Application assignment 2
Student 601
Chapter9.pdf
Strategic Management: Theory and Practice
Strategy Formulation
Contributors: By: John A. Parnell
Book Title: Strategic Management: Theory and Practice
Chapter Title: "Strategy Formulation"
Pub. Date: 2014
Access Date: March 24, 2018
Publishing Company: SAGE Publications, Ltd
City: 55 City Road
Print ISBN: 9781452234984
Online ISBN: 9781506374598
DOI: http://dx.doi.org/10.4135/9781506374598.n9
Print pages: 246-269
©2014 SAGE Publications, Ltd. All Rights Reserved.
This PDF has been generated from SAGE Knowledge. Please note that the pagination of
the online version will vary from the pagination of the print book.
Strategy Formulation
Chapter Outline
Strengths and Weaknesses
Human Resources Board of Directors
Top Management
Middle Management, Supervisors, and Employees
Organizational Resources
Physical Resources
Opportunities and Threats
The SW/OT Matrix
Issues in Strategy Formulation Evaluating Strategic Change
Strategy, Corporate Social Responsibility, and Managerial Ethics
Effects on Organizational Resources
Anticipated Responses From Competitors and Customers
Summary
Key Terms
Review Questions and Exercises
Practice Quiz
Student Study Site
Notes
This chapter marks a shift from analysis toward recommendations. Reconsidering the firm's current strategic initiatives is the first step in evaluating its activities and thinking about what
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the firm should be doing.
After the firm's mission and ongoing strategic directions are well understood, the organization can begin to craft a strategy. The first step in this process, a SWOT (strengths, weaknesses, opportunities, and threats) analysis, enables top managers to position the firm to take advantage of select opportunities in the environment while avoiding or minimizing
environmental threats.1. In doing so, the organization attempts to emphasize its strengths and moderate the potential negative consequences of its weaknesses. Sometimes referred to as TOWS, the SWOT analysis also helps uncover strengths that have not yet been fully utilized and identify weaknesses that can be corrected. Matching information about the environment with knowledge of the organization's capabilities enables management to formulate realistic
strategies for attaining its goals.2.
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Strengths and Weaknesses
The first two elements of the SWOT analysis—strengths and weaknesses—represent internal firm attributes. In addition, a firm's strengths and weaknesses are considered relative to key competitors in its industry. In other words, customer loyalty would be viewed as a strength or weakness for an organization if it is more pronounced in that firm than in most others in the industry. Hence, strengths can be viewed as artifacts of past success in an organization whereas weaknesses can be seen as gaps between an organization's current position and the industry norm. As an extension of this logic, the notion of gap analysis seeks to identify the distance between a firm's current position and its desired position with regard to an internal weakness. When possible, a firm should take action to close the gap—especially when the gap leaves a firm vulnerable to external threats in its environment. Simply closing performance gaps is not sufficient, however. Strategic decisions should accentuate competitive advantage, not just seek to match rivals or industry norms.
The value chain is also a useful concept for analyzing a firm's strengths and weaknesses and understanding how they might translate into competitive advantage or disadvantage. The value chain describes the activities that comprise the economic performance and capabilities of the firm. The organization is viewed as an intermediary that systemically transforms low- value inputs into high-value outputs. Specifically, the value chain identifies primary and support activities that create value for customers. Primary activities in the chain include inbound logistics, operations, outbound logistics, marketing, and service. Support activities include the firm infrastructure, human resources management (HRM), technology, and procurement. Each of these activities plays a role in the transformation and can be evaluated
in terms of effectiveness and efficiency, ultimately connoting strengths and weaknesses.3.
By considering all of the firm's processes from the procurement of raw materials to the delivery of a final product and/or service, strategic managers can identify discrete activities performed along the way that may add exceptional value to the end product or detract from it. For example, in March 2002, after a gradual decline in travel agency commissions throughout the industry, Delta Airlines announced an end to most of the commissions it pays to travel agents. With Delta's ability to trim sales costs through direct selling, airline executives no longer believed that domestic travel agents were adding sufficient value to justify the
expense.4. Other major airlines followed suit, and by the late 2000s, all major airlines were utilizing their Internet sites to provide the sales and support services traditionally provided by third-party travel agencies. Today, firms like Orbitz, Travelocity, and the remaining traditional travel agencies have found other ways to add value, such as emphasizing tour packages, online search features, personal service, convenience, or hotel-car-airline packages.
There are three broad categories of firm resources that form the foundation for firm strengths and weaknesses:
Human resources: The experience, capabilities, knowledge, skills, and judgment of all the firm's employees Organizational resources: The firm's systems and processes, including its strategies at various levels, structure, and culture Physical resources: Plant and equipment, geographic locations, access to raw materials, distribution network, and technology.
Each resource category is discussed in greater detail next.
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Human Resources
The most attractive organizational and physical resources are useless without a competent workforce of managers and employees. A firm's human resources (HR) can be examined at three levels: (1) the board of directors; (2) top management; and (3) middle management, supervisors, and employees.
Board of Directors
Because board members are becoming increasingly involved in corporate affairs, they can materially influence the firm's effectiveness. In examining strengths and weaknesses they bring to the firm, one should consider the following issues:
Prospective contributions of corporate board members: Strong board members possess considerable experience, knowledge, and judgment, as well as valuable outside political connections. Tenure (experience) as members of the corporate board: Long-term stability enables board members to gain organizational knowledge, but some turnover is beneficial because new members often bring a fresh perspective to strategic issues. Connection to the firm (i.e., internal or external) and ability to represent various stakeholders: Although it is common for several top managers to be board members, a disproportionate representation of them diminishes the identity of the board as a group apart from top management. Ideally, board members should represent diverse stakeholders, including minorities, creditors, customers, and the local community. A diverse board membership can contribute to the health of the firm.
Top Management
Three issues should be considered relative to the strengths and weaknesses of any firm's top management.
Backgrounds and capabilities of top managers: Comprehending their strengths and weaknesses in experience, managerial style, decision-making capability, and team building is useful. Although having executives who have an extensive knowledge of the firm and its industry can be advantageous, managers from diverse and complementary backgrounds may generate innovative strategic ideas. In addition, an organization's management needs may change as the firm grows and matures. Because firms are often started by innovative entrepreneurs who happen to be poor administrators, they often add key administrators to the top management team, which includes the group of top-level executives—headed by the chief executive officer (CEO)—all of whom play instrumental roles in the strategic management process. Tenure (experience) as members of top management: Although lengthy tenure can mean consistent and stable strategy development and implementation, low turnover may breed conformity, complacency, and a failure to explore new opportunities. CEO turnover is even desirable when the firm is unable to meet its performance targets. Strengths and weaknesses of individual top managers: Some executives may excel in strategy formulation, for instance, but be weak in implementation. Some may spend considerable time on internal stakeholders and operations whereas others may concentrate on external constituents. As with the board of directors, it is helpful for
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board members to possess complementary skills to function well as a team. In addition, a number of large companies offer financial incentives to sign and retain top executives with knowledge critical to the firm.
Middle Management, Supervisors, and Employees
Even the best strategies will fail without a talented workforce to implement them. A firm's personnel and their knowledge, abilities, commitment, and performance tend to reflect the firm's human resource programs. These factors can be explored by considering five key issues:
Existence of a comprehensive human resource planning program: Developing such a program requires that the firm forecast its personnel needs, including types of positions and requisite qualifications, for the next several years based on its strategic plan. Strategically relevant knowledge or expertise possessed by members of the firm: Many firms place a great emphasis on retaining high-quality individuals in a number of areas, such as research and development (R & D) or sales. This is a critical issue when a firm is heavily involved in global competition. Interestingly, all companies claim to have the best workforce, but clearly this is not the case. Emphasis on training and development: Some firms view training and development as a strategic issue and seek long-term benefits from its training programs. In contrast, other firms view training as a short-term necessity and emphasize cost minimization in their programs. Turnover: High turnover relative to levels among close competitors generally reflects personnel problems, such as poor management-employee relations, low compensation or benefits, or low job satisfaction due to other causes. Emphasis on effective performance appraisal (PA): Progressive firms utilize PA to provide accurate feedback to managers and employees, link rewards to actual performance, and show managers and employees how to improve performance, as well as comply with all equal employment opportunity requirements. Firms that do not adequately appraise high performers—and reward them—are more likely to lose them.
Organizational Resources
The alignment between organizational resources and business strategy is critical for long- term success. In this regard, seven key issues are noteworthy:
Consistency among corporate, business, and functional strategies: To facilitate strategy integration, managers at the corporate, business unit, and functional level should be represented at each level of strategic planning. The strategy at each level should influence and be influenced by the strategy at the other levels. Consistency between organizational strategies and the firm's mission and goals: The mission, goals, and strategies must be compatible and integrated to reflect a clear sense of identity and purpose for the organization. Consistency between the firm's strategies and its culture: For a strategy to be effective, it must be supported by an organizational culture that emphasizes values that support it. Consistency between the firm's strategies and its structure: It is important to note any structural changes that might be required should the organization seek to implement a major change in strategy.
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Position in the industry: All things equal, firms that possess strong market positions are in a better position to implement strategic changes than those in weak positions. For firms operating globally, this assessment must be made in the various nations in which the firm operates. Product and service quality: It is important to comprehend how quality levels of the firm's products and services compare with those of rival firms. Reputation of the firm and/or brand: Many firms have established reputations for factors such as high quality and customer service. Recent surveys have identified a number of strong brands such as Coca-Cola, McDonald's, Apple, Starbucks, and Google. The Toyota brand lost considerable value after the brake crisis in 2009 and 2010, but
appeared to recover well in 2011 and 2012.5.
Physical Resources
Physical resources can differ considerably from one organization to another, even among close competitors. For example, Amazon.com requires different physical plants than a consulting firm. Nonetheless, five issues concerning the strengths and weaknesses of physical resources should be considered:
Currency of technology: All things equal, competitors with superior technology and the ability to use it have a decided competitive advantage in the marketplace. This is especially true in global markets and should be assessed in each of the nations in which the firm operates. Quality and sophistication of distribution network: Distribution networks apply to both manufacturing and service concerns. American Airlines’ domination of passenger gates at Dallas/Fort Worth Airport and Delta's similar control in Atlanta give both of these service companies a competitive advantage. Production capacity: A continual backlog of orders may indicate a growing market acceptance of a firm's product, or it may depict serious problems associated with insufficient capacity. A firm can expand its capacity by increasing production shifts or obtaining additional facilities, but such measures can be costly. Reliable access to cost-effective sources of supplies: Suppliers who are unreliable, lack effective quality control programs, or cannot control their costs well do not foster a competitive advantage for the buying firm. Favorable location(s): Ideally, the organization should be located where skilled labor, suppliers, and customers are readily accessible.
In an optimal setting, all three types of resources work together to provide the firm with a competitive advantage that can be sustained. Following the resource-based perspective introduced in Chapter 1, firm success depends primarily on the combination of resources it possesses The VRIO (valuable, rare, imitable, and organization) framework helps strategic managers evaluate the competitive quality of the resources controlled by the organization on
the basis of four progressive characteristics:6.
Valuable: Can the resource be employed to exploit an opportunity or neutralize an external threat? Resources that are merely valuable can assist the firm in attaining competitive parity with rivals but not competitive advantage. Rare: Is the resource controlled by a relatively small number of individuals or firms? Resources that are both valuable and rare can produce temporary competitive advantage. This is worthwhile, but a resource's scarcity tends to erode over time.
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Imitable: Can other firms easily imitate or acquire the resource? If rivals cannot imitate or acquire a valuable and rare resource, then a firm has the potential for achieving and maintaining competitive advantage over the long term. Organization: Is the firm poised to exploit the resource? Firms that are able to leverage valuable, rare, and inimitable resources can attain sustained competitive advantage. While firm resources—both tangible and intangible—ultimately constitute the firm's strengths and weaknesses, merely possessing a resource does not always benefit the organization. Resources are translated into desired results by a firm's capabilities, its
skills at coordinating and leveraging resources to create value.7.
Table 9.1 VRIO Framework8.
Resourc e Charact eristic
Definition Implication
Valuabl e
Can be employed to exploit an opportunity or neutralize a threat
If only valuable, then there is only parity with rivals. There is no competitive advantage.
Rare Controlled by one or a few entities
If only valuable and rare, competitive advantage exists but is likely to be temporary.
Inimitab le
Costly for rivals to duplicate If valuable, rare, and inimitable, the firm has the potential for long-term competitive advantage.
Organiz ation
The firm possesses the appropriate capabilities to leverage the resource
If valuable, rare and inimitable, and if the firm has the appropriate capabilities, then sustainable competitive advantage can be achieved.
Capabilities are essential if valuable, inimitable, and rare resources are to be effectively employed. The ability to manage supply chains, adjust pricing, and execute flexible production represent a few capabilities Toyota has leveraged during the past two decades. Although resources and capabilities are sometimes used interchangeably in the popular press and both can represent strengths or weaknesses, the distinction between the two concepts is
an important one.9.
The unique combination of a firm's human, organizational, and physical resources— as transformed into capabilities—should be emphasized in its strategy. As the firm acquires additional resources, unique synergies occur between its new and existing resources. Because each firm possesses its own distinct combination of resources, the particular types of synergies that occur will differ from one firm to another. Leveraging these synergies into sustained competitive advantages is a key task of top management (see Case Analysis 9.1).
Case Analysis 9.1 Step 16: What Strengths Exist for the Organization?
Step 17: What Weaknesses Exist for the Organization?
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Resources and strategic capabilities are the foundation for a firm's internal strengths and weaknesses. The VRIO framework should be employed to evaluate the competitive quality of firm resources. The organization's strengths and weaknesses should be numbered, each with as much depth and justification as possible. Many possible organizational strengths and weaknesses can emanate from its resource base, including (but not limited to) the following:
Brand names and recognition
Company reputation
Control systems
Costs (internal)
Customer loyalty
Decision making
Distribution
Economies of scale
Environmental scanning
Executive leadership
Financial resources
Forecasting
Government lobbying
HR
Information systems and technology
Internet presence
Labor relations
Location
Logistics and inventory management
Manufacturing and operations
Market share
Organizational structure
Physical facilities and equipment
Product/service differentiation
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Product/service quality
Promotion and advertising
Public relations
Purchasing and channel management
Quality control
R & D
Sales
Strategic capabilities
Technology and patents
The previous list includes examples of strengths and weaknesses, but there are many others. To set the stage for the remainder of the analysis, it is important to state clearly how each strength has benefited the organization and how each weakness has hindered it. In many instances, the strengths are the primary catalysts for the organization's successes, and its weaknesses are the main reasons why it has failed in certain endeavors.
There is no set target for the number of strengths or weaknesses that should be identified in a case analysis. When only several are identified, however, it is likely that the effort is not thorough. When the list becomes too long-as would be the case if all of the items in the previous list happened to be associated with strengths and/or weaknesses-it becomes cumbersome to manage in the remaining steps of the analysis. In this situation, it is necessary to consider pooling several items into a single one whenever feasible. For example, “expertise in advertising” and “a strong sales force” could be merged into a single item entitled “marketing expertise.”
Opportunities and Threats
The last two elements of the SWOT analysis—opportunities and threats—are associated with factors outside the organization. As such, they must emanate from the earlier analyses of the industry and the macroenvironment (i.e., PEST, or political-legal, economic, social, and technological forces). Although an industry-level analysis may identify general factors, this stage shifts to the firm level and considers how the external forces could affect the organization under consideration. For example, an analysis of the social forces affecting investment houses may identify consumer acceptance of the Internet as a social force affecting the industry. Considering online broker TD Ameritrade, this force may be translated into both opportunities (e.g., a growing market of potential online investors who are still utilizing traditional brokers) and threats (e.g., intense competition from the myriad of Internet sources that may erode the loyalty of current customers to Ameritrade offerings).
External opportunities and threats must not be confused with internal strengths and weaknesses. Factors associated with the firm such as a poor financial position, an ineffective
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marketing strategy, or a strong brand image are internal factors and therefore must be classified as strengths or weaknesses. In contrast, factors outside the firm such as demographic changes, competitive threats, or recent legislation are external factors and therefore must be classified as opportunities or threats. At the international level, a number of external factors should be considered as prospective opportunities and threats, including the cyclical or seasonal nature of the industry in which the firm operates, as well as the intensity of global competition.
It is also critical to distinguish between opportunities and alternatives, although the distinction can sometimes appear to be one of semantics. Opportunities represent the application of forces in the external environment to a specific organization. Alternatives emanate from the SW/OT matrix (discussed later) and represent specific courses of action that the organization may choose to pursue. The two are related but must be distinguished. For example, increasing societal interest in Cajun food may present an opportunity for a restaurant. When evaluated in the SW/OT matrix relative to internal factors such as the company's existing locations in Louisiana and its strong reputation for innovative cuisine, this opportunity may lead to an alternative for the company to consider, such as introducing a new line of Cajun offerings (see Case Analysis 9.2).
Case Analysis 9.2 Step 18: What Opportunities Exist for the Organization?
Step 19: What Threats Exist for the Organization?
In the SWOT analysis, one must not only identify strengths and weaknesses but must also translate the analysis of the macroenvironment and industry into opportunities and threats. Although these issues will have been addressed at the industry level earlier in the analysis, they should be integrated into a discussion that highlights specifically how they present opportunities to or threaten the organization. For example, if it was previously noted that the industry rises and falls abruptly with economic conditions, then the prospects of a recession may pose a major threat for the firm. If it was noted that technological advances have not yet been incorporated into production processes in the industry, then application of this technology may become an opportunity worth considering for the organization.
There is no set target for the number of opportunities or threats that should be identified. When only several in each category are identified, however, it is likely that the analysis is superficial and key issues have not been included.
The SW/OT Matrix
After the SWOT analysis is completed, alternative courses of action may be analyzed by
creating a SW/OT matrix.10. The SW/OT matrix extends the SWOT analysis by using it as a tool for generating strategic alternatives for the firm. This is why it is critical that external opportunities not be confused with alternative courses of action. Prospective strategic options for the firm emanate from the SW/OT matrix.
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A SW/OT matrix is created with strengths and weaknesses listed vertically on the left side and opportunities and threats listed across the top. Alternatives emerge from the combination of one or more strengths/weaknesses from the left side of the matrix with one or more opportunities/threats from the top. For example, a company that can develop and produce high-quality electronic products in a short period of time—a strength—could take advantage of an increased consumer interest in smartphones—an opportunity—by developing and marketing one, a strategic alternative. This does not mean that the company should necessarily pursue such a strategy but merely that the alternative warrants further consideration. The SW/OT matrix is a systematic means of developing strategic alternatives available to the organization, but it also requires brainstorming and creative skills as well. The SW/OT matrix helps top managers position a firm in its environment so that it leverages its strengths while minimizing the detrimental effects of its weaknesses.
In general, four categories of alternatives emerge from the SW/OT matrix, each representing the combination of one or more strengths or weaknesses with one or more opportunities or threats:
Strength-Opportunity: These “offensive” alternatives tend to be the most common and involve utilizing an organizational strength to address an opportunity. In the late 2000s, Canadian donut shop Tim Horton's began a campaign to expand rapidly into U.S.
markets.11. Tim Horton was leveraging a strength—its success and strong track record in Canada—to pursue an opportunity: increasing demand for donut shops in bordering states. At the same time, Honda utilized two strengths: (1) a combination of motorcycle quality and (2) affordability along with a strong partnership with an Indian manufacturer —to capitalize on an opportunity—increasing disposable income and demand for economical transportation in India—to produce and sell more than 4 million motorcycles and scooters in India, accounting for more than one-half of the nation's
market share.12.
Weakness-Threat: These “defensive” alternatives involve taking some corrective action
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to eliminate or minimize a weakness so as to minimize the effect of a threat. If an airline with an aging, fuel-inefficient fleet (a weakness) is facing the prospects of a substantial increase in the price of fuel (a threat), it may consider a weakness-threat alternative such as consolidating flights or upgrading its airplanes to newer, more efficient models. Strength-Threat: These alternatives involve utilizing a strength to eliminate or minimize the effect of a threat. Strength-threat alternatives may be offensive or defensive. Suppose a manufacturer with a strong track record of innovation (a strength) is facing the prospects of increased consumer scrutiny and government regulation of its products because of ecological concerns (a threat). This firm may consider a strength- threat alternative such as a product redesign to address the changing needs of the marketplace and regulatory environment ahead of its rivals. Weakness-Opportunity: These alternatives involve shoring up a weakness so that the organization can take advantage of an opportunity and may be offensive or defensive. Borders bet on a brick-and-mortar strategy in the early 2000s but changed course in
2008 because of continued growth in online sales.13. Borders sought to overcome a weakness—a lack of a branded e-commerce site—by pursuing an opportunity, growth in the Internet segment. Borders’ action was too late, however, as the company liquidated in 2011. Motorcycle icon Harley-Davidson, suffering from a 35% decline in U.S. retail sales, opted to join Honda and sought to take advantage of prospects for rapid growth in the Indian market. Unlike Honda, however, Harley is pursuing the most affluent Indian consumers with a line of motorcycles starting at more than $15,000,
more than 15 times the average annual salary.14. The ultimate success of Harley- Davidson's strategy remains to be seen.
Typically, most of the individual internal-external combinations (i.e., matches between strengths/weaknesses and opportunities/threats) will not produce viable alternatives. Further, several different combinations of internal and external factors can produce the same alternative. Some of the alternatives that emerge might be eliminated from further consideration for obvious reasons (e.g., taking the action would be illegal). In addition, a given SW/OT matrix might generate a large number of alternatives in a particular category whereas only a few may be generated in other categories. Emphasis should be placed on the specific alternatives, not the four categories of alternatives. Once generated, strategic alternatives should be analyzed further.
Figure 9.2 provides a simplified example of a SW/OT matrix for McDonald's. Assume that the SWOT analysis for McDonald's identified strengths of financial stability, brand recognition, and a strong ability to produce consistent products throughout the world. Two weaknesses were identified as well: (1) a reputation for lackluster taste and (2) a heavy dependence on fried foods. There were two key opportunities: (1) economic growth in emerging economies and (2) the increasing health consciousness in the United States and other global markets. Two threats were highlighted as well, including the global economic downturn and the increasing popularity of easy-to-prepare microwaveable foods. A thorough SWOT analysis for McDonald's would develop many more than two or three factors in each category in our simple example. Nonetheless, the number and complexity of the factors are kept to a minimum in this example so that the process of developing alternatives can be clearly illustrated.
Figure 9.2 A Simple SW/OT Matrix for McDonald's
Opportunities Threats
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Growth in emerging economies Increasing health consciousness in U.S. and other markets
Global economic downturn Growing popularity of easy- toprepare items in grocery stores
Strengths
Financial stability and resources Brand name and recognition Consistency in operations
Alternative 1: Launch new locations in BRIC (Brazil, Russia, India, and China) nations (S1, S2, O1) Alternative 2: Expand healthier food alternatives (W1, W2, O2) Alternative 3: Launch foods in grocery outlets (S2, S3, T2)Weaknesses
Reputation for bland-tasting fast food Dependence on fried foods
Following the example, three possible alternative courses of action can be identified for further consideration. First, McDonald's could emphasize its financial and brand strengths and seize an emerging market opportunity by expanding aggressively into the rapidly growing BRIC (Brazil, Russia, India, and China) nations. Other nations (e.g., Mexico, South Africa) could also be considered as part of the alternative, but this example assumes that industry and/or external environment assessments highlighted specific advantages of the BRIC nations.
Second, McDonald's could address its weaknesses of declining market share and dependence on fast food and capitalize on increasing health awareness in the United States and other parts of the world by expanding its offerings of healthier foods such as grilled chicken and salads. McDonald's has moved in this direction in recent years, but most of its revenues are still derived from traditional fried foods (e.g., hamburgers, french fries), soft drinks, and the like.
Third, McDonald's could emphasize its brand name and consistency strengths and address the threat of increased popularity of easy-to-prepare grocery items by introducing its own line of grocery products. Other fast-food and fast casual restaurants such as Taco Bell and T.G.I. Fridays have introduced products in grocery stores, and White Castle even distributes it famous hamburgers, known as “sliders,” in microwave-ready form.
This simple example considers only a few hypothetical items in each of the SWOT categories, suggests only three prospective alternatives, and does not suggest that McDonald's should necessarily adopt any of them. Continuing to implement the current strategy in its present form—the so-called “no change” option—should be considered. This alternative—denoted as the final option in the previous example—should be analyzed as critically as the other ones.
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Selecting the “no change” alternative should not be considered as a low-risk option because resisting change may be just as likely to expose a firm to great danger as embracing it.
The strategic alternatives should also be presented in the strategy level-strategy complexity (SLSC) matrix. The SLSC matrix compares and contrasts the alternatives on the basis of strategy level—corporate, business, or functional—and strategy complexity—the extent to which executing the strategy would require substantial change, resources, and uncertainty. All things equal, the lower the strategy level (i.e., closer to functional level) and the less complex the strategy, the easier it will be to execute. Alternatively, the higher the strategy level and the more complex the strategy, the more difficult execution is likely to be. For this reason, implementing multiple high level, complex strategies is usually not advisable.
Figure 9.3 applies the SLSC matrix to the McDonald's example. Each of the alternatives except the “no change” option appears in the matrix. Although most alternatives influence each strategy level to some extent, developing and emphasizing more healthy foods is largely a functional strategy concern most closely associated with production and marketing. In contrast, launching new locations is associated with corporate growth and involves all of the complexities of global operations. Emphasizing frozen foods in grocery outlets involves both functional (e.g., production and distribution) and business level strategy changes. Relatively speaking, developing a new distribution channel and producing a line of frozen food might be viewed as a moderately complex endeavor. In this example, the SLSC enables the decision maker to examine the strategies available to the firm in terms of resources required for execution.
Figure 9.3 Strategy Level-Strategy Complexity Matrix for McDonald's
Evaluating the pros and cons of strategic alternatives in a detailed, objective, and thorough manner is critical. In some instances, a logistical problem can pose a serious challenge to an alternative. When automakers began to develop electric cars in the late 2000s, the need for ready access to inexpensive, plentiful electricity had not been fully addressed. If drivers charge their cars at night when electricity demand is low, utility companies will enjoy greater revenues without necessarily having to add capacity. However, if drivers charge their cars during the day when electricity demand is high, utilities will be faced with a capacity problem
and rates will likely rise.15. Given the high demand for electric cars at the time, this potential drawback would not be sufficient to preclude the alternative from consideration. The potential problem and possible solutions should be seriously considered when evaluating the
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alternative, however.
Problems with implementation can often be traced to the lack of a thorough evaluation of the strategic alternatives available to a firm (see Case Analysis 9.3). For example, it is easy to assume that well-known brands will be readily accepted in new markets or that competitors will not respond effectively to major strategic changes. Even major retailers, however, can find
themselves battling stiff local competition when they expand abroad.16.
Case Analysis 9.3 Step 20: What Strategic Alternatives Are Available to the Organization?
Alternatives are organizational courses of action that (1) are worth considering because they offer some potentially positive benefits and (2) are within the realm of possibilities for the organization. For starters, one alternative is to continue with the present strategy. Sometimes this alternative is the most desirable, but typically some changes are needed. Additional alternatives should be identified from the SW/OT matrix in two ways. First, one should consider more fully utilizing one's strengths to take advantage of existing opportunities or palliate threats if the organization is not presently doing so. For example, if an organization has excess production capacity and there exists a market not presently served, then moving into this market is worth considering. Second, one should also consider taking action to minimize the weaknesses so that the organization can pursue opportunities or minimize the effect of threats. It is critical to identify the S/W-O/T combinations that result in the identification of each alternative, but it is not worthwhile to include alternatives that are obviously implausible or unattractive (e.g., McDonald's could close its fast-food stores to concentrate on promoting frozen foods through grocery outlets) for the sake of creating a list. All of the alternatives to be considered should be deemed viable upon cursory examination. Alternatives should also be plotted in the SLSC matrix.
There is no set number of alternatives that should be generated. As with the identification of elements within the SWOT, too few alternatives imply a superficial analysis whereas too many alternatives can become difficult to assess.
Step 21: What Are the Pros and Cons of These Alternatives?
Some of the alternatives identified in Step 20 may be mutually exclusive whereas others may not. Inevitably, one must assess the attractiveness of each alternative. It is not appropriate to subjectively promote one or two that will be recommended later. Rather, pros and cons must be objectively identified for each alternative. Even attractive alternatives have costs and downsides, and others may have limited prospects for success-factors that should be converted to dollars whenever possible. For example, quality circles may be proposed as a solution to low morale without considering the costs. Quality circles require a commitment of time (i.e., lost production) and effort if they are to be successful, and management must also be willing to implement suggestions. In the final analysis, quality circles may be desirable, but no strategy can be implemented cost-free.
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Interestingly, the quality circles recommendation also has another problem. Most scholars and practitioners have reported that quality circles are effective only when part of a larger approach to employee empowerment. As such, a quality circle alternative should encompass an overall strategic change as related to the organization's HR, not simply the implementation of a technique.
It is important to consider competitive responses in concert with this and the subsequent case analysis step. For example, a McDonald's drop in price for the Big Mac cannot be considered in isolation of a likely price cut at Burger King. In many cases, anticipated retaliation is a “con” of the alternative and could ultimately render the alternative as undesirable. Assuming that competitor behavior will not change over time-especially in response to a major strategic change-is shortsighted.
Step 22: Which Alternative(s) should be Pursued and Why?
This phase necessitates an objective and subjective analysis of the pros and cons associated with each alternative. It is important that an alternative not be selected without both arguing for its selection and explaining why competing alternatives were rejected. When two or more options are mutually exclusive, eliminating the options not chosen is just as important as selecting the desired choices. While it is important to spend time analyzing the alternatives, one must resist the temptation to overana-lyze and avoid making the difficult choices, a process often referred to as analysis to paralysis.
The direction of a strategic change can affect the difficulty of its implementation. In general, a business pursuing differentiation can shift to a cost leadership approach more easily than a low-cost business can shift to differentiation. Because a low-cost business is likely to be associated with value rather than quality, it is difficult to convince buyers that they should pay more because its products are differentiated.
Issues in Strategy Formulation
Crafting a strategy is not an easy task, even with the assistance of tools like the SW/OT and SLSC matrices. When a strategy appears attractive, a number of issues should be considered before it is implemented. Four such issues are discussed in this section.
Evaluating Strategic Change
Should an organization change course when performance declines, or should it stay the course? On the one hand, its strategic managers may choose to commit to a strategic course of action for an extended period of time and enjoy the benefits of specialization, expertise, organizational learning, and a clear customer image. Alternatively, an organization can remain flexible so that it does not become committed to products, technology, or market approaches that may become outdated. In a perfect world, organizations commit to predictable, successful courses of action, and strategic change is only incremental. However, outcomes are not always predictable.
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As with many strategic issues, there are two compelling sides to this debate. When traditional firms perform poorly, their strategic managers are exhorted by business analysts to promote flexibility and strategic renewal to improve profitability. In contrast, when bold strategic changes fail, pundits assert that a company must return to its “core business.” Hence, it is easy to migrate freely from one side of the debate to the other, often with convincing empirical and intuitively appealing arguments.
The needs for strategic flexibility or commitment can be debated on at least four grounds. First, a strategy tends to yield superior performance when it fits with the organization's environment. Without strategic flexibility, an organization cannot adapt to its changing external environment. Even if an organization's strategy and its environment are in concert, an environmental shift may necessitate strategic change to maintain alignment. Changes in competition and technology can also necessitate a change in the knowledge base within the organization if it is to prosper. The state of the environment is not always fully understood by strategy formula-tors, and top managers may be most likely to contemplate a strategic change when perceived environmental uncertainty is high.
The economic downturn of the late 2000s prompted many luxury retailers to develop new or more greatly emphasize existing outlet stores. Saks Fifth Avenue renamed its Off Fifth outlets to “Saks Fifth Avenue Off Fifth” to more closely link the outlets with the Saks brand. Nike
renovated its outlet stores and added new ones to attract bargain shoppers.17.
In contrast, however, a change in any key strategic, environmental, or organizational factors may entice strategic managers in a business to modify its strategy to incorporate these changes. However, since such variables are constantly evolving, this is a challenging process, and strategic inaction may minimize uncertainty. Indeed, a strategic change is most risky when competitors are better equipped to respond if it is deemed successful. As such, strategic change can challenge the assumptions of all organizational members and may be difficult to implement even with employee support.
Second, flexibility is necessary if an organization is to seek first-mover advantages by entering a new market or developing a new product or service prior to its competitors. Being a first mover can help secure access to scarce resources, increase the organization's knowledge base, and result in substantial long-term competitive advantage, especially when switching costs are high. Maintaining commitment to the firm's strategy can preclude movement into
attractive strategic domains.18.
In 2008, Fisher-Price began to emphasize its toys in China, Brazil, Russia, and Poland, developing nations where brand-name American products in many categories were not common. Emerging markets like these have fast-growing middle classes. By promoting its products in these nations, Fisher-Price sought to establish a foothold while the market was
still in its infancy.19.
However, even when strategic change results in a successful new product or service, there is no assurance that this success can be maintained. In fact, competitors may distort consumer perceptions and reap the benefits of the initial strategic change. When a consumer goods company imitates another, for example, consumers may purchase the imitation product thinking it is the original. If consumers dislike the product, this dissatisfaction can be transferred to the original. On the other hand, a consumer who likes the product may realize that it is an imitation and transfer the positive associations with the original product to that of the imitator. Either scenario can prove costly to the originator.
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Third, if a firm's environment is relatively stable, strategic change can be attractive when the organization's set of unique human, physical, capital, and informational resources change. Resource shifts necessitating strategic change may be more prevalent in some organizations than in others. Following this logic, strategic change can improve an organization's ability to adapt by forcing healthy changes within the business. The initial pain associated with change may be offset by the emergence of a lean, rejuvenated organization with a fresh focus on its
goals and objectives.20.
However, consumer confusion may result from strategic change even when the new strategy represents a better fit with the firm's resources. Apple discovered this in 2007 when it cut the price of the iPhone from $599 to $399 after just 10 weeks on the market. Although customers who paid the higher price were offered a $100 rebate, many felt a sense of remorse. In addition, this rapid price shift might have conditioned prospective customers in the future to
wait for price cuts when new Apple products are released in the future.21. Apple survived this challenge, and the iPhone continues to be one of the most popular smartphones well into the 2010s.
Fourth, strategic change may be necessary if desired performance levels are not being attained by the organization. In some cases, a change in strategy may be required to improve the ability of the business to generate revenues or profits, increase market share, and/ or improve return on assets or investment. In many cases, new CEOs are recruited for that purpose.
In contrast, the measures required to implement a change in strategy may necessitate substantial outlays of capital, thereby further denigrating the organization's financial position. Considering the Miles and Snow typology as an example, a shift from a prospector or analyzer strategy to a defender strategy may require investments in sophisticated production equipment to lower production costs, a characteristic more important to effective implementation of a defender strategy. Likewise, a shift from defender or analyzer to prospector may require substantial outlays to develop or enhance R & D facilities.
Carrefour faced these trade-offs in 2010 when it embarked on a major strategic change. Carrefour was the world's second largest retailer at that time with stores and offerings similar to those of its larger rival, Wal-Mart. After losing global market share for several years, CEO Lars Olofsson embarked on an effort to transform the company from a big box selling other companies’ brands into a strong consumer label in its own right. Just as IKEA Group found success by establishing and selling its own brand of furniture, Olofsson envisioned Carrefour as a retailer that emphasizes its own private labels at the lowest prices in the industry. The strategic shift required initial outlays of an estimated several hundreds of millions of dollars, including store makeovers and the implementation of a cost-saving stock-management
system the company pioneered in China.22.
Ironically, Wal-Mart was experiencing some strategic difficulties of its own. Same-store sales in the United States declined every quarter from mid-2009 to mid-2011, a time marked by a recession and general economic stagnation. Wal-Mart attempted to broaden its appeal beyond traditional price-oriented customers during this period by raising some prices, widening aisles, and adding more brand-name merchandise but was unsuccessful. The big box did not break the losing streak until its third fiscal quarter in 2011 when revenues increased at a 1.3% clip. Wal-Mart had to cut prices to reverse the trend, but lower margins
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also led to a decline in profits.23.
The decision to incorporate a substantial change in strategy can be alluring, especially when performance is poor. In some instances, however, strategic change is required for survival, as was the case for 789 Chrysler dealers that were eliminated in 2010 as part of the company's bankruptcy reorganization effort. Some dealerships simply closed, while others continued selling other brands, focused on vehicle repairs, or embarked on new business ventures. In Clarkston, Michigan, Chuck Fortinberry opened a furniture store after his Chrysler dealership
closed—while revamping the car store to make vehicles handicap accessible.24. I t i s necessary to recognize the costs associated with strategic change before resources are committed.
Strategy, Corporate Social Responsibility, and Managerial Ethics
Strategy decisions should not be based solely on projected effects on financial performance. An organization's strategies at all levels should be compatible with its stance on social responsibility and ethics. Strategic alternatives should be considered in light of stated positions on corporate social responsibility (CSR). Marketers of alcoholic beverages must consider whether or not attractive advertising campaigns may attract minors as well. A manufacturer must consider how a plant relocation might affect the community in which it is currently located. Video game developers, for example, must consider how much violence is acceptable in the games they market to various age groups. Hence, there are social responsibility and/or ethical considerations facing every organization.
Effects on Organizational Resources
Executing a strategy requires resources that could be used for another purpose. The most obvious example is capital. If a firm pursues aggressive expansion into an uncharted geographical area, for example, the capital required will not be available for other purposes such as R & D or a new advertising campaign. If a firm launches a service enhancement effort by requiring sales representatives to make more frequent visits to existing customers, they will not be able to pursue new accounts as vigorously as before. These trade-offs should be considered before a strategy is adopted.
Unfortunately, many firms do not fully consider these trade-offs. Instead, they devise strategies whose success depends on “doing more with less.” Managers and employees are stretched thin while new programs are implemented without eliminating old ones. In the end, an organization may find itself performing lots of activities but none of them well.
Anticipated Responses from Competitors and Customers
Strategies are not implemented in a vacuum. Competitive responses should be expected when a substantial strategic change is employed. In many situations, the prospective gains associated with a strategic change will be reduced when the response is considered. For example, the development of new products may produce few new customers if competitors respond quickly by developing a similar offering.
In some cases, considering the retaliation makes an otherwise attractive strategic alternative undesirable. For example, American Airlines could probably secure more fliers than Delta on common routes if its fares were priced below those of the rival. If American initiated a price
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cut, however, Delta would almost certainly match it. It is likely that the reduced fares would attract few additional fliers to either airline. Hence, both airlines would be forced to operate the same routes with virtually the same number of customers at lower fares. When competitive retaliation is considered in this example, American is probably best served not to spark a price war with Delta.
Consider another example that illustrates the fact that changes in the competitive environment do not always materialize as one might expect. When an airline hub closes, for example, one might expect flights to and from the affected city to increase in price because of the departed competitor. In the United States, however, discount airlines often fill the empty gates, actually
fostering greater price competition.25. Hence, one could argue that it may be in the best interest of traditional carriers not to drive less competitive rivals out of key hubs lest they be bombarded by greater competition. Customer responses can be difficult to predict, but responses to strategic change should be anticipated and accounted for, especially when there are substantial shifts in prices or product line.
Given the complexity of competitor retaliation, some firms opt for a blue ocean strategy, an approach to growth contingent on inventing or discovering a new industry or industry segment that creates new demand. In many respects, Starbucks, eBay, and Cirque du Soleil reinvented the coffee house, auction, and circus industries by executing a radically different
approach that opened up substantial, previously untapped markets.26. Put another way, Starbucks did not reinvent the cup of coffee but rather reinvented the coffee shop experience. A large number of firms and new enterprises have failed in their attempts to charter new waters, however, suggesting that successful blue ocean approaches require research, creativity, and a lot of savvy.
Summary
The SWOT analysis serves as the basis for the formulation of strategies at all levels. The SWOT summarizes the organization's internal (i.e., strengths and weaknesses) and external (i.e., opportunities and threats) characteristics. Strengths and weaknesses emanate from an analysis of human, organizational, and physical resources. Opportunities and threats are based on analyses of the macroenvironment and industry. The SW/OT matrix generates strategic alternatives by combining internal and external factors delineated in the SWOT analysis.
Before a strategy is selected, however, several other considerations should be made. These include the costs associated with strategic change, the strategy's fit with the organization's stance on social responsibility and managerial ethics, effects on organizational resources, anticipated responses from competitors, and potential difficulties in implementing the strategy. The SLSC matrix helps evaluate alternatives by considering the level of analysis—corporate, business, or functional—and the degree of strategic complexity.
Key Terms
Blue Ocean Strategy: A growth strategy contingent on inventing or discovering a new industry or industry segment that creates new demand. Capabilities: A firm's skills at coordinating and leveraging resources to create value (often called strategic capabilities or dynamic capabilities). Gap Analysis: Identifying the distance between a firm's current position and its desired
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1. 2.
3. 4.
position with regard to an internal weakness. All things equal, it is desirable to take action to close the gap, especially when the gap leaves a firm vulnerable to external threats in its environment. Human Resources (HR): The experience, capabilities, knowledge, skills, and judgment of the firm's employees. Organizational Resources: The firm's systems and processes, including its strategies at various levels, structure, and culture. Physical Resources: An organization's plant and equipment, geographic locations, access to raw materials, distribution network, and technology. Strategy Level-Strategy Complexity (SLSC) Matrix: A tool for evaluating strategic alternatives that considers the organizational level of the alternative and the degree of strategic complexity. SWOT (Strengths, Weaknesses, Opportunities, and Threats) Analysis: An analysis intended to match the firm's strengths and weaknesses (the S and W in the acronym) with the opportunities and threats (the O and T) posed by the environment. SW/OT Matrix: A tool for generating alternative courses of action by identifying relevant combinations of internal characteristics (i.e., strengths and weaknesses) and external forces (i.e., opportunities and threats). Value Chain: A useful tool for analyzing a firm's strengths and weaknesses and understanding how they might translate into competitive advantage or disadvantage. The value chain describes the activities that comprise the economic performance and capabilities of the firm. VRIO (Valuable, Rare, Inimitable, and Organization) Framework: A tool for assessing the competitive quality of a firm's resources by examining value, rarity, imitability, and organization.
Review Questions and Exercises
What is the value chain? How is it useful to strategy formulation? How do a SWOT analysis and SW/OT matrix help managers in the strategic decision- making process? What types of alternatives can be generated from a SW/OT matrix? Should an organization change strategies when performance declines? Explain.
Practice Quiz
True of False?
1. The first step in crafting a strategy is the SWOT analysis. 2. The value chain is an analytical technique for identifying organizational opportunities and threats. 3. Opportunities and threats should emanate from the analysis of macroenvironmental and industry forces. 4. A factor can be both an opportunity and a strength. 5. Another name for an opportunity is an alternative. 6. Choosing the “no change” strategy and thereby recommending that the current strategy be continued is the least risky option.
Multiple Choice
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A. B. C. D.
A. B. C. D.
A. B. C. D.
A.
7.
The tool that enables executives to position an organization to take advantage of particular opportunities in the environment while avoiding or minimizing environmental threats is called_______.
PEST analysis SWOT analysis total quality management (TQM) analysis none of the above
8.
The description of activities that comprise the economic performance and capabilities of the firm is known as_______.
the value chain process innovation quality assessment none of the above
9.
To sustain competitive advantage, firms must acquire or develop resources that are_______.
difficult for competitors to imitate long lasting difficult for competitors to acquire on the market all of the above
10.
Physical resources include_______.
production facilitiesA. B. C. D.
A. B. C. D.
A. B. C. D.
production facilities plant locations production capacity all of the above
11.
Which of the following could not be an example of a weakness?
product quality fierce competition human resources all of the above
12.
Which type of alternative is always defensive in nature?
strength-opportunity strength-threat weakness-opportunity weakness-threat
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Student Study Site
Visit the student study site at www.sagepub.com/parnell4e to access these additional materials:
Answers to Chapter 9 practice quiz questions Web quizzes SAGE journal articles Web resources eFlashcards
Notes
1. K. W. Glaister and J. R. Falshaw, “Strategic Planning: Still Going Strong?” Long Range Planning 32, no. 1 (1999): 107-116.
2. P. C. Nutt, “Making Strategic Choices,” Journal of Management Studies 39 (2002): 67-96.
3. The concept of the value chain is only introduced in this chapter. For a more thorough discussion, see M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (Boston: Free Press, 1985).
4. N. Harris and S. Carey, “Delta Ends Commissions for Most Travel Agents,” Wall Street Journal Interactive Edition, March 15, 2002.
5. J. Gapper, “Big Names Prove Worth in Crisis,” Financial Times, A p r i l 2 8 , 2 0 1 0 , www.ft.com/intl/cms/s/0/258c534a-50ca-lldf-bc86- 00l44feab49a,s01=l.html#axzz1f2CB8HvX(accessed November 28, 2011).
6. J. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17(1991): 99-120.
7. K. M. Eisenhardt and J. A. Martin, “Dynamic Capabilities: What Are They?” Strategic Management Journal 21 (2000): 1105-1121.
8. J. Barney, “Firm Resources and Sustained Competitive Advantage.”
9. J. B. Barney, Gaining and Sustaining Competitive Advantage (Upper Saddle River, NJ: Prentice Hall, 2007); D. Teece, G Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” Strategic Management Journal 18(1997): 509-533.
10. Based on H. Wilrich, “The TOWS Matrix—A Tool for Structural Analysis,” Long Range Planning 15(2) (1982): 54-66.
11. D. Belkin, “A Canadian Icon Turns Its Glaze Southward,” Wall Street Journal, May 15, 2007, B1.
12. J. Murphy and E. Bellman, “Riding Two-Wheelers in India,” Wall Street Journal, June 6, 2008, B1.
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13. J. A. Trachtenberg, “Borders Business Plan Gets a Rewrite,” Wall Street Journal, March 22, 2007, B1.
14. E. Bellman, “Harley to Ride Indian Growth,” Wall Street Journal, August 28, 2009, B1.
15. R. Smith, “Utilities, Plug-In Cars: Near Collision?”, Wall Street Journal, May 2, 2008, B1.
16. S. Jung-a, “Carrefour's Korean Stores to Go Upmarket,” Financial Times, October 7, 2003, 18.
17. V. O'Connell, “Luxury Retailers Pin Hopes on Outlets,” Wall Street Journal, April 30, 2008, B1.
18. B. Peterson and D. E. Welch, “Creating Meaningful Switching Options in International Operations,” Long Range Planning 3 3 ( 2 0 0 0 ) : 6 8 8 - 7 0 5 ; M . B . L i e b e r m a n a n d D . B . Montgomery, “First-Mover Advantages,” Strategic Management Journal 9 (1988): 41-58.
19. N. Casey, “Fisher-Price Game Plan: Pursue Toy Sales in Developing Markets,” Wall Street Journal, May 29, 2008, B1.
20. J. B. Barney, “Is the Resource-Based ‘View’ a Useful Perspective for Strategic Management Research?” Academy of Management Review 26 (2001): 41-56.
21. R. Karlgaard, “The Cheap Revolution,” Wall Street Journal, October 3, 2007, A19.
22. C. Passariello, “Carrefour's Makeover Plan: Become IKEA of Groceries,” Wall Street Journal, September 16, 2010, B1-B2.
23. K. Talley, “Wal-Mart Sticks to Low Prices,” Wall Street Journal, November 16, 2011, B3.
24. J. Bennett, “After Getting the Boot, Car Dealers Regroup,” Wall Street Journal, October 11, 2010, B1, B2.
25. S. McCartney, “Why Travelers Benefit When an Airline Hub Closes,” Wall Street Journal, November 1, 2005, D1, D8.
26. W. C. Kim and R. Mauborgne, “Blue Ocean Strategy,” Harvard Business Review 82, no. 10 (2004): 76-84.
Strategy + Business Reading: 10 Clues to Opportunity
Market anomalies and incongruities may point the way to your next breakthrough strategy.
by Donald Sull
During their heyday in the late 19th and early 20th centuries, transatlantic cruise lines such as the Hamburg America Line and the White Star Line transported tens of millions of passengers between Europe and the United States. By the 1960s, however,
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1.
2.
3.
their business was being threatened by the rise of a disruptive new enterprise, namely, nonstop transatlantic flights. As it happened, the cruise ship lines had one potential strategy with which to save their business: vacation cruises. Starting in the 1930s, some of these lines had sailed to the Caribbean during the winter, thus using their boats when rough seas made the Atlantic impassable. And in 1964, when a new port was opened in Miami, Fla., the pleasure cruise business began to boom.
But the great cruise lines missed this breakthrough opportunity. They saw their profitability fall while dozens of startups, including Royal Caribbean and Carnival, retrofitted existing ships to offer pleasure cruises and built an entirely new travel and leisure category that continues to grow today.
Managers and entrepreneurs walk past lucrative opportunities all the time, and later kick themselves when someone else exploits the strategy they overlooked. Why does this happen? It's often because of the natural human tendency known to psychologists as confirmation bias: People tend to notice data that confirms their existing attitudes and beliefs, and ignore or discredit information that challenges them.
Although it is difficult to overcome confirmation bias, it is not impossible. Managers can increase their skill at spotting hidden opportunities by learning to pay attention to the subtle clues all around them. These are often contradictions, incongruities, and anomalies that don't jibe with most of the prevailing assumptions about what should happen. Here is my own “top 10” field guide to clues for hidden breakthrough opportunities, observed in a wide variety of industries, countries, and markets. If you find yourself noticing one or more of them, a major opportunity for growth could be lurking behind it.
This product should already exist (but it doesn't). As the accessories editor for Mademoiselle magazine in the early 1990s, Kate Brosnahan spotted a gap in the handbag market between functional bags that lacked style and extremely expensive but impractical designer bags from Hermès or Gucci. Brosnahan quit her job, and with her partner Andy Spade, founded Kate Spade LLC, which produced fabric handbags combining functionality and fashion. These attracted the attention of celebrities such as Gwyneth Paltrow and Julia Roberts. Many well-known product innovations—including the airplane, the mobile phone, and the tablet computer—began similarly, as products that people felt should already exist.
This customer experience doesn't have to be time-consuming, arduous, expensive, or annoying (but it is). Consumer irritation is a reliable indicator of a potential opportunity, because people will typically pay to make it go away. Reed Hastings, for example, founded Netflix Inc. after receiving a US$40 late fee for a rented videocassette of Apollo 13 that he had misplaced. Charles Schwab created the largest low-cost brokerage house because he was fed up with paying the commissions of conventional stockbrokers. Scott Cook got the idea for Quicken after watching his wife grow frustrated tracking their finances by hand.
This resource could be worth something (but it is still priced low). Sometimes an asset is underpriced because only a few people recognize its potential. When a low-cost airline such as easyJet or Ryanair announces its
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4.
5.
6.
7.
intention to fly to a new airport, real estate investors often leap to buy vacation property nearby. They rightfully expect a jump in real estate values. Similarly, the founders of Infosys Technologies Ltd., India's pioneering provider of outsourced information technology services, were among the first to recognize that Indian engineers, working for very low salaries, could provide great value to multinational clients. The company earned high profits on the spread between what they charged clients and what they paid local engineers.
This discovery must be good for something (but it's not clear what that is). Researchers sometimes recognize that they have stumbled on a promising resource or technology without knowing the best uses for it right away. The resulting search for a problem to solve can lead to great profitability. One example was the founding of the ArthroCare Corporation, a $355 million producer of medical devices based on a process called coblation, which uses radio frequency energy to dissolve damaged tissue with minimal effect on s u r r o u n d i n g p a r t s o f t h e b o d y . M e d i c a l s c i e n t i s t H i r a T h a p l i y a l , w h o codiscovered this process, founded a company to offer it for cardiac surgery, but that market turned out to be too small and competitive to support a new venture. Undeterred, he looked for other potential uses, and found one in orthopedics, where there are more than 2 million arthroscopic surgeries per year.
This product or service should be everywhere (but it isn't). Sometimes people chance upon an attractive business model that has failed to gain the widespread adoption it deserves. Two archetypal retail food stories illustrate this. In 1954, restaurant equipment salesman Ray Kroc visited the McDonald brothers’ hamburger stand in southern California, and convinced them to franchise their assembly-line approach to flipping burgers. In 1982, coffee machine manufacturing executive Howard Schultz visited a coffee bean producer called Starbucks in Seattle. He recognized the potential of a chain restaurant based on European coffee bars, and he joined Starbucks, hoping to convince the company's leadership to convert their retail store to this format. When they didn't, he started his own coffeehouse chain, later buying the Starbucks retail unit as the core of his new business.
Customers have adapted our product or service to new uses (but not with our support). Chinese appliance maker Haier Group discovered that customers in one rural province used its clothes washing machines to clean vegetables. Hearing this, a product manager spotted an opportunity. She had company engineers install wider drain pipes and coarser filters that wouldn't clog with vegetable peels, and then added pictures of local produce and instructions on how to wash vegetables safely. This innovation, along with others including a washing machine designed to make goat's-milk cheese, helped Haier win share in China's rural provinces, while avoiding the cutthroat price wars that plagued the country's appliance industry.
Customers shouldn't want this product (but they do). When Honda Motor Company entered the U.S. motorcycle market in the late 1950s, it expected to sell large motorcycles to leather-clad bikers. Despite a concerted effort, the company managed to sell fewer than 60 of its large bikes each month, far short of its monthly sales goal of 1,000 units. Then a mechanical failure forced the
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8.
9.
10.
company to recall these models. In desperation, it promoted its smaller 50cc motorbike, the Cub, which Honda executives had assumed would not interest the U.S. market. When the smaller bikes sold well, Honda realized it had d i s c o v e r e d a n u n t a p p e d s e g m e n t l o o k i n g f o r t w o - w h e e l m o t o r i z e d transportation. (The campaign is still remembered for its catchphrase, “You meet the nicest people on a Honda.”)
Customers have discovered a product (but not the one we offered). Joint J u i c e , a r o u g h l y $ 2 m i l l i o n c o m p a n y t h a t p r o d u c e s a n e a s y - t o - d i g e s t glucosamine liquid, was founded by Kevin Stone, a prominent San Francisco orthopedic surgeon. He learned about the nutrient from some of his patients, who took it for joint pain instead of the ibuprofen he had prescribed. Many doctors might have ignored this or even scolded their patients for falling prey to fads, but Stone recognized he might be missing something. He looked up the clinical research on glucosamine in Europe, where it was the leading nutritional supplement. (Veterinarians, he discovered, swore by it, and their patients fell for neither fads nor placebos.) Then he built a business around it.
This product or service is thriving elsewhere (but no one offers it here). In the early 1990s, a Swedish business student named Carl August Svensen- Ameln tried to store some of his belongings in Sweden while at school in Seattle, but found that all the local self-storage facilities were full. He studied the storage industry, already prevalent in the United States, and discovered a business model characterized by high rents, low turnover, and negligible operating costs. Yet self-storage, at the time, was virtually nonexistent in continental Europe. Svensen-Ameln and a friend from business school set up a partnership with an established U.S. company, Shurgard Storage Centers Inc. The resulting company, European Mini-Storage S.A., was the first of several such companies that Svensen-Ameln started in Europe, to great success.
That new product or service shouldn't make much money (but it does). Established competitors are often surprised when upstart rivals do well. In his 2008 book, The Partnership: The Making of Goldman Sachs (Penguin Press), Charles D. Ellis noted that for decades, Goldman Sachs partners had avoided investment management, which they believed generated lower fees than trading and investment banking. When Donaldson, Lufkin & Jenrette Inc. published its financial performance as part of a 1970 stock offering, Goldman partners were startled to learn that fees and brokerage commissions on frequent trades added up to a highly profitable business. Shortly thereafter, Goldman expanded into managing corporate pension funds, and aggressively built its business.
Incongruities like these can offer a critical clue about where your assumptions no longer match reality. From there, you are more likely to uncover the kinds of opportunities that you might otherwise have missed—and that your competitors still don't recognize. Start by asking yourself, What are the most unexpected things happening in our business right now? Which competitors are doing better than expected? Which customers are behaving in ways we hadn't anticipated? Take yourself through the list of top 10 clues. Leaders who consistently notice and explore anomalies increase the odds of spotting emerging opportunities before their rivals.
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Author Profile:
Donald Sull is a professor of strategic and international management at the London Business School, where he is also the faculty director for executive education. His books include The Upside of Turbulence: Seizing Opportunity in an Uncertain World (Harper Business, 2009).
http://dx.doi.org/10.4135/9781506374598.n9
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