differentiation Best-Cost
Resources
and
capabilities
required
Capabilities
for driving
costs out of
the value
chain
system.
Examples:
large-scale
automated
plants, an
efficiency-
oriented
culture,
bargaining
power.
Capabilities
concerning
quality,
design,
intangibles,
and
innovation.
Examples:
marketing
capabilities,
R&D teams,
technology.
Capabilities
to lower costs
on niche
goods.
Examples:
lower input
costs for the
specific
product
desired by
the niche,
batch
production
capabilities.
Capabilities
to meet the
highly
specific
needs of
niche
members.
Examples:
custom
production,
close
customer
relations.
Capabilities to
simultaneously
deliver lower cost
and higher-
quality/differentiated
features.
Examples: TQM
practices, mass
customization.
Generic Strategies and the Three Different Approaches to
Competitive Advantage
Just as a company’s resources and capabilities underlie its choice of generic strategy, its generic strategy
determines its approach to gaining a competitive advantage. There are three such approaches. Clearly,
low-cost strategies aim for a cost advantage over rivals, differentiation strategies strive to create relatively
more perceived value for consumers, while best-cost strategies aim to do better than the average rival on
both dimensions. Whether the strategy is broad based or focused makes no difference as to the basic
approach employed (see Figure 5.1).
Exactly how this works is best understood with the use of the value-price-cost framework, first
introduced in Chapter 1 in the context of different kinds of business models. Figure 5.4 illustrates the
three basic approaches to competitive advantage in terms of the value-price-cost framework. The left
figure in the diagram represents an average competitor’s cost (C) of producing a good, how highly the
customer values it (V), and its price (P). The difference between the good’s value to the customer (V) and
its cost (C) is the total economic value (V-C) produced by the average competitor. And as explained in
Chapter 4, a company has a competitive advantage over another if its strategy generates more total
economic value. It is this excess in total economic value over rivals that allows the company to offer
customers a better value proposition or earn larger profits (or both). The dashed yellow lines facilitate a
comparison of the average competitor’s costs (C) and perceived value (V) with the costs and value
produced by each of the three basic types of generic strategies (low cost, differentiation, best cost). In this
way, it also facilitates a comparison of the total economic value generated by each of the three
representative generic strategies in relation to the average competitor, thereby shedding light on the nature
of each strategy’s competitive advantage.
FIGURE 5.4 Three Approaches to Competitive Advantage and the Value-Price-Cost
Framework
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As Figure 5.4 shows, a low-cost generic strategy aims to achieve lower costs than an
average competitor, at the sacrifice of some of the perceived value to the consumer. If the decrease in
costs is less than the decrease in perceived value, then the total economic value (V-C) for the low-cost
leader will be greater than the total economic value produced by its average rival and the low-cost leader
will have a competitive advantage. This is clearly the case for the example of a low-cost strategy depicted
in Figure 5.4. As is common with low-cost strategies, the example company has chosen to charge a lower
price than its average rival. The result is that even with a lower V, the low-cost leader offers the consumer
a more attractive (larger) consumer value proposition (depicted in mauve) and finds itself with a better
profit formula (depicted in blue).
In contrast, the example of a differentiation strategy shows that costs might well exceed those of the
average competitor. But with a successful differentiation strategy, that disadvantage is more than made up
for by the rise in the perceived value (V) of the differentiated good, giving the differentiator a clear
competitive advantage over the average rival (greater V-C). And while the price charged in this example
is a good deal higher in comparison with the average rival’s price, this differentiation strategy enables
both a larger consumer value proposition (in mauve) as well as greater profits (in blue).
The depiction of a best-cost strategy shows a company pursuing the middle ground of offering neither
the most highly valued goods in the market nor the lowest costs. But in comparison with the average
rival, it does better on both scores, resulting in more total economic value (V-C) and a substantial
competitive advantage. Once again, the example shows both a larger customer value proposition as well
as a more attractive profit formula.
The last thing to note is that the generic strategies depicted in Figure 5.4 are examples of successful
generic strategies. Being successful with a generic strategy depends on much more than positioning. It
depends on the competitive context (the company’s external situation) and on the company’s internal
situation, including its complement of resources and capabilities. Importantly, it also depends on how well
the strategy is executed—the topic of this text’s three concluding chapters.
KEY POINTS
1. Deciding which of the five generic competitive strategies to employ—broad low-cost, broad
differentiation, focused low-cost, focused differentiation, or best-cost—is perhaps the most important
strategic commitment a company makes. It tends to drive the remaining strategic actions a company
undertakes and sets the whole tone for pursuing a competitive advantage over rivals.
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LO 5-1, LO 5-2, LO
5-3, LO 5-4
2. In employing a broad low-cost strategy and trying to achieve a low-cost advantage over rivals, a
company must do a better job than rivals of cost-effectively managing value chain activities and/or it
must find innovative ways to eliminate cost-producing activities. An effective use of cost drivers is key.
Low-cost strategies work particularly well when price competition is strong and the products of rival
sellers are virtually identical, when there are not many ways to differentiate, when buyer switching
costs are low, and when buyers are price-sensitive or have the power to bargain down prices.
3. Broad differentiation strategies seek to produce a competitive edge by incorporating attributes that set a
company’s product or service offering apart from rivals in ways that buyers consider valuable and
worth paying for. This depends on the appropriate use of value drivers. Successful differentiation
allows a firm to (1) command a premium price for its product, (2) increase unit sales (if additional
buyers are won over by the differentiating features), and/or (3) gain buyer loyalty to its brand
(because some buyers are strongly attracted to the differentiating features and bond with the
company and its products). Differentiation strategies work best when buyers have diverse product
preferences, when few other rivals are pursuing a similar differentiation approach, and when
technological change is fast-paced and competition centers on rapidly evolving product features. A
differentiation strategy is doomed when competitors are able to quickly copy the appealing product
attributes, when a company’s differentiation efforts fail to interest many buyers, and when a company
overspends on efforts to differentiate its product offering or tries to overcharge for its differentiating
extras.
4. A focused strategy delivers competitive advantage either by achieving lower costs than rivals in
serving buyers constituting the target market niche or by developing a specialized ability to offer niche
buyers an appealingly differentiated offering that meets their needs better than rival brands do. A
focused strategy based on either low cost or differentiation becomes increasingly attractive when the
target market niche is big enough to be profitable and offers good growth potential, when it is costly or
difficult for multisegment competitors to meet the specialized needs of the target market niche and at
the same time satisfy the expectations of their mainstream customers, when there are one or more
niches that present a good match for a focuser’s resources and capabilities, and when few other rivals
are attempting to specialize in the same target segment.
5. Best-cost strategies create competitive advantage on the basis of their capability to incorporate
attractive or upscale attributes at a lower cost than rivals. Best-cost strategies can be either broad or
focused. A best-cost strategy works best in broad or narrow market segments with value-conscious
buyers desirous of purchasing better products and services for less money.
6. In all cases, competitive advantage depends on having competitively superior resources and capabilities
that are a good fit for the chosen generic strategy. A sustainable advantage depends on maintaining that
competitive superiority with resources, capabilities, and value chain activities that rivals have trouble
matching and for which there are no good substitutes.
ASSURANCE OF LEARNING EXERCISES
1. Best Buy is the largest consumer electronics retailer in the United States, with
fiscal 2019 sales of nearly $43 billion. The company competes aggressively on
price with such rivals as Costco, Sam’s Club, Walmart, and Target, but it is also
known by consumers for its first-rate customer service. Best Buy customers have
commented that the retailer’s sales staff is exceptionally knowledgeable about
the company’s products and can direct them to the exact location of difficult-to-
find items. Best Buy customers also appreciate that demonstration models of PC
monitors, digital media players, and other electronics are fully powered and
ready for in-store use. Best Buy’s Geek Squad tech support and installation
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LO 5-2
LO 5-1, LO 5-2, LO
5-3, LO 5-4
LO 5-3
LO 5-1, LO 5-2, LO
5-3, LO 5-4
services are additional customer service features that are valued by many
customers.
How would you characterize Best Buy’s competitive strategy? Should it be
classified as a low-cost strategy? A differentiation strategy? A best-cost strategy?
Also, has the company chosen to focus on a narrow piece of the market, or does
it appear to pursue a broad market approach? Explain your answer.
2. Illustration Capsule 5.1 discusses Vanguard’s position as the low-cost leader in
the investment management industry. Based on information provided in the
capsule, explain how Vanguard built its low-cost advantage in the industry and
why a low-cost strategy can succeed in the industry.
3. USAA is a Fortune 500 insurance and financial services company with 2018
annual sales exceeding $30 billion. The company was founded in 1922 by 25
Army officers who decided to insure each other’s vehicles and continues to limit
its membership to active-duty and retired military members, officer candidates,
and adult children and spouses of military-affiliated USAA members. The
company has received countless awards, including being listed among Fortune’s
World’s Most Admired Companies in 2014 through 2019 and 100 Best
Companies to Work For in 2010 through 2019. You can read more about the
company’s history and strategy at www.usaa.com.
How would you characterize USAA’s competitive strategy? Should it be
classified as a low-cost strategy? A differentiation strategy? A best-cost strategy?
Also, has the company chosen to focus on a narrow piece of the market, or does
it appear to pursue a broad market approach? Explain your answer.
4. Explore Kendra Scott’s website at www.kendrascott.com and see if you can
identify at least three ways in which the company seeks to differentiate itself
from rival jewelry firms. Is there reason to believe that Kendra Scott’s
differentiation strategy has been successful in producing a competitive
advantage? Why or why not?
EXERCISEs FOR SIMULATION PARTICIPANTS
1. Which one of the five generic competitive strategies can best be utilized to
compete successfully in the business simulation by your company?
2. Which rival companies appear to be employing a low-cost strategy?
3. Which rival companies appear to be employing a differentiation strategy?
4. Which rival companies appear to be employing a best-cost strategy?
5. Which cost drivers and/or value drivers are important for creating superior total
economic value in the business simulation?
6. What is your company’s action plan to achieve a sustainable competitive
advantage over rival companies? List at least three (preferably more than three)
specific kinds of decision entries on specific decision screens that your company
has made or intends to make to win this kind of competitive edge over rivals.
ENDNOTES
1 Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980), chap. 2; Michael E. Porter, “What Is
Strategy?” Harvard Business Review 74, no. 6 (November–December 1996).
2 Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).
http://www.usaa.com./
http://www.kendrascott.com/
page 155
3 Richard L. Priem, “A Consumer Perspective on Value Creation,” Academy of Management Review 32, no. 1 (2007), pp. 219–235.
4 jrscience.wcp.muohio.edu/nsfall01/FinalArticles/Final-IsitWorthitBrandsan.html.
5 D. Yoffie, “Cola Wars Continue: Coke and Pepsi in 2006,” Harvard Business School case 9-706-447.
6 Peter J. Williamson and Ming Zeng, “Value-for-Money Strategies for Recessionary Times,” Harvard Business Review 87, no. 3 (March 2009), pp. 66–74.
http://jrscience.wcp.muohio.edu/nsfall01/FinalArticles/Final-IsitWorthitBrandsan.html.
page 156
chapter 6
Strengthening a Company’s
Competitive Position
Strategic Moves, Timing, and
Scope of Operations
Learning Objectives
After reading this chapter, you should be able to:
LO 6-1 Understand whether, how, and when to deploy offensive
or defensive strategic moves.
LO 6-2 Identify when being a first mover, a fast follower, or a
late mover is most advantageous.
LO 6-3 Explain the strategic benefits and risks of expanding a
company’s horizontal scope through mergers and
acquisitions.
LO 6-4 Explain the advantages and disadvantages of extending
the company’s scope of operations via vertical
integration.
LO 6-5 Recognize the conditions that favor farming out certain
value chain activities to outside parties.
LO 6-6 Understand how to capture the benefits and minimize
the drawbacks of strategic alliances and partnerships.
Fanatic Studio/Getty Images
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Whenever you look at any potential merger or acquisition, you look at the potential to create value
for your shareholders.
Dilip Shanghvi—Founder and managing director of Sun Pharmaceuticals
Alliances have become an integral part of contemporary strategic thinking.
Fortune Magazine
The important thing about outsourcing . . . is that it becomes a very powerful tool to leverage
talent, improve productivity, and reduce work cycles.
Azim Premji—Chairman of Wipro Limited (India’s third-largest outsourcer)
Once a company has settled on which of the five generic competitive strategies to
employ, attention turns to what other strategic actions it can take to complement its
competitive approach and maximize the power of its overall strategy. The first set of
decisions concerns whether to undertake offensive or defensive competitive moves,
and the timing of such moves. The second set concerns expanding or contracting the
breadth of a company’s activities (or its scope of operations along an industry’s entire
value chain). All in all, the following measures to strengthen a company’s competitive
position must be considered:
Whether to go on the offensive and initiate aggressive strategic moves to improve
the company’s market position.
Whether to employ defensive strategies to protect the company’s market position.
When to undertake new strategic initiatives—whether advantage or disadvantage lies
in being a first mover, a fast follower, or a late mover.
Whether to bolster the company’s market position by merging with or acquiring
another company in the same industry.
Whether to integrate backward or forward into more stages of the industry value
chain system.
Which value chain activities, if any, should be outsourced.
Whether to enter into strategic alliances or partnership arrangements with other
enterprises.
This chapter presents the pros and cons of each of these strategy-enhancing
measures.
LAUNCHING STRATEGIC OFFENSIVES
TO IMPROVE A COMPANY’S MARKET
POSITION
• LO 6-1
Understand whether,
how, and when to
deploy offensive or
defensive strategic
moves.
No matter which of the five generic competitive strategies a firm employs,
there are times when a company should go on the offensive to improve its
market position and performance. Strategic offensives are called for when a
company spots opportunities to gain profitable market share at its rivals’
expense or when a company has no choice but to try to whittle away at a
strong rival’s competitive advantage. Companies like Facebook, Amazon,
Apple, and Google play hardball, aggressively pursuing competitive
advantage and trying to reap the benefits a competitive edge offers—a
leading market share, excellent profit margins, and rapid growth.1 The best
offensives tend to incorporate several principles: (1) focusing relentlessly on
building competitive advantage and then striving to convert it into a
sustainable advantage, (2) applying resources where rivals are least able to
defend themselves, (3) employing the element of surprise as opposed to
doing what rivals expect and are prepared for, and (4) displaying a capacity
for swift and decisive actions to overwhelm rivals.2
Choosing the Basis for Competitive Attack
As a rule, challenging rivals on competitive grounds where they are strong is
an uphill struggle.3 Offensive initiatives that exploit competitor weaknesses
stand a better chance of succeeding than do those that challenge competitor
strengths, especially if the weaknesses represent important vulnerabilities and
weak rivals can be caught by surprise with no ready defense.
Sometimes a
company’s best
strategic option is to
seize the initiative,
go on the attack,
and launch a
strategic offensive to
improve its market
position.
Strategic offensives should exploit the power of a company’s strongest
competitive assets—its most valuable resources and capabilities such as a
better-known brand name, a more efficient production or distribution system,
greater technological capability, or a superior reputation for quality. But a
consideration of the company’s strengths should not be made without also
considering the rival’s strengths and weaknesses. A strategic offensive should
be based on those areas of strength where the company has its greatest
competitive advantage over the targeted rivals. If a company has especially
good customer service capabilities, it can make special sales pitches to the
customers of those rivals that provide subpar customer service. Likewise, it
may be beneficial to pay special attention to buyer segments that a rival is
neglecting or is weakly equipped to serve. The best offensives use a
company’s most powerful resources and capabilities to attack rivals in the
areas where they are weakest.
The best offensives
use a company’s
most powerful
resources and
capabilities to attack
rivals in the areas
where they are
competitively
weakest.
Ignoring the need to tie a strategic offensive to a company’s competitive
strengths and what it does best is like going to war with a popgun—the
prospects for success are dim. For instance, it is foolish for a company with
relatively high costs to employ a price-cutting offensive. Likewise, it is ill-
advised to pursue a product innovation offensive without having proven
expertise in R&D and new product development.
The principal offensive strategy options include the following:
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1. Offering an equally good or better product at a lower price. Lower prices
can produce market share gains if competitors don’t respond with price
cuts of their own and if the challenger convinces buyers that its product is
just as good or better. However, such a strategy increases total profits only
if the gains in additional unit sales are enough to offset the impact of
thinner margins per unit sold. Price-cutting offensives should be initiated
only by companies that have first achieved a cost advantage.4 British
airline EasyJet used this strategy successfully against rivals such as British
Air, Alitalia, and Air France by first cutting costs to the bone and
then targeting leisure passengers who care more about low price
than in-flight amenities and service.5 Spirit Airlines is using this strategy in
the U.S. airline market.
2. Leapfrogging competitors by being first to market with next-generation
products. In technology-based industries, the opportune time to overtake
an entrenched competitor is when there is a shift to the next generation of
the technology. Eero got its whole-home Wi-Fi system to market nearly
one year before Linksys and Netgear developed competing systems,
helping it build a sizable market share and develop a reputation for cutting-
edge innovation in Wi-Fi systems.
3. Pursuing continuous product innovation to draw sales and market share
away from less innovative rivals. Ongoing introductions of new and
improved products can put rivals under tremendous competitive pressure,
especially when rivals’ new product development capabilities are weak.
But such offensives can be sustained only if a company can keep its
pipeline full with new product offerings that spark buyer enthusiasm.
4. Pursuing disruptive product innovations to create new markets. While this
strategy can be riskier and more costly than a strategy of continuous
innovation, it can be a game changer if successful. Disruptive innovation
involves perfecting a new product with a few trial users and then quickly
rolling it out to the whole market in an attempt to get many buyers to
embrace an altogether new and better value proposition quickly. Examples
include online universities, Twitter, Venmo, CampusBookRentals, and
Waymo (Alphabet’s self-driving tech company).
5. Adopting and improving on the good ideas of other companies (rivals or
otherwise). The idea of warehouse-type home improvement centers did not
originate with Home Depot cofounders Arthur Blank and Bernie Marcus;
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they got the “big-box” concept from their former employer, Handy Dan
Home Improvement. But they were quick to improve on Handy Dan’s
business model and take Home Depot to the next plateau in terms of
product-line breadth and customer service. Offensive-minded companies
are often quick to adopt any good idea (not nailed down by a patent or
other legal protection) and build on it to create competitive advantage for
themselves.
6. Using hit-and-run or guerrilla warfare tactics to grab market share from
complacent or distracted rivals. Options for “guerrilla offensives” include
occasionally lowballing on price (to win a big order or steal a key account
from a rival), surprising rivals with sporadic but intense bursts of
promotional activity (offering a discounted trial offer to draw customers
away from rival brands), or undertaking special campaigns to attract the
customers of rivals plagued with a strike or problems in meeting buyer
demand.6 Guerrilla offensives are particularly well suited to small
challengers that have neither the resources nor the market visibility to
mount a full-fledged attack on industry leaders.
7. Launching a preemptive strike to secure an industry’s limited resources or
capture a rare opportunity.7 What makes a move preemptive is its one-of-
a-kind nature—whoever strikes first stands to acquire competitive assets
that rivals can’t readily match. Examples of preemptive moves include (1)
securing the best distributors in a particular geographic region or country;
(2) obtaining the most favorable site at a new interchange or intersection,
in a new shopping mall, and so on; (3) tying up the most reliable, high-
quality suppliers via exclusive partnerships, long-term contracts, or
acquisition; and (4) moving swiftly to acquire the assets of distressed rivals
at bargain prices. To be successful, a preemptive move doesn’t have to
totally block rivals from following; it merely needs to give a firm a prime
position that is not easily circumvented.
How long it takes for an offensive action to yield good results
varies with the competitive circumstances.8 It can be short if buyers respond
immediately (as can occur with a dramatic cost-based price cut, an
imaginative ad campaign, or a disruptive innovation). Securing a competitive
edge can take much longer if winning consumer acceptance of the company’s
product will take some time or if the firm may need several years to debug a
new technology or put a new production capacity in place. But how long it
takes for an offensive move to improve a company’s market standing—and
whether the move will prove successful—depends in part on whether market
rivals recognize the threat and begin a counterresponse. Whether rivals will
respond depends on whether they are capable of making an effective response
and if they believe that a counterattack is worth the expense and the
distraction.9
Choosing Which Rivals to Attack
Offensive-minded firms need to analyze which of their rivals to challenge as
well as how to mount the challenge. The following are the best targets for
offensive attacks:10
Market leaders that are vulnerable. Offensive attacks make good sense
when a company that leads in terms of market share is not a true leader in
terms of serving the market well. Signs of leader vulnerability include
unhappy buyers, an inferior product line, aging technology or outdated
plants and equipment, a preoccupation with diversification into other
industries, and financial problems. Caution is well advised in challenging
strong market leaders—there’s a significant risk of squandering valuable
resources in a futile effort or precipitating a fierce and profitless
industrywide battle for market share.
Runner-up firms with weaknesses in areas where the challenger is strong.
Runner-up firms are an especially attractive target when a challenger’s
resources and capabilities are well suited to exploiting their weaknesses.
Struggling enterprises that are on the verge of going under. Challenging a
hard-pressed rival in ways that further sap its financial strength and
competitive position can weaken its resolve and hasten its exit from the
market. In this type of situation, it makes sense to attack the rival in the
market segments where it makes the most profits, since this will threaten its
survival the most.
Small local and regional firms with limited capabilities. Because small
firms typically have limited expertise and resources, a challenger with
broader and/or deeper capabilities is well positioned to raid their biggest
and best customers—particularly those that are growing rapidly, have
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increasingly sophisticated requirements, and may already be thinking about
switching to a supplier with a more full-service capability.
Blue-Ocean Strategy—a Special Kind of
Offensive
A blue-ocean strategy seeks to gain a dramatic competitive advantage by
abandoning efforts to beat out competitors in existing markets and, instead,
inventing a new market segment that allows a company to create and capture
altogether new demand.11 This strategy views the business universe as
consisting of two distinct types of market space. One is where industry
boundaries are well defined, the competitive rules of the game are
understood, and companies try to outperform rivals by capturing a bigger
share of existing demand. In such markets, intense competition constrains a
company’s prospects for rapid growth and superior profitability
since rivals move quickly to either imitate or counter the successes
of competitors. The second type of market space is a “blue ocean,” where the
industry does not really exist yet, is untainted by competition, and offers
wide-open opportunity for profitable and rapid growth if a company can
create new demand with a new type of product offering. The “blue ocean”
represents wide-open opportunity, offering smooth sailing in uncontested
waters for the company first to venture out upon it.
CORE
CONCEPT
A blue-ocean
strategy offers
growth in revenues
and profits by
discovering or
inventing new
industry segments
that create
altogether new
demand.
A terrific example of such blue-ocean market space is the online auction
industry that eBay created and now dominates. Other companies that have
created blue-ocean market spaces include NetJets in fractional jet ownership,
Drybar in hair blowouts, Tune Hotels in limited service “backpacker” hotels,
Uber and Lyft in ride-sharing services, and Cirque du Soleil in live
entertainment. Cirque du Soleil “reinvented the circus” by pulling in a whole
new group of customers—adults and corporate clients—who not only were
noncustomers of traditional circuses (like Ringling Brothers) but also were
willing to pay several times more than the price of a conventional circus
ticket to have a “sophisticated entertainment experience” featuring stunning
visuals and star-quality acrobatic acts. Australian winemaker Casella Wines
used a blue ocean strategy to find some uncontested market space for its
Yellow Tail brand. By creating a product designed to appeal to wider market
—one that also includes beer and spirit drinkers—Yellow Tail was able to
unlock substantial new demand, becoming the fastest growing wine brand in
U.S. history. Illustration Capsule 6.1 discusses the way that Etsy used a blue
ocean strategy to open up new competitive space in online retailing.
Blue-ocean strategies provide a company with a great opportunity in the
short run but they don’t guarantee a company’s long-term success, which
depends more on whether a company can protect the market position it
opened up and sustain its early advantage. Gilt Groupe serves as an example
of a company that opened up new competitive space in online luxury retailing
only to see its blue-ocean waters ultimately turn red. Its competitive success
early on prompted an influx of fast followers into the luxury flash-sale
industry, including HauteLook, RueLaLa, Lot18, and MyHabit.com. The new
rivals not only competed for online customers, who could switch costlessly
from site to site (since memberships were free), but also competed for unsold
designer inventory. Once valued at over $1 billion, Gilt Groupe was finally
sold to Hudson’s Bay, the owner of Sak’s Fifth Avenue, for just $250 million
in 2016.
DEFENSIVE STRATEGIES—
PROTECTING MARKET POSITION AND
COMPETITIVE ADVANTAGE
In a competitive market, all firms are subject to offensive challenges from
rivals. The purposes of defensive strategies are to lower the risk of being
http://myhabit.com/
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attacked, weaken the impact of any attack that occurs, and induce challengers
to aim their efforts at other rivals. While defensive strategies usually don’t
enhance a firm’s competitive advantage, they can definitely help fortify the
firm’s competitive position, protect its most valuable resources and
capabilities from imitation, and defend whatever competitive advantage it
might have. Defensive strategies can take either of two forms: actions to
block challengers or actions to signal the likelihood of strong retaliation.
ILLUSTRATION
CAPSULE 6.1 Etsy’s Blue Ocean Strategy in
Online Retailing of Handmade Crafts
Etsy, the online artisanal marketplace, was the inspirational idea of three New York
entrepreneurs who saw that eBay had become too large and ineffective for craftsman
and artisans who wished to sell their one-of-a-kind products online. While eBay’s timed
auction format made for an exciting experience for bargain-hunting consumers, Etsy in
contrast promoted its ability to connect thoughtful consumers with artisans selling unique
hand-crafted items. Typical Etsy buyers valued craftsmanship and wanted to know how
items were made and who made them. The ability to develop a direct relationship with
the seller was important to many Etsy buyers who enjoyed a personalized shopping
experience. Purchases made by Etsy buyers ranged from $5 ornaments to $50 hand-
made clothing items to $2,000 custom-made coffee tables.
Etsy thrived in what was initially uncontested competitive space. In 2015, to the
surprise of many, theirs was the largest venture capital backed IPO (Initial Public
Offering) to have come out of New York City. By 2018, they had 39 million active buyers
and 2.1 million crafters and artisans offering their products. The company’s gross
merchandise sales totaled more than $3.9 billion that same year. Etsy charged sellers a
3.5 percent transaction fee and a 20-cent listing fee and generated additional revenue
from payment processing fees and the sales of shipping labels. The company’s revenues
had grown from $74.6 million in 2012 to $603.7 million in 2018.
Piotr Swat/Shutterstock
The tremendous success of the company’s Blue Ocean Strategy had not gone
unnoticed. Amazon announced in May 2016 that it would launch a site featuring artisan
goods named Handmade. Amazon believed that its free 2-day shipping to Prime
members would give it an advantage over Etsy. Etsy’s share price took a steep dive in
2016, but by late 2019, the company’s stock was back up to nearly three times its IPO
first-day closing price of $22.24. The strength of its strategy and the quality of its
execution would determine if Etsy would be able to continue to thrive despite well-funded
new entrants into its specialty online retailing sector.
Note: Developed with Rochelle R. Brunson and Marlene M. Reed.
Blocking the Avenues Open to Challengers
The most frequently employed approach to defending a company’s present
position involves actions that restrict a challenger’s options for initiating a
competitive attack. There are any number of obstacles that can be put in the
path of would-be challengers. A defender can introduce new features, add
new models, or broaden its product line to close off gaps and vacant niches to
opportunity-seeking challengers. It can thwart rivals’ efforts to attack with a
lower price by maintaining its own lineup of economy-priced options. It can
discourage buyers from trying competitors’ brands by lengthening
warranties, making early announcements about impending new products or
price changes, offering free training and support services, or providing
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coupons and sample giveaways to buyers most prone to experiment. It can
induce potential buyers to reconsider switching. It can challenge the
quality or safety of rivals’ products. Finally, a defender can grant
volume discounts or better financing terms to dealers and distributors to
discourage them from experimenting with other suppliers, or it can convince
them to handle its product line exclusively and force competitors to use other
distribution outlets.
Good defensive
strategies can help
protect a competitive
advantage but rarely
are the basis for
creating one.
Signaling Challengers That Retaliation Is Likely
The goal of signaling challengers that strong retaliation is likely in the event
of an attack is either to dissuade challengers from attacking at all or to divert
them to less threatening options. Either goal can be achieved by letting
challengers know the battle will cost more than it is worth. Signals to would-
be challengers can be given by
Publicly announcing management’s commitment to maintaining the firm’s
present market share.
Publicly committing the company to a policy of matching competitors’
terms or prices.
Maintaining a war chest of cash and marketable securities.
Making an occasional strong counterresponse to the moves of weak
competitors to enhance the firm’s image as a tough defender.
To be an effective
defensive strategy
signaling needs to
be accompanied by
a credible
commitment to
follow through.
To be an effective defensive strategy, however, signaling needs to be
accompanied by a credible commitment to follow through.
TIMING A COMPANY’S STRATEGIC
MOVES
• LO 6-2
Identify when being
a first mover, a fast
follower, or a late
mover is most
advantageous.
When to make a strategic move is often as crucial as what move to make.
Timing is especially important when first-mover advantages and
disadvantages exist. Under certain conditions, being first to initiate a
strategic move can have a high payoff in the form of a competitive advantage
that later movers can’t dislodge. Moving first is no guarantee of success,
however, since first movers also face some significant disadvantages. Indeed,
there are circumstances in which it is more advantageous to be a fast follower
or even a late mover. Because the timing of strategic moves can be
consequential, it is important for company strategists to be aware of the
nature of first-mover advantages and disadvantages and the conditions
favoring each type of move.12
CORE
CONCEPT
Because of first-
mover advantages
and
disadvantages,
competitive
advantage can
spring from when a
move is made as
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well as from what
move is made.
The Potential for First-Mover Advantages
Market pioneers and other types of first movers typically bear greater risks
and greater development costs than firms that move later. If the market
responds well to its initial move, the pioneer will benefit from a monopoly
position (by virtue of being first to market) that enables it to recover its
investment costs and make an attractive profit. If the firm’s pioneering move
gives it a competitive advantage that can be sustained even after other firms
enter the market space, its first-mover advantage will be greater still. The
extent of this type of advantage, however, will depend on whether and how
fast follower firms can piggyback on the pioneer’s success and either imitate
or improve on its move.
There are six such conditions in which first-mover advantages
are most likely to arise:
1. When pioneering helps build a firm’s reputation and creates strong brand
loyalty. Customer loyalty to an early mover’s brand can create a tie that
binds, limiting the success of later entrants’ attempts to poach from the
early mover’s customer base and steal market share. For example, Open
Table’s early move as an online restaurant-reservation service built a
strong brand that has since fueled its expansion worldwide.
2. When a first mover’s customers will thereafter face significant switching
costs. Switching costs can protect first movers when consumers make large
investments in learning how to use a specific company’s product or in
purchasing complementary products that are also brand-specific. Switching
costs can also arise from loyalty programs or long-term contracts that give
customers incentives to remain with an initial provider. FreshDirect, for
example, offers its grocery-delivery customers bigger savings, the longer
they keep their service subscription.
3. When property rights protections thwart rapid imitation of the initial move.
In certain types of industries, property rights protections in the form of
patents, copyrights, and trademarks prevent the ready imitation of an early
mover’s initial moves. First-mover advantages in pharmaceuticals, for
example, are heavily dependent on patent protections, and patent races in
this industry are common. In other industries, however, patents provide
limited protection and can frequently be circumvented. Property rights
protections also vary among nations, since they are dependent on a
country’s legal institutions and enforcement mechanisms.
4. When an early lead enables the first mover to reap scale economies or
move down the learning curve ahead of rivals. If significant scale-based
advantages are available to an early mover, later entrants (with a smaller
market share) will face relatively higher production costs. This
disadvantage will make it even harder for later entrants to gain share and
overcome the first-mover scale advantage. When there is a steep learning
curve and when learning can be kept proprietary, a first mover can benefit
from volume-based cost advantages that grow ever larger as its experience
accumulates and its scale of operations increases. This type of first-mover
advantage is self-reinforcing and, as such, can preserve a first mover’s
competitive advantage over long periods of time. Honda’s advantage in
small multiuse motorcycles has been attributed to such an effect.
5. When a first mover can set the technical standard for the industry. In many
technology-based industries, the market will converge around a single
technical standard. By establishing the industry standard, a first mover can
gain a powerful advantage that, like experience-based advantages, builds
over time. The lure of such an advantage, however, can result in standard
wars among early movers, as each strives to set the industry standard. The
key to winning such wars is to enter early on the basis of strong fast-cycle
product development capabilities, gain the support of key customers and
suppliers, employ penetration pricing, and make allies of the producers of
complementary products.
6. When strong network effects compel increasingly more consumers to
choose the first mover’s product or service. As we described in Chapter 3,
network effects are at work whenever consumers benefit from having other
consumers use the same product or service that they use—a benefit that
increases with the number of consumers using the product. An example is
FaceTime. The more that people you know have FaceTime on their phones
or devices, the more that you are able to have a video conversation with
them if you also have FaceTime—a benefit that grows with the number of
users in your circle. Network effects can also occur with respect to
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suppliers. eBay has enjoyed a considerable first-mover advantage for
years, not just because of early brand name recognition but also because of
powerful network effects on the supply and demand side. The
more suppliers choose to auction their items on eBay, the more
attractive it is for others to do so as well, since the greater number of items
being auctioned attracts more and more potential buyers, which in turn
attracts more and more items being auctioned. Strong network effects are
self-reinforcing and may lead to a winner-take-all situation for the first
mover.
ILLUSTRATION
CAPSULE 6.2 Tinder Swipes Right for First-
Mover Success
Tinder, a simple, swipe-based dating app, entered the market in 2012 with a bang,
gaining over a million monthly active users in less than a year. While other dating apps
were already in existence, Tinder started the swiping phenomenon, thereby easing the
process of finding love online and making the use of dating apps commonplace. By 2014,
Tinder was processing over a billion swipes daily and users were spending an average of
an hour and a half on the app each day. (Today, the average user spends about an hour
on Facebook, Instagram, Snapchat, and Twitter—combined.)
Tinder’s fast start had much to do with the fact that it was easy-to-use, without the
time-consuming questionnaires of other dating services, and fun, with a game-like aspect
that many called addictive. In addition, Tinder was rolled out on college campuses using
viral marketing techniques that helped it to quickly gain acceptance among social circles
such as fraternities and sororities, in which “key influencers” boosted its popularity to the
point where it reached a critical mass. But its sustained success has had more to do with
the fact that it has been able to reap the benefits of a first mover advantage, as the first
major entrant into the field of mobile dating.
In the dating service industry, efficacy is wholly dependent on network effects (where
users of an app benefit increasingly as the number of users of that same app increases).
By focusing first on ensuring high usage among local social domains, Tinder benefited
from strong local network effects. As its popularity spread, users increasingly found
Tinder to be the most attractive app to use, since so many others were using it—thereby
strengthening the network effect advantage, and drawing ever more people to download
the Tinder app. With increased volume, Tinder gained other classic first mover
advantages, such as enhanced reputational benefits, learning curve efficiencies, and
increased interest from investors. By 2019, Tinder had nearly 8 million users, making the
app the most popular online dating app in the United States.
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BigTunaOnline/Shutterstock
Tinder’s first mover advantage has not kept others from entering the mobile dating
market. In fact, Tinder’s phenomenal success has led to a surge in new entrants, with
many imitating the Tinder’s most popular features. Despite this, Tinder’s first mover
advantage has proven protective in many ways. Tinder’s user base far outstrips the user
base of rivals. And while other apps have been trying to play catch up, Tinder has been
introducing new subscription products and other paid features to turn its market share
advantage into a profitability advantage. As it stands, most analysts see Tinder as the
mobile dating application with the highest commercial potential. And with a valuation of
$3B and the distinction of Apple’s top-grossing app in August 2017, it seems that Tinder
is here to stay.
Note: Developed with Lindsey Wilcox and Charles K. Anumonwo.
Sources: https://www.inc.com/issie-lapowsky/how-tinder-is-winning-the-mobile-
dating-wars.html; http://www.adweek.com/digital/mediakix-time-spent-social-
media-infographic/; www.pewresearch.org/fact-tank/2016/02/29/5-facts-about-
online-dating/; https://www.forbes.com/sites/stevenbertoni/2017/08/31/tinder-hits-3-
billion-valuation-after-match-group-converts-options/#653a516f34f9; company
website; J. Clement. Statista, November 22, 2019.
Illustration Capsule 6.2 describes how Tinder achieved a first-mover
advantage in the field of mobile dating.
https://www.inc.com/issie-lapowsky/how-tinder-is-winning-the-mobile-dating-wars.html
http://www.adweek.com/digital/mediakix-time-spent-social-media-infographic/
http://www.pewresearch.org/fact-tank/2016/02/29/5-facts-about-online-dating/
https://www.forbes.com/sites/stevenbertoni/2017/08/31/tinder-hits-3-billion-valuation-after-match-group-converts-options/#653a516f34f9
The Potential for Late-Mover Advantages or First-
Mover Disadvantages
In some instances there are advantages to being an adept follower rather than
a first mover. Late-mover advantages (or first-mover disadvantages) arise in
four instances:
When the costs of pioneering are high relative to the benefits accrued and
imitative followers can achieve similar benefits with far lower costs. This
is often the case when second movers can learn from a pioneer’s
experience and avoid making the same costly mistakes as the pioneer.
When an innovator’s products are somewhat primitive and do not live up
to buyer expectations, thus allowing a follower with better-performing
products to win disenchanted buyers away from the leader.
When rapid market evolution (due to fast-paced changes in either
technology or buyer needs) gives second movers the opening to leapfrog
a first mover’s products with more attractive next-version products.
When market uncertainties make it difficult to ascertain what will
eventually succeed, allowing late movers to wait until these needs are
clarified.
When customer loyalty to the pioneer is low and a first mover’s skills,
know-how, and actions are easily copied or even surpassed.
When the first mover must make a risky investment in complementary
assets or infrastructure (and these may be enjoyed at low cost or risk by
followers).
To Be a First Mover or Not
In weighing the pros and cons of being a first mover versus a fast follower
versus a late mover, it matters whether the race to market leadership in a
particular industry is a 10-year marathon or a 2-year sprint. In marathons, a
slow mover is not unduly penalized—first-mover advantages can be fleeting,
and there’s ample time for fast followers and sometimes even late movers to
catch up.13 Thus, the speed at which the pioneering innovation is likely to
catch on matters considerably as companies struggle with whether to pursue
an emerging market opportunity aggressively (as a first mover) or cautiously
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(as a late mover). For instance, it took 5.5 years for worldwide mobile phone
use to grow from 10 million to 100 million, and it took close to 10 years for
the number of at-home broadband subscribers to grow to 100 million
worldwide. The lesson here is that there is a market penetration curve for
every emerging opportunity. Typically, the curve has an inflection point at
which all the pieces of the business model fall into place, buyer demand
explodes, and the market takes off. The inflection point can come early on a
fast-rising curve (like the use of e-mail and watching movies streamed over
the Internet) or farther up on a slow-rising curve (as with battery-powered
motor vehicles, solar and wind power, and textbook rental for college
students). Any company that seeks competitive advantage by being a first
mover thus needs to ask some hard questions:
Does market takeoff depend on the development of complementary
products or services that currently are not available?
Is new infrastructure required before buyer demand can surge?
Will buyers need to learn new skills or adopt new behaviors?
Will buyers encounter high switching costs in moving to the newly
introduced product or service?
Are there influential competitors in a position to delay or derail the
efforts of a first mover?
When the answers to any of these questions are yes, then a
company must be careful not to pour too many resources into getting ahead
of the market opportunity—the race is likely going to be closer to a 10-year
marathon than a 2-year sprint.14 On the other hand, if the market is a winner-
take-all type of market, where powerful first-mover advantages insulate early
entrants from competition and prevent later movers from making any
headway, then it may be best to move quickly despite the risks.
STRENGTHENING A COMPANY’S
MARKET POSITION VIA ITS SCOPE OF
OPERATIONS
Apart from considerations of competitive moves and their timing, there is
another set of managerial decisions that can affect the strength of a
company’s market position. These decisions concern the scope of a
company’s operations—the breadth of its activities and the extent of its
market reach. Decisions regarding the scope of the firm focus on which
activities a firm will perform internally and which it will not.
CORE
CONCEPT
The scope of the
firm refers to the
range of activities
that the firm
performs internally,
the breadth of its
product and service
offerings, the extent
of its geographic
market presence,
and its mix of
businesses.
Consider, for example, Ralph Lauren Corporation. In contrast to Rambler’s
Way, a sustainable clothing company with a small chain of retail stores,
Ralph Lauren designs, markets, and distributes fashionable apparel and other
merchandise to approximately 13,000 major department stores and specialty
retailers throughout the world. In addition, it operates nearly 500 retail stores,
more than 650 concession-based shops within shops, and 10 e-commerce
sites. Scope decisions also concern which segments of the market to serve—
decisions that can include geographic market segments as well as product and
service segments. Almost 50 percent of Ralph Lauren’s sales are made
outside North America, and its product line includes apparel, fragrances,
home furnishings, eyewear, watches and jewelry, and handbags and other
leather goods. Its lineup of brands includes Polo Ralph Lauren, Club
Monaco, Chaps, and Double RL, as well as its Ralph Lauren Collection
brands.
Decisions such as these, in essence, determine where the boundaries of a
firm lie and the degree to which the operations within those boundaries
cohere. They also have much to do with the direction and extent of a
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business’s growth. In this chapter, we discuss different types of decisions
regarding the scope of the company in relation to a company’s business-level
strategy. In the next two chapters, we develop two additional dimensions of a
firm’s scope; Chapter 7 focuses on international expansion—a matter of
extending the company’s geographic scope into foreign markets; Chapter 8
takes up the topic of corporate strategy, which concerns diversifying into a
mix of different businesses. Scope issues are at the very heart of corporate-
level strategy.
Several dimensions of firm scope have relevance for business-level
strategy in terms of their capacity to strengthen a company’s position in a
given market. These include the firm’s horizontal scope, which is the range
of product and service segments that the firm serves within its product or
service market. Mergers and acquisitions involving other market participants
provide a means for a company to expand its horizontal scope. Expanding the
firm’s vertical scope by means of vertical integration can also affect the
success of its market strategy. Vertical scope is the extent to which the firm
engages in the various activities that make up the industry’s entire value
chain system, from initial activities such as raw-material production all the
way to retailing and after-sale service activities. Outsourcing decisions
concern another dimension of scope since they involve narrowing the firm’s
boundaries with respect to its participation in value chain activities. We
discuss the pros and cons of each of these options in the sections
that follow. Because strategic alliances and partnerships
provide an alternative to vertical integration and acquisition strategies and are
sometimes used to facilitate outsourcing, we conclude this chapter with a
discussion of the benefits and challenges associated with cooperative
arrangements of this nature.
CORE
CONCEPT
Horizontal scope is
the range of product
and service
segments that a firm
serves within its
focal market.
CORE
CONCEPT
Vertical scope is
the extent to which a
firm’s internal
activities encompass
the range of
activities that make
up an industry’s
entire value chain
system, from raw-
material production
to final sales and
service activities.
HORIZONTAL MERGER AND
ACQUISITION STRATEGIES
• LO 6-3
Explain the strategic
benefits and risks of
expanding a
company’s
horizontal scope
through mergers and
acquisitions.
Mergers and acquisitions are much-used strategic options to strengthen a
company’s market position. A merger is the combining of two or more
companies into a single corporate entity, with the newly created company
often taking on a new name. An acquisition is a combination in which one
company, the acquirer, purchases and absorbs the operations of another, the
acquired. The difference between a merger and an acquisition relates more to
the details of ownership, management control, and financial arrangements
than to strategy and competitive advantage. The resources and competitive
capabilities of the newly created enterprise end up much the same whether
the combination is the result of an acquisition or a merger.
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Horizontal mergers and acquisitions, which involve combining the
operations of firms within the same product or service market, provide an
effective means for firms to rapidly increase the scale and horizontal scope of
their core business. For example, the merger of AMR Corporation (parent of
American Airlines) with US Airways has increased the airlines’ scale of
operations and extended their reach geographically to create the world’s
largest airline.
Merger and acquisition strategies typically set sights on achieving any of
five objectives:15
1. Creating a more cost-efficient operation out of the combined companies.
When a company acquires another company in the same industry, there’s
usually enough overlap in operations that less efficient plants can be closed
or distribution and sales activities partly combined and downsized.
Likewise, it is usually feasible to squeeze out cost savings in
administrative activities, again by combining and downsizing such
administrative activities as finance and accounting, information
technology, human resources, and so on. The combined companies may
also be able to reduce supply chain costs because of greater bargaining
power over common suppliers and closer collaboration with supply chain
partners. By helping consolidate the industry and remove excess capacity,
such combinations can also reduce industry rivalry and improve industry
profitability.
2. Expanding a company’s geographic coverage. One of the best and quickest
ways to expand a company’s geographic coverage is to acquire rivals with
operations in the desired locations. Since a company’s size increases with
its geographic scope, another benefit is increased bargaining power with
the company’s suppliers or buyers. Greater geographic coverage can also
contribute to product differentiation by enhancing a company’s name
recognition and brand awareness. The vacation rental marketplace,
HomeAway, Inc., relied on an aggressive horizontal acquisition strategy to
expand internationally, as well as to extend its reach across the United
States. It now offers vacation rentals in 190 countries through its 50
websites in 23 languages. Travel company Expedia has since acquired
HomeAway, thus extending its reach horizontally into the vacation rental
product category—an objective described in the next point.
3. Extending the company’s business into new product categories.
Many times a company has gaps in its product line that need to be filled in
order to offer customers a more effective product bundle or the benefits of
one-stop shopping. For example, customers might prefer to acquire a suite
of software applications from a single vendor that can offer more
integrated solutions to the company’s problems. Acquisition can be a
quicker and more potent way to broaden a company’s product line than
going through the exercise of introducing a company’s own new product to
fill the gap. In 2018, Keurig Green Mountain vastly expanded its range of
beverage offerings by acquiring the Dr Pepper Snapple Group in an $18.7
billion deal.
4. Gaining quick access to new technologies or other resources and
capabilities. Making acquisitions to bolster a company’s technological
know-how or to expand its skills and capabilities allows a company to
bypass a time-consuming and expensive internal effort to build desirable
new resources and capabilities. Over the course of its history, Cisco
Systems has purchased over 200 companies to give it more technological
reach and product breadth, thereby enhancing its standing as the world’s
largest provider of hardware, software, and services for creating and
operating Internet networks.
5. Leading the convergence of industries whose boundaries are being blurred
by changing technologies and new market opportunities. In fast-cycle
industries or industries whose boundaries are changing, companies can use
acquisition strategies to hedge their bets about the direction that an
industry will take, to increase their capacity to meet changing demands,
and to respond flexibly to changing buyer needs and technological
demands. The convergence of the pharmacy industry with health insurers
and the benefits management industry led to the merger between Cigna and
Express Scripts as well as that between CVS and Aetna in 2018.
Illustration Capsule 6.3 describes how Walmart employed a horizontal
acquisition strategy to expand into the e-commerce domain.
Why Mergers and Acquisitions Sometimes Fail to
Produce Anticipated Results
page 170
Despite many successes, mergers and acquisitions do not always produce the
hoped-for outcomes.16 Cost savings may prove smaller than expected. Gains
in competitive capabilities may take substantially longer to realize or, worse,
may never materialize at all. Efforts to mesh the corporate cultures can stall
due to formidable resistance from organization members. Key employees at
the acquired company can quickly become disenchanted and leave; the
morale of company personnel who remain can drop to disturbingly low levels
because they disagree with newly instituted changes. Differences in
management styles and operating procedures can prove hard to resolve. In
addition, the managers appointed to oversee the integration of a newly
acquired company can make mistakes in deciding which activities to leave
alone and which activities to meld into their own operations and systems.
ILLUSTRATION
CAPSULE 6.3 Walmart’s Expansion into E-
Commerce via Horizontal Acquisition
As the boundaries between traditional retailing and online retailing have begun to blur,
Walmart has responded by expanding its presence in e-commerce via horizontal
acquisition. In 2016, Walmart acquired Jet.com, an innovative U.S. e-commerce start-up
that was designed to compete with Amazon. Jet sells everything from household goods
and electronics to beauty products, apparel, and toys from more than 2,400 retailer and
brand partners. Jet.com rewards customers for ordering multiple items, using a debit card
instead of a credit card, or choosing a no-returns option; it passes its cost savings on to
customers in the form of lower prices. The low-price approach of Jet.com fit well with
Walmart’s low-price strategy. In addition, Walmart hoped that the acquisition would help it
to accelerate its growth in e-commerce, provide quick access to some valuable e-
commerce knowledge and capabilities, increase its breadth of online product offerings,
and attract new customer segments.
Walmart, like other brick and mortar retailers, was facing a myriad of issues caused by
changing customer expectations. Consumers increasingly valued large assortments of
products, a convenient shopping experience, and low prices. Price sensitivity was
increasing due to the ease of comparing prices online. As a traditional retailer, Walmart
was facing stiff competition from Amazon, the world’s largest and fastest growing e-
commerce company. Amazon’s seemingly endless inventory of goods, excellent
customer service, expertise in search engine marketing, and appeal to a wide consumer
demographic added pressure on the overall global retail industry.
http://jet.com/
http://jet.com/
http://jet.com/
The acquisition of Jet built on the foundation already in place for Walmart to respond to
the external pressure and continue growing as an omni-channel retailer (i.e., bricks and
mortar, online, or mobile). After investing heavily in their own online channel,
Walmart.com, the company was looking for other ways to attract customers by lowering
prices, broadening their product assortment, and offering the simplest, most convenient
shopping experience. Jet’s breadth of products, access to millennial and higher-income
customer segments, and best in-class pricing algorithm would accelerate Walmart’s
progress across all of these priorities.
Sundry Photography/Shutterstock
Since the acquisition, Jet has continued to expand its own offerings with private-label
groceries, further increasing competition with Amazon’s AmazonFresh grocery business.
More recently, Walmart made several other acquisitions of online apparel companies,
thereby strengthening Jet’s apparel offerings and further expanding Walmart’s presence
in e-commerce. These include ShoeBuy (a competitor of Amazon-owned Zappos),
Bonobos in menswear, Moosejaw in outdoor gear and apparel, and Modcloth in vintage
and indie womenswear. While Walmart’s e-commerce sales still pale in comparison to
Amazon, this represents a promising start for Walmart, as the retail industry continues to
transform.
Note: Developed with Dipti Badrinath.
Sources: http://www.businessinsider.com/jet-walmart-weapon-vs-amazon-2017-9;
https://news.walmart.com/2016/08/08/walmart-agrees-to-acquire-jetcom-one-of-the-
fastest-growing-e-commerce-companies-in-the-us;
https://www.fool.com/investing/2017/10/03/1-year-later-wal-marts-jetcom-
acquisition-is-an-un.aspx; https://blog.walmart.com/business/20160919/five-big-
reasons-walmart-bought-jetcom.
http://walmart.com/
http://www.businessinsider.com/jet-walmart-weapon-vs-amazon-2017-9
https://news.walmart.com/2016/08/08/walmart-agrees-to-acquire-jetcom-one-of-the-fastest-growing-e-commerce-companies-in-the-us
https://www.fool.com/investing/2017/10/03/1-year-later-wal-marts-jetcom-acquisition-is-an-un.aspx
https://blog.walmart.com/business/20160919/five-big-reasons-walmart-bought-jetcom
page 171
A number of mergers and acquisitions have been notably unsuccessful.
Google’s $12.5 billion acquisition of struggling smartphone manufacturer
Motorola Mobility in 2012 turned out to be minimally beneficial in helping to
“supercharge Google’s Android ecosystem” (Google’s stated reason for
making the acquisition). When Google’s attempts to rejuvenate Motorola’s
smartphone business by spending over $1.3 billion on new
product R&D and revamping Motorola’s product line resulted in
disappointing sales and huge operating losses, Google sold Motorola
Mobility to China-based PC maker Lenovo for $2.9 billion in 2014 (however,
Google retained ownership of Motorola’s extensive patent portfolio). The
jury is still out on whether Lenovo’s acquisition of Motorola will prove to be
a moneymaker.
VERTICAL INTEGRATION STRATEGIES
• LO 6-4
Explain the
advantages and
disadvantages of
extending the
company’s scope of
operations via
vertical integration.
Expanding the firm’s vertical scope by means of a vertical integration
strategy provides another possible way to strengthen the company’s position
in its core market. A vertically integrated firm is one that participates in
multiple stages of an industry’s value chain system. Thus, if a manufacturer
invests in facilities to produce component parts that it had formerly purchased
from suppliers, or if it opens its own chain of retail stores to bypass its former
distributors, it is engaging in vertical integration. A good example of a
vertically integrated firm is Maple Leaf Foods, a major Canadian producer of
fresh and processed meats whose best-selling brands include Maple Leaf and
Schneiders. Maple Leaf Foods participates in hog and poultry production,
with company-owned hog and poultry farms; it has its own meat-processing
and rendering facilities; it packages its products and distributes them from
company-owned distribution centers; and it conducts marketing, sales, and
customer service activities for its wholesale and retail buyers but does not
otherwise participate in the final stage of the meat-processing vertical chain
—the retailing stage.
CORE
CONCEPT
A vertically
integrated firm is
one that performs
value chain activities
along more than one
stage of an
industry’s value
chain system.
A vertical integration strategy can expand the firm’s range of activities
backward into sources of supply and/or forward toward end users. When
Tiffany & Co., a manufacturer and retailer of fine jewelry, began sourcing,
cutting, and polishing its own diamonds, it integrated backward along the
diamond supply chain. Mining giant De Beers Group and Canadian miner
Aber Diamond integrated forward when they entered the diamond retailing
business.
A firm can pursue vertical integration by starting its own operations in
other stages of the vertical activity chain or by acquiring a company already
performing the activities it wants to bring in-house. Vertical integration
strategies can aim at full integration (participating in all stages of the vertical
chain) or partial integration (building positions in selected stages of the
vertical chain). Firms can also engage in tapered integration strategies, which
involve a mix of in-house and outsourced activity in any given stage of the
vertical chain. Oil companies, for instance, supply their refineries with oil
from their own wells as well as with oil that they purchase from other
producers—they engage in tapered backward integration. Coach, Inc., the
maker of Coach handbags and accessories, engages in tapered forward
integration since it operates full-price and factory outlet stores but also sells
its products through third-party department store outlets.
page 172
The Advantages of a Vertical Integration Strategy
Under the right conditions, a vertical integration strategy can add materially
to a company’s technological capabilities, strengthen the firm’s competitive
position, and boost its profitability.17 But it is important to keep in mind that
vertical integration has no real payoff strategy-wise or profit-wise unless the
extra investment can be justified by compensating improvements in company
costs, differentiation, or competitive strength.
Integrating Backward to Achieve Greater Competitiveness It is harder
than one might think to generate cost savings or improve profitability by
integrating backward into activities such as the manufacture of parts
and components (which could otherwise be purchased from
suppliers with specialized expertise in making the parts and components). For
backward integration to be a cost-saving and profitable strategy, a company
must be able to (1) achieve the same scale economies as outside suppliers and
(2) match or beat suppliers’ production efficiency with no drop-off in quality.
Neither outcome is easily achieved. To begin with, a company’s in-house
requirements are often too small to reach the optimum size for low-cost
operation. For instance, if it takes a minimum production volume of 1 million
units to achieve scale economies and a company’s in-house requirements are
just 250,000 units, then it falls far short of being able to match the costs of
outside suppliers (which may readily find buyers for 1 million or more units).
Furthermore, matching the production efficiency of suppliers is fraught with
problems when suppliers have considerable production experience, when the
technology they employ has elements that are hard to master, and/or when
substantial R&D expertise is required to develop next-version components or
keep pace with advancing technology in components production.
CORE
CONCEPT
Backward
integration involves
entry into activities
previously
performed by
suppliers or other
enterprises
positioned along
earlier stages of the
industry value chain
system; forward
integration involves
entry into value
chain system
activities closer to
the end user.
That said, occasions still arise when a company can gain or extend a
competitive advantage by performing a broader range of industry value chain
activities internally rather than having such activities performed by outside
suppliers. There are several ways that backward vertical integration can
contribute to a cost-based competitive advantage. When there are few
suppliers and when the item being supplied is a major component, vertical
integration can lower costs by limiting supplier power. Vertical integration
can also lower costs by facilitating the coordination of production flows and
avoiding bottlenecks and delays that disrupt production schedules.
Furthermore, when a company has proprietary know-how that it wants to
keep from rivals, then in-house performance of value-adding activities related
to this know-how is beneficial even if such activities could otherwise be
performed by outsiders.
Apple decided to integrate backward into producing its own chips for
iPhones, chiefly because chips are a major cost component, suppliers have
bargaining power, and in-house production would help coordinate design
tasks and protect Apple’s proprietary iPhone technology. International Paper
Company backward integrates into pulp mills that it sets up near its paper
mills and reaps the benefits of coordinated production flows, energy savings,
and transportation economies. It does this, in part, because outside suppliers
are generally unwilling to make a site-specific investment for a buyer.
Backward vertical integration can support a differentiation-based
competitive advantage when performing activities internally contributes to a
better-quality product or service offering, improves the caliber of customer
service, or in other ways enhances the performance of the final product. On
occasion, integrating into more stages along the industry value chain system
can add to a company’s differentiation capabilities by allowing it to
strengthen its core competencies, better master key skills or strategy-critical
page 173
technologies, or add features that deliver greater customer value. Spanish
clothing maker Inditex has backward integrated into fabric making, as well as
garment design and manufacture, for its successful Zara brand. By tightly
controlling the process and postponing dyeing until later stages, Zara can
respond quickly to changes in fashion trends and supply its customers with
the hottest items. Amazon and Netflix backward integrated by establishing
Amazon Studios and Netflix Originals to produce high-quality original
content for their streaming services.
Integrating Forward to Enhance Competitiveness Like backward
integration, forward integration can enhance competitiveness and contribute
to competitive advantage on the cost side as well as the differentiation (or
value) side. On the cost side, forward integration can lower costs by
increasing efficiency and reducing or eliminating the bargaining
power of companies that had wielded such power further along the value
system chain. It can allow manufacturers to gain better access to end users,
improve market visibility, and enhance brand name awareness. For example,
Harley-Davidson’s and Ducati’s company-owned retail stores are essentially
little museums, filled with iconography, that provide an environment
conducive to selling not only motorcycles and gear but also memorabilia,
clothing, and other items featuring the brand. Insurance companies and
brokerages like Allstate and Edward Jones have the ability to make
consumers’ interactions with local agents and office personnel a
differentiating feature by focusing on building relationships.
In many industries, independent sales agents, wholesalers, and retailers
handle competing brands of the same product and have no allegiance to any
one company’s brand—they tend to push whatever offers the biggest profits.
To avoid dependence on distributors and dealers with divided loyalties,
Goodyear has integrated forward into company-owned and franchised retail
tire stores. Consumer-goods companies like Coach, Under Armour,
Pepperidge Farm, Bath & Body Works, Nike, Tommy Hilfiger, and Ann
Taylor have integrated forward into retailing and operate their own branded
stores in factory outlet malls, enabling them to move overstocked items,
slow-selling items, and seconds.
Some producers have opted to integrate forward by selling directly to
customers at the company’s website. Indochino in custom men’s suits, Warby
page 174
Parker in eyewear, and Everlane in sustainable apparel are examples.
Bypassing regular wholesale and retail channels in favor of direct sales and
Internet retailing can have appeal if it reinforces the brand and enhances
consumer satisfaction or if it lowers distribution costs, produces a relative
cost advantage over certain rivals, and results in lower selling prices to end
users. In addition, sellers are compelled to include the Internet as a retail
channel when a sufficiently large number of buyers in an industry prefer to
make purchases online. However, a company that is vigorously pursuing
online sales to consumers at the same time that it is also heavily promoting
sales to consumers through its network of wholesalers and retailers is
competing directly against its distribution allies. Such actions constitute
channel conflict and create a tricky route to negotiate. A company that is
actively trying to expand online sales to consumers is signaling a weak
strategic commitment to its dealers and a willingness to cannibalize dealers’
sales and growth potential. The likely result is angry dealers and loss of
dealer goodwill. Quite possibly, a company may stand to lose more sales by
offending its dealers than it gains from its own online sales effort.
Consequently, in industries where the strong support and goodwill of dealer
networks is essential, companies may conclude that it is important to avoid
channel conflict and that their websites should be designed to partner with
dealers rather than compete against them.
The Disadvantages of a Vertical Integration
Strategy
Vertical integration has some substantial drawbacks beyond the potential for
channel conflict.18 The most serious drawbacks to vertical integration include
the following concerns:
Vertical integration raises a firm’s capital investment in the industry,
thereby increasing business risk (what if industry growth and profitability
unexpectedly go sour?).
Vertically integrated companies are often slow to adopt technological
advances or more efficient production methods when they are saddled with
older technology or facilities. A company that obtains parts and
components from outside suppliers can always shop the market
for the newest, best, and cheapest parts, whereas a vertically
integrated firm with older plants and technology may choose to continue
making suboptimal parts rather than face the high costs of writing off
undepreciated assets.
Vertical integration can result in less flexibility in accommodating shifting
buyer preferences. It is one thing to eliminate use of a component made by
a supplier and another to stop using a component being made in-house
(which can mean laying off employees and writing off the associated
investment in equipment and facilities). Integrating forward or backward
locks a firm into relying on its own in-house activities and sources of
supply. Most of the world’s automakers, despite their manufacturing
expertise, have concluded that purchasing a majority of their parts and
components from best-in-class suppliers results in greater design flexibility,
higher quality, and lower costs than producing parts or components in-
house.
Vertical integration may not enable a company to realize economies of
scale if its production levels are below the minimum efficient scale. Small
companies in particular are likely to suffer a cost disadvantage by
producing in-house.
Vertical integration poses all kinds of capacity-matching problems. In
motor vehicle manufacturing, for example, the most efficient scale of
operation for making axles is different from the most economic volume for
radiators, and different yet again for both engines and transmissions.
Building the capacity to produce just the right number of axles, radiators,
engines, and transmissions in-house—and doing so at the lowest unit costs
for each—poses significant challenges and operating complications.
Integration forward or backward typically calls for developing new types of
resources and capabilities. Parts and components manufacturing, assembly
operations, wholesale distribution and retailing, and direct sales via the
Internet represent different kinds of businesses, operating in different types
of industries, with different key success factors. Many manufacturers learn
the hard way that company-owned wholesale and retail networks require
skills that they lack, fit poorly with what they do best, and detract from
their overall profit performance. Similarly, a company that tries to produce
many components in-house is likely to find itself very hard-pressed to keep
up with technological advances and cutting-edge production practices for
each component used in making its product.
page 175
In today’s world of close working relationships with suppliers and efficient
supply chain management systems, relatively few companies can make a
strong economic case for integrating backward into the business of suppliers.
The best materials and components suppliers stay abreast of advancing
technology and best practices and are adept in making good quality items,
delivering them on time, and keeping their costs and prices as low as
possible.
Weighing the Pros and Cons of Vertical
Integration
All in all, therefore, a strategy of vertical integration can have both strengths
and weaknesses. The tip of the scales depends on (1) whether vertical
integration can enhance the performance of strategy-critical activities in ways
that lower cost, build expertise, protect proprietary know-how, or increase
differentiation; (2) what impact vertical integration will have on investment
costs, flexibility, and response times; (3) what administrative costs will be
incurred by coordinating operations across more vertical chain activities; and
(4) how difficult it will be for the company to acquire the set of skills and
capabilities needed to operate in another stage of the vertical chain. Vertical
integration strategies have merit according to which capabilities and value-
adding activities truly need to be performed in-house and which
can be performed better or cheaper by outsiders. Absent solid
benefits, integrating forward or backward is not likely to be an attractive
strategy option.
ILLUSTRATION
CAPSULE 6.4 Tesla’s Vertical Integration
Strategy
Unlike many vehicle manufacturers, Tesla embraces vertical integration from component
manufacturing all the way through vehicle sales and servicing. The majority of the
company’s $11.8 billion in 2017 revenue came from electric vehicle sales and leasing,
with the remainder coming from servicing those vehicles and selling residential battery
packs and solar energy systems.
At its core an electric vehicle manufacturer, Tesla uses both backward and forward
vertical integration to achieve multiple strategic goals. In order to drive innovation in a
critical part of its supply chain, Tesla has invested in a “gigafactory” that manufacturers
the batteries that are essential for a long-lasting electric vehicle. According to Tesla’s
former VP of Production, in-house manufacturing of key components and new parts that
require frequent updates has enabled the company to learn quickly and launch new
versions faster. Moreover, having closer relationships between engineering and
manufacturing gives Tesla greater control over product design. Tesla uses forward
vertical integration to improve the customer experience by owning the distribution and
servicing of the vehicles it builds. Their network of dealerships allows Tesla to sell directly
to consumers and handle maintenance needs without relying on third parties that
sometimes have competing priorities.
Beyond vertically integrating the manufacture and distribution of their electric vehicles,
Tesla uses the strategy to build the ecosystem that is necessary to support further
adoption of their vehicles. As many consumers perceive electric cars to have limited
range and long charging times that prevent long-distance travel, Tesla is building a
network of Supercharger stations to overcome this pain point. By investing in this
development themselves, Tesla does not need to wait for another company to deliver the
critical infrastructure that drivers demand before they switch from traditional gasoline-
powered cars. Similarly, Tesla sells solar power generation and storage products that
make it easier for customers to make the switch to transportation powered by sustainable
energy.
Hadrian/Shutterstock
While Tesla’s mission to accelerate the world’s transition to sustainable energy has
required large investments throughout the value chain, this strategy has not been without
challenges. Unlike batteries, seats are of limited strategic importance, yet Tesla decided
to manufacture their Model 3 seats in house. While there is no indication that the seats
were the source of major production delays in 2017, diverting resources to develop new
page 176
manufacturing capabilities could have added to the problem. Although Tesla’s vertical
integration strategy is not without downsides, it has enabled the firm to quickly roll out
innovative new products and launch the network that is required for widespread vehicle
adoption. Investors have rewarded Tesla for this bold strategy by lifting its valuation to
$80 billion by the start of 2020, higher than the other major American automakers.
Note: Developed with Edward J. Silberman.
Sources: Tesla 2017 Annual Report; G. Reichow, “Tesla’s Secret Second Floor,” Wired,
October 18,2017, https://www.wired.com/story/teslas-secret-second-floor/; A. Sage,
“Tesla’s Seat Strategy Goes Against the Grain. . . For Now,” Reuters, October 26, 2017,
https://www.reuters.com/article/us-tesla-seats/teslas-seat-strategy-goes-against-
the-grain-for-now-idUSKBN1CV0DS; Yahoo Finance.
Electric automobile maker Tesla, Inc. has made vertical integration a
central part of its strategy, as described in Illustration Capsule 6.4.
OUTSOURCING STRATEGIES:
NARROWING THE SCOPE OF
OPERATIONS
• LO 6-5
Recognize the
conditions that favor
farming out certain
value chain activities
to outside parties.
In contrast to vertical integration strategies, outsourcing strategies narrow the
scope of a business’s operations, in terms of what activities are performed
internally. Outsourcing involves contracting out certain value chain activities
that are normally performed in-house to outside vendors.19 Many PC makers,
for example, have shifted from assembling units in-house to outsourcing the
entire assembly process to manufacturing specialists, which can operate more
efficiently due to their greater scale, experience, and bargaining power over
components makers. Nearly all name-brand apparel firms have in-house
https://www.wired.com/story/teslas-secret-second-floor/
https://www.reuters.com/article/us-tesla-seats/teslas-seat-strategy-goes-against-the-grain-for-now-idUSKBN1CV0DS
capability to design, market, and distribute their products but they outsource
all fabric manufacture and garment-making activities. Starbucks finds
purchasing coffee beans from independent growers far more advantageous
than having its own coffee-growing operation, with locations scattered across
most of the world’s coffee-growing regions.
CORE
CONCEPT
Outsourcing
involves contracting
out certain value
chain activities that
are normally
performed in-house
to outside vendors.
Outsourcing certain value chain activities makes strategic sense whenever
An activity can be performed better or more cheaply by outside specialists.
A company should generally not perform any value chain activity
internally that can be performed more efficiently or effectively by outsiders
—the chief exception occurs when a particular activity is strategically
crucial and internal control over that activity is deemed essential. Dolce &
Gabbana, for example, outsources the manufacture of its brand of
sunglasses to Luxottica—a company considered to be the world’s best
sunglass manufacturing company, known for its Oakley, Oliver Peoples,
and Ray-Ban brands. Colgate-Palmolive, for instance, has reduced its
information technology operational costs by more than 10 percent annually
through an outsourcing agreement with IBM.
The activity is not crucial to the firm’s ability to achieve sustainable
competitive advantage. Outsourcing of support activities such as
maintenance services, data processing, data storage, fringe-benefit
management, and website operations has become commonplace. Many
smaller companies, for example, find it advantages to outsource HR
activities such as benefit administration, training, recruiting, hiring and
payroll to specialists, such as XcelHR, Insperity, Paychex, and Aon Hewitt.
The outsourcing improves organizational flexibility and speeds time to
market. Outsourcing gives a company the flexibility to switch suppliers in
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the event that its present supplier falls behind competing suppliers.
Moreover, seeking out new suppliers with the needed capabilities already
in place is frequently quicker, easier, less risky, and cheaper than hurriedly
retooling internal operations to replace obsolete capabilities or trying to
install and master new technologies.
It reduces the company’s risk exposure to changing technology and buyer
preferences. When a company outsources certain parts, components, and
services, its suppliers must bear the burden of incorporating state-of-the-art
technologies and/or undertaking redesigns and upgrades to accommodate a
company’s plans to introduce next-generation products. If what a supplier
provides falls out of favor with buyers, or is rendered unnecessary by
technological change, it is the supplier’s business that suffers rather than
the company’s.
It allows a company to concentrate on its core business, leverage its key
resources, and do even better what it already does best. A company is
better able to enhance its own capabilities when it concentrates its full
resources and energies on performing only those activities.
United Colors of Benetton and Sisley, for example, outsource the
production of handbags and other leather goods while devoting their
energies to the clothing lines for which they are known. Apple outsources
production of its iPod, iPhone, and iPad models to Chinese contract
manufacturer Foxconn and concentrates in-house on design, marketing, and
innovation. Hewlett-Packard and IBM have sold some of their
manufacturing plants to outsiders and contracted to repurchase the output
instead from the new owners.
The Risk of Outsourcing Value Chain Activities
The biggest danger of outsourcing is that a company will farm out the wrong
types of activities and thereby hollow out its own capabilities.20 For example,
in recent years companies eager to reduce operating costs have opted to
outsource such strategically important activities as product development,
engineering design, and sophisticated manufacturing tasks—the very
capabilities that underpin a company’s ability to lead sustained product
innovation. While these companies have apparently been able to lower their
operating costs by outsourcing these functions to outsiders, their ability to
lead the development of innovative new products is weakened because so
many of the cutting-edge ideas and technologies for next-generation products
come from outsiders.
A company must
guard against
outsourcing
activities that hollow
out the resources
and capabilities that
it needs to be a
master of its own
destiny.
Another risk of outsourcing comes from the lack of direct control. It may
be difficult to monitor, control, and coordinate the activities of outside parties
via contracts and arm’s-length transactions alone. Unanticipated problems
may arise that cause delays or cost overruns and become hard to resolve
amicably. Moreover, contract-based outsourcing can be problematic because
outside parties lack incentives to make investments specific to the needs of
the outsourcing company’s internal value chain.
Companies like Cisco Systems are alert to these dangers. Cisco guards
against loss of control and protects its manufacturing expertise by designing
the production methods that its contract manufacturers must use. Cisco keeps
the source code for its designs proprietary, thereby controlling the initiation
of all improvements and safeguarding its innovations from imitation. Further,
Cisco has developed online systems to monitor the factory operations of
contract manufacturers around the clock so that it knows immediately when
problems arise and can decide whether to get involved.
STRATEGIC ALLIANCES AND
PARTNERSHIPS
page 178
• LO 6-6
Understand how to
capture the benefits
and minimize the
drawbacks of
strategic alliances
and partnerships.
Strategic alliances and cooperative partnerships provide one way to gain
some of the benefits offered by vertical integration, outsourcing, and
horizontal mergers and acquisitions while minimizing the associated
problems. Companies frequently engage in cooperative strategies as an
alternative to vertical integration or horizontal mergers and acquisitions.
Increasingly, companies ayre also employing strategic alliances and
partnerships to extend their scope of operations via international expansion
and diversification strategies, as we describe in Chapters 7 and 8. Strategic
alliances and cooperative arrangements are now a common means of
narrowing a company’s scope of operations as well, serving as a useful way
to manage outsourcing (in lieu of traditional, purely price-oriented contracts).
For example, oil and gas companies engage in considerable vertical
integration—but Shell Oil Company and Pemex (Mexico’s state-owned
petroleum company) have found that joint ownership of their Deer Park
Refinery in Texas lowers their investment costs and risks in comparison to
going it alone. The colossal failure of the Daimler–Chrysler
merger formed an expensive lesson for Daimler AG about what
can go wrong with horizontal mergers and acquisitions; the Renault–Nissan–
Mitsubishi Alliance has proved more successful in developing the
capabilities for the manufacture of plug-in electric vehicles and introducing
the Nissan Leaf.
Many companies employ strategic alliances to manage the problems that
might otherwise occur with outsourcing—Cisco’s system of alliances guards
against loss of control, protects its proprietary manufacturing expertise, and
enables the company to monitor closely the assembly operations of its
partners while devoting its energy to designing new generations of the
switches, routers, and other Internet-related equipment for which it is known.
A strategic alliance is a formal agreement between two or more separate
companies in which they agree to work collaboratively toward some
strategically relevant objective. Typically, they involve shared financial
responsibility, joint contribution of resources and capabilities, shared risk,
shared control, and mutual dependence. They may be characterized by
cooperative marketing, sales, or distribution; joint production; design
collaboration; or projects to jointly develop new technologies or products.
They can vary in terms of their duration and the extent of the collaboration;
some are intended as long-term arrangements, involving an extensive set of
cooperative activities, while others are designed to accomplish more limited,
short-term objectives.
CORE
CONCEPT
A strategic alliance
is a formal
agreement between
two or more
separate companies
in which they agree
to work
cooperatively toward
some common
objective.
Collaborative arrangements may entail a contractual agreement, but they
commonly stop short of formal ownership ties between the partners (although
sometimes an alliance member will secure minority ownership of another
member).
A special type of strategic alliance involving ownership ties is the joint
venture. A joint venture entails forming a new corporate entity that is jointly
owned by two or more companies that agree to share in the revenues,
expenses, and control of the newly formed entity. Since joint ventures involve
setting up a mutually owned business, they tend to be more durable but also
riskier than other arrangements. In other types of strategic alliances, the
collaboration between the partners involves a much less rigid structure in
which the partners retain their independence from one another. If a strategic
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alliance is not working out, a partner can choose to simply walk away or
reduce its commitment to collaborating at any time.
CORE
CONCEPT
A joint venture is a
partnership involving
the establishment of
an independent
corporate entity that
the partners own
and control jointly,
sharing in its
revenues and
expenses.
An alliance becomes “strategic,” as opposed to just a convenient business
arrangement, when it serves any of the following purposes:21
1. It facilitates achievement of an important business objective (like lowering
costs or delivering more value to customers in the form of better quality,
added features, and greater durability).
2. It helps build, strengthen, or sustain a core competence or competitive
advantage.
3. It helps remedy an important resource deficiency or competitive weakness.
4. It helps defend against a competitive threat, or mitigates a significant risk
to a company’s business.
5. It increases bargaining power over suppliers or buyers.
6. It helps open up important new market opportunities.
7. It speeds the development of new technologies and/or product innovations.
Strategic cooperation is a much-favored approach in industries where new
technological developments are occurring at a furious pace along many
different paths and where advances in one technology spill over to affect
others (often blurring industry boundaries). Whenever industries are
experiencing high-velocity technological advances in many areas
simultaneously, firms find it virtually essential to have
cooperative relationships with other enterprises to stay on the leading edge of
technology, even in their own area of specialization. In industries like these,
alliances are all about fast cycles of learning, gaining quick access to the
latest round of technological know-how, and developing dynamic
capabilities. In bringing together firms with different skills and knowledge
bases, alliances open up learning opportunities that help partner firms better
leverage their own resources and capabilities.22
In 2017, Daimler entered into an agreement with automotive supplier
Robert Bosch GmbH to develop self-driving taxis that customers can hail
with a smartphone app; the objective is to make this a reality in urban areas
by the beginning of the next decade.
Microsoft has been partnering with a variety of companies to advance
technology in the healthcare industry. Its 2017 alliance with PAREXEL, a
clinical research organization, aims to use their combined capabilities to
accelerate drug development and bring new therapies to patients sooner. In
2018, it joined forces with immuno-sequencing company Adaptive
Biotechnologies to find ways to detect cancers and other diseases earlier
using Microsoft’s artificial intelligence capabilities.
Companies that
have formed a host
of alliances need to
manage their
alliances like a
portfolio.
Because of the varied benefits of strategic alliances, many large
corporations have become involved in 30 to 50 alliances, and a number have
formed hundreds of alliances. Hoffmann-La Roche, a multinational
healthcare company, has set up Roche Partnering to manage their more than
190 alliances. Companies that have formed a host of alliances need to
manage their alliances like a portfolio—terminating those that no longer
serve a useful purpose or that have produced meager results, forming
promising new alliances, and restructuring existing alliances to correct
performance problems and/or redirect the collaborative effort.
The best alliances
are highly selective,
focusing on
particular value
chain activities and
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on obtaining a
specific competitive
benefit. They enable
a firm to build on its
strengths and to
learn.
Capturing the Benefits of Strategic Alliances
The extent to which companies benefit from entering into alliances and
partnerships seems to be a function of six factors:23
1. Picking a good partner. A good partner must bring complementary
strengths to the relationship. To the extent that alliance members have
nonoverlapping strengths, there is greater potential for synergy and less
potential for coordination problems and conflict. In addition, a good
partner needs to share the company’s vision about the overall purpose of
the alliance and to have specific goals that either match or complement
those of the company. Strong partnerships also depend on good chemistry
among key personnel and compatible views about how the alliance should
be structured and managed.
2. Being sensitive to cultural differences. Cultural differences among
companies can make it difficult for their personnel to work together
effectively. Cultural differences can be problematic among companies
from the same country, but when the partners have different national
origins, the problems are often magnified. Unless there is respect among
all the parties for cultural differences, including those stemming from
different local cultures and local business practices, productive working
relationships are unlikely to emerge.
3. Recognizing that the alliance must benefit both sides. Information must be
shared as well as gained, and the relationship must remain forthright and
trustful. If either partner plays games with information or tries to take
advantage of the other, the resulting friction can quickly erode the value of
further collaboration. Open, trustworthy behavior on both sides is essential
for fruitful collaboration.
4. Ensuring that both parties live up to their commitments. Both parties have
to deliver on their commitments for the alliance to produce the intended
benefits. The division of work has to be perceived as fairly apportioned,
and the caliber of the benefits received on both sides has to be perceived as
adequate.
5. Structuring the decision-making process so that actions can be taken
swiftly when needed. In many instances, the fast pace of technological and
competitive changes dictates an equally fast decision-making process. If
the parties get bogged down in discussions or in gaining internal approval
from higher-ups, the alliance can turn into an anchor of delay and inaction.
6. Managing the learning process and then adjusting the alliance agreement
over time to fit new circumstances. One of the keys to long-lasting success
is adapting the nature and structure of the alliance to be responsive to
shifting market conditions, emerging technologies, and changing customer
requirements. Wise allies are quick to recognize the merit of an evolving
collaborative arrangement, where adjustments are made to accommodate
changing conditions and to overcome whatever problems arise in
establishing an effective working relationship.
Most alliances that aim at sharing technology or providing market access
turn out to be temporary, lasting only a few years. This is not necessarily an
indicator of failure, however. Strategic alliances can be terminated after a few
years simply because they have fulfilled their purpose; indeed, many
alliances are intended to be of limited duration, set up to accomplish specific
short-term objectives. Longer-lasting collaborative arrangements, however,
may provide even greater strategic benefits. Alliances are more likely to be
long-lasting when (1) they involve collaboration with partners that do not
compete directly, such as suppliers or distribution allies; (2) a trusting
relationship has been established; and (3) both parties conclude that
continued collaboration is in their mutual interest, perhaps because new
opportunities for learning are emerging.
The Drawbacks of Strategic Alliances and Their
Relative Advantages
While strategic alliances provide a way of obtaining the benefits of vertical
integration, mergers and acquisitions, and outsourcing, they also suffer from
some of the same drawbacks. Anticipated gains may fail to materialize due to
an overly optimistic view of the potential or a poor fit in terms of the
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combination of resources and capabilities. When outsourcing is conducted
via alliances, there is no less risk of becoming dependent on other companies
for essential expertise and capabilities—indeed, this may be the Achilles’
heel of such alliances. Moreover, there are additional pitfalls to collaborative
arrangements. The greatest danger is that a partner will gain access to a
company’s proprietary knowledge base, technologies, or trade secrets,
enabling the partner to match the company’s core strengths and costing the
company its hard-won competitive advantage. This risk is greatest when the
alliance is among industry rivals or when the alliance is for the purpose of
collaborative R&D, since this type of partnership requires an extensive
exchange of closely held information.
The question for managers is when to engage in a strategic alliance and
when to choose an alternative means of meeting their objectives. The answer
to this question depends on the relative advantages of each method and the
circumstances under which each type of organizational arrangement is
favored.
The principal advantages of strategic alliances over vertical integration or
horizontal mergers and acquisitions are threefold:
1. They lower investment costs and risks for each partner by facilitating
resource pooling and risk sharing. This can be particularly important when
investment needs and uncertainty are high, such as when a dominant
technology standard has not yet emerged.
2. They are more flexible organizational forms and allow for a more adaptive
response to changing conditions. Flexibility is essential when
environmental conditions or technologies are changing rapidly. Moreover,
strategic alliances under such circumstances may enable the development
of each partner’s dynamic capabilities.
3. They are more rapidly deployed—a critical factor when speed is of the
essence. Speed is of the essence when there is a winner-take-all type of
competitive situation, such as the race for a dominant technological design
or a race down a steep experience curve, where there is a large first-mover
advantage.
The key advantages of using strategic alliances rather than arm’s-length
transactions to manage outsourcing are (1) the increased ability to exercise
control over the partners’ activities and (2) a greater willingness for the
partners to make relationship-specific investments. Arm’s-length transactions
discourage such investments since they imply less commitment and do not
build trust.
On the other hand, there are circumstances when other organizational
mechanisms are preferable to alliances and partnering. Mergers and
acquisitions are especially suited for situations in which strategic alliances or
partnerships do not go far enough in providing a company with access to
needed resources and capabilities. Ownership ties are more permanent than
partnership ties, allowing the operations of the merger or acquisition
participants to be tightly integrated and creating more in-house control and
autonomy. Other organizational mechanisms are also preferable to alliances
when there is limited property rights protection for valuable know-how and
when companies fear being taken advantage of by opportunistic partners.
While it is important for managers to understand when strategic alliances
and partnerships are most likely (and least likely) to prove useful, it is also
important to know how to manage them.
How to Make Strategic Alliances Work
A surprisingly large number of alliances never live up to expectations. Even
though the number of strategic alliances increases by about 25 percent
annually, about 60 to 70 percent of alliances continue to fail each year.24 The
success of an alliance depends on how well the partners work together, their
capacity to respond and adapt to changing internal and external conditions,
and their willingness to renegotiate the bargain if circumstances so warrant.
A successful alliance requires real in-the-trenches collaboration, not merely
an arm’s-length exchange of ideas. Unless partners place a high value on the
contribution each brings to the alliance and the cooperative arrangement
results in valuable win–win outcomes, it is doomed to fail.
While the track record for strategic alliances is poor on average, many
companies have learned how to manage strategic alliances successfully and
routinely defy this average. Samsung Group, which includes Samsung
Electronics, successfully manages an ecosystem of over 1,300 partnerships
that enable productive activities from global procurement to local marketing
to collaborative R&D. Companies that have greater success in managing their
strategic alliances and partnerships often credit the following factors:
page 182
They create a system for managing their alliances. Companies need to
manage their alliances in a systematic fashion, just as they manage other
functions. This means setting up a process for managing the
different aspects of alliance management from partner selection to
alliance termination procedures. To ensure that the system is followed on a
routine basis by all company managers, many companies create a set of
explicit procedures, process templates, manuals, or the like.
They build relationships with their partners and establish trust.
Establishing strong interpersonal relationships is a critical factor in making
strategic alliances work since such relationships facilitate opening up
channels of communication, coordinating activity, aligning interests, and
building trust.
They protect themselves from the threat of opportunism by setting up
safeguards. There are a number of means for preventing a company from
being taken advantage of by an untrustworthy partner or unwittingly losing
control over key assets. Contractual safeguards, including noncompete
clauses, can provide other forms of protection.
They make commitments to their partners and see that their partners do the
same. When partners make credible commitments to a joint enterprise, they
have stronger incentives for making it work and are less likely to “free-
ride” on the efforts of other partners. Because of this, equity-based
alliances tend to be more successful than nonequity alliances.25
They make learning a routine part of the management process. There are
always opportunities for learning from a partner, but organizational
learning does not take place automatically. Whatever learning occurs
cannot add to a company’s knowledge base unless the learning is
incorporated systematically into the company’s routines and practices.
Finally, managers should realize that alliance management is an
organizational capability, much like any other. It develops over time, out of
effort, experience, and learning. For this reason, it is wise to begin slowly,
with simple alliances designed to meet limited, short-term objectives. Short-
term partnerships that are successful often become the basis for much more
extensive collaborative arrangements. Even when strategic alliances are set
up with the hope that they will become long-term engagements, they have a
page 183
better chance of succeeding if they are phased in so that the partners can learn
how they can work together most fruitfully.
KEY POINTS
1. Once a company has settled on which of the five generic competitive
strategies to employ, attention turns to how strategic choices regarding (1)
competitive actions, (2) timing of those actions, and (3) scope of
operations can complement its competitive approach and maximize the
power of its overall strategy.
2. Strategic offensives should, as a general rule, be grounded in a company’s
strategic assets and employ a company’s strengths to attack rivals in the
competitive areas where they are weakest.
3. Companies have a number of offensive strategy options for improving
their market positions: using a cost-based advantage to attack competitors
on the basis of price or value, leapfrogging competitors with next-
generation technologies, pursuing continuous product innovation, adopting
and improving the best ideas of others, using hit-and-run tactics to steal
sales away from unsuspecting rivals, and launching preemptive strikes. A
blue-ocean type of offensive strategy seeks to gain a dramatic new
competitive advantage by inventing a new industry or distinctive market
segment that renders existing competitors largely irrelevant and
allows a company to create and capture altogether new demand
in the absence of direct competitors.
4. The purposes of defensive strategies are to lower the risk of being attacked,
weaken the impact of any attack that occurs, and influence challengers to
aim their efforts at other rivals. Defensive strategies to protect a company’s
position usually take one of two forms: (1) actions to block challengers or
(2) actions to signal the likelihood of strong retaliation.
5. The timing of strategic moves also has relevance in the quest for
competitive advantage. Company managers are obligated to carefully
consider the advantages or disadvantages that attach to being a first mover
versus a fast follower versus a late mover.
6. Decisions concerning the scope of a company’s operations—which
activities a firm will perform internally and which it will not—can also
affect the strength of a company’s market position. The scope of the firm
refers to the range of its activities, the breadth of its product and service
offerings, the extent of its geographic market presence, and its mix of
businesses. Companies can expand their scope horizontally (more broadly
within their focal market) or vertically (up or down the industry value
chain system that starts with raw-material production and ends with sales
and service to the end consumer). Horizontal mergers and acquisitions
(combinations of market rivals) provide a means for a company to expand
its horizontal scope. Vertical integration expands a firm’s vertical scope.
7. Horizontal mergers and acquisitions typically have any of five objectives:
lowering costs, expanding geographic coverage, adding product categories,
gaining new technologies or other resources and capabilities, and preparing
for the convergence of industries.
8. Vertical integration, forward or backward, makes most strategic sense if it
strengthens a company’s position via either cost reduction or creation of a
differentiation-based advantage. Otherwise, the drawbacks of vertical
integration (increased investment, greater business risk, increased
vulnerability to technological changes, less flexibility in making product
changes, and the potential for channel conflict) are likely to outweigh any
advantages.
9. Outsourcing involves contracting out pieces of the value chain formerly
performed in-house to outside vendors, thereby narrowing the scope of the
firm. Outsourcing can enhance a company’s competitiveness whenever (1)
an activity can be performed better or more cheaply by outside specialists;
(2) the activity is not crucial to the firm’s ability to achieve sustainable
competitive advantage; (3) the outsourcing improves organizational
flexibility, speeds decision making, and cuts cycle time; (4) it reduces the
company’s risk exposure; and (5) it permits a company to concentrate on
its core business and focus on what it does best.
10. Strategic alliances and cooperative partnerships provide one way to gain
some of the benefits offered by vertical integration, outsourcing, and
horizontal mergers and acquisitions while minimizing the associated
problems. They serve as an alternative to vertical integration and mergers
and acquisitions, and as a supplement to outsourcing, allowing more
control relative to outsourcing via arm’s-length transactions.
LO 6-1, LO 6-2, LO
6-3
LO 6-4
LO 6-5
page 184
11. Companies that manage their alliances well generally (1) create a system
for managing their alliances, (2) build relationships with their partners and
establish trust, (3) protect themselves from the threat of opportunism by
setting up safeguards, (4) make commitments to their partners and see that
their partners do the same, and (5) make learning a routine part of the
management process.
ASSURANCE OF LEARNING EXERCISES
1. Live Nation Entertainment operates music venues,
provides management services to music artists, and
promotes more than 35,000 shows and 100 festivals
in 40 countries annually. The company acquired
House of Blues, merged with Ticketmaster, and
acquired concert and festival promoters in the
United States, Australia, and Great Britain. How has
the company used horizontal mergers and
acquisitions to strengthen its competitive position?
Are these moves primarily offensive or defensive?
Has either Live Nation or Ticketmaster achieved any
type of advantage based on the timing of its strategic
moves?
2. Tesla, Inc. has rapidly become a stand-out among
American car companies. Illustration Capsule 6.4
describes how Tesla has made vertical integration a
central part of its strategy. What value chain
segments has Tesla chosen to enter and perform
internally? How has vertical integration and
integration of its ecosystem aided the organization in
building competitive advantage? Has vertical
integration strengthened its market position?
Explain why or why not.
3. Perform an Internet search to identify at least two
companies in different industries that have entered
into outsourcing agreements with firms with
LO 6-6
LO 6-1, LO 6-2
LO 6-3
LO 6-4
LO 6-5
page 185
specialized services. In addition, describe what
value chain activities the companies have chosen to
outsource. Do any of these outsourcing agreements
seem likely to threaten any of the companies’
competitive capabilities?
4. Using your university library’s business research
resources, find two examples of how companies
have relied on strategic alliances or joint ventures to
substitute for horizontal or vertical integration.
EXERCISES FOR SIMULATION PARTICIPANTS
1. Has your company relied more on offensive or
defensive strategies to achieve your rank in the
industry? What options for being a first mover does
your company have? Do any of these first-mover
options hold competitive advantage potential?
2. What would be an advantage of a horizontal merger
within the industry?
3. What are the pros and cons of vertical integration in
the industry?
4. What do you see as pros and cons of outsourcing in
the business simulation?
ENDNOTES
1 George Stalk, Jr., and Rob Lachenauer, “Hardball: Five Killer Strategies for Trouncing the Competition,” Harvard
Business Review 82, no. 4 (April 2004); Richard D’Aveni, “The Empire Strikes Back: Counterrevolutionary Strategies for
Industry Leaders,” Harvard Business Review 80, no. 11 (November 2002); David J. Bryce and Jeffrey H. Dyer,
“Strategies to Crack Well-Guarded Markets,” Harvard Business Review 85, no. 5 (May 2007).
2 George Stalk, “Playing Hardball: Why Strategy Still Matters,” Ivey Business Journal 69, no.2 (November–December
2004), pp. 1–2; W. J. Ferrier, K. G. Smith, and C. M. Grimm, “The Role of Competitive Action in Market Share Erosion
and Industry Dethronement: A Study of Industry Leaders and Challengers,” Academy of Management Journal 42, no. 4
(August 1999), pp. 372–388.
3 David B. Yoffie and Mary Kwak, “Mastering Balance: How to Meet and Beat a Stronger Opponent,” California
Management Review 44, no. 2 (Winter 2002), pp. 8–24.
4 Ian C. MacMillan, Alexander B. van Putten, and Rita Gunther McGrath, “Global Gamesmanship,” Harvard Business
Review 81, no. 5 (May 2003); Ashkay R. Rao, Mark E. Bergen, and Scott Davis, “How to Fight a Price War,” Harvard
Business Review 78, no. 2 (March–April 2000).
5 D. B. Yoffie and M. A. Cusumano, “Judo Strategy–the Competitive Dynamics of Internet Time,”
Harvard Business Review 77, no. 1 (January–February 1999), pp. 70–81.
6 Ming-Jer Chen and Donald C. Hambrick, “Speed, Stealth, and Selective Attack: How Small Firms Differ from Large
Firms in Competitive Behavior,” Academy of Management Journal 38, no. 2 (April 1995), pp. 453–482; William E.
Rothschild, “Surprise and the Competitive Advantage,” Journal of Business Strategy 4, no. 3 (Winter 1984), pp. 10–18.
7 Ian MacMillan, “Preemptive Strategies,” Journal of Business Strategy 14, no. 2 (Fall 1983), pp. 16–26.
8 Ian C. MacMillan, “How Long Can You Sustain a Competitive Advantage?” in Liam Fahey (ed.), The Strategic Planning
Management Reader (Englewood Cliffs, NJ: Prentice Hall, 1989), pp. 23–24.
9 Kevin P. Coyne and John Horn, “Predicting Your Competitor’s Reactions,” Harvard Business Review 87, no. 4 (April
2009), pp. 90–97.
10 Philip Kotler, Marketing Management, 5th ed. (Englewood Cliffs, NJ: Prentice Hall, 1984).
11 W. Chan Kim and Renée Mauborgne, “Blue Ocean Strategy,” Harvard Business Review 82, no. 10 (October 2004), pp.
76–84.
12 Jeffrey G. Covin, Dennis P. Slevin, and Michael B. Heeley, “Pioneers and Followers: Competitive Tactics, Environment,
and Growth,” Journal of Business Venturing 15, no. 2 (March 1999), pp. 175–210; Christopher A. Bartlett and Sumantra
Ghoshal, “Going Global: Lessons from Late-Movers,” Harvard Business Review 78, no. 2 (March-April 2000), pp. 132–
145.
13 Costas Markides and Paul A. Geroski, “Racing to Be 2nd: Conquering the Industries of the Future,” Business Strategy
Review 15, no. 4 (Winter 2004), pp. 25–31.
14 Fernando Suarez and Gianvito Lanzolla, “The Half-Truth of First-Mover Advantage,” Harvard Business Review 83, no.
4 (April 2005), pp. 121–127.
15 Joseph L. Bower, “Not All M&As Are Alike–and That Matters,” Harvard Business Review 79, no. 3 (March 2001); O.
Chatain and P. Zemsky, “The Horizontal Scope of the Firm: Organizational Tradeoffs vs. Buyer-Supplier Relationships,”
Management Science 53, no. 4(April 2007), pp. 550–565.
16 Jeffrey H. Dyer, Prashant Kale, and Harbir Singh, “When to Ally and When to Acquire,” Harvard Business Review 82,
no. 4 (July–August 2004), pp. 109–110.
17 John Stuckey and David White, “When and When Not to Vertically Integrate,” Sloan Management Review (Spring
1993), pp. 71–83.
18 Thomas Osegowitsch and Anoop Madhok, “Vertical Integration Is Dead, or Is It?” Business Horizons 46, no. 2 (March–
April 2003), pp. 25–35.
19 Ronan McIvor, “What Is the Right Outsourcing Strategy for Your Process?” European Management Journal 26, no. 1
(February 2008), pp. 24–34.
20 Gary P. Pisano and Willy C. Shih, “Restoring American Competitiveness,” Harvard Business Review 87, no. 7-8 (July–
August 2009), pp. 114–125; Jérôme Barthélemy, “The Seven Deadly Sins of Outsourcing,” Academy of Management
Executive 17, no. 2 (May 2003), pp. 87–100.
21 Jason Wakeam, “The Five Factors of a Strategic Alliance,” Ivey Business Journal 68, no. 3 (May–June 2003), pp. 1–4.
22 A. Inkpen, “Learning, Knowledge Acquisition, and Strategic Alliances,” European Management Journal 16, no. 2 (April
1998), pp. 223–229.
23 Advertising Age, May 24, 2010, p. 14.
24 Patricia Anslinger and Justin Jenk, “Creating Successful Alliances,” Journal of Business Strategy 25, no. 2 (2004), pp.
18–23; Rosabeth Moss Kanter, “Collaborative Advantage: The Art of the Alliance,” Harvard Business Review 72, no. 4
(July–August 1994), pp. 96-108; Gary Hamel, Yves L. Doz, and C. K. Prahalad, “Collaborate with Your Competitors–and
Win,” Harvard Business Review 67, no. 1 (January–February 1989), pp. 133–139.
25 Y. G. Pan and D. K. Tse, “The Hierarchical Model of Market Entry Modes,” Journal of International Business Studies
31, no. 4 (2000), pp. 535–554.
page 186
chapter 7
Strategies for Competing in
International Markets
Learning Objectives
After reading this chapter, you should be able to:
LO 7-1 Identify the primary reasons companies choose to
compete in international markets.
LO 7-2 Understand how and why differing market conditions
across countries influence a company’s strategy
choices in international markets.
LO 7-3 Identify the differences among the five primary modes
of entry into foreign markets
LO 7-4 Identify the three main strategic approaches for
competing internationally.
LO 7-5 Explain how companies are able to use international
operations to improve overall competitiveness.
LO 7-6 Identify the unique characteristics of competing in
developing-country markets.
page 187
Fanatic Studio/Getty Images
Our key words now are globalization, new products and businesses, and speed.
Tsutomu Kanai—Former chair and president of Hitachi
You have no choice but to operate in a world shaped by globalization and the information
revolution. There are two options: Adapt or die.
Andy Grove—Former chair and CEO of Intel
What counts in global competition is the right strategy.
Heinrich von Pierer—Former CEO of Siemens AG
Any company that aspires to industry leadership in the 21st century must think in terms
of global, not domestic, market leadership. The world economy is globalizing at an
page 188
accelerating pace as ambitious, growth-minded companies race to build stronger
competitive positions in the markets of more and more countries, as countries
previously closed to foreign companies open up their markets, and as information
technology shrinks the importance of geographic distance. The forces of globalization
are changing the competitive landscape in many industries, offering companies
attractive new opportunities and at the same time introducing new competitive threats.
Companies in industries where these forces are greatest are therefore under
considerable pressure to come up with a strategy for competing successfully in
international markets.
This chapter focuses on strategy options for expanding beyond domestic boundaries
and competing in the markets of either a few or a great many countries. In the process
of exploring these options, we introduce such concepts as the Porter diamond of
national competitive advantage; and discuss the specific market circumstances that
support the adoption of multidomestic, transnational, and global strategies. The chapter
also includes sections on cross-country differences in cultural, demographic, and
market conditions; strategy options for entering foreign markets; the importance of
locating value chain operations in the most advantageous countries; and the special
circumstances of competing in developing markets such as those in China, India, Brazil,
Russia, and eastern Europe.
WHY COMPANIES DECIDE TO ENTER
FOREIGN MARKETS
A company may opt to expand outside its domestic market for any of five
major reasons:
1. To gain access to new customers. Expanding into foreign markets offers
potential for increased revenues, profits, and long-term growth; it becomes
an especially attractive option when a company encounters dwindling
growth opportunities in its home market. Companies often expand
internationally to extend the life cycle of their products, as Honda has done
with its classic 50-cc motorcycle, the Honda Cub (which is still selling
well in developing markets, more than 60 years after it was first introduced
in Japan). A larger target market also offers companies the opportunity to
earn a return on large investments more rapidly. This can be particularly
important in R&D-intensive industries, where development is fast-paced or
competitors imitate innovations rapidly.
• LO 7-1
Identify the primary
reasons companies
choose to compete
in international
markets.
2. To achieve lower costs through economies of scale, experience, and
increased purchasing power. Many companies are driven to sell in more
than one country because domestic sales volume alone is not large enough
to capture fully economies of scale in product development,
manufacturing, or marketing. Similarly, firms expand internationally to
increase the rate at which they accumulate experience and move down the
learning curve. International expansion can also lower a company’s input
costs through greater pooled purchasing power. The relatively small size of
country markets in Europe and limited domestic volume explains why
companies like Michelin, BMW, and Nestlé long ago began selling their
products all across Europe and then moved into markets in North America
and Latin America.
3. To gain access to low-cost inputs of production. Companies in industries
based on natural resources (e.g., oil and gas, minerals, rubber, and lumber)
often find it necessary to operate in the international arena since raw-
material supplies are located in different parts of the world and can be
accessed more cost-effectively at the source. Other companies enter
foreign markets to access low-cost human resources; this is particularly
true of industries in which labor costs make up a high proportion of total
production costs.
4. To further exploit its core competencies. A company may be able to extend
a market-leading position in its domestic market into a position of regional
or global market leadership by leveraging its core competencies further.
H&M Group is capitalizing on its considerable expertise in fashion
retailing to expand its reach internationally. By 2020, it had more than
5000 retail stores operating in 74 countries, and was continuing to expand
its global reach. Companies can often leverage their resources
internationally by replicating a successful business model, using it as a
page 189
basic blueprint for international operations, as Starbucks and McDonald’s
have done.1
5. To gain access to resources and capabilities located in foreign markets. An
increasingly important motive for entering foreign markets is to acquire
resources and capabilities that may be unavailable in a company’s home
market. Companies often make acquisitions abroad or enter into cross-
border alliances to gain access to capabilities that complement their own or
to learn from their partners.2 In other cases, companies choose to establish
operations in other countries to utilize local distribution networks, gain
local managerial or marketing expertise, or acquire specialized technical
knowledge.
In addition, companies that are the suppliers of other companies
often expand internationally when their major customers do so, to meet their
customers’ needs abroad and retain their position as a key supply chain
partner. For example, when motor vehicle companies have opened new plants
in foreign locations, big automotive parts suppliers have frequently opened
new facilities nearby to permit timely delivery of their parts and components
to the plant. Similarly, Newell-Rubbermaid, one of Walmart’s biggest
suppliers of household products, has followed Walmart into foreign markets.
WHY COMPETING ACROSS NATIONAL
BORDERS MAKES STRATEGY MAKING
MORE COMPLEX
Crafting a strategy to compete in one or more countries of the world is
inherently more complex for five reasons. First, different countries have
different home-country advantages in different industries; competing
effectively requires an understanding of these differences. Second, there are
location-based advantages to conducting particular value chain activities in
different parts of the world. Third, different political and economic conditions
make the general business climate more favorable in some countries than in
others. Fourth, companies face risk due to adverse shifts in currency
exchange rates when operating in foreign markets. And fifth, differences in
buyer tastes and preferences present a challenge for companies concerning
customizing versus standardizing their products and services.
• LO 7-2
Understand how and
why differing market
conditions across
countries influence a
company’s strategy
choices in
international
markets.
Home-Country Industry Advantages and the
Diamond Model
Certain countries are known for their strengths in particular industries. For
example, Chile has competitive strengths in industries such as copper, fruit,
fish products, paper and pulp, chemicals, and wine. Japan is known for
competitive strength in consumer electronics, automobiles, semiconductors,
steel products, and specialty steel. Where industries are more likely to
develop competitive strength depends on a set of factors that describe the
nature of each country’s business environment and vary from country to
country. Because strong industries are made up of strong firms, the strategies
of firms that expand internationally are usually grounded in one or more of
these factors. The four major factors are summarized in a framework
developed by Michael Porter and known as the Diamond of National
Competitive Advantage (see Figure 7.1).3
FIGURE 7.1 The Diamond of National Competitive
Advantage
Source: Adapted from Michael E. Porter, “The Competitive Advantage of Nations,” Harvard
Business Review, March–April 1990, pp. 73–93.
page 190
page 191
Demand Conditions The demand conditions in an industry’s home market
include the relative size of the market, its growth potential, and the nature of
domestic buyers’ needs and wants. Differing population sizes, income levels,
and other demographic factors give rise to considerable differences in market
size and growth rates from country to country. Industry sectors that are larger
and more important in their home market tend to attract more resources and
grow faster than others. For example, owing to widely differing population
demographics and income levels, there is a far bigger market for luxury
automobiles in the United States and Germany than in Argentina, India,
Mexico, and China. At the same time, in developing markets like India,
China, Brazil, and Malaysia, market growth potential is far higher than it is in
the more mature economies of Britain, Denmark, Canada, and Japan. The
potential for market growth in automobiles is explosive in China,
where 2017 sales of new vehicles amounted to 28.9 million,
surpassing U.S. sales of 17.2 million and making China the world’s largest
market for the eighth year in a row.4 Demanding domestic buyers for an
industry’s products spur greater innovativeness and improvements in quality.
Such conditions foster the development of stronger industries, with firms that
are capable of translating a home-market advantage into a competitive
advantage in the international arena.
Factor Conditions Factor conditions describe the availability, quality, and
cost of raw materials and other inputs (called factors of production) that firms
in an industry require for producing their products and services. The relevant
factors of production vary from industry to industry but can include
different types of labor, technical or managerial knowledge, land,
financial capital, and natural resources. Elements of a country’s infrastructure
may be included as well, such as its transportation, communication, and
banking systems. For instance, in India there are efficient, well-developed
national channels for distributing groceries, personal care items, and other
packaged products to the country’s 13 million retailers, (as of 2020) whereas
in China distribution is primarily local and there is a limited national network
for distributing most products. Competitively strong industries and firms
develop where relevant factor conditions are favorable.
Related and Supporting Industries Robust industries often develop in
locales where there is a cluster of related industries, including others within
the same value chain system (e.g., suppliers of components and equipment,
distributors) and the makers of complementary products or those that are
technologically related. The sports car makers Ferrari and Maserati, for
example, are located in an area of Italy known as the “engine technological
district,” which includes other firms involved in racing, such as Ducati
Motorcycles, along with hundreds of small suppliers. The advantage to firms
that develop as part of a related-industry cluster comes from the close
collaboration with key suppliers and the greater knowledge sharing
throughout the cluster, resulting in greater efficiency and innovativeness.
Firm Strategy, Structure, and Rivalry Different country environments
foster the development of different styles of management, organization, and
strategy. For example, strategic alliances are a more common strategy for
firms from Asian or Latin American countries, which emphasize trust and
cooperation in their organizations, than for firms from North America, where
individualism is more influential. In addition, countries vary in terms of the
competitive rivalry of their industries. Fierce rivalry in home markets tends to
hone domestic firms’ competitive capabilities and ready them for competing
internationally.
The Diamond
Framework can be
used to
1. predict from which
countries foreign
entrants are most
likely to come
2. decide which
foreign markets to
enter first
3. choose the best
country location
for different value
chain activities
For an industry in a particular country to become competitively strong, all
four factors must be favorable for that industry. When they are, the industry is
likely to contain firms that are capable of competing successfully in the
international arena. Thus the diamond framework can be used to reveal the
answers to several questions that are important for competing on an
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international basis. First, it can help predict where foreign entrants into an
industry are most likely to come from. This can help managers prepare to
cope with new foreign competitors, since the framework also reveals
something about the basis of the new rivals’ strengths. Second, it can reveal
the countries in which foreign rivals are likely to be weakest and thus can
help managers decide which foreign markets to enter first. And third, because
it focuses on the attributes of a country’s business environment that allow
firms to flourish, it reveals something about the advantages of conducting
particular business activities in that country. Thus the diamond framework is
an aid to deciding where to locate different value chain activities most
beneficially—a topic that we address next.
Opportunities for Location-Based Advantages
Increasingly, companies are locating different value chain activities in
different parts of the world to exploit location-based advantages that vary
from country to country. This is particularly evident with respect to the
location of manufacturing activities. Differences in wage rates, worker
productivity, energy costs, and the like create sizable variations in
manufacturing costs from country to country. By locating its plants
in certain countries, firms in some industries can reap major
manufacturing cost advantages because of lower input costs (especially
labor), relaxed government regulations, the proximity of suppliers and
technologically related industries, or unique natural resources. In such cases,
the low-cost countries become principal production sites, with most of the
output being exported to markets in other parts of the world. Companies that
build production facilities in low-cost countries (or that source their products
from contract manufacturers in these countries) gain a competitive advantage
over rivals with plants in countries where costs are higher. The competitive
role of low manufacturing costs is most evident in low-wage countries like
China, India, Pakistan, Cambodia, Vietnam, Mexico, Brazil, Guatemala, the
Philippines, and several countries in Africa and eastern Europe that have
become production havens for manufactured goods with high labor content
(especially textiles and apparel). Hourly compensation for manufacturing
workers in 2016 averaged about $3.27 in India, $2.06 in the Philippines,
$3.60 in China, $3.91 in Mexico, $9.82 in Taiwan, $8.60 in Hungary, $7.98
in Brazil, $10.96 in Portugal, $22.98 in South Korea, $23.67 in New Zealand,
$26.46 in Japan, $30.08 in Canada, $39.03 in the United States, $43.18 in
Germany, and $60.36 in Switzerland.5 China emerged as the manufacturing
capital of the world in large part because of its low wages—virtually all of
the world’s major manufacturing companies now have facilities in China.
For other types of value chain activities, input quality or availability are
more important considerations. Tiffany & Co. entered the mining industry in
Canada to access diamonds that could be certified as “conflict free” and not
associated with either the funding of African wars or unethical mining
conditions. Many U.S. companies locate call centers in countries such as
India and Ireland, where English is spoken and the workforce is well
educated. Other companies locate R&D activities in countries where there are
prestigious research institutions and well-trained scientists and engineers.
Likewise, concerns about short delivery times and low shipping costs make
some countries better locations than others for establishing distribution
centers.
The Impact of Government Policies and
Economic Conditions in Host Countries
Cross-country variations in government policies and economic conditions
affect both the opportunities available to a foreign entrant and the risks of
operating within the host country. The governments of some countries are
eager to attract foreign investments, and thus they go all out to create a
business climate that outsiders will view as favorable. Governments eager to
spur economic growth, create more jobs, and raise living standards for their
citizens usually enact policies aimed at stimulating business innovation and
capital investment; Ireland is a good example. They may provide such
incentives as reduced taxes, low-cost loans, site location and site
development assistance, and government-sponsored training for workers to
encourage companies to construct production and distribution facilities.
When new business-related issues or developments arise, “pro-business”
governments make a practice of seeking advice and counsel from business
leaders. When tougher business-related regulations are deemed appropriate,
they endeavor to make the transition to more costly and stringent regulations
somewhat business-friendly rather than adversarial.
page 193
On the other hand, governments sometimes enact policies that, from a
business perspective, make locating facilities within a country’s borders less
attractive. For example, the nature of a company’s operations may make it
particularly costly to achieve compliance with a country’s environmental
regulations. Some governments provide subsidies and low-
interest loans to domestic companies to enable them to better
compete against foreign companies. To discourage foreign imports,
governments may enact deliberately burdensome procedures and
requirements regarding customs inspection for foreign goods and may
impose tariffs or quotas on imports. Additionally, they may specify that a
certain percentage of the parts and components used in manufacturing a
product be obtained from local suppliers, require prior approval of capital
spending projects, limit withdrawal of funds from the country, and require
partial ownership of foreign company operations by local companies or
investors. There are times when a government may place restrictions on
exports to ensure adequate local supplies and regulate the prices of imported
and locally produced goods. Such government actions make a country’s
business climate less attractive and in some cases may be sufficiently onerous
as to discourage a company from locating facilities in that country or even
selling its products there.
A country’s business climate is also a function of the political and
economic risks associated with operating within its borders. Political risks
have to do with the instability of weak governments, growing possibilities
that a country’s citizenry will revolt against dictatorial government leaders,
the likelihood of new onerous legislation or regulations on foreign-owned
businesses, and the potential for future elections to produce corrupt or
tyrannical government leaders. In industries that a government deems critical
to the national welfare, there is sometimes a risk that the government will
nationalize the industry and expropriate the assets of foreign companies. In
2012, for example, Argentina nationalized the country’s top oil producer,
YPF, which was owned by Spanish oil major Repsol. In 2015, they
nationalized all of the Argentine railway network, some of which had been in
private hands. Other political risks include the loss of investments due to war
or political unrest, regulatory changes that create operating uncertainties,
security risks due to terrorism, and corruption. Economic risks have to do
with instability of a country’s economy and monetary system—whether
inflation rates might skyrocket or whether uncontrolled deficit spending on
the part of government or risky bank lending practices could lead to a
breakdown of the country’s monetary system and prolonged economic
distress. In some countries, the threat of piracy and lack of protection for
intellectual property are also sources of economic risk. Another is
fluctuations in the value of different currencies—a factor that we discuss in
more detail next.
CORE
CONCEPT
Political risks stem
from instability or
weakness in
national
governments and
hostility to foreign
business.
Economic risks
stem from instability
in a country’s
monetary system,
economic and
regulatory policies,
and the lack of
property rights
protections.
The Risks of Adverse Exchange Rate Shifts
When companies produce and market their products and services in many
different countries, they are subject to the impacts of sometimes favorable
and sometimes unfavorable changes in currency exchange rates. The rates of
exchange between different currencies can vary by as much as 20 to 40
percent annually, with the changes occurring sometimes gradually and
sometimes swiftly. Sizable shifts in exchange rates pose significant risks for
two reasons:
1. They are hard to predict because of the variety of factors involved and the
uncertainties surrounding when and by how much these factors will
change.
page 194
2. They create uncertainty regarding which countries represent the low-cost
manufacturing locations and which rivals have the upper hand in the
marketplace.
To illustrate the economic and competitive risks associated with fluctuating
exchange rates, consider the case of a U.S. company that has located
manufacturing facilities in Brazil (where the currency is reals—pronounced
“ray-alls”) and that exports most of the Brazilian-made goods to
markets in the European Union (where the currency is euros). To
keep the numbers simple, assume that the exchange rate is 4 Brazilian reals
for 1 euro and that the product being made in Brazil has a manufacturing cost
of 4 Brazilian reals (or 1 euro). Now suppose that the exchange rate shifts
from 4 reals per euro to 5 reals per euro (meaning that the real has declined in
value and that the euro is stronger). Making the product in Brazil is now
more cost-competitive because a Brazilian good costing 4 reals to produce
has fallen to only 0.8 euro at the new exchange rate (4 reals divided by 5 reals
per euro = 0.8 euro). This clearly puts the producer of the Brazilian-made
good in a better position to compete against the European makers of the same
good. On the other hand, should the value of the Brazilian real grow stronger
in relation to the euro—resulting in an exchange rate of 3 reals to 1 euro—the
same Brazilian-made good formerly costing 4 reals (or 1 euro) to produce
now has a cost of 1.33 euros (4 reals divided by 3 reals per
euro = 1.33 euros), putting the producer of the Brazilian-made good in a
weaker competitive position vis-à-vis the European producers. Plainly, the
attraction of manufacturing a good in Brazil and selling it in Europe is far
greater when the euro is strong (an exchange rate of 1 euro for 5 Brazilian
reals) than when the euro is weak and exchanges for only 3 Brazilian reals.
But there is one more piece to the story. When the exchange rate changes
from 4 reals per euro to 5 reals per euro, not only is the cost-competitiveness
of the Brazilian manufacturer stronger relative to European manufacturers of
the same item but the Brazilian-made good that formerly cost 1 euro and now
costs only 0.8 euro can also be sold to consumers in the European Union for a
lower euro price than before. In other words, the combination of a stronger
euro and a weaker real acts to lower the price of Brazilian-made goods in all
the countries that are members of the European Union, which is likely to spur
sales of the Brazilian-made good in Europe and boost Brazilian exports to
Europe. Conversely, should the exchange rate shift from 4 reals per euro to 3
page 195
reals per euro—which makes the Brazilian manufacturer less cost-
competitive with European manufacturers of the same item—the Brazilian-
made good that formerly cost 1 euro and now costs 1.33 euros will sell for a
higher price in euros than before, thus weakening the demand of European
consumers for Brazilian-made goods and acting to reduce Brazilian exports
to Europe. Brazilian exporters are likely to experience (1) rising demand for
their goods in Europe whenever the Brazilian real grows weaker relative to
the euro and (2) falling demand for their goods in Europe whenever the real
grows stronger relative to the euro. Consequently, from the standpoint of a
company with Brazilian manufacturing plants, a weaker Brazilian real is a
favorable exchange rate shift and a stronger Brazilian real is an unfavorable
exchange rate shift.
It follows from the previous discussion that shifting exchange rates have a
big impact on the ability of domestic manufacturers to compete with foreign
rivals. For example, U.S.-based manufacturers locked in a fierce competitive
battle with low-cost foreign imports benefit from a weaker U.S. dollar. There
are several reasons why this is so:
Declines in the value of the U.S. dollar against foreign currencies raise the
U.S. dollar costs of goods manufactured by foreign rivals at plants located
in the countries whose currencies have grown stronger relative to the U.S.
dollar. A weaker dollar acts to reduce or eliminate whatever cost advantage
foreign manufacturers may have had over U.S. manufacturers (and helps
protect the manufacturing jobs of U.S. workers).
A weaker dollar makes foreign-made goods more expensive in dollar terms
to U.S. consumers—this curtails U.S. buyer demand for foreign-made
goods, stimulates greater demand on the part of U.S. consumers
for U.S.-made goods, and reduces U.S. imports of foreign-made
goods.
Fluctuating
exchange rates
pose significant
economic risks to a
company’s
competitiveness in
foreign markets.
Exporters are
disadvantaged when
the currency of the
country where
goods are being
manufactured grows
stronger relative to
the currency of the
importing country.
A weaker U.S. dollar enables the U.S.-made goods to be sold at lower
prices to consumers in countries whose currencies have grown stronger
relative to the U.S. dollar—such lower prices boost foreign buyer demand
for the now relatively cheaper U.S.-made goods, thereby stimulating
exports of U.S.-made goods to foreign countries and creating more jobs in
U.S.-based manufacturing plants.
A weaker dollar has the effect of increasing the dollar value of profits a
company earns in foreign-country markets where the local currency is
stronger relative to the dollar. For example, if a U.S.-based manufacturer
earns a profit of €10 million on its sales in Europe, those €10 million
convert to a larger number of dollars when the dollar grows weaker against
the euro.
A weaker U.S. dollar is therefore an economically favorable exchange rate
shift for manufacturing plants based in the United States. A decline in the
value of the U.S. dollar strengthens the cost-competitiveness of U.S.-based
manufacturing plants and boosts buyer demand for U.S.-made goods. When
the value of the U.S. dollar is expected to remain weak for some time to
come, foreign companies have an incentive to build manufacturing facilities
in the United States to make goods for U.S. consumers rather than export the
same goods to the United States from foreign plants where production costs
in dollar terms have been driven up by the decline in the value of the dollar.
Conversely, a stronger U.S. dollar is an unfavorable exchange rate shift for
U.S.-based manufacturing plants because it makes such plants less cost-
competitive with foreign plants and weakens foreign demand for U.S.-made
goods. A strong dollar also weakens the incentive of foreign companies to
locate manufacturing facilities in the United States to make goods for U.S.
consumers. The same reasoning applies to companies that have plants in
countries in the European Union where euros are the local currency. A weak
euro versus other currencies enhances the cost-competitiveness of companies
page 196
manufacturing goods in Europe vis-à-vis foreign rivals with plants in
countries whose currencies have grown stronger relative to the euro; a strong
euro versus other currencies weakens the cost-competitiveness of companies
with plants in the European Union.
Domestic
companies facing
competitive pressure
from lower-cost
imports benefit when
their government’s
currency grows
weaker in relation to
the currencies of the
countries where the
lower-cost imports
are being made.
Cross-Country Differences in Demographic,
Cultural, and Market Conditions
Buyer tastes for a particular product or service sometimes differ substantially
from country to country. In France, consumers prefer top-loading washing
machines, whereas in most other European countries consumers prefer front-
loading machines. People in Hong Kong prefer compact appliances, but in
Taiwan large appliances are more popular. Ice cream flavors like matcha,
black sesame, and red beans have more appeal to East Asian customers than
they have for customers in the United States and in Europe. Sometimes,
product designs suitable in one country are inappropriate in another because
of differing local standards—for example, in the United States electrical
devices run on 110-volt electric systems, but in some European countries the
standard is a 240-volt electric system, necessitating the use of different
electrical designs and components. Cultural influences can also affect
consumer demand for a product. For instance, in South Korea many parents
are reluctant to purchase PCs even when they can afford them because of
concerns that their children will be distracted from their schoolwork by
surfing the Web, playing PC-based video games, and becoming Internet
“addicts.”6
Consequently, companies operating in an international marketplace have to
wrestle with whether and how much to customize their offerings in each
country market to match local buyers’ tastes and preferences or whether to
pursue a strategy of offering a mostly standardized product worldwide. While
making products that are closely matched to local tastes makes them more
appealing to local buyers, customizing a company’s products country by
country may raise production and distribution costs due to the greater variety
of designs and components, shorter production runs, and the complications of
added inventory handling and distribution logistics. Greater standardization
of a global company’s product offering, on the other hand, can lead to scale
economies and learning-curve effects, thus reducing per-unit production costs
and contributing to the achievement of a low-cost advantage. The tension
between the market pressures to localize a company’s product offerings
country by country and the competitive pressures to lower costs is one of the
big strategic issues that participants in foreign markets have to resolve.
STRATEGIC OPTIONS FOR ENTERING
INTERNATIONAL MARKETS
• LO 7-3
Identify the
differences among
the five primary
modes of entry into
foreign markets.
Once a company decides to expand beyond its domestic borders, it must
consider the question of how to enter foreign markets. There are five primary
modes of entry to choose among:
1. Maintain a home-country production base and export goods to foreign
markets.
2. License foreign firms to produce and distribute the company’s products
abroad.
3. Employ a franchising strategy in foreign markets.
page 197
4. Establish a subsidiary in a foreign market via acquisition or internal
development.
5. Rely on strategic alliances or joint ventures with foreign companies.
Which mode of entry to employ depends on a variety of factors, including
the nature of the firm’s strategic objectives, the firm’s position in terms of
whether it has the full range of resources and capabilities needed to operate
abroad, country-specific factors such as trade barriers, and the transaction
costs involved (the costs of contracting with a partner and monitoring its
compliance with the terms of the contract, for example). The options vary
considerably regarding the level of investment required and the associated
risks—but higher levels of investment and risk generally provide the firm
with the benefits of greater ownership and control.
Export Strategies
Using domestic plants as a production base for exporting goods to foreign
markets is an excellent initial strategy for pursuing international sales. It is a
conservative way to test the international waters. The amount of capital
needed to begin exporting is often minimal; existing production capacity may
well be sufficient to make goods for export. With an export-based entry
strategy, a manufacturer can limit its involvement in foreign markets by
contracting with foreign wholesalers experienced in importing to handle the
entire distribution and marketing function in their countries or regions of the
world. If it is more advantageous to maintain control over these functions,
however, a manufacturer can establish its own distribution and sales
organizations in some or all of the target foreign markets. Either way, a
home-based production and export strategy helps the firm minimize
its direct investments in foreign countries. Such strategies are
commonly favored by Chinese, Korean, and Italian companies—products are
designed and manufactured at home and then distributed through local
channels in the importing countries. The primary functions performed abroad
relate chiefly to establishing a network of distributors and perhaps conducting
sales promotion and brand-awareness activities.
Whether an export strategy can be pursued successfully over the long run
depends on the relative cost-competitiveness of the home-country production
base. In some industries, firms gain additional scale economies and learning-
curve benefits from centralizing production in plants whose output capability
exceeds demand in any one country market; exporting enables a firm to
capture such economies. However, an export strategy is vulnerable when (1)
manufacturing costs in the home country are substantially higher than in
foreign countries where rivals have plants, (2) the costs of shipping the
product to distant foreign markets are relatively high, (3) adverse shifts occur
in currency exchange rates, and (4) importing countries impose tariffs or
erect other trade barriers. Unless an exporter can keep its production and
shipping costs competitive with rivals’ costs, secure adequate local
distribution and marketing support of its products, and effectively hedge
against unfavorable changes in currency exchange rates, its success will be
limited.
Licensing Strategies
Licensing as an entry strategy makes sense when a firm with valuable
technical know-how, an appealing brand, or a unique patented product has
neither the internal organizational capability nor the resources to enter
foreign markets. Licensing also has the advantage of avoiding the risks of
committing resources to country markets that are unfamiliar, politically
volatile, economically unstable, or otherwise risky. By licensing the
technology, trademark, or production rights to foreign-based firms, a
company can generate income from royalties while shifting the costs and
risks of entering foreign markets to the licensee. One downside of the
licensing alternative is that the partner who bears the risk is also likely to be
the biggest beneficiary from any upside gain. Disney learned this lesson
when it relied on licensing agreements to open its first foreign theme park,
Tokyo Disneyland. When the venture proved wildly successful, it was its
licensing partner, the Oriental Land Company, and not Disney who reaped
the windfall. Another disadvantage of licensing is the risk of providing
valuable technological know-how to foreign companies and thereby losing
some degree of control over its use; monitoring licensees and safeguarding
the company’s proprietary know-how can prove quite difficult in some
circumstances. But if the royalty potential is considerable and the companies
to which the licenses are being granted are trustworthy and reputable, then
licensing can be a very attractive option. Many software and pharmaceutical
companies use licensing strategies to participate in foreign markets.
page 198
Franchising Strategies
While licensing works well for manufacturers and owners of proprietary
technology, franchising is often better suited to the international expansion
efforts of service and retailing enterprises. McDonald’s, Yum! Brands (the
parent of Pizza Hut, KFC, Taco Bell, and WingStreet), the UPS Store, Roto-
Rooter, 7-Eleven, and Hilton Hotels have all used franchising to build a
presence in foreign markets. Franchising has many of the same advantages as
licensing. The franchisee bears most of the costs and risks of
establishing foreign locations; a franchisor has to expend only the
resources to recruit, train, support, and monitor franchisees. The big problem
a franchisor faces is maintaining quality control; foreign franchisees do not
always exhibit strong commitment to consistency and standardization,
especially when the local culture does not stress the same kinds of quality
concerns. A question that can arise is whether to allow foreign franchisees to
make modifications in the franchisor’s product offering so as to better satisfy
the tastes and expectations of local buyers. Should McDonald’s give
franchisees in each nation some leeway in what products they put on their
menus? Should franchised KFC units in China be permitted to substitute
spices that appeal to Chinese consumers? Or should the same menu offerings
be rigorously and unvaryingly required of all franchisees worldwide?
Foreign Subsidiary Strategies
Very often companies electing to compete internationally prefer to have
direct control over all aspects of operating in a foreign market. Companies
that want to participate in direct performance of all essential value chain
activities typically establish a wholly owned subsidiary, either by acquiring a
local company or by establishing its own new operating organization from
the ground up. A subsidiary business that is established internally from
scratch is called an internal startup or a greenfield venture.
CORE
CONCEPT
A greenfield
venture (or internal
startup) is a
subsidiary business
that is established
by setting up the
entire operation from
the ground up.
Acquiring a local business is the quicker of the two options; it may be the
least risky and most cost-efficient means of hurdling such entry barriers as
gaining access to local distribution channels, building supplier relationships,
and establishing working relationships with government officials and other
key constituencies. Buying an ongoing operation allows the acquirer to move
directly to the task of transferring resources and personnel to the newly
acquired business, redirecting and integrating the activities of the acquired
business into its own operation, putting its own strategy into place, and
accelerating efforts to build a strong market position.
One thing an acquisition-minded firm must consider is whether to pay a
premium price for a successful local company or to buy a struggling
competitor at a bargain price. If the buying firm has little knowledge of the
local market but ample capital, it is often better off purchasing a capable,
strongly positioned firm. However, when the acquirer sees promising ways to
transform a weak firm into a strong one and has the resources and managerial
know-how to do so, a struggling company can be the better long-term
investment.
Entering a new foreign country via a greenfield venture makes sense when
a company already operates in a number of countries, has experience in
establishing new subsidiaries and overseeing their operations, and has a
sufficiently large pool of resources and capabilities to rapidly equip a new
subsidiary with the personnel and what it needs otherwise to compete
successfully and profitably. Four more conditions combine to make a
greenfield venture strategy appealing:
When creating an internal startup is cheaper than making an acquisition.
When adding new production capacity will not adversely impact the
supply–demand balance in the local market.
When a startup subsidiary has the ability to gain good distribution access
(perhaps because of the company’s recognized brand name).
When a startup subsidiary will have the size, cost structure, and capabilities
to compete head-to-head against local rivals.
page 199
Greenfield ventures in foreign markets can also pose
problems, just as other entry strategies do. They represent a costly capital
investment, subject to a high level of risk. They require numerous other
company resources as well, diverting them from other uses. They do not
work well in countries without strong, well-functioning markets and
institutions that protect the rights of foreign investors and provide other legal
protections. Moreover, an important disadvantage of greenfield ventures
relative to other means of international expansion is that they are the slowest
entry route—particularly if the objective is to achieve a sizable market share.
On the other hand, successful greenfield ventures may offer higher returns to
compensate for their high risk and slower path.
Collaborative
strategies involving
alliances or joint
ventures with foreign
partners are a
popular way for
companies to edge
their way into the
markets of foreign
countries.
Alliance and Joint Venture Strategies
Strategic alliances, joint ventures, and other cooperative agreements with
foreign companies are a widely used means of entering foreign markets.7 A
company can benefit immensely from a foreign partner’s familiarity with
local government regulations, its knowledge of the buying habits and product
preferences of consumers, its distribution-channel relationships, and so on.8
Both Japanese and American companies are actively forming alliances with
European companies to better compete in the 28-nation European Union (and
the five countries that are candidates to become EU members). Many U.S.
and European companies are allying with Asian companies in their efforts to
enter markets in China, India, Thailand, Indonesia, and other Asian countries.
Another reason for cross-border alliances is to capture economies of scale
in production and/or marketing. By joining forces in producing components,
assembling models, and marketing their products, companies can realize cost
savings not achievable with their own small volumes. A third reason to
employ a collaborative strategy is to share distribution facilities and dealer
networks, thus mutually strengthening each partner’s access to buyers. A
fourth benefit of a collaborative strategy is the learning and added expertise
that comes from performing joint research, sharing technological know-how,
studying one another’s manufacturing methods, and understanding how to
tailor sales and marketing approaches to fit local cultures and traditions. A
fifth benefit is that cross-border allies can direct their competitive energies
more toward mutual rivals and less toward one another; teaming up may help
them close the gap on leading companies. And, finally, alliances can be a
particularly useful way for companies across the world to gain agreement on
important technical standards—they have been used to arrive at standards for
assorted PC devices, Internet-related technologies, high-definition
televisions, and mobile phones.
Cross-border
alliances enable a
growth-minded
company to widen
its geographic
coverage and
strengthen its
competitiveness in
foreign markets; at
the same time, they
offer flexibility and
allow a company to
retain some degree
of autonomy and
operating control.
Cross-border alliances are an attractive means of gaining the
aforementioned types of benefits (as compared to merging with or acquiring
foreign-based companies) because they allow a company to preserve its
independence (which is not the case with a merger) and avoid using scarce
financial resources to fund acquisitions. Furthermore, an alliance offers the
flexibility to readily disengage once its purpose has been served or if the
benefits prove elusive, whereas mergers and acquisitions are more permanent
arrangements.9
page 200
Alliances may also be used to pave the way for an intended merger; they
offer a way to test the value and viability of a cooperative arrangement with a
foreign partner before making a more permanent commitment. Illustration
Capsule 7.1 shows how Walgreens pursued this strategy with Alliance Boots
in order to facilitate its expansion abroad.
ILLUSTRATION
CAPSULE 7.1 Walgreens Boots Alliance,
Inc.: Entering Foreign Markets via Alliance
Followed by Merger
Walgreens pharmacy began in 1901 as a single store on the South Side of Chicago and
grew to become the largest chain of pharmacy retailers in America. Walgreens was an
early pioneer of the “self-service” pharmacy and found success by moving quickly to build
a vast domestic network of stores after the Second World War. This growth-focused
strategy served Walgreens well up until the beginning of the 21st century, by which time it
had nearly saturated the U.S. market. By 2014, 75 percent of Americans lived within five
miles of a Walgreens. The company was also facing threats to its core business model.
Walgreens relies heavily on pharmacy sales, which generally are paid for by someone
other than the patient, usually the government or an insurance company. As the
government and insurers started to make a more sustained effort to cut costs,
Walgreens’s core profit center was at risk. To mitigate these threats, Walgreens looked to
enter foreign markets.
Walgreens found an ideal international partner in Alliance Boots. Based in the UK,
Alliance Boots had a global footprint with 3,300 stores across 10 countries. A partnership
with Alliance Boots had several strategic advantages, allowing Walgreens to gain swift
entry into foreign markets as well as complementary assets and expertise. First, it gave
Walgreens access to new markets beyond the saturated United States for its retail
pharmacies. Second, it provided Walgreens with a new revenue stream in wholesale
drugs. Alliance Boots held a vast European distribution network for wholesale drug sales;
Walgreens could leverage that network and expertise to build a similar model in the
United States. Finally, a merger with Alliance Boots would strengthen Walgreens’s
existing business by increasing the company’s market position and therefore bargaining
power with drug companies. In light of these advantages, Walgreens moved quickly to
partner with and later acquire Alliance Boots and merged both companies in 2014 to
become Walgreens Boots Alliance. Walgreens Boots Alliance, Inc. is now one of the
world’s largest drug purchasers, able to negotiate from a strong position with drug
companies and other suppliers to realize economies of scale in its current businesses.
page 201
Jonathan Weiss/Shutterstock
The market has thus far responded favorably to the merger. Walgreens Boots
Alliance’s stock has more than doubled in value since the first news of the partnership in
2012. However, the company is still struggling to integrate and faces new risks such as
currency fluctuation in its new combined position. Yet as the pharmaceutical industry
continues to consolidate, Walgreens is in an undoubtedly stronger position to continue to
grow in the future thanks to its strategic international acquisition.
Note: Developed with Katherine Coster.
Sources: Company 10-K Form, 2015,
investor.walgreensbootsalliance.com/secfiling.cfm?filingID=1140361-15-
38791&CIK=1618921; L. Capron and W. Mitchell, “When to Change a Winning Strategy,”
Harvard Business Review, July 25, 2012, hbr.org/2012/07/when-to-change-a-winning-
strat; T. Martin and R. Dezember, “Walgreen Spends $6.7 Billion on Alliance Boots
Stake,” The Wall Street Journal, June 20, 2012.
The Risks of Strategic Alliances with Foreign Partners Alliances and
joint ventures with foreign partners have their pitfalls, however. Sometimes a
local partner’s knowledge and expertise turns out to be less valuable than
expected (because its knowledge is rendered obsolete by fast-changing
market conditions or because its operating practices are archaic). Cross-
border allies typically must overcome language and cultural barriers and
figure out how to deal with diverse (or conflicting) operating practices. The
transaction costs of working out a mutually agreeable arrangement and
monitoring partner compliance with the terms of the arrangement
http://investor.walgreensbootsalliance.com/secfiling.cfm?filingID=1140361-15-38791&CIK=1618921;
http://hbr.org/2012/07/when-to-change-a-winning-strat
can be high. The communication, trust building, and coordination costs are
not trivial in terms of management time.10 Often, partners soon discover they
have conflicting objectives and strategies, deep differences of opinion about
how to proceed, or important differences in corporate values and ethical
standards. Tensions build, working relationships cool, and the hoped-for
benefits never materialize.11 It is not unusual for there to be little personal
chemistry among some of the key people on whom the success or failure of
the alliance depends—the rapport such personnel need to work well together
may never emerge. And even if allies are able to develop productive personal
relationships, they can still have trouble reaching mutually agreeable ways to
deal with key issues or launching new initiatives fast enough to stay abreast
of rapid advances in technology or shifting market conditions.
One worrisome problem with alliances or joint ventures is that a firm may
risk losing some of its competitive advantage if an alliance partner is given
full access to its proprietary technological expertise or other competitively
valuable capabilities. There is a natural tendency for allies to struggle to
collaborate effectively in competitively sensitive areas, thus spawning
suspicions on both sides about forthright exchanges of information and
expertise. It requires many meetings of many people working in good faith
over a period of time to iron out what is to be shared, what is to remain
proprietary, and how the cooperative arrangements will work.
Even if the alliance proves to be a win–win proposition for both parties,
there is the danger of becoming overly dependent on foreign partners for
essential expertise and competitive capabilities. Companies aiming for global
market leadership need to develop their own resources and capabilities in
order to be masters of their destiny. Frequently, experienced international
companies operating in 50 or more countries across the world find less need
for entering into cross-border alliances than do companies in the early stages
of globalizing their operations.12 Companies with global operations make it a
point to develop senior managers who understand how “the system” works in
different countries, plus they can avail themselves of local managerial talent
and know-how by simply hiring experienced local managers and thereby
detouring the hazards of collaborative alliances with local companies. One of
the lessons about cross-border partnerships is that they are more effective in
helping a company establish a beachhead of new opportunity in world
markets than they are in enabling a company to achieve and sustain global
market leadership.
INTERNATIONAL STRATEGY: THE
THREE MAIN APPROACHES
Broadly speaking, a firm’s international strategy is simply its strategy for
competing in two or more countries simultaneously. Typically, a company
will start to compete internationally by entering one or perhaps a select few
foreign markets—selling its products or services in countries where there is a
ready market for them. But as it expands further internationally, it will have
to confront head-on two conflicting pressures: the demand for responsiveness
to local needs versus the prospect of efficiency gains from offering a
standardized product globally. Deciding on the competitive approach to best
address these competing pressures is perhaps the foremost strategic issue that
must be addressed when a company is operating in two or more foreign
markets.13 Figure 7.2 shows a company’s three options for resolving this
issue: choosing a multidomestic, global, or transnational strategy.
• LO 7-4
Identify the three
main strategic
approaches for
competing
internationally.
CORE
CONCEPT
An international
strategy is a
strategy for
competing in two or
more countries
simultaneously.
page 202
FIGURE 7.2 Three Approaches for Competing Internationally
Multidomestic Strategies—a “Think-Local, Act-
Local” Approach
A multidomestic strategy is one in which a company varies its product
offering and competitive approach from country to country in an effort to
meet differing buyer needs and to address divergent local-market conditions.
It involves having plants produce different product versions for different local
markets and adapting marketing and distribution to fit local customs,
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cultures, regulations, and market requirements. In the food products industry,
it is common for companies to vary the ingredients in their products and sell
the localized versions under local brand names to cater to country-specific
tastes and eating preferences. Government requirements for gasoline
additives that help reduce carbon monoxide, smog, and other emissions are
almost never the same from country to country. BP utilizes localized
strategies in its gasoline and service station business segment because of
these cross-country formulation differences and because of customer
familiarity with local brand names. For example, the company markets
gasoline in the United States under its BP and Arco brands, but markets
gasoline in Germany, Belgium, Poland, Hungary, and the Czech Republic
under the Aral brand. Castrol, a BP-owned specialist in oil lubricants,
produces over 3,000 different formulas of lubricants to meet the
requirements of different climates, vehicle types and uses, and
equipment applications that characterize different country markets.
In essence, a multidomestic strategy represents a think-local, act-local
approach to international strategy. A think-local, act-local approach to
strategy making is most appropriate when the need for local responsiveness is
high due to significant cross-country differences in demographic, cultural,
and market conditions and when the potential for efficiency gains from
standardization is limited, as depicted in Figure 7.2. A think-local, act-local
approach is possible only when decision making is decentralized, giving local
managers considerable latitude for crafting and executing strategies for the
country markets they are responsible for. Giving local managers decision-
making authority allows them to address specific market needs and respond
swiftly to local changes in demand. It also enables them to focus their
competitive efforts, stake out attractive market positions vis-à-vis local
competitors, react to rivals’ moves in a timely fashion, and target new
opportunities as they emerge.14
CORE
CONCEPT
A multidomestic
strategy is one in
which a company
varies its product
offering and
competitive
approach from
country to country in
an effort to be
responsive to
differing buyer
preferences and
market conditions. It
is a think-local, act-
local type of
international
strategy, facilitated
by decision making
decentralized to the
local level.
Despite their obvious benefits, think-local, act-local strategies have three
big drawbacks:
1. They hinder transfer of a company’s capabilities, knowledge, and other
resources across country boundaries, since the company’s efforts are not
integrated or coordinated across country boundaries. This can make the
company less innovative overall.
2. They raise production and distribution costs due to the greater variety of
designs and components, shorter production runs for each product version,
and complications of added inventory handling and distribution logistics.
3. They are not conducive to building a single, worldwide competitive
advantage. When a company’s competitive approach and product offering
vary from country to country, the nature and size of any resulting
competitive edge also tends to vary. At the most, multidomestic strategies
are capable of producing a group of local competitive advantages of
varying types and degrees of strength.
Global Strategies—a “Think-Global, Act-Global”
Approach
A global strategy contrasts sharply with a multidomestic strategy in that it
takes a standardized, globally integrated approach to producing, packaging,
selling, and delivering the company’s products and services worldwide.
Companies employing a global strategy sell the same products under the
page 204
same brand names everywhere, utilize much the same distribution channels in
all countries, and compete on the basis of the same capabilities and marketing
approaches worldwide. Although the company’s strategy or product offering
may be adapted in minor ways to accommodate specific situations in a few
host countries, the company’s fundamental competitive approach (low cost,
differentiation, best cost, or focused) remains very much intact worldwide
and local managers stick close to the global strategy.
A think-global, act-global approach prompts company managers to
integrate and coordinate the company’s strategic moves worldwide and to
expand into most, if not all, nations where there is significant buyer demand.
It puts considerable strategic emphasis on building a global brand name and
aggressively pursuing opportunities to transfer ideas, new products, and
capabilities from one country to another. Global strategies are characterized
by relatively centralized value chain activities, such as production and
distribution. While there may be more than one manufacturing plant and
distribution center to minimize transportation costs, for example, they tend to
be few in number. Achieving the efficiency potential of a global
strategy requires that resources and best practices be shared,
value chain activities be integrated, and capabilities be transferred from one
location to another as they are developed. These objectives are best facilitated
through centralized decision making and strong headquarters control.
CORE
CONCEPT
A global strategy is
one in which a
company employs
the same basic
competitive
approach in all
countries where it
operates, sells
standardized
products globally,
strives to build
global brands, and
coordinates its
actions worldwide
with strong
headquarters
control. It represents
a think-global, act-
global approach.
Because a global strategy cannot accommodate varying local needs, it is an
appropriate strategic choice when there are pronounced efficiency benefits
from standardization and when buyer needs are relatively homogeneous
across countries and regions. A globally standardized and integrated
approach is especially beneficial when high volumes significantly lower costs
due to economies of scale or added experience (moving the company further
down a learning curve). It can also be advantageous if it allows the firm to
replicate a successful business model on a global basis efficiently or engage
in higher levels of R&D by spreading the fixed costs and risks over a higher-
volume output. It is a fitting response to industry conditions marked by
global competition.
Consumer electronics companies such as Apple, Nokia, and Motorola
Mobility tend to employ global strategies. The development of universal
standards in technology is one factor supporting the use of global strategies.
So is the rise of global accounting and financial reporting standards.
Whenever country-to-country differences are small enough to be
accommodated within the framework of a global strategy, a global strategy is
preferable because a company can more readily unify its operations and focus
on establishing a brand image and reputation that are uniform from country to
country. Moreover, with a global strategy a company is better able to focus its
full resources on securing a sustainable low-cost or differentiation-based
competitive advantage over both domestic rivals and global rivals.
There are, however, several drawbacks to global strategies: (1) They do not
enable firms to address local needs as precisely as locally based rivals can;
(2) they are less responsive to changes in local market conditions, in the form
of either new opportunities or competitive threats; (3) they raise
transportation costs and may involve higher tariffs; and (4) they involve
higher coordination costs due to the more complex task of managing a
globally integrated enterprise.
Transnational Strategies—a “Think-Global, Act-
Local” Approach
page 205
A transnational strategy (sometimes called glocalization) incorporates
elements of both a globalized and a localized approach to strategy making.
This type of middle-ground strategy is called for when there are relatively
high needs for local responsiveness as well as appreciable benefits to be
realized from standardization, as Figure 7.2 suggests. A transnational strategy
encourages a company to use a think-global, act-local approach to balance
these competing objectives.
CORE
CONCEPT
transnational
strategy is a think-
global, act-local
approach that
incorporates
elements of both
multidomestic and
global strategies.
Often, companies implement a transnational strategy with mass-
customization techniques that enable them to address local preferences in an
efficient, semi-standardized manner. McDonald’s, KFC, and Starbucks have
discovered ways to customize their menu offerings in various countries
without compromising costs, product quality, and operating effectiveness.
Unilever is responsive to local market needs regarding its consumer products,
while realizing global economies of scale in certain functions. Otis Elevator
found that a transnational strategy delivers better results than a global
strategy when it is competing in countries like China, where local needs are
highly differentiated. By switching from its customary single-brand approach
to a multibrand strategy aimed at serving different segments of the market,
Otis was able to double its market share in China and increased its revenues
sixfold over a nine-year period.15
As a rule, most companies that operate internationally
endeavor to employ as global a strategy as customer needs and market
conditions permit. Electronic Arts (EA) has two major design studios—one
in Vancouver, British Columbia, and one in Los Angeles—and smaller design
studios in locations including San Francisco, Orlando, London, and Tokyo.
page 206
This dispersion of design studios helps EA design games that are specific to
different cultures—for example, the London studio took the lead in designing
the popular FIFA Soccer game to suit European tastes and to replicate the
stadiums, signage, and team rosters; the U.S. studio took the lead in
designing games involving NFL football, NBA basketball, and NASCAR
racing.
A transnational strategy is far more conducive than other strategies to
transferring and leveraging subsidiary skills and capabilities. But, like other
approaches to competing internationally, transnational strategies also have
significant drawbacks:
1. They are the most difficult of all international strategies to implement due
to the added complexity of varying the elements of the strategy to
situational conditions.
2. They place large demands on the organization due to the need to pursue
conflicting objectives simultaneously.
3. Implementing the strategy is likely to be a costly and time-consuming
enterprise, with an uncertain outcome.
Illustration Capsule 7.2 explains how Four Seasons Hotels has been able to
compete successfully on the basis of a transnational strategy.
Table 7.1 provides a summary of the pluses and minuses of the three
approaches to competing internationally.
TABLE 7.1 Advantages and Disadvantages of
Multidomestic, Global, and Transnational Strategies
Advantages Disadvantages
Multidomestic
(think local, act
local)
Can meet the specific needs
of each market more
precisely
Can respond more swiftly to
localized changes in demand
Can target reactions to the
moves of local rivals
Can respond more quickly to
local opportunities and
threats
Hinders resource and
capability sharing or cross-
market transfers
Has higher production and
distribution costs
Is not conducive to a
worldwide competitive
advantage
Advantages Disadvantages
Global (think
global, act
global)
Has lower costs due to scale
and scope economies
Can lead to greater
efficiencies due to the ability
to transfer best practices
across markets
Increases innovation from
knowledge sharing and
capability transfer
Offers the benefit of a global
brand and reputation
Cannot address local needs
precisely
Is less responsive to
changes in local market
conditions
Involves higher
transportation costs and
tariffs
Has higher coordination and
integration costs
Transnational
(think global,
act local)
Offers the benefits of both
local responsiveness and
global integration
Enables the transfer and
sharing of resources and
capabilities across borders
Provides the benefits of
flexible coordination
Is more complex and harder
to implement
Entails conflicting goals,
which may be difficult to
reconcile and require trade-
offs
Involves more costly and
time-consuming
implementation
ILLUSTRATION
CAPSULE 7.2 Four Seasons Hotels: Local
Character, Global Service
Four Seasons Hotels is a Toronto, Canada–based manager of luxury hotel properties.
With more than 100 properties located in many of the world’s most popular tourist
destinations and business centers, Four Seasons commands a following of many of the
world’s most discerning travelers. In contrast to its key competitor, Ritz-Carlton, which
strives to create one uniform experience globally, Four Seasons Hotels has gained
market share by deftly combining local architectural and cultural experiences with globally
consistent luxury service.
When moving into a new market, Four Seasons always seeks out a local capital
partner. The understanding of local custom and business relationships this financier
brings is critical to the process of developing a new Four Seasons hotel. Four Seasons
also insists on hiring a local architect and design consultant for each property, as
opposed to using architects or designers it’s worked with in other locations. While this
can be a challenge, particularly in emerging markets, Four Seasons has found it is worth
it in the long run to have a truly local team.
The specific layout and programming of each hotel is also unique. For instance, when
Four Seasons opened its hotel in Mumbai, India, it prioritized space for large banquet
halls to target the Indian wedding market. In India, weddings often draw guests
numbering in the thousands. When moving into the Middle East, Four Seasons designed
its hotels with separate prayer rooms for men and women. In Bali, where destination
weddings are common, the hotel employs a “weather shaman” who, for some guests,
provides reassurance that the weather will cooperate for their special day. In all cases,
the objective is to provide a truly local experience.
When staffing its hotels, Four Seasons seeks to strike a fine balance between
employing locals who have an innate understanding of the local culture alongside
expatriate staff or “culture carriers” who understand the DNA of Four Seasons. It also
uses global systems to track customer preferences and employs globally consistent
service standards. Four Seasons claims that its guests experience the same high level of
service globally but that no two experiences are the same.
Chris Lawrence/Alamy Stock Photo
While it is much more expensive and time-consuming to design unique architectural
and programming experiences, doing so is a strategic trade-off Four Seasons has made
to achieve the local experience demanded by its high-level clientele. Likewise, it has
recognized that maintaining globally consistent operation processes and service
standards is important too. Four Seasons has struck the right balance between thinking
globally and acting locally—the marker of a truly transnational strategy. As a result, the
company has been rewarded with an international reputation for superior service and a
leading market share in the luxury hospitality segment.
Note: Developed with Brian R. McKenzie.
page 207
Sources: Four Seasons annual report and corporate website; interview with Scott
Woroch, executive vice president of development, Four Seasons Hotels, February 22,
2014.
INTERNATIONAL OPERATIONS AND
THE QUEST FOR COMPETITIVE
ADVANTAGE
There are three important ways in which a firm can gain competitive
advantage (or offset domestic disadvantages) by expanding outside its
domestic market. First, it can use location to lower costs or achieve greater
product differentiation. Second, it can transfer competitively valuable
resources and capabilities from one country to another or share
them across international borders to extend its competitive
advantages. And third, it can benefit from cross-border coordination
opportunities that are not open to domestic-only competitors.
• LO 7-5
Explain how
companies are able
to use international
operations to
improve overall
competitiveness.
Using Location to Build Competitive Advantage
To use location to build competitive advantage, a company must consider two
issues: (1) whether or not to concentrate some of the activities it performs in
only a few select countries of those in which they operate and if so (2) in
which countries to locate particular activities.
Companies that
compete
internationally can
pursue competitive
advantage in world
markets by locating
their value chain
activities in whatever
nations prove most
advantageous.
When to Concentrate Activities in a Few Locations It is advantageous
for a company to concentrate its activities in a limited number of locations
when
The costs of manufacturing or other activities are significantly lower in
some geographic locations than in others. For example, much of the
world’s athletic footwear is manufactured in Asia (China, Vietnam, and
Indonesia) because of low labor costs; much of the production of circuit
boards for PCs is located in Taiwan because of both low costs and the high-
caliber technical skills of the Taiwanese labor force.
Significant scale economies exist in production or distribution. The
presence of significant economies of scale in components production or
final assembly means that a company can gain major cost savings from
operating a few super-efficient plants as opposed to a host of small plants
scattered across the world. Makers of digital cameras and LED TVs located
in Japan, South Korea, and Taiwan have used their scale economies to
establish a low-cost advantage in this way. Achieving low-cost leadership
status often requires a company to have the largest worldwide
manufacturing share (as distinct from brand share or market share), with
production centralized in one or a few giant plants. Some companies even
use such plants to manufacture units sold under the brand names of rivals
to further boost production-related scale economies. Likewise, a company
may be able to reduce its distribution costs by establishing large-scale
distribution centers to serve major geographic regions of the world market
(e.g., North America, Latin America, Europe and the Middle East, and the
Asia-Pacific region).
Sizable learning and experience benefits are associated with performing an
activity. In some industries, learning-curve effects can allow a manufacturer
to lower unit costs, boost quality, or master a new technology more quickly
by concentrating production in a few locations. The key to riding down the
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learning curve is to concentrate production in a few locations to increase
the cumulative volume at a plant (and thus the experience of the plant’s
workforce) as rapidly as possible.
Certain locations have superior resources, allow better coordination of
related activities, or offer other valuable advantages. Companies often
locate a research unit or a sophisticated production facility in a particular
country to take advantage of its pool of technically trained personnel.
Adidas located its first robotic “speedfactory” in Germany to benefit from
its superior technological resources and to allow greater oversight from the
company’s headquarters (which are in Germany). Where just-in-time
inventory practices yield big cost savings and/or where an assembly firm
has long-term partnering arrangements with its key suppliers, parts
manufacturing plants may be clustered around final-assembly plants. A
customer service center or sales office may be opened in a particular
country to help cultivate strong relationships with pivotal customers
located nearby. Airbus established a major assembly site for their
commercial aircraft in Alabama since the United States is a major market.
When to Disperse Activities across Many Locations In some instances,
dispersing activities across locations is more advantageous than concentrating
them. Buyer-related activities—such as distribution, marketing, and after-sale
service—usually must take place close to buyers. This makes it necessary to
physically locate the capability to perform such activities in every country or
region where a firm has major customers. For example, firms that make
mining and oil-drilling equipment maintain operations in many locations
around the world to support customers’ needs for speedy equipment repair
and technical assistance. Large public accounting firms have offices in
numerous countries to serve the foreign operations of their international
corporate clients. Dispersing activities to many locations is also
competitively important when high transportation costs, diseconomies of
large size, and trade barriers make it too expensive to operate from a central
location. Many companies distribute their products from multiple locations to
shorten delivery times to customers. In addition, dispersing activities helps
hedge against the risks of fluctuating exchange rates, supply interruptions
(due to strikes, natural disasters, or transportation delays), and adverse
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political developments. Such risks are usually greater when activities are
concentrated in a single location.
Even though global firms have strong reason to disperse buyer-related
activities to many international locations, such activities as materials
procurement, parts manufacture, finished-goods assembly, technology
research, and new product development can frequently be decoupled from
buyer locations and performed wherever advantage lies. Components can be
made in Mexico; technology research done in Frankfurt; new products
developed and tested in Phoenix; and assembly plants located in Spain,
Brazil, Taiwan, or South Carolina, for example. Capital can be raised
wherever it is available on the best terms.
Sharing and Transferring Resources and
Capabilities across Borders to Build Competitive
Advantage
When a company has competitively valuable resources and capabilities, it
may be able to leverage them further by expanding internationally. If its
resources retain their value in foreign contexts, then entering new foreign
markets can extend the company’s resource-based competitive advantage
over a broader domain. For example, companies like Tiffany, Cartier, and
Rolex have utilized their powerful brand names to extend their
differentiation-based competitive advantages into markets far beyond their
home-country origins. In each of these cases, the luxury brand name
represents a valuable competitive asset that can readily be shared by all of the
company’s international stores, enabling them to attract buyers and gain a
higher degree of market penetration over a wider geographic area than would
otherwise be possible.
Another way for a company to extend its competitive advantage
internationally is to transfer technological know-how or other important
resources and capabilities from its operations in one country to its operations
in other countries. For instance, if a company discovers ways to assemble a
product faster and more cost-effectively at one plant, then that know-how can
be transferred to its assembly plants in other countries. Whirlpool’s efforts to
link its product R&D and manufacturing operations in North America, Latin
America, Europe, and Asia allowed it to accelerate the discovery
of innovative appliance features, coordinate the introduction of these features
in the appliance products marketed in different countries, and create a cost-
efficient worldwide supply chain. Whirlpool’s conscious efforts to integrate
and coordinate its various operations around the world have helped it achieve
operational excellence and speed product innovations to market. Walmart is
expanding its international operations with a strategy that involves
transferring its considerable resource capabilities in distribution and discount
retailing to its retail units in 28 foreign countries.
Cross-border sharing or transferring resources and capabilities provides a
cost-effective way for a company to leverage its core competencies more
fully and extend its competitive advantages into a wider array of geographic
markets. The cost of sharing or transferring already developed resources and
capabilities across country borders is low in comparison to the time and
considerable expense it takes to create them. Moreover, deploying them
abroad spreads the fixed development costs over a greater volume of unit
sales, thus contributing to low unit costs and a potential cost-based
competitive advantage in recently entered geographic markets. Even if the
shared or transferred resources or capabilities have to be adapted to local-
market conditions, this can usually be done at low additional cost.
Consider the case of Walt Disney’s theme parks as an example. The
success of the theme parks in the United States derives in part from core
resources such as the Disney brand name and characters like Mickey Mouse
that have universal appeal and worldwide recognition. These resources can be
freely shared with new theme parks as Disney expands internationally.
Disney can also replicate its theme parks in new countries cost-effectively
since it has already borne the costs of developing its core resources, park
attractions, basic park design, and operating capabilities. The cost of
replicating its theme parks abroad is relatively low, even if the parks need to
be adapted to a variety of local country conditions. Thus, in establishing
Disney parks in Tokyo, Paris, Hong Kong, and Shanghai, Disney has been
able to leverage the differentiation advantage conferred by resources such as
the Disney name and the park attractions. And by moving into new foreign
markets, it has augmented its competitive advantage further through the
efficiency gains that come from cross-border resource sharing and low-cost
capability transfer and business model replication.
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Sharing and transferring resources and capabilities across country borders
may also contribute to the development of broader or deeper competencies
and capabilities—helping a company achieve dominating depth in some
competitively valuable area. For example, the reputation for quality that
Honda established worldwide began in motorcycles but enabled the company
to command a position in both automobiles and outdoor power equipment in
multiple-country markets. A one-country customer base is often too small to
support the resource buildup needed to achieve such depth; this is particularly
true in a developing or protected market, where competitively powerful
resources are not required. By deploying capabilities across a larger
international domain, a company can gain the experience needed to upgrade
them to a higher performance standard. And by facing a more challenging set
of international competitors, a company may be spurred to develop a stronger
set of competitive capabilities. Moreover, by entering international markets,
firms may be able to augment their capability set by learning from
international rivals, cooperative partners, or acquisition targets.
However, cross-border resource sharing and transfers of capabilities are
not guaranteed recipes for competitive success. For example, whether a
resource or capability can confer a competitive advantage abroad
depends on the conditions of rivalry in each particular market. If
the rivals in a foreign-country market have superior resources and
capabilities, then an entering firm may find itself at a competitive
disadvantage even if it has a resource-based advantage domestically and can
transfer the resources at low cost. In addition, since lifestyles and buying
habits differ internationally, resources and capabilities that are valuable in
one country may not have value in another. Sometimes a popular or well-
regarded brand in one country turns out to have little competitive clout
against local brands in other countries.
Benefiting from Cross-Border Coordination
Companies that compete on an international basis have another source of
competitive advantage relative to their purely domestic rivals: They are able
to benefit from coordinating activities across different countries’ domains.16
For example, an international manufacturer can shift production from a plant
in one country to a plant in another to take advantage of exchange rate
fluctuations, to cope with components shortages, or to profit from changing
wage rates or energy costs. Production schedules can be coordinated
worldwide; shipments can be diverted from one distribution center to another
if sales rise unexpectedly in one place and fall in another. By coordinating
their activities, international companies may also be able to enhance their
leverage with host-country governments or respond adaptively to changes in
tariffs and quotas. Efficiencies can also be achieved by shifting workloads
from where they are unusually heavy to locations where personnel are
underutilized.
CROSS-BORDER STRATEGIC MOVES
While international competitors can employ any of the offensive and
defensive moves discussed in Chapter 6, there are two types of strategic
moves that are particularly suited for companies competing internationally.
The first is an offensive move that an international competitor is uniquely
positioned to make, due to the fact that it may have a strong or protected
market position in more than one country. The second type of move is a type
of defensive action involving multiple markets.
Waging a Strategic Offensive
One advantage to being an international competitor is the possibility of
having more than one significant and possibly protected source of profits.
This may provide the company with the financial strength to engage in
strategic offensives in selected country markets. The added financial
capability afforded by multiple profit sources gives an international
competitor the financial strength to wage an offensive campaign against a
domestic competitor whose only source of profit is its home market. The
international company has the flexibility of lowballing its prices or launching
high-cost marketing campaigns in the domestic company’s home market and
grabbing market share at the domestic company’s expense. Razor-thin
margins or even losses in these markets can be subsidized with the healthy
profits earned in its markets abroad—a practice called cross-market
subsidization.
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CORE
CONCEPT
Cross-market
subsidization—
supporting
competitive
offensives in one
market with
resources and
profits diverted from
operations in
another market—
can be a powerful
competitive weapon.
The international company can adjust the depth of its price
cutting to move in and capture market share quickly, or it can shave prices
slightly to make gradual market inroads (perhaps over a decade or more) so
as not to threaten domestic firms precipitously and trigger protectionist
government actions. If the domestic company retaliates with matching price
cuts or increased marketing expenses, it thereby exposes its entire revenue
stream and profit base to erosion; its profits can be squeezed substantially and
its competitive strength sapped, even if it is the domestic market leader.
A company is said to
be dumping when it
sells its goods in
foreign markets at
prices that are
1. well below the
prices at which it
normally sells
them in its home
market or
2. well below its full
costs per unit.
When taken to the extreme, cut-rate pricing attacks by international
competitors may draw charges of unfair “dumping.” A company is said to be
dumping when it sells its goods in foreign markets at prices that are (1) well
below the prices at which it normally sells them in its home market or (2)
well below its full costs per unit. Almost all governments can be expected to
retaliate against perceived dumping practices by imposing special tariffs on
goods being imported from the countries of the guilty companies. Indeed, as
the trade among nations has mushroomed over the past 10 years, most
governments have joined the World Trade Organization (WTO), which
promotes fair trade practices among nations and actively polices dumping.
Companies deemed guilty of dumping frequently come under pressure from
their own government to cease and desist, especially if the tariffs adversely
affect innocent companies based in the same country or if the advent of
special tariffs raises the specter of an international trade war.
Defending against International Rivals
Cross-border tactics involving multiple country markets can also be used as a
means of defending against the strategic moves of rivals with multiple
profitable markets of their own. If a company finds itself under competitive
attack by an international rival in one country market, one way to respond is
to conduct a counterattack against the rival in one of its key markets in a
different country—preferably where the rival is least protected and has the
most to lose. This is a possible option when rivals compete against one
another in much the same markets around the world and engage in
multimarket competition.
For companies with at least one major market, having a presence in a
rival’s key markets can be enough to deter the rival from making aggressive
attacks. The reason for this is that the combination of market presence in the
rival’s key markets and a highly profitable market elsewhere can send a
signal to the rival that the company could quickly ramp up production
(funded by the profit center) to mount a competitive counterattack if the rival
attacks one of the company’s key markets.
Multimarket
competition refers to
a situation where
rivals compete
against one another
in many of the same
markets.
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When international rivals compete against one another in multiple-country
markets, this type of deterrence effect can restrain them from taking
aggressive action against one another, due to the fear of a retaliatory response
that might escalate the battle into a cross-border competitive war. Mutual
restraint of this sort tends to stabilize the competitive position of
multimarket rivals against one another. And while it may prevent each firm
from making any major market share gains at the expense of its rival, it also
protects against costly competitive battles that would be likely to erode the
profitability of both companies without any compensating gain.
CORE
CONCEPT
When the same
companies compete
against one another
in multiple
geographic markets,
the threat of cross-
border
counterattacks may
be enough to
encourage mutual
restraint among
international rivals.
STRATEGIES FOR COMPETING IN THE
MARKETS OF DEVELOPING
COUNTRIES
• LO 7-6
Identify the unique
characteristics of
competing in
developing-country
markets.
Companies racing for global leadership have to consider competing in
developing-economy markets like China, India, Brazil, Indonesia, Thailand,
Poland, Mexico, and Russia—countries where the business risks are
considerable but where the opportunities for growth are huge, especially as
their economies develop and living standards climb toward levels in the
industrialized world.17 In today’s world, a company that aspires to
international market leadership (or to sustained rapid growth) cannot ignore
the market opportunities or the base of technical and managerial talent such
countries offer. For example, in 2018, China was the world’s second-largest
economy (behind the United States), based on the purchasing power of its
population of over 1.4 billion people. China’s growth in demand for
consumer goods has made it the fifth largest market for luxury goods, with
sales greater than those in developed markets such as Germany, Spain, and
the United Kingdom. Thus, no company that aspires to global market
leadership can afford to ignore the strategic importance of establishing
competitive market positions in the so-called BRIC countries (Brazil, Russia,
India, and China), as well as in other parts of the Asia-Pacific region, Latin
America, and eastern Europe.
Tailoring products to fit market conditions in developing countries,
however, often involves more than making minor product changes and
becoming more familiar with local cultures. McDonald’s has had to offer
vegetable burgers in parts of Asia and to rethink its prices, which are often
high by local standards and affordable only by the well-to-do. Kellogg has
struggled to introduce its cereals successfully because consumers in many
less developed countries do not eat cereal for breakfast. Single-serving
packages of detergents, shampoos, pickles, cough syrup, and cooking oils are
very popular in India because they allow buyers to conserve cash by
purchasing only what they need immediately. Thus, many companies find
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that trying to employ a strategy akin to that used in the markets of developed
countries is hazardous.18 Experimenting with some, perhaps many, local
twists is usually necessary to find a strategy combination that works.
Strategy Options for Competing in Developing-
Country Markets
There are several options for tailoring a company’s strategy to fit the
sometimes unusual or challenging circumstances presented in developing-
country markets:
Prepare to compete on the basis of low price. Consumers in developing
markets are often highly focused on price, which can give low-cost local
competitors the edge unless a company can find ways to attract buyers with
bargain prices as well as better products. For example, in order to enter the
market for laundry detergents in India, Unilever had to develop a low-cost
detergent (named Wheel), construct new low-cost production facilities,
package the detergent in single-use amounts so that it could be sold at a
very low unit price, distribute the product to local merchants by handcarts,
and craft an economical marketing campaign that included painted signs on
buildings and demonstrations near stores. The new brand quickly captured
$100 million in sales and by 2014 was the top detergent brand in India-
based dollar sales. Unilever replicated the strategy in India with
low-priced packets of shampoos and deodorants and in South
America with a detergent brand-named Ala.
Modify aspects of the company’s business model to accommodate the
unique local circumstances of developing countries. For instance,
Honeywell had sold industrial products and services for more than 100
years outside the United States and Europe using a foreign subsidiary
model that focused international activities on sales only. When Honeywell
entered China, it discovered that industrial customers in that country
considered how many key jobs foreign companies created in China, in
addition to the quality and price of the product or service when making
purchasing decisions. Honeywell added about 150 engineers, strategists,
and marketers in China to demonstrate its commitment to bolstering the
Chinese economy. Honeywell replicated its “East for East” strategy when it
entered the market for industrial products and services in India. Within 10
years of Honeywell establishing operations in China and three years of
expanding into India, the two emerging markets accounted for 30 percent
of the firm’s worldwide growth.
Try to change the local market to better match the way the company does
business elsewhere. An international company often has enough market
clout to drive major changes in the way a local country market operates.
When Japan’s Suzuki entered India, it triggered a quality revolution among
Indian auto parts manufacturers. Local component suppliers teamed up
with Suzuki’s vendors in Japan and worked with Japanese experts to
produce higher-quality products. Over the next two decades, Indian
companies became proficient in making top-notch components for
vehicles, won more prizes for quality than companies in any country other
than Japan, and broke into the global market as suppliers to many
automakers in Asia and other parts of the world. Mahindra and Mahindra,
one of India’s premier automobile manufacturers, has been recognized by a
number of organizations for its product quality. Among its most noteworthy
awards was its number-one ranking by J.D. Power Asia Pacific for new-
vehicle overall quality.
Stay away from developing markets where it is impractical or
uneconomical to modify the company’s business model to accommodate
local circumstances. Home Depot expanded successfully into Mexico, but
it has avoided entry into other developing countries because its value
proposition of good quality, low prices, and attentive customer service
relies on (1) good highways and logistical systems to minimize store
inventory costs, (2) employee stock ownership to help motivate store
personnel to provide good customer service, and (3) high labor costs for
housing construction and home repairs that encourage homeowners to
engage in do-it-yourself projects. Relying on these factors in North
American markets has worked spectacularly for Home Depot, but the
company found that it could not count on these factors in China, from
which it withdrew in 2012.
Company experiences in entering developing markets like Brazil, Russia,
India, and China indicate that profitability seldom comes quickly or easily.
Building a market for the company’s products can often turn into a long-term
process that involves reeducation of consumers, sizable investments in
advertising to alter tastes and buying habits, and upgrades of the local
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infrastructure (transportation systems, distribution channels, etc.). In such
cases, a company must be patient, work within the system to improve the
infrastructure, and lay the foundation for generating sizable revenues and
profits once conditions are ripe for market takeoff.
Profitability in
developing markets
rarely comes quickly
or easily—new
entrants have to
adapt their business
models to local
conditions, which
may not always be
possible.
DEFENDING AGAINST GLOBAL
GIANTS: STRATEGIES FOR LOCAL
COMPANIES IN DEVELOPING
COUNTRIES
If opportunity-seeking, resource-rich international companies are looking to
enter developing-country markets, what strategy options can local companies
use to survive? As it turns out, the prospects for local companies facing
global giants are by no means grim. Studies of local companies in developing
markets have disclosed five strategies that have proved themselves in
defending against globally competitive companies19:
1. Develop business models that exploit shortcomings in local distribution
networks or infrastructure. In many instances, the extensive collection of
resources possessed by the global giants is of little help in building a
presence in developing markets. The lack of well-established local
wholesaler and distributor networks, telecommunication systems,
consumer banking, or media necessary for advertising makes it difficult for
large internationals to migrate business models proved in developed
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markets to emerging markets. Emerging markets sometimes favor local
companies whose managers are familiar with the local language and
culture and are skilled in selecting large numbers of conscientious
employees to carry out labor-intensive tasks. Shanda, a Chinese producer
of massively multiplayer online role-playing games (MMORPGs),
overcame China’s lack of an established credit card network by selling
prepaid access cards through local merchants. The company’s focus on
online games also protects it from shortcomings in China’s software piracy
laws. An India-based electronics company carved out a market niche for
itself by developing an all-in-one business machine, designed especially
for India’s millions of small shopkeepers, that tolerates the country’s
frequent power outages.
2. Utilize keen understanding of local customer needs and preferences to
create customized products or services. When developing-country markets
are largely made up of customers with strong local needs, a good strategy
option is to concentrate on customers who prefer a local touch and to
accept the loss of the customers attracted to global brands.20 A local
company may be able to astutely exploit its local orientation—its
familiarity with local preferences, its expertise in traditional products, its
long-standing customer relationships. A small Middle Eastern cell phone
manufacturer competes successfully against industry giants Samsung,
Apple, Nokia, and Motorola by selling a model designed especially for
Muslims—it is loaded with the Koran, alerts people at prayer times, and is
equipped with a compass that points them toward Mecca. Shenzhen-based
Tencent has become the leader in instant messaging in China through its
unique understanding of Chinese behavior and culture.
3. Take advantage of aspects of the local workforce with which large
international companies may be unfamiliar. Local companies that lack the
technological capabilities of foreign entrants may be able to rely on their
better understanding of the local labor force to offset any disadvantage.
Focus Media is China’s largest outdoor advertising firm and has relied on
low-cost labor to update its more than 170,000 LCD displays and
billboards in over 90 cities in a low-tech manner, while international
companies operating in China use electronically networked screens that
allow messages to be changed remotely. Focus uses an army of
employees who ride to each display by bicycle to change
advertisements with programming contained on a USB flash drive or
DVD. Indian information technology firms such as Infosys Technologies
and Satyam Computer Services have been able to keep their personnel
costs lower than those of international competitors EDS and Accenture
because of their familiarity with local labor markets. While the large
internationals have focused recruiting efforts in urban centers like
Bangalore and Delhi, driving up engineering and computer science salaries
in such cities, local companies have shifted recruiting efforts to second-tier
cities that are unfamiliar to foreign firms.
4. Use acquisition and rapid-growth strategies to better defend against
expansion-minded internationals. With the growth potential of developing
markets such as China, Indonesia, and Brazil obvious to the world, local
companies must attempt to develop scale and upgrade their competitive
capabilities as quickly as possible to defend against the stronger
international’s arsenal of resources. Most successful companies in
developing markets have pursued mergers and acquisitions at a rapid-fire
pace to build first a nationwide and then an international presence.
Hindalco, India’s largest aluminum producer, has followed just such a path
to achieve its ambitions for global dominance. By acquiring companies in
India first, it gained enough experience and confidence to eventually
acquire much larger foreign companies with world-class capabilities.21
When China began to liberalize its foreign trade policies, Lenovo (the
Chinese PC maker) realized that its long-held position of market
dominance in China could not withstand the onslaught of new international
entrants such as Dell and HP. Its acquisition of IBM’s PC business allowed
Lenovo to gain rapid access to IBM’s globally recognized PC brand, its
R&D capability, and its existing distribution in developed countries. This
has allowed Lenovo not only to hold its own against the incursion of
global giants into its home market but also to expand into new markets
around the world.22
5. Transfer company expertise to cross-border markets and initiate actions to
contend on an international level. When a company from a developing
country has resources and capabilities suitable for competing in other
country markets, launching initiatives to transfer its expertise to foreign
markets becomes a viable strategic option. Televisa, Mexico’s largest
media company, used its expertise in Spanish culture and linguistics to
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become the world’s most prolific producer of Spanish-language soap
operas. By continuing to upgrade its capabilities and learn from its
experience in foreign markets, a company can sometimes transform itself
into one capable of competing on a worldwide basis, as an emerging global
giant. Sundaram Fasteners of India began its foray into foreign markets as
a supplier of radiator caps to General Motors—an opportunity it pursued
when GM first decided to outsource the production of this part. As a
participant in GM’s supplier network, the company learned about emerging
technical standards, built its capabilities, and became one of the first Indian
companies to achieve QS 9000 quality certification. With the expertise it
gained and its recognition for meeting quality standards, Sundaram was
then able to pursue opportunities to supply automotive parts in Japan and
Europe.
Illustration Capsule 7.3 discusses the strategy behind the success of
WeChat (China’s most popular messenger app), in keeping out international
social media rivals.
ILLUSTRATION
CAPSULE 7.3 WeChat’s Strategy for
Defending against International Social Media
Giants in China
WeChat, a Chinese social media and messenger app similar to Whatsapp, allows users
to chat, post photos, shop online, and share information as well as music. It has
continued to add new features, such as WeChat Games and WePay, which allow users
to send money electronically, much like Venmo. The company now serves more than a
billion active users, a testament to the success of its strategy.
WeChat has also had incredible success keeping out international rivals. Due to
censorship and regulations in China, Chinese social media companies have an inherent
advantage over foreign competitors. However, this is not why WeChat has become an
indispensable part of Chinese life.
WeChat has been able to surpass international rivals because, by better understanding
Chinese customer needs, it can anticipate their desires. WeChat added features that
allow users to check traffic cameras during rush hour, purchase tickets to movies, and
book doctor appointments all on the app. Booking appointments with doctors is a feature
that is wildly popular with the Chinese customer base due to common scheduling
difficulties. Essentially, WeChat created its own distribution network for sought after
information and goods in busy Chinese cities.
WeChat also has an understanding of local customs that international rivals can’t
match. In order to promote WePay, WeChat created a Chinese New Year lottery-like
promotion in which users could win virtual “red envelopes” on the app. Red envelopes of
money are traditionally given on Chinese New Year as presents. WePay was able to
grow users from 30 to 100 million in the month following the promotion due to the
popularity of the New Year’s feature. By 2020, many of WeChat’s over one billion active
users were also using WePay. WeChat continues to allow users to send red envelopes
and has continued New Year’s promotions in subsequent years with success. Even
Chinese companies have been bested by WeChat. Rival founder of Alibaba, Jack Ma,
admitted the promotion put WeChat ahead of his company, saying it was a “pearl harbor
attack” on his company. Chinese tech experts noted that the promotion was Ma’s
nightmare because it pushed WeChat to the forefront of Chinese person-to-person
payments.
BigTunaOnline/Shutterstock
WeChat’s strategy of continually developing new features also keeps the competition
at bay. As China’s “App for Everything,” it now permeates all walks of life in China in a
way that will likely continue to keep foreign competitors out.
Note: Developed with Meaghan I. Haugh.
Sources: Guilford, Gwynn. “WeChat’s Little Red Envelopes Are Brilliant Marketing for
Mobile Payments.” Quartz, January 29, 2014; Pasternack, Alex. “How Social Cash Made
WeChat the App for Everything,” Fast Company, January 3, 2017; “WeChat’s World,” The
Economist, August 6, 2016; Stanciu, Tudor. “Why WeChat City Services Is a Game-
Changing Move for Smartphone Adoption,” TechCrunch, April 24, 2015.
page 217
KEY POINTS
1. Competing in international markets allows a company to (1) gain access to
new customers; (2) achieve lower costs through greater economies of
scale, learning, and increased purchasing power; (3) gain access to low-
cost inputs of production; (4) further exploit its core competencies; and (5)
gain access to resources and capabilities located outside the company’s
domestic market.
2. Strategy making is more complex for five reasons: (1) Different countries
have home-country advantages in different industries; (2) there are
location-based advantages to performing different value chain activities in
different parts of the world; (3) varying political and economic risks make
the business climate of some countries more favorable than others; (4)
companies face the risk of adverse shifts in exchange rates when operating
in foreign countries; and (5) differences in buyer tastes and preferences
present a conundrum concerning the trade-off between customizing and
standardizing products and services.
3. The strategies of firms that expand internationally are usually grounded in
home-country advantages concerning demand conditions; factor
conditions; related and supporting industries; and firm strategy, structure,
and rivalry, as described by the Diamond of National Competitive
Advantage framework.
4. There are five strategic options for entering foreign markets. These include
maintaining a home-country production base and exporting goods to
foreign markets, licensing foreign firms to produce and distribute the
company’s products abroad, employing a franchising strategy, establishing
a foreign subsidiary via an acquisition or greenfield venture, and using
strategic alliances or other collaborative partnerships.
5. A company must choose among three alternative approaches for competing
internationally: (1) a multidomestic strategy—a think-local, act-local
approach to crafting international strategy; (2) a global strategy—a think-
global, act-global approach; and (3) a combination think-global, act-local
approach, known as a transnational strategy. A multidomestic strategy
page 218
(think local, act local) is appropriate for companies that must vary their
product offerings and competitive approaches from country to country in
order to accommodate different buyer preferences and market conditions.
The global strategy (think global, act global) works best when there are
substantial cost benefits to be gained from taking a standardized, globally
integrated approach and there is little need for local responsiveness. A
transnational strategy (think global, act local) is called for when there is a
high need for local responsiveness as well as substantial benefits from
taking a globally integrated approach. In this approach, a company strives
to employ the same basic competitive strategy in all markets but still
customizes its product offering and some aspect of its operations to fit
local market circumstances.
6. There are three general ways in which a firm can gain competitive
advantage (or offset domestic disadvantages) in international markets. One
way involves locating various value chain activities among nations in a
manner that lowers costs or achieves greater product differentiation. A
second way draws on an international competitor’s ability to extend its
competitive advantage by cost-effectively sharing, replicating, or
transferring its most valuable resources and capabilities across borders. A
third looks for benefits from cross-border coordination that are unavailable
to domestic-only competitors.
7. Two types of strategic moves are particularly suited for companies
competing internationally. The first involves waging strategic offenses in
international markets through cross-subsidization—a practice of
supporting competitive offensives in one market with resources
and profits diverted from operations in another market. The
second is a defensive move used to encourage mutual restraint among
competitors when there is international multimarket competition by
signaling that each company has the financial capability for mounting a
strong counterattack if threatened. For companies with at least one highly
profitable or well defended market, having a presence in a rival’s key
markets can be enough to deter the rival from making aggressive attacks.
8. Companies racing for global leadership have to consider competing in
developing markets like the BRIC countries—Brazil, Russia, India, and
China—where the business risks are considerable but the opportunities for
growth are huge. To succeed in these markets, companies often have to (1)
LO 7-1, LO 7-3
compete on the basis of low price, (2) modify aspects of the company’s
business model to accommodate local circumstances, and/or (3) try to
change the local market to better match the way the company does
business elsewhere. Profitability is unlikely to come quickly or easily in
developing markets, typically because of the investments needed to alter
buying habits and tastes, the increased political and economic risk, and/or
the need for infrastructure upgrades. And there may be times when a
company should simply stay away from certain developing markets until
conditions for entry are better suited to its business model and strategy.
9. Local companies in developing-country markets can seek to compete
against large international companies by (1) developing business models
that exploit shortcomings in local distribution networks or infrastructure,
(2) utilizing a superior understanding of local customer needs and
preferences or local relationships, (3) taking advantage of competitively
important qualities of the local workforce with which large international
companies may be unfamiliar, (4) using acquisition strategies and rapid-
growth strategies to better defend against expansion-minded international
companies, or (5) transferring company expertise to cross-border markets
and initiating actions to compete on an international level.
ASSURANCE OF LEARNING EXERCISES
1. L’Oréal markets over 500 brands of products in all
sectors of the beauty business in 140 countries. The
company’s international strategy involves
manufacturing these products in 43 plants located
around the world. L’Oréal’s international strategy is
discussed in its operations section of the company’s
website (www.loreal.com/careers/who-you-can-
be/operations) and in its press releases, annual
reports, and presentations. Why has the company
chosen to pursue a foreign subsidiary strategy? Are
there strategic advantages to global sourcing and
production in the cosmetics, fragrances, and hair
care products industry relative to an export strategy?
http://www.loreal.com/careers/who-you-can-be/operations
LO 7-1, LO 7-3
page 219
LO 7-2, LO 7-4
LO 7-5, LO 7-6
2. Alliances, joint ventures, and mergers with foreign
companies are widely used as a means of entering
foreign markets. Such arrangements have many
purposes, including learning about unfamiliar
environments, and the opportunity to access the
complementary resources and capabilities of a
foreign partner. Illustration Capsule 7.1 provides an
example of how Walgreens used a strategy of
entering foreign markets via alliance, followed by a
merger with the same entity. What was this entry
strategy designed to achieve, and why would this
make sense for a company like Walgreens?
3. Assume you are in charge of developing the strategy
for an international company selling products in
some 50 different countries around the
world. One of the issues you face is
whether to employ a multidomestic strategy, a
global strategy, or a transnational strategy.
a. If your company’s product is mobile phones,
which of these strategies do you think it would
make better strategic sense to employ? Why?
b. If your company’s product is dry soup mixes and
canned soups, would a multidomestic strategy
seem to be more advisable than a global strategy
or a transnational strategy? Why or why not?
c. If your company’s product is large home
appliances such as washing machines, ranges,
ovens, and refrigerators, would it seem to make
more sense to pursue a multidomestic strategy, a
global strategy, or a transnational strategy? Why?
4. Using your university library’s business research
resources and Internet sources, identify and discuss
three key strategies that General Motors is using to
compete in China.
LO 7-2
LO 7-2
page 220
EXERCISES FOR SIMULATION PARTICIPANTS
The following questions are for simulation participants whose
companies operate in an international market arena. If your company
competes only in a single country, then skip the questions in this section.
1. To what extent, if any, have you and your co-
managers adapted your company’s strategy to take
shifting exchange rates into account? In other words,
have you undertaken any actions to try to minimize
the impact of adverse shifts in exchange rates?
2. To what extent, if any, have you and your co-
managers adapted your company’s strategy to take
geographic differences in import tariffs or import
duties into account?
3. What are the attributes of each of the following
approaches to competing in international markets?
Multidomestic or think-local, act-local approach.
Global or think-global, act-global approach.
Transnational or think-global, act-local approach.
Explain your answer and indicate two or three
chief elements of your company’s strategy for
competing in two or more different geographic
regions.
ENDNOTES
1 Sidney G. Winter and Gabriel Szulanski, “Getting It Right the Second Time,” Harvard Business Review 80, no. 1
(January 2002), pp. 62–69.
2 P. Dussauge, B. Garrette, and W. Mitchell, “Learning from Competing Partners: Outcomes and Durations of Scale and
Link Alliances in Europe, North America and Asia,” Strategic Management Journal 21, no. 2 (February 2000), pp. 99–
126; K. W. Glaister and P. J. Buckley, “Strategic Motives for International Alliance Formation,” Journal of Management
Studies 33, no. 3 (May 1996), pp. 301–332.
3 Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review, March–April 1990, pp. 73–93.
4 Tom Mitchell and Avantika Chilkoti, “China Car Sales Accelerate Away from US and Brazil in 2013,” Financial Times,
January 9, 2014, www.ft.com/cms/s/0/8c649078-78f8-11e3-b381-00144feabdc0.html#axzz2rpEqjkZO.
5 U.S. Department of Labor, Bureau of Labor Statistics, “International Comparisons of Hourly Compensation Costs in
Manufacturing 2012,” August 9, 2013. (The numbers for India and China are estimates.)
http://www.ft.com/cms/s/0/8c649078-78f8-11e3-b381-00144feabdc0.html#axzz2rpEqjkZO.
page 221
6 Sangwon Yoon, “South Korea Targets Internet Addicts; 2 Million Hooked,” Valley News, April 25, 2010, p. C2.
7 Joel Bleeke and David Ernst, “The Way to Win in Cross-Border Alliances,” Harvard Business Review 69, no. 6
(November–December 1991), pp. 127–133; Gary Hamel, Yves L. Doz, and C. K. Prahalad, “Collaborate with Your
Competitors– and Win,” Harvard Business Review 67, no. 1 (January–February 1989), pp. 134–135.
8 K. W. Glaister and P. J. Buckley, “Strategic Motives for International Alliance Formation,” Journal of Management
Studies 33, no. 3 (May 1996), pp. 301–332.
9 Jeffrey H. Dyer, Prashant Kale, and Harbir Singh, “When to Ally and When to Acquire,” Harvard Business Review 82,
no. 7–8 (July–August 2004).
10 Yves Doz and Gary Hamel, Alliance Advantage: The Art of Creating Value through Partnering (Harvard Business
School Press, 1998); Rosabeth Moss Kanter, “Collaborative Advantage: The Art of the Alliance,” Harvard Business
Review 72, no. 4 (July–August 1994), pp. 96–108.
11 Jeremy Main, “Making Global Alliances Work,” Fortune, December 19, 1990, p. 125.
12 C. K. Prahalad and Kenneth Lieberthal, “The End of Corporate Imperialism,” Harvard Business Review 81, no. 8
(August 2003), pp. 109–117.
13 Pankaj Ghemawat, “Managing Differences: The Central Challenge of Global Strategy,” Harvard Business Review 85,
no. 3 (March 2007).
14 C. A. Bartlett and S. Ghoshal, Managing across Borders: The Transnational Solution, 2nd ed. (Boston: Harvard
Business School Press, 1998).
15 Lynn S. Paine, “The China Rules,” Harvard Business Review 88, no. 6 (June 2010), pp. 103–108.
16 C. K. Prahalad and Yves L. Doz, The Multinational Mission: Balancing Local Demands and Global Vision (New York:
Free Press, 1987).
17 David J. Arnold and John A. Quelch, “New Strategies in Emerging Markets,” Sloan Management Review 40, no. 1
(Fall 1998), pp. 7–20.
18 Tarun Khanna, Krishna G. Palepu, and Jayant Sinha, “Strategies That Fit Emerging Markets,” Harvard Business
Review 83, no. 6 (June 2005), p. 63; Arindam K. Bhattacharya and David C. Michael, “How Local Companies Keep
Multinationals at Bay,” Harvard Business Review 86, no. 3 (March 2008), pp. 94–95.
19 Tarun Khanna and Krishna G. Palepu, “Emerging Giants: Building World-Class Companies in Developing Countries,”
Harvard Business Review 84, no. 10 (October 2006), pp. 60–69.
20 Niroj Dawar and Tony Frost, “Competing with Giants: Survival Strategies for Local Companies in Emerging Markets,”
Harvard Business Review 77, no. 1 (January–February 1999), p. 122; Guitz Ger, “Localizing in the Global Village: Local
Firms Competing in Global Markets,” California Management Review 41, no. 4 (Summer 1999), pp. 64–84.
21 N. Kumar, “How Emerging Giants Are Rewriting the Rules of M&A,” Harvard Business Review, May 2009, pp. 115–
121.
22 H. Rui and G. Yip, “Foreign Acquisitions by Chinese Firms: A Strategic Intent Perspective,” Journal of World Business
43 (2008), pp. 213–226.
page 222
chapter 8
Corporate Strategy
Diversification and the Multibusiness
Company
Learning Objectives
After reading this chapter, you should be able to:
LO 8-1 Explain when and how business diversification can enhance shareholder
value.
LO 8-2 Describe how related diversification strategies can produce cross-business
strategic fit capable of delivering competitive advantage.
LO 8-3 Identify the merits and risks of unrelated diversification strategies.
LO 8-4 Use the analytic tools for evaluating a company’s diversification strategy.
LO 8-5 Understand the four main corporate strategy options a diversified company
can employ to improve company performance.
page 223
Richard Schneider/Getty Images
I suppose my formula might be: dream, diversify, and never miss an angle.
Walt Disney—Founder of the Walt Disney Company
Make winners out of every business in your company. Don’t carry losers.
Jack Welch—Legendary CEO of General Electric
Fit between a parent and its businesses is a two-edged sword: A good fit can create value; a bad one can destroy it.
Andrew Campbell, Michael Goold, and Marcus Alexander—Academics, authors, and consultants
This chapter moves up one level in the strategy-making hierarchy, from strategy making in a single-business
enterprise to strategy making in a diversified, multibusiness enterprise. Because a diversified company is a
collection of individual businesses, the strategy-making task is more complicated. In a one-business company,
managers have to come up with a plan for competing successfully in only a single industry environment—the result
is what Chapter 2 labeled as business strategy (or business-level strategy). But in a diversified company, the
strategy-making challenge involves assessing multiple industry environments and developing a set of business
strategies, one for each industry arena in which the diversified company operates. And top executives at a
diversified company must still go one step further and devise a companywide (or corporate) strategy for improving
page 224
the performance of the company’s overall business lineup and for making a rational whole out of its diversified
collection of individual businesses.
In the first part of this chapter, we describe what crafting a diversification strategy entails, when and why
diversification makes good strategic sense, the various approaches to diversifying a company’s business lineup,
and the pros and cons of related versus unrelated diversification strategies. The second part of the chapter looks at
how to evaluate the attractiveness of a diversified company’s business lineup, how to decide whether it has a good
diversification strategy, and the strategic options for improving a diversified company’s future performance.
WHAT DOES CRAFTING A DIVERSIFICATION
STRATEGY ENTAIL?
The task of crafting a diversified company’s overall corporate strategy falls squarely in the lap of
top-level executives and involves three distinct facets:
1. Picking new industries to enter and deciding on the means of entry. Pursuing a diversification
strategy requires that management decide which new industries to enter and then, for each new
industry, whether to enter by starting a new business from the ground up, by acquiring a company
already in the target industry, or by forming a joint venture or strategic alliance with another
company. The choice of industries depends upon on the strategic rationale (or justification) for
diversifying and the type of diversification being pursued—important issues that we discuss more
fully in sections to follow.
2. Pursuing opportunities to leverage cross-business value chain relationships, where there is
strategic fit, into competitive advantage. The task here is to determine whether there are
opportunities to strengthen a diversified company’s businesses by such means as transferring
competitively valuable resources and capabilities from one business to another, combining the
related value chain activities of different businesses to achieve lower costs, sharing resources,
such as the use of a powerful and well-respected brand name or an R&D facility, across multiple
businesses, and encouraging knowledge sharing and collaborative activity among the businesses.
3. Initiating actions to boost the combined performance of the corporation’s collection of
businesses. Strategic options for improving the corporation’s overall performance include (1)
sticking closely with the existing business lineup and pursuing opportunities presented by these
businesses, (2) broadening the scope of diversification by entering additional industries, (3)
retrenching to a narrower scope of diversification by divesting either poorly performing
businesses or those that no longer fit into management’s long-range plans, and (4) broadly
restructuring the entire company by divesting some businesses, acquiring others, and
reorganizing, to put a whole new face on the company’s business lineup.
The demanding and time-consuming nature of these three tasks explains why corporate
executives generally refrain from becoming immersed in the details of crafting and executing
business-level strategies. Rather, the normal procedure is to delegate lead responsibility for business
strategy to the heads of each business, giving them the latitude to develop strategies suited to the
particular industry environment in which their business operates and holding them accountable for
producing good financial and strategic results.
WHEN TO CONSIDER DIVERSIFYING
page 225
As long as a company has plentiful opportunities for profitable growth in its present industry, there
is no urgency to pursue diversification. But growth opportunities are often limited in mature
industries and markets where buyer demand is flat or declining. In addition, changing industry
conditions—new technologies, inroads being made by substitute products, fast-shifting buyer
preferences, or intensifying competition—can undermine a company’s ability to deliver ongoing
gains in revenues and profits. Consider, for example, what mobile phone companies and
marketers of Voice over Internet Protocol (VoIP) have done to the revenues of long-
distance providers such as AT&T, British Telecommunications, and NTT in Japan. Thus,
diversifying into new industries always merits strong consideration whenever a single-business
company encounters diminishing market opportunities and stagnating sales in its principal business.
The decision to diversify presents wide-ranging possibilities. A company can diversify into
closely related businesses or into totally unrelated businesses. It can diversify its present revenue
and earnings base to a small or major extent. It can move into one or two large new businesses or a
greater number of small ones. It can achieve diversification by acquiring an existing company,
starting up a new business from scratch, or forming a joint venture with one or more companies to
enter new businesses. In every case, however, the decision to diversify must start with a strong
economic justification for doing so.
BUILDING SHAREHOLDER VALUE: THE ULTIMATE
JUSTIFICATION FOR DIVERSIFYING
• LO 8-1
Explain when and
how business
diversification can
enhance
shareholder value.
Diversification must do more for a company than simply spread its business risk across various
industries. In principle, diversification cannot be considered wise or justifiable unless it results in
added long-term economic value for shareholders—value that shareholders cannot capture on their
own by purchasing stock in companies in different industries or investing in mutual funds to spread
their investments across several industries. A move to diversify into a new business stands little
chance of building shareholder value without passing the following three Tests of Corporate
Advantage1:
CORE
CONCEPT
To add shareholder
value, a move to
diversify into a new
business must pass
the three Tests of
Corporate
Advantage:
page 226
1. The industry
attractiveness test
2. The cost of entry
test
3. The better-off test
1. The industry attractiveness test. The industry to be entered through diversification must be
structurally attractive (in terms of the five forces), have resource requirements that match those of
the parent company, and offer good prospects for growth, profitability, and return on investment.
2. The cost of entry test. The cost of entering the target industry must not be so high as to exceed the
potential for good profitability. A catch-22 can prevail here, however. The more attractive an
industry’s prospects are for growth and good long-term profitability, the more expensive it can be
to enter. Entry barriers for startup companies are likely to be high in attractive industries—if
barriers were low, a rush of new entrants would soon erode the potential for high profitability.
And buying a well-positioned company in an appealing industry often entails a high acquisition
cost that makes passing the cost of entry test less likely. Since the owners of a successful and
growing company usually demand a price that reflects their business’s profit prospects, it’s easy
for such an acquisition to fail the cost of entry test.
3. The better-off test. Diversifying into a new business must offer potential for the company’s
existing businesses and the new business to perform better together under a single corporate
umbrella than they would perform operating as independent, stand-alone businesses—an effect
known as synergy. For example, let’s say that company A diversifies by purchasing company B
in another industry. If A and B’s consolidated profits in the years to come prove no greater than
what each could have earned on its own, then A’s diversification won’t provide its
shareholders with any added value. Company A’s shareholders could have achieved the
same 1 + 1 = 2 result by merely purchasing stock in company B. Diversification does not result in
added long-term value for shareholders unless it produces a 1 + 1 = 3 effect, whereby the
businesses perform better together as part of the same firm than they could have performed as
independent companies.
CORE
CONCEPT
Creating added
value for
shareholders via
diversification
requires building a
multibusiness
company in which
the whole is greater
than the sum of its
parts; such 1 + 1 = 3
effects are called
synergy.
Diversification moves must satisfy all three tests to grow shareholder value over the long term.
Diversification moves that can pass only one or two tests are suspect.
page 227
APPROACHES TO DIVERSIFYING THE BUSINESS
LINEUP
The means of entering new businesses can take any of three forms: acquisition, internal startup, or
joint ventures with other companies.
Diversifying by Acquisition of an Existing Business
Acquisition is a popular means of diversifying into another industry. Not only is it quicker than
trying to launch a new operation, but it also offers an effective way to hurdle such entry barriers as
acquiring technological know-how, establishing supplier relationships, achieving scale economies,
building brand awareness, and securing adequate distribution. Acquisitions are also commonly
employed to access resources and capabilities that are complementary to those of the acquiring firm
and that cannot be developed readily internally. Buying an ongoing operation allows the acquirer to
move directly to the task of building a strong market position in the target industry rather than
getting bogged down in trying to develop the knowledge, experience, scale of operation, and market
reputation necessary for a startup entrant to become an effective competitor.
CORE
CONCEPT
An acquisition
premium, or control
premium, is the
amount by which the
price offered
exceeds the
preacquisition
market value or
stock price of the
target company.
However, acquiring an existing business can prove quite expensive. The costs of acquiring
another business include not only the acquisition price but also the costs of performing the due
diligence to ascertain the worth of the other company, the costs of negotiating the purchase
transaction, and the costs of integrating the business into the diversified company’s portfolio. If the
company to be acquired is a successful company, the acquisition price will include a hefty premium
over the preacquisition value of the company for the right to control the company. For example, the
$1.2 billion that luxury fashion company Michael Kors paid to acquire luxury accessories brand
Jimmy Choo included a 36.5 percent premium over Jimmy Choo’s share price before being put up
for sale. Premiums are paid in order to convince the shareholders and managers of the target
company that it is in their financial interests to approve the deal. The average premium paid by U.S.
companies over the last 15 years was more often in the 20 to 25 percent range.
While acquisitions offer an enticing means for entering a new business, many fail to deliver on
their promise.2 Realizing the potential gains from an acquisition requires a successful integration of
the acquired company into the culture, systems, and structure of the acquiring firm. This can be a
costly and time-consuming operation. Acquisitions can also fail to deliver long-term shareholder
value if the acquirer overestimates the potential gains and pays a premium in excess of the realized
gains. High integration costs and excessive price premiums are two reasons that an
acquisition might fail the cost of entry test. Firms with significant experience in making acquisitions
are better able to avoid these types of problems.3
Entering a New Line of Business through Internal Development
Achieving diversification through internal development involves starting a new business subsidiary
from scratch. Internal development has become an increasingly important way for companies to
diversify and is often referred to as corporate venturing or new venture development. Although
building a new business from the ground up is generally a time-consuming and uncertain process, it
avoids the pitfalls associated with entry via acquisition and may allow the firm to realize greater
profits in the end. It may offer a viable means of entering a new or emerging industry where there
are no good acquisition candidates.
CORE
CONCEPT
Corporate
venturing (or new
venture
development) is the
process of
developing new
businesses as an
outgrowth of a
company’s
established
business operations.
It is also referred to
as corporate
entrepreneurship or
intrapreneurship
since it requires
entrepreneurial-like
qualities within a
larger enterprise.
Entering a new business via internal development, however, poses some significant hurdles. An
internal new venture not only has to overcome industry entry barriers but also must invest in new
production capacity, develop sources of supply, hire and train employees, build channels of
distribution, grow a customer base, and so on, unless the new business is quite similar to the
company’s existing business. The risks associated with internal startups can be substantial, and the
likelihood of failure is often high. Moreover, the culture, structures, and organizational systems of
some companies may impede innovation and make it difficult for corporate entrepreneurship to
flourish.
Generally, internal development of a new business has appeal only when (1) the parent company
already has in-house most of the resources and capabilities it needs to piece together a new business
and compete effectively; (2) there is ample time to launch the business; (3) the internal cost of entry
is lower than the cost of entry via acquisition; (4) adding new production capacity will not adversely
impact the supply–demand balance in the industry; and (5) incumbent firms are likely to be slow or
ineffective in responding to a new entrant’s efforts to crack the market.
Using Joint Ventures to Achieve Diversification
page 228
Entering a new business via a joint venture can be useful in at least three types of situations.4 First,
a joint venture is a good vehicle for pursuing an opportunity that is too complex, uneconomical, or
risky for one company to pursue alone. Second, joint ventures make sense when the opportunities in
a new industry require a broader range of competencies and know-how than a company can marshal
on its own. Many of the opportunities in satellite-based telecommunications, biotechnology, and
network-based systems that blend hardware, software, and services call for the coordinated
development of complementary innovations and the tackling of an intricate web of financial,
technical, political, and regulatory factors simultaneously. In such cases, pooling the resources and
competencies of two or more companies is a wiser and less risky way to proceed. Third, companies
sometimes use joint ventures to diversify into a new industry when the diversification move entails
having operations in a foreign country. However, as discussed in Chapters 6 and 7, partnering with
another company can have significant drawbacks due to the potential for conflicting objectives,
disagreements over how to best operate the venture, culture clashes, and so on. Joint ventures are
generally the least durable of the entry options, usually lasting only until the partners decide to go
their own ways.
Choosing a Mode of Entry
The choice of how best to enter a new business—whether through internal development,
acquisition, or joint venture—depends on the answers to four important questions:
Does the company have all of the resources and capabilities it requires to enter the business
through internal development, or is it lacking some critical resources?
Are there entry barriers to overcome?
Is speed an important factor in the firm’s chances for successful entry?
Which is the least costly mode of entry, given the company’s objectives?
The Question of Critical Resources and Capabilities If a firm has all the resources it needs to
start up a new business or will be able to easily purchase or lease any missing resources, it may
choose to enter the business via internal development. However, if missing critical resources cannot
be easily purchased or leased, a firm wishing to enter a new business must obtain these missing
resources through either acquisition or joint venture. Bank of America acquired Merrill Lynch to
obtain critical investment banking resources and capabilities that it lacked. The acquisition of these
additional capabilities complemented Bank of America’s strengths in corporate banking and opened
up new business opportunities for the company. Firms often acquire other companies as a way to
enter foreign markets where they lack local marketing knowledge, distribution capabilities, and
relationships with local suppliers or customers. McDonald’s acquisition of Burghy, Italy’s only
national hamburger chain, offers an example.5 If there are no good acquisition opportunities or if
the firm wants to avoid the high cost of acquiring and integrating another firm, it may choose to
enter via joint venture. This type of entry mode has the added advantage of spreading the risk of
entering a new business, an advantage that is particularly attractive when uncertainty is high. De
Beers’s joint venture with the luxury goods company LVMH provided De Beers not only with the
complementary marketing capabilities it needed to enter the diamond retailing business but also
with a partner to share the risk.
page 229
The Question of Entry Barriers The second question to ask is whether entry barriers would
prevent a new entrant from gaining a foothold and succeeding in the industry. If entry barriers are
low and the industry is populated by small firms, internal development may be the preferred mode
of entry. If entry barriers are high, the company may still be able to enter with ease if it has the
requisite resources and capabilities for overcoming high barriers. For example, entry barriers due to
reputational advantages may be surmounted by a diversified company with a widely known and
trusted corporate name. But if the entry barriers cannot be overcome readily, then the only feasible
entry route may be through acquisition of a well-established company. While entry barriers may
also be overcome with a strong complementary joint venture, this mode is the more uncertain
choice due to the lack of industry experience.
The Question of Speed Speed is another determining factor in deciding how to go about entering
a new business. Acquisition is a favored mode of entry when speed is of the essence, as is the case
in rapidly changing industries where fast movers can secure long-term positioning advantages.
Speed is important in industries where early movers gain experience-based advantages that grow
ever larger over time as they move down the learning curve. It is also important in technology-based
industries where there is a race to establish an industry standard or leading technological platform.
But, in other cases, it can be better to enter a market after the uncertainties about
technology or consumer preferences have been resolved and learn from the missteps of
early entrants. In these cases, when it is more advantageous to be a second-mover, joint venture or
internal development may be preferred.
The Question of Comparative Cost The question of which mode of entry is most cost-effective
is a critical one, given the need for a diversification strategy to pass the cost of entry test.
Acquisition can be a high-cost mode of entry due to the need to pay a premium over the share price
of the target company. When the premium is high, the price of the deal will exceed the worth of the
acquired company as a stand-alone business by a substantial amount. Whether it is worth it to pay
that high a price will depend on how much extra value will be created by the new combination of
companies in the form of synergies. Moreover, the true cost of an acquisition must include the
transaction costs of identifying and evaluating potential targets, negotiating a price, and
completing other aspects of deal making. Often, companies pay hefty fees to investment banking
firms, lawyers, and others to advise them and assist with the deal-making process. Finally, the true
cost must take into account the costs of integrating the acquired company into the parent company’s
portfolio of businesses.
CORE
CONCEPT
Transaction costs
are the costs of
completing a
business agreement
or deal, over and
above the price of
the deal. They can
include the costs of
searching for an
attractive target, the
costs of evaluating
its worth, bargaining
costs, and the costs
of completing the
transaction.
Joint ventures may provide a way to conserve on such entry costs. But even here, there are
organizational coordination costs and transaction costs that must be considered, including settling
on the terms of the arrangement. If the partnership doesn’t proceed smoothly and is not founded on
trust, these costs may be significant.
CHOOSING THE DIVERSIFICATION PATH:
RELATED VERSUS UNRELATED BUSINESSES
Once a company decides to diversify, it faces the choice of whether to diversify into related
businesses, unrelated businesses, or some mix of both. Businesses are said to be related when
their value chains exhibit competitively important cross-business commonalities. By this we mean
that there is a close correspondence between the businesses in terms of how they perform key value
chain activities and the resources and capabilities each needs to perform those activities. The big
appeal of related diversification is the opportunity to build shareholder value by leveraging these
cross-business commonalities into competitive advantages for the individual businesses, thus
allowing the company as a whole to perform better than just the sum of its businesses. Businesses
are said to be unrelated when the resource requirements and key value chain activities are so
dissimilar that no competitively important cross-business commonalities exist.
CORE
CONCEPT
Related
businesses
possess
competitively
valuable cross-
business value
chain and resource
commonalities;
unrelated
businesses have
dissimilar value
chains and resource
requirements, with
no competitively
important cross-
business
commonalities at the
value chain level.
The next two sections explore the ins and outs of related and unrelated diversification.
DIVERSIFICATION INTO RELATED BUSINESSES
page 230
• LO 8-2
Describe how
related
diversification
strategies can
produce cross-
business strategic fit
capable of delivering
competitive
advantage.
A related diversification strategy involves building the company around businesses where there is
good strategic fit across corresponding value chain activities. Strategic fit exists whenever one or
more activities constituting the value chains of different businesses are sufficiently similar to
present opportunities for cross-business sharing or transferring of the resources and
capabilities that enable these activities.6 That is to say, it implies the existence of
competitively important cross-business commonalities. Prime examples of such opportunities
include:
CORE
CONCEPT
Strategic fit exists
whenever one or
more activities
constituting the
value chains of
different businesses
are sufficiently
similar to present
opportunities for
cross-business
sharing or
transferring of the
resources and
capabilities that
enable these
activities.
Transferring specialized expertise, technological know-how, or other competitively valuable
strategic assets from one business’s value chain to another’s. Google’s ability to transfer software
developers and other information technology specialists from other business applications to the
development of its Android mobile operating system and Chrome operating system for PCs aided
considerably in the success of these new internal ventures.
Sharing costs between businesses by combining their related value chain activities into a single
operation. For instance, it is often feasible to manufacture the products of different businesses
in a single plant, use the same warehouses for shipping and distribution, or have a single sales
force for the products of different businesses if they are marketed to the same types of
customers.
page 231
Exploiting the common use of a well-known brand name. For example, Yamaha’s name in
motorcycles gave the company instant credibility and recognition in entering the personal-
watercraft business, allowing it to achieve a significant market share without spending large
sums on advertising to establish a brand identity for the WaveRunner. Likewise, Apple’s
reputation for producing easy-to-operate computers was a competitive asset that facilitated the
company’s diversification into digital music players, smartphones, and connected watches.
Sharing other resources (besides brands) that support corresponding value chain activities across
businesses. When Disney acquired Marvel Comics, management saw to it that Marvel’s iconic
characters, such as Spiderman, Iron Man, and the Black Widow, were shared with many of the
other Disney businesses, including its theme parks, retail stores, motion picture division, and
video game business. (Disney’s characters, starting with Mickey Mouse, have always been among
the most valuable of its resources.) Automobile companies like Ford share resources such as their
relationships with suppliers and dealer networks across their lines of business.
Engaging in cross-business collaboration and knowledge sharing to create new competitively
valuable resources and capabilities. Businesses performing closely related value chain activities
may seize opportunities to join forces, share knowledge and talents, and collaborate to create
altogether new capabilities (such as virtually defect-free assembly methods or increased ability to
speed new products to market) that will be mutually beneficial in improving their competitiveness
and business performance.
Related diversification is based on value chain matchups with respect to key value chain activities
—those that play a central role in each business’s strategy and that link to its industry’s key success
factors. Such matchups facilitate the sharing or transfer of the resources and capabilities that enable
the performance of these activities and underlie each business’s quest for competitive advantage. By
facilitating the sharing or transferring of such important competitive assets, related diversification
can elevate each business’s prospects for competitive success.
The resources and capabilities that are leveraged in related diversification are specialized
resources and capabilities. By this we mean that they have very specific applications; their use is
restricted to a limited range of business contexts in which these applications are competitively
relevant. Because they are adapted for particular applications, specialized resources and capabilities
must be utilized by particular types of businesses operating in specific kinds of industries to have
value; they have limited utility outside this designated range of industry and business
applications. This is in contrast to general resources and capabilities (such as general
management capabilities, human resource management capabilities, and general accounting
services), which can be applied usefully across a wide range of industry and business types.
CORE
CONCEPT
Related
diversification
involves sharing or
transferring
specialized
resources and
capabilities.
Specialized
resources and
capabilities have
very specific
applications and
their use is limited to
a restricted range of
industry and
business types, in
contrast to general
resources and
capabilities, which
can be widely
applied and can be
deployed across a
broad range of
industry and
business types.
L’Oréal is the world’s largest beauty products company, with almost $30 billion in revenues and a
successful strategy of related diversification built on leveraging a highly specialized set of resources
and capabilities. These include 18 dermatologic and cosmetic research centers, R&D capabilities
and scientific knowledge concerning skin and hair care, patents and secret formulas for hair and
skin care products, and robotic applications developed specifically for testing the safety of hair and
skin care products. These resources and capabilities are highly valuable for businesses focused on
products for human skin and hair—they are specialized to such applications, and, in consequence,
they are of little or no value beyond this restricted range of applications. To leverage these resources
in a way that maximizes their potential value, L’Oréal has diversified into cosmetics, hair care
products, skin care products, and fragrances (but not food, transportation, industrial services, or any
application area far from the narrow domain in which its specialized resources are competitively
relevant). L’Oréal’s businesses are related to one another on the basis of its value-generating
specialized resources and capabilities and the cross-business linkages among the value chain
activities that they enable.
Corning’s most competitively valuable resources and capabilities are specialized to applications
concerning fiber optics and specialty glass and ceramics. Over the course of its 165-year history, it
has developed an unmatched understanding of fundamental glass science and related technologies
in the field of optics. Its capabilities now span a variety of sophisticated technologies and include
expertise in domains such as custom glass composition, specialty glass melting and forming,
precision optics, high-end transmissive coatings, and optomechanical materials. Corning has
leveraged these specialized capabilities into a position of global leadership in five related market
segments: display technologies based on glass substrates; environmental technologies using ceramic
substrates and filters; optical communications, providing optical fiber, cable and connectivity
solutions; life sciences supporting research and drug discovery; and specialty materials employing
advanced optics and specialty glass solutions. The market segments into which Corning has
diversified are all related by their reliance on Corning’s specialized capability set and by the many
value chain activities that they have in common as a result.
General Mills has diversified into a closely related set of food businesses on the basis of its
capabilities in the realm of “kitchen chemistry” and food production technologies. Its four U.S.
retail divisions—meals and baking, cereal, snacks, and yogurt—include brands such as Old El Paso,
Cascadian Farm Lucky Charms and General Mills brand cereals, Nature Valley, Annie’s Organic,
Pillsbury and Betty Crocker, and Yoplait yogurt. Earlier it had diversified into restaurant businesses
on the mistaken notion that all food businesses were related. By exiting these businesses in the mid-
1990s, the company was able to improve its overall profitability and strengthen its position in its
remaining businesses. The lesson from its experience—and a takeaway for the managers of any
page 232
diversified company—is that it is not product relatedness that defines a well-crafted related
diversification strategy. Rather, the businesses must be related in terms of their key value chain
activities and the specialized resources and capabilities that enable these activities.7 An example is
Citizen Watch Company, whose products appear to be different (watches, machine tools, and flat
panel displays) but are related in terms of their common reliance on miniaturization know-how and
advanced precision technologies.
While companies pursuing related diversification strategies may also have opportunities to share
or transfer their general resources and capabilities (e.g., information systems; human
resource management practices; accounting and tax services; budgeting, planning, and
financial reporting systems; expertise in legal and regulatory affairs; and fringe-benefit management
systems), the most competitively valuable opportunities for resource sharing or transfer always
come from leveraging their specialized resources and capabilities. The reason for this is that
specialized resources and capabilities drive the key value-creating activities that both connect the
businesses (at points along their value chains where there is strategic fit) and link to the key success
factors in the markets where they are competitively relevant. Figure 8.1 illustrates the range of
opportunities to share and/or transfer specialized resources and capabilities among the value chain
activities of related businesses. It is important to recognize that even though general resources and
capabilities may be also shared by multiple business units, such resource sharing alone cannot form
the backbone of a strategy keyed to related diversification. Illustration Capsule 8.1 provides
examples of a few successful firms with related diversification strategies.
FIGURE 8.1 Related Businesses Provide Opportunities to Benefit from
Competitively Valuable Strategic Fit
Identifying Cross-Business Strategic Fit along the Value Chain
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Cross-business strategic fit can exist anywhere along the value chain—in R&D and technology
activities, in supply chain activities and relationships with suppliers, in manufacturing, in sales and
marketing, in distribution activities, or in customer service activities.8
ILLUSTRATION
CAPSULE 8.1 Examples of Companies Pursuing a Related
Diversification Strategy
INDITEX
Inditex began as a small family business making women’s clothing, but it has since evolved into one of the world’s
largest and most successful fashion retailers. The company is not just a retailer, however—it is involved with all
aspects of producing fashion: design, manufacture, distribution, and retail. Its growth has been driven by acquisition
as well as by internal growth and development. By 2020, Inditex included eight distinct brands or lines of business:
Zara, Zara Home, Pull&Bear, Massimo Dutti, Berksha (which includes the BSK and Man brands), Stradivarius,
Oysho (women’s lingerie, beachwear, and sport), and Uterqüe (accessories, leatherwear).
NEWS CORP
News Corp was created in 2013 when News Corporation was split into two independent companies: 21st Century
Fox and News Corp. This move allowed News Corp to focus on the newspaper and publishing businesses, while
21st Century Fox retained the other parts of News Corporation (mainly television and film). News Corp characterizes
itself today as a mass media company. The companies in its network include The New York Post, Harper Collins
Publishers, News Corp Australia, News UK, News America Marketing, Storyful (a social media newswire), Dow
Jones and Move (a provider of real estate information). News Corp Australia actually includes a broad portfolio of
national, metropolitan, regional, and community newspapers; while News UK has similar breadth. Despite the
general disruption in the newspaper industry due to Internet-related developments, News Corp recently announced
record-setting subscriber performances at Dow Jones and the Wall Street Journal—two of their most important
holdings.
KIMBERLY-CLARK CORPORATION
Kimberly-Clark is a Texas based multinational in the personal care industry, producing mostly paper-based
consumer products. Its products include iconic brands such as Kleenex, Huggies, Pull-Ups, Cottonelle, Scott, Viva,
Kotex, and Depend. The company has organized its products into five related lines of business: Adult Care, Baby
and Child Care, Family Care, Feminine Care, and K-C Professional. Its products are recognized and trusted around
the world—distributed across more than 175 countries. With its sharp focus on the consumer and financial discipline,
Kimberly-Clark has managed to sustain its record of solid performance and growth even during recessionary
periods, since the types of products it offers are always in demand. Its outlook for 2020 and beyond continues to
look rosy.
page 234
(top): Shutterstock/lentamart; (middle): Edith38/Shutterstock; (bottom): Neilson Barnard/Staff/Getty Images
Sources: Company websites, Wikipedia; https://www.businesswire.com/news/home/20200207005506/en/News-
Corp-Announces-Record-Setting-Subscriber-Performances-Dow; https://finance.yahoo.com/news/kimberly-
clarks-impressive-momentum-continue-130001056.html, accessed February 10, 2020.
Strategic Fit in Supply Chain Activities Businesses with strategic fit with respect to their
supply chain activities can perform better together because of the potential for transferring skills in
https://www.businesswire.com/news/home/20200207005506/en/News-Corp-Announces-Record-Setting-Subscriber-Performances-Dow
https://finance.yahoo.com/news/kimberly-clarks-impressive-momentum-continue-130001056.html
page 235
procuring materials, sharing resources and capabilities in logistics, collaborating with common
supply chain partners, and/or increasing leverage with shippers in securing volume discounts on
incoming parts and components. Dell’s strategic partnerships with leading suppliers of
microprocessors, circuit boards, disk drives, memory chips, flat-panel displays, wireless
capabilities, long-life batteries, and other PC-related components have been an important element of
the company’s strategy to diversify into servers, data storage devices, networking components,
plasma TVs, and printers—products that include many components common to PCs and that can be
sourced from the same strategic partners that provide Dell with PC components.
Strategic Fit in R&D and Technology Activities Businesses with strategic fit in R&D or
technology development perform better together than apart because of potential cost savings in
R&D, shorter times in getting new products to market, and more innovative products or processes.
Moreover, technological advances in one business can lead to increased sales for both.
Technological innovations have been the driver behind the efforts of cable TV companies to
diversify into high-speed Internet access (via the use of cable modems) and, further, to explore
providing local and long-distance telephone service to residential and commercial customers either
through a single wire or by means of Voice over Internet Protocol (VoIP) technology. These
diversification efforts have resulted in companies such as DISH Network and Comcast (through its
XFINITY subsidiary) offering TV, Internet, and phone bundles.
Manufacturing-Related Strategic Fit Cross-business strategic fit in manufacturing-related
activities can be exploited when a diversifier’s expertise in quality control and cost-efficient
production methods can be transferred to another business. When Emerson Electric diversified into
the chain-saw business, it transferred its expertise in low-cost manufacture to its newly acquired
Beaird-Poulan business division. The transfer drove Beaird-Poulan’s new strategy—to be the low-
cost provider of chainsaw products—and fundamentally changed the way Beaird-Poulan chain saws
were designed and manufactured. Another benefit of production-related value chain commonalities
is the ability to consolidate production into a smaller number of plants and significantly reduce
overall production costs. When snowmobile maker Bombardier diversified into motorcycles, it was
able to set up motorcycle assembly lines in the manufacturing facility where it was assembling
snowmobiles. When Smucker’s acquired Procter & Gamble’s Jif peanut butter business, it was able
to combine the manufacture of the two brands of peanut butter products while gaining greater
leverage with vendors in purchasing its peanut supplies.
Strategic Fit in Sales and Marketing Activities Various cost-saving opportunities spring from
diversifying into businesses with closely related sales and marketing activities. When the products
are sold directly to the same customers, sales costs can often be reduced by using a single sales
force instead of having two different salespeople call on the same customer. The products of related
businesses can be promoted at the same website and included in the same media ads and sales
brochures. There may be opportunities to reduce costs by consolidating order processing and billing
and by using common promotional tie-ins. When global power toolmaker Black & Decker acquired
Vector Products, it was able to use its own global sales force to sell the newly acquired
Vector power inverters, vehicle battery chargers, and rechargeable spotlights because the
types of customers that carried its power tools (discounters like Kmart, home centers, and hardware
stores) also stocked the types of products produced by Vector.
A second category of benefits arises when different businesses use similar sales and marketing
approaches. In such cases, there may be competitively valuable opportunities to transfer selling,
page 236
merchandising, advertising, and product differentiation skills from one business to another. Procter
& Gamble’s product lineup includes Pampers diapers, Olay beauty products, Tide laundry
detergent, Crest toothpaste, Charmin toilet tissue, Gillette razors and blades, Vicks cough and cold
products Oral-B toothbrushes, and Head & Shoulders shampoo. All of these have different
competitors and different supply chain and production requirements, but they all move through the
same wholesale distribution systems, are sold in common retail settings to the same shoppers, and
require the same marketing and merchandising skills.
Distribution-Related Strategic Fit Businesses with closely related distribution activities can
perform better together than apart because of potential cost savings in sharing the same distribution
facilities or using many of the same wholesale distributors and retail dealers. When Conair
Corporation acquired Allegro Manufacturing’s travel bag and travel accessory business, it was able
to consolidate its own distribution centers for hair dryers and curling irons with those of Allegro,
thereby generating cost savings for both businesses. Likewise, since Conair products and Allegro’s
neck rests, ear plugs, luggage tags, and toiletry kits were sold by the same types of retailers
(discount stores, supermarket chains, and drugstore chains), Conair was able to convince many of
the retailers not carrying Allegro products to take on the line.
Strategic Fit in Customer Service Activities Strategic fit with respect to customer service
activities can enable cost savings or differentiation advantages, just as it does along other points of
the value chain. For example, cost savings may come from consolidating after-sale service and
repair organizations for the products of closely related businesses into a single operation. Likewise,
different businesses can often use the same customer service infrastructure. For instance, an electric
utility that diversifies into natural gas, water, appliance repair services, and home security services
can use the same customer data network, the same call centers and local offices, the same billing
and accounting systems, and the same customer service infrastructure to support all of its products
and services. Through the transfer of best practices in customer service across a set of related
businesses or through the sharing of resources such as proprietary information about customer
preferences, a multibusiness company can also create a differentiation advantage through higher-
quality customer service.
Strategic Fit, Economies of Scope, and Competitive Advantage
Strategic fit in the value chain activities of a diversified corporation’s different businesses opens up
opportunities for economies of scope—a concept distinct from economies of scale. Economies of
scale are cost savings that accrue directly from a larger-sized operation—for example, unit costs
may be lower in a large plant than in a small plant. In contrast, economies of scope are cost savings
that flow from operating in multiple businesses (a larger scope of operation). They stem
directly from strategic fit along the value chains of related businesses, which in turn
enables the businesses to share resources or to transfer them from business to business at low cost.
Significant scope economies are open only to firms engaged in related diversification, since they are
the result of related businesses performing R&D together, transferring managers from one business
to another, using common manufacturing or distribution facilities, sharing a common sales force or
dealer network, using the same established brand name, and the like. The greater the cross-business
economies associated with resource sharing and transfer, the greater the potential for a related
diversification strategy to give the individual businesses of a multibusiness enterprise a cost
advantage over rivals.
CORE
CONCEPT
Economies of
scope are cost
reductions that flow
from operating in
multiple businesses
(a larger scope of
operation). This is in
contrast to
economies of scale,
which accrue from a
larger-sized
operation.
From Strategic Fit to Competitive Advantage, Added Profitability, and Gains in Shareholder
Value The cost advantage from economies of scope is due to the fact that resource sharing allows
a multibusiness firm to spread resource costs across its businesses and to avoid the expense of
having to acquire and maintain duplicate sets of resources—one for each business. But related
diversified companies can benefit from strategic fit in other ways as well.
Sharing or transferring valuable specialized assets among the company’s businesses can help
each business perform its value chain activities more proficiently. This translates into competitive
advantage for the businesses in one or two basic ways: (1) The businesses can contribute to greater
efficiency and lower costs relative to their competitors, and/or (2) they can provide a basis for
differentiation so that customers are willing to pay relatively more for the businesses’ goods and
services. In either or both of these ways, a firm with a well-executed related diversification strategy
can boost the chances of its businesses attaining a competitive advantage.
The greater the relatedness among a diversified company’s businesses, the bigger a company’s
window for converting strategic fit into competitive advantage. The strategic and business logic is
compelling: Capturing the benefits of strategic fit along the value chains of its related businesses
gives a diversified company a clear path to achieving competitive advantage over undiversified
competitors and competitors whose own diversification efforts don’t offer equivalent strategic-fit
benefits.9 Such competitive advantage potential provides a company with a dependable basis for
earning profits and a return on investment that exceeds what the company’s businesses could earn as
stand-alone enterprises. Converting the competitive advantage potential into greater profitability is
what fuels 1 + 1 = 3 gains in shareholder value—the necessary outcome for satisfying the better-off
test and proving the business merit of a company’s diversification effort.
Diversifying into
related businesses
where competitively
valuable strategic-fit
benefits can be
captured puts a
company’s
businesses in
position to perform
better financially as
part of the company
than they could have
performed as
independent
page 237
enterprises, thus
providing a clear
avenue for
increasing
shareholder value
and satisfying the
better-off test.
There are five things to bear in mind here:
1. Capturing cross-business strategic-fit benefits via a strategy of related diversification builds
shareholder value in ways that shareholders cannot undertake by simply owning a portfolio of
stocks of companies in different industries.
2. The capture of cross-business strategic-fit benefits is possible only via a strategy of related
diversification.
3. The greater the relatedness among a diversified company’s businesses, the bigger the company’s
window for converting strategic fit into competitive advantage for its businesses.
4. The benefits of cross-business strategic fit come from the transferring or sharing of competitively
valuable resources and capabilities among the businesses—resources and capabilities
that are specialized to certain applications and have value only in specific types of
industries and businesses.
5. The benefits of cross-business strategic fit are not automatically realized when a company
diversifies into related businesses; the benefits materialize only after management has
successfully pursued internal actions to capture them.
ILLUSTRATION
CAPSULE 8.2 The Kraft–Heinz Merger: Pursuing the
Benefits of Cross-Business Strategic Fit
The $62.6 billion merger between Kraft and Heinz that was finalized in the summer of 2015 created the third largest
food and beverage company in North America and the fifth largest in the world. It was a merger predicated on the
idea that the strategic fit between these two companies was such that they could create more value as a combined
enterprise than they could as two separate companies. As a combined enterprise, Kraft Heinz would be able to
exploit its cross-business value chain activities and resource similarities to more efficiently produce, distribute, and
sell profitable processed food products.
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Hayden Stirling/Shutterstock
Kraft and Heinz products share many of the same raw materials (milk, sugar, salt, wheat, etc.), which allows the
new company to leverage its increased bargaining power as a larger business to get better deals with suppliers,
using strategic fit in supply chain activities to achieve lower input costs and greater inbound efficiencies. Moreover,
because both of these brands specialized in prepackaged foods, there is ample manufacturing-related strategic fit in
production processes and packaging technologies that allow the new company to trim and streamline manufacturing
operations.
Their distribution-related strategic fit will allow for the complete integration of distribution channels and
transportation networks, resulting in greater outbound efficiencies and a reduction in travel time for products moving
from factories to stores. The Kraft Heinz Company is currently looking to leverage Heinz’s global platform to expand
Kraft’s products internationally. By utilizing Heinz’s already highly developed global distribution network and brand
familiarity (key specialized resources), Kraft can more easily expand into the global market of prepackaged and
processed food. Because these two brands are sold at similar types of retail stores (supermarket chains, wholesale
retailers, and local grocery stores), they are now able to claim even more shelf space with the increased bargaining
power of the combined company.
Strategic fit in sales and marketing activities will allow the company to develop coordinated and more effective
advertising campaigns. Toward this aim, the Kraft Heinz Company is moving to consolidate its marketing capabilities
under one marketing firm. Also, by combining R&D teams, the Kraft Heinz Company could come out with innovative
products that may appeal more to the growing number of on-the-go and health-conscious buyers in the market.
Many of these potential and predicted synergies for the Kraft Heinz Company have yet to be realized, since merger
integration activities always take time.
Note: Developed with Maria Hart.
Sources: www.forbes.com/sites/paulmartyn/2015/03/31/heinz-and-kraft-merger-makes-supply-management-
sense/; fortune.com/2015/03/25/kraft-mess-how-heinz-deal-helps/;
www.nytimes.com/2015/03/26/business/dealbook/kraft-and-heinz-to-merge.html?_r=2; company websites
(accessed December 3, 2015).
Illustration Capsule 8.2 describes the merger of Kraft Foods Group, Inc. with the H. J. Heinz
Holding Corporation, in pursuit of the strategic-fit benefits of a related diversification strategy.
DIVERSIFICATION INTO UNRELATED
BUSINESSES
http://www.forbes.com/sites/paulmartyn/2015/03/31/heinz-and-kraft-merger-makes-supply-management-sense/
http://fortune.com/2015/03/25/kraft-mess-how-heinz-deal-helps/
• LO 8-3
Identify the merits
and risks of
unrelated
diversification
strategies.
Achieving cross-business strategic fit is not a motivation for unrelated diversification. Companies
that pursue a strategy of unrelated diversification often exhibit a willingness to diversify into any
business in any industry where senior managers see an opportunity to realize consistently good
financial results. Such companies are frequently labeled conglomerates because their business
interests range broadly across diverse industries. Companies engaged in unrelated diversification
nearly always enter new businesses by acquiring an established company rather than by forming a
startup subsidiary within their own corporate structures or participating in joint ventures.
With a strategy of unrelated diversification, an acquisition is deemed to have potential if it passes
the industry-attractiveness and cost of entry tests and if it has good prospects for attractive financial
performance. Thus, with an unrelated diversification strategy, company managers spend much time
and effort screening acquisition candidates and evaluating the pros and cons of keeping or divesting
existing businesses, using such criteria as
A willingness to
diversify into any
business in any
industry is unlikely to
result in successful
unrelated
diversification. The
key to success even
for unrelated
diversification is to
create economic
value for
shareholders.
Whether the business can meet corporate targets for profitability and return on investment.
Whether the business is in an industry with attractive growth potential.
Whether the business is big enough to contribute significantly to the parent firm’s bottom line.
But the key to successful unrelated diversification is to go beyond these considerations and
ensure that the strategy passes the better-off test as well. This test requires more than just growth in
revenues; it requires growth in profits—beyond what could be achieved by a mutual fund or a
holding company that owns shares of the businesses without adding any value. Unless the
combination of businesses is more profitable together under the corporate umbrella than they are
apart as independent businesses, the strategy cannot create economic value for shareholders. And
unless it does so, there is no real justification for unrelated diversification, since top executives
have a fiduciary responsibility to maximize long-term shareholder value for the company’s owners
(its shareholders). Illustration Capsule 8.3 provides some examples of successful companies with
unrelated diversification.
page 239
Building Shareholder Value via Unrelated Diversification
Given the absence of cross-business strategic fit with which to create competitive advantages,
building shareholder value via unrelated diversification ultimately hinges on the ability of the parent
company to improve its businesses (and make the combination better off ) via other means. Critical
to this endeavor is the role that the parent company plays as a corporate parent.10 To the extent that
a company has strong parenting capabilities—capabilities that involve nurturing, guiding,
grooming, and governing constituent businesses—a corporate parent can propel its businesses
forward and help them gain ground over their market rivals. Corporate parents also contribute to the
competitiveness of their unrelated businesses by sharing or transferring general resources and
capabilities across the businesses—competitive assets that have utility in any type of industry and
that can be leveraged across a wide range of business types as a result. Examples of the kinds of
general resources that a corporate parent leverages in unrelated diversification include the
corporation’s reputation, credit rating, and access to financial markets; governance
mechanisms; management training programs; a corporate ethics program; a central data
and communications center; shared administrative resources such as public relations and legal
services; and common systems for functions such as budgeting, financial reporting, and quality
control.
ILLUSTRATION
CAPSULE 8.3 Examples of Companies Pursuing an
Unrelated Diversification Strategy
Tata
The Tata group is a global enterprise with total revenues exceeding $115 billion in 2020. It is organized into 11
“verticals,” which are essentially industry domains. The verticals include Information Technology, Steel, Automotive,
Consumer and Retail, Infrastructure, Financial Services, Aerospace and Defense, Tourism and Travel, Telecom and
Media, and Trading and Investments. Within these 11 verticals are 30 or more independently managed companies.
The most well-known of these include: Tata Motors, Tata Steel, Tata Chemicals, Titan (jewelry and eyewear), Tata
Power, Tata Communications, Tata Consumer Products, Tata Capital, Tata Consultancy Services, and Indian Hotels.
Berkshire Hathaway
Berkshire Hathaway is an American conglomerate with a long and successful history, often attributed to the sage
investment and acquisition strategy of its Chairman and CEO, Warren Buffet. Its holdings include an insurance
group, an energy group, a financial products group, and a diverse group covering manufacturing, service, and
retailing. Companies that are wholly owned by Berkshire Hathaway include GEICO, Dairy Queen, Duracell, Fruit of
the Loom, Burlington Northern Sante Fe Railway, and Helzberg Diamonds. It owns a significant share of a number of
other companies, including Bank of America, Southwest Airlines, Kraft Heinz, American Express, and Coca Cola.
Yamaha Corporation
The Yamaha Corporation no longer includes Yamaha Motor Co. (the motorcycle, snowmobile, boat, and motorized
product maker), although it is still a major shareholder. But even without Yamaha Motor, the Yamaha Corporation still
produces a wide array of products. It is the world’s largest producer of all types of musical instruments, along with
arguably related audio equipment and communication devices. But, in addition, it is involved in the production of
industrial robots, home appliances, sporting goods, industrial machinery and components, specialty metals, golf
products, resorts, and semiconductors.
page 240
(top left): The India Today Group/Contributor/Getty Images; (top right): Ranta Images/Shutterstock; (bottom):
Gwenael_LE_VOT/Getty Images
Sources: Company websites, Wikipedia, accessed February 14, 2020.
The Benefits of Astute Corporate Parenting One of the most important ways that corporate
parents contribute to the success of their businesses is by offering high-level oversight and
guidance.11 The top executives of a large diversified corporation have among them many years of
accumulated experience in a variety of business settings and can often contribute expert problem-
solving skills, creative strategy suggestions, and first-rate advice and guidance on how to improve
competitiveness and financial performance to the heads of the company’s various business
subsidiaries. This is especially true in the case of newly acquired, smaller businesses. Particularly
astute high-level guidance from corporate executives can help the subsidiaries perform better than
they would otherwise be able to do through the efforts of the business unit heads alone. The
outstanding leadership of Royal Little, the founder of Textron, was a major reason that the company
became an exemplar of the unrelated diversification strategy while he was CEO. Little’s bold moves
transformed the company from its origins as a small textile manufacturer into a global powerhouse
known for its Bell helicopters, Cessna aircraft, and a host of other strong brands in a wide array of
industries. Norm Wesley, a former CEO of the conglomerate Fortune Brands, is similarly credited
with driving the sharp rise in the company’s stock price while he was at the helm. Under his
leadership, Fortune Brands became the $7 billion maker of products ranging from spirits (e.g., Jim
Beam bourbon and rye, Gilbey’s gin and vodka, Courvoisier cognac) to golf products (e.g., Titleist
golf balls and clubs, FootJoy golf shoes and apparel, Scotty Cameron putters) to hardware (e.g.,
Moen faucets, American Lock security devices). (Fortune Brands has since been converted into two
separate entities, Beam Inc. and Fortune Brands Home & Security.)
Corporate parents can also create added value for their businesses by providing them with other
types of general resources that lower the operating costs of the individual businesses or that enhance
their operating effectiveness. The administrative resources located at a company’s corporate
headquarters are a prime example. They typically include legal services, accounting expertise and
tax services, and other elements of the administrative infrastructure, such as risk management
capabilities, information technology resources, and public relations capabilities. Providing
individual businesses with general support resources such as these creates value by lowering
companywide overhead costs, since each business would otherwise have to duplicate the centralized
activities.
CORE
CONCEPT
Corporate
parenting refers to
the role that a
diversified
corporation plays in
nurturing its
component
businesses through
the provision of top
management
expertise,
disciplined control,
financial resources,
and other types of
general resources
and capabilities
such as long-term
planning systems,
business
development skills,
management
development
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processes, and
incentive systems.
Corporate brands that do not connote any specific type of product are another type of general
corporate resource that can be shared among unrelated businesses. General Electric, for example,
successfully applied its GE brand to such unrelated products and businesses as medical products
and health care (GE Healthcare), jet engines (GE Aviation), and power and water technologies (GE
Power and Water). Corporate brands that are applied in this fashion are sometimes called umbrella
brands. Utilizing a well-known corporate name (GE) in a diversified company’s individual
businesses has the potential not only to lower costs (by spreading the fixed cost of developing and
maintaining the brand over many businesses) but also to enhance each business’s customer value
proposition by linking its products to a name that consumers trust. In similar fashion, a
corporation’s reputation for well-crafted products, for product reliability, or for trustworthiness can
lead to greater customer willingness to purchase the products of a wider range of a
diversified company’s businesses. Incentive systems, financial control systems, and a
company’s culture are other types of general corporate resources that may prove useful in enhancing
the daily operations of a diverse set of businesses. The parenting activities of corporate executives
may also include recruiting and hiring talented managers to run individual businesses.
An umbrella brand
is a corporate brand
name that can be
applied to a wide
assortment of
business types. As
such, it is a type of
general resource
that can be
leveraged in
unrelated
diversification.
We discuss two other commonly employed ways for corporate parents to add value to their
unrelated businesses next.
Judicious Cross-Business Allocation of Financial Resources By reallocating surplus cash
flows from some businesses to fund the capital requirements of other businesses—in essence,
having the company serve as an internal capital market—corporate parents may also be able to
create value. Such actions can be particularly important in times when credit is unusually tight (such
as in the wake of the worldwide banking crisis that began in 2008) or in economies with less well
developed capital markets. Under these conditions, with strong financial resources a corporate
parent can add value by shifting funds from business units generating excess cash (more than they
need to fund their own operating requirements and new capital investment opportunities) to other,
cash-short businesses with appealing growth prospects. A parent company’s ability to function as its
own internal capital market enhances overall corporate performance and increases shareholder value
to the extent that (1) its top managers have better access to information about investment
opportunities internal to the firm than do external financiers or (2) it can provide funds that would
otherwise be unavailable due to poor financial market conditions.
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Acquiring and Restructuring Undervalued Companies Another way for parent companies to
add value to unrelated businesses is by acquiring weakly performing companies at a bargain price
and then restructuring their operations in ways that produce sometimes dramatic increases in
profitability. Restructuring refers to overhauling and streamlining the operations of a business—
combining plants with excess capacity, selling off underutilized assets, reducing unnecessary
expenses, revamping its product offerings, consolidating administrative functions to reduce
overhead costs, and otherwise improving the operating efficiency and profitability of a company.
Restructuring generally involves transferring seasoned managers to the newly acquired business,
either to replace the top layers of management or to step in temporarily until the business is returned
to profitability or is well on its way to becoming a major market contender.
CORE
CONCEPT
Restructuring
refers to overhauling
and streamlining the
activities of a
business—
combining plants
with excess
capacity, selling off
underutilized assets,
reducing
unnecessary
expenses, and
otherwise improving
the productivity and
profitability of a
company.
Restructuring is often undertaken when a diversified company acquires a new business that is
performing well below levels that the corporate parent believes are achievable. Diversified
companies that have proven turnaround capabilities in rejuvenating weakly performing companies
can often apply these capabilities in a relatively wide range of unrelated industries. Newell Brands
(whose diverse product line includes Rubbermaid food storage, Sharpie pens, Graco strollers and
car seats, Goody hair accessories, Calphalon cookware, and Yankee Candle—all businesses with
different value chain activities) developed such a strong set of turnaround capabilities that the
company was said to “Newellize” the businesses it acquired.
Successful unrelated diversification strategies based on restructuring require the parent company
to have considerable expertise in identifying underperforming target companies and in negotiating
attractive acquisition prices so that each acquisition passes the cost of entry test. The capabilities in
this regard of Lord James Hanson and Lord Gordon White, who headed up the storied British
conglomerate Hanson Trust, played a large part in Hanson Trust’s impressive record of profitability.
The Path to Greater Shareholder Value through Unrelated
Diversification
For a strategy of unrelated diversification to produce companywide financial results above and
beyond what the businesses could generate operating as standalone entities, corporate executives
must do three things to pass the three Tests of Corporate Advantage:
1. Diversify into industries where the businesses can produce consistently good earnings and returns
on investment (to satisfy the industry-attractiveness test).
2. Negotiate favorable acquisition prices (to satisfy the cost of entry test).
3. Do a superior job of corporate parenting via high-level managerial oversight and resource
sharing, financial resource allocation and portfolio management, and/or the restructuring of
underperforming businesses (to satisfy the better-off test).
The best corporate parents understand the nature and value of the kinds of resources at their
command and know how to leverage them effectively across their businesses. Those that are able to
create more value in their businesses than other diversified companies have what is called a
parenting advantage. When a corporation has a parenting advantage, its top executives have the
best chance of being able to craft and execute an unrelated diversification strategy that can satisfy
all three Tests of Corporate Advantage and truly enhance long-term economic shareholder value.
CORE
CONCEPT
A diversified
company has a
parenting
advantage when it
is more able than
other companies to
boost the combined
performance of its
individual
businesses through
high-level guidance,
general oversight,
and other corporate-
level contributions.
The Drawbacks of Unrelated Diversification
Unrelated diversification strategies have two important negatives that undercut the pluses: very
demanding managerial requirements and limited competitive advantage potential.
Demanding Managerial Requirements Successfully managing a set of fundamentally different
businesses operating in fundamentally different industry and competitive environments is a
challenging and exceptionally difficult proposition.12 Consider, for example, that corporations like
General Electric, ITT, Mitsubishi, and Bharti Enterprises have dozens of business subsidiaries
making hundreds and sometimes thousands of products. While headquarters executives can glean
information about an industry from third-party sources, ask lots of questions when making
occasional visits to the operations of the different businesses, and do their best to learn about the
company’s different businesses, they still remain heavily dependent on briefings from business unit
heads and on “managing by the numbers”—that is, keeping a close track on the financial and
operating results of each subsidiary. Managing by the numbers works well enough when business
conditions are normal and the heads of the various business units are capable of consistently
meeting their numbers. But problems arise if things start to go awry in a business and corporate
management has to get deeply involved in the problems of a business it does not know much about.
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Because every business tends to encounter rough sledding at some juncture, unrelated
diversification is thus a somewhat risky strategy from a managerial perspective.13 Just one or two
unforeseen problems or big strategic mistakes—which are much more likely without close
corporate oversight—can cause a precipitous drop in corporate earnings and crash the parent
company’s stock price.
Hence, competently overseeing a set of widely diverse businesses can turn out to be much harder
than it sounds. In practice, comparatively few companies have proved that they have
top-management capabilities that are up to the task. There are far more companies
whose corporate executives have failed at delivering consistently good financial results with an
unrelated diversification strategy than there are companies with corporate executives who have been
successful.14 Unless a company truly has a parenting advantage, the odds are that the result of
unrelated diversification will be 1 + 1 = 2 or even less.
Limited Competitive Advantage Potential The second big negative is that unrelated
diversification offers only a limited potential for competitive advantage beyond what each
individual business can generate on its own. Unlike a related diversification strategy, unrelated
diversification provides no cross-business strategic-fit benefits that allow each business to perform
its key value chain activities in a more efficient and effective manner. A cash-rich corporate parent
pursuing unrelated diversification can provide its subsidiaries with much-needed capital, may
achieve economies of scope in activities relying on general corporate resources, may extend an
umbrella brand and may even offer some managerial know-how to help resolve problems in
particular business units, but otherwise it has little to add in the way of enhancing the competitive
strength of its individual business units. In comparison to the highly specialized resources that
facilitate related diversification, the general resources that support unrelated diversification tend to
be relatively low value, for the simple reason that they are more common. Unless they are of
exceptionally high quality (such as GE’s world-renowned general management capabilities and
umbrella brand or Newell Rubbermaid’s turnaround capabilities), resources and capabilities that are
general in nature are less likely to provide a significant source of competitive advantage for the
businesses of diversified companies. Without the competitive advantage potential of strategic fit in
competitively important value chain activities, consolidated performance of an unrelated group of
businesses may not be very much more than the sum of what the individual business units could
achieve if they were independent, in most circumstances.
Relying solely on
leveraging general
resources and the
expertise of
corporate executives
to wisely manage a
set of unrelated
businesses is a
much weaker
foundation for
enhancing
shareholder value
than is a strategy of
related
diversification.
Misguided Reasons for Pursuing Unrelated Diversification
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Companies sometimes pursue unrelated diversification for reasons that are entirely misguided.
These include the following:
Risk reduction. Spreading the company’s investments over a set of diverse industries to spread
risk cannot create long-term shareholder value since the company’s shareholders can more
flexibly (and more efficiently) reduce their exposure to risk by investing in a diversified portfolio
of stocks and bonds.
Growth. While unrelated diversification may enable a company to achieve rapid or continuous
growth, firms that pursue growth for growth’s sake are unlikely to maximize shareholder value.
Only profitable growth—the kind that comes from creating added value for shareholders—can
justify a strategy of unrelated diversification.
Stabilization. Managers sometimes pursue broad diversification in the hope that market
downtrends in some of the company’s businesses will be partially offset by cyclical upswings in
its other businesses, thus producing somewhat less earnings volatility. In actual practice, however,
there’s no convincing evidence that the consolidated profits of firms with unrelated diversification
strategies are more stable or less subject to reversal in periods of recession and economic stress
than the profits of firms with related diversification strategies.
Managerial motives. Unrelated diversification can provide benefits to managers such as
higher compensation (which tends to increase with firm size and degree of
diversification) and reduced their unemployment risk. Pursuing diversification for these reasons
will likely reduce shareholder value and violate managers’ fiduciary responsibilities.
Because unrelated diversification strategies at their best have only a limited potential for creating
long-term economic value for shareholders, it is essential that managers not compound this problem
by taking a misguided approach toward unrelated diversification, in pursuit of objectives that are
more likely to destroy shareholder value than create it.
Only profitable
growth—the kind
that comes from
creating added
value for
shareholders—can
justify a strategy of
unrelated
diversification.
COMBINATION RELATED–UNRELATED
DIVERSIFICATION STRATEGIES
There’s nothing to preclude a company from diversifying into both related and unrelated businesses.
Indeed, in actual practice the business makeup of diversified companies varies considerably. Some
diversified companies are really dominant-business enterprises—one major “core” business
accounts for 50 to 80 percent of total revenues and a collection of small related or unrelated
businesses accounts for the remainder. Some diversified companies are narrowly diversified around
a few (two to five) related or unrelated businesses. Others are broadly diversified around a wide-
ranging collection of related businesses, unrelated businesses, or a mixture of both. A number of
multibusiness enterprises have diversified into unrelated areas but have a collection of related
businesses within each area—thus giving them a business portfolio consisting of several unrelated
groups of related businesses. There’s ample room for companies to customize their diversification
strategies to incorporate elements of both related and unrelated diversification, as may suit their
own competitive asset profile and strategic vision. Combination related–unrelated diversification
strategies have particular appeal for companies with a mix of valuable competitive assets, covering
the spectrum from general to specialized resources and capabilities.
Figure 8.2 shows the range of alternatives for companies pursuing diversification.
FIGURE 8.2 Three Strategy Options for Pursuing Diversification
EVALUATING THE STRATEGY OF A DIVERSIFIED
COMPANY
• LO 8-4
Use the analytic
tools for evaluating a
company’s
diversification
strategy.
Strategic analysis of diversified companies builds on the concepts and methods used for single-
business companies. But there are some additional aspects to consider and a couple of new analytic
tools to master. The procedure for evaluating the pluses and minuses of a diversified company’s
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strategy and deciding what actions to take to improve the company’s performance involves six
steps:
1. Assessing the attractiveness of the industries the company has diversified into, both individually
and as a group.
2. Assessing the competitive strength of the company’s business units and drawing a nine-cell
matrix to simultaneously portray industry attractiveness and business unit competitive strength.
3. Evaluating the extent of cross-business strategic fit along the value chains of the
company’s various business units.
4. Checking whether the firm’s resources fit the requirements of its present business lineup.
5. Ranking the performance prospects of the businesses from best to worst and determining what
the corporate parent’s priorities should be in allocating resources to its various businesses.
6. Crafting new strategic moves to improve overall corporate performance.
The core concepts and analytic techniques underlying each of these steps merit further
discussion.
Step 1: Evaluating Industry Attractiveness
A principal consideration in evaluating the caliber of a diversified company’s strategy is the
attractiveness of the industries in which it has business operations. Several questions arise:
1. Does each industry the company has diversified into represent a good market for the company to
be in—does it pass the industry-attractiveness test?
2. Which of the company’s industries are most attractive, and which are least attractive?
3. How appealing is the whole group of industries in which the company has invested?
The more attractive the industries (both individually and as a group) that a diversified company is
in, the better its prospects for good long-term performance.
Calculating Industry-Attractiveness Scores A simple and reliable analytic tool for gauging
industry attractiveness involves calculating quantitative industry-attractiveness scores based on the
following measures:
Market size and projected growth rate. Big industries are more attractive than small industries,
and fast-growing industries tend to be more attractive than slow-growing industries, other things
being equal.
The intensity of competition. Industries where competitive pressures are relatively weak are more
attractive than industries where competitive pressures are strong.
Emerging opportunities and threats. Industries with promising opportunities and minimal threats
on the near horizon are more attractive than industries with modest opportunities and imposing
threats.
The presence of cross-industry strategic fit. The more one industry’s value chain and resource
requirements match up well with the value chain activities of other industries in which the
company has operations, the more attractive the industry is to a firm pursuing related
diversification. However, cross-industry strategic fit is not something that a company committed
to a strategy of unrelated diversification considers when it is evaluating industry attractiveness.
Resource requirements. Industries in which resource requirements are within the company’s reach
are more attractive than industries in which capital and other resource requirements could strain
corporate financial resources and organizational capabilities.
Social, political, regulatory, and environmental factors. Industries that have significant problems
in such areas as consumer health, safety, or environmental pollution or those subject to intense
regulation are less attractive than industries that do not have such problems.
Industry profitability. Industries with healthy profit margins and high rates of return on investment
are generally more attractive than industries with historically low or unstable profits.
Each attractiveness measure is then assigned a weight reflecting its relative importance in
determining an industry’s attractiveness, since not all attractiveness measures are equally important.
The intensity of competition in an industry should nearly always carry a high weight (say, 0.20 to
0.30). Strategic-fit considerations should be assigned a high weight in the case of companies with
related diversification strategies; but for companies with an unrelated diversification strategy,
strategic fit with other industries may be dropped from the list of attractiveness measures altogether.
The importance weights must add up to 1.
Finally, each industry is rated on each of the chosen industry-attractiveness measures, using a
rating scale of 1 to 10 (where a high rating signifies high attractiveness, and a low rating signifies
low attractiveness). Keep in mind here that the more intensely competitive an industry is, the lower
the attractiveness rating for that industry. Likewise, the more the resource requirements associated
with being in a particular industry are beyond the parent company’s reach, the lower the
attractiveness rating. On the other hand, the presence of good cross-industry strategic fit should be
given a very high attractiveness rating, since there is good potential for competitive advantage and
added shareholder value. Weighted attractiveness scores are then calculated by multiplying the
industry’s rating on each measure by the corresponding weight. For example, a rating of 8 times a
weight of 0.25 gives a weighted attractiveness score of 2. The sum of the weighted scores for all the
attractiveness measures provides an overall industry-attractiveness score. This procedure is
illustrated in Table 8.1.
TABLE 8.1 Calculating Weighted Industry-Attractiveness Scores
Industry-Attractiveness Measure
Industry A Industry B Industry C
Industry-
Attractiveness
Assessments
Importance
Weight
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Market size and
projected growth
rate
0.10 8 0.80 3 0.30 5 0.50
Intensity of
competition 0.25 8 2.00 2 0.50 5 1.25
Emerging
opportunities and
threats
0.10 6 0.60 5 0.50 4 0.40
Cross-industry
strategic fit 0.30 8 2.40 2 0.60 3 0.90
Resource
requirements 0.10 5 0.50 5 0.50 4 0.40
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Industry-Attractiveness Measure
Industry A Industry B Industry C
Industry-
Attractiveness
Assessments
Importance
Weight
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Social, political,
regulatory, and
environmental
factors
0.05 8 0.40 3 0.15 7 1.05
Industry
profitability
0.10 5 0.50 4 0.40 6 0.60
Sum of
importance
weights
1.00
Weighted overall
industry-
attractiveness
scores
7.20 2.95 5.10
*Rating scale: 1 = very unattractive to company; 10 = very attractive to company.
Interpreting the Industry-Attractiveness Scores Industries with a score much below 5
probably do not pass the attractiveness test. If a company’s industry-attractiveness scores are all
above 5, it is probably fair to conclude that the group of industries the company operates in is
attractive as a whole. But the group of industries takes on a decidedly lower degree of attractiveness
as the number of industries with scores below 5 increases, especially if industries with low scores
account for a sizable fraction of the company’s revenues.
For a diversified company to be a strong performer, a substantial portion of its revenues and
profits must come from business units with relatively high attractiveness scores. It is particularly
important that a diversified company’s principal businesses be in industries with a good outlook for
growth and above-average profitability. Having a big fraction of the company’s
revenues and profits come from industries with slow growth, low profitability, intense
competition, or other troubling conditions tends to drag overall company performance down.
Business units in the least attractive industries are potential candidates for divestiture, unless they
are positioned strongly enough to overcome the unattractive aspects of their industry environments
or they are a strategically important component of the company’s business makeup.
Step 2: Evaluating Business Unit Competitive Strength
The second step in evaluating a diversified company is to appraise the competitive strength of each
business unit in its respective industry. Doing an appraisal of each business unit’s strength and
competitive position in its industry not only reveals its chances for success in its industry but also
provides a basis for ranking the units from competitively strongest to competitively weakest and
sizing up the competitive strength of all the business units as a group.
Calculating Competitive-Strength Scores for Each Business Unit Quantitative measures of
each business unit’s competitive strength can be calculated using a procedure similar to that for
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measuring industry attractiveness. The following factors are used in quantifying the competitive
strengths of a diversified company’s business subsidiaries:
Relative market share. A business unit’s relative market share is defined as the ratio of its market
share to the market share held by the largest rival firm in the industry, with market share
measured in unit volume, not dollars. For instance, if business A has a market-leading share of 40
percent and its largest rival has 30 percent, A’s relative market share is 1.33. (Note that only
business units that are market share leaders in their respective industries can have relative market
shares greater than 1.) If business B has a 15 percent market share and B’s largest rival has 30
percent, B’s relative market share is 0.5. The further below 1 a business unit’s relative market
share is, the weaker its competitive strength and market position vis-à-vis rivals.
Costs relative to competitors’ costs. Business units that have low costs relative to those of key
competitors tend to be more strongly positioned in their industries than business units struggling
to maintain cost parity with major rivals. The only time a business unit’s competitive strength
may not be undermined by having higher costs than rivals is when it has incurred the higher costs
to strongly differentiate its product offering and its customers are willing to pay premium prices
for the differentiating features.
Ability to match or beat rivals on key product attributes. A company’s competitiveness depends in
part on being able to satisfy buyer expectations with regard to features, product performance,
reliability, service, and other important attributes.
Brand image and reputation. A widely known and respected brand name is a valuable
competitive asset in most industries.
Other competitively valuable resources and capabilities. Valuable resources and capabilities,
including those accessed through collaborative partnerships, enhance a company’s ability to
compete successfully and perhaps contend for industry leadership.
Ability to benefit from strategic fit with other business units. Strategic fit with other
businesses within the company enhances a business unit’s competitive strength and may
provide a competitive edge.
Ability to exercise bargaining leverage with key suppliers or customers. Having bargaining
leverage signals competitive strength and can be a source of competitive advantage.
Profitability relative to competitors. Above-average profitability on a consistent basis is a signal
of competitive advantage, whereas consistently below-average profitability usually denotes
competitive disadvantage.
After settling on a set of competitive-strength measures that are well matched to the
circumstances of the various business units, the company needs to assign weights indicating each
measure’s importance. As in the assignment of weights to industry-attractiveness measures, the
importance weights must add up to 1. Each business unit is then rated on each of the chosen
strength measures, using a rating scale of 1 to 10 (where a high rating signifies competitive strength,
and a low rating signifies competitive weakness). In the event that the available information is too
limited to confidently assign a rating value to a business unit on a particular strength measure, it is
usually best to use a score of 5—this avoids biasing the overall score either up or down. Weighted
strength ratings are calculated by multiplying the business unit’s rating on each strength measure by
the assigned weight. For example, a strength score of 6 times a weight of 0.15 gives a weighted
strength rating of 0.90. The sum of the weighted ratings across all the strength measures provides a
quantitative measure of a business unit’s overall competitive strength. Table 8.2 provides sample
calculations of competitive-strength ratings for three businesses.
TABLE 8.2 Calculating Weighted Competitive-Strength Scores for a Diversified
Company’s Business Units
Competitive-Strength Measures
Business A in Industry A Business B in Industry B Business C inIndustry C
Competitive-Strength
Measures
Importance
Weight
Strength
Rating*
Weighted
Score
Strength
Rating*
Weighted
Score
Strength
Rating*
Weighted
Score
Relative market
share 0.15 10 1.50 2 0.30 6 0.90
Costs relative to
competitors’ costs 0.20 7 1.40 4 0.80 5 1.00
Ability to match or
beat rivals on key
product attributes
0.05 9 0.45 5 0.25 8 0.40
Ability to benefit from
strategic fit with sister
businesses
0.20 8 1.60 4 0.80 8 0.80
Bargaining leverage
with
suppliers/customers
0.05 9 0.45 2 0.10 6 0.30
Brand image and
reputation 0.10 9 0.90 4 0.40 7 0.70
Other valuable
resources/capabilities 0.15 7 1.05 2 0.30 5 0.75
Profitability relative to
competitors
0.10 5 0.50 2 0.20 4 0.40
Sum of importance
weights 1.00
Weighted overall
competitive
strength scores
7.85 3.15 5.25
*Rating scale: 1 = very weak; 10 = very strong.
Interpreting the Competitive-Strength Scores Business units with competitive-strength ratings
above 6.7 (on a scale of 1 to 10) are strong market contenders in their industries. Businesses with
ratings in the 3.3-to-6.7 range have moderate competitive strength vis-à-vis rivals. Businesses with
ratings below 3.3 have a competitively weak standing in the marketplace. If a diversified company’s
business units all have competitive-strength scores above 5, it is fair to conclude that its business
units are all fairly strong market contenders in their respective industries. But as the number of
business units with scores below 5 increases, there’s reason to question whether the company can
perform well with so many businesses in relatively weak competitive positions. This concern takes
on even more importance when business units with low scores account for a sizable fraction of the
company’s revenues.
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive
Strength The industry-attractiveness and business-strength scores can be used to portray the
strategic positions of each business in a diversified company. Industry attractiveness is plotted on
the vertical axis and competitive strength on the horizontal axis. A nine-cell grid emerges from
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dividing the vertical axis into three regions (high, medium, and low attractiveness) and the
horizontal axis into three regions (strong, average, and weak competitive strength). As shown in
Figure 8.3, scores of 6.7 or greater on a rating scale of 1 to 10 denote high industry attractiveness,
scores of 3.3 to 6.7 denote medium attractiveness, and scores below 3.3 signal low attractiveness.
Likewise, high competitive strength is defined as scores greater than 6.7, average strength as scores
of 3.3 to 6.7, and low strength as scores below 3.3. Each business unit is plotted on the
nine-cell matrix according to its overall attractiveness score and strength score, and then
it is shown as a “bubble.” The size of each bubble is scaled to the percentage of revenues the
business generates relative to total corporate revenues. The bubbles in Figure 8.3 were located on
the grid using the three industry-attractiveness scores from Table 8.1 and the strength scores for the
three business units in Table 8.2.
FIGURE 8.3 A Nine-Cell Industry-Attractiveness–Competitive-Strength Matrix
The locations of the business units on the attractiveness–strength matrix provide valuable
guidance in deploying corporate resources. Businesses positioned in the three cells in the upper left
portion of the attractiveness–strength matrix (like business A) have both favorable industry
attractiveness and competitive strength.
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Next in priority come businesses positioned in the three diagonal cells stretching from the lower
left to the upper right (like business C). Such businesses usually merit intermediate priority in the
parent’s resource allocation ranking. However, some businesses in the medium-priority
diagonal cells may have brighter or dimmer prospects than others. For example, a small
business in the upper right cell of the matrix, despite being in a highly attractive industry, may
occupy too weak a competitive position in its industry to justify the investment and resources
needed to turn it into a strong market contender.
Businesses in the three cells in the lower right corner of the matrix (like business B) have
comparatively low industry attractiveness and minimal competitive strength, making
them weak performers with little potential for improvement. At best, they have the
lowest claim on corporate resources and may be good candidates for being divested (sold to other
companies). However, there are occasions when a business located in the three lower-right cells
generates sizable positive cash flows. It may make sense to retain such businesses and divert their
cash flows to finance expansion of business units with greater potential for profit growth.
The nine-cell attractiveness–strength matrix provides clear, strong logic for why a diversified
company needs to consider both industry attractiveness and business strength in allocating resources
and investment capital to its different businesses. A good case can be made for concentrating
resources in those businesses that enjoy higher degrees of attractiveness and competitive strength,
being very selective in making investments in businesses with intermediate positions on the grid,
and withdrawing resources from businesses that are lower in attractiveness and strength unless they
offer exceptional profit or cash flow potential.
Step 3: Determining the Competitive Value of Strategic Fit in
Diversified Companies
While this step can be bypassed for diversified companies whose businesses are all unrelated (since,
by design, strategic fit is lacking), assessing the degree of strategic fit across a company’s
businesses is central to evaluating its related diversification strategy. But more than just checking
for the presence of strategic fit is required here. The real question is how much competitive value
can be generated from whatever strategic fit exists. Are the cost savings associated with economies
of scope likely to give one or more individual businesses a cost-based advantage over rivals? How
much competitive value will come from the cross-business transfer of skills, technology, or
intellectual capital or the sharing of competitive assets? Can leveraging a potent umbrella brand or
corporate image strengthen the businesses and increase sales significantly? Could cross-business
collaboration to create new competitive capabilities lead to significant gains in performance?
Without significant cross-business strategic fit and dedicated company efforts to capture the
benefits, one has to be skeptical about the potential for a diversified company’s businesses to
perform better together than apart.
The greater the
value of cross-
business strategic fit
in enhancing the
performance of a
diversified
company’s
businesses, the
more competitively
powerful is the
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company’s related
diversification
strategy.
Figure 8.4 illustrates the process of comparing the value chains of a company’s businesses and
identifying opportunities to exploit competitively valuable cross-business strategic fit.
FIGURE 8.4 Identifying the Competitive Advantage Potential of Cross-
Business Strategic Fit
Step 4: Checking for Good Resource Fit
The businesses in a diversified company’s lineup need to exhibit good resource fit. In firms with a
related diversification strategy, good resource fit exists when the firm’s businesses have well-
matched specialized resource requirements at points along their value chains that are critical for the
businesses’ market success. Matching resource requirements are important in related diversification
because they facilitate resource sharing and low-cost resource transfer. In companies pursuing
unrelated diversification, resource fit exists when the company has solid parenting capabilities or
resources of a general nature that it can share or transfer to its component businesses.
Firms pursuing related diversification and firms with combination related–unrelated
diversification strategies can also benefit from leveraging corporate parenting capabilities and other
general resources. Another dimension of resource fit that concerns all types of multibusiness firms
is whether they have resources sufficient to support their group of businesses without being spread
too thin.
CORE
CONCEPT
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A company pursuing
related
diversification
exhibits resource fit
when its businesses
have matching
specialized resource
requirements along
their value chains; a
company pursuing
unrelated
diversification has
resource fit when
the parent company
has adequate
corporate resources
(parenting and
general resources)
to support its
businesses’ needs
and add value.
Financial Resource Fit The most important dimension of financial resource fit concerns whether
a diversified company can generate the internal cash flows sufficient to fund the capital
requirements of its businesses, pay its dividends, meet its debt obligations, and otherwise remain
financially healthy. (Financial resources, including the firm’s ability to borrow or otherwise raise
funds, are a type of general resource.) While additional capital can usually be raised in financial
markets, it is important for a diversified firm to have a healthy internal capital market that can
support the financial requirements of its business lineup. The greater the extent to which a
diversified company is able to fund investment in its businesses through internally generated cash
flows rather than from equity issues or borrowing, the more powerful its financial resource fit and
the less dependent the firm is on external financial resources. This can provide a competitive
advantage over single business rivals when credit market conditions are tight, as they have been in
the United States and abroad in recent years.
CORE
CONCEPT
A strong internal
capital market
allows a diversified
company to add
value by shifting
capital from
business units
generating free cash
flow to those
needing additional
capital to expand
and realize their
growth potential.
A portfolio approach to ensuring financial fit among a firm’s businesses is based
on the fact that different businesses have different cash flow and investment characteristics. For
example, business units in rapidly growing industries are often cash hogs—so labeled because the
cash flows they are able to generate from internal operations aren’t big enough to fund their
operations and capital requirements for growth. To keep pace with rising buyer demand, rapid-
growth businesses frequently need sizable annual capital investments—for new facilities and
equipment, for new product development or technology improvements, and for additional working
capital to support inventory expansion and a larger base of operations. Because a cash hog’s
financial resources must be provided by the corporate parent, corporate managers have to decide
whether it makes good financial and strategic sense to keep pouring new money into a cash hog
business.
CORE
CONCEPT
A portfolio
approach to
ensuring financial fit
among a firm’s
businesses is based
on the fact that
different businesses
have different cash
flow and investment
characteristics.
CORE
CONCEPT
A cash hog
business generates
cash flows that are
too small to fully
fund its growth; it
thereby requires
cash infusions to
provide additional
working capital and
finance new capital
investment.
In contrast, business units with leading market positions in mature industries may be cash cows
in the sense that they generate substantial cash surpluses over what is needed to adequately fund
their operations. Market leaders in slow-growth industries often generate sizable positive cash flows
over and above what is needed for growth and reinvestment because their industry-leading positions
tend to generate attractive earnings and because the slow-growth nature of their industry often
entails relatively modest annual investment requirements. Cash cows, although not attractive from a
growth standpoint, are valuable businesses from a financial resource perspective. The surplus cash
flows they generate can be used to pay corporate dividends, finance acquisitions, and provide funds
for investing in the company’s promising cash hogs. It makes good financial and strategic sense for
diversified companies to keep cash cows in a healthy condition, fortifying and defending their
market position so as to preserve their cash-generating capability and have an ongoing source of
financial resources to deploy elsewhere. General Electric considers its advanced materials,
equipment services, and appliance and lighting businesses to be cash cow businesses.
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CORE
CONCEPT
A cash cow
business generates
cash flows over and
above its internal
requirements, thus
providing a
corporate parent
with funds for
investing in cash
hog businesses,
financing new
acquisitions, or
paying dividends.
Viewing a diversified group of businesses as a collection of cash flows and cash requirements
(present and future flows) can be helpful in understanding what the financial ramifications of
diversification are and why having businesses with good financial resource fit can be important. For
instance, a diversified company’s businesses exhibit good financial resource fit when the excess cash
generated by its cash cow businesses is sufficient to fund the investment requirements of promising
cash hog businesses. Ideally, investing in promising cash hog businesses over time results in
growing the hogs into self-supporting star businesses that have strong or market-leading
competitive positions in attractive, high-growth markets and high levels of profitability. Star
businesses are often the cash cows of the future. When the markets of star businesses begin to
mature and their growth slows, their competitive strength should produce self-generated cash flows
that are more than sufficient to cover their investment needs. The “success sequence” is thus cash
hog to young star (but perhaps still a cash hog) to self-supporting star to cash cow. While the
practice of viewing a diversified company in terms of cash cows and cash hogs has declined in
popularity, it illustrates one approach to analyzing financial resource fit and allocating financial
resources across a portfolio of different businesses.
Aside from cash flow considerations, there are two other factors to consider in assessing whether
a diversified company’s businesses exhibit good financial fit:
Do any of the company’s individual businesses present financial challenges with respect to
contributing adequately to achieving companywide performance targets? A business exhibits
poor financial fit if it soaks up a disproportionate share of the company’s financial resources,
while making subpar or insignificant contributions to the bottom line. Too many
underperforming businesses reduce the company’s overall performance and ultimately
limit growth in shareholder value.
Does the corporation have adequate financial strength to fund its different businesses and
maintain a healthy credit rating? A diversified company’s strategy fails the resource-fit test when
the resource needs of its portfolio unduly stretch the company’s financial health and threaten to
impair its credit rating. Many of the world’s largest banks, including Royal Bank of Scotland,
Citigroup, and HSBC, recently found themselves so undercapitalized and financially
overextended that they were forced to sell off some of their business assets to meet regulatory
requirements and restore public confidence in their solvency.
Nonfinancial Resource Fit Just as a diversified company must have adequate financial resources
to support its various individual businesses, it must also have a big enough and deep enough pool of
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managerial, administrative, and other parenting capabilities to support all of its different businesses.
The following two questions help reveal whether a diversified company has sufficient nonfinancial
resources:
Does the parent company have (or can it develop) the specific resources and capabilities needed
to be successful in each of its businesses? Sometimes the resources a company has accumulated
in its core business prove to be a poor match with the competitive capabilities needed to succeed
in the businesses into which it has diversified. For instance, BTR, a multibusiness company in
Great Britain, discovered that the company’s resources and managerial skills were quite well
suited for parenting its industrial manufacturing businesses but not for parenting its distribution
businesses (National Tyre Services and Texas-based Summers Group). As a result, BTR decided
to divest its distribution businesses and focus exclusively on diversifying around small industrial
manufacturing. For companies pursuing related diversification strategies, a mismatch between the
company’s competitive assets and the key success factors of an industry can be serious enough to
warrant divesting businesses in that industry or not acquiring a new business. In contrast, when a
company’s resources and capabilities are a good match with the key success factors of industries
it is not presently in, it makes sense to take a hard look at acquiring companies in these industries
and expanding the company’s business lineup.
Are the parent company’s resources being stretched too thinly by the resource requirements of one
or more of its businesses? A diversified company must guard against overtaxing its resources and
capabilities, a condition that can arise when (1) it goes on an acquisition spree and management is
called on to assimilate and oversee many new businesses very quickly or (2) it lacks sufficient
resource depth to do a creditable job of transferring skills and competencies from one of its
businesses to another. The broader the diversification, the greater the concern about whether
corporate executives are overburdened by the demands of competently parenting so many
different businesses. Plus, the more a company’s diversification strategy is tied to transferring
know-how or technologies from existing businesses to newly acquired businesses, the more time
and money that has to be put into developing a deep-enough resource pool to supply these
businesses with the resources and capabilities they need to be successful.15 Otherwise, its
resource pool ends up being spread too thinly across many businesses, and the opportunity for
achieving 1 + 1 = 3 outcomes slips through the cracks.
Step 5: Ranking Business Units and Assigning a Priority for
Resource Allocation
Once a diversified company’s strategy has been evaluated from the perspective of industry
attractiveness, competitive strength, strategic fit, and resource fit, the next step is to use this
information to rank the performance prospects of the businesses from best to worst. Such ranking
helps top-level executives assign each business a priority for resource support and capital
investment.
The locations of the different businesses in the nine-cell industry-attractiveness– competitive-
strength matrix provide a solid basis for identifying high-opportunity businesses and low-
opportunity businesses. Normally, competitively strong businesses in attractive industries have
significantly better performance prospects than competitively weak businesses in unattractive
industries. Also, the revenue and earnings outlook for businesses in fast-growing industries is
normally better than for businesses in slow-growing industries. As a rule, business subsidiaries with
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the brightest profit and growth prospects, attractive positions in the nine-cell matrix, and solid
strategic and resource fit should receive top priority for allocation of corporate resources.
However, in ranking the prospects of the different businesses from best to worst, it is usually wise to
also take into account each business’s past performance in regard to sales growth, profit growth,
contribution to company earnings, return on capital invested in the business, and cash flow from
operations. While past performance is not always a reliable predictor of future performance, it does
signal whether a business is already performing well or has problems to overcome.
Allocating Financial Resources Figure 8.5 shows the chief strategic and financial options for
allocating a diversified company’s financial resources. Divesting businesses with the
weakest future prospects and businesses that lack adequate strategic fit and/or resource fit
is one of the best ways of generating additional funds for redeploym
