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JWI 540 – Lecture Notes (1214) Page 1 of 13

JWI 540: Strategy

Week Four Lecture Notes

JWI 540 – Lecture Notes (1214) Page 2 of 13

ASSESSING RISK AND REWARD What It Means Strategy is about clearly defining what you will focus on and how you plan to “win” in your competitive

space. Your entire organization needs to understand it and bring it to life. Winning strategies need to be

action-driven, but they must be built around a realistic understanding of your organization’s core

competencies and how they stack up against the risks and rewards associated with a potential strategic

move. A winning strategy must not just identify the pathway with the greatest potential. It must be clear on

the risks in implementing the strategy, and what the potential downside is if things do not go as planned.

Why It Matters

• Assessing risk and reward helps identify core competencies so your business can stay focused and avoid distractions.

• Evaluating risks and rewards forces organizations to challenge assumptions with the goal of defining what they can do better than their rivals.

• Businesses employing a proven strategic framework aren’t as likely to get lost in the euphoria of an exciting new vision and fail to assess the dangers of a potential move.

“If you don’t have a competitive

advantage, don’t compete.”

Jack Welch

JWI 540 – Lecture Notes (1214) Page 3 of 13

YOUR STARTING POINT

1. How much thought does your organization give to what’s coming in the year ahead?

2. What concerns you the most about the year ahead? What possible shifts in the playing field

could threaten your business in a short time?

3. Are there potential changes to the macro environment (such as the overall economy, the

regulatory environment or the development of alternate technologies/solutions) that could

impact the entire playing field?

4. What new products could your rivals launch that could hurt your business?

5. Other than product advancements, what other moves could a competitor make that would hurt

your business?

6. Does your organization have a readiness plan to respond quickly to “trigger events” (such as

those identified in the preceding questions) if they were to occur?

JWI 540 – Lecture Notes (1214) Page 4 of 13

UNDERSTANDING STRATEGIC RISK

What’s the difference between a strategic risk-reward assessment and a tactical risk-reward assessment?

This is a fundamental question that must be addressed. Yet, it often gets lost in the “upside versus

downside” calculus. Many business leaders approach risk-reward analysis from a tactical perspective

rather than a strategic one. They ask questions like “What will it cost us to invest in this new product, or

develop a new branding campaign, or try a new pricing model?” and “What happens if it doesn’t work

out?”

To be clear, these are the right questions to ask, but in many cases, the analysis they lead to is focused

too narrowly on tactical moves, not strategic ones. Analysis of strategic risk and reward must be viewed

from a longer-term perspective. It must focus on the costs to acquire, develop, and leverage core

competencies your competitors cannot easily duplicate. Assessing this balance is made clearer by

leveraging models like Porter’s Five Forces (more on this below).

The strategic risk-reward assessment is best framed as:

• What are the core competencies we must possess in order to create a sustainable competitive

advantage?

• What are the risks associated with building/buying/protecting these core competencies?

• What are the risks if we do not build/buy/protect these core competencies?

• What is the potential reward if we do?

Remember, you must assess risks and rewards in terms of both magnitude and probability. A potentially

huge payoff that is unlikely to actually occur would not justify taking a big risk.

Analysis of the strategic risk and reward must be approached in terms that are broader than a simple ROI

calculation. Strategic risk for a company involves many factors, including damage to the brand and the

opportunity costs associated with focusing on a particular direction and missing out on other

opportunities. Let us start by addressing the most important question any strategist can ask – how secure

is our competitive advantage?

WHAT CAN WE DO THAT OUR RIVALS CANNOT?

What can you do that your competitors cannot do, or cannot do as well as you can, is the central question

in assessing the risks your business faces and in building a winning strategy. You may have developed a

product or service that customers crave. You may do a terrific job of letting them know about it,

manufacturing or delivering it, and even providing them with excellent follow-up after their purchase. But if

your competitors can do the same thing, your first-class offering does you little good. If, however, rivals

are not able to match what you do in some important aspect, you enjoy competitive advantage. One of

the defining elements of business strategy is determining your source of advantage.

A company might get ahead of its rivals by providing, for example, better products (Apple), services

(Starbucks), or value (Walmart). Such an advantage typically goes to the very heart of a company’s

identity. It shapes everything from a company’s investments to its hiring, from its selection of suppliers to

JWI 540 – Lecture Notes (1214) Page 5 of 13

its choice of distribution channels. For example, the strategy of a big pharmaceutical company like Merck

relies on its patents for unique and effective drugs. Consequently, every important strategic decision –

whether about R&D investments, advertising budgets, or relationships with regulators – is made with the

aim of reinforcing and protecting this advantage.

Competitive advantages, like strategies, sometimes originate with a blinding insight, an “Aha!” moment

about how you can meet the needs of a customer group better than anyone else in the marketplace.

Absent such inspiration, how do you systematically identify your organization’s current or potential

competitive advantages? You need to understand their source.

WHERE DOES COMPETITIVE ADVANTAGE COME FROM?

To evaluate the sources of competitive advantage, consider two major categories: assets and

capabilities.

• Assets are quantifiable, usually tangible resources that can be bought and sold. These include

physical assets like machines and buildings, as well as more intangible yet measurable assets

like patents and brands.

• Capabilities are intangible and difficult to quantify, buy, or sell. They include such attributes as

effective management processes, operational or leadership skills, and a distinct ability to attract

and retain talent, create and maintain a stellar corporate reputation, or continuously innovate.

You can develop capabilities over time, or you can hire or acquire the people or companies that have

them. Remember, though, that people may not bring the full value of their capabilities with them when

they join you. Their capabilities may be based on something, such as an innovative corporate culture or a

complex ordering system, which they leave behind at their former employer.

So, competitive advantage can arise from what a company has (its assets) or what a company does (its

capabilities). It can also arise from what a company does with what it has. For example, Merck’s patents

(an asset) and its management of relationships with healthcare professionals (a capability) together

create tremendous value.

One caveat: simply possessing or investing in assets or capabilities does not guarantee a competitive

advantage. Sears had an iconic brand in the early 2000s, but the company was not able to create a

strategy around its brand that gave it an advantage over similar retailers.

HOW DO YOU KNOW IF YOU HAVE AN ADVANTAGE?

There is an elusive quality that all organizations strive to capture – sustainable competitive advantage.

These are the long-lasting strengths that allow a company to become a permanent market leader; they

are the ultimate strategic goal. In reality, nothing is permanent. But some advantages are definitely longer

lasting than others.

JWI 540 – Lecture Notes (1214) Page 6 of 13

Sustainable competitive advantage does not come easy. It results from the coordination of activities,

decisions, and processes across an organization. It lasts over long periods of time and holds up in the

face of uncertainty and changing environments. The aim of that coordinated effort is to use your

capabilities and assets in a way that (a) creates value, (b) is distinctive or even unique, and (c) is difficult

or even impossible to imitate.

To gain an advantage, a company must develop a strategy that creates value either by increasing

revenue (getting more customers to pay for its goods or services), or by decreasing costs (thereby

generating greater profit from each unit of revenue) more effectively than its rivals. This sounds pretty

obvious, but there are countless examples of companies pursuing a strategy that makes the company

better than it was in the past, but not better than its competitors. For example, despite significant

improvements in costs, product selection, and inventory turns in recent years, Sears did not achieve a

competitive advantage because its moves improved on its historical performance but did not create more

value than its rivals. By contrast, GE’s strategy under Jack to have each of its businesses become first or

second in its industry improved the performance of those businesses relative to competitors.

An effective strategy for your business is unlike anyone else’s. It is tempting to follow successful

companies with a “me-too” strategy. But while it makes sense to pay attention when a rival discovers a

new way to create value in your industry, it does not make sense to simply copy it. Doing so may allow

you to tie the game, but not win it.

Taken together, creating value and being unique can get you closer to sustainable competitive

advantage. Blockbuster’s value came from providing convenient video rentals in an easy-to-navigate

store format. It created something unique when it became the only large company among many small

mom-and-pop video rental shops, giving it economies of scale to lower costs and the power to negotiate

special deals with movie distributors. While it failed to anticipate the threats posed by advances in digital

technology exploited by Netflix, it was still able to operate a highly profitable business for many years.

Value-creating advantages that are not only unique, but are also difficult to copy, are the holy grail of

strategy. Unique strategies can be a source of tremendous competitive advantage, but that leg up is

usually temporary. If you have a successful strategy, others will eventually try to copy it. And while the

benefits for the copying company are limited, the loss of benefit to your company is substantial because

your strategy is no longer unique. But when a company’s capabilities are difficult or costly to replicate –

even though rivals see their value – they can create sustained competitive advantage. Advantages that

are not immediately obvious to outsiders, that are costly or time-consuming to create, or that are

organization-specific, are the most difficult to imitate. For example, companies can often hide key aspects

of their strategy.

• They keep their special sauce a secret – think of Google’s search algorithm.

• Strategies with many interdependent parts may be too costly for rivals to replicate – Ritz-Carlton’s

unique employee training program is one.

• Strategies anchored in the specific history of an organization or in the personality of its leaders

are nearly impossible to imitate – Virgin Group’s CEO Richard Branson is just such a charismatic

leader.

JWI 540 – Lecture Notes (1214) Page 7 of 13

As Sherman explains in chapter 4 of If You’re in a Dogfight, Become a Cat!, it is not an inevitability that

behemoth companies will eventually lose the basis of their competitive advantage. Such assumptions are

based on the belief that large companies will eventually exhibit strategic inertia. While there are many

examples of companies like Blockbuster, Sears, and Kodak who may have succumbed to this inertia, it is

not necessarily the final chapter. Still, Sherman notes that “It is true that if a company, whether small or

large, focuses more on defending current market positions than on renewing its basis of competitive

advantage with meaningfully differentiated innovative products and services, it will fail...” (pp. 98-99)

WHO ELSE HAS AN ADVANTAGE?

Most great strategists are experts in their industry. They understand who the players are, what the key

challenges are, and what the rules are. For example, industries that are capital-intensive are quite

different from those that are not. Each industry has a value chain that determines how raw materials are

transformed into products and services, even though this chain may change over time. The computer

value chain prior to Dell’s entry into the market, for example, involved middlemen who bought computers

from manufacturers and sold them to consumers, usually in brick-and-mortar stores. Dell pioneered a

different model in which customers had their computers built to order, and they usually placed their order

directly with the manufacturer, first by telephone and later over the Internet. Dell shook up the entire

industry’s value chain.

Who is gunning to shake up your industry? Industries are complicated, so to perform this kind of strategic

analysis efficiently, we need to know what we are looking for. One well-known industry analysis tool is

Michael Porter’s 5 Forces model:

• Force 1: Rivals

These are the companies directly competing with you for the hearts and minds of your target

customers. A few well-chosen questions can help identify challenges and opportunities: How

large are your competitors? Are there many of them or few? How mature are they in the space?

In what ways are you better or different from them? Rivals are central to your industry analysis.

They compete with you both for raw materials from suppliers (Force 2) and for customers (Force

3). At the same time, you and your rivals may share a common enemy, in the form of a substitute

product (Force 4) or a new market entrant (Force 5).

• Force 2: Suppliers

Look at the supply chain in your industry – start by analyzing suppliers. Are the suppliers large

and few in number, or do many small players predominate? Which critical types of goods are

most scarce?

• Force 3: Customers

Then, you need to look to the other end of the supply chain, toward your customers. Are they

fragmented into multiple types, or is there a dominant buying group? What are the switching costs

they would incur to move to or away from your products?

• Force 4: Substitutes

Unlike direct rivals, these represent indirect competition for your product or service. What other

goods and services are close substitutes for yours? Whom might suppliers sell to, or from whom

JWI 540 – Lecture Notes (1214) Page 8 of 13

might customers buy, instead of you? For example, watching movies at home and going to live

plays are both substitutes for seeing movies at a public theater. Competitors to theaters would

want to understand the price difference or delivery mechanism that might prompt customers to

choose one form of entertainment over another.

• Force 5: New Entrants

You need to be on the lookout for new direct competitors. Which players, or types of companies,

might enter your market and compete against you? Do they represent an opportunity as well as a

threat? Say you were a delicatessen selling sandwiches and salads in 1988. At the time, large

supermarkets were beginning to experiment with prepared foods. They might have been seen as

a new entrant threatening to steal many of your customers. Conversely, they might have

represented customers for your prepared foods, thereby expanding your business.

As you analyze your industry in terms of Porter’s Five Forces, ask yourself: Where is the power? If you

have it, how can you exploit it? If not, how can you defend yourself? Can you develop a strategy that will

improve your position and make you the biggest, the best, or the most distinctive in your market?

Remember our earlier admonition: strategic frameworks like this one are only a means to an end. They

are intended to illuminate business situations and reveal new insights for managers. They are intended to

show you how to win.

HOW DO WE CAPITALIZE ON OUR CORE COMPETENCIES?

Returning to our core theme of assessing risk against potential reward, you must be crystal clear in

identifying where your competitive advantage comes from and how defensible that advantage is to

attacks from your competitors. Asking how you can match your competitors in certain capabilities,

qualities, or price points can be important, but it is a “me-too” approach that will not lead to market

domination by itself. The real key in formulating an effective strategy is to focus on what you can do better

than anyone else.

What enables a company to do something really well? Sometimes, it is just plain hard work. Sometimes, it

is timing or luck. But at the core of every successful organization are a handful of capabilities that result in

high performance. These capabilities are known as core competencies. The phrase, coined by Gary

Hamel and C.K. Prahalad (1994), refers to an organization's complementary value-creating skills or

activities that other companies cannot easily imitate. They typically extend across an entire organization

and contribute to success across markets or industries. Examples include technical know-how, a reliable

manufacturing process, close relationships with customers or suppliers, or a culture that fosters employee

loyalty. Technologies, by themselves, are not core competencies. But the distinctive way that a company

exploits a technology may be.

A company’s core competencies can be difficult to isolate and identify. In fact, sometimes, they are not

appreciated until after they have eroded or the people responsible for creating them have left the

company. That is why it is worth figuring out your company’s core competencies. If you do not know what

they are, you can’t maintain and strengthen them.

JWI 540 – Lecture Notes (1214) Page 9 of 13

IDENTIFYING YOUR CORE COMPETENCIES

To clarify further, all core competencies are advantages, but all advantages are not necessarily core

competencies. As you identify the core competencies that contribute to your company’s success, ask

yourself some questions:

• Does it truly create value? Although your company may boast a world-class capability, that

does not mean it creates value for customers or your company. For example, your company’s

renowned

designers may boast incredible design skills, but your customers may prefer convenience over

style. Or competitors may match your design abilities, giving you a competency that you clearly

cannot rely on for your success. Or your design strength can be undermined through an

inefficient distribution network that hinders your ability to get your stylish products to market.

• Is it difficult to imitate? You want a sustainable advantage over rivals. That is more likely when

a competency relies on a complex combination of activities and knowledge. Even if the

competition figures out how you create value, it will take considerable time for them to imitate

you. They will have a reasonably high chance of getting it wrong, as well. Think about how major

airlines launched low-cost carriers in an attempt to match the initial success of Southwest

Airlines. It was easy to replicate Southwest’s routes, fares, and policy of not assigning seats, but

the skills and activities needed to profitably run an airline with low ticket prices - everything from

pilot training to getting passengers to help clean the plane between flights - proved extremely

difficult to copy.

• Does it further your strategy? It sounds obvious, but a core competency should be closely

linked to your strategic advantage. You don’t want to invest heavily in providing superior service,

for example, if you don’t intend to position yourself in your chosen market segments as the best

service provider.

DEVELOPING A CORE COMPETENCY

Building up a core competency from scratch isn’t easy. You first need to be sure that you’re creating

something that is truly superior to the industry standard. You should try to quantify what will make your

capability clearly superior, being sure to use current and relevant data. For example, simply hiring more

researchers than your rivals won’t just make R&D one of your core competencies.

You also want to ensure that the part of the business where the new competency will reside holds a

position of true power in the organization. At Procter & Gamble, for instance, the core consumer-

marketing skill resides in advertising, and brand managers from that department have traditionally shaped

decisions across the entire company. Although several departments may be candidates to house the new

competencies, only one can be chosen. Resources shouldn’t be diluted in the pursuit of too many paths

to greatness. If the right area is chosen, it will be the only one you need.

JWI 540 – Lecture Notes (1214) Page 10 of 13

And only the best managers should be working in core areas. These managers champion programs and

follow through on them, have a laser-sharp ability to keep their priorities straight, are great

communicators about the company’s priorities, and see the connections between their own area and

other parts of the business.

There are two basic ways to develop a competency in-house.

1. The most common way is to shift resources and decision-making power to the competency you

want to develop. For example, if you were trying to develop strategic capability in the area of

product miniaturization, the engineering department may play a larger role in marketing decisions

or may relocate some of its people to work more closely with IT on their plans and priorities.

2. Alternatively, some companies will allow or encourage a group of individuals to leave their normal

work for a while and focus only on development of the new competency. Ideally, this “skunk work”

team will be isolated from day-to-day operations and given the chance to nurture the competency

until it is strong enough to be integrated into the organization. In this case, a separate engineering

team of miniaturization specialists might work with marketing, IT, operations, and logistics experts

to develop processes and products that would otherwise not be likely to survive in the business.

To get more traction, an incubator should be protected from unnecessary meddling. But it still

faces big challenges when it tries to bring the new capability back into the business.

Sometimes, it pays to employ both approaches at the same time. When Jack launched GE's Six Sigma

initiative, he systematically shifted resources and decision-making power from the old-line quality control

managers, who had been excluded from the power centers within GE businesses, to a new cross-

business hierarchy of influential executives that reported to one of GE's most senior corporate officers. At

the same time, Jack freed up a number of people from their day-to-day responsibilities so that they could

devote their energies to acquiring the competencies needed to become Master Black Belts. Thereafter,

they assumed responsibility for teaching the tools and skills of Six Sigma to tens of thousands of other

GE employees.

ACQUIRING A CORE COMPETENCY

Buying another company is a common and relatively speedy way to gain the skills you seek, which we will

address in greater detail in Week 8. However, in order to get the desired set of skills, you may also have

to buy a set that you don’t necessarily want. Getting rid of lines of business or geographies should also be

done quickly so that resources can be redirected toward the core value-creating activities.

Keep in mind that in many cases, competencies are embedded in a company’s culture or rely on a

complex set of activities or a team. One of the risks in trying to acquire a competency is that this

embeddedness is disrupted. Before breaking up the acquired company, be sure you understand the true

sources of value so that the wrong people or assets are not removed.

JWI 540 – Lecture Notes (1214) Page 11 of 13

DEFENDING A CORE COMPETENCY

No strategic initiative is risk free or lasts forever. Whether you build or buy your core competency, you will

need to protect it. As mentioned earlier, one way to do this is to create a competency with numerous

elements or one that requires teams of employees with special skills working together. But you also want

to continuously invest in your competency. That may mean helping employees upgrade their skills, hiring

more people, adding new machinery, and otherwise shoring up your advantage – again, especially in

ways that make your competency difficult to replicate. Keep in mind that this can be politically tricky.

Especially at budget time, other parts of the business may resent the increased investments in an area

that already seems to get more than it deserves. As you work to protect your competency, do not forget to

keep a close watch on rivals. They may try to make your competency irrelevant by investing heavily in

their own.

In closing, the core principle to keep in mind in assessing the risks and rewards of a strategic direction

centers on what it takes to develop/acquire and defend a core competency against the potential upside if

you can successfully do so. Without this assessment, even the best ideas can be blindsided by a

competitive attack you never saw coming.

JWI 540 – Lecture Notes (1214) Page 12 of 13

SUCCEEDING BEYOND THE COURSE

As you read the materials and participate in class activities, stay focused on the key learning outcomes

for the week and how they can be applied to your job.

• Assess risk and reward as drivers of competitive advantage

In assessing risks, you must evaluate the upside and downside potential. If the bet you take pays

off, what will the business gain? If it doesn’t work, what will you lose? A big risk must be balanced

by a big potential reward. While there is no textbook answer for what the right or wrong amount of

risk is, the risk must align with the mission of the organization. If taking a risk is necessary to win,

then what can be done to protect the organization as much as possible if things don’t go well?

• Examine criteria to evaluate the health of an existing strategy

Determining whether an existing strategy is “healthy” or not is about more than whether the

company is making money. It includes the following:

o Communicating a Shared Strategy: Do you have a current strategic direction that is

clearly understood by the organization? If yes, how well are we embracing it?

o Measurements: Which metrics do you use to monitor how effectively each part of the

organization embraces the strategy and executes it?

o Openness to Change: Even as the organization executes the strategies that are in

place, is it open to changing direction based on external forces and new information?

o Performance Management: Do you have a consistent approach to address parts of the

organization where change is not embraced, or progress is not fast enough?

o Candid Self-Assessment: Do you have a clear analysis of the strengths and

weaknesses of your own organization in the same way you analyze a competitor?

o Systems and Structures: Do you have the tools and technology to grow? Is there

funding allocated if capital expenditures are necessary?

• Apply the questions in Jack’s fourth and fifth slides to articulate threats and opportunities

Assign each member of your team to become a pitch person for one of your key competitors.

Have them research the organization and deliver a presentation on how they are going to knock

your organization off its feet in the next year. The more convincing and threatening they can be,

the better. After you have done that, shift the focus to opportunities. Dream big. Be open to the

possibilities of finding new areas of growth. Encourage the team to share their biggest, most

optimistic “What if…?” ideas. In the first round of brainstorming, nothing should be off the table.

JWI 540 – Lecture Notes (1214) Page 13 of 13

ACTION PLAN

To apply what I have learned this week in my course to my job, I will…

Action Item(s)

Resources and Tools Needed (from this course and in my workplace)

Timeline and Milestones

Success Metrics