Assignment 2
TEMON1
Chapters1.docxChapters 1-3
Chapter 1
As we see from the Opening Case, Borders was highly unsuccessful because of its inabil- ity to compete against other major book retailers, especially in the area of Internet book sales. Therefore, we can conclude that Borders was not competitive (unable to achieve strategic competitiveness). It clearly was unable to earn above-average returns. In fact, it suffered significant net losses and eventually had to declare bankruptcy because of inadequate cash flow and assets that were valued less that its liabilities. Its competitors, Barnes & Noble and Amazon, were more competitive and adjusted more effectively to changes in the book retail market. For example, both firms had eReaders (the NOOK and Kindle, respectively) to sell along with electronic books. They used the strategic management process (see Figure 1.1) as the foundation for the commitments, decisions, and actions they took to pursue strategic competitiveness and above-average terms. Obviously, Borders did not use this process and it cost the firm in major ways, perhaps even its ability to survive. The strategic management process is fully explained in this book. We introduce you to this process in the next few paragraphs.
Strategic competitiveness is achieved when a firm successfully formulates and implements a value-creating strategy. A strategy is an integrated and coordinated set of commitments and actions designed to exploit core competencies and gain a com- petitive advantage. When choosing a strategy, firms make choices among competing alternatives as the pathway for deciding how they will pursue strategic competitive- ness.1 In this sense, the chosen strategy indicates what the firm will do as well as what the firm will not do.
As explained in the Opening Case, Borders tried to enrich its traditional approach with more marketing and making its stores more attractive. However, because the number of books sold through large chain store retailers has been declining, this strat- egy had little chance for success. A recent study conducted to identify the factors that contribute to the success of top corporate performers showed why Borders was unsuccessful. This study found that the top performers were entrepreneurial, market oriented (effective knowledge of the customers’ needs), used valuable competencies, and offered innovative products and services.2 Borders displayed none of these attri- butes. It clearly did not understand its market and customers and it was not innova- tive. Therefore, its lack of success is not surprising. A firm’s strategy also demonstrates how it differs from its competitors. Recently, Ford Motor Company devoted efforts to explain to stakeholders how the company differs from its competitors. The main idea is that Ford claims that it is “greener” and more technically advanced than its competi- tors, such as General Motors and Chrysler Group LLC (an alliance between Chrysler and Fiat SpA).
A firm has a competitive advantage when it implements a strategy that creates superior value for customers and that its competitors are unable to duplicate or find too costly to imitate.4 An organization can be confident that its strategy has resulted in one or more useful competitive advantages only after competitors’ efforts to duplicate its strategy have ceased or failed. In addition, firms must understand that no competitive advantage is permanent.5 The speed with which competitors are able to acquire the skills needed to duplicate the benefits of a firm’s value-creating strategy determines how long the competitive advantage will last.
Above-average returns are returns in excess of what an investor expects to earn from other investments with a similar amount of risk. Risk is an investor’s uncertainty about the economic gains or losses that will result from a particular investment.7 The most successful companies learn how to effectively manage risk. Effectively managing risks reduces investors’ uncertainty about the results of their investment.8 Returns are often measured in terms of accounting figures, such as return on assets, return on equity, or return on sales. Alternatively, returns can be measured on the basis of stock market returns, such as monthly returns (the end-of-the-period stock price minus the begin- ning stock price, divided by the beginning stock price, yielding a percentage return). In smaller, new venture firms, returns are sometimes measured in terms of the amount and speed of growth (e.g., in annual sales) rather than more traditional profitability measures9 because new ventures require time to earn acceptable returns (in the form of return on assets and so forth) on investors’ investments.10
Understanding how to exploit a competitive advantage is important for firms seeking to earn above-average returns.11 Firms without a competitive advantage or that are not competing in an attractive industry earn, at best, average returns. Average returns are returns equal to those an investor expects to earn from other investments with a simi- lar amount of risk. In the long run, an inability to earn at least average returns results first in decline and, eventually, failure. Failure occurs because investors withdraw their investments from those firms earning less-than-average returns. This is what happened to Borders when it was unable to earn returns. Indeed, it lost money and because of the investors’ lack of confidence in the firm, its stock price fell perilously close to zero.
As we noted above, there are no guarantees of permanent success. This is true for Borders, which enjoyed a considerable amount of success in the 1990s. Even considering Apple’s excellent current performance, it still must be careful not to become overconfident and continue its quest to be the leader in its markets. (Apple is the topic of a Strategic Focus segment later in this chapter.)
The strategic management process (see Figure 1.1) is the full set of commitments, decisions, and actions required for a firm to achieve strategic competitiveness and earn above-average returns. The firm’s first step in the process is to analyze its external envi- ronment and internal organization to determine its resources, capabilities, and core competencies—the sources of its “strategic inputs.” Obviously, Borders’ process failed at this point because it did not understand the market in which it competed. It performed poorly against other large chain-store retailers and failed to foresee the major changes in the market with increasing sales of electronic books.
With the information gained from external and internal analyses, the firm develops its vision and mission and formulates one or more strategies. To implement its strate- gies, the firm takes actions toward achieving strategic competitiveness and above-average returns. Effective strategic actions that take place in the context of carefully integrated strategy formulation and implementation efforts result in positive outcomes. This dynamic strategic management process must be maintained as ever-changing markets and competitive structures are coordinated with a firm’s continuously evolving strategic inputs.12
In the remaining chapters of this book, we use the strategic management process to explain what firms do to achieve strategic competitiveness and earn above-average returns. These explanations demonstrate why some firms consistently achieve competi- tive success while others fail to do so.13 As you will see, the reality of global competition is a critical part of the strategic management process and significantly influences firms’ performances.14 Indeed, learning how to successfully compete in the globalized world is one of the most significant challenges for firms competing in the current century.15
Several topics will be discussed in this chapter. First, we describe the current competi- tive landscape. This challenging landscape is being created primarily by the emergence of a global economy, globalization resulting from that economy, and rapid technolog- ical changes. Next, we examine two models that firms use to gather the information and knowledge required to choose and then effectively implement their strategies. The insights gained from these models also serve as the foundation for forming the firm’s vision and mission. The first model (the industrial organization or I/O model) suggests that the external environment is the primary determinant of a firm’s strategic actions. Identifying and then competing successfully in an attractive (i.e., profitable) industry or segment of an industry are the keys to competitive success when using this model.16 The second model (resource-based) suggests that a firm’s unique resources and capabilities are the critical link to strategic competitiveness.17 Thus, the first model is concerned primarily with the firm’s external environment while the second model is concerned primarily with the firm’s internal organization. After discussing vision and mission, direction-setting statements that influence the choice and use of strategies, we describe the stakeholders that organizations serve. The degree to which stakeholders’ needs can be met increases when firms achieve strategic competitiveness and earn above-average returns. Closing the chapter are introductions to strategic leaders and the elements of the strategic management process.
The Competitive Landscape
The fundamental nature of competition in many of the world’s industries is changing. The reality is that financial capital continues to be scarce and markets are increasingly volatile.18 Because of this, the pace of change is relentless and ever-increasing. Even deter- mining the boundaries of an industry has become challenging. Consider, for example, how advances in interactive computer networks and telecommunications have blurred the boundaries of the entertainment industry. Today, not only do cable companies and satellite networks compete for entertainment revenue from television, but telecommu- nication companies are moving into the entertainment business through significant improvements in fiber-optic lines.19 Partnerships among firms in different segments of the entertainment industry further blur industry boundaries. For example, MSNBC is co-owned by NBC Universal and Microsoft. In turn, General Electric owns 49 percent of NBC Universal while Comcast owns the remaining 51 percent.20
Other characteristics of the current competitive landscape are noteworthy. Conventional sources of competitive advantage such as economies of scale and huge advertising budgets are not as effective as they once were in terms of helping firms earn above-average returns. Moreover, the traditional managerial mind-set is unlikely to lead a firm to strategic competitiveness. Managers must adopt a new mind-set that values flexibility, speed, innovation, integration, and the challenges that evolve from constantly changing conditions. The conditions of the competitive landscape result in a perilous business world, one in which the investments that are required to compete on a global scale are enormous and the consequences of failure are severe. Effective use of the stra- tegic management process reduces the likelihood of failure for firms as they encounter the conditions of today’s competitive landscape.
Hypercompetition is a term often used to capture the realities of the competitive landscape. Under conditions of hypercompetition, assumptions of market stability are replaced by notions of inherent instability and change. Hypercompetition results from the dynamics of strategic maneuvering among global and innovative combatants. It is a condition of rapidly escalating competition based on price-quality positioning, com- petition to create new know-how and establish first-mover advantage, and competition to protect or invade established product or geographic markets. In a hypercompetitive market, firms often aggressively challenge their competitors in the hopes of improving their competitive position and ultimately their performance.
Several factors create hypercompetitive environments and influence the nature of the current competitive landscape. The emergence of a global economy and technology, specifically rapid technological change, are the two primary drivers of hypercompetitive environments and the nature of today’s competitive landscape.
The Global Economy
A global economy is one in which goods, services, people, skills, and ideas move freely across geo- graphic borders. Relatively unfettered by artificial constraints, such as tariffs, the global economy sig- nificantly expands and complicates a firm’s com- petitive environment.
Interesting opportunities and challenges are associated with the emergence of the global econ- omy.28 For example, the European Union (com- posed of several countries) has become one of the world’s largest markets, with 700 million poten- tial customers. “In the past, China was generally seen as a low-competition market and a low-cost producer. Today, China is an extremely competi- tive market in which local market-seeking MNCs [multinational corporations] must fiercely com- pete against other MNCs and against those local companies that are more cost effective and faster in product development. While China has been viewed as a country from which to source low-cost goods, lately, many MNCs, such as P&G (Procter and Gamble), are actually net exporters of local management talent; they have been dis- patching more Chinese abroad than bringing foreign expatriates to China.”29 China has become the second-largest economy in the world, surpassing Japan. India, the world’s largest democracy, has an economy that also is growing rapidly and now ranks as the fourth largest in the world.30 Simultaneously, many firms in these emerging economies are moving into international markets and are now regarded as multinational firms. This fact is explored in the Strategic Focus on Huawei. The discussion shows that barriers to entering foreign markets still exist, however. Essentially, Huawei must build credibility in the U.S. market, and especially build a positive relationship with stakeholders such as the U.S. government.
The statistics detailing the nature of the global economy reflect the realities of a hypercompetitive business environment and challenge individual firms to think seriously about the markets in which they will compete. Consider the case of General Electric (GE). Although headquartered in the United States, GE expects that as much as 60 percent of its revenue growth through 2015 will be generated by competing in rapidly developing economies (e.g., China and India). The decision to count on revenue growth in emerg- ing economies instead of in developed countries such as the United States and European nations seems quite reasonable in the global economy. GE achieved significant growth in 2010 partly because of signing contracts for large infrastructure projects in China and Russia. GE’s CEO, Jeffrey Immelt, argues that we have entered a new economic era in which the global economy will be more volatile and that most of the growth will come from emerging economies such as Brazil, China, and India.31 Therefore, GE is investing significantly in these emerging economies, in order to improve its competitive position in vital geographic sources of revenue and profitability.
The March of Globalization
Globalization is the increasing economic interdependence among countries and their organizations as reflected in the flow of goods and services, financial capital, and knowl- edge across country borders.32 Globalization is a product of a large number of firms competing against one another in an increasing number of global economies.
In globalized markets and industries, financial capital might be obtained in one national market and used to buy raw materials in another. Manufacturing equipment bought from a third national market can then be used to produce products that are sold in yet a fourth market. Thus, globalization increases the range of opportunities for com- panies competing in the current competitive landscape.33
Firms engaging in globalization of their operations must make culturally sensitive decisions when using the strategic management process.34 Additionally, highly globalized firms must anticipate ever-increasing complexity in their operations as goods, services, people, and so forth move freely across geographic borders and throughout different economic markets.
Overall, it is important to note that globalization has led to higher performance standards in many competitive dimensions, including those of quality, cost, productiv- ity, product introduction time, and operational efficiency. In addition to firms compet- ing in the global economy, these standards affect firms competing on a domestic-only basis. The reason is that customers will purchase from a global competitor rather than a domestic firm when the global company’s good or service is superior. Because workers now flow rather freely among global economies, and because employees are a key source of competitive advantage, firms must understand that increasingly, “the best people will come from ... anywhere.”35 Thus, managers have to learn how to operate effectively in a “multi-polar” world with many important countries having unique interests and environ- ments.36 Firms must learn how to deal with the reality that in the competitive landscape of the twenty-first century, only companies capable of meeting, if not exceeding, global standards typically have the capability to earn above-average returns.
Although globalization offers potential benefits to firms, it is not without risks. Collectively, the risks of participating outside of a firm’s domestic country in the global economy are labeled a “liability of foreignness.”37
One risk of entering the global market is the amount of time typically required for firms to learn how to compete in markets that are new to them. A firm’s performance can suffer until this knowledge is either developed locally or transferred from the home market to the newly established global location.38 Additionally, a firm’s performance may suffer with substantial amounts of globalization. In this instance, firms may over- diversify internationally beyond their ability to manage these extended operations.39 Overdiversification can have strong negative effects on a firm’s overall performance.
Thus, entry into international markets, even for firms with substantial experience in the global economy, requires effective use of the strategic management process. It is also important to note that even though global markets are an attractive strategic option for some companies, they are not the only source of strategic competitiveness. In fact, for most companies, even for those capable of competing successfully in global markets, it is critical to remain committed to and strategically competitive in both domestic and international markets by staying attuned to technological opportunities and potential competitive disruptions that innovations create.40
Technology and Technological Changes
Technology-related trends and conditions can be placed into three categories: technology diffusion and disruptive technologies, the information age, and increasing knowledge intensity. Through these categories, technology is significantly altering the nature of com- petition and contributing to unstable competitive environments as a result of doing so.
Technology Diffusion and Disruptive Technologies
The rate of technology diffusion, which is the speed at which new technologies become available and are used, has increased substantially over the past 15 to 20 years. Consider the following rates of technology diffusion:
It took the telephone 35 years to get into 25 percent of all homes in the United States. It took TV 26 years. It took radio 22 years. It took PCs 16 years. It took the Internet 7 years.41
Perpetual innovation is a term used to describe how rapidly and consistently new, information-intensive technologies replace older ones. The shorter product life cycles resulting from these rapid diffusions of new technologies place a competitive premium on being able to quickly introduce new, innovative goods and services into the marketplace.42
In fact, when products become somewhat indistinguishable because of the widespread and rapid diffusion of technologies, speed to market with innovative products may be the primary source of competitive advantage (see Chapter 5).43 Indeed, some argue that the global economy is increasingly driven by or revolves around constant innovations. Not surprisingly, such innovations must be derived from an understanding of global standards and expectations of product functionality.44 Although some argue that large established firms may have trouble innovating, evidence suggests that today these firms are developing radically new technologies that transform old industries or create new ones.45 Apple is an excellent example of a large established firm capable of radical innovation. Also, in order to diffuse the technology and enhance the value of an innovation, additional firms need to be innovative in their use of the new technology, building it into their products.46
Another indicator of rapid technology diffusion is that it now may take only 12 to 18 months for firms to gather information about their competitors’ research and develop- ment and product decisions.47 In the global economy, competitors can sometimes imitate a firm’s successful competitive actions within a few days. In this sense, the rate of tech- nological diffusion has reduced the competitive benefits of patents. Today, patents may be an effective way of protecting proprietary technology in a small number of industries such as pharmaceuticals. Indeed, many firms competing in the electronics industry often do not apply for patents to prevent competitors from gaining access to the technological knowledge included in the patent application.
Disruptive technologies—technologies that destroy the value of an existing technology and create new markets48—surface frequently in today’s competitive markets. Think of the new markets created by the technologies underlying the development of products such as iPods, iPads, WiFi, and the browser. These types of products are thought by some to represent radical or breakthrough innovations.49 (We discuss more about radical innova- tions in Chapter 13.) A disruptive or radical technology can create what is essentially a new industry or can harm industry incumbents. However, some incumbents are able to adapt based on their superior resources, experience, and ability to gain access to the new technol- ogy through multiple sources (e.g., alliances, acquisitions, and ongoing internal research).50
Clearly, Apple has developed and introduced “disruptive technologies” such as the iPod, and in so doing changed several industries. For example, the iPod and its comple- mentary iTunes have revolutionized how music is sold to and used by consumers. In con- junction with other complementary and competitive products (e.g., Amazon’s Kindle), Apple’s iPad is contributing to and speeding major changes in the publishing industry, moving from hard copies to electronic books. Apple’s new technologies and products are also contributing to the new “information age.” Thus, Apple provides an example of entrepreneurship through technology emergence across multiple industries.51
The Information Age
Dramatic changes in information technology have occurred in recent years. Personal computers, cellular phones, artificial intelligence, virtual reality, massive databases, and multiple social networking sites are only a few examples of how information is used differ- ently as a result of technological developments. An important outcome of these changes is that the ability to effectively and efficiently access and use information has become an important source of competitive advantage in virtually all industries. Information tech- nology advances have given small firms more flexibility in competing with large firms, if that technology can be efficiently used.52
Both the pace of change in information technology and its diffusion will continue to increase. For instance, the number of personal computers in use globally is expected to surpass three billion by 2012. More than 335 million were sold in the United States alone in 2011.53 The declining costs of information technologies and the increased accessibility to them are also evident in the current competitive landscape. The global proliferation of relatively inexpensive computing power and its linkage on a global scale via computer networks combine to increase the speed and diffusion of information technologies. Thus, the competitive potential of information technologies is now available to companies of all sizes throughout the world, including those in emerging economies.54
The Internet is another technological innovation contributing to hypercompetition. Available to an increasing number of people throughout the world, the Internet provides an infrastructure that allows the delivery of information to computers in any location. Access to the Internet on smaller devices such as cell phones is having an ever-growing impact on competition in a number of industries. However, possible changes to Internet Service Providers’ (ISPs) pricing structures could affect the rate of growth of Internet-based applications. Users downloading or streaming high-definition movies, playing video games online, and so forth would be affected the most if ISPs were to base their pricing structure around total usage.
Increasing Knowledge Intensity
Knowledge (information, intelligence, and expertise) is the basis of technology and its application. In the competitive landscape of the twenty-first century, knowledge is a criti- cal organizational resource and an increasingly valuable source of competitive advantage.55 Indeed, starting in the 1980s, the basis of competition shifted from hard assets to intan- gible resources. For example, “Wal-Mart trans-
formed retailing through its proprietary approach to supply chain management and its information- rich relationships with customers and suppliers.”56 Relationships with customers and suppliers are an example of an intangible resource.
Knowledge is gained through experience, obser- vation, and inference and is an intangible resource (tangible and intangible resources are fully described in Chapter 3). The value of intangible resources, including knowledge, is growing as a proportion of total shareholder value in today’s competitive land- scape.57 In fact, the Brookings Institution estimates that intangible resources contribute approximately 85 percent of that value.58 The probability of achiev- ing strategic competitiveness is enhanced for the firm that develops the ability to capture intelligence, transform it into usable knowledge, and diffuse it rapidly throughout the company.59 Therefore, firms must develop (e.g., through training programs) and acquire (e.g., by hiring educated and experienced employees) knowledge, integrate it into the organization to create capabilities, and then apply it to gain a competitive advantage.60
A strong knowledge base is necessary to create innovations. In fact, firms lacking the appropriate internal knowledge resources are less likely to invest money in research and development.61 Firms must continue to learn (building their knowledge stock) because knowledge spillovers to competitors are common. There are several ways in which knowledge spillovers occur, including the hiring of professional staff and managers by competitors.62 Because of the potential for spillovers, firms must move quickly to use their knowledge in productive ways. In addition, firms must build routines that facilitate the diffusion of local knowledge throughout the organization for use everywhere that it has value.63 Firms are better able to do these things when they have strategic flexibility.
Strategic flexibility is a set of capabilities used to respond to various demands and opportunities existing in a dynamic and uncertain competitive environment. Thus, stra- tegic flexibility involves coping with uncertainty and its accompanying risks.64 Firms should try to develop strategic flexibility in all areas of their operations. However, those working within firms to develop strategic flexibility should understand that the task is not easy, largely because of inertia that can build up over time. A firm’s focus and past core competencies may actually slow change and strategic flexibility.65
To be strategically flexible on a continuing basis and to gain the competitive benefits of such flexibility, a firm has to develop the capacity to learn. Continuous learning provides the firm with new and up-to-date skill sets, which allow it to adapt to its environment as it encounters changes.66 Firms capable of rapidly and broadly applying what they have learned exhibit the strategic flexibility and the capacity to change in ways that will increase the probability of successfully dealing with uncertain, hypercompetitive environments.
The I/O Model of Above-Average Returns
From the 1960s through the 1980s, the external environment was thought to be the primary determinant of strategies that firms selected to be successful.67 The industrial organization model of above-average returns explains the external environment’s dominant influence on a firm’s strategic actions. The model specifies that the industry or segment of an industry in which a company chooses to compete has a stronger influence on performance than do the choices managers make inside their organizations.68 The firm’s performance is believed to be determined primarily by a range of industry properties, including economies of scale, barriers to market entry, diversification, product differentiation, and the degree of concen- tration of firms in the industry.69 We examine these industry characteristics in Chapter 2.
Grounded in economics, the I/O model has four underlying assumptions. First, the external environment is assumed to impose pressures and constraints that determine the strategies that would result in above-average returns. Second, most firms competing within an industry or within a segment of that industry are assumed to control similar strategically relevant resources and to pursue similar strategies in light of those resources. Third, resources used to implement strategies are assumed to be highly mobile across firms, so any resource differences that might develop between firms will be short-lived. Fourth, organizational decision makers are assumed to be rational and committed to act- ing in the firm’s best interests, as shown by their profit-maximizing behaviors.70 The I/O model challenges firms to find the most attractive industry in which to compete. Because most firms are assumed to have similar valuable resources that are mobile across compa- nies, their performance generally can be increased only when they operate in the industry with the highest profit potential and learn how to use their resources to implement the strategy required by the industry’s structural characteristics.71
The five forces model of competition is an analytical tool used to help firms find the industry that is the most attractive for them. The model (explained in Chapter 2) encom- passes several variables and tries to capture the complexity of competition. The five forces model suggests that an industry’s profitability (i.e., its rate of return on invested capital relative to its cost of capital) is a function of interactions among five forces: sup- pliers, buyers, competitive rivalry among firms currently in the industry, product substi- tutes, and potential entrants to the industry.72
Firms use the five forces model to identify the attractiveness of an industry (as mea- sured by its profitability potential) as well as the most advantageous position for the firm to take in that industry, given the industry’s structural characteristics.73 Typically, the model suggests that firms can earn above-average returns by producing either standardized goods or services at costs below those of competitors (a cost leadership strategy) or by producing differentiated goods or services for which customers are willing to pay a price premium (a differentiation strategy). (The cost leadership and product differentiation strategies are discussed in Chapter 4.) The fact that “... the fast food industry is becoming a ‘zero-sum industry’ as companies battle for the same pool of customers”74 suggests that fast food giant McDonald’s is competing in a relatively unattractive industry. However, by focusing on product innovations and enhancing existing facilities while buying properties outside the United States at attractive prices for selectively building new stores, McDonald’s is posi- tioned in the fast food (or quick-service) restaurant industry to earn above-average returns.
The Resource-Based Model of Above-Average Returns
The resource-based model assumes that each organization is a collection of unique resources and capabilities. The uniqueness of its resources and capabilities is the basis of a firm’s strategy and its ability to earn above-average returns.78
Resources are inputs into a firm’s production process, such as capital equipment, the skills of individual employees, patents, finances, and talented managers. In general, a firm’s resources are classified into three categories: physical, human, and organizational capital. Described fully in Chapter 3, resources are either tangible or intangible in nature.
Individual resources alone may not yield a competitive advantage.79 In fact, resources have a greater likelihood of being a source of competitive advantage when they are formed into a capability. A capability is the capacity for a set of resources to perform a task or an activity in an integrative manner. Capabilities evolve over time and must be managed dynamically in pursuit of above-average returns.80 Core competencies are resources and capabilities that serve as a source of competitive advantage for a firm over its rivals. Core competencies are often visible in the form of organizational functions. For example, Apple’s R&D function is likely one of its core competencies. There is little doubt that its ability to produce innovative new products that are perceived as valuable in the market- place is a core competence for Apple, as suggested in the earlier Strategic Focus.
According to the resource-based model, differences in firms’ performances across time are due primarily to their unique resources and capabilities rather than the industry’s structural characteristics. This model also assumes that firms acquire different resources and develop unique capabilities based on how they combine and use the resources; that resources and certainly capabilities are not highly mobile across firms; and that the differ- ences in resources and capabilities are the basis of competitive advantage.81 Through con- tinued use, capabilities become stronger and more difficult for competitors to understand and imitate. As a source of competitive advantage, a capability “should be neither so simple that it is highly imitable, nor so complex that it defies internal steering and control.”82
The resource-based model of superior returns is shown in Figure 1.3. This model suggests that the strategy the firm chooses should allow it to use its competitive advan- tages in an attractive industry (the I/O model is used to identify an attractive industry).
Not all of a firm’s resources and capabilities have the potential to be the foundation for a competitive advantage. This potential is realized when resources and capabilities are valuable, rare, costly to imitate, and nonsubstitutable.83 Resources are valuable when they allow a firm to take advantage of opportunities or neutralize threats in its external envi- ronment. They are rare when possessed by few, if any, current and potential competitors. Resources are costly to imitate when other firms either cannot obtain them or are at a cost disadvantage in obtaining them compared with the firm that already possesses them. And they are nonsubstitutable when they have no structural equivalents. Many resources can either be imitated or substituted over time. Therefore, it is difficult to achieve and sustain a competitive advantage based on resources alone.84 Individual resources are often integrated to produce integrated configurations in order to build capabilities. These capabilities are more likely to have these four attributes.85 When these four criteria are met, however, resources and capabilities become core competencies.
As noted previously, research shows that both the industry environment and a firm’s internal assets affect that firm’s performance over time.86 Thus, to form a vision and mission, and subsequently to select one or more strategies and determine how to imple- ment them, firms use both the I/O and the resource-based models.87 In fact, these mod- els complement each other in that one (I/O) focuses outside the firm while the other (resource-based) focuses inside the firm. Next, we discuss the forming of the firm’s vision and mission—actions taken after the firm understands the realities of its external envi- ronment (Chapter 2) and internal organization (Chapter 3).
Vision and Mission
After studying the external environment and the internal organization, the firm has the information it needs to form its vision and a mission (see Figure 1.1). Stakeholders (those who affect or are affected by a firm’s performance, as explained later in the chapter) learn a great deal about a firm by studying its vision and mission. Indeed, a key purpose of vision and mission statements is to inform stakeholders of what the firm is, what it seeks to accomplish, and who it seeks to serve.
Vision
Vision is a picture of what the firm wants to be and, in broad terms, what it wants to ulti- mately achieve.88 Thus, a vision statement articulates the ideal description of an organization and gives shape to its intended future. In other words, a vision statement points the firm in the direction of where it would like to be in the years to come.89 An effective vision stretches and challenges people as well. In her book about Steve Jobs, Apple’s phenomenally successful CEO, Carmine Gallo argues that one of the reasons that Apple is so innovative was Jobs’ vision for the company. She suggests that he thought bigger and differently than most people—she describes it as “putting a dent in the universe.” To be innovative, she explains that one has to think differently about their products and customers—“sell dreams not products”—and differently about the story to “create great expectations.”90 Steve Jobs passed away in October 2011. Apple will be challenged to remain highly innovative without him. Interestingly, many new entrepreneurs are highly optimistic when they develop their ventures.91
It is also important to note that vision statements reflect a firm’s values and aspirations and are intended to capture the heart and mind of each employee and, hopefully, many of its other stakeholders. A firm’s vision tends to be enduring while its mission can change with new environmental conditions. A vision statement tends to be relatively short and concise, making it easily remembered. Examples of vision statements include the following:
Our vision is to be the world’s best quick service restaurant. (McDonald’s) To make the automobile accessible to every American. (Ford Motor Company’s vision
when established by Henry Ford)
As a firm’s most important and prominent strategic leader, the CEO is responsible for working with others to form the firm’s vision. Experience shows that the most effec- tive vision statement results when the chief executive officer (CEO) involves a host of stakeholders (e.g., other top-level managers, employees working in different parts of the organization, suppliers, and customers) to develop it. In addition, to help the firm reach its desired future state, a vision statement should be clearly tied to the conditions in the firm’s external environment and internal organization. Moreover, the decisions and actions of those involved with developing the vision, especially the CEO and the other top-level managers, must be consistent with that vision.
Mission
The vision is the foundation for the firm’s mission. A mission specifies the business or busi- nesses in which the firm intends to compete and the customers it intends to serve.92 The firm’s mission is more concrete than its vision. However, similar to the vision, a mission should establish a firm’s individuality and should be inspiring and relevant to all stake- holders.93 Together, the vision and mission provide the foundation that the firm needs to choose and implement one or more strategies. The probability of forming an effective mis- sion increases when employees have a strong sense of the ethical standards that guide their behaviors as they work to help the firm reach its vision.94 Thus, business ethics are a vital part of the firm’s discussions to decide what it wants to become (its vision) as well as who it intends to serve and how it desires to serve those individuals and groups (its mission).95
Even though the final responsibility for forming the firm’s mission rests with the CEO, the CEO and other top-level managers often involve more people in developing the mission. The main reason is that the mission deals more directly with product markets and customers, and middle- and first-level managers and other employees have more direct contact with customers and the markets in which they are served. Examples of mission statements include the following:
Be the best employer for our people in each community around the world and deliver operational excellence to our customers in each of our restaurants. (McDonald’s)
Our mission is to be recognized by our customers as the leader in applications engineer- ing. We always focus on the activities customers desire; we are highly motivated and strive to advance our technical knowledge in the areas of material, part design and fabrication technology. (LNP, a GE Plastics Company)
McDonald’s mission statement flows from its vision of being the world’s best quick- service restaurant. LNP’s mission statement describes the business areas (material, part design, and fabrication technology) in which the firm intends to compete.
Some believe that vision and mission statements provide little value. One expert believes, “Most vision statements are either too vague, too broad in scope, or riddled with superlatives.”96 Clearly, vision and mission statements that are poorly developed do not provide the direction a firm needs to take appropriate strategic actions. Still, as shown in Figure 1.1, a firm’s vision and mission are critical aspects of the strategic inputs required to engage in strategic actions that help to achieve strategic competitiveness and earn above-average returns. Therefore, firms must accept the challenge of forming effective vision and mission statements.
Stakeholders
Every organization involves a system of primary stakeholder groups with whom it estab- lishes and manages relationships.97 Stakeholders are the individuals, groups, and organi- zations who can affect the firm’s vision and mission, are affected by the strategic outcomes achieved, and have enforceable claims on the firm’s performance.98 Claims on a firm’s performance are enforced through the stakeholders’ ability to withhold participation essential to the organization’s survival, competitiveness, and profitability.99 Stakeholders continue to support an organization when its performance meets or exceeds their expec- tations.100 Also, research suggests that firms that effectively manage stakeholder relation- ships outperform those that do not. Stakeholder relationships can therefore be managed to be a source of competitive advantage.101
Although organizations have dependency relationships with their stakeholders, they are not equally dependent on all stakeholders at all times;102 as a consequence, not every stakeholder has the same level of influence.103 The more critical and valued a stakehold- er’s participation, the greater a firm’s dependency on it. Greater dependence, in turn, gives the stakeholder more potential influence over a firm’s commitments, decisions, and actions. Managers must find ways to either accommodate or insulate the organization from the demands of stakeholders controlling critical resources.104
Classifications of Stakeholders
The parties involved with a firm’s operations can be separated into at least three groups.105 As shown in Figure 1.4, these groups are the capital market stakeholders (shareholders and the major suppliers of a firm’s capital), the product market stakeholders (the firm’s primary customers, suppliers, host communities, and unions representing the work- force), and the organizational stakeholders (all of a firm’s employees, including both non-managerial and managerial personnel).
Each stakeholder group expects those making strategic decisions in a firm to provide the leadership through which its valued objectives will be reached.106 The objectives of the various stakeholder groups often differ from one another, sometimes placing those involved with a firm’s strategic management process in situations where trade-offs have to be made. The most obvious stakeholders, at least in U.S. organizations, are shareholders— individuals and groups who have invested capital in a firm in the expectation of earning a positive return on their investments. These stakeholders’ rights are grounded in laws governing private property and private enterprise.
In contrast to shareholders, another group of stakeholders—the firm’s customers— prefers that investors receive a minimum return on their investments. Customers could have their interests maximized when the quality and reliability of a firm’s products are improved, but without high prices. High returns to customers, therefore, might come at the expense of lower returns for capital market stakeholders.
Because of potential conflicts, each firm must carefully manage its stakeholders. First, a firm must thoroughly identify and understand all important stakeholders. Second, it must prioritize them in case it cannot satisfy all of them. Power is the most critical criterion in prioritizing stakeholders. Other criteria might include the urgency of satisfying each particular stakeholder group and the degree of importance of each to the firm.107
When the firm earns above-average returns, the challenge of effectively managing stakeholder relationships is lessened substantially. With the capability and flexibility provided by above-average returns, a firm can more easily satisfy multiple stakeholders simultaneously. When the firm earns only average returns, it is unable to maximize the interests of all stakeholders. The objective then becomes one of at least minimally satisfy- ing each stakeholder.
Trade-off decisions are made in light of how important the support of each stake- holder group is to the firm. For example, environmental groups may be very important to firms in the energy industry but less important to professional service firms.108 A firm earning below-average returns does not have the capacity to minimally satisfy all stakeholders. The managerial challenge in this case is to make trade-offs that minimize the amount of support lost from stakeholders. Societal values also influence the general weightings allocated among the three stakeholder groups shown in Figure 1.4. Although all three groups are served by firms in the major industrialized nations, the priorities in their service vary because of cultural differences. Next, we present additional details about each of the three major stakeholder groups.
Capital Market Stakeholders
Shareholders and lenders both expect a firm to preserve and enhance the wealth they have entrusted to it. The returns they expect are commensurate with the degree of risk accepted with those investments (i.e., lower returns are expected with low-risk invest- ments while higher returns are expected with high-risk investments). Dissatisfied lend- ers may impose stricter covenants on subsequent borrowing of capital. Dissatisfied shareholders may reflect their concerns through several means, including selling their stock. Institutional investors (e.g., pension funds, mutual funds) often are willing to sell their stock if the returns are not what they desire, or take actions to improve the firm’s performance such as pressuring top managers to improve the gov- ernance oversight by the board of directors. Some institutions owning major shares of a firm’s stock may have conflicting views of the actions needed, which can be challenging for managers. This is because some may want an increase in returns in the short term while the others desire a focus on building long-term competitiveness.109 Managers may have to balance their desires with other shareholders or prioritize the importance of the institutional owners with different goals. Clearly shareholders who hold a large share of stock (sometimes referred to as blockholders—see Chapter 10 for more explanation) are influential, especially in the determination of the firm’s capital structure (i.e., the amount of equity versus the amount of debt used). Often large shareholders prefer that the firm minimize its use of debt because of the risk of debt, its cost, and the possibility that debt holders have first call on the firm’s assets in case of default over the shareholders.110
When a firm is aware of potential or actual dissatisfactions among capital market stakeholders, it may respond to their concerns. The firm’s response to stakeholders who are dissatisfied is affected by the nature of its dependency relationship with them (which, as noted earlier, is also influenced by a society’s values). The greater and more signifi- cant the dependency relationship is, the more likely a direct and significant response by the firm. Before liquidating, Circuit City took several actions to try to satisfy its capital market stakeholders. For example, it closed stores, changed the top management team, and sought potential buyers.111 However, none of these actions allowed Circuit City to meet the expectations of its capital market stakeholders, and it declared bankruptcy and went out of business.
Product Market Stakeholders
Some might think that product market stakeholders (customers, suppliers, host com- munities, and unions) share few common interests. However, all four groups can benefit as firms engage in competitive battles. For example, depending on product and indus- try characteristics, marketplace competition may result in lower product prices being charged to a firm’s customers and higher prices being paid to its suppliers (the firm might be willing to pay higher supplier prices to ensure delivery of the types of goods and services that are linked with its competitive success).112
Customers, as stakeholders, demand reliable products at the lowest possible prices. Suppliers seek loyal customers who are willing to pay the highest sustainable prices for the goods and services they receive. Although all product market stakeholders are important, without customers, the other product market stakeholders are of little value. Therefore, the firm must try to learn about and understand current and potential customers.113 Host communities want companies willing to be long-term employers and providers of tax revenue without placing excessive demands on public support services. Union officials are interested in secure jobs, under highly desirable working conditions, for employees they represent. Thus, product market stakeholders are generally satisfied when a firm’s profit margin reflects at least a balance between the returns to capital market stakehold- ers (i.e., the returns lenders and shareholders will accept and still retain their interests in the firm) and the returns in which they share.
Organizational Stakeholders
Employees—the firm’s organizational stakeholders—expect the firm to provide a dynamic, stimulating, and rewarding work environment. As employees, we are usually satisfied working for a company that is growing and actively developing our skills, espe- cially those skills required to be effective team members and to meet or exceed global work standards. Workers who learn how to use new knowledge productively are critical to organizational success. In a collective sense, the education and skills of a firm’s workforce are competitive weapons affecting strategy implementation and firm performance.114 Strategic leaders are ultimately responsible for serving the needs of organizational stake- holders on a day-to-day basis. In fact, to be successful, strategic leaders must effectively use the firm’s human capital.115 The importance of human capital to their success is likely why outside directors are more likely to propose layoffs compared to inside strategic leaders, while such insiders are likely to use preventative cost-cutting measures and seek to protect incumbent employees.116 A highly important means of building employee skills for the global competitive landscape is through international assignments. The process of managing expatriate employees and helping them build knowledge can have significant effects over time on the firm’s ability to compete in global markets.117
Strategic Leaders
Strategic leaders are people located in different areas and levels of the firm using the strategic management process to select strategic actions that help the firm achieve its vision and fulfill its mission. Regardless of their location in the firm, successful strategic leaders are decisive, committed to nurturing those around them,118 and committed to helping the firm create value for all stakeholder groups.119 In this vein, research evidence suggests that employees who perceive that their CEO is a visionary leader also believe that the CEO leads the firm to operate in ways that are consistent with the values of all stakeholder groups rather than emphasizing only maximizing profits for shareholders. In turn, visionary leadership helps to obtain extra effort by employees, thereby achieving enhanced firm performance. These findings are consistent with the argument that “To regain society’s trust ... business leaders must embrace a way of looking at their role that goes beyond their responsibility to the shareholder to include a civic and personal com- mitment to their duty as institutional custodians.”120
When identifying strategic leaders, most of us tend to think of CEOs and other top- level managers. Clearly, these people are strategic leaders. In the final analysis, CEOs are responsible for making certain their firm effectively uses the strategic management process. Indeed, the pressure on CEOs to manage strategically is stronger than ever.121 However, many other people help choose a firm’s strategy and then determine the actions for successfully implementing it.122 The main reason is that the realities of twenty-first- century competition that we discussed earlier in this chapter (e.g., the global economy, globalization, rapid technological change, and the increasing importance of knowledge and people as sources of competitive advantage) are creating a need for those “closest to the action” to be making decisions and determining the actions to be taken.123 In fact, the most effective CEOs and top-level managers understand how to delegate strategic respon- sibilities to people throughout the firm who influence the use of organizational resources. In fact, delegation also helps to avoid too much managerial hubris at the top and the problems it causes, especially in situations allowing significant managerial discretion.124
Organizational culture also affects strategic leaders and their work. In turn, strategic leaders’ decisions and actions shape a firm’s culture. Organizational culture refers to the complex set of ideologies, symbols, and core values that are shared throughout the firm and that influence how the firm conducts business. It is the social energy that drives—or fails to drive—the organization.125 For example, Southwest Airlines is known for having a unique and valuable culture. Its culture encourages employees to work hard but also to have fun while doing so. Moreover, its culture entails respect for others—employees and customers alike. The firm also places a premium on service, as suggested by its commit- ment to provide POS (Positively Outrageous Service) to each customer.
Some organizational cultures are a source of disadvantage. It is important for stra- tegic leaders to understand, however, that whether the firm’s culture is functional or dysfunctional, their effectiveness is influenced by that culture. The relationship between organizational culture and strategic leaders’ work is reciprocal in that the culture shapes the outcomes of their leadership while their leadership helps shape an ever-evolving organizational culture.
The Work of Effective Strategic Leaders
Perhaps not surprisingly, hard work, thorough analyses, a willingness to be brutally hon- est, a penchant for wanting the firm and its people to accomplish more, and tenacity are prerequisites to an individual’s success as a strategic leader.126 In addition, strategic leaders must have a strong strategic orientation while simultaneously embracing change in the dynamic competitive landscape we have discussed.127 In order to deal with this change effectively, strategic leaders must be innovative thinkers and promote innovation in their organization.128 Promoting innovation is facilitated by a diverse top manage- ment team representing different types of expertise and leveraging relationships with external parties.129 Strategic leaders can best leverage partnerships with external parties and organizations when their organizations are ambidextrous. That is, the organizations simultaneously promote exploratory learning of new and unique forms of knowledge and exploitative learning that adds incremental knowledge to existing knowledge bases, allowing them to better understand and use their existing products.130 In addition, stra- tegic leaders need to have a global mindset, or what some refer to as an ambicultural approach to management.131
Strategic leaders, regardless of their location in the organization, often work long hours, and their work is filled with ambiguous decision situations.132 However, the opportunities afforded by this work are appealing and offer exciting chances to dream and to act.133 The following words, given as advice to the late Time Warner chair and co- CEO Steven J. Ross by his father, describe the opportunities in a strategic leader’s work:
There are three categories of people—the person who goes into the office, puts his feet up on his desk, and dreams for 12 hours; the person who arrives at 5 a.m. and works for 16 hours, never once stopping to dream; and the person who puts his feet up, dreams for one hour, then does something about those dreams.134
The operational term used for a dream that challenges and energizes a company is vision. The most effective strategic leaders provide a vision as the foundation for the firm’s mis- sion and subsequent choice and use of one or more strategies.
Predicting Outcomes of Strategic Decisions: Profit Pools
Strategic leaders attempt to predict the outcomes of their decisions before taking efforts to implement them, which is difficult to do. Many decisions that are a part of the strategic management process are concerned with an uncertain future and the firm’s place in that future. As such, managers try to predict the effects on the firm’s profits of strategic deci- sions that they are considering.135
Mapping an industry’s profit pool is something strategic leaders can do to anticipate the possible outcomes of different decisions and to focus on growth in profits rather than strictly growth in revenues. A profit pool entails the total profits earned in an industry at all points along the value chain.136 (We explain the value chain in Chapter 3 and discuss it further in Chapter 4.) Analyzing the profit pool in the industry may help a firm see something others are unable to see and to understand the primary sources of profits in an industry. There are four steps to identifying profit pools: (1) define the pool’s boundaries, (2) estimate the pool’s overall size, (3) estimate the size of the value-chain activity in the pool, and (4) reconcile the calculations.137
For example, McDonald’s might desire to map the quick-service restaurant indus- try’s profit pools. First, McDonald’s would need to define the industry’s boundaries and, second, estimate its size (which is large, because McDonald’s operates in markets across the globe). The net result of this is that McDonald’s tries to take market share away from competitors such as Burger King and Wendy’s, and growth is more likely in inter- national markets. Armed with information about its industry, McDonald’s could then estimate the amount of profit potential in each part of the value chain (step 3). In the quick-service restaurant industry, marketing campaigns and customer service are likely more important sources of potential profits than are inbound logistics’ activities (see Chapter 3). With an understanding of where the greatest amount of profits are likely to be earned, McDonald’s would then be ready to select the strategy to use to be successful where the largest profit pools are located in the value chain.138 As this brief discussion shows, profit pools are a potentially useful tool to help strategic leaders recognize the actions to take to increase the likelihood of increasing profits. Of course, profits made by a firm and in an industry can be partially interdependent on the profits earned in adja- cent industries.139 For example, profits earned in the energy industry can affect profits in other industries (e.g., airlines). When oil prices are high, it can reduce the profits earned in industries that must use a lot of energy to provide their goods or services.
The Strategic Management Process
As suggested by Figure 1.1, the strategic management process is a rational approach firms use to achieve strategic competitiveness and earn above-average returns. Figure 1.1 also features the topics we examine in this book to present the strategic management process to you.
This book is divided into three parts. In Part 1, we describe what firms do to analyze their external environment (Chapter 2) and internal organization (Chapter 3). These analyses are completed to identify marketplace opportunities and threats in the exter- nal environment (Chapter 2) and to decide how to use the resources, capabilities, core competencies, and competitive advantages in the firm’s internal organization to pursue opportunities and overcome threats (Chapter 3). The analyses explained in Chapters 2 and 3 compose the well-known SWOT analyses (strengths, weaknesses, opportunities, threats).140 With knowledge about its external environment and internal organization, the firm forms its strategy taking into account the firm’s vision and mission.
The firm’s strategic inputs (see Figure 1.1) provide the foundation for choosing one or more strategies and deciding how to implement them. As suggested in Figure 1.1 by the horizontal arrow linking the two types of strategic actions, formulation and imple- mentation must be simultaneously integrated to successfully use the strategic manage- ment process. Integration happens as decision makers think about implementation issues when choosing strategies and as they think about possible changes to the firm’s strategies while implementing a currently chosen strategy.
In Part 2 of this book, we discuss the different strategies firms may choose to use. First, we examine business-level strategies (Chapter 4). A business-level strategy describes the actions a firm takes to exploit its competitive advantage over rivals. A company compet- ing in a single product market (e.g., a locally owned grocery store operating in only one location) has but one business-level strategy while a diversified firm competing in mul- tiple product markets (e.g., General Electric) forms a business-level strategy for each of its businesses. In Chapter 5, we describe the actions and reactions that occur among firms in marketplace competition. Competitors typically respond to and try to anticipate each other’s actions. The dynamics of competition affect the strategies firms choose as well as how they try to implement the chosen strategies.141
To examine actions taken to implement strategies, we consider several topics in Part 3 of the book. First, we examine the different mechanisms used to govern firms (Chapter 10). With demands for improved corporate governance being voiced by many stake- holders in the current business environment, organizations are challenged to learn how to simultaneously satisfy their stakeholders’ different interests.143 Finally, the organi- zational structure and actions needed to control a firm’s operations (Chapter 11), the patterns of strategic leadership appropriate for today’s firms and competitive environ- ments (Chapter 12), and strategic entrepreneurship (Chapter 13) as a path to continuous innovation are addressed.
It is important to emphasize that primarily because they are related to how a firm interacts with its stakeholders, almost all strategic management process decisions have ethical dimensions.144 Organizational ethics are revealed by an organization’s culture; that is to say, a firm’s decisions are a product of the core values that are shared by most or all of a company’s managers and employees. Especially in the turbulent and often ambiguous competitive landscape of the twenty-first century, those making decisions as a part of the strategic management process are challenged to recognize that their deci- sions affect capital market, product market, and organizational stakeholders differently and to regularly evaluate the ethical implications of their decisions.145 Decision makers failing to recognize these realities accept the risk of placing their firm at a competitive disadvantage with regard to ethical business practices.146
As you will discover, the strategic management process examined in this book calls for disciplined approaches to serve as the foundation for developing a competitive advan- tage. These approaches provide the pathway through which firms will be able to achieve strategic competitiveness and earn above-average returns. Mastery of this strategic man- agement process will effectively serve you, our readers, and the organizations for which you will choose to work.
