STRATEGIC

MANAGEMENT

An Integrated Approach 6th Edition

Chapter 1 Objectives Introduce students to the concept of strategy. Specify the relationships between superior performance, profitability, competitive advantage and sustainable competitive advantage. Identify the roles and responsibilities of strategic managers at different levels within the organization Outline the main components of the strategic management process covered in subsequent chapters and show how hey fit together. Contrast the rational, deterministic view of strategy with alternative views, which describe strategy as an emergent process. Explain why formal strategic planning may not always lead to success, and identify ways of avoiding some of the common pitfalls associated with strategic planning. Identify the attributes associated with superior strategic leadership. Overview Why do some organizations succeed and other fail? An answer can be found in the subject matter of this course. This course is about strategic management and the advantages that accrue to organizations that think strategically. A strategy is a course of action that managers take in the effort to attain superior performance. Understanding the roots of success and failure is not an empty academic exercise. Through such understanding comes a better appreciation for the strategies that must be pursued to increase the probability or failure.

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Superior Performance and Competitive Advantage For businesses, superior performance is demonstrated through above-averaged profitability, as compared to other firms in the same industry. Profitability is typically measured using after tax return on invested capital. When a firms profitability is greater than the average profitability for all firms in its industry, it has a competitive advantage over its rivals. The greater the profitability, the greater is its competitive advantage. A sustained competitive advantage occurs when a firm maintains above-average profitability for a number of years. A business model describes managers beliefs about how a firms strategies will lead to competitive advantage and superior profitability. An appropriate business model is one component of a successful strategy. Another component of a successful strategy is a favorable competitive or industry environment. Strategic management is relevant to many different kinds of organizations from large multi-business organizations to small oneperson enterprises and from publicly held profit-seeking corporations to nonprofit organizations.

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Strategic Managers and Strategic Leadership General managers are responsible for the overall performance of the organisation or for one of its major self-contained divisions. Functional Managers are responsible for specific business functions, such as human resources, purchasing, production, sales, customer service and accounts.

The three main levels of management are the corporate level, the business level, and the functional level. General managers are found at the first two of these levels but their strategic role, though of a different kind.

Figure 1.2
Levels of Strategic Management

Corporate level CEO, board of Directors and corporate staff

HEAD OFFICE

Business Level
Divisional managers and staff

Division A

Division B

Division C

Functional managers

Business functions

Business functions

Business functions

Market A

Market B

Market C

The corporate level consists of the CEO, board of directors and corporate staff. The CEOs role is to define the mission and goals of the firm, determine what business the firm should be in, allocate resources to the different business areas of the firm and formulate and implement strategies that span individual businesses. The business level consists of the heads of the individual business units (divisional) CEOs role is to translate general statements of intent at the corporate level into concrete strategies for individual businesses. Functional level consists of the managers of specific business operations. They develop functional strategies that help fulfill the business-and corporate level general managers to formulate strategies. They are closer to the customer than the typical general manager and therefore functional managers may generate important strategic ideas. They are responsible for the implementation of corporate- and business level decisions.

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Strategic Planning The formal strategic management planning process can be broken down into a number of components. Each component forms a section of this course. Thus it is important to understand how the different components fit together. Together, the components form a cycle from strategy formulation to implementation. After implementation, the results that are obtained must monitored, and the results become an input to the formulation process on the next cycle. Thus the strategic process is continous.

The main Components of the Strategic Planning Process

Figure 1.3

Mission and Goals

External Analysis: Opportunities and Threats Chapter 2

SWOT Strategic Choice

Internal Analysis Strengths and Weaknesses chapter 3

Functional-level strategy Chapter 4

Business-level strategy Chapter 5,6 & 7

Global strategy Chapter 8

Corporate-level strategy Chapters 9 & 10

Strategy Implementation

Corporate Performance Governance, and Ethics Chapter 11

Implementing Strategy in a Single Industry (Chpt 12)

Implementing Strategy across Industries and countries(chpt 13)

The components are organized into two phases. The first phase is strategy formulation, which includes selection of the corporate mission, values and goals; analysis of the external and internal environments; and the selection of appropriate strategies. The second phase is strategy implementation, which includes corporate governance and ethics issues as well as the actions that managers take to translate the formulated strategy into reality.

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Corporate Mission, Values and Goals A corporate mission or vision is a formal statement of what the company is trying to achieve over a medium to long term time frame. The mission states why an organisation exists and what it should be doing. Abell used a customer-oriented definition when he claimed that a mission statement should describe the customer, their needs and the method the firm will use to satisfy those needs.

Figure 1.4
Abels Framework for Defining the Business

Who is being Satisfied? Customer groups

What is being Satisfied? Customer needs

How are Customer needs satisfied Distinctive Competencies

The values of a company state how managers and employees should conduct themselves, how they do business, and what kind of organisation they build to help a company achieve its mission. Values are the foundation of a companys organizational culture. Values include respect for the organisations diverse stakeholders. A goal is a desired future state or an objective to be achieved. Corporate goals are a more specific statement of the ideas articulated in the corporate mission. Well-constructed goals are precise and measureable, address crucial issues, are challenging but realistic, and have a specified time horizon for completion. A major goal of business is to provide high returns to shareholders, either through dividends or through an appreciation in share value. Thus high profitability provides the best return to shareholders. However, managers must be aware that the profitability should be sustainable, and they should not sacrifice long-term profits for short-term profits. External analysis identifies strategic opportunities and threats that exist in three components of the external environment: the specific industry environment within which the organization is based, the country or national environment and the macroenvironment. 7

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Internal analysis identifies the strengths and weaknesses of the organization. This involves identifying the quantity and quality of an organisations resources. Together, the external and internal analysis result in a SWOT analysis, delineating a firms strengths, weaknesses, opportunities and threats. The SWOT analysis is then used to create a business model to achieve competitive advantage, identifying strategies that align, fit, or match a companys resources to the demands of the environment. This model is called a fit model. Strategic choice involves generating a series of strategic alternatives, based on the firms mission, values, goals and SWOT analysis, and then choosing those strategies that achieve the best fit. Organisations identify the best strategies at the functional, business, global and corporate levels. Functional level strategy is directed at improving the effectiveness of functional operations within a company, such as manufacturing, marketing, materials management, research and develop, and human resource. The business-level strategy of a company encompasses the overall competitive theme that a company chooses to stress, the way it positions itself in the market place to gain a competitive advantage, and the different positioning strategies that can be used in different industry settings. More and more, to achieve a competitive advantage and maximize performance, a company has to expand its operations outside the home country. Global strategy addresses how to expand operations outside the home country. Corporate-level strategy must answer this question: What business should we be in to maximize the long-run profitability of the organization? The answer may involve vertical intergration, diversification, strategic alliances, acquisition, new ventures, or some combination thereof.

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Strategy implementation consists of a consideration of corporate governance and business ethics, as well as actions that should be taken, for companies that compete in a single industry and companies that compete in more than one industry or country.

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Strategy as an Emergent Process The formal planning process implies that all strategic decision making is rational, structured, led by top management. However, some criticisms of the formal planning process include the view that the real world is often too unpredictable, that lower-level employees often play an important role in formulating process, and that successful strategies are often the result of good luck rather than rational planning. We live in an uncertain world, in which even thoughtful strategic plans may be rendered useless by rapid environmental changes. Therefore organizations must be able to respond quickly to changing circumstances. According to critics, such a flexible approach to strategy making is not possible within the framework of the traditional strategic planning process, with its implicit assumptions that an organisations strategies need to be reviewed only during the annual planning exercise. Mintzberg believed that strategies can emerge from deep within an organization, and therefore, he defined strategy as a pattern in stream of decisions or actions. The pattern is a product of whatever aspects of an organisations intended (planned) strategy. Strategies that are intended may be deliberately implemented, or realized. They may also be abandoned, or unrealized. Unintended strategies may spring from anywhere in the organization or emerge and are thus called emergent strategies.

Figure 1.5
Emergent and Deliberate Strategies

Intended Strategies

Deliberate strategy

Realised strategy

Unrealized Strategy

Emergent strategy

Nevertheless top management still has to evaluate the worth of emergent strategies and determine whether each one fits the organizations external environment and internal operations. Moreover, an organisations capability to produce emergent strategies is a function of the kind of culture fostered by its structure and control systems. Thus the different components of the strategic management process are just as important from the perspective of emergent strategies as they are from the perspective of intended strategies. The formulation of intended strategies is a top-down process, whereas the formulation of emergent strategies is a bottom-up process. In practice, the strategies of many firms are a mix of the intended and the emergent. The trick for managers is to recognize the process of emergence and to intervene selectively, killing off bad emergent strategies but nurturing good ones (strategic management process for intended and emergent strategies)

Strategic Planning in Practice Research indicates that formal planning does help companies make better strategic decisions. However, one mistake made by planners is to focus on the present, which is known, and neglect to study the future, which is more unpredictable but also more essential for strategic decisions. Studying the future means making accurate estimates of future conditions. The text highlights

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the use of scenario planning which was developed at Royal Dutch/Shell and is a helpful forecasting technique. Another serious mistake that is often associated with the use of formal planning is ignoring the potential contributions of any employees that are not part of the top management team. This error is known as ivory-tower planning. This approach can result in strategic plans that are formulated by planning executives who have little understanding or appreciation of operating realities and are not the ones who must implement the plans. This separation between thinking and doing causes more harm than good. o Correcting the ivory-tower approach to planning involves recognising that, to succeed, planning must embrace all levels of the production levels of the corporation. Most of the planning can and should be done by functional managers. They are the ones closest to the facts. The role of corporate-level planners should be that of facilitators who help functional managers do the planning. o It is not enough just to involve lower level managers in the strategic planning process. They also need to perceive that the decision-making process is judged to be fair. Three criteria have been found to influence the extent to which strategic decisions are seen as just: engagement, explanation, and clarity of expectations. Another serious error was pointed out by Hamel and Prahalad, who assert that adopting the fit model to strategy formulation leads to a mindset in which management focuses too much upon the existing resources of a company and current environmental opportunities-and not enough on building new resources and capabilities to create and exploit future opportunities. When companies have bold ambitions that outstrip their existing resources and capabilities and want to achieve global leadership, then they build the resources and capabilities that would enable them to attain this goal. The top management of these companies created an obsession with winning at all levels of the organization and then sustained that obsession

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over the long term. Hamel and Prahalad refer to this obsession as strategic intent. 8. Strategic Leadership and Decision Making One of the key strategic roles of any manager, whether general or functional is to provide strategic leadership for subordinates. Strategic leadership refers to the ability to articulate a strategic vision for the company and to motivate others to buy into that vision. Strong leaders meet six criteria. i. Strong leaders have a vision of where the organization should go, are eloquent enough to communicate this vision to others within the organization in terms that energize people, and consistently articulate their vision until it becomes part of the culture of the organisation. ii. Strong leaders demonstrate their commitment to their vision by actions and words, and they often lead by example. iii. Strong leaders are well informed, developing a network of formal and informal sources of information that keep them well apprised of what is going on within the organization so that they do not have to rely on formal information channels. iv. Strong leaders are skilled delegators. They recognize that, unless they delegate, they can quickly become overloaded with responsibilities. Besides, they recognize that empowering subordinates to make decisions is an effective motivational tool. Empowerment also makes sense when it results in shifting decisions to those who must implement them, v. Strong leaders are politically astute. They play the power game with skill, preferring to build consensus for their ideas rather than use their authority to force ideas through. They act as members of a coalition rather than as dictators. Recognizing the uncertain nature of their forecasts, they commit to a

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vision rather than to specific projects or deadlines. They also realize that a big change may be more easily implemented in small, piecemeal steps. vi. Strong leaders exhibit emotional intelligence, which includes self-awareness, self-regulation, motivation, empathy, and social skills. Leaders who exhibit a high degree of emotional intelligence tend to be more effective. WHY SP FAIL The best-designed strategic planning systems will fail to produce the desired results if strategic decision makers fail to use the information at their disposal effectively. Our rationality as decision makers is bounded by our own cognitive capabilities. Experimental evidence shows that all humans suffer from innate flaws in their reasoning ability, when making decisions, and sometimes they lead to severe and systematic errors in the decision-making improvement techniques. o The prior hypothesis bias refers to the fact that decision makers who have strong prior beliefs about the relationship between two variables tend to make decisions on the basis of these beliefs, even when presented with evidence that their beliefs are wrong. o Escalating commitment occurs when, having already committed significant resources to a project, decision makers commit even more resources even if they receive feedback that the project is failing. This may be an irrational response; a more logical response may be to abandon the project and move on, rather than escalate commitment. o Reasoning by analogy involves the use of simple analogies to make sense out of complex problems. However, because they oversimplification of a complex problem, such analogies can be misleading. o Representatives refers to the tendency on the part of many decision makers to generalize from a small sample or even a single vivid anecdote. Generalizing from small samples

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violates the statistical law of large numbers, which tells us that it is inappropriate to generalize from a small sample, to say nothing of a single case. o The illusion of control is the tendency on the part of decision makers to overestimate their ability to control events. Top-level managers seem to be particularly prone to this bias. Having risen to the top of an organization, they tend to be overconfident about their ability to succeed. Another cause of poor strategic decision making appears to be phenomenon referred to as group think. Groupthink occurs when a group of decision makers decides on a course of action without questioning underlying assumptions. Typically, a group coalesces around commitment to a person or policy. Information that could be used to question the policy is ignored or filtered out, while the group develops after-the-fact rationalizations for its decisions. Thus commitment is based on an emotional rather than an objective assessment of what is the correct course of action. The existence of cognitive biases and groupthink raises the problem of how to bring critical information to bear on the decision mechanism to ensure that strategic decisions made by the firm are realistic. Two techniques that have been proposed to guard against this problem are devils advocacy and dialectic inquiry. Devils advocacy involves the generation of a plan and a critical analysis of it. A member of the group should act as the devils advocate, bringing out all the reasons why the proposal should not be adopted. The decision makers can be aware of the possible perils of recommended courses of action. Dialectic inquiry involves the generation of a plan and a counter plan reflecting plausible but conflicting courses of action. A debate between the advocates of the plan and those of the counter plan should be considered by senior strategic managers. The debate is intended to reveal problems with definitions, recommended courses of action, and assumptions. As a

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consequence, corporate decision makers and planners can form a new more encompassing final plan (a synthesis).

Figure 1.6
Two Decision-Making Processes That Cognitive Biases and Groupthink

Devils Advocacy

Dialectic Inquiry

Expert Plan

Expert plan 1 (Thesis)

Expert plan 2 (antithesis)

Devils Advocate Criticizes

Debate (synthesis)

Final Plan

Final Plan

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Chapter 2
The identification of Industry Opportunities and Threats 1. Overview For a company to succeed, its strategy must either fit the industry environment in which it operates to its advantage through its choice of strategy. Companies typically fail when their strategy no longer fits the environment in which they operate. To achieve a good fit, managers must understand the forces that shape competition in their external environment. This understanding enables them to identify strategic opportunities and threats. Opportunities arise when a company can take advantage of conditions in its environment to formulate and implement strategies that enable it to become more profitable. Threats arise when conditions in the external environment endanger the integrity and profitability of the companys business.

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Defining and Industry An industry can be defined as a group of companies offering products or services that are close substitutes for each other. Close substitutes are products or services that satisfy the same basic consumer needs. Firms within the same industry are rivals, also called competitors. - A correct industry definition can be the difference between success and failure. - Managers must define industries based on the customer need (demand side of he market) and not the products the industry offers (supply side of the market) Several industries combine to create a sector. For example, the Pc industry, the handheld industry, and the mainframe industry together create the computer sector.

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Figure 2.1 The computer Sector Industries and Segments

Computer Sector

Computer Component Computer Industries

Supply inputs

Computer Hardware Industries

Computer Software Industries

Provide complements

Disk Drive industry

Mainframe industry

Semiconductor industry

Personal Computer industry Handheld Computer industry

Notebook PC Market segment Desktop PC Market segment

Modem industry

Server Market segment

Within industries, customers with a common need group need to come together to form a market segment. For example, the soft drink, soft drink industry contains regular, diet, and caffeine-free market segments. Industry boundaries are not fixed, but can change overtime. Industries may fragment into a set of smaller industries, such as

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when the auto industry fragmented into the car and SUV industries. Industries may also consolidate, such as the blurring of the boundary between the handled computer and cell phone industries. 3. Porters Five Forces Model

This model was devised by Michael Porter to describe forces that shape competition within an industry and help to identify strategic opportunities and threats. The stronger each of these forces is the more established companies are limited in their ability to raise price and earn greater profits. A strong competitive force is a threat because it depresses profits. A weak competitive force is an opportunity because it allows the company to earn greater returns. Figure 2.2
The five Forces Model

Risk of entry By potential Competitors

Bargaining power of suppliers

Intensity of Rivalry among established firms

Bargaining power of buyers

Threat of substitute products

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One of Porters Five Forces is the risk of entry by potential competitors. Potential competitors are companies that are currently not competing in the industry but have the capability to do so. New entry into an industry expands supply. This in turn depresses prices and profits. Thus a high risk of new entry constitutes a strategic threat. A low risk of new entry allows established companies to raise their prices, so it constitutes an opportunity. The risk of entry is determined by several factors.

a. The extent to which established companies have brand loyalty from their customers is one factor. Loyal customers would discourage potential competitors. b. Potential competitors are also discouraged when established companies enjoy an absolute cost advantage over potential entrants. Cost advantages might include factor such as patents, control of a specific raw material, or access to cheaper funds. c. Potential competitors are also discouraged when established companies have economies of scale, that is, when established companies are able to produce at a lower cost than the new entrants due to their large size and greater experience. d. When customers switching costs, that accrue to a customer that intends to switch from the product offering of an established company to the product offering of a new entrant, high, potential new entrants are discouraged. e. Government regulation, such as establishing a protected monopoly, tends to protect established firms, thus to constitute a barrier to entry. When industries are deregulated, new entrants usually proliferate. Another of Porters Five Forces is rivalry among established companies. Strong rivalry tends to lower prices and raise costs, which constitutes a threat to established companies, whereas weak rivalry creates an opportunity to earn greater returns. The extent of rivalry among established firms depends on several factors. a. Industry environment (i) Many fragmented industries are characterized by low entry barriers and commodity-type products that are hard on new

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entrants, excess capacity, and price wars, leading to low industry profits and exit from the industry. The more commodity-like an industrys product, the more vicious will be the price war. The bust part of the cycle will continue until overall industry capacity is brought into line with demand (through bankruptcies), at which point prices may stabilize again. (ii) Consolidated industries are interdependent, so that the competitive actions of one company directly affect the profitability of competitors, forcing a response from them. The consequence can be price wars like those the airline industry has experienced. Thus interdependence can be price wars like those the airline industry has experienced. Thus interdependence is a major threat. This threat can be reduced when tacit price-leadership agreements exist within the industry and when companies are successful in emphasizing nonprice competition. (b) Demand conditions also determine the intensity of rivalry among established companies. Growing demand moderates competition by providing room for expansion. Declining demand results in more competition as companies fight to maintain revenues and market share. (c)Exit barriers are serious competitive threat, especially when demand is declining. Economic, strategic, and emotional factors can keep companies competiting in an industry even when returns are low. This in turn leads to excess capacity and price wars. Exit barriers include: a. b. c. d. e. investments in specialized assets high fixed costs of exit such as severance pay emotional attachments to an industry economic dependence on a single industry the need to maintain expensive assets in order to compete effectively in that industry.

A third factor in Porters Five Forces Model is the bargaining power of buyers. Buyers can be individual consumers, other businesses, wholesalers, or retailers. Buyers can be viewed as a competitive threat when they force down prices or when they raise expenses by

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demanding higher quality and better service. The ability of buyers to make demands on a company depends on their power relative to that of the company. Buyers tend to be powerful when: a. b. c. d. they are in industries that are more highly consolidated than the companys industry. they purchase in large quantities or consume a significant buyer for that industry. buyers can easily switch to substitute product or an alternate supplier. buyers can readily produce the product themselves.

A fourth factor is the bargaining power of suppliers. Suppliers are any organization that suppliers materials, services, or labour (such as labour unions) to the company. Suppliers are a threat when they are able to force up the price the company must pay for inputs or to reduce the quality of goods supplied. The ability of suppliers to make demands on a company depends on their power relative to that of the company. Suppliers tend to be powerful when: a. b. c. d. e. the suppliers product has no substitutes or is vital to the company the company is not important to the supplier the company has a switching cost to change suppliers suppliers can readily enter the companys industry the company cannot readily enter the suppliers industry.

A fifth factor is the threat of substitute products. The existence of adequate substitute products limit the price that companies in an industry can charge without losing their customers to makes of substitutes. The threat of substitutes tends to be greater when: the substitute is a close one, equally adequate in filling customers needs b. the price of substitute is equal to or less than the companys products. Recently, Intel CEO Andy Grove proposed a sixth force: complementors, or companies that sell products that are used in a.

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addition to and along with the enterprises own products. When there is a weak supply of complementary products, demand in the industry will be weak, and revenues and profits will be low. The threat from a lack of complementors tends to be greater when: few complementary products exist. the existing complementary products are not attractive to customers, due to high prices inadequate features, and so on. Strategic Groups Within Industries Strategic Groups in the Pharmaceutical Industry High a. b.

4.

Proprietary Group Merck Pfizer Eli Lilly

Price charged

Generic Group
Marion labs Carter Wallace ICN Pharmaceuticals

Low

R & D Spending Low high

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A strategic group is a group of companies within an industry that are pursuing the same basic strategy as the companies with the group, but different strategies from companies outside the group. The strategies may be based on a variety of factors, such as differences in quality, market segment served, or distribution channel utilized. Normally a limited number of strategic groups capture the essence of strategic differences among companies within an industry.

A companys immediate competitors are those in its strategic group. Because all companies in a strategic group are pursuing similar strategies, Strategic groups have several implications for internal analysis. 1. A companys immediate competitors are those in its strategic group. Because all companies in a strategic group are pursuing similar strategies, consumers tend to view the product of such enterprises as direct substitutes for each other. Different strategic groups can have a different standing with respect to the threats and opportunities they face from each of Porters five competitive forces. Some strategic groups are more desirable than others, in sofar as they are characterized by a lower level of threats and/or by greater opportunities. Mobility barriers are factors that inhibit movement between groups. They are analogous to industry entry barriers and are based on the same factors: brand loyalty, absolute cost advantages, and economies of scale. Mobility barriers make it difficult for companies to move into another strategic group, and they also protect group members from entry by companies from other groups.

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Over time, industries pass through a series of well-defined stages with different implications for the nature of competition. Porters five competitive forces and competitive dynamics change as an

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industry evolves. Managers must learn to anticipate the changes that will occur as the industry develops over time. An embryonic industry is one that is just beginning to develop. Growth is slow because of buyer unfamiliarity with the industrys products, poor distribution channels, and high prices stemming from the inability of companies to reap economies of scale. Barriers to entry at this stage tend to be based on access to key technological know-how, rather than cost economies or brand loyalty. Rivalry in embryonic industries is based on educating customers, opening up distribution channels, and perfecting the design of the product. Embryonic industries provide a good opportunity for firms to capture loyal customers, capitalizing on the lack of rivalry.

A growth industry is one where first-time demand is expanding readily as new consumers enter the marketplace. Typically, demand takes off when consumers become familiar with product, prices fall with the attainment of economies of scale, and distribution channels develop. During an industrys growth stage, there tends to be little rivalry. Rapid growth in demand enables companies to expand their revenues and profits without taking market share away from competitors. Growth industries provide opportunities for firms to expand their market share and revenues in relatively low rivalry situation. Firms entering at this stage avoid the high expenses of initial product development.

An industry shakeout occurs when the rate of industry growth slows down as demand approaches saturation levels. A saturated market is one where there are few first time buyers left. Most of the demand is limited to replacement demand. As an industry enters the shakeout stage, rivalry between companies becomes intense, with excess

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productive capacity and severe price discounting. Many firms exist the industry at this point. Industry shakeout provides an opportunity for those firms that are dedicated to success in this particular industry to consolidate their power, often by acquiring the assets of firms existing the industry.

Figure 2.5 Stages of the Industry Life Cycle Demand

Embryonic

Growth

Shakeout

Mature

Declining

Time A mature industry is one where the market is totally saturated, growth is very low or near zero, and demand is limited to replacement demand. Most competitors have exited the industry, creating an oligopoly dominated by a few, large companies. As an industry enters maturity, barriers to entry increase and the threat of entry from potential competitors decreases. Intense competition for market share can develop, driving down prices. In mature industries, companies tend to recognize their interdependency and try to avoid price wars if possible. 25

Stable demand gives them the opportunity to enter into price-leadership agreements, reducing the intensity of rivalry and allowing greater profitability. However, the stability of mature industry is always threatened by further price wars, especially in an economic downturn. In the decline stage, growth becomes negative. companies exit the industry. Virtually all

Depending on the speed of the decline and the height of exit barriers, competitive pressures can become as fierce as in the shakeout stage. Falling demand leads to excess capacity, causing companies to engage in price wars. The greater the exit barriers, the harder it is for companies to reduce capacity and the greater is he threat of severe price competition.

6.

Limitations of Models for Industry Analysis The Five Forces, strategic groups, and industry life cycle models constitute very useful ways of thinking about and analyzing the nature of competition within an industry. However, these models have limitations. It does not mean the models are useless. However it does mean that management must be aware of the limitations as they apply these models to their firms. One important limitation of the life cycle model is that industry life cycles vary considerably, skipping or repeating stages, moving slowly or rapidly through the stages or remaining stuck at a particular stage. Another limitation of all of these models is the lack of attention paid to the consequences of innovation. Overtime, innovation in many industries competition leads to new strategic groups or market segments, speed or slow an industrys life cycle, and otherwise disrupt the orderly predictations of all three the models for industry analysis. Michael Porter, the originator of the Five Forces model, has recently shifted focus to acknowledge the role of innovations as unfreezing and reshaping industry

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structure. Porter describes a model punctured equilibrium, in which an innovation triggers a period of turbulence, followed by a period of stability. The punctuated equilibrium theory allows Porters Five Forces Models continue to be somewhat useful, in spite of limitation. This theory asserts that the Five Forces Model is not a good predictor of the changes that take place in the short time just after an important innovation, but it is useful in the longer periods of stability that follow the turbulence. Figure 2.6 Growth in demand and capacity

Express capacity Units

Capacity Demand

Time However, there are those who question the validity of the punctured equilibrium approach. Richard DAveni has argued that many industries are hyper competitive, being characterized by permanent and ongoing innovation. In such industries, industry structure is constantly being revolutionized by innovation: there are no periods of equilibrium. Thus, the three models of internal analysis are not useful. Another limitation of the models for internal analysis of the lack of attention paid to firm-specific factors. Studies point to 27

t1

t2

enormous variance in the profit rates of individual companies within an industry, with industry effects accounting for only 10 to 20 percent of the variance. These studies suggest that the individual resources and capabilities of a company are far more important determinants of that companys profitability than the industry or the strategic group of which the company is a member. 7. The role of the Macroenvironment The macroenvironment refers to the broader economic, technological, demographic, social, and political environment within which an industry is embedded. It is apparent that changes in this macroenvironment can have a direct impact on any one of the five forces Porters model, thereby altering the relative strength of these forces and with it, the attractiveness of an industry. There are five important forces in the macroenvironment.

The role of the Macroenvironment

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Political and Legal Environment Potential Competitors

Technological Environment

Supplier Power

Rivalry

Buyer power

Substitutes

Demographic Macroeconomic Environment

Environment

Social Environment

Macroeconomic forces include changes in the growth rate of the economy, interest rates, currency exchange rates, and inflation rates: these are all major determinants of the overall level of demand. Adverse changes in any of these can threaten profitability in an industry, whereas positive changes tend to increase profitability. Technological forces are characterized by an accelerated pace of innovation and change. Technological change can make established products obsolescent overnight, but at the same time, it can create new products and processes.

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Demographic forces consist of any trends related to population and movement of people across national boundaries. Changing demographics create both opportunities and threats, spawning new industries and products while eliminating others. Social forces consist of changes in social preferences and values. New social movements also create opportunities and threats. For example, the impact of the trend toward greater health consciousness has Political and legal forces are shaped by changing laws and regulations. Factors such as deregulation, insurance reform, and even the political party makeup of the Congress can create opportunities and threats for companies in many industries.

8.

The Global and National Environments International trade and foreign direct investments have grown rapidly in the last few years, driven by lower tariffs and nontariff barriers. This has led to the globalization of production and markets. - The globalization of production has occurred, as firms are increasingly able to disperse parts of their production operations around the world, reducing costs. - The globalization of markets has led to decreased emphasis on national markets, and increased focus on one huge global marketplace. The tastes and preferences of consumers in different nations are beginning to converge at some global norm.

There are several implications of the globalization of products and markets that are important to managers. Implications of the globalization of production and markets include the need for companies to recognize that industry boundaries do not stop at national boarders, and competitors can be found in other national markets.

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Another implication is that competitive rivalry will increase as relatively protected national markets are transformed into segments of fragmented global industries where a large number of companies battle one another for market share and profits in country after country around the globe. A third implication is that the rate of innovation will continue to skyrocket, compressing product lifecycles, and perhaps, reducing the importance of static models of external analysis, such as Porters Five Model or strategic groups. A final implication is that, in spite of the increased threats due to globalization, it has also created enormous opportunities. The decline in trade barriers has opened up many once-protected markets to companies based outside those markets.

National Competitive Advantage The national context of a company influences the competitiveness of companies based within that nation. Despite the globalization of production and markets, many of the most successful companies in certain industries are still clustered in a small number of countries. Individual companies need to understand the link between national context and competitive advantage in order to identify where their most significant competitors are likely to come from and to identify where they might want to locate certain productive activities. In a study of national competitive advantage, Michael Porter identified four attributes of a national state that have an important impact upon the global competitiveness of companies located within that nation. Porter speaks of these four attributes as constituting the diamond. He argues that firms are most likely to succeed in industries or industry segments where conditions with regard to the four attributes are favourable. He also argues that the dependent on the state of others.

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Intensity of Rivalry

Factor endowments

National competitive advantage

Local demand conditions

Competitiveness of related and supporting industries

One attribute is factor endowments, which include the cost and quality of factors of production. Factors of production includes basic factors, such as land, labour capital, and raw materials, along with advanced factors such as technological know-how, managerial sophistication, and physical infrastructure (for example, roads, railways, and ports) Companies gain competitive advantage when their home countries are rich in factor endowments. Another attribute is local demand conditions. Companies are typically most sensitive to the needs of their closest customers. Thus the characteristics of home are particularly important in shaping the -attributes of domestically made products and in creating pressures for innovation and quality. Companies gain competitive advantage if their domestic consumers pressure them to meet high standards of product quality and to produce innovative products. A third attribute is the presence of related and supporting industries that are internationally competitive. The benefits of

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investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally. Successful industries within a country tend to be grouped into clusters of related industries. A fourth attribute is the strategy, structure, and rivalry of companies within the nation. Different nations are characterized by different management ideologies which either help them or do not help them to build national competitive advantage. Also, companies that experience a vigorous domestic rivalry look for ways to improve efficiency, which in turn makes them better international competitors. Domestic rivalry creates pressures to innovate, to improve efficiency, to reduce costs, and invest in upgrading advanced factors.

Chapter 3
Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability 1. Overview A choice of industry affects firm performance but within any given industry, some companies are more profitable than other. Why do some companies do better than their competitors? What is the basis of competitive advantage?

Internal analysis leads to the identification of a firms strengths and weakness, and especially its distinctive competencies, including its resources and capabilities. Distinctive competencies enable firms to create superior value for customers, by helping them to achieve the four main building blocks of competitive advantage: efficiency, quality, innovation, and responsiveness to customers.

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Superior value creation is driven by a firms ability to differentiate its products or reduce its expenses. When firms are able to create superior value, they experience higher profitability. It is also important for firms to sustain their competitive advantages over time, to maintain their competitive advantage, and to take steps to avoid competitive failure.

2.

Distinctive Competencies and Competitive Advantage A company has a competitive advantage when its profit rate is higher that the average for its industry, and it has a sustained competitive advantage when it is able to maintain this high profit rate over a number of years. Competitive advantage derives from a firms distinctive competencies, which are of two types: resources and capabilities Resources refer to the financial, physical, human, technological, and organizational resources of the company. They can be divided into tangible resources, such as brand names, reputation, patents, and technological or marketing knowledge.

a. Resources that are firm-specific and difficult to imitate are unique. Resources that create a strong demand for the firms products are valuable. b. Unique and valuable resources lead to a distinctive competency. Capabilities refer to a companys skills at coordinating its resource and putting them to productive use. a. b. These skills reside in the way a company makes decisions and manages its internal processes. Capabilities are, by definition are intangible. They reside not so much in individuals as in the way individuals

34

interact, cooperate, and make decisions within the context of an organization. The distinction between resources and capabilities is of the utmost importance in understanding the source of a distinctive competency. A company may have unique and valuable resources, but unless it has the capability to use those resources effectively, it may not be able to create or sustain a distinctive competency. Thus, unique and valuable resources are helpful in creating distinctive competencies, but capabilities are essential.

Figure 3.2 Strategy, Resources Capabilities and Competencies Build Resources

Distinctive Competencies

shape

Strategies

Competetitive Advantage

Superior Profitability

Capabilities

Build

A companys profit rate and hence competitive advantage is determined by the value customers place on the companys goods or services, the price the company charges for the products or service, and the companys costs of production.

Figure 3.3 Value Creation per Unit ------------V-P

35

-----P-C ---C Includes cost of capital Per unit

-----------V = Value to consumer P = Price C = Costs of production V P = Consumer surplus P C = profit margin V C = Value created 4. Looking at Figure 3.3, the companys profit margin is equal to the difference between price and costs (P-C), whereas the consumer surplus is equal to the difference between value and price (V-P). The company makes a profit so long as the price is greater than the cost. Its profit rate will be greater the lower costs are, relative to the price. The lower the competitive intensity, he greater the difference that ca exist between price and value. 5. Looking at figure 3.4, a company can create more value for its customers in two ways. a. Under Option 1, a company can make the product more attractive, raising costs (C) but also raising value (V). Customers are then willing to pay a higher price (P increases). Under Option 2, a company can lower its price (P), creating a higher value (V) more demand, and increased volume of sales. Economies of scale realized because of the increased volume allow the company to reduce its costs. (C)

b.

Figure 3.4 Value creation and Pricing Options Option 2: Lower prices to generate demand

Option 1 : Raise price to reflect value

V -P V-P 36

P1 V-P P2 V* P-C V Po P-C P2 Co C C V*

P-C

C2 C

a.

b.

c.

Value is assigned by customers based on product attributes such as performance, design, and quality. The more value a company creates, the more flexibility it has in assigning a price. The price a company charges is typically less than the value assigned by the consumer. The customer captures that difference in value as a consumer surplus, which occurs because the company is competing with other companies and so must charge a lower price than it could as a monopoly supplier. Another factor that causes the price to be lower than the value is the impossibility of segmenting the market so that the company can charge each customer a price that reflects that individuals reservation price (their assessment of the value of a product)

The Roots of Competitive Advantage

Resources

Superior 37

Distinctive Competencies

. Efficiency . Quality . Innovation . Customer responsiveness

Differentiation Value Creation Low cost Super Profits

Capabilities

Low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry. Competitive advantage (and higher profits) goes to those companies that can create superior value-and the way to create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price.

The value chain Primary Activities Input Research and Production development Marketing and sales customer service Output

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Company infrastructure

Information systems

Materials management

Human Resources

Support Activities 3. The Value Chain A companys value chain is a sequency of interrelated activities for transforming inputs into outputs that customers value. The process consists of a number of primary activities and support activities, each of which can add value to the product. Primary activities have to do with the design, creation and delivery of the product, its marketing, and with its support and after-sales service. There are four primary activities: research and development, production, marketing and sales, and service. a. Research and development (R&D) is concerned with the design of products and production processes. R&D occurs in manufacturing enterprises as well as service companies. By superior product design, R&D can develop superior product designs, which increase the functionality of products, making them more attractive to consumers. Alternatively, R&D may develop more efficient production processes, lowering costs. b. Production is concerned with the creation of a good or service. For physical products, production means manufacturing. For services , productions takes place when when the service is actually delivered to the customer. The production function creates value by performing its activities efficiently so that lower costs result. Production can also create value by performing its activities in a way that is consistent with high product quality, which leads to differentiation and lower costs. c. Marketing and sales functions create value through brand positioning and advertising, which increase the perceived 39

product value. They also create value by discovering consumer needs and communicating them to the R&D function of the company, which can then design products that better match those needs. d. The role of the customer service function is to provide after-sales service and support. This function can create a perception of superior value in the minds of consumers by solving customer problems and supporting customers after they have purchased the product. The support activities of the value chain provide inputs that allow the primary activities to take place.

a. The materials management function controls the transmission of physical materials through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly lower cost, thereby creating more value. b. The human resource function helps to create value by ensuring that the company has the right mix of skilled people to perform its value creation activities effectively. It is also the job of the human resources function to ensure that people are adequately trained, motivated, and compensated to perform their value creation tasks. c. information systems refer to the (largely) electronic systems for managing inventory, tracking sales, pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled with the communications features of the Internet, are holding out the promise of being able to alter the efficiency and effectiveness with which a company manages its other value chain activities.

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The final support activity is the company infrastructure, or the company-wide context within which all the other value-creation activities take place. The infrastructure includes the organisational structure, control system, and organisational culture. Because top management can exert considerable influence in shaping these aspects of a company, they should also be viewed as part of the infrastructure of a company 4. The Generic Building Blocks of Competitive Advantage d. Four generic factors build competitive advantage by allowing companies to better differentiate their products or become more efficient in reducing costs: efficiency, quality, innovation, and responsiveness to customers. They are generic because they represent actions that any company can adopt, irrespective of industry. The factors are all highly interrelated.

Generic building Blocks Of competitive advantage

Superior quality

Competitive Advantage: 41

Superior efficiency

. Low cost . Differentiation

Superior customer responsiveness

Superior innovation

Efficiency is measured by the cost of inputs required to produce a given output. - The more efficient a company, the lower the cost of inputs required to produce a given output. Thus efficiency helps a company attain a low-cost competitive advantage - One of the keys to achieving high efficiency is utilizing inputs in the most productive way possible. Companies with high employee productivity and capital productivity will have low costs of production. Ouality products are goods and services that have attributes that customers perceive as desirable. An important attribute is reliability, meaning that the product does the job it was designed for and does it well. Quality applies equally to goods and to services. - Providing high-quality products creates a brand-name reputation for a companys products. In turn, this enhanced reputation allows the company to charge a higher price for its products. - Higher product quality can also result in greater efficiency, with less employee time wasted fixing defective products or services. This translates into higher employee productivity, which means lower unit costs. Process innovation occurs if there is anything new or novel about the way a company operates. Product innovation occurs if there is anything new or novel about the companys products. Thus innovation includes advances in the kinds of products, production processes, management systems, organizational structures, and strategies developed by a company. 42

Successful innovation gives a company something unique that its competitors lack (that is, until imitation occurs). This uniqueness allows a company to differentiate and charge a premium price. - Successful innovation may also allow a company to reduce its unit costs. Achieving customer responsiveness requires that a company gives its customers exactly what they want when they want it. It involves doing everything possible to identify customer needs and to satisfy those needs. - One way to increase customer responsiveness is to improve the efficiency production processes and the quality of products. - Another way to increase responsiveness is to develop new products that have features currently not incorporated in existing products. - Another way to increase responsiveness is to customize goods and services to the unique demands of individual customers - Another way to increase responsiveness is to reduce customer response time, or the amount of time it takes for a good to be delivered or a service to be performed. In summary, superior efficiency enables a company to lower its costs; superior quality enables a company both to charge a higher price and to lower its costs; superior innovation can lead to higher prices or lower unit costs; and superior customer responsiveness enables a company to charge a higher price. -

5. Analyzing Competitive Advantage and Profitability Managers must understand the financial impact of their strategies. They can compare their processes and outcomes to competitors, using benchmarking. The most widely used measure of financial performance is profitability. - Profitability can be measured in different ways, but return on invested capital (ROIC) is one of the most widely used.

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Drivers of Profitability (ROIC) COGS/Sales

Return on sales (Net profit/Sales)

SG&A/Sales

ROIC ROIC

R&D /sales

Capital turnover (Sales/Invested Capital)

Working capital/sales

PPE/Sales

ROIC is calculated as net profits divided by invested capital. ROIC represents the effectiveness with which a company is using the funds it has available for investment - ROIC can be decomposed into two parts. Return on Sales is calculated as net profit divided by revenues, and represents how effectively the company converts sales revenues into profits. Capital turnover is calculated as revenues divided by invested capital, and represents how effectively the company uses its invested capital to generate revenues. Managers can increase profitability by increasing returns on sales, either by reducing expenses for a given level of sales, or by increasing sales revenues faster than expenses. They can also increase profitability by getting more sales revenue from their capital investment -

6. The Durability of Competitive Advantage Durability refers to the length of time that a competitive advantage lasts, once it has been created. Successful companies earn above-average returns, which send a signal to competitors.

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Three factors lead to durability: high barriers to imitation, poor capability of competitors, and low dynamism in the industry.

.Barriers to imitation are factors that make it difficult for a competitor to copy a companys distinctive competency. The longer it takes to imitate a companys distinctive competency, the greater is the opportunity for the company to improve on that competency or build other competencies. a. The easiest distinctive competencies to imitate are those based on firm-specific tangible resources such as buildings, plant, and equipment, which are visible to competitors and can be readily purchased b. Intangible resources are more difficult to imitate. Brand names symbolise a companys reputation, and are protected by law. c. Marketing and technological know-how are intangible resources that are relatively easy to imitate i) Marketing strategies are visible to competitors, and the movement of marketing personnel between companies facilitates the diffusion of know-how. ii) Technological know-how should be protected by patents, but in practice, it is often possible to invent around patents. d. Imitation of capabilities is more difficult than imitation of resources. Capabilities are often invisible to outsiders, and are based on the way in which decisions are made and processes managed deep within a company. Also, a companys capabilities are not dependent upon one individual, but are the product of how numerous individuals interact within a unique organizational setting. Thus, no one person can duplicate capabilities, and therefore personnel movement will not be as useful in imitating capabilities 2. When a company is committed to a particular way of doing business based on a set of resources and capabilities, the company will find it difficult to respond to new competition if doing so requires a break

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3.

with this commitment. This influence on the durability of competitive advantage is called capability of competitors. a) A related concept is absorptive capacity - that is, the ability of an enterprise to identify, assimilate, and utilize new knowledge. Firms with a low absorptive capacity may experience an internal inertia that slows their ability to innovate and imitate. b) Therefore, when innovations reshape the rules of competition in an industry, value often migrates away from established competitors and toward new interprises that are operating with new business models. Industry dynamism refers to the rate of product innovation. A high dynamism (rapid rate of innovation) means that product life cycles are shortening and that competitive advantage can be very transitory. Durability of competitive advantage is difficult for nay company to sustain in a highly dynamic industry.

7. Avoiding Failure and Sustaining Competitive Advantage Failing companies are not just below average; they earn very low or negative profits. Three related reasons for failure are explored here: inertia, prior strategic commitments, and the Icarus paradox. - The inertia argument is that companies find it difficult to change their strategies and structures in order to adapt to changing competitive conditions. a) An organizations capabilities contribute to inertia, because they are difficult to change. Changing capabilities would require a redistribution of power and influence among the the key decision makers, and therefore will be resisted. Turf battles may result. b) Thus, capabilities can provide competitive advantage and also competitive disadvantage. - Prior strategic commitments, such as investments in specialized resources, may also contribute to competitive

46

failure, because the resources are not well suited for other, evolving uses. Changing resources is difficult and expensive - The Icarus paradox is based on the Greek myth of Icarus, who made himself a pair of wings from wax and feathers, then flew so well that he went too close to the sun, melting the wings and plunging to his death. The paradox is that his greatest asset, his ability to fly, gave rise to his demise a) Many successful companies become so dazzled by their own early success that they believe that persuing the same course of action is the way to future success. They may pursue strategies such as craftsmen, builders , pioneers, and salesmen. b) This attitude, however, leads a company to become so specialized and inner-directed that it loses sight of market realities and the fundamental requirements for achieving a competitive advantage. Sooner or later failure ensues. To avoid failure , companies can focus on the building blocks of competitive advantage, institute continous improvement and learning, track best industrial practice and use benchmarking, and overcome inertia. Managers can also learn to exploit luck. - Maintaining a competitive advantage requires a company to continue focusing on the four generic building blocks of competitive advantage efficiency, quality, innovation, and customer responsiveness and to do whatever is necessary to develop distinctive competencies that contribute toward superior performance in these areas. - In todays dynamic and fast-paced environments, the only way that a company can maintain a competitive advantage over time is to continually improve its efficiency, quality, innovatio , and customer responsiveness. The most successful firms are those that continually learn, seeking out ways of improving their operations and constantly upgrading the value of their distinctive competencies or creating new competencies - One of the best ways to develop distinctive competencies is to identify best industrial practice and to adopt it. Only by doing so will a company be able to build and maintain the resources and capabilities the underpin excellence in

47

productivity, quality, innovation, and customer responsiveness. The ability to overcome the inertial barriers to change within an organization is one of the key requirements for continuing to maintain a competitive advantage Luck can play a critical role in determining competitive success and failure, but it is an unconvincing explanation for the persistent success of a company. It is difficult to imagine how sustained excellence could be the product of anything other than conscious effort, that is, of strategy. However, companies can be flexible and prepared to exploit lucky breaks as they occur.

Chapter 4
Building Competitive Advantage Through Functional-Level Strategy 1. Overview This chapter addresses the role that functional-level strategies play in improving the effectiveness of functional operations within a company, such as manufacturing. Marketing, materials management, research and development, and human resources. Functional strategies may also cut across two or more functions to attain a common goal Functional-level strategies can improve effectiveness by helping an organization to achieve efficiency, quality, innovation, and customer responsiveness. Functional strategies are responsible for building the resources and capabilities that lead to distinctive competencies, allowing a firm to pursue a differentiation and/or low cost strategy

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The roots of competitive advantage Build Resources

Distinctive shape Competencies . Efficiency Value . Innovation . Customer responsiveness . Quality Capabilities Build

Superior

Differentiation value Creation Low cost Superior profitabilit y

2. Achieving Superior Efficiency Efficiency is measured by the cost of inputs (labor, capital, equipment, know-how, and so on) required to produce a given output (the good or service produced by the company). The more efficient a company, the lower the cost of inputs is required to produce a given output. An efficient company has higher productivity than its rivals, and, therefore, lower costs. Economies of scale are unit cost reductions associated with a large scale of output. Both manufacturing and service companies can benefit from economies of scale - One source of economies of scale is the ability to spread fixed costs over a large production volume - Another source is the ability of companies producing in large volumes to achieve a greater division of labor and specialization. Specialization improves employee

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productivity because it enables individuals to become very skilled at performing a particular task Economies of scale raise ROIC in two ways. They reduce spending on COGS, SG &A, and R&D as a percentage of sales, improving return on sales. They also make more intensive use of existing PPE, increasing capital turnover Economies of scale do not continue indefinitely. Typically, diseconomies of scale are reached at very high volumes, due to increased bureaucracy and the resulting inefficiencies.

Economy of scale

Unit Costs costs

B Average

Learning effect C Average Costs

Output Learning effects Learning effects refers to cost saving that come from learning by doing. Labor productivity increases as individuals learn the most efficient way to perform a particular task and mangers learn how best to run the operation - Learning effects are most important in a technologically complex task that is repeated , and are really important only during the start-up period of a new process. The importance of learning effects tends to cease after two or three years.

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Although economies of scale move a firm downward along the unit cost curve, learning effects shift the entire curve downwards

Figure 4.4

The Experience Curve Unit costs

Accumulated Output over time Products The experience curve refers to systematic unit-cost reductions that have been observed to occur over the life of a product. According to the experience-curve concept, unit manufacturing costs for a product typically decline by some characteristic amount each time accumulated output of the product is doubled.

Figure 4.5

Integrated Mill $ A

Minimill $

Costs in an Integrated Steel Mill and a Mindmill

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Qi

Output

Qi Volume of Output

Qm Volume of

Economies of scale and learning effects underlie the experience-curve phenomenon. As a company increases the accumulated volume of its output over time, it is able to realize both economies of scale (as volume increases) and learning effects. As a consequence, unit costs fall with increases in accumulated output. The experience curve suggests that increasing a companys product volume and market share will bring cost advantages over the competition. The concept is perhaps most important in those industries where the production process involves the mass production of a standardized out put ( for instance, the manufacture of semiconductor chips) If a company wishes to attain a low-cost position, it must ride down the experience curve as quickly as possible. This involves building an efficient scale plant ahead of demand and aggressively pursuing learning effects. It also involves aggressive price cutting and marketing in order to expand sales and get down the experience curve ahead of competitors. However, the company furthest down the experience curve must not become complacent about its position for three reasons.

a) The experience curve bottoms out at some point, which implies that other companies can catch up b) Cost advantage gained from experience effects can be made obsolete by the development of new technologies that require new methods of production. c) The experience curve suggests that high volume leads to a cost advantage, but this does not always happen. In some

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industries, there are two or more different production technologies, one of which is cost-efficient at high volumes, and the other at low volumes. A company using low-volume technology may be able to operate with a cost structure similar to that of companies using a high-volume technology. It seems then, that the best way to reduce costs is to produce high volumes of a standard product. However, this view has been challenged by the rise of flexible manufacturing technologies, also called lean production. Flexible manufacturing technologies allows a firm to produce a wider variety of product while still achieving the efficiencies of high volume production. Cost efficiencies are achieved by reducing setup times for complex equipment, increasing the utilization of individual machines through better scheduling, and improving quality control at all stages of the manufacturing process. Mass customization refers to the use of flexible manufacturing technologies to achieve low cost and differentiation through product customization.

Manufacturing

a. Traditional Manufacturing

b. Flexible

The Tradeoff
Between costs and products variety

Unit cost

Total
Total

Unit Cost

Variety
related

Volume Related

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Volume

Variety related

related Low High High Low

Production Volume Product Variety and

Production Volume and Product Variety

One type of flexible manufacturing technology is flexible machine cells, which are groupings of four to six various machines, a materials handler, and a central computer. The machines are computer controlled, allowing each cell to switch quicly between the production of different products a) Flexible machine cells allow for improved capacity utilization due to a reduction in set up times and better coordination of production flow between machines b) Flexible machine reduce work in progress and waste because of the tight coordination between machines and the ability of computer-controlled machinery to identify how to transform inputs into outputs while producing a minimum of unusable waste material. Marketing strategy refers to the position that a company takes with regard to pricing, promotion, advertising, product design and distribution 1. Marketing strategy can increase efficiency by using aggressive pricing, promotions, and advertising to improve sales and help the organization ride down the experience curve. 2. Another aspect of marketing strategy that can improve efficiency is the creation of customer loyalty, through high customer satisfaction. Loyalty reduces customer defection rates, or the percentage of a companys customers that defect every year to competitors. a)There is a direct relationship between defection rates and costs. Acquiring a new customer entails one-time fixed costs for advertising, promotions, and the like

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a)

The longer company retains a customer, the greater is the volume of customer-generated unit sales that can be set against these fixed costs and the lower is the average unit cost of each sale (+) The Relationship Between Customer Loyalty and profit Per Customer

Profit per customer with company

0 Length of time customer stays

(-)

Efficiency can also be improved though the use of materials management, which encompasses the activities necessary to get materials to a production facility, through the production process, and through a distribution system to the end user. Materials management is also called supply chain management. - Materials management typicallly accounts for 50 to 70 percent of manufacturers costs thus even a small reduction can have a great impact - Improving the efficiency of the materials management function typically requires the adoption of just-in-time (JIT) inventory systems. JIT reduces inventory-holding costs by having materials arrive at a manufacturing plant just in time to enter the production process, and not before. - The draw back of JIT systems is that they leave a firm without a buffer stock of inventory. Although buffer stocks of inventory are expensive to store, they can help tide a firm over shortages on inputs brought about by disruption among suppliers.

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The R&D function can boost efficiency by designing products that are easy to manufacture cutting down on the number of parts and reducing assembly time. R&D can also pioneer process innovations to improve efficiency The human resources function can aid in improving efficiency by raising employee productivity. - Recruiting is one area where human resources can help. Carefully hiring individuals with the right attitudes and values can raise employee productivity. Skilled employees can also interact with customers in ways that improve customer loyalty. - Another way to raise employee productivity is through training. Skilled individuals perform tasks more quickly and accurately, and are better able to learn complex tasks. A company can upgrade the skill level of its employees through training - Self-managing teams, where members are responsible for coordinating their own activities, are another source of efficiency gain. Team members learn all team tasks and rotate from job to job, creating a more flexible workforce in which members can fill in for absent coworkers. Teams also take over managerial duties, and the resulting empowerment is a motivator. - Another boost to productivity comes from linking pay to performance. Successful companies are careful to specify the quality, as well as the quantity, of production. Successful firms also tend to reward group, rather than individual, performance, in order to improve cooperation among employees. With the rapid growth of computers, the Internet, corporate intranents, and high bandwidth communications, the information systems function contributes to operational efficiencies. - Information systems can improve labor efficiency by automating tasks that were previously performed manually. - Web-based information systems can reduce the costs of supply chain coordination, including the relationships

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between the company and its customers, and the company and its suppliers - On-line sellers can replace their capital-intensive physical locations with a much less costly web site. Infrastructure can also improve efficiency, as a companywide commitment to low costs can be built through top management leadership. Leaders can also facilitate cooperation among functions in the pursuit of efficiency goals.

Table 4.1 Primary roles of Value Creation Functions in Achieving Superior Efficiency Value Creation Function Primary Roles Infrastructure (leadership) Production Marketing 1. Provide companywide commitment efficiency 2. Facilitate cooperation among functions 1. Where appropriate, pursue economies of scale 2. Implement flexible manufacturing systems 1. Where appropriate, adopt aggressive marketing to ride Down the experience curve 2. limit customer defection rates by building brand loyalty 1. Implement JIT systems 1. Design products for ease of manufacture 2. Seek process innovations 1. Use information systems to automate processes. 2. Use information systems to reduce costs of coordination 1. 2. 3. Institute training programs to build skills Implement self-managing teams Implement pay for performance 57

Materials management R&D Information systems Human Resources

3. Achieving Superior Quality Achieving superior quality gives a company two advantages. First, the enhanced reputation for quality allows the company to differentiate and thus charge a premium price for its products. Second, by eliminating defects or errors from the production process, superior quality can result in greater efficiency and hence lower costs. One aspect of quality is reliability. Total Quality Management (TQM) is a technique to improve reliability. TQM stresses that quality should be a main concern of the company, and that all of a companys operations should be oriented toward this end. The TQM philosophy, as articulated by Deming and others, is based on a five-step chain reaction. i) Improved quality means that costs decrease because of less rework, fewer mistakes, fewer delays, and better use of time and materials. ii) As a result, productivity improves iii) Better quality leads to higher market share and allows the company to raise prices. iv) This increases companys profitability and enables it to stay in business. v) Thus the company creates more jobs - American firms are increasing their focus on quality, but still do not give it the same attention as overseas competitors. Many firms do not fully understand or have not yet fully embraced TQM, and therefor are not realizing the full benefits of it -

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Table 4.2 summarizes the contribution that each functional area can make to a TQM program.

How to implement TQM a) Infrastructure (firm leadership) can build an organizational commitment to quality. TQM must be embraced by all, and top managers serve as role models. Also the human resources function must take on responsibility for company wide training in TQM techniques. c) A focus on the customer is the starting point of the whole quality philosophy. The marketing function, because it provides the primary point of contact with the customer, should play a major role here. The role of marketing is to identify customer needs, to identify the quality gap that exists between the customers wants and what they actually get, and in conjunction with other functional areas, to formulate a plan for closing the quality gap.

Value Table 4.2 Creation Function

Primary Roles

The Role Played by Different Functions in Implementing TQM Infrastructure (Leadership) 1. Provide leadership and commitment to quality 2. Find ways to measure quality 3. Set goal, and create incentives 4. Solicit input from employees 5. Encourage cooperation among functions Production Marketing Materials management 1. Shorten production runs 2. Trace defects back to source. 1. Focus on the customer 2. Provide customers feedback on quality 1. Rationalze suppliers 2. Help suppliers implement TQM 3. trace defects back to suppliers 1. Design products that re easy to manufacture 1. Use information systems to monitor defect rates 1. 2. Institute TQM training programs. Organise employees into teams

R&D Information systems Human Resources

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a) TQM requires objective measures of quality, including identification of the customers perspective on quality, and development of a metric to capture this. Top management, with input from other functional areas, should formulate various metrics to measure quality. b) Top management and human resources should get goals and create performance incentives, to motivate workers to reach quality targets. c) Employees can be an important source of information regarding the sources of poor quality. Therefore, some framework must be established for soliciting employee suggestions as to the improvements that can be made (for example, quality circles). Top managers should establish a communication mechanism. d) A major source of product defects is the production process. TQM preaches the need to identify defects in the work process, trace them to the source, find out why they occurred, and make appropriate corrections. Manufacturing and materials management typically have primary responsibility for this task e) Poor quality raw materials and components are a major source of poor-quality finished goods. Personnel in the materials management function can improve quality by reducing the number of suppliers and then building cooperative relationships with those that remain

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f) R&D and manufacturing need to be involved in designing products that are easy to manufacture, in order to reduce mistakes and defects. g) Top management must ensure that there is close cooperation among functions. In addition to reliability, superior quality depends upon the development of other attributes, such as form, features, performance, durability, and styling, which contribute to differentiation.

Table 4.3 Attributes Associated with a Product Offering

Product Attributes Form Features Performance Durability Reliability Style

Service Attributes Ordering ease Delivery Installation Customer training Customer consulting Maintenance and repair

Associated Personnel Attributes Competence Courtesy Credibility Reliability Responsiveness Communication

Table4.3 summarises attributes of products, services, and personnel that may be valued by customers A companys products and services must be superior to competitors offerings in order to be regarded as high quality. 61

a) To accomplish this, marketing intelligence is used to identify the attributes that customers value b) Then, products must be designed and personnel trained to deliver that attribute. c) Next, the companys marketers must decide which attributes to promote and how to position them for consumers. Usually, firms focus on just one or two critical attributes. d) Finally, a strong R&D function can help the firm continual improve its offerings to stay ahead of competitors 4. Achieving Superior Innovation In many ways, innovation is the single most important building block of competitive advantage. - Innovation is what gives a company something unique. Uniqueness allows a company to charge a premium price or to lower its cost structure below that of its rivals - Studies in several industries have shown that innovation is a major driver of superior profitability However, the failure rate of innovation is high, due to a variety of causes. Only about 12 percent of R&D projects result in a product for which the profits exceed the companys cost of capital - Investment in R&D is a high-risk, high return strategy. The high risk comes from the high failure rate of most new-product innovations. The high return comes from the quasi-monopoly revenues that a successful innovation can earn for a company - Uncertainty about the future is one reason for the high failure rate of innovation. New-product development requires asking a question whose answer is impossible to know prior to market introduction, namely, is there sufficient market demand? Although good market research can minimise uncertainty about demand, the certainty cannot be eradicated altogether. a) Quantum innovations represent a radical departure from current technology, whereas incremental innovations represent an extension of existing technology.

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b) Quantum innovations are accompanied by higher uncertainty, and thus are more likely to fail than are incremental innovations. Another reason for the high failure rate of new-product introduction is poor commercialization, which occurs when there is demand for a new product, but the companys offering is not well adapted to consumer needs because of poor design or poor quality. - Another cause of innovation failure is the poor positioning strategy that arises when an attractive new product garners low sales because it is poorly positioned in the marketplace. Positioning strategy is the position a company adopts for a product on four main dimensions of marketing price, distribution, promotion and advertising, and product features. - Another reason why many new products fail is that companies often make the mistake of marketing product based on a technology for which there is not enough customer demand. Technological myopia occurs when a company gets blinded by the wizardry of a new technology and fails to examine whether there is consumer demand for the product - New products fail when companies are slow to get their products to market. The longer the time between initial development and final marketing, the more likely that someone will beat the firm to market. Also, slow innovators tend to update their products less frequently than fast innovators and therefore, can be perceived as technical laggards relative to the fast innovators. There are a number of actions that firms can take to build competencies in innovation and reduce the chances of failure. - Building skills in basic and applied research requires the employment of research scientists and engineers and the establishment of a work environment that fosters creativity. A number of top companies try to achieve this by setting up university-style research facilities, where scientists and engineers are given time to work on their own research -

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projects, in addition to projects that are linked directly to ongoing company research. Project management is the overall management of the innovation process, and it requires three important skills: the ability to encourage idea generation, the ability to select the most promising projects at an early stage of development, and the ability to minimize time to market the product.

Figure 4.8 The development Funnel

Phase 1: Idea Generation

Gate 1

Phase 2: Project Refinement

gate 2

Phase 3: Project Execution

MARKE T

a) Effective project management can be facilitated by using a three-phase development funnel. The objective in Phase 1 of the development funnel is to widen the mouth of the funnel to encourage as much idea generation as possible. To do so, a company should solicit input from all functions of the company, as well as from customers, competitors, and suppliers 64

b) At Gate 1 , the funnel is narrowed. Here ideas are reviewed by a cross-functional team of managers that were not involved in the original concept development. The concepts that are ready to proceed then move on to phase 11 of the funnel, which is where the details of the project proposal are worked out. c) Gate 2 , is a go, no-go evaluation point. Senior managers are brought in to review the various projects and to select those that seem likely winners. Any project selected to go forward at this stage will be funded and staffed with the expectation that it will be carried through to market introduction. d) In phase III, the project development proposal is executed by a cross-functional team in order to ensure that time to market is minimized. - Tight cross-functional integration between R&D production, and marketing can help a company to ensure that 1) product development projects are driven by customer needs, 2) new products are designed for ease of manufacture, 3) development costs are kept in check, and 4) time to market is minimized a) Close integration between R&D and marketing is required to ensure that product development projects are driven by the unmet needs of customers b) Integration between R&D and production can help a company to ensure that new products are designed with existing manufacturing capabilities in mind - One of the best ways to achieve cross-functional integration is to establish cross-functional product-development teams. These are teams composed of representatives from R&D, marketing, and production. The objective of a team should be to take a product development project through from the initial concept development to market introduction. a) The team should be led by a heavyweight project manager who has high status within the organization and who has the power and authority required to get the financial and human resources that the team needs to succeed.

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b) The team should be composed of at least one member from key function c) The team members should be physically co-located to create a sense of camaraderie and to facilitate communication d) The team should have a clear plan and clear goals, particularly with regard to critical development milestones and development budgets e) Each team needs to develop its own processes for communication and conflict resolution - One way in which a product development team can speed time market is to use a partly parallel development process. Traditionally, product development processes are sequential. In a partly parallel development process, stages overlap so that work can be done in more than one stage simultaneously, shortening time market.

Sequential and Partly Parallel Development Processes (a) Sequential Process Opportunity identification Concept development Process design Commercial Production

Product design

(b)

A partly Parallel Process

Opportunity identification Concept development

Product design

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Process design

Commercial production

Table 4.4 summarize the roles that various functional areas play in achieving superior innovation

Table 4.4 Function Roles for Achieving Superior Innovation Value Creation Function Value Crea Infrastructure (leadership) Production Primary Roles 1. Manage overall project (i.e manage the development function) 2. Facilitate cross-functional cooperation. 1. Cooperate with R & D on designing products that are easy to Manufacture 2. Work with R & D to develop process innovations. 1. Provide market information to R & D 2. Work with R &D to develop new products. No primary responsibility. 1. Develop new products and processes. 2. Cooperate with other functions, particularly marketing and Manufacturing, in the development process. 1. Use information systems to coordinate cross-functional and Cross-company product development work. 1. Hire talented scientists and engineers.

Marketing Materials management R& D

Information Systems Human Resources

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5. Achieving Superior Customer Responsiveness Achieving Superior Customer Responsiveness requires that a company gives customers what they want when they want it and at a price they are willing to pay so long as the companys long-term profitability is not compromised in the process. - The more responsive a company is to the needs of its customers, the greater the brand loyalty that the company can command. In turn, strong brand loyalty may enable a company to charge a premium price for its products or sell more goods and services to customers. - Achieving superior efficiency, quality, and innovation are all part of achieving superior customer responsiveness. A company must know its customers needs in order to respond to them. Thus the first step in building superior customer responsiveness is to get the whole company to focus on the customer. - Customer focus must start at the top of the organization with leadership. A commitment to superior customer responsiveness involves attitudinal changes throughout a company that can only be affected through strong leadership. - Achieving a superior customer focus requires the right employee attitudes leadership alone is not enough. Employees need to be trained to put themselves in the customers shoes, to identify ways of improving the quality of a customers experience with the company. To reinforce this mindset, incentive systems should reward employees for satisfying customers - Another aspect of knowing the customer is listening to what customers say and bringing them into the company. This may mean soliciting feedback from customers and building information systems that communicate the feedback to the relevant people.

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The next task is to satisfy customer needs, with efficiency, quality, and innovation all playing a part. - In addition to efficiency, quality , and innovation, companies can satisfy customer needs through customization. This involves varying the features of a good or service to tailor it to the unique needs of groups of customers, or in the extreme case, individual customers. Traditionally customization raises costs, however, flexible manufacturing allows a company to produce a greater variety of products without raising costs - Customization has fragmented many markets into eversmaller niches, allowing firms to cater to the particular needs of a small segment of customers Giving customers what they want when they want it requires speed of response to customer demands. To gain a competitive advantage, a company often needs to be fast at responding to consumer demands. Increased speed allows a company to charge a significant premium. - Reducing response time requires a marketing function that can quickly communicate customer requests to manufacturing. - The manufacturing and materials management functions that can quickly adjust production schedules in response to unanticipated customer demands also enable the firm to respond more rapidly - Rapid responses also relies on information systems that can help manufacturing and marketing in this process. - Table 4.5 summarizes the roles that various functional areas play in achieving superior responsiveness to customers.

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Table 4.5 The Primary Role of Different Functions in Achieving Superior Responsiveness to Customers Value Creation Function Infrastructure (leadership) Production Primary Roles 1. Through leadership by example, build a companywide Commitment to responsiveness to customers. 1. 2. Marketing Materials Management R&D Information Systems Human Resources 1. 2. 1. 1. 1. 1. Achieve customization through implementation of Flexible manufacturing. Achieve rapid response through flexible manufacturing. Know the customer. Communicate customer feedback to appropriate functions Develop logistics systems capable of responding Quickly to unanticipated customer demands (JIT). Bring customers into the product development process Use web-based information systems to increase Responsiveness to customers. Develop training programs that get employees to think like Customers themselves.

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Chapter 5
Building Competitive Advantage Through Business-Level Strategy 1. Introduction This chapter examines the issue of how a company can use business-level strategy to compete effectively in an industry, maximizing its competitive advantage and profitability. Business-level strategy refers to the plan of action that strategic managers adopt for using a companys resources and distinctive competencies to gain a competitive advantage over its rivals in a market or industry

2.

What is business level strategy? To choose an appropriate business-level strategy, a firm must first describe its business model. One critical component of a business model is the companys definition of customer needs, which describes what is being satisfied. Customer needs are desires that can be satisfied by attributes of a product. - Customer needs can be satisfied by the products price or by its differentiation from other, similar products. - All companies must differentiate their products to satisfy some customer needs, but some companies do this to a much greater degree than others. - Companies that use differentiation are seeking to create something unique about their products to satisfy needs in a way in which other companies cannot. Even within relatively narrow market segments, customer needs differ widely. - Companies must balance their desire to differentiate their product against the accompanying increase in price. However, customers are often willing to pay a premium price for a product that closely meets their specific needs - Uniqueness springs from product attributes.

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a) Uniqueness may spring from physical characteristics of the product, such as quality or reliability. b) Uniqueness may be based on an appeal to a psychological need of customers, such as status or prestige. A second component of a business model is the definition of customer groups and market segmentation, or who is to be satisfied. Market segmentation depends on the way the company groups its customers according to important differences in needs or preferences. - Market segmentation may be based upon the price the customer is willing to pay, or it may be based on the particular need being satisfied by a product. - Companies must develop a strategy for differentiating products for each market segment. a) One strategy is to serve the average customer, ignoring market segmentation b) Another strategy consists of segmenting the market into different groups and developing a product to suit each group. As compared to the average customer strategy, this strategy allows the firm to better serve more customers needs, generating more revenue. c) A third strategy has companies concentrating their efforts on serving only one or a few market segments - Some products do not allow very much differentiation, such as cement. In this industry, price becomes the most important consideration

Figure 5.1 The Dynamics of Business-Level Strategy

Pricing option

Differentiation

Industry Competitive Structure (e.g five forces model)

Market demand

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Cost Structure

Functional-level strategies To lower costs

The third component of a business model is the decision about what type of distinctive competency to pursue or how a customers needs are to be satisfied. The four major types of distinctive competencies are superiority in efficiency, quality, innovation and responsiveness to customers. Differentiation and costs affect each other in a dynamic process - The decision to differentiate increases value for the customer , which increases demand , leading to economies of scale and lower unit costs - Differentiation also requires higher costs, to provide the attributes that contribute to the products uniqueness, and that contributes to higher unit costs - Pricing then must be carefully set, to compensate for the cost of differentiation, but not so high as to stifle demand - Companies must seek to drive down costs, while maintaining the source of differentiation - In addition, each of these above decisions is made in a competitive environment, so companies must carefully consider the actions of their competitors as they choose their level of differentiation, cost structure, pricing and so on.

3. Choosing a Generic Business-Level Strategy

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Table 5.1 Product/Market/Distinctive Competency Choices and Generic Competitive Strategies Cost Leadership . Product Differentiation Market Segmentation Distinctive Competency Low (principally by price) Low (mass market) Manufacturing and materials management Differentiation High (principally by Uniqueness) High (many market Segments) Research and Development, sales and marketing Focus Low to High (price or uniqueness) Low (one or a few segment)
Any kind of distinctive

competency

There are several generic Business-Level Strategies. Generic refers to the fact that these strategies could be pursued by any company, operating in an industry. Cost Leadership A companys goal in pursuing a cost leadership strategy is to outperform competitors by producing goods and services at a lower cost - This strategy can lead to above-average profits

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a) First when all companies charge the same price, the cost leader makes higher profits because its costs are lower b) Second, if price wars develop and competition increases, then high cost companies will be driven out of the industry before the cost leader. Strategic Choices of a cost leader To become the cost leader a company must make choices about its product, market and distinctive competencies a) The cost leader chooses low product differentiation, aiming for a level of product differentiation obtainable at low cost b) The cost leader chooses to serve the needs of the average customer to avoid the high costs of serving different market segments.. Perhaps no one is wholly satisfied with the product, but because its price is lower, some customers choose it. c) The cost leader chooses to develop competencies in manufacturing because it must ride down the experience curve to lower costs. Materials management and information technology are other important sources of cost savings. Other functions tailor their distinctive competencies to meet the needs of these three areas. Advantages of a low cost Leader The cost leadership strategy provides business with some advantages, as discussed in terms of Porters five forces model a) In the area of competitors, the cost leader is protected by its cost advantage b) Lower costs mean that the cost leader will be less affected by powerful suppliers than competitors. Also, he cost leaders large volume purchases give the firm an advantage over suppliers. c) The cost leader is less affected by buyers power to set prices, because its prices are already low -

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d) The cost leader is better able than its competitors to reduce its price in order to compete against potential substitutes. e) Potential entrants face high barriers to entry because of the cost leaders low-price advantage Dangers of a Cost leader A cost leader faces some dangers

a) Competitors may find ways of lowering their costs, perhaps because of technological developments or because of cost savings, such as those foreign competitors can sometimes achieve. b) Competitors may imitate the cost leaders methods, reducing their own costs c) In a single minded effort to reduce costs, the cost leader may lose sight of changes in consumer tastes The choice of cost leadership strategy has some implications for managers. a) managers must diligently pursue cost advantages in every function, especially the key cost drivers of manufacturing, materials management, and information technology b) managers must constantly monitor the industry conditions, and be alert to the possibility of competitors mimicking their firms low-cost methods. c) managers must monitor the industrys differentiators to ensure that their firm doesnt fall too far behind in offering attributes that customer desire. Differentiation Strategy The objective of differentiation is to achieve a competitive advantage by creating a product or service that is perceived to be unique in some way. - This strategy can lead to above-average profits

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a) A differentiator can charge a premium price for its products that is, a price higher than its competitors prices because customers perceive the products differentiated qualities to be worth it b) For a differentiator, product pricing is done on the basis of what the market will bear. - To become a differentiator a company must make choices about its product, market and distinctive competencies a) The differentiator aims for a very high level of differentiation and frequently produces a wide range of products. Differentiation can be achieved through quality, innovation and responsiveness to customers b) A differentiator segments its market into many niches, offering products for may market niches. c) For a differentiator the importance of each function depends on the source of the differentiation. For example, if it seeks a competitive advantage based on innovation, the key function is R&D . This does not imply that manufacturing is unimportant. Instead the differentiator wants to control costs enough so that the price charged is not higher than what customers are willing to pay. Advantages of Differentiation a) b) The differentiation strategy provides business with some advantages as discussed in Porters five forces model. Competitors are less of a threat for differentiators, due to the companys brand loyalty. Powerful suppliers are rarely a problem because the differentiators strategy is not as focused on driving down costs as is a cost leaders strategy. Increased costs can often be passed on to customers Powerful buyers are rarely a problem because only the company can supply the differentated product The threat of substitute products is low, due to the low probability of finding another product that can meet the same customer needs and break brand loyalty

c) d)

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e) Potential entrants are discouraged by the high cost of developing a unique product to compete against the differentiator, who enjoys strong brand loyalty.

Disadvantages of a differentiator a) A differentiator must maintain its perceived uniqueness in customers eyes and defend itself against agile imitator. This is especially critical when the source of the differentiation is a physical feature of the product, which is often relatively easy to imitate. b) Another threat is that a source of uniqueness may be overridden by changes in consumer tastes and demands. A company must constantly look for ways to match its unique strengths to changing product/market opportunities c) A differentiator must be cautious in setting prices. If prices are perceived as too high, customers may switch in spite of the differentiated products uniqueness Cost Leadership & Differentiation * Due primarily to the impact of flexible manufacturing technologies, it is possible to follow both generic strategies simultaneously. Flexible manufacturing systems enable companies to manufacture many different models of a product at little extra cost than if they produced large batches of standardized products Flexible manufacturing allows companies to build many different models of a product cost-effectively, because of the use of standardized components Some companies provide efficient customization by allowing the customers to choose from a limited number of options Many firms are using the Internet to have customers perform some of their own service, paying bills, gathering

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information and so on. This reduces cost allowing the company to differentiate itself through higher service - Direct sales businesses use the Internet for marketing and logistics, reducing costs and increasing responsiveness to customers - Overseas manufacturing reduces labor expenses so much that companies are able to produce differentiated products at low cost. - Firms that pursue both strategies have a competitive advantage compared with the differentiator because they have lower production costs, they also have an advantage compered with the cost leader because they can charge a premium price. Consequently more and more firms are pursuing both strategies simultaneously * The focus strategy positions a company to compete for customers in particular market segment, based on geography, customer type, or market segment Focus Strategy Figure 5.2 Why Focus Strategies Are different Offers products to only Offers products to one group of customer many kinds of customers Cost-leadership Strategy

Offers low-priced Focused Cost Products to Leadership Strategy customers

Offers unique Or distinctive Products to customers

Focused differentiation strategy

Differentiation Strategy

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A focus strategy can be pursued using either a differentiation or a low-cost approach. a) If a company adopts a focused low-cost strategy, it compete against the market cost leader only in those segments where it has no cost disadvantage, such as small niches or complex products that do not lend themselves to economies of scale. b) a company adopts a focused differentiation, it competes against the differentiator by exploiting their knowledge of a small customer set or of a particular specialization within the broader range of products c) Forcused differentiators may also be more innovative than larger firms because the focuser is concentrating on the needs of just one type of customer. Strategic Choices To become a focuser a company must make choices about its product, market, and distinctive competencies a) Product differentiation is low for a focused cost leader and high for a focused differentiator b) Market segmentation is low, with the focuser filling just one or a few niches c) The choice of distinctive competency depends on the companys source of competitive advantage. If it is differentiation, the competency could be R&D or service, if it is low cost, the competency could be local manufacturing Advantages The focused strategy provides businesses with some advantages. Forcusers can find a niche that is unfilled by the large firms, and then develop a specialized product to fill that need. Fcused companies can also grow by taking over other focusers. Other advantages exist, as discussed in terms of Porters five forces model.

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a) Focusers are protected against rivals because it can provide a product or service at a price or quality others cannot offer b) Powerful suppliers are a threat because the focuser buys insuch small volumes that it has less bargaining power. However, if the company is pursuing a focused differentiation strategy and can pass on price increases, this is less of a problem. c) A focusers ability to satisfy unique customer needs gives the company power over its buyers, they cannot get the same thing from other companies d) Potential entrant have to overcome the hurdle of consumer loyalty, so the focuser is somewhat protected. e) Substitute products must overcome consumer brand loyalty, so again, the focuser is somewhat protected. Disadvantages - A focuser faces some risks a) Because the focuser produces at smaller volumes, its costs will be higher than those of the low-cost company b) If the focusers niche suddenly disappears because of changes in technology or consumer tastes, it is hard to switch to a new niche quickly c) Large differentiators may compete for the focusers niche if it becomes very profitable, as occurred in IBMs fight with Apple. Stuck in the middle The objective of differentiation is to achieve a competitive advantage by creating a product or service that is perceived to be unique in some way. When a company chooses a generic strategy that is inconsistent with its capabilities and resources, or when a company simply fails to choose and implement a coherent strategy, that firm is said to be stuck in the middle.

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Such firms are unable to obtain a competitive advantage and they will earn below- average profits. - There are many paths that lead to a company becoming stuck in the middle a) A company may start out by pursuing a generic strategy but loses the strategy because it makes the wrong choices or because the environment changes. b) A successful focuser may unsuccessfully try to become broad differentiator c) Differentiators may find competitors entering their market and chipping away at their competitive advantage. 4. Competitive Positioning and Business-Level Strategy Strategic Group Analysis One of the tools that managers can use to position themselves with regard to competitors is strategic group analysis. - Companies in an industry that are pursuing the same business-level strategy make up a strategic group - A careful analysis of strategic groups can help managers understand the past actions and likely future actions of competitors - A company is most threatened by members of its own strategic group, because those firms are pursuing the same strategy, and consumers tend to view their products as being substitutes - Different strategic groups can have a different standing with respect to each of Porters five forces because the five forces affect companies with different ways - Mobility barriers inhibit the movement of companies between strategic groups,and the height of mobility barriers determines how successfully companies in one group can compete with companies in another - If companies in one strategic group can either lower their costs or increase differentiation, they can compete successfully with companies in another strategic group. In effect, they have created yet another strategic group a

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combined low-cost and differentiation strategic group, which has the strongest competitive advantage and the greatest ability to earn above-average profits. Choosing an Investment Strategy at the Business Level

Another tool that managers can use to position themselves with regards to competitors is investment analysis - An investment analysis refers to decisions about the amount and type of resources that must be invested to gain a competitive advantage - Different strategies require different amounts and types of resources. Differentiation is the most expensive strategy because of the need to provide uniqueness. Cost leadership is less expensive, once the initial investment in plant and equipment has been made. Focus is the least expensive because fewer resources are needed to serve just one market segment rather than the whole market - In deciding on an investment strategy, the company must evaluate the returns from a strategy against the cost of developing that strategy. Two factors are important in determining the potential returns from an investment strategy: the strength of a companys competitive position and the stage of the industry life cycle. a) One required factor in choosing an investment strategy is knowledge about the strength of a companys competitive position 1) Competitive position is a function of a firms market share. Large market share provides the company with experience-curve effects or suggests that a company has brand loyalty. Also, a large market share creates a large cash flow, providing resources for investment in developing competencies 2) Competitive position is also a function of a firms strength in its distinctive competencies. For example the more difficult its R&D or service expertise is to imitate, the stronger is its position

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3) These factors reinforce one another, so a company with both is in very strong position and is probably a good investment b) The second factor influencing investment strategy is the stage of the industry life cycle. 1) The nature of the opportunities and threats from the environment is different at each stage, affecting the potential returns from a competitive strategy Table 5.2 Choosing and Investment Strategy at the Business Level

Strong Competitive Position S Stage of Industry Life Cycle Embryonic Growth Shakeout Maturity Decline Share Building Growth Share increasing Hold-and-maintain or profit Market concentration or Harvest (asset reduction)

Weak Competitive Position

Share building Market concentration Market concentration or harvest Liquidation Harvest or liquidation/divestiture Turnaround, liquidation or

2) At the embryonic stage, companies are developing a distinctive competency so investment needs are very great, leading to a strategy for building market share. Companies require large amounts of capital to develop a

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3)

4)

5)

6)

competitive advantage and much of this must come from outside investors At the growth stage, a company should try to grow in pace with the growth of the market, in order to consolidate its position and survive the coming shakeout. Growing requires large amounts of capital, as does the development of distinctive competencies. Companies in strong positions segment their markets to increase market share, whereas companies in a weak position become a focuser to lower expenses. Very weak companies exit the industry. By the shakeout stage, companies in strong competitive positions are increasing their market share by attracting customers from existing companies. Cost leaders invest in cost control. Differentiators enter more market segments and offer more products. Weak companies choose a focus strategy, or if very weak a harvest or liquidation strategy. By the maturity stage , companies want to reap profits from their past investment in the business. All companies tend to pursue both cost leadership and differentiation. Strong companies stop aggressively pursuing new customers and invest less. This works well if the environment is constant and the number of competitors stable. All too often, however, large companies rest on their laurels and allow competitors to catch them unawares. Weak companies use the decline strategies . T he decline stage starts when demand for the industrys products begins to fall. Companies in strong positions that are cost leaders choose a market concentration strategy, consolidating products and markets, or an asset-reduction (or harvest strategy), decreasing investment and milking profits. Strong companies that are differentiators use a turnaround strategy. If these strategies are not possible, the company may liquidate assets, or it may sell the entire business, called divestiture.

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Game Theory Another tool that managers can use to position themselves with regards to competitors is game theory. - Game theory is a branch of social sciences theory that describes the actions and reactions of rivals in a competitive game. - Business competition can be modeled using game theory. In this game, companies make decisions that can affect outcomes (profitability) without knowing each others moves. a) Games may be sequential, with moves following one after another, such as occurs in chess. b) Games may also be simultaneous when players choose at the same time, as occurs in rock-paper-scissors. c) Business competition entails use of both sequential and simultaneous games. - Game theory works well in describing situations where the number of rivals is stable and limited, and the interdependence between the players is high. This situation occurs in mature, competitive industries - Game theory consists of a number of related principles. a) The principle of look forward and reason back says that managers should try to predict and anticipate the future and then use that information to reason backward to determine the strategic moves they need to make today i) Strategies that appear at first glance to be effective may not be when the likely reactions of competitors is included in the model. iii) Decision trees are one tool that can be used to look forward and reason back.

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Figure 5.3 A decision Tree for UPSs Pricing Strategy

FedEx Cuts Prices by 15% UPS profit

(Profitability = 70%)

Cut prices by 15%

FedEx Doesnt Change Prices UPS profit = $180m

UPS

(Probability = 30%)

Do not change prices

UPS profit =$100m

b) A second principle of game theory is know thy rival, because a companys ability to make accurate predictions about a competitors likely future action is based upon knowledge about the competitors cost structure, pricing and so on. c) A third principle is find the most profitable dominant strategy This principle asks managers to try to find a strategy that gives their company an advantage, no matter what strategies competitors follow. i) A payoff matrix can be used to determine likely outcomes under different combinations of strategies selected by a company and its competitors.

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Figure 5.4 A payoff Matrix for rebates GM and Ford No cash rebates Fords Strategy No cash rebates Cash

(800, 800) (1600)

(200, 1000) (1200)

Cash rebates

(1000, 200) (1200)

(400, 400) (800)

ii) A common outcome is that when each company picks its best strategy, the resulting combination offers the lowest profits to the competitors. This sets up a prisoners dilemma situation, in which competition leads to low outcomes while cooperation results in higher outcomes. d) A forth principle is strategy shapes the payoff structure of the game' i) This principle taken together with the first three principles, for example, says that the way out of a destructive price war is for competitors to change their business models and increase their product differentiation, reducing customers sensitivity to price. ii) Another implication of this principle is that companies need to think about more than just the effectiveness of a particular strategy, they also need to consider how their strategic choices can affect the payoff structure of competition in their industry.

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Chapter 6 Competitive Strategy and the Industry Environment 1. Overview This chapter examines the development of a firms strategy to manage its industry environment. Firms have to manage competitive relations with other firms, and these relationships differ depending on the nature of the competitive industry environment. First strategies to compete in fragmented industries are described. Next, strategies that are appropriate for embryonic, growth, mature and declining industry environments are discussed.

2.

Strategies in Fragmented Industries A fragmented industry comprises a large number of small- and medium-sized companies, such as the dry cleaning or restaurant industries. An industry may be fragmented for several reasons. - It may be fragmented because of lack of economies of scale leading to low barriers to entry. E.g. , customers prefer to deal with local real estate agents. - Some industries are fragmented due to diseconomies of scale, such as occurs when customers prefer the taste of local restaurant food to the standardized offings of chain restaurants. - Low barriers to entry allow a constant influx of entrepreneurs in some specialised industries - High transportation costs, such that local production is the only efficient method, can contribute to fragmentation. - Specialized customer needs mean that companies cannot take advantage of mass production and encourage fragmentation.

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A focused strategy is an appropriate competitive choice in a fragmented industry. Examples are small specialty or :custommade: companies and service organizations. However if a way can be found to overcome the factors that cause industry fragmentation and to let the industry consolidate, the potential returns are high. This is what firms like Wal-Mart and Mcdonalds and chain of health clubs, lawyers and accountants have done. Chaining involves establishing a network of linked merchandise outlets to obtain the advantages of a costleadership or differentiation strategy. It allows bulk purchasing, economies of scale in adverstising, increased ability to serve customers. Examples include restaurant chains, discount store chains , and supermarket chains. In franchising, the local outlets of a chain are owned and managed by the same person. Thus there is a strong motivation for the owner-manager to control costs and maintain quality. The personal service they offer is especially helpful for differentiators. Franchising also permits quick expansion and thus growth. The franchisers operations can be small and local, while still taking advantage of the same opportunities that larger firms enjoy. When one firm in an industry takes over and merges with another firm, a horizontal merger has occurred. The result of horizontal mergers is less competition and greater ability to influence price and output decisions, which increases industry profitability. Chapter 9 contains a more expanded discussion of horizontal mergers. The Internet is the latest means by which companies have been able to consolidate a fragmented industry. Good examples of this approach are a eBay in the auction industry and amazon.com in the bookstore industry.

3.

Strategies in Embryonic and Growth Industries Embryonic and growth industries pose special challenges for strategists because customer attributes change as markets

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develop. Also the rate of market growth exercises a significant influence over the success of the chosen strategy. Embryonic industries typically arise through innovations by pioneering companies Customer demand in embryonic industries is typically limited, due to the limited performance and poor quality of the first products, customer unfamiliarity with what the new product can do for them, poorly developed distribution channels to get the product to the customers, lack of complementary products to increase the value of the product for customer, and high production costs because of small volumes of production. Embryonic industries become growth industries as a mass market develops for the firms products. This occurs when technological progress increases the value of the product to the customer, key complementary products are developed, and companies reduce production costs and set a low price, stimulating demand. Understanding changes in market demand is critical for firms in the embryonic and growth stages.

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Figure 6.1 Market Development And Customer Groups

Mature saturation

Laggards

Late Majority

Market penetration Early majority developers Early adopters Mass market

Innovators triggered by standard Initial growth Emergence of

Embryonic

Growth

Mature

Growth follows an S-curve, with demand first accelerating and then decelerating. a) The first customer to enter a market are innovators, who enjoy tinkering with new products and are willing to pay high prices. b) Early adopters follow the innovators. They are visionaries, and see the possibility of using the new product in diverse and ingenious ways. c) These are followed by the early majority, who constitute the leading edge and signal of the arrival of the mass 92

market. They are practical, weighing product benefits against costs. They arrive in large numbers. d) After about 30% of potential customers have entered the market, the late majority enters. This is a more cautious group of customers, but it is as large as the early majority. e) Finally, the laggards, who tend to be very conservative and perhaps even techno-phobic, arrive. Figure 6.2 Market Share of Different Customer Groups

1%

5%

24%

45%

24%

Innovators Laggards

Early adopters

Early majority

Late Majority

Pioneering companies that fail often attract innovators and early adopters, but fail to attract the majority, leading to few sales and ultimately, the firms failure. Companies that attract the majority on the other hand, are likely o experience very high sales and high profits.

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a) b) c)

d)

Geoffrey Moore argues that innovators and early adopters have very different needs than the early majority, and thus firms need a different set of competencies to serve them effectively. Innovators tolerate technical problems, but the early majority favors ease of use and reliability. Innovators can be reached through specialty retailers, but the early majority uses mass distribution channels. Innovators are few and are not price sensitive, so skills in mass production are not required. When the early majority arrives, mass production is necessary to ensure quality at a lower cost. Moving from an embryonic market to a mass market is not easy and smooth, instead it represents a competitive chasm. Thus embryonic markets consists of many small firms, but most fall into the chasm and disappear, leaving only a few firms in a mass market. Managers in embryonic and growth industries must learn how to compete for the mass market. One important focus for these managers is to ,correctly identify the needs of the first members of the early majority very early on, while the growth is still primarily being driven by innovators and early adopters. Managers must then alter their business model and their value chain activities so as to effectively reach the early majority. Managers must also not become too focused on meeting the needs of innovators and early adopters, who dont contribute significant sales. Managers must be aware of and respond effectively to their competitors actions. Game theory is useful here. Managers must understand the S-curve of growth, and realize that industries develop at different rates. By their strategic choices and actions, managers can change their industrys growth rate, and thus, its profitability. A factor that accelerates customer demand is a new products relative advantage, that is, the degree to which

a)

b)

c)

d) e)

i)

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a new product is perceived as better at satisfying customer needs than the product it supersedes. ii) Another factor is compatibility, which refers to the degree to which a new product is perceived as being consistent with the current needs or values of potential adopters. iii) Complexity, the degree to which a new product is perceived as difficult to understand and use, is another factor. iv) A forth factor is trialability, which is the degree to which a new product can be experimented with on a hands-on trial basis. v) A fifth factor is observability, which refers to the degree to which the results of adopting a new product can be clearly seen and appreciated by other people. vi) A final factor that is very important in the growth of many new products is the availability of complementary products Therefore one way for managers to help their industries grow rapidly is to use these six factors to their advantage. E.g, increase the products compatibility, reduce its complexity. Another concept that can be helpful to managers is to think of the spread of demand for a new product as analogous to a viral infection. Thus companies can identify and court community opinion leaders.

4. Strategy in Mature Industries A mature industry becomes consolidated so that it comprises a small number of large companies that are interdependent, they recognize that their actions affect one another. Thus the main issue facing a company in a mature industry is to adopt a competitive strategy that simultaneously enables it to maximize its profitability given the strategies that all other companies in the industry are likely to pursue.

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Firms in a mature industry can pursue strategies based on game theory principles to increase the profitability of all competitors in the industry One important goal of firms in mature industries is to deter potential entrants. The second goal is to reduce Industry rivalry

Figure 6.4 Strategies for Deterring Entry Of Rivals Strategic for deterring entry of rivals

Product proliferation

Pricing games

Maintaining excess capacity

a) One method for deterring potential entrants is product proliferation, which occurs when a company tries to broaden its product line and provide products for all market segments in order to make it very hard for a potential competitor to enter the market. Such an effort is also called filling the niches. When the niches are filled it is hard to enter except at a disadvantage. b) Another way to deter potential entrants is through the use of pricing games. i) Companies can deter entry by cutting prices every time a potential entrant contemplates entering, sending a strong signal. However firms must be careful to avoid illegal 96

predatory pricing, which a large company uses revenue generated in one market to support pricing below the cost of production in another market. ii) Another pricing game is the use of limit pricing, in which existing companies with scale economies can set prices above their cost of production , but under the new entrants cost of production, which will be higher due to their smaller size and lack of experience. However, firms that plan to enter and use a new, lower-cost technology will not be deterred by limiting pricing.

Figure 6.5 Product Proliferation in the restaurant industry

Candlelight dining

Atmosphere

Unoccupied product space

Mcdonald s Fast food Average Quality of Food iii) Both of these strategies will be unsuccessful against a powerful new entrant, for example, a firm that is already Gourmet

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successful in another industry and now wishes to enter other industries. c) A third way to deter potential entrants is by maintaining excess capacity. Existing firms threaten potential entrants on notice with the possibility that they will increase production and drive down prices to a level at which new entry would be unprofitable. Managing Rivalry Another important goal of firms in mature industries is to reduce industry rivalry. a) price signaling is the process by which firms convey their intentions to rivals concerning pricing strategy and how they will compete in the future or how they will react to the competitive moves of their rivals i) For example, firms can announce that they will follow along with other firms price cuts or increases. This is called a tit-for-tat strategy. b) price leadership, in which one company takes the responsibility of setting industry prices, in another way of using price signaling to enhance industry profitability. By setting prices, the leader creates a model that other firms can follow. i) The price leader is generally the strongest firm in the industry, so it can best threaten other companies that might cut prices. ii) Such price setting is illegal, so the process is often very subtle. For example, frequently, the weakest firms those with the highest cost structures, are used as a price model for the other competitors. iii) Price leadership stabilizes industry relationships, giving weaker firms more time to strengthen. However, it can lead to complacency and makes existing firms vulnarable to competitors with new, lower-cost technologies. c) A third way that companies try to reduce industry rivalry is by the use of nonprice competition, such as product differentiation. Nonprice competition reduces rivalry -

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because it keeps a competitor from gaining access to its customers and from attacking its market share. Product differentiation also reduces rivalry because it minimizes the risk that companies will compete by price, which hurts everybody.

Figure 6.6

Four Nonprice Competitive Strategies Products

Existing

New

Existing Market penetration Market Segments Product development

New Market development

Product proliferation

i) Market penetration is one type of nonprice competition. It occurs when a company expands into more segments of its existing market. This strategy uses heavy advertising to promote and build product differentiation

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ii)

iii)

iv)

Product development involves consistently creating new or improved products to replace existing ones. This strategy relies on extensive R&D and can be expensive. In some industries, preemptive signaling, or announcing a product development that is not yet ready for sale, is widely used. Market development involves finding new market segments to exploit a companys products. The firm is seeking to capitalize on its brand name in new markets, as the Japanese did in entering the luxury segment of the car market. Product proliferation can also be used to reduce rivalry. Here each firm in the industry makes sure that it is in every niche to prevent any firm from gaining a competitive advantage, and if a new niche develops, it rushes to provide a product to fill the niche and reestablish industry stability.

Capacity Control d) Although firms prefer nonprice competition, price competition is likely to break out when industry overcapacity exists, due to overbuilding, falling demand, technological advancement, or entry into the industry. e) Firms control industry capacity preemptively, when one first-mover rapidly increases capacity and deters others from doing so. i) This strategy is risky because it involves committing to investment before the market demand is clear ii) It is risky because it may also fail to deter competitors. f) Firms may instead choose to control capacity through a coordination strategy in which firms signal to another their intentions concerning their future capacity. By indirectly informing one another of their plans, they seek to ensure jointly that capacity does not become so large that it promotes a price war. However, they must avoid overt signaling which is considered to be illegal tacit collusion under antitrust law.

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Supply and Distribution Strategy Another important goal of firms in mature industries is to effectively manage its relationships with buyers and suppliers. Companies in mature industries tend to have high power over buyers and suppliers. Both buyers and suppliers tend to become dependent on the firm in a consolidate industry. One common strategy is for companies to own their supply or distribution operations, which is called vertical integration . Another common strategy is for the firm to outsource some of its functions in order to lower costs. There are important reasons to control supplier-distributor relationships. The firm can safeguard its ability to dispose of its outputs or acquire inputs in a timely, reliable manner, thereby reducing costs and improving product quality. One type of relationship between a firm and its buyers or suppliers is the anonymous approach, in which the two parties have an arms-length, short-term relationship. This type of relationship has been the norm in American business for years. Another type of relationship is the relational approach in which the two parties develop a long-term, mutually supportive relationship built on trust. This type of relationship offers benefits to both parties and is becoming more common in the U.S. There are several ways to distribute products. The company can sell to an independent distributor that sells to retailers, or the firm may sell directly to retailers or even directly to the customer. The complexity of the product and the amount of information it requires will determine which method a company will use to distribute its products. The more complex the product, the more likely a company is to try to control the way its products are sold and serviced.

a)

b)

c) d)

i)

ii)

e)

i)

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ii)

However, large firms that sell nationwide usually sell directly to the retailer because they save the profit that would otherwise have gone to the wholesaler or distributor.

5. Strategy in Declining Industries Once demand starts to fall, an industry is in decline and competitive pressures become even more intense. Industries usually decline due to changes in technology, social trends, or demographics. Four critical factors determine the intensity of competition in a declining industry. Rapid decline, high exit barriers, high fixed costs, and commodity products generate more competition. Also segments within an industry may decline at different rates.

Figure 6.7 Factors that determine the Intensity of Competition in declining industries Speed of decline Height of Exit barriers Level of Fixed costs Commodity Nature of product

Intensity of Competition Companies have different strategies available to deal with decline.

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Figure 6.8 (Strategy Selection in a Declining Industry)

High Dives t Niche or harvest

Intensity of Competition In declining industry

Harves t or divest Low Few

Leader ship or niche

Many Company Strengths Relative to Remaining pockets of demand - One strategy for dealing with decline is the leadership strategy, which is an attempt to pick up the market share of companies leaving an industry. This makes it most sense when a company has distinctive strengths that give it a competitive advantage and the rate of decline is moderate. a) The tactical steps companies might use to achieve a leadership position include aggressive pricing and marketing to build market share, acquiring established competitors to consolidate the industry and raising the stakes for other competitors. b) The leadership strategy signals to competitors that a firm is willing to stay and compete and may speed up exit of competitors from the industry., - Another strategy for decline is the niche strategy, which focuses on pockets of demand where demand is stable or declining less slowly than in the industry as a whole. This

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strategy makes sense when the company has distinctive competencies in that particular segment of the market - A third decline strategy is the harvest strategy, which involves a company optimizing its cash flow as it exits an industry. This strategy makes sense when the firm anticipates a very steep decline or when it lacks distinctive competencies. a) Tactical steps for achieving a harvest strategy include cutting all investment in the business, then continuing to produce until sales decline, after which divestitute follows. d) In practice this strategy may be difficult to implement because employee morale suffers, and if customers realize what is happening they may defect rapidly and hasten the decline. - A fourth strategy is the divestment strategy. Once a company has recognized that an industry is in decline it moves early to sell the business to maximize the value that it can get for it. Often it might sell to the leadership company which is the best positioned to weather the storms ahead.
Chapter 7

Strategy in High-Technology Industries 1. Overview Technology refers to the body of scientific knowledge used in the production of goods or services. High-technology industries (also called high-tech industries) are ones in which the scientific knowledge used by companies in the industry is advancing rapidly leading to rapid changes in the attributes of goods and services. Examples of high-tech industries include the computer industry, telecommunications, consumer electronics, pharmaceuticals, power generation, and aerospace , among others High-technology industries deserve special consideration because they are an ever-increasing part of our economy, many traditionally low-technology industries and products are becoming more hightech, and high-tech firms a similar competitive situation.

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2.

Technical Standards and Format Wars

Technical standards are a set of technical specifications that producers adhere to when making the product or component and they can be a source of differentiation, leading to competitive advantage. - Competitive struggles over control of technical standards are called format wars. - Examples of technical standards include the layout of a computer keyboard, the dimensions of shipping containers such as trucks and rail cars, and the components included in a personal computer. - When an industry relies upon a common set of features or design characteristics, such as the Wintel design for personal computers, this is called a dominant design. Each dominant design may be made up of a set of related technical standards. Figure 7.1 Technical Standards For Personal Computers

Dominant Design
Microsoft Operating system

Slots for peripherals

connecting

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Intel microprocessor
USB

Ram

Internal Hard drive drive Monitor Floppy disk

Winter standard

Mouse

CD

TCP/ P drive

QWERTY

Modem

Standards provide economic benefits to those companies that adhere to them. - Standards guarantee compatibility, such as the ability to use the same software programs on different brands of PCs. - Standards help reduce consumer confusion. When consumers sense that the technology is still evolving, they may delay purchase, which can cause the technology itself to fail to gain initial acceptance in the market. - Standards serve to reduce production costs, by facilitating mass production, along with its consequent economies of scale and lower costs. Both manufacturers and components suppliers are able to benefit from standards, reducing the cost of components too. - Standards reduce the ridk associated with supplying complementary products. Makers of complementary products such as a software providers for the PC industry, will hesitate to invest in producing complementary products until standards are reached. A low supply of complementary products can reduce sales of the product. 106

Standards emerge in an industry in several ways. When standards are set by the government or industry group they are part of the public domain meaning that any company can use that standard in their products. - Companies may lobby the government to mandate an industry standard. An example would be the digital TV broadcast standards put forth by the FCC. - Companies may band together to cooperatively establish standards, without government intervention as DVD manufacturers did. - Standards may also be chosen by consumers who use market demand as a selection mechanism. Microsoft and Intel both use proprietary standards which are protected through patents. Network effects arise in industries where the number of complementary products is a primary determinant of standards. For example the success of VCRs is driven by the standard VHS format for tapes, creating a positive feedback loop, in which demand for VCRs led to demand for tapes, and the increased availability of tapes led to further demand for VCRs.

Figure 7.2 Positive Feedback In the Market for VCRs

Installed base of VHS format VCRs

(+)

Supply of movies for Rent on VHS tapes

+ Demand for VHS players Value of VHS Players To consumers

(+)

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In a format war, the winner will be the company that best exploits positive feedback loops. Microsoft beat Apple by creating open computer code for its operating system, Matsushita beat Sony in VHS tapes by licensing its technology to competitors. Companies that fail to adopt the dominant design as it emerges may find themselves locked out of the market. Customers may be unwilling to bear the switching costs of changing to an alternate technology. Unless the benefits of doing so outweigh the costs. As a new technology becomes more widely adopted, there comes a point at which the prior technology becomes outmoded. For example CDs replaced the long-playing record.

3. Strategies for Winning a Format War

Its clear that firms benefit when they exploit network effects and when positive feed back loops are in operation so companies must find a way to make the effects work in their favor and against their competitors. Therefore they must build an installed base as rapidly as possible, leveraging the positive feedback loop forcing customers to bear switching costs, and locking the market into their technology. One important step for firms to take in winning a format war is to ensure a supply of complementary products. One way for companies to ensure a supply of complements is to diversify into the production of complements themselves - Another way is to create incentives for others to produce complements such as reducing licensing fees or providing technical assistance. Another important step is to leverage killer applications, those uses of a prodcut that are so compelling to customers that they kill demand for competing formats. The killer applications can either be developed by the company itself or by other firms -

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A third strategy for winning a format war is for the companies to price and market their products aggressively - One common pricing strategy is to price the product low and the complements high, such as the way Hewlett-Packerd prices printers at cost and then charges substantial markup on ink cartridges. - Aggressive marketing strategies include substantial p-front marketing and point-of0sale promotion to encourage firsttime buyers Yet another strategy involves cooperation with competitors in order to ensure compatibility and lock out alternative technologies. Another strategy requires licensing the fornmat so that the licensing firm maay profit from licensing fees while also boosting demand and speeding adoption of the format. A relatively low licensing fee reduces the financial incentive for competitors to develop their own alternative formats. These five strategies may be used in combination depending upon the unique demands of the situation. Care is needed to select the optimal mix of strategies as well as to ensure that strategies are working together and not counteracting against each other.

4. Costs in High-Technology Industries In most high-tech industries the fixed costs of product development are very high, whereas the marginal costs the costs of producing one extra unit of the product are very low. The initial costs of R&D and building manufacturing capacity contribute to the high fixed costs, whereas the marginal costs might be just a small amount, especially in a mass production environment where the product might be a DVD or a piece of software. The high fixed costs and low marginal costs of high-tech industries stands in contrast to many traditional industries where the marginal costs tend to increase as production rises. Figure 7.3 graphically illustrates how the differing relationships between fixed and marginal costs lead to different levels of profitability.

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The implication for strategy is that companies should try to switch from an industry with increasing marginal costs to one where marginal costs are lower in order to increase profitability. Another strategic implication is that companies should deliberately drive prices down to drive volume up leading to increased profitability.

Company : Low Tech Company Company : High Tech Company price price

Marginal costs pm Average costs pm

Average costs 0 Q1 Output

Fig 7.3 Cost structures in High-Technology Industries 5. Managing Intellectual Property Rights

Marginal costs

Q1 Output

Intellectual property refers to the product of any intellectual and creative effort, which would include products such as music , film, graphic arts, manufacturing and other processes, and new technology of any type. Intellectual property is a very important driver of economic progress and social wealth. That is nations where many individuals

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or firms are creating valuable intellectual property will prosper as will the individuals or firms. However the creation of intellectual property is often expensive risky and time-consuming. The costs of a new technology may be in the hundreds of millions of dollars, and the failure rate may be close to 90% in some industries. Because of the expensive and risk few would undertake that creation of intellectual property unless thgey expected some economic return. Therefore patents, copyrights and trade marks are used to give incentive for its creation - Protection of intellectual property rights is an important strategy for high-tech firms, and they may use law suits against competitors, both to stop actual violations and as a deterrent against future violations. - The protection of intellectual property rights has been complicated in recent years due to digitalization or the rendering of creative output in digital form, which is common today for artistic works and computer software. - Digitalization lowers the cost of copying and distributing intellectual property aided by the internet, making the marginal costs almost zero. - The low cost of copying and distributing creates an opportunity for piracy the theft of intellectual property. Piracy is quite common in the computer software and music recording industries, costing each of those industries billions of dollars in lost sales annually. - Companies in the software and music industries dont rely solely on legal protection they also protect their works with encryption software. However sophisticated pirates know how to defeat the encryption. Digital rights can be effectively managed through the use of several tactics - One strategy relies on giving something away for free to boost sales of complementary products, just as companies do to win format wars. - Another strategy is to keep prices low that customers have little incentive to steal.

6. Capturing First-Mover Advantages

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Companies in high-tech industries strive to be first mover, that is the first to develop a new product. - First movers initially have a monopoly position which can be very profitable if consumers adopt the new technology. - Once a first mover has been profitable with a new product imitators rush into the market lowering returns for all competitors.

Fig 7.4

Combined profits Of all imitators

Profits

First movers profits

Time

The impact of imitation on profits of a First Mover

Transparency 50 In spite of imitators, some first movers have been able to turn that initial advantage into an enduring advantage. For example , Cisco was the first to create an Internet router and still dominates that market. They do this by slowing the rate of imitation - However , there are also first mover disadvantages, which occur when a first mover pursues an inappropriate strategy. First movers have five key advantages -

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they can exploit network effects and positive feedback loops - they can establish brand royalty - they can increase production earlier than rivals and thus benefit from cost savings due to scale economies and learning effects - they can create customer switching costs - they can accumulate valuable knowledge about customers, distribution, technology and so on. First movers also have four potential disadvantages - they have to bear the costs of initial development and marketing, called pioneering costs. Later entrants can freeride on the pioneers investment - they make more mistakes than do later entrants - they risk building the wrong resources and capabilities, because they are focusing on a typical customer segment, the innovators and early adopters - they may invest in inferior technology. Later entrants may be able to leapfrog the first mover and introduce products based on a more sophisticated technology, due to the rapidly changing nature of the technology First movers can exploit their advantages in a number of ways - In order to choose an appropriate strategy, the first mover must answer three key questions. a) Does the company possess the complementary assets needs to exploit the new innovation? Complementary assets might include competitive, expandable manufacturing facilities, the ability to ride quickly down the experience curve, marketing know-how, access to distribution networks, customer support network, and a sufficient capital. b) What is the height of barriers to imitation? Barriers to imitation might include patents and a secret development process. c) Are there capable competitors that could rapidly imitate the innovation? Competitors are capable if they have excellent R&D skills and access to complementary assets. The first mover can choose to develop and market the innovation itself, if the firm has complementary assets, barriers to imitation are -

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high, and capable competitors are few. If this strategy can be sustained, it will lead to the highest level of profits- but it may not be possible. The first mover can use a joint venture or strategic alliance to develop and market the innovation with other companies, if the firm lacks complementary assets, barriers to imitation are high, and there are several capable competitors. The joint venture partner should be a firm that possesses the required complementary assets. The first mover can license the innovation to other s and let them develop the market if the firm lacks complementary assets, barriers to imitation are low, and there are many capable competitors. a modest licensing fee will discourage development of competing innovations.

7. Technological paradigm Shifts Technological paradigm Shifts occur when new technology revolutionizes the structure of an industry. This alters the nature of competition and requires the use of new strategies. An example is the current trend toward digital photography in replacing chemical photography. Paradigm shifts occur when an industry is mature, with technology approaching its natural limit and when a new technology has begun to be adopted by customers who are poorly served by the existing technology. The technology S-curve (shown in Figure 7.5) decrscribes the relationship between performance of a technology and time. Early on., new technologies improve rapidly in performance, but the smaller incremental improvements can be made. Transparency 51: Figure 7.5 The Technology S-Curve

Natural limit of technology Profitability Of paradigm Shift increases As technology approaches Natural limit.
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Performance /functionality of desired attributes

Diminishing returns

Inflection point

Increasing returns
The technology S-Curve

Accumulated R&D effort its natural limit, researchers When a technology approaches
begin to investgate possible alternative technologies, increasing the chances that a paradigm shift will occur.

his means that a technology that has just been developed will not be useful as the existing technology until after a period of refinement and improvement. Therefore new technologies are sometimes mistakenly dismissed by competitors.

Transparency 52: Figure 7.6 Established and Successor Technologies

Performance /functionality Of desired attributes.

Established technology (horse and cart)

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Successor Technology (automobile)

T1 Time

T2

In many situations the old technology is dying out just as a host of new technologies are being developed. Its often very difficult for established companies to decide which of the possible alternatives will ultimately be successful.

Transparency 53: Figure 7.7: Swarm of Successor Technologies

Discontinuity

Performance /functionality of desired attributes

Swarm of

Established technology

Successor Technology

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T1 Time

T2

Clayton Christensen has developed a theory about disruptive technologies, or a new technology that gets its start away from the mainstream of the industry, and then invades the main market causing a paradigm shift. - Christensen claims that established companies are often aware of the new alternatives, but they listens to their customers, and their customers dont want the new technology because its not yet efficient. - As the performance of the new technology improves, customers do want it, but its too late for the established firms to accumulate the technical knowledge in time to meet rising market demand. - Christensen identifies other factors that make it difficult for established firms to adopt a new technology, including the assumption that new technologies only serve a small market niche, the necessity of adopting a new business model and the lack of a new network of suppliers and distributors. What can established companies do to remain competitive when disruptive technologies emerge? - Companies should understand the process of technological disruption and particularly the rapidity with which a new technology can replace an older one. Awareness of the process could lead to better strategic decisions - Established companies should invest in newly emerging technologies hedging their bets by investing in several alternatives. They might also enter into joint ventures with new technology companies or acquire them. 117

Established companies should separate new technology into its own autonomous division. This allows the new technology to develop in spite of what is often significant internal opposition. Autonomy also helps the division develop a new business model with radically different value chain. What should new entrants do to gain an advantage of established enterprises? - New entrants must deal with problems such as the raising of capital the management of rapid growth and moving their technology from a small niche to a mass market. - Another concern of new entrants is the choice of whether to partner with an established company or go it alone. -

Chapter 8 Strategy in the Global Environment 1. Overview This chapter considers the contribution of global strategy to the process of building and maintaining a competitive advantage, outlining and discussing global strategies. Also covered are the decisions mangers make about when and how to enter a foreign market. Multinational companies, companies that do business in two or more countries, are also discussed, as are global strategic alliances.

2. Increasing Profitability Through Global Expansion Expanding globally lets both large and small companies increase their profitability in a number of ways not available to purely domestic enterprises.

Location Economies One way for firms to increase their profitability through internationalization is the realization of location economies, those benefits that arise from performing a value creation activity in the

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optimal location of that activity, where ever in the world that might be. - One benefit of location economies is the lowering of costs for raw materials, power,labour and so on. This is consistent with the business-level strategy of cost leadership. - Another benefit of location economies is the firms improved ability to differentiate its product, consistent with a differentiation business-level strategy. - However a negative consequence of pursing location economies is the potential for increased transportation costs and unfavourable trade barriers. - Another possible negative consequence is the increased political and economic risk in regions where governments are unstable or implementing unfavorable business policies. Experience Curve Another way that firms can benefit from global expansion is through the increased ability to ride down the experience curve reducing the costs of production over the life of a product. Moving down the experience curve is consistent with the business-level strategy of cost leadership. - Global markets are larger than domestic markets, and therefore companies that serve a global market from a single location are likely to build up accumulated volume quickly. - The cost advantages of serving the world market from a single location will be all the more significant if that location is also the optimal one for realizing location economies.

Transferring Distinctive Competence Yet another benefit of global expansion is the ability to further exploit distinctive competencies. Companies with valuable distinctive competencies can often realize enormous returns by applying those competencies to foreign markets, where indigenous competitors lack similar competencies.

Leveraging the Global Subsidiaries

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Another benefit of global expansion is the ability of multinational firms to leverage the skills of global subsidiaries. Multinational firms with foreign subsidiaries can have valuable competencies arise in any of their locations and then share that knowledge with other subsidiaries. This creates important new challenges for managers - Managers must recognize that competencies can develop anywhere, and be on the lookout for those new competencies - The firm must have an incentive system for local subsidiaries to develop new competencies. - Managers must be able to identify new competencies and help to transfer them within the company.

3. Pressures for Cost Reductions and Local Responsiveness Companies that compete in the global market place face competitive pressures for cost reductions and pressures to be locally responsive. These competitive pressures place conflicting demands on a company. - Responding to pressures for cost reductions demands that a company try to minimize its unit costs. To accomplish this a company must base its activities at the most favorable low-cost location, wherever in the world that might be. It might also offer a standardized product to the global market place in order to ride down the experience curve as quickly as possible. - Reacting to pressures to be locally responsive requires a company to differentiate its product offering and marketing strategy from country to country. It must try to accommodate the diverse demands arising from national differences, which can lead to significant duplication and a lack of standardization, raising costs.

Figure 8.1 Pressures for Cost Reductions and Local Responsiveness High

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Pressure For cost reductions

Company A

Company C

Company B

Low Pressures for local responsiveness

High

Pressures for cost reductions arise from several sources

Customer Tastes and Prerefences Pressures for Cost Reductions are intense in industries producing commodity-type products that serve universal needs. For these products differentiation on nonprice factors is difficult and price is the main competitive weapon. Pressures for Cost Reductions are also strong in industries where major competitors are based in low-cost locations, where there is persistent excess capacity and where consumers are powerful and face low switching costs. Liberalization of the world trade and investment environment in recent decades has generally increased cost pressures by facilitating greater international competition.

Pressures for local responsiveness arise from several sources. - One source of strong pressures for local responsiveness emerge when consumer tastes and preferences differ significantly between countries, for historic or cultural reasons. Products and marketing messages have to be customized for local tastes and preferences,

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leading to the delegation of production and marketing functions to national subsidiaries. a. However some observers claim that consumer demands for local customization are on the decline worldwide, because modern communications and transportation technologies have led to convergence of tastes and preferences. The result is the emergence of enormous global markets for standardized consumer products. b. However other commentators have observed that in some industries consumers have reacted to an overdose of standardized global products by showing a renewed preference for products that are differentiated to local conditions. Difference Infrastructure and Traditional Practice Another source of pressures for local responsiveness emerge when there are differences in infrastructure and traditional practices between countries, creating a need to customize the product. This may necessitate the delegation of manufacturing and production functions to foreign subsidiaries.

Difference in Distinctive Channels Pressures for local responsiveness may arise when a companys marketing strategies have to be responsive to differences in distribution channels between countries. This may necessitate the delegation of marketing functions to natural subsidiaries. Government Demands Economic and political demands imposed by host country governments may require a degree of local responsiveness. Examples of threats from host governments include protectionism, economic natianalism and regulations to ensure local content.

4. Choosing a Global Strategy

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Companies use four basic strategies to enter and compete in the international environment: 1) international strategy; 2) multidomestic strategy ; 3) global strategy; 4) transnational strategy. Each of these strategies has advantages and disadvantages. The appropriateness of each strategy varies with the extent of pressures for cost reductions and local responsiveness. A firm must balance the pressures for costs reductions with the pressures for local responsiveness. In order to customize products to respond to local demands, the firm may have to give up some of the potential cost savings. Also, the firm may not be able to fully leverage its distinctive competencies.

Figure 8.2- Four Basic Strategies

High

Global strategy Pressures For cost reductions

Transnational
Strategy

Internationa l Strategy

Multidomestic strategy

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Low Pressures for local responsiveness International Strategy -

High

One global strategy is the international strategy, in which a firm tries to create value by transferring valuable skills and products to foreign markets where indigenous competitors lack those skills and products.

a. International companies create value by transferring differentiated product offerings developed at home to new markets overseas. They centralize product development functions at home. b. However international companies also establish manufacturing and marketing functions in each major country. They undertake limited local customization of products and marketing strategy but the head office retains tight control over these. C An international strategy can be very profitable if a company has a valuable distinctive competency that indigenous competitors lack and if the pressures for local responsiveness and cost reductions are relatively weak.

d. However when pressures for local responsiveness are strong companies pursuing this strategy lose out to companies that customize products for local conditions. Moreover because they must duplicate manufacturing facilities, international companies suffer from high operating costs. Multi Domestic Strategy
Another global strategy is the muiltidomestic strategy, in which a firm orients itself toward achieving maximum local responsiveness. a) Muitidomestic companies transfer skills and products developed at home to foreign markets, however unlike international companies they extensively customize both their product offering and their marketing strategy. b) Multidomestic firms also establish a complete set of value creation activities in each major national market in which they do business. Multidomestic companies are unable to realize value from experience curve effects and location economies and therefore have a high cost structure and are unable to leverage distinctive competencies. c) A multidomestic strategy makes sense when there are strong pressures for local responsiveness and weak pressures for cost reductions.

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d) Another drawback of this strategy is that many multidomestic companies develop into decentralized federations in which each national subsidiary functions in a largely autonomous manner. They typically lack the ability to transfer local distinctive competencies to their worldwide subsidiaries..

Global Strategy
A third global strategy is the global strategy which focuses on increasing profitability by reaping the cost reductions that come from experiencecurve effects and location economies. Firms pursuing a global strategy are attempting to be cost leaders. The production , marketing and R&D activities of companies pursuing a global strategy are concentrated in a few favorable locations. Global companies do not customize their products and marketing strategy to local conditions because customization raises costs. Instead, global companies market a standardized product worldwide so that they can reap the maximum benefits from the economies of scale that underlie the experience curve. Global companies use their cost advantage to support aggressive pricing A global strategy makes most sense when there are strong pressures for cost reductions, but minimal demands for local responsiveness. These conditions prevail in many industrial goods industries, but are not as common in consumer goods.

a) b)

c)

d)

Transnational Strategy -

Every one of the preceding strategies has some serious drawbacks. Increasingly companies must be both low cost and differentiated in order to compete especially in the intense rivalry found in industries with many multinational competitors. A transnational strategy allows companies to pursue both goals simultaneously. a) A transnational strategy allows skills and products to flow in both directions between the home country and the foreign subsidiaries in a process referred to as global learning. b) The transnational makes sense when a company faces high pressures for cost reductions and high pressures for local responsiveness. However this strategy is not an easy one to pursue because pressures for local responsiveness and cost reductions place conflicting demands on a company c) To deal with cost pressures companies can design their products to use identical components. Another tactic is to invest in a few large-scale manufacturing facilities sited at favorable locations and then augment those with assembly plants in each of its major markets which allows for tailoring the finished product to local needs

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Table 8.1 summarizes the advantages and disadvantages of the four strategies just discussed. Although a transnational strategy appears to offer the most advantages it should not be forgotten that implementing it raises difficult organizational issues. The appropriateness of each strategy depends on the relative strength of pressures for cost reductions and pressures for local responsiveness.

Figure 8.3 The Advantages and Disadvantages of Different Strategies for Competing Globally. High

Pressures For cost reductions

Caterpillar Inc

Low Basic Entry Decisions

Pressures for local responsiveness

Low

A firm contemplating expansion into foregn markets must confront decisions about which markets to enter when to enter and on what scale to enter.

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The choice among different foreign markets must be made on the basis of an assessment of their long-run profit potential, balancing the benefits, costs and risks associated with doing business in that country. a) The long-run economic benefits of doing business in a country are a function of factors such as the number of buyers in a market the purchasing power of buyers and their likely future purchasing power. b) The benefit-cost risk-calculation is complicated by the fact that the potential long-run benefits bear little relationship to a nations current stage of economic development or political stability. Rather they depend on likely future economic growth rates, which are a function of a free market system and a countrys capacity for growth which may be greater in less-developed nations. c) Another factor is the value that international business can create in a foreign market through offering a product that has been unavailable and that satisfies an unmet need.

Timing Entry

With regard to the timing of entry we say that entry is early when an international business enters a foreign market before other foreign firms, and late when it enters after other international businesses have already established themselves.

a) Several first-mover advantages are frequently associated with entering a

market early 1) One advantage is the ability to preempt rivals and capture demand by establishing a strong brand name. 2) A second advantage is the ability to build up sales volume, revenue and market share in that country and ride down the experience curve ahead of rivals 3) A third advantage is the ability of early entrants to create switching costs that tie customers into their products or services. b) There can also be disadvantages associated with entering a foreign market before other international businesses. 1) One disadvantage is pioneering costs, or costs that an early entrant has to bear but a later entrant can avoid. 2) Pioneering costs can arise when a business system in a foreign country is very different than in a firms home market. 3) Pioneering costs also arise when the company makes strategic mistakes through ignorance. 4) Another source of pioneering costs is the cost of educating customers about products with which they may be unfamiliar

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5) Researchers shows evidence that the early mover advantage s are

outweighed by the disadvantages in most cases. Therefore it pays for companies to be late entrants into new foreign markets.

Scale of Entry a) An international business also needs to decide on the scale of its entry into foreign market. Entering a market on a large scale involves the commitment of significant resources to that venture. Smaller companies may not have the resources necessary to enter on a large scale. Even some large enterprises prefer to enter foreign markets on a small scale and then build their presence slowly over time as they become familiar with the foreign market in order to reduce risk. A strategic commitment is a decision that has a long-term impact and is difficult to reverse. Deciding to enter a foreign market on a significant scale is a major strategic commitment Strategic commitments such as large-scale market entry can have an important influence on the nature of competition in a market through signaling to competitors. Large companies are more likely to have the resources necessary to successfully implement a strategic commitment to early entry than are small companies. Small-scale entry is a way of gathering more information about a foreign market before making a large-scale strategic commitment and therefore can reduce risk and increase the chances of entry success, although delay will also cause the company to lose any first-mover advantage. The Choice of Entry Mode Most manufacturing companies begin their global expansion as exporters, making their products in the home country and then transporting them to foreign markets for sale.

b)

1)

2)

3)

5.

Exporting avoids that costs of having to establish manufacturing operations in the host country, and it is consistent with a pure global strategy. However exporting from the companys home base may not be appropriate if there are lower-cost locations for manufacturing the product abroad. High transport costs or tariff barriers can make exporting uneconomical.

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Also many exporters rely on local sales agents and it is difficult for the company to ensure that the agent act in the companys best interest. Some exporters establish wholly owned market subsidiaries in the host country to eliminate this concern.

Licencing

Companies that lack capital to develop operations overseas or that are unwilling to make a significant investment in a risky country, choose licensing as their entry mode. Like exporting , licensing is a fairly lowrisk strategy. Licensing involves a company selling the rights for certain intangibles such as product design or brand name to foreign licensees in return for loyalty payments. - The advantage of licensing is that the company does not have to bear the development costs and risks associated with opening up a foreign market. - A drawback of licensing is the lack of tight control over manufacturing, marketing and strategic functions which can hinder the firms ability to realize experience curve and location economies. - Competing in a global market place may require a company to coordinate strategic moves across countries so that the profits earned in one country can be used to support competitive attacks in another. Licensing severely limits a companys ability to do so. - By licensing its technology a company often gives away value knowhow to future competitors. To limit this risk some companies use a cross-licensing agreement. This agreement asks the foreign licensee to license some of its valuable technology to the licensor in addition to loyalty payments.. Franchising occurs when a company sells limited rights to franchisees to use its brand name in return for a lump sum payment and a share of the franchisees profits. Franchising involves the sale of intangible assets but also typically imposes strict rules on the franchisee. Franchising is often for a longer period of time than is licensing. Licensing is common among manufacturing companies, whereas franchising is used primarily by service companies. - The advantages of franchising as an entry mode are the same as those of licensing. The franchiser doesnt bear the development costs and risks. Therefore a global presence can be built quickly and inexpensively. - The disadvantages of franchising are somewhat less than those of licensing. One disadvantage is that franchising may inhibit global strategic coordination.

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Another disadvantage is that foreign franchisers may not be as concerned about quality as the franchiser is, and poor quality may mean not only lost sales, but also a decline in the companys worldwide reputation. To alleviate this concern some companies set up subsidiaries in each country, which then oversee the franchisees to ensure that quality is maintained. Joint ventures require sharing of ownership along with sharing of all attendant costs and benefits between a company in the home country and one in the host country. To maintain control some multinational firms maintain a majority share of ownership. - Joint ventures have the advantage that a multinational can benefit from a local partners knowledge of a host countrys competitive conditions, culture, language, political systems and business systems - Another advantage is the sharing of costs and risk of setting up business with a local partner. - A third advantage is that in many countries political considerations make joint venture the only feasible entry mode. - One drawback of joint ventures is the risk of losing control over technology. Some companies cope with this threat by not allowing foreign partners to own a majority stake in the venture. However some foreign partners may not be willing to accept minority ownership. - Another drawback exists because a joint venture does not give a company tight control over different subsidiaries that it needs to realize economies or engage in coordinated global attacks against global rivals. A wholly owned subsidiary is created when the parent company owns 100% of its subsidiarys stock. A company can establish a wholly owned subsidiary either by acquisition or by setting up a completely new operation. - One advantage to a wholly owned subsidiary is the tight control the company maintains over its distinctive competencies, which can be especially important when the competitive advantage is based on control over a technological competency. - Another advantage is that a wholly owned subsidiary gives a company the kind of tight control over operations in different countries that is necessary for pursuing a global strategy supporting competitive attacks in one country with profits from another. - A wholly owned subsidiary allows the company to realize location and experience curve economies. -

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However a wholly owned subsidiary is the most costly method of serving a foreign market and companies taking this approach bear the full costs and risks associated with setting up overseas operations. - These costs and risks can be diminished somewhat by using acquisition rather than setting up a new operation. However acquisitions raise a host of additional problems such ad trying to integrate two disparate operations and cultures. Acquisitions and the problems associated with them are discussed in more detail in Chapter 10. Inevitably choosing an entry mode involves trade-offs. Therefore it is difficult to make specific recommendations as to what a company should do. A number of rough generalizations can be made , however. -

Entry Mode

Advantages

Disadvantages

Exporting

Table 8.2 Experience curve economies - Trade barriers The Advantages and Disadvantages of Different Entry Modes local marketing - Problems with

Ability to realize location and

- High transportation costs Agents

Licensing
eNTRY Exportin

Low development costs and

Franchising Joint Ventures

Low development costs & risks Access to local partners Knowledge Protection of technology Ability to engage in global coordination Ability to realize location and experience-curve economies

- Inability to realize location and Experience curve economies - Inability to engage in global Strategic coordination - Lack of control over quality - Inability to engage in global Strategic coordination - Inability to realize location and experience-curve economies - Lack of control over technology - High costs and risks 131

Wholly owned Subsidiaries

 a)

b)

c)

5.

One area that companies must consider when choosing a mode of entry into international markets is the source of their competitive advantage. If a companys competitive advantage is based on control of proprietary technological know-how wholly owned subsidiary is the best strategy to minimize the risk of losing control over that technology. Other entry modes might work also if measures are taken to reduce the risks. If the company is using technological know-how but the technological advantage is expected to be short-lived anyway, then a licensing strategy might be more appropriate because it allows rapid diffusion of the technology. Rapid diffusion raises royalty payments, and makes it more likely that the companys technology will be accepted as the dominant design. If the competitive advantage of many service companies is based on management know-how where the risk of losing control is not high . The valuable asset of such companies is their brand name which is protected by international trademark laws. Such companies should use franchising and wholly owned or joint venture because it is more politically accepted and brings a degree of local knowledge. - A second area for consideration in choosing an entry mode is the level of pressures for cost reduction. a) The greater the pressures for cost reductions, the more a company should pursue some combination of exporting and wholly owned subsidiaries. By manufacturing in those locations where factor conditions are optimal and then exporting to the rest of the world, a company may be able to realize substantial location economies and experience-curve effects. b) Wholly owned subsidiaries are preferable to joint ventures because they give the company tighter control over marketing, increasing coordination and allowing the profits generated in one market to be used to improve competitive position in another. Global Strategic Alliances

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Figure 8.4 Structuring Alliances to Reduce Opportunisn

Probability of opportunism By alliance partner reduced by

Walling off critical technology

Establishing contractual safeguards

Global Strategic Alliances are cooperative agreements between companies from different countries that are actual or potential competitors. Strategic alliances very considerably in the length of time and degree of interrelatedness they offer. Companies enter into strategic alliances with actual or potential competitors in order to achieve certain strategic objectives - strategic alliances may facilitate entry into a foreign market. - Strategic alliances allow companies to share the fixed costs and associated risks that arise from the development of new products or processes. - Alliances bring together complementary skills and assets that neither company could easily develop on its own. - Alliances help companies set technological standards for their industry, which can benefit the allied firms. One problem with global strategic alliances is that they can give a firms competitors a low- cost route to gaining new technology and market access. Unless it is careful, a company can give away more than it gets in return. 7.Making Strategic Alliance Work The failure rate of global strategic alliances is quite high-two thirds have some initial problems and one-third are eventually rated as failures. The benefits a company derives from a strategic alliance seem to be function of several factors. - One of the keys to making a strategic alliance work is to select the right kind of partner. a) The partner must be able to help the company achieve its strategic goals through the possession of capabilities that the company lacks but values b) The partner must share the companys vision for the purpose of the alliance.

Agreeing to swap Valuable skills and technologies

Seeking credible commitments

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c) The partner must be unlikely to try to opportunistically exploit the alliance for its own ends, expropriating the companys technological know-how while giving little in return. d) Therefore companies must thoroughly research potential alliance partners. - Another critical factor in alliance success is a structure that reduces the risks of a company giving too much away to its alliance partner without getting anything in return. Transparency 58 ; Table 8.4 Structuring Alliances to Reduce Opportunism a) Alliance can be designed to make it difficult to transfer technology that is not meant to be transferred. Specifically, the product or process may be structured so as to wall off the most sensitive technologies and prevent their leakage to others. b) Contractual safeguards can be written into an alliance agreement to diminish the risk of opportunism by a partner. c) Both parties can agree in advance to exchange skills and technologies that the other wants, thereby ensuring an equitable gain. Cross-licensing agreements are one way of achieving this goal. d) The risk of opportunism can be decreased if the company extracts a significant credible commitment in advance requiring each partner to make such a substantial and long-term investment that the chances of opportunism are sharply reduced. - The last critical factor for success is to manage the alliance in a way that maximizes benefits. a) One important management tactic is to develop sensitivity to cultural differences. Managers must take differences into account when dealing with their partner. b) Another contributor to managing an alliance successfully is building interpersonal relationships between managers from the different companies which means building trust as well as an informal network to resolve issues. c) Learning from the partner is a major factor in determining how much a company gains from an alliance. Firms that view the alliance as merely a cost or risk sharing device receive fewer benefits Therefore an effective strategy will be to educate all employees about the partners strengths and weaknesses as well as informing them about the particular skills that the company hopes to learn from the partner. Then, the resultant learning must be spread in a coordinated fashion throughout the company

Chapter 9

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Corporate Strategy: Horizontal Integration, Vertical Intergration, and Strategic Outsourcing 1. Overview

The principal concern of corporate strategy is identifying the business areas in which a company should participate the value creation activities it should perform and the best means for expanding or contracting business in order to maximize its long-run profitability. To add value, a corporate strategy should enable one or more of a companys business units to perform one or more of the value-creation functions at a lower cost or perform them in a way that allows differentiation and brings a premium price. 2. Horizontal Integration Horizontal Integration is the process of acquiring or merging with industry competitors to achieve the competitive advantages that come with large scale and scope. Horizontal Integration may be achieved by acquisition as when a company purchases another company, or by a merger, meaning an agreement by which equals pool their operations and create a new entity. - Horizontal Integration has been a popular strategy since the early 1990s. The trend toward horizontal integration peaked in 2000 The net results of all the horizontal integration has been to increase the consolidation in many industries. - The popularity of this strategy is due to the benefits that horizontally integrated firms realize. Benefits of Horizontal Integration a) Horizontal Integration allows companies to grow, and therefore to realize economies of scale. This is especially important in industries with high fixed costs. b) Another benefit of Horizontal Integration is the cost savings due reducing duplication between the two companies, for example, eliminating duplicate headquarter offices. c) In addition Horizontal Integration can allow the company to offer a wider range of products that can be sold together for a single

135

d)

e)

f) g)

h)

price, a strategy called product bundling. Customers value the inconvenience of bundled products leading to differentiation. Horizontal Integration facilitates another strategy, similar to bundling called a total solution. This is an important strategy for example in the computer industry where corporate customers prefer the ease and coordination of purchasing all their hardware and service from a single source. Horizontal Integration also aids in value creation by supporting cross selling as occurs when a company tries to leverage its relationship with customers by acquiring additional product categories that can be sold to them. Again customers preference for convenience leads to differentiation. Horizontal Integration helps companies manage industry rivalry by reducing excess capacity in the industry. Horizontal integration also reduces the number of players in an industry thus making it easier to implement tacit price coordination. Companies gain bargaining power over buyers and suppliers through Horizontal Integration, because industry consolidation increases the remaining firms power. This is called market power, or monopoly power.

Limitations of Horizontal Merger However, Horizontal Integration also has some drawbacks and limitations a) Mergers and acquisitions are difficult to implement successfully and therefore may destroy value rather than creating it. Problems include disparate cultures, high management turn over an underestimation of integration expenses and a tendency to overestimate the expected benefits and to overpay. This topic is discussed in more detail in Chapter 10. b) Antitrust law is designed to provide protection against the abuse of market power and trends to favor industries with numerous, smaller companies rather than consolidated industries. The U.S. Justice -

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Department sometimes blocks proposed mergers and acquisitions because of these concerns about reducing competition and raising prices for consumers. 3. Vertical Integration Vertical Integration means that a company is producing its own inputs (backward or upstream integration) or is disposing of its own outputs (forward or downstream integration). There are four main stages in a typical raw-material-to-consumer production chain: raw materials, component part manufacturing; final assembly and retail. For a company based in the assembly stage backward integration involves moving into intermediate manufacturing and raw-material production. Forward integration involves movement into distribution. See Figure 9.1 for details. Figure 9.1 Stages in the Raw Material to Consumer Value Chain Raw Materials Component Part manufacturing g Final assembly Downstream Industries Retail

Upstream Industries -

At each stage in the chain value is added to the product. The difference between the price paid for inputs and the price at which the product is sold is a measure of the value added at that stage. Thus, vertical integration involves a choice about which value-added stages of the raw-material-to-consumer chain to compete in. Another important distinction is the difference between full integration which occurs when a company produces all of its own inputs or disposes of all of its own output, and taper integration, in
which a company buys from independent suppliers in addition to companyowned suppliers or when it disposes of its output through independent outlets in addition to company-owned outlets.

Figure 9.3

137

Full and Taper Integration Full intergation In house suppliers Taper Integration In house suppliers In house manufacturing Outside Suppliers Benefits of Vertical Integration a) Firms pursuing a strategy of vertical integration realize some benefits. By vertical integration backward or forward a company can build barriers to new entry limiting competition and enabling the company to charge a higher price and make greater profits. Vertical integration facilitates investment in specialized assets. a specialized asset is an asset that is designed to perform a specific task and whose value is significantly reduced in its next best use. It may be a tangible or an intangible asset. Specialised assets lower the costs of value creation and provide better differentiation, and thus provide the basis for achieving a competitive advantage. It may be difficult to persuade companies in an adjacent stage of the production chain to invest in specialized assets because there is a risk that one will take advantage of the other demanding more favorable terms after the companies commit to the relationship. This is referred to as holdup. Instead the company may vertically integrate and invest in specialized assets for itself. Independence distributors In house distributors In house manufacturing Inhouse distributors

b)

1)

2)

3)

138

c) By protecting product quality, vertical integration enables a company to become a differentiated player in its core business, leading to more pricing options d) Strategic advantages arise from the easier planning, coordination, and scheduling of adjacent processes made possible in vertically integrated organisations. This can be particularly important in companies trying to realize the benefits of just-in-time inventory systems. The assumption underlying this argument is that scheduling is somehow more problematic between freestanding enterprises an argument that seems rather dubious. Advantages of Vertical Integration However vertical integration has some disadvantages. Because of these disadvantages the benefits of vertical integration are not always as substantial as they might seem initially. Although often undertaken to gain a production cost advantage, vertical integration can raise costs if a company becomes committed to purchasing inputs from company-owned suppliers when low-cost external source of supply exist. Company owned suppliers might have high operating costs relative to independent suppliers because they know that they can always sell their output to other parts of company. The fact that they do not have to compete for orders with other suppliers reduces their incentive to minimize operating costs. The problem may be less serious, however when the company pursues taper rather than full integration because the need to compete with independent suppliers can produce a downward pressure on the cost structure of company-owned suppliers. When technology is changing rapidly vertical integration poses the hazard of tying a company to an obsolescent technology. Vertical integration can inhibit a companys ability to change its suppliers or its distribution systems to match the requirements of changing technology. Vertical integration can be risky in unstable or unpredictable demand conditions because it may be difficult to achieve close coordination among vertically integrated activities. The resulting inefficiencies can give rise to significant bureaucratic costs.

a)

1)

2)

b)

c)

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1) The problem involves balancing capacity among different stages of a process. For example if demand falls the company maybe locked into a business that is running below capacity. Clearly this would not be economical. 2) If demand conditions are unpredictable, taper integration might be somewhat less risky than full integration. When the company provides only part of its total input requirements from company-owned suppliers, in times of low demand it can keep its in-house suppliers running at full capacity by ordering exclusively from them. d) Bureaucratic costs are the costs of running an organisation. They include the costs arising from the lack of incentive on the part of company-owned suppliers to reduce their operating costs and from a possible lack of strategic flexibility in the face of changing technology or uncertain demand conditions. 1) Bureaucratic costs place a limit on the amount of vertical integration that can be profitably pursued. The farther a company moves from its core business the more marginal the economic value and the higher the Bureaucratic costs. 2) Given the existence, it makes sense for a company to integrate vertically only when the value created by such a strategy exceeds the Bureaucratic costs associated with expanding the boundaries of the organization to incorporate additional upstream or downstream activities. 4. Alternatives to Vertical Integration: Cooperative Relationships Under certain conditions companies can realize the gains associated with vertical integration without having to bear the associated bureaucratic costs, if they enter into long-term cooperative relationships called strategic alliances with their trading partners However companies will not realize gains from short-term (less than one year) contracts with their trading partners. - Because it signals a lack of long-term commitment to its suppliers by a company, the strategy of short-term contracting and competitive
bidding makes it very difficult for that company to realize the gains associated with vertical integration This is not a problem when there is minimal need for close cooperation between the company and its suppliers to facilitate investments in specialized assets, improving scheduling, improve product quality. Indeed,

140

in such cases competitive bidding may be optimal. However a competitive bidding strategy can be a serious drawback when these considerations do arise.

In contrast to short-term contracts, long-term contracts are cooperative arrangements by which one company agrees to supply the other and the other agrees to continue purchasing from that supplier. - In a long-term contract both parties make a commitment to work together and seek ways of lowering the costs or raising the quality of inputs - This stable long-term relationship lets the participating companies share the value that might be created by vertical integration while avoiding many of its bureaucratic costs. Thus long-term contracts can be a substitute for vertical integration. Companies can take some specific steps to ensure that a long-term relationship can succeed and to lessen the chances of one party taking advantage of the other. - One way of designing long-term cooperative relationships is to build trust and reduce the possibility of a company reneging on an agreement is for the company making investments in specialized assets to demand a hostage from its partner. This occurs when companies both invest in specialized assets in order to serve each other and it makes them mutually dependent and therefore less likely to renege. - A credible commitment is a believable commitment to support the development of a long-term relationship between companies. Credible commitment involve long-term and substantial investments and therefore are believable guarantees of trust. - Building a cooperative long-term relationship is more readily relied upon when a company can maintain some kind of market discipline on its partner to ensure that the partner doesnt lack incentives to maintain efficiency. a) One way of maintaining market discipline is to periodically renegotiate the agreement. Thus a partner knows that if it fails to live up to its side of the agreement the company may refuse to renew. b) Another way to maintain market discipline is to enter into long-term relationships with other suppliers use a parallel sourcing policy . Under this arrangement a company enters into a long-term contract with two suppliers for the same part. The idea is that when a company has two or more suppliers for a single part each supplier knows that it must fulfill its side of the bargain, lest the company terminate the contract and switch business to the other supplier.

5. Strategic Outsourcing

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The opposite of integration (a firms growth, in number of businesses) is outsourcing value-creation activities to subcontractors. In recent years there has been a clear move among many enterprises to outsource noncore or nonstrategic activities. Any function can be outsourced, if it is not critical to a firms success (is not one of its distinctive competencies). Outsourcing begins with an identification of a firms distinctive competencies these will continue to be performed within the acompany. All other activities are then reviewed to see whether they can be performed more effectively and efficiently by independent suppliers. If they can these activities are outsourced to those suppliers. The relationships between the company and those suppliers are then often structured as long term contractual relationships.

Figure 9.4 Strategic Outsourcing of Primary Value Creation Functions

Company Boundary Before Outsourcing

Research and development

Production

Marketing and sales

Customer service

Company Boundary After Outsourcing

Research And development

Outsourced

Marketing And sales

Outsourced

Production

Customer service 142

The term virtual corporation has been coined to describe companies that have pursued extensive strategic outsourcing.

Advantages of Outsourcing
There are several advantages of strategic outsourcing - First by outsourcing a noncore acivity to supplier who is more efficient at performing that particular activity the company may reduce its own cost structure, enhancing its cost leadership strategy a) supplier may be more efficient due to economies of scale or learning effects b) supplier may also be more efficient because of a low-cost location - by outsourcing a noncore value-creation activity to a supplier that has a distinctive competency in that particular activity the company may be able to better differentiate its final product. - A third advantage of strategic outsourcing is that it allows the company to remove distractions focusing more resources on strengthening its distinctive competencies.

Disadvantages of Outsourcing
There are also some risks associated with strategic outsourcing. - There is a risk of hold up or becoming too dependent on an outsourced activity a) this risk can be reduced by outsourcing from several companies at once, using a parallel sourcing policy b) Another way to manage this risk is simply to signal to the subcontractors the companys willingness to choose a different provider when the contract is up for renewal - A further drawback of outsourcing is the potential for loss of control of scheduling. This problem is intensified by a long supply chain unpredictable demand and outsourcing to a number of competing companies rather than just one. Another concern is the potential for a loss of important competitive information. This risk can be managed by ensuring good communication between the subcontractor and the company

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Chapter 10 Corporate Strategy : Diversification, Acquisitions, and Internal New Ventures 1. Overview This chapter is the second chapter that deals with corporate strategy and focuses on diversification, the process of adding new business to the company that are distinct from its established operations. Thus, a diversified company is involved in two or more distinct business. Another focus is on the execution of a diversification strategy . This might take place through internal new venturing, which is starting a business from scratch, acquisition or buying an existing business and joint ventures established with the help of a partner. A third topic is restructuring the opposite of diversification, in which a company reduces the scope of its operations by existing industries.

2. Expanding Beyond a Single Industry Corporate-level managers identify which industries a company should compete in to maximize long-run profitability.

Advantages of a single business - Often it is better to compete within a single industry a) One advantage of a single business corporation is the ability to focus more resources and attention on that one area. b) Another advantage is that a firm sticks with what it knows and does best and does not risk making the mistake of moving into areas in which it has no distinctive competencies. - These are also disadvantages to a single business strategy Disadvantages of a single business

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a) One disadvantage is the increased risk that comes from tying corporate profitability to just one industry. b) Another disadvantage is that a firm may miss out on opportunities to further leverage its distinctive competencies A company as Portifolio of distinctive Competencies One model of a corporation looks at the firm as a portfolio of distinctive competencies, rather than a portfolio of products. Managers can then consider how to leverage those competencies. Hamel and Prahalad claim that once a firm has identified its current competencies it should use a matrix such as the one presented in Figure 10.1 to establish an agenda for building and leveraging competencies to create new business.

Figure 10.1 Establishing a Competency Agenda Industry New Mega-opportunities

Existing

Premier plus 10

Mega-opportunities What new competencies will we need to build to participate in the most exciting industries of the future?

New

What new competencies will we need to build to protect and extend our franchise in current industries?

Competence
Fill in the blanks What is the opportunity to improve our position in existing industries and better leverage our existing competencies

White space What new products or services could we create by creatively redeploying or recombining our current 145 competencies

Existing

The lower left corner of the matrix represents the companys current portifolio of competencies. This quadrant is called fill-in-the blanks because the recommended strategy here is to transfer existing competencies in order to improve its position in existing industries

Premier + 10 The upper left matrix quadrant is called premier plus 10 to suggest that managers must be building new competencies today to ensure that the firm is a premier provider ten years from now.

White Space The lower left quadrant is white spaces and it indicates the firms search for new industries where its existing distinctive competencies could be deployed through diversification.

Mega Opportunities The upper left quadrant is referred to as megaopportunities and it represents opportunities for entry into new industries where the company currently has none of the required competencies. Use of this matrix helps managers think strategically about competencies and industries as they change over time. Managers who use this matrix will be unlikely to enter new markets where they do not have a competitive advantage.

Multi business model

146

Companies that wish to expand beyond a single industry must develop their business model at two levels. - First, they must develop a business model for each industry in which they plan to compete. - Then the company must develop a higher-level multibusiness model that justifies entry into different industries in terms of profitability. This model should describe how the firm plans to leverage its distinctive competencies across industries. The model must also describe how the business and corporate strategies boost profitability.

3. Increasing Profitability Through Diversification Diversification is the process of adding new business to the company that are distinct from its established operations. Thus, a diversified company is involved in two or more distinct businesses. To increase profitability diversification should allow the company to lower costs, differentiate its products, or better manage industry rivalry. When the firm is generating free cash flow that is profits about the level necessary to meet current expenses and obligations, the firms managers may choose to return dividends to shareholders or to invest the cash in diversification. For diversification to make economic sense the expected return on invested capital (ROIC) from the diversification must exceed the returns shareholders could realize through investing that capital in a diversified investment portfolio

Transferring and leveraging Competence One way that firms use diversification to boost profitability is through their ability to transfer their existing distinctive competencies to an existing business in another industry. The transfer must involve competencies that are important for competitive advantage in that business.

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Figure 10.2 Transfer of Competencies at Phillip Morris Tobacco Industry Research And development Brewing Industry Research And development Production Marketing And sales Customer service Marketing And sales Customer Service

Production

Transfer of competency

Another way of boosting profitability requires that the company leverage its existing distinctive competencies by using them to create a new business in a different industry. a) Leveraging competencies involves creation of a new business, whereas transferring competencies involves an existing business. This distinction is important because the two different situations require the use of different managerial skills. b) Companies that leverage competencies tend to use R&D skills to build a new venture in a technology related industry, whereas companies companies that transfer competencies tend to acquire established businesses. Sharing Resources (Economies of Scope) Another way to use diversification to increase profitability is through sharing resources across multiple businesses in order to obtain cost reductions. This sharing is called economies of scope.

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a) Economies of scope occur because each business can invest less in the shared resource than in resources that are not shared. Figure 10.3 Sharing Resources at Procter & Gamble Disposable Diapers

Research And development

Production

Marketing And sales

Customer service

shared Research And development

shared Marketing And sales

Production

Customer Service

b) Economies of scale generate economies of scope because resource sharing allows the company to use the resource more intensively. c) Economies of scope are obtained only when there is significant commonality between one or more value creation functions in the two businesses. d) Also managers must weigh the benefits obtained by resource sharing against the increased bureaucratic costs of doing so. - Diversification can also boost profitability by enabling the company to better manage rivalry through the use of multipoint competition.

Expecting General Organisational Competencies a) Multipoint competition occurs when two companies rival each
other in more than one industry.

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Expecting General Organisational Competencies -

b) The threat of increasing competitive rivalry in one industry can keep a competitor from entering another industry or can cause the competitor to lessen the intensity of competitive pressure.

a)

b)

c) 1)

2) 3) 4) -

1) 2)

3)

4)

A final way that profitability can increase due to diversification is through the improved use of general organizational competencies, that is corporate-level competencies that transcend individual functions or business. General organizational competencies require the use of rare managerial skills and are difficult to develop and implement. One general organizational competency is an intrepreneurial capacity, which allows managers to recognize and develop new businesses internally. Companies with this competency are skilled at encouraging risk taking while also limiting the amount of risk undertaken. Another general organizational competency is the ability to develop effective organization structure and controls. Effective structure and controls encourage business-level managers to maximize efficiency and effectiveness, increasing profitability. Companies with effective structure and controls tend to use self-contained business divisions ,ZBC, ZESA and ZSR Companies with effective structure and controls tend to be decentralized. Companies with effective structure and controls tend to link pay to performance. d) Another general organizational competency is a superior strategic capability such that top managers have good governance skills and can effectively manage the firms business-level managers. One aspect of superior strategic capability is a flair for entrepreneurship. Superior strategic capability also express itself in an ability to recognize ways to improve the performance of individuals, functions and businesses. Another aspect of effective governance is the ability to diagnose the real source of problems and then to know the appropriate steps to take to fix those problems. Superior strategic capability is at work when a diversified company acquires a new business and then restructure s it to improve performance.

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4. Types of Diversification
Related diversification moves the company into a new activity that is linked to its existing activity by a commonality between value chain activities. - Typically the commonality lies in the manufacturing, marketing and technology functions. - Typically firms pursuing a strategy of related diversification expect to benefit from transferring and leveraging competencies and from sharing resources. - Also, companies pursuing a strategy of related diversification are likely to encounter their rivals in several related industries and thus are likely to benefit from managing that rivalry through multipoint competition. - Unrelated diversification moves the company into a new activity that has no obvious commonalities with any of the companys existing activities. - Typically firms expect to benefit from unrelated diversification through the exploitation of general organizational competencies. - Typically firms pursuing unrelated diversification are unlikely to meet their rivals in more than one industry, and thus are unlikely to benefit from managing rivalry through multipoint competition

6. The Limits of Diversification

Diversification in many cases can dissipate value instead of creating it. - Although related diversification has more ways to increase profitability and seems to involve fewer risks research has shown that related firms achieve profits that are only slightly higher than unrelated firms. - Firms that are extensively diversified with many businesses tend to be less profitable. - A study by Michel Porter found that over time companies divested many more of their acquisitions than they kept. One reason for the failure of diversification to achieve its goals is that the bureaucratic costs of diversification exceed the value created by it.

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The level of bureaucratic costs is a function of a number of businesses in a companys portfolio a) The greater the number of businesses the more difficult it is for managers to remain informed about the complexities of each business. They simply do not have the time to process all the information. - Therefore corporate-level managers end up making important decisions based on a superficial analysis of each business. - Corporate managers lack of familiarity with operations increases the probability that business-level managers will be able to distort information provided to those at the corporate level.

b) Thus information overload can result in substantial inefficiencies within extensively diversified companies. c) In order to overcome information overload some corporate managers limit the extent of diversification at their firms. - Another source of bureaucratic costs is the coordination required to realize value from transferring competencies and resource sharing.

Figure 10.4 Coordination Among Related Business Units

Head Office

Household products

Marketing and sales

Packaged and food products 152

Customer

a) Bureaucratic costs arise from an inability to identify the unique

profit contribution of a business unit that is sharing resources and functions with another unit. b) This problem can be resolved if corporate management directly audits both divisions however doing so requires both time and effort from corporate managers. c) The accountability problem is far more serious at companies that are extensively diversified. Information overload occurs and corporate management effectively loses control of the company. - Thus bureaucratic costs, which increase as a function of the number of businesses and the extent of resource sharing place limit on the value created by diversification. If a company continues to diversify after the point at which costs exceed benefits, profitability will decline. Then divestment is the best solution.

Related or unrelated Diversification

Another reason that companies fail to realize the expected benefits of a diversification is that companies make an inappropriate choice between related and unrelated diversification. - Although the ways that related diversified companies can create value are more numerous, the bureaucratic costs of a related diversification strategy are higher than those of an unrelated strategy. Thus related firms may be more profitable than unrelated firms. - Related diversification should be chosen when the firms distinctive competencies in its core business have commonalities with the competencies required to compete in other businesses and when the bureaucratic costs of implementation do not exceed the value created through resource sharing ZBC

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A company should pursue unrelated diversification when its distinctive competencies are highly specialized and have few applications outside the core business when top management possesses super strategic capabilities and when the bureaucratic costs of implementation do not exceed the value created through restructuring.

Diversification that dispates value

Another reason for the failure of diversification strategy to meet its objectives is that many companies diversify for the wrong reasons and end up dissipating value rather than creating it. - One inappropriate reason for diversification is to pool risk. a) Risk pooling is said to create a more stable income stream reducing the risk of bankruptcy which is in the best interests of stockholders. However this argument ignores two facts. 1) Stockholders can easily eliminate the risks inherent in holding an individual stock by diversifying their own portfolios and they can do so at a much lower cost than the company can 2) Research shows that corporate diversification is not a very effective way to pool risks. The business cycles of different industries are not easy to predict and in any case tend to be a less important influence on share price than a general economic downturn which hits all industries simultaneously. b) A second inappropriate reason to diversify is to achieve greater growth. Such diversification is not a coherent strategy because growth on its own does not create value, despite the fact that empire-building top executives sometimes pursue growth for its own sake.

6. Entry Strategy : Internal New Ventures c) Internal new venturing is one method that companies can use to execute a corporate-level diversification strategy. d) Internal new venturing is an appropriate strategy to use for several reasons

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1. Internal new venturing is used when a company possesses a set of valuable competencies in its existing businesses that can be leveraged or recombined to enter the new business area. 2. Science based companies that use their technology to create market opportunities in related areas tend to favor new internal venturing. 3. Even if it lacks the competencies required to compete in a new business area, a company may use internal new venturing to entry a newly emerging or embryonic industry where there are no established players that possess the competencies required to compete in that industry. Thus internal new venturing is the only option. e) There are some drawbacks to the use of internal new ventures, which have a very high failure rate. Scale of entry 1. Large-scale entry into a new business is more likely to be successful than is small-scale entry, because it entails greater short-term costs but gives greater returns in the long run. This is due to the greater economies of scale, brand loyalty and access to distribution channels that large firms enjoy. The effect is specially noticeable when a firm is entering an established industry with powerful incumbents.

Figure 10.5 Scale of Entry, Profitability, and Cash Flow (+) Large-scale entry

smal l-scale entry

0 155

(-)

Commercialization 2. Another concern with internal new ventures is that a company can

become blinded by the technological possibilities of a new product and fail to analyze market opportunities properly, leading to poor commercialization. Successful commercialization requires that there be a market demand for the technology.

Poor Implementation 3. Internal new ventures can also fail due to a poor implementation.

Common mistakes here include pursuit of too many ventures at once leading to strained resources, failure to ensure the strategic value of the venture beforehand, and failure to anticipate the tie-and-cost demands- leading to an unrealistic profit expectation.

Guidelines for Successful Internal new ventures

To avoid the above pitfalls, managers can follow a number of guidelines to reduce the risk of new venture failure. 4. A company should use a structured approach to new venture development including both exploratory (basic) research and development research. a) Good basic research comes from strong ties to university research communities and from giving researchers enough resources to pursue blue-sky projects of their own choosing. b) However basic research alone will not lead a successful commercial venture. c) Good development research also requires resources to be given to business-level managers who are ideally situated to recognize commercially viable technologies. d) Good development research also requires communicating company strategies and goals to researchers so that their research will be relevant to those goals.

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5. Another way to increase the probability of new venture success is to foster close links between R&D and marketing and R&D and manufacturing. a) Project teams with members from the various functional areas are an effective way to foster close links. b) These teams can also significanlty reduce product development time. 6. Another strategy is to devise a selection process for choosing only the ventures that demonstrate the greatest probability of commercial success. 7. To ensure success, managers must also monitor the new venture closely focusing on market share rather than on profit goals for the first few years. Large market facilities economies of scale and learning effects which will ultimately lead to superior profitability. 8. Finally companies can help to ensure new venture success by thinking big. They should look for products that have high potential demand, construct efficient-scale manufacturing plants ahead of need, and spend generously on marketing. These steps will help to lead to high market share and profitability. 7. Entry Strategy: Acquisitions Acquisitions are the main strategy for implementing horizontal integration and they are also used in vertical integration and diversification strategies.

Advantages of Acquisitions
Acquisition is an appropriate strategy to use for several reasons. 9. A company ca use acquisition to enter a new business area when they lack important competencies required in that area, and they can purchase an incumbent company that has those competencies at a reasonable price. 10. Acquisition is a quick way to establish a significant market presence and generate profitability. 11. Acquisitions are perceived to be somewhat less risky than internal new ventures because they involve less uncertainty. When a company makes an acquisition it is acquiring known profitability, revenues and market share thus it reduces uncertainty. 12. Acquisition is a good entry mode when the industry to be entered is well established with high barriers to entry. The greater the barriers to entry the more likely it is that acquisitions will be the favored entry mode.

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Disadvantages of Acquisitions
There are some drawbacks to the use of acquisition which have a high failure rate and often dissipate value instead of creating it. A challenge for acquiring firms is to smooth postacquisition integration of the two companies. Unanticipated problems often occur when an attempt is made to marry two divergent corporate cultures. This can lead to high management turnover and can depress profitability. Another challenge is that companies often overestimate the potential for creating value by joining together different businesses. They overestimate the strategic advantages of the acquisition and thus overpay for the target company. `Richard Roll attributes this top management hubris. Another drawback relates to the price of acquisitions which tend to be very expensive. Stockholders of the target company do not want to sell unless they are offered a premium price. In addition several bidders are sometimes pursuing the same target company bidding up the price to result in a typical increase in market value of 40 to 80 %. Another drawback is that when firms overpay for the acquisition the resulting debt can depress company profits Yet another drawback is that many companies make acquisition decision without thoroughly analyzing the potential benefits and costs. As a consequence after the acquisition is complete, many acquiring companies find that they have purchased a troubled organization instead of a well-run business.

Guidelines to reduce risk of Acquisition

To avoid the above pitfalls, managers can follow a number of guidelines to reduce the risk of acquisition failure. Thorough screening of acquisition targets leads to a more realistic assessment of the costs and benefits of an acquisition. a) The company should begin with an assessment of the strategic rationale for the acquisition and identify the types of companies that would make good candidates. b) Next, the company should scan the target population, assessing such items as finances, management capabilities and corporate culture.

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c) Then, favorable targets should be identified and evaluated more thoroughly. This may involve talking to third parties as well as performing a detailed audit, if the acquisition is a friendly one. 13. Good bidding strategy help to reduce risk because it can reduce the price of an acquisition. a) Friendly takeovers are more likely to have a favorable price. b) The timing of the acquisition is also important. Essentially sound businesses that are suffering from short-term or localized problems are usually undervalued. 14. Taking positive steps to quickly integrate the acquired business into the companys organizational structure is also key to an acquisitions success. a) Integration should focus on the source of the expected competitive advantages b) Integration should be accompanied by eliminating of any duplication of assets or functions 15. Acquirers should also take steps to learn from previous experience with acquisitions.

8. Entry Strategy: Joint Ventures

f) Joint ventures are used as a diversification mode less frequently than are internal new ventures and acquisitions. g) Joint venture is an appropriate strategy to use for several reasons. 1. Joint ventures are particularly appealing when a firm wishes to enter an embryonic or emerging market, but hesitates to commit the resources. Joint ventures allow two or more companies to share the risks of a new business. 2. Companies use joint ventures when they possess some of the skills and assets needed by the new business, but not all. They can team up with a firm complementary skills to increase the probability of success. h) There are some drawbacks to the use of joint ventures. 1. Although a joint venture allows a company to share the risks and costs of developing a new business, it also means that it must share the profits if the new business is successful. 2. By definition in the case of a joint venture control must be shared with the venture partner. This can lead to substantial problems if the two companies have different business philosophies, time horizons, or investment preferences. Conflicts over how to run the joint venture can tear it apart and result in business failure.

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3. When a company enters into a joint venture , it always runs the risk of giving way critical know-how to its joint-venture partner. 9. Restructuring i) Restructuring or strategies for reducing the scope of the company by existing from business areas, is the opposite of diversification which increase scope. j) Restructuring is becoming increasingly popular among firms that diversified in the 1980s and 1990s. k) Restructuring occurs in response to several factors. 1. In recent years investors have assigned a diversification discount to highly diversified companies, meaning that their stock was undervalued as compared to the stock of less diversified firms. a) Investors are deterred by the complexity and lack of transparency in the financial statements of highly diversified firms, leading to an increased risk for the investment b) Investors have learned from experience that many companies overdiversify, or diversify for the wrong reasons, leading to lower profitability. c) Therefore companies have restructured in order to split the company and increase returns to shareholders. 2. Restructuring can be a response to failed acquisitions. 3. Due to innovations in management processes and strategies the advantages of being vertically integrated or diversified have diminished and so companies are restructuring. l) Companies use a variety of strategies to implement restructuring that is to exit a business. Divestment strategies

1. Divestment is the best way for a company to recoup as much of its

initial investment in a business as possible. The idea is to sell the business to the highest bidder. There are three types of buyers. a) Selling a business to independent investors is referred to as a spinoff. A spinoff makes good sense when the unit to be sold is profitable and the stock market is looking for new stock issues. b) Selling off a unit to another company is another strategy. The buyer is often a competitor in the same line of business. In such cases the purchaser may pay a considerable amount of money for the opportunity to substantially increase the size of its business immediately.

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c) Selling off a unit to its management is normally referred to as

management buyout (MOB). In an MOB management finances the purchase through the sale of high-yield bonds to investors. In recent years the lack of investors interested in high-yield , highrisk bonds (also called junk bonds), has made it difficult to carry out any MOBs.

Harvest Strategies 2. A harvest strategy is implemented when a company ceases investment

in a business, but continues to harvest profits from it for as long as possible. a) Although this strategy sounds nice in theory it is often a poor one to pursue in practice because the morale of the units employees as well as the confidence of the businesss customers and suppliers in its continuing operation can all decline rapidly once it becomes apparent that the business is pursuing a harvest strategy. b) Therefore the rapid decline in the businesss revenues can make the strategy untenable. The strategy is thus much less desirable than a divestment strategy. 3. A liquidation strategy requires a company to cease operations in that business and sell its assets. Liquidation Strategy a) A liquidation strategy is the least attractive of all to pursue because the company has to write off its investment in a business unit often at a considerable cost. b) Liquidation is much less desirable than either a divestment or a harvest strategy c) More information about harvest and liquidation strategies is available in chapter 6, in the final section that discusses strategies for declining industries.

Chapter 10 Corporate Strategy : Diversification, Acquisitions, and Internal New Ventures 1. Overview

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This chapter is the second chapter that deals with corporate strategy and focuses on diversification, the process of adding new business to the company that are distinct from its established operations. Thus, a diversified company is involved in two or more distinct business. Another focus is on the execution of a diversification strategy . This might take place through internal new venturing, which is starting a business from scratch, acquisition or buying an existing business and joint ventures established with the help of a partner. A third topic is restructuring the opposite of diversification, in which a company reduces the scope of its operations by existing industries.

2. Expanding Beyond a Single Industry Corporate-level managers identify which industries a company should compete in to maximize long-run profitability.

Advantages of a single business - Often it is better to compete within a single industry a) One advantage of a single business corporation is the ability to focus more resources and attention on that one area. b) Another advantage is that a firm sticks with what it knows and does best and does not risk making the mistake of moving into areas in which it has no distinctive competencies. - These are also disadvantages to a single business strategy

Disadvantages of a single business a) One disadvantage is the increased risk that comes from tying corporate profitability to just one industry. b) Another disadvantage is that a firm may miss out on opportunities to further leverage its distinctive competencies

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A company as Portifolio of distinctive Competencies One model of a corporation looks at the firm as a portfolio of distinctive competencies, rather than a portfolio of products. Managers can then consider how to leverage those competencies. Hamel and Prahalad claim that once a firm has identified its current competencies it should use a matrix such as the one presented in Figure 10.1 to establish an agenda for building and leveraging competencies to create new business.

Figure 10.1 Establishing a Competency Agenda Industry New Mega-opportunities

Existing

Premier plus 10

Mega-opportunities What new competencies will we need to build to participate in the most exciting industries of the future?

New

What new competencies will we need to build to protect and extend our franchise in current industries?

Competence
Fill in the blanks

Existing

What is the opportunity to improve our position in existing industries and better leverage our existing competencies

White space What new products or services could we create by creatively redeploying or recombining our current competencies

The lower left corner of the matrix represents the companys current portifolio of competencies. This quadrant is called fill-in-the blanks because the recommended strategy here is to transfer existing competencies in order to improve its position in existing industries

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Premier + 10 The upper left matrix quadrant is called premier plus 10 to suggest that managers must be building new competencies today to ensure that the firm is a premier provider ten years from now.

White Space The lower left quadrant is white spaces and it indicates the firms search for new industries where its existing distinctive competencies could be deployed through diversification.

Mega Opportunities The upper left quadrant is referred to as megaopportunities and it represents opportunities for entry into new industries where the company currently has none of the required competencies. Use of this matrix helps managers think strategically about competencies and industries as they change over time. Managers who use this matrix will be unlikely to enter new markets where they do not have a competitive advantage.

Multi business model Companies that wish to expand beyond a single industry must develop their business model at two levels. - First, they must develop a business model for each industry in which they plan to compete. - Then the company must develop a higher-level multibusiness model that justifies entry into different industries in terms of profitability. This model should describe how the firm plans to leverage its distinctive competencies across industries. The model must also describe how the business and corporate strategies boost profitability.

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3. Increasing Profitability Through Diversification Diversification is the process of adding new business to the company that are distinct from its established operations. Thus, a diversified company is involved in two or more distinct businesses. To increase profitability diversification should allow the company to lower costs, differentiate its products, or better manage industry rivalry. When the firm is generating free cash flow that is profits about the level necessary to meet current expenses and obligations, the firms managers may choose to return dividends to shareholders or to invest the cash in diversification. For diversification to make economic sense the expected return on invested capital (ROIC) from the diversification must exceed the returns shareholders could realize through investing that capital in a diversified investment portfolio

Transferring and leveraging Competence One way that firms use diversification to boost profitability is through their ability to transfer their existing distinctive competencies to an existing business in another industry. The transfer must involve competencies that are important for competitive advantage in that business.

Figure 10.2 Transfer of Competencies at Phillip Morris Tobacco Industry Research And development Marketing And sales Customer Service 165

Production

Transfer of competency

Brewing Industry Research And development Production Marketing And sales Customer service

Another way of boosting profitability requires that the company leverage its existing distinctive competencies by using them to create a new business in a different industry. a) Leveraging competencies involves creation of a new business, whereas transferring competencies involves an existing business. This distinction is important because the two different situations require the use of different managerial skills. b) Companies that leverage competencies tend to use R&D skills to build a new venture in a technology related industry, whereas companies companies that transfer competencies tend to acquire established businesses. Sharing Resources (Economies of Scope) Another way to use diversification to increase profitability is through sharing resources across multiple businesses in order to obtain cost reductions. This sharing is called economies of scope. a) Economies of scope occur because each business can invest less in the shared resource than in resources that are not shared. Figure 10.3 Sharing Resources at Procter & Gamble

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Disposable Diapers

Research And development

Production

Marketing And sales

Customer service

shared Research And development

shared Marketing And sales

Production

Customer Service

b) Economies of scale generate economies of scope because resource sharing allows the company to use the resource more intensively. c) Economies of scope are obtained only when there is significant commonality between one or more value creation functions in the two businesses. d) Also managers must weigh the benefits obtained by resource sharing against the increased bureaucratic costs of doing so. - Diversification can also boost profitability by enabling the company to better manage rivalry through the use of multipoint competition.

Expecting General Organisational Competencies a) Multipoint competition occurs when two companies rival each

Expecting General Organisational Competencies -

other in more than one industry. b) The threat of increasing competitive rivalry in one industry can keep a competitor from entering another industry or can cause the competitor to lessen the intensity of competitive pressure.

A final way that profitability can increase due to diversification is through the improved use of general organizational

167

a)

b)

c) 1)

2) 3) 4) -

1) 2)

3)

4)

competencies, that is corporate-level competencies that transcend individual functions or business. General organizational competencies require the use of rare managerial skills and are difficult to develop and implement. One general organizational competency is an intrepreneurial capacity, which allows managers to recognize and develop new businesses internally. Companies with this competency are skilled at encouraging risk taking while also limiting the amount of risk undertaken. Another general organizational competency is the ability to develop effective organization structure and controls. Effective structure and controls encourage business-level managers to maximize efficiency and effectiveness, increasing profitability. Companies with effective structure and controls tend to use self-contained business divisions ,ZBC, ZESA and ZSR Companies with effective structure and controls tend to be decentralized. Companies with effective structure and controls tend to link pay to performance. d) Another general organizational competency is a superior strategic capability such that top managers have good governance skills and can effectively manage the firms business-level managers. One aspect of superior strategic capability is a flair for entrepreneurship. Superior strategic capability also express itself in an ability to recognize ways to improve the performance of individuals, functions and businesses. Another aspect of effective governance is the ability to diagnose the real source of problems and then to know the appropriate steps to take to fix those problems. Superior strategic capability is at work when a diversified company acquires a new business and then restructure s it to improve performance.

4. Types of Diversification

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Related diversification moves the company into a new activity that is linked to its existing activity by a commonality between value chain activities. - Typically the commonality lies in the manufacturing, marketing and technology functions. - Typically firms pursuing a strategy of related diversification expect to benefit from transferring and leveraging competencies and from sharing resources. - Also, companies pursuing a strategy of related diversification are likely to encounter their rivals in several related industries and thus are likely to benefit from managing that rivalry through multipoint competition. - Unrelated diversification moves the company into a new activity that has no obvious commonalities with any of the companys existing activities. - Typically firms expect to benefit from unrelated diversification through the exploitation of general organizational competencies. - Typically firms pursuing unrelated diversification are unlikely to meet their rivals in more than one industry, and thus are unlikely to benefit from managing rivalry through multipoint competition

1. The Limits of Diversification

Diversification in many cases can dissipate value instead of creating it. - Although related diversification has more ways to increase profitability and seems to involve fewer risks research has shown that related firms achieve profits that are only slightly higher than unrelated firms. - Firms that are extensively diversified with many businesses tend to be less profitable. - A study by Michel Porter found that over time companies divested many more of their acquisitions than they kept. One reason for the failure of diversification to achieve its goals is that the bureaucratic costs of diversification exceed the value created by it. - The level of bureaucratic costs is a function of a number of businesses in a companys portfolio a) The greater the number of businesses the more difficult it is for managers to remain informed about the complexities of each business. They simply do not have the time to process all the information.

169

Therefore corporate-level managers end up making important decisions based on a superficial analysis of each business. Corporate managers lack of familiarity with operations increases the probability that business-level managers will be able to distort information provided to those at the corporate level.

Figure 10.4 Coordination Among Related Business Units

b) Thus information overload can result in substantial inefficiencies within extensively diversified companies. c) In order to overcome information overload some corporate managers limit the extent of diversification at their firms. - Another source of bureaucratic costs is the coordination required to realize value from transferring competencies and resource sharing.

Head Office

Household products

Marketing and sales

Packaged and food products

Customer

a) Bureaucratic costs arise from an inability to identify the unique

profit contribution of a business unit that is sharing resources and functions with another unit. b) This problem can be resolved if corpoprate management directly audits both divisions however doing so requires both time and effort from corporate managers.

170

c) The accountability problem is far more serious at companies that are extensively diversified. Information overload occurs and corporate management effectively loses control of the company. - Thus bureaucratic costs, which increase as a function of the number of businesses and the extent of resource sharing place limit on the value created by diversification. If a company continues to diversify after the point at which costs exceed benefits, profitability will decline. Then divestment is the best solution.

Related or unrelated Diversification

Another reason that companies fail to realize the expected benefits of a diversification is that companies make an inappropriate choice between related and unrelated diversification. - Although the ways that related diversified companies can create value are more numerous, the bureaucratic costs of a related diversification strategy are higher than those of an unrelated strategy. Thus related firms may be more profitable than unrelated firms. - Related diversification should be chosen when the firms distinctive competencies in its core business have commonalities with the competencies required to compete in other businesses and when the bureaucratic costs of implementation do not exceed the value created through resource sharing ZBC - A company should pursue unrelated diversification when its distinctive competencies are highly specialized and have few applications outside the core business when top management possesses super strategic capabilities and when the bureaucratic costs of implementation do not exceed the value created through restructuring.

Diversification that dispates value

Another reason for the failure of diversification strategy to meet its objectives is that many companies diversify for the wrong reasons and end up dissipating value rather than creating it. - One inappropriate reason for diversification is to pool risk. Risk pooling is said to create a more stable income stream reducing the risk of bankruptcy which is in the best interests of stockholders. However this argument ignores two facts.

171

1) Stockholders can easily eliminate the risks inherent in holding

an individual stock by diversifying their own portfolios and they can do so at a much lower cost than the company can 2) Research shows that corporate diversification is not a very effective way to pool risks. The business cycles of different industries are not easy to predict and in any case tend to be a less important influence on share price than a general economic downturn which hits all industries simultaneously. A second inappropriate reason to diversify is to achieve greater growth. Such diversification is not a coherent strategy because growth on its own does not create value, despite the fact that empire-building top executives sometimes pursue growth for its own sake.

6. Entry Strategy : Internal New Ventures Internal new venturing is one method that companies can use to execute a corporate-level diversification strategy. Internal new venturing is an appropriate strategy to use for several reasons Internal new venturing is used when a company possesses a set of valuable competencies in its existing businesses that can be leveraged or recombined to enter the new business area. Science based companies that use their technology to create market opportunities in related areas tend to favor new internal venturing. Even if it lacks the competencies required to compete in a new business area, a company may use internal new venturing to entry a newly emerging or embryonic industry where there are no established players that possess the competencies required to compete in that industry. Thus internal new venturing is the only option. There are some drawbacks to the use of internal new ventures, which have a very high failure rate. Scale of entry

172

Large-scale entry into a new business is more likely to be successful than is small-scale entry, because it entails greater short-term costs but gives greater returns in the long run. This is due to the greater economies of scale, brand loyalty and access to distribution channels that large firms enjoy. The effect is specially noticeable when a firm is entering an established industry with powerful incumbents.

Figure 10.5 Scale of Entry, Profitability, and Cash Flow (+) Large-scale entry

l-scale entry

smal

(-)

Commercialization
Another concern with internal new ventures is that a company can become blinded by the technological possibilities of a new product and fail to analyze market opportunities properly, leading to poor commercialization. Successful commercialization requires that there be a market demand for the technology.

173

Poor Implementation
Internal new ventures can also fail due to a poor implementation. Common mistakes here include pursuit of too many ventures at once leading to strained resources, failure to ensure the strategic value of the venture beforehand, and failure to anticipate the tieand-cost demands- leading to an unrealistic profit expectation.

Guidelines for Successful Internal new ventures

To avoid the above pitfalls, managers can follow a number of guidelines to reduce the risk of new venture failure. A company should use a structured approach to new venture development including both exploratory (basic) research and development research. a) Good basic research comes from strong ties to university research communities and from giving researchers enough resources to pursue blue-sky projects of their own choosing. b) However basic research alone will not lead a successful commercial venture. c) Good development research also requires resources to be given to business-level managers who are ideally situated to recognize commercially viable technologies. d) Good development research also requires communicating company strategies and goals to researchers so that their research will be relevant to those goals. Another way to increase the probability of new venture success is to foster close links between R&D and marketing and R&D and manufacturing. a) Project teams with members from the various functional areas are an effective way to foster close links. b) These teams can also significanlty reduce product development time. Another strategy is to devise a selection process for choosing only the ventures that demonstrate the greatest probability of commercial success. To ensure success, managers must also monitor the new venture closely focusing on market share rather than on profit goals for the first few years. Large market facilities economies of scale and learning effects which will ultimately lead to superior profitability.

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Finally companies can help to ensure new venture success by thinking big. They should look for products that have high potential demand, construct efficient-scale manufacturing plants ahead of need, and spend generously on marketing. These steps will help to lead to high market share and profitability.

2. Entry Strategy: Acquisitions Acquisitions are the main strategy for implementing horizontal integration and they are also used in vertical integration and diversification strategies.

Advantages of Acquisitions
Acquisition is an appropriate strategy to use for several reasons. A company ca use acquisition to enter a new business area when they lack important competencies required in that area, and they can purchase an incumbent company that has those competencies at a reasonable price. Acquisition is a quick way to establish a significant market presence and generate profitability. Acquisitions are perceived to be somewhat less risky than internal new ventures because they involve less uncertainty. When a company makes an acquisition it is acquiring known profitability, revenues and market share thus it reduces uncertainty. Acquisition is a good entry mode when the industry to be entered is well established with high barriers to entry. The greater the barriers to entry the more likely it is that acquisitions will be the favored entry mode.

Disadvantages of Acquisitions
There are some drawbacks to the use of acquisition which have a high failure rate and often dissipate value instead of creating it. A challenge for acquiring firms is to smooth postacquisition integration of the two companies. Unanticipated problems often occur when an attempt is made to marry two divergent corporate cultures. This can lead to high management turnover and can depress profitability.

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Another challenge is that companies often overestimate the potential for creating value by joining together different businesses. They overestimate the strategic advantages of the acquisition and thus overpay for the target company. `Richard Roll attributes this top management hubris. Another drawback relates to the price of acquisitions which tend to be very expensive. Stockholders of the target company do not want to sell unless they are offered a premium price. In addition several bidders are sometimes pursuing the same target company bidding up the price to result in a typical increase in market value of 40 to 80 %. Another drawback is that when firms overpay for the acquisition the resulting debt can depress company profits Yet another drawback is that many companies make acquisition decision without thoroughly analyzing the potential benefits and costs. As a consequence after the acquisition is complete, many acquiring companies find that they have purchased a troubled organization instead of a well-run business.

Guidelines to reduce risk of Acquisition

To avoid the above pitfalls, managers can follow a number of guidelines to reduce the risk of acquisition failure. Thorough screening of acquisition targets leads to a more realistic assessment of the costs and benefits of an acquisition. a) The company should begin with an assessment of the strategic rationale for the acquisition and identify the types of companies that would make good candidates. b) Next, the company should scan the target population, assessing such items as finances, management capabilities and corporate culture. c) Then, favorable targets should be identified and evaluated more thoroughly. This may involve talking to third parties as well as performing a detailed audit, if the acquisition is a friendly one. Good bidding strategy help to reduce risk because it can reduce the price of an acquisition. a) Friendly takeovers are more likely to have a favorable price. b) The timing of the acquisition is also important. Essentially sound businesses that are suffering from short-term or localized problems are usually undervalued. Taking positive steps to quickly integrate the acquired business into the companys organizational structure is also key to an acquisitions success.

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a) Integration should focus on the source of the expected

competitive advantages b) Integration should be accompanied by eliminating of any duplication of assets or functions Acquirers should also take steps to learn from previous experience with acquisitions.

3. Entry Strategy: Joint Ventures

Joint ventures are used as a diversification mode less frequently than are internal new ventures and acquisitions. Joint venture is an appropriate strategy to use for several reasons. Joint ventures are particularly appealing when a firm wishes to enter an embryonic or emerging market, but hesitates to commit the resources. Joint ventures allow two or more companies to share the risks of a new business. Companies use joint ventures when they possess some of the skills and assets needed by the new business, but not all. They can team up with a firm complementary skills to increase the probability of success. There are some drawbacks to the use of joint ventures. Although a joint venture allows a company to share the risks and costs of developing a new business, it also means that it must share the profits if the new business is successful. By definition in the case of a joint venture control must be shared with the venture partner. This can lead to substantial problems if the two companies have different business philosophies, time horizons, or investment preferences. Conflicts over how to run the joint venture can tear it apart and result in business failure. When a company enters into a joint venture , it always runs the risk of giving way critical know-how to its joint-venture partner. 4. Restructuring Restructuring or strategies for reducing the scope of the company by existing from business areas, is the opposite of diversification which increase scope. Restructuring is becoming increasingly popular among firms that diversified in the 1980s and 1990s. Restructuring occurs in response to several factors.

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In recent years investors have assigned a diversification discount to highly diversified companies, meaning that their stock was undervalued as compared to the stock of less diversified firms. a) Investors are deterred by the complexity and lack of transparency in the financial statements of highly diversified firms, leading to an increased risk for the investment b) Investors have learned from experience that many companies overdiversify, or diversify for the wrong reasons, leading to lower profitability. c) Therefore companies have restructured in order to split the company and increase returns to shareholders. Restructuring can be a response to failed acquisitions. Due to innovations in management processes and strategies the advantages of being vertically integrated or diversified have diminished and so companies are restructuring. Companies use a variety of strategies to implement restructuring that is to exit a business. Divestment strategies Divestment is the best way for a company to recoup as much of its initial investment in a business as possible. The idea is to sell the business to the highest bidder. There are three types of buyers. a) Selling a business to independent investors is referred to as a spinoff. A spinoff makes good sense when the unit to be sold is profitable and the stock market is looking for new stock issues. b) Selling off a unit to another company is another strategy. The buyer is often a competitor in the same line of business. In such cases the purchaser may pay a considerable amount of money for the opportunity to substantially increase the size of its business immediately. c) Selling off a unit to its management is normally referred to as management buyout (MOB). In an MOB management finances the purchase through the sale of high-yield bonds to investors. In recent years the lack of investors interested in high-yield , highrisk bonds (also called junk bonds), has made it difficult to carry out any MOBs.

Harvest Strategies

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A harvest strategy is implemented when a company ceases investment in a business, but continues to harvest profits from it for as long as possible. a) Although this strategy sounds nice in theory it is often a poor one to pursue in practice because the morale of the units employees as well as the confidence of the businesss customers and suppliers in its continuing operation can all decline rapidly once it becomes apparent that the business is pursuing a harvest strategy. b) Therefore the rapid decline in the businesss revenues can make the strategy untenable. The strategy is thus much less desirable than a divestment strategy. A liquidation strategy requires a company to cease operations in that business and sell its assets. Liquidation Strategy a) A liquidation strategy is the least attractive of all to pursue because the company has to write off its investment in a business unit often at a considerable cost. b) Liquidation is much less desirable than either a divestment or a harvest strategy c) More information about harvest and liquidation strategies is available in chapter 6, in the final section that discusses strategies for declining industries.

Chapter 12 Implementing Strategy in Companies That Compete in a Single Industry 1. Overview A well thought-out strategy can lead to success only if it is properly implemented, thus the study of implementation is critical to an understanding of strategy. This chapter introduces concepts related to implementation with a focus on functional and business-level strategy implementation. Strategy implementation refers to the ways a firm creates, uses and combines organizational structure, control systems and culture

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2.

to pursue strategies that lead to a competitive advantage and superior performance. Implementing Strategy Through Organizational Structure, Control and Culture. The first component of strategy implementation is organizational structure, which assigns employees to specific tasks and specifies how those tasks link together to realize a competitive advantage. The purpose of organizational structure is to coordinate and integrate the efforts of all employees at the corporate , business and functional levels and across functions and business units, so that they work together to help the firm achieve its strategies successfully. Another component of implementation is a strategic control system which provides the incentives that motivate employees to help the firm achieve its strategies. Control system also provide performance feedback to managers so that corrective action can be taken if needed. Organizational culture is another important component of strategy implementation and it consists of the values, norms, beliefs and attitudes that are shared by people in an organization. Culture guides the way that employees interact with each other and with stakeholders outside the organization, and thus will have an important impact on the implementation of an organizations strategies.

Figure 12.1 Implementing Strategy Organisational Structure To achieve superior: Strategic control systems
Coordinate and motivate employees

Efficiency Quality Innovation Responsiveness to customers 180

Organisational culture

3.

Building Blocks of Organizational Structure One issue that managers must address as they design an organizational structure that will aid in accomplishing the firms strategic goals is the grouping of items. Tasks must be grouped into functions and functions grouped into divisions or business. The tasks an organization must perform are based on its strategy and therefore an organizations structure tends to match its strategy. Tasks must be grouped into functions, which are collection of people who work together and perform the same types of work or holds similar positions. Functions are designed to minimize bureaucratic costs - the costs of operating an organizational structure. Functions then are grouped into divisions.

Allocating Authority and Responsibility One important characteristic of organizational structure is the way in which it allocates authority and responsibility. - The hierarchy of authority refers to the organizations chain of command extending from the CEO down to the lowest-level employees. - Every manager at every level supervises some number of employees which is called the span of control. - Managers decide how many levels to have in the organizational chain of command. Organizations with many levels are called tall because of the long and vertical appearance of their organization charts. Organizations with few levels are called flat

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Figure: 12.2 Tall and Flat Structures

1 2 3 4 5 6 7 8 Tall Structure (8 levels) 1

2 3 Flat Structure (3 levels)

As companies grow taller problems may arise. a) Communication problems are prevalent in tall organizations because the long delays that occur as messages move up and down numerous levels can lead to confusion. b) Another reason for communication problems is that the large number of levels leads to differing perceptions of the meaning of the messages. c) Another problem is that a tall organization has more managers and managers are very expensive - To avoid these problems, managers should follow the principle of the minimum chain of command that is they should use the minimum number of hierarchical levels required for implementing a strategy successfully. Too many levels in the hierarchy cause a variety of problems. Centralisation or Decentralisation

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a)

b) c)

a) b) c)

Decentralization of decision-making authority is one tactic for overcoming the disadvantages associated with a tall organizational structure. Decentralization delegates authority to lower-level employees. Decentralization reduces information overload because managers spend time making only those decisions that must be made at their organizational level. Decentralization gives lower level employees autonomy, increasing flexibility, motivation and accountability. Decentralization reduces the need for expensive, high-level managers, because lower level employees can make their own decisions with little supervision. On the other hand , centralization also offers some advantages. Therefore organizations balance the advantages and disadvantages of differing levels of centralization as they design their organizational structure. Centralization implies a coordinated strategy and quicker decision making when needed. Centralization ensures that decisions reflect the organizations overall strategy. Centralization fosters strong leadership because authority is centered on one person or group.

Integration and Integrating mechanisms In large complex organizations, coordination through the hierarchy of command isnt enough and organizations turn to other integrating mechanisms. Companies can choose from various integrating mechanisms to increase coordination and communication. These mechanisms fall on a continuum from single to complex. In general the more complex the organization the more need for complex forms of integration. Direct Contact Direct contact is a simple integrating mechanism that asks managers in different functions to wok together to solve mutual problems. However when managers in different

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functions disagree it is hard to achieve coordination because they all have equal authority. Liason Role When the volume of contacts between two departments increases one person in each department is given responsibility of coordinating activities between the two. This is called interdepartmental liason roles. They meet to solve problems and then feed the outcomes of their discussion back to their respective departments. When two or more functions share many common on-going problems a permanent integrating mechanism is needed such as a team. A team consists of members who are managers of the various function and they meet to make decisions jointly.

Teams -

4. Strategic Control Systems After managers establish an organisations strategy and structure then they turn their attention to ensuring that the strategy and structure are in fact achieving the desired results. Strategic control systems provide the means by which a company monitors, evaluates, and changes the performance of its various functions and divisions. Strategic control is not just about current performance, it also means keeping an organization on track and future focused. Strategic control is important because it helps managers achieve efficiency, quality, innovation and responsiveness to customers. Strategic control systems consist of target setting , monitoring and feed back mechanisms, and the process contains four steps.

Figure 12.3 Steps in Designing an Effective Control System

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Established standards and targets

Create measuring and monitoring systems

Compare actual performance against the established targets Evaluate result and take action if necessary Step 1 is to establish the standards against which performance is to be evaluated. Standards express the way the company chooses to evaluate its performance they are generally derived from its strategy. - Step 2 requires managers to create the measuring and monitoring systems that indicate whether or not the targets are being achieved . This can be a complex task because many activities are difficult to evaluate. - Step 3 managers compare actual performance against the established targets. If performance is lower then expected it is often difficult to explain why. - Step 4 is about initiating corrective action when it is decided that the standards and targets are not being achieved. Appropriate corrections depend upon an appropriate diagnosis. Control systems are used to measure performance at all levels in the organization corporate, divisional, functional and individual levels. Care must be taken to ensure that the controls used at different levels are compatible. -

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Figure 12.4 Levels of Organizational Control Board of Directors (set controls which provide context for)

Corporate-level managers (set control which provide context for) Divisional-level managers (set controls which provide context for) Functional-level managers (set controls which provide context for)

First-Level managers Types of Strategic Control Systems There are seven types of strategic controls - One type is the balanced scorecard approach which was discussed in Chapter 11.

Personal Control Another type of control is personal control in which superiors or peers interact face-to-face with an employee, influencing the employees behavior.

.Output Control A third type control is output control, which is used when a company forecasts performance goals and then monitors goal achievement . Output control is used at all levels of the organization.

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a) At the divisional level, challenging goals are set for efficiency, quality, innovation and responsiveness to customers b) At the functional level, goal are set for functional managers to develop skills leading to competitive advantage in support of divisional goals. c) Employees are given individual goals that support the achievement of divisional and functional goals. d) Output controls must be used carefully because they can encourage conflict between units, as well as provide an incentive for dishonesty. 3. Behavioral Control A fourth type of control is behavior control, which establishes rules and procedures to guide individual action. Rules specify how things are to be done and thus standardize behavior so that the result is predictable. a) Operating budgets are one type of behavior control. They specify the amount of resources available to achieve goals. Managers decide how to allocate the funds across the various activities. Performance is then measured by looking at profits relative to resources. b) Standardization is also a very important means of behavior control. 1) Inputs can be standardized by screening them so that only high-quality inputs enter the company. 2) Conversion activities are standardized so that tasks are done in the same way time and time again. This improves predictability. 3) Organizational outputs are standardized by specifying performance characteristics of the final product. Only goods and services that meet these criteria are allowed to leave the organization. c) Managers must periodically review behavior controls to ensure they are still effective. Companies tend to accumulate rules over time, reducing flexibility and ultimately reducing effectiveness. -

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4.

Using Information Technology Information technology (IT) is playing an increasing role in strategy implementation at many firms. - ITs ability to provide better and faster information aids managers as they use control systems. - IT can provide standardization, which can be used to control behavior or to perform output control. - IT is an integration mechanism, because of information sharing.

5.

Strategic Rewards System Linking reward systems to control systems facilities control. - Managers must decide what behaviors to reward and then link one of the control systems to the reward system. - The design of the organizations incentive system is crucial because it motivates and reinforces desired behaviors. It helps overcome the agency problem and align the interests of shareholders, managers, and employees at other levels in the organization. - Typically companies use some combination of base pay and stock options.

6.

Organizational Culture Another factor in successful strategy implementation is Organizational Culture, the values and norms shared by people and groups in an organization. Organizational values are beliefs about what kinds of goals members of an organization should pursue and about the appropriate standards of behavior organizational members should use. Based on their values, organizations develop organizational norms, that is expectations that prescribe appropriate behavior. Managers use organizational culture as a strategic control when they develop and nurture values that support employees in achieving the organizations objectives. Because different

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organizations have different goals they also have different cultures. Employees learn organizational culture through a process called socialization. - Culture is transmitted to organizational members through stories, myths, and language people use in an organizational setting - Once an employee is socialized into an organizations culture they will behave appropriately without much conscious thought. Thus culture is a very powerful form of control. The values of an organizations culture are strongly influenced by the values of its founder and top managers. People often are attracted to a company because they share its founders values and many organizations select only such people for employment. Hence the cultures of different organizations tend to become more distinct and different over time. Organizational structure also affects organizational culture. The way an organization designs its structure affects the cultural norms and values that develop within the organization. Adaptive culture are those that are innovative and encourage initiative taking by middle-and lower-level managers. Inert cultures are those that are more cautious and conservative and do not value initiative and innovation as highly . - Organizations with adaptive cultures adapt more readily to environmental changes. Adaptive cultures share several traits. a) Adaptive cultures have a bias toward action, which emphasizes autonomy and entrepreneurship and encourages people to take risks and adopt a hands-on approach. b) Adaptive cultures promote the organizations mission and protect the source of its competitive advantage. Companies should stick to what they do best and stay close to their customers. This is called stick to the knitting. c) Adaptive cultures help organizations improve the way they operate. They help to motivate employees, increase coordination and integration and reward employees for good performance.

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6. Building Distinctive Competencies at the Functional Level There are three important components of implementing strategy at the functional level.

Functional Structure Organizational structure is an important component of implementing strategy at the functional level. a) As the organization grows the range of value chain activities to be performed expands. It becomes clear that each person can only effectively perform one value chain activity. b) A functional organizational structure groups people together if they perform similar tasks or if they use the same skills or equipment. Figure 12.5 Functional Structure CEO

Research and Sales and Materials development marketing Manufacturing management Engineering c.The functional structure has several advantages for organizational structure. 1. When people who perform similar tasks are grouped together they can learn from one another and become more expert and specialized. 2. They can also monitor one another and prevent shirking by other team members. 3. Because there are many different functional hierarchies (one in production, one in finance and so on) there is more control in the structure.

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Strategic control has an important role in managing an organization with a functional structure. A .Strategic control helps managers to set ambitious goals and then encourages employees to meet those goals. B .Strategic control enables organizational learning as employees and their superiors work closely together. c. Output control is easy with a functional structure because each function can clearly see its contribution to the performance of the organization. d. Strategic control facilitates implementation of a fair , objective system of rewards. e. Functional structures make it easy to build a cohesive culture, which also supports effective control.
Even large companies usually retain some elements of a functional structure because of its benefits but a functional structure does entail some bureaucratic costs. - Functions can become increasingly remote from one another because they each develop a unique perspective over time leading to communication problems. - As the number of its products grows a company struggles to measure the contribution of one product to overall profitability - Growth in products also causes interaction with more varied types of customers. Firms have a difficult time coping with the expanded product range that results. - A functional structure is too centralized for controlling production or sales in many different regions because managers cannot be sensitive to the needs of their diverse customers. - Finally as managers spend more and more time and resources coping with the above problems, long-term strategic considerations may be ignored. If a firm is growing too complex to use an exclusively functional structure, one way that the firm may respond is to switch to the use of outsourcing in one or more functions. - A firm should not outsource in an area in which it has an important distinctive competency. - However use of outsourcing can free up managerial and other resources to focus on the truly important functions.

6. Implementing Strategy in a Single Industry

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To pursue its business-level strategy successfully, managers must find the right combination of structure, control and culture that links and combines the competencies in a companys value chain functions Effective strategy implementation allows the company to be more successful in pursuing a cost leader or differentiation strategy.

Figure 12.6 How Organizational Design Increases Profitability

Economizes on bureaucratic costs

Enhances a companys Value chain competencies and capabilities

Leading to low cost structure and the ability to choose a low price option

Leading to differentiation advantages and option of charging a premium price

That leads to competitive advantage, profitability, and superior return on investment

Implementing a cost-leader approach Strategy implementation aids firms I pursuing a cost leader strategy because it can help them reduce expenses in all functions through improved coordination and control. - Managers must choose the combination of structure , control, and culture that will lead to the lowest cost. - Managers must continuously monitor their structure, control, and culture to ensure that costs are continuously driven down.

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Differentiation Approach Strategy implementation aids firms that are pursuing a differentiation strategy because it helps the company to add value and uniqueness to its products. - A differentiation strategy requires a broad product line leading to high bureaucratic costs. Thus an effective coordination mechanism is especially important. - To successfully pursue a differentiation strategy a companys functions must work cooperatively together. Behavior controls and culture are more effective than output controls in cooperative situation, because its hard to measure the relative contribution of different groups when they are cooperating. - Thus differentiators tend to have a very different culture than cost leaders. Differentiators tend to have a collegial or professional culture, based on expertise and cooperation.

Broad Product live Product structure As companies try to both increase differentiation and reduce costs simultaneously, strategy implementation becomes much more complex. This leads to new forms of structure and control systems. - To cope with the complexity of producing many products for many market segments, companies can adopt a product structure. a) To implement a product structure, a company must first group its products into categories targeted at specific groups of customers and managed by one set of managers b) Support activities from the value chain are centralized to keep costs low. However sub-groups within each function specialize in meeting the needs of a particular product group. c) The organization then develops a control system that examines each product group separately. This creates an ability to rapidly spot problem areas, and also a way to give rewards for high performance.

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d) However, rewards still are closely tied to organizational and not group , performance to ensure that managers work together across units as needed. Market Structure - Companies that are focused on meeting the needs of many different groups of customers can use the market structure. Figure 12.7 Market Structure CEO

Central support functions

Commercial

Consumer

Government

Corporate

a) To group people into units based on the customers they serve, it is first important to clearly understand the needs of each customer group. b) Employees then become close to each customer segment, while support functions are centralized.

Geographic Structure Geographic structures are appropriate for firms that are attempting to expand their geographic reach.

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a) Geographic regions become the basis for grouping organizational activities. b) Activities at the level of the region are controlled by regional managers, but there is still control by top managers at the center, as well as centralized support from the specialist functions. Matrix or Product team Companies competing in a fast-changing high tech environment can use either the matrix or the product-team structure. a) Fast-paced environments make the costs associated with lack of communication and coordination even greater. b) Often the firm must organize around the needs of the R&D function. However managers must work to ensure that the new high-tech products meet customer needs and are affordable. -

Figure 12.8 Geographic Structure

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Regional operations

Central Operations
Reg iona l Op

CEO

Regional Operations

Individual stores c) A structure that addresses these concerns is the matrix structure, in which value chain activities are grouped in two different ways at the same time.

Figure 12.9 Matrix Structure. President

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Functional managers

Engineering

Sales & marketing

Finance

Research & development

Purchasing

Project A Project B
Project

C Project C 1) Activities are grouped by function to obtain the advantages of a functional structure 2) Activities are also grouped by product, to obtain those advantages. This results in a complex design of reporting relationships. 3) The matrix structure is very flat because above the functional bosses and the project bosses there is only the CEO. Mid-and-lower-level managers and employees report to two bosses both the functional boss and the project boss. The bosses are responsible for maintaining coordination between the functions and projects. 4) A matrix structure has the advantage of strong cross-functional integration which improves the organizations speed and flexibility on dealing with change. 5) In the matrix structure, hierarchical control is minimal and employees are expected to coordinate their own activities to get the work done. Matrix structure also allow team members to join and then leave to join other teams as their skills are needed.

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Well-thought-out matrix structures can free managers from spending lots of time on operating matters, as employees and teams are self-directed to a great extent. An effective implementation of the matrix structure requires a culture based on innovation and quality. A disadvantage of the matrix structure is the time and effort that it spent just formulating the teams and getting them started on their tasks. Another disadvantage is the conflict that can occur between the two bosses the project manager and the functional manager due to different goals. The former seek cost reduction, the latter seek improved quality. Another disadvantage is the difficulty in monitoring ever-changing teams in which each worker is reporting to two bosses. Product Team Structures Companies may also use the product-team structure in high-tech environments.

Figure 12.10 Product-Team Structure. CEO

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Research & development

Sales & marketing

Materials management

Engineering

Product teams

Manufacturing Units 1 .The product-team structure is very similar to the matrix structure except that the teams are permanent rather than the temporary teams of the matrix design. 2 .Product teams are formed at the beginning of the process, so that every function is involved in a project from the start. 3. Product teams also have decentralized authority and are ultimately responsible for new product development. 4. Product teams differ from the product structure, because support functions are not centralized but are distributed to each team. 5. The costs of coordinating the teams activities are lower in a product team than in a matrix structure, but a company still obtains the gains from close cooperation across functional boundaries. Companies that compete with a focus strategy often use a functional structure which both increases differentiation and reduces costs. -Focusers tend to be smaller firms, and therefore the functional structure which both increases differentiation and reduces costs. -A functional structure is also very flexible, which is important to focusers who must adapt to customers constantly-changing requirements. 7. Restructuring and Reengineering

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To improve corporate performance, a single business firm can use restructuring and reengineering. Restructuring involves reducing the number of levels in the organizational hierarchy (flattening in the organization) and downsizing the workforce. These measures are implemented to reduce costs. There are valid reasons for restructuring, however many times restructuring occurs because firms have not made incremental changes as they were needed, and so a radical readjustment is called for. Another way to improve corporate performance is through the use of reengineering which is a radical rethinking and redesign of a firms business processes. Note that reengineering focuses on processes not on functions. A business process is any activity that is vital to competitive advantage and involves several functions simultaneously. Firms that are reengineering ignore their traditional tasks, functions, groupings and so on. Instead they look at what they do from a customers point of view and attempt to maximize the value the customer receives from the organization Reengineering is compatible with and complementary to, TQM. Firms often use both together to first redesign processes and then to further refine the processes and improve quality. Advances in information technology that have led to more and better quality information help firms reengineer.

Chapter 13 Implementing Strategy in Companies That Compete Across Industries and Countries. 1. Overview This chapter addresses issues of implementing strategy in multibusiness organizations, which in some cases, are extensions of concepts explored in Chapter 12 (implementation in single business firms). In other cases the increased complexity of simultaneously managing more than one business creates new concerns and issues. Managing Corporate Strategy Through the Multidivisional Structure.

2.

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Bureaucratic costs are likely to be higher in multibusiness firms than in single business ones. For multibusiness firms the multidivisional structure is superior to the functional structure for several reasons.

Figure 13.1 Multidivisional Structure CEO

Corporate headquarters staff

Oil division (Functional structure)

Pharmaceuticals division (product team structure) Plastic division (matrix structure)

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Each business unit is placed in a self-contained division and supplied with all support functions. Thus each part essentially operates separately from the other parts of the company. The office of corporate headquaters staff is created to control and oversee the divisions. Headquaters also provides corporate support functions such as a finance and R&D. Divisional mangers have operating responsibility, corporate managers have strategic responsibility. Each division is treated as a profit center and can adopt the structure and control systems that best serve its strategy.

A multidivisional structure has several advantages. Enhanced corporate financial control is one advantage of the ultidivisional structure. The profitability of the different divisions is very clear allowing the corporate staff to readily determine the best resource allocation scheme. Enhanced strategic control is another benefit because corporate staffs are freed from operating responsibilities and can concentrate on corporate strategy. The structure overcomes limits to growth because it permits the company to operate many businesses without information overload or requiring too much intervention from corporate managers. Because divisional performance has greater visibility divisional managers realize that corporate managers can detect inefficiencies and thus are motivated to perform at a higher level. Implementing a multidivisional structure has drawbacks as well and the advantages must be balanced against them. Managing the balance of power between corporate and divisional managers is difficult. The problem lies in deciding how much authority to centralize at the corporate level and how much to decentralize at the divisional level. Too much centralizing puts divisional managers in

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a straitjacket. Too much decentralizing however may cause the company to lose control over its strategy damaging corporate performance. If the corporate puts too much financial pressure on the divisions, they may be encouraged to distort the information they supply to corporate managers. For example they may pursue short-run rather than long-run profit maximization Divisions may start to compete for resources, which reduces cooperation and learning across units. When divisions are competing it is difficult to set fair prices for trading resources between them. Each division tries to set the highest price it can to maximize its own ROIC, but such efforts can hurt corporate performance and corporate ROIC. This is referred to as the transfer pricing problem. If divisions are being evaluated strictly on return on investment targets, they might cut back on R&D to improve their financial performance Each division has its own support services, which can lead to a duplication of functions and increased expenses. This is an especially critical problem in regard to highly expensive R&D. Type of Control After a company chooses a multidivisional structure, it then must ----------------------------------------------------develop the controlNeed for mechanisms Financial appropriate for that that are Corporate Appropriate Behaviour Organisational Strategystructure. The type of control mechanism that are used depends Structure Integration Control Control Culture on whether the firm is using unrelated diversification, vertical integration or related diversification. Unrelated Multidivisional Low (no Great use Some use Little use
Diversification

Table 13.1

exchanges between divisions) (scheduling Resource Transfers

(e.g ROI)

(e.g budgets)

Corporate Strategy, Structure and Control use Vertical Multidivisional Medium Great
Intergration e.g ROI, transfer pricing Little use

Great use(e.g Some use standardization shared norms budgets and values Great use e.g rules & budgets Great use norms, values common language203

Related Multidivisional High Diversification synergies Divisions by Integrating roles

Because there are no linkages between divisions, unrelated diversification is the easiest and cheapest strategy to manage, with the lowest of bureaucratic costs. a) Normally a multidivisional structure is used for this strategy and the corporate headquarters tends to be small because the need for integration among divisions is low The control used is principally financial control corporate headquarters uses measures such as ROIC as the main means of evaluating each divisions performance. They treat the corporations businesses as an investment portfolio, attempting to allocate resources so as to realize the greatest profitability Divisions are completely autonomous thus the idea of corporate culture is meaningless.

b)

c)

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Vertical integration is the next most expensive strategy to coordinate. Bureaucratic costs are higher because corporate headquarters must control sequential resource transfers from one division to the next. a) By adopting the multidivisional structure a vertically integrated company gains centralized control and corporate managers can control resource transfers between divisions Market and behavior control are also applied as the company seeks to standardize resource transfers and to use budgets as well as ROIC to evaluate divisional performance. The company also uses rules as a control mechanism In addition handling resource transfers increases the need for integration and task forces are likely to be established to guide interdivisional coordination.

b)

c)

Related diversification increases the number of linkages between divisions that have to be managed making this strategy the most expensive. a) Output control is difficult to measure due to extensive cooperation so culture control is used more frequently. b) Integration roles and teams are required to integrate the work of multiple divisions c) Reward systems must be carefully designed to ensure that managers have an incentive to share resources. Information technology helps divisions share knowledge and leverage competencies, and it facilitates strategic control by providing better more timely information. IT eases decentralization and makes it more difficult to distort information. IT eases the transfer pricing problems because it makes comparisons with external sources of inputs easier. 3. Implementing Strategy Across Countries Most large companies have a global dimension to their strategies because they sell their products in global markets There are four strategies that firms that compete in the global market can follow.

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1) A multidomestic strategy is oriented toward local responsiveness, and a company decentralizes authority to each country in which it operates, which leads to customized products for each local market. 2) In an international strategy , R&D and marketing are centralized in the home country whereas all other functions are performed locally 3) A global strategy requires centralization of all functions and thus leads to low cost Companies pursuing a transnational strategy centralize some functions and decentralize others, depending on each products and regions characteristics. As a company moves from a multidomestic, to an international, to a global and then to a transnational strategy, the need for coordination increases and companies adopt a more complex structure and more complex ways of controlling their activities. As complexity increases so too do management challenges and bureaucratic costs. To choose from the four preceding strategies a firm must answer three questions. 1) The firm must decide how to distribute authority between the home country and local operations to maintain effective control. 2) The firm must choose the organizational structure that allows the most efficient allocation of resources and the best service to customers. 3) The firm must design control systems and organizational culture to allow the structure to work effectively. When a firm chooses a multidomestic strategy, it generally chooses a global area structure. Figure 13.2 Global Area Structure Corporate Headquarters

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North American region

South American region

European region

Pacific region

1) The global area structure duplicates all its value-creation functions in every country in which it operates and establishes a foreign division in every country. 2) The need for integration is low, and control over business strategy is decentralized to these divisions 3) Managers at global headquarters use output and market control to evaluate the business units performance 4) Each region or country is virtually an autonomous operating entity and no corporate culture develops on a global level 5) A disadvantage of this choice is the probability of duplicating some expensive specialist functions. Also this strategy reduces the chances of organizationwide learning. With an international strategy a company often adopts an international division structure to coordinate and oversee their activities.

Figure 13.3 International Division Structure Corporate Headquarters

Division 1

Division 2

Division 3

International division

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United States

United kingdom

Japan

France

1.

In an international division structure the company creates an international division which is just one of the companys divisions. It handles the distribution of products to the foreign subdiaries on a country by-country basis The international division integrates between the domestic divisions and foreign subsidiaries and allows a company to engage in complex foreign operations with relatively low bureaucratic costs. Disadvantages include the potential for conflict between domestic and international managers and the resistance of foreign managers to adopting business practices that are at odds with their local cultural practices. When a global strategy is used a global product division structure is chosen.

2.

3.

Figure 13.4 Global Product Division Structure.

Corporate Headquarters 208

Product Group 1

Product Group 2

Product Group 3

United states

United Kingdom

Japan

France

1.

A product division headquarters is created to coordinate the activities of both domestic and foreign operations Product division managers coordinate all aspects of global valuecreation activities for example deciding what should be produced or designed at which global location. Each major activity is performed at only one global location Problems include a lack of local responsiveness to the needs of each country and the difficulty of integrating the activities of the different product groups A company embarking on a transnational strategy typically adopts the global matrix structure.

2.

3.

1.

One aspect of the structure is based on the companys major product groups. The second aspect is the foreign divisions in the various countries in which a company competes. Thus each worker reports to both a product boss and a regional boss.

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Figure 13.8 Global Matrix Structure

North American Product Group 1

European SBU

Pacific SBU

Product Group 2

Product Group 3

Control is decentralized but corporate managers still retain some control. Managers in the foreign subsidiary control foreign operations and are responsible for local responsiveness. 1. The global matrix strategy is best for sharing information and enabling learning. 2. A global culture is very important in helping to provide the integration that makes a matrix structure work effectively, and global networks of managers provide extra coordination

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3.

4.

One factor that is important in making the global matrix strategy work is the development of a strong cross-country organizational culture. Information technology such as teleconferencing, e-mail and global intranets is facilitating strong global cultures and easing the difficulties of worldwide coordination mechanisms.

4. Entry Mode and Implementation Over time, strategies change and corporations wish to enter new industries. One mode of entry into a new business is through internal new venturing. Internal new ventures create organizational arrangements that allow employees to be entrepreneurial. Internal entrepreneurs are called intrapreneurs. This mode of entry is often used by large established companies.

Organizations must design their structures, control mechanisms and culture to encourage innovation and risk-taking, while also ensuring that the new ventures contribute to the organizations overall strategy. a) One approach encourages researchers to spend time developing their own ideas. b) Another way is through the establishment of cross-functional teams to foster values of cooperation and innovation. c) The use of reward systems that place a high value on innovations leads to an innovative culture. d. Other organizations believe that new ventures have the highest chances for success when they are removed from the day-to-day pressures of the organization. a) This is accomplished by the creation of new-ventures divisions. The company sets up a division separate from other divisions and not subject to day-to-day scrutiny of top management and allows it to develop a culture for innovation. b) Preserving the autonomy of the new-ventures division is crucial, top management must not be allowed to put it in a straightjacket. Therefore output controls are de-emphasized while culture is used as a control mechanism instead.

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c)

Companies that follow the develop-in-place model such as 3M, have enjoyed greater success than those who created separate newventure divisions. Many of their products failed to reach market and those that did were burdened with high costs. Scientists may not be qualifies to develop successful business models because they lack training in that area. Another mode of entering a new industry is joint venturing.

Joint ventures are created when two or more companies agree to pool resources and work together. 2. Monitoring the performance of the venture is necessary for both parties and neither wants to give up any proprietary knowledge. Sometimes ownership of the new venture is split 51/49 rather than 50/5 to make it clear which company owns any new products. 3. The purpose of the joint venture (new product development, joint distribution and marketing and so on) and whether the partners are also competitors are factors that affect implementation. 4. The CEO and top managers are chosen from both firms and that team together develops a business model decides upon the organizations structure and control systems and creates a company culture. 5 .Some companies prefer to avoid the uncertainty and risk associated with joint venturing and just acquire a company that possesses the necessary skills. * Mergers and acquisitions are also used to enter new industries. 1. 2. Mergers and acquisitions have a high failure at least in part due to the lack of forethought about integration issues. One of the key challenges is to establish new lines of authority and responsibility. Managers who are dissatisfied may leave the company taking valuable expertise with them Then the new units must be integrated with the rest. The more these new businesses differ from the core business, the greater are the problems. When the company is pursuing unrelated diversification corporate managers should not make radical changes that will interfere with the performance of the new unit Companies use output and behavior controls to standardize practices across all the units, including the new ones.

3.

5.

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6.

Acquired Companies Probably Have Different Cultures So It Is Often Difficult To Integrate The New Divisions Into The Companys Existing Structure.

5. IT, the Internet and Outsourcing IT has a number of benefits that aid in strategy implementation 1) Information technology (IT) makes it easier to implement strategy because of better and more timely information and information sharing 2) IT consists of both physical systems which are relatively easy to imitate, and IT know-how which can be very hard to imitate 3) IT provides knowledge that allows managers to better differentiate their products. IT contributes to innovation by helping managers use knowledge completely. 4) IT has also affected organizational structure, aiding the development of flatter structures, greater decentralization and increased integration while reducing the organizations dependence on other, more costly forms of coordination. The enhanced capabilities of IT have led to the development of the virtual organization, composed of workers who are linked by computers, e-mail, fax and so on and who hardly ever meet face-to-face. Another major impact of IT on strategy implementation is an increased ability to outsource. IT enables outsourcing by allowing better coordination of the flow of parts and products, while also allowing better sharing of competencies such as design. One application of IT that has had a big impact on many businesses is the development of business-to-business (B2B) networks. These networks provide an online way for companies in the same industry to link with suppliers and buyers improving supply chain operations.. IT has also reduced information costs so that global strategic alliances are more attractive , in many cases than is vertical integration To implement outsourcing many firms use a network structure that is a set of strategic alliances with suppliers , manufacturers and distributors. Network structures allow many firms to cooperate, while reducing the bureaucratic costs that would be incurred if the activities occurred in one complex organization.

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Network structures lead to low costs, adaptability to change and structural flexibility

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