Evaluating Mission Statements

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Chapter 1

Strategic Management

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Learning Objectives

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By the time you have completed this chapter, you should be able to do the following:

Appreciate the complexity of strategic management and how it is critical to achieving ongoing and future corporate success. Understand the role of strategy and strategic planning in strategic management. Understand the basic framework of a strategic analysis used to determine what strategy a company should pursue. Appreciate that a corporation—or any organization—doesn't exist in a vacuum but in the context of its operating and larger environment. Appreciate that in a capitalist society with free markets, competition governs what products are produced (the ones people are willing to buy). Understand how �irms compete for customers. Understand the �ine distinction between a strategy and a business model. Get a feel for what constitutes "success" in business. Understand the range of stakeholders to whom the corporation owes some duty.

You are about to embark on a journey where you will learn what managing a large or small company is all about and how to plan and manage a company to realize its long-term vision, purpose, strategy, and objectives. To be successful, the company must continually become a stronger competitor and constantly seek new opportunities, because the world is changing rapidly. Leading and managing a company for long-term success is really what strategic management is all about.

Chapter 1 sets the stage for understanding the topic of strategic management and the key concepts that underlie it. You will need to become familiar with many new terms that are vital to understanding concepts in later chapters.

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Strategically managing a corporate business year after year is dif�icult to do, as demonstrated by corporate failures such as Enron.

Associated Press/Pat Sullivan

1.1 What Is Strategic Management?

Strategic management is nothing less than steering and managing a company to be successful over time—not just for the next quarter or year, but for the long term. It involves deciding the direction in which the company should go, what the company should produce, and hence in what industry it competes. It requires identifying who are its competitors and how it might beat them. It means knowing who its customers are and what they want. It entails determining whether it can produce the kinds of products customers want to buy, whether it has the people and organization to make it all happen, and, most important, how to make a pro�it when all is said and done.

The corporate graveyard is littered with notable failures—Enron, Pan Am, Tyco, Arthur Andersen, Circuit City, and Adelphia to name a few— demonstrating that managing strategically is very dif�icult to do year after year. And how does strategic management differ from just ordinary management? If one were suddenly called in to manage a company that continued to do what it had been doing and all one had to do was make sure it was done well, we might say that would constitute "managing." However, if one worried about external challenges—emerging low-cost foreign competition, changing customer tastes, impending legislation, rising material costs, and a slowing economy, to name a few—and began to look at how the company might have to change, what that change would cost, and where the money would come from for it to remain in business and be successful, then that would constitute "managing strategically."

The Strategic Management Model

Although strategic management is complex and dif�icult, it can be understood and learned. Just as you need a diagram and instructions and tools to assemble certain purchases in kit form, so too do you need a process or model for strategic management. Most writings on strategic management are based on a model, which can be de�ined as a device for codifying a complex activity that is at once easy to explain, understand, and learn providing the reader with a "road map" as to how everything �its together. While the model enables the components of

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such a complex activity to be examined separately and in detail, it cannot begin to describe the dif�iculties that constantly arise in the real world as companies try to implement everything.

Figure 1.1 presents the strategic-management model on which this text is based. The model is aligned with the approach espoused by the Association for Strategic Planning (ASP), whose slogan is "Think—Plan—Act." In other words, it prescribes strategic thinking, strategic planning, and strategic implementation. This catchphrase is also the subtitle of this text, which you should look at again now that you know what it means.

Figure 1.1: The strategic-management model

Elements of Strategic Management

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To appreciate and understand the totality of strategic management, you have to understand all its elements and how they affect each other. Training in strategic management and the real-world experience you obtain will help further your career, perhaps one day even to the position of chief executive of�icer. It is at this level with a view of the entire organization and its environment that the responsibility for managing a company strategically lies.

Strategy Formulation

Strategic management involves both strategy formulation and implementation. Strategy formulation, also known as strategic planning, is a complex process in its own right involving �ive discrete steps: (1) strategic thinking including external analysis, (2) internal analysis, (3) identifying key strategic issues, (4) developing viable strategic alternatives, and (5) choosing the best strategy using as criteria whatever the company de�ines as "success."

Strategic thinking is a continual activity that seeks to �ind whether a better strategy and business model exist, and seeking a market space that is not currently served and has few competitors. This cannot be done without external analysis, which entails observing, analyzing, and understanding what is changing in a company's external environment to anticipate what the future might hold.

Internal analysis means knowing, analyzing, and understanding everything about the company itself, especially what makes it a strong competitor or why it isn't as strong as it could be. Does it have a core competence, an enabling culture, strong leadership, adequate �inancial resources, and a good understanding of its customers?

Key strategic issues are a synthesis of both the external and internal analyses that focus the management's attention on the most important issues the company faces. Viable strategic alternatives are bona �ide strategic options or alternative futures from which a company can choose the best one. They consist of strategies, strategic intent, programs, and methods of �inancing.

Strategy Implementation

Some experts suggest that strategy implementation comprises as much as 90% of strategic management. It is all about successfully executing the strategies developed, thereby enabling the company to achieve the vision and meet the objectives set by management. The �irst step is operational and budget planning to determine who will do what to implement the strategy and to ensure that the company has the resources—money, people, and know-how—to do these things. A consideration in this planning stage must be how progress will be measured. The actual performance of the myriad tasks involved in implementing the strategy is called operations. An information system to collect and analyze operational data must be devised and constructed. Actual performance must be measured at regular intervals and the data entered into the system to compare against planned estimates. When things don't go according to plan or resources are being wasted,

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The Association for Strategic Planning has a strategic- management model, whose slogan is "Think—Plan—Act."

Chris Clinton/Digital Vision/Thinkstock

corrective action should be taken immediately. Lastly, the strategic-planning process itself must be managed and improved on an ongoing basis.

Figure 1.1 shows in which chapters the various parts of the process are presented. It also shows that the adjustments a company must make in response to challenges and changing conditions as it implements the strategy in turn affect the assessment of the company the following year. A strategically managed company is constantly updating its information and mental models to take into account the changes occurring both outside and inside the company.

People have their own ideas about things in the world around them. Sometimes they know very little about something and sometimes they know a lot. What we know or think we know about something forms our mental model of it. For example, our mental models about pollution may not be well formed. It's a complex topic with many facets, and our motivation for learning more about it and what needs to be done may be low. Most people were probably not aware that ships had for years been dumping plastic waste into the Paci�ic Ocean on the probable assumptions that, in the vastness of the ocean, this would go unnoticed and no harm done. Their mental model of marine pollution was likely not based on personal observation but limited to what they might have occasionally read in newspapers. For many, that mental model must have been radically updated when a series of articles about ocean pollution revealed the existence of the Paci�ic Trash Vortex consisting of non- biodegradable plastics �loating in the "western garbage patch" off the coast of Hawaii and the "eastern garbage patch" off the United States continental coast.

The latter was estimated to be twice the size of Texas (Weiss, 2006). In another example, we are all familiar with newspapers and bookstores and no doubt think we have pretty good mental models of those businesses. But can you imagine a world without either of them, at least in their current form? There's a good chance that might happen in the next few years. If that happens, we will have two more mental models to update (Olivarez-Giles, 2011).

Strategic planning and strategic management are best explained while examining a company that is in only one business. This approach is used in the �irst 10 chapters. Chapter 11 explains how diversi�ied (multi-business) companies, international companies, and global companies operate and why they are considerably more complex to plan for and to manage. Companies in very fast-moving industries, as with most

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high-tech businesses, are also dif�icult to manage because keeping abreast of rapid changes often requires a technology strategy in addition to a company strategy and requires a higher level of investment.

The coming sections in this introductory chapter explain the context of business, what is meant by "success," the meaning of strategy and strategic planning (among the most misused and misunderstood words in business), what business models are and why every business has one, and the importance of stakeholders in business decision making. The remaining chapters in the book explore in greater detail each of the major elements of strategic management and clarify them. In the end, you will have a conceptual grasp of how everything �its and works together. To manage strategically well takes years of practice and accumulated experience, often people's entire careers.

Discussion Questions

1. The Association for Strategic Planning's motto of "think—plan—act" also forms the foundation of this book. Are these three basic elements enough?

2. What are the principal elements of the strategic-management process? How are they interrelated? 3. How does strategic planning differ from strategic management? 4. What part of doing strategic planning appears, in your opinion, to be the most dif�icult to do? Which part, if not done well, would be most likely to lead to poor strategic decisions?

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Market share is the percentage of a �irm's annual sales based on the annual sales of the

Gunnar Pippel/iStockphoto/Thinkstock

1.2 About Competition

In this section, we'll begin to examine the different kinds of competition at various stages and levels of business.

Free Versus Regulated Markets

Capitalism allows a free market to exist and promotes competition. The United States is a mixed economy, which means that some markets are freely competitive with almost no state intervention, and some are highly regulated, making competition very dif�icult. It is convenient to assume initially that a market is not regulated until the nature and degree of the regulation can be identi�ied and understood. An example of a regulated market is public utilities, regarded as a public good and which require regulation to maintain high levels of accessibility, affordability, and safety that otherwise might be jeopardized in pursuit of pro�it. Other regulated markets include communications, energy, food production, trucking, workplace safety, and airlines, to name a few. All involve public-safety issues and the need to balance the public interest with what's good just for a particular company.

Industries Versus Markets

The terms market and industry are often used interchangeably in everyday usage, but they have quite distinct meanings. The collection of �irms that provides similar products or services to the same customers is called an industry. The buyers for those products or services are collectively called the market. To an economist, the industry is the "supply" side of the equation and the market is the "demand" side, which is illustrated in Figure 1.2 below. When demand is greater than supply and people can't get enough of what they want, they become willing to pay more. The price will go up until the point where demand again equals supply and prices stabilize. Conversely, when companies can't sell all that they have produced, supply is greater than demand. Producers will try to reduce accumulated inventories and the price will go down until supply again equals demand and prices stabilize.

Thus, it is more accurate to talk about industries—not markets—being regulated (or not). The exception is the term market share, which means a �irm's annual sales as a percentage of the annual sales of the entire industry. Given this de�inition, "industry share" is more accurate than "market share," because that is how it is calculated. However, using the term market

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entire industry.share to mean this is so ingrained in the business lexicon that we will go along with the norm and call it market share in this book (even though we mean industry share). At least you will know what it really means when you read about companies and their market shares.

Figure 1.2: Industries vs. markets

How Firms Compete in an Industry

In any industry regardless of the degree of regulation, �irms compete with each other to sell more products or services to customers; their purpose being to "capture more of the customer's dollar." Firms are free at any time to offer whatever products they think people need at any price they believe people would be willing to pay. If they succeed, customers will buy their product; if not, they won't. That's the nature of competition. Ultimately, consumers, whether individuals or businesses, communicate through their buying behavior exactly what goods and services they need. Companies that fail to deliver products that satisfy customers' needs will soon go out of business.

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In one extreme situation in which a particular �irm is the only company in an industry, then it has a monopoly. It can charge any price it likes since customers cannot get the product from any other source. At the other end of the scale, when many �irms in an industry all produce essentially the same product (such as paper clips or fertilizer), they compete on the basis of price. In such a market, customers' perceptions that products are all the same will base purchase decisions on price alone. This is called price or "perfect" competition. Another example of this is that people who believe that supermarkets are all the same will buy from any one, especially the one that reduces their overall grocery bill the most.

Differentiation

Companies can also compete by being differentiated, that is, have a strong and distinctive brand, along with unique or different products. In that instance they can charge more for their products because in the consumer's mind, they are offering something that no one else is offering. Examples of this are a designer perfume or a Porsche automobile. Differentiation can, depending on the product, be achieved by offering customers superior quality, product features, technology, convenience, selection, style, performance, safety, comfort, reliability, cost savings, warranties, return policy, customer service, and so on. The key is to differentiate based on the customers' needs, not what the �irm thinks they need. When consumers perceive that your product alone best meets their need, they will buy it and be willing to pay more for it.

Companies can compete based on many other factors beyond attributes of the product or service. They may offer customers on-time delivery or shipment without spoilage or damage for products such as fresh produce. Ef�icient distribution such as Net�lix provides, automated warehouse operations, and excellent management of the supply chain all may provide a competitive advantage that a company can use to attract customers. The list is endless. As with product differentiation, the point is to address the needs of the customer.

Case Study Case of Mistaken Differentiation

A watch manufacturer once made a very average watch that sold just well enough to keep the company going as it did not offer customers any distinct advantages over competing products. The company was forced to compete on price, thus returning thin margins. The CEO lamented that the company's watch was never the "best" in any dimension, so he couldn't charge more for it. This changed when his chief engineer observed that he could make the watch accurate to within a fraction of a second per year for only a $10 increase in price. The CEO concluded that with the most accurate watch in the world he could raise the price by more than $10. He gave the go-ahead.

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Today, many companies are increasingly cooperating through partnerships, agreements, and joint ventures rather than competing with each other. A recent example of this is the cooperation of aircraft companies Grumman and Boeing to build the U.S. Air Force's KC-135 tanker planes.

Associated Press/Azamat Imanaliev

The marketing department created a new ad campaign touting the watch's accuracy and doubled the advertising budget. Soon, the watches were distributed to retailers, and the campaign blitzed the media.

To the dismay of the CEO, sales never picked up. He instructed his VP of marketing to �ind out what was going on. The report was troubling. Potential watch buyers weren't interested in accuracy. In fact, losing or gaining minutes a year was not a concern for them. What they really wanted was for the watch to be more of a fashion accessory with interchangeable snap-on covers in different designs and colors.

The CEO realized too late that, while the company's watch could actually be differentiated from the competition, it had to be perceived by customers to be differentiated along some dimension that they valued. Differentiation strategies must be preceded by market research to determine what customer need is not being met and then move quickly to meet it. Only then will customers be willing to pay more for the product and the company command higher margins.

Cooperation

Companies are increasingly cooperating with other �irms in an industry rather than competing, or doing both. They do this through partnerships, agreements, and joint ventures. Is cooperating really competing? In certain industries, the answer is yes. For instance, companies in the defense- aerospace industry used to prepare proposals on their own to bid on large military contracts. As military hardware has become increasingly complex and expensive, the cost to vendors of preparing such proposals has over time soared to many millions of dollars, exposing them to greater risk. This in turn effectively raised the cost of such contracts to the military. In response, pairs or consortia of competitors got together to bid together on such contracts to lower the risk and costs. The military allowed such cooperation as it also reduced its own costs. The Boeing Company and Northrop Grumman Corporation have collaborated on many large military contracts that would be prohibitively expensive for a single company such as the Ground-Based

Midcourse Defense (GMD) component of the United States ballistic missile defense system. Such an instance of cooperation is described as an

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agreement or strategic alliance, where two �irms partner for their mutual bene�it but retain their distinct corporate identity. There are other kinds of strategic alliance, discussed in Section 1.6, including simple contracts for services rendered at one end of the scale (minimum commitment) to minority ownership of another �irm or joint venture at the other (heavy commitment).

Discussion Questions

1. You own a small �irm selling grass seed. Who might your competitors be? (Think about factors other than other �irms selling grass seed.) How might you cope with some of these competitive threats?

2. Competitors are usually thought of as other companies like yours producing similar products for the same market. Would any factor that reduced overall demand for your product also be viewed as a competitor? Why or why not?

3. Over the last 10 years or so, do you believe more companies are cooperating with one another? Why or why not? 4. Why do you pay exorbitant prices for concessions at movie theaters and sports venues?

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Globalization is the process by which regional economies, cultures, and societies become integrated in a global network of political and economic ideas through communication, trade, and transportation.

Robert Humberman/SuperStock

1.3 The Globalization of Business

The world today is a lot different than it was just a decade ago. The global human population has surpassed 7 billion people (U.S. Census Bureau, 2011), and technological advances have profoundly affected our daily lives. New York Times columnist Thomas Friedman describes the arrival and spread of the Internet as "�lattening the world," meaning that the reach of every individual has become global and the power of consumers equalized (Friedman, 2007). We have all heard the expression, "the world is shrinking," alluding to the fact that international travel is easier, and we have instant access to news about events in just about every corner of the earth.

A de�inition of globalization as it is commonly used is "the development of an increasingly integrated global economy marked especially by free trade, free �low of capital, and the tapping of cheaper foreign labor markets" (Merriam-Webster's Collegiate Dictionary, 2004, p. 532). A more comprehensive de�inition for the purposes of this discussion is an amalgam from two sources. "Globalization describes the process by which regional economies, societies, and cultures have become integrated through a global network of political ideas through communication, transportation, and trade" (Bhagwati, 2004). Globalization is typically identi�ied as being propelled by a combination of economic, technological, sociocultural, political, and biological factors. The term can also refer to the transmission of ideas, languages, or popular culture across national boundaries. Some facet of life that has undergone this process can be considered to be globalized (Croucher, 2004).

What does all this mean with respect to strategic management? Not too long ago, companies might have asked themselves whether they should globalize; today, they should instead ask why they shouldn't (Yip, 2003). Consider the following scenarios and the challenges they pose to businesses.

If you managed a local or regional company, you might think that you would be competing just locally or regionally. This assumption is no longer true. It's highly likely that foreign competitors would be getting a foothold in your market. You or your competitors would almost certainly be buying parts or materials from foreign companies to make your products at lower costs. You could even be outsourcing your entire manufacturing to a foreign company; lately it seems that everything one buys is made in China. You may well be employing people from other countries. Without question you would be using equipment, from machines to cell phones to cars,

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made by foreign companies. So even an American company competing in the United States experiences globalization in every facet of its business.

If you directed an American company and your domestic market had matured or become saturated, meaning that sales had leveled off and no unserved demand exists, you would want to �ind new avenues for growth. If you believed that consumers in other countries buy your product, you would want to expand to one or more foreign countries to continue growing and making a pro�it. Globalization means doing just that, but you can expect to face tough foreign competition from other companies chasing the same customers. To succeed, you will have to do this in a country whose laws, culture, currency, customs, and even language are unfamiliar. You will have to make critical decisions such as whether to make the product in the United States and ship it to those countries or manufacture the product there. As you can imagine, this gets complicated very quickly.

While even the most global of companies must have their headquarters in one country, that aside, they are truly global. They have operations all over the world with employees from each of the countries in which they are located. Research and development centers may be established on several continents. Manufacturing is conducted in many locations, typically located near suppliers and customers to minimize transportation costs. Sales of�ices are found everywhere the company sells its products. It may be that products have to be tailored to a particular country, for example, cars out�itted with steering on the right for countries that drive on the left or appliances that operate on different voltages depending on the country. An enormous challenge is that a company must comply with the laws of each country in which it does business. An example of a company in this scenario is Volkswagen, a German auto company that sells cars in the United States that are manufactured in Mexico.

Today, anyone starting a company in the proverbial garage can �ind customers all over the world through the Internet. Imagine, a craftsman or rug maker in Northern India with access to an Internet connection can now sell his products globally. Conversely, a consumer in the United States shopping for a particular product can now choose from suppliers or retailers anywhere in the world. Of course, this ability also brings with it new considerations for the consumer. The reliability of buying from an Internet retailer, the security of making payment, and return policies would all factor into the purchase decision.

Case Study Globalization at Work in San Miguel

In San Miguel de Allende, a colonial town in Central Mexico and World Heritage Site, a collection of upscale art and furniture galleries occupies what was once a textile factory. Negociación Fabril de la Aurora was a company that once supplied manta, or

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Free trade agreements resulted in a transformation of the Mexican textile industry. When cotton imports �looded the market, many textile plants like Negociación Fabril de la Aurora were forced to close their doors.

Associated Press/Eduardo Verdugo

unbleached muslin, to all of Mexico.

Constructed in 1902 by an English company, the factory was equipped with cylinders, spindles, and looms to process the bales of raw cotton from the central part of Mexico and from Sinaloa and Sonora states. The raw �iber was cleaned, ginned, carded, and spun into yarn or thread and �inally woven into manta. The Aurora manta was of high quality and used to make indigenous clothing and home linens. By the 1970s, production included heavy canvas used for making tennis shoes.

In the mid-1950s, most of the English machinery was replaced with later models from Germany and Switzerland. Until the time of its closing, La Aurora was the largest employer in San Miguel de Allende with a work force of over 300 and an integral part of the daily lives of its workers and the community. It sponsored soccer and baseball teams, held picnics for families on Sundays with a live band on the grounds, and even arranged an altar inside the factory for a local priest to deliver Mass.

"Free trade agreements brought many changes to the Mexican textile industry and La Aurora was not an exception. Cotton imports began �looding the market and domestic production was greatly affected. As a result, the steam-generated whistle which signaled the start and �inish of each shift and was a notable sound in San Miguel for almost 90 years blew for the last time on March 11, 1991." (Fabrica La Aurora, para. 7)

Source: Fabrica La Aurora. History of Negociación Fabril de La Aurora (1902–1991), framed at the entrance to La Aurora, photographed on March 26, 2011.

Discussion Questions

1. Can a company today survive in its domestic market by remaining entirely domestic? How would you rank order the threats it faces from nondomestic companies?

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2. How can a company determine where else in the world its products might be in demand and how tough the competition might be in those markets?

3. Name some of the most global businesses in the world. What do they produce, and how did they get to be so big and expansive?

4. In the case of La Aurora, the company appeared to have been suddenly overwhelmed by events that led to its demise. Could it have foreseen any of these events? If so, what might it have done to counter them?

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While most industries have regulations in place, corruption and con�licts of interest still exist in U.S. businesses.

Comstock/Thinkstock

1.4 The Inexorable Pace of Change

The world today is changing at an ever-faster pace compared even to a few years or a decade ago. Given the rate of change, it's easy to get lost in just how far technology has advanced in such a short time. For instance, Facebook didn't exist until 2004, YouTube until 2005, and the iPhone, which has gone through numerous updates, wasn't unveiled until 2007. Kodak, for decades the producer of the most popular photographic �ilm in the world, stopped marketing �ilm cameras in January 2004 in the United States, Canada, and Western Europe. By 2007 it neither manufactured nor licensed any �ilm camera with the Kodak name. The world had truly gone digital. In early 2012, this company, which had been a prominent entry in the Fortune 500 list since that ranking �irst appeared, was facing bankruptcy.

It is easy to observe how rapidly technologies are advancing and the products they spawn are being developed. High-tech industries in which such rapid changes are occurring and where changes in market share are temporary are termed hypercompetitive. Profound changes are occurring all the time in other areas as well. The political maps of Eastern Europe, the Middle East, and Africa have all changed radically over the past 20 years. The so-called Arab Spring of 2011 saw popular uprisings overthrow autocratic regimes in Tunisia, Egypt, and Libya that had brutally oppressed their citizens for decades. Many observers and participants cite the use of Twitter and Facebook, tools that did not exist even �ive years before, with facilitating the wave of revolutions. Political upheavals, even in distant parts of the world, can bring both threats such as the disruption of oil supplies and the rise in the price of gasoline in all countries, and opportunities like the opening of new markets and sources of materials. Businesses must be attentive to seemingly unrelated events happening in faraway places.

Many legislative and regulatory changes affect business. Building codes get updated so that buildings might withstand earthquakes or hurricanes. Environmental safety regulations mandate reduction in non-biodegradable plastics, new limits on air and water pollution, and promote an increase in recycling. The pace of such change is increasing.

Ethical behaviors by both individuals and businesses are also changing, but perhaps in the wrong direction. It appears that corruption, bribery and kickbacks, con�licts of interest, and greed are rampant in the United States and, regrettably, becoming more like the norm than

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the exception (Fisman, 2009). It has infected politics at every level, the highest echelons of business, and industries like pharmaceuticals, real- estate development, health care insurance, and banking and �inancial services. People are far more motivated now by money (gained legally or covertly) than what's good for the company, the public good, or other people. This trend, unsettling as it is, has profound implications as to how companies are run and even how they compete.

Discussion Questions

1. Discuss elements in your own life that have changed faster than you would have imagined. How did the changes happen? 2. What things can or do you buy now that did not exist �ive years ago? Three years ago? 3. What are some things that will become available in the next 3–5 years that are not now available? What do companies have to do to make them happen (besides, of course, having the necessary technology)?

4. How can a company's strategic-planning process take into account very rapid changes in its environment? 5. In which areas do you think the most profound and rapid changes are occurring? Why?

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A company does not know its true worth or market value until it is bought.

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1.5 What Is "Success"?

Most companies have one or more purposes they are trying to achieve, even though their purpose may never be expressed in writing or conveyed to the employees. These purposes can be construed to represent what the companies consider "being successful."

The most common purposes are to survive, to increase shareholder value, and to make a pro�it. Surviving means enduring. While survival cannot be measured, it is at the back of all executives' minds, simply because many companies don't survive.

Shareholder Value

Shareholder value is a computed value based on a company's projected cash �lows for the next 10 years, discounted to the present time using discounted- cash-�low (DCF) analysis and an appropriate discount rate. From that computed value is subtracted all current debt. If computed exactly the same way, even using different discount rates over time, one can keep track of shareholder value and use it as a criterion in decision making and investing (Rappaport, 1997).

Michael Raynor, who came to prominence for his contribution to the idea of disruptive innovation, believes that companies should adopt as their main purpose survival rather than shareholder value (Raynor, 2009). His thesis questions the choice of shareholder as the most important stakeholder because they are "owners" of the corporation and therefore deserve to have their investment maximized. Instead, as he says, "A stock certi�icate is a particular sort of claim on corporate wealth . . . not a deed of ownership" (Raynor, 2009, p. 5 ). More accurately, as suppliers of capital to the corporation, stockholders deserve to be paid enough to keep them investing, just as employees deserve enough payment to keep them motivated. Rather than maximizing stockholders' returns at the expense of returns to other stakeholders, Raynor advocates being fair to all suppliers of inputs at a level that guarantees their continuation to ensure the corporation's survival.

Net Worth

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Calculating the net worth or value of a privately held company is more dif�icult but becomes necessary if a company wants to be acquired or if it wants to issue shares to investors. What is typically done is that a valuation consultant is engaged and uses several (usually 3–5) valuation methods, eventually taking an average. Not until a company is actually bought is its true worth or market value established. Market value is distinct from book value, which is what is re�lected on the company's balance sheet and takes into account its depreciated and amortized assets, inventory, and goodwill. Market value represents the value an asset might fetch if sold on the open market. For example, a customer list (part of goodwill) has one value to an accountant and perhaps far more value to an acquirer.

Pro�it

Pro�it is a popular reason why companies stay in business, but, as said in various ways in the �inancial sector, "Cash is fact, pro�it is opinion." Certainly, it's complicated. In the sense used here, we mean net pro�it after taxes (NIAT) or "the bottom line." It is what is left after all allowable expenses have been deducted over a speci�ied period. There are other kinds of pro�it: gross pro�it; operating pro�it; earnings before interest, taxes, depreciation, and amortization (EBITDA); earnings before interest and taxes (EBIT); and net income before taxes (NIBT). Just look at any income statement.

NIAT is an accounting artifact, approved by the American Institute of Certi�ied Public Accountants (AICPA) and conforming to widely accepted accounting rules called GAAP (Generally Accepted Accounting Principles). The �inal value depends on depreciation and amortization of assets on arti�icial schedules created by accountants. Some equipment, for example, may be fully depreciated, having zero value, yet continue to be used for years.

As if to support the previous point, a company can spend cash but not pro�its. Nor can it spend retained earnings, which is a balance-sheet account that accumulates pro�its or losses from previous years. It can spend only cash. At some point, pro�its show up as operating cash, loans are an in�lux of cash, investment gains result in cash, and even selling stock results in cash in�low. So it's cash that is king, not pro�its. Having said that, NIAT is so pervasively used in business as an indicator of success that companies continue to use it widely.

Highly related to NIAT are several �inancial ratios that use NIAT, like net pro�it margin (NPM), which is NIAT divided by revenues, and return on equity (ROE), which is NIAT divided by total stockholders' equity. NPM is a measure of a �irm's pro�itability relative to its revenues, and ROE is a proxy for the net pro�its that are, in a sense, generated by stockholders' investment in the company.

Market Share

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Mario Tama/Getty Images

Another measure of success is market share. Every company wants to be the market leader, but only one can be. What is not so obvious, especially to companies that publicly avow to increase market share, is that to do so, their revenues have to grow faster than total industry revenues. They will maintain their market share if they grow as fast as the industry, and actually lose market share if their growth lags behind the industry's.

Some years ago, a graduate student prepared a report on the company he worked for, a defense-aerospace contractor in Los Angeles. He was tired of hearing the CEO constantly telling everyone he wanted the company to gain market share. His study revealed that the company would have had to invest about $1.5 billion over the next three years to do so, and simply did not have that amount of money, either in cash or borrowed funds, to invest. When he showed his results to the CEO, the CEO changed his tune about wanting to gain market share.

Often, market share cannot be measured, whether because there are simply too many competitors or because many competitors are privately held. In addition, it may not be possible to know how fast the industry's total sales are growing against which a company could compare its own rate of revenue growth. In these circumstances, market share is not a good indicator of success. A closely related indicator is the company's own revenue growth, which can be measured.

Another indicator of success is whether the company has a core competence, a capability that gives it a strategic or competitive advantage over its competitors. This will be discussed in more detail in Chapter 4.

Brand Equity

Having a strong reputation, strong brand, or strong brand equity are also indicators of competitive success. These signify a successful differentiation strategy and, more than likely, a sizable market share, strong revenue growth, and healthy pro�its. A company is doing well on this criterion when customers buy its product because its brand is the primary reason for their purchase decision. Many people when they are thirsty go for a Coke, because Coca-Cola has such a strong brand and they have developed a habit of buying that brand. McDonald's has a similar grip on many people wanting a quick hamburger. In the auto industry, Mercedes, BMW, Porsche, Lexus, Volvo, Toyota, and Honda all conjure up speci�ic brands—a unique set of promises—that attract loyal customers. They have strong brands and meet the needs of people who buy their cars.

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Nordstrom's excellent customer service has become its core competence and its brand. If employees do not maintain a high level of customer service, the brand's worth will decline.

Brand equity or brand strength refers to the power of a brand to in�luence purchases and loyalty. Brands and reputations can increase, remain the same, or erode over time if efforts to maintain them aren't made. The main reasons for brand erosion are competitors duplicating the quality of a brand so that it

is no longer unique or a company failing to perform in ways that the brand promises. Nordstrom's department store offers an illustration of a successful differentiation strategy. More than the strategy, Nordstrom's legendary customer service has become its core competence and its brand. However, if other department stores provided similar outstanding service or Nordstrom's own employees failed to live up to the company's reputation, its brand equity could begin to decline. People would then stop shopping there because its brand had eroded, thereby adversely affecting its performance on other measures like revenues and pro�its

Discussion Questions

1. Imagine you are a country's minister for health. What measures of success might you adopt in order to judge whether health expenditures are being made wisely?

2. What measures might you look at personally to assess how happy you are? 3. Imagine you have just graduated and are in the job market. What criteria might you use to help you land the best job, assuming you got more than one offer?

4. It is widely held that it is enough for a �irm to be pro�itable. Is it? What other measures might you consider using to help ensure that the company would still be in business �ive years from now?

5. Imagine you are on the verge of retiring. Looking back on your career, how would you gauge how successful it was? 6. Imagine you have only a few days to live. What criteria would you use to indicate to yourself how good a life you have lived?

7. How might you tell that your company is the technological leader in its industry?

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1.6 What Is Strategy?

Strategy is how a company actually competes (Abraham, 2006). This simple de�inition is not only true but also effective because it tacitly recognizes that companies could have a bad or ineffective strategy and hence not be able to compete well. Typical de�initions of strategy are, in fact, de�initions of a good or ideal strategy (see Appendix A for 77 such de�initions). While these are commonly accepted terms, there is no agreement on a single de�inition of good or ideal strategy. In this section the most common strategies are introduced, grouped for convenience into seven categories: concentration strategies, product-development strategies, market-development strategies, conglomerate- diversi�ication strategies, innovation strategies, technology strategies, and generic strategies

Concentration Strategies

A concentration strategy is some combination of producing an existing, improved, or new product or service for an existing, expanded, or new market. It's useful to think of them as being one of the following types.

Product-Development Strategies

Product-development strategies entail continuing to produce an existing product or service, improving them over time, and introducing new ones, all for the same market. The best examples are the auto companies that bring out improved versions of every model every year and, usually every four years, redesign every model. They periodically also introduce completely new models, like Honda's Element, Toyota's Scion line, and Nissan's Leaf. Likewise, software companies bring out successively improved versions of their product by labeling them Version 2.0, 2.1, 2.2, 3.0, and so on. Microsoft has introduced successive versions of its ubiquitous Windows operating system, from 1.0 through the famous XP and the infamous Vista to the current Windows 7, a remarkable feat of constant improvement.

Market-Development Strategies

Market-development strategies involve penetrating an existing market, expanding into related markets, or �inding new markets for the existing products or services a company produces. A jeans manufacturer targeting young men could target older men or children. Banks expand their presence by opening of�ices in supermarkets. If a company does business in only one state, expanding to other states and eventually nationally is �inding new markets, as is a domestic company expanding internationally.

A combination of product- and market-development strategies is employed when expanding a market or �inding a new market requires modifying the product. Examples of this are jeans for men having to be redesigned for women, or cars having to be modi�ied for countries

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Innovation strategy is a product-development strategy that requires research and development to focus on introducing technologically advanced processes or products.

JupiterImages/Creatas/Thinkstock

where drivers drive on the other side of the road. Sometimes modifying a product is the only way of expanding the market. Increasing a car's performance to appeal to younger male buyers, adjusting its size and �lexibility to appeal to families, expanding its range of colors to appeal to women buyers, or adding luxury features and status to attract higher-income and older people all illustrate this approach. Most concentration strategies fall into this category.

Conglomerate-Diversi�ication Strategy

A conglomerate-diversi�ication strategy is one in which a company introduces a brand new product or service for a new market. In business, this is rare because of the high risk, and few if any companies use it. If a company really wants to do this, it would instead purchase another company in the industry it wants to enter, which would drastically reduces its risk.

Innovation and Technology Strategies

Innovation strategy is a product-development strategy that deserves discussion on its own. Innovation strategy requires research and development (R&D) and focuses on introducing technologically advanced products or processes. The "R" of R&D involves both basic and applied research. Basic research focuses on discovering new things and processes unimagined before and is very costly with uncertain outcomes. Applied research takes existing knowledge and concentrates on commercializing it. The "D" of R&D is highly applied and focuses on improving existing products.

Figure 1.3 shows the basic types of innovation strategy, varying from short-term, relatively inexpensive, and low-risk in the bottom-right corner of the �igure to long-term, requiring considerable investment, and high-risk in the top left. As the degree of change increases along either dimension, the likelihood that the project will require more time and resources also increases. The ideal situation for a company pursuing an innovation strategy is to have a balanced portfolio including projects ready without much investment in the near term, some requiring more investment and time ready in the medium term, and some more risky, long-term projects requiring more research and advanced development.

Figure 1.3: Degrees of innovation strategy

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permission.

Technology strategy, another facet of an innovation strategy, instead focuses on developing new or improving existing technologies and becomes the domain of companies whose products or whose very existence depends on winning the technological race. Technology refers to both abstract and concrete tools—such as knowledge, skills, and artifacts—that can be used to create, produce, and deliver products.

Generic Strategies

Michael Porter (1985) discovered in his research that a lack of a competitive advantage was the reason companies generated below-industry- average pro�its. He proposed that the way to obtaining a competitive advantage was through one of three generic strategies, so called because they applied to any industry. Those generic strategies are differentiation, low-cost leadership, and focus.

Differentiation

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A differentiation strategy involves developing a product that is unique from or superior to the product offered by the competition. There are myriad ways of doing this as was discussed when differentiation was introduced (Section 1.2). The dif�iculty of competing in this way is that customers must perceive the product as being differentiated. It does not matter how differentiated you think your product is, if customers don't perceive it, they won't buy your product. An attraction of this strategy is that if your product is differentiated, you can charge more for it because customers will be willing to pay more. When companies "play a different game" and leave competitors behind, they take differentiation to a new level.

One special case of differentiation is a blue-ocean strategy, which is a way of competing that requires �inding a market that is not being served at all. In other words, identifying a market where you are the only provider and have no competitors. Such a market space is called a blue ocean. The name comes from an analogy where a "red ocean" represents a bloody shark-feeding frenzy all going after some prey, meaning there is too much competition. A blue ocean, on the other hand, is free of any predator except you—no competition, no blood.

Having a strong brand is another form of differentiation but is singled out because the basis of the differentiation is reputation. Companies with strong brands have strong reputations and are highly differentiated from each other. The reputation is built over time and represents the degree to which a company has met or exceeded its promises to customers. The more a company delivers on or exceeds its promises, the stronger will be its reputation. In turn, more people will have con�idence buying from the company. For example, if a company promises great customer service and consistently treats every customer like a VIP, it will become known for customer service—just as with Nordstrom's department stores—and people will shop there because of that great customer service. Reputations and brands can, if a company is not careful, erode with time, either because a company is not so assiduous doing what it promised or because competitors are successfully imitating it. If all department stores improved their customer service to the level of Nordstrom's, would customers still make a point of shopping there? Curiously, though it isn't rocket science, no other department store has been able to match Nordstrom's customer service for a long time and diminish its brand.

Low-Cost Leadership

A low-cost leadership strategy is completely invisible; neither competitors nor customers know what a company's costs are. Yet, if a price war were ever started, the company with the lowest costs in the industry would be the one standing at the end. This strategy isn't about just reducing costs but rather reducing them to be the lowest in the industry. Thus, through subtle and not-so-subtle signals that are put out to other industry players, a company can tell its competitors, "Don't mess with me, because I have the lowest costs." This is one reason that makes Walmart the most formidable of competitors.

Focus

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A specialization or focus strategy targets a very small market (often called a niche) and, in so doing, reduces greatly the number of competitors in the arena. Big competitors won't be interested in a niche market with a relatively few customers. For example, instead of being a publisher or even a textbook publisher, be a medical-textbook publisher with only medical students as customers. You will have a chance to dominate the niche as not many other publishers will want to specialize in that niche and even charge enough to cover higher unit costs because of the lower volume.

Strategic Alliances

Strategic alliances are basically agreements between two companies, ranging from simple contracts (minimal integration and collaboration) to joint ventures and minority ownership (heavy integration and collaboration), but where each company remains separate. Figure 1.4 shows various kinds of strategic alliances and where along the spectrum they lie. The following discussion elaborates on the �igure beginning at the left-hand end.

Outsourcing and Simple Contracts

Into this category fall simple purchase agreements for products or services, like engaging consultants that often spell out terms such as deliverables and payments. Companies need protection in case products delivered are faulty, services are unsatisfactory, or even payment is late or not paid. Agreements take care of these eventualities.

Licensing

Companies that own a patent or desirable trademark make extra money through licensing use of it to other companies. In this way, they control use of that asset, how much they are compensated, and the extent to which their brand is strengthened. Harley-Davidson, the global motorcycle manufacturer, licenses its name and logo on clothing, mugs, and telephones, while Disney makes a fortune licensing use of its proprietary characters such as Superman, Spiderman, and Mickey Mouse on all kinds of products made by others. Have you ever wondered why clothing and caps from your alma mater are so expensive? About half the price goes toward the university itself as a licensing fee.

Licensing works both ways. Not only do owners of patents and trademarks bene�it but companies on the other end are happy to pay the licensing fees and royalties for using someone else's intellectual property since they are spared the years and expense of developing that product themselves. For example, just about every company in the world making inkjet printers licenses the basic technology from Canon.

Shared Resources and Competences

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Companies may share the cost of R&D to develop technologies that require large amounts of capital and risk. A consortium of semiconductor manufacturers did this in the 1980s and '90s when they created Sematech. Companies may negotiate exclusive cross-distribution agreements whereby two companies in different countries agree to market each other's products in their own country. Joint R&D projects between companies and universities for the bene�it of both is becoming increasingly common. Sharing resources is common in the auto industry— Ford, for example, had Mazda develop a new transmission for the Ford Probe when the two companies decided that Mazda's transmission was better than Ford's.

Partial Acquisitions (50%)

Sometimes small, high-tech startup companies come up with new technologies and products that revolutionize industries or take them by storm. They desperately need capital for additional R&D or to take the product to market. Some entrepreneurs feel that venture capitalists often take too large a chunk of equity for the capital they provide, earning the nickname "vulture capitalists." An alternate source of capital can be large companies looking for new ideas and technologies that would bene�it them. In fact, many have "venture divisions" for just that purpose—to �ind and invest in promising new companies and technologies. To be sure, they want an equity stake, but the equity demands are typically more reasonable since they are more interested in �irst rights to the technology when it is developed, giving them a competitive advantage. These investments typically result in 10–30% equity stakes in these companies in exchange for investments of $1–10 million. Such investor companies also may acquire a controlling interest in the small company later for an additional investment.

Joint Ventures

Whereas two companies forming a strategic alliance still remain separate entities, forming a joint venture (JV) requires the formation of a new corporate entity jointly owned by the two companies. An apt analogy often used in the literature is two parents giving birth to a child. The JV is governed by a detailed and encompassing agreement that speci�ies what each parent will contribute to the child, how much of the risk each parent incurs and the percentage of pro�it each is due, how long the agreement will endure, under what circumstances the agreement can be terminated, and how the remaining assets are distributed. Initial contributions take the form of capital, management, technology and patents, facilities, and so on. Research has shown that JVs tend to be more successful when the management team comes from one parent—usually the dominant one—rather than both parents, especially in international JVs (Killing, 1983).

In the 1950s, Fujitsu and TRW formed a JV called TRW-Fujitsu, based in Los Angeles, for the express purpose of marketing Fujitsu products in the United States. Fujitsu contributed technology, products, and capital, while TRW contributed management and staff, facilities, and capital. Ultimately, it was terminated a few years later because sales did not meet expectations.

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When British Airways merged with Spanish air carrier Iberia, they were adopting a strategy that would make them more competitive in the marketplace.

Associated Press/Ian Nicholson/PA Wire

Acquisitions and Mergers

An acquisition strategy is one in which a company buys another to take full control of it. It may purchase anywhere from a majority 51% stake to an outright 100% ownership. "Full control" means that the acquirer makes all subsequent decisions, and its board of directors and management survive intact; the acquired companies do not. However, if it is doing well, it may make sense to retain the full management of the acquired company and simply invest in it so that it can grow and do even better. Acquisitions are paid for with cash, a combination of cash and debt and stock, or entirely with stock. In an all-stock acquisition, shares of stock in the acquired company would be exchanged for a negotiated number in the combined company. In any acquisition the �inal price and method of payment is, of course, negotiated by both boards of directors.

The principal reason to acquire another company is because it �its with the overall strategy, but other reasons are also common, such as for �inancial gain

or appreciation, to prevent a competitor from doing so. Acquisitions are often risky, because the value it was expected to add is seldom realized. In many cases this happens because the acquirer overpaid. Additionally, problems can arise if the cultures of the acquired company and the acquirer clash and key personnel in the acquired company leave (Ackatcherian, 2001).

Figure 1.4: Continuum of strategic alliances

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A merger strategy also combines two companies, but the combined entity makes joint decisions and literally merges its operations carefully —some members of the board, senior management, and operational management stay on in the combined company. Often the CEO is from one company and the president from the other. Mergers succeed only when the cultures of the two entities are similar and both parties feel that merging would be in their mutual interest. In common usage the term merger is loosely used to refer to an acquisition, which is a very different arrangement.

Diversi�ication

A diversi�ication strategy signals a move to enter another industry, which could be related to the industry it's in or unrelated. It is often misused when companies call the broadening or extending of their product line "diversi�ication." There are two principal ways to enter another industry or segment. The �irst approach is through internal R&D, as when, for example, a new technology or product has application in another industry. A company that invented a �low meter to measure more accurately gas �low in an automobile was able to implement this strategy when it learned that this same �low meter could, in a much smaller design, be used to measure blood �low in a human being.

The second route to diversi�ication is through acquisition, particularly in an industry in which no one in the company has any experience. The idea is to not only become an instant player in that industry but also minimize the risk by having managers and employees already experienced in that industry. The strategy works particularly well when a growth industry is targeted and all the company needs to grow and succeed is capital. Mattel, Inc., the toy company, sought to diversify into the electronic segment of children's games and acquired The Learning Company for $3.6 billion, badly overpaying for it (Mattel, Inc., 2000).

Retrenchment and Divestiture

A retrenchment strategy is a conscious decision to become smaller. This could be a response to a declining industry or declining level of funding such as some defense companies had to do when military budgets were slashed. In other situations a company will divest itself of some assets by selling off a division or closing poorly performing stores. When revenues suddenly decline, companies have to trim expenses and payroll accordingly to �it their new reality. Selling off a division or major assets is also called a divestiture strategy.

Continuing the Mattel story, after paying too much for The Learning Company, it ran into �inancial trouble. Instead of increasing pro�its by $50 million the next year, it subsequently incurred $300 million in losses and resulted in $7 billion lopped off the company's valuation—a 61%

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plunge in its stock price, costing CEO Jill Barad her job. The new CEO immediately divested The Learning Company for a fraction of its purchase price (many said "given away") in October 2000 (Mattel, Inc., 2000).

Being acquired, or selling the company, is a special case of a divestiture strategy where the whole company is divested, that is, sold to another company or person. It is the opposite of an acquisition strategy. Are there circumstances when any company would actually want to do this? The answer is Yes. Selling a company represents a change in ownership, but in most cases the company continues to exist. In some cases, however, it does get "folded into" the acquiring company and for all intents and purposes disappears. The reasons for selling a company may include an owner wanting to cash out and retire or receiving an offer that is simply too good to pass up. Alternatively, a company might be doing so poorly that the only strategy left is to sell it–but this should be a last resort, as it would get only cents on the dollar in this scenario.

Discussion Questions

1. What are the risks of forming a strategic alliance with a foreign company? Consider things like selling through a distributor based in a particular country, outsourcing to a factory in a particular country, a cross-distribution alliance, and so forth.

2. What strategies might you consider using against established competitors with low costs and signi�icant market share? Which of these might be best and why?

3. Imagine a �irm 100% owned by a family whose wealth derives entirely from the �irm's operations. The family has so far refused requests to go public or sell any equity position to outside investors. Would such a �irm be likely to continue its current successful ways, pursue a related-diversi�ication strategy, or pursue an unrelated-diversi�ication strategy?

4. In 1984, General Motors (GM) and Toyota created and operated a joint venture (JV) in California called NUMMI—New United Motor Manufacturing, Inc.—to produce vehicles that would be sold by both companies. In June 2009 GM withdrew from the venture, and in March 2010, Toyota transferred the remaining production to its other plants. In forming the JV, GM was interested in learning how to manufacture high-quality small cars from Toyota, and Toyota was interested in gaining access to GM's U.S. distribution network and in reducing the political liability associated with local content laws. Which of the two �irms, in your opinion, might have derived most bene�it from the JV while it lasted? Why?

5. Strategic alliances are often thought of as a way of getting help to compete instead of going it alone. In what ways might one be better than the other?

6. A recent newspaper article about Apple, Inc., said, in part: "The company . . . is increasingly evolving from a computer maker into a multi-product international powerhouse and a major force in the entertainment and publishing industries" (Puzzanghera & Sarno, 2011). How do you think it could have transformed itself in such a short time? In other words, what strategies do you think it used—either simultaneously or not—in the process?

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In some companies, only the CEO does strategic planning. Others use a selected top-management team to implement the plan to lower management.

Flirt/Superstock

1.7 The Strategic-Planning Process and Strategic Decision Making

First and foremost, strategic planning is a process. A company collectively tries to agree on where it is going (its vision) and how it's going to get there (its strategy). Those are the two principal purposes of strategic planning. Other valid purposes include achieving "success" as the company de�ines it, such as increasing its shareholder value, market share, or long-term pro�itability. Yet another purpose could be to develop a core competence and sustainable competitive advantage. Consequently, identifying the purpose or purposes to be achieved is an integral part of the process. How and whether those purposes are achieved in reality is the job of the strategy (and management in implementing it). So choosing the right strategy is crucial. This is another answer to the question, "Why have a strategy?" It also answers the question, "Why engage in strategic planning?"

Participants in Strategic Planning

A critical dimension of strategic planning is who gets to participate in the process. In a few companies, only the CEO participates with the mindset that whatever he or she says goes. In others, the top-management team participates, which is better, and then relays what has been decided to lower management levels and employees in general. In still others, the participants include those who will help implement the plan, that is, middle managers and key other people in addition to top management. This last inclusive approach is the best. Section 8.6 outlines a suggested strategic-planning process and elaborates on the importance of involving the right people in the process.

Because the outcomes of strategic planning are so dependent on who participates, the particular process used, and the information on which decisions are based, it is clear that doing strategic planning remains very much an art. It is a highly creative yet disciplined process that draws on the individuals' and group's intuition, experience, know-how, and powers of persuasion.

While the strategic-planning process is relatively straightforward, actually doing it is much more dif�icult for a number of reasons. People seldom agree on where the company stands right now and how it is performing, whether because they have a limited perspective, don't have

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access to the same data, or have personal or hidden agendas. Sometimes politics gets in the way of candor and truth. The information that the company and its people possess, for example on customers and competitors, may be incomplete, dated, inaccurate, or irrelevant, while the information they most need is often unavailable. Lastly, the planning horizon is typically three to �ive years in the future, a future that is unknown, ambiguous, and changing before our very eyes.

Strategic Decisions

Besides deciding on a vision and the best strategy for achieving it, strategic planning is often used to make other strategic decisions. Strategic decisions differ from operational or tactical decisions primarily in that their complexity and consequences are more consequential for the organization. For this reason strategic decisions tend to get made only after appreciable analysis, discussion, and debate, and typically involve a number of people in the decision. Examples of strategic decisions include selecting a strategy, deciding which company to acquire or merge with, choosing which technology to adopt, deciding whether to form a strategic alliance and with whom, to franchise rather than expand with owned facilities, which new CEO to hire, whether to sell the business, whether to enter another industry or segment.

Operational decisions are not made during the strategic-planning process, but subsequent to it. The reason is that operational decisions and plans �low from the strategic decisions made, and so the latter must precede the former. Operational decisions are made when doing operational planning (discussed in Chapter 7) and involve deciding what has to be done (programs, activities, tasks, projects), who will do it, who is accountable, what amount of budget is allocated, and a deadline for completing it. Examples of operational decisions include upgrading the accounting system, installing a new production process, changing an advertising campaign, offering discounts or other promotional incentives, lobbying for tariffs, hiring anyone other than the CEO, reducing costs, �inancing a particular initiative, investing surplus cash, and so on.

Discussion Questions

1. Some corporations, like manufacturers of aircraft and nuclear plants, have to look 20–30 years into the future when making decisions. How might strategic planning be different for them with such long planning horizons? What other information or analysis might they require to help them make more robust decisions?

2. We know that operational decisions �low from strategic decisions, and must be made subsequently. Are they less important? Why or why not?

3. Managers who are used to making and following operational and tactical decisions are often promoted to VP or C-level executive positions. Explain what dif�iculties they might encounter as they transition from making operational decisions to making strategic ones.

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4. The CEO of a small company has been making all the decisions for the past 20 years, and the company is doing well. What can you say about the manager's decision making? On the face of it, one might conclude that no strategic planning is taking place. Would you agree?

5. Why is hiring a CEO a strategic decision but hiring anyone else isn't? Hiring what other position might be strategic and under what conditions?

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1.8 About Business Models

Business models are different from strategies, but in some people's eyes the distinction is �ine. Earlier, we de�ined strategy as "how a company actually competes." A business model describes the way in which a �irm does what it does to deliver customer value (Abraham, 2006, pp. 10– 11). For example, a hospital's strategy would be concentration (both market and product development) and possibly acquisition. Its business model should answer some basic questions:

How to get people to come to the hospital for services? Will it attract patients by delivering high quality services, offering low prices to insurance companies, training courteous staff, promoting wellness, etc.? How to make money? Will it control costs by streamlining processes and removing wasteful steps, seeking volume discounts from suppliers, selling more wellness products, etc.? How to grow? Will it produce growth by expanding services that can be ef�iciently served by existing facilities, acquiring physician practices, etc.?

Three well-known instances of companies transforming an industry by successfully using a different business model are Dell, Inc., Progressive Insurance, and Net�lix. These examples will illustrate why business models are important and how they can be so easily confused with strategy.

Prior to Dell's 1985 debut, businesses buying computers for their employees relied on a system in which they purchased a large number of identical computers at a generous discount. Dell provided a fresh option to corporations, in which employees could personalize their computer orders at the same low price point. Because employees such as engineers, accountants, and sales staff all used computers in different ways, this provided the option to purchase a computer based on speci�ic features and functionality. Dell pioneered this "con�igure to order" style of manufacturing by using a JIT assembly process, in which standard components are used to create custom products. In the �irst year alone, Dell made more than $73 million. The JIT process minimized its inventory costs, another critical part of its business model in an industry where components depreciate very rapidly (Fortune 500, n.d.). Although Dell did not radically change the way that computers are

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Reed Hastings got tired of video rental late fees and established Net�lix. With this new business model, customers would receive their movies in the mail and there would never be a late fee.

Associated Press/Paul Sakuma

McDonalds is leading the pack in innovation execution. It's all about the ability to personalize its products in the global marketplace. The company keeps its brand individual while local markets are given latitude to appeal to their speci�ic customers.

McDonalds: Decentralization of Business Model

produced, the way it sold computers—its business model—was vastly different from industry competitors.

During the 1980s the state of California required rollbacks in auto-insurance premiums and the process of utilizing auto -insurance was complicated and

tedious. A company called Progressive Insurance created a new policy in the 1990s to make the process more bene�icial to its customers. Instead of taking weeks to process insurance claims, Progressive began settling them immediately, often before competitors were even aware there had been an accident. In quoting rates to customers, it quoted competitors' rates as well, even if they were lower. Also, it based its rates more on where and when a car was driven rather than on age, a driver's record, and other established criteria. The result was that it grew six times faster than the industry and achieved a net pro�it margin of 8% compared to the underwriting losses experienced by its competitors at the time (Abraham & Knight, 2001). Although Progressive Insurance, like its competitors, provided auto insurance for drivers, the way it did it —its business model—was radically different.

For years, Blockbuster dominated the video rental industry, possessing over 9,000 stores in 2002 (over 5,000 in the United States) and boasting $6.1 billion in sales (Blockbuster Inc., 2005). No true competition existed. Reed Hastings was a Blockbuster customer who had formerly been successful in selling his own software company for $750 million. After becoming frustrated with the late fees Blockbuster charged, Hastings decided to start his own company: Net�lix. He envisioned renting movies using proprietary Cinematch software, whereby customers could save money by renting online, avoid late fees, and receive access to reviews and recommendations—all services that Blockbuster did not offer.

Customers could go to the Net�lix website, choose from several subscription plans, and have access to its library of movies, which he kept expanding every month by making deals with producers. Net�lix's business model also included a mail service, whereby each DVD sent to the customer included a built-in return envelope. Using a large set of distribution centers, movies were delivered quickly, often by the "next

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McDonalds: Decentralization of Business Model From Title: The Execution Plan (https://fod.infobase.com/PortalPlaylists.aspx?

wID=100753&xtid=39954)

business day." By 2003, the popular company soon had over 3 million subscribers. Today, customers now have the option of streaming movies directly to their computer or TV.

As with Dell and Progressive Insurance, even though Net�lix was ultimately providing the same service—movie rentals—as its competitors, it did so using a brand new business model. Despite Blockbuster's eventual efforts to copy Net�lix, it was unable to do so and ultimately �iled for bankruptcy in September 2010. In April 2011, it was auctioned to Dish Network for $320 million (Fritz, 2011).

Discussion Questions

1. What is the business model for a typical university? And for the university you are currently taking this course from? Does such a business model have anything to do with strategy?

2. If you are currently working for a company—even a branch or division of it—try to articulate its business model. If you found this exercise dif�icult to do, why do you think it was dif�icult?

https://fod.infobase.com/PortalPlaylists.aspx?wID=100753&xtid=39954

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Stakeholders are groups or individuals who can effect and be affected by the organization's performance. Shareholders are the largest of these groups.

Jürgen Schwarz/Getty images

1.9 Importance of Stakeholders

Stakeholders are "the individuals and groups who can affect, and are affected by, the strategic outcomes achieved by and who have enforceable claims on a �irm's performance" (Hitt, Ireland, & Hoskisson, 2007, p. 21)—stated somewhat more simply, those to whom a company owes any duty or obligation. Several groups of people or companies can be de�ined as stakeholders, including investors in the corporation, creditors, employees, customers, host communities, and even the environment. While the role of each body may differ in its involvement, each is nonetheless a participant and/or has a stake in the company and its welfare.

Investors

Investors in the corporation, called stockholders or shareholders, are the stakeholders that �irst come to most people's minds. Investors have taken a risk by investing in the company and expect to be appropriately rewarded. Rewards come in two forms: stock appreciation and dividends. It is conventional wisdom that unless companies provide such returns, investors will withdraw their money and invest elsewhere; that is, they will sell their stock in the company and �ind a more lucrative investment. Investors in privately held companies are not called stockholders or shareholders, but simply investors. In too many cases, however, top managements endeavor to keep the stock price high, not so much to reward the �irm's investors but rather to line their own pockets, as a large portion of their compensation comes in the form of stock.

Creditors

Creditors are another form of stakeholder. These are banks, other �inancial institutions, or individuals that loan the company money. If the company does not repay its loans as agreed, it may �ind it dif�icult to continue getting new loans when it needs capital and could damage its credit rating, thus raising the interest rate on future loans. Creditors also include anyone to whom the company owes money, for example, a supplier that has sold goods to the company for which payment has not yet been made or employee wages that have not been paid.

Employees

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As they are the ones providing the good or service, it goes without saying that employees are also one of the �irm's most vital stakeholders. If the business fails, investors lose just their investment and banks just their loans, but employees lose their jobs and put their families in jeopardy. Companies vary greatly in how they treat their employees. At one end of the spectrum, employees are highly valued and sometimes are co-owners of the company. Ocean Spray Cranberries and, at one time, United Airlines include employees in the ownership structure. Companies invest in them, train them, and provide long-term bene�its. At the other end of the continuum, employees are treated as commodities or objects, hired and let go at will, even being replaced by part-timers to "save" the cost of having real employees. In Mexican maquiladoras, duty-free zones along the U.S.-Mexico border are low-cost-labor-manufacturing plants owned by U.S. and Japanese companies. For every employee hired, another 10–20 wait to take their place. The incentive to give them opportunity, career paths, and even stock in the company is zero. Likewise in China, some workers are forced to work in almost inhumane conditions around the clock until they burn out. This is not considered a problem because, again, many others are ready to take their place. Cultures differ on this, but valuing the employee stakeholder can have its own rewards.

Many companies believe, however, that they owe no duty to employees other than simply employing them. With this attitude, employees are considered a "cost" and neither a resource nor stakeholder. Companies feel proud to outsource a lot of their operations for "cost-effective reasons," laying off employees without a second thought. They also try to automate their processes, particularly expanding the use of information technology (IT) and justify the cost-effectiveness of the changes by laying off workers. A company that valued employee stakeholders might be more likely to use IT to free up workers to do other valuable work for the company.

Customers

Customers are another body with a stake in the company, but are they really stakeholders? In truth, every company makes promises to its customers, either explicit or implicit, that when they buy a product or service, it will perform as advertised, will not harm them, and will not break down in the �irst few days or months. Companies that consider customers as stakeholders want them to believe that any product it sells will keep or exceed its promises. Such companies have strong brand reputations. Other companies' products break down often or harm buyers and eventually cause customers to buy elsewhere; for such companies, customers are not stakeholders, but rather nothing more than a source of revenues.

Other Stakeholders

Host communities, which are towns or cities where a company is based, are considered to have a stake in the company as well. While some companies feel the most they owe to a host community is to provide employment, other companies take a more active role in the community. Providing employment does indeed support many other businesses and services in the town, and many towns in turn exist because of a single

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large employer. Company towns, although at �irst owned by their only employer, sometimes became regular public cities and towns as they grew. Sometimes, a single corporation employs most of a town's inhabitants, resulting in a physical and economic setting much like a company town. Usually, company towns are detached from neighbors and centered around a manufacturing setting such as lumber or steel mills or an automobile plant. Locals will typically work for the company or be related to those who do. When a company is unsuccessful or fails, the �inancial toll on the town can be disastrous (Green, 2010). Beyond providing employment, a more active company might contribute works of art for public display and sponsor many community and educational activities. Is this corporate social responsibility or valuing a host community as a stakeholder? It doesn't matter. What matters is that the environment in which employees live is valued as much as the employees themselves. Generally speaking, a happy employee is more inclined to be productive at work and loyal to the company.

But things can turn ugly when a large corporation decides, for economic or competitive reasons, to close a factory in a small town where it is the largest or even its only employer. Clearly, cost savings and pro�its dominate the decision. What happens to the employees that lose their job and the other myriad small businesses that depend on them are rarely factored into the decision. These companies clearly do not consider the host community a stakeholder.

Lastly, but important nonetheless, is the role of the environment as a stakeholder in a company. What duty do companies owe the environment? In the past, the answer to that question would be, None. For years, companies' factories would belch forth smoke and soot or dump contaminants into running streams and rivers just because they could. In Mexico, pollution from maquiladoras continues unabated, and exhaust from cars make Mexico City the most polluted city in the world (Energy Information Agency, n.d.). This is what economists call "externalizing the costs of doing business."

In the past, some workers were forced to work in hazardous environments without adequate protection, breathing in dangerous fumes for hours and days on end, and contracting all manner of illnesses. If not for regulations that protect the general and workplace environments, such practices would continue. Regulations are another way of saying, "Treat the environment as a stakeholder"; the public interest and the future of our planet is worth protecting and trumps the private interests of one company. To comply with regulations, companies have to build air–treatment systems that release only pure air into the environment, dispose of toxic byproducts of production in approved ways instead of dumping them into the nearby river or sewer, and give employees protective masks to �ilter unhealthy fumes. These increase a company's cost of doing business and may even make it uncompetitive with foreign companies whose behavior is unregulated; but in this country, it's the law.

Recently, in an effort to slow climate change, companies are being required to "reduce their carbon footprint," that is, to minimize or cease emission of greenhouse gases (carbon dioxide equivalent) into the atmosphere. Although there is no law as yet in the area of being eco- friendly, many companies are "going green" not only because they believe in not wasting or degrading precious resources but also because it

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has become a value embraced by their employees and even their customers. Thus, in many ways, the environment, thought of on many different levels, is becoming an important stakeholder.

Discussion Questions

1. Who are the stakeholders in your life? Which of them are important, and which have you never thought about until now? 2. Who are the stakeholders in a politician's life? Do you believe that the most important stakeholder—the voter—is often ignored? Why might this be so? Which stakeholders are given most attention? Why?

3. Investment brokers, by their very nature, invest their clients' money where they believe returns will be greatest given the risk involved. Who are their stakeholders? Is it just the clients they serve? If not, are all of them equally served? If not, why not?

4. Health-insurance companies have come under �ire recently for raising premiums of their subscribers by substantial amounts. They are accused, especially by those whose premiums have been raised, of catering to only themselves and their stockholders. Do they serve other stakeholders? If so, why aren't they perceived as serving other stakeholders?

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Summary

Strategic management is a complex process that is fundamental to a company's ongoing and future success. It includes both strategic formulation (planning) and implementation. Successful companies use feedback from their planning and operations to improve the decisions they make the next time around.

Strategic planning is the way of deciding what strategy the company should pursue in order to be more successful in the future. Some companies, especially small companies or those run by a founder or autocratic CEO, typically don't do strategic planning. In a changing world, making decisions without good data, analysis, and the inputs of those who will have to implement the strategy is foolhardy. Strategic planning is a structured and proven process for choosing the best strategy for a company to follow and making good strategic decisions. Without competitors, a company wouldn't need a strategy.

Competition is a capitalist society's way for consumers to tell producers what they need and want to buy. A company and its competitors comprise an industry and serve markets comprised of groups of customers. Markets are often confused with industries yet are very different: the former buy products and services while the latter produce them.

Companies compete in many ways—on price, through differentiating by making it easier for customers to buy, or through partnering with other companies. Competition has now become global; many foreign companies have the advantage of very low manufacturing costs and are increasingly taking over the manufacturing function of domestic companies.

Strategic thinking is a fundamental driver of good strategic planning and decision making. Strategic thinking involves having as accurate a perception as possible of a company's external environment. The extraordinary pace of change is making the job of strategic thinking more dif�icult and urgent. Doing strategic planning without strategic thinking leads to poor strategies and strategic decisions.

The outputs of strategic thinking, coupled with a candid assessment of the company itself and the resources at its disposal, form the basis for arriving at strategic issues—the most pressing issues facing the company at that time—and what strategic alternatives (or alternative futures) the company should consider before deciding on the strategies it should pursue over the next three or so years. It's the logical framework of a strategic analysis and of strategic planning for determining the best strategy a company should pursue.

The strategies that companies follow to compete effectively include concentration, innovation, differentiation, low–cost leadership, focus or specialization, �inding a "blue ocean," acquiring or merging with another company, forming strategic alliances, diversifying into another industry or segment, retrenchment, and divesting.

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Although similar on the surface, strategies differ from business models; a strategy is how a company actually competes, whereas a business model states how a company attracts customers, how it expects to make money, and how it will grow and includes its strategy.

"Success" means doing well on a set of performance–related measures and is different for every company. Success criteria include revenues, NIAT, pro�it ratios, shareholder value, market share, developing a competitive advantage, brand value and, for some companies going through hard times, their very survival.

A corporation owes some measure of duty to its stakeholders. These include stockholders and investors, creditors, employees, customers, host communities, and the environment. Ideally, a corporation should ful�ill its duty to all its stakeholders; in practice this is rarely the case. Employees, customers, host communities, and the environment are the stakeholders most likely to have their interests ignored.

Concept Check

Key Terms

acquisition strategy Involves buying another company to take full control of it (anywhere from a majority 51% stake to an outright 100% ownership).

applied research Takes something already discovered and patented and �inds ways of commercializing it (part of the "R" in R&D).

basic research Focuses on discovering new things and processes unimagined before and is very costly with uncertain outcomes (part of the "R" in R&D).

being acquired strategy A special case of a divestiture strategy where the whole company is divested (i.e., sold to another company or person). It is the opposite of an acquisition strategy.

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blue ocean An unserved market. The name stems from an analogy where a "red ocean" represents a bloody shark–feeding frenzy all going after some prey (too much competition), whereas a "blue ocean" is free of any predators except you—no competition, no blood.

blue–ocean strategy A strategy that involves �inding a market space that is not served at all, where the company is the only provider of a product or service and has no competitors; such a market space is called a blue ocean.

book value The value of a company asset shown on its balance sheet (which might have been depreciated or amortized); this may differ from what the same asset might fetch if sold on the open market (market value).

brand Represents a unique set of promises that a company warrants to its customers and that customers in turn expect from a company. Carefully crafted, a brand is used to position a company in the consumer's mind (safety, taste, performance, power, reliability, etc.). A strong brand is an indication of a successful differentiation strategy.

brand equity Refers to the power of a brand to in�luence purchases and loyalty. It can increase, remain the same, or decline over time. The main reasons for its erosion are competitors duplicating the quality of a brand so that it is no longer unique or a company failing to perform in ways that the brand promises.

business model Describes the way in which a company does what it does to deliver customer value. It should describe how it gets customers, how it will make money, and how it will grow.

concentration strategy Involves some combination of producing an existing, improved, or new product or service for an existing, expanded, or new market. Includes an innovation strategy and a technology strategy (both geared toward new–product development).

conglomerate–diversi�ication strategy Producing a brand new product or service for a brand new market. A seldom–used form of a concentration strategy.

core competence A capability that gives a company a strategic or competitive advantage over its competitors.

differentiation Developing a product that is unique from or superior to the product offered by the competition, and, as a consequence, having a strong and distinctive brand, which enables companies to charge more for their products because, in the consumer's mind, they are offering something no one else is offering (one of Michael Porter's three generic strategies).

differentiation strategy The development of a product that is unique from or superior to the product offered by the competition.

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diversi�ication strategy A strategy to enter another industry or segment, which could be related or unrelated to a company's current industry. Companies can do this through internal R&D or through acquisition of a company already in the new industry.

divestiture strategy A strategy to sell off a division or major assets of the �irm.

focus strategy Targets a very small market (often called a niche market) and, in so doing, avoids competing with large competitors that are not interested in serving such a small market.

free market A market in which the state does not regulate or interfere with the economy, apart from overseeing property ownership and private contracts.

generic strategies First introduced by Michael Porter in the early 1980s as ways for a company to achieve a competitive advantage and above–industry–average pro�its. They are differentiation, low–cost leadership, and focus or niche strategies.

globalization Describes the process by which regional economies, societies, and cultures have become integrated through communication, transportation, and trade. It is typically identi�ied as being propelled by a combination of economic, technological, sociocultural, political, and biological factors. The term can also refer to the transmission of ideas, languages, or popular culture across national boundaries. Any facet of life that has undergone this process can be considered to be globalized.

hypercompetitive industries Industries in which technological changes are occurring so rapidly that changes in market share are �leeting and temporary.

innovation strategy A product–development strategy that requires research and development (R&D) and focuses on introducing technologically advanced products or processes.

industry A collection of �irms that provides similar products or services to the same customers.

internal analysis Knowing, analyzing, and understanding everything about the company itself, especially what makes it a strong competitor.

joint venture (JV) Requires the formation of a new corporate entity (referred to in the literature as a "child") jointly owned by two companies (referred to as "the parents"). It is a kind of strategic alliance that enables the two parents to accomplish more than just having an agreement between them.

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key strategic issues A synthesis of both the external and internal analyses that focuses the company's attention on the most important issues it faces.

low–cost leadership A strategy that gives a company the lowest costs in its industry. One of Porter's three generic strategies.

maquiladoras Duty–free zones in large cities along the U.S.–Mexico border that contain low-cost-labor-manufacturing plants owned mostly by U.S. and Japanese companies.

market The collective name given to the buyers of the products or services produced by an industry.

market–development strategies Penetrating an existing market, expanding into related markets, or �inding new markets. Part of a concentration strategy.

market share A �irm's annual sales as a percentage of the annual sales of its industry or segment (really "industry share" but universally known as "market share").

market value The value that any company asset might fetch if sold on the open market; this value may differ from that carried on the company's books (book value).

mental model What we know or think we know about something, which can be modi�ied or updated as we come to learn more about it over time. Everyone has a mental model about everything but may not realize it.

merger strategy This strategy combines two companies, but through making joint decisions. Mergers succeed only when the cultures of the two entities are similar and both parties feel that merging would be in their mutual interest. A merger strategy is often used synonymously with an acquisition strategy, which is very different.

mixed economy A free market but where substantial state intervention (regulation) exists to protect the public interest.

model A way of codifying a complex activity in a way that is at once easy to explain, understand, and learn—and gives someone a "road map" as to how everything �its together.

monopoly When a particular �irm is the only company in an industry and can charge any outcomes price it likes, since customers cannot get the product from anyone else.

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net pro�it after taxes (NIAT) On the income statement, the amount that is left after all allowable expenses (including depreciation and amortization, which are accounting artifacts and not real expenses) have been deducted (often also referred to as "the bottom line"). Income statements are typically produced quarterly or annually.

net pro�it margin (NPM) A �inancial ratio calculated by dividing NIAT by revenues.

niche market A small subset of a larger market that has particular needs and which large competitors avoid because it is too small to be worth their time to serve.

operational decisions Made when doing operational planning and involve deciding what has to be done (programs, activities, tasks, projects), who will do it, who is accountable, what amount of budget is allocated, and a deadline for completing it.

product–development strategy Continuing to produce existing products or services, improving them over time, or introducing new products, all for the same market. Part of a concentration strategy.

retrenchment strategy A strategy re�lecting a conscious decision to become a smaller competitor in the industry.

return on equity (ROE) A �inancial ratio calculated by dividing NIAT by total stockholders' equity.

shareholder value A computed value based on a company's projected cash �lows for the next 10 years, discounted to the present time using discounted–cash–�low (DCF) analysis and an appropriate discount rate, and subtracting from the result all current debt.

stakeholders Individuals and groups that can impact a company's strategic outcomes and who have a vested interest in and power over a company's performance. Or groups of people to whom a company owes some form of duty, including investors, creditors, employees, customers, host communities, and the environment (the public interest and the future of the planet).

strategic alliance Two �irms partnering for their mutual bene�it but retaining their distinct corporate identity. Strategic alliances vary in their level of integration and commitment, ranging from simple contracts to joint ventures and owning minority stakes in other companies.

strategic alternatives Bona �ide strategic options (more like alternative futures) from which a company can choose the best one. They consist of strategies, strategic intent, programs, and how they might be �inanced.

strategic decisions These differ from operational or tactical decisions primarily in their complexity and consequences, which are more substantial for the organization.

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strategic management Steering and managing a company to be successful over time—not just for one year, but also year after year. Strategic management involves both strategy formulation and strategy implementation.

strategic-management model A reproducible series of activities that if followed would enable a company to formulate and implement strategies (i.e., do strategic management). The one used in this book is shown in Figure 1.1.

strategic planning The process by which a company develops a strategy to achieve certain purposes (what it considers "success").

strategic thinking A continual activity that seeks to �ind a better strategy and business model, including a market space that is not currently served and has no competitors (blue ocean). This cannot be done without knowing and understanding what is changing in a company's external environment and what the future might hold.

strategy How a company actually competes.

strategy formulation Otherwise known as strategic planningand a complex process in its own right, involves (1) strategic thinking(which includes external analysis), (2) internal analysis, (3) determining key strategic issues, (4) developing viable strategic alternatives, and (5) choosing the best strategy using as criteria whatever the company de�ines as "success."

strategy implementation Involves executing the strategies successfully and enabling the company to achieve its vision and meet its objectives.

supply chain Includes all companies from whom the �irm buys parts or materials in order to make or assemble their product and the companies that supply those companies, and so on back to the raw material. Includes only the part of the value chain "upstream" of the company (toward the raw materials).

technology Both the abstract and concrete tools—such as knowledge, skills, and artifacts—that can be used to create, produce, and deliver products.

technology strategy Focuses on developing new, or improving existing, technologies.