Case study: Amazon

STRATEGIC M a n a g e m e n : ’

EDITION Concepts and Cases

PEARSON

A COM PETITIVE ADVANTAGE APPRO ACH

G LO B A L EDITION

Fred R. David Francis Marion University Florence, South Carolina

Forest R. David Strategic Planning Consultant

Boston Columbus Indianapolis New York San Francisco Upper Saddle River

Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto

Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

Brief Contents

Preface 15

Acknowledgments 25

About the Authors 27

Chapter 1 Strategic Management Essentials 37

THE COHESION CASE: ADIDAS GROUP-2013 58

Chapter 2 Outside-USA Strategic Planning 75

Chapter 3 Ethics/Social Responsibility/Sustainability 109

Chapter 4 Types of Strategies 131

Chapters Vision and Mission Analysis 169

Chapter 6 The Internal Audit 187

Chapter 7 The External Audit 225

Chapter 8 Strategy Generation and Selection 255

Chapter 9 Strategy Implementation 295

Chapter 10 Strategy Execution 331

Chapter 11 Strategy M onitoring 371

Appendix 1 Guidelines for Case Analysis 393

Glossary 662

Name Index 673

Subject Index 677

5

Contents

Preface 15

Acknowledgments 25

About the Authors 27

Chapter 1 Strategic Management Essentials 37

SINGAPORE AIRLINES: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 38

What Is Strategic Management? 39 Defining Strategic Management 39 ■ Stages of Strategic Management 39 ■ Integrating Intuition and Analysis 40 ■ Adapting to Change 41

Key Terms in Strategic Management 42 Competitive Advantage 42 ■ Strategists 43 ■ Vision and Mission Statements 44 ■ External Opportunities and Threats 44 ■ Internal Strengths and Weaknesses 44 ■ Long-Term Objectives 45 ■ Strategies 45 Annual Objectives 45 ■ Policies 46

The Strategic-Management Model 47 Benefits of Strategic Management 48

Financial Benefits 49 ■ Nonfinancial Benefits 50 Why Some Firms Do No Strategic Planning 50 Pitfalls in Strategic Planning 50 Guidelines for Effective Strategic Management 51 Comparing Business and Military Strategy 52 Special Note to Students 53

THE COHESION CASE: ADIDAS GROUP—2013 58 ASSURANCE OF LEARNING EXERCISES 69 Assurance of Learning Exercise 1 A: Assess Singapore Airline's Most Recent Quarterly Performance Data 69 Assurance of Learning Exercise 1B: Gathering Strategy Information onadidasAG 70 Assurance of Learning Exercise 1C: Getting Familiar with the Free Excel Student Template 70 Assurance of Learning Exercise 1D: Evaluating An Oral Student Presentation 71 Assurance of Learning Exercise 1E: Strategic Planning at Nestle 71 Assurance of Learning Exercise 1F: Interviewing Local Strategists 72

Chapter 2 Outside-USA Strategic Planning 75 HONDA: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 76

Multinational Organizations 79 Advantages and Disadvantages of International Operations 80 The Global Challenge 81

Globalization 82

Corporate Tax Rates Globally 82

United States versus Foreign Business Cultures 84 Communication Differences Across Countries 87 Business Culture Across Countries 87

Mexico— Business Culture 88 ■ Japan—Business Culture 89 ■ Brazil—Business Culture 90 ■ Germany— Business Culture 90 ■ Egypt—Business Culture 91 ■ China— Business Culture 92 ■ India— Business Culture 92 ■ Nigeria—Business Culture 93

Business Climate Across Countries/Continents 94 Union Membership Across Europe 94 ■ African Countries 95 ■ China 97 ■ Philippines 99 ■ Taiwan 99 ■ India 99 ■ Germany 100 ■ Mexico 101

Special Note to Students 102 ASSURANCE OF LEARNING EXERCISES 104 Assurance of Learning Exercise 2A: The adidas Group wants to enter Africa. Help them. 104 Assurance of Learning Exercise 2B: Assessing Differences in Culture Across Countries 105 Assurance of Learning Exercise 2C: Honda Motor Company wants to enter the Vietnamese market. Help them. 105 Assurance of Learning Exercise 2D: Does My University Recruit in Foreign Countries? 106

Chapter 3 Ethics/Social Responsibility/ Sustainability 109

Business Ethics 110 NESTLE: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 110 Code of Business Ethics 112 ■ An Ethics Culture 113 ■ Whistle-Blowing 113 ■ Bribes 114 ■ Workplace Romance 115

Social Responsibility 117 Social Policy 118 ■ Social Policies on Retirement 118

Environmental Sustainability 119 What Is a Sustainability Report? 120 ■ Lack of Standards Changing 120 ■ Managing Environmental Affairs in the Firm 121 ■ IS0 14000/14001 Certification 122 ■ Wildlife 122 ■ Solar Power 123

Special Note to Students 124 ASSURANCE OF LEARNING EXERCISES 126 Assurance of Learning Exercise 3A: Sustainability and Nestle 126 Assurance of Learning Exercise 3B: How Does My Municipality Compare To Others on Being Pollution-Safe? 127 Assurance of Learning Exercise 3C: Compare adidas AG versus Nike on Social Responsibility 127 Assurance of Learning Exercise 3D: How Do You Rate adidas AG's Sustainability Efforts? 127 Assurance of Learning Exercise 3E: How Do You Rate Nestles Sustainability Efforts? 127 Assurance of Learning Exercise 3F:The Ethics of Spying on Competitors 128

7

8 CONTENTS

Chapter 4 Types of Strategies 131 Long-Term Objectives 132

The Nature of Long-Term Objectives 132 PETRONAS: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 132 Financial versus Strategic Objectives 133 ■ Not Managing by Objectives 134

Types of Strategies 134 Levels of Strategies 136

Integration Strategies 137 Forward Integration 137 ■ Backward Integration 139 ■ Horizontal Integration 140

Intensive Strategies 141 Market Penetration 141 ■ Market Development 142 ■ Product Development 142

Diversification Strategies 143 Related Diversification 144 ■ Unrelated Diversification 145

Defensive Strategies 146 Retrenchment 146 ■ Divestiture 147 ■ Liquidation 148

Michael Porter's Five Generic Strategies 149 Cost Leadership Strategies (Type 1 and Type 2) 149 ■ Differentiation Strategies (Type 3) 151 ■ Focus Strategies (Type 4 and Type 5) 152 ■ Strategies for Competing in Turbulent, High-Velocity Markets 153

Means for Achieving Strategies 153 Cooperation Among Competitors 153 ■ Joint Venture and Partnering 154 ■ Merger/Acquisition 155 ■ Private-Equity Acquisitions 157 ■ First Mover Advantages 157 ■ Outsourcing and Reshoring 158

Strategic Management in Nonprofit and Governmental Organizations 159

Educational Institutions 159 ■ Medical Organizations 160 ■ Governmental Agencies and Departments 160

Strategic Management in Small Firms 161 Special Note to Students 161

ASSURANCE OF LEARNING EXERCISES 164 Assurance of Learning Exercise 4A: Market Development: Petronas 164 Assurance of Learning Exercise 4B: Alternative Strategies for Petronas 164 Assurance of Learning Exercise 4C: Private-Equity Acquisitions 164 Assurance of Learning Exercise 4D: The strategies of adidas AG: 2013-2015 165 Assurance of Learning Exercise 4E: Lessons in Doing Business Globally 165 Assurance of Learning Exercise 4F: Petronas 2013-2015 165 Assurance of Learning Exercise 4G: What Strategies Are Most Risky? 166 Assurance of Learning Exercise 4H: Exploring Bankruptcy 166 Assurance of Learning Exercise 41: Examining Strategy Articles 166 Assurance of Learning Exercise 4J: Classifying Some Strategies 166

Chapter 5 Vision and Mission Analysis 169 SAMSUNG: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 170

What Do We Want to Become? 171 What Is Our Business? 171

Vision versus Mission 173 ■ Vision Statement Analysis 173 « T h e Process of Developing Vision and Mission Statements 173

Importance (Benefits) of Vision and Mission Statements 174 A Resolution of Divergent Views 174

Characteristics of a Mission Statement 176 A Declaration of Attitude 176 ■ A Customer Orientation 177 ■ Mission Statement Components 177

Writing and Evaluating Mission Statements 179 Special Note to Students 180

ASSURANCE OF LEARNING EXERCISES 182 Assurance of Learning Exercise 5A: Examining Potential Changes Needed in a Firm's Vision/Mission 182 Assurance of Learning Exercise 5B: Studying an Alternative View of Mission Statement Content 183 Assurance of Learning Exercise 5C: Evaluating Mission Statements 183 Assurance of Learning Exercise 5D: Evaluating the Mission Statement of Under Armour—a Competitor of adidas AG 184 Assurance of Learning Exercise 5E: Selecting the Best Vision and Mission Statements in a Given Industry 184 Assurance of Learning Exercise 5F: Writing an Excellent Vision and Mission Statement for Novartis AG 185

Chapter 6 The Internal Audit 187 The Nature of an Internal Audit 188

VOLKSWAGEN: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 188 Key Internal Forces 189 ■ The Process of Performing an Internal Audit 190

The Resource-Based View 191 Integrating Strategy and Culture 192 Management 194

Planning 194 ■ Organizing 196 ■ Motivating 197 ■ Staffing 197 ■ Controlling 198 ■ Management Audit Checklist of Questions 198

Marketing 198 Customer Analysis 199 ■ Selling Products and Services 199 ■ Product and Service Planning 200 ■ Pricing 200 ■ Distribution 201 ■ Marketing Research 201 ■ CostI Benefit Analysis 202 ■ Marketing Audit Checklist of Questions 202

Finance and Accounting 202 Finance and Accounting Functions 202 ■ Basic Types of Financial Ratios 204

Breakeven Analysis 207 Finance and Accounting Audit Checklist 209

Production and Operations 209 Production and Operations Audit Checklist 211

Research and Development 211 Internal and External Research and Development 212 ■ Research and Development Audit 213

Management Information Systems 213 Management Information Systems Audit 213

Value Chain Analysis 213 Benchmarking 214

The Internal Factor Evaluation Matrix 216 Special Note to Students 218

ASSURANCE OF LEARNING EXERCISES 221 Assurance of Learning Exercise 6A: Develop a Corporate IFE Matrix for Volkswagen Group 221 Assurance of Learning Exercise 6B: Should VW Deploy More Resources or Less Outside of the USA? 222

CONTENTS 9

Assurance of Learning Exercise 6C: Apply Breakeven Analysis 222 Assurance of Learning Exercise 6D: Performing a Financial Ratio Analysis for adidas AG 222 Assurance of Learning Exercise 6E: Constructing an IFE Matrix for adidas AG 222 Assurance of Learning Exercise 6F: Analyzing Your College or University's Internal Strategic Situation 223

Chapter 7 The External Audit 225 The Nature of an External Audit 226

MICHELIN: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 226 Key External Forces 227 ■ The Process of Performing an External Audit 228

The Industrial Organization (I/O) View 229 Economic Forces 229 Social, Cultural, Demographic, and Natural Environment Forces 231 Political, Governmental, and Legal Forces 232

Labor Unions 234 Technological Forces 236 Competitive Forces 237

Competitive Intelligence Programs 238 ■ Market Commonality and Resource Similarity 239

Competitive Analysis: Porter's Five-Forces Model 239 Rivalry Among Competing Firms 240 ■ Potential Entry of New Competitors 240 ■ Potential Development of Substitute Products 241 ■ Bargaining Power of Suppliers 241 ■ Bargaining Power of Consumers 242

Sources of External Information 242 Forecasting Tools and Techniques 243

Making Assumptions 243 Industry Analysis: The External Factor Evaluation Matrix 244 The Competitive Profile Matrix 245 Special Note To Students 247

ASSURANCE OF LEARNING EXERCISES 250 Assurance of Learning Exercise 7A: Michelin and Africa: An External Assessment 250 Assurance of Learning Exercise 7B: Preparing a CPM for Michelin Based on Countries Rather than Companies 251 Assurance of Learning Exercise 7C: Develop Divisional Michelin EFE Matrices 251 Assurance of Learning Exercise 7D: Developing an EFE Matrix for adidas AG 251 Assurance of Learning Exercise 7E: The External Assessment 252 Assurance of Learning Exercise 7F: Developing a CPM for Michelin 252 Assurance of Learning Exercise 7G: Developing a CPM for adidas AG 252 Assurance of Learning Exercise 7H: Analyzing Your College or University's External Strategic Situation 253

Chapter 8 Strategy Generation and Selection 255

The Nature of Strategy Analysis and Choice 256 The Process of Generating and Selecting Strategies 256

UNILEVER: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 256

A Comprehensive Strategy-Formulation Analytical Framework 258 The Input Stage 259

The Matching Stage 259 The SWOT Matrix 259 The Strategic Position and Action Evaluation (SPACE) Matrix 262 The Boston Consulting Group (BCG) Matrix 267 The Internal-External (IE) Matrix 270 The Grand Strategy Matrix 273 The Decision Stage 275 The Quantitative Strategic Planning Matrix (QSPM) 275

Positive Features and Limitations of the QSPM 280 Cultural Aspects of Strategy Choice 280 The Politics of Strategy Choice 280 Governance Issues 281 Special Note to Students 284

ASSURANCE OF LEARNING EXERCISES 287 Assurance of Learning Exercise 8A: Should Unilever Penetrate Southeast Asia Further? 287 Assurance of Learning Exercise 8B: Perform a SWOT Analysis for Unilever's Global Operations 288 Assurance of Learning Exercise 8C: Preparing a BCG Matrix for Unilever 288 Assurance of Learning Exercise 8D: Developing a SWOT Matrix for adidas AG 288 Assurance of Learning Exercise 8E: Developing a SPACE Matrix for adidas AG 289 Assurance of Learning Exercise 8F: Developing a BCG Matrix for adidas AG 289 Assurance of Learning Exercise 8G: Developing a QSPM for adidas AG 289 Assurance of Learning Exercise 8H: Developing a SWOT Matrix for Unilever 289 Assurance of Learning Exercise 81: Developing a SPACE Matrix for Unilever 290 Assurance of Learning Exercise 8J: Developing a BCG Matrix for your College or University 290 Assurance of Learning Exercise 8K: Developing a QSPM for a Company that You Are Familiar With 290 Assurance of Learning Exercise 8L: Formulating Individual Strategies 291 Assurance of Learning Exercise 8M: The Mach Test 291

Chapter 9 Strategy Implementation 295 The Nature of Strategy Implementation 296

ROYAL DUTCH SHELL: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 296

Current Marketing Issues 297 New Principles of Marketing 298

Market Segmentation 299 Retention-Based Segmentation 300 ■ Does the Internet Make Market Segmentation Easier? 302

Product Positioning/Perceptual Mapping 302 Finance and Accounting Issues 304

Acquiring Capital to Implement Strategies 305 ■ Projected Financial Statements 310 ■ Projected Financial Statement Analysis for Whole Foods Market 312 ■ Financial Budgets 313 ■ Company Valuation 315 ■ Deciding Whether to Go Public 319 ■ Research and Development (R&D) Issues 320

Management Information Systems (MIS) Issues 322 Business Analytics 322

Special Note to Students 323 ASSURANCE OF LEARNING EXERCISES 326 Assurance of Learning Exercise 9A: Preparing an EPS/EBIT Analysis for Royal Dutch Shell pic 326

10 CONTENTS

Assurance of Learning Exercise 9B: Developing a Product-Positioning Map for adidas AG 327 Assurance of Learning Exercise 9C: Performing an EPS/EBIT Analysis for adidas AG 327 Assurance of Learning Exercise 9D: Preparing Projected Financial Statements for adidas AG 327 Assurance of Learning Exercise 9E: Determining the Cash Value of adidas AG 328 Assurance of Learning Exercise 9F: Developing a Product-Positioning Map for My College 328 Assurance of Learning Exercise 9G: Do Banks Require Projected Financial Statements? 328

Chapter 10 Strategy Execution 331 The Nature of Strategy Implementation 332

ACCENTURE: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 332 Management Perspectives 334

Annual Objectives 335 Policies 337 Resource Allocation 339 Managing Conflict 339 Matching Structure with Strategy 340

The Functional Structure 341 ■ The Divisional Structure 342 ■ The Strategic Business Unit (SBU) Structure 345 ■ The Matrix Structure 346 ■ Some Do's and Don’ts in Developing Organizational Charts 348

Restructuring 350 Restructuring 350

Linking Performance and Pay to Strategies 351 Managing Resistance to Change 353 Creating a Strategy-Supportive Culture 354 Production and Operations Concerns When Implementing Strategies 355 Human Resource Concerns When Implementing Strategies 356

Employee Stock Ownership Plans (ESOPs) 358 ■ Balancing Work Life and Home Life 359 ■ Benefits of a Diverse Workforce 361 ■ Corporate Wellness Programs 361

Special Note to Students 363 ASSURANCE OF LEARNING EXERCISES 366 Assurance of Learning Exercise 10A: Developing an Organizational Chart for Accenture pic 366 Assurance of Learning Exercise 10B: Assessing Accenture's Philanthrophy Efforts 367 Assurance of Learning Exercise 10C: Revising adidas AG's Organizational Chart 367 Assurance of Learning Exercise 10D: Exploring Objectives 367 Assurance of Learning Exercise 10E: Understanding My University's Culture 368

Chapter 11 Strategy Monitoring 371 The Nature of Strategy Evaluation 372

BHP BILLITON: EXCELLENT STRATEGIC MANAGEMENT SHOWCASED 372 The Process of Evaluating Strategies 375

A Strategy-Evaluation Framework 376 Reviewing Bases of Strategy 376 ■ Measuring Organizational Performance 378 ■ Taking Corrective Actions 379

The Balanced Scorecard 381 Published Sources of Strategy-Evaluation Information 382 Characteristics of an Effective Evaluation System 383 Contingency Planning 384 Auditing 385 21st-Century Challenges in Strategic Management 386

The Art or Science Issue 386 ■ The Visible or Hidden Issue 386 ■ The Top-Down or Bottom-Up Approach 387

Special Note to Students 387 ASSURANCE OF LEARNING EXERCISES 390 Assurance of Learning Exercise 11 A: Evaluating BHP Billiton's Strategies 390 Assurance of Learning Exercise 11B: Preparing a Strategy-Evaluation Report for adidas AG 390 Assurance of Learning Exercise 11C: Preparing a Strategy-Evaluation Report for adidas AG 390 Assurance of Learning Exercise 11D: Evaluate My University's Strategies 390

Appendix 1 Guidelines for Case Analysis 393 What Is a Strategic-Management Case? 394 Guidelines for Preparing Case Analyses 394

The Need for Practicality 394 ■ The Need for Justification 394 ■ The Need for Realism 394 ■ The Need for Specificity 394 ■ The Need for Originality 395 ■ The Need to Contribute 395

Preparing a Case for Class Discussion 395 The Case Method versus Lecture Approach 395

The Cross-Examination 396 Preparing a Written Case Analysis 396

The Executive Summary 396 ■ The Comprehensive Written Analysis 396 ■ Steps in Preparing a Comprehensive Written Analysis 397

Making an Oral Presentation 397 Organizing the Presentation 397 ■ Controlling Your Voice 398 ■ Managing Body Language 398 ■ Speaking from Notes 398 ■ Constructing Visual Aids 398 ■ Answering Questions 398

Tips for Success in Case Analysis 399 Content Tips 399 ■ Process Tips 400 ■ Sample Case Analysis Outline 400 STEPS IN PRESENTING AN ORAL CASE ANALYSIS 401 Oral Presentation— Step 1: Introduction (2 minutes) 401 Oral Presentation—Step 2: Mission and Vision (4 minutes) 401 Oral Presentation—Step 3: Internal Assessment (8 minutes) 401 Oral Presentation—Step 4: External Assessment (8 minutes) 402 Oral Presentation—Step 5: Strategy Formulation (14 minutes) 402 Oral Presentation—Step 6: Strategy Implementation (8 minutes) 402 Oral Presentation—Step 7: Strategy Evaluation (2 minutes) 403 Oral Presentation—Step 8: Conclusion (4 minutes) 403

Glossary 662

Name Index 673

Subject Index 677

Cases Service Firms

1ẻ Ryanair 406 2. The Emirates Group 418

3. UPS 427 4. Amazon 438

5ế Netflix 450

6. Gap 462 7. Walt Disney 474 8. Staples Inc. 484

9. Office Depot Inc. 496 10. Domino's Pizza Inc. 505 11 ề Royal Caribbean Cruises 515

12. Carnival Corp. 524 13. JPMorgan Chase & Co. 535

Manufacturing Firms

14. Proctor and Gamble 546

15. Avon Products Inc. 556

16. Revlon 564

17. L'Oréal 575

18. Dr Pepper Snapple Group 583

19. The Coca-Cola Company 593

20. Starbucks 602

21. Pearson PLC 610

22. BMW 619

23ế Apple 626

24. Microsoft Corp. 636

25. Lenovo 645

26. Netgear 654

11

Welcome Forest, and Thank You:

• For joining me as a coauthor on this 15th edition • For preparing the Case Instructor's Manual for this textbook and five previous editions • For publishing many strategic management papers and articles with me and other authors • For your wise strategic-management counsel over many years as this textbook has evolved • For assisting students for many years through the Strategy Club (www.strategyclub.com) that now also

offers your free Excel Student Template • For developing an outstanding Case MyLab testing feature for this edition • For preparing the Chapter Instructor's Manual for this edition

Preface

Why Adopt This Text? This textbook is trusted around the world to provide managers the latest skills and concepts needed to effectively formulate and efficiently implement a strategic plan— a game plan, if you will— that can lead to sustainable competitive advantage for any type of business. The Association to Advance Collegiate Schools of Business (AACSB) increasingly advocates a more skills-oriented. practical approach in business books, which the David text provides, rather than a theory-based approach. This textbook meets all AACSB-International guidelines for the strategic-managcment course at both the graduate and undergraduate levels, and previ­ ous editions have been used at more than 500 colleges and universities around the world. We believe you will find this edition to be the best textbook available for communicating both the excitement and value of strategic management. Concise and exceptionally well orga­ nized. this text is now published in English. Chinese. Spanish, Thai. German, Japanese, Farsi, Indonesian, Indian, and Arabic. A version in Russian is being negotiated. Not only universi­ ties, but also hundreds of companies, organizations, and governmental bodies use this text as a management guide.

In contrast to many other strategic-management textbooks, the David book provides:

1. An effective process for developing a clear strategic plan, rather than simply presenting seminal theories in strategy, and

2. An effective model or flow for actually doing strategic planning.

Eric N. Sims, a professor w'ho in 2013 adopted the David book for his classes at Sonoma State University in California, says:

“I have read many strategy books. I am going to use the David book. What I like— to steal a line from Alabama coach Nick Saban— is your book teaches ‘a process.’ I believe at the end of your book, you can actually help a company do strategic planning. In contrast, the other books teach a number of near and far concepts related to strategy.”

A recent reviewer of this textbook says:

“One thing I admire most about the David text is that it follows the fundamental sequence of strategy formulation, implementation, and evaluation. There is a basic flow from vision/ mission to internal/external environmental scanning, to strategy development, selection, implementation, and evaluation. This has been, and continues to be, a hallmark of the David text. Many other strategy texts are more disjointed in their presentation, and thus confusing to the student, especially at the undergraduate level.”

New Chapter Features 1. The fifteenth edition is 40 percent new and improved from the prior edition. 2. Chapter 2, Outside-USA Strategic Planning, is expanded 30 percent with new coverage of

cultural and conceptual strategic-management differences across countries. Doing business globally has become a necessity in most industries. Nearly all strategic decisions today are affected by global issues and concerns.

3. Chapter 3, Ethics/Social Responsibility/Sustainability, is expanded 30 percent, provid­ ing extensive new coverage of ethics, workplace romance, and sustainability. This text emphasizes that “good ethics is good business.” Unique to strategic-management texts, the sustainability discussion is strengthened in this edition to promote and encourage firms to conduct operations in an environmentally sound manner. Respect for the natural environment has become an important concern for consumers, companies, society, and AACSB-International.

15

16 PREFACE

4. An updated Cohesion Case on adidas AG is provided, adidas is one of the most suc­ cessful, well-known, and best-managed global companies in the world. Students apply strategy concepts to adidas at the end of each chapter through brand new Assurance of Learning Exercises.

5. New or improved Assurance of Learning Exercises appear at the end of all chapters to apply chapter concepts. The exercises prepare students for strategic-management case analysis.

6. A new boxed insert at the beginning of each chapter showcases a company doing strategic management exceptionally well.

7. There are all new examples in all the chapters. 8. There is new narrative on strategic-management theory and concepts in every chapter. 9. On average, 10 new review questions are provided at the end of each chapter.

10. New color photographs bring this new edition to life and illustrate “the practice of strategic management.”

11. All current readings at the end of all chapters are new, as new research and theories of sem­ inal thinkers arc included. However, practical aspects of strategic management are center stage and the trademark of this text.

12. For the first time ever, the Excel Student Template is provided free at www.strategyclub. com to all students who use this textbook. Widely used for more than a decade by both students and businesses, and improved dramatically just for this edition, the free Excel Student Template enables students to more easily apply strategic-management concepts while engaging in assurance of learning exercises or case analysis. Using the Template, students can devote more time to applying strategy concepts and less time to the mechanics of formatting strategy matrices, tables, and PowerPoints.

13. Every sentence and paragraph has been scrutinized, modified, clarified, deleted, stream­ lined, updated, and improved to enhance the content and caliber of presentation.

New Case Features 1. All 26 cases are on student-friendly, well-known companies, thus exciting and effective for

applying strategy concepts; 2. All 26 cases are undisguised, featuring real organizations in real industries using real

names (nothing is fictitious in any case); 3. All 26 cases feature an organization and industry undergoing strategic change; 4. All 26 cases provide ample, excellent quantitative information, so students can prepare a

defensible strategic plan; 5. All 26 cases are written in a lively, concise writing style that captures the reader's

interest; 6. All 26 cases are “comprehensive,” focusing on multiple business functions, rather than a

single problem or issue; 7. All 26 cases include financial statements for the firm, so students can show the impact of a

proposed strategic plan; 8. All 26 cases provide an organizational chart and a vision and mission statement—

important strategy concepts; 9. Certain cases are supported by an excellent teacher’s note, provided to professors in a new

Case Instructor's Manual; 10. All 26 cases have been class-tested to ensure that they are interesting, challenging, and

effective for illustrating strategy concepts; 11. The 26 case companies provide an excellent mix of firms performing really well and some

performing very poorly, including service-based and manufacturing-based firms, and a good mix of small cap to large cap firms.

12. All 26 case companies have excellent websites in English that provide detailed financial information, history, sustainability statements, ethics statements, and press releases, so students can easily access current information to apply strategy concepts.

PREFACE 17

13. Certain cases are written by the authors, to ensure maximum control and effectiveness in applying strategic-management concepts through case analysis.

14. A Case MyLab testing feature (for 12 cases) has been carefully developed and designed specifically to apply strategic-management concepts through case analysis. The Case MyLab product assures that the cases apply the concepts, simplifies grading for professors, and achieves AACSB’s key assurance of learning objectives— even in purely or partly on­ line class settings. The new Case MyLab testing feature enables professors to use the cases to monitor student learning of strategy concepts, as revealed in the Concepts by Cases Matrix given below.

Time-Tested Features 1. This text meets all AACSB-International guidelines that support a practitioner orientation

rather than a theory/research approach. This text offers a skills-oriented process for devel­ oping a vision and mission statement; performing an external audit; conducting an internal assessment; and formulating, implementing, and evaluating strategies.

2. The author’s writing style is concise, conversational, interesting, logical, lively, and supported by numerous current examples.

3. A simple, integrative strategic-management model appears in all chapters and on the inside front cover. The model is widely used by strategic planning consultants and companies worldwide.

4. An exciting, updated Cohesion Case on adidas AG follows Chapter 1 and is revisited at the end of each chapter, allowing students to apply strategic-management concepts and tech­ niques to a real company as chapter material is covered, thus preparing students for case analysis as the course evolves.

5. End-of-chapter Assurance of Learning Exercises apply chapter concepts and techniques in a challenging, meaningful, and enjoyable manner.

6. There is excellent pedagogy, including learning objectives opening each chapter and key terms, current readings, discussion questions, and assurance of learning exercises ending each chapter.

7. There is excellent coverage of strategy formulation issues, such as business ethics, global versus domestic operations, vision and mission, matrix analysis, partnering, joint ventur­ ing, competitive analysis, value chain analysis, governance, and matrices for assimilating and evaluating information.

8. There is excellent coverage of strategy implementation issues such as corporate cul­ ture, organizational structure, outsourcing, marketing concepts, financial analysis, business ethics, whistleblowing, bribery, pay and performance linkages, and workplace romance.

9. A systematic, analytical “process” is presented that includes nine matrices; 1FEM, EFEM, CPM. SWOT, BCG, IE, GRAND. SPACE, and QSPM.

10. Both the chapter material and case material is published in four colors. 11. For the chapter material, an outstanding ancillary package includes a comprehensive

Instructor’s Manual, Test Bank, TestGen, and Chapter PowerPoints.

Instructor Supplements At www.pearsonglobaleditions.com /david, instructors can access a variety of resources that accompany this new edition. Registration is easy, please contact your Pearson Sales Representative who will provide you with the access information you need.

If you ever need assistance, our dedicated technical support team is ready to help with the media supplements that accompany this text. Visit http://247.pearsoned.coni/ for answers to frequently asked questions and toll-free user support phone numbers.

18 PREFACE

The following supplements are available to adopting instructors:

• Chapter Instructor's Manual • Case Instructor’s Manual • Chapter PowerPoints • Test Bank • TestGen

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20 PREFACE

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Mid-America Christian

Millersville University

Mississippi University for Women

Morgan State University

Morrison College of Reno

Mount Marty College— South Dakota

Mount Mercy University Mount Wachusett Community College Mt. Hood Community College

Ml. Vernon Nazarene MTI Western Business College

Muhlenberg College Murray State University

New England College

New Mexico State University

New York University North Carolina Wesleyan College

North Central College

North Central State College

Northwest Arkansas Community College

Northwestern College

Northwood University— Cedar Hill

Notre Dame of Maryland University

Nyack College

Oakland University

Ohio Dominican University

Oklahoma Christian University

Oklahoma State University

Olivet College Oral Roberts University

Pace University— Pleasantville

Park University

Penn State University— Abington

Penn State University— Hazleton

Pensacola State College

Philadelphia University

Point Park University Prince George's Community College

Queens College of CUNY

Richard Stockton University

Rider University

Roger Williams University

Saint Edwards University

Saint Leo University

Saint Mary’s College

Saint Mary’s College— Indiana

Saint Xavier University

San Antonio College

Santa Fe College Savannah State University

PREFACE 23

Shippcnsburg University

Siena Heights University

Southern Nazarene University

Southern New Hampshire University

Southern Oregon University

Southern University— Baton Rouge

Southern Wesleyan University

Southwest Baptist University

Southwest University

St. Bonaventure University

St. Francis University St. Louis University

St. Martins University Sterling College

Stevenson University

Slraycr University— DC Texas A&M University— Commerce Texas A&M University—Texarkana

Texas A&M— San Antonio

Texas Tech University

The College of St. Rose The Masters College

Tri-County Technical College

Trinity Christian College

Troy State University

Troy University— Dothan

Troy University— Main Campus

Troy University—Montgomery

University Alabama— Birmingham

University Maryland— College Park University of Arkansas— Fayetteville

University of Findlay University of Houston—Clearlake

University of Louisiana at Monroe

University of Maine at Augusta

University of Maine— Fort Kent

University of Maryland

University of Massachusetts— Boston Harbor University of Massachusetts— Dartmouth

University of Miami

University of Michigan— Flint

University of Minnesota— Crookston

University of Mobile

University of Montevallo

University of Nebraska— Omaha

University of Nevada Las Vegas

PREFACE

University of New Orleans

University of North Texas

University of North Texas— Dallas

University of Pikeville

University of Sioux Falls

University of South Florida

University of St. Joseph

University of Tampa

University of Texas—Pan American

University of The Incarnate Word

University of Toledo

Upper Iowa University

Valley City State University

Virginia Community College System

Virginia State University

Virginia Tech

Wagner College

Wake Forest University

Washington University

Webber International University

Webster University

West Chester University

West Liberty University

West Valley College

West Virginia Wesleyan College

Western Connecticut State University

Western Kentucky University

Western Michigan University

Western Washington University

William Jewell College

W'illiams Baptist College

Winona State University

Winston-Salem State University

WSU Vancouver

Sample of Countries Outside the USA Where This Textbook is Very Widely Used Mexico, China, Japan, Australia, Singapore, Canada. Indonesia, Pakistan, Iran. Kenya, Congo. Hong Kong, India, England, Argentina, Equador, Zambia, Guam, Italy, Cyprus, Colombia, Philippines, South Africa, Peru. Turkey, Malaysia, and Egypt

Acknowledgments

Many persons have contributed time, energy, ideas, and suggestions for improving this text over 15 editions. The strength of this text is largely attributed to the collective wisdom, work, and experiences of strategic-management professors, researchers, students, and practitioners. Names of particular individuals whose published research is referenced in this edition are listed alphabetically in the Name Index. To all individuals involved in making this text so popular and successful, we are indebted and thankful.

Many special persons and reviewers contributed valuable material and suggestions for this edition. We would like to thank our colleagues and friends at Auburn University. Mississippi State University, East Carolina University, the University of South Carolina, Campbell University, the University of North Carolina at Pembroke, and Francis Marion University. We have taught strategic management at all these universities. Scores of students and professors at these schools helped shape the development of this text. Many thanks go to the following reviewers whose comments shaped the fourteenth and fifteenth editions:

Moses Acquaah, University of North Carolina at Greensboro Gary L. Arbogast, Glenville State College

Charles M. Byles. Virginia Commonwealth University Charles J. Capps III. Sam Houston State University

Neil Dworkin, Western Connecticut State University

Jacalyn M. Florn. University of Toledo

John Frankenstein. Brooklyn College/City University of New York

Bill W. Godair, Landmark College, Community College of Vermont

Carol Jacobson, Purdue University

Susan M. Jensen, University of Nebraska at Kearney

Dmitry Khanin, California State University at Fullerton

Thomas E. Kulik, Washington University at St. Louis

Jerrold K. Leong, Oklahoma State University

Trina Lynch-Jackson, Indiana University

Elouise Mintz, Saint Louis University

Raza Mir, William Paterson University

Gerry N. Muuka, Murray State University

Braimoh Oseghale, Fairleigh Dickinson University

Lori Radulovich, Baldwin-W'allace College

Thomas W. Sharkey, University of Toledo

Frederick J. Slack, Indiana University of Pennsylvania Daniel Slater, Union University

Demetri Tsanacas, Ferrum College

Jill Lynn Vihtelic, Saint M ary’s College

Michael W. Wakefield, Colorado State University-Pueblo Don Wicker, Brazosport College

We want to thank you, the reader, for investing the time and effort to read and study this text. It will help you formulate, implement, and evaluate strategies for any organization with which you become associated. We hope you come to share our enthusiasm for the rich subject area of strategic management and for the systematic learning approach taken in this text. We want

ACKNOW LEDGM ENTS

to welcome and invite your suggestions, ideas, thoughts, comments, and questions regarding any part of this text or the ancillary materials. Please contact Dr. Fred R. David at the following e-mail [email protected], or write him at the School of Business, Francis Marion University, Florence, SC 29501. We sincerely appreciate and need your input to continually improve this text in future editions. Your willingness to draw my attention to specific errors or deficiencies in coverage or exposition will especially be appreciated.

Thank you for using this text. Fred R. David and Forest R. David

Pearson would also like to thank and acknowledge Ivan Ninov, The Emirates Academy of Hospitality Management, and Aykut Arslan, Haliç Üniversitesi, for reviewing the Global Edition.

About the Authors

Fred R. and Forest R. David, a father-son team, have published more than 50 journal articles in outlets such as Academy o f Management Review, Academy o f Management Executive, Journal o f Applied Psychology, Long Range Planning, International Journal o f Management, Journal o f Business Strategy, and Advanced Management Journal. Fred and Forest’s February 2011 Business Horizons article titled “What are Business Schools Doing for Business Today?” is changing the way many business schools view their curricula.

Fred and Forest are coauthors of Strategic Management: Concepts and Cases that has been on a two-year revision cycle since 1986 when the first edi­ tion was published. This text is among the best-selling strategic-management textbooks in the world. This text has led the field of strategic management for more than two decades in providing an applications, practitioner-approach to the discipline. More than 500 colleges and universities have used this textbook Fred R. David over the years, including Harvard University, Duke University, Carnegie- Mellon University, Johns Hopkins University, the University of Maryland, University of North Carolina, University of Georgia, San Francisco State University, University of South Carolina, Wake Forest University, and count­ less universities in Japan, China, Australia, Mexico, and the Middle East. For six editions of this book. Forest has been sole author of the Case Instructor's Manual, having developed extensive teachers’ notes (solutions) for all the cases. Forest is author of the Case MyLab ancillary and the free Excel Student Template that accompany this fifteenth edition.

Fred and Forest actively assist businesses globally in doing strategic planning. They have written and published more than 100 strategic manage­ ment cases. Fred and Forest were recently keynote speakers at the Pearson International Forum in Monterrey. Mexico. With a PhD in Management from the University of South Carolina. Fred is the TranSouth Professor of Strategic Planning at Francis Marion University (FMU) in Florence, South Carolina. Forest has taught strategic-management courses at Mississippi State University, Campbell University, and FMU.

Forest R. David

27

The Case Rationale Case analysis remains the primary learning vehicle used in most strategic-management classes, for five important reasons:

1. Analyzing cases gives students the opportunity to work in teams to evaluate the internal operations and external issues facing various organizations and to craft strategies that can lead these firms to success. Working in teams gives students practical experience solving problems as part of a group. In the business world, important decisions are generally made within groups; strategic-management students learn to deal with overly aggressive group members and also timid, noncontributing group members. This experience is valuable because strategic-management students are near graduation and soon enter the working world full-time.

2. Analyzing cases enables students to improve their oral and written communication skills as well as their analytical and interpersonal skills by proposing and defending particular courses of action for the case companies.

3. Analyzing cases allows students to view a company, its competitors, and its industry con­ currently, thus simulating the complex business world. Through case analysis, students learn how to apply concepts, evaluate situations, formulate strategies, and resolve imple­ mentation problems.

4 . Analyzing cases allows students to apply concepts learned in many business courses. Students gain experience dealing with a wide range of organizational problems that impact all the business functions.

5. Analyzing cases gives students practice in applying concepts, evaluating situations, formu­ lating a “game plan,” and resolving implementation problems in a variety of business and industry settings.

Case MyLab Testing Feature New to this edition is an enhanced MyLab with some new cases that include gradeable outcomes. This feature assures that the cases are excellent for testing student learning of the key strategic-management concepts, thus serving as a great mechanism for professors to achieve AACSB's Assurance of Learning Objectives. This new testing feature simplifies grading for professors in both traditional and online class settings.

The Case MyLab testing feature includes multiple choice questions for some of the cases, comprised of Basic questions that simply test whether the student read the case before class, and Applied questions that test the student’s ability to apply various strategic-management concepts. In addition, there arc Discussion questions per case. This testing feature enables professors to determine, before class if desired, whether students 1) read the case in Basic terms, and/or 2) are able to Apply strategy concepts to resolve issues in the case. For example, the MyLab case Basic question may be: In what country is BMW headquartered? Whereas, a MyLab case Applied question may be: What are three aspects of the organizational chart given in the BMW case that violate strategic-management guidelines? The Answers to these questions can be found in the Case Instructor's Manual.

30 CONCEPTS BY CASES MATRIX

Case Information Matrix

Case Company Stock Symbol Headquarters URL

Number of Employees

Financials (US$, millions)

Case Year

Profit Revenue %

C o h e s io n C a s e adidas Group ADS Her/.ogenaurach. Germany www.adidas.com 46,300 1,599 19,558 8.2' 2013

S e rv ice F ir m s Ryanair Holdings, pic RYAAY Dublin, Ireland www.ryanair.ie 7,200 413 4,043 10.2 2011

The Emirates Group n/a Garhoud. Dubai. UAE www.theemiratesgroup.com 67,000 986 20,934 4.7" 2013

United Parcel Service, Inc. UPS Atlanta. GA. USA www.ups.com 399,000 869 12.124 7.2 2013

Amazon.com, Inc. AMZN Seattle, WA, USA ww w.amazon .com 33,700 1,152 34.204 3.3 2011

Netflix. Inc. NFLX Los Gatos, CA, USA www.netflix.com 2,500 160 2,162 7.4 2011

Gap Inc. GPS San Fransisco, CA. USA www.gapinc.com 135,000 1,102 14.197 7.7 2011

Walt Disney Company DIS Burbank, CA, USA www.disney.com 166.000 6,173 42,278 14.6 2013

Staples, Inc. SPLS Farmingham, MA. USA www.staples.com 54,100 881 25,545 3.4 2011

Office Depot Inc. ODP Boca Raton. FL, USA www.officcdepot.com 41,000 34 11.633 0.3 2011

Domino’s Pizza, Inc. DPZ Ann Arbor. MI. USA www.dominos.com 10,000 112 1,678 6.7 2013

Royal Caribbean RCL Miami, FL. USA www.royalcaribbean.com 57,000 547 6,752 8.1 2011 Cruises Ltd.

Carnival Corporation CCL Miami, FL, USA www.carnivalcorp.com 85,200 1,978 14.469 13.6 2011 & pic

J PM organ Chase & Co. JPM New York, NY, USA www.jpmorganchase.com 240.000 21,284 97,031 21.9 2013

CONCEPTS BY CASES MATRIX 31

Case Company Stock Symbol Headquarters URL

Number of Employees

Financials (US$, millions)

Case Year

Profit Revenue %

M a n u f a c t u r in g F ir m s Proctor & Gamble Company

PC. Cincinnati. OH. USA www.pg.com 127,(XX) 12,736 78,938 16.1 2011

Avon Products, Inc. AVP New York, NY, USA www.avoncompany.coni 39,100 314 10,717 2.9 2013 Revlon. Inc. REV New York, NY, USA www.revlon.com 4,800 327 1,321 24.7 2011 L’Oreal SA LRLCF Clichy. France www.loreal.com 72,600 2.867 22,462 12.8 2013 Dr Pepper Snapple Group Inc.

DPS Plano, TX, USA www'.drpeppersnapple.com 19,000 528 5.636 9.4 2011

Coca-Cola Company KO Atlanta. GA, USA www.coca-colacompany.com 5,200 38 1.442 4.3 2011 Starbucks Corporation SBUX Seattle, WA, USA www.starbucks.com 137,000 945 10,707 8.8 2011 Pearson PLC PSORF London. UK www.pearson.com 37.000 824 8,094 10.2"* 2013 Bayerische Motoren Werke (BMW) Group

BMW Munich, Germany www.bmwgroup.com 105.000 4.226 79,386 5.3’ 2013

Apple, Inc. AAPL Cupertino, CA, USA www.apple.com 46.600 14,013 65,225 21.5 2011 Microsoft Corporation MSFT Redmond, WA, USA www'.microsoft.com 94.000 16,978 73,723 23.0 2013 Lenovo Group Limited LNVGY Beijing, China w'w'w.lenovo.com 27,000 631 33,873 1.9 2013 Netgcar. Inc. NTGR San Jose, CA, USA www.netgear.com 850 86 1,271 6.8 2013

'Originally reported in EUR - converted at rate of 1EUR = 1.35USD "Originully reported in AED - converted at rate of 1AED = 0.27USD "'Originally reported in GBP - converted at rate of 1GBP = 1.6USD

32 CONCEPTS BY CASES MATRIX

Topical Content Areas

1 2 3 4 5 6 7 8 9 10 11 12 13 14

C o h e s io n C a s e

adidas Group Y N Y Y N Y N N Y Y N N Y Y

S e r v ic e F ir m s

Ryanair Y Y Y Y Y Y Y Y Y Y Y N Y Y

The Emirates Group Y Y Y Y N N N N Y N N N Y Y

UPS Y Y Y Y Y Y Y Y Y N Y Y N N

Amazon Y Y Y Y Y Y Y Y Y N N Y N N

Netflix Y Y Y N Y Y Y Y Y N N Y N N

Gap Y Y Y N Y Y Y Y Y N N Y N N

Walt Disney Y Y Y Y N N N Y Y N N N Y N

Staples Inc. Y Y Y Y Y Y Y Y Y N N N Y N

Office Depot Inc. Y Y Y Y Y Y Y Y Y Y Y N Y N

Domino’s Pizza Inc. Y Y Y Y Y N N N Y N N Y N N

Royal Caribbean Cruises Y Y Y Y Y Y Y Y Y N N Y N N

Carnival Corp. Y Y Y Y Y Y Y Y Y N N Y N N

JPMorgan Chase & Co. Y Y Y Y Y N Y Y Y Y N Y N N

CONCEPTS BY CASES MATRIX 33

M a n u f a c t u r in g F ir m s

Proctor and Gamble Y Y Y Y Y N Y Y Y N Y N Y N

Avon Products Inc. Y Y Y Y N Y N N Y Y Y Y N N

Revlon Y Y Y Y N N Y Y Y N N N Y N

L’Ore'al Y Y Y N N Y N N Y N N Y N Y

Dr Pepper Snapple Group Y Y Y N Y Y Y Y Y N Y N Y N

The Coca-Cola Company Y Y Y Y Y Y Y Y Y N N Y N N

Starbucks Y Y Y Y Y Y Y Y Y N N N Y N

Pearson PLC Y Y Y N N N N Y Y N Y Y N Y

BMW Y Y Y N N N N N Y N N Y N Y

Apple Y Y Y Y Y N N Y Y N N N Y N

Microsoft Corp. Y Y Y Y N N N N Y N Y Y N N

Lenovo Y Y Y N Y N Y Y Y N N Y N Y

Netgear Y Y Y N N N N N Y N Y Y N N

1. Financial Statements Provided? 2. Organizational Chart Provided? 3. Does Company Do Business Outside the United States? 4. Is a Vision or Mission Statement Provided? 5. Business Ethics Issues Included? 6. Sustainability Issues Included? 7. Strategy Formulation Emphasis? 8. Strategy Implementation Emphasis? 9. By-Segment Financial Data Included?

10. Firm Has Declining Revenues? 11. Firm Has Declining Net Income? 12. Case Company Appears in Text for First Time? 13. Case Company Appeared in Prior Edition and Updated Now? 14. Firm Headquartered Outside the United States?

STRATEGIC MANAGEMENT ’ Concepts and Cases A COM PETITIVE ADVANTAGE APPRO ACH

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MyManagementLab® Improve Your Grade! Over 10 million students improved their results using the Pearson MyLabs. Visit m ym anag em entlab .co m for simulations, tutorials, and end-of-chapter problems.

36

Strategie Management Essentials C H A P T E R O B J E C T IV E S After studying this chapter, you should be able to do the following:

1. Discuss the nature and role of a chief strategy officer (CSO). 2. Describe the strategic-management process. 3. Explain the need for integrating analysis and intuition in strategic management. 4 . Define and give examples of key terms in strategic management. 5. Discuss the nature of strategy formulation, implementation, and evaluation

activities.

6. Describe the benefits of good strategic management.

7. Discuss the relevance of Sun Tzu's The Art of War to strategic management. 8. Discuss how a firm may achieve sustained competitive advantage.

A S S U R A N C E O F L E A R N IN G EXERCISES The following exercises are found at the end of this chapter.

Assess Singapore Airline’s Most Recent Quarterly Performance Data

Gathering Strategy Information on adidas AG

Getting Familiar with the Free Excel Student Template Evaluating An Oral Student Presentation

Strategic Planning at Nestle

Interviewing Local Strategists

EX ER C ISE 1A

EX ER C ISE 1B

EX ER C ISE 1C

EX ER C ISE 1 D

EX ER C ISE 1 E

EX ER C ISE 1F

38 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

When CEOs from the big three U.S. automakers— Ford, General Motors (GM), and Chrysler—showed up a few years ago without a clear strategic plan to ask congressional leaders for bailout monies, they were sent home w'ith instructions to develop a clear strategic plan for the future. Austan Goolsbce, one of President Barack Obama’s

top economic advisers, said, “Asking for a bailout without a convincing business plan was crazy.” Goolsbee also said, “If the three auto CEOs need a bridge, it’s got to be a bridge to somewhere, not a bridge to nowhere.” 1 This textbook gives the instructions on how to develop a clear strategic plan—a bridge to somewhere rather than nowhere.

This chapter provides an overview of strategic management. It introduces a practical, integrative model of the strategic-management process; it defines basic activities and terms in strategic management.

This chapter also introduces the notion of boxed inserts. A boxed insert at the beginning of each chapter reveals how' some firms are doing really well competing in a growing economy. The firms showcased are utilizing excellent strategic management to prosper as their rivals weaken. Each boxed insert examines the strategics of firms doing great amid rising consumer demand and intense price competition. The first company featured for excellent performance is the 5-star airline— Singapore Airlines Limited (SIA).

adidas AG is featured as the new Cohesion Case because it is a well-known global firm undergoing strategic change and is well managed. By working through the adidas AG-related Assurance of Learning Exercises at the end of each chapter, you will be well prepared to develop an effective strategic plan for any company assigned to you this semester. The end- of-chapter exercises apply chapter tools and concepts.

EXCELLENT STRATEGIC MANAGEMENT SHOWCASED

Singapore Airlines Singapore Airlines Limited (SIA) is the 5-star airline of Singapore. Singapore Airlines operates trans-Pacific flights, including the world's longest non-stop commercial flights from Singapore to Los Angeles and Newark on the Airbus A340-500. In late 2013, the company ceased offering those two long flights although Los Angeles is still served via Tokyo-Narita. The luxury airline has a strong presence in Asia. A mem­ ber of the Star Alliance, Singapore Airlines carried around 18 million passengers in 2012, up from 16.9 million in 2011.

Singapore Airlines is very well managed strategically. The company has diversified airline-related businesses, such as aircraft handling and engineering, and owns SilkAir that manages regional flights to secondary cities with smaller capacity requirements. Singapore Airlines operates passenger sen/ices to more than 60 cities in over 30 countries around the world. Within Asia, passengers can connect to over 30 cities served by SilkAir. The company is the official sponsor of Singapore national football team and has been marketing Singapore Girl as central image to the airline's brand. Fortune in 2013 ranked Singapore Airlines as the 31st most admired company in the world outside the United States. In December 2012, Singapore Airlines sold its 49 percent stake in Virgin Atlantic for US$360 million.

In April 2012, Singapore Airlines phased out the 747 from its fleet after 40 years of service. A final round-trip commemorative flight was operated from Singapore to Hong Kong. In December 2012, Singapore Airlines began using the A380 to San Francisco via Hong Kong as a win­ ter seasonal service, but still uses a Boeing 777-300ER for the remainder

of the year. In May 2013, S i n g a p o r e Airlines made a commitment to order 30 Boeing 787-1 OX to be delivered in 2018-2019 timeframe. In September 2013, Singapore Airlines began using the Airbus A380 on selected flights to and from Shanghai, China.

Singapore Airlines' passenger carriage (measured in revenue pas­ senger kilometers) grew 8.6 percent in August 2013 year-on-year along with a 3.1 percent increase in capacity (measured in available seat kilometers). The company's passenger load factor (PLF) improved by 4.1 percentage points to 82.4 percent as the number of passengers carried in August 2013 increased by 11.7 percent to 1.7 million. Load factors improved across all regions, bolstered by strong leisure travel demand during the Lebaran/Hari Raya holidays, coupled with returning summer traffic. Traffic to West Asia and Africa also saw improvements.

SilkAir's systemwide passenger carriage in August 2013 increased 10.7 percent year-on-year along with a 13.4 percent growth in capacity. For that month, SilkAir's PLF was 1.8 percentage points lower at 71.7 percent. Singapore Airlines' cargo traffic (measured in freight- tonne-kilometres) was 5.7 percent lower in August 2013 year-on-year, while cargo capacity was reduced by 5.0 percent.

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 39

What Is Strategic Management? Once there were two company presidents who competed in the same industry. These two presidents decided to go on a camping trip to discuss a possible merger. They hiked deep into the woods. Suddenly, they came upon a grizzly bear that rose up on its hind legs and snarled. Instantly, the first president took off his knapsack and got out a pair of jogging shoes. The second president said, “Hey. you can’t outrun that bear.” The first president responded, “Maybe I can’t outrun that bear, but I surely can outrun you!” This story captures the notion of strategic management, which is to achieve and maintain competitive advantage.

Defining Strategic Management Strategic management can be defined as the art and science of formulating, implementing, and evaluating cross-functional decisions that enable an organization to achieve its objectives. As this definition implies, strategic management focuses on integrating management, marketing, finance and accounting, production and operations, research and development, and information systems to achieve organizational success. The term strategic management in this text is used synonymously with the term strategic planning. The latter term is more often used in the business world, whereas the former is often used in academia. Sometimes the term strategic management is used to refer to strategy formulation, implementation, and evaluation and strategic planning referring only to strategy formulation. The purpose of strategic management is to exploit and create new and different opportunities for tomorrow; long-range planning, in contrast, tries to optimize for tomorrow the trends of today.

The term strategic planning originated in the 1950s and was popular between the mid-1960s and the mid-1970s. During these years, strategic planning was widely believed to be the answer for all problems. At the time, much of corporate America was “obsessed” with strate­ gic planning. Following that boom, however, strategic planning was cast aside during the 1980s as various planning models did not yield higher returns. The 1990s, however, brought the revival of strategic planning, and the process is widely practiced today in the business world. Many companies today have a chief strategy officer (CSO).

A strategic plan is, in essence, a company’s game plan. Just as a football team needs a good game plan to have a chance for success, a company must have a good strategic plan to compete successfully. Profit margins among firms in most industries are so slim that there is little room for error in the overall strategic plan. A strategic plan results from tough managerial choices among numerous good alternatives, and it signals commitment to specific markets, policies, procedures, and operations in lieu of other, “less desirable” courses of action.

The term strategic management is used at many colleges and universities as the title for the capstone course in business administration. This course integrates material from all business courses, and, in addition, introduces new strategic management concepts and techniques being widely used by firms in strategic planning.

Stages of Strategic Management The strategic-management process consists o f three stages: strategy formulation, strategy implementation, and strategy evaluation. Strategy formulation includes developing a vision and mission, identifying an organization’s external opportunities and threats, determining internal strengths and weaknesses, establishing long-term objectives, generating alternative strategies, and choosing particular strategies to pursue. Strategy-formulation issues include deciding what new businesses to enter, what businesses to abandon, whether to expand operations or diversify, whether to enter international markets, whether to merge or form a joint venture, and how to avoid a hostile takeover.

Because no organization has unlimited resources, strategists must decide which alternative strategies will benefit the firm most. Strategy-formulation decisions commit an organization to specific products, markets, resources, and technologies over an extended period of time. Strategies determine long-term competitive advantages. For better or worse, strategic decisions have major multifunctional consequences and enduring effects on an organization. Top managers have the best perspective to understand fully the ramifications of strategy-formulation decisions; they have the authority to commit the resources necessary for implementation.

40 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

Strategy implementation requires a firm to establish annual objectives, devise policies, motivate employees, and allocate resources so that formulated strategies can be executed. Strategy implementation includes developing a strategy-supportive culture, creating an effective organizational structure, redirecting marketing efforts, preparing budgets, developing and using information systems, and linking employee compensation to organizational performance.

Strategy implementation often is called the “action stage” of strategic management. Implementing strategy means mobilizing employees and managers to put formulated strategies into action. Often considered to be the most difficult stage in strategic management, strategy implementation requires personal discipline, commitment, and sacrifice. Successful strategy implementation hinges on managers’ ability to motivate employees, which is more an arL than a science. Strategies formulated but not implemented serve no useful purpose.

Interpersonal skills are especially critical for successful strategy implementation. Strategy-implementation activities affect all employees and managers in an organization. Every division and department must decide on answers to questions such as “What must we do to implement our part of the organization’s strategy?” and “How best can we get the job done?” The challenge of implementation is to stimulate managers and employees throughout an organization to work with pride and enthusiasm toward achieving stated objectives.

Strategy evaluation is the final stage in strategic management. Managers desperately need to know when particular strategies are not working well: strategy evaluation is the primary means for obtaining this information. All strategies are subject to future modification because external and internal factors are constantly changing. Three fundamental strategy-evaluation activities are (1) reviewing external and internal factors that are the bases for current strategies, (2) measuring performance, and (3) taking corrective actions. Strategy evaluation is needed because success today is no guarantee of success tomorrow! Success always creates new and different problems; complaccnt organizations experience demise.

Formulation, implementation, and evaluation of strategy activities occur at three hierarchical levels in a large organization: corporate, divisional or strategic business unit, and functional. By fostering communication and interaction among managers and employees across hierarchical levels, strategic management helps a firm function as a competitive team. Most small businesses and some large businesses do not have divisions or strategic business units; they have only the corporate and functional levels. Nevertheless, managers and employees at these two levels should be actively involved in strategic-management activities.

Peter Drucker says the prime task of strategic management is thinking through the overall mission of a business:

that is, of asking the question, “What is our business?” This leads to the setting of objectives, the development of strategies, and the making of today’s decisions for tomorrow’s results. This clearly must be done by a part of the organization that can see the entire business; that can balance objectives and the needs of today against the needs of tomorrow; and that can allocate resources of men and money to key results.“

Integrating Intuition and Analysis Edward Deming once said, “In God we trust. All others bring data.” The strategic-management process can be described as an objective, logical, systematic approach for making major decisions in an organization. It attempts to organize qualitative and quantitative information in a way that allows effective decisions to be made under conditions of uncertainty. Yet strategic management is not a pure science that lends itself to a nice, neat, one-two-three approach.

Based on past experiences, judgment, and feelings, most people recognize that intuition is essential to making good strategic decisions. Intuition is particularly useful for making decisions in situations of great uncertainty or little precedent. It is also helpful when highly interrelated variables exist or when it is necessary to choose from several plausible alternatives. Some managers and owners of businesses profess to have extraordinary abilities for using intuition alone in devising brilliant strategies. For example. Will Durant, who organized GM. was described by Alfred Sloan as “a man who would proceed on a course of action guided solely, as far as I could tell, by some intuitive flash of brilliance. He never felt obliged to make an engineering hunt for the facts. Yet at times, he was astoundingly correct in his judgment.”3 Albert Einstein acknowledged the importance of intuition when he said, “I believe in intuition

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 41

and inspiration. At times I feel certain that I am right while not knowing the reason. Imagination is more important than knowledge, because knowledge is limited, whereas imagination embraces the entire world:'4

Although some organizations today may survive and prosper because they have intuitive geniuses managing them, most are not so fortunate. Most organizations can benefit from strategic management, which is based on integrating intuition and analysis in decision making. Choosing an intuitive or analytic approach to decision making is not an either-or proposition. Managers at all levels in an organization inject their intuition and judgment into strategic- management analyses. Analytical thinking and intuitive thinking complement each other.

Operating from the Tve-already-made-up-my-mind-don't-bother-me-with-the-facts mode is not management by intuition; it is management by ignorance.'5 Drucker says, “I believe in intuition only if you discipline it. 'Hunch’ artists, who make a diagnosis but don’t check it out with the facts, are the ones in medicine who kill people, and in management kill businesses.’’6 As Henderson notes:

The accelerating rate of change today is producing a business world in which customary managerial habits in organizations are increasingly inadequate. Experience alone was an adequate guide when changes could be made in small increments. But intuitive and experience-based management philosophies are grossly inadequate when decisions are strategic and have major, irreversible consequences.7

In a sense, the strategic-management process is an attempt to duplicate what goes on in the mind of a brilliant, intuitive person who knows the business and assimilates and integrates that knowledge using analysis to formulate effective strategies.

Adapting to Change The strategic-management process is based on the belief that organizations should continually monitor internal and external events and trends so that timely changes can be made as needed. The rate and magnitude of changes that affect organizations are increasing dramatically, as evidenced by how the global economic recession caught so many firms by surprise. Firms, like organisms, must be “adept at adapting” or they will not survive.

One company trying hard to adapt is the Washington Post Company, best known as publisher of the Washington Post newspaper that has a circulation of 525.000 in the Washington, DC area. But the newspaper industry is in decline globally, so the Washington Post Company recently diversified by acquiring Celtic Healthcare, a provider of hospice and home health care facilities in Pennsylvania and Maryland. Treating patients at home instead of paying for hospital stays is a much faster growing industry than selling newspapers. The Washington Post Company also owns Kaplan, a well-known source of test preparation materials, and six TV stations.

To survive, all organizations must astutely identify and adapt to change. The strategic- management process is aimed at allowing organizations to adapt effectively to change over the long run. As Waterman has noted:

In today’s business environment, more than in any preceding era, the only constant is change. Successful organizations effectively manage change, continuously adapting their bureaucracies, strategies, systems, products, and cultures to survive the shocks and prosper from the forces that decimate the competition.8

On a political map, the boundaries between countries may be clear, but on a competitive map showing the real flow of financial and industrial activity, the boundaries have largely disappeared. The speedy flow of information has eaten away at national boundaries so that people worldwide readily see for themselves how other people live and work. We have become a borderless world with global citizens, global competitors, global customers, global suppliers, and global distributors! U.S. firms are challenged by large rival companies in many industries. For example, Samsung recently surpassed Apple and Lenovo surpassed HP and Dell in revenues.

The need to adapt to change leads organizations to key strategic-management questions, such as “What kind of business should we become?” “Are we in the right fteld(s)?” “Should we reshape our business?” “What new competitors are entering our industry?” “What strategies

42 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

should we pursue?” “How are our customers changing?” “Are new technologies being developed that could put us out of business?”

The Internet promotes endless comparison shopping, which thus enables consumers worldwide to band together to demand discounts. The Internet has transferred power from businesses to individuals. Buyers used to face big obstacles when attempting to get the best price and service, such as limited time and data to compare, but now consumers can quickly scan hundreds of vendor offerings. Both the number of people shopping online and the average amount they spend is increasing dramatically. Digital communication has become the name of the game in marketing. Consumers today are flocking to blogs, sending tweets, watching and posting videos on YouTube, and spending hours on Tumbler, Facebook, Reddit, Instagram, and Linkedln instead of watching television, listening to the radio, or reading newspapers, and magazines. Facebook and Myspace recently unveiled features that further marry these social sites to the wider Internet. Users on these social sites now can log on to many business shopping sites from their social site so their friends can see what items they have purchased on various shopping sites. Both of these social sites want their members to use their identities to manage all their online identities. Most traditional retailers have learned that their online sales can boost in-store sales if they use their websites to promote in-store promotions.

Key Terms in Strategic Management Before we further discuss strategic management, we should define nine key terms: competitive advantage, strategists, vision and mission statements, external opportunities and threats, internal strengths and weaknesses, long-term objectives, strategies, annual objectives, and policies.

Competitive Advantage Strategic management is all about gaining and maintaining competitive advantage. This term can be defined as “anything that a firm does especially well compared to rival firms.” When a firm can do something that rival firms cannot do or owns something that rival firms desire, that can represent a competitive advantage. For example, having ample cash on the firm’s balance sheet can provide a major competitive advantage. Some cash-rich firms are buying distressed rivals. Examples of cash- rich (cash as a percentage of total assets) companies today include Priceline.com (63%), Altera (80%), Franklin Resources (51%), Gilead Sciences (57%), and Lorillard (54%). Microsoft, Apple, and Samsung are cash rich, as is the Cohesion Case company, adidas AG.

Having less fixed assets than rival firms also can provide major competitive advantages. For example, Apple has no manufacturing facilities of its own, and rival Sony has 57 electronics factories. Apple relies exclusively on contract manufacturers for production of all of its products, whereas Sony owns its own plants. Less fixed assets has enabled Apple to remain financially lean with virtually no long-term debt. Sony, in contrast, has built up massive debt on its balance sheet.

CEO Paco Underhill of Envirosell says, “Where it used to be a polite war, it’s now a 21st-century bar fight, where everybody is competing with everyone else for the customers’ money.” Shoppers are “trading down,” so Nordstrom is taking customers from Neiman Marcus and Saks Fifth Avenue, TJ Maxx and Marshalls are taking customers from most other stores in the mall, and Family Dollar is taking revenues from Walmart.lj Getting and keeping competi­ tive advantage is essential for long-term success in an organization. In mass retailing, big-box companies such as Walmart. Best Buy, and Sears are losing competitive advantage to smaller stores, so there is a dramatic shift in mass retailing to becoming smaller. As customers shift more to online purchases, less brick and mortar is definitely better for sustaining competitive advantage in retailing. Walmart Express stores of less than 40.0(H) square feet each, rather than 185,000-square-foot Supercenters, and Office Depot’s new 5,000-square-foot stores are examples of smaller is better.

Normally, a firm can sustain a competitive advantage for only a certain period because of rival firms imitating and undermining that advantage. Thus, it is not adequate to simply obtain competitive advantage. A firm must strive to achieve sustained competitive advantage by (1) continually adapting to changes in external trends and events and internal capabilities, competencies, and resources; and by (2) effectively formulating, implementing, and evaluating strategies that capitalize on those factors.

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 43

An increasing number of companies are gaining a competitive advantage by using the Internet for direct selling and for communication with suppliers, customers, creditors, partners, shareholders, clients, and competitors who may be dispersed globally. E-commerce allows firms to sell products, advertise, purchase supplies, bypass intermediaries, track inventory, eliminate paperwork, and share information. In total, e-commerce is minimizing the expense and cumbersomeness of time, distance, and space in doing business, thus yielding better customer service, greater efficiency, improved products, and higher profitability.

Strategists Strategists are the individuals most responsible for the success or failure of an organization. Strategists have various job titles, such as chief executive officer, president, owner, chair of the board, executive director, chancellor, dean, or entrepreneur. Jay Conger, professor of organizational behavior at the London Business School and author of Building Leaders, says, “All strategists have to be chief learning officers. We are in an extended period of change. If our leaders aren’t highly adaptive and great models during this period, then our companies won't adapt either, because ultimately leadership is about being a role model.”

Strategists help an organization gather, analyze, and organize information. They track industry and competitive trends, develop forecasting models and scenario analyses, evaluate corporate and divisional performance, spot emerging market opportunities, identify business threats, and develop creative action plans. Strategic planners usually serve in a support or staff role. Usually found in higher levels of management, they typically have considerable authority for decision making in the firm. The CEO is the most visible and critical strategic manager. Any manager who has responsibility for a unit or division, responsibility for profit and loss outcomes, or direct authority over a major piece of the business is a strategic manager (strategist). In the last few years, the position of CSO has emerged as a new addition to the top management ranks of many organizations, including Sun Microsystems, Network Associates, Clarus, Lante, Marimba, Sapient, Commerce One, BBDO, Cadbury Schweppes, General Motors, Ellie Mae, Cendant, Charles Schwab, Tyco, Campbell Soup, Morgan Stanley, and Reed-Elsevier. This corporate officer title represents recognition of the growing importance of strategic planning in business. Franz Koch, the CSO of German sportswear company Puma AG, was recently promoted to CEO of Puma. When asked about his plans for the company, Koch said on a conference call “I plan to just focus on the long-term strategic plan.”

Strategists differ as much as organizations themselves, and these differences must be considered in the formulation, implementation, and evaluation of strategies. Some strategists will not consider some types of strategies because of their personal philosophies. Strategists differ in their attitudes, values, ethics, willingness to take risks, concern for social responsibility, concern for profitability, concern for short-run versus long-run aims, and management style. The founder of Hershey Foods. Milton Hershey, built the company to manage an orphanage. From corporate profits, Hershey Foods today cares for about 900 boys and l .000 girls in its boarding school for pre-K through 12 grade.

Several CSOs who spoke at the CSO Summit in May 2013 in San Francisco were:

Roland Pan at Skype Mark Achler at Redbox

Jon Berlin at Wells Fargo

Drew Aldrich at Trans-Lux

Ann Neir at Cisco Systems Jennifer Scott at Virgin Media

Gina Copeland at Mitsubishi Electric Raj Ratnaker at Tyco Electronics

Tim Johnsone at Hopelink Nhat Ngo at Omnicell

Daniel Gastel at UBS

Clarence So at Salesforce Barry Margerum at Plantronics

44 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

Vision and Mission Statements Many organizations today develop a vision statement that answers the question “What do we want to become?” Developing a vision statement is often considered the first step in strategic planning, preceding even development of a mission statement. Many vision statements are a single sentence. For example, the vision statement of Stokes Eye Clinic in Florence, South Carolina, is “Our vision is to take care of your vision.”

Mission statements are “enduring statements of purpose that distinguish one business from other similar firms. A mission statement identifies the scope of a firm’s operations in product and market terms.” 10 It addresses the basic question that faces all strategists: “What is our business?” A clear mission statement describes the values and priorities of an organization. Developing a mission statement compels strategists to think about the nature and scope of present operations and to assess the potential attractiveness of future markets and activities. A mission statement broadly charts the future direction of an organization. A mission statement is a constant reminder to its employees of why the organization exists and what the founders envisioned when they put their fame and fortune at risk to breathe life into their dreams.

External Opportunities and Threats External opportunities and external threats refer to economic, social, cultural, demographic, environmental, political, legal, governmental, technological, and competitive trends and events that could significantly benefit or harm an organization in the future. Opportunities and threats are largely beyond the control of a single organization—thus the word external. A few opportunities and threats that face many firms are listed here:

• Availability of capital can no longer be taken for granted. • Consumers expect green operations and products. • Marketing is moving rapidly to the Internet. • Commodity food prices are increasing. • Political unrest in the Middle East is raising oil prices. • Computer hacker problems are increasing. • Intense price competition is plaguing most firms. • Unemployment and underemployment rates remain high globally. • Interest rates are rising. • Product life cycles are becoming shorter. • State and local governments are financially weak. • Drug cartel-related violence in Mexico. • Winters are colder and summers hotter than usual. • Home prices remain exceptionally low. • Global markets offer the highest growth in revenues.

These types of changes are creating a different type of consumer and consequently a need for different types of products, services, and strategies. Many companies in many industries face the severe external threat o f online sales capturing increasing market share in their industry.

Other opportunities and threats may include the passage of a law, the introduction of a new product by a competitor, a national catastrophe, or the declining value of the Euro. A competi­ tor’s strength could be a threat. A growing middle class in Africa, rising energy costs, or social media networking could represent an opportunity or a threat.

A basic tenet of strategic management is that firms need to formulate strategies to take advantage of external opportunities and avoid or reduce the impact of external threats. For this reason, identifying, monitoring, and evaluating external opportunities and threats are essen­ tial for success. This process of conducting research and gathering and assimilating external information is sometimes called environmental scanning or industry analysis. Lobbying is one activity that some organizations use to influence external opportunities and threats.

Internal Strengths and Weaknesses Internal strengths and internal weaknesses are an organization’s controllable activi­ ties that are performed especially well or poorly. They arise in the management, mar­ keting, finance/accounting, production/operations, research and development (R&D), and

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 45

management information systems (MIS) activities of a business. Identifying and evaluating organizational strengths and weaknesses in the functional areas of a business is an essential strategic-management activity. Organizations strive to pursue strategies that capitalize on inter­ nal strengths and eliminate internal weaknesses.

Strengths and weaknesses are determined relative to competitors. Relative deficiency or superiority is important information. Also, strengths and weaknesses can be determined by elements of being rather than performance. For example, a strength may involve ownership of natural resources or a historic reputation for quality. Strengths and weaknesses may be determined relative to a firm’s own objectives. For example, high levels of inventory turnover may not be a strength for a firm that seeks never to stock-out.

In performing a strategic-management case analysis, it is important to be as divisional as possible when determining and stating internal strengths and weaknesses. In other words, for a company such as Walmart saying that Sam Club’s revenues grew 11 percent in the recent quar­ ter. rather than Walmart couching all of their internal factors in terms of Walmart as a whole. This practice will enable strategies to be more effectively formulated because in strategic plan­ ning, firms must allocate resources among divisions (segments) of the firm (that is, by product, region, customer, or whatever the various units of Lhe firm are), such as Sam’s Club versus Supercenters or Mexico versus Europe at Walmart.

Both internal and external factors should be stated in specific terms to the extent possible, using numbers, percentages, dollars, and ratios, as well as comparisons over time and to rival firms. Specificity is important because strategies will be formulated and resources allocated based on this information. The more specific the underlying external and internal factors, the more effectively strategies can be formulated and resources allocated. Determining the numbers takes more time, but survival of the firm often is at stake, so identifying and estimating numbers associated with key factors is essential.

Internal factors can be determined in a number of ways, including computing ratios, measuring performance, and comparing to past periods and industry averages. Various types of surveys also can be developed and administered to examine internal factors such as employee morale, production efficiency, advertising effectiveness, and customer loyalty.

Long-Term Objectives Objectives can be defined as specific results that an organization seeks to achieve in pursuing its basic mission. Long-term means more than one year. Objectives are essential for organizational success because they provide direction; aid in evaluation; create synergy; reveal priorities; focus coordination; and provide a basis for effective planning, organizing, motivating, and controlling activities. Objectives should be challenging, measurable, consistent, reasonable, and clear. In a multidimensional firm, objectives should be established for the overall company and for each division.

Strategies Strategies are the means by which long-term objectives will be achieved. Business strategies may include geographic expansion, diversification, acquisition, product development, market penetration, retrenchment, divestiture, liquidation, and joint ventures. Strategies currently being pursued by some companies are described in Table 1-1

Strategies are potential actions that require top management decisions and large amounts of the firm’s resources. In addition, strategies affect an organization’s long-term prosperity, typically for at least five years, and thus are future-oriented. Strategies have multifunctional or multidivisional consequences and require consideration of both the external and internal factors facing the firm.

Annual Objectives Annual objectives are short-term milestones that organizations must achieve to reach long-term objectives. Like long-term objectives, annual objectives should be measurable, quantitative, chal­ lenging, realistic, consistent, and prioritized. They should be established at the corporate, divisional, and functional levels in a large organization. Annual objectives should be stated in terms of man­ agement. marketing, finance/accounting, production/operations, R&D, and MIS accomplishments.

TABLE 1-1 Sample Strategies in Action in 2013

46 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

Walgreen Company

Do you prefer Walgreen’s or CVS? Headquartered in Deerfield. Illinois. Walgreen’s is deepening its penetration into the southeastern portion of the USA by acquiring firms such as USA Drug, May’s Drug, Med-X. Drug Warehouse, and Super D Drug. At the same time, Walgreen’s is expanding globally through acquisition of firms such as U.K pharmacy-led health-and-beauty retailer Alliance Boots GmbH. Perhaps a reason Walgreen's is acquiring firms is that its same-store pharmacy sales have dropped 15 percent in (he last year, mainly as a result of selling more generic rather than prescription drugs, and their same-store-overall sales have dropped 10 percent, mainly because of the chain’s exit from pharmacy- benefit manager Express Scripts Holding. Of course, their major rival firm, CVS, could also be a key reason why Walgreen’s is acquiring other firms—to show net growth, despite lower organic (internal) revenue declines. Netflix Inc.

Based in Los Gatos, California, the long-time DVD-by-mail provider is struggling to survive as the firm switches from the DVD business to (a) providing Internet-delivered streaming content and (b) expanding to overseas markets. Major rivals to Netflix include News Corp.’s Hulu and Coinstar’s Redbox, who are growing rapidly, in the USA. Netflix’s overseas efforts arc not going well because that strategy requires country-by-country deals to line up video content. In a recent quarter, Netflix lost 850,000 DVD subscribers and added 530,(XK) movie and TV-show streaming customers. Netflix’s international streaming business lost about $400 million in 2012. Microsoft

Based in Redmond, Washington. Microsoft added 35 retail “pop-up stores” in late 2012 to go with its 30 existing retail stores in the United States and one store in Toronto. This forward integration strategy coincided with Microsoft introducing its first tablet computer. Surface, which unlike Apple’s iPad, runs popular Microsoft Office apps such as Word and Excel. The Surface also has an innovative keyboard cover that makes typing easier. In addition to its new retail stores, Microsoft is also selling its new Surface tablet online, but many customers want to touch and see before buying such a product online.

A set of annual objectives is needed for each long-term objective. Annual objectives are especially important in strategy implementation, whereas long-term objectives are particularly important in strategy formulation. Annual objectives represent the basis for allocating resources.

Policies Policies are the means by which annual objectives will be achieved. Policies include guidelines, rules, and procedures established to support efforts to achieve stated objectives. Policies are guides to decision making and address repetitive or recurring situations.

Policies are most often stated in terms of management, marketing, finance/accounting, production/operations, R&D, and MIS activities. Policies can be established at the corporate level and apply to an entire organization at the divisional level and apply to a single division, or they can be established at the functional level and apply to particular operational activities or departments. Policies, like annual objectives, are especially important in strategy implementa­ tion because they outline an organization’s expectations of its employees and managers. Policies allow consistency and coordination within and between organizational departments.

Substantial research suggests that a healthier workforce can more effectively and efficiently implement strategies. Smoking has become a heavy burden for Europe’s state-run social welfare systems, with smoking-related diseases costing more than $100 billion a year. Smoking also is a huge burden on companies worldwide, so firms are continually implementing policies to curtail smoking. Starbucks in mid-2013 banned smoking within 25 feet of its 7,000 stores not located inside another retail establishment.

Hotel and motels in the United States are rapidly going “smoke-free throughout” with more than 13,000 now having this policy. The American Hotel and Lodging Association says there are 50,800 hotel/motels in the USA with 15 or more rooms. All Marriotts are now nonsmoking. Almost all (except Hertz) car rental companies are exclusively nonsmoking, including Avis, Dollar, Thrifty, and Budget. Most rental car companies charge a $250 cleaning fee if a customer

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

smokes in iheir rental vehicle. More cigarettes are smoked in Russia per capita (2,786) than any other country in the world, but that country in 2013 instituted strict, mandatory new antismoking policies among all restaurants and bars and government facilities.” Sixty percent of men in Russia smoke. Other heavily smoking countries per capita include Japan (1,841), China (1,711), and Indonesia (1,085), compared to the USA (1,028). Excise taxes in Russia on tobacco prod­ ucts are set to rise 135 percent by 2015. About 400,000 Russians die each year as a result of smoking, costing the country 1.5 trillion rubles (S48.1 billion) annually in health-care costs.

The Strategie-Management Model The strategic-management process can best be studied and applied using a model. Every model represents some kind of process. The framework illustrated in Figure 1-1 with white shading is a widely accepted, comprehensive model of the strategic-management process.1 2 This model does not guarantee success, but it does represent a clear and practical approach for formulating, implement­ ing, and evaluating strategies. Relationships among major components of the strategic-management process are shown in the model, which appears in all subsequent chapters with appropriate areas

I_______________________________ Strategy ________________________ Formulation

FIGURE 1-1 A Comprehensive Strategie-Management Model

Strategy Implementation

Strategy ____I Evaluation I

Source: Fred R. David, adapted from “How Companies Define Their Mission,” Long Range Planning 22, no. 3 (June 1988): 40, © Fred R. David.

48 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

shaped to show the particular focus of each chapter. These are three important questions to answer in developing a stralegic plan:

Where are we now?

Where do we want to go?

How are we going to get there?

Identifying an organization's existing vision, mission, objectives, and strategies is the logical starting point for strategic management because a firm’s present situation and condition may preclude certain strategies and may even dictate a particular course of action. Every organi­ zation has a vision, mission, objectives, and strategy, even if these elements are not consciously designed, written, or communicated. The answer to where an organization is going can be determined largely by where the organization has been!

The strategic-management process is dynamic and continuous. A change in any one of the major components in the model can necessitate a change in any or all of the other components. For instance, African countries coming online could represent a major opportunity and require a change in long-term objectives and strategies; a failure to accomplish annual objectives could require a change in policy; or a major competitor's change in strategy could require a change in the firm's mission. Therefore, strategy formulation, implementation, and evaluation activities should be performed on a continual basis, not just at the end of the year or semiannually. The strategic-management process never really ends.

Note in the strategic-management model that business ethics, social responsibility, and environmental sustainability issues impact all activities in the model as discussed in Chapter 3. Also, note in the model that global and international issues also impact virtually all strategic decisions today, as described in detail in Chapter 2.

The strategic-management process is not as cleanly divided and neatly performed in practice as the strategic-management model suggests. Strategists do not go through the process in lockstep fashion. Generally, there is give-and-take among hierarchical levels of an organization. Many organizations conduct formal meetings semiannually to discuss and update the firm's vision, mission, opportunities, threats, strengths, weaknesses, strategies, objectives, policies, and performance. These meetings are commonly held off-premises and are called retreats. The rationale for periodically conducting strategic-management meetings away from the work site is to encourage more creativity and candor from participants. Good communication and feedback are needed throughout the strategic-management process.

Application of the strategic-management process is typically more formal in larger and well-established organizations. Formality refers to the extent that participants, responsibilities, authority, duties, and approach are specified. Smaller businesses tend to be less formal. Firms that compete in complex, rapidly changing environments, such as technology companies, tend to be more formal in strategic planning. Firms that have many divisions, products, markets, and technologies also tend to be more formal in applying strategic-management concepts. Greater formality in applying the strategic-management process is usually positively associated w'ith the cost, comprehensiveness, accuracy, and success of planning across all types and sizes of

13organizations.

Benefits of Strategic Management Strategic management allows an organization to be more proactive than reactive in shaping its own future; it allows an organization to initiate and influence (rather than just respond to) activities— and thus to exert control over its own destiny. Small business owners, chief executive officers, presidents, and managers of many for-profit and nonprofit organizations have recog­ nized and realized the benefits of strategic management.

Historically, the principal benefit of strategic management has been to help organizations formulate better strategies through the use of a more systematic, logical, and rational approach to strategic choice. This certainly continues to be a major benefit of strategic management, but research studies now indicate that the process, rather than the decision or document, is the more important contribution of strategic management.14 Communication is a key to successful strategic management. Through involvement in the process, in other words, through dialogue

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 49

FIGURE 1-2 Benefits to a Firm That Does Strategic Planning

and participation, managers and employees become committed to supporting the organization. Figure 1-2 illustrates this intrinsic benefit of a firm engaging in strategic planning. Note that all firms need all employees “on a mission” to help the firm succeed. Dale McConkey said “plans are less important than planning.”

The manner in which strategic management is carried out is thus exceptionally important. A major aim of the process is to achieve understanding and commitment from all managers and employees. Understanding may be the most important benefit of strategic management, followed by commitment. When managers and employees understand what the organization is doing and why, they often feel a part of the firm and become committed to assisting it. This is especially true when employees also understand links between their own compensation and organizational performance. Managers and employees become surprisingly creative and innova­ tive when they understand and support the firm's mission, objectives, and strategies. A great benefit of strategic management, then, is the opportunity that the process provides to empower individuals. Em powerm ent is the act of strengthening employees’ sense of effectiveness by encouraging them to participate in decision making and to exercise initiative and imagination, and rewarding them for doing so. William Fulmer said “you want your people to run the busi­ ness as it if were their own.”

Strategic planning is a learning, helping, educating, and supporting process, not merely a paper-shuffling activity among top executives. Strategic-management dialogue is more impor­ tant than a nicely bound strategic-management document.1'̂ The worst thing strategists can do is develop strategic plans themselves and then present them to operating managers to execute. Through involvement in the process, line managers become “owners” of the strategy. Ownership of strategies by the people who have to execute them is a key to success!

Although making good strategic decisions is the major responsibility of an organization’s owner or chief executive officer, both managers and employees must also be involved in strategy formulation, implementation, and evaluation activities. Participation is a key to gaining commit­ ment for needed changes.

An increasing number of corporations and institutions are using strategic management to make effective decisions. But strategic management is not a guarantee for success; it can be dysfunctional if conducted haphazardly.

Financial Benefits Research indicates that organizations that use strategic-management concepts are more profitable and successful than those that do not.16 Businesses using strategic-management concepts show significant improvement in sales, profitability, and productivity compared to firms without systematic planning activities. High-performing firms tend to do systematic planning to prepare for future fluctuations in their external and internal environments. Firms with planning systems more closely resembling strategic-management theory generally exhibit superior long-term financial performance relative to their industry.

High-performing firms seem to make more informed decisions with good anticipation of both short- and long-term consequences. In contrast, firms that perform poorly often engage in activities that are shortsighted and do not reflect good forecasting of future conditions. Strategists of low-performing organizations are often preoccupied with solving internal

50 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

problems and meeting paperwork deadlines. They typically underestimate their competitors’ strengths and overestimate their own firm’s strengths. They often attribute weak performance to uncontrollable factors such as a poor economy, technological change, or foreign competition.

More than 100,000 businesses in the USA fail annually. Business failures include bankruptcies, foreclosures, liquidations, and court-mandated receiverships. Although many factors besides a lack of effective strategic management can lead to business failure, the planning concepts and tools described in this text can yield substantial financial benefits for any organization. The business failure rate in the USA fell dramatically in 2012/2013. but rates rose significantly throughout Europe.

Nonfinancial Benefits Besides helping lirms avoid financial demise, strategic management offers other tangible benefits, such as an enhanced awareness of external threats, an improved understanding of competitors’ strategies, increased employee productivity, reduced resistance to change, and a clearer understanding of performance-reward relationships. Strategic management enhances the problem-prevention capabilities of organizations because it promotes interaction among managers at all divisional and functional levels. Firms that have nurtured their managers and employees, shared organizational objectives with them, empowered them to help improve the product or service, and recognized their contributions can turn to them for help in a pinch because of this interaction.

In addition to empowering managers and employees, strategic management often brings order and discipline to an otherwise floundering firm. It can be the beginning of an efficient and effective managerial system. Strategic management may renew confidence in the current business strategy or point to the need for corrective actions. The strategic-management process provides a basis for identifying and rationalizing the need for change to all managers and employees of a firm; it helps them view change as an opportunity rather than as a threat. Some nonfinancial benefits of a firm utilizing strategic management, according to Greenley, are increased discipline, improved coordination, enhanced communication, reduced resistance to change, increased forward thinking, improved decision-making, increased synergy, and more effective allocation of time and resources.17

Why Some Firms Do No Strategic Planning Some firms do no strategic planning, and some firms do strategic planning but receive no support from managers and employees. Ten reasons (excuses) often given for poor or no strategic planning in a firm are as follows:

1. No formal training in strategic management 2. No understanding of or appreciation for the benefits of planning 3. No monetary rewards for doing planning 4. No punishment for not planning 5. Too busy “firefighting” (resolving internal crises) to plan ahead 6. To view planning as a waste of time, since no product7service is made 7. Laziness; effective planning takes time and effort; time is money 8. Content with current success; failure to realize that success today is no guarantee for

success tomorrow; even Apple Inc. is an example 9. Overconfident

10. Prior bad experience with strategic planning done sometime/somewhere

Pitfalls in Strategic Planning Strategic planning is an involved, intricate, and complex process that takes an organization into uncharted territory. It does not provide a ready-to-use prescription for success; instead, it takes the organization through a journey and offers a framework for addressing questions and solving problems. Being aware of potential pitfalls and being prepared to address them is essential to success.

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 51

Some pitfalls to watch for and avoid in strategic planning are these:

• Using strategic planning to gain control over decisions and resources • Doing strategic planning only to satisfy accreditation or regulator)' requirements • Too hastily moving from mission development to strategy formulation • Failing to communicate the plan to employees, who continue working in the dark • Top managers making many intuitive decisions that conflict with the formal plan • Top managers not actively supporting the strategic-planning process • Failing to use plans as a standard for measuring performance • Delegating planning to a “planner” rather than involving all managers • Failing to involve key employees in all phases of planning • Failing to create a collaborative climate supportive of change • Viewing planning as unnecessary or unimportant • Becoming so engrossed in current problems that insufficient or no planning is done • Being so formal in planning that flexibility and creativity are stilled18

Guidelines for Effective Strategic Management Failing to follow certain guidelines in conducting strategic management can foster criticisms of the process and create problems for the organization. Issues such as “Is strategic management in our firm a people process or a paper process?” should be addressed. Some organizations spend an inordinate amount of time developing a strategic plan, but then fail to follow through with effective implementation. Change and results in a firm come through implementation, not through formulation, although effective formulation is critically important for successful imple­ mentation. Continual evaluation of strategies is also essential because the world changes so rapidly that existing strategies can need modifying often.

Strategic management must not become a self-perpetuating bureaucratic mechanism. Rather, it must be a self-reflective learning process that familiarizes managers and employees in the organization with key strategic issues and feasible alternatives for resolving those issues. Strategic management must not become ritualistic, stilted, orchestrated, or too for­ mal, predictable, and rigid. Words supported by numbers, rather than numbers supported by words, should represent the medium for explaining strategic issues and organizational responses. A key role of strategists is to facilitate continuous organizational learning and change.

R. T. Lenz offers six guidelines for effective strategic management:

1. Keep the process simple and easily understandable. 2. Eliminate vague planning jargon. 3. Keep the process nonroutine, so vary assignments, team membership, meeting formats,

settings, and even the planning calendar. 4. Welcome bad news and encourage devil's advocate thinking. 5. Do not allow technicians to monopolize the planning process. 6. To the extent possible, involve managers from all areas of the firm.19

An important guideline for effective strategic management is open-mindedness. A will­ ingness and eagerness to consider new information, new viewpoints, new ideas, and new pos­ sibilities is essential: all organizational members must share a spirit of inquiry and learning. Strategists such as chief executive officers, presidents, owners of small businesses, and heads of government agencies must commit themselves to listen to and understand managers’ posi­ tions well enough to be able to restate those positions to the managers’ satisfaction. In addition, managers and employees throughout the firm should be able to describe the strategists’ positions to the satisfaction of the strategists. This degree of discipline will promote understanding and learning.

No organization has unlimited resources. No firm can take on an unlimited amount of debt or issue an unlimited amount of stock to raise capital. Therefore, no organization can pursue all the strategies that potentially could benefit the firm. Strategic decisions thus always have to be made to eliminate some courses of action and to allocate organizational resources among others. Most organizations can afford to pursue only a few corporate-level strategies at any given time.

52 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

TABLE 1-2 Seventeen Guidelines for the Strategic-Planning Process to Be Effective

1. It should he a people process more than a paper process. 2. It should be a learning process for all managers and employees. 3. It should be words supported by numbers rather than numbers supported by words. 4. It should be simple and nonroutine. 5. It should vary assignments, team memberships, meeting formats, and even the planning calendar. 6. It should challenge the assumptions underlying the current corporate strategy. 7. It should welcome bad news. 8. It should welcome open-mindness and a spirit of inquiry and learning. 9. It should not be a bureaucratic mechanism.

10. It should not become ritualistic, stilted, or orchestrated. 11. It should not be too formal, predictable, or rigid. 12. It should not contain jargon or arcane planning language. 13. It should not be a formal system for control. 14. It should not disregard qualitative information. 15. It should not be controlled by “technicians.” 16. Do not pursue too many strategies at once. 17. Continually strengthen the “good ethics is good business" policy.

It is a critical mistake for managers to pursue too many strategies at the same time, thereby spreading the firm’s resources so thin that all strategies are jeopardized.

Strategic decisions require trade-offs such as long-range versus short-range consider­ ations or maximizing profits versus increasing shareholders’ wealth. There are ethics issues too. Strategy trade-offs require subjective judgments and preferences. In many cases, a lack of objectivity in formulating strategy results in a loss of competitive posture and profitability. Most organizations today recognize that strategic-management concepts and techniques can enhance the effectiveness of decisions. Subjective factors such as attitudes toward risk, con­ cern for social responsibility, and organizational culture will always affect strategy-formula- tion decisions, but organizations need to be as objective as possible in considering qualitative factors. Table 1-2 summarizes important guidelines for the strategic-planning process to be effective.

Comparing Business and Military Strategy A strong military heritage underlies the study of strategic management. Terms such as objectives, mission, strengths, and weaknesses first were formulated to address problems on the battlefield. According to Webster’s New World Dictionary, strategy is “the science of planning and directing large-scale military operations, of maneuvering forces into the most advanta­ geous position prior to actual engagement with the enemy”20. The word strategy comes from the Greek strategos, which refers to a military general and combines stratos (the army) and ago (to lead). The history of strategic planning began in the military. A key aim of both business and military strategy is “to gain competitive advantage.” In many respects, business strategy is like military strategy, and military strategists have learned much over the centuries that can benefit business strategists today. Both business and military organizations try to use their own strengths to exploit competitors' weaknesses. If an organization’s overall strategy is wrong (ineffective), then all the efficiency in the world may not be enough to allow success. Business or military success is generally not the happy result of accidental strategies. Rather, success is the product of both continuous attention to changing external and internal conditions and the formulation and implementation of insightful adaptations to those conditions. The element of surprise provides great competitive advantages in both military and business strategy; informa­ tion systems that provide data on opponents’ or competitors’ strategies and resources are also vitally important.

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 53

Of course, a fundamental difference between military and business strategy is that business strategy is formulated, implemented, and evaluated with an assumption of competition, whereas military strategy is based on an assumption of conflict. Nonetheless, military conflict and business competition are so similar that many strategic-management techniques apply equally to both. Business strategists have access to valuable insights that military thinkers have refined over time. Superior strategy formulation and implementation can overcome an opponent’s superiority in numbers and resources.

Born in Pella in 356 b .c .f.., Alexander the Great was king of Macedon, a state in northern ancient Greece. Tutored by Aristotle until the age of 16, Alexander had created one of the largest empires of the ancient world by the age of 30, stretching from the Ionian Sea to the Himalayas. Alexander was undefeated in battle and is considered one of history’s most success­ ful commanders. He became the measure against which military leaders even today compare themselves, and military academies throughout the world still teach his strategies and tactics. Alexander the Great once said: “Greater is an army o f sheep led by a lion, than an army o f Hons led be a sheep." This quote reveals the overwhelming importance of an excellent strategic plan for any organization to succeed. The legendary Alabama football coach Bear Bryant once said: / will defeat the opposing coach’s team with my players, but i f given a week's notice, / could defeat the opposing coach team with his players and he take my players.

Both business and military organizations must adapt to change and constantly improve to be successful. Too often, lirms do not change their strategies when their environment and competi­ tive conditions dictate the need to change. Gluck offered a classic military example of this:

When Napoleon won. it was because his opponents were committed to the strategy, tactics, and organization of earlier wars. When he lost—against Wellington, the Russians, and the Spaniards— it was because he, in turn, used tried-and-true strategies against enemies who thought afresh, who were developing the strategies not of the last war but of the next.21

Similarities can be construed from Sun Tzu’s writings to the practice of formulating and implementing strategies among businesses today. Table 1-3 provides narrative excerpts from The Art o f War. As you read through the table, consider which of the principles of war apply to business strategy as companies today compete aggressively to survive and grow.

The Art o f War has been applied to many fields well outside of the military. Much of the text is about how to fight wars without actually having to do battle: it gives tips on how to out­ smart one’s opponent so that physical battle is not necessary. As such, it has found application as a training guide for many competitive endeavors that do not involve actual combat, such as in devising courtroom trial strategy or acquiring a rival company. There are business books applying its lessons to office politics and corporate strategy. Many Japanese companies make the book required reading for their top executives. The book is a popular read among Western busi­ ness managers who have turned to it for inspiration and advice on how to succeed in competitive business situations.

The Art o f War has also been applied in the world of sports. NFL coach Bill Belichick is know'n to have read the book and used its lessons to gain insights in preparing for games. Australian cricket, as well as Brazilian association football coaches Luis Felipe Scolari and Carolos Alberto Parreira. embraced the text. Scolari made the Brazilian World Cup squad of 2002 study the ancient work during their successful campaign.

Special Note to Students In performing strategic-management case analysis, emphasize throughout your project, beginning with the first page or slide, where your firm has competitive advantages and disad­ vantages. More importantly, emphasize throughout how you recommend the firm sustain and grow its competitive advantages and how you recommend the firm overcome its competitive disadvantages. Begin paving the way early for what you ultimately recommend your firm should do over the next three years. The notion of competitive advantage should be integral to the discussion of every page or PowerPoint slide. Therefore, avoid being merely descriptive in your written or oral analysis; rather, be prescriptive, insightful, and forward-looking through­ out your project.

TA BLE 1-3 Excerpts from Sun Tzu's The A rt o f War Writings

54 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

• War is a matter of vital importance to the state: a matter of life or death, the road either to survival or rain. Hence, it is imperative that it be studied thoroughly.

• Warfare is based on deception. When near the enemy, make it seem that you are far away; when far away, make it seem that you are near. Hold out baits to lure the enemy. Strike the enemy when he is in disorder. Avoid the enemy when he is stronger. If your opponent is of choleric temper, try to irritate him. If he is arrogant, try to encourage his egotism. If enemy troops are well prepared after reorganization, try to wear them down. If they arc united, try to sow dissension among them. Attack the enemy where he is unprepared, and appear where you are not expected. These are the keys to victory for a strategist. It is not possible to formulate them in detail beforehand.

• A speedy victory is the main object in war. If this is long in coming, weapons are blunted and morale depressed. When the army engages in protracted campaigns, the resources of the state will fall short. Thus, while we have heard of stupid haste in war. we have not yet seen a clever operation that was prolonged.

• Generally, in war the best policy is to take a state intact; to ruin it is inferior to this. To capture the enemy’s entire army is better than to destroy it; to take intact a regiment, a company, or a squad is better than to destroy it. For to win one hundred victories in one hundred battles is not the epitome of skill. To subdue the enemy without fighting is the supreme excellence. Those skilled in war subdue the enemy’s army without battle.

• The art of using troops is this: When ten to the enemy’s one. surround him. W'hen live times his strength, attack him. If double his strength, divide him. If equally matched, you may engage him with some good plan. If weaker, be capable of withdrawing. And if in all respects unequal, be capable of eluding him.

• Know your enemy and know yourself, and in a hundred battles you will never be defeated. When you are ignorant of the enemy but know yourself, your chances of winning or losing are equal. If ignorant both of your enemy and of yourself, you are sure to be defeated in every battle.

• He who occupies the field of battle first and awaits his enemy is at ease, and he who comes later to the scene and rushes into the light is weary. And therefore, those skilled in war bring the enemy to the field of battle and are not brought there by him. Thus, when the enemy is at ease, be able to tire him; when well fed, be able to starve him; when at rest, be able to make him move.

• Analyze the enemy’s plans so that you will know his shortcomings as well as his strong points. Agitate him to ascertain the pattern of his movement. Lure him out to reveal his dispositions and to ascertain his position. Launch a probing attack to learn where his strength is abundant and where deficient. It is according to the situation that plans are laid for victory, but the multitude does not comprehend this.

• An army may be likened to water, for just as flowing water avoids the heights and hastens to the lowlands, so an army should avoid strength and strike weakness. And as water shapes its How in accordance with the ground, so an army manages its victory in accordance with the situation of the enemy. And as water has no constant form, there are in warfare no constant conditions. Thus, one able to win the victory by modifying his tactics in accordance with the enemy situation may be said to be divine.

• If you decide to go into battle, do not announce your intentions or plans. Project “business as usual." • Unskilled leaders work out their conflicts in courtrooms and battlefields. Brilliant strategists rarely

go to battle or to court; they generally achieve their objectives through tactical positioning well in advance of any confrontation.

• When you do decide to challenge another company (or army), much calculating, estimating, analyzing, and positioning bring triumph. Little computation brings defeat.

• Skillful leaders do not let a strategy inhibit creative counter-movement. Nor should commands from those at a distance interfere with spontaneous maneuvering in the immediate situation.

• When a decisive advantage is gained over a rival, skillful leaders do not press on. They hold their position and give their rivals the opportunity to surrender or merge. They do not allow their forces to be damaged by those who have nothing to lose.

• Brilliant strategists forge ahead with illusion, obscuring the area(s) of major confrontation, so that opponents divide their forces in an attempt to defend many areas. Create the appearance of confusion, fear, or vulnerability so the opponent is helplessly drawn toward this illusion of advantage.

Note: Substitute the words strategy or strategic planning for war or warfare.

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 55

Conclusion All firms have a strategy, even if it is informal, unstructured, and sporadic. All organizations are heading somewhere, but unfortunately some organizations do not know where they are going. The old saying “If you do not know where you are going, then any road will lead you there!” accents the need for organizations to use strategic-management concepts and techniques. The strategic-management process is becoming more widely used by small firms, large companies, nonprofit institutions, governmental organizations, and multinational conglomerates alike. The process of empowering managers and employees has almost limitless benefits.

Organizations should take a proactive rather than a reactive approach in their industry, and they should strive to influence, anticipate, and initiate rather than just respond to events. The strategic-management process embodies this approach to decision making. It represents a logical, systematic, and objective approach for determining an enterprise’s future direction. The stakes are generally too high for strategists to use intuition alone in choosing among alternative courses of action. Successful strategists take the time to think about their businesses, where they are with their businesses, and what they want to be as organizations— and then they implement programs and policies to get from where they are to where they want to be in a reasonable period of time.

It is a known and accepted fact that people and organizations that plan ahead are much more likely to become what they want to become than those that do not plan at all. A good strate­ gist plans and controls his or her plans, whereas a bad strategist never plans and then tries to control people! This textbook is devoted to providing you with the tools necessary to be a good strategist.

Key Terms and Concepts annual objectives (p. 45) competitive advantage (p. 42) empowerment (p. 49) environmental scanning (p. 44) external opportunities (p. 44) external threats (p. 44) internal strengths (p. 44) internal weaknesses (p. 44) intuition (p. 40) long-range planning (p. 39) long-term objectives (p. 45) mission statements (p. 44) policies (p. 46)

retreats (p. 48) strategic management (p. 39) strategic-management model (p. 48) strategic-management process (p. 39) strategic planning (p. 39) strategies (p. 45) strategists (p. 43) strategy evaluation (p. 40) strategy formulation (p. 39) strategy implementation (p. 40) sustained competitive advantage (p. 42) vision statement (p. 44)

Issues for Review and Discussion 1- 1. Singapore Airlines has done very well in 2013. Briefly

explain whether this strategy will be just as effective 1-3 . Compare and contrast the activities involved in

strategy formulation versus those involved in strategy implementation.going forward.

1-2. Does Singapore Airlines have its strategic plan posted on its website? Should the company do so? Why or why not?

56 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

1-4. Given the political and economic collapse of various Middle Eastern and European countries, identify a list of companies for which gaining and sustaining com­ petitive advantage has permanently changed.

1-5. There is a dramatic shift in mass retailing to become smaller. Give four reasons for this phenomenon, with corporate examples of each.

1-6. Avoid being merely descriptive in your written or oral case analysis: rather, be prescriptive, insightful, and forward-looking throughout your project. Discuss the meaning of this sentence.

1-7. Briefly explain what Dale McConkey means when he says, “plans are less important than planning.’"

1-8. In terms of developing a strategic plan, explain what Edward Deming means by “In God we trust. All others bring data.”

1-9. In an organization, at which three hierarchal levels would strategy formulation, implementation, and evaluation activities occur?

1-10. Explain Einstein’s rationale for saying “Imagination is more important than knowledge.” Would you agree with Einstein? Why?

1-11. Explain Drucker’s statement “I believe in intuition only if you discipline it.” Do you agree with it? Give reasons for your answer.

1-12. Strategic management is all about gaining and maintaining competitive advantage. Explain using examples.

1-13. Based on the definition of strategists in Chapter 1, identify the top three strategists that you have personally spoken to, and interacted with.

1-14. Would the collapse of the euro be a major threat, or opportunity, for your college or university? Why? In your opinion, what is the probability of such a collapse?

1-15. Strategic management is not a panacea for success. It can be dysfunctional if conducted haphazardly. Give five examples of potential “haphazard” aspects of the planning process.

1-16. Explain why open-mindedness is an important guideline for effective strategic management.

1-17. Explain how and why firms use social networks these days to gain a competitive advantage.

1-18. Compare and contrast vision statements with mission statements.

1-19. Identify the top 10 external factors that you feel axe affecting your university. Rank them with one being most important.

1-20. In order of importance, list six benefits of a firm engaging in strategic management.

1-21. Rank six reasons, in order of their importance, why firms don't have strategic plans.

1-22. Identify six guidelines required while conducting strategic management activities.

1-23. Discuss how relevant you think Sun Tzu’s Art o f War writings are. for firms today, in developing and carrying out a strategic plan.

1-24. Determine the ways and means that your college or university does strategic planning, and report on these efforts to your class.

1-25. Go to the Strategy club website (www.strategyclub. com) and describe the strategic planning products offered.

1-26. Compare and contrast the extent to which strategic- planning concepts are used by companies in your country with those in the United States.

1-27. Would strategy formulation or strategy implementation concepts differ more across countries? Why?

1-28. Compare strategic planning with long range planning. 1-29. Which three activities comprise strategy evaluation?

Why is strategy evaluation important, even for successful firms?

1-30. Explain how a firm can achieve sustained competitive advantage.

1-31. Identify and give an overview of three social net­ working sites that firms are using to gain competitive advantage.

1-32. List four strategists whom you know personally. Rank them on their effectiveness as a leader in their organization.

1-33. List six characteristics of objectives, using examples.

1-34. Conduct an Internet research to determine what percent­ age of your country's population smoke. What implica­ tions does this have for firms in your country?

1-35. List four financial and four nonfinancial benefits of a firm engaging in strategic planning.

1-36. Discuss the comparisons between business strategy and military strategy.

1-37. Briefly explain whether strategic planning should be more of a people-process than a paper process.

1-38. Do you agree with the fact that strategic planning should not be controlled by technicians. Briefly explain the reasons for your answer.

1-39. According to Sun Tzu, warfare is based on decep­ tion. Should strategic planning be based on deception? Explain.

1-40. Explain Sun Tzu's statement “Generally, in war the best policy is to take a state intact: to ruin it is inferior to this." Is this true in corporate strategic planning? Explain.

1-41. What is Singapore Airlines’ competitive advantage? How can this advantage be sustained?

1-42. Are there any compelling reasons why the external audit, and internal audit, should not be conducted simultaneously?

1-43. Which stage of strategic management do you feel is the most important? Give reasons for your answer.

1-44. Should strategic planning be more open or closed (i.e., hidden or transparent)? Why?

1-45. Discuss the extent to which strategic planning concepts would be applicable to individuals managing their own lives.

CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS 57

MyManagementLab® Go to m ym anag em entlab .co m for the following Assisted-graded writing questions:

1-46 . Strengths and weaknesses should be determined relative empowerment to be successful? Which relies most on to competitors, or by elements of being, or relative to a statistics? Justify your answers, firm's own objectives. Explain. 1-48 . Mymanageinentlab Only— comprehensive writing

1-47. What are the three stages in strategic management? assignment for this chapter. Which stage is more analytical? Which relies most on

Current Readings Foote, Nathaniel. Russell Eisenstat. and Tobias Fredberg.

“The Higher-Ambition Leader." Harvard Business Review (September 2011): 94.

Frisch, Bob. “Who Really Makes the Big Decisions in Your Companv?" Harvard Business Review (December 2011): 104.

Gavetti, Giovanni. “The New Psychology of Strategic Leadership.'' Harvard Business Review (July-August 2011): 118.

Isaacson, Walter. “The Real Leadership Lessons of Steve Jobs.” Harvard Business Review (April 2012): 92.

Lafley, A. G. and Noel M. Tichy. “The Ait and Science of Finding the Right CEO." Harvard Business Review (October 2011): 66.

Leavy, Brian. “Michael Beer— Higher Ambition Leadership.” Strategy and Leadership 40, no. 4 (2012): 5-11.

Reeves, Martin and Mike Deimler. “Adaptability: The New Competitive Advantage." Harvard Business Review (July-August 2011): 134.

Reeves, Martin, Claire Love, and Philipp Tillmanns. “Your Strategy Needs a Strategy." Harvard Business Review (September 2012): 56.

Ronda-Pupo. Guillermo Armando, and Luis Angel Guerras. “Dynamics of the Evolution of the Strategy Concept 1962-2008: A Co-word Analysis.” Strategic Management Journal 33, no. 2 (February 2012): 162-188.

Stieger, Daniel, Kurt Matzler, Sayan Chatterjee, and Florian Ladstaetter-Fussenegger. “Democratizing Strategy: How Crowdsourcing Can Be Used for Strategy Dialogues.” Inside CMR 54, no. 4 (Summer 2012): 44.

Zachary, Miles A., Aaron F. McKenny, Jeremy C. Short, and David J. Ketchen. “Strategy in Motion: Using Motion Pictures to Illustrate Strategic Management Concepts.” Business Horizons 55, no. 1 (January 2012): 5-10.

Zahra, Shaker A., and Satish Nambisan. “Entrepreneurship and Strategic Thinking in Business Ecosystems.” Business Horizons 55. no. 3 (May 2012): 219-229.

Zook, Chris, and James Allen. “The Great Repeatable Business Model." Ha/yard Business Review (November 2011): 106.

58 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

adidas Group - 2013 Forest R. and Fred R. David Francis Marion University www.adidas-group.com

Headquartered in Herzogenaurach, Germany, adidas AG is a sports apparel and footwear manufac­ turer and parent company of the adidas Group, which includes the Reebok sportswear company, the TaylorMade-adidas Golf, and Rockport footwear, as well as many other globally-known brands. Besides sports footwear, adidas also produces accessory products such as bags, shirts, watches, eyewear, and other sports- and clothing-related goods. The company is the largest sportswear manufacturer in Europe and the second-largest sportswear manufacturer in the world, with Nike being the first.

The company sells sports shoes, apparel, and equipment, sporting its three-stripe design in 170 countries and focuses on training equipment and apparel for sports such as soccer, basketball, and track athletics, as well as lifestyle goods including SLVR and Y-3 fashion brands, adidas has three segments: Wholesale, Retail, and Other Business. The Wholesale division supplies adidas and Reebok products to retailers globally, while the company’s Retail segment operates almost 2.500 Reebok and adidas stores. The Other Business segment includes TaylorMade-adidas Golf, Rockport, Reebok-CCM Hockey, and other brands.

History At the age of 20, Adolf A d i’ Dassler was driven by a single idea when he made his first shoe. His vision was to produce the most durable and safest footwear for athletes in different sports. Dassler continued this vision until his death in 1978. His first shoe in 1920 was constructed of canvas due to few materials being available in the post-war period. By the 1930s, Dassler was making 30 different styles of shoes for I 1 different sports and employed around 100 workers. After World War II, Dassler found himself once again making shoes with limited materials and in 1947, with only 47 workers, he resurrected shoe manufacturing using canvas and rubber from American fuel tanks. His brother, Rudolf, founded rival company Puma, which is also head­ quartered in Herzogenaurach. Dassler made the first post-war sports shoes in 1949 and formally registered his company adidas. which is the first three letters of his first and last names. To this day, adidas is still referred to as the “Three Stripes Company."

Perhaps the earliest and greatest pioneer in sports marketing, Dassler garnered many famous athletes to endorse his product, including Jesse Owens. Muhammad Ali, Franz Beckenbauer. The German football team won the 1954 World Cup wearing adidas shoes with screw-in studs, spurring the company to develop and promote many new products for major sporting events.

In January 2006. adidas acquired Reebok International Ltd., furthering the adidas Group as one of the top athletic footwear, apparel, and sports hardware producers in the world. In 2008, adidas entered the English cricket market by sponsoring English batsman Kevin Pietersen. The follow­ ing year, adidas signed the English player Ian Bell and the Indian Player Ravindra Jadeja as brand spokesmen. The lines under which adidas produces and sells cricket bats currently include Incurza, Pellara. and Libro, and additionally, adidas manufactures the uniforms worn by both the England and the Australia cricket teams.

CHAPTER 1 • THE COHESION CASE 59

At the London 2012 Olympic Games, adidas outfitted all volunteers, technical staff, and officials. As the Official Partner of Team GB, adidas provided all British athletes in all Olympic sports with performance products, alongside Licensed and Event-Branded Olympic fan wear in those games.

Second Quarter (Q2) of 2013 Results

For Q2 of 2013. adidas reported growth in their Retail stores segment, but sales declined in their Wholesale and Other Businesses segments. Also for that quarter, adidas’ revenues in Western Europe decreased 11 percent compared to the prior year. The company’s sales in North America were down 2 percent, mainly due to sales declines at TaylorMade-adidas Golf. In Greater China for Q2, company sales were up 6 percent, while revenues in Other Asian Markets increased 7 percent. For Q2 of 2013, the best performing region for the company was Latin America where sales grew 21 percent.

From a brand perspective, adidas’ sales at Reebok grew 11 percent while sales from the company’s TaylorMade-adidas Golf segment declined 8 percent. The company’s Rockport sales grew 7 percent and Reebok-CCM Hockey sales increased 2 percent.

Overall, adidas’ revenues declined 4 percent to €3.383 billion in Q2 of 2013, from €3.517 billion in Q2 of 2012. The operating profit declined 2 percent to €252 million compared to €256 million in 2012. The company’s net income grew 4 percent to €172 million (2012: €165 million) and their earnings per share rose to €0.82 (2012: €0.79).

adidas Segments Wholesale In 2012. sales in the adidas W'holesale segment grew 2 percent, driven by strong growth at adidas that more than offset sales declines at Reebok. Wholesale’s gross profit grew 8 percent to €3.840 billion from €3.570 billion in 2011. Wholesale’s operating profit improved 10 percent to €2.965 billion versus €2.690 billion in the prior year. In 2012, adidas’ Wholesale segment increased in all regions except North America, where sales were down 9 percent. In 2012, adidas Sport Performance wholesale rev­ enues grew 6 percent mainly a result of double-digit sales increases in the football, running, basketball and outdoor categories. In 2012, Reebok wholesale revenues decreased 28 percent due mainly due to the discontinuation of the NFL license agreement.

Retail

In 2012, adidas’ Retail revenues increased 14 percent. The company’s Concept stores, factor)' outlets, concession, and e-commerce comers were all up versus the prior year. The adidas Retail Segmental operating profit increased 22 percent to €724 million versus €593 million in the prior year. Retail sales increased in all regions, especially in the UK, Germany and France. Sales in European Emerging Markets rose 19 percent, with Russia leading the way. Sport Performance revenues grew 11 percent in 2012, Sport Style sales rose 20 percent. Reebok sales rose 12 percent, store sales for the adidas brand rose 7 percent. At year-end 2012, the Retail segment operated 2.446 stores, up 62 stores or 3 percent versus the prior year-end level. Of the total number of stores, 1,353 were adidas and 363 were Reebok branded and there were 730 factory outlets. During 2012, adidas opened 323 new stores, 261 stores were closed and 92 stores were remodeled. In addition in 2012, adidas opened 250 new concept stores, 110 concept stores were closed, 57 concept stores were reclassified as concession comers, and one concept store was reclassified as a factory outlet. As a result, the number of concept stores increased by 82 to 1,437 with 1,171 being adidas brand and 266 Reebok. Also in 2012, sales from adidas and Reebok e-commerce platforms were up 68 percent.

60 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

Other Businesses

The Other Businesses revenues increased at a double-digit rate in all regions. Revenues in Western Europe were up 16 percent led by double-digit sales growth at Other Centrally Managed Brands and TaylorMade-adidas Golf. Sales at Reebok-CCM Hockey grew at a low-single-digit rate, and revenues at Rockport declined at a double-digit rate. Sales in European Emerging Markets increased 17 percent led by strong double-digit growth at Rockport. Revenues at Reebok-CCM Hockey and TaylorMade-adidas Golf were up at a high-single- and mid-single-digit rate, respec­ tively. North America revenues rose 19 percent, led by double-digit growth at TaylorMade-adidas Golf and Reebok-CCM Hockey. Revenues in Greater China were up 10 percent while sales in Other Asian Markets grew 12 percent. In Latin America, sales grew 37 percent, as a result of strong double-digit growth at TaylorMade-adidas Golf and Rockport. In 2012, TaylorMade-adidas Golf revenues grew 20 percent and Rockport revenues increased 2 percent. The company's Other Centrally Managed Brands revenues grew 61 percent.

Internal Issues Vision and Mission

The overall mission of adidas is "to be the leading and most loved sports brand in the world.”, whilst adidas’ vision for their Retail segment is "to become a top retailer by delivering healthy, sustainable growth with outstanding return on investment." TaylorMade-adidas Golf's mission is “to maintain its status as the world’s leading golf company in terms of sales and profitability.” Rockport’s mission is “to become one of the world’s leading leather footwear brands through the innovative combination of contemporary style and engineered comfort.”

Organizational Structure

Four young white male executives comprise the top management team at adidas. The individuals are listed below:

1. Herbert Hainer, CEO 2. Glenn Bennett. Director of Global Operations 3. Robin Stalker, CFO 4. Erich Stamminger, Director of Global Brands

Production

Production for almost all of adidas" footwear, apparel and hardware is outsourced to independent third-party suppliers, primarily located in Asia. The company operates ten production and assembly sites in Germany (1), Sweden ( I ), Finland (1), the USA (4) and Canada (3). In comparison, in 2012, adidas had 337 independent manufacturing partners (2011: 308). The number of suppliers increased throughout all product categories (footwear, apparel and hardware). Among these manufacturing partners, 76 percent were located in Asia, 16 percent in the Americas and 8 percent in Europe. In total. 31 percent of all adidas suppliers were located in China. In fact, 96 percent of adidas' total 2012 footwear volume for adidas, Reebok and adidas Golf was produced in Asia (2011: 97%). Vietnam housed 31 percent of adidas’ production and Indonesia had 26 percent. The volume of footwear that adidas sources from Cambodia increased strongly in 2012. Overall for that year, adidas’ footwear suppliers produced approximately 244 million pairs of shoes (2011: 245 million pairs), with the largest footwear factory producing about 10 percent of the footwear sourcing volume (2011: 9%). Rockport produced approximately 8 million pairs of footwear in 2012, a decrease of 5 percent from the prior year.

CHAPTER 1 • THE COHESION CASE 61

Apparel production in Turkey increases significantly in 2012 as company sourced 84 percent of its total apparel volume from Asia (2011: 83%). Europe remained the second-largest apparel sourcing region, representing 11% of the volume (2011: 11%). The Americas accounted for 5 percent of the volume (2011: 6%). The largest apparel factory produced approximately 10percent.

R&D

R&D expenses increased 12 percent in 2012 to €128 million (2011: €115 million).

Finance

For the first half of 2013, adidas revenues increased its Retail and Other Businesses (TaylorMade- adidas golf and Rockport) but declined in Wholesale, as indicated in Exhibit 1. The company relies heavily on third-party Wholesale retail channels, including department stores, c-tailers and specialist sports retailers.. Over the past five years, adidas has evolved into a significant retailer itself, operating 2.446 stores for the adidas and Reebok brands worldwide, which comprise the company's Retail segment.

In the first half of 2013, adidas sales grew in all regions except Western Europe, as indicated in Exhibit 2. Revenues in Western Europe decreased 9 percent, as growth in France and Poland was more than offset by double-digit sales declines in the UK. Italy and Spain. In European Emerging Markets, adidas’ reported slight sales growth in all countries except Ukraine. Sales in North America grew 1 percent and in Greater China rose 6 percent on a currency-neutral basis. Revenues in Other Asian Markets grew 1 percent, with higher increases in India. South Korea and Australia. In Latin Amcrica, adidas’ sales grew 16 percent.

EXH IBIT 1 adidas Revenues by Category

First Half Year 2013

First Half Year 2012

Change y-o-y in euro terms

€ in millions € in millions in %

Wholesale 4,495 4,727 (5) Retail 1.589 1,547 3 Other Businesses 1,050 1.067 (2) Total 7,134 7,341 (3)

Source: adidas First Half Year Repori 2013.

EXH IBIT 2 adidas Sales by Region

First Half Year First Half Year Change y-o-y in 2013 2012 euro terms

€ in millions € in millions in %

Western Europe 1.907 2,098 (9) European Emerging Markets 901 917 (2) North America 1,716 1,728 0 ) Greater China 781 732 7 Other Asian Markets 1,064 1,162 (8) Latin America 765 704 9 Total 7,134 7341 (3)

Source: adidas First Half Year Report 2013.

62 CHAPTER 1 • STRATEGIC M ANAGEM ENT ESSENTIALS

In the first half of 2013, adidas' net incomc increased 6 percent to €480 million from €455 million in 2012. Net borrowings at June 30.2013 amounted to €94 million, a decrease of €223 million, or 70 percent, versus €318 million at the end of June 2012.

Sustainability

For the 13th consecutive year in 2013, adidas was included in the Dow Jones Sustainability Indexes (DJSI) and the FTSE4Good Europe Index, the Vigeo Group’s Ethibel Sustainability Index Excellence Europe as well as in the ASPI Eurozone Index. For 2012. adidas was included for the eighth con­ secutive time in “The Global 100 Most Sustainable Corporations in the World.” a list that is revealed each year at the World Economic Forum in Davos, Switzerland. The company is a constituent of the STOXX Global ESG Leaders indices.

Product Areas Football

As the world’s most popular sport, football is a key strategic focus for adidas. and the company puts research and development into technologies for boots, apparel, and footballs at a position of high priority. In late 2013, adidas launched a stream of new and innovative football products for the W'orld Cup. In 2013, adidas reported successes in football, such as brand spokesman Lionel Messi being awarded the FIFA Ballon d'Or as the best player of the year for the fourth time in a row, Chelsea FC won an all-adidas-sponsored final in the UEFA Europa League, and FC Bayern Munich was recently crowned UEFA Champions League winner. At the 2013 FIFA Confederations Cup, four out of eight teams are equipped by adidas, including the World and European Champion Spain. Asian Champion Japan. CONCACAF Champion Mexico and the 2013 Africa Cup winner Nigeria. The Japan team was also the very lirst team to qualify the 2014 FIFA World Cup in Brazil.

The company cxpects to achieve record sales of €2 billion in the football category in 2014. As the official sponsor, supplier and licensee of the 2014 FIFA World Cup, to be held in Brazil, and will again supply the official ball of the tournament as well as equipment for officials, referees, and volunteers. Additionally, having extended their partnership with the Union of European Football Associations, adidas will also supply the balls and equipment for the UEFA EURO 2016 tourna­ ment. These partnerships continue adidas’ 30-year history of sponsoring some of the world’s largest sporting events, which also includes the FIFA Confederations Cup and UEFA Champions League. Sponsorship of high-profile events such as these provide adidas with important platforms to assert and showcase their dominance in football.

In 2012 adidas sponsored Spain winning the UEFA EURO 2012 and Chelsea FC becoming the winner of the UEFA Champions League in an all-adidas final against host club FC Bayern Munich. The adizero f50 featuring miCoach has changed the way football is played and how data is analyzed. The introduction of Predator Lethal Zones marked the successful recognition of the Predator family, the most successful boot concept in football history.

Basketball

The company is expanding its market share in the North American and Chinese basketball markets and capitalizing on the growing popularity of the sport in the emerging markets by building brand equity, leveraging its status as the official NBA outfitter, and capitalizing on relationships with some of the most promising stars of the NBA. including Derrick Rose and Dwight Howard. In 2012, adidas Basketball focused on expanding the Derrick Rose signature collection and launched the 269g adizero Crazy Light 2. Also introduced were the D Rose 3.0 basketball shoe and Derrick Rose’s first signature apparel collection.

CHAPTER 1 • THE COHESION CASE 63

Training

In 2012, adidas introduced several new technologies and product updates, such as the Adipure Trainer 360, a training shoe for men and women offering unrestricted foot movement using lightweight and flexible materials. In 2013, adidas Training introduced the next generation of the ClimaCool and ClimaWarm apparel technologies, featuring advanced fabrics, as well as expanding the Adipure foot­ wear range, to provide athletes with the highest functionality and comfort.

Outdoor

In 1978. climbing legend Reinhold Messner used new adidas boots to reach base camp on his way to becoming the first man to climb Mount Everest without artificial oxygen. Today, adidas offers a wide range of boots for mountaineers, climbers, and hikers, as well as technical footwear, apparel, backpacks and eyewear, sometimes in collaboration with partners such as Gore-Tex, Windstopper, Primaloft and Continental. The adidas Outdoor group has close relationships with the mountain guides from the Alpine Centre in Zermatt. Switzerland, and some of the best climbing and moun­ taineering athletes from around the world, including world-renowned climbers like Alexander and Thomas Huber, Mayan Smith-Gobat, Dean Potter and Sasha DiGiulian, a rising star in competitive climbing. Special adidas Outdoor offerings include the Terrex Fast R and the HydroterraShandal and the Terrexlcefeather Gore-Tex Pro-Shell jacket. In 2013, adidas Outdoor launched the Terrex Solo Stealth, the first adidas shoe with Stealth rubber designed for technical climbing, where perfect grip is essential.

Sport Style

Street-wear and lifestyle sports fashion now makes up more than 28 percent of adidas brand sales glob­ ally. Originals is recognized as a legitimate sports lifestyle brand offering a wide range of products aimed at the 16- to 24-year-old consumer.

Y-3

Y-3 athletic sportswear is elegant and chic. In 2013, the Y-3 portfolio was extended with stores in London, Vienna and Hong Kong and increased emphasis on the Y-3 global e-commerce website.

Porsche Design Sport

Working closely with Porsche Design Sport, adidas creates luxury sportswear that features leading- edge performance technologies. An adidas spokesperson in this category is José Mourinho who show­ cases the image of Porsche Design Sport. In 2012, the men’s collection included apparel, footwear and accessories in the categories of Driving, Golf, Gym, Running, W'ater and Snow. In 2013, adidas launched its first women’s collection and introduced it with the support of its new brand ambassador, tennis player Daniela Hantuchova. New adidas products include the Made in Germany Cleat II and Compound II as well as an exclusive offer of heli-skiing items. Porsche Design Sport is available in Porsche Design stores, adidas Concept Stores and high-end department stores.

SLVR

SLVR is a sportswear clothing product offering that combines comfort and style with advanced fabrics and techniques. In fall 2013, adidas SLVR created a global e-commerce store.

64 CHAPTER 1 • STRATEGIC M ANAGEMENT ESSENTIALS

Fitness Brand

The adidas-owned brand Reebok strives to become the leading fitness brand in the world, having helped usher in the aerobics movement years ago with groundbreaking, game-changing products and marketing. While the sporting goods industry and the world have changed considerably since then. Reebok wants lo help shift the paradigm and change the perception of fitness, evolving it from a chore to a series of activities and a lifestyle choice. Therefore, Reebok is on a mission to empower people to be “lit for life”, supporting them to achieve their full potential in a fun, collaborative and engaging way. In 2013, Reebok significantly expanded its fitness offerings and broadened its com­ munication of what the brand stands for and what it means to wear Reebok.

Studio

In 2013 adidas began its Reebok Studio offerings that include Dance, Yoga and Aerobics product concepts and programmes for women. Dance and Yoga products launched in spring 2013, while Aerobics launched in the second half of 2013. The key dance product is the Dance UR Lead - a technical dance shoe.

TaylorMade-adidas Golf Strategy

The TaylorMade-adidas Golf segment consists of four of the most widely known and respected brands in the sport: TaylorMade, adidas Golf, Adams Golf and Ashworth.

TaylorMade is arguably the market leader in the metal woods and irons categories, and is among the leaders in other golf categories. TaylorMade-adidas Golf is a global leader in golf apparel and is among the top three in footwear sales. In 2012, TaylorMade-adidas Golf acquired Adams Golf, a company that had focused on clubs for game improvement as well as for senior and women golfers in contrast to TaylorMade’s focus on younger and lower-handicap golfers. TaylorMade is the clear market leader in metalwoods (drivers, fairway woods and hybrids). The TaylorMadeRocketBallz iron w'as the best-selling iron in 2012 in the USA. TaylorMade offers wedges such as the ATV (All-Terrain Versatility) wedge, with its innovative sole that makes it highly effective from a wide variety of lies. The ATV was played widely on tour in 2012, and in the USA it rose to be a best-selling wedge at retail during October 2012. TaylorMade’s Ghost line of putters sell well, especially the Ghost Spider line introduced in 2013, including the Ghost Spider Daddy Long Legs. In the golf ball category', in 2013, TaylorMade launched its newest tour ball. Lethal, introduced in February 2013, as well as the RocketBallz Urethane, with its three-piece construction and a tour-validated urethane cover priced well below most urethane balls.

Rockport

Rockport shoes are popular globally; 43 percent of the total Rockport revenues in 2012 came from outside Germany. In that year alone, Rockport opened more than 40 stores in Russia/CIS, Japan, South Korea and other markets around the world.

CHAPTER 1 • THE COHESION CASE 65

Reebok-CCM Hockey Reebok-CCM Hockey is a leading designer and marketer of ice hockey equipment and related apparel, equipping more professional hockey players than any other company, including NHL superstars Sidney Crosby and Pavel Datsyuk. Reebok-CCM Hockey is also the official outfitter of the NHL as well as several NCAA and national teams.

Competitors Columbia Sportswear (COLM) Headquartered in Portland. Oregon, leading sportswear chain, Columbia Sportswear CompanyColumbia’s trademark Bugaboo parka with weatherproof shell sells well globally. Columbia offers many sportswear accessories, boots, and rugged footwear, sold under brands Columbia, Mountain Hardwear. SoreL and Montrail. Controlled by the Boyle family and run by president and CEO Tim Boyle, Columbia recently strengthened its presence in the growing Indian market by forming a distribution agreement with the New Delhi-based Chogori India Retail Ltd. whereby Chogori will serve as the sole distributor of Columbia’s brands in India.

The Indian sportswear industry is growing rapidly as Indians are increasingly taking to outdoor leisure activities. Columbia Sportswear will have to compete with local brands, like Bata. Liberty and Woodland, and international players, like Nike and adidas AG. Columbia’s outdoor apparel, footwear and other products are sold in approximately 100 countries. Apart from India, the company has also formed a joint venture with Swire Resources Ltd. in China to expand the company’s sales there.

Puma SE Another rival to adidas is Puma. Both firms are headquartered in Herzogenaurach, Bavaria, Germany primarily because Puma was formed when German brothers Rudi and Adi Dassler feuded and split their family firm into adidas and Puma. Puma designs and makes footwear, apparel, and accessories sold under the Puma. Tretom, and Cobra Golf labels. WTiile shoes are Puma’s primary product line, apparel accounts for a growing portion of sales. Puma has been expanding its athletic apparel styles to include men’s golf, sailing, motorsports, and denim items. Puma also operates its own retail stores and controls product distribution in many countries. French luxury-goods giant Keringowns a majority stake in Puma.

Puma owns 25 percent of American brand sports clothing maker Logo Athletic, which is licensed by American professional basketball and association football leagues. In 2013, Puma signed multi­ year deals to make kits for the Rangers FC team, the Football League Championship Wolverhampton Wanderers FC. the Serbian Red Star Belgrade, and the Arsenal Football Club.

66 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

Nike (NKE) The world's largest shoe and apparel company, Nike designs, develops, and sells a hundreds of products and services to help in playing basketball and soccer (football), as well as in running, men’s and women’s training, and other action sports. Nike also markets products for golf, tennis, and walking, and sportswear by Converse and Hurley. Nike sells through thousands of wholesalers but also has more than 800-owned retail stores worldwide, an e-commerce site.

Nike's recent fiscal year ended May 31, 2013 when the company reported that revenues were up 8 percent to $25.3 billion. Nike Brand wholesale revenues increased 8 percent to SI 8.4 billion, while Direct-to-Consumer (DTC) revenues grew 24 percent to $4.3 billion, driven by 14 percent growth in same store sales and new door expansion. As of May 31. 2013 the Nike Brand had 645 DTC stores in operation as compared to 557 the prior year. Nike reported that revenues for its Other Businesses grew 9 percent. Overall for fiscal 2013, Nike’s net income increased 9 percent to $2.5 billion and inventories were $3.4 billion, up 7 percent from the prior year.

Under Armour (UA) A rising star in the athletic appeal industry, Under Armour is very popular among young athletes. The company has license contracts with some major American universities as a provider of sports appeal and jerseys to their athletic teams. Under Armour develops, markets, and distributes performance apparel, footwear, and accessories for men, women, and youth primarily in the USA and Canada. UA offers products made from moisture-wicking fabrics designed to regulate body temperature regard­ less of weather conditions. The company provides products in three fit types: compression (tight fitting), fitted (athletic cut), and loose (relaxed) extending across the sporting goods, outdoor, and active lifestyle markets.

Under Armour’s footwear offerings include football cleats, baseball, lacrosse, and softball cleats, and slides. The company also provides baseball bats, football, golf, and running gloves, as well as hats, eye wear, bags, and many more sports accessories. Under Armour prides itself on technology and being a good corporate citizen. Three of their main technology marketing tools are HeatGcar, ColdGear, and AlISeasonGear.

Callaway Golf (ELY) Callaway G olf is for sale and adidas is rumored to be interested in acquiring the company. Headquartered in Carlsbad. California and founded in 1982 by Eli Callaway, Callaway Goll sells, designs, and manufactures golf clubs and balls worldwide. The company also sells many accessories such as golf bags, gloves, shoes, and other apparel. Callaway gained an early reputa­ tion for producing top quality products with their 1990 introduction of the Big Bertha Driver. Today, Callaway’s most innovative breakthrough clubs are sold under the Diablo name. Callaway has produced more than 1.100 United States patents, more than any other golf manufacturer.

Callaway’s CEO since March 2012 is Chip Brewer is pursuing a turnaround for the company that has not made an annual profit since 2008. Brewer is seeking to restore profitability by reducing costs, streamlining operations and building market share. Callaway recently cut its 2013 revenue forecast for the second time to $810 million, its lowest annual sales in a decade and down from its $850 million projection in January.

CHAPTER 1 • THE COHESION CASE 67

Conclusion Nike in late 2013 wrestled away from adidas the rights to the British athletics team footwear and apparel until 2020, winning the contract after a legal battle involving current supplier adidas. The new agree­ ment includes the world athletics championships to be hosted in London in 2017. “The scale and length of their commitment is significant and demonstrates their confidence in the future of British Athletics,” said UK Athletics chief executive Niels de Vos, welcoming the deal with Nike. Media reports said the contract was worth 15 million pounds ($23.44 million), double the current deal. Athletics is enjoy­ ing its highest profile in Britain since the 1980s, following the excitement generated by the London Olympicsin 2012, and will remain the kit supplier for the British Olympic team.

A clear strategic plan is needed for adidas' future. Acquisitions may be an effective means to make inroads into Nike’s market share, perhaps by acquiring firms such as Callaway Golf, or even maybe Under Armour. Using adidas’ financial statements provided at the end of this case, develop projected financial statements for the company given what you would recommend adidas do over the coming three years?

adidas AG Consolidated Statement of Financial Position (IFRS) (€ in millions)

June 30, 2013

June 30, 2012

Change in %

Dec. 31, 2012

ASSETS Cash and cash equivalents 1,197 1,013 18.2 1,670 Short-term financial assets 29 377 (92.2) 265 Accounts receivable 2,029 2,118 (4.2) 1.688 Other current financial assets 239 256 (6-6) 192 Inventories 2,611 2,721 (4.0) 2,486 Income tax receivables 66 57 15.7 76 Other current assets 538 482 11.7 489 Assets classified as held for sale 11 25 55.4 11

Total current assets 6,720 7,049 (4.7) 6,877 Property, plant and equipment 1,123 1,003 11.9 1,095 Goodwill 1,288 1,576 (18.3) 1.281 Trademarks 1,496 1,555 (3.8) 1,484 Other intangible assets 157 156 0.5 167 Long-term financial assets 116 103 12.7 112 Other non-current financial assets 23 33 (28.5) 21 Deferred tax assets 504 506 0.3 528 Other non-current assets 98 111 12.8 86

Total non-current assets 4,805 5,043 (4.7) 4,774

Total assets 11,525 12,092 (4.7) 11,651

(continued)

68 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

Continued

June 30, 2013

June 30, 2012

Change in %

Dec. 31, 2012

LIABILITIES AND EQUITY Short-term borrowings 163 495 (67.0) 280 Accounts payable 1,746 1,874 (6.9) 1,790 Other current financial liabilities 61 81 (26.2) 83 Income taxes 252 260 (3.1) 275 Other current provisions 462 544 (15.0) 563 Current accrued liabilities 1,123 1.053 6.7 1,084 Other current liabilities 323 319 1.5 299 Liabilities classified as held for sale — 0 (100.0) 0

Total current liabilities 4,130 4,626 (10.7) 4,374 Long-term borrowings 1,158 1,214 (4.6) 1,207 Other non-current financial liabilities 13 6 122.0 17 Pensions and similar obligations 258 215 20.2 251 Deferred tax liabilities 385 424 (9.8) 368 Other non-current provisions 50 48 4.3 69 Non-current accrued liabilities 42 33 28.8 40 Other non-current liabilities 28 35 (23.9) 34

Total non-current liabilities 1,934 1,975 (2.2) 1,986 Share capital 209 209 — 209 Reserves 615 909 (32.4) 641

Retained earnings 4.652 4,383 6.2 4,454

Shareholders’ equity 5,476 5,501 (0.5) 5,304 Non-controlling interests (13.0) (10.0) 28.3 (13.0)

Total equity 5,463 5,491 (0.5) 5,291

Total liabilities and equity 11,527 12,092 (4.7) 11,651

Rounding differences may arise in (percentages and totals

adidas AG Consolidated Income Statement (IFRS) (€ in millions)

First half year 2013

First half year 2012 Change

Second quarter

2013

Second quarter

2012 Change

Net sales 7,134 7,341 (2.8%) 3,383 3,517 (3.8%)

Cost of sales 3,559 3,819 (6.8%) 1,689 1,820 (7.2%)

Gross profit 3,575 3,522 1.5% 1,694 1,697 (0.1%) (% of net sales) 50.1% 48.0% 2-1 pp 50.1% 48.2% 1.8pp

Royalty and commission income 51 52 (1.9%) 26 27 (4.6%)

Other operating income 47 47 (0.4%) 29 22 32.4%

Other operating expenses 2,980 2.956 0.8%' 1.497 1,490 0.6%

(% of net sales) 41.8% 40.3% 1.5pp 44.3% 42.4% L9pp

CHAPTER 1 • THE COHESION CASE 69

Continued

First half year 2013

First half year 2012 Change

Second quarter

2013

Second quarter

2012 Change

Operating profit 693 665 4.2% 252 256 (1.9%) (% of net sales) 9.7% 9.1% 0.7pp 7.4% 7.3% 0.1 pp

Financial income 10 17 (40.7%) 6 8 (34.5%) Financial expenses 40 57 (30.2%) 22 29 (29.9%)

Income before taxes 663 625 6.2% 236 235 0.4% (% of net sales) 9.3% 8.5% ().8pp 7.0% 6.7% 0.3pp

Income taxes 182 171 6.5% 65 71 (9.6%) (% of income before taxes) 27.5% 27.4% 0.1 pp 27.5% 30.5% (3.0pp)

Net income 481 454 6.0% 171 164 4.8% (% of net sales) 6.7% 6.2% 0.6pp 5.1% 4.7% 0.4pp

Net income attributable to shareholders 480 455 6.5% 172 165 4.1% (% of net sales) 6.7% 6.2% 0-5 pp 5.1% 4.7% 0.4pp

Net income attributable to non-controlling interests 1 (1) 194.1% (1) (1) 71.1% Basic earnings per share (in €) 2.29 2.17 5.6% 0.82 0.79 4.1% Diluted earnings per share (in €) 2.29 2.17 5.6% 0.82 0.79 4.1%

Rounding differences may arise in percentages and totals

Source: http://www.adidas-group.coni/en/mvestors/financial-reports/

70 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

ASSU R A N CE OF LEARNING E X ER C IS ES

EXERCISE 1A Assess Singapore Airline’s Most Recent Quarterly Performance Data

Purpose This exercise gives you practice examining the progress a firm is making in executing its strategic plan. Singapore Airlines utilizes excellent strategic management as showcased at the beginning of Chapter I.

Instructions Step 1 Go to Singapore Airlines' website. Click on About Us and then Investor Relations. Step 2 Review Singapore Airlines’ most recent quarterly report. Step 3 Examine the change in performance variables for that most recent quarter versus the prior

year-over-year quarter. Step 4 What strategic changes were made during that quarter? What additional changes in your

view are still needed? How is the company doing? What are key problem areas?

EXERCISE 1B Gathering Strategy Information on adidas AG

Purpose The purpose of this exercise is to get you familiar with strategy terms introduced and defined in Chapter l . Let’s apply these terms to the Cohesion Case on adidas AG.

Instructions Step 1 Go to the adidas corporate website. Click on Investors and then Financial Reports. Download

the most recent Annual Report. This document may be quite long, so you may want to copy the document electronically. The Annual Report contains excellent information for develop­ ing a list of internal strengths and weaknesses for adidas.

Step 2 Go to your college library and make a copy of Standard & Poor’s Industry Surveys for the athletic footwear and apparel industry. This document will contain excellent information for developing a list of external opportunities and threats facing adidas.

Step 3 Go on the Internet and find and print information about adidas's three major competitors: Nike. Puma, and Callaway Golf.

Step 4 Using the information gathered above, on a separate sheet of paper, list what you consider to be adidas’s three major strengths, three major weaknesses, three major opportunities, and three major threats. Kach factor listed for this exercise must include a %, #. S, or ratio to reveal some quantified fact or trend. These factors provide the underlying basis for a strate­ gic plan, because a firm strives to take advantage of strengths, improve weaknesses, avoid threats, and capitalize on opportunities. Estimate the #’s as needed.

Step 5 Through class discussion, compare your lists of external and internal factors to those devel­ oped by other students and add to your lists of factors. Keep this information for use in later exercises at the end of other chapters.

Step 6 Be mindful that whatever case company is assigned to you and/or your team of students this semester, you can start to update the information on your company by following the steps listed for any publicly held firm.

CHAPTER 1 • THE COHESION CASE 71

EXERCISE 1C Getting Familiar with the Free Excel Student Template

Purpose This exercise is designed to help strategic management students become familiar with the free Excel student template for the case analysis offered by the authors.

Instructions Step 1 Go to the Strategy Club’s website. Download the free Excel student template. Step 2 Write a one-page summary summarizing the template and explaining why how the template

will benefit you the most in this course.

EXERCISE 1D Evaluating An Oral Student Presentation

Purpose Quite often in a strategic management course, a team of students is required to give a 15 to 25 minute case analysis oral presentation. This exercise gives you insight on some do’s and don’ts regarding oral presentations.

Instructions Step 1 Go to Strategy Club’s website and watch the student case analysis presentation given there.

Critique the presentation. What are four aspects that you liked most and four aspects that you liked least?

EXERCISE 1E Strategic Planning at Nestlé

Purpose The purpose of this exercise is to give you experience investigating the strategic plan of large, pub­ licly held firms such as Nestlé SA. An important aspect of formulating a strategic plan is to assess the strategic plans of rival firms. For this exercise, you are on the top management team of M&M Mars, a large chocolate company that competes with Nestlé in the confectionery business worldwide.

Instructions Step 1 Go to Nestlé’s website and review the company’s recent Annual Report. List as clearly as

you can the five major strategies that Nestlé is pursuing worldwide. Step 2 Go to M&M Mars’s website and determine as best you can what the privately held firm is

doing worldwide to compete with Nestlé. Step 3 Write a one-page paper that summarizes your assessment of Nestlé’s strategic plan as

compared to M&M Mars’s strategic plan. Include whether you feel being privately held, as M&M Mars is, enables a firm to conceal its strategic plan from rival firms. Do you feel it is advantageous to keep strategies secret from shareholders, employees, creditors, suppliers, and other stakeholders? What would be the advantages of being publicly held?

72 CHAPTER 1 • STRATEGIC MANAGEMENT ESSENTIALS

EXERCISE 1F Interviewing Local Strategists

Purpose This exercise is designed to give you experience learning first hand how strategists in your city/town formulate and implement strategics. This information can be used to compare and contrast concepts presented in this textbook with practices of local strategists. Recall that strategists include owners of businesses, directors of nonprofit organizations, top managers of large firms, CEOs, presidents, and many others.

Instructions Visit five strategists in your city. Interview them, asking the following questions. Prepare answers and report back to your professor.

1. How do you decide which strategies to implement in this organization? 2. How often do you change strategies or take a fresh look at existing strategies? 3. How many persons assist you in formulating strategies? 4. Does your organization have written mission, vision, and objective statements? 5. Is the strategic planning process in your company more secret or open in regard to process and

procedure? Which approach do you feel is best? Why?

Endnotes 1. Kathy Kiely, "Officials Say Auto CEOs M ust Be Specific

on Plans,” USA Today, Novem ber 24, 2008, 3B.

2. Peter Drucker, Management: Tasks, Responsibilities, and Practices (New York: Harper & Row, 1974), 611.

3. Alfred Sloan, Jr., Adventures o f the White Collar Man (New York: Doubleday, 1941), 104.

4. Quoted in Eugene Raudsepp, “Can You Trust Your Hunches?” Management Review 49, no. 4 (April 1960): 7.

5. Stephen Harper, “Intuition: W hat Separates Executives from M anagers,” Business Horizons 31, no. 5 (Septem ber-O ctober 1988): 16.

6. Ron Nelson, “How to Be a Manager,” Success, Ju ly-A ugust 1985, 69.

7. Bruce Henderson, Henderson on Corporate Strategy (Boston: Abt Books. 1979), 6.

8. Robert Waterman, Jr.. The Renewal Factor: How the Best Get and Keep the Competitive Edge (New York: Bantam, 1987). See also BusinessWeek, Septem ber 14. 1987, 100. Also, see Academy o f Management Executive 3, no. 2 (M ay 1989): 115.

9. Jayne O ’Donnell, “Shoppers Flock to D iscount Stores,” USA Today, February 25, 2009, B 1.

10. John Pearce II and Fred David, “The Bottom Line on Corporate Mission Statements,” Academy o f Management Executive 1, no. 2 (May 1987): 109.

11. Lukas Alpert, “ Kremlin Cracks Down on Big Tobacco,” Wall Street Journal (October 16, 2012): B l.

12. Fred R. David, “How Com panies Define Their Mission,” Long Range Planning 22. no. 1 (February 1989): 91.

13. Jack Pearce and Richard Robinson, Strategic Management, 7th ed. (New York: M cGraw-Hill, 2000), 8.

14. Ann Langley, “The Roles o f Formal Strategic Planning,” Long Range Planning 21, no. 3 (June 1988): 40.

15. Bernard Reimann, “Getting Value from Strategic Planning,” Planning Review 16, no. 3 (M ay-June 1988): 42.

16. G. L. Schwenk and K. Schrader, “ Effects o f Form al S trategic Planning in Financial Perform ance in Small Firms: A M eta-A nalysis,” Entrepreneurship and Practice 3, no. 17 (1993): 53-64 . A lso, C. C. M iller and L. B. Cardinal, “Strategic Planning and Firm

CHAPTER 1 • THE COHESION CASE 73

Perform ance: A Synthesis o f M ore Than Two Decades o f Research,” Academy o f Management Journal 6, no. 27 (1994): 1649-1665; M ichael Peel and John Bridge, “How Planning and Capital B udgeting Im prove SM E Perform ance,” Long Range Planning 31, no. 6 (O ctober 1998): 848-856 : Julia Sm ith. “Strategies for Start- Ups,” Long Range Planning 31, no. 6 (O ctober 1998): 857-872.

17. Gordon Greenley, “Does Strategic Planning Improve Com pany Perform ance?” Long Range Planning 19, no. 2 (April 1986): 106.

18. Adapted from www.des.calstate.edu/limitations.html and www.entarga.com/stratplan/purposes.hlml

19. R. T. Lenz, “M anaging the Evolution o f the Strategic Planning Process,” Business Horizons 30, no. 1 (January-February 1987): 39.

20. Webster's New World Dictionary, Year: 1998. Publisher: Pearson pic. Edition: 4th. Edited by Victoria Neufeldt. Pearson purchased this Dictionary from Simon & Schuster in 1998, but sold it to IDG Books in 1999.

21. Frederick Gluck, “Taking the M ystique out of Planning,” Across the Board, July-A ugust 1985. 59.

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MyManagementLab® Improve Your Grade! Over 10 million students improved their results using the Pearson MyLabs. Visit m ym anagem entlab.com for simulations, tutorials, and end-of-chapter problems.

Outside-US A Strategie Planning C H A P T E R O B JE C T IV E S After studying this chapter, you should be able to do the following:

1. Discuss the nature and implications of labor union membership across Europe. 2. Discuss income tax rates and practices across countries. 3. Explain the advantages and disadvantages of entering global markets. 4. Discuss protectionism as it impacts the world economy. 5. Explain when and why a firm (or industry) may need to become more or less global

in nature to compete. 6. Discuss the global challenge facing U.S. firms. 7. Compare and contrast business culture in the United States with many other

countries.

8. Describe how management style varies globally. 9. Discuss communication differences across countries.

10. Discuss Africa as the newest hotspot for business entry.

A S S U R A N C E O F L E A R N IN G E X E R C IS E S The following exercises are found at the end of this chapter. e x e r c i s e 2A The adidas Group wants to enter Africa. Help them.

e x e r c i s e 2B Assessing Differences in Culture Across Countries

e x e r c i s e 2C Honda M otor Company wants to enter the Vietnamese market. Help them.

e x e r c i s e 2D D o es M y U n iv ers ity R e c ru it in F o re ign C o u n trie s?

76 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

As illustrated in Figure 2-1 with white shading, global considerations impact virtually all strategic decisions. The boundaries o f countries no longer can define the limits o f our imaginations. To see and appreciate the world from the perspective o f others has become a matter o f survival for businesses. The underpinnings o f strategic m anagem ent hinge on managers gaining an understanding o f com petitors, markets, prices, suppliers, distributors, governments, creditors, shareholders, and custom ers worldwide. The price and quality o f a firm ’s products and services must be com petitive on a worldwide basis, not just on a local basis. Shareholders expect substantial revenue growth, so doing business globally is one o f the best ways to achieve this end. As indicated in the boxed insert, Honda is an example business that has grown dramatically with a well-conceived rollout across the world.

The consulting firm A.T. Kearney reported in mid-2013 that the USA for the first time since 2001 has replaced China as the country with the highest prospects for foreign direct investment (FDI). Brazil is num ber 3, followed by Canada, India, Australia, Germany, United Kingdom (UK), Mexico, and Singapore. China's allure has dimmed lately due to rising wages, whereas the USA’s surge in oil and gas production promises lower energy costs, coupled with high respect for human rights and freedom, and has led to renewed interest in the USA for FDI.

Exports o f goods and services from the USA account for only 11 percent o f U.S. gross domestic product, so the USA is still largely a domestic, continental economy. W hat happens inside the USA largely determines the strength o f the economic recovery. In contrast, as a per­ cent o f gross domestic product (GDP), exports com prise 35.3 percent of the German economy, 24.5 percent o f the Chinese economy, and 156 percent o f the Singapore economy. S ingapore's number is so high because they import oil and other products and then re-export them glob­ ally. A point here also is that the USA has substantial room for improvement in doing business globally based on the 11 percent exports to GDP number.

SHOWCASEDSTRATEGIC MANAGEMENT

Honda Honda Motor Company, headquartered in Minato, Tokyo, Japan, is the world's largest motorcycle manufacturer and the world's largest manu­ facturer of internal combustion engines. Honda was the eighth largest automobile manufacturer in the world. Honda will re-enter Formula One racing in 2015 as an engine supplier to the McLaren team. Honda annually produces and sells thousands of scooters, water pumps, lawn and garden equipment tools, tillers, outboard motors, robotics, jet engines, and solar cells. Honda has about 180,000 employees. In 2013, Fortune ranked Honda Motor Company as the 50th most admired company in the world.

In late 2013, Honda moved away from its time-tested nickel-metal hydride batteries to lighter, smaller and more powerful lithium ion chemistry, such as with the 2014 Accord Hybrid. Rival Toyota con­ tinues to stick with NMH batteries on its conventional hybrids, citing their reliability and lower cost. However, with its 2014 Accord Hybrid delivering an EPA-certified rating of 50 mpg in city driving, Honda now offers a full three miles per gallon better than the previous "gas economy king," the 47 mpg Ford Fusion Hybrid. The Toyota Camry Hybrid comes in at 43 and the Hyundai Sonata Hybrid at 40.Honda's 2014 Accord Hybrid gets about 10 percent better fuel economy around town than the original Toyota Prius, a dedicated gas-electric model that features a super-aerodynamic, ultralight body. The new hybrid arrived in dealerships in late 2013. The number 50 is significant because only the Prius has ever hit that EPA estimate mark for vehicles not plugged in for charging.

Honda is in­ vesting another $215 million in its Ohio opera­ tions, pushing the company's total to $2.7 billion in North American operations in only the past three years. The majority of the monies will be spent on an expansion of manufacturing capabilities at the company's Anna, Ohio, Engine Plant, while the remainder is ear­ marked for a new building in Marysville, Ohio. Honda already has the strongest foothold of any Japanese automaker, and produces more cars with U.S.-sourced parts than any automaker other than General Motors. Nine of Honda's 16 mass-market cars are made with over half American- made parts, according to the survey - that's more than Ford.

Honda is building a new car factory in Brazil, doubling its capacity in that country to 240,000 cars a year. The new factory is being built in Ityrapina, a city of almost 15,000, located approximately 120 miles northwest of Sao Paulo, Brazil’s largest city. The existing Honda factory in Brazil is in Sumare, a city of around 100,000, located halfway be­ tween Ityrapina and Sao Paulo. The cost of the new factory, including the purchasing of the 1,433 acres it will be located on, is about $435 million. It will employ approximately 2,000 people, and produce the Honda Fit. The new plant should begin operations in 2015.

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

C Chapter 2: Outside-USA Strategic Planning D

Strategy Implementation

Strategy __ I Evaluation

__________________ Strategy ________________________ I Formulation

FIGURE 2-1 A Comprehensive Strategie-Management Model Source: Fred R. David, adapted from "How Companies Define Their Mission,” Long Range Planning 22, no. 3 (June 1988): 40, © Fred R. David.

A world market has em erged from what previously was a multitude o f distinct national markets, and the climate for international business today is more favorable than in years past. M ass com m unication and high technology have created sim ilar patterns of consum ption in diverse cultures worldwide. This means that many com panies may find it difficult to survive by relying solely on domestic markets.

It is no exaggeration that in an industry that is, or is rapidly becoming, global, the riskiest possible posture is to remain a domestic competitor. The domestic com petitor will watch as more aggressive com panies use this growth to capture econom ies of scale and learning. The dom estic com petitor will then be faced with an attack on domestic markets using different (and possibly superior) technology, product design, manufacturing, marketing approaches, and econom ies o f scale .1

As a point o f global reference, the 5 largest com panies in nine different countries are listed in Table 2-1. The largest o f all 45 com panies listed is Walmart, headquartered in Bentonville, Arkansas, and employing 2.1 million people worldwide. Fortune annually determ ines the most adm ired and least admired com panies in the world in terms o f "global com petitiveness.” Table 2-2 reveals the rankings in early 2012.

78 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

TABLE 2-1 The Five Largest (by revenue) Companies in Nine Countries (2012)

Britain India Japan 1. BP 1. Indian Oil 1. Toyota Motor 2. HSBC Holdings 2. Reliance Industries 2. Japan Post Holdings 3. Lloyds Banking Group 3. Bharat Petroleum 3. Nippon TeleG & TeleP 4. Tesco 4. State Bank of India 4. Hitachi 5. Aviva 5. Hindustan Petroleum 5. Honda Motor Australia Brazil China 1. BHP Billiton 1. Petrobras 1. Sinopec Group 2. Wesfarmers 2. Banco do Brasil 2. China National Petroleum 3. Wool worths 3. Banco Bradesco 3. State Grid 4. Commonwealth Bank 4. Vale 4. Ind. & Com. Bank of China 5. Westpac Banking 5. JBS 5. China Mobile Communi. USA Canada Germany 1. Walmart Stores 1. Manulife Financial 1. Volkswagen 2. ExxonMobil 2. Royal Bank of Canada 2. Daimier 3. Chevron 3. Suncor Energy 3. Allianz 4. Conoco Phillips 4. Power Corp. of Canada 4. E. ON 5. Fannie Mae 5. George Weston 5. Siemens

Source: Based on http://nioney.cnn.com/inaea7ines/foniinc/slobal500/201 l/countrics/US.html.

TABLE 2-2 Fortune's Most and Least Admired Companies in the World for "Global Competitiveness"

MOST ADMIRED 1. Gas Natural Fenosa 2. McDonald’s 3. Nestle 4. Apple 5. IBM 6. Procter & Gamble 7. Philip Morris International 8. Yum Brands 9. Caterpillar

10. RWE LEAST ADMIRED

1. WellCare Health Plans 2. Universal American 3. Coventry Health Care 4. Amerigroup 5. China South Industries Group 6. Health Net 7. Cracker Barrel Old Country Store 8. Jack in the Box 9. China FAW Group

10. Dongfeng Motor

Source: Based on http://money.cnn.com/magazines/fortune/most-admired/2012/ best_worst/bcst9.htinl and http://money.cnn.com/magazines/fortune/most- admired/2012/best_vvorst/worst9.html.

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING 79

Multinational Organizations O rganizations that conduct business operations across national borders are called international firms or multinational corporations. The strategic-m anagem ent process is conceptually the same for multinational firms as for purely dom estic firms; however, the process is more com plex for international firms as a result o f more variables and relationships. The social, cultural, dem ographic, environm ental, political, governmental, legal, technological, and com petitive opportunities and threats that face a m ultinational corporation are almost lim itless, and the num ber and com plexity o f these factors increase dram atically with the num ber o f products produced and the number o f geographic areas served.

More tim e and effort are required to identify and evaluate external trends and events in m ultinational corporations than in dom estic corporations. Geographic distance, cultural and national differences, and variations in business practices often make com m unication between dom estic headquarters and overseas operations difficult. Strategy implementation can be more difficult because different cultures have different norms, values, and work ethics.

For example, in 2013 Home Depot closed all seven o f its remaining big-box stores in China after years of losses. That firm jo ins a growing list of retailers who stumbled in China by failing to consider local culture and customs. Historically cheap labor, coupled with apartm ent-based living in China, were two reasons why Home Depot, which entered China in 2006, never gained traction in that country. Mattel and Best Buy are other firms that faltered in China. Yum Brands, which owns Kentucky Fried Chicken and Pizza Hut, obtains almost 50 percent o f its revenues from China, but the com pany's sam e-store sales in China dropped 4 percent in the fourth quarter of 2012, resulting prim arily from thousands o f new fast-food restaurants opening in China every year.

Even variables such as unem ploym ent rates vary greatly across countries as indicated in Table 2.3. Note that Spain has the highest and A ustria the lowest unem ployment rate among the European countries listed. Unem ploym ent rates are a good indicator o f consum ers’ disposable income for purchasing all kinds o f things, and the rates are a good indicator of a country’s overall financial soundness and attractiveness for doing business.

In late 2012, France lost its triple-A rating by M oody's Investors Service after the S&P Ratings Services delivered a stinging critique o f President Francois Hollanders attem pts to turn the French economy around. Hollande is trying to shift 20 billion euros from payroll taxes to taxes on consumers, and he is pushing for 25 billion o f new taxes to cut the country’s deficit to 3 percent o f GDP in 2013 from the expected 4.5 percent.

TABLE 2.3 Variations in Unemployment Rates Across Europe (2012)

Country Unemployment Rate (%)

Spain 25.1 Greece 23.1 Portugal 15.7 Ireland 14.9 Euro-zone average 11.3 Italy 10.7 France 10.3 Finland 7.6 Belgium 7.2 Germany 5.5 Austria 4.5

Source: Based on Eurostat and Gabriele Steinhauser, “Euro Zone Considers Central Budget to Fix Cracks,” Wall Street Journal (September 26. 2012): A 12.

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M ultinational corporations (M NCs) face unique and diverse risks, such as expropriation o f assets, currency losses through exchange rate fluctuations, unfavorable foreign court interpretations o f contracts and agreements, social/political disturbances, import/export restrictions, tariffs, and trade barriers. Strategists in M NCs are often confronted with the need to be globally competitive and nationally responsive at the same time. With the rise in world com merce, government and regulatory bodies are more closely monitoring foreign business practices. The U.S. Foreign Corrupt Practices Act, for example, monitors business practices in many areas.

Before entering international markets, firms should scan relevant journals and patent reports, seek the advice of academic and research organizations, participate in international trade fairs, form partnerships, and conduct extensive research to broaden their contacts and dim inish the risk o f doing business in new markets. Firm s can also offset some risks o f doing business internationally by obtaining insurance from the U.S. governm ent’s Overseas Private Investment Corporation (OPIC).

Advantages and Disadvantages of International Operations Firms have numerous reasons for formulating and implementing strategies that initiate, continue, or expand involvement in business operations across national borders. Perhaps the greatest advantage is that firms can gain new custom ers for their products and services, thus increasing revenues. Growth in revenues and profits is a com mon organizational objective and often an expectation o f shareholders because it is a measure o f organizational success.

Potential advantages to initiating, continuing, or expanding international operations are as follows:

1. Firms can gain new custom ers for their products. 2. Foreign operations can absorb excess capacity, reduce unit costs, and spread economic

risks over a wider number of markets. 3. Foreign operations can allow firms to establish low-cost production facilities in locations

close to raw materials or cheap labor. 4. Com petitors in foreign markets may not exist, or com petition may be less intense than in

domestic markets. 5. Foreign operations may result in reduced tariffs, lower taxes, and favorable political

treatment. 6. Joint ventures can enable firms to learn the technology, culture, and business practices

o f other people and to make contacts with potential customers, suppliers, creditors, and distributors in foreign countries.

7. Econom ies o f scale can be achieved from operation in global rather than solely domestic markets. Larger-scale production and better efficiencies allow higher sales volum es and lower-price offerings.

8. A firm ’s power and prestige in domestic m arkets may be significantly enhanced if the firm com petes globally. Enhanced prestige can translate into improved negotiating power among creditors, suppliers, distributors, and other important groups.

The availability, depth, and reliability of economic and marketing inform ation in different countries vary extensively, as do industrial structures, business practices, and the number and nature o f regional organizations. There are also numerous potential disadvantages o f initiating, continuing, or expanding business across national borders, such as the following:

1. Foreign operations could be seized by nationalistic factions. 2. Firms confront different and often little-understood social, cultural, dem ographic,

environmental, political, governmental, legal, technological, econom ic, and com petitive forces when doing business internationally. These forces can make com m unication difficult in the firm.

3. W eaknesses o f competitors in foreign lands are often overestim ated, and strengths are often underestimated. Keeping inform ed about the number and nature o f com petitors is more difficult when doing business internationally.

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING 81

4. Language, culture, and value systems differ among countries, which can create barriers to com m unication and problem s m anaging people.

5. Gaining an understanding of regional organizations such as the European Econom ic Community, the Latin American Free Trade Area, the International Bank for Reconstruction and Development, and the International Finance Corporation is difficult but is often required in doing business internationally.

6. Dealing with two or more monetary systems can com plicate international business operations.

The Global Challenge Few com panies can afford to ignore the presence of international com petition. Firms that seem insulated and com fortable today may be vulnerable tomorrow; for example, foreign banks do not yet com pete or operate in most o f the USA, but this too is changing.

The U.S. economy is becom ing much less American. A world econom y and monetary system are em erging. Corporations in every corner of the globe are taking advantage o f the opportunity to obtain custom ers globally. M arkets are shifting rapidly and in many cases converging in tastes, trends, and prices. Innovative transport system s are accelerating the transfer o f technology. Shifts in the nature and location o f production systems, especially to China and India, are reducing the response time to changing market conditions. China has more than l .3 billion residents and a dram atically growing middle class anxious to buy goods and services.

Business in Brazil is booming, with that country having more than a 7 percent annual growth in GDP. The capital o f Brazil, Rio de Janeiro, is making massive preparations for the 2 0 16 Sum m er Olympics, including a $5 billion investment program to extend the subway system, improve railroads, and construct new highways. Two firms in Rio that are growing exponentially are Petrobras, the w orld’s fourth-largest oil producer, and Vale, the w orld’s largest iron-ore mining company. Rio de Janeiro is B razil’s second largest manufacturing center in the country, but its scenic beauty and elaborate port facilities are world renowned.

M ore and more countries around the world are welcom ing foreign investment and capital. As a result, labor markets have steadily becom e more international. East Asian countries are market leaders in labor-intensive industries, Brazil offers abundant natural resources and rapidly developing markets, and Germany offers skilled labor and technology. The drive to improve the efficiency o f global business operations is leading to greater functional specialization. This is not limited to a search for the fam iliar low-cost labor in Latin America or Asia. O ther considerations include the cost o f energy, availability o f resources, inflation rates, tax rates, and the nature of trade regulations.

M any countries becam e m ore pro tection ist during the recent global econom ic recession. Protectionism refers to countries im posing tariffs, taxes, and regulations on firm s outside the country to favor their own com panies and people. M ost econom ists argue that protectionism harm s the world econom y because it inhibits trade am ong countries and invites retaliation.

Advancements in telecom m unications are drawing countries, cultures, and organizations worldwide closer together. Foreign revenue as a percentage o f total com pany revenues already exceeds 50 percent in hundreds of U.S. firms, including ExxonM obil, Gillette, Dow Chemical, Citicorp. Colgate-Palmolive, and Texaco.

A primary reason why most dom estic firms do business globally is that growth in demand for goods and services outside the USA is considerably higher than inside. For example, the dom estic food industry is growing ju st 3 percent per year, so Kraft Foods, the second largest food com pany in the world behind Nestle, is focusing on foreign acquisitions.

Shareholders and investors expect sustained growth in revenues from firms; satisfactory growth for many firms can only be achieved by capitalizing on demand outside the USA. Joint ventures and partnerships between domestic and foreign firms are becoming the rule rather than the exception!

Fully 95 percent o f the w orld’s population lives outside the USA, and this group is growing 70 percent faster than the U.S. population. The lineup o f com petitors in virtually all industries is global. General M otors, Ford, and Chrysler com pete with Toyota and Hyundai.

82 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

General Electric and W estinghouse battle Siemens and M itsubishi. C aterpillar and John Deere com pete with Komatsu. G oodyear battles M ichelin, Bridgestone/Firestone, and Pirelli. Boeing com petes with Airbus. Only a few U.S. industries— such as furniture, printing, retailing, con­ sum er packaged goods, and retail banking— are not yet greatly challenged by foreign com ­ petitors. But many products and com ponents in these industries too are now m anufactured in foreign countries. International operations can be as sim ple as exporting a product to a single foreign country or as complex as operating manufacturing, distribution, and m arketing facilities in many countries.

Globalization Based in Wayne, New Jersey, Toys “R” Us is adding 30 new stores in China in 2013-2014 and launching heavy online selling efforts in China. The company knows that a growing middle class in China see playtime as increasingly essential. The firm ’s focus in China is on “educational toys,” such as microscopes and building blocks. Sales o f toys in China is growing about 20 percent annually, as increasingly affluent consum ers make sure their children have plenty to play with, especially educational toys rather than Barbie Dolls.

Com panies growing perhaps even faster than in China or India are those located in Thailand, Vietnam, Philippines, Indonesia, and Singapore in Southeast Asia. A Wall Street Journal article (12-4-12, C4) detailed how the growing m iddle class in these countries are hungry to consum e products and services from around the world. The governm ents o f these countries have becomc stable and are spending heavily on in frastructure projects. A frican countries too are rapidly becom ing attractive for business. GE in m id-2013 began building a huge pow er plant in Tanzania in East Africa. The International M onetary Fund (IM F) reported in m id-2013 that by 2018, five o f the w orld’s fastest growing econom ies will be in sub-Saharan Africa. The IM F says A frica’s econom y will grow 5.6 percent in 2013 com pared to 3.6 percent worldwide. Shareholders o f all com panies want high growth; A frica offers high growth.

Globalization is a process o f doing business w orldwide, so strategic decisions are made based on global profitability of the firm rather than ju st dom estic considerations. A global strategy seeks to meet the needs o f custom ers w orldwide, with the highest value at the lowest cost. This may mean locating production in countries with the low est labor costs or abundant natural resources, locating research and com plex engineering centers where skilled scientists and engineers can be found, and locating m arketing activities close to the markets to be served.

A global strategy includes designing, producing, and marketing products with global needs in mind, instead o f considering individual countries alone. A global strategy integrates actions against com petitors into a worldwide plan. Today, there are global buyers and sellers and the instant transmission o f money and information across continents.

It is clear that different industries become global for different reasons. The need to am ortize massive research and development (R&D) investments over many markets is a major reason why the aircraft manufacturing industry became global. M onitoring globalization in one's industry is an important strategic-m anagem ent activity. Knowing how to use that information for one’s com petitive advantage is even more important. For example, firms may look around the world for the best technology and select one that has the most prom ise for the largest number of markets. When firms design a product, they design it to be marketable in as many countries as possible. When firms manufacture a product, they select the lowest-cost source, which may be Japan for semiconductors, Sri Lanka for textiles, M alaysia for sim ple electronics, and Europe for precision machinery.

Corporate Tax Rates Globally Corporate tax rates vary considerably across countries and com panies. Berm uda has a zero corporate incom e tax rate. Ireland has a 12.5 corporate tax rate. M any Internet com panies have established headquarters and get the bulk o f their European revenue in Ireland. For exam ple, although Google has more than 300 em ployees in France, G oog le’s custom ers in

CHAPTER 2 • 0UTSIDE-U5A STRATEGIC PLANNING 83

France buy ads from Google Ireland Ltd., so G oogle pays France fees through a m arketing agreem ent, rather than paying the 34 percent corporate tax rate in France. M icrosoft has a sim ilar arrangem ent in France as Google. Tax rates in countries are im portant in strategic decisions regarding where to build m anufacturing facilities or retail stores or even where to acquire other firm s. Japan recently cut its corporate tax rate by five percentage points, leaving the USA with the highest corporate tax rate am ong all nations in the world. Having the highest corporate tax rates is not a good position for the USA because it com petes with other nations as a location for investment. High corporate tax rates deter investment in new factories and also provide strong incentives for corporations to avoid and evade taxes. However, it should be pointed out here that a recent Wall Street Journal article (7-2-13, p. A4) reported that on average, large, profitable U.S. com panies pay a U.S. federal incom e tax rate o f 12.6 percent o f their w orldwide incom e, com pared to the average individual federal incom e-tax rate o f 7.2 percent.

Since the 1980s, most countries have been steadily lowering their tax rates, but the United States has not cut its top statutory corporate tax rate since 1993. Top com bined statutory rates am ong developed countries, excluding the USA, fell from an average of about 48 percent in the early 1980s to less than 25 percent in 2013.

Even within countries there is significant variation in federal taxes paid. For example. Carnival, the w orld’s largest cruise line company, is incorporated in Panam a and pays an effective tax rate o f less than 1 percent even though the com pany is headquartered in M iami. Florida.

To avoid paying U.S. taxes on incom e m ade in other countries, many U.S. com panies are cash-rich outside the USA but cash-poor inside the USA, and they bring cash back to the USA only as needed. For exam ple in late 2012, M icrosoft had S66.6 billion in total cash, but only $8.6 billion in the USA. G eneral E lectric had $85.5 billion in total cash, but only $30.7 billion in the USA. Em erson E lectric has S2 billion in total cash with alm ost all o f it in Europe and Asia so the firm had to borrow money in the USA rather than bring its cash back and pay a 35 percent corporate USA tax on corporate profits m inus w hatever ax it has already paid overseas. A Wall Street Journal article (12-4-12, p. B l) details this repercussion o f the USA having the highest tax rate in the world. The article reveals that Johnson & Johnson keeps virtually all o f its $24.5 billion in cash outside the USA, as does Illinois Tool Works Inc. W hirlpool has 85 percent o f its cash offshore. Bruce Nolop, form er CFO of Pitney Bowes explains it this way: “You end up w ith the really peculiar result where you are borrow ing money in the USA, w hile you show cash on the balance sheet that is trapped overseas. It is a totally inefficient capital structure.” The U.S. tax system , unfortunately for A m ericans, is structured so that com panies can cut their tax bill by shifting incom e offshore to lower-tax countries.

An increasing num ber of U.S. com panies are reincorporating in foreign countries to reduce their tax burden, and doing this typically by acquiring a foreign firm. Some U.S. firms that recently relocated are Aon Corp.. Eaton Corp, Ensco International, D.E. M aster Blenders, Transocean Ltd., Noble Corp, W eatherford International Ltd., and Rowan Com panies. The 102-year old Eaton Corp. moved its headquarters from Cleveland. Ohio, to downtown Dublin, Ireland, and expects to save about $160 million in taxes annually solely as a result o f the move. Critics o f the USA tax code also point out that most developed countries tax only domestic earnings, whereas the USA taxes com pany profits earned abroad.

As indicated in Table 2-4, the top national statutory corporate tax rates in 2012 among sample countries ranged from 10 percent in Serbia to 35 percent in the USA. Note the countries that have a flat tax, which often, on adoption, triggers a surge in foreign direct investment.

Other factors besides the corporate tax rate obviously affect com panies’ decisions o f where to locate plants and facilities and whether to acquire other firms. For example, the large, affluent market and efficient infrastructure in both Germany and Britain attract com panies, but the high labor costs and strict labor laws there keep other com panies away. The rapidly growing GDP in Brazil and India attracts com panies, but violence and political unrest in M iddle East countries deter investment. The USA perhaps should lower its rate to reward com panies that invest in jobs domestically. Lowering the U.S. corporate tax rate should also reduce unem ploym ent and spur growth domestically.

84 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

TABLE 2-4 Corporate Tax Rates Across Countries in 2012 (from high to low)

Country Corporate Tax Rate (%) USA 35 Brazil 34 France 33.33 Germany 33 India 30 Mexico 30 Italy 27.5 Japan 25.5 Israel 25 Austria 25 China 25. Portugal 25 Finland 24.5 U.K. 24 Ukraine 21 Estonia 21 Russia 20 Greece 20 Croatia 20 Libya 20 Netherlands 20 Turkey 20 Poland 19 Czech Republic 19 Hungary 19 Singapore 17 Canada 16.5 Hong Kong 16.5 Romania 16 Latvi 15 Lithuani 15 Ireland 12.5 Serbi 10 Bulgaria 10 Cyprus 10

Source: Based on 11 - 1 - 12 information at http:/Avww.worldwidc-tax. com/#partthree.

United States versus Foreign Business Cultures An excellent website to visit on this topic is w ww.worldbusinessculture.com . There you may select any country in the world and check out how business culture varies in that country vs. other lands. To com pete successfully in world markets, U.S. managers must obtain a better knowledge of historical, cultural, and religious forces that motivate and drive people in other countries. In Japan, for example, business relations operate within the context o f Wa. which stresses group harmony and social cohesion. In China, business behavior revolves around guanxi. or personal relations. In South Korea, activities involve concern for inhwa, or harmony based on respect of hierarchical relationships, including obedience to authority."

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING 85

In Europe, it is generally true that the farther north on the continent, the more participatory the m anagem ent style. M ost European workers are unionized and enjoy more frequent vacations and holidays than U.S. workers. A 90-m inute lunch break plus 20-minute morning and afternoon breaks are com mon in European firms. Guaranteed perm anent employment is typically a part o f em ploym ent contracts in Europe. In socialist countries such as France, Belgium, and the United Kingdom, the only grounds for imm ediate dism issal from work is a crim inal offense. A six-month trial period at the beginning o f em ploym ent is usually part o f the contract with a European firm. Many Europeans resent pay-for-perform ance, com mission salaries, and objective m easurem ent and reward systems. This is true especially o f workers in southern Europe. Many Europeans also find the notion of team spirit difficult to grasp because the unionized environm ent has dichotom ized w orker-m anagem ent relations throughout Europe.

A weakness o f some U.S. firms in com peting with Pacific Rim firms is a lack of understanding of Asian cultures, including how Asians think and behave. Spoken Chinese, for example, has more in com mon with spoken English than with spoken Japanese or Korean. U.S. managers consistently put more w eight on being friendly and liked, whereas Asian and European managers often exercise authority without this concern. Americans tend to use first nam es instantly in business dealings with foreigners, but foreigners find this presumptuous. In Japan, for example, first names are used only am ong family members and intimate friends; even longtime business associates and cow'orkers shy away from the use o f first names. Table 2-5 lists other cultural differences or pitfalls that U.S. managers need to know about.

U.S. managers have a low tolerance for silence, whereas Asian managers view extended periods o f silence as important for organizing and evaluating one’s thoughts. U.S. managers are much more action-oriented than their counterparts around the world; they rush to appointments, conferences, and meetings— and then feel the day has been productive. But for many foreign managers, resting, listening, m editating, and thinking is considered productive. Sitting through a conference without talking is unproductive in the United States, but it is viewed as positive in Japan if one’s silence helps preserve unity.

U.S. managers place greater em phasis on short-term results than foreign managers. In marketing, for example, Japanese managers strive to achieve ‘“everlasting custom ers,” whereas many Am ericans strive to make a onetime sale. M arketing managers in Japan see making a sale

TABLE 2-5 Cultural Pitfalls That May Help You Be a Better Manager

• Waving is a serious insult in Greece and Nigeria, particularly if the hand is near someone’s face.

• Making a “good-bye’‘ wave in Europe can mean “No,” but it means “Come here” in Peru. • In China, last names are written first. • A man named Carlos Lopez-Garcia should be addressed as Mr. Lopez in Latin America

but as Mr. Garcia in Brazil. • Breakfast meetings are considered uncivilized in most foreign countries. • Latin Americans are on average 20 minutes late to business appointments. • Direct eye contact is impolite in Japan. • Do not cross your legs in any Arab or many Asian countries—it is rude to show the sole

of your shoe. • In Brazil, touching your thumb and first finger—an American “Okay” sign—is the

equivalent of raising your middle finger. • Nodding or tossing your head back in southern Italy, Malta, Greece, and Tunisia means

“No.” In India, this body motion means “Yes.” • Snapping your fingers is vulgar in France and Belgium. • Folding your arms across your chest is a sign of annoyance in Finland. • In China, leave some food on your plate to show that your host was so generous that you

could not finish. • Do not eat with your left hand when dining with clients from Malaysia or India. • One form of communication works the same worldwide. It is the smile—so take that

along wherever you go.

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as the beginning, not the end, o f the selling process. This is an im portant distinction. Japanese managers often criticize U.S. managers for worrying more about shareholders, whom they do not know, than employees, whom they do know. Americans refer to “hourly em ployees” whereas many Japanese com panies still refer to “ lifetime employees."*

Rose Knotts recently summarized some important cultural differences between U.S. and foreign m anagers.3 Awareness and consideration o f these differences can enable a m anager to be more effective, regardless o f his or her own nationality.

1. Americans place an exceptionally high priority on time, viewing time as an asset. Many foreigners place more worth on relationships. This difference results in foreign managers often viewing U.S. managers as “more interested in business than people.”

2. Personal touching and distance norms differ around the world. Am ericans generally stand about three feet from each other when carrying on business conversations, but Arabs and Africans stand about one foot apart. Touching another person with the left hand in business dealings is taboo in some countries.

3. Family roles and relationships vary in different countries. For example, males are valued more than females in some cultures, and peer pressure, work situations, and business interactions reinforce this phenomenon.

4. Business and daily life in some societies are governed by religious factors. Prayer times, holidays, daily events, and dietary restrictions, for example, need to be respected by m anagers not fam iliar with these practices in some countries.

5. Time spent with the family and the quality of relationships are more important in some cultures than the personal achievement and accom plishments espoused by the traditional U.S. manager.

6. Many cultures around the world value modesty, team spirit, collectivity, and patience much more than com petitiveness and individualism, which are so important in the United States.

7. Punctuality is a valued personal trait when conducting business in the USA. but it is not revered in many o f the world's societies. Eating habits also differ dram atically across cultures. For example, belching is acceptable in some countries as evidence o f satisfaction with the food that has been prepared. Chinese culture considers it good m anners to sample a portion o f each food served.

8. To prevent social blunders when meeting with managers from other lands, one must learn and respect the rules o f etiquette of others. Sitting on a toilet scat is viewed as unsanitary in most countries, but not in the USA. Leaving food or drink after dining is considered impolite in some countries, but not in China. Bowing instead o f shaking hands is customary in many countries. Some cultures view Americans as unsanitary for locating toilet and bathing facilities in the same area, whereas Americans view people o f some cultures as unsanitary for not taking a bath or shower every day.

9. Americans often do business with individuals they do not know, unlike businesspersons in many other cultures. In Mexico and Japan, for example, an am icable relationship is often mandatory before conducting business.

In many countries, effective managers are those who are best at negotiating with government bureaucrats rather than those who inspire workers. Many U.S. managers are uncom fortable with nepotism, which are practiced in some countries. The USA defends women from sexual harassment, and defends minorities from discrimination, but not all countries em brace the same values. For example, in Indonesia, in mid-2013, legislators were considering making sex among singles a crim e with up to a 5-year prison sentence, and cohabitation a crim e with up to 1 year in prison.

U.S. managers in China have to be careful about how they arrange office furniture because Chinese workers believe in feng shui, the practice of harnessing natural forces. U.S. managers in Japan have to be careful about nem asw ashio, whereby Japanese workers expect supervisors to alert them privately o f changes rather than informing them in a meeting. Japanese managers have little appreciation for versatility, expecting all managers to be the sam e. In Japan, “ If a nail sticks out, you hit it into the wall,” says Brad Lashbrook, an international consultant for Wilson Learning.

Probably the biggest obstacle to the effectiveness of U.S. m anagers— or managers from any country working in another— is the fact that it is almost impossible to change the attitude of a

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foreign workforce. “The system drives you; you cannot fight the system or culture,” says Bill Parker, president o f Phillips Petroleum in Norway.

Communication Differences Across Countries Americans increasingly interact with managers in other countries, so it is important to understand foreign business cultures. Am ericans often com e across as intrusive, manipulative, and garrulous; this impression may reduce their effectiveness in com munication. Forbes provided the following cultural hints from Charis Intercultural Training:

1. Italians, Germans, and French generally do not soften up executives with praise before they criticize. Am ericans do soften up folks, and this practice seems manipulative to Europeans.

2. Israelis are accustomed to fast-paced meetings and have little patience for U.S. inform ality and small talk.

3. British executives often com plain that U.S. executives chatter too much. Informality, egalitarianism , and spontaneity from Americans in business settings jo lt many foreigners.

4. Europeans feel they are being treated like children when asked to wear name tags by Americans.

5. Executives in India are used to interrupting one another. Thus, when U.S. executives listen without asking for clarification or posing questions, they are viewed by Indians as not paying attention.

6. When negotiating orally with M alaysian or Japanese executives, it is appropriate to allow periodically for a tim e o f silence. However, no pause is needed when negotiating in Israel.

7. Refrain from asking foreign managers questions such as “How was your weekend?” That is intrusive to foreigners, who tend to regard their business and private lives as totally separate.4

Business Culture Across Countries^ A recent USA Today article (9-24-12. p. 8A) tilled “Arab Spring Leaving Women Out in Cold" reveals that the recent changeover o f regimes in Middle Eastern countries has unfortunately resulted in arguably less rights for women. Nawal A1 Saadawi says for example in Egypt “Things d idn 't improve for women, and we are going backward.” Even in a relatively progressive Middle Eastern country such as M orocco, there is legislation that allows men who rape or have sex with minors to avoid prosecution by wedding their victims. Sexual harassment o f women in the streets, according to the article, especially spikes during M uslim holidays. Perhaps the worst country for w om en's rights is Afghanistan, although Saudi Arabia is quite restrictive. In contrast, South Korea elected its first fem ale president late in 2012. She is Park Geun-hye, the daughter of the general who ruled the country in the 1960s and 1970s. Park jo ins the following other current female presidents o f countries:

Australia. Julia Gillard

Denmark, Helle Thorning-Schm idt

Germany, Angela Merkel

Iceland, Johanna Sigurdardottir

Switzerland, Eveline W idm er-Schlum pf

Many countries have in the past have had female presidents, including Canada, Chile, Israel. New Zealand. Norway, Slovak Republic. Turkey, and the United Kingdom.

Another recent USA Today article (12-4-12, 6B) titled “Europe Tries to Put Women on Boards” reveals that in the UK. 20 percent o f senior m anagement is female, but this is higher than in the Netherlands where the percentage is 18, Denm ark at 15, or Germany at 13. G erm any’s upper house o f parliam ent recently approved a bill to guarantee that women m ake up 20 percent o f boards at publicly traded com panies by 2018, and 40 percent by 2023. Chancellor Angela Merkel o f Germany, however, has said that she prefers voluntary m easures over mandatory quotas. In Norway, 40 percent o f nonexecutive board members o f publicly listed com panies are women, w hich is perhaps best o f all countries on the planet.

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Mexico— Business Culture M exico is an authoritarian society in term s o f schools, churches, businesses, and fam ilies. Employers seek workers who are agreeable, respectful, and obedient, rather than innovative, creative, and independent. M exican workers tend to be activity oriented rather than problem solvers. W hen visitors walk into a Mexican business, they are im pressed by the cordial, friendly atm osphere. This is almost always true because M exicans desire harm ony rather than conflict: desire for harmony is part o f the social fabric in w orker-m anager relations. There is a much lower tolerance for adversarial relations or friction at work in M exico as com pared to the USA.

M exican em ployers are paternalistic, providing workers with more than a paycheck, but in return they expect allegiance. Weekly food baskets, free meals, free bus service, and free day care are often part o f compensation. The ideal working condition for a M exican worker is the family model, with people all working together, doing their share, according to their designated roles. M exican workers do not expect or desire a work environment in w'hich self-expression and initiative are encouraged. W hereas U.S. business em bodies individualism, achievem ent, competition, curiosity, pragmatism, informality, spontaneity, and doing more than expected on the job. M exican businesses stress collectivism, continuity, cooperation, belongingness, formality, and doing exactly what is told.

In Mexico, business associates rarely entertain each other at their homes, which are places reserved exclusively for close friends and family. Business meetings and entertaining are nearly always done at a restaurant. Preserving one’s honor, saving face, and looking important are also exceptionally important in Mexico. This is why Mexicans do not accept criticism and change easily; many find it humiliating to acknowledge having made a mistake. A meeting among em ployees and managers in a business located in M exico is a forum for giving orders and directions rather than for discussing problem s or participating in decision making. M exican workers want to be closely supervised, cared for, and corrected in a civil manner. Opinions expressed by em ployees are often regarded as back talk in Mexico. Mexican supervisors are viewed as weak if they explain the rationale for their orders to workers.

M exicans do not feel com pelled to follow' rules that are not associated with a particular person in authority they work for or know well. Thus, signs to w ear earplugs or safety glasses, or attendance or seniority policies, and even one-way street signs are often ignored. W'hereas Americans follow the rules, M exicans often do not.

Life is slower in Mexico than in the USA. The first priority is often assigned to the last request, rather than to the first. Telephone systems break down. Banks may suddenly not have pesos. Phone repair can take a month. Electricity for an entire plant or town can be down for hours or even days. Business and government offices may open and close at odd hours. Buses and taxis may be hours off schedule. Meeting limes for appointments are not rigid. Tardiness is common everywhere. Effectively doing business in M exico requires knowledge o f the Mexican way o f life, culture, beliefs, and customs.

In M exico, when greeting others, it is custom ary for women to pat each other on the right forearm or shoulder, rather than shaking hands. Men shake hands or, if close friends, use the traditional hug and back slapping upon greeting. If visiting a M exican home, bring a gift such as flowers or sweets. Avoid m arigolds because they sym bolize death. Arrive up to 30 m inutes late, but definitely not early. Avoid red flowers which have a negative connotation. W hite flowers are an excellent choice. If you receive a gift, open it im m ediately and react enthusiastically. At dinner, do not sit until you are invited to and wait to be told w'here to sit. This is true in most foreign countries and in the USA. Do not begin eating until the hostess starts. Only men give toasts in M exico. It is also polite to leave som e food on your plate after a meal. For business appointm ents, as opposed to hom e visits, it is best to arrive on time, although your M exican counterparts may be up to 30 minutes late. Do not get irritated at their lack of punctuality.

M exicans often judge or stereotype a person by who introduces them and changing that first impression is difficult in business. Expect to answer questions about personal background, family, and life interests— because M exicans consider trustworthiness and character to be of upmost importance. M exicans are status conscious, so business titles and rank are important. Face-to-face meetings are preferred over telephone calls, letters, o r e-mail. Negotiations in Mexico include a fair am ount of haggling, so do not give a best offer first.

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Japan— Business Culture Japan elected a new prime minister. Shinzo Abe, in December 2012. Abe promises aggressive new monetary policy, big public works spending, and lull economic recovery. Walmart believes in Abe because it, under the name Seiyu Ltd.. is adding 22 stores in Japan in 2013-2014, to go along with its already 368 stores in Japan. Two trends in Japan driving the Walmart expansion are (1) single-person households, especially among the elderly, are continuing to grow and (2) people have less money to spend. Japanese consumers have traditionally equated discounts with poor quality, but that is changing. Also, Walmart gained much support throughout Japan with its quick response flying in water and food immediately after the earthquake and tsunami hit Japan in 2011.

The Japanese place great importance on group loyalty and consensus, a concept called Wa. Nearly all corporate activities in Japan encourage Wa among managers and em ployees. Wa requires that all members of a group agree and cooperate; this results in constant discussion and com prom ise. Japanese managers evaluate the potential attractiveness of alternative business decisions in terms of the long-term effect on the group 's Wa. This is why silence, used for pondering alternatives, can be a plus in a formal Japanese meeting. Discussions potentially disruptive to Wa are generally conducted in informal settings, such as at a bar. so as to minimize harm to the group’s Wa. Entertaining is an important business activity in Japan because it strengthens Wra. Formal meetings are often conducted in informal settings. When confronted with disturbing questions or opinions, Japanese managers tend to remain silent, whereas Americans tend to respond directly, defending themselves through explanation and argument.

Americans have more freedom to control their own fates than do the Japanese. The USA offers more upward mobility to its people, as indicated below:

America is not like Japan and can never be. A m erica’s strength is the opposite: It opens its doors and brings the w orld 's disorder in. It tolerates social change that would tear most other societies apart. This openness encourages Americans to adapt as individuals rather than as a group. A m ericans go west to California to get a new start; they move east to M anhattan to try to make the big time; they move to Vermont or to a farm to get close to the soil. They break away from their parents’ religions or values or class; they rediscover their ethnicity. They go to night school; they change their nam es.6

M ost Japanese managers are reserved, quiet, distant, introspective, and other oriented, whereas most U.S. managers are talkative, insensitive, impulsive, direct, and individual oriented. Am ericans often perceive Japanese managers as wasting time and carrying on pointless conversations, whereas U.S. managers often use blunt criticism , ask prying questions, and make quick decisions. These kinds o f cultural differences have disrupted many potentially productive Japanese-A m crican business endeavors. Viewing the Japanese com m unication style as a prototype for all Asian cultures is a stereotype that must be avoided.

In Japan, a person's age and status are o f param ount im portance, whether in the fam ily unit, the extended family, or a social or business situation. Schoolchildren learn early that the oldest person in the group is to be honored. O lder folks are served first and their drinks are poured for them. Greetings in Japan are formal and ritualized. Wait to be introduced because it may be viewed as impolite to introduce yourself, even in a large gathering. Foreigners may shake hands, but the traditional form of greeting is to bow. The deeper you bow. the more respect you show, but at least bow the head slightly in greetings.

In gift giving in Japan, chocolates or small cakes are excellent choices, but do not give lilies, camellias, lotus blossoms, or white flowers because they all are associated with funerals. Do not give potted plants because they encourage sickness, although a bonsai tree is always acceptable. Give items in odd numbers, but avoid the number 9. Gifts are not opened when received. If going to a Japanese home, remove your shoes before entering and put on the slippers left at the doorway. Leave shoes pointing away from the doorway you are about to walk through. If going to the toilet in a Japanese home, put on the toilet slippers and remove them when you exit.

In Japan, w'hen finally seated for dinner, never point the chopsticks. Learn how to use chopsticks before visiting Japan and do not pierce food with chopsticks. Japanese oftentimes slurp their noodles and soup, but mixing other food with rice is inappropriate. Instead of mixing, cat a bit of rice and then a bit o f food. To signify that you do not want more rice or drink, leave some in the bowl or glass. Conversation over dinner is generally subdued in Japan because they prefer to savor their food.

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Unlike Americans, Japanese prefer to do business on the basis o f personal relationships rather than impersonally speaking over the phone or by written correspondence. Therefore, build and maintain relationships by sending greeting, thank you, birthday, and seasonal cards. You need to be a good “correspondent” to effectively do business with the Japanese. Punctuality is important so arrive on time for meetings and be mindful that it may take several meetings to establish a good relationship. The Japanese are looking for a long-term relationship. Always give a small gift as a token of your appreciation, and present it to the most senior person at the end of any meeting.

Like many Asian and African cultures, the Japanese are non-confrontational. They have a difficult tim e saying “no," so you must be vigilant at observing their nonverbal com m unication. Rarely refuse a request, no matter how difficult or non-profitable it may appear at the time. In com municating with Japanese, phrase questions so that they can answer yes. For example, do you disagree with this? Group decision making and consensus are vitally important. The Japanese often remain silent in meetings for long periods o f time and may even close their eyes when they want to listen intently.

Business cards are exchanged in Japan constantly and with excitem ent. Invest in quality business cards and keep them in pristine condition. Do not write on them. Have one side o f your card translated in Japanese and give it to the person with the Japanese side facing the recipient. Business cards are generally given and received with two hands and a slight bow. Examine any business card you receive carefully.

Brazil— Business Culture In both Brazil and the USA, men greet each other by shaking hands while maintaining steady eye contact. Women greet each other with kisses in Brazil, starting with the left and alternating cheeks. Hugging and backslapping are also common greetings among Brazilian close friends. If a woman wishes to shake hands with a man, she should extend her hand first. Brazilians speak Portuguese. If going to som eone’s house in Brazil, bring the hostess flowers or a small gift. Orchids are nice, but avoid purple or black, because these are mourning colors. Arrive at least 30 m inutes late if your invitation is for dinner and arrive up to an hour late for a party or large gathering. Never arrive early. Brazilians dress with a flair and judge others on their appearance, so even casual dress is more formal than in many other countries. Always err on the side of over-dressing in Brazil rather than under-dressing.

Avoid embarrassing a Brazilian by criticizing an individual publically: that causes that person to lose face with all others at a business meeting, and the person making the criticism also loses face because they have disobeyed the unwritten Brazilian rule. It is considered acceptable, however, to interrupt someone who is speaking. Face-to-face, oral com m unication is preferred over written com munication. As for business agreements, Brazilians insist on drawing up detailed legal contracts. They are more com fortable doing business with and negotiating with people than companies. Therefore, wait for a Brazilian colleagues to raise the business subject. Never rush the prebusiness relationship-building time. Brazilians take their time when negotiating. Use local lawyers and accountants for negotiations because Brazilians resent an outside legal presence.

Appointments are com monly cancelled or changed at the last m inute in Brazil, so do not be surprised or get upset. In the cities o f Sao Paulo and Brasilia, arrive on time for meetings, but in Rio de Janeiro arrive a few m inutes late for a meeting. Do not appear im patient if kept waiting, because relationship building always takes precedence over adhering to a strict schedule. Brazilians pride themselves on dressing well, so men should wear conservative, dark-colored business suits or even three-piece suits for executives. Women should wear suits or dresses that are elegant and fem inine with good, quality accessories. And ladies, m anicures are expected.

Germany— Business Culture Business com munication in Germany is formal, so the home is a welcom e, informal place. Germans take great pride in their home, which is generally neat and tidy inside and out. Only close friends and relatives are invited into the sanctity o f a person’s house, so consider that an honor if you get that invitation, and bring a gift, such as chocolates or yellow roses or tea roses— but not red roses, which symbolize rom antic intentions. A lso do not bring carnations, lilies, or chrysanthem um s, which in Germany symbolize m ourning. If you bring w ine to a

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G erm an’s home, il should be imported, French or Italian. Always arrive on time but never early, and always send a handwritten note the following day to thank your hostess for her hospitality.

When it is time to have dinner, remain standing until invited to sit down. As is custom in many countries, you may be shown to a particular seat. Table manners in Germany are strictly Continental with the fork being held in the left hand and the knife in the right while eating. Do not begin eating until the hostess starts or someone says guten appetit (“good appetite“’). Wait for the hostess to place her napkin in her lap before doing so yourself and do not rest your elbows on the table. Cut as much o f your food with your fork as possible because this com plim ents the cook by indicating the food is tender. Break bread or rolls apart by hand, but if a loaf is in the middle for all, then touch only what you extract to eat. This sanitary’ practice is a must in all countries including the USA. Finish everything on your plate and indicate you have finished eating by laying your knife and fork parallel across the right side o f your plate, with the fork over the knife.

Germ ans are like A m ericans in that they do not need a personal relationship to do business. They are more interested in a businessperson’s academic credentials and their com pany’s credentials. A quick, firm handshake is the traditional greeting, even with children. At the office, Germans do not have an open-door policy and often work with their office door closed, so knock and wait to be invited to enter. Appointm ents are mandatory and should be made one to two weeks in advance. Germans are often direct to the point of bluntness. Punctuality is extremely important in Germany, so if you are going to be delayed, telephone imm ediately and offer an explanation. It is rude to cancel a m eeting at the last minute and this could jeopardize the whole business relationship. German meetings adhere to strict agendas, including starting and ending times. Germ ans maintain direct eye contact while speaking.

There is a strict protocol to follow in Germany when entering a room — the eldest or highest-ranking person enters first and men enter before women if their age and status are roughly equivalent. Germans are detail oriented and want to understand every innuendo before com ing to an agreement. Business decision making is autocratic and held at the top of the company. Final decisions will not be changed and are expected to be im plem ented by lower- level m anagers and em ployees with no questions asked. Am ericans are more flexible in many respects than Germans.

Egypt— Business Culture In Egypt, greetings are based on both social class and religion, so follow the lead o f others. Handshakes, although limp and prolonged, are the customary greeting among Egyptians of the same sex. Handshakes are always given with a hearty smile and direct eye contact. Once a relationship has developed, it is com mon to greet with a kiss on one cheek and then the other, while shaking hands, men with men and women with women. In greetings between men and women, the woman will extend her hand first. Otherwise, a man should bow his head in greeting.

If you are invited to an Egyptian’s home, remove your shoes before entering, just as you would do in China and Japan. As a gift, bring chocolates, sweets, or pastries to the hostess. Do not give flowers, which are usually reserved for weddings or the ill, unless you know that the host will appreciate them. Always give gifts with the right hand or both hands if the gift is heavy. G ifts are not opened when received. Never sit at a dinner table until the host or hostess tells you where to sit. Eat with the right hand only and com pliment the host by taking second helpings. Always show appreciation for the meal. Putting salt or pepper on your food is considered an insult to a cook. This is true to a lesser extent even in the USA. Leave a small am ount of food on your plate when you have finished eating. O therw ise your Egyptian host may keep bringing you more food.

Egyptians prefer to do business with those they know and respect, so expect to spend time cultivating a personal relationship before business is conducted. W ho you know is more important than what you know in Egypt, so network and cultivate a number o f contracts. You should expect to be offered coffee or tea whenever you meet someone in Egypt because this dem onstrates hospitality. Even if you do not want the drink, always accept the beverage because declining the offer is viewed as rejecting the person.

In Egypt, appearance is im portant, so wear, conservative clothes and present yourself well at all times. For Egyptians, direct eye contact is a sign of honesty, so be prepared for overly intense stares. Hierarchy and rank are important. Unlike in Germany. Egyptian business people

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do have an open-door policy, even when they are in a meeting, so you may experience frequent interruptions as others wander into the room and start a different discussion. It is best that you not try to bring the topic back to the original discussion until the new person leaves. Business meetings generally start after prolonged inquiries about health, family, and such.

Egyptians must know and like you to conduct business. Personal relationships are necessary for long-term business. The highest-ranking person makes decisions, after obtaining group consensus. Decisions are reached after great deliberation. In Egypt, business moves at a slow pace and society is extremely bureaucratic— even in the post-Hosni M ubarak era. Egyptians respect age and experience and engage in a fair amount o f haggling. They are tough negotiators and do not like confrontation or having to say no. Egyptian women must be careful to cover themselves appropriately. Skirts and dresses should cover the knee and sleeves should cover most o f the arm. Women are daily gaining more rights, however, throughout the M iddle East, and that is a good thing. In late 2011. women in Saudi Arabia were finally granted the right to vole, but women still are not allowed to drive cars in that country.

China— Business Culture In China, greetings are formal and the oldest person is always greeted first. Like in the United States, handshakes are the most common form of greeting. Many Chinese will look toward the ground when greeting someone. The Chinese have an excellent sense o f humor. They can easily laugh at themselves if they have a com fortable relationship with the other person. In terms of gifts, a food basket makes an excellent gift, but do not give scissors, knives, or other cutting utensils because these objects indicate severing o f the relationship. Never give clocks, handkerchiefs, flowers, or straw sandals because they are associated with funerals. Do not wrap gifts in white, blue, or black paper. In China, the num ber 4 is unlucky, so do not give four of anything. Eight is the luckiest number, so giving eight o f something is a great idea.

If invited to a Chinese person’s home, consider this a great honor and arrive on time. Remove your shoes before entering the house and bring a small gift to the hostess. Eat heartily to demonstrate that you are enjoying the food. Use chopsticks and wait to be told where to sit. You should try everything that is offered and never eat the last piece from the serving tray. Hold the rice bowl close to your mouth while eating. Do not be offended if a Chinese person makes slurping or belching sounds; it merely indicates that they are enjoying their food.

The Chinese rarely do business with com panies or people they do not know. Your position on an organizational chart is extremely important in business relationships. G ender bias is generally not an issue. Meals and social events are not the place for business discussions. There is a demarcation between business and socializing in China, so try to be careful not to intertw ine the two.

Like in the USA and Germany, punctuality is important in China. Arriving late to a meeting is an insult and could negatively affect your relationship. Meetings require patience because mobile phones ring frequently and conversations tend to be boisterous. Never ask the Chinese to turn off their mobile phones because this causes you both to lose face. The Chinese are non-confrontational and virtually never overtly say no. Rather, they will say “they w ill think about it” or “they will see.” The Chinese are shrewd negotiators, so an initial offer or price should leave room for negotiation.

India—Business Culture According to United N ations’ statistics, India’s rate o f female participation in the labor force is 34.2 percent, which is quite low, especially because women make up 42 percent o f college graduates in India. But Indian women with a college degree are expected to let their careers take a back seat to caring for their husband, children, and elderly parents. “The measures of daughterly guilt are much higher in Indian women than in other countries,” says Sylvia Ann Hewlett, president o f the Center for Work-Life Policy, a Manhattan think tank, who headed a recent study on the challenges Indian women face in the workplace.8 Sylvia says, “Since taking care of elderly parents usually becomes a reality later in a wom an’s career, it takes them out o f the workplace just when they should be entering top management roles.” That is why gender disparities at Indian companies unfortunately grow more pronounced at higher levels o f management.

Like in many Asian cultures, people in India do not like to say no, verbally or nonverbally. Rather than disappoint you, they often will say som ething is not available, will offer you the

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response that they think you want to hear, or will be vague with you. This behavior should not be considered dishonest. Shaking hands is com mon in India, especially in the large cities among the more educated who are accustom ed to dealing with westerners. Men may shake hands with other men and women may shake hands with other women; however, there are seldom handshakes between men and women because of religious beliefs.

Indians believe that giving gifts eases the transition into the next life. G ifts o f cash are com mon, but do not give frangipani or white flowers because they represent mourning. Yellow, green, and red are lucky colors, so use them to wrap gifts. Because Hindus consider cows to be sacred, do not give gifts made o f leather to Hindus. M uslim s should not be given gifts made of pigskin or alcoholic products. Gifts are usually not opened when received.

Before entering an Indian’s house, take off shoes just as you would in China or Japan. Politely turn down the host’s first offer o f tea, coffee, or snacks. You will be asked again and again. Saying no to the first invitation is part o f the protocol. Be mindful that neither Hindus nor Sikhs eat beef, and many are vegetarians. M uslim s do not eat pork or drink alcohol. Lamb, chicken, and fish are the most com m only served main courses. Table manners are somewhat formal, but much Indian food is eaten with the fingers. Like most places in the world, wait to be told where and when to sit at dinner. Women in India typically serve the men and eat later. You may be asked to wash your hands before and after sitting down to a meal. Always use your right hand to eat, whether using utensils or your fingers. Leave a small amount o f food on your plate to indicate that you are satisfied. Finishing all your food means that you are still hungry, which as true in Egypt, China. Mexico, and many countries.

Indians prefer to do business with those with whom they have established a relationship built on mutual trust and respect. Punctuality is important. Indians generally do not trust the legal system, and som eone's word is often sufficient to reach an agreement. Do not disagree publicly with anyone in India.

Titles such as professor, doctor, or engineer are important in India, as is a person’s age, university degree, caste, and profession. Use the right hand to give and receive business cards. Business cards need not be translated into Hindi but always present your business card so the recipient may read the card as it is handed to them. This is a nice, expected gesture in most countries around the world.

Nigeria—Business Culture W ith the largest population o f any country in Africa and the largest city in Africa (Lagos), N igeria on the west coast bordering the G ulf o f Guinea, is a dem ocratic country with English as its official language. H alf o f N igeria 's population is under age 18. With a growing economy, N igeria’s constitution guarantees religious freedom. Christians in Nigeria live mostly in the south, whereas M uslims live mostly in the north. Native religions in which people believe in deities, spirits, and ancestor worship are spread throughout Nigeria, as are different languages. Christm as and Easter are national holidays. M uslim s observe Ramadan, the Islamic month of fasting, and the two Eids. Working hours in the north often vary from the south, primarily because M uslims do not work on their holy day— Friday.

Endowed with vast quantities o f natural resources and being the sixth largest oil-producing nation on the planet, Nigeria has a well-educated and industrious people who are proud of their country. N igerians are fond of the expression, “W hen Nigeria sneezes, the rest of Africa catches a cold (except South Africa).” Nigeria re-elected its president in 2011, a zoology professor-turned-president, Goodluck Jonathan.

In Nigeria, extended families are still the backbone o f social and business systems. Grandparents, cousins, aunts, uncles, sisters, brothers, and in-laws all work as a unit through life. Hierarchy and seniority within extended families are important; the oldest person in a group is revered and honored, and is greeted and served first. In return, however, the most senior person has the responsibility to make good decisions for the extended family.

The most com mon greeting in Nigeria is a handshake with a warm, welcom ing smile. M uslim s will not generally shake hands with members o f the opposite sex. Nigerians do not use first nam es readily, so wait to be invited to do this before engaging. Gift giving is com mon and even expected, but gifts from a man to a woman must be said to come from the m an’s mother, wife, sister, or other female relative, never from the man himself. Never rush a greeting because that is extrem ely rude: rather, spend tim e inquiring about the other person’s general well-being.

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Foreigners who take the tim e to get to know a Nigerian as a person are often welcom ed into the N igerian’s inner circle o f family and close friends. Nigerians are generally outgoing and friendly, especially in the southwest, where the Yoruba often use hum or even during business m eetings and serious discussions.

To combat the AIDS epidemic in sub-Saharan Africa, the World Bank is now paying young girls cash to stop accepting gifts and cash from older men in exchange for sex. This “sugar daddy” relationship is com mon in many African countries and is fueling the AIDS problem because the percent o f men aged 30-34 that test positive for HIV is upward o f 30 percent in countries such as Zimbabwe. The World Bank has a billboard in the M bare vegetable market in Harare, Zimbabwe, that reads, “Your future is brighter w ithout a sugar daddy.”

Business Climate Across Countries/Continents The World Bank and the International Finance Corporation annually rank 183 countries in terms o f their respective ease of doing business (http://www.doingbusiness.org/rankings). The index ranks nations from 1 (best) to 183 (worst). For each nation, the ranking is calculated as the simple average of the percentile rankings on how easy is it to: (1) start a business, (2) deal with construction permits, (3) register property, (4) get credit, (5) protect investors, (6) pay taxes, (7) trade across borders, (8) enforce contracts, (9) resolving insolvency, and (10) get electricity.

Among all countries on the planet, M orocco improved its ranking m ost in 2012, clim bing 21 places to 94, by sim plifying the construction permitting process, easing the adm inistrative burden of tax com pliance, and providing greater protections to minority shareholders. Table 2-6 reveals the 2012 Ease of Doing Business rankings for the top 10 nations in various regions of the world. Note for example that Norway is rated the sixth best country on the planet for ease o f doing business and Chile is the best country in South America.

Union Membership Across Europe There is great variation in Europe as per levels o f union membership, ranging from 74 percent o f em ployees in Finland and 71 percent in Sweden to 9 percent in Lithuania and 8 percent in France. However, percentage of union m embership is not the only indicator o f strength because in France for example, unions have repeatedly shown that despite low levels o f m em bership they are able to mobilize workers in mass strikes and dem onstrations to great effect.

The average level o f union m embership across the whole of the European Union (EU), weighted by the numbers em ployed in the different member states, is 23 percent compared to about 11 percent in the USA. The European average is held down by relatively low levels o f membership in some o f the larger EU states, Germany with 19 percent, France with 8 percent. Spain with 16 percent, and Poland with 15 percent. The three sm allest states, Cyprus, Luxembourg, and Malta, have levels well above the average.

TABLE 2-6 The Top 10 Nations to Do Business With Across Continents

Overall Best East Asia Pacific

East Europe Central Asia

Latin America Caribbean

Mid-East Africa

South Africa

l . Singapore Singapore Georgia Chile Saudi Arabia Mauritius

2. Hong Kong Hone Kong Latvia Peru UAE S. Africa

3. New Zealand Thailand Macedonia Colombia Qatar Rwanda

4. USA Malaysia Lithuania Puerto Rico Bahrain Botswana

5. Denmark Taiwan Cyprus St. Lucia Tunisia Ghana

6. Norway Tonga Kazakhstan Mexico Oman Nambia

7. United Kingdom Samoa Armenia Antiqua Kuwait Zambia

8. South Korea Solomon Isis. Montenegro Panama Morocco Seychelles

9. Iceland Vanuatu Bulgaria Dominica Jordan Kenya

10. Ireland Fiji Azerbajan Trinidad Yemen Ethiopia

Source: Based on information at http://www.doingbusiness.org/rankings in November 2012.

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The three Nordic countries o f Denmark, Sweden, and Finland are at the top o f the table with around 70 percent o f all em ployees in unions. In part this is because, as in Belgium, which also has above average levels of union density, unem ploym ent and other social benefits are normally paid out through the union. High union density in the Nordic countries also reflects an approach that sees union m embership as a natural part o f employment, as shown by the relatively high proportion o f em ployees (around 53 percent) who are union members in Norway, where unem ployment benefits are not paid through the unions.

Central and Eastern Europe nations generally have below' average levels o f union membership. In Poland for example 16 percent o f em ployees are estim ated to be union m embers. Level o f union membership is clearly trending downward all over Europe. Only 8 out o f the 27 EU states plus Norway— Belgium. Cyprus, Ireland, Italy, Luxembourg, Malta, Norway and Spain— have seen a gain in union members among the em ployed in recent years, and in most of these countries. This growth has not kept pace with the overall growth in em ployment, meaning that union density has drifted downward. The two exceptions appear to be Ireland and Italy where union membership is slowly growing.

African Countries In 2012, 23 African countries held dem ocratic elections, whereas in 1989 only 3 African countries were considered dem ocracies. Currencies in Africa are stabilizing and many countries are fund-raising to build modern highways, ports, and power grids. African countries are winning over investors as indicated by Zam bia raising $750 million in bonds recently, followed by Rwanda, Nigeria, and Kenya doing the same. Yields on some African bonds are only slightly higher than the yield on the debt o f some troubled European econom ies, such as Spain. Investors are looking closely at Africa now in the wake o f low interest rates and slow growth elsewhere on the planet.7

Many African com panies are expanding in Africa, such as South A frica’s Shoprite Group in 2013 adding 223 stores in 16 African countries other than South Africa. Shoprite is especially targeting Nigeria and the Congo. Dangote Group, based in Nigeria, is building a cem ent factor}' in Zambia, and Togo-based Ecobank Transnational now operates in 32 African countries. D om ino’s recently opened stores in Nigeria, Egypt, M orocco, and Kenya. Reasons com panies are opening outlets in Africa is the rapidly growing middle class and an average GDP growth o f 5 percent for the continent through 2017 according to the IMF. Also, the World Bank saying food demand across A frica will double between 2012 and 2020.

Financial troubles in Europe, as well as rioting in the M uslim world, are problem s for African currencies, such as the Ghana cedi and the Kenya shilling, which depreciated rapidly in 2012. Perennial challenges remain in Africa, such as lack o f reliable roads, phone lines, and pow'er grids, but consum er spending in Africa is expected to double from $500 billion in 2012 to SI trillion in 2020, creating great opportunities for thousands of firms.*

M arriott added its first sub-Saharan Africa hotel in 2013, in the capital o f Rwanda, w'hich is Kigali. Rw anda’s GDP has grown 8 percent annually since 2004 as their president, Paul Kagame, wants to turn the tiny, landlocked equatorial country into an African Singapore. M arriott previously had 7 hotels in northern Africa (M orocco, Algiers, and Egypt), but none below the Sahara desert. M arriott now plans to build 2 hotels in Ghana, 2 in Nigeria, and 2 in Ethiopia between 2013 and 2015. “M ost o f Africa is a bit o f a blank piece of paper for the hospitality industry,” says Alex Kyriakidis, ch ief o f M arriott’s Middle East and Africa division. South A frica’s Protea Hospitality Group plans to add 9 hotels in 2013-2014 to its 36 African properties outside its home country. All total, 208 new', large hotels were added across Africa in 2012 com pared to 159 the prior year. M any firms are globally acquiring firms in Africa, such as India’s number-2 tire maker, Apollo Tyres, recently buying South A frica’s Dunlop Tyres for $62 million. Apollo plans to triple sales to $6 billion by 2015, with 60 percent of that revenue com ing from outside India.

Airlines are beginning to really serve Africa, led by Delta in the USA and Persian G ulf carriers such as Qatar Airways, Emirates, and Etihad Airways. The five largest airports in sub-Saharan Africa ranked by available seats in June 2013 were:

Johannesburg, South Africa (278.392)

Addis Ababa, Ethiopia (167,408)

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Khartoum, Sudan (142,408)

Nairobi, Kenya ( 126,729)

Lagos, N igeria (120,034)

The McKinsey Global Institute reports that approxim ately 40 percent o f Africans now live in urban areas and the num ber o f households with discretionary income should increase 50 percent by the end of this decade.9 Graham Allan, CEO o f Yum Restaurants International, recently said, “A lot of com panies, especially Chinese ones, have invested in Africa; we share the general view that Africa over the next 10 to 20 years will have massive potential.” M cKinsey & Co. says the num ber o f consum ers who can spend beyond bare necessities is greater now in Africa than India. From 2000 to 2009, foreign direct investment in A frica increased 600 percent to $58.56 billion.

Walmart recently acquired South African retailer M assm art Holdings for $4.6 billion, providing the company with 290 stores in 13 African countries: Ghana, N igeria, Zam bia, Botswana, Namibia, South Africa, Lesotho, M ozambique, Zimbabwe, M auritius, Malawi, Tanzania, and Uganda. The Walmart acquisition paves the way for many firm s now viewing Africa as a deal-making destination. For example, HSBC Holdings is trying to acquire a majority stake in Nedbank Group, South A frica’s fourth-largest bank, and Nippon Telegraph and Telephone in Japan is buying A frica’s largest technology company, Dim ension Data. Huge purchases such as these have been a wake-up call to the rest o f the world, which now views Africa as a growing, attractive new market.

Table 2-7 provides a summary of the economic situation in 12 African countries. Note that Angola is rated lowest in terms of doing business, whereas South Africa is rated highest. Recent regime changes in Egypt, Tunisia, Libya, and Algeria may spur further investment in Africa as democracy and capitalism strengthens. Many multinational com panies are now gaining first mover advantages by engaging Africa at all levels. For example, Nokia and Coca-Cola have distribution networks in nearly every African country. Unilever has a presence in 20 o f A frica’s 50 countries. Nestle is in 19 African countries, Barclays is in 12, Societe Generale is in 15, and Standard Chartered Bank is in 14. Africa has about 10 percent o f the w orld’s oil reserves, 40 percent o f its gold ore, and 85 percent o f the w orld’s deposits o f chrom ium and platinum. A frica's population is young, growing, and moving into jobs in the cities. Forty percent of Africans today live in the cities, a proportion close to China and India. The general stereotype

TABLE 2-7 Sampling of African Countries— Ease-of-Doing-Business Rankings

Population in Millions

Ease of Doing Business

Among all Countries Capital City

South Africa 49 35 out of 183 Pretoria Tunisia 11 46 out of 183 Tunis

Ghana 24 63 out of 183 Accra Morocco 32 94 out of 183 Rabat

Kenya 39 109 out of 183 Nairobi

Egypt 79 110 out of 183 Cairo Ethiopia 86 111 out of 183 Addis Ababa

Uganda 33 123 out of 183 Kampala

Nigeria 150 133 out of 183 Abuja

Sudan 41 135 out of 183 Khartoum

Mozambique 22 139 out of 183 Maputo

Angola 13 172 out of 183 Luanda

Source: Based on information at http:/Avww.doingbusiness. org/rankings on November 1. 2012.

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o f Africa is rapidly changing from subsistence farmers avoiding lions, to millions o f smartphone carrying consumers in cities purchasing products.

Africa has the w orld 's largest deposits o f platinum, chrome, and diam onds— and many Chinese com panies in particular are investing there. A frica’s largest food retailer, Shoprite Holdings, has more than 1,000 stores in 17 countries. Shoprite is a potential acquisition target being considered by European retailers Carrefour and Tesco. Diageo PLC sells Guinness beer, Sm irnoff vodka, Baileys liqueur, and Johnnie W alker whiskey in more than 40 countries across Africa. Nestlé SA now has more than 25 factories in Africa.

Yum Brands recently doubled the num ber o f Kentucky Fried Chicken (KFC) outlets in Africa to 1,200 and increased its revenue from the continent to almost $2 billion. “Africa w asn’t even on our radar screen 10 years ago, but now we see it exploding with opportunity" says David Novak, Yum’s chairm an and CEO. Yum Brands is excited about A frica’s growing middle class, vast population, and im proving political stability o f most African governments. Yum Brands is especially targeting Nigeria, Nam ibia, M ozam bique, Ghana, Zambia, and South Africa. The com pany says it wants to reach more of A frica’s one billion people than its current custom er base o f 180 million. But KFC currently has about 45 percent o f South A frica’s fast-food market, followed by N ando’s with 6 percent and M cD onald 's with 5 percent. KFC is opening 25 new outlets in Ghana in 2013-2014, part o f the com pany’s 1,200 KFCs in Africa by year-end 2014.

Ghana recently became A frica’s newest oil-producing nation when the 1.5-billion-banrel Jubilee field began pumping oil. A lthough G hana’s estim ated 4 billion barrels o f reserves are about a third those o f Nigeria, Ghana has a stable political and econom ic situation. Ethiopia is also doing well economically. SABM iller PLC recently invested $20 million in a manufacturing plant in E thiopia’s large city. Ambo. That factory today produces 40,000 glass bottles o f mineral water per hour. Ambo sells for about $6 a bottle in New York restaurants. Ambo water is part of the SABM iller portfolio that includes 45 African beers.10

Nairobi, Kenya, is the center o f several m ajor telecom com panies trying to gain market share in the rapidly growing African cellphone business. Vodafone Safaricom Ltd. dom inates the Kenyan telecom m unications sector with 77 percent market share, but India’s Bharti Airtel Ltd. boosted its market share in the last year to alm ost 20 percent. There are currently more than 440 million mobile subscribers in Africa generating more than $15 billion in telecom revenue annually. All o f Africa is com ing online, representing huge opportunities for countless com panies. M cKinsey & Co. estim ates that w ithin five years another 220 million Africans that today can meet only basic needs will join the middle class as consum ers.11 There are more than 950 million people who live in Africa.

China In late 2012, C hina’s econom y began to accelerate after nearly two years o f slowing growth. China's industrial production grew 9.6 percent in O ctober 2012, up from a 9.2 percent gain in September. C hina’s GDP grew at 7.4 percent in the third quarter o f 2012 year-over-year. Analysts expect continued increasing growth, giving a lift to global economic prospects. Although the USA is the w orld’s largest economy with a GDP o f over $15 trillion annually, China recently passed Japan to become the w orld’s second-largest economy with a GDP o f about $5.75 trillion annually, com pared to Japan’s $6 trillion. China, however, is still an em erging economy, as indicated by a per-capita GDP of $10,000, com pared to the USA and Japan per-capita GDPs of $48,000 and $47.000. respectively. C hina’s econom ic (GDP) growth of over 9 percent annually for several decades is, however, much faster than either the USA or Japan. Premier Wen Jiabao recently proclaim ed that C hina’s annual GDP growth will be held to 7.0 percent if possible to constrain inflation. Goldman Sachs predicts that China will overtake the USA as the w orld’s largest econom y by 2027.

C hina’s rapid growth has created substantial pollution, extensive inequality, and deeply em bedded corruption. In fact, C hina’s com m unist government is concerned that political unrest in the M iddle East may spread to China in a "Jasm ine Revolution” because the masses in China barely make enough to survive. The World Bank estim ates that more than 100 million Chinese citizens, nearly the size o f Japan’s entire population, live on less than $2 a day— but C hina’s middle class is growing rapidly.

For many decades, low wage rates in China helped keep world prices low on hundreds of products— but that is changing, because all 31 Chinese provinces and regions recently boosted

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their minimum wage for the second consecutive year. Analysts expect dem and for workers in China to outstrip supply by 2014, and this is contributing to rapidly rising wage rates and worldwide inflation. Commercial and industrial developm ent in C hina’s west has turned interior cities such as Chongqing into production centers that com pete for labor with coastal factories. According to Credit Suisse in Hong Kong, pay to migrant laborers who fuel C hina’s export industry rose 40 percent in 2010 and 30 percent in 201 1, and sim ilar increases are expected in 2012. Average monthly pay in 2009 in Shenzhen on the southern China coast was $235, com pared to Seoul’s $ 1 ,220, Taipei's $888, Ho Chi Minh C ity’s S100. Jakarta’s $148, and $47 in Dhaka. B angladesh.12

China has become the biggest trading partner for Australia, Japan. Korea. India. Russia, and South Africa and has replaced the USA as the top export market for Brazil. The w orld 's two fastest-growing major economies, China and India, recently announced that the two countries will more than double their bilateral trade between 2010 and 2015 to $100 b illion .13 China is opening its large consumer m arkets more to Indian goods. China may soon support India having a permanent seat on the United Nations Security Council. China has long opposed a permanent seat for India. The increased cooperation between China and India is good news for com panies worldwide doing business in that part o f Asia.

As indicated in Table 2-7, China ranks 91st out o f 183 countries in terms of doing business, for a variety o f reasons ranging from human rights issues to substantial disregard for copyright, patent, and trademark rules o f law. Best Buy and Home Depot are exam ple com panies that are closing stores in China. Both firms have not com peted well in China as a result o f being too "high priced” compared to home-grown, sim ilar businesses. The Chinese are price conscious. In contrast, luxury handbag maker. Coach Inc. has made China the cornerstone of its international strategy as the firm ’s sales and profits are rising sharply in China. Interestingly, Coach is adding more products for men and opening m en’s stores in China.

China is gaining a stronger and stronger foothold into Japanese businesses. The five largest recent Chinese investments in Japan are Mitsubishi UFJ Financial (92 billion yen). Canon (74.5 billion yen), Sumitomo Mitsui (57.9 billion yen), Nippon T& T (49.2 billion yen), M itsubishi (47.8 billion yen), Takeda Pharm (45.4 billion yen), and Sony (41.6 billion yen). The Japanese investment adviser Chibagin Asset M anagement says China state funds have recently more than doubled their investment in Japan to 1.62 trillion yen in 90 com panies.

Note also in Table 2-8 that Singapore is rated the best country on the planet for doing business.

TABLE 2-8 Sampling of Asian Countries— Ease-of-Doing-Business Rankings

Population in Millions

Ease of Doing Business Among all Countries Capital City

Singapore 5 1 out of 183 Singapore South Korea 49 8 out of 183 Seoul Malaysia 26 18 out of 183 Kuala Lumpur Thailand 66 19 out of 183 Bangkok

Japan 127 20 out of 183 Tokyo

Taiwan 23 25 out of 183 Taipei

China 1,500 91 out of 183 Beijing

Pakistan 175 105 out of 183 Islamabad

Russia 140 120 out of 183 Moscow

Indonesia 241 129 out of 183 Jakarta

India 1,160 132 out of 183 New Delhi

Philippines 98 136 out of 183 Manila

Source: Based on information at http://www.doingbusiness. org/rankings on November 1, 2012.

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Philippines A highly educated, English speaking country, the Philippines overtook India in early 2011 in call-center jobs, em ploying 350.000 com pared with India’s 330.000.u Call centers in the Philippines produced $7.4 billion in revenue in 2011. and that figure is growing about 15 percent annually. The Philippines recently also overtook Indonesia as the w orld’s biggest supplier of voice-based call-center services.15 Citigroup and Chase are just two com panies outsourcing custom er calls, back-office work, and other operations to the Philippines. A major reason why the Philippines is an attractive place for call centers is the country’s overall business culture to “deliver absolutely fantastic service.” An associate professor at the City University o f Hong Kong, Jane Lockwood, says “Filipinos go out o f their way, not just in call centers, but in tourism and events management, to ensure people are well looked after.” 16

As indicated in Table 2-8, the Philippines has about 98 million people, m aking the country the w orld’s 12th largest in population. Located in Southeast Asia, the Philippines was a founding m em ber of the United Nations and is active in that organization. Filipinos love Americans who rescued them in World War II. Thousands o f Filipinos today work all-night shifts to accom m odate the normal 8 am-to-5 pm business time zone in the USA. Philippines president Benigno Aquino recently indicated that services outsourced to the Philippines from around the world will generate up to $100 billion in 2020. representing 20 percent of the global offshoring m arket share.

Unemployment is at 6.9 percent in the Philippines, but under-em ploym ent— defined as people who work only part-tim e or with minimal incomes— is 18 percent. The average per capita income of Filipinos is about $1,790 a year, so hundreds of thousands of Filipinos work outside the country. In fact, the Philippines’ economy depends greatly on outside workers sending monies back to the country and also traveling to and from the country.

The television advertising market in the Philippines is nearly $4 billion annually, larger than India’s and on par w ith Indonesia’s.' Television is the most enjoyed media am ong the Philippines’ 7.100 island people, whereas newspapers are the most important media outlet in India. Television ads com prise 75 percent o f advertising spending in the Philippines.

Among m ajor em erging econom ies, the Philippines has only a 9 percent Internet penetration rate among its population, which is low com pared to China (28.9% ), Nigeria (28.4% ), Mexico (28.3% ), and Russia (29.0% ). But the Philippines’ 9 percent rate is above the Internet penetration rate among Indonesia’s population (8.7% ) and India’s population (5 .1% ).18 These percentages reveal the percentage o f the country’s people that could shop online.

Taiwan Located off the southeast coast o f mainland China, Taiwan has a dynam ic, capitalist, export-driven economy with gradually decreasing state involvement in investment and foreign trade. Many large, governm ent-owned banks and industrial firms are being privatized in Taiwan. Real annual growth in GDP has averaged about 8 percent during the past three decades. Exports have provided the primary impetus for industrialization. The trade surplus is substantial, and foreign reserves are the w orld’s fifth largest. As indicated in Table 2-8. Taiwan is rated 25th am ong all countries in the world for doing business.

Both exports and imports for the year reached record levels, totaling U.S. $274 billion and $251 billion, respectively. Agriculture constitutes only 2 percent o f Taiwan's GDP, down from 35 percent in 1952. Some brands from Taiwan that are leaders globally include: Acer, HTC, ASUS. TrendM icro, M asterKong, Want-Want, M axxis, Giant, Synnex, Transcend, Uni-President, Advantech, D-Link. ZyXel, Merida. Johnson, Gigabyte, CyberLink, Genius, and Depo.

India India passed a law in late 2011 that for the first time allows foreign firms to own 100 percent o f some Indian retail ventures, up from a previous 51 percent. One com pany taking advantage o f this change in the law is IKEA that is opening up 25 new stores in India between 2012 and 2015. Since India’s growth in GDP has fallen to below 6 percent, the Indian government began to allow much greater foreign investment especially in Indian retail, airlines, and broadcasting in 2012 .19 The country also greatly reduced the expensive government subsidies on diesel fuel and Indian banks are lowering interest rates also to spur growth.

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In late 2 0 12, India instituted a five-year road map to improve it finances, aiming to narrow its budget deficit to 5.3 percent o f gross domestic product to 3 percent by 2017. A slowdown in growth to 5 percent in 2012, coupled with massive welfare spending, has led to an unmanageable budget deficit in India. Com plicating matters in India are high interest rates and som e corruption scandals. The Indian Parliament recently approved higher overseas ownership in their insurance and pension investments sectors o f the economy.

The Indian government is slowly improving the country’s education system, but an enorm ous am ount o f work remains. Only 74 percent of Indian men and 48 percent o f Indian women are literate, compared to 96 percent o f men and 88 percent o f women in China. India's “knowledge econom y" em ploys only about 2.23 million people out o f 750 million available.

Prime M inister M anmohan Singh’s government has instituted education reform s, so the num ber of Indian children out o f school has dropped greatly from 18 million in 2000. Dropout ratios in primary schools have improved as well. However, at present only 12 percent o f India’s citizens enter higher education, and the government hopes to increase this to 21 percent by 2017. The Indian Institutes o f Technology— a group o f universities focused on engineering and technology— arc world renowned but offer only a m iniscule 7.000 places to students each year. There is elaborate red tape required to establish and operate any business in India. Also, India's tax code is archaic and many new sectors are not even open to foreign direct investment.

India will surpass China as the most populated country in 2030. India’s highest density growth and population is in the northwest and east-central areas o f the country. India has a literacy rate now o f 74 percent, up from 65 percent a decade ago.

Germany G erm any’s cars, machinery, and other products are in high demand in Asia, especially China. As Europe’s debt crisis has pushed the euro lower. German goods arc more com petitive abroad. The economic and fiscal crises in Greece, Ireland, Portugal, and Spain have only lim ited direct impact on G erm any’s $3.24 trillion economy. There is a growing north-south divide in Europe, with the north doing much better economically than the south. G erm any's budget deficit was 3.5 percent in 2010, the first lime in years that the country has exceeded the 3 percent limit set by EU budget rules, but that percent is w'ell below the deficit in the USA. the UK, and Japan— so overall the German economy is healthy. Note in Table 2-9 that Germany ranks 22nd out o f 183 countries in ease of doing business.

German automobile producers such as Daim ler AG, BMW AG, and Volkswagen AG have fallen behind rivals such as GM. Renault SA, and Nissan M otor in m ass-producing electric cars. The German com panies are playing catch up in this key area of industrial grow th, partly because the German government has com mitted just $688 million in state support for electric battery research and infrastructure projects, such as car-charging stations. That am ount is only a small fraction of the U.S. (and Chinese) government support for electric cars. Because one

TABLE 2-9 Sampling of European Countries— Ease-of-Doing-Business Rankings

Population in Millions

Ease of Doing Business Among

All Countries Capital City

UK 62 7 out of 183 London

Sweden 9 14 out of 183 Stockholm

Germany 83 19 out of 183 Berlin

France 64 29 out of 183 Paris

Czech Republic 11 64 out of 183 Prague

Turkey 77 71 out of 183 Ankara

Italy 59 87 out of 183 Rome

Ukraine 46 152 out of 183 Kiev

Source: Based on information at http://www.doingbusiness.org/rankings on November 1, 2012.

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out of seven German jobs is connected to the country’s car markers and domestic suppliers, this issue is important. M ore than 15 percent o f German exports stem from the autom obile industry. Germany also fallen way behind in electric car lithium-ion battery development and production.

The EU is a single economic bloc with free movement o f people, goods, and services among its 27 nations, but in matters such as taxes and labor costs, each country sets its own rules. Businesses entering Europe for the first tim e need to carefully research the various countries. Belgium, for exam ple, has the highest labor costs in Europe with 53 percent o f workers there being unionized, but that percent is only the fifth highest in Europe.

Germany has one of Europe's fastest aging and shrinking populations. Germany now faces shortages o f skilled labor and aggressive recruiting from abroad for the country’s top engineering and scientific talent.20 More people em igrate from Germany than relocate to Germany, especially highly educated professionals— partly because Germany has a restrictive labor code and in ward-looking hiring practices. Germany might need to follow the lead of Italy, w'hich has the same, albeit more severe, problem but has enacted excellent new' laws and incentives to both keep and attract young, highly educated professionals.

Mexico In late 2012. M exico elected a new president. Enrique Pena Nieto, who inherits a country with a hom icide rate o f 24 per 100.000 residents up from 10 per 100,000 in 2006. But hom icides in M exico fell 7 percent in the first nine months o f 2012, and Nieto plans to continue his predecessor's war on drug cartels and war on corruption. For example, all 600 municipal policem en in M exico’s business-leading city o f M onterrey were fired recently and replaced with M exican military personnel because o f suspected corruption.

M exico has recently reenergized its autom obile m anufacturing industry and now is the fourth largest autom obile exporter on the planet, behind Germ any, Japan, and South Korea. One in 10 cars sold in 201 1 in the USA was m ade in M exico.-1 Every new' taxi in New York C ity ’s fleet is m ade in M exico. A lm ost all m ajor autom obile producers globally have recently announced plans to build new p lants in M exico, including the upcom ing new S I .3 billion Volkswagen plant. An already existing Volkswagen plant in Puebla, M exico, is the com pany’s largest in North A m erica, with a capacity to produce 2,500 cars a day. “ M exico is extrem ely com petitive,” says Carlos G hosn, N issan’s CEO. G hosn cites the high productiv ity of M exican em ployees, currency advantages, and the typical $40 per day wage rate for M exican assem bly-line w orkers, which is approaching the average m anufacturing wage in C hina o f $3 per hour. Honda is opening a 3 ,200-em ployee factory in 2014 in M exico to produce its subcom pact m odel Fit. A nother key advantage for producing vehicles in M exico over Europe and A sia is that shipm ent to the USA takes only a day or two, instead of a few w eeks by ship.

No country was hurt m ore in the last decade by the rise o f China than M exico, but Chinese policy today is to boost wages to boost consum er spending. The Boston Consulting G roup estim ates that “C hina’s average m anufacturing w'age exceeded M exico’s in 2012 for the first time, when accounting for differences in productivity; M exican workers typically produce more per hour than Chinese workers.”22 The average w'age plus benefits across M exico is S3.50 an hour. This fact, coupled with C hina’s rising wages and slowing growth and M exico 's close proxim ity to the USA, represents a great opportunity for M exico to recoup some of a lot o f the m anufacturing prowess it lost in the last decade to China. Viaststems Group, based in St. Louis, recently shifted some o f its m anufacturing back to M exico from China. A lthough Dell Inc. com puters are produced by Foxconn in China. U.S. custom ers can order a custom ized Dell com puter online that is assem bled and delivered from a 1,200-acre Foxconn plant near C iudad Juarez.

Foreign direct investm ent (FDI) in M exico in 2013 surged to alm ost $30 billion, led by autom obile m anufacturers such as Volkswagen AG building new factories, and auto-parts suppliers such as Delphi Automotive PLC following. Hom e Depot will soon have 125 stores in M exico. The FDI surge is expected to last at least through 2018, spurred by low' w-ages, and governm ent policies that allow foreign com panies to import raw materials w ithout paying duties or tariffs, a 30 percent corporate tax rate, and rising wages in China. However, note in Table 2-10 that M exico fell from 35th place to 53rd place in the last tw'o years am ong all nations in term s o f ease o f doing business.

102 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

TABLE 2-10 Sampling of North and South American Countries—Ease-of-Doing-Business Rankings

Population in Millions

Ease of Doing Business Among all Countries Capital City

USA 308 4 out of 183 Washington. DC Canada 34 13 out of 183 Ottawa Chile 17 39 out of 183 Santiago Peru 30 41 out of 183 Lima Mexico 112 53 out of 183 Mexico City Argentina 41 113 out of 183 Buenos Aires Brazil 199 126 out of 183 Brasilia Ecuador 15 130 out of 183 Quito Bolivia 10 153 out of 183 La Paz Venezuela 27 177 out of 183 Caracus

Source: Based on information at http://www.doingbusiness.org/rankings on November 1, 2012.

Mexico is especially attractive for manufacturing products that are bulky or costly to transport, so for example. Nissan M otor and Volkswagen AG are planning to build factories in Mexico. The key variable hurting Mexico is drug-related violence since a 2011 United National report says M exico’s homicide rate was 18.1 people per 100,000 com pared with a per capita rate o f about 5.0 in the USA and 1.1 in China, if M exico can improve its security situation as it intends, then hundreds o f firms may consider moving back there from China (and India).

Special Note to Students Even the smallest businesses today regularly serve customers globally and gain com petitive advantages and econom ies o f scale doing so. Many iconic U.S. businesses, such as Tupperware, obtain more than 80 percent of their revenue from outside the USA. Therefore, in perform ing a strategic-m anagement case analysis, you must evaluate the scope, magnitude, and nature o f what your company is doing globally com pared to rival firms. Then, determ ine what your com pany should be doing to garner global business. Continuously throughout your presentation or written report, com pare your firm to rivals in terms o f global business and make recom m endations based on careful analysis. Be “prescriptive and insightful” rather than “descriptive and m undane” with every slide presented to pave the way for your specific recommendations with costs regarding global reach of your firm.

Conclusion The population of the world has surpassed 7 billion. Just as they did for centuries before Columbus reached America, businesses search for new opportunities beyond their national boundaries for centuries to come. There has never been a more internationalized and economically competitive society than today’s model. Some U.S. industries, such as textiles, steel, and consum er electronics, are in disarray as a result o f the international challenge.

Success in business increasingly depends on offering products and services that are competitive on a world basis, not just on a local basis. If the price and quality o f a firm ’s products and services are not competitive with those available elsewhere in the world, the firm may soon face extinction. Global markets have become a reality in all but the most remote areas o f the world. Certainly throughout the USA. even in small towns, firms feel the pressure of world competitors.

This chapter has provided some basic global information that can be essential to consider in developing a strategic plan for any organization. The advantages o f engaging in international business may well offset the drawbacks for most firms. It is important in strategic planning to be effective, and the nature o f global operations may be the key com ponent in a plan's overall effectiveness.

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING 103

Key Terms and Concepts feng shui (p. 86) inhwa (p. 84) global strategy (p. 82) multinational corporations (p. 79) globalization (p. 82) nem aswashio (p. 86) guanxi (p. 84) protectionism (p. 81) international firms (p. 79) Wa (p. 84)

Issues for Review and Discussion 2-1. Honda M otor Com pany has been very 2-14.

successful in recent years. W hat percentage o f 2-15. H onda’s revenues com es from the United States ver­ sus Europe? How does this percentage com pare with rival firm s? 2-16.

2-2. Explain why consum ption patterns are becoming 2-17. sim ilar worldwide. W hat are the strategic implications o f this trend? 2-18.

2-3. W hat are the advantages and disadvantages of beginning export operations in a foreign country? 2-19.

2-4. W hat are the major differences between U.S. and multi­ national operations that affect strategic m anagem ent? 2-20.

2-5. W hy is globalization o f industries a com mon factor today? 2-21.

2-6. Com pare and contrast U.S. versus foreign cultures in term s o f doing business. 2-22.

2-7. List six reasons why strategic m anagem ent is more com plex in a multinational firm. 2-23.

2-8. Do you feel that protectionism is good or bad for the world econom y? W hy? 2-24.

2-9. Why are some industries more “global” than others? Discuss. 2-25.

2-10. Wa, guanxi and inliwa are important management terms in Japan. China, and Korea respectively. W hat would be analogous terms to describe American 2-26. management practices?

2-11. W hy do many Europeans also find the notion of 2-27. “ team spirit" in a work environm ent difficult to grasp? 2-28.

2-12. In China, feng shui, is important in business, whereas in Japan nemaswashio, is important. W hat are analogous American terms and practices? 2-29.

2-13. Describe the business culture in Mexico.

Describe the business culture in Japan. Com pare tax rates in the United States versus other countries. W'hat impact could these differences have on “keeping jobs at hom e?” Discuss the requirem ents for doing business in India. Select four countries. Evaluate Honda M otor C om pany’s operations in those countries. Com pare business practices and culture in northern Europe with southern Europe. Explain how the Arab Spring movement in the Middle East will likely impact Pfizer. W hat five countries in Asia have the highest GDP? W hat are its implications for adidas? Africa is rapidly joining the world economic community. Give 10 examples to justify this. Which six African countries do you feel are most attractive for foreign investment? Com pare business practice and culture in the USA with your own country. Explain in your own words the “Special Note to Students” section at the end of the chapter. Select three countries in South America. Prepare a one-page sum m ary for each to reveal their attractive­ ness for foreign direct investment. Com pare sexual harassment policies and practice across continents and countries. Discuss Australia as a continent for doing business in. In terms o f presenting flowers as business gifts, com ­ pare and contrast the practices and custom s across six countries. Discuss how business etiquette at dinner varies across countries.

104 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

MyManagementLab® Go to m ym anagem entlab.com for the following Assisted-graded writing questions:

2-30. Make a good argument for keeping the statutory 2-32. M ym anagem entlab Only— com prehensive writing corporate tax rate in the United States the highest in assignment for this chapter, the world. M ake the counterargument.

2-31. W hat are the advantages and disadvantages o f begin­ ning export operations in a foreign country?

Current Readings Aguinis, Herman, Harry Joo, Ryan K. Gottfredson.

“Perform ance M anagem ent Universals: Think Globally and Act Locally.” Business Horizons 55, no. 4 (July 2012): 385-392.

Berthon, Pierre R., Leyland F. Pitt, Kirk Plangger, and Daniel Shapiro. “M arketing M eets Web 2.0, Social Media, and Creative Consumers: Im plications for International M arketing Strategy.” Business Horizons 55, no. 3 (May 2012): 261-271.

Bloom, Nicholas, Christos Genakos, Raffaella Sadun, and John Van Reenen. “M anagem ent Practices Across Firm s and Countries.” The Academy o f Management Perspectives 26, no. 1 (February 2012): 12.

Govindarajan, Vijay and Chris Trimble. “Reverse Innovation: A Global Growth Strategy That Could Pre-empt Disruption at Home.” Strategy and Leadership 40, no. 5 (2012): 5 -11.

Honeycutt, Earl D., Vincent P. Magnini, and Shawn T. Thelen. “Solutions for Custom er Com plaints About Offshoring and Outsourcing Services.” Business Horizons 55, no. 1 (January 2012): 33-42.

Ichii, Shigeki, Susumu Hattori, and David M ichael. “How to Win in Emerging Markets: Lessons from Japan.” Harvard Business Review (May 2012): 126.

Ignatius, Adi. “Captain Planet.” Harvard Business Review (June 2012): 112.

Pagnattaro, M arisa Anne. “Preventing Know-How From Walking Out the Door in China: Protection of Trade Secrets.” Business Horizons 55, no. 4 (July 2012): 329-337.

Porter, Michael E., and Jan W. Rivkin. “Choosing the USA.” Harvard Business Review (March 2012): 80.

Ramamurti, Ravi. “Com peting with Em erging M arket Multinationals.” Business Horizons 55, no. 3 (May 2012): 241-249.

Thomas, Robert J., Joshua Beilin, Claudy Jules, and Nandani Lynton. “Global Leadership Teams: Diagnosing Three Essential Qualities.” Strategy and Leadership 40, no. 4 (2012): 25-29.

Underwood, Robert L. “Automotive Foreign Direct Investm ent in the USA: Economic and Market Consequences of Globalization.” Business Horizons 55, no. 5 (Septem ber 2012): 463-474.

W aldman, David A., Mary Sully de Luque, and Danni Wang. “W hat Can We Really Learn About M anagement Practices Across Firms and Countries?” The Academy of Management Perspectives 26, no. 1 (February 2012): 34.

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING 105

A SSU R A N CE OF LEA RN IN G EX ER C ISES EXERCISE 2A The adidas Group wants to enter Africa. Help them.

Purpose More and more companies every day decide to begin doing business in Africa. Research is necessary to determine the best strategy for being the first mover in many African countries (i.e., being the first competitor doing business in various countries).

Step 1 Print a map of Africa. Step 2 Print demographic data on 10 African countries. Step 3 Gather competitive information regarding the presence of shoe companies doing business

in Africa. Step 4 List in prioritized order eight countries that you would recommend for adidas to enter.

Country 1 is your best, and Country 2 is your next best. Based on your research, indicate how many adidas/Reebok/TaylorMade stores you would recommend building over the next three years in each country. List in prioritized order three cities in each of your eight African countries where you believe adidas should build most of its stores.

EXERCISE 2B Assessing Differences in Culture Across Countries

Purpose Americans can be more effective in dealing with businesspeople from other countries if they have some awareness and understanding of differences in culture across countries. This is a fun exercise that provides information for your class regarding some of these key differences.

Instructions Step 1 Identify four individuals who either grew up in a foreign country or have lived in a foreign

country for more than one year. Interview those four persons. Try to have four different countries represented. During each interview, develop a list of eight key differences between American style/custom and that particular country’s style/custom in terms of various aspects of speaking, meetings, meals, relationships, friendships, and communication that could impact business dealings.

Step 2 Develop a 15-minute PowerPoint presentation for your class and give a talk summarizing your findings. Identify in your talk the persons you interviewed as well as the length of time those persons lived in the respective countries. Give your professor a hard copy of your PowerPoint presentation.

EXERCISE 2C Honda Motor Company wants to enter the Vietnamese market. Help them.

Purpose More and more companies every day decide to begin doing business in Vietnam. Research is necessary to determine the best strategy for being competitive in Vietnam. Review the opening chapter boxed insert and Honda Motor Company’s website.

106 CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING

Instructions Step 1 Print off a map of Vietnam. Step 2 Print off demographic data on 10 cities in Vietnam. Step 3 Gather competitive information regarding the presence of automobile companies doing busi­

ness in Vietnam. Step 4 List in prioritized order the five cities that you would recommend for Honda to expand their

business operations into.

EXERCISE 2D Does My University Recruit in Foreign Countries?

Purpose A competitive climate is emerging among colleges and universities around the world. Colleges and universities in Europe and Japan are increasingly recruiting U.S. students to offset declining enroll­ ments. Foreign students already make up more than one-third of the student body at many U.S. universities. The purpose of this exercise is to identify particular colleges and universities in foreign countries that represent a competitive threat to your college.

Instructions Step 1 Select a foreign country. Conduct research to determine the number and nature of colleges

and universities in that country. What are the major educational institutions in that country? What programs are those institutions recognized for offering? What percentage of under­ graduate and graduate students attending those institutions are citizens of your country'? Do these institutions actively recruit students from your country? Are any of the Schools of Business at the various universities AACSB-lntemational accredited?

Step 2 Prepare a report for the class that summarizes your research findings. Present your report to the class.

Notes 1. Frederick Gluck, “Global Com petition in the 1990s,”

Journal o f Business Strategy (Spring 1983): 22-24.

2. Jon Alston, “Wa, Guanxi. and Inhwa: M anagerial 6. Principles in Japan, China and Korea ” Business Horizons 32. no. 2 (M arch-A pril 1989): 26.

3. Rose Knotts, “Cross-Cultural M anagement: Transform ations and Adaptations,1- Business Horizons. 7. January-February 1989 .29-33 .

4. Lalita Khosla. “You Say Tomato,” Forbes, May 21, 2001, 36. 8.

country-profiles.html and http://w w w .kw intessential.co.uk/ resources/global -etiquette/.

Mehul Srivastava, “Keeping Women on the Job in India," Bloomberg Businessweek. M arch 7-13 , 2011, 11-12; Stratford Sherman, “How to Beat the Japanese? Fortune, April 10, 1989. 145.

Patrick McGroarty. “Debt Investors Put Faith in a More Stable Africa,” Wall Street Journal (October 24, 2012): C l .

Ibid.

5. Some o f the narrative in this section is based on information at: http://www.kwintessential.co.uk/resources/

CHAPTER 2 • OUTSIDE-USA STRATEGIC PLANNING 107

9. Julie Jargon, “KFC Savors Potential in Africa,” Wall Street Journal, Decem ber 8, 2 0 10. B I . Peter Wonacott, “A Continent o f New Consum ers Beckons,” Wall Street Journal, January 13, 2 0 11, B l .

10. Peter W onacott, “SABM iller Taps E thiopia’s Holy Water,” Wall Street Journal, January 13, 2011, B 1.

11. Sarah Childress, “Telecom Giants Battle for Kenya,” Wall Street Journal, January 14, 2011, B l.

12. Sophie Leung and Simon Kennedy with Cotton Timberlake and Chris Burritt, “Global Inflation Starts W'ith Chinese Workers.” Bloomberg Businessweek, M arch 7-13 , 2 0 1 1 ,9 -1 0 .

13. Arpan M ukherjee and Abhrajit Gangopadhyay. “India, China Aim to Double Trade,” Wall Street Journal. Decem ber 17, 2010, A15.

14. M ichelle Yun and Kathy Chu, “Philippines May Answer Call,” USA Today. January 10. 2011, 1-2B.

15. Ibid.

16. James Hookway, “D ollar’s Fall Rocks Far-Flung Families,” Wall Street Journal, February 25, 201 1, A 12.

17. James Hookway, “High Drama for Philippine TV,” Wall Street Journal, M arch 3, 2 0 1 I, B 10.

18. Amol Sharma, “Dot-Coms Begin to Blossom in India,” Wall Street Journal, April 12, 2011. B 1.

19. Rumman Ahmed and Romit Guha. “India Faces Fight Over Foreign Firms.” Wall Street Journal {September 17, 2012): A12.

20. Vanessa Fuhrmans, “Exodus of Skilled Labor Saps Germany,” Wall Street Journal, M arch 11. 2011, A 12.

21. Nicholas Casey, “In M exico, Auto Plants Hit the Gas,” Wall Street Journal (11 -20-12): A 1.

22. Luhnow, David and Bob Davis, “For M exico, an Edge on China,” Wall Street Journal (Septem ber 17, 2012): A 12.

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108

Ethics/ Social Responsibility/ Sustainability C H A P T E R O B JE C T IV E S After studying this chapter, you should be able to do the following:

1. Discuss the ethics of workplace romance. 2. Explain why concern for wildlife is a strategic issue for firms. 3. Explain why good ethics is good business in strategic management. 4. Explain how firms can best ensure that their code of business ethics guides decision

making instead of being ignored. 5. Explain why whistle-blowing is important to encourage in a firm. 6. Discuss the nature and role of corporate sustainability reports. 7. Discuss specific ways that firms can be good stewards of the natural environment. 8. Explain ISO 14000 and 14001. 9. Discuss recent trends in bribery law.

A S S U R A N C E OF L E A R N IN G E X E R C IS E S The following exercises are found at the end of this chapter. e x e r c i s e 3A Sustainability and Nestle

e x e r c i s e 3B How Does My M unicipality Compare To Others on Being Pollution-Safe?

e x e r c i s e 3C Compare adidas AG versus Nike on Social Responsibility

e x e r c i s e 3D How Do You Rate adidas AG’s Sustainability Efforts?

e x e r c i s e 3E How DoYou Rate N estle's Sustainability Efforts?

e x e r c i s e 3F The Ethics o f Spying on Competitors

110 CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY

Although the three sections o f this chapter (business ethics, social responsibility, and sustainability) are distinct, the topics are quite related. M any people, for example, consider it unethical for a firm to be socially irresponsible. Social responsibility refers to actions an organization takes beyond what is legally required to protect or enhance the well-being o f living things. Sustainability refers to the extent that an organization's opera­ tions and actions protect, mend, and preserve rather than harm or destroy the natural environ­ ment. Polluting the environment, for example, is unethical, irresponsible, and in many cases illegal. Business ethics, social responsibility, and sustainability issues therefore are interrelated and impact all areas o f the comprehensive strategic-m anagem ent model, as illustrated in Figure 3 -1 with white shading.

Business Ethics The Institute o f Business Ethics (IBE) recently did a study titled “Does Business Ethics Pay?” and concluded that com panies displaying a “clear com m itm ent to ethical conduct” consistently outperform com panies that do not display ethical conduct. Philippa Foster Black o f the IBE stated: “Not only is ethical behavior in business life the right thing to do in principle, it pays off in financial returns.” Alan Simpson said: “If you have integrity, nothing else matters. If you don’t have integrity, nothing else matters.” Table 3 -1 provides some results o f the IBE study.

EXCELLENT STRATEGIC MANAGEMENT

Nestlé Nestlé S.A., headquartered in Vevey, Switzerland, is the largest food company in the world measured by revenues. Nestlé has hundreds of products that include cereals, coffee, dairy products, pet foods, snacks, baby food, and bottled water. Thirty of Nestlé’s brands have annual sales of over 1 billion Swiss francs (about $1.1 billion), including Nespresso, Nescafe, Kit Kat, Smarties, Nesquick, Stouffers, Vittel, and Maggi. Nestlé has around 450 factories, operates in 86 countries, and employs around 328,000 people. It is one of the main shareholders of L'Oreal, the world's largest cosmetics company. In April 2012, Nestlé acquired Pfizer's infant-nutrition business for $11.9 billion. In May 2013, Nestlé began a $500 million expansion of its R&D center in Singapore, with a primary focus on health and nutrition.

In order to ensure that various standards within the supply chain maintain a certain level, Nestlé developed the Nestlé Supplier Code. The Code sets out non-negotiable minimum standards which all employees, subcontractors, and suppliers must meet and adhere to whilst doing busi­ ness with Nestlé. Available in 22 languages on the corporate website, the Nestlé Supplier Code forms an important part of all contracts, orders, and commercial agreements that Nestlé enters into with all 165,000 suppliers and 680,000 farmers that form the Nestlé supply chain. The aim of the Nestlé Supplier Code is to ensure that all the company's suppliers and farmers conduct business in a manner that upholds Nestlé's high values and emphasis on fairness and integrity.

Nestle's per­ formance for the first half of 2013 was exemplary. The company's profit margins ----------------------------------------- by-region, in the Americas, Europe, and Asia/Oceania/Africa were 17.8, 14.9, and 19.1 percent respectively. The profit margins for Nestle Waters and Nestlé Nutrition were 10 percent and 20 percent respectively. Overall for Nestlé for the first half of 2013, the company generated a positive 4.1 percent organic growth and a 15.1 operating profit margin - both exemplary results.

Regarding Nestlé's by-product financial results for the first of 2013, the company's operating profit margins were all positive, as follows: 1) Powdered and liquid beverages (24%), 2) Water (10.7%), 3) Milk products and ice cream (15.9%), 4) Nutrition & Healthcare (18.6%), 5) Prepared dishes and cooking aids (13.5%), 6) Confectionery (12.7%), and PetCare (19.0%). All of the reported results are also exemplary.

Source: Based on company documents.

CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY 111

I____________________ Strategy ________________________ 1________ Strategy _________ Strategy ______ I Formulation I Implementation I Evaluation I

FIGURE 3-1 A Comprehensive Strategic-Management Model Source: Fred R. David, adapted from “How Companies Define Their Mission,” Long Range Planning 22, no. 3 (June 1988): 40. © Fred R. David.

Good ethics is good business. Bad ethics can derail even the best strategic plans. This chap­ ter provides an overview o f the im portance o f business ethics in strategic management. B usiness eth ics can be delined as principles o f conduct within organizations that guide decision making and behavior. Good business ethics is a prerequisite for good strategic management; good ethics is just good business!

TABLE 3-1 Seven Principles of Admirable Business Ethics

1. Be trustworthy, because no individual or business wants to do business with an entity they do not trust. 2. Be openminded, continually asking for “ethics-related feedback” from all internal and external stakeholders. 3. Honor all commitments and obligations. 4. Do not misrepresent, exaggerate, or mislead with any print materials. 5. Be visibly a responsible community citizen. 6. Utilize your accounting practices to identify and eliminate questionable activities. 7. Follow the motto: Do unto others as you would have them do unto you.

Source: Based on http://sbinformation.about.eom/od/bestpractices/a/businessethics.htm.

112 CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY

A rising tide o f consciousness about the importance o f business ethics is sweeping the USA and the rest o f the world. Strategists such as CEOs and business owners are the individuals primarily responsible for ensuring that high ethical principles are espoused and practiced in an organization. All strategy formulation, im plementation, and evaluation decisions have ethical ramifications.

N ew spapers and business m agazines daily report legal and m oral breaches o f ethical conduct by both public and private organizations. Being unethical can be expensive. For exam ple, som e o f the largest payouts for class-action legal fraud suits ever were against Enron (S7.16 billion), W orldCom ($6.16 billion), Cendant ($3.53 b illion), Tyco ($2.98 billion), AOL Tim e W arner ($2.5 billion), Nortel N etw orks ($2.47 b illion), and Royal A hold ($ 1.09 billion).

O ther business actions considered to be unethical include m isleading advertising or labeling, causing environmental harm, poor product or service safety, padding expense accounts, insider trading, dumping banned or Hawed products in foreign markets, not providing equal opportuni­ ties for women and minorities, overpricing, m oving jobs overseas, and sexual harassment.

The Food and Drug Adm inistration (FDA) recently warned both Avon Products and L’Oreal about m isleading marketing of certain o f its antiwrinkle products. The FDA’s position is that Avon and L’O real’s claims that discuss things like the stimulation o f skin cells or reactivating the skin’s repair process are not true.

Yahoo Vs CEO Scott Thompson recently was forced to resign as a result o f his “resum e padding or inflating.” J.P. Morgan Chase CEO Jamie Dimon is currently under fire after the investment bank’s $2.3 billion trading blunder that has already cost a key deputy her job. Increasingly, executives’ and m anagers’ personal and professional decisions are placing them in the cross hairs o f angry shareholders, disgruntled employees, and even their own boards o f directors— making even the imperious CEO far more vulnerable to personal, public, and corporate missteps than ever before. “Certainly, anybody who is doing something that can be construed as unethical, immoral or greedy is being taken to task,” says Paul D orf o f Com pensation Resources, a consultant to boards of directors.1

Social media and business-centric websites such as glassdoor.com and vault.com as well as disclosure mandates required under Sarbanes-Oxley are ju st several o f many outlets that today quickly spread fact and rumor about the inside dealings o f Corporate Am erica, revealing ethical breaches and internal business practices that may never have surfaced before the Internet and a 24/7 media culture. “God forbid anyone who isn’t squeaky-clean these days or misrepresents their credentials at the top of the company,” says Wendy Patrick, who teaches business ethics at San Diego State University. “Anything em barrassing and you begin to question everything. If they aren’t making good decisions in their personal lives, it can bleed over to the way they run their com panies.”

“The pressure and scrutiny on performance has shortened the tenure of the average CEO from about 10 years to about 5Vi years since the 1990s,” says John C hallenger o f consultants Challenger Gray and Christmas. Challenger notes that 42 CEOs were forced out o f their jobs in 2011 and that pace is up 5 percent in 2012.2

Code of Business Ethics A new wave of ethics issues related to product safety, em ployee health, sexual harassment, AIDS in the workplace, smoking, acid rain, affirmative action, waste disposal, foreign business practices, cover-ups. takeover tactics, conflicts o f interest, em ployee privacy, inappropriate gifts, and security o f company records has accentuated the need for strategists to develop a clear code of business ethics. Internet fraud, hacking into company com puters, spreading viruses, and identity theft are other unethical activities that plague every sector o f online com m erce.

Merely having a code o f ethics, however, is not sufficient to ensure ethical business behav­ ior. A code of ethics can be viewed as a public relations gimmick, a set o f platitudes, or window dressing. To ensure that the code is read, understood, believed, and rem em bered, periodic ethics workshops are needed to sensitize people to workplace circum stances in which ethics issues may arise.3 If em ployees see exam ples of punishm ent for violating the code as well as rewards for upholding the code, this reinforces the im portance o f a firm ’s code o f ethics. The website www.ethicsweb.ca/codes provides guidelines on how to write an effective code o f ethics.

CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY 113

An Ethics Culture Reverend Billy Graham once said: “When wealth is lost, nothing is lost: when health is lost, some­ thing is lost; when character is lost, all is lost." An ethics “culture” needs to permeate organizations! To help create an ethics culture. Citicorp developed a business ethics board game that is played by thousands o f employees worldwide. Called “The Word Ethic,” this game asks players busi­ ness ethics questions, such as how do you deal with a customer who offers you football tickets in exchange for a new, backdated IRA? Diana Robertson at the Wharton School o f Business believes the game is effective because it is interactive. Many organizations have developed a code-of-conduct manual outlining ethical expectations and giving examples o f situations that commonly arise in their businesses.

One reason strategists' salaries are high is that they must take the moral risks of the firm. Strategists are responsible for developing, communicating, and enforcing the code of business ethics for their organizations. Although primary responsibility for ensuring ethical behavior rests with a firm's strategists, an integral part of the responsibility o f all managers is to provide ethics leadership by constant example and demonstration. Managers hold positions that enable them to influence and educate many people. This makes managers responsible for developing and implementing ethical decision making. Gellerman and Drucker, respectively, offer some good advice for managers:

All m anagers risk giving too much because o f what their com panies demand from them. But the same superiors, who keep pressing you to do more, or to do it better, or faster, or less expensively, will turn on you should you cross that fuzzy line between right and wrong. They will blame you for exceeding instructions or for ignoring their warnings. The smartest managers already know that the best answer to the question “ How far is too far?" is don’t try to find out.4

A man (or woman) might know too little, perform poorly, lack judgm ent and abil­ ity, and yet not do too much dam age as a manager. But if that person lacks character and integrity— no m atter how knowledgeable, how brilliant, how successful— he destroys. He destroys people, the most valuable resource o f the enterprise. He destroys spirit. And he destroys performance. This is particularly true o f the people at the head of an enterprise because the spirit o f an organization is created from the top. If an organization is great in spirit, it is because the spirit o f its top people is great. If it decays, it does so because the top rots. As the proverb has it. “Trees die from the top.” No one should ever become a strategist unless he or she is willing to have his or her character serve as the model for subordinates.'1

No society anywhere in the world can com pete long or successfully with people stealing from one another or not trusting one another, with every bit o f inform ation requiring notarized confirm ation, w ith every disagreem ent ending up in litigation, or with governm ent having to regulate businesses to keep them honest. Being unethical is a recipe for headaches, inefficiency, and waste. History has proven that the greater the trust and confidence o f people in the ethics of an institution or society, the greater its econom ic strength. Business relationships are built mostly on mutual trust and reputation. Short-term decisions based on greed and questionable ethics will preclude the necessary self-respect to gain the trust o f others. More and more firms believe that ethics training and an ethics culture create strategic advantage. Max Killan said: “If business is not based on ethical grounds, it is o f no benefit to society, and will, like all other unethical com binations, pass into oblivion.”

Whistle-Blowing Harris Corporation and other firms warn managers and em ployees that failing to report an ethical violation by others could bring discharge. The Securities and Exchange Com mission (SEC) recently strengthened its whistle-blowing policies, virtually mandating that anyone seeing unethical activity report such behavior. Whistle-blowing refers to policies that require em ployees to report any unethical violations they discover or see in the firm.

W histle-blowers in the corporate world receive up to 25 percent o f the proceeds of legal proceedings against firms for wrongdoing. W histle-blower payouts are becoming more and more com mon. In late 2012, Brad Birkenfeld, the form er Zurich-based UBS AG banker who

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told the Interna] Revenue Service (IRS) how the bank helped thousands of Americans evade taxes, received an IRS award of $104 million, perhaps the largest payout ever for an individual U.S. whistle-blower. The largest bank in Switzerland, UBS's Birkenfeld told IRS agents how UBS bankers came to the USA to woo rich Americans, managed $20 billion o f their assets, and helped them cheat the IRS. He pleaded guilty to conspiracy in 2008. a year after reporting the bank’s conduct to the Justice Department, U.S. Senate, IRS. and Securities and Exchange Commission. Birkenfeld went briefly to prison for his involvement in the bank schem e, but UBS avoided prosecution in the USA by agreeing to pay S780 million, disclosing data on more than 250 Swiss accounts, and adm itting it helped foster tax evasion. It later agreed to hand over data on another 4,450 accounts. Since Birkenfeld came forward, at least 33,000 Am ericans have voluntarily disclosed offshore accounts to the IRS, generating more than $5 billion.

In October 2012, the IRS in a separate case paid another whistle-blower $38 million which was between 15 and 30 percent of the taxes recovered from another large corporation. The name o f this company and the whistle-blower rem ain com pletely confidential, proving that the IRS can reward corporate whistle-blowers without ever revealing their identity. Pfizer paid out $2.3 billion in a whistle-blower settlement case and Eli Lilly paid out $1.4 billion. M ost firms have internal whistle-blowing incentives and policies and try to keep such matters internal, but recent laws and court cases are shifting disclosure and settlements outside the firm .6

An accountant recently tipped off the IRS that his em ployer was skim ping on taxes and received S4.5 million in the first IRS whistle-blower award. The accountant’s tip netted the IRS $20 million in taxes and interest from the errant financial-services firm. The award represented a 22 percent cut of the taxes recovered. The IRS program, designed to encourage tips in large- scale cases, mandates awards o f 15 to 30 percent o f the amount recouped. "It's a w in-win for both the government and taxpayers. These are dollars that are being returned to the Treasury that otherwise w ouldn’t be,” said lawyer Eric Young.

Ethics training programs should include messages from the CEO or owner of the business emphasizing ethical business practices, the development and discussion of codes o f ethics, and procedures for discussing and reporting unethical behavior. Firms can align ethical and strategic decision making by incorporating ethical considerations into long-term planning, by integrating ethical decision making into the perform ance appraisal process, by encouraging whistle-blowing or the reporting o f unethical practices, and by monitoring departmental and corporate perfor­ mance regarding ethical issues.

Bribes Bribery is defined by Black's Law Dictionary' as the offering, giving, receiving, or soliciting of any item of value to influence the actions o f an official or other person in discharge o f a public or legal duty. A bribe is a gift bestowed to influence a recipient’s conduct. The gift may be any money, good, right in action, property, preferment, privilege, em olum ent, object o f value, advantage, or merely a promise or undertaking to induce or influence the action, vote, or influ­ ence of a person in an official or public capacity. Bribery is a crime in m ost countries o f the world, including the United States.'

The U.S. Foreign Corrupt Practices Act (FCPA) that governs bribery is being enforced more strictly. This act and a new provision in the Dodd-Frank financial-regulation law allows company em ployees or others who bring cases of financial fraud, such as bribery, to the governm ent’s attention to receive up to 30 percent o f any sum recovered. Bribery suits against a company also expose the firm to shareholder lawsuits.

In 2012. Pfizer paid $60.2 million to settle a federal investigation into briber)' overseas whereby the firm was accused of bribing doctors, hospitals administrators, and regulators in several countries in Europe and Asia to prescribe their medicines. Pfizer allegedly gave doctors in China cellphones and tea sets, while plying Croatian doctors with cash and international trips, and then sought to hide the briber)' by recording the payments in accounting records as legitimate expenses.

Avon Products is currently being investigated for bribery charges related to their winning the first dircct-sales license awarded by China to a foreign company. Even form er Avon CEO Andrea Jung is being interrogated through her attorney Theodore Wells Jr. Avon is also being examined for spending millions of dollars in Brazil and France to consultants hired to assist the company with tax bills in those countries.

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A recent (11-15-12) Wall Street Journal article titled “Bribery Law Dos and D on 'ts” provides a synopsis o f the recent 130-page docum ent released by the U.S. Justice Department and the SEC to respond to com plaints from com panies that ambiguity in the FCPA has forced them to abandon business in high-risk countries and spend millions of dollars investigating them selves.8 Numerous examples of bribery are given, such as "1) providing a $12,000 birthday trip for a government official from M exico that incudes visits to w ineries and m useum s” or 2) $10,000 spent on a government official for drinks, dinners, and entertainment.”

In mid-2013, the SEC began investigating electronics giant Panasonic for bribery within its subsidiary, Avionics, based in Lake Forest, California. From 2009 to mid-2013, the U.S. Justice Department filed 110 bribery cases and the SEC filed 80 bribery cases.

The United K ingdom ’s new Bribery Law forbids any com pany doing any business in the United Kingdom from bribing foreign or domestic officials to gain com petitive advantage. The British law is more stringent even than the sim ilar U.S. FCPA. The British Bribery Law carries a maxim um 10-year prison sentence for those convicted of bribery. The law stipulates that "failure to prevent bribery” is an offense and stipulates that facilitation paym ents, or paym ents to gain access, are not a valid defense to prevent bribery.

Great B ritain’s Bribery Act applies even to bribes between private businesspersons, and if the individual who makes the paym ent does not realize the transaction was a bribe, he or she is still liable. The new bribery law is being enforced by B ritain’s Serious Fraud Office (SFO) and boosts the maximum penalty for bribery to 10 years in prison from 7, and sets no lim its on fines. M ore and m ore nations are taking a tougher stance against corruption, and com panies w orldwide are installing elaborate program s to avoid running afoul o f the FCPA or the SFO.

Paying bribes is considered both illegal and unethical in the USA, but in some foreign countries, paying bribes and kickbacks is acceptable. Tipping is even considered bribery in some countries. Im portant antibriber}' and extortion initiatives are advocated by many organizations, including the World Bank, the International M onetary Fund, the European Union (EU). the Council o f Europe, the Organization of American States, the Pacific Basin Econom ic Council, the Global Coalition for Africa, and the United Nations.

The U.S. Justice Department recently increased its prosecutions of alleged acts o f foreign bribery. Businesses have to be much more careful these days. For years, taking business associ­ ates to lavish dinners and giving them expensive holiday gifts and even outright cash may have been expected in many countries, such as South Korea and China, but there is now stepped-up enforcement o f bribery laws.

The SEC and Justice Departm ent are investigating several pharmaceutical com panies, including Merck, AstraZeneca PLC, Bristol-M yers Squibb, and GlaxoSm ithKline PLC, for allegedly paying bribes in certain foreign countries to boost sales and speed approvals. Four types o f violations are being rev iewed: bribing government-employed doctors to purchase drugs; paying com pany sales agents com m issions that are passed along to government doctors; paying hospital com m ittees to approve drug purchases; and paying regulators to win drug approvals. Johnson & Johnson recently paid $70 million to settle allegations that it paid bribes to doctors in Greece, Poland, and Rom ania to use their surgical implants and to prescribe its drugs. Pfizer paid S60 million to resolve sim ilar probes to win business overseas.

The SEC and the Justice Departm ent are also investigating Hewlett-Packard for allegedly paying Russian government officials bribes to secure a $44.5 million information technology network. Similarly, the engineering giant Siemens AG is being investigated on bribery charges related to a $27 million traffic-control system installed in Moscow, Russia.

The U.S. FCPA prohibits U.S. com panies from paying or offering to pay foreign government officials or em ployees o f state com panies to gain a business advantage. U nder the U.S. Dodd-Frank Act, passed in 2010, employees are encouraged to report possible acts of bribery and whistle-blowers are rewarded between 10 percent and 30 percent o f any financial sanctions against com panies.

Workplace Romance Director o f the U.S. Central Intelligence Agency (CIA). Gen. David Petraeus abruptly resigned in Novem ber 2012, citing workplace romance as the reason. Petraeus wrote in the letter to his staff that he was going to the W hite House to ask President Obama “for personal reasons” to

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resign. “After being married for more than 37 years, I showed extrem ely poor judgm ent by engaging in an extramarital affair." Petraeus wrote in his letter. “Such behavior is unacceptable, both as a husband and as a leader o f an organization such as ours.” Petraeus’s w'ife is Holly Petraeus whom he met when he was a cadet at the U.S. Military Academy at West Point.

Just hours after Petraeus resigned, the CEO o f Lockheed Martin Corp., Chris Kubasik. was fired for having a “close personal relationship” with a subordinate. The com pany said the C EO 's “improper conduct" violated the com pany’s code of ethics. Kubasik. who is married, had his relationship revealed by a whistle-blower, at which point Lockheed hired external investigators to examine the allegation. Lockheed manufactures num erous military products, so the firm is perhaps more prudent than most in monitoring relationships because spying is a concern within defense firms.

Workplace romance is an intimate relationship between two truly consenting em ployees, as opposed to sexual harassment, which the Equal Employm ent Opportunity Com m ission (EEOC) defines broadly as unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct o f a sexual nature. Sexual harassment (and discrimination ) is illegal, unethical, and detrimental to any organization and can result in expensive lawsuits, lower morale, and reduced productivity.

Workplace romance between two consenting em ployees simply happens, so the question is generally not whether to allow the practice, and or even how to prevent it, but rather how best to manage the phenomena. An organization probably should not strictly forbid workplace romance because such a policy could be construed as an invasion of privacy, overbearing, or unnecessary. Some romances actually improve work perform ance, adding a dynam ism and energy that translates into enhanced morale, com munication, creativity, and productivity.9

However, it is important to note that workplace romance can be detrimental to workplace morale and productivity, for a num ber of reasons that include:

1. Favoritism com plaints can arise. 2. Confidentiality o f records can be breached. 3. Reduced quality and quantity o f work can become a problem. 4. Personal arguments can lead to work arguments. 5. W hispering secrets can lead to tensions and hostilities am ong coworkers. 6. Sexual harassment (or discrimination) charges may ensue, either by the involved fem ale or

a third party. 7. Conflicts of interest can arise, especially when well being o f the partner trumps well-being

o f the company.

In some states, such as California, managers can be held personally liable for dam ages that arise from workplace romance. Organizations should establish guidelines or policies that address workplace romance, for at least six reasons:

1. Guidelines can enable the firm to better defend itself against and avoid sexual harassment or discrimination charges.

2. Guidelines can specify reasons (such as the seven listed previously) why workplace romance may not be a good idea.

3. Guidelines can specify resultant penalties for rom ancing partners if problems arise. 4. Guidelines can promote a professional and fair work atmosphere. 5. Guidelines can help assure compliance with federal, state, and local laws and recent court cases, 6. Lack o f any guidelines sends a lackadaisical message throughout the firm.

Workplace romance guidelines should apply to all employees at all levels of the firm and should specify certain situations in which affairs are especially discouraged, such as supervisor and subordinate. Company guidelines or policies in general should discourage workplace romance because “the downside risks generally exceed the upside benefits” for the firm. Best Buy CEO Brian Dunn recently resigned when directors learned of his inappropriate relationship with a young subordinate, a violation o f that com pany’s code of ethics. Based in Fremont, California, IGate Corp., fired its CEO. Phaneesh Murthy, in May 2013 for allegedly failing to report a work­ place romance relationship that turned into a sexual harassment issue with a subordinate.

Flirting is a step down from workplace romance, but a new full-page Wall Street Journal article titled ‘'The New Rules of Flirting” reveal the do fs and don’ts o f flirting .10 Flirting

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is defined by researchers as “rom antic behavior that is am biguous and goal oriented,” or said differently, “am biguous behavior with potential sexual or romantic overtones that is goal-oriented.” A few flirting rules given in the article are:

1. Do not flirt with someone you know is looking for a relationship if you are not interested in a new relationship.

2. Do flirt within a relationship that you want to strengthen. 3. Do not flirt to make your partner jealous because this is manipulative behavior. 4. Flirting between power differences, such as boss and em ployee or professor and student,

usually leads to trouble, as many defendants in sexual-harassm ent com plaints know'. 5. Do not make physical contact w ith the person you are flirting with, unless it is w ithin a

desired relationship.

Among colleges and universities, the federal Office o f Civil Rights (OCR) has stepped up its investigation o f sexual harassment cases brought forward by fem ale students against profes­ sors. Yale University has been in the news in this regard as well as numerous other institutions currently being investigated. At no charge to the student, the OCR will investigate a female student’s claim if evidence is compelling.

A Wall Street Journal article recapped U.S. standards regarding boss and subordinate love affairs at w ork .11 Only 5 percent o f all firms sampled had no restrictions on such relationships; 80 percent of firms have policies that prohibit relationships between a supervisor and a subordi­ nate. Only 4 percent o f firms strictly prohibited such relationships, but 39 percent o f firms had policies that required individuals to inform their supervisors whenever a romantic relationship begins with a coworker. Only 24 percent of firms required the two persons to be in different departments.

In Europe, romantic relationships at work are largely viewed as private matters and most firms have no policies on the practice. How'ever. European firms are increasingly adopting explicit, U .S.-style sexual harassm ent laws. The U.S. military strictly bans officers from dating or having sexual relationships with enlistees. At the World Bank, sexual relations between a supervisor and an em ployee are considered “a de facto conflict of interest which must be resolved to avoid favoritism.” World Bank president Paul W olfowitz recently was forced to resign as a result o f a relationship he had with a bank staff person.

A recent Bloomberg Businessweek article reports that in the sluggish job market, employees are filing sexual harassment com plaints as a way to further their own job security. Many of these filings are increasingly third-party individuals not even directly involved in the relationship but alleging their own job was impacted. Largely the result o f the rise o f third-party discrim ination claim s, the EEOC recovers about $500 million on behalf o f office romance victim s.12

Social Responsibility Fortune annually lists the most admired and least adm ired com panies globally on social responsibility. Fortune's 2012 top three most adm ired socially responsible com panies are GDF Suez, M arquard & Bahls, and RWE. The top three least admired com panies are China Railway Group. China Railway Construction, and China State Construction Engineering.1’’ Chinese firms dom inate the least admired list.

W almart was socially responsible in the wake o f the earthquake and tsunami that devastated Japan in 2011. Following the catastrophe. Walmart quickly mobilized a local relief effort to deliver supplies such as water and flashlights to survivors. Walmart has a history o f helping imm ensely in times o f crisis— the retailer was also able to get supplies to people who needed them following Hurricane Katrina.

Some strategists agree with Ralph Nader, who proclaims that organizations have trem endous social obligations. Nader points out. for example, that ExxonM obil has more assets than most countries, and because of this, such firms have an obligation to help society cure its many ills. O ther people, however, agree with the econom ist M ilton Friedman, w'ho asserts that organiza­ tions have no obligation to do any more for society than is legally required. Friedman may contend that it is irresponsible for a firm to give monies to charity.

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Do you agree more with Nader or Friedm an? Surely we can all agree that the first social responsibility o f any business m ust be to make enough profit to cover the costs o f the future because if this is not achieved, no other social responsibility can be met. Indeed, no social need can be met by the firm if the firm fails.

Strategists should examine social problem s in terms o f potential costs and benefits to the firm and focus on social issues that could benefit the firm most. For example, should a firm avoid laying off em ployees so as to protect the em ployees’ livelihood, when that decision may force the firm to liquidate?

Social Policy The term social policy em braces managerial philosophy and thinking at the highest level o f the firm, which is why the topic is covered in this textbook. Social policy concerns what respon­ sibilities the firm has to em ployees, consumers, environmentalists, m inorities, com m unities, shareholders, and other groups. After decades of debate, many firms still struggle to determine appropriate social policies.

The impact of society on business and vice versa is becoming more pronounced each year. Corporate social policy should be designed and articulated during strategy formulation, set and adm inistered during strategy implementation, and reaffirmed or changed during strategy evaluation.14

Firms should strive to engage in social activities that have economic benefits. Merck & Co. once developed the drug ivermectin for treating river blindness, a disease caused by a fly-borne parasitic worm endemic in poor tropical areas of Africa, the Middle East, and Latin America. In an unprecedented gesture that reflected its corporate com m itm ent to social responsibility, Merck then made ivermectin available at no cost to medical personnel throughout the world. M erck’s action highlights the dilemma of orphan drugs, which offer pharm aceutical com panies no economic incentive for profitable development and distribution. Merck did however garner substantial goodwill among its stakeholders for its actions.

Social Policies on Retirement Some countries around the w orld are facing severe w orkforce shortages associated with their aging populations. The percentage o f persons age 65 or older exceeds 20 percent in Japan, Italy, and G erm any— and w ill reach 20 percent in 2018 in France. In 2036, the percentage of persons age 65 or o lder will reach 20 percent in the USA and C hina. U nlike the USA, Japan is reluctant to rely on large-scale im m igration to bolster its w orkforce. Instead, Japan provides incentives for its elderly to work until ages 65 to 75. W estern European countries are doing the opposite, providing incentives for its elderly to retire at ages 55 to 60. The International Labor O rganization says 71 percent o f Japanese men ages 60 to 64 work, com pared to 57 percent o f A m erican men and ju st 17 percent o f French m en in the sam e age group.

Sachiko Ichioka, a typical 67-year-old man in Japan, says, “ I want to work as long as I 'm healthy. The extra money means I can go on trips, and I’m not a burden on my children.” Better diet and health care have raised Japan’s life expectancy now to 82, the highest in the world. Japanese women are having on average only 1.28 children com pared to 2.04 in the USA. Keeping the elderly at work, coupled with reversing the old-fashioned trend of keeping women at home, are Japan’s two key remedies for sustaining its workforce in factories and busi­ nesses. This prescription for dealing with problem s associated with an aging society should be considered by many countries around the world. The Japanese government is phasing in a shift from age 60 to age 65 as the date when a person may begin receiving a pension, and premiums paid by Japanese em ployees are rising while payouts are falling. Unlike the USA, Japan has no law against discrimination based on age.

Worker productivity increases in Japan are not able to offset declines in num ber o f workers, thus resulting in a decline in overall economic production. Like many countries, Japan does not view immigration as a good way to solve this problem. Japan’s shrinking workforce has become such a concern that the government just recently allowed an unspecified num ber o f Indonesian and Filipino nurses and caregivers to work in Japan for two years. The num ber of working-age

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TABLE 3-2 The Best and Worst Companies Globally in Regard to Being Socially Responsible

The Best The Worst

1. GDF Suez 1. China Railway Group

2ễ Marquard & Baïlis 2. China Railway Construction

3. RWE 3. China State Construction Engineering

4. Altria Group 4. China South Industries Group

5ẽ Starbucks 5. China FAW Group

6. Walt Disney 6. Aviation Industry Corporation of China

7. United Natural Foods 7Ỗ Dongleng Motor

8. Sealed Air 8. MF Global Holdings

9. Chevron 9. China North Industries 10. Whole Foods Market 10ắ Hon Hai Precision Industry

Sources: Based on http://money.cnn.com/magazines/fbrtune/most-admired/2012/best_worst/best4.html and http://monev.cnn.com/magazines/fortune/most-admired/2012/best_worst/worst4.html.

Japanese— those between ages 15 and 64— is projected to shrink to 70 million by 2030. Using foreign workers is known as gaikokujin roudousha in Japanese. M any Filipinos have recently been hired now to work in agriculture and factories throughout Japan.

Fortune's best and worst com panies globally in regard to being socially responsible in 2012 are listed in Table 3-2. Note that the 10 worst com panies are all based in China.

Environmental Sustainability In October o f every year, three world renowned corporate sustainability rankings are published: (1) the Dow Jones Sustainability Index (DJSI). (2) the Carbon Disclosure Project, and (3) Newsweek's “Green” rankings. Regarding the DJSI, some notable companies that were added to the DJSI 2012 Index for being especially sustainable were Microsoft, Target. Hewlett-Packard, and the Canadian National Railway Company. Some notable companies that were kicked out of the 2012 DJSI sustain­ ability rankings were GlaxoSmithKline PLC. Duke Energy. IBM, United Technologies, and Dell.

Launched in 1999. DJSI annually reveals the best corporations in the world in various industries in terms o f sustainability. A few of the num ber-1 (best) com panies in the world on sustainability in the DJSI 2012 in their respective industries were: BMW, Unilever NV, Roche Holding AG, Siemens AG. Alcatel-Lucent SA. and Air France-KLM .

The strategies o f both com panies and countries are increasingly scrutinized and evaluated from a natural environm ent perspective. Com panies such as Walmart now m onitor not only the price its vendors offer for products, but also how those products are made in terms of environm ental practices, as well as safety and infrastructure soundness particularly o f Southeast Asia factories. A growing number o f business schools offer separate courses and even a concen­ tration in environm ental management.

Businesses must not exploit and decim ate the natural environm ent. Mark S tank at George Washington University says, “Halting and reversing worldwide ecological destruction and dete­ rioration is a strategic issue that needs imm ediate and substantive attention by all businesses and managers. A ccording to the International Standards Organization (ISO), the word env ironm ent is defined as “surroundings in which an organization operates, including air, water, land, natural resources, flora, fauna, humans, and their interrelation." This chapter illustrates how many firms are gaining com petitive advantage by being good stewards of the natural environment.

Em ployees, consum ers, governm ents, and society are especially resentful o f firms that harm rather than protect the natural environm ent. Conversely people today are especially appreciative of firms that conduct operations in a way that mends, conserves, and preserves the natural envi­ ronment. Consum er interest in businesses preserving nature’s ecological balance and fostering a clean, healthy environm ent is high.

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No business wants a reputation as being a polluter. A bad sustainability record will hurt the firm in the market, jeopardize its standing in the community, and invite scrutiny by regulators, investors, and environmentalists. Governments increasingly require businesses to behave responsibly and require, for example, that businesses publicly report the pollutants and wastes their facilities produce.

In terms o f megawatts of wind power generated by various states in the United States, Iowa’s 2,791 recently overtook California’s 2,517, but Texas’s 7.118 megawatts dw arfs all other states. M innesota also is making substantial progress in wind power generation. New Jersey recently outfitted 200,000 utility poles with solar panels, which made it the nation’s second-largest producer o f solar energy behind California. New Jersey is also adding solar panels to corporate rooftops. The state’s $514 million solar program doubled its solar capacity to 160 megawatts in 2013. The state’s goal is to obtain 3 percent o f its electricity from the sun and 12 percent from offshore wind by 2020.

What Is a Sustainability Report? A sustainability report reveals a firm ’s operations impact the natural environment. This docum ent discloses to shareholders information about the firm ’s labor practices, product sourcing, energy efficiency, environmental impact, and business ethics practices.

It is good business for a company to provide a sustainability report annually to the public. With 60.000 suppliers and more than $350 billion in annual sales. W almart works with its suppliers to make sure they provide such reports. Many firms use the W almart sustainability report as a benchmark, guideline, and model to follow in preparing their own report.

The Global Reporting Initiative recently issued a set o f detailed reporting guidelines specifying what information should go into sustainability reports. The proxy advisory firm Institutional Shareholder Services reports that an increasing num ber o f shareholder groups are pushing firms to provide sustainability information annually. Two com panies that released sustainability reports for the first time in 2012 were Hyatt Hotels & Resorts and Las Vegas Sands Corporation. Rival firm Hilton W orldwide does not have a stand-alone sustainability report, but M arriott and Wyndham W orldwide do release annual sustainability reports and o f late revealed excellent reductions in energy, w'ater, waste, and carbon dioxide emissions.

Walmart encourages and expects its 1.35 million U.S. em ployees to adopt w'hat it calls Personal Sustainability Projects, which include such measures as organizing weight-Ioss or sm oking-cessation support groups, biking to work, or starting recycling programs. Employee wellness can be a part o f sustainability.

Walmart is installing solar panels on its stores in California and Hawaii, providing as much as 30 percent o f the power in some stores. It may go national with solar power if this test works well. A lso moving to solar energy is departm ent-store chain Kohl’s Corp., which is converting 64 of its 80 California stores to use solar power. There are big subsidies for solar installations in some states.

Home Depot, the w orld’s second largest retailer behind Walmart, recently more than dou­ bled its offering o f environm entally friendly products such as all-natural insect repellent. Home Depot has made it much easier for consum ers to find its organic products by using special labels sim ilar to T im berland’s (the outdoor company) Green Index tags.

M anagers and em ployees o f firms must be careful not to becom e scapegoats blamed for com pany environmental wrongdoings. Harming the natural environm ent can be unethi­ cal, illegal, and costly. When organizations today lace crim inal charges for polluting the environm ent, they increasingly turn on their managers and em ployees to win leniency. Employee firings and dem otions are becoming com mon in pollution-related legal suits. M anagers were fired at Darling International, Inc., and Niagara M ohawk Power Corporation for being indirectly responsible for their firms polluting water. M anagers and em ployees today must be careful not to ignore, conceal, or disregard a pollution problem , or they may find them ­ selves personally liable.

Lack of Standards Changing A few years ago. firms could get away with placing “green” term inology on their products and labels using such terms as organic, green, safe, earth-friendly, nontoxic, or natural because there wrere no legal or generally accepted definitions. Today, however, these term s carry much

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more specific connotations and expectations. Uniform standards defining environm entally responsible com pany actions are rapidly being incorporated into the legal landscape. It has becom e more and more difficult for firms to make “green" claim s when their actions are not substantive, com prehensive, or even true. Lack of standards once made consum ers cynical about corporate environm ental claim s, but those claims today are increasingly being chal­ lenged in courts. Joel M akower says, “One o f the main reasons to truly become a green firm is for your employees. T hey’re the first group that needs assurance than any claim s you make hold water.” 1''

Around the world, political and corporate leaders now realize that the "business green” topic will not go away and in fact is gaining ground rapidly. Strategically, com panies more than ever m ust dem onstrate to their custom ers and stakeholders that their green efforts are substantive and set the firm apart from com petitors. A firm ’s perform ance facts and figures must back up their rhetoric and be consistent with sustainability standards.

Managing Environmental Affairs in the Firm The ecological challenge facing all organizations requires managers to formulate strategies that preserve and conserve natural resources and control pollution. Special natural environm ent issues include ozone depletion, global warming, depletion o f rain forests, destruction o f animal habitats, protecting endangered species, developing biodegradable products and packages, waste management, clean air, clean water, erosion, destruction of natural resources, and pollution con­ trol. Firms increasingly are developing green product lines that are biodegradable or are made from recycled products. Green products sell well.

M anaging as if “health o f the planet” matters requires an understanding o f how interna­ tional trade, com petitiveness, and global resources are connected. M anaging environm ental affairs can no longer be sim ply a technical function performed by specialists in a firm; more em phasis m ust be placed on developing an environm ental perspective among all em ployees and m anagers o f the firm. Many com panies are moving environm ental affairs from the staff side of the organization to the line side, thus making the corporate environm ental group report directly to the ch ief operating officer. Firms that manage environmental affairs will enhance relations with consum ers, regulators, vendors, and other industry players, substantially improving their prospects o f success.

Environmental strategies could include developing or acquiring green businesses, divesting or altering environm ent-dam aging businesses, striving to become a low-cost producer through waste minimization and energy conservation, and pursuing a differentiation strategy through green-product features. In addition, firms could include an environmental representative on their board of directors, conduct regular envrionmental audits, implement bonuses for favorable environmental results, become involved in environmental issues and programs, incorporate envi­ ronmental values in mission statements, establish environmentally oriented objectives, acquire environmental skills, and provide environmental training programs for company employees and managers.

Preserving the environm ent should be a perm anent part o f doing business for the following reasons:

1. Consum er dem and for environm entally safe products and packages is high. 2. Public opinion dem anding that firms conduct business in ways that preserve the natural

environm ent is strong. 3. Environmental advocacy groups now have more than 20 million Am ericans as members. 4. Federal and state environm ental regulations are changing rapidly and becoming more

complex. 5. M ore lenders are exam ining the environm ental liabilities o f businesses seeking loans. 6. M any consum ers, suppliers, distributors, and investors shun doing business with environ­

mentally weak firms. 7. Liability suits and fines against firms having environmental problem s are on the rise.

M ore firms are becoming environm entally proactive— doing more than the bare minimum to develop and im plem ent strategies that preserve the environment. The old undesirable alterna­ tive o f being environm entally reactive— changing practices only when forced to do so by law or

122 CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY

consum er pressure— more often today leads to high cleanup costs, liability suits, reduced market share, reduced custom er loyalty, and higher medical costs. In contrast, a proactive policy views environmental pressures as opportunities and includes such actions as developing green products and packages, conserving energy, reducing waste, recycling, and creating a corporate culture that is environm entally sensitive.

ISO 14000/14001 Certification Based in Geneva, Switzerland, the International Organization for Standardization (ISO) is a network o f the national standards institutes o f 147 countries, with one member per country. ISO is the w orld’s largest developer o f sustainability standards. W idely accepted all over the world, ISO standards are voluntary because ISO has no legal authority to enforce their implementation. ISO itself does not regulate or legislate.

Governmental agencies in various countries, such as the Environmental Protection Agency (EPA) in the USA. have adopted ISO standards as part o f their regulatory framework, and the standards are the basis of much legislation. Adoptions are sovereign decisions by the regulatory authorities, governments, or com panies concerned.

ISO 14000 refers to a series o f voluntary standards in the environm ental field. The ISO 14000 family o f standards concerns the extent to which a firm minimizes harmful effects on the environm ent caused by its activities and continually monitors anti improves its own environm en­ tal performance. Included in the ISO 14000 series are the ISO 14001 standards in fields such as environmental auditing, environmental perform ance evaluation, environm ental labeling, and life-cycle assessment.

ISO 14001 is a set o f standards adopted by thousands o f firm s w orldwide to certify to their constituencies that they are conducting business in an environm entally friendly manner. ISO 14001 standards offer a universal technical standard for environm ental com pliance that more and more firms are requiring not only o f them selves but also o f their suppliers and distributors.

The ISO 14001 standard requires that a com munity or organization put in place and implement a series o f practices and procedures that, when taken together, result in an env ironm enta l m anagem en t system (EM S). ISO 14001 is not a technical standard and as such does not in any way replace technical requirem ents em bodied in statutes or regulations. It also does not set prescribed standards o f perform ance for organizations. Not being certified with ISO 14001 can be a strategic disadvantage for towns, counties, and com panies because people today expect organizations to minimize or. even belter, to elim inate environm ental harm they cause .16 The major requirem ents o f an EMS under ISO 14001 include the following:

• Show commitments to prevention o f pollution, continual improvement in overall environmental performance, and compliance with all applicable statutory and regulatory requirements.

• Identify all aspects of the organization’s activities, products, and services that could have a significant impact on the environment, including those that are not regulated.

• Set performance objectives and targets for the management system that link back to three policies: (1) prevention of pollution, (2) continual improvement, and (3) com pliance.

• Meet environmental objectives that include training em ployees, establishing work instructions and practices, and establishing the actual metrics by which the objectives and targets will be measured.

• Conduct an audit operation of the EMS. • Take corrective actions when deviations from the EMS occur.

Wildlife In mid-2012, South Korea announced plans to resume whaling despite a 1986 m oratorium on commercial whaling. Many countries are upset at these plans, including Australia where the Prime M inister Julia Gillard said: “We are com pletely opposed to whaling; there’s no excuse for scientific whaling.” Only a few countries, such as Norway, Japan, and Russia, favor and engage in commercial whaling.

CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY 123

Fairm ont H otels & Resorts in 2 0 12 instituted a policy rem oving shark fin soup from its menu, follow ing the lead o f S hangri-La Hotels & Resorts. Even the C hinese governm ent has recently stopped serving shark fin soup at m ost official banquets. S tudies reveal that many shark species have been reduced 90 percent in recent decades, largely by overfishing for shark fins. The dem and for shark fin soup in Asia is arguably the m ajor cause o f the alarm ­ ing decline o f blue sharks off the British coast and much o f the A tlantic. Scientists from the United Kingdom and Portugal recently tracked sharks and confirm that sharks are being deliberately targeted by fisherm en with long-line fishing that can stretch as long as 100 km. The fins are cut off and the bodies discarded onsite. Blue sharks are the m ost frequently- caught shark species, with drastic population declines. M any shark species are now clas­ sified as “near-threatened” on the International Union for C onservation o f Nature (IUCN) Red L ist.17

The European Parliam ent in late 2012 voted with an overw helm ing 566-47 m argin to force all boats in EU w aters and EU -registered boats around the world to land sharks with their fins attached and prove the animal had not been thrown back. Uta Bellion o f the Pew Environm ent G roup said: “the parliam ent's vote is a m ajor m ilestone in ending the w aste­ ful practice o f shark finning.” EU fisheries ch ief M aria Dam anaki said the law would “ease control and help us eradicate shark finning,” which she called cruel to the anim als and a vast waste o f resources. Sharks are vulnerable to over-exploitation because they m ature late and give birth to small numbers o f young at a tim e. Shark fins are in high dem and in Asia for soup and alleged cures. Damanaki said som e 75 m illion sharks a year are killed for the use o f their lins only, with the EU being the biggest exporter. As a result, the ham m erhead shark is as good as extinct in the M editerranean Sea. Damanaki has com pared shark finning to killing elephants only for their tusks.

A rctic sea ice shrank to a record low of 1.32 m illion square m iles (3.41 m illion square km) in late 2012 according to the N ational O ceanic and A tm ospheric Agency. However, polar bears’ designation as a threatened species is being challenged in a U.S. appeals court. A deci­ sion is expected in 2013. A laska and oil com panies have argued that Endangered Species Act protections for polar bears dim inish opportunities for A laska energy developm ent. The state has said in its appeals court filing that bears have survived previous warm ing periods and m ost populations have grown or rem ained stable despite shrinkage o f ice. The case is Safari Club International et al u Ken Salazar et al and Center fo r Biological Diversity et al, No. 11-5219.

According to the Convention on the International Trade in Endangered Species (CITES), more than 25,000 elephants are killed each year for their ivory— even though international trade in ivory has been outlawed since 1989.

A recent Wall Street Journal article titled “America Gone W ild" talks about how wildlife populations in the USA have experienced an “astonishing resurgence.” 18 A drawback o f the resurgence is that the total cost o f w ildlife dam age to U.S. crops, landscaping, and infrastructure now exceeds S28 billion a year, including $1.5 billion from deer-vehicle crashes alone.

Solar Power The Solar Energy Industries A ssociation reported in late 2012 that the USA is on pace to install as much solar power in 2012 as it did in the prior eleven put together, at least 2,500 megawatts, the equivalent o f m ore than two nuclear-pow er plants. GTM Research says the U.S. solar-pow er industry grew 71 percent in 2012 and will grow 20 to 40 percent annually through 2016. To cut greenhouse-gas em issions and fight clim ate change, states such as C alifornia have created subsidies for solar power developers and requirem ents for utilities to buy solar power. C hina supplies nearly half o f the solar panels used globally but two leading U.S. suppliers o f solar panels are Solarcity. which has more than 2,000 em ployees, and Sunrun Inc. Thousands o f com panies are looking into install solar panels as part o f their sustainability efforts.

Table 3-3 reveals the impact that bad environm ental policies have on two o f nature's many ecosystems.

124 CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY

TABLE 3-3 Songbirds and Coral Reefs Need Help

Songbirds

Be a good steward of the natural environment to save our songbirds. Bluebirds are one of 76 songbird species in the USA that have dramatically declined in numbers in the last two decades. Not all birds are considered songbirds, and why birds sing is not clear. Some scientists say they sing when calling for mates or warning of danger, but many scientists now contend that birds sing for sheer pleasure. Songbirds include chickadees, orioles, swallows, mockingbirds, warblers, sparrows, vireos, and the wood thrush. "These birds are telling us there’s a problem, something’s out of balance in our environment,” says Jeff Wells, bird conservation director for the National Audubon Society. Songbirds may be telling us that their air or water is too dirty or that we are destroying too much of their habitat. People collect Picasso paintings and save historic buildings. “Songbirds are part of our natural heritage. Why should we be willing to watch songbirds destroyed any more than allowing a great work of art to be destroyed?” asks Wells. Whatever message songbirds are singing to us today about their natural environment, the message is becoming less and less heard nationwide. Listen when you go outside today. Each of us as individuals, companies, states, and countries should do what we reasonably can to help improve the natural environment for songbirds.1'' A recent study concludes that 67 of the 800 bird species in the USA are endangered, and another 1X4 species are designated of “conservation concern.” The birds of Hawaii are in the greatest peril.

Coral Reefs

Be a good steward of the natural environment to save our coral reefs. The ocean covers more than 71 percent of the earth. The destructive effect of commercial fishing on ocean habitats coupled with increasing pollution runoff into the ocean and global warming of the ocean have decimated fisheries, marine life, and coral reefs around the world. The unfortunate consequence of fishing over the last century has been overfishing, with the principal reasons being politics and greed. Trawl fishing with nets destroys coral reefs and has been compared to catching squirrels by cutting down forests because bottom nets scour and destroy vast areas of the ocean. The great proportion of marine life caught in a trawl is “by-catch" juvenile fish and other life that are killed and discarded. Warming of the ocean as a result of carbon dioxide emissions also kills thousands of acres of coral reefs annually. The total area of fully protected marine habitats in the USA is only about 50 square miles, compared to some 93 million acres of national wildlife refuges and national parks on the nation's land. A healthy ocean is vital to the economic and social future of the nation—and, indeed, all countries of the world. Everything we do on land ends up in the ocean, so we all must become better stewards of this last frontier on earth to sustain human survival and the quality of life.20

Special Note to Students No company or individual wants to do business with someone who is unethical or is insensitive to natural environment concerns. It is no longer just cool to be environmentally proactive, it is expected, and in many respects is the law. Firms are being compared to rival firms ever)' day on sustainability and ethics behavior, actually every minute on Facebook, Twitter, Myspace, Linkedln, and YouTube. Issues presented in this chapter therefore comprise a competitive advantage or dis­ advantage for all organizations. Thus, you should include in your case analysis recommendations for your firm to exceed stakeholder expectations on ethics, sustainability, and social responsibility. Make comparisons to rival firms to show how your firm can gain or sustain competitive advantage on these issues. Reveal suggestions for the firm to be a good corporate citizen and promote that for competitive advantage. Be mindful that the first responsibility o f any business is to stay in business, so use cost/benefit analysis as needed to present your recommendations effectively.

Conclusion In a final analysis, ethical standards com e out of history and heritage. Our predecessors have left us wiih an ethical foundation to build on. Even the legendary football coach Vince Lom bardi knew that some things were worth more than winning, and he required his players to have three kinds of loyalty: to God, to their families, and to the Green Bay Packers, “ in that order.” Employees, customers, and shareholders have become less and less tolerant o f business ethics violations in firms, and more and more appreciative o f model ethical firms. Inform ation-sharing across the Internet increasingly reveals such model firms versus irresponsible firms.

Consum ers across the country and around the world appreciate firms that do more than is legally required to be socially responsible. But staying in business while adhering to all laws and regulations must be a primary objective of any business. One o f the best ways to be socially responsible is for the firm to proactively conserve and preserve the natural environm ent. For example, to develop a corporate sustainability report annually is not legally required, but such a report, based on concrete actions, goes a long way toward assuring stakeholders that the firm is worthy o f their support. Business ethics, social responsibility, and environm ental sustainability are interrelated and key strategic issues facing all organizations.

CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY 125

Key Terms and Concepts bribe (p. 114) ISO 14001 (p. 122) bribery (p. 114) sexual harrassm ent (p. 116) business ethics (p. I l l ) social policy (p. 118) code of business ethics (p. 112) social responsibility (p. 110) environm ent (p. 119) sustainability (p. 110) environm ental m anagem ent system (HMS) (p. 122) whistle-blowing (p. 113) ISO 14000 (p. 122) workplace romance (p. 116)

Issues for Review and Discussion 3-1. Nestle SA has done really well in 201 1-2013. Visit

their corporate website and determ ine if business ethics and sustainability issues may be key reasons for their success.

3-2. If you owned a small business, would you develop a code o f business conduct? If yes, what variables would you include? If no, how would you ensure that ethical busi­ ness standards were being followed by your employees?

3-3. W hat is the relationship between personal ethics and business ethics? Are they, or should they be the same?

3-4. How can firms best ensure that their code o f business ethics is read, understood, believed, rem em bered, and acted upon?

3-5. Why is it important not to view the concept o f “whistleblowing” as “tattle-telling’' or “ratting” on another em ployee?

3-6. List six desired results o f “ethics training programs,” in terms o f recommended business ethics policies or

procedures in the firm. 3-7. D iscuss bribery. W ould actions such as politicians

adding earm arks in legislation, o r pharm aceuti­ cal salespersons giving away drugs to physicians constitu te bribery? Identify three business activities that w ould constitu te bribery and three actions that would not.

3-8. How could a strategist’s attitude toward social respon­ sibility affect a firm ’s strategy? On a 1 to 10 scale, ranging from N ader’s view lo Friedm an’s view, what is your attitude toward social responsibility?

3-9. How do social policies on retirement differ in various countries around the world?

3-10. Firm s should form ulate and implement strategies from an environm ental perspective. List eight ways firms can do this.

3-11. Discuss the major requirem ents o f an EMS under ISO 14001.

MyManagementLab® Go to m ym anagem entlab.com for the following Assisted-graded writing questions:

3-12. Firms should formulate and implement strategies from 3-14. M ymanagementlab Only— com prehensive writing an environm ental perspective. List eight ways firms can assignment for this chapter, do this.

3-13. Discuss the m ajor requirem ents o f an EMS under ISO 14001.

126 CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY

Current Readings Aguinis. Herman and Ante Glavas. “What We Know and D on't

Know About Corporate Social Responsibility: A Review and Research Agenda." Journal o f Management 38, no. 4 (July 2012): 932.

Barnett, M ichael L., and Robert M. Salomon. “Does it pay to be really good? Addressing the shape o f the relation­ ship between social and financial performance.” Strategic Management Journal 33, no. 11 (November 2012): 1304-1320.

Fremeth, Adam R„ and Brian K. Richter. “Profiting from Environmental Regulatory Uncertainty: Integrated Strategies for Com petitive Advantage.” California Management Review 54, no. 1 (Fall 2011): 145-165.

Lange, Donald, and Nathan T. Washburn. “Understanding Attributions of Corporate Social Irresponsibility.” The Academy o f Management Review 37, no. 2 (April 2012): 300.

Langvardt, Arlen W. “Business Ethics and Intellectual Property in the Global M arketplace.” Business Horizons 55, no. 4 (July 2012): 325-327.

Karnani, Aneel. “Doing Well by Doing Good: The Grand Allusion.” California Management Review 53. no. 2 (W inter 2011): 69-86.

Kleyn. Nicola, Russell Abratl. Kerry Chipp. and Michael Goldman. “ Building a Strong Corporate Ethical Identify: Key Findings From Suppliers.” California Management Review 54, no. 3 (Spring 2012): 61-76.

Langvardt, Arlen W. “Ethical Leadership and the Dual Roles o f Examples.” Business Horizons 55, no. 4 (July 2012): 373-384.

Mayer, David M „ Karl Aquino, Rebecca L. Greenbaum, and M aribeth Kuenzi. “W ho Displays Ethical Leadership, and Why Does It M atter? An Examination of Antecedents and

Consequences o f Ethical Leadership." The Academy o f Management Journal 55, no. 1, February 2012): 151.

Peloza, John. Moritz Loock, Jam es Cerruti, and Micahel Muyot. "Sustainability: How Stakeholder Perceptions Differ from Corporate Reality.” Inside CMR 55. no. 1 (Fall 2012): 74.

Ramchander, Sanjay, Robert G. Schwebach, and KIM Staking. “The Informational Relevance o f Corporate Social Responsibility: Evidence from DS400 Index Reconstitutions.” Strategic Management Journal 33, no. 3 (M arch 2012): 303-314'

Rubin, Joel D. “Fairness in Business: Does it Matter, and W'hat Does it M ean?” Business Horizons 55, no. I (January 2012): 11-15.

Schaubroeck, John M., Sean T. Hannah, Bruce J. Avolio, Steve W. J. Kozlowski, Robert G. Lord, Linda K. Trevino, Nikolaos Dimotakis, and Ann C. Peng. “Embedding Ethical Leadership within and across Organization Levels.” Academy o f Management Journal 55. no. 5 (October 2012): 1053.

Vallaster, Christine, Adam Lindgreen, and François Maon. “Strategically Leveraging Corporate Social Responsibility: A Corporate Branding Perspective.” California Management Review 54, no. 3 (Spring 2012): 34-60.

Wang, Taiyuan, and Pratima Bansal. “Social Responsibility in New Ventures: Profiting from a Long-term Orientation." Strategic Management Journal 33, no. 10 (October 2012): 1135-1153.

Wong, Elaine M., M argaret E. Orm iston, and Philip E. Tetlock. "The Effects o f Top M anagement Team Integrative Com plexity and Decentralized D ecision Making on Corporate Social Performance.” The Academy o f Management Journal 54, no. 6 (Decem ber 201 1 ): 1207.

CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY 127

A SSU R A N CE OF LEARN IN G EX ER C ISES EXERCISE 3A

Sustainability and Nestle

Purpose Nestlé is the opening case at the beginning of Chapter 3. Headquartered in Vevey. Switzerland, Nestlé is the largest food company in the world measured by revenues. Nestlé has hundreds of products that include cereals, coffee, dairy products, pet foods, snacks, baby food, and bottled water. Thirty of Nestlé’s brands have annual sales of over l billion Swiss francs (about $ 1.1 billion), including Nespresso, Nescafe, Kit Kat, Smarties, Nesquick. Stouffers, Vittel, and Maggi. Nestlé has around 450 factories, operates in 86 countries, and employs around 328,000 people.

This exercise can give you practice evaluating a company’s sustainability efforts. At the company’s website, note the three key sustainability areas the firm engages in are I ) Nutrition, 2) CSV-Water, and 3) Rural Development.

Instructions Conduct research to evaluate Nestlé’s sustainability efforts. Prepare a report for the class giving your assessment of Nestlé's sustainability work versus rival firms.

EXERCISE 3B

How Does My Municipality Compare To Others on Being Pollution-Safe?

Purpose Sometimes it is difficult to know how safe a particular municipality or county is regarding industrial and agricultural pollutants. A website that provides consumers and businesses excellent information in this regard is http://scorecard.goodguide.com. This type information is often used in assessing where to locate new business operations.

Instructions Go to http://scorecard.goodguide.com/. Put in your zip code. Print off the information available for your city/county regarding pollutants. Prepare a comparative analysis of your municipality versus state and national norms on pollution issues. Does your locale receive an A. B. C, D, or F?

EXERCISE 3C

Compare adidas AG versus Nike on Social Responsibility

Purpose This exercise aims to familiarize you with corporate social responsibility programs.

Instructions Step 1 Go to adidas' Code of Conduct, which is provided within the Corporate Governance section

of the corporate website. Step 2 Go to Nike’s corporate website at http://www.nikeinc.com and navigate to the Sustainability

section to review Nike’s Corporate Responsibility Report. Step 3 Compare adidas’ social responsibility efforts with Nike’s. Summarize your findings in a

three-page report for your professor.

128 CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY

E X E R C IS E 3D

How Do You Rate adidas AG’s Sustainability Efforts?

Purpose This exercise aims to familiarize you with corporate sustainability programs.

Instructions Step 1 Go to http://www.adidas-group.com and click on Sustainability. Review the annual sustain­

ability reports available in this section of the website. Step 2 On a separate sheet of paper, list six aspects that you like most and six aspects that you like

least about adidas’ sustainability efforts. Step 3 Provide a two-page executive summary of your assessment of adidas’ sustainability efforts.

E X E R C IS E 3E

How Do You Rate Nestle’s Sustainability Efforts?

Purpose This exercise aims to familiarize you with corporate sustainability programs. Review the opening chapter company discussion. Review the material at Nestle’s corporate website. Note that Nestle' recently kept Oxlam’s scorecard top slot.

Instructions Step 1 On a separate sheet of paper, list six aspects that you like most and six aspccts that you like

least about Nestles sustainability efforts. Step 2 Provide a two-page executive summary of your assessment of Nestle’s sustainability efforts.

E X E R C IS E 3F

The Ethics of Spying on Competitors

Purpose This exercise gives you an opportunity to discuss in class ethical and legal issues related to methods being used by many companies to spy on competing firms. Gathering and using infor­ mation about competitors is an area o f strategic management that Japanese firms do more profi­ ciently than American firms.

Instructions On a separate sheet of paper, write down numbers 1 to 18. For the 18 spying activities that follow, indicate whether or not you believe the activity is ethical or unethical and legal or illegal. Place either an E for ethical or U for unethical, and either an L for legal or an / for illegal for each activity. Compare your answers to those of your classmates and discuss any differences.

Step 1 Buying competitors’ garbage Step 2 Dissecting competitors’ products

CHAPTER 3 • ETHICS/SOCIAL RESPONSIBILITY/SUSTAINABILITY 129

Step 3 Taking competitors’ plant tours anonymously Step 4 Counting tractor-trailer trucks leaving competitors’ loading bays Step 5 Studying aerial photographs of competitors’ facilities Step 6 Analyzing competitors’ labor contracts Step 7 Analyzing competitors’ help-wanted ads Step 8 Quizzing customers and buyers about the sales of competitors’products Step 9 Infiltrating customers’ and competitors’ business operations

Step 10 Quizzing suppliers about competitors’ level of manufacturing Step 11 Using customers to buy out phony bids Step 12 Encouraging key customers to reveal competitive information Step 13 Quizzing competitors’ former employees Step 14 Interviewing consultants who may have worked with competitors Step 15 Hiring key managers away from competitors Step 16 Conducting phony job interviews to get competitors' employees to reveal information Step 17 Sending engineers to trade meetings to quiz competitors’ technical employees Step 18 Quizzing potential employees who worked for or with competitors

Notes 1. http://www.usatoday.com/money/companies/ 12. Spencer Morgan, ‘ The End of the Office Affair,”

management/story/2012-05- 14/ceo-firings/54964476/l Bloomberg Businessweek, September 20-26 , 2010, 74.

2. Ibid.

3. Joann Greco, ‘'Privacy— Whose Right Is It Anyhow?” Journal o f Business Strategy, January-February 2001, 32.

4. Ashby Jones and JoAnn Lublin, “New Law Prompts Blowing Whistle,” Wall Street Journal, November 1. 2010, B l.

5. Saul Gellerman, “W'hy ‘Good’ Managers Make Bad Ethical Choices,” Harvard Business Review 64, no. 4 (July-August 1986): 88.

6. Peter Drucker, Management: Tasks, Responsibilities, and Practices (New York: Harper & Row, 1974), 462, 463.

7. www.wikipcdia.org.

8. Joe Palazzolo and Christopher Matthews, "Bribery Law D o’s and Don’ts," Wall Street Journal (November 15, 2012): B l.

9. http://www.businessknowhow.com/manage/romancc.htm

10. Elizabeth Bernstein "The New Rules o f Flirting,” Wall Street Journal (11-13-12): D 1.

11. Phred Dvorak, Bob Davis, and Louise Radnofsky, “Firms Confront Boss-Subordinate Love Affairs,” Wall Street Journal, October 27, 2008, B5.

13. http://money.cnn.com/magazines/fortune/most-admired/ 2012/best_worst/best4.html and http://money.cnn.com/ magazines/fortune/most-admired/2012/best_worst/ worst4.html.

14. Archie Carroll and Frank Hoy, “Integrating Corporate Social Policy into Strategic Management,” Journal o f Business Strategy 4, no. 3 ( Winter 1984): 57.

15. Kerry Hannon, ‘‘Businesses’ Green Opportunities Are Wride, But Complex,” USA Today, January 2, 2009, 5B.

16. Adapted from the w w w.iso14000.com website and the www.epa.gov website.

17. http://www.guardian.co.uk/environment/2012/mar/09/ shark-fin-soup-blue-sharks-uk

18. Jim Sterba, “America Gone Wild,” Wall Street Journal (11-8-12): p. C l.

19. Tom Brook, “Declining Numbers Mute Many Birds’ Songs,” USA Today, September 11, 2001, 4A.

20. John Ogden. “Maintaining Diversity in the Oceans,” Environment, April 2001, 29-36.

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130

Types of Strategies

C H A P T E R O B JE C T IV E S After studying this chapter, you should be able to do the following:

1. Define and discuss secondary buyouts and dividend recapitalizations.

2. Identify the benefits and drawbacks of merging with another firm.

3. Discuss the value of establishing long-term objectives.

4. Identify 16 types of business strategies.

5. Identify numerous examples of organizations pursuing different types of strategies.

6. Discuss guidelines when particular strategies are most appropriate to pursue. 7. Discuss Porter's five generic strategies.

8 . Describe strategic management in nonprofit, governmental, and small organizations.

9. Discuss the nature and role of joint ventures in strategic planning.

10. Compare and contrast financial with strategic objectives.

11. Discuss the levels of strategies in large versus small firms.

12. Explain the first mover advantages concept.

13. Discuss recent trends in outsourcing and reshoring.

A S S U R A N C E O F L E A R N IN G EXERCISES The following exercises are found at the end of this chapter.

EXERCISE 4A Market Development: Petronas

EXERCISE 4B Alternative Strategies for Petronas

EXERCISE 4C Private-Equity Acquisitions

EXERCISE 4D The strategies of adidas AG: 2 0 13-2015

EXERCISE 4E Lessons in Doing Business Globally

EXERCISE 4F Petronas 2 0 13-2015

EXERCISE 4G What Strategies Are Most Risky?

EXERCISE 4H Exploring Bankruptcy

EXERCISE 41 Examining Strategy Articles

EXER C ISE 4J Classifying Some Strategies

131

132 CHAPTER 4 • TYPES OF STRATEGIES

Hundreds o f companies today, including IBM. Wells Fargo, and General Electric, have embraced strategic planning fully in their quest for higher revenues and profits. Kent Nelson, former chair of UPS. explains why his company has created a new strategic- planning department: “Because we're making bigger bets on investments in technology, we can't afford to spend a whole lot o f money in one direction and then find out live years later it was the wrong direction.” 1

This chapter brings strategic management to life with many contemporary examples. Sixteen types of strategies are defined and exemplified, including Michael Porter’s generic strategies: cost leadership, differentiation, and focus. Guidelines are presented for determining when each strategy is most appropriate to pursue. An overview o f strategic management in nonprofit organizations, governmental agencies, and small firms is provided. As showcased below, Petronas is an example company that for many years has exemplified excellent strategic management.

Long-Term Objectives Long-term objectives represent the results expected from pursuing certain strategies. Strategies represent the actions to be taken to accomplish long-term objectives. The time frame for objec­ tives and strategies should be consistent, usually from two to five years.

The Nature of Long-Term Objectives Objectives should be quantitative, measurable, realistic, understandable, challenging, hierarchi­ cal, obtainable, and congruent among organizational units. Each objective should also be associ­ ated with a timeline. Objectives are commonly staled in terms such as growth in assets, growth in sales, profitability, market share, degree and nature o f diversification, degree and nature o f vertical integration, earnings per share, and social responsibility. Clearly established objectives

STRATEGIC MANAGEMENT^

Petronas PETRONAS, short for Petroliam Nasional Berhad, is a Malaysian oil and gas company, wholly owned by the Government of Malaysia. Headquartered in Kuala Lumpur, PETRONAS owns the entire oil and gas resources in Malaysia and is responsible for developing and adding value to these resources. In 2013, Fortune ranked PETRONAS as the 75th largest company in the world, the 19th most profitable company in the world, and the most profitable company in Asia. PETRONAS has business interests in 35 countries and is engaged in a wide spectrum of petroleum activities, including upstream exploration and production of oil and gas as well as downstream oil refining, marketing, and distribu­ tion. Revenue derived from PETRONAS provides roughly 45 percent of the Malaysian government's annual budget. PETRONAS was one of the main sponsors of the BM W Sauber Formula One team before sponsor­ ing the Mercedes Grand Prix team. PETRONAS is the main sponsor for the Malaysian Grand Prix and co-sponsors the Chinese Grand Prix.

Among other strategies, PETRONAS is pursuing backward inte­ gration by purchasing its own ships to transport its own oil and gas, especially its liquefied natural gas (LNG). PETRONAS is directly procur­ ing new LNG ships to meet its LNG transportation requirements. The strategy will allow PETRONAS to have direct access to LNG shipping

EXCELLENT

capacity at the lowest pos­ sible costs. P E T R O N A S has engaged MISC Bhd to -------------------------------------------- provide Project M an ag em en t and Technical Consultancy services for the construction of its new LNG ships; MISC's has extensive experience and expertise in the LNG ship­ ping sector and is familiar with PETRONAS' business needs.

PETRONAS since 1975 has awarded 20,600 Malaysian students scholarships, including a total of 400 deserving students in 2013 to pursue their education under its PETRONAS Education Sponsorship Programme (PESP). Scholarship recipients are chosen during rigor­ ous selection days held across Malaysia, and are offered opportuni­ ties to take education at overseas institutions or at the Universiti Teknologi PETRONAS in Perak. The aim of PESP is to develop the skills of a pool of young people who meet PETRONAS' business requirements.

CHAPTER 4 • TYPES OF STRATEGIES 133

TA B LE 4-1 Varying Performance Measures by Organizational Level

Organizational Level Basis for Annual Bonus or Merit Pay

Corporate 75% based on long-term objectives 25% based on annual objectives

Division 50% based on long-term objectives 50% based on annual objectives

Function 25% based on long-term objectives 75% based on annual objectives

offer many benefits. They provide direction, allow synergy, aid in evaluation, establish priori­ ties, reduce uncertainty, minimize conflicts, stimulate exertion, and aid in both the allocation of resources and the design of jobs. Objectives provide a basis for consistent decision making by managers whose values and attitudes differ. Objectives serve as standards by which individuals, groups, departments, divisions, and entire organizations can be evaluated.

Long-term objectives are needed at the corporate, divisional, and functional levels of an organization. They arc an important measure o f managerial performance. Many practitioners and academicians attribute a significant part o f U.S. industry’s competitive decline to the short­ term. rather than long-term, strategy orientation of managers in the USA. Arthur D. Little argues that bonuses or merit pay for managers today must be based to a greater extent on long-term objectives and strategies. An example framework for relating objectives to performance evalua­ tion is provided in Table 4 - 1. A particular organization could tailor these guidelines to meet its own needs, but incentives should be attached to both long-term and annual objectives.

Without long-term objectives, an organization would drift aimlessly toward some unknown end. It is hard to imagine an organization or individual being successful without clear objectives. You probably have worked hard the last few years striving to achieve an objective to graduate with a business degree. Success only rarely occurs by accident: rather, it is the result o f hard work directed toward achieving certain objectives. Table 4-2 reveals the desired characteristics of objectives, while Table 4-3 summarizes the benefits of having clear objectives.

Financial versus Strategic Objectives Two types o f objectives are especially common in organizations: financial and strategic objec­ tives. Financial objectives include those associated with growth in revenues, growth in earn­ ings. higher dividends, larger profit margins, greater return on investment, higher earnings per share, a rising stock price, improved cash flow, and so on: whereas strategic objectives include things such as a larger market share, quicker on-time delivery than rivals, shorter design-to-mar- ket times than rivals, lower costs than rivals, higher product quality than rivals, wider geographic coverage than rivals, achieving technological leadership, consistently getting new or improved products to market ahead of rivals, and so on.

Although financial objectives are especially important in firms, oftentimes there is a trade­ off between financial and strategic objectives such that crucial decisions have to be made.

TA B LE 4-2 The Desired Characteristics of Objectives

1. Quantitative 2. Measurable 3. Realistic 4. Understandable 5. Challenging 6. Hierarchical 7. Obtainable 8. Congruent across departments

134 CHAPTER 4 • TYPES OF STRATEGIES

TA BLE 4-3 The Benefits of Having Clear Objectives

1. Provide direction by revealing expectations 2. Allow synergy 3. Aid in evaluation by serving as standards 4. Establish priorities 5. Reduce uncertainty 6. Minimize conflicts 7. Stimulate exertion 8. Aid in allocation of resources 9. Aid in design of jobs

10. Provide basis for consistent decision making

For example, a firm can do certain things to maximize short-term financial objectives that would harm long-term strategic objectives. To improve financial position in the short run through higher prices may. for example, jeopardize long-term market share. The dangers associated with trading off long-term strategic objectives with near-term bottom-line performance are especially severe if competitors relentlessly pursue increased market share at the expense o f short-term profitability. And there are other trade-offs between financial and strategic objectives, related to riskiness o f actions, concern for business ethics, need to preserve the natural environment, and social responsibility issues. Both financial and strategic objectives should include both annual and long-term performance targets. Ultimately, the best way to sustain competitive advantage over the long run is to relentlessly pursue strategic objectives that strengthen a firm’s business position over rivals. Financial objectives can best be met by focusing first and foremost on achieving strategic objectives that improve a firm's competitiveness and market strength.

Not Managing by Objectives An unidentified educator once said. “If you think education is expensive, try ignorance.” The idea behind this saying also applies to establishing objectives. Strategists should avoid the following alternative ways o f “not managing by objectives.”

• Managing by Extrapolation— adheres to the principle “If it ain't broke, don’t fix it.” The idea is to keep on doing the same things in the same ways because things are going well.

• Managing by Crisis— based on the belief that the true measure o f a really good strategist is the ability to solve problems. Because there are plenty of crises and problems to go around for every person and every organization, strategists ought to bring their time and creative energy to bear on solving the most pressing problems o f the day. Managing by crisis is actually a form of reacting rather than acting and o f letting events dictate the what and when of management decisions.

• Managing by Subjectives— built on the idea that there is no general plan for which way to go and what to do; just do the best you can to accomplish what you think should be done. In short, “Do your own thing, the best way you know how” (sometimes referred to as the mystery' approach to decision making because subordinates are left to figure out what is happening and why).

• Managing by Hope— based on the fact that the future is laden with great uncertainly and that if we iry and do not succeed, then we hope our second (or third) attempt will succeed. Decisions are predicated on the hope that they will work and that good times are just around the corner, especially if luck and good fortune are on our side!“

Types of Strategies The model illustrated in Figure 4 - 1 provides a conceptual basis for applying strategic manage­ ment. Defined and exemplified in Table 4-4, alternative strategies that an enterprise could pursue can be categorized into 11 actions: forward integration, backward integration, horizontal inte­ gration, market penetration, market development, product development, related diversification.

CHAPTER 4 • TYPES OF STRATEGIES 135

I____________________ Strategy ________________________ I________ Strategy _________ Strategy ______ I Formulation I Implementation I Evaluation I

FIGURE 4-1 A Comprehensive Strategie-Management Model

Source: Fred R. David, adapted from “How Companies Define Their Mission,” Long Range Planning 22, no. 3 (June 1988): 40, © Fred R. David.

unrelated diversification, retrenchment, divestiture, and liquidation. Each alternative strategy has countless variations. For example, market penetration can include adding salespersons, increas­ ing advertising expenditures, couponing, and using similar actions to increase market share in a given geographic area.

Many, if not most, organizations simultaneously pursue a combination o f two or more strat­ egies, but a combination strategy can be exceptionally risky if carried too far. No organization can afford to pursue all the strategies that might benefit the firm. Difficult decisions must be made. Priority must be established. Organizations, like individuals, have limited resources. Both organizations and individuals must choose among alternative strategies and avoid excessive indebtedness.

Hansen and Smith explain that strategic planning involves “choices that risk resources” and “trade-offs that sacrifice opportunity.” In other words, if you have a strategy to go north, then you must buy snowshoes and warm jackets (spend resources) and forgo the opportunity of “faster population growth in southern states.” You cannot have a strategy to go north and then take a step east, south, or west “just to be on the safe side.” Firms spend resources and focus on a finite number o f opportunities in pursuing strategies to achieve an uncertain outcome in the future. Strategic planning is much more than a roll o f the dice; it is a wager based on predictions

136 CHAPTER 4 • TYPES OF STRATEGIES

TA BLE 4-4 Alternative Strategies Defined and Exemplified

Strategy Definition Examples

Forward Gaining ownership or increased Forward Integration—PayPal is pushing Integration control over distributors or retailers its service off the Web and into stores via

an agreement with Discover card. Backward Seeking ownership or increased Backward Integration—Fancy Motels Inc. Integration control of a firm’s suppliers acquiring a furniture manufacturer. Horizontal Seeking ownership or increased Horizontal Integration— Britain's Integration control over competitors GlaxoSmithKline PLC acquired Human

Genome Sciences Inc. for $3 billion. Market Seeking increased market share Market Penetration—PepsiCo is heavily Penetration for present products or services in advertising its new Diet Pepsi special-

present markets through greater edition silver cans featuring the blue- marketing efforts and-red Pepsi logo in a heart shape.

Market Introducing present products or Market Development—China Development services into new geographic area Petrochemical purchased three Canadian

oil companies. Daylight Energy, Tanganyika Oil. and Syncrude Canada.

Product Seeking increased sales by Product Development—General Electric Development improving present products or is building new composite material jet

services or developing new ones engines, whereas rival Pratt & Whitney is developing newly designed jet engines.

Related Adding new but related products or Related Diversification—The toy retailer. Diversification services Toys ’R‘ Us developed a new Wi-Fi tablet

computer for children (the Tabeo for $149.99).

Unrelated Adding new, unrelated products or Unrelated Diversification— Retailer IKEA Diversification services is opening a chain of motels in Europe. Retrenchment Regrouping through cost and asset Retrenchment—Callaway Golf cut

reduction to reverse declining sales 12 percent of its workforce; Deutsche and profit Bank AG cut 1.000 jobs from its invest­

ment bank segment. Divestiture Selling a division or part of an Divestiture—Dean Foods sold off its

organization WhiteWave-AIpro organic dairy business. Liquidation Selling all of a company’s assets, in Liquidation— Big Sky Farms, one of

parts, for their tangible worth Canada's biggest hog-producing firms, liquidated.

and hypotheses that are continually tested and refined by knowledge, research, experience, and learning. Survival o f the firm itself may hinge on your strategic plan.3

Organizations cannot do too many things well because resources and talents get spread thin and competitors gain advantage. In large, diversified companies, a combination strategy is com­ monly employed when different divisions pursue different strategies. Also, organizations strug­ gling to survive may simultaneously employ a combination of several defensive strategies, such as divestiture, liquidation, and retrenchment.

Levels of Strategies Strategy making is not just a task for top executives. Middle-and lower-level managers also must be involved in the strategic-planning process to the extent possible. In large firms, there are actu­ ally four levels o f strategies: corporate, divisional, functional, and operational— as illustrated in Figure 4-2. However, in small firms, there are actually three levels o f strategies: company, functional, and operational.

In large firms, the persons primarily responsible for having effective strategies at the various levels include the CEO at the corporate level: the president or executive vice president at the divisional level; the respective chief finance officer (CFO), chief information officer (CIO).

CHAPTER 4 • TYPES OF STRATEGIES 137

Corporate Level—chief

executive officer

Division Level—division president or executive

vice president

Functional Level—finance, marketing, R&D, manufacturing, information systems,

and human resource managers

Operational Level—plant managers, sales managers, p ro d u c tio n a n d d e p a r tm e n t m an ag ers

Company' evel—owners or president

Functional Level— finance, marketing, R&D,

manufacturing, information systems, and human resource managers

Large Company

FIGURE 4-2 Levels of Strategies With Persons Most Responsible

Operational Level—plant managers, sales /managers, production and department managers''

Small Company

human resource manager (HRM), chief marketing officer (CMO), and so on at the functional level: and the plant manager, regional sales manager, and so on at the operational level. In small firms, the persons primarily responsible for having effective strategies at the various levels include the business owner or president at the company level and then the same range o f persons at the lower two levels, as with a large firm.

It is important that all managers at all levels participate and understand the firm’s strate­ gic plan to help ensure coordination, facilitation, and commitment while avoiding inconsis­ tency, inefficiency, and miscommunication. Plant managers, for example, need to understand and be supportive o f the overall strategic plan (game plan), whereas the president and the CEO need to be knowledgeable o f strategies being employed in various sales territories and manufacturing plants.

Integration Strategies The exclusively online men’s pants company, Bonobos, now sells menswear wholesale to Nordstrom and in addition is opening its own stores in New York, Palo Alto, Chicago, and other cities. However, shoppers do not walk out o f Bonobos stores with anything; the stores are simply for customers to try on the clothing before ordering online.

Forward integration, backward integration, and horizontal integration are sometimes collec­ tively referred to as vertical integration strategies. Vertical integration strategies allow a firm to gain control over distributors, suppliers, or competitors.

Forward Integration Forward integration involves gaining ownership or increased control over distributors or retail­ ers. Increasing numbers o f manufacturers (suppliers) today are pursuing a forward integration strategy by establishing websites to directly sell products to consumers. This strategy is causing turmoil in some industries. For example, Amazon is doubling down on forward integration by quietly installing large metal cabinets, called Amazon Lockers, in hundreds o f grocery, 7-Eleven, and drugstores that accept the packages for customers for later pickup. This strategy dispels the concern o f urban apartment dwellers who fear they will miss an Amazon delivery or have their item stolen. This strategy also combats a growing problem o f thieves following UPS and FedEx trucks and stealing packages at doorsteps. Amazon has lockers in the USA and United Kingdom. This strategy entails Amazon emailing customers a code to open the locker holding their mer­ chandise. Curtailing failed deliveries is essential for Amazon because otherwise consumers call

138 CHAPTER 4 • TYPES OF STRATEGIES

customer service, switch to a competitor, or get a replacement item. Amazon pays a small fee each month to store owners where it has lockers.

To combat Amazon’s forward integration, Walmart too is pursuing forward integration by launching its Walmart-to-go service in which the company promises same-day delivery in many cities for orders placed online. With that new service. Walmart ships products from its company’s stores rather than a warehouse or distribution center. The new' Walmart service costs $10 regardless o f size of the order.

Ford Motor in 2014-2015 is opening a nationwide network o f exclusive Lincoln dealers in China to promote an image of “luxury with simplicity” to compete with China’s heavyweight luxury brands, Volkswagen AG’s Audi, BMW AG, and Daimler AG’s Mcrcedes-Bcnz. Jim Farley, Ford Group VP for Global Marketing Sales and Service says that through extensive interviews and surveys the company knows that: “China is changing. Chinese wants to show off less. They want to consume for themselves, not for other people.” Ford is hunting for new dealers in China. The new Lincolns will have large back seats, a must in the Chinese luxury-car market where owners often employ drivers. Ford added 115 new dealers in China in 2012 and will increase its total to 500 by 2015.

Samsung in mid-2013 began adding upfront boutiques in all Best Buy stores. For the first time ever, Samsung is recruiting and training thousands o f retail workers to staff their new bou­ tiques. This forward integration strategy is a big move for Samsung, who unlike rivals Apple and Microsoft, currently own no retail stores of their own. Samsung is one o f Best Buy’s top five vendors (suppliers). Also using forward integration, IKEA, the huge furniture retailer, has recently agreed to begin building hotels, i.e. the Moxy brand, with Marriott. Most Moxy hotels will feature rooms prefabricated offsite and then assembled with IKEA furniture.

An effective means of implementing forward integration is franchising. Approximately 2,000 companies in about 50 different industries in the USA use franchising to distribute their products or services. Businesses can expand rapidly by franchising because costs and opportuni­ ties are spread among many individuals. Total sales by franchises in the United States are annu­ ally about $1 trillion.

The International Franchise Association Educational Foundations reports that there are about 800,000 franchise businesses in the USA. However, a growing trend is for franchisees, who for example may operate 10 franchised restaurants, stores, or whatever, to buy out their part of the business from their franchiser (corporate owner). There is a growing rift between franchi­ sees and franchisers as the segment often outperforms the parent. McDonald’s today owns only 67 percent of its restaurants, up from 20 percent a decade ago. Restaurant chains are increas­ ingly being pressured to own fewer of their locations. Companies such as M cDonald’s are using proceeds from the sale o f company stores and restaurants to franchisees to buy back company stock, pay higher dividends, and make other investments to benefit shareholders.

Also, McDonald’s franchisees in 2012-2013 are opposing the company’s remodeling investments, marketing campaigns, and discounting. Mark Kalinowski. lead restaurant analyst at Janney Capital Markets, recently asked 30 McDonald’s franchisees to gauge how they felt about what’s going on, and some comments were as follows:

• “We are bankrupting the system in the name o f ‘rebranding’ the system!” • “Major remodel projects arc wiping out our cash flow and our equity.” • “Cash How is trending up, but not as fast as McDonald's cash flow is.” • “We cannot absorb all these costs, do all this discounting, and still pay to remodel our land­

lord’s (McDonald’s) building.”

McDonald’s ironically gets 67 percent of its sales from company-owned restaurants. However, rival fast-food chain Burger King is converting virtually all o f its company-owned outlets to franchised operations, with revenue from franchisees going from 30 percent o f sales in 2011 to 90 percent in 2015. This change results in more than a 60 percent drop in Burger King revenues in two years since franchisees show revenues on their own personal income statements, but Burger King’s operating profit more than doubled during this time. Burger King already has 45 percent o f its stores outside the USA. and the company plans to increase that percentage dramatically. Rival Yum Brands owns virtually all o f its outside-U.S. restaurants and says that policy gives greater control and benefits if things go well (or bad). In contrast. Burger King has so much long-term debt it has to rely on franchisees for capital.

CHAPTER 4 • TYPES OF STRATEGIES 139

The following six guidelines indicate when forward integration may be an especially effective strategy:4

• When an organization’s present distributors are especially expensive, unreliable, or incapable of meeting the firm’s distribution needs.

• When the availability o f quality distributors is so limited as to offer a competitive advantage to those firms that integrate forward.

• When an organization competes in an industry that is growing and is expected to continue to grow markedly; this is a factor because forward integration reduces an organization’s ability to diversify if its basic industry falters.

• When an organization has both the capital and human resources needed to manage the new business o f distributing its own products.

• When the advantages o f stable production are particularly high; this is a consideration because an organization can increase the predictability o f the demand for its output through forward integration.

• When present distributors or retailers have high profit margins; this situation suggests that a company could profitably distribute its own products and price them more competitively by integrating forward.

Backward Integration In March 2 0 13. Starbucks purchased its first coffee farm— a 600 acre property in Costa Rica. This backward integration strategy was utilized primarily to develop new coffee varieties and to test methods to combat a fungal disease known as coffee rust that plagues the industry. Both manufacturers and retailers purchase needed materials from suppliers. Backward integration is a strategy o f seeking ownership or increased control of a firm’s suppliers. This strategy can be especially appropriate when a firm’s current suppliers are unreliable, too costly, or cannot meet the firm’s needs.

Campbell Soup recently acquired one o f its primary suppliers, Bolthouse Farms, head­ quartered in Bakersfield, California, for $1.55 billion in an effort to move more aggressively into fresher foods rather than relying so heavily on canned foods. Canned foods, including Campbell’s famous soups, are full o f preservatives so they will last a long time on shelves, but for an increasing number o f consumers, freshness trumps longevity.

Starbucks in early 2014 will open its first company-owned factory to make soluble products such as its VIA Ready Brew and the coffee base for Frappuccinos and many of the company’s ready-to-drink beverages. These products are currently made in Colombia, South America, and in Switzerland by third-party manufacturers. Starbucks says this backward integration strategy will enable the company to save on transportation and ensure better qual­ ity. The new Starbucks plant is being built in Augusta. Georgia. In addition, Starbucks recently began producing and selling a single-cup coffee brewing machine that will brew coffee, lattes, and espresso in one machine. Some analysts are concerned that consumers may now make their own Starbucks drink at home for one dollar, rather than going to a Starbucks and buying that drink for four dollars.

Priceline.com Inc., recently acquired Kayak Software for $1.8 billion, representing a 29 percent premium over Kayak's closing stock price. Priceline wanted Kayak because that company makes money by referring customers to online travel agencies such as Priceline and rival Expedia. Kayak operated websites and mobile applications for travelers to compare prices for airline, hotel, and rental-car bookings.

Some industries in the USA, such as the automotive and aluminum industries, are reducing their historical pursuit o f backward integration. Instead of owning their suppliers, companies negotiate with several outside suppliers. Ford and Chrysler buy more than half o f their component parts from outside suppliers such as TRW, Eaton, General Electric (GE), and Johnson Controls. De-integration makes sense in industries that have global sources o f supply. Companies today shop around, play one seller against another, and go with the best deal.

Global competition is also spurring firms to reduce their number o f suppliers and to demand higher levels o f service and quality from those they keep. Although traditionally rely­ ing on many suppliers to ensure uninterrupted supplies and low prices, U.S. firms now are following the lead o f Japanese firms, which have far fewer suppliers and closer, long-term

140 CHAPTER 4 • TYPES OF STRATEGIES

relationships with those few. “Keeping track o f so many suppliers is onerous,” says Mark Shimelonis, formerly o f Xerox.

Seven guidelines when backward integration may be an especially effective strategy are:'5

• When an organization’s present suppliers are especially expensive, unreliable, or incapable of meeting the firm's needs for parts, components, assemblies, or raw materials.

• When the number of suppliers is small and the number o f competitors is large. • When an organization competes in an industry that is growing rapidly: this is a factor

because integrative-type strategies (forward, backward, and horizontal) reduce an organization’s ability to diversify in a declining industry.

• When an organization has both capital and human resources to manage the new business of supplying its own raw materials.

• When the advantages o f stable prices are particularly important; this is a factor because an organization can stabilize the cost o f its raw materials and the associated price o f its product(s) through backward integration.

• When present suppliers have high profit margins, which suggests that the business o f supplying products or services in the given industry is a worthwhile venture.

• When an organization needs to quickly acquire a needed resource.

Horizontal Integration Horizontal integration refers to a strategy o f seeking ownership o f or increased control over a firm’s competitors. One o f the most significant trends in strategic management today is the increased use of horizontal integration as a growth strategy. Mergers, acquisitions, and takeovers among competitors allow for increased economies o f scale and enhanced transfer of resources and competencies. Kenneth Davidson makes the following observation about hori­ zontal integration:

The trend towards horizontal integration seems to reflect strategists’ misgivings about their ability to operate many unrelated businesses. Mergers between direct com peti­ tors are more likely to create efficiencies than mergers between unrelated businesses, both because there is a greater potential for eliminating duplicate facilities and because the management o f the acquiring firm is more likely to understand the business o f the target.6

Pearson PLC’s Penguin book publishing business recently merged with Bertelsmann SE's Random House book publishing division to create a new company named Penguin Random House. This horizontal integration strategy for the two parent firms combines Penguin's 10 percent U.S. book market share with Random House’s 20 percent market share into the new

joint-venture company. Combining forces allows the new' firm to gain more heft in negotiat­ ing terms with retailers such as Amazon. Combining forces in the publishing industry is also deemed necessary because publishers’ revenue coming from e-books is growing rapidly, to about 18 percent now. compared to 6.3 percent in 2010.

Based in Frankfurt, Germany, Bayer AG actively pursues horizontal integration, having just recently acquired vitamins maker Schiff Nutrition for $1.2 billion, as well as AgraQuest, a maker o f biological crop protection and Teva Pharmaceutical Industries’ U.S. animal health business. Based in Salt Lake City, Utah. Schiff produces Airborne, as well as many vitamin supplements and nutrition bars.

Sherwin-Williams recently acquired Mexico-based coatings maker Consorcio Comex SA for about $2.34 billion. Sherwin-Williams CEO Chris Connor said: “The transaction will significantly increase our presence in markets where our store count is low and it builds upon our strategy to grow our architectural paint business in the Americas.”

Two rival Canadian furniture and appliance retailers, Leon’s Furniture Ltd. and Brick Ltd. recently merged. Leon’s CEO said: “During these economic times where we have seen multiple American corporations make inroads into our country through acquisitions, it is a pleasure to see two successful Canadian retailers reach an agreement that will better serve Canadian consumers."

CHAPTER 4 • TYPES OF STRATEGIES 141

In the kidney-dialysis market, the second largest manufacturer, Baxter International, recently acquired the third largest manufacturer, Gambro, based in Sweden, for S4 billion. More than two million patients globally receive some form of kidney dialysis, with treatment rates increasing more than 5 percent annually.

These five guidelines indicate when horizontal integration may be an especially effective strategy:7

• When an organization can gain monopolistic characteristics in a particular area or region without being challenged by the federal government for “tending substantially” to reduce competition.

• When an organization competes in a growing industry. • When increased economies of scale provide major competitive advantages. • When an organization has both the capital and human talent needed to successfully manage

an expanded organization. • When competitors arc faltering as a result o f a lack of managerial expertise or a need for

particular resources that an organization possesses: note that horizontal integration would not be appropriate if competitors are doing poorly because in that case overall industry sales are declining.

Intensive Strategies Market penetration, market development, and product development are sometimes referred to as intensive strategies because they require intensive efforts if a firm’s competitive position with existing products is to improve.

Market Penetration A market penetration strategy seeks to increase market share for present products or services in present markets through greater marketing efforts. This strategy is widely used alone and in combination with other strategies. Market penetration includes increasing the number of salespersons, increasing advertising expenditures, offering extensive sales promotion items, or increasing publicity efforts. Chrysler Group LLC recently launched a new marketing campaign for its redesigned Ram pickup truck that features new technology and improved fuel economy. Chrysler desires to make inroads into the market share of the truck sales leader F-150. Chrysler’s new ads feature gruff-voiced actor Sam Elliott promoting Ram trucks over the Chevrolet Silverado and the GMC Sierra trucks.

General Motors in 2 0 13 rolled out its global advertising campaign for its Chevrolet brand in hopes of improving the brand’s image globally and halting its market-share slide in the United States. The new tagline for the GM campaign is “Find New Roads” that replaces the lackluster "Chevy Runs Deep” slogan. The new ad campaign is designed to support GM introducing 13 new or refreshed Chevrolet vehicles in the United States in 2013 and another 12 in different regions around the world.

In the 2013 Super Bowl, Anheuser-Busch InBev launched a huge new advertising campaign to coincide with its new Black Crown brand of beer. The prior year, the company had used the Super Bowl to launch its Bud Light Platinum brand. The company believes the Super Bowl is the ideal venue to launch something new because viewers o f the game surpass 110 million annually. Black Crown is a golden amber lager that is a little bit darker and a little bit more flavorlul than tradition Budweiser lager, and Black Crown has a 6 percent alcohol content rather than 5 percent. Anheuser is especially targeting the 21- to 34-year-old-age group with the new ads and brand.

These five guidelines indicate when market penetration may be an especially effective strategy:8

• When current markets are not saturated with a particular product or service. • When the usage rate of present customers could be increased significantly. • When the market shares of major competitors have been declining while total industry

sales have been increasing. • When the correlation between dollar sales and dollar marketing expenditures historically

has been high. • When increased economies o f scale provide major competitive advantages.

142 CHAPTER 4 • TYPES OF STRATEGIES

Market Development Market developm ent involves introducing present products or services into new geographic areas. India is a target for numerous firms to expand geographically. For example. Coca-Cola Company and its bottling partners are investing $5 billion in India between 2 0 13 and 2020 because that country has 1.2 billion people who on average only consume 12 eight-ounce bottles o f Coke a year compared with 240 in Brazil and 90 bottles globally. PepsiCo is also expanding aggressively into India (the CEO of PepsiCo is Indra Nooyi who was born in India). The Swedish furniture company, IKEA Group, is investing $ 1.9 billion in India to open 25 new stores between 2013 and 2018. Seattle-based Starbucks Corp. opened its first store in India in late 2012.

PepsiCo is also expanding aggressively into China and just opened its sixth snack plant in that country, in China’s landlocked city of Wuhan. CEO Nooyi at Pepsi said: “China will be the largest consumer market in the next decade, and PepsiCo aims to be the largest food-and- beverage company in that market.” The snack-food market in China was about $12 billion in 2012, up 44 percent from 2008. PepsiCo's revenue from emerging markets increased from 58 billion in 2008 to over $25 billion in 2013.

China’s Dalian Wanda Group Corp. recently acquired all 346 AMC (AMC Entertainment Holdings) multiplex theaters in the USA and Canada. Valued at $2.6 billion, the acquisition was the largest ever between a Chinese company and the U.S. film industry. AMC was the second- largest theater chain in the USA behind Regal Entertainment. Carmike is another competitor in the theater industry.

These six guidelines indicate when market development may be an especially effective strategy:9

• When new channels o f distribution are available that are reliable, inexpensive, and of good quality.

• When an organization is successful at what it does. • When new untapped or unsaturated markets exist. • When an organization has the needed capital and human resources to manage expanded

operations. • When an organization has excess production capacity. • When an organization’s basic industry is rapidly becoming global in scope.

Product Development Product developm ent is a strategy that seeks increased sales by improving or modifying pres­ ent products or services. Product development usually entails large research and development expenditures. Walt Disney Company is quickly developing a Disney Baby line o f products and services that it expects to become a powerful baby brand for customers ages zero to two. Bob Chapek, president o f Disney Consumer Products, recently said: ‘‘This gives Disney the opportu­ nity to reach out to moms when magical moments begin: there is no more special occasion than the birth o f a baby.” The company plans to create Disney Baby sections in its 200-plus Disney Stores in the USA. Disney Baby online will sell everything from $14 Disney Cuddly Bobysuits to $69 Peeking Pooh Premiere Crib Bumpers.

Microsoft Corp. just released Office 365, an Internet-based (or cloud), subscription-based office system, in conjunction with its new Office 2013. Office 365 represents a culture shift for Microsoft, as web-based software such as Google's Chrome, Android, and Doc and mobile devices undermine the strategic importance o f PCs and programs install on them.

Ford Motor is set to release its aluminum body F-150 in 2014, which will cut the weight of that truck by 15 percent or 800 pounds and enable 25 percent lower gas mileage and use o f a smaller engine. This is a huge strategic bet by Ford because the F-150 truck accounts for up to a third of their $8 billion operating profit globally. The F-250 and F-350 do not fall under the new emission guidelines so are not being redesigned. Aluminum is more expensive than steel and harder to work with, so Ford is betting that this strategy will work, rather than having the vehicle shut down at stoplights to conserve fuel, or investing as GM is doing for its trucks, in designing more efficient engines. GM and Ford rarely take such divergent strategic paths, but in this case they are. Ford is betting on aluminum and GM is not. The F-Series pickup is Ford's top money­ maker and has been the top-selling vehicle o f any kind in the USA for 30 years.

CHAPTER 4 • TYPES OF STRATEGIES 143

Merck is testing a new cancer drug that can unleash the body's immune system ’s power to fight malignancies. The new drug, known as MK-3475, is among a new class o f agents called PD-I inhibitors, than enable the immune system to destroy cancer cells. Also using product development. Burger King is doubling its offerings o f coffee, to include ten items, such as flavored iced coffee and vanilla lattes. Burger King is trying to catch up with rival McDonald's whose specialty coffee line, McCafc, is growing rapidly. Burger King also wants to regain the #2 burger chain in the USA in sales, having lost that ranking to Wendy’s.

These five guidelines indicate when product development may be an especially effective strategy to pursue:10

• When an organization has successful products that are in the maturity stage o f the product life cycle; the idea here is to attract satisfied customers to try new (improved) products as a result o f their positive experience with the organization’s present products or services.

• When an organization competes in an industry that is characterized by rapid technological developments.

• When major competitors offer better-quality products at comparable prices. • When an organization competes in a high-growth industry. • When an organization has especially strong research and development capabilities.

Diversification Strategies For the first time its 129-year history. Cincinnati-based Kroger began adding clothing to its lineup of products. The new Kroger apparel section in its store in Mansfield. Ohio, includes branded shoes, jewelry, outerwear, and undergarments from Levi, Carhartt, Carter, Skechers. Hanes. Maidenform, and other apparel producers. There is only about a 1 percent profit margin in the grocery business, so Kroger is trying to diversify.

There are two general types o f d iversification strategies: related diversification and unrelated diversification . Businesses are said to be related when their value chains possesses com petitively valuable cross-business strategic fits; businesses are said to be unre­ lated when their value chains are so dissimilar that no com petitively valuable cross-business relationships ex ist.11 Most companies favor related diversification strategies to capitalize on synergies as follows:

• Transferring competitively valuable expertise, technological know-how, or other capabili­ ties from one business to another.

• Combining the related activities o f separate businesses into a single operation to achieve lower costs.

• Exploiting common use o f a well-known brand name. • Cross-business collaboration to create competitively valuable resource strengths and

capabilities.12

Diversification strategies are becoming less popular because organizations are finding it more difficult to manage diverse business activities. In the 1960s and 1970s, the trend was to diversify to avoid being dependent on any single industry, but the 1980s saw a general reversal of that thinking. Diversification is now on the retreat. Michael Porter, o f the Harvard Business School, says, “Management found it couldn’t manage the beast.” Hence businesses are selling, or closing, less profitable divisions to focus on core businesses. Although many firms are suc­ cessful operating in a single industry, new technologies, new products, or fast-shifting buyer preferences can decimate a single business.

Diversification must do more than simply spread business risk across different industries, because shareholders could accomplish this by simply purchasing equity in different firms across different industries or by investing in mutual funds. Diversification makes sense only to the extent the strategy adds more to shareholder value than what shareholders could accomplish acting individually. Thus, the chosen industry for diversification must be attractive enough to yield consistently high returns on investment and offer potential across the operating divisions for synergies greater than those entities could achieve alone.

144 CHAPTER 4 • TYPES OF STRATEGIES

A few companies today, however, pride themselves on being conglomerates, from small firms such as Pentair Inc. and Blount International to huge companies such as Textron, Allied Signal, Emerson Electric, GE, Viacom, and Samsung. Conglomerates prove that focus and diversity are not always mutually exclusive.

Many strategists contend that firms should “stick to the knitting” and not stray too far from the firms’ basic areas o f competence. However, diversification is still sometimes an appropriate strategy, especially when the company is competing in an unattractive industry. Hamish Maxwell, Philip Morris’s former CEO, says, “We want to become a consumer-products company.” Diversification makes sense for Philip Morris because cigarette consumption is declining, product liability suits are a risk, and some investors reject tobacco stocks on principle.

Related Diversification Firms are generally moving away from diversification to focus. For example, ITT recently divided itself into three separate, specialized companies. ITT once owned everything from Sheraton hotels and Hartford Insurance to the maker of Wonder bread and Hostess Twinkies. About the ITT breakup, analyst Barry Knap said, “Companies generally are not very efficient diversifiers; investors usually can do a better job of that by purchasing stock in a variety of companies.”

Bucking the trend however is Berkshire Hathaway, a holding company for diverse compa­ nies that include Dairy Queen. Burlington Northern Santa Fe Railroad, and Geico Insurance. Also bucking the trend, Amazon.com continues to diversify and is expected in 2013 to enter the smartphone business, to complement its Kindle e-reader and tablet devices. About 675 smart­ phones were sold in 2012, up 39 percent from 2011, whereas tablet sales increased 75 percent to I 13 million. In another related diversification move in 2012. Amazon acquired mapping app maker UpNext. In addition, analysts expect Amazon to soon enter the mobile payments business and compete with offerings from eBay and Square.

Google in late 2012 entered the cable operator business by providing high-speed Internet and TV service in Kansas City, Missouri, and beyond. This new service entails Google supply­ ing Web connections rather than the services that run on them. Google plans to expand this new service to all markets that Verizon has not entered. Google's new service costs $120 a month and provides 100 times faster Internet service than Time Warner. Google provides less money options but the $120 gets users online file storage space and a Nexus 7 computer tablet that they can use as a remote control, as well as DVR storage of 500 hours of shows, including eight shows simultaneously that can be watched on demand, and more.

IBM recently paid a 42 percent premium (42 percent more than the book value) to acquire Kenexa Corp. for about $1.3 billion, to move more deeply into the online business software applications business. Kenexa was a leading supplier o f human-resources software and consult­ ing services that help about 9,000 customers recruit, retain, and develop their employees. This acquisition moved IBM into competition with enterprise-software makers such as SAP AG. that recently acquired a company named Success Factors that competes with Kenexa. and with Oracle Corp., that recently bought human-resources software maker Taleo for S I.9 billion.

Starbucks recently made its largest acquisition ever, acquiring Atlanta-based tea retailer Teavana Holdings for a 54 percent premium over Teavana’s closing stock price. Teavana customers tend to be to aficionados, so Starbucks plans to bring its tried-and-truc strategy to Teavana, with a tea bar offering customized hot and cold tea drinks. Teavana currently sells most of its tea in loose-leaf form for home consumption.

Six guidelines for when related diversification may be an effective strategy are as follow s.13

• When an organization competes in a no-growth or a slow-growtb industry. • When adding new, but related, products would significantly enhance the sales o f current

products. • When new, but related, products could be offered at highly competitive prices. • When new, but related, products have seasonal sales levels that counterbalance an

organization’s existing peaks and valleys. • When an organization’s products are currently in the declining stage of the product’s

life cycle. • When an organization has a strong management team.

CHAPTER 4 • TYPES OF STRATEGIES 145

Unrelated Diversification Based in Memphis, Tennessee, the huge overnight delivery firm FedEx recently entered the computer repair business offering major corporations with overnight computer repair. FedEx’s Todd Taylor, manager o f the company’s TechConnect computer repair division says "What we offer is unparalleled turnaround time.” FedEx’s new computer repair service is initially focused on the enterprise market, but the company plans to expand the services to small businesses and consumers in the new future.

An unrelated diversification strategy favors capitalizing on a portfolio o f businesses that are capable o f delivering excellent financial performance in their respective industries, rather than striving to capitalize on value chain strategic fits among the businesses. Firms that employ unrelated diversification continually search across different industries for companies that can be acquired for a deal and yet have potential to provide a high return on investment. Pursuing unrelated diversification entails being on the hunt to acquire companies whose assets are undervalued, companies that are financially distressed, or companies that have high growth prospects but are short on investment capital. An obvious drawback o f unrelated diversification is that the parent firm must have an excellent top management team that plans, organizes, motivates, delegates, and controls effectively. It is much more difficult to manage businesses in many industries than in a single industry. However, some firms are successful pursuing unrelated diversification, such as Walt Disney, which owns ABC, and GE, which owns NBC Universal. GE also produces locomotives, airplanes, appliances, and MRI machines and offers consumer finance, media, entertainment, oil, gas, and lighting products and sen ices.

Numerous hotels are entering the beer brewing business to offer their guests a unique experience at “social” and “happy” hours. Specialty (or craft) beer sales are increasing about 15 percent annually. Four Fairmont hotels for example recently created their own microbrews using honey from on-site beehives. The Four Points by Sheraton in Los Angeles has a new director o f brewer relations, a new beer advisory board, and customized in-room beer fridges.

Speaking o f hotels and unrelated diversification, perhaps the first underwater hotel on the planet is being built in Dubai by Drydocks World in cooperation with BIG InvestConsult AG. The hotel is to be completed in 2015 and will offer 21 underwater rooms, with big windows looking out into the Persian Gulf, and disc-shaped luxury hotel attached above the water line.

Best Buy recently introduced its own tablet computer, the Insignia Flex, for $250. The new product is available only at Best Buy, the new product is 9.7 inches wide, putting it in the same size category as Apple’s iPad and Microsoft’s Surface. This is Best Buy’s first foray into manufacturing its own electronic devices.

Deutsche Bank recently opened the $4 billion, 3.000-room Cosmopolitan casino on the Las Vegas Strip. The huge German bank was originally just funding the project, but when developers defaulted on their loans. Deutsche decided to finish the last two years of work on the project and own and operate the new casino themselves. The Cosmopolitan features a three-story, crystal- strewn bar meant to evoke the inside of a chandelier. Other financial institutions worldwide perhaps should consider unrelated diversification also by taking over some of their gone-bad projects rather than taking huge losses. Many more firms have failed at unrelated diversification than have succeeded as a result o f immense management challenges.

Ten guidelines for when unrelated diversification may be an especially effective strategy are:14

• When revenues derived from an organization's current products or services would increase significantly by adding the new, unrelated products.

• When an organization competes in a highly competitive or a no-growth industry, as indicated by low industry profit margins and returns.

• When an organization's present channels o f distribution can be used to market the new products to current customers.

• When the new products have countercyclical sales patterns compared to an organization’s present products.

• When an organization’s basic industry is experiencing declining annual sales and profits. • When an organization has the capital and managerial talent needed to compete successfully

in a new' industry. • When an organization has the opportunity to purchase an unrelated business that is an

attractive investment opportunity.

146 CHAPTER 4 • TYPES OF STRATEGIES

• When there exists financial synergy between the acquired and acquiring firm. (Note that a key difference between related and unrelated diversification is that the former should be based on some commonality in markets, products, or technology, whereas the latter is based more on profit considerations.)

• When existing markets for an organization’s present products are saturated. • When antitrust action could be charged against an organization that historically has

concentrated on a single industry.

Defensive Strategies In addition to integrative, intensive, and diversification strategies, organizations also could pur­ sue retrenchment, divestiture, or liquidation.

Retrenchment Retrenchment occurs when an organization regroups through cost and asset reduction to reverse declining sales and profits. Sometimes called a turnaround or reorganizational strat­ egy. retrenchment is designed to fortify an organization’s basic distinctive competence. During retrenchment, strategists work with limited resources and face pressure from shareholders, employees, and the media. Retrenchment can entail selling off land and buildings to raise needed cash, pruning product lines, closing marginal businesses, closing obsolete factories, automating processes, reducing the number o f employees, and instituting expense control systems.

Cosmetic company Revlon, whose brands include Almay and Mitchum, is closing its manu­ facturing plant in France and laying off 5 percent o f its workforce in 2013 to combat high raw material costs, weakness in Europe, and a slowdown in China. Avon Products Inc. is presently exiting the South Korea and Vietnam markets and laying off 1,500 employees, as new CEO Sheri McCoy tries to stabilize the company, reeling from bribery allegations and falling sales.

In some cases, bankruptcy can be an effective type of retrenchment strategy. Bankruptcy can allow a firm to avoid major debt obligations and to void union contracts. There are five major types of bankruptcy: Chapter 7. Chapter 9, Chapter 11, Chapter 12. and Chapter 13.

Chapter 7 bankruptcy is a liquidation procedure used only when a corporation sees no hope of being able to operate successfully or to obtain the necessary creditor agreement. All the orga­ nization’s assets are sold in parts for their tangible worth. Chapter 7 is also the bankruptcy provi­ sion most frequently used by individuals to wipe out many types o f unsecured debt. Strauss Auto in 2012 filed Chapter 7 liquidation bankruptcy, after five previous times in its history filing and coming out o f Chapter I 1 reorganization bankruptcy. This time however, the auto-repair chain is closing its 46 remaining stores and selling its assets for their tangible worth.

Chapter 9 bankruptcy applies to municipalities. Stockton, a river port city o f 290.000 in the Central Valley o f California, declared Chapter 9 bankruptcy in 2012. to avoid having to close key functions such as their police and fire departments. A judge now, rather than city officials, has control over Stockton’s debt-management problems. Stockton has twice in recent years toped Forbes magazine’s list o f “America’s most miserable cities.” However, the largest munici­ pal (Chapter 9) bankruptcy in U.S. history occurred in 2011 in Birmingham, Alabama (Jefferson County). There were 13 municipal bankruptcies filed in 201 1. Detroit, Michigan is eyeing the situation in Stockton to see if it needs to lile for bankruptcy.

Chapter I I bankruptcy allows organizations to reorganize and come back after filing a peti­ tion for protection. The Santa Ysabel Resort and Casino located 50 miles north o f San Diego filed for Chapter 11 protection in mid-2012 to avoid having to shut down totally. Owned by the local Indian tribe Lipay Nation of Santa Ysabel, the casino owes $9 million to the Yavapai Apache Nation and that tribe needs to collect on their investment. Two military transport airlines declared bankruptcy in 2012, Southern Air and Global Aviation Holdings. Both firms cited the U.S. withdrawal o f forces from Afghanistan as the primary reason for their demise.

Based in Mechanicsville, Virginia, the world's largest operator o f bowling alleys, AMF Bowling Worldwide, filed for bankruptcy-court protection in late 2012 as the company failed to adapt to customers who shifted from being “blue-collar bowlers in leagues” to middle-class bowlers averse to leagues but who desire attractive amenities and facilities. AMF the last few years was too heavily burdened by debt to financially afford to refurbish its 262 bowling centers

CHAPTER 4 • TYPES OF STRATEGIES 147

in the USA. Mom-and-pop operators and small bowling chains now operate more than 5,000 bowling alleys in the U.S.

Chapter 12 bankruptcy was created by the Family Farmer Bankruptcy Act o f 1986. This law became effective in 1987 and provides special relief to family farmers with debt equal to or less than $1.5 million.

Chapter 13 bankruptcy is a reorganization plan similar to Chapter 11, but it is available only to small businesses owned by individuals with unsecured debts of less than $100,000 and secured debts of less than $350,000. The Chapter 13 debtor is allowed to operate the business while a plan is being developed to provide for the successful operation of the business in the future.

Five guidelines for when retrenchment may be an especially effective strategy to pursue are as follow s:15

• When an organization has a clearly distinctive competence but has failed consistently to meet its objectives and goals over time.

• When an organization is one of the weaker competitors in a given industry. • When an organization is plagued by inefficiency, low profitability, poor employee morale,

and pressure from stockholders to improve performance. • When an organization has failed to capitalize on external opportunities, minimize external

threats, take advantage o f internal strengths, and overcome internal weaknesses over time; that is, when the organization’s strategic managers have failed (and possibly will be replaced by more competent individuals).

• When an organization has grown so large so quickly that major internal reorganization is needed.

Divestiture Selling a division or part o f an organization is called divestiture. Divestiture often is used to raise capital for further strategic acquisitions or investments. Divestiture can be part o f an overall retrenchment strategy to rid an organization o f businesses that are unprofitable, that require too much capital, or that do not fit well with the firm’s other activities. Divestiture has also become a popular strategy for firms to focus on their core businesses and become less diversified. For example, United Technologies recently sold two divisions o f its Hamilton Sundstrand pump and air compressor subsidiary to help pay for the company’s $16.5 billion acquisition o f Goodrich Corp. Owner o f the Atlanta Braves baseball team, Liberty Media Corp., recently divested its Star/, television network, but retains its large investments in Sirius XM Radio, Live Nation Entertainment, and Barnes & Noble.

New York Times Company (NYTC) recently sold its About.com how-to-website to a rival company, Answers.com, for $270 million. NYTC divested nearly 20 regional newspapers in the last twelve months and also divested its remaining stake in the Boston Red Sox. In addition, NYTC plans to divest The Boston Globe, the twenty third largest newspaper in the USA.

Bank o f America just sold its overseas wealth-management operations for $880 million to Swiss private-banking specialist Julius Baer Group AG. Since Brian Moynihan became CEO of Bank of America in 2010, he divested more than $50 billion in what he calls noncore assets, dropping Bank o f America below J.P. Morgan Chase as the largest bank in the USA.

Time Warner recently divested its magazine division, soon after News Corp. divested its publishing division. The year 2013 exceeded the prior two years in divestitures as firms used the strategy to increase stock price and overall value.

Six guidelines for when divestiture may be an especially effective strategy to pursue follow:16

• When an organization has pursued a retrenchment strategy and failed to accomplish needed improvements.

• When a division needs more resources to be competitive than the company can provide. • When a division is responsible for an organization’s overall poor performance. • When a division is a misfit with the rest o f an organization; this can result from radically

different markets, customers, managers, employees, values, or needs. • When a large amount of cash is needed quickly and cannot be obtained reasonably from

other sources. • When government antitrust action threatens an organization.

148 CHAPTER 4 • TYPES OF STRATEGIES

Liquidation Selling all o f a company’s assets, in parts, for their tangible worth is called liquidation. Liquidation is a recognition of defeat and consequently can be an emotionally difficult strat­ egy. However, it may be better to cease operating than to continue losing large sums o f money. For example, the New York City-based discount retailer o f designer clothing. Daffy’s, recently liquidated, closing all its 19 stores and selling all its inventory. A family-run business based in Secaucus, New Jersey and founded in 1961, Daffy’s decided it could not compete with T.J. Maxx and Marshalls, which had expanded aggressively into New York City. All 1,300 employees o f Daffy’s received severance pay of 60 days worth of work.

Delta Airlines recently liquidated its 35-year-old regional carrier Comair and sent termina­ tion notices to Comair’s 1.700 remaining employees. More than 1,000 Comair employees were in the Cincinnati and northern Kentucky region, some 700 of those in Kentucky. Comair had slashed its fleet, flights and workforce in the last seven years and was down to 290 flights a day. Delta decided how'ever that small regional planes are too expensive to fly because they are not as fuel-efficient and are more costly to maintain as the fleet ages. “We just really couldn’t get the cost structure to where we wanted to get it,” said Don Bornhorst, senior vice president o f Delta Connection and a former Comair president. “It ultimately was a cost issue; it wasn’t a quality issue with Comair. They’re a good airline, great employees, very innovative. . . we just could not solve the cost issues.”

Based in Waltham, Massachusetts, A 123 Systems, the electric-car battery manufacturer, filed for bankruptcy recently and then sold all its tangible assets to Johnson Controls. Similarly, solar-panel manufacturer, Solyndra LLC, recently liquidated.

Based in Irving, Texas, Hostess Brands in late 2012 told all 18,000 o f its workers that the firm will liquidate in five days unless the union-striking employees returned to work. The union work stoppage basically shut down two-thirds o f Hostess' 36 manufacturing plants. Four unions were involved: (1) bakery. (2) confectionary, (3) tobacco workers, and (4) grain millers. The largest union’s president. Frank Hurt, said: “I am well aware o f the possibility o f a liquidation, but our people will only take so much when it comes to cuts to their wages and benefits.” The following brands were predicted by the Wall St reel Journal in May 2013 to disappear in 2014:

J.C. Penney

Barnes & Noble's Nook

Martha Stewart’s Living Magazine

Living Social (a daily deals website)

Volvo

Olympus cameras

Women's National Basketball Association (WNBA)

Leap Wireless International

Mitsubishi Motors

Road & Track (the automotive magazine)

Thousands of small businesses in Europe and the USA liquidate annually without ever mak­ ing the news. It is tough to start and successfully operate a small business. In China and Russia, thousands o f government-owned businesses liquidate annually as those countries try to privatize and consolidate industries.

These three guidelines indicate when liquidation may be an especially effective strategy to pursue:17

• When an organization has pursued both a retrenchment strategy and a divestiture strategy, and neither has been successful.

• When an organization’s only alternative is bankruptcy. Liquidation represents an orderly and planned means o f obtaining the greatest possible cash for an organization’s assets. A company can legally declare bankruptcy first and then liquidate various divisions to raise needed capital.

• When the stockholders of a firm can minimize their losses by selling the organization's assets.

CHAPTER 4 • TYPES OF STRATEGIES 149

Michael Porter’s Five Generic Strategies Probably the three most widely read books on competitive analysis in the 1980s were Michael Porter’s Competitive Strategy (1980), Competitive Advantage (1985), and Competitive Advantage o f Nations (1989). Accordins to Porter, strategies allow organizations to gain com­ petitive advantage from three different bases: cost leadership, differentiation, and focus. Porter calls these bases generic strategies.

Cost leadership emphasizes producing standardized products at a low per-unit cost for consuméis who are price-sensitive. Two alternative types o f cost leadership strategies can be defined. Type I is a low-cost strategy that offers products or services to a wide ranee o f custom­ ers at the lowest price available on the market Type 2 is a best-value stratecy that offers prod­ ucts or services to a wide range of customers at the best price-value available on the market: the best-value strategy aims to offer customers a range o f products or services at the lowest price available compared to a rival's products with similar attributes. Both Type 1 and Type 2 strate­ gies target a large market.

Poller’s Type 3 Generic strategy is differentiation, a strategy aimed at producing products and services considered unique industrywide and directed at consumers who are relatively price-insensitive.

Focus means p r o d u c in g products and services that fulfill the needs o f small groups o f consumers. Two alternative types o f focus strategies are Type 4 and Type 5. Type 4 is a low-cost focus strategy that offers products or services to a small range (niche group) o f customers at the lowest price available on the market. Examples o f firms that use the Type 4 strategy include Jiffy Lube International and Pizza Hut, as well as local used car dealers and hot dog restaurants. Type 5 is a best-value focus strategy that offers products or services to a small range o f customers at the best price-value available on the market. Sometimes called “focused differentiation,” the best-value focus strategy aims to offer a niche group o f customers products or services that meet their tastes and requirements better than rivals’ products doế Both Type 4 and Type 5 focus strategies target a small market. However, the difference is that Type 4 strategies offer products or services to a niche group at the low­ est price, whereas Tvpe 5 offers products and services to a niche group at higher prices but loaded with features so the offerings are perceived as the best value. Examples o f firms that use the Type 5 strategy include Cannondale (top-of-the-line mountain bikes), Maytag (washing machines), and Lone Star Restaurants (steakhouse), as well as bed-and-breakfast inns and local retail boutiques.

Porter’s five strategies imply different organizational arrangements, control procedures, and incentive systems. Larger firms with greater access to resources typically compete on a cost leadership or differentiation basis, whereas smaller firms often compete on a focus basis. Porter's five generic strategies are illustrated in Figure 4-3. Note Lhat a differentiation strategy (Type 3) can be pursued with either a small target market or a large target market. However, it is not effective to pursue a cost leadership strategy in a small market because profits margins are generally too small. Likewise, it is not effective to pursue a focus strategy in a large market because economies o f scale would generally favor a low-cost or best-value cost leadership strat­ egy to gain or sustain competitive advantage.

Porter stresses the need for strategists to perform cost-benefit analyses to evaluate “sharing opportunities” among a firm’s existing and potential business units. Sharing activities and resources enhances competitive advantage by lowering costs or increasing differentiation. In addition to prompting sharing, Porter stresses the need for firms to effectively “transfer” skills and expertise among autonomous business units to gain competitive advantage. Depending on factors such as type of industry, size o f firm, and nature of competition, various strategies could yield advantages in cost leadership, differentiation, and focus.

Cost Leadership Strategies (Type 1 and Type 2) A primary reason for pursuing forward, backward, and horizonial integration strategies is to gain low-cost or best-value cost leadership benefits. But cost leadership generally must be pursued in conjunction with differentiation. A number o f cost elements affect the relative attractive­ ness o f generic strategies, including economies or diseconomies o f scale achieved, leamina and experience curve effects, the percentage o f capacity utilization achieved, and linkages with

150 CHAPTER 4 • TYPES OF STRATEGIES

Type 1: Cost Leadership— Low Cost Type 2: Cost Leadership— Best Value Type 3: Différentiation Type 4: Focus— Low Cost Type 5: Focus— Best Value

GENERIC STRATEGIES

Cost Leadership Differentiation Focus

m22 < 2

Large Type 1 Type 2

Type 3

Type 3 Type 4 Type 5

FIGURE 4-3 Porter's Five Generic Strategies

Source: Based on Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980), 35-40.

suppliers and distributors. Other cost elements to consider in choosing among alternative strate­ gies include the potential for sharing cosLs and knowledge within the organization, research and development (R&D) costs associated with new product development or modification o f existing products, labor costs, tax rates, energy costs, and shipping costs.

Striving to be the low-cost producer in an industry can be especially effective when the market is composed o f many price-sensitive buyers, when there are few ways to achieve product differentiation, when buyers do not care much about differences from brand to brand, or when there are a large number o f buyers with significant bargaining power. The basic idea is to under­ price competitors and thereby gain market share and sales, entirely driving some competitors out of the market. Companies employing a low-cost (Type 1) or best-value (Type 2) cost leadership strategy must achieve their competitive advantage in ways that are difficult for competitors to copy or match. If rivals find it relatively easy or inexpensive to imitate the leader’s cost leader­ ship methods, the leaders’ advantage will not last long enough to yield a valuable edge in the marketplace. Recall that for a resource to be valuable, it must be either rare, hard to imitate, or not easily substitutable. To employ a cost leadership strategy successfully, a firm must ensure that its total costs across its overall value chain are lowrer than competitors' total costs. There are two w'ays to accomplish this:18

1. Perform value chain activities more efficiently than rivals and control the factors that drive the costs o f value chain activities. Such activities could include altering the plant layout, mastering newly introduced technologies, using common parts or components in different products, simplifying product design, finding ways to operate close to full capacity year- round, and so on.

2, Revamp the firm’s overall value chain to eliminate or bypass som e cost-producing activities. Such activities could include securing new suppliers or distributors, selling products online, relocating manufacturing facilities, avoiding the use o f union labor, and so on.

When employing a cost leadership strategy, a firm must be careful not to use such aggres­ sive price cuts that their own profits are low or nonexistent. Constantly be mindful o f cost-saving technological breakthroughs or any other value chain advancements that could erode or destroy

CHAPTER 4 • TYPES OF STRATEGIES 151

the firm’s competitive advantage. A Type I or Type 2 cost leadership strategy can be especially effective under the following conditions:19

1. When price competition among rival sellers is especially vigorous. 2. When the products o f rival sellers are essentially identical and supplies are readily

available from any o f several eager sellers. 3. When there are few ways to achieve product differentiation that have value to buyers. 4. When most buyers use the product in the same ways. 5. When buyers incur low costs in switching their purchases from one seller to another. 6. When buyers are large and have significant power to bargain down prices. 7. When industry newcomers use introductory low prices to attract buyers and build a cus­

tomer base.

A successful cost leadership strategy usually permeates the entire firm, as evidenced by high efficiency, low overhead, limited perks, intolerance of waste, intensive screening of budget requests, wide spans of control, rewards linked to cost containment, and broad employee partici­ pation in cost control efforts. Some risks of pursuing cost leadership are that competitors may imitate the strategy, thus driving overall industry profits down; that technological breakthroughs in the industry may make the strategy ineffective; or that buyer interest may swing to other dif­ ferentiating features besides price. Several example firms that are well known for their low-cost leadership strategies are Walmart, BIC, McDonald's, Black & Decker. Lincoln Electric, and Briggs & Stratton.

Differentiation Strategies (Type 3) Different strategies offer different degrees o f differentiation. Differentiation does not guaran­ tee competitive advantage, especially if standard products sufficiently meet customer needs or if rapid imitation by competitors is possible. Durable products protected by barriers to quick copying by competitors are best. Successful differentiation can mean greater product flexibility, greater compatibility, lower costs, improved service, less maintenance, greater convenience, or more features. Product development is an example of a strategy that offers the advantages of differentiation.

A differentiation strategy should be pursued only after a careful study o f buyers’ needs and preferences to determine the feasibility of incorporating one or more differentiating features into a unique product that features the desired attributes. A successful differentiation strategy allows a firm to charge a higher price for its product and to gain customer loyalty because consumers may become strongly attached to the differentiation features. Special features that differentiate one’s product can include superior service, spare parts availability, engineering design, product performance, useful life, gas mileage, or case o f use.

A risk o f pursuing a differentiation strategy is that the unique product may not be valued highly enough by customers to justify the higher price. When this happens, a cost-leadership strategy easily will defeat a differentiation strategy. Another risk o f pursuing a differentiation strategy is that competitors may quickly develop ways to copy the differentiating features. Firms thus must find durable sources o f uniqueness that cannot be imitated quickly or cheaply by rival firms.

Common organizational requirements for a successful differentiation strategy include strong coordination among the R&D and marketing functions and substantial amenities to attract scientists and creative people. Firms can pursue a differentiation (Type 3) strategy based on many different competitive aspects. For example, Mountain Dew and root beer have a unique taste; Lowe’s, Home Depot, and Walmart offer wide selection and one-stop shopping; Dell Computer and FedEx offer superior service; BMW' and Porsche offer engineering design and performance; IBM and Hewlett-Packard offer a wide range of products; and E*Trade and Ameritrade offer Internet convenience. Differentiation opportunities exist or can potentially be developed anywhere along the firm’s value chain, including supply chain activities, product R&D activities, production and technological activities, manufacturing activities, human resource management activities, distribution activities, or marketing activities.

The most effective differentiation bases are those that are hard or expensive for rivals to duplicate. Competitors are continually trying to imitate, duplicate, and outperform rivals along any differentiation variable that has yielded competitive advantage. For example, when U.S. Airways cut

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its prices. Delta quickly followed suit. When Caterpillar instituted its quick-delivery-of-spare-parts policy, John Deere soon followed suit. To the extent that differentiating attributes are tough for rivals to copy, a differentiation strategy will be especially effective, but the sources o f uniqueness must be time-consuming, cost prohibitive, and simply too burdensome for rivals to match. A firm, therefore, must be careful when employing a differentiation (Type 3) strategy. Buyers will not pay the higher differentiation price unless their perceived value exceeds the price they are paying.20 Based on such matters as attractive packaging, extensive advertising, quality o f sales presenta­ tions. quality of website, list o f customers, professionalism, size of the firm, or profitability of the company, perceived value may be more important to customers than actual value.

A Type 3 differentiation strategy can be especially effective under the following conditions:21

1. When there are many ways to differentiate the product or service and many buyers perceive these differences as having value.

2. When buyer needs and uses are diverse. 3. When few rival firms are following a similar differentiation approach. 4. When technological change is fast paced and competition revolves around rapidly evolving

product features.

Focus Strategies (Type 4 and Type 5) A successful focus strategy depends on an industry segment that is o f sufficient size, has good growth potential, and is not crucial to the success o f other major competitors. Strategies such as market penetration and market development offer substantial focusing advantages. Midsize and large firms can effectively pursue focus-based strategies only in conjunction with differentiation or cost leadership-based strategies. All firms in essence follow a differentiated strategy. Because only one firm can differentiate itself with the lowest cost, the remaining firms in the industry must find other ways to differentiate their products.

Focus strategies are most effective when consumers have distinctive preferences or requirements and when rival firms are not attempting to specialize in the same target segment. For example, Clorox Company, which obtains 80 percent of its revenue from the United States, is focusing on brands viewed as environmentally friendly. To refocus, Clorox just sold its auto-care business and acquired personal care company. Burt's Bees, and expanded its Green Works line o f household cleaners and Brita water filters. Clorox’s CEO Don Knauss loves the United States and is avoiding a costly push into China, Brazil, or India. Knauss's focus is on natural cleaning products, including bleaches and peroxide-based disinfectants for both consumers and hospitals.

Marriott continues to focus on is hotel business by announcing plans to double its hotels in Asia to 260 by 2016, especially growing its China-based hotels to about 125 from 60 and cover­ ing nearly 75 percent of Chinese provinces. Reasoning for Marriott’s strategy is than Chinese tourists are traveling at home and abroad in dramatically increased numbers, up 21 percent on average year-over-year.

Risks of pursuing a focus strategy include the possibility that numerous competitors will rec­ ognize the successful focus strategy and copy it or that consumer preferences will drift toward the product attributes desired by the market as a whole. An organization using a focus strategy may concentrate on a particular group of customers, geographic markets, or on particular product-line segments to serve a well-defined but narrow market better than competitors who serve a broader market.

A low-cost (Type 4) or best-value (Type 5) focus strategy can be especially attractive under the following conditions:22

1. When the target market niche is large, profitable, and growing. 2. When industry leaders do not consider the niche to be crucial to their own success. 3. When industry leaders consider it too costly or difficult to meet the specialized needs of the

target market niche w hile taking care o f their mainstream customers. 4. When the industry has many different niches and segments, thereby allowing a focuser to

pick a competitively attractive niche suited to its own resources. 5. When few, if any, other rivals are attempting to specialize in the same target segment.

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Strategies for Competing in Turbulent, High-Velocity Markets The world is changing more and more rapidly, and consequently industries and firms them­ selves are changing faster than ever. Some industries are changing so fast that researchers call them turbulent, high-velocity markets, such as telecommunications, medical, biotechnology, pharmaceuticals, computer hardware, software, and virtually all Internet-based industries. High-velocity change is clearly becoming more and more the rule rather than the exception, even in such industries as toys, phones, banking, defense, publishing, and communication.

Meeting the challenge of high-velocity change presents the firm with a choice o f whether to react, anticipate, or lead the market in terms o f its own strategies. To primarily react to changes in the industry would be a defensive strategy used to counter, for example, unexpected shifts in buyer tastes and technological breakthroughs. The react-to-change strategy would not be as effective as the anticipate-change strategy, which would entail devising and following through with plans for dealing with the expected changes. However, firms ideally strive to be in a posi­ tion to lead the changes in high-velocity markets, whereby they pioneer new and better tech­ nologies and products and set industry standards. Being the leader or pioneer o f change in a high-velocity market is an aggressive, offensive strategy that includes rushing next-generation products to market ahead o f rivals and being continually proactive in shaping the market to one's own benefit. Although a lead-change strategy is best whenever the firm has the resources to pur­ sue this approach, on occasion even the strongest firms in turbulent industries have to employ the react-to-the-market strategy and the anticipate-the-market strategy.

An example turbulent, high-velocity market is the U.S. defense industry, especially with dra­ matic cuts looming and a shift to higher technology and space defense systems. Based in Hartford. Connecticut, United Technologies, which produces Blackhawk helicopters and a diverse array of other products such as Carrier air conditioners and Otis elevators, recently reduced is sales forecasts. One strategy to compete in a high turbulent industry is to diversify into less turbulent industries. United Technologies continues to diversify, recently acquiring Goodrich Corp. for $16.5 billion, as well as Rolls Royce Holdings PLC’s stake in the company's engine joint venture.

Means for Achieving Strategies Cooperation Among Competitors In a recent Wall Street Journal article titled “Facebook, Yahoo Kiss and Make-Up." these two rival firms, locked for years in bitter patent litigation, revealed what they called a new strategic alliance, which included a patent cross-license, a new advertising partnership, expanded joint distribution, and joint media event coverage.23

Strategies that stress cooperation among competitors are being used more. For collabora­ tion between competitors to succeed, both firms must contribute something distinctive, such as technology, distribution, basic research, or manufacturing capacity. But a major risk is that unintended transfers o f important skills or technology may occur at organizational levels below where the deal was signed.24 Information not covered in the formal agreement often gets traded in the day-to-day interactions and dealings o f engineers, marketers, and product developers. Firms often give away too much information to rival firms when operating under cooperative agreements! Tighter formal agreements are needed.

Perhaps the best example o f rival firms in an industry forming alliances to compete against each other is the airline industry. Today there are three major alliances: Star. SkyTeam, and Oneworld. but other alliances are forming, such as the trans-Atlantic joint venture among American Air, British Air. and Iberia Air formed by Oneworld. There is also a trans-Pacific joint venture among American, Japan Air. United Continental, and All Nippon Air.

The idea of joining forces with a competitor is not easily accepted by Americans, who often view cooperation and partnerships with skepticism and suspicion. Indeed, joint ventures and cooperative arrangements among competitors demand a certain amount o f trust if companies are to combat paranoia about whether one firm will injure the other. However, multinational firms are becoming more globally cooperative, and increasing numbers o f domestic firms are joining forces with competitive foreign firms to reap mutual benefits. Kathryn Harrigan at Columbia University says, “Within a decade, most companies will be members o f teams that compete

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against each other.” Once major rivals, Google's YouTube and Vivendi SA’s Universal Music Group have formed a partnership called Vevo to provide a new music-video service. Google provides the technology and Universal Music provides the content, and both firms share the revenues. The two firms now operate the stand-alone site Vevo.com.

U.S. companies often enter alliances primarily to avoid investments, being more interested in reducing the costs and risks of entering new businesses or markets than in acquiring new skills. In contrast, learning from the partner is a major reason why Asian and European firms enter into cooperative agreements. U.S. firms, too. should place learning high on the list o f reasons to be cooperative with competitors. U.S. companies often form alliances with Asian firms to gain an understanding o f their manufacturing excellence, but Asian competence in this area is not easily transferable. Manufacturing excellence is a complex system that includes employee training and involvement, integration with suppliers, statistical process controls, value engineering, and design. In contrast, U.S. know-how in technology and related areas can be imitated more easily. U.S. firms thus need to be careful not to give away more intelligence than they receive in cooperative agreements with rival Asian firms.

Joint Venture and Partnering Renault SA and British racing-car company Caterham Cars recently developed a joint venture to design, develop, and manufacture a family o f sports cars that will be available in 2 0 15. The partnership, named Societe des Automobiles Alpine Caterham, gives the British Formula One race-car maker access to Renault’s manufacturing clout.

Joint venture is a popular strategy that occurs when two or more companies form a tempo­ rary partnership or consortium for the purpose of capitalizing on some opportunity. Often, the tw'o or more sponsoring firms form a separate organization and have shared equity ownership in the new' entity. Other types o f cooperative arrangem ents include research and development partnerships, cross-distribution agreements, cross-licensing agreements, cross-manufacturing agreements, and joint-bidding consortia.

Joint ventures and cooperative arrangements arc being used increasingly because they allow companies to improve communications and networking, to globalize operations, and to minimize risk. Joint ventures and partnerships are often used to pursue an opportunity that is too complex, uneconomical, or risky for a single firm to pursue alone. Such business creations also are used w'hen achieving and sustaining competitive advantage when an industry requires a broader range o f competencies and know-how than any one firm can marshal. Kathryn Rudie Harrigan, summarizes the trend toward increased joint venturing:

In today’s global business environment o f scarce resources, rapid rates o f technologi­ cal change, and rising capital requirements, the important question is no longer “Shall we form a joint venture?” Now the question is "Which joint ventures and cooperative arrangements are most appropriate for our needs and expectations?” followed by “How do w'e manage these ventures most effectively?”2^

In a global market tied together by the Internet, joint ventures, partnerships, and alliances are proving to be a more effective way to enhance corporate growth than mergers and acquisi­ tions.26 Strategic partnering takes many forms, including outsourcing, information sharing, joint marketing, and joint research and development. Many companies, such as Eli Lilly, now host partnership training classes for their managers and partners. There are today more than 10.000 joint ventures formed annually, more than all mergers and acquisitions. There are countless examples o f successful strategic alliances, such as Internet coverage.

A major reason why firms are using partnering as a means to achieve strategies is global­ ization. Walmart’s successful joint venture with M exico’s Cifra is indicative of how a domestic firm can benefit immensely by partnering with a foreign company to gain substantial presence in that new country. Technology also is a major reason behind the need to form strategic alliances, with the Internet linking widely dispersed partners. The Internet paved the way and legitimized the need for alliances to serve as the primary means for corporate growth. Neiman Marcus and Target recently announced a partnership whereby both firms will offer a limited collection of 50 items from stationery to sporting goods at the same price with all the items carrying both the Target bulls-eye logo and the Neiman Marcus logo. This unusual partnership betw-een a

CHAPTER 4 • TYPES OF STRATEGIES 155

high-end and low-end retailer benefits Neiman by expanding its reach and notoriety, while benefiting Target by raising its overall perceived quality.

Evidence is mounting that firms should use partnering as a means for achieving strate­ gies. How'ever, the sad fact is that most U.S. firms in many industries— such as financial services, forest products, metals, and retailing— still operate in a merger or acquire mode to obtain growth. Partnering is not yet taught at most business schools and is often viewed within companies as a financial issue rather than a strategic issue. However, partnering has become a core competency, a strategic issue of such importance that top management involvement initially and throughout the life of an alliance is vital.27

Joint ventures among once rival firms are commonly being used to pursue strategies rang­ ing from retrenchment to market development. Although ventures and partnerships are preferred over mergers as a means for achieving strategies, certainly they are not all successful. The good news is that joint ventures and partnerships are less risky for companies than mergers, but the bad news is that many alliances fail. There are countless examples o f failed joint ventures. A few common problems that cause joint ventures to fail are as follow's:

1. Managers who must collaborate daily in operating the venture are not involved in forming or shaping the venture.

2. The venture may benefit the partnering companies but may not benefit customers, who then complain about poorer service or criticize the companies in other ways.

3. The venture may not be supported equally by both partners. If supported unequally, problems arise.

4. The venture may begin to compete more with one o f the partners than the other.28

Six guidelines for when a joint venture may be an especially effective means for pursuing strategies are:

• When a privately-ow'ned organization is forming a joint venture with a publicly-ow'ned organization; there are some advantages to being privately held, such as closed ownership; there are some advantages o f being publicly held, such as access to stock issuances as a source o f capital. Sometimes, the unique advantages of being privately and publicly held can be synergistically combined in a joint venture.

• W'hen a domestic organization is forming a joint venture with a foreign company; a joint venture can provide a domestic company with the opportunity for obtaining local management in a foreign country, thereby reducing risks such as expropriation and harassment by host country officials.

• When the distinct competencies o f tw'o or more firms complement each other especially well.

• W'hen some project is potentially profitable but requires overwhelming resources and risks. • When two or more smaller firms have trouble competing with a large firm. • When there exists a need to quickly introduce a new' technology.

Merger/Acquisition As of December 2012. there wrere 10,346 merger-and-acquisition deals in the USA for the year, a 9 percent increase over the prior year, but an 8 percent decline in terms o f the dollar volume. Late in 2012, ConAgra bought Ralcorp for $5 billion and Equity Residential (and AvalonBay) bought Archstone for $6.5 billion.

Merger and acquisition are two commonly used ways to pursue strategies. A merger occurs when two organizations o f about equal size unite to form one enterprise. An acquisition occurs when a large organization purchases (acquires) a smaller firm, or vice versa. When a merger or acquisition is not desired by both parties, it can be called a takeover or hostile takeover. In contrast, if the acquisition is desired by both firms, it is termed a friendly merger. Most mergers are friendly. For example, two Japanese steel producers, Nippon Steel Corp. and Sumitomo Metal Industries Ltd., recently merged in friendly fashion to form the world’s second largest steel producer behind ArcelorMittal.

Despite many investment bankers predicting the demise of hostile takeovers because it is dif­ ficult to pull off. the number of hostile takeovers are on the rise. For example, Glaxo recently gave Human Genome a deadline to accept their offer or face a hostile takeover. Genomma recently

156 CHAPTER 4 • TYPES OF STRATEGIES

TABLE 4-5 Key Reasons Why Many Mergers and Acquisitions Fail

• Integration difficulties • Inadequate evaluation of target • Large or extraordinary debt • Inability to achieve synergy • Too much diversification • Managers overly focused on acquisitions • Too large an acquisition • Difficult to integrate different organizational cultures • Reduced employee morale due to layoffs and relocations

made an unsolicited offer to acquire Prestige at $16.60 a share and nominated a full slate of direc­ tors for election at Prestige’s annual shareholder meeting. Prestige’s board is not staggered, so Genomma has the chance to push out a majority o f Prestige’s board, clearing the way for a take­ over. Other recent hostile takeovers or attempts include Martin Marietta trying to takeover Vulcan Materials and Westlake Chemical trying to take over Georgia Gulf and Roche’s bid for Dlumina.

In a rare example o f a Chinese company engaging in a hostile takeover. Shanghai-based Cathy Fortune recently bypassed the board of cooper miner Discovery Metals Ltd. with an offer of 830 million Australian dollars. This was a 51 percent premium over the value o f Sydney- based Discovery Metals’ common stock. China consumes about 40 percent o f the world’s cop­ per output but historically avoids hostile takeovers altogether.

W hite knight is a term that refers to a firm that agrees to acquire another firm when that other firm is facing a hostile takeover by some company. For example, Palo Alto, California- based CV Thereapeutics Inc., a heart-drug maker, was fighting a hostile takeover bid by Japan’s Astellas Pharma. Then CVT struck a friendly deal to be acquired by Forest City. California- based Gilead Sciences at a higher price o f $1.4 billion in cash. Gilead is known for its HIV drugs, so its move into the heart-drug business surprised many analysts.

Not all mergers arc effective and successful. For example, even 12 months after PulteGroup bought rival Centex Corp., for $1.3 billion in stock, creating the largest home builder in the USA, PultcGroup’s profits were still negative and the company’s stock price was 30 percent lower than the week of the acquisition. PulteGroup’s dismal performance is in sharp contrast to rival firms such as Toll Brothers and Lennar Corp., whose stock price is up 22 percent during the same period. So a merger between two firms can yield great benefits, but the price and reasoning must be right. Some key reasons why many mergers and acquisitions fail are provided in Table 4-5.

Among mergers, acquisitions, and takeovers in recent years, same-industry combinations have predominated. A general market consolidation is occurring in many industries, especially banking, insurance, defense, and health care, but also in pharmaceuticals, food, airlines, account­ ing. publishing, computers, retailing, financial services, and biotechnology. For example, there are many potential benefits o f merging with or acquiring another firm, as indicated in Table 4-6.

The volume of mergers completed annually worldwide is growing dramatically and excceds $1 trillion. There are annually more than 10,000 mergers in the USA that total more

TA BLE 4-6 Potential Benefits of Merging With or Acquiring Another Firm

• To provide improved capacity utilization • To make better use of the existing sales force • To reduce managerial staff • To gain economies of scale • To smooth out seasonal trends in sales • To gain access to new suppliers, distributors, customers, products, and creditors • To gain new technology • To reduce tax obligations

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than $700 billion. The proliferation o f mergers is fueled by companies' drive for market share, efficiency, and pricing power, as well as by globalization, the need for greater economies of scale, reduced regulation and antitrust concerns, the Internet, and e-commerce.

A leveraged buyout (LBO) occurs when a corporation's shareholders are bought (hence buyout) by the company’s management and other private investors using borrowed funds (hence leverage). Besides trying to avoid a hostile takeover, other reasons for initiating an LBO are senior management decisions that particular divisions do not fit into an overall corporate strategy, must be sold to raise cash, or receipt o f an attractive offering price. An LBO takes a corporation private.

Private-Equity Acquisitions As stock prices increased and companies became cash-rich in 2 0 12—2 0 13, private-equity (PE) firms such as Kohlberg Kravis Roberts (KKR) jumped aggressively back into the business of acquiring and selling firms. PE firms have unleashed a wave o f new' initial public offerings (IPO). Apollo Global Management is a large private-equity firm that owns many companies.

The intent of virtually all PE acquisitions is to buy firms at a low price and sell them later at a high price, arguably just good business. Par Pharmaceutical was recently acquired by PE firm TPG for SI 84 million in cash. Based in Woodcl iff Lake, New Jersey, Par’s shareholders received $50 in cash lor each share, a premium of about 37 percent over the firm’s closing stock price.

PE firms increasingly are buying companies from other PE firms, such as Clayton, Dubilier & Rice recently buying David’s Bridal from Leonard Green & Partners LP for S i.05 billion. Such PE to PE acquisitions, called secondary buyouts, totaled $30 billion in 2 0 12 in the USA compared to S I0.5 billion in 2 0 1 1.

PE firms especially, but other firms also, in 2012 extensively borrowed money, more than S70 billion, at record low interest rates, simply to fund dividend payouts to themselves, a contro­ versial practice known as dividend recapitalizations. The previous annual record for dividend recapitalizations, according to S&P's Capital IQ LCD data service, was $40.5 billion in 2010. Critics say dividend recapitalization saddles a company with debt, burdening its operations. One reason for the high 2 0 12 number wjas the expectation that taxes on dividends would increase in 2 0 13, so the thinking was pay me now.

For all o f 2 0 12, the value o f private-equity deals by country o f investment is given below (in millions $) for the top seven:

1. USA (99.3) 2. UK (23.9) 3. Germany (9.8) 4. China (9.7) 5. Australia (5.2) 6. Canada (4.1) 7. France (4 .1)

First Mover Advantages First mover advantages refer to the benefits a firm may achieve by entering a new' market or developing a new product or service prior to rival firms. As indicated in Table 4-7, some advan­ tages o f being a first mover include securing access to rare resources, gaining new knowledge of key factors and issues, and carving out market share and a position that is easy to defend and costly for rival firms to overtake. First mover advantages are analogous to taking the high ground first, w hich puts one in an excellent strategic position to launch aggressive campaigns and to defend territory. Being the first mover can be an excellent strategy w'hen such actions (a) build a firm’s image and reputation with buyers, (b) produce cost advantages over rivals in terms of new technologies, new components, new distribution channels, and so on, (c) create strongly loyal customers, and (d) make imitation or duplication by a rival hard or unlikely.

To sustain the competitive advantage gained by being the first mover, a firm needs to be a fast learner. There are, however, risks associated with being the first mover, such as unexpected and unanticipated problems and costs that occur from being the first firm doing business in the new market. Therefore, being a slow mover (also called fa s t follower or late mover) can be effective when a firm can easily copy or imitate the lead firm’s products or services. If technol­ ogy is advancing rapidly, slow movers can often leapfrog a first mover’s products with improved

158 CHAPTER 4 • TYPES OF STRATEGIES

TA B LE 4-7 Benefits of a Firm Being the First Mover

1. Secure access and commitments to rare resources 2. Gain new knowledge of critical success factors and issues 3. Gain market share and position in the best locations 4. Establish and secure long-term relationships with customers, suppliers, distributors, and investors 5. Gain customer loyalty and commitments

second-generation products. Samsung is an example in the smartphone business. Apple has always been a good example o f a first mover firm, although o f late Apple is stumbling a bit as Samsung gains momentum.

First mover advantages tend to be greatest when competitors are roughly the same size and possess similar resources. If competitors are not similar in size, then larger competitors can wait while others make initial investments and mistakes and then respond w'ith greater effectiveness and resources. Lenovo has done this o f late, as has Volkswagen.

Outsourcing and Reshoring Business-process outsourcing (BPO) involves companies hiring other companies to take over various parts o f their the functional operations, such as human resources, information systems, payroll, accounting, customer service, and even marketing. Companies choose to outsource their functional operations for several reasons: (a) it is less expensive, (b) it allows the firm to focus on its core businesses, and (c) it enables the firm to provide better services. Other advantages of outsourcing are that the strategy (a) allows the firm to align itself with “best-in-world” suppli­ ers who focus on performing the special task, (b) provides the firm flexibility should customer needs shift unexpectedly, and (c) allows the firm to concentrate on other internal value chain activities critical to sustaining competitive advantage. BPO is a means for achieving strategies that are similar to partnering and joint venturing.

Reshoring is the new term that refers to U.S. companies planning to move some o f their manufacturing back to the USA. About 14 to 37 percent o f U.S. companies plan to reshore in 2012-2014 for the following reasons: a desire to get products to market faster and respond rap­ idly to customer orders; savings from reduced transportation and warehousing; improved quality and protection of intellectual property: pressure to increase U.S. jobs.30 For example, Google's new Nexus Q music and video player is being manufactured in the USA, something unusual for consumer electronics. GE’s w-ebsite has an “American Jobs Map” that gives details o f 14,500 new GE jobs in the USA. A bill named the “Bring Jobs Home Act” is being considered in Congress.

“Made in the U SA” is making a comeback. Even Walmart, which pioneered looking glob­ ally for the lowest-cost suppliers, is increasing by $50 billion its spending with U.S. suppliers in this decade. U.S. manufacturing is leading the way on superautomated factories that require less labor but more high-tech machines. For example, the 200,000 sq. ft. GE battery plant in Schenectady, NY has only 370 full-time employees but ships batteries around the world. New, high-tech, U.S. factories are leading to extensive “reshoring” in America.

Many firms, such as Dearborn, M ichigan-based Visteon Corp. and J.P. Morgan Chase & Co., outsource their computer operations to IBM, which competes with firms such as Electronic Data Systems and Computer Sciences Corp. in the computer outsourcing business. 3M Corp. is outsourcing all o f its manufacturing operations to Flextronics International Ltd. o f Singapore or Jabil Circuit in Florida. 3M is also outsourcing all design and manufacturing of low-end standardized volume products by building a new design center in Taiwan.

U.S. and European companies for more than a decade have been outsourcing their manufacturing, tech support, and back-office work, but most insisted on keeping research and devel­ opment activities in-house. However, an ever-growing number of firms today are outsourcing their product design to Asian developers. China and India are becoming increasingly important suppliers of intellectual property.

The details o f what work to outsource, to whom, where, and for how much can challenge even the biggest, most sophisticated companies. And some outsourcing deals do not work out. such as the J.P Morgan Chase deal with IBM and Dow Chemical's deal with Electronic Data Systems. Both outsourcing deals were abandoned after several years. Lehman Brothers Holdings

CHAPTER 4 • TYPES OF STRATEGIES 159

and Dell Inc. both recently reversed decisions to move customer call centers to India after a customer rebellion. India has become a booming place for outsourcing. Outsourcing generally aims to achieve one or more of the following benefits:

• Cost savings: Access lower wages in foreign countries. • Focus on core business: Focus resources on developing the core business rather than being

distracted by other functions. • Cost restructuring: Outsourcing changes the balance o f fixed costs to variable costs by

moving the firm more to variable costs. Outsourcing also makes variable costs more predictable.

• Improve quality: Improve quality by contracting out various business functions to specialists.

• Knowledge: Gain access to intellectual property and wider experience and knowledge. • Contract: Gain access to services within a legally binding contract with financial penalties

and legal redress. This is not the case with services performed internally. • Operational expertise: Gain access to operational best practice that would be too difficult

or time consuming to develop in-house. • Access to talent: Gain access to a larger talent pool and a sustainable source o f skills,

especially science and engineering. • Catalyst for change: Use an outsourcing agreement as a catalyst for major change that

cannot be achieved alone. • Enhance capacity for innovation: Use external knowledge to supplement limited in-house

capacity for product innovation. • Reduce time to market: Accelerate development or production o f a product through

additional capability brought by the supplier. • Risk management: Manage risk by partnering with an outside firm. • Tax benefit: Capitalize on lax incentives to locate manufacturing plants to avoid high taxes

in various countries.

Strategic Management in Nonprofit and Governmental Organizations Nonprofit organizations are basically just like for-profit companies except for two major dif­ ferences: ( l ) nonprofits do not pay taxes and (2) nonprofits do not have shareholders to pro­ vide capital. In virtually all other ways, nonprofits are just like for-profits. Nonprofits have competitors that want to put them out o f business. Nonprofits have em ployees, customers, creditors, suppliers, and distributors as well as financial budgets, income statements, balance sheets, cash flow statements, and so on. Nonprofit organizations embrace strategic planning just as much as for-profit firms, and perhaps even more, because equity capital is not an alter­ native source o f financing.

The strategic-management process is being used effectively by countless nonprofit and governmental organizations, such as the Girl Scouts, Boy Scouts, the Red Cross, chambers of commerce, educational institutions, medical institutions, public utilities, libraries, government agencies, and churches. The nonprofit sector, surprisingly, is by far the largest employer in the USA. Many nonprofit and governmental organizations outperform private firms and corpora­ tions on innovativeness, motivation, productivity, and strategic management.

Compared to for-profit firms, nonprofit and governmental organizations may be totally dependent on outside financing. Especially for these organizations, strategic management pro­ vides an excellent vehicle for developing and justifying requests for needed financial support.

Educational Institutions The world o f higher education is rapidly moving to massive open online courses (MOOC), w'ith many o f the courses being free to anyone with an Internet connection. The American Council on Education, an association for higher education presidents, is considering allowing free, online courses to be eligible for credit toward a degree and eligible for transfer credit. Several companies, including edX, Udacity. Coursera. and the Jack Welch Management Institute, are most associated with MOOCs, but the list is growing weekly.

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Educational institutions are more frequently using strategic-management techniques and concepts. Richard Cyert, former president o f Carnegie Mellon University, said, “I believe we do a far better job of strategic management than any company I know.” Population shifts nationally from the Northeast and Midw-est to the Southeast and West are but one factor causing trauma for educational institutions that have not planned for changing enrollments. Ivy League schools in the Northeast are recruiting more heavily in the Southeast and West. This trend represents a sig­ nificant change in the competitive climate for attracting the best high school graduates each year.

Online college degrees are commonplace and represent a threat to traditional colleges and universities. “You can put the kids to bed and go to law school,” says Andrew Rosen, chief oper­ ating officer o f Kaplan Education Centers, a subsidiary o f the Washington Post Company.

Many U.S. colleges and universities have now established campuses outside the USA. For example. Yale University and the National University o f Singapore established a joint campus in Singapore in 2 0 13. The institution is Singapore’s first liberal-aits college and Yale’s first campus outside the Ivy League institution in New Haven, Connecticut.

Medical Organizations The $200 billion U.S. hospital industry is experiencing declining margins, excess capacity, bureaucratic overburdening, poorly planned and executed diversification strategies, soaring health-care costs, reduced federal support, and high administrator turnover. The seriousness of this problem is accented by a 20 percent annual decline in use by inpatients nationwide. Declining occupancy rates, deregulation, and accelerating growth of health maintenance organizations, pre­ ferred provider organizations, urgent care centers, outpatient surgery centers, diagnostic centers, specialized clinics, and group practices are other major threats facing hospitals today. Many private and state-supported medical institutions are in financial trouble as a result o f traditionally taking a reactive rather than a proactive approach in dealing with their industry.

Hospitals— originally intended to be warehouses for people dying o f tuberculosis, smallpox, cancer, pneumonia, and infectious diseases— are creating new' strategies today as advances in the diagnosis and treatment of chronic diseases are undercutting that previous mission. Hospitals are beginning to bring services to the patient as much as bringing the patient to the hospital; health care is more and more being concentrated in the home and in the residential community, not on the hospital campus. Chronic care will require day-treatment facilities, electronic monitoring at home, user-friendly ambulatory services, decentralized service networks, and laboratory testing. A successful hospital strategy for the future w'ill require renewed and deepened collaboration w’ith physicians, who are central to hospitals’ well-being, and a reallocation o f resources from acute to chronic care in home and community settings.

Current strategies being pursued by many hospitals include creating home health services, establishing nursing homes, and forming rehabilitation centers. Backward integration strategies that some hospitals are pursuing include acquiring ambulance services, waste disposal services, and diagnostic services. Millions o f persons annually research medical ailments online, which is causing a dramatic shift in the balance o f power betw-een doctor, patient, and hospitals. The number o f persons using the Internet to obtain medical information is skyrocketing. A motivated patient using the Internet can gain knowledge on a particular subject far beyond his or her doctor's knowledge because no person can keep up with the results and implications of billions o f dollars’ worth of medical research reported weekly. Patients today often walk into the doctor’s office with a file folder of the latest articles detailing research and treatment options for their ailments.

Governmental Agencies and Departments Federal, state, county, and municipal agencies and departments, such as police departments, cham­ bers of commerce, forestry associations, and health departments, are responsible for formulating, implementing, and evaluating strategies that use taxpayers' dollars in the most cost-effective way to provide services and programs. Strategic-management concepts are generally required and thus widely used to enable governmental organizations to be more effective and efficient.

Strategists in governmental organizations operate with less strategic autonomy than their counterparts in private firms. Public enterprises generally cannot diversify into unrelated busi­ nesses or merge w'ith other firms. Governmental strategists usually enjoy little freedom in aliering the organizations' missions or redirecting objectives. Legislators and politicians often have direct or indirect control over major decisions and resources. Strategic issues get discusscd and debated

CHAPTER 4 • TYPES OF STRATEGIES 161

in the media and legislatures. Issues become politicized, resulting in fewer strategic choice alterna­ tives. There is now more predictability in the management of public sector enterprises.

Government agencies and departments are finding that their employees get excited about the opportunity to participate in the strategic-management process and thereby have an effect on the organization's mission, objectives, strategies, and policies. In addition, government agen­ cies are using a strategic-management approach to develop and substantiate formal requests for additional funding.

Strategic Management in Small Firms The reason why “becoming your ow;n boss” has become a national obsession is that entrepre­ neurs are role models in the USA. Almost everyone w'ants to ow'n a business— from teens and college students, who are signing up for entrepreneurial courses in record numbers, to those older than age 65, who are forming more companies every year.

Strategic management is vital for large firms’ success, but w'hat about small firms? The strategic-management process is just as vital for small companies. From their inception, all organiza­ tions have a strategy, even if the strategy just evolves from day-to-day operations. Even if conducted informally or by a single ow ner or entrepreneur, the strategic-management process can significantly enhance small firms’ growth and prosperity. Because an ever-increasing number o f men and women in the United States are starting their own businesses, more individuals aie becoming strategists. Widespread corporate layoffs have contributed to an explosion in small businesses and new ideas.

Numerous magazine and journal articles have focused on applying strategic-management con­ cepts to small businesses. A major conclusion of these articles is that a lack of strategic-management knowledge is a serious obstacle for many small business ow'ners. Other problems often encoun­ tered in applying strategic-management concepts to small businesses are a lack o f both sufficient capital to exploit external opportunities and a day-to-day cognitive frame of reference. Research also indicates that strategic management in small firms is more informal than in large firms, but small firms that engage in strategic management outperform those that do not.

Special Note to Students There are numerous alternative strategies that could benefit any firm, but your strategic manage­ ment case analysis should result in specific recommendations that you decide will best provide the firm competitive advantages. Because company recommendations w'ith costs comprise the most important pages or slides in your case project, introduce bits o f that information early in the presentation as relevant supporting material is presented to justify your expenditures. Your recommendations page(s) itself should therefore be a summary o f suggestions mentioned throughout your paper or presentation, rather than being a surprise shock to your reader or audi­ ence. You may even want to include with your recommendations insight as to why certain other feasible strategies were not chosen for implementation. That information too should be anchored in the notion o f competitive advantage and disadvantage with respect to perceived costs and ben­ efits. If someone asks “what is the difference between recommendations and strategies,” respond saying: “Recommendations are alternative strategies actually selected for implementation.”

Conclusion The main appeal o f any managerial approach is the expectation that it w ill enhance organiza­ tional performance. This is especially true o f strategic management. Through involvement in strategic-management activities, managers and employees achieve a better understanding of an organization’s priorities and operations. Strategic management allows organizations to be efficient, but more important, it allows them to be effective. Although strategic management does not guarantee organizational success, the process allows proactive rather than reactive decision making. Strategic management may represent a radical change in philosophy for some organizations, so strategists must be trained to anticipate and constructively respond to questions and issues as they arise. The strategies discussed in this chapter can represent a new beginning for many firms, especially if managers and employees in the organization understand and sup­ port the plan for action.

162 CHAPTER 4 • TYPES OF STRATEGIES

Key Terms and Concepts acquisition (p. 155) backward integration (p. 139) bankruptcy (p. 146) business-process outsourcing (BPO) (p. 158) combination strategy (p. 135) cooperative arrangements (p. 154) cost leadership (p. 149) de-integration (p. 139) differentiation (p. I49) diversification strategies (p. 143) divestiture (p. 147) dividend recapitalizations (p. 157) financial objectives (p. 133) first mover advantages (p. 157) focus (p. 149) forward integration (p. 137) franchising (p. 138) friendly merger (p. 155) generic strategies (p. 149) horizontal integration (p. 140) hostile takeover (p. 155)

integration strategies (p. 137) intensive strategies (p. 141) joint venture (p. 154) leveraged buyout (LBO) (p. 157) liquidation (p. 148) long-term objectives (p. 132) market development (p. 142) market penetration (p. 141) merger (p. 155) product development (p. 142) related diversification (p. 143) reshoring (p. 158) retrenchment (p. 146) secondary buyouts (p. 157) strategic objectives (p. 133) takeover (p. 155) turbulent, high-velocity markets (p. 153) unrelated diversification (p. 143) vertical integration (p. 137) white knight (p. 156)

Issues for Review and Discussion 4-1. For Petronas, featured at the beginning o f the chapter,

give a hypothetical strategy for each o f the following categories: market penetration, related diversification, divestiture, and retrenchment.

4-2. For Petronas, featured at the beginning o f the chapter, give a hypothetical strategy for each o f the following categories: market development, unrelated diversifica­ tion, backward integration, and product development.

4-3. Identify five situations when forward integration is a particularly good strategy.

4-4. What three strategies defined in the chapter do you feel are most widely used by small businesses?

4-5. Should non-profit organizations post their strategic plan on their website? What about corporations? Why?

4-6. Give some guidelines of when divestiture is a particularly effective strategy.

4-7. For adidas, w'hat two strategies do you feel is best for that company to pursue going forward? Why?

4-8. Give some examples o f Type 4 and Type 5 focus strate­ gies according to Porter’s generic strategy approach.

4-9. List three industries when cooperation among competitors is most likely and explain w'hy.

4-10. Do a Google search on joint ventures. What important new concepts did you learn that were not presented in the chapter?

4-11. Identify three joint ventures that have worked especially well in the past.

4-12. List four important reasons w'hy many mergers and acquisitions fail.

4-13. Explain how strategic management differs in governmental organizations as compared to educational institutions.

4-14. Explain how and w'hy Petronas has been so successful in recent years.

4-15. List six characteristics of objectives and an example o f each.

4-16. In order o f importance, rank six major benefits of a firm having objectives.

4-17. Give a hypothetical example of forward integration, backward integration, and horizontal integration for Volkswagen.

4-18. Give a hypothetical example o f market penetration, market development, and product development for Toyota Motors.

CHAPTER 4 • TYPES OF STRATEGIES 163

4-19. Give a hypothetical example o f related diversification 4-29. and an example o f unrelated diversification for Google.

4-20. Give a hypothetical example o f retrenchment and 4-30. divestiture for Wal-Mart.

4-21. When would market development generally be the pre- 4-31. ferred strategy over backward or forward integration?

4-22. W’hy can firms generally not pursue several or many o f 4-32. the strategies presented in this chapter?

4-23. When should a firm diversify? 4-33. 4-24. List and describe the five types of bankruptcy. If your

college or university had to declare bankruptcy, which type would be appropriate? 4-34.

4-25. Explain why you believe some analysts consider Michael Porter’s generic strategies to be too few and 4-35. too vague.

4-26. Explain the difference between joint ventures and part- 4-36. nerships as a means for achieving various strategies.

4-27. List the pros and cons o f a hostile versus friendly takeover o f another firm. 4-37.

4-28. In order o f importance, list six reasons why many mergers and acquisitions fail.

In order o f importance, list six potential benefits o f two firms merging. Give three hypothetical examples of lirms being a ‘'first mover.” List three ways a country could prevent its companies from outsourcing jobs to other countries. Explain how strategic planning differs across types and sizes o f firms. Identify three local businesses in your city. What three strategies do these three firms pursue? List the strate­ gies in order of prevalence. What strategies are best for turbulent, high-velocity markets? Based on the information given for Petronas, what three strategies are being pursued by the firm? Elaborate on this chapter's “Special Note to Students” at the end. in terms o f giving a case analysis presentation. identify three companies that use outsourcing effec­ tively. Explain how and w'hy those firms utilize this management approach.

MyManagementLab® Go to mymanagementlab.com for the following Assisted-graded writing questions:

4-38. What are the pros and cons of a firm merging w'ith a 4-40. Mymanagementlab Only— comprehensive writing rival firm? assignment for this chapter.

4-39. Discuss the nature of as well as the pros and cons of a “friendly merger” versus “hostile takeover” in acquiring another firm. Give an example o f each.

Current Readings Ashkenas, Suzanne Francis, and Rick Heinick.

“The Merger Dividend.” Harvard Business Review (July-August 2011): 126.

Barczak, Gloria, and Kenneth B. Kahn. “Identifying New Product Development Best Practice.” Business Horizons 55, no. 3 (May 2012): 293-305.

Bouchikhi. Hamid, and John R. Kimberly. “Making Mergers Work.” MlTSloan Management Review 54, no. 1 (Fall 2012): 63.

Fieldstad, 0ystein D., Charles C. Snow, and Raymond E. Miles. “The Architecture o f Collaboration” Strategic Management Journal 33, no. 6 (June 2012): 734—750.

Haieblian, Jerayr. Gerry McNamara, Kalin Kolev. and Bemadine J. Dykes. “Exploring Firm Characteristics that Differentiate Leaders from Follow'ers in Industry Merger Waves: A Competitive Dynamics Perspective.” Strategic Management Journal 33, no. 9 (September 2012): 1037-1052.

Holweg, Matthias, and Frits K. Pil. “Outsourcing Complex Business Processes: Lessons From An Enterprise Partnership.” California Management Review 54, no. 3 (Spring 2012): 98-115.

Honeycutt Jr., Earl D., Vincent P. Magnini, and Shaw-n T. Thelen. “Solutions for customer complaints about offshor­ ing and outsourcing services.” Business Horizons 55. no. I (January-February 2012): 33.

Leavy, Brian. “Collaborative Innovation as the New Imperative— Design Thinking. Value Co-creation and the Power o f Pull.” Strategy and Leadership 40. no. 3 (2012): 25-34.

Muehlfeld. Katrin. Padma Rao Sahib, and Arien Van Witteloostuijn. “A Contextual Theory o f Organizational Learning from Failures and Successes: A Study o f Acquisition Completion in the Global Newspaper Industry, 1981-2008." Strategic Management Journal 33, no. 8 (August 2012): 938-964.

164 CHAPTER 4 • TYPES OF STRATEGIES

Thomke, Stefan, and Donald Reinertsen. “Six Myths o f Product Development.” Harvard Business Review (May 2 0 12): 84.

Tsai, Wenpin, Kuo-Hsien Su, and Ming-Jer Chen. “Seeing Through the Eyes o f a Rival: Competitor Acumen Based on Rival-Centric Perceptions.” The Academy o f Management Review 54. no. 4 (August 2 0 11): 76!.

Souder, David, Zeki Simsek, and Scon G. Johnson. “The Differing Effects o f Agent and Founder CEOs on the

Firm’s Market Expansion.” Strategic Management Journal 33, no. I (January 2 0 12): 23—4 1.

Weigelt, Carmen, and MB Sarkar. “Performance Implications o f Outsourcing for Technological Innovations: Managing the Efficiency and Adaptability Trade-off.” Strategic Management Journal 33, no. 2 (February 2012): 189-216.

Wunker, Stephen. “Better Growth Decisions: Early Mover, Fast Follower or Late Follower?” Strategy and Leadership 40, no. 3 (2012): 43-48.

A SSU R A N CE OF LEARNING EX ER C IS ES E X E R C IS E 4 A

Market Development: Petronas Purpose Petronas is featured in the opening chapter case as a firm that engages in excellent strategic planning.

The purpose of this exercise is to give you practice extending a company’s global strategy into new geographic regions.

Instructions

Step 1 Visit the Petronas website and review the company’s latest Annual Report. Especially assess where and in what respect does Petronas do business in Asia. Australia, and the Middle East. Identify six countries that Petronas currently does not do business with.

Step 2 Based on your analysis in Step 1. evaluate the six countries identified in terms of their busi­ ness culture, environment, and attractiveness for Petronas to begin doing business there.

Step 3 Rank order the six countries identified and evaluated in terms of a proposed plan for Petronas to begin doing business in these places. Prepare a two-page executive summary to support your suggested plan.

E X E R C IS E 4B

Alternative Strategies for Petronas Purpose This exercise will give you practice labeling hypothetical strategies that a firm could pursue.

Instructions For each of the strategies listed below, identify a hypothetical strategy that you believe may be good for Petronas to pursue. Refer to Chapter 4 for a description of the strategics.

Forward Integration Backward Integration Horizontal Integration Market Penetration Market Development Product Development Related Diversification Unrelated Diversification Retrenchment Divestiture Liquidation

E X E R C IS E 4C

Private-Equity Acquisitions Purpose As stock prices increase and companies become more cash-rich, private-equity firms such as Kohl berg Kravis Roberts (KKR) have jumped aggressively back into the business of acquiring and selling firms. Private-equity firms have unleashed a wave of new initial public offerings (IPOs), such

CHAPTER 4 • TYPES OF STRATEGIES 165

as the IPO of Nielsen Holdings BV. the largest private-equity-backed IPO in the United States in five years. Apollo Global Management is a large private-equity lirms that owns many companies. Some private-equity owned firms expected to go public soon include Bank United Inc., Kinder Morgan Inc.. and Toys “R” Us Inc.

The purpose of this exercise is to give you practice identifying and evaluating the nature and role of private-equity acquisitions in Europe.

Instructions

Step I Identify the top live IPOs in Europe in the last 12 months. Step 2 Identify the top five private-equity firms in Europe. Step 3 Prepare a two-page executive summary of the nature and role of private-equity acquisitions

in Europe in the last 12 months. Include your expectations over the next 12 months for this activity to increase or decrease across Europe. Give supporting rationales.

EXERCISE 4D

The strategies of adidas AG: 2013-2015 Purpose In performing strategic management case analysis, you can find information about the company’s actual and planned strategies. Comparing what is planned versus what you recommend is an impor­ tant part of case analysis. Do not recommend what the firm actually plans, unless in-depth analysis of the situation reveals those strategies to be the best among all feasible alternatives. This exercise gives you experience conducting library and Internet research to determine what adidas AG plans to do in 2013-2015.

Instructions

Step 1 Go to Reebok and TaylorMade's websites. Find some recent articles about these subsidiaries and the parent—adidas AG. Review adidas’ website also.

Step 2 Prepare a three-page report titled "Strategic'* Being Pursued By adidas in 2011-2013.”

EXERCISE 4E

Lessons in Doing Business Globally Purpose The purpose o f this exercise is to discover some important lessons learned by local businesses that do business internationally.

Instructions Contact several local business leaders by telephone. Find at least three firms that engage in interna­ tional or export operations. Visit the owner or manager of each business in person. Ask the business person to give you several important lessons that his or her firm has learned in globally doing busi­ ness. Record the lessons on paper and report your findings to the class.

EXERCISE 4F

Petronas 2013-2015 Purpose In performing strategic management case analysis, you should find information about the company’s actual and planned strategies. Comparing what is planned versus what you recommend is an impor­ tant part o f case analysis. Do not recommend what the firm actually plans, unless in-depth analysis of the situation reveals those strategies to be the best among all feasible alternatives. This exercise gives you experience conducting library' and Internet research 10 determine what Petronas plans to do in 2013-2015.

Instructions

Step 1 Go to the Petronas corporate web site. Study the information provided there. Step 2 Prepare a three-page report titled “Strategies Being Pursued by Petronas in 2013-2015.”

166 CHAPTER 4 • TYPES OF STRATEGIES

EXERCISE 4G

What Strategies Are Most Risky? Purpose This exercise encourages you to think about the relative riskiness of various strategies.

Instructions

Step 1 List the strategies delined in Chapter 4 in order of low risk to high risk. Step 2 Write a synopsis that explains your rankings.

EXERCISE 4H

Exploring Bankruptcy Purpose Bankruptcy is becoming more and more common among business firms. This exercise is designed to enhance your knowledge of bankruptcy.

Instructions Identify five firms in your country that are operating under bankruptcy. Compare and contrast the nature of the bankruptcy among these firms.

EXERCISE 41

Examining Strategy Articles Purpose Strategy articles can be found weekly in journals, magazines, and newspapers. By reading and studying strategy articles, you can gain a better understanding of the strategic management process. Several of the best journals in which to lind corporate strategy articles are: Advanced Management Journal, Business Horizons, Long Range Planning. Journal o f Business Strategy, and Strategic Management Journal. These journals are devoted to reporting the results of empirical research in management. They apply strategic management concepts to specific organizations and industries. They introduce new strategic management techniques and provide short case studies on selected firms. Other good journals in w’hich to find strategic management articles are Harvard Business Review, Sloan Management Review. California Management Review, Academy of Management Review, Academy o f Management Journal, Academy o f Management Executive. Journal o f Management, and Journal o f Small Business Management. In addi­ tion to journals, many magazines regularly publish articles that focus on business strategies. Several of the best magazines in which to find applied strategy articles are: Dun’s Business Month. Fortune, Forbes. Business Week, Inc, and Industry Week. Newspapers such as USA Today, Wall Street Journal, New York Times, and Barrons cover strategy events when they occur— for example, a joint venture announcement, a bankruptcy declaration, a new advertising campaign start, acquisition of a company, divestiture of a division, a chief executive officers hiring or firing, or a hostile takeover attempt. In combination, jour­ nal. magazine, and newspaper articles can make the strategic management course more exciting. These sources provide information about the strategies of for-profit and non-profit organizations.

Instructions

Step 1 Go to your college library and find a recent journal article that focuses on a strategic manage­ ment topic. Select your article from one of the journals listed previously, not from a magazine. Copy the article and bring it to class.

Step 2 Give a three-minute oral report summarizing the most important information in your article. Include comments giving your personal reaction to the article. Pass your article around in class.

EXERCISE 4J

Classifying Some Strategies Purpose This exercise can improve your understanding of various strategies by giving you experience classify­ ing strategies. This skill will help you use the strategy-formulation tools presented later. Consider the following 12 (actual or possible) strategies by various firms:

CHAPTER 4 • TYPES OF STRATEGIES 167

1. Dunkin' Donuls is increasing the number of its U.S. stores from 5.500 to 15,000. 2. Brown-Forman Corp. sold its Hartmann luggage and leather-goods business. 3. Motorola, which makes TVs, acquired Terayon Communication, a supplier of TV equipment. 4. Macy’s department stores is adding bistros and Starbucks coffee shops at many of its stores. 5. Dell just allowed Wal-Mart to begin selling its computers. This was its first move away from

direct mail order selling of computers. 6. Motorola cut 7.500 additional jobs. 7. Hilton Hotels is building 55 new properties in Russia, the United Kingdom, and Central

America. 8. Video-sharing w'ebsite YouTube launched its services into nine new' countries. 9. Cadbury Schweppes PLC is slashing 7,500 jobs, shedding product variations, and closing

factories globally. 10. General Electric sold its plastics division for $ 1 1.6 million to Saudi Basic Industries Corp. of

Saudi Arabia. 11. Cadbury Schweppes PLC. the maker of Trident gum, just bought Turkish gum maker Intergum. 12. Limited Brands is selling its Express and Limited divisions to focus on its Victoria’s Secret and

Bath & Body Works divisions.

Instructions

Step 1 On a separate sheet of paper, write down numbers I to 12. These numbers correspond to the strategies described.

Step 2 What type of strategy best describes the 12 actions cited? Indicate your answers. Step 3 Exchange papers with a classmate, and grade each other’s paper as your instructor gives the

right answers.

Notes 1. John Byrne, “Strategic Planning— It’s Back,”

BusinessWeek. August 26, 1996, 46. 2. Steven C. Brandt, Strategic Planning in Emerging

Companies (Reading, MA: Addison-Wesley, 1981). Reprinted with permission of the publisher.

3. F. Hansen and M. Smith, “Crisis in Corporate America: The Role o f Strategy,” Business Horizons (January- February 2003, 9.

4. Adapted from F. R. David, “How Do We Choose Among Alternative Growth Strategies?’* Managerial Planning 33, no. 4 (January-February 1985): 14-17 ,22 .

5. Ibid. 6. Kenneth Davidson, “Do Megamergers Make Sense?”

Journal o f Business Strategy 7, no. 3 (Winter 1987): 45. 7. David, “How Do We Choose.” 8. Ibid. 9. Ibid.

10. Ibid. 11. Arthur Thompson Jr., A. J. Strickland III, and John Gamble,

Crafting and Executing Strategy: Text and Readings (New York: McGraw-Hill/Irwin, 2005, 241.

12. Michael E. Porter, Competitive Strategy: Techniques fo r Analyzing Industries and Competitors (New York: Free Press, 1980), 53-57 , 318-319.

13. David, “How Do We Choose." 14. Ibid. 15. Ibid. 16. Ibid.

17. Ibid. 18. Michael Porter, Competitive Advantage (New York: Free

Press, 1985), 97. Also, Arthur Thompson Jr.. A. J. Strickland III, and John Gamble. Crafting and Executing Strategy: Text and Readings (New' York: McGraw-Hill/Irwin, 2005), 117.

19. Arthur Thompson Jr., A. J. Strickland III, and John Gamble, Crafting and Executing Strategy: Text and Readings (New York: McGraw-Hill/Irwin, 2005), 125-126.

20. Porter. Competitive Advantage. 160-162. 21. Thompson, Strickland, and Gamble, 129-130. 22. Ibid., 134. 23. John Letzing, “Facebook, Yahoo Kiss and Make-Up," Wall

Street Journal (July 9, 2102): B3. 24. Gary Hamel, Yves Doz, and C. K. Prahalad, “Collaborate

w'ith Your Competitors— and Win,” Harvard Business Review 61. no. 1 (January-February 1989): 133.

25. Kathryn Rudie Harrigan, “Joint Ventures: Linking for a Leap Forward,” Planning Review 14. no. 4 (July-August 1986): 10.

26. Matthew Schifrin. “Partner or Perish,” Forbes (May 21,2001): 26.

27. Ibid., 28. 28. Ibid., 32. 29. David, “How Do We Choose.” 30. James Hagerty, “Some Firms Opt to Bring

Manufacturing Back to USA,” Wall Street Journal (July 18, 2012): B8.

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168

Vision and Mission Analysis C H A P T E R O B JE C T IV E S After studying this chapter, you should be able to do the following:

1. Describe the nature and role of vision and mission statements in strategic management.

2. Discuss why the process of developing a mission statement is as important as the resulting document.

3. Identify the components of mission statements.

4. Discuss how clear vision and mission statements can benefit other strategic-management activities.

5. Evaluate mission statements of different organizations.

6. Write good vision and mission statements.

A S S U R A N C E O F L E A R N IN G EXERCISES The following exercises are found at the end of this chapter.

e x e r c i s e 5 A Examining Potential Changes Needed in a F irm ’s Vision/Mission

e x e r c i s e 5B Studying an Alternative View of Mission Statement Content

e x e r c i s e s c Evaluating Mission Statements

e x e r c i s e 5 D Evaluating the Mission Statement o f Under Armour— a Competitor o f adidas AG

e x e r c i s e 5E Selecting the Best Vision and Mission Statements in a Given Industry

e x e r c i s e 5F W riting an Excellent Vision and Mission Statement for Novartis AG

170 CHAPTER 5 • VISION AND MISSION ANALYSIS

This chapter focuses on the concepts and tools needed to evaluate and write business vision and mission statements. A practical framework for developing mission statements is provided. Actual mission statements from large and small organizations and for-profit and nonprofit enterprises are presented and critically examined. The process o f creating a vision and mission statement is discussed. The recent economic recession resulted in many firms changing direction and thereby altering their entire vision and mission. For example, Microsoft entered the smartphone business with Nokia, and IBM is focusing more on business analytics.

The boxed insert company examined in this chapter is Samsung which has a clear strategic plan.

We can perhaps best understand vision and mission by focusing on a business when it is first started. In the beginning, a new business is simply a collection of ideas. Starting a new business rests on a set o f beliefs that the new organization can offer some product or service to some customers in some geographic area using some type o f technology at a profitable price. A new' business owner typically believes that the management philosophy o f the new' enterprise will result in a favorable public image and that this concept of the business can be communicated to. and will be adopted by, important constituencies. When the set o f beliefs about a business at its inception is put into writing, the resulting document mirrors the same basic ideas that underlie the vision and mission statements. As a business grows, owners or managers find it necessary to revise the founding set o f beliefs, but those original ideas usually are reflected in the revised statements of vision and mission.

Vision and mission statements often can be found in the front o f annual reports. They often are displayed throughout a firm’s premises and are distributed w'ith company informa­ tion sent to constituencies. The statements are pail o f numerous internal reports, such as loan requests, supplier agreements, labor relations contracts, business plans, and customer service agreements.

EXCELLENT STRATEGIC MANAGEMENT

Samsung Samsung Electronics Co., Ltd., headquartered in Suwon, South Korea, is the world's largest information company. Samsung has assem­ bly plants and sales networks in 88 countries and employs around 270,000 people. Samsung is the leading smartphone manufacturer, as well as a leading producer of lithium-ion batteries, semiconduc­ tors chips, flash memory and hard drive devices, as well as tablet computers. Samsung is the world's largest maker of LCD panels, and the world's largest television manufacturer. In 2013, Fortune ranked Samsung as the 12th largest firm in the wcrld, the 12tn most profit­ able, and the 35th most admired company outside the United States.

Samsung's vision statement is posted on their website, as: "Samsung is dedicated to developing innovative technologies and efficient pro­ cesses that create new markets, enrich people's lives and continue to make Samsung a digital leader." The company's mission statement is called a statement of philosophy and also is given on the corporate website. Samsung does an excellent job in strategic management.

In late 2013, Samsung began mass-producing the industry's first three-dimensional (3D) Vertical NAND (V-NAND) flash memory. The new 3D V-NAND is now used for a wide range of consumer electronics and enterprise applications, including embedded NAND storage and solid state drives (SSDs). In September 2013, Samsung launched a massive global advertising campaign to promote the new Galaxy Note 3 and Galaxy Gear products. Samsung has annual sales of about $190 billion.

Headquartered in Ridgefield Park, New Jersey, Samsung Electronics America (SEA) houses the company's Consumer Business Division (CBD)

and Enterprise Business Division (EBD).CBD offers scores of digital products, such as LEDs and plasma TVs, home the­ ater systems and camcorders as well as refrigerators, washers and dryers, ranges, dishwashers, microwave ovens and vacuums. Samsung EBD offers printers, desktop monitors, laptop computers, digital signage, and projectors.

Samsung Telecommunications America (STA), headquartered in Dallas, Texas, offers handheld wireless phones, wireless communications infrastructure systems, fiber optics anc enterprise communication systems.

Samsung Semiconductor, Inc. (SSI), headquartered in San Jose, California, is the second largest semiconductor manufacturer in the world and the industry leader in DRAM, NAND Flash, SRAM memory and TFT-LCD panels.

Samsung Information Systems America (SISA), located in Southern California, offers hard disk drives, digital TV technologies, printer soft­ ware, wireless connectivity and software.

Samsung Austin Semiconductor (SAS), located in Austin, Texas, is the company's only semiconductor manufacturing plant outside Korea. SAS produces NAND Flash memory and Mobile SoC chips.

CHAPTER 5 • VISION AND MISSION ANALYSIS 171

What Do We Want to Become? It is especially important for managers and executives in any organization to agree on the basic vision that the firm strives to achieve in the long term. A vision statement should answer the basic question, “What do we want to becom e?” A clear vision provides the foundation for developing a comprehensive mission statement. Many organizations have both a vision and mission statement, but the vision statement should be established first and foremost. The vision statement should be short, preferably one sentence, and as many managers as possible should have input into developing the statement. Where there is no vision, the people perish (Proverbs 29: 18)

Several example vision statements are provided in Table 5-1.

What Is Our Business? Current thought on mission statements is based largely on guidelines set forth in the mid-1970s by Peter Drucker. who is often called “the father of modern management” for his pioneering studies at General Motors and for his 22 books and hundreds o f articles. Harvard Business Review has called Drucker “the preeminent management thinker of our time.”

Drucker says that asking the question “What is our business?” is synonymous with asking the question “What is our mission?” An enduring statement o f purpose that distinguishes one organization from other similar enterprises, the mission statement is a declaration o f an organization’s “reason for being.” It answers the pivotal question “What is our business?” A clear mission statement is essential for effectively establishing objectives and formulating strategies.

Sometimes culled a creed statem ent, a statement of purpose, a statement o f philoso­ phy, a statement of beliefs, a statement of business principles, or a statement “defining our business,” a mission statement reveals what an organization wants to be and whom it wants to serve. All organizations have a reason for being, even if strategists have not consciously transformed this reason into writing. As illustrated with white shading in Figure 5-1. care­ fully prepared statements o f vision and mission are w'idely recognized by both practitioners and academicians as the first step in strategic management. Drucker has the following to say about mission statements (paraphrased):

T A B L E 5-1 V isio n Statem ent Exam ples

Tyson Foods’ vision is to be the world’s first choice for protein solutions while maximizing shareholder value. (Author comment: Good statement, unless Tyson provides nonprotein products) General Motors' vision is to be the world leader in transportation products and related services. (Author comment: Good statement) PepsiCo’s responsibility is to continually improve all aspects of the world in which we operate— environment, social, economic—creating a better tomorrow than today. (Author comment: Statement is too vague: it should reveal beverage and food business) Dell's vision is to create a company culture where environmental excellence is second nature. (Author comment: Statement is too vague; it should reveal computer business in some manner: the word environmental is generally used to refer to natural environment so is unclear in its use here) The vision of First Reliance Bank is to be recognized as the largest and most profitable bank in South Carolina. (Author comment: This is a small new bank headquartered in Florence, South Carolina, so this goal is not achievable in Jive years: the statement is too futuristic) Samsonite's vision is to provide innovative solutions for the traveling world. (Author comment: Statement needs to be more specific, perhaps mention luggage; statement as is could refer to air carriers or cruise lines, which is not good) Royal Caribbean’s vision is to empower and enable our employees to deliver the best vacation experience for our guests, thereby generating superior returns for our shareholders and enhancing the well-being of our communities. (Author comment: Statement is good but could end after the word "guests ”) Procter & Gamble’s vision is to be, and be recognized as. the best consumer products company in the world. (Author comment: Statement is too vague and readability is not that good)

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I_____________________ Strategy ________________ Formulation

FIGURE 5-1 A Com prehensive Strategie-M anagem ent M odel

Source: Fred R. David, adapted from “How Companies Define Their Mission,” Long Range Planning 22, no. 3 (June I9K8): 40. <9 Fred R. David.

A mission statement is the foundation for priorities, strategies, plans, and work assignments. It is the starting point for the design o f jobs and organizational structures. Nothing may seem simpler or more obvious than to know what a company’s business is. A lumber mill makes lumber, an airline carries passengers and freight, and a bank lends money. But “What is our business?” is almost always a difficult question and the right answer is usually anything but obvious. The answer to this question is the first responsibility o f strategists.1

Some strategists spend almost every moment o f every day on administrative and tactical concerns, and strategists who rush quickly to establish objectives and implement strategies often overlook the development of a vision and mission statement. This problem is widespread even among large organizations. Many corporations in the USA have not yet developed a formal vision or mission statement. An increasing number o f organizations are developing these statements.

Some companies develop mission statements simply because they feel it is fashionable, rather than out of any real commitment. However, as described in this chapter, firms that develop and systematically revisit their vision and mission statements, treat them as living documents, and consider them to be an integral part o f the firm’s culture realize great benefits. Johnson & Johnson (J&J) is an example firm. J&J managers meet regularly with employees to review.

Strategy __________Strategy _______ I Implementation I Evaluation

CHAPTER 5 • VISION AND MISSION ANALYSIS 173

reword, and reaffirm the firm’s vision and mission. The entire J&J workforce recognizes the value that top management places on this exercise, and these employees respond accordingly.

Vision versus Mission Many organizations develop both a mission statement and a vision statement. Whereas the mission statement answers the question "What is our business?” the vision statement answers the question “What do we want to become?” Many organizations have both a mission and vision statement.

For many if not most corporations, profit rather than mission or vision is the primary motivator. But prolit alone is not enough to motivate people. Profit is perceived negatively by many stakeholders of a firm. For example, employees may see profit as something that they earn and management then uses and even gives away to shareholders. Although this perception is undesired and disturbing to management, it clearly indicates that both profit and vision are needed to motivate a workforce effectively.

When employees and managers together shape or fashion the vision and mission statements for a firm, the resultant documents can reflect the personal visions that managers and employees have in their hearts and minds about their own futures. Shared vision creates a commonality o f interests that can lift workers out of the monotony o f daily work and put them into a new world of opportunity and challenge.

Vision Statement Analysis A vision statement should at a minimum reveal the type o f business the firm engages. For example, to have a vision that says “to become the best retailing firm in the USA” is not good, because that firm could be selling anything from boats to bunnies.

S t a r b u c k s P r o p o s e d V is io n S t a t e m e n t

“Starbucks strives to ethically find and roast the highest quality Arabica coffee in the world. With stores around the world, we are the premier roaster and retailer of specialty coffee globally.”

S t a r b u c k s “ I m p r o v e d ” V is io n S t a t e m e n t

Starbucks’ vision is to be the most well-known, specialty coffee, tea. and pastry restaurant in the world, offering sincere customer service, a welcoming atmosphere, and unequaled quality.

S t a r b u c k s V is io n S t a t e m e n t A n a l y s is

• The existing vision statement does not state what the company wants to become. Nor does it acknowledge the firm’s movement into specialty tea offerings.

• The improved vision statement reveals the company's aspirations for the future and acknowledges that upscale tea and pastries complement their premium coffee offerings.

The Process of Developing Vision and Mission Statements As indicated in the strategic-management model, clear vision and mission statements are needed before alternative strategies can be formulated and implemented. As many managers as possible should be involved in the process o f developing these statements because, through involvement, people become committed to an organization.

A widely used approach to developing a vision and mission statement is first to select several articles about these statements and ask all managers to read these as background information. Then ask managers themselves to prepare a vision and mission statement for the organization. A facilitator or committee of top managers should then merge these statements into a single document and distribute the draft statements to all managers. A request for modifications, additions, and deletions is needed next, along with a meeting to revise the document. To the extent that all managers have input into and support the final documents, organizations can more easily obtain managers’ support for other strategy formulation, implementation, and evaluation activities. Thus, the process o f developing a vision and mission statement represents a great opportunity for strategists to obtain needed support from all managers in the firm.

174 CHAPTER 5 • VISION AND MISSION ANALYSIS

During the process of developing vision and mission statements, some organizations use discussion groups o f managers to develop and modify existing statements. Some organizations hire an outside consultant or facilitator to manage the process and help draft the language. Sometimes an outside person with expertise in developing such statements, who has unbiased views, can manage the process more effectively than an internal group or committee o f managers. Decisions on how best to communicate the vision and mission to all managers, employees, and external constituencies of an organization ¿ire needed when the documents are in final form. Some organizations even develop a videotape to explain the statements and how they were developed.

An article by Campbell and Yeung emphasizes that the process of developing a mission statement should create an “emotional bond” and “sense o f mission” between the organization and its employees.2 Commitment to a company’s strategy and intellectual agreement on the strategies to be pursued do not necessarily translate into an emotional bond; hence, strategies that have been formulated may not be implemented. These researchers stress that an emotional bond comes when an individual personally identifies with the underlying values and behavior of a firm, thus turning intellectual agreement and commitment to strategy into a sense o f mission. Campbell and Yeung also differentiate between the terms vision and mission . saying that vision is “a possible and desirable future state of an organization” that includes specific goals, whereas mission is more associated with behavior and the present.

Importance (Benefits) of Vision and Mission Statements The importance (benefits) o f vision and mission statements to effective strategic management is well documented in the literature, although research results are mixed. Rarick and Vitton found that firms with a formalized mission statement have twice the average return on shareholders' equity than those firms without a formalized mission statement have; Bart and Baetz found a positive relationship between mission statements and organizational performance; BusinessWeek reports that firms using mission statements have a 30 percent higher return on certain financial measures than those without such statements; however, some studies have found that having a mission statement does not directly contribute positively to financial performance.3 The extent of manager and employee involvement in developing vision and mission statements can make a difference in business success. This chapter provides guidelines for developing these important documents. In actual practice, wide variations exist in the nature, composition, and use of both vision and mission statements. King and Cleland recommend that organizations carefully develop a written mission statement in order to reap the following benefits:

1. To make sure all employees/managers understand the firm’s purpose or reason for being. 2. To provide a basis for prioritization o f key internal and external factors utilized to formu­

late feasible strategies. 3. To provide a basis for the allocation of resources. 4. To provide a basis for organizing work, departments, activities, and segments around a

common purpose.'4

Reuben Mark, former CEO o f Colgate, maintains that a clear mission increasingly must make sense internationally. Mark’s thoughts on vision are as follows:

When it comes to rallying everyone to the corporate banner, it's essential to push one vision globally rather than trying to drive home different messages in different cultures. The trick is to keep the vision simple but elevated: “W'e make the world's fastest computers” or “Telephone service for everyone.” You’re never going to get anyone to charge the machine guns only for financial objectives. It's got to be something that makes people feel better, feel a part o f something.5

A Resolution of Divergent Views Another benefit o f developing a comprehensive mission statement is that divergent views among managers can be revealed and resolved through the process. The question “What is our business?” can create controversy. Raising the question often reveals differences among strategists in the organization. Individuals who have worked together tor a long time and who think they know- each other suddenly may realize that they are in fundamental disagreement.

CHAPTER 5 • VISION AND MISSION ANALYSIS 175

For example, in a college or university, divergent views regarding the relative importance of teaching, research, and service often are expressed during the mission statement development process. Negotiation, compromise, and eventual agreement on important issues are needed before people can focus on more specific strategy-formulation activities.

Considerable disagreement among an organization’s strategists over vision and mission statements can cause trouble if not resolved. For example, unresolved disagreement over the business mission was one o f the reasons for W. T. Grant’s bankruptcy and eventual liquidation. Top executives o f the firm, including Ed Staley and Lou Lustenberger, were firmly entrenched in opposing positions that W. T. Grant should be like Kmart or JC Penney respectively. W.T. Grant decided to become a bit like both Kmart and JC Penney; this compromise was a huge strategic mistake. In other words, top executives of W. T. Grant never resolved their vision/mission issue, which ultimately led to the firm’s disappearance.6

Too often, strategists develop vision and business mission statements only when the organization is in trouble. O f course, it is needed then. Developing and communicating a clear mission during troubled times indeed may have spectacular results and even may reverse decline. However, to wait until an organization is in trouble to develop a vision and mission statement is a gamble that characterizes irresponsible management. According to Drucker, the most important time to ask seriously, "What do we want to become?” and ‘'W'hat is our business?” is when a company has been successful;

Success always obsoletes the very behavior that achieved it, always creates new realities, and always creates new and different problems. Only the fairy tale story ends, “They lived happily ever after.” It is never popular to argue with success or to rock the boat. It will not be long before success will turn into failure. Sooner or later, even the most successful answer to the question “What is our business?” becomes obsolete.1'

In multidivisional organizations, strategists should ensure that divisional units perform strategic-management tasks, including the development o f a statement of vision and mission. Each division should involve its own managers and employees in developing a vision and mis­ sion statement that is consistent with and supportive of the corporate mission. Ten benefits of having a clear mission and vision are provided in Table 5-2.

An organization that fails to develop a vision statement as well as a comprehensive and inspiring mission statement loses the opportunity to present itself favorably to existing and potential stakeholders. All organizations need customers, employees, and managers, and most firms need creditors, suppliers, and distributors. The vision and mission statements are effective vehicles for communicating with important internal and external stakeholders. The principal benefit o f these statements as tools o f strategic management is derived from their specification of the ultimate aims of a firm. Vision and mission statements reveal the firm’s shared expecta­ tions internally among all employees and managers. For external constituencies, the statements reveal the firm’s long-term commitment to responsible, ethical action in providing a needed product and/or service for customers.

T A B L E 5-2 Ten Benefits o f H avin g a C lear M ission and V ision

1. Achieve clarity of purpose among all managers and employees. 2. Provide a basis for all other strategic planning activities, including internal and external

assessment, establishing objectives, developing strategies, choosing among alternative strategies, devising policies, establishing organizational structure, allocating resources, and evaluating performance.

3. Provide direction. 4. Provide a focal point for all stakeholders of the firm. 5. Resolve divergent views among managers. 6. Promote a sense of shared expectations among all managers and employees. 7. Project a sense of worth and intent to all stakeholders. 8. Project an organized, motivated organization worthy of support. 9. Achieve higher organizational performance.

10. Achieve synergy among all managers and employees.

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Characteristics of a Mission Statement A Declaration of Attitude A mission statement is more than a statement o f specific details; it is a declaration o f attitude and outlook. It usually is broad in scope for at least two major reasons. First, a good mission statement allows for the generation and consideration o f a range of feasible alternative objectives and strategies without unduly stifling management creativity. Excess specificity would limit the potential o f creative growth for the organization. However, an overly general statement that does not exclude any strategy alternatives could be dysfunctional. Apple Computer’s mission state­ ment, for example, should not open the possibility for diversification into pesticides— or Ford Motor Company’s into food processing.

Second, a mission statement needs to be broad to reconcile differences effectively among, and appeal to, an organization's diverse stakeholders, the individuals and groups of individuals who have a special stake or claim on the company. Thus, a mission statement should be reconcilatory. Stakeholders include employees, managers, stockholders, boards o f directors, customers, suppliers, distributors, creditors, governments (local, state, federal, and foreign), unions, competitors, environmental groups, and the general public. Stakeholders affect and are affected by an organization’s strategies, yet the claims and concerns of diverse constituen­ cies vary and often conflict. For example, the general public is especially interested in social responsibility, whereas stockholders are more interested in profitability. Claims on any business literally may number in the thousands, and they often include clean air. jobs, taxes, investment opportunities, career opportunities, equal employment opportunities, employee benefits, salaries, wages, clean water, and community services. All stakeholders’ claims on an organization cannot be pursued with equal emphasis. A good mission statement indicates the relative attention that an organization will devote to meeting the claims of various stakeholders.

The fine balance between specificity and generality is difficult to achieve, but it is well worth the effort. George Steiner offers the following insight on the need for a mission statement to be broad in scope:

Most business statements of mission are expressed at high levels o f abstraction. Vagueness nevertheless has its virtues. Mission statements are not designed to express concrete ends, but rather to provide motivation, general direction, an image, a tone, and a philosophy to guide the enterprise. An excess of detail could prove counterproductive since concrete specification could be the base for rallying opposition. Precision might stifle creativity in the formulation of an acceptable mission or purpose. Once an aim is cast in concrete, it creates a rigidity in an organization and resists change. Vagueness leaves room for other managers to fill in the details.8

As indicated in Table 5-3, in addition to being broad in scope, an effective mission statement should not be too lengthy; recommended length is less than 250 words. An effective mission statement should arouse positive feelings and emotions about an organization; it should be inspiring in the sense that it motivates readers to action. A mission statement should be enduring. All o f these are desired characteristics o f a statement. An effective mission statement

T A B L E 5-3 Characteristics o f a M ission Statem ent

1. Broad in scope: do not include monetary amounts, numbers, percentages, ratios, or objectives 2. Less than 250 words in length 3. Inspiring 4. Identify the utility of a firm's products 5. Reveal diat the firm is socially responsible 6. Reveal that the firm is environmentally responsible 7. Include nine components customers, products or services, markets, technology, concern for

survival/growth/profits, philosophy, self-concept, concern for public image, concern for employees 8. Reconciliatory 9. Enduring

CHAPTER 5 • VISION AND MISSION ANALYSIS 177

generates the impression that a firm is successful, has direction, and is worthy of time, support, and investment— from all socioeconomic groups o f people.

It reflects judgments about future growth directions and strategies that are based on forward-looking external and internal analyses. A business mission should provide useful criteria for selecting among alternative strategies. A clear mission statement provides a basis for generating and screening strategic options. The statement of mission should be dynamic in orientation, allowing judgments about the most promising growth directions and those considered less promising.

A Customer Orientation A good mission statement describes an organization's purpose, customers, products or services, markets, philosophy, and basic technology. According to Vern McGinnis, a mission statement should (a) define what the organization is and what the organization aspires to be, (b) be limited enough to exclude some ventures and broad enough to allow for creative growth, (c) distinguish a given organization from all others, (d) serve as a framework for evaluating both current and prospective activities, and (e) be stated in terms sufficiently clear to be widely understood throughout the organization.9

A good mission statement reflects the anticipations of customers. Rather than developing a product and then trying to find a market, the operating philosophy o f organizations should be to identify customers’ needs and then provide a product or service to fulfill those needs.

Good mission statements identify the utility of a firm’s products to its customers. This is why AT&T’s mission statement focuses on communication rather than on telephones; it is why ExxonMobil’s mission statement focuses on energy rather than on oil and gas: it is why Union Pacific’s mission statement focuses on transportation rather than on railroads: it is why Universal Studios“ mission statement focuses on entertainment rather than on movies. A major reason for developing a business mission statement is to attract customers who give meaning to an organization.

The following utility statements are relevant in developing a mission statement:

Do not offer me things.

Do not offer me clothes. Offer me attractive looks. Do not offer me shoes. Offer me comfort for my feet and the pleasure o f walking. Do not offer me a house. Offer me security, comfort, and a place that is clean and happy. Do not offer me books. Offer me hours o f pleasure and the benefit o f knowledge. Do not offer me CDs. Offer me leisure and the sound of music. Do not offer me tools. Offer me the benefits and the pleasure that come from making beau­ tiful things.

Do not offer me furniture. Offer me comfort and the quietness o f a cozy place. Do not offer me things. Offer me ideas, emotions, ambience, feelings, and benefits. Please, do not offer me things.

Mission Statement Components Mission statements can and do vary in length, content, format, and specificity. Most practitioners and academicians of strategic management feel that an effective statement should include these nine m ission statem ent com ponents. Because a mission statement is often the most visible and public part o f the strategic-management process, it is important that it includes Lhe nine characteristics as summarized in Table 5-3, as well as the following nine components:

1. Customers— Who are the firm's customers? 2. Products or services— What are the firm’s major products or services? 3. M arkets— Geographically, where does the firm compete? 4. Technology— Is the firm technologically current ? 5. Concern for survival, grow th, and profitability— Is the firm committed to growth and

financial soundness? 6. Philosophy— What are the basic beliefs, values, aspirations, and ethical priorities o f the firm? 7. Self-concept— What is the firm’s distinctive competence or major competitive advantage? 8. Concern fo r public image— Is the firm responsive to social, community, and

environmental concerns? 9. Concern fo r employees— Are employees a valuable asset of the firm?10

TA BLE 5-4 Examples of the Nine Essential Components of a Mission Statement

178 CHAPTER 5 • VISION AND MISSION ANALYSIS

1. Customers We believe our first responsibility is to the doctors, nurses, patients, mothers, and all others who use our products and services. (Johnson & Johnson) To earn our customers’ loyalty, we listen to them, anticipate their needs, and act to create value in their eyes. (Lexmark International)

2. Products or Services AM AX's principal products are molybdenum, coal, iron ore, copper, lead. /inc. petroleum and natural gas, potash, phosphates, nickel, tungsten, silver, gold, and magnesium. (AMAX Engineering Company) Standard Oil Company (Indiana) is in business to find and produce crude oil, natural gas. and natural gas liquids; to manufacture high-quality products useful to society from these raw materials; and to distribute and market those products and to provide dependable re­ lated services to the consuming public at reasonable prices. (Standard Oil Company)

3. Markets We are dedicated to the total success o f Corning Glass Works as a worldwide competitor. (Corning Glass Works) Our emphasis is on North American markets, although global opportunities will be explored. (Blockway)

4. Technology Control Data is in the business o f applying micro-electronics and computer technology in two general areas: computer-related hardware; and computing-enhancing services, which include computation, information, education, and finance. (Control Data) We will continually strive to meet the preferences o f adult smokers by developing technologies that have the potential to reduce the health risks associated with smoking. (RJ Reynolds)

5. Concern for Survival, Growth, and Profitability In this respect, the company will conduct its operations prudently and will provide the profits and growth which will assure Hoover’s ultimate success. (Hoover Universal) To serve the worldwide need for knowledge at a fair profit by adhering, evaluating, producing, and distributing valuable information in a way that benefits our customers, employees, other investors, and our society. (McGraw-Hill )

6. Philosophy Our world-class leadership is dedicated to a management philosophy that holds people above profits. (Johnson Company) It’s all part o f the Mary Kay philosophy— a philosophy based on the golden rule. A spirit of sharing and caring where people give cheerfully of their time, knowledge, and experience. (Mary Kay Cosmetics)

7. Self-Concept Crown Zellerbach is committed to leapfrogging ongoing competition within 1,000 days by unleashing the constructive and creative abilities and energies o f each of its employees. (Crown Zellerbach)

8. Concern for Public Image To share the world’s obligation for the protection o f the environment. (Dow Chemical) To contribute to the economic strength o f society and function as a good corporate citizen on a local, state, and national basis in all countries in which we do business. (Pfizer)

9. Concern for Employees To recruit, develop, motivate, reward, and retain personnel o f exceptional ability, character, and dedication by providing good working conditions, superior leadership, compensation on the basis o f performance, an attractive benefit program, opportunity for growth, and a high degree o f employment security. (Barnes Corporation) To compensate its employees w ith remuneration and fringe benefits competitive with other employment opportunities in its geographical area and commensurate with their contributions toward efficient corporate operations. (Public Service Electric & Gas Company)

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Excerpts from the mission statements o f different organizations are provided in Table 5-4 to exemplify the nine essential mission statement components.

Writing and Evaluating Mission Statements Perhaps the best way to develop a skill for writing and evaluating mission statements is to study actual company missions. Therefore, the mission statements presented in Table 5-5 are evaluated based on the nine desired components. Note in Table 5-5 that numbers provided in each statement reveal what components are included in the respective documents. Among the statements in Table 5-5, note that the Dell mission statement is the best because it lacks only one component, whereas the L’Oreal statement is the worst, lacking six o f the nine recommended components.

There is no one best mission statement for a particular organization, so good judgment is required in evaluating mission statements. Realize that some individuals are more demanding than others in assessing mission statements in this manner. For example, if a statement merely includes the word “customers” without specifying who the customers are. is that satisfactory?

TA B LE 5-5 Example Mission Statements

Fleetwood Enterprises will lead the recreational vehicle and manufactured housing industries (2 .1} in providing quality products, with a passion for customer-driven innovation (I). We will emphasize training, embrace diversity and provide growth opportunities for our associates and our dealers (9). We will lead our industries in the application of appropriate technologies (4). We will operate at the highest levels of ethics and compliance with a focus on exemplary corporate governance (6). We will deliver value to our shareholders, positive operating results and industry-leading earnings (5). (Author comment: Statement lacks two components: Markets and Concern fo r Public Image) We aspire to make PepsiCo the world’s (3) premier consumer products company, focused on convenient foods and beverages (2) We seek to produce healthy financial rewards for investors (5) as we provide opportunities for growth and enrichment to our employees. (9) our business partners and the communities (8) in which we operate. And in everything we do. we strive to act with honesty, openness, fairness and integrity (6). (Author comment: Statement lacks three components: Customers, Technology, and Self-Concept) We are loyal to Royal Caribbean and Celebrity and strive for continuous improvement in everything we do. We always provide service with a friendly greeting and a smile (7). We anticipate the needs of our customers and make all efforts to exceed our customers’ expectations (1). We take ownership of any problem that is brought to our attention. We engage in conduct that enhances our corporate reputation and employee morale (9). We are committed to act in the highest ethical manner and respect the rights and dignity of others. (6). (Author comment: Statement lacks Jive components: Products/Services, Markets, Technology, Concern fo r Survival/Growth/Profits, Concern fo r Public Image) Dell's mission is to be the most successful computer company (2) in the world (3) at delivering the best customer experience in markets we serve (1). In doing so, Dell will meet customer expectations of highest quality; leading technology (4); competitive pricing; individual and company accountability (6): best-in-class service and support (7); flexible customization capability (7); superior corporate citizenship (8); financial stability (5). (Author comment: Statement lacks only one component: Concern fo r Employees) Procter & Gamble will provide branded products and services of superior quality and value (7) that improve the lives of the world’s (3) consumers. As a result, consumers (1) will reward us with indus­ try leadership in sales, profit (5), and value creation, allowing our people (9), our shareholders, and the communities (8) in which we live and work to prosper. (Author comment: Statement lacks three components: Products/Services, Technology, and Philosophy) At L*Oreal. we believe that lasting business success is built upon ethical (6) standards which guide growth and on a genuine sense of responsibility to our employees (9), our consumers, our environment and to the communities in which we operate (8). (Author comment: Statement lacks six components: Customers, Products/Services, Markets, Technology, Concern fo r Sur\’ival/Growth/ProJits, Concern for Public Image)

Note: The numbers in parentheses correspond to the nine components listed on page 178; author comments also refer to those components.

180 CHAPTER 5 • VISION AND MISSION ANALYSIS

Ideally a statement would provide more than simply inclusion o f a single word such as “products” or “employees" regarding a respective component. Why? Because the statement should be informative, inspiring, enduring, and serve to motivate stakeholders to action. Evaluation o f a mission statement regarding inclusion of the nine components is just the begin­ ning of the process to assess a statement’s overall effectiveness.

Special Note to Students Recall that gaining and sustaining competitive advantage is the essence o f strategic management, so when presenting your vision or mission analysis for the firm, be sure to address the “self-concept” or “distinctive competence” component. Compare your recommended vision or mission statement both with the firm’s existing statements and with rival firms’ statements to clearly reveal how your recommendations or strategic plan enables the firm to gain and sus­ tain competitive advantage. Thus, your proposed mission statement should certainly include the nine components and nine characteristics, but in your vision or mission discussion, focus on competitive advantage. In other words, be prescriptive, forward-looking, and insightful— couching your vision/mission overview in terms of how you believe the firm can best gain and sustain competitive advantage. Do not be content with merely showing a nine-component com ­ parison of your proposed statement with rival firms’ statements, although that would be nice to include in your analysis.

Conclusion Every organization has a unique purpose and reason for being. This uniqueness should be reflected in vision and mission statements. The nature o f a business vision and mission can represent either a competitive advantage or disadvantage for the firm. An organization achieves a heightened sense of purpose when strategists, managers, and employees develop and commu­ nicate a clear business vision and mission. Drucker says that developing a clear business vision and mission is the “first responsibility o f strategists.”

A good mission statement reveals an organization’s customers; products or services; markets; technology; concern for survival, growth, and profitability; philosophy; self-concept; concern for public image: and concern for em ployees. These nine basic components serve as a practical framework for evaluating and writing mission statements. As the first step in strategic management, the vision and mission statements provide direction for all planning activities.

Well-designed vision and mission statements are essential for formulating, implement­ ing, and evaluating strategy. Developing and communicating a clear business vision and mission are the most commonly overlooked tasks in strategic management. Without clear statements o f vision and mission, a firm’s short-term actions can be counterproductive to long-term interests. Vision and mission statements always should be subject to revision, but. if carefully prepared, they will require infrequent major changes. Organizations usually reexamine their vision and mission statements annually. Effective mission statements stand the test o f time.

Vision and mission statements are essential tools for strategists, a fact illustrated in a short story told by Porsche’s former CEO Peter Schultz (paraphrased):

Three guys were at work building a large church. All were doing the same job, but when each was asked what his job was, the answers varied: “Pouring cement,” the first replied; “Earning a paycheck,” responded the second; “Helping to build a cathedral.” said the third. Few of us can build cathedrals. But to the extent we can see the cathedral in whatever cause we are following, the job seems more worthwhile. Good strategists and a clear mission help us find those cathedrals in what otherwise could be dismal issues and empty causes.11

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Key Terms and Concepts concern for employees (p. 177) concern for public image (p. 177) concern for survival, growth, and profitability (p. 177) creed statement (p. 171) customers (p. 177) markets (p. 177) mission statement (p. 171) mission statement components (p. 177)

philosophy (p. 177) products or services (pề 177) reconciliatorv (p. 176) self-concept (p. 177) stakeholders (p. 176) technology (p. 177) vision statement (p. 173)

Issues for Review and Discussion 5-1. Develop (or find) a mission statement for Samsung 5-13.

Electronics. Analyze the company’s mission statement in light o f the guidelines in Chapter 5.

5-2. Summarize Samsung’s successful global strategy for 5-14. the last decade. Can that strategy be as successful in 2014? Explain.

5-3. See if you can find a vision statement for Samsung. If 5-15. not, write a proposed vision statement for the company.

5-4Ề Should the mission statement components vary in 5-16. importance depending on type o f business? If yes, how would their relative importance vary for Samsung 5-17. versus Singapore Airlines?

5-5. List three things you are on a mission to accomplish 5-18. in the next three years. How relevant is the concept of vision/mission to an individual in their personal and professional life? Explain.

5-6. Conduct a G ood e search for the key words “mission 5-19ế statement.” What are the two best websites in your opinion that provide example mission statements?

5-7. Write a vision statement for your university. Write 5-20. a vision statement foiế vour School (or College) of Business within the university. 5-21.

5-8. If you just purchased a 10-einployee company, how would you establish a clear vision and mission? 5-22ẽ

5-9. Identify from the Internet six mission statement examples. Evaluate the six statements and brinơ your analysis to class. 5-23.

5-10. How and why could Lhe process o f developing a vision and mission statement vary across countries? 5-24ề

5-11. In order of importance, list six benefits o f having a clearly defined vision and mission statement.

5-12. Only the fairy story ends “they lived happily ever after.” 5-25. What is the relevance o f this statement to the concepts vision and mission statement?

Explain the meaning, and significance of the term “reconciliatory” in developing mission statements. List the nine mission statement components. Give an example of each component for your college or university. In order o f importance, rank seven characteristics o f a mission statement. Write a vision and mission statement for a local restaurant in your area. Write an excellent sentence for Samsung, which includes four mission statement components. Within a given industry, compare the mission state­ ments of three companies in your country versus three competing companies in the United States. How did they differ? Does Singapore Airlines have its vision and mission statement posted on its website? Should the company? Why or why not? How often do you think a firm's vision and mission statements should be changed? Why? Explain how a mission statement can be “reconciliatory.” Give an example. Do local fast food restaurants need a mission statement posted in their place of business? Why or why not? Find 5 mission statements on the Internet. Evaluate the statements in terms o f six characteristics. Referring to the end o f Chapter 5. explain how a team of students should couch their mission statement discussion o f slides in a presentation. List the four most important characteristics o f a mission statement for a small retail store. Explain.

182 CHAPTER 5 • VISION AND MISSION ANALYSIS

MyManagementLab® Go to m ym anagem entlab.com for the following Assisted-graded writing questions:

5-26. Explain why a mission statement should not include 5-28. Mymanagementlab Only— comprehensive writing strategies and objectives. assignment for this chapter.

5-27. List seven characteristics o f a mission statement.

Current Readings Bartkus, Barbara, Myron Glassman, and R. Bruce McAfee.

“Mission Statements: Are They Smoke and Mirrors?” Business Horizons 43, no. 6 (November-December 2000): 23.

Church Mission Statements, http://www.missionstatements. com/church_mission_statements.html.

Collins, David J., and Michael G. Rukstad. “Can You Say What Your Strategy Is?” Harvard Business Review, April 2008, 82.

Company Mission Statements, http://www.missionstatements. com/company _mission_statements.html.

Conger, Jay A., and Douglas A. Ready. “Enabling Bold Visions.” M IT Sloan Management Review 49, no. 2 (Winter 2008): 70.

Day, George S., and Paul Schoemaker. “Peripheral Vision: Sensing and Acting on Weak Signals.” Long Range Planning 37, no. 2 (April 2004): I 17.

Ibarra, Herminia, and Otilia Obodaru. “Women and the Vision Thing.” Harvard Business Review, January 2009, 62-71.

Lissak, Michael, and Johan Roos. “Be Coherent, Not Visionary.” Long Range Planning 34, no. 1 (February 2001): 53.

Newsom, Mi Kyong, David A. Collier, and Eric O. Olsen. “Using ‘Biztainment’ to Gain Competitive Advantage.” Business Horizons. March-April 2009, 167-166.

Nonprofit Organization Mission Statements, http://www. missionstatements.com/nonprofit_mission_statements.html.

Restaurant Mission Statements, http://www.missionstatements. com/restaurant_mission_statements.html.

School Mission Statements, http://www.missionstatements. com/school_mission_statements.html.

CHAPTER 5 • VISION AND MISSION ANALYSIS 183

A SSU R A N CE OF LEA RN IN G EX ER C ISES EXERCISE 5A

Examining Potential Changes Needed in a Firm’s Vision/Mission

Purpose Samsung Electronics is featured in the opening chapter insert as a firm that engages in excellent strategic planning. This exercise gives you practice examining the change or needed change in a company’s vision and mission statements, given a change in the company’s product offerings. Visit the Samsung corporate website. Samsung’s vision statement is posted on their website, as: “Samsung is dedicated to developing innovative technologies and efficient processes that create new markets, enrich people’s lives and continue to make Samsung a digital leader.” The company’s mission state­ ment is called a statement of philosophy and also is given on the corporate website. Samsung does an excellent job in strategic management.

Instructions Step 1 Evaluate Samsung’s vision and mission statements in light of the characteristics and compo­

nents in Chapter 5. Step 2 Write improved vision and mission statements for Samsung Electronics given:

a) shortcomings of the statements based on Chapter 5 concepts, and b) Samsung’s new products being rolled oul globally.

EXERCISE 5B

Studying an Alternative View of Mission Statement Content

Purpose This exercise presents a somewhat different view of mission statements as compared to concepts presented in Chapter 5. For example, according to Bart (1997). a mission statement consists of three essential components:

1. Key market - Who is your target client/customer? 2ế Contribution - What product or service do you provide to that client? 3. Distinction - What makes your product or service unique, so that the client would choose you?

For example, if you locate McDonald’s mission statement on the Internet. Bart's essential components are covered in the following ways:

1. Key Market: the fast food customer world-wide 2. Contribution: tasty and reasonably-priced food prepared in a high-quality manner 3. Distinction: delivered consistently (world-wide) in a low-key decor and friendly atmosphere.

Another example ịệs Courtyard by Marriott, which provides travelers with economy and quality lodging. Its key components are:

1. Key Market: economy and quality mindedtravelers 2. Contribution: moderate priced lodging 3ề Distinction: consistently perceived as clean, comfortable, well-maintained, and attractive, staffed by

friendly, attentive and efficient people

Instructions Compare and contrast the guidelines presented by Bart with the guidelines presented in Chapter 5.

Source: Based on information at 1) Christopher K. Bart. “Sex, Lies, and Mission Statements:’ Business Horizons, pp. 9-18. November-December. 1997. and 2) www.wikipedia.com.

184 CHAPTER 5 • VISION AND MISSION ANALYSIS

EXERCISE 5C

Evaluating Mission Statements

Purpose A business mission statement is an integral pan of strategic management. It provides direction for formulating, implementing, and evaluating strategic activities. This exercise will give you practice evaluating mission statements, a skill that is a prerequisite to writing a good mission statement. The mission statement for adidas is given below:

“The adidas Group strives to be the global leader in the sporting goods industry with sports brands built on a passion for sports and a sporting lifestyle. We are dedicated to consistently delivering out­ standing financial results. We are innovation and design leaders who seek to help athletes of all skill levels achieve peak performance with every product we bring to market. We are consumer focused and therefore we continuously improve the quality, look, feel and image of our products and our organiza­ tional structures to match and exceed consumer expectations and to provide them w ith the highest value. We ¿ire a global organization that is socially and environmentally responsible, creative and financially rewarding for our employees and shareholders. We are committed to continuously strengthening our brands and products to improve our competitive position.”

Instructions Step 1 On a separate sheet of paper, write the nine mission statement components down the left side. Step 2 Write "yes" or “no” beside each number to indicate whether you feel the adidas mission

statement has included the respective component. For any component that you record a “no ” write a good sentence to encompass that component.

Step 3 Turn your paper in to your instructor for a classwork grade.

EXERCISE 5D

Evaluating the Mission Statement of Under Armour— a Competitor of adidas AG

Purpose There is always room for improvement in regard to an existing vision and mission statement. Under Armour was founded in 1996 by former University of Maryland football player Kevin Plank. Under Armour sportswear is designed to keep athletes cool, dry and light throughout the course of a game, practice or workout. The technology behind Under Armour's diverse product assortment is complex, but the advice is simple: wear HeatGear® when it’s hot, ColdGear® when it’s cold, and AllSeasonGear® between the extremes (www.underarmour.com). Visit the Under Armour website and locate their mission statement.

Instructions Step 1 On a separate sheet of paper, write the nine mission statement components down the lefthand

side. Step 2 Write "yes” or “no” beside each number to indicate whether you feel the Under Armour mis­

sion statement has included the respective component. For any component that you record a “no." write a good sentence to encompass that component.

Step 3 Turn your paper in to your instructor for a classwork grade.

CHAPTER 5 • VISION AND MISSION ANALYSIS 185

EXERCISE 5E

Selecting the Best Vision and Mission Statements in a Given Industry

Purpose This exercise is designed to get you familiar with existing vision and mission statements in an industry of your choosing.

Instructions Identify 10 companies in an industry that you are interested in working in one day. Find the companies' vision and mission statements. Keep searching until you have found five vision statements and five mission statements. The statements do not have to be from the same companies. Rank your five vision statements and your five mission statements in order of attractiveness, with l being the best and 5 being the worst.

EXERCISE 5F

Writing an Excellent Vision and Mission Statement for Novartis AG

Purpose This exercise is designed to give you practice developing from scratch or improving an existing vision and mission statement.

Instructions Step 1 Go to the Novartis AG website and look for the company’s vision statement and mission

statement. Recall from Chapter 5 that companies use different names or titles for these documents.

Step 2 Prepare an improved vision and mission statement for Novartis AG whether or not you were able to find these statements on the company’s website or in the firm’s Annual Report.

Notes 1. Peter Dmcker, Management: Tasks, Responsibilities, and

Practices (New York: Harper & Row, 1974), 61.

2. Andrew' Campbell and Sally Yeung, ‘‘Creating a Sense of Mission,” Long Range Planning 24. no. 4 (August 1991): 17.

3. Charles Rarick and John Vitton, “Mission Statements Make Cents.” Journal o f Business Strategy 16 (1995): 1 1. Also, Christopher Bart and Mark Baetz, “The Relationship Between Mission Statements and Firm Performance: An Exploratory Study,” Journal o f Management Studies 35 (1998): 823; “Mission Possible,” Business Week (Aueust 1999): FI2.

4. W. R. King and D. I. Cleland, Strategic Planning and Policy (New York: Van Nostrand Reinhold, 1979), 124.

6. “How W. T. Grant Lost $175 Million Last Year,” Business Week, February 25, 1975, 75.

7. Drucker, Management, 88.

8. John Pearce II, “The Company Mission as a Strategic Tool." Sloan Management Review 23, no. 3 (Spring 1982): 74.

9. George Steiner, Strategic Planning: What Every Manager Must Know (New York: The Free Press, 1979), 160.

10. Vern McGinnis, “The Mission Statement: A Key Step in Strategic Planning,” Business 31, no. 6 (November-December 1981): 41.

11. http://ezinearticles.com/7Elements-of-a-Mission- Statement&id=3846671.

5. Brian Dumaine, “What the Leaders o f Tomorrow See,” Fortune, July 3. 1989, 50.

MyManagementLab® Improve Your Grade! More than 10 million students improved their results using the Pearson MyLabs. Visit m ym anagem entlab.com for simulations, tutorials, and end-of-chapter problems.

The Internal Audit

C H A P T E R O B J E C T IV E S After studying this chapter, you should be able to do the following:

1. Explain how the nature and role of chief marketing officer has changed.

2. Be able to work out breakeven analysis business problems.

3. Describe how to perform an internal strategic-management audit.

4. Discuss the resource-based view (RBV) in strategic management.

5. Discuss key interrelationships among the functional areas of business.

6. Identify the basic functions or activities that make up management, marketing, finance and accounting, production and operations, research and development, and management information systems.

7. Explain how to determine and prioritize a firm's internal strengths and weaknesses.

8 . Explain the importance of financial ratio analysis.

9. Discuss the nature and role of management information systems in strategic management.

10. Develop an internal factor evaluation (IFE) matrix.

11. Explain cost/benefit analysis, value chain analysis, and benchmarking as strategic-management tools.

A S S U R A N C E O F L E A R N IN G EXERCISES The following exercises are found at the end of this chapter.

Develop a Corporate IFE Matrix for Volkswagen Group

Should VW Deploy More Resources or Less Outside of the USA?

Apply Breakeven Analysis

Performing a Financial Ratio Analysis for adidas AG

Constructing an IFE Matrix for adidas AG

Analyzing Your College or University’s Internal Strategic Situation

E X E R C I S E 6A

E X E R C I S E 6B

E X E R C I S E 6C

E X E R C I S E 6 D

E X E R C I S E 6E

E X E R C I S E 6F

188 CHAPTER 6 • THE INTERNAL AUDIT

This chapter focuses on identifying and evaluating a fil m's strengths and weaknesses in the functional areas of business, including management, marketing, finance and accounting, production and operations, research and development (R&D), and management information systems (MIS). Relationships among these areas OÍ business arc examined. Strategic implications o f important functional area concepts are examined. The process of performing an internal audit is described. The resource-based view (RBV) o f strategic management is introduced as is the value chain analysis (VCA) concept. Volkswagen has done an excellent job in using its strengths to capitalize on external opportunities. Volkswagen is showcased in the opening chapter boxed insert.

The Nature of an Internal Audit All organizations have strengths and weaknesses in the functional areas o f business. No enterprise is equally strong or weak in all areas. Maytag, for example, is known for excellent production and product design, whereas Procter & Gamble is known for superb marketing. Internal strengths and weaknesses, coupled with external opportunities and threats and clear vision and mission statements, provide the basis for establishing objectives and strategies. Objectives and strategies are established with the intention o f capitalizing on internal strengths and overcoming weaknesses. The internal-audit part of the strategic-management process is illustrated in Figure 6 -1 with white shading.

STRATEGIC MANAGEMENT

Volkswagen Volkswagen (VW) Group is a global automobile manufacturer head­ quartered in Wolfsburg, Lower Saxony, Germany. The largest German automaker and the third largest automaker in the world, v w produces more than 7 million cars, trucks, and vans annually, including the Beatle, Golf, Passat (trade wind), Jetta (jet stream), Rabbit, and Fox. v w also owns luxury carmakers— AUDI, Lamborghini, Bentley, and Bugatti, and other brands such as SEAT (family cars, Spain) and Skoda (family cars, the Czech Republic), v w owns 49.9 percent of Porsche. WV's American and Chinese version of the Passat won the 2012 Motor Trend Car of the Year. The v w Golf won the 2013 European Car of the Year. In 2013, Fortune ranked v w as the 9th largest company in the world, the 6ih most profit­ able, and the 33rd most admired company outside the United States.

In an August 2013 study by the Trendence Institute (Tl), the v w Group rose from 4th to 2nd place in the rankings of the most attrac­ tive employers in Europe, trailing only USA-based Google. In the study, 320,000 students from 24 European countries were interviewed with regard to their career plans and preferred employers. Ralph Linde, Head of the Volkswagen Group Academy, stated that as well as a trainee scheme for university graduates, Volkswagen also takes great pride in the mentoring and individual career development of each of its employees. This result confirms an April 2013 Tl survey with 37,000 Gerr,ẵ<3ii students that revealed that companies in the Volkswagen Group are the most sought-after employers among German students.

For the J a n u a r y through August 2013 period, V o lk s w a g e n delivered 3.84 (+3.1 percent) million passen­ ger cars worldwide, doing particularly well in China, where 1.56 (+18.4 percent) million units were delivered, and in Mexico, with 92,100 (+18.3 percent) deliveries. For that period, Audi delivered 1.03 million vehicles worldwide, an increase of 7.2 percent, led by China, where 310,300 (+19.5 percent) Audi vehicles were delivered. Audi deliveries during that period in the United States rose 14.7 per­ cent compared with the same prior-year period, with 101,300 cars sold. VW's sports car manufacturer Porsche, which joined Volkswagen Group on August 1, 2012, delivered 106,800 vehicles in the first eight months of 2013 with the 32,500 units sold in the Asia-Pacific region comprising the largest share of Porsche deliveries. Another 31,400 Porsche's were handed over to customers in the North America region. Also during those eight months, VW's SKODA delivered 598,400 (-5.5 percent) vehicles worldwide, while SEAT delivered 234,200 ( +11.4 percent) vehicles.

CHAPTER 6 • THE INTERNAL AUDIT 189

I____________________ Strategy ________________________ I________ Strategy _________ Strategy ______ I Formulation I Implementation I Evaluation

FIGURE 6-1 A Comprehensive Strategie-Management Model

Source: Fred R. David, adapted from “How Companies Define Their M ission” Long Range Planning 22. no. 3 (June 1988): 40, © Fred R. David.

Key Internal Forces It is not possible in a strategic-management text to review in depth all the material presented in courses such as marketing, finance, accounting, management, management information systems, and production and operations; there are m any subareas within these functions, such as customer service, warranties, advertising, packaging, and pricing under marketing. But strategic planning must include a detailed assessment of how the firm is doing in all internal areas.

For different types of organizations, such as hospitals, universities, and government agencies, the functional business areas, of course, differ. In a hospital, for example, functional areas may include cardiology, hematology, nursing, maintenance, physician support, and receivables. Functional areas of a university can include athletic programs, placement services, housing, fund-raising, academic research, counseling, and intramural programs. Within large organizations, each division has certain strengths and weaknesses.

A firm’s strengths that cannot be easily matched or imitated by competitors are called distinctive competencies. Building competitive advantages involves taking advantage of distinctive competencies. Strategies are designed in part to improve on a firm’s weaknesses, turning them into strengths—and maybe even into distinctive competencies.

190 CHAPTER 6 • THE INTERNAL AUDIT

Weaknesses => Slrenghts => Distinctive Competencies => Competitive Advantage

FIGURE 6-2 The Process of Gaining Competitive Advantage in a Firm

Figure 6-2 illustrates that ail firms should continually strive to improve on their weaknesses, turning them into strengths, and ultimately developing distinctive competencies that can provide the firm with competitive advantages over rival firms.

The Process of Performing an Internal Audit The process of performing an internal audit closely parallels the process of performing an external audit. Representative managers and employees from throughout the firm need to be involved in determining a firm’s strengths and weaknesses. The internal audit requires gathering and assimilating information about the firm’s management, marketing, finance and accounting, production and operations. R&D, and MIS operations. Key factors should be prioritized as described in Chapter 7 so that the firm's most important strengths and weaknesses can be determined collectively.

Compared to the external audit, the process of performing an internal audit provides more opportunity for participants to understand how their jobs, departments, and divisions fit into the whole organization. This is a great benefit because managers and employees perform better when they understand how their work affects other areas and activities of the firm. For example, when marketing and manufacturing managers jointly discuss issues related to internal strengths and weaknesses, they gain a better appreciation of the issues, problems, concerns, and needs of all the functional areas. In organizations that do not use strategic management, marketing, finance, and manufacturing managers often do not interact with each other in significant ways. Performing an internal audit thus is an excellent vehicle or forum for improving the process of communication in the organization. Communication may be the most important word in management.

Performing an internal audit requires gathering, assimilating, and evaluating information about the firm’s operations. Key internal factors, consisting of both strengths and weaknesses, can be identified and prioritized in the manner discussed in Chapter 7. According to William King, a task force of managers from different units of the organization, supported by staff, should be charged with determining the 20 most important strengths and weaknesses that should influence the future of the organization. He says:

The development of conclusions on the 20 most important organizational strengths and weaknesses can be, as any experienced manager knows, a difficult task, when it involves managers representing various organizational interests and points of view. Developing a 20-page list of strengths and weaknesses could be accomplished relatively easily, but a list of the 20 most important ones involves significant analysis and negotiation. This is true because of the judgments that are required and the impact which such a list will inevitably have as it is used in the formulation, implementation, and evaluation of strategies.1

Strategic management is a highly interactive process that requires effective coordination among management, marketing, finance and accounting, production and operations, R&D, and MIS managers. Although the strategic-management process is overseen by strategists, success requires that managers and employees from all functional areas work together to provide ideas and information. Financial managers, for example, may need to restrict the number of feasible options available to operations managers, or R&D managers may develop products for which marketing managers need to set higher objectives. A key to organizational success is effective coordination and understanding among managers from all functional business areas. Through involvement in performing an internal strategic-management audit, managers from different departments and divisions of the firm come to understand the nature and effect of decisions in other functional business areas in their firm. Knowledge of these relationships is critical for effectively establishing objectives and strategies.

CHAPTER 6 • THE INTERNAL AUDIT 191

A failure to recognize and understand relationships among the functional areas of business can be detrimental to strategic management, and the number of those relationships that must be managed increases dramatically with a firm's size, diversity, geographic dispersion, and the number of products or services offered. Governmental and nonprofit enterprises traditionally have not placed sufficient emphasis on relationships among the business functions. Some firms place too great an emphasis on one function at the expense of others. Ansoff explained:

During the first fifty years, successful firms focused their energies on optimizing the performance of one of the principal functions: production/operations, R&D, or marketing. Today, due to the growing complexity and dynamism of the environment, success increasingly depends on a judicious combination of several functional influences. This transition from a single function focus to a multifunction focus is essential for successful strategic management.-

Financial ratio analysis exemplifies the complexity of relationships among the functional areas of business. A declining return on investment or profit margin ratio could be the result of ineffective marketing, poo r management policies, R&D errors, or a weak MIS. The effectiveness of strategy formulation, implementation, and evaluation activities hinges on a clear understanding of how major business functions affect one another. For strategies to succeed, a coordinated effort among all the functional areas of business is needed. In the case of planning, George wrote:

We may conceptually separate planning for the purpose of theoretical discussion and analysis, but in practice, neither is it a distinct entity nor is it capable of being separated. The planning function is mixed with all other business functions and, like ink once mixed with water, it cannot be set apart. It is spread throughout and is a part of the whole of managing an organization/

The Resource-Based View Some researchers emphasize the importance of the internal audit part of the strategic-management process by comparing it to the external audit. Robert Grant concluded that the internal audit is more important, saying:

In a world where customer preferences are volatile, the identity of customers is changing, and the technologies for serving customer requirements are continually evolving, an externally focused orientation does not provide a secure foundation for formulating long-term strategy. When the external environment is in a state of flux, the firm’s own resources and capabilities may be a much more stable basis on which to define its identity. Hence, a definition of a business in terms of what it is capable of doing may offer a more durable basis for strategy.4

The resource-based view (RBV) approach to competitive advantage contends that internal resources are more important for a firm than external factors in achieving and sustaining competitive advantage. In contrast to the Industrial Organization (I/O) theory presented in Chapter 7, proponents of the RBV view contend that organizational performance will primarily be determined by internal resources that can be grouped into three all-encompassing catego­ ries: physical resources, human resources, and organizational resources.5 Physical resources include all plant and equipment, location, technology, raw materials, machines; human resources include all employees, training, experience, intelligence, knowledge, skills, abilities: and organizational resources include firm structure, planning processes, information systems, patents, trademarks, copyrights, databases, and so on. RBV theory asserts that resources are actually what helps a firm exploit opportunities and neutralize threats.

The basic premise of the RBV is that the mix, type, amount, and nature of a firm’s internal resources should be considered first and foremost in devising strategies that can lead to sustainable competitive advantage. Managing strategically according to the RBV involves developing and exploiting a firm’s unique resources and capabilities, and continually maintaining and strengthening those resources. The theory asserts that it is advantageous for a

192 CHAPTER 6 • THE INTERNAL AUDIT

firm to pursue a strategy that is not currently being implemented by any competing firm. When other firms are unable to duplicate a particular strategy, then the focal firm has a sustainable competitive advantage, according to RBV theorists.

For a resource to be valuable, it must be either (a) rare, (b) hard to imitate, or (c) not easily substitutable. Often called empirical indicators, these three characteristics of resources enable a firm to implement strategies that improve its efficiency and effectiveness and lead to a sustainable competitive advantage. The more a resource(s) is rare, nonimitable, and nonsubsti- tutable, the stronger a firm’s competitive advantage will be and the longer it will last.

Rare resources are resources that other competing firms do not possess. If many firms have the same resource, then those firms will likely implement similar strategies, thus giving no one firm a sustainable competitive advantage. This is not to say that resources that are common are not valuable; they do indeed aid the firm in its chance for economic prosperity. However, to sustain a competitive advantage, it is more advantageous if the resource(s) is also rare.

It is also important that these same resources be difficult to imitate. If firms cannot easily gain the resources, say RBV theorists, then those resources will lead to a competitive advantage more so than resources easily imitable. Even if a firm employs resources that are rare, a sustainable competitive advantage may be achieved only if other firms cannot easily obtain these resources.

The third empirical indicator that can make resources a source of competitive advantage is substitutability. Borrowing from Porter’s Five-Forces Model, to the degree that there are no viable substitutes, a firm will be able to sustain its competitive advantage. However, even if a competing firm cannot perfectly imitate a firm’s resource, it can still obtain a sustainable com­ petitive advantage of its own by obtaining resource substitutes.

RBV has continued to grow in popularity and continues to seek a better understanding of the relationship between resources and sustained competitive advantage in strategic management. However, as alluded to in Chapter 7, one cannot say with any degree of certainly that either external or internal factors will always or even consistently be more important in seeking competitive advantage. Understanding both external and internal factors, and more importantly, understanding the relationships among them, will be the key to effective strategy formulation (discussed in Chapter 8). Because both external and internal factors continually change, strategists seek to identify and take advantage of positive changes and buffer against negative changes in a continuing effort to gain and sustain a firm’s competitive advantage. This is the essence and chal­ lenge of strategic management, and oftentimes survival of the firm hinges on this work.

Integrating Strategy and Culture Relationships among a firm’s functional business activities perhaps can be exemplified best by focusing on organizational culture, an internal phenomenon that permeates all departments and divisions of an organization. Organizational culture can be defined as “a pattern of behavior that has been developed by an organization as it learns to cope with its problem of external adaptation and internal integration, and that has worked well enough to be considered valid and to be taught to new members as the correct way to perceive, think, and feel.”6 This definition emphasizes the importance of matching external with internal factors in making strategic decisions.

Organizational culture captures the subtle, elusive, and largely unconscious forces that shape a workplace. Remarkably resistant to change, culture can represent a major strength or weakness for the firm. It can be an underlying reason for strengths or weaknesses in any of the major business functions.

Defined in Table 6-1, cultural products include values, beliefs, rites, rituals, ceremonies, myths, stories, legends, sagas, language, metaphors, symbols, heroes, and heroines. These products or dimensions are levers that strategists can use to influence and direct strategy formulation, implementation, and evaluation activities. An organization’s culture compares to an individual’s personality in the sense that no two organizations have the same culture and no two individuals have the same personality. Both culture and personality arc enduring and can be warm, aggressive, friendly, open, innovative, conservative, liberal, harsh, or likable.

At Google, the culture is informal. Employees are encouraged to wander the halls on employee-sponsored scooters and brainstorm on public whiteboards provided everywhere. In contrast, the culture at Procter & Gamble (P&G) is so rigid that employees jokingly call

CHAPTER 6 • THE INTERNAL AUDIT 193

TA B LE 6-1 Example Cultural Products Defined

Legend

Ritual Myth

Saga

Story Folktale Symbol Language M e tap h o rs

Ceremonial

Values Belief Heroes/Heroines

Rites Planned sets o f activities that consolidate various forms of cultural expressions into one event. Several rites connected together. A standardized set of behaviors used to manage anxieties.

A narrative of imagined events, usually not supported by facts. A historical narrative describing the unique accomplishments of a group and its leaders. A handed-down narrative of some wonderful event, usually not supported by facts. A narrative usually based on true events. A fictional story. Any object, act, event, quality, or relation used to convey meaning. The manner in which members of a group communicate. Shorthand of words used to capture a vision or to reinforce old or new values. Life-directing attitudes that serve as behavioral guidelines. An understanding of a particular phenomenon. Individuals greatly respected.

Source: Based on H. M. Trice and J. M. Beyer, “Studying Organizational Cultures through Rites and Ceremonials," Academy o f Management Review 9, no. 4 (October 1984): 655.

themselves “Proctoids.” Despite this difference, the two companies are swapping employees and participating in each other’s staff training sessions. Why? Because P&G spends more money on advertising than any other company and Google desires more of P&G’s $8.7 billion in annual advertising expenses; P&G has come to realize that the next generation of laundry-detergent, toilet-paper, and skin-cream customers now spend more time online than watching TV.

Dimensions of organizational culture permeate all the functional areas of business. It is something of an art to uncover the basic values and beliefs that are deeply buried in an orga­ nization’s rich collection of stories, language, heroes, and rituals, but cultural products can represent both important strengths and weaknesses. Culture is an aspect of an organization that can no longer be taken for granted in performing an internal strategic-management audit because culture and strategy must work together.

Table 6-2 provides some example (possible) aspects of an organization’s culture. Note you could ask employees and managers to rate the degree that the dimension characterizes the firm. When one firm acquires another firm, integrating the two cultures can be important. For example, in Table 6-2, one firm may score mostly l ’s (low) and the other firm may score mostly 5’s (high), which would present a challenging strategic problem.

The strategic-management process takes place largely within a particular organization’s culture. Lorsch found that executives in successful companies are emotionally committed to the firm’s culture, but he concluded that culture can inhibit strategic management in two basic ways. First, managers frequently miss the significance of changing external conditions because they are blinded by strongly held beliefs. Second, when a particular culture has been effective in the past, the natural response is to stick with it in the future, even during times of major strategic change.7 An organization’s culture must support the collective commitment of its people to a common purpose. It must foster competence and enthusiasm among managers and employees.

Organizational culture significantly affects business decisions and thus must be evaluated during an internal strategic-management audit. If strategies can capitalize on cultural strengths, such as a strong work ethic or highly ethical beliefs, then management often can swiftly and easily implement changes. However, if the firm’s culture is not supportive, strategic changes may be ineffective or even counterproductive. A firm’s culture can become antagonistic to new strategies, with the result being confusion and disorientation.

194 CHAPTER 6 • THE INTERNAL AUDIT

TA BLE 6-2 Fifteen Example (Possible) Aspects of an Organization's Culture

Dimension Low Degree High

I. Strong work ethic: arrive early and leave late 1 2 3 4 5 2. High ethical beliefs; clear code of business ethics followed 1 2 3 4 5 3. Formal dress; shirt and tie expected 1 2 3 4 5 4. Informal dress; many casual dress days 1 2 3 4 5 5. Socialize together outside of work 1 2 3 4 5 6. Do not question supervisor’s decision 1 2 3 4 5 7. Encourage whistle-blowing 1 2 3 4 5 8. Be health conscious; have a wellness program I 2 3 4 5

9. Allow substantial “working from home" 1 2 3 4 5

10. Encourage creativity, innovation, and open-mindness 1 2 3 4 5

11. Support women and minorities; no glass ceiling 1 2 3 4 5

12. Be highly socially responsible; be philanthropic 1 2 3 4 5

13. Have numerous meetings 1 2 3 4 5

14. Have a participative management style 1 2 3 4 5

15. Preserve the natural environment: have a sustainability program 1 2 3 4 5

An organization’s culture should infuse individuals with enthusiasm for implementing strategies. Allarie and Firsirotu emphasized the need to understand culture:

Culture provides an explanation for the insuperable difficulties a firm encounters when it attempts to shift its strategic direction. Not only has the “right” culture become the essence and foundation of corporate excellence, it is also claimed that success or failure of reforms hinges on management’s sagacity and ability to change the firm's driving culture in time and in time with required changes in strategies.8

The potential value of organizational culture has not been realized fully in the study of strategic management. Ignoring the effect that culture can have on relationships among the functional areas of business can result in barriers to communication, lack of coordination, and an inability to adapt to changing conditions. Some tension between culture and a firm’s strategy is inevitable, but the tension should be monitored so that it does not reach a point at which relationships are severed and the culture becomes antagonistic. The resulting disarray among members of the organization would disrupt strategy formulation, implementation, and evalua­ tion. In contrast, a supportive organizational culture can make managing much easier.

Internal strengths and weaknesses associated with a firm’s culture sometimes are over­ looked because of the interfunctional nature of this phenomenon. It is important, therefore, for strategists to understand their firm as a sociocultural system. Success is often determined by linkages between a firm's culture and strategies. The challenge of strategic management today is to bring about the changes in organizational culture and individual mind-sets that are needed to support the formulation, implementation, and evaluation of strategies.

Management The functions of management consist of five basic activities: planning, organizing, motivating, staffing, and controlling. An overview of these activities is provided in Table 6-3. These activities are important to assess in strategic planning because an organization should continually capitalize on its management strengths and improve on its management weak areas.

Planning The only thing certain about the future of any organization is change, and planning is the essential bridge between the present and the future that increases the likelihood of achieving desired results. Planning is the process by which one determines whether to attempt a task, works out the most effective way of reaching desired objectives, and prepares to overcome

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TA B LE 6-3 The Basic Functions of Management

Function Description Stage of Strategie-Management Process When Most Important

Planning Planning consists of all those managerial activities related to preparing for the future. Specific tasks include forecasting, establishing objectives, devising strategies, developing policies, and setting goals.

Strategy Formulation

Organizing Organizing includes all those managerial activities that result in a structure of task and authority relationships. Specific areas include organizational design, job specialization, job descriptions, job specifications, span of control, unity o f command, coordination, job design, and job analysis.

Strategy Implementation

Motivating Motivating involves efforts directed toward shaping human behavior. Specific topics include leadership, communication, work groups, behavior modification, delegation of authority, job enrichment, job satisfaction, needs fulfillment, organizational change, employee morale, and managerial morale.

Strategy Implementation

Staffing Staffing activities are centered on personnel or human resource management. Included are wage and salary administration, employee benefits, interviewing, hiring, firing, training, management development, employee safety, affirmative action, equal employment opportunity, union relations, career development, personnel research, discipline policies, grievance procedures, and public relations.

Strategy Implementation

Controlling Controlling refers to all those managerial activities directed toward ensuring that actual results are consistent with planned results. Key areas of concern include quality control, financial control, sales control, inventory control, expense control, analysis of variances, rewards, and sanctions.

Strategy Evaluation

unexpected difficulties with adequate resources. Planning is the stari of the process by which an individual or business may turn empty dreams into achievements. Planning enables one to avoid the trap of working extremely hard but achieving little.

Planning is an up-front investment in success. Planning helps a firm achieve maximum effect from a given effort. Planning enables a firm to take into account relevant factors and focus on the critical ones. Planning helps ensure that the firm can be prepared for all reasonable even­ tualities and for all changes that will be needed. Planning enables a firm to gather the resources needed and carry out tasks in the most efficient way possible. Planning enables a firm to con­ serve its own resources, avoid wasting ecological resources, make a fair profit, and be seen as an effective, useful firm. Planning enables a firm to identify precisely what is to be achieved and to detail precisely the who, what, when, where, why, and how needed to achieve desired objectives. Planning enables a firm to assess whether the effort, costs, and implications associated with achieving desired objectives are warranted.9 Planning is the cornerstone of effective strategy formulation. But even though it is considered the foundation of management, it is commonly the task that managers neglect most. Planning is essential for successful strategy implementa­ tion and strategy evaluation, largely because organizing, motivating, staffing, and controlling activities depend on good planning.

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The process of planning must involve managers and employees throughout an organization. The time horizon for planning decreases from two to live years for top-level to less than six months for lower-level managers. The important point is that all managers do planning and should involve subordinates in the process to facilitate employee understanding and commitment.

Planning can have a positive impact on organizational and individual performance. Planning allows an organization to identify and take advantage of external opportunities as well as minimize the impact of external threats. Planning is more than extrapolating from the past and present into the future (long-range planning). It also includes developing a mission, forecasting future events and trends, establishing objectives, and choosing strategies to pursue (strategic planning).

An organization can develop synergy through planning. Synergy exists when everyone pulls together as a team that knows what it wants to achieve; synergy is the 2 + 2 = 5 effect. By establishing and communicating clear objectives, employees and managers can work together toward desired results. Synergy can result in powerful competitive advantages. The strategic- management process itself is aimed at creating synergy in an organization.

Planning allows a firm to adapt to changing markets and thus to shape its own destiny. Strategic management can be viewed as a formal planning process that allows an organization to pursue proactive rather than reactive strategies. Successful organizations strive to control their own futures rather than merely react to external forces and events as they occur. Historically, organisms and organizations that have not adapted to changing conditions have become extinct. Swift adaptation is needed today more than ever because changes in markets, economies, and competitors worldwide are accelerating. Many firms did not adapt to the global recession of late and went out of business.

Organizing The purpose of organizing is to achieve coordinated effort by defining task and authority relationships. Organizing means determining who does what and who reports to whom. There are countless examples in history of we 11-organized enterprises successfully competing against— and in some cases defeating—much stronger but less-organized firms. A we 11-organized firm generally has motivated managers and employees who are committed to seeing the organization succeed. Resources are allocated more effectively and used more efficiently in a well-organized firm than in a disorganized firm.

The organizing function of management can be viewed as consisting of three sequential activities: breaking down tasks into jobs (work specialization), combining jobs to form departments (departmentalization), and delegating authority. Breaking down tasks into jobs requires the development of job descriptions and job specifications. These tools clarify for both managers and employees what particular jobs entail. In The Wealth o f Nations, published in 1776. Adam Smith cited the advantages of work specialization in the manufacture of pins:

One man draws the wire, another straightens it. a third cuts it, a fourth points it. a fifth grinds it at the top for receiving the head. Ten men working in this manner can produce 48.000 pins in a single day. but if they had all wrought separately and independently, each might at best produce twenty pins in a day.111

Combining jobs to form departments results in an organizational structure, span of control, and a chain of command. Changes in strategy often require changes in structure because positions may be created, deleted, or merged. Organizational structure dictates how resources are allocated and how objectives are established in a firm. Allocating resources and establishing objectives geographically, for example, is much different from doing so by product or customer.

The most common forms of departmentalization are functional, divisional, strategic business unit, and matrix. These types of structure are discussed further in Chapter 10.

Delegating authority is an important organizing activity, as evidenced in the old saying “You can tell how good a manager is by observing how his or her department functions when he or she isn't there.” Employees today are more educated and more capable of participating in organizational decision making than ever before. In most cases, they expect to be delegated authority and responsibility and to be held accountable for results. Delegation of authority is embedded in the strategic-management process.

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Motivating Motivating can be defined as the process of influencing people to accomplish specific objectives." Motivation explains why some people work hard and others do not. Objectives, strategies, and policies have little chance of succeeding if employees and managers are not motivated to implement strategies once they are formulated. The motivating function of management includes at least four major components: leadership, group dynamics, communication, and organizational change.

When managers and employees of a firm strive to achieve high levels of productivity, this indicates that the firm’s strategists are good leaders. Good leaders establish rapport with subordi­ nates, empathize with their needs and concerns, set a good example, and are trustworthy and fair. Leadership includes developing a vision of the firm’s future and inspiring people to work hard to achieve that vision. Kirkpatrick and Locke reported that certain traits also characterize effective leaders: knowledge of the business, cognitive ability, self-confidence, honesty, integrity, and drive. l_Sun Tzu said: ''Weak leadership can wreck the soundest strategy.”

Research suggests that democratic behavior on the part of leaders results in more positive attitudes toward change and higher productivity than does autocratic behavior. Drucker said:

Leadership is not a magnetic personality. That can just as well be demagoguery. It is not “making friends and influencing people.” That is flatter}-. Leadership is the lifting of a person’s vision to higher sights, the raising of a person's performance to a higher standard, the building of a person’s personality beyond its normal limitations.1 '

Group dynamics play a major role in employee morale and satisfaction. Informal groups or coalitions form in every organization. The norms of coalitions can range from being positive to negative toward management. It is important, therefore, that strategists identify the composition and nature of informal groups in an organization to facilitate strategy formulation, implementa­ tion. and evaluation. Leaders of informal groups are especially important in formulating and implementing strategy changes.

Communication, perhaps the most important word in management, is a major component in motivation. An organization’s system of communication determines whether strategies can be implemented successfully. Good two-way communication is vital for gaining support for departmental and divisional objectives and policies. Top-down communication can encourage bottom-up communication. The strategic-management process becomes a lot easier when subordinates are encouraged to discuss their concerns, reveal their problems, provide recommendations, and give suggestions. A primary reason for instituting strategic management is to build and support effective communication networks throughout the firm.

The manager of tomorrow must be able to get his people to commit themselves to the business, whether they are machine operators or junior vice-presidents. The key issue will be empowerment, a term whose strength suggests the need to get beyond merely sharing a little information and a bit of decision making.14

Staffing The management function of staffing, also called personnel management or human resource management, includes activities such as recruiting, interviewing, testing, selecting, orienting, training, developing, caring for. evaluating, rewarding, disciplining, promoting, transferring, demoting, and dismissing employees, as well as managing union relations.

Staffing activities play a major role in strategy-implementation efforts, and for this reason, human resource managers are becoming more actively involved in the strategic-management process. It is important to identify strengths and weaknesses in the staffing area.

The complexity and importance of human resource activities have increased to such a degree that all but the smallest organizations now need a full-time human resource manager. Numerous court cases that directly affect staffing activities are decided each day. Organizations and indi­ viduals can be penalized severely for not following federal, state, and local laws and guidelines related to staffing. Line managers simply cannot stay abreast of all the legal developments and requirements regarding staffing. The human resources department coordinates staffing decisions in the firm so that an organization as a whole meets legal requirements. This department also

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provides needed consistency in administering company rules, wages, policies, and employee benefits as well as collective bargaining with unions.

Human resource management is particularly challenging for international companies. For example, the inability of spouses and children to adapt to new surroundings can be a staffing problem in overseas transfers. The problems include premature returns, job performance slumps, resignations, discharges, low morale, marital discord, and general discontent. Firms such as Ford Motor and ExxonMobil screen and interview spouses and children before assigning persons to overseas positions. 3M Corporation introduces children to peers in the target country and offers spouses educational benefits.

Controlling The controlling function of management includes all of those activities undertaken to ensure that actual operations conform to planned operations. All managers in an organization have controlling responsibilities, such as conducting performance evaluations and taking necessary action to minimize inefficiencies. The controlling function of management is particularly important for effective strategy evaluation. Controlling consists of four basic steps:

1. Establishing performance standards 2. Measuring individual and organizational performance 3. Comparing actual performance to planned performance standards 4. Taking corrective actions

Measuring individual performance is often conducted ineffectively or not at all in organi­ zations. Some reasons for this shortcoming are that evaluations can create confrontations that most managers prefer to avoid, can take more time than most managers are willing to give, and can require skills that many managers lack. No single approach to measuring individual perfor­ mance is without limitations. For this reason, an organization should examine various methods, such as the graphic rating scale, the behaviorally anchored rating scale, and the critical incident method, and then develop or select a performance-appraisal approach that best suits the firm’s needs. Increasingly, firms are striving to link organizational performance with managers’ and employees’ pay. This topic is discussed further in Chapter 10.

Management Audit Checklist of Questions The following checklist of questions can help determine specific strengths and weaknesses in the functional area of business. An answer of no to any question could indicate a potential weakness, although the strategic significance and implications of negative answers, of course, will vary by organization, industry, and severity of the weakness. Positive or yes answers to the checklist questions suggest potential areas of strength.

1. Does the firm use strategic-management concepts? 2. Are company objectives and goals measurable and well communicated ? 3. Do managers at all hierarchical levels plan effectively? 4. Do managers delegate authority well? 5. Is the organization’s structure appropriate? 6. Are job descriptions and job specifications clear? 7. Is employee morale high? 8. Are employee turnover and absenteeism low? 9. Are organizational reward and control mechanisms effective?

Marketing Marketing can be described as the process of defining, anticipating, creating, and fulfilling customers’ needs and wants for products and services. There are seven basic functions of marketing: (1) customer analysis, (2) selling products and services, (3) product and service planning, (4) pricing, (5) distribution, (6) marketing research, and (7) opportunity analysis.I;> Understanding these functions helps strategists identify and evaluate marketing strengths and weaknesses.

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Customer Analysis Customer analysis—the examination and evaluation of consumer needs, desires, and wants— involves administering customer surveys, analyzing consumer information, evaluating market positioning strategies, developing customer profiles, and determining optimal market segmentation strategies. The information generated by customer analysis can be essential in developing an effective mission statement. Customer profiles can reveal the demographic characteristics of an organization's customers. Buyers, sellers, distributors, salespeople, managers, wholesalers, retailers, suppliers, and creditors can all participate in gathering information to successfully identify customers’ needs and wants. Successful organizations continually monitor present and potential customers’ buying patterns.

Selling Products and Services Successful strategy implementation generally rests on the ability of an organization to sell some product or service. Selling includes many marketing activities, such as advertising, sales promotion, publicity, personal selling, sales force management, customer relations, and dealer relations. These activities are especially critical when a firm pursues a market penetration strategy. The effectiveness of various selling tools for consumer and industrial products varies. Personal selling is most important for industrial goods companies, whereas advertising is most important for consumer goods companies.

For example, the J.M. Smucker Company has $5.5 and 4.8 billion in revenue in 2012 and 2011. respectively, and spent S119 and $ 115 million in advertising during those two years, comprising 2 .1 and 2.4 percent of revenues, respectively. About 3 percent of revenues is normal for companies to spend on advertising although this can vary across industries. J.M. Smucker has a product portfolio that includes coffee, peanut butter, fruit spreads, jams, shortening and oils, baking mixes, canned milk. Hour, syrups, pickles, and more. One aspect of ads recently is that they generally take more direct aim at competitors, and this marketing practice is holding true in our bad economic times. Nick Brien at Mediabrands says, “Ads have to get combative in bad times. It’s a dog fight, and it’s about getting leaner and meaner.” Ads are less lavish and glamorous today and are also more interactive. Table 6-4 lists specific characteristics of ads in response to the economic hard times many people nationwide and worldwide are facing.

Marketers spent about S3 million per 30-second advertising spot during the 2012 Super Bowl. Advertising can be expensive, and that is why marketing is a major business function to be studied carefully. Without marketing, even the best products and services have little chance of being successful.

Chief marketing officers (CMOs) such as Eduardo Conrado at Motorola now spend more than 50 percent of their budget on technology to manage activities like online marketing and social media.16 Marketing is becoming technical w'ith software to track and target customers and manage customer relationships, predict consumer behavior, run online storefronts, analyze social media, manage websites, and craft targeted advertisements. IBM in response to this trend is shifting its attention from CIOs to CMOs as their primary clients.

TA B LE 6-4 Desirable Characteristics of Ads Today

1. Take direct aim at competitors: so leaner, meaner, and to the point.

2. Be less lavish and glamorous, requiring less production dollars to develop. 3. Be short and sweet, mostly 10- and 15-second ads rather than longer than 30 seconds. 4. “Make you feel good" or “put you in a good mood” because (a) ads can be more easily avoided

than ever and (b) people are experiencing hard times and seek comfort. 5. Be more pervasive such as on buses, elevators, cell phones, and trucks. 6. Appear less on websites as banner ads become the new junk mail. 7. Red will overtake ihe color orange as the most popular ad color. 8. More than ever emphasize low price and value versus rivals. 9. More than ever emphasize how the product or service will make your life better.

Source: Based on Suzanne Vranica. “Ads to Go Leaner, Meaner in ’09." Wall Street Journal, January 5, 2009. B8.

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The world’s largest social network, Facebook may epitomize where the advertising industry is going. Facebook allows a company to “leverage the loyalty” of its best customers. If you have recently gotten engaged and updated your Facebook status, you may start seeing ads from local jewelers who have used Facebook’s automated ad system to target you. Facebook enables any firm today to effectively target their exact audience with perfect advertising.17 In performing a strategic planning analysis, in addition to comparing rival firms’ websites, it is important to compare rival firms’ Facebook page.

One of the last off-limit advertising outlets has historically been books, but with the proliferation of e-books, marketers are experimenting more and more with advertising to consumers as they read e-books. New ads are being targeted based on the book’s content and the demographic profile of the reader. Digital e-book companies such as Wowio and Amazon are trying to insert ads between chapters and along borders of digital pages. Random House says its e-books will soon include ads, but only with author approval.

Determining organizational strengths and weaknesses in the selling function of marketing is an important part of performing an internal strategic-management audit. With regard to advertising products and services on the Internet, a new trend is to base advertising rates exclusively on sales rates. This new accountability contrasts sharply with traditional broadcast and print advertising, which bases rates on the number of persons expected to see a given adver­ tisement. The new cost-per-sale online advertising rates are possible because any website can monitor which user clicks on which advertisement and then can record whether that consumer actually buys the product. If there are no sales, then the advertisement is free.

Product and Service Planning Product and service planning includes activities such as test marketing; product and brand positioning; devising warranties; packaging: determining product options, features, style, and quality; deleting old products: and providing for customer service. Product and service planning is particularly important when a company is pursuing product development or diversification.

One of the most effective product and service planning techniques is test marketing. Test markets allow an organization to test alternative marketing plans and to forecast future sales of new products. In conducting a test market project, an organization must decide how many cities to include, which cities to include, how long to run the test, what information to collect during the test, and what action to take after the test has been completed. Test marketing is used more frequently by consumer goods companies than by industrial goods companies. Test marketing can allow an organization to avoid substantial losses by revealing weak products and ineffective marketing approaches before large-scale production begins.

After extensive test marketing, the chocolate maker Hershey recently launched its first candy in China, a condensed milk candy. The company also opened a new Shanghai-based Asia Innovation Center to test market many potential premium milk type chocolate candies in vari­ ous Asian countries. Hershey increased its number of stores in China by 32 percent and its sales force by 60 percent in 2013.

Pricing In late 2012, J.C. Penney abandoned its month-long specials that cut prices of select items by 20 to 29 percent, and instead implemented permanent price cuts on a large amount of merchandise in their stores. Penney’s pricing strategy gave consumers two options: everyday low prices and clearance sales on certain items. Penney’s price change strategy came as the company’s stock price had dropped 40 percent in recent months. To support the new pricing strategy, Penney’s began offering free haircuts every Sunday for children aged 5 to 12. Free is a good price and this program exists in 949 of Penney’s 1,100 stores totaling about I million haircuts per month. “It definitely drove new people and reintroduced J.C. Penney to existing customers who didn't know about the latest changes,” said Jan Hodges, senior vice president of Penney’s salon services. But in an about-face after losses, Penney’s fired CEO Ron Johnson, brought back his predecessor Myron “Mike” Ullman, and began a “we’re listening” campaign on Facebook to woo customers back into the stores.

Five major stakeholders affect pricing decisions: consumers, governments, suppliers, distributors, and competitors. Sometimes an organization will pursue a forward integration strategy primarily to gain better control over prices charged to consumers. Governments can

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impose constraints on price fixing, price discrimination, minimum prices, unit pricing, price advertising, and price controls. For example, the Robinson-Patman Act prohibits manufacturers and wholesalers from discriminating in price among channel member purchasers (suppliers and distributors) if competition is injured.

Competing organizations must be careful not to coordinate discounts, credit terms, or condition of sale; not to discuss prices, markups, and costs at trade association meetings; and not to arrange to issue new price lists on the same date, to rotate low bids on contracts, or to uniformly restrict production to maintain high prices. Strategists should view price from both a short-run and a long-run perspective because competitors can copy price changes with relative ease. Often a dominant firm will aggressively match all price cuts by competitors.

With regard to pricing, as the value of the dollar increases, U.S. multinational companies have a choice. They can raise prices in the local currency of a foreign country or risk losing sales and market share. Alternatively, multinational firms can keep prices steady and face reduced profit when their export revenue is reported in the United States in dollars.

Intense price competition, coupled with Internet price-comparative shopping, has reduced profit margins to bare minimum levels for most companies. For example, when Toys ‘R’ Us introduced its first tablet for kids (the Tabeo) in late 2012 for $149.99, the company's three main competitors instantly reduced their tablet for kids: the Kurlo 7 by Techno Source, the Lexibook by Lexibook Ltd., and the Meep by Oregon Scientific. To help combat Internet comparative shopping, the Tabeo is available only at Toys R’ Us stores.

Nike raised its shoe and clothing prices by 5 to 10 percent in late 2012 when the company introduced its new LeBron James basketball shoe that sells for $315. That shoe features embedded motion sensors that can measure how high players jump. Even the price of Nike’s venerable Converse All-Star sneaker increased to just slightly more than $50. Nike faces rising labor costs in China, where it m anufactu res a third of its products.

Target Corp. recently joined Best Buy in offering to match online prices of rival retailers. Both companies are seeking to combat “showrooming” by shoppers who check out products in their stores but buy them on rival’s websites. Both Target and Best Buy are matching prices from Amazon.com and Walmart.com and Toysrus.com.

Distribution Distribution includes warehousing, distribution channels, distribution coverage, retail site locations, sales territories, inventory levels and location, transportation carriers, wholesaling, and retailing. Most producers today do not sell their goods directly to consumers. Various marketing entities act as intermediaries; they bear a variety of names such as wholesalers, retailers, brokers, facilitators, agents, vendors—or simply distributors.

Distribution becomes especially important when a firm is striving to implement a market development or forward integration strategy. Some of the most complex and challenging decisions facing a firm concern product distribution. Intermediaries flourish in our economy because many producers lack the financial resources and expertise to carry out direct marketing. Manufacturers who could afford to sell directly to the public often can gain greater returns by expanding and improving their manufacturing operations.

Successful organizations identify and evaluate alternative ways to reach their ultimate market. Possible approaches vary from direct selling to using just one or many wholesalers and retailers. Strengths and weaknesses of each channel alternative should be determined according to economic, control, and adaptive criteria. Organizations should consider the costs and benefits of various wholesaling and retailing options. They must consider the need to motivate and control channel members and the need to adapt to changes in the future. Once a marketing channel is chosen, an organization usually must adhere to it for an extended period of time.

Marketing Research Marketing research is the systematic gathering, recording, and analyzing of data about problems relating to the marketing of goods and services. Marketing research can uncover critical strengths and weaknesses, and marketing researchers employ numerous scales, instruments, procedures, con­ cepts, and techniques to gather information. Marketing research activities support all of the major business functions of an organization. Organizations that possess excellent marketing research skills have a definite strength in pursuing generic strategies. The president of PepsiCo said.

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Looking at the competition is the company’s best form of market research. The majority of our strategic successes are ideas that we borrow from the marketplace, usually from a small regional or local competitor. In each case, we spot a promising new idea, improve on it, and then out-execute our competitor.18

Cost/Benefit Analysis The seventh function of marketing is cost/benefit analysis, which involves assessing the costs, benefits, and risks associated with marketing decisions. Three steps are required to perform a cost/benefit analysis: (1) compute the total costs associated with a decision, (2) estimate the total benefits from the decision, and (3) compare the total costs with the total benefits. When expected benefits exceed total costs, an opportunity becomes more attractive. Sometimes the variables included in a cost/benefit analysis cannot be quantified or even measured, but usually reasonable estimates can be made to allow the analysis to be performed. One key factor to be considered is risk. Cost/benefit analysis should also be performed when a company is evaluating alternative ways to be socially responsible.

The practice of cost/benefit analysis differs among countries and industries. Some of the main differences include the types of impacts that are included as costs and benefits within appraisals, the extent to which impacts are expressed in monetary terms, and differences in the discount rate. Government agencies across the world rely on a basic set of key cost/benefit indi­ cators, including the following:

1. net present value (NPV) 2. present value of benefits (PVB) 3. present value of costs (PVC) 4. benefit cost ratio (BCR) = PVB / PVC 5. Net benefit = PVB - PVC 6. NPV/k (where k is the level of funds available)19

Marketing Audit Checklist of Questions The following questions about marketing must be examined in strategic planning:

1. Are markets segmented effectively? 2. Is the organization positioned well among competitors? 3. Has the firm’s market share been increasing? 4. Are present channels of distribution reliable and cost effective? 5. Does the firm have an effective sales organization? 6. Does the firm conduct market research? 7. Are product quality and customer service good? 8. Are the firm’s products and services priced appropriately? 9. Does the firm have an effective promotion, advertising, and publicity strategy?

10. Are marketing, planning, and budgeting effective? 11. Do the firm’s marketing managers have adequate experience and training? 12. Is the firm’s Internet presence excellent as compared to rivals?

Finance and Accounting Financial condition is often considered the single best measure of a firm’s competitive position and overall attractiveness to investors. Determining an organization’s financial strengths and weak­ nesses is essential to effectively formulating strategies. A firm’s liquidity, leverage, working capital, profitability, asset utilization, cash flow, and equity can eliminate some strategies as being feasible alternatives. Financial factors often alter existing strategies and change implementation plans.

Especially good websites from which to obtain financial information about firms are provided in Table 6-5.

Finance and Accounting Functions According to James Van Home, the functions of finance/accounting comprise three decisions: the investment decision, the financing decision, and the dividend decision.20 Financial ratio anal­ ysis is the most widely used method for determining an organization's strengths and weaknesses

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TA B LE 6-5 Excellent Websites to Obtain Information on Companies, Including Financial Ratios

1. www.money.msn.com 2. http://linance.yahoo.com 3. www.morningstar.com 4. www.hoovers.com 5. http://globaledge.msu.edu/industries/

in the investment, financing, and dividend areas. Because the functional areas of business are so closely related, financial ratios can signal strengths or weaknesses in management, marketing, production, R&D, and MIS activities. Financial ratios are equally applicable in for-profit and nonprofit organizations. Even though nonprofit organizations obviously would not have return- on-investment or earnings-per-share ratios, they would routinely monitor many other special ratios. For example, a church would monitor the ratio of dollar contributions to number of members, whereas a zoo would monitor dollar food sales to number of visitors. A university would monitor number of students divided by number of professors. Therefore, be creative when performing ratio analysis for nonprofit organizations because they strive to be financially sound just as for-profit firms do. Nonprofit organizations need strategic planning just as much as for- profit firms.

The investment decision, also called capital budgeting, is the allocation and reallocation of capital and resources to projects, products, assets, and divisions of an organization. Once strategies are formulated, capital budgeting decisions are required to successfully implement strategies. The financing decision determines the best capital structure for the firm and includes examining various methods by which the firm can raise capital (for example, by issuing stock, increasing debt, selling assets, or using a combination of these approaches). The financing decision must consider both short-term and long-term needs for working capital. Two key financial ratios that indicate whether a firm’s financing decisions have been effective are the debt-to-equity ratio and the debt-to-total-assets ratio.

Dividend decisions concern issues such as the percentage of earnings paid to stockholders, the stability of dividends paid over time, and the repurchase or issuance of stock. Dividend decisions determine the amount of funds that are retained in a firm compared to the amount paid out to stockholders. Three financial ratios that are helpful in evaluating a firm’s dividend decisions are the earnings-per-share ratio, the dividends-per-share ratio, and the price-earnings ratio. The benefits of paying dividends to investors must be balanced against the benefits of internally retaining funds, and there is no set formula on how to balance this trade-off. For the reasons listed here, dividends are sometimes paid out even when funds could be better reinvested in the business or when the firm has to obtain outside sources of capital:

1. Faying cash dividends is customary. Failure to do so could be thought of as a stigma. A dividend change is considered a signal about the future.

2. Dividends represent a sales point for investment bankers. Some institutional investors can buy only dividend-paying stocks.

3. Shareholders often demand dividends, even in companies with great opportunities for reinvesting all available funds.

4. A myth exists that paying dividends will result in a higher stock price.

In the second quarter of 2012 alone, 505 U.S. companies boosted their dividends, after 677 firms boosted their dividends in the first quarter. In fact, 70 percent of the stocks in the S&P 500 raised their dividend in 2012. S&P companies are on average today paying out 31 percent of their earnings in the form of dividends, but that is down from 52 percent of earnings in some years."'For calendar 2013, companies in the S&P 500 are expected to pay at least S300 billion in dividends, topping 2012’s $282 billion. Companies are also buying back their own stock (called Treasury stock) at record levels.

Unlike most firms. RadioShack Corp. recently suspended its 12.5 cents-a-share quarterly dividend, saving $50 million annually to avoid a liquidity crunch as the company seeks to lower its debt. The 91-year-old company has 4,700 stores in towns and cities across the United States

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and Mexico, but RadioShack is struggling to compete with online-only rivals such as Amazon because customers increasingly order electronics online.

Based in London. BP PLC recently boosted its quarterly dividend 13 percent to $0.09 a share. BP's board, in announcing the increase, said the company has a bright future with its recent $26.8 billion cash-and-shares deal to acquire a 20 percent stake in Russia’s state-con­ trolled OAO Rosneft. Despite not yet settling lawsuits related to the Gulf of Mexico Deepwater Horizons oil spill. BP posted a net profit for the three months ended September, 30. 2012. of $5.43 billion, up from $5.04 billion the prior year.

Costco in late 2012 borrowed $3.5 billion just to pay its shareholders a $7 dividend per share, totaling $3 billion. The dividend payout, without the borrowing, would have depleted Costco's cash account. Many companies near the end of 2012 paid “special” dividends, 175 in November 2012 alone or firms paid dividends early, to avoid the expected 2013 substantial increase in taxes on dividends.

Basic Types of Financial Ratios Financial ratios are computed from an organization's income statement and balance sheet. Computing financial ratios is like taking a picture because the results reflect a situation at just one point in time. Comparing ratios over time and to industry averages is more likely to result in meaningful statistics that can be used to identify and evaluate strengths and weaknesses. Trend analysis, illustrated in Figure 6-3, is a useful technique that incorporates both the time and industry average dimensions of financial ratios. Note that the dotted lines reveal projected ratios. Some websites, such as those provided in Table 6-5. calculate financial ratios and provide data with charts.

Tabic 6-6 provides a summary of key financial ratios showing how each ratio is calculated and what each ratio measures. However, all the ratios are not significant for all industries and companies. For example, accounts receivable turnover and average collection period are not meaningful to a company that primarily does a cash receipts business. Key financial ratios can be classified into the following five types:

Current ratio

Profit margin (percent) 10%

Company

2011 2012

FIGURE 6-3 A Financial Ratio Trend Analysis

2013 2014 2015

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1. Liquidity ratios measure a firm’s ability to meet maturing short-term obligations.

Current ratio Quick (or acid-test) ratio

2. Leverage ratios measure the extent to which a firm has been financed by debt.

Debt-to-total-assets ratio Debt-to-equity ratio Long-term debt-to-equity ratio Times-interest-earned (or coverage) ratio

3. Activity ratios measure how effectively a firm is using its resources.

Inventory turnover Fixed assets turnover Total assets turnover Accounts receivable turnover Average collection period

4. Profitability ratios measure management’s overall effectiveness as shown by the returns generated on sales and investment.

Gross profit margin Operating profit margin Net profit margin Return on total assets (ROA) Return on stockholders' equity (ROE) Earnings per share (EPS) Price-carnings ratio

5. Growth ratios measure the firm's ability to maintain its economic position in the growth of the economy and industry.

Sales Net income Earnings per share Dividends per share

Financial ratio analysis must go beyond the actual calculation and interpretation of ratios. The analysis should be conducted on three separate fronts:

1. How has each ratio changed over time? This information provides a means of evaluating historical trends. It is important to note whether each ratio has been historically increasing, decreasing, or nearly constant. For example, a 10 percent profit margin could be bad if the trend has been down 20 percent each of the last three years. But a 10 percent profit margin could be excellent if the trend has been up. up. up. Therefore, calculate the percentage change in each ratio from one year to the next to assess historical financial performance on that dimension. Identify and examine large percent changes in a financial ratio from one year to the next.

2. How does each ratio compare to industry norms? A firm’s inventory turnover ratio may appear impressive at first glance but may pale when compared to industry standards or norms. Industries can differ dramatically on certain ratios. For example grocery companies, such as Kroger, have a high inventory turnover whereas automobile dealerships have a lower turnover. Therefore, comparison of a firm’s ratios within its particular industry can be essential in determining strength and weakness.

206 CHAPTER 6 • THE INTERNAL AUDIT

TA BLE 6-6 A Summary of Key Financial Ratios

Ratio How Calculated What It Measures

Liquidity Ratios

Current Ratio Current assets The extent to which a firm can meet its Current liabilities short-term obligations

Quick Ratio Current assets minus inventory The extent to which a firm can meet its

Leverage Ratios

Current liabilities short-term obligations without relying on the sale of its inventories

Debt-to-Total-Assets Ratio Total debt The percentage of total funds that are provided Total assets by creditors

Debt-to-Equity Total debt The percentage of total funds provided by Ratio Total stackholders’ equity creditors versus by owners

Long-Term Dcbt-to-Equity Long-term debt The balance between debt and equity in a Ratio Total stackholdcrs’ equity firm's long-term capital structure

Times-Interest-Eamed Ratio Profits before interest and taxes The extent to which earnings can decline

Activity Ratios

Total interest charges without the firm becoming unable to meet its annual interest costs

Inventory Turnover Sales Whether a firm holds excessive stocks of Inventory of finished goods inventories and whether a firm is slowly

selling its inventories compared to the industry average

Fixed Assets Turnover Sales Sales productivity and plant and equipment Fixed assets utilization

Total Assets Turnover Sales Whether a firm is generating a sufficient Total assets volume of business for the size of its asset

investment Accounts Receivable Turnover Annual credit sales The average length of time it takes a firm to

Accounts receivable collect credit sales (in percentage terms)

Average Collection Period Accounts receivable The average length of time it takes a firm to

Profitability Ratios Total credit sales/365 days collect on credit sales (in days)

Gross Profit Margin Sales minus cost of goods sold The total margin available to cover operating Sales expenses and yield a profit

Operating Profit Margin Earnings before interest and taxes EBIT Profitability without concern for taxes anti Sales interest

Net Profit Margin Net income Sales

After-tax profits per dollar of sales

Return on Total Assets (ROA) Net income After-tax profits per dollar of assets; this ratio Total assets is also called return on investment (ROI)

Return on Stockholders' Equity (ROE) After-tax profits per dollar of stockholders’ investment in the firm

Earnings Per Share (EPS) Net income Earnings available to the owners of common Number of shares of common stock outstanding stock

Price-Earnings Ratio

Growth Ratios

Market price per share Earnings per share

Attractiveness of firm on equity markets

Sales Annual percentage growth in total sales Firm’s growth rate in sales

Net Income Annual percentage growth in profits Firm's growth rate in profits

Earnings Per Share Annual percentage growth in EPS Firm’s growth rate in EPS

Dividends Per Share Annual percentage growth in dividends per share Firm’s growth rate in dividends per share

CHAPTER 6 • THE INTERNAL AUDIT 207

3. How does each ratio compare with key competitors? Oftentimes competition is more intense between several competitors in a given industry or location than across all rival firms in the industry. When this is true, financial ratio analysis should include comparison to those key competitors. For example, if a firm’s profitability ratio is trending up over time and compares favorably to the industry average, but it is trending down relative to its leading competitor, there may be reason for concern.

Financial ratio analysis is not without some limitations. First of all, financial ratios are based on accounting data, and firms differ in their treatment of such items as depreciation, inventory valuation. R&D expenditures, pension plan costs, mergers, and taxes. Also, seasonal factors can influence comparative ratios. Therefore, conformity to industry composite ratios does not establish with certainty that a firm is performing normally or that it is well managed. Likewise, departures from industry averages do not always indicate that a firm is doing especially well or badly. For example, a high inventory turnover ratio could indicate efficient inventory management and a strong working capital position, but it also could indicate a serious inventory shortage and a weak working capital position.

Another limitation of financial ratios in terms of including them as key internal factors in the upcoming 1FE Matrix is that financial ratios are not very “actionable” in terms of revealing potential strategies needed, i.e. since they generally are based on performance of the overall firm. For example, to include as a key internal factor that the firm’s “current ratio increased from 1.8 to 2.1” is not as “actionable” as “the firm's fragrance division revenues increased 18 percent in Africa in 2013.” Chapter 7 discusses the importance of selecting “actionable” key factors, both externally and internally, upon which to formulate strategies. Selecting “actionable” key factors, both externally and internally, upon which to formulate strategies is important.

A firm’s financial condition depends not only on the functions of finance, but also on many other factors that include (1) management, marketing, management production and operations, R&D, and MIS; (2) actions by competitors, suppliers, distributors, creditors, customers, and shareholders; and (3) economic, social, cultural, demographic, environmental, political, govern­ mental, legal, and technological trends.

Breakeven Analysis Because consumers remain price sensitive, many firms have lowered prices to compete. As a firm lowers prices, its breakeven (BE) point in terms of units sold increases, as illustrated in Figure 6-4. The breakeven point can be defined as the quantity of units that a firm must sell for its total revenues (TR) to equal its total costs (TC). Note that the before and after chart in Figure 6-4 reveals that the TR line rotates to the right with a decrease in price, thus increasing the quantity (Q) that must be sold just to break even. Increasing the breakeven point is thus a huge drawback of lowering prices. Of course when rivals are lowering prices, a firm may have to lower prices anyway to compete. However, the breakeven concept should be kept in mind because it is so important, especially in recessionary times.

TR

Q Q FIGURE 6-4 A Before and After Breakeven Chart When Prices Are Lowered

208 CHAPTER 6 • THE INTERNAL AUDIT

Notice in Figure 6-5 that increasing fixed costs (FC) also raises a firm’s breakeven quantity. Note the before and after chart in Figure 6-5 reveals that adding fixed costs such as more stores, or more plants, or even more advertising as part of a strategic plan raises the TC line, which makes the intersection of the TC and TR lines at a point farther down the Quantity axis. Increasing a firm’s FC thus significantly raises the quantity of goods that must be sold to break even. This is not just theory for the sake of theory. Firms with less fixed costs, such as Apple and Amazon.com, have lower breakeven points, which give them a decided competitive advantage in harsh economic times. Figure 6-5 reveals that adding fixed costs (FC), such as plant, equipment, stores, advertising, and land, may be detrimental whenever there is doubt that significantly more units can be sold to offset those expenditures.

Firms must be cognizant of the fact that lowering prices and adding fixed costs could be a catastrophic double whammy because the firm's breakeven quantity needed to be sold is increased dramatically. Figure 6-6 illustrates this double whammy. Note how far the breakeven point shifts with both a price decrease and an increase in fixed costs. If a firm does not break­ even, then it will of course incur losses, and losses are not good, especially sustained losses.

Finally, note in Figures 6-4, 6-5, and 6-6 that variable costs (VC), such as labor and materials, when increased, have the effect of raising the breakeven point, too. Raising VC is reflected by the VC line shifting left or becoming steeper. When the TR line remains constant, the effect of increasing VC is to increase TC, which increases the point at which TR = TC = BE.

The formula for calculating breakeven point is BE Quantity = TFC divided by (price - VC). In other words, the quantity or units of product that need to be sold for a firm to breakeven is total fixed costs divided by (price per unit - variable costs per unit). A breakeven problem is given in Table 6-7.

Suffice it to say here that various strategies can have dramatically beneficial or harmful effects on the firm’s financial condition because of the concept of breakeven analysis.

Before After j r

FIGURE 6-5 A Before and After Breakeven Chart When Fixed Costs Are Increased

FIGURE 6-6 A Before and After Breakeven Chart When Prices Are Lowered and Fixed Costs Are Increased

CHAPTER 6 • THE INTERNAL AUDIT 209

Seeing a need for childcare in her town. Joy is considering opening her own day-care service. Joy’s Day Care needs to be affordable, so Joy would like to care for each child for SI 2 a day. But Joy also wants to make money. Joy needs to know how many children she will have to watch per day to make money. Joy gathered the following information about her potential new business.

• The month of June has 20 workdays. Monday through Friday for 4 weeks. • Insurance and rent on her business will be $200 and S400, respectively, per month. • Expenses per student per day will be snacks (2 @ SI .00) + meals (2 @ S3.00).

Joy’s Analysis Breakeven = Operating Expenses ($12.00 - S8.00) Breakeven = $600 -r- $4.00 Breakeven = 150 units (children) in June. Because there are 20 days in June. Joy must watch 150 -r- 20 = 7.5 kids, or 8 children every day to make a profit. Joy’s Conclusion Thanks to breakeven analysis, Joy is pondering whether or not she can care for 8 children daily. Instead of abruptly opening the business. Joy is now considering adding a helper for S50 per day and charging $20 per student per day. How many students now would Joy have to care for to make a profit under this scenario? (Answer 6.6 = 7) What do you think would be an ideal scenario for Joy in planning for her new business?

There are some limitations of breakeven analysis, including the following points:

1. Breakeven analysis is only a supply side (i.e., costs only) analysis because it tells you nothing about what sales are likely to be for the product at various prices.

2. It assumes that fixed costs are constant. Although this is true in the short run, an increase in the scale of production will cause fixed costs to rise.

3. It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales.

4. It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in beginning or ending inventory).

5. In multiproduct companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).22

Finance and Accounting Audit Checklist The following finance and accounting questions, like the similar questions about marketing and management previously, should be examined:

1. Where is the firm financially strong and weak as indicated by financial ratio analyses? 2. Can the firm raise needed short-term capital? 3. Can the firm raise needed long-term capital through debt or equity? 4. Does the firm have sufficient working capital? 5. Are capital budgeting procedures effective? 6. Are dividend payout policies reasonable? 7. Does the firm have good relations with its investors and stockholders? 8. Are the firm's financial managers experienced and well trained? 9. Is the firm’s debt situation excellent?

Production and Operations The extent to which a manufacturing plant's output reaches its potential output is called capacity utilization, a key strategic variable. The higher the capacity utilization the better because otherwise equipment may sit idle. The estimated plant capacity utilization in Europe for the major auto producers is Volkswagen (84%), Renault (77%), Peugeot (73%), Ford (66%). GM (60%). and Fiat (55%).23

The production/operations function of a business consists of all those activities that transform inputs into goods and services. Production and operations management deals with inputs, transformations, and outputs that vary across industries and markets. A manufacturing operation transforms or converts inputs such as raw materials, labor, capital, machines, and facilities into finished goods and services. As indicated in Table 6-8. Roger Schroeder suggested

T A B LE 6-7 Applying Breakeven Analysis for Joy's Day Care

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TA BLE 6-8 The Basic Functions (Decisions) Within Production/Operations

Decision Areas Example Decisions

1. Process These decisions include choice of technology, facility layout, process flow analysis, facility location, line balancing, process control, and transportation analysis. Distances from raw materials to production sites to customers arc a major consideration.

2. Capacity These decisions include forecasting, facilities planning, aggregate planning, scheduling, capacity planning, and queuing analysis. Capacity utilization is a major consideration.

3. Inventory These decisions involve managing the level of raw materials, work-in-process, and finished goods, especially considering what to order, when to order, how much to order, and materials handling.

4. Workforce These decisions involve managing the skilled, unskilled, clerical, and managerial employees by caring for job design, work measurement, job enrichment, work standards, and motivation techniques.

5. Quality These decisions are aimed at ensuring that high-quality goods and services are produced by caring for quality control, sampling, testing, quality assurance, and cost control.

Source: Based on R. Schroeder, Operations Management (New York: McGraw-Hill. ] 981 ), 12.

that production and operations management comprises five functions or decision areas: process, capacity, inventory, workforce, and quality.

Production and operations activities often represent the largest part of an organization’s human and capital assets. In most industries, the major costs of producing a product or service are incurred within operations, so production and operations can have great value as a competitive weapon in a company’s overall strategy. Strengths and weaknesses in the five functions of production can mean the success or failure of an enterprise.

Many production and operations managers are finding that cross-training of employees can help their lirms respond faster to changing markets. Cross-training of workers can increase efficiency, quality, productivity, and job satisfaction. For example, at General Motors' Detroit gear and axle plant, costs related to product defects were reduced 400 percent in 2 years as a result of cross-training workers. As shown in Table 6-9, James Dilworth outlined implications of several types of strategic decisions that a company might make.

A magazine that had been printed since 1933, Newsweek, ended its print edition of the magazine on December 31, 2012. after suffering through years of declining profits and falling subscriptions. Now only an all digital-tablet version, Newsweek Global, is available with a paid subscription. As a result of this strategic decision, Newsweek is laying off employees and closing production facilities both in the USA and abroad. Among the USA's three icon weekly magazines, Time, Newsweek, and U.S. News and World Report, only Time now remains in print version. The weekly cost to publish and distribute the print version of Newsweek was $42 million. The top 10 print magazines by circulation in 2012 are:

1. AARP Magazine (22,528,478) 2. AARP Bulletin (22,283,41 1) 3. Game Informer (8,169,524) 4. Better Homes and Gardens (7.617,038) 5. Reader's Digest (5,577.717) 6. Good Housekeeping (4,346,757) 7. National Geographic (4,232,205) 8. Family Circle (4,100,977) 9. People (3,563,035)

10. Woman's Day (3.449.692)

A current trend that is accelerating among U.S. manufacturers is to extend the payment term on monies owed to suppliers. Procter & Gamble is leading the way on this trend, treeing

CHAPTER 6 • THE INTERNAL AUDIT 211

T A B LE 6-9 Implications of Various Strategies on Production and Operations

Various Strategies Implications

I. Low-cost provider Creates high barriers to entry Creates larger market Requires longer production runs and fewer product changes

2. A high-quality provider Requires more quality-assurance efforts Requires more expensive equipment Requires highly skilled workers and higher wages

3. Provide great customer service Requires more service people, service parts, and equipment Requires rapid response to customer needs or changes in customer tastes Requires a higher inventory investment

4. Be the first to introduce new products Has higher research and development costs Has high retraining and tooling costs

5. Become highly automated Requires high capital investment Reduces flexibility May affect labor relations Makes maintenance more crucial

6. Minimize layoffs Serves the security needs of employees and may develop employee loyalty Helps to attract and retain highly skilled employees

Source: Based on: J. Dilworth, Production and Operations Management: Manufacturing and Nonmanufacturing, 2nd ed. Copyright © 1983 by Random House, Inc.

up nearly $2 billion in cash annually by delaying payments to suppliers. Hundreds of other firms are doing the same, including Unilever and even retailers such as Walmart and Kohl’s.

Another trend among U.S. manufacturers and retailers regarding suppliers is to quit doing busi­ ness with unsafe factories, such as the one in Bangladesh that recently collapsed and killed 1.100 people. Walmart has publicly blacklisted 250 Bangladeshi suppliers found to have safety problems.

Production and Operations Audit Checklist Questions such as the following should be examined:

1. Are supplies of raw materials, parts, and subassemblies reliable and reasonable? 2. Are facilities, equipment, machinery, and offices in good condition? 3. Are inventory-control policies and procedures effective? 4. Are quality-control policies and procedures effective? 5. Are facilities, resources, and markets strategically located? 6. Does the firm have technological competencies?

Research and Development The fifth major area of internal operations that should be examined for specific strengths and weaknesses is research and development (R&D). iMany firms today conduct no R&D, and yet many other companies depend on successful R&D activities for survival. Firms pursuing a product development strategy especially need to have a strong R&D orientation. Founded in 1897 and headquartered in Orrville, Ohio, J.M. Smucker Company had $5.5 and 4.8 billion in revenue in 2012 and 201 1, and spent S21.9 and $20.9 million in R&D during those two years, com­ prising 0.39 and 0.43 percent of revenues, respectively. In contrast, Microsoft had revenues of $73.7 and $69.9 billion in 2012 and 2011 and spent $9.8 and $9.0 billion on R&D. comprising 13.3 and 12.9 percent of revenues respectively. High-tech firms such as Microsoft spend a much larger proportion of their revenues on R&D.

212 CHAPTER 6 • THE INTERNAL AUDIT

Huawei Technologies, the world’s largest supplier of telecom equipment, increased its R&D spending by 25 percent in 2012 to $4.7 billion, almost equal to rival Ericsson’s R&D expenditures of $4.8 billion. A key decision for many firms is whether to be a “first mover” or a “late follower.” i.e. spending heavily on R&D to be the first to develop radically new products, or alternatively spending less on R&D by imitating/duplicating/improving upon products once rival firms develop them.

Organizations invest in R&D because they believe that such an investment will lead to a superior product or service and will give them competitive advantages. R&D expenditures are directed at developing new products before competitors do. at improving product quality, or at improving manufacturing processes to reduce costs.

Effective management of the R&D function requires a strategic and operational partnership between R&D and the other vital business functions. A spirit of partnership and mutual trust between general and R&D managers is evident in the best-managed firms today. Managers in these firms jointly explore; assess; and decide the what, when, where, why, and how much of R&D. Priorities, costs, benefits, risks, and rewards associated with R&D activities are discussed openly and shared. The overall mission of R&D thus has become broad based, including supporting existing businesses, helping launch new businesses, developing new products, improving product quality, improving manufacturing efficiency, and deepening or broadening the company's technological capabilities.24

The best-managed firms today seek to organize R&D activities in a way that breaks the isolation of R&D from the rest of the company and promotes a spirit of partnership between R&D managers and other managers in the firm. R&D decisions and plans must be integrated and coordinated across departments and divisions by having the departments share experiences and information. The strategic-management process facilitates this cross-functional approach to managing the R&D function.

R&D spending in the USA was $418.6 billion in 2012 and is expected to increase only l.2 percent to $423.7 billion in 2013. The inflation-adjusted R&D spending for 20I3 actually is expected to decline 0.7 percent. In comparison, the number-2 R&D spending country, China, spent $197.3 billion in 2012. but it is annually increasing its expenditure 10 to 12 percent. According to the Battelle Memorial Institute, China will achieve parity with the USA in R&D spending in 2022.

Internal and External Research and Development Cost distributions among R&D activities vary by company and industry, but total R&D costs generally do not exceed manufacturing and marketing start-up costs. Four approaches lo deter­ mining R&D budget allocations commonly are used: (1) financing as many project proposals as possible. (2) using a percentage-ol-sales method. (3) budgeting about the same amount that competitors spend for R&D. or (4) deciding how many successful new products are needed and working backward to estimate the required R&D investment.

R&D in organizations can take two basic forms: (1) internal R&D. in which an organization operates its own R&D department, or (2) contract R&D, in which a firm hires independent researchers or independent agencies to develop specific products. Many companies use both approaches to develop new products. A widely used approach for obtaining outside R&D assis­ tance is to pursue a joint venture with another firm. R&D strengths (capabilities) and weak­ nesses (limitations) play a major role in strategy formulation and strategy implementation.

Most firms have no choice but to continually develop new and improved products because of changing consumer needs and tastes, new technologies, shortened product life cycles, and increased domestic and foreign competition. A shortage of ideas for new products, increased global competition, increased market segmentation, strong special-interest groups, and increased govern­ ment regulations are several factors making the successful development of new products more and more difficult, costly, and risky. In the pharmaceutical industry, for example, only one out of every few thousand drugs created in the laboratory ends up on pharmacists’ shelves. Scarpello. Boulton, and Hofer emphasized that different strategies require different R&D capabilities:

The focus of R&D efforts can vary greatly depending on a firm’s competitive strategy. Some corporations attempt to be market leaders and innovators of new products, while others are satisfied to be market followers and developers of currently available products. The basic skills required to support these strategies will vary, depending on whether R&D becomes the driving force behind competitive strategy. In cases where new product introduction is the driving force for strategy. R&D activities must be extensive."'*

CHAPTER 6 • THE INTERNAL AUDIT 213

Research and Development Audit Questions such as the following should be asked in performing an R&D audit:

1. Does the firm have R&D facilities? Are they adequate? 2. If outside R&D firms are used, are they cost-effective? 3. Are the organization’s R&D personnel well qualified? 4. Are R&D resources allocated effectively? 5. Arc management information and computer systems adequate? 6. Is communication between R&D and other organizational units effective? 7. Are present products technologically competitive?

Management Information Systems Billions of bits of information are now “in the cloud:' Information ties all business functions together and provides the basis for all managerial decisions. It is the cornerstone of all orga­ nizations. Information represents a major sourcc of competitive management advantage or disadvantage. Assessing a firm’s internal strengths and weaknesses in information systems is a critical dimension of performing an internal audit.

A MIS's purpose is to improve the performance of an enterprise by improving the quality of managerial decisions. An effective information system thus collects, codes, stores, synthesizes, and presents information in such a manner that it answers important operating and strategic questions. The heart of an information system is a database containing the kinds of records and data important to managers.

A management information system (MIS) receives raw material from both the external and internal evaluation of an organization. It gathers data about marketing, finance, production, and personnel matters internally, and social, cultural, demographic, environmental, economic, political, governmental, legal, technological, and competitive factors externally. Data are integrated in ways needed to support managerial decision making.

There is a logical flow of material in an information system, whereby data are input to the system and transformed into output. Outputs include computer printouts, written reports, tables, charts, graphs, checks, purchase orders, invoices, inventory records, payroll accounts, and a variety of other documents. Payoffs from alternative strategies can be calculated and estimated. Data becomes information only when it is evaluated, filtered, condensed, analyzed, and orga­ nized for a specific purpose, problem, individual, or time.

Management Information Systems Audit Questions such as the following should be asked when conducting this audit:

1. Do all managers in the firm use the information system to make decisions? 2. Is there a chief information officer or director of information systems position in the firm? 3. Are data in the information system updated regularly? 4. Do managers from all functional areas of the firm contribute input to the information system? 5. Are there effective passwords for entry into the firm’s information system? 6. Are strategists of the firm familiar with the information systems of rival firms? 7. Is the information system user-friendly? 8. Do all users of the information system understand the competitive advantages that

information can provide firms? 9. Are computer training workshops provided for users of the information system?

10. Is the firm’s information system continually being improved in content and user-friendliness?

Value Chain Analysis According to Porter, the business of a firm can best be described as a value chain, in which total revenues minus total costs of all activities undertaken to develop and market a product or service yields value. All firms in a given industry have a similar value chain, which includes

214 CHAPTER 6 • THE INTERNAL AUDIT

activities such as obtaining raw materials, designing products, building manufacturing facilities, developing cooperative agreements, and providing customer service. A firm will be profitable as long as total revenues exceed the total costs incuưed in creating and delivering the product or service. Firms should strive to understand not only their own value chain operations but also their competitors’, suppliers’, and distributors’ value chains.

Value chain analysis (VCA) refers to the process whereby a firm determines the costs asso­ ciated with organizational activities from purchasing raw materials to manufacturing procJuct(s) to marketing those products. VCA aims to identify where low-cost advantages or disadvantages exist anywhere along the value chain from raw material to customer service activities. VCA can enable a firm to better identify its own strengths and weaknesses, especially as compared to competitors’ value chain analyses and their own data examined over time.

Substantial judgment may be required in performing a VCA because different items along the value chain may impact other items positively or negatively, so there exist complex inter­ relationships. For example, exceptional customer service may be especially expensive yet may reduce the costs of returns and increase revenues. Cost and price differences among rival firms can have their origins in activities performed by suppliers, distributors, creditors, or even share­ holders. Despite the complexity of VCA, the initial step in implementing this procedure is to divide a firm’s operations into specific activities or business processes. Then the analyst attempts to attach a cost to each discrete activity, and the costs could be in terms of both time and money. Finally, the analyst converts the cost data into information by looking for competitive cost strengths and weaknesses that may yield competitive advantage or disadvantage. Conducting a VCA is supportive of tile RBV’s examination of a firm’s assets and capabilities as sources of distinctive competence.

When a major competitor or new market entrant offers products or services at low prices, this may be because that firm has substantially lower value chain costs or peihaps the rival firm is just waging a desperate attempt to gain sales or market share. Thus, VCA can be critically important for a firm in monitoring whether its prices and costs are competitive. An example value chain is illustrated in Figure 6-7. There can be more than a hundred particular value- creating activities associated with the business of producing and marketing a product or service, and each one of the activities can represent a competitive advantage or disadvantage for the firm. The combined costs of all the various activities in a company’s value chain define the firm’s cost of doing business. Firms should determine where cost advantages and disadvantages in their value chain occur relative to the value chain of rival firms.

Value chains differ immensely across industries and firms. Whereas a paper prod­ ucts company, such as Stone Container, would include on its value chain timber farming, logging, pulp mills, and papermaking, a company such as Hewlett-Packard would include programming, peripherals, software, hardware, and laptops. A motel would include food, housekeeping, check-in and check-out operations, website, reservations system, and so on. However, all firms should use VCA 10 develop and nurture a core competence and convert this competence into a distinctive competence. A core competence is a VCA that a firm performs especially well. When a core competence evolves into a major competitive advantage, then it is called a distinctive competence. Figure 6-8 illustrates this process.

More and more companies are using VCA to gain and sustain competitive advantage by being especially efficient and effective along various parts of the value chain. For example, Walmart has built powerful value advantages by focusing on exceptionally tight inventory con­ trol and volume purchasing of products. Computer companies in contrast compete aggressively along the distribution end of the value chain. Price competitiveness is a key component of com­ petitiveness lor both mass retailers and computer firms.

Benchmarking Benchmarking is an analytical tool used to determine whether a firm’s VCA are competitive compared to rivals and thus conducive to winning in the marketplace. Benchmarking entails mea­ suring costs of value chain activities across an industry to determine “best practices” among com­ peting firms for the purpose of duplicating or improving on those best practices. Benchmarking enables a firm to take action to improve its competitiveness by identifying (and improving on) value chain activities where rival firms have comparative advantages in cost, service, reputation, or operation.

CHAPTER 6 • THE INTERNAL AUDIT 215

Supplier Costs ----------- Raw materials --------- Fuel Energy --------- Transportation Truck drivers --------- Truck maintenance --------- Component parts Inspection --------- Storing Warehouse --------- !

Production Costs Inventory system --------- Receiving Plant layout --------- Maintenance Plant location --------- Computer --------- R&D Cost accounting --------- 1

Distribution Costs Loading --------- Shipping --------- j Budgeting --------- Personnel --------- Internet --------- Trucking Railroads --------- Fuel Maintenance ---------

Sales and Marketing Costs ------- Salespersons Website --------- Internet --------- Publicity Promotion --------- Advertising --------- Transportation --------- Food and lodging

Customer Service Costs --------- 1— Postage --------- Phone --------- Internet Warranty ------------

Management Costs

Human resources Administration Employee benefits Labor relations --------- Managers --------- Employees Finance and legal

FIGURE 6-7 An Example Value Chain for a Typical Manufacturing Firm

216 CHAPTER 6 • THE INTERNAL AUDIT

FIGURE 6-8 Transforming Value Chain Activities into Sustained Competitive Advantage

A comprehensive survey on benchmarking was recently commissioned by the Global Benchmarking Network, a network of benchmarking centers representing 22 countries. More than 450 organizations responded from over 40 countries. The results showed that:

1. Mission and vision statements along with customer (client) surveys are the most used (77 percent of organizations) of 20 improvement tools, followed by SWOT analysis (72 percent), and informal benchmarking (68 percent). Performance benchmarking was used by 49 percent and best practice benchmarking by 39 percent.

2. The tools that are likely to increase in popularity the most over the next three years are performance benchmarking, informal benchmarking, SWOT, and best practice benchmarking. More than 60 percent of organizations not currently using these tools indicated they are likely to use them in the next three years.26

The hardest part of benchmarking can be gaining access to other firms’ VCA with associ­ ated costs. Typical sources of benchmarking information, however, include published reports, trade publications, suppliers, distributors, customers, partners, creditors, shareholders, lobbyists, and willing rival firms. Some rival firms share benchmarking data. However, the International Benchmarking Clearinghouse provides guidelines to help ensure that restraint of trade, price fixing, bid rigging, briber)', and other improper business conduct do not arise between participating firms.

Because of the popularity of benchmarking today, numerous consulting firms such as Accenture, AT Kearney, Best Practices Benchmarking & Consulting, as well as the Strategic Planning Institute's Council on Benchmarking, gather benchmarking data, conduct benchmark­ ing studies, and distribute benchmark information without identifying the sources.

The Internal Factor Evaluation Matrix A summary step in conducting an internal strategic-management audit is to construct an Internal Factor Evaluation (IFE) Matrix. This strategy-formulation tool summarizes and evaluates the major strengths and weaknesses in the functional areas of a business, and it also provides a basis for identifying and evaluating relationships among those areas. Intuitive judgments are required in developing an IFE Matrix, so the appearance of a scientific approach should not be interpreted to mean this is an all-powerful technique. A thorough understanding of the factors included is more important than the actual numbers. Similar to the EFE Matrix and CPM described in Chapter 7, an IFE Matrix can be developed in five steps:

1. List key internal factors as identified in the internal-audit process. Use a total of 20 internal factors, including both strengths and weaknesses. List strengths first and then weaknesses. Be as specific as possible, using percentages, ratios, and comparative numbers. Recall that Edward Deming said: “In God we trust. Everyone else bring data.” Include “actionable" factors that can provide insight regarding strategies to pursue. For example, the factor “our Quick Ratio is 2.1 vs. industry average of 1.8“ is not actionable, whereas the factor “our chocolate division’s ROI increased from 8 to 15 percent in South America” is actionable.

2. Assign a weight that ranges from 0.0 (not important) to 1.0 (all-important) to each factor. The weight assigned to a given factor indicates the relative importance of the factor to being successful in the firm’s industry. Regardless of whether a key factor is an internal strength

CHAPTER 6 • THE INTERNAL AUDIT 217

or weakness, factors considered to have the greatest effect on organizational performance should be assigned the highest weights. The sum of all weights must equal l.O.

3. Assign a l-to-4 rating to each factor to indicate whether that factor represents a major weakness (rating = l), a minor weakness (rating = 2) a minor strength (rating = 3), or a major strength (rating = 4). Note that strengths must receive a 3 or 4 rating and weaknesses must receive a l or 2 rating. Ratings are thus company-based, whereas the weights in step 2 are industry-based.

4. Multiply each factor’s weight by its rating to determine a weighted score for each variable. 5. Sum the weighted scores for each variable to determine the total weighted score for the

organization.

Regardless of how many factors are included in an IFE Matrix, the total weighted score can range from a low of l .0 to a high of 4.0, with the average score being 2.5. Total weighted scores well below 2.5 characterize organizations that are weak internally, whereas scores significantly above 2.5 indicate a strong internal position. Like the EFE Matrix, an IFE Matrix should include 20 key factors. The number of factors has no effect on the range of total weighted scores because the weights always sum to l.O.

When a key internal factor is both a strength and a weakness, the factor may be included twice in the IFE Matrix, and a weight and rating assigned to each statement. For example, the Playboy logo both helps and hurts Playboy Enterprises; the logo attracts customers to Playboy magazine, but it keeps the Playboy cable channel out of many markets. Be as quantitative as possible when stating factors. Use monetär)' amounts, percentages, numbers, and ratios to the extent possible.

An example IFE Matrix is provided in Table 6-I0 for a retail computer store. Note that the two most important factors to be successful in the retail computer store business are “revenues from repair/service in the store” and “location of the store." Also note that the store is doing best on “average customer purchase amount” and “in-store technical support.” The store is having major problems with its carpet, bathroom, paint, and checkout procedures. Note also that the matrix con­ tains substantial quantitative data rather than vague statements; this is excellent. Overall, this store

TA BLE 6-10 A Sample Internai Factor Evaluation Matrix for a Retail Computer Store

Key Internal Factors W eight Rating W eighted Score

Strengths

l . Inventory turnover increased from 5.8 to 6.7 0.05 3 0.15 2. Average customer purchase increased from $97 to $128 0.07 4 0.28 3. Employee morale is excellent 0.10 3 0.30 4. In-store promotions resulted in 20 percent increase in sales 0.05 3 0.15 5. Newspaper advertising expenditures increased 10 percent 0.02 3 0.06 6. Revenues from repair/service segment of store up 16 percent 0.15 3 0.45 7. In-store technical support personnel have MIS college degrees 0.05 4 0.20 8. Store’s debt-to-total assets ratio declined to 34 percent 0.03 3 0.09 9. Revenues per employee up 19 percent 0.02 3 0.06

Weaknesses

1. Revenues from software segment of store down 12 percent 0.10 2 0.20 2. Location of store negatively impacted by new Highway 34 0.15 2 0.30 3. Carpet and paint in store somewhat in disrepair 0.02 1 0.02 4. Bathroom in store needs refurbishing 0.02 1 0.02 5. Revenues from businesses down 8 percent 0.04 1 0.04 6. Store has no website 0.05 2 0.10 7. Supplier on-time deliver)' increased to 2.4 days 0.03 I 0.03 8. Often customers have to wait to check out 0.05 1 0.05 Total 1.00 2.50

218 CHAPTER 6 • THE INTERNAL AUDIT

T A B LE 6-11 An Actual IFE Matrix for Fresenius, Inc.

Strengths W eight Rating WScore

1. Sales and earnings per share have not declined a single year for 10 years 0.09 4 0.36 2. Fresenius Medical Care is the market leader in dialysis services and products 0.09 4 0.36 3. Trading volume increased by 17 percent in 2011 0.05 3 0.15 4. Dividends were just raised for the 20th consecutive year 0.06 4 0.24 5. Financial analysts ratings show 23 “buy,” 2 “hold.” and no “sell" 0.06 3 0.18 6. Has a renown training school for nurses and other health workers 0.0.3 3 0.09 7. DAX30 ranking in market capitalization steadily improving 0.05 4 0.20 8. Fresenius Medical increased worldwide clinics by 6 percent 0.03 3 0.09 9. Fresenius Helios is the second largest private hospital operators in Germany 0.06 3 0.18

10. Diversified 4 business segments in different healthcare sectors 0.05 3 0.15 Weaknesses

1. Quick Ratio of 0.65 shows a lack of ability to cover cash needs 0.07 2 0.14 2. Group sales decreased by 4 percent in North America 0.03 2 0.06 3. Group debt increased by 9 percent 0.05 1 0.05 4. Fresenius Biotech has a negative EBIT of approx. $-38.6 million 0.05 2 0.10 5. Decrease of 21% in operating cash flow from 2010 to 2011 0.08 1 0.08 6. Fresenius Helios dropped 3.1 billion euro takeover of rival Rhoen-KIinikum 0.01 2 0.02

on September 3. 2012, because of rival hospital operators blocking the merger 7. Fresenius Vamed made no material acquisitions 0.02 2 0.04 8. No racial diversity on management and supervisory boards 0.04 2 0.08 9. Healthcare Group board members and committees comprised of all males 0.04 1 0.04

10. Only one female in all top management 0.04 1 0.04

Total 1.0 2.65

receives a 2.5 total weighted score, which on a l-to-4 scale is exactly average/halfway, indicating there is definitely room for improvement in store operations, strategics, policies, and procedures.

The IFE Matrix provides important information for strategy formulation. For example, this retail computer store might want to hire another checkout person and repair its carpet, paint, and bathroom problems. Also, the store may want to increase advertising for its repair/services, because that is a really important (weight 0.15) factor to being successful in this business.

Headquartered in Germany and specializing in kidney dialysis. Fresenius provides health­ care products and services in about 100 countries. Fresenius owns and operates 2.800 dialysis clinics and many other healthcare facilities. Table 6-11 provides an actual IFE matrix created for Fresenius in late 2012. As indicated in Table 6-11, Fresenius is financially strong, but needs to include women and minorities in its management.

In multidivisional firms, each autonomous division or strategic business unit should construct an IFE Matrix. Divisional matrices then can be integrated to develop an overall corporate IFE Matrix. Be as divisional as possible when developing a corporate IFE Matrix. Also, in developing an IFE Matrix, do not allow more than 30 percent of the key factors to be financial ratios because financial ratios are generally the result of many other factors so it is difficult to know what particular strategies should be considered based on financial ratios. For example, a firm would have no insight on whether to sell in Brazil or South Africa to take advantage of a high corporate ROI ratio.

Special Note to Students It can be debated whether external or internal factors are more important in strategic planning, but there is no debate regarding the fact that gaining and sustaining competitive advantage is the essence or purpose of strategic planning. In the internal portion of your case analysis, emphasize how and why your internal strengths and weaknesses can be leveraged to both gain competitive advantage and overcome competitive disadvantage, in light of the direction you are taking the firm. Maintain your project’s upbeat, insightful, and forward-thinking demeanor during the internal assessment, rather than being mundane, descriptive, and vague. Focus on how your

CHAPTER 6 • THE INTERNAL AUDIT 219

firm’s resources, capabilities, structure, and strategies, with your recommended improve­ ments, can lead the firm to prosperity. Although the numbers absolutely must be there, must be accurate, and must be reasonable, do not bore a live audience or class with overreliance on numbers. Periodically throughout your presentation or written analysis, refer to your recommen­ dations, explaining how your plan of action will improve the firm’s weaknesses and capitalize on strengths in light of anticipated competitor countermoves. Keep your audience’s attention, interest, and suspense, rather than “reading” to them or “defining” ratios for them.

Conclusion Management, marketing, finance and accounting, production and operations. R&D. and MIS represent the core operations of most businesses. A strategic-management audit of a firm's inter­ nal operations is vital to organizational health. Many companies still prefer to be judged solely on their bottom-line performance. However, an increasing number of successful organizations are using the internal audit to gain competitive advantages over rival firms.

Systematic methodologies for performing strength-weakness assessments are not well developed in the strategic-management literature, but it is clear that strategists must identify and evaluate internal strengths and weaknesses to effectively formulate and choose among alterna­ tive strategies. The EFE Matrix, CPM, 1FE Matrix, and clear statements of vision and mission provide the basic information needed to successfully formulate competitive strategies. The process of performing an internal audit represents an opportunity for managers and employees throughout the organization to participate in determining the future of the firm. Involvement in the process can energize and mobilize managers and employees.

Key Terms and Concepts activity ratios (p. 205) benchmarking (p. 214) breakeven (BE) point (p. 207) capacity utilization (p. 209) capital budgeting (p. 203) communication (p. 190) controlling (p. 198) core competence (p. 214) cost/benefit analysis (p. 202) cultural products (p. 192) customer analysis (p. 199) data (p. 213) distinctive competencies (p. 189) distribution (p. 201) dividend decisions (p. 203) empirical indicators (p. 192) financial ratio analysis (p. 191) fixed costs (FC) (p. 208) financing decision (p. 203) functions of finance/accounting (p. 202 ) functions of management (p. 194) functions of marketing (p. 194) growth ratios (p. 205) human resource management (p. 197) information (p. 213)

internal audit (p. 190) internal factor evaluation (IFE) matrix (p. 216) investment decision (p. 203) leverage ratios (p. 205) liquidity ratios (p. 205) management information system

(MIS) (p. 213) marketing research (p. 201) motivating (p. 197) organizational culture (p. 192) organizing (p. 196) personnel management (p. 197) planning (p. 194) pricing (p. 200) product and service planning (p. 200) production/operations function (p. 209) profitability ratios (p. 205) research and development (R&D) (p. 211) resource-based view (RBV) (p. 191) selling (p. 199) staffing (p. 197) synergy (p. 196) test marketing (p. 200) value chain analysis (VCA) (p. 214) variable costs (VC) (p. 208)

220 CHAPTER 6 • THE INTERNAL AUDIT

Issues for Review and Discussion 6-1. Volkswagen (VW) Group has been very successful in the

last decade. Research VW and sec if they have strategic planning. Create a report of your findings for your class.

6-2. Visit VW's corporate website. See the list of top execu­ tives for VW and create an organizational chart for VW.

6-3. Given the fifteen examples of (possible) aspects of an organization's culture as presented in the chapter, rate a company you are very familiar with in terms of the extent each culture item exists. Explain.

6-4. Rank the seven functions of marketing in order of importance for a small hardware business.

6-5. Develop a quantitative problem to show your understanding of cost/benefit analysis.

6-6. Develop a quantitative problem to show that you understand breakeven analysis.

6-7. For VW, determine their most recent dividend payout amount per share. How has that amount changed over the last 12 months?

6-8. List some advantages and disadvantages of a company paying dividends versus reinvesting that money in the company, and striving for stock price increase as the primary way to reward investors.

6-9. Illustrate a breakeven chart for VW. Explain how it may work for the organization.

6-10. VW has historically spent more on R&D than almost any other automobile company in the world. What are the major advantages and disadvantages of this strategy?

6-11. Perform a value chain analysis for an organization of your choice.

6-12. Discuss the relationship between benchmarking and value chain analysis.

6-13. Explain why the ratings in an 1FE Matrix should be 4 or 3 for strengths, and 1 or 2 for weaknesses as compared to the EFE Matrix—where the ratings should be 1, 2, 3, or 4 anywhere among both the opportunities and threats.

6-14. Compare the financial ratio analysis for VW on the four different websites identified in the chapter. Which site do you like best? Why?

6-15. Conduct a Google search for value chain analysis. In a two-page report, expand on the concepts presented in the chapter.

6-16. What competitive advantages would Amazon have over Wal-Mart stores in doing business outside the United States?

6-17. How could the “process of performing an internal audit” differ across countries, given varying global management styles?

6-18. Why is sole reliance on financial ratios an ineffective means of deriving internal strengths and weaknesses?

6-19. Give an example of two resources for a fast-food chain that you believe meet the three “empirical indicators” criteria.

6-20. Prepare a culture assessment table, as presented in the chapter, for a local business that you are familiar with.

In other words, rate that business on all 15 culture crite­ ria presented. What are the implications of your ratings on the strategic planning process within that firm?

6-21. Why is human resource management particularly challenging for international firms?

6-22. List some specific characteristics of advertisements, in the w'akc of a lingering recession in Europe.

6-23. How do changes in the value of the dollar affect pricing of products of global firms?

6-24. Historically, what has been the attitude of technology firms toward paying dividends? Give some examples.

6-25. Describe Singapore as a place to locate or start a business. 6-26. Visit the strategyclub website, and describe the strategic

planning products offered. 6-27. Develop a value chain analysis for a large global firm

and its primary rival firm. 6-28. Identify four major strengths and weaknesses each, of

your college or university. Rank each factor in terms of importance.

6-29. Look up financial information about VW. Identify three financial ratios where the firm is weak and three financial ratios the firm is strong.

6-30. What five cultural products do you feel are most important? Justify your selections.

6-31. Rate the company where you work, or would like to work, on the 15 aspects of culture listed in the chapter.

6-32. Develop a breakeven chart for a company, w'hich simul­ taneously lays off employees and closes facilities.

6-33. Financial ratio analysis should be conducted on three separate fronts. W'hat are these fronts and which is most important?

6-34. Explain breakeven analysis using three graphs that show changes in breakeven given: 1) a change in price. 2) a change in advertising expenditures, and 3) a change in labor costs.

6-35. Why is breakeven analysis such an important strategic planning concept?

6-36. What are the basic functions of production/operations in a large manufacturing company? W'hy are these factors important in an internal strategic management audit?

6-37. Explain benchmarking. 6-38. Go to the www.strategyclub.com website and review

the benefits of using the free excel template. 6-39. For the adidas Cohesion Case, what do you consider to

be the company's four major strengths and four major weaknesses?

6-40. Prepare a financial ratio analysis for adidas. Include comparative ratios for adidas.

6-41. Explain how' adidas could utilize breakeven analysis. 6-42. Explain how top executives of adidas could utilize

Porter’s Five Forces Model to aid the firm in strategic planning.

6-43. Since adidas and Puma are based in the same city, could this close proximity benefit or hinder the two firms 1) cooperating with each other on R&D. or 2)

CHAPTER 6 • THE INTERNAL AUDIT 221

gathering and assimilating competitive intelligence on the other firm?

6-44. Since adidas is so divisional, how could the company best develop a corporate IFE Matrix for various divisional IFE Matrices?

6-45. When is it more important to capitalize on strengths than improve on weaknesses in strategic planning?

6-46. Explain what 20 internal factors is a recommended num­ ber to include in an IFE Matrix, rather than 10 or 40 total

6-47. Do you think the RBV view or the I/O theorists view is more important/accurate in performing a strategic analysis? What would be important implications for a business?

MyManagementLab® Go to m ym anagem entlab.com for the following Assisted-graded writing questions:

6-48. List three ways that financial ratios should be compared 6-50. Mymanagementlab Only—comprehensive writing or used. Which of the three comparisons do you feel is assignment for this chapter, most important? Why?

6-49. Would you ever pay out dividends when your firm’s annual net profit is negative? W'hy? What effect could this have on a firm's strategies?

Current Readings Arora, Ashish and Anand Nandkumar. “Insecure Advantage?

Markets for Technology and the Value of Resources for Entrepreneurial Ventures.” Strategic Management Journal 33, no. 3 (March 2012): 231-251.

Browning, Tyson R., Sanders, and Nada R. “Can Innovation Be Lean?” California Management Review 54, no. 4 (Summer 2012): 5-19.

Knott, Anne Marie. “The Trillion-Dollar R&D Fix.” Harvard Business Review (May 2012): 76.

Lemper, Timothy A. “The Critical Role of Timing in Managing Intellectual Property.” Business Horizons 55, no. 4 (July 2012): 339-347.

Lindenberg, Siegwart, and Nicolai J. Foss. “Managing Joint Production Motivation: The Role of Goal Framing and Governance Mechanisms.” The Academy o f Management Review 36, no. 3 (July 2011): 500.

Mossholder, Kevin W.. Hettie A. Richardson, and Randall P. Settoon. “Human Resource Systems and Helping in Organizations: A Relational Perspective.” The Academy o f Management Review 36, no. 1 (January 2011): 33.

Rader, David. “How Cloud Computing Maximizes Growth Opportunities for a Firm Challenging Established Rivals.” Strategy and Leadership 40. no. 4 (2012): 36-43.

Turner, Karynne L.. and Mona V. Makhija. “The Role of Individuals in the Information Processing Perspective.” Strategic Management Journal 33. no. 6 (June 2012): 661-680.

Watkins. Michael D. “How Managers Become Leaders.” Harvard Business Review (June 2012): 64.

A SSU R A N C E OF LEARNING EX ER C IS ES EXERCISE 6A

Develop a Corporate IFE Matrix for Volkswagen Group Purpose Volkswagen Group is featured in the openinc chapter case as a firm that engages in excellent strategic planning. VW has four major geographic business segments. Each of these divisions of VW would pre- paretheừ own IFE Matrices, which would be assimilated to develop an overall corporate IFE Matrix.

This exercise gives you practice developing divisional IFE Matrices and assimilating those into an overall corporate IFE Matrix.

Instructions Step 1 Review VW's most recent Annual Report in regards to the company's four geographic business

segments, which are North America. South America, Asia-Pacific, and Europe. Step 2 Review the latest s&p industry Survey for companies that producc and market automobiles. Step 3 Develop a divisional IFE Matrix for each of VW's business segments. Step 4 Assimilate your divisional IFE Matrices into an overall corporate IFE Matrix for VW.

222 CHAPTER 6 • THE INTERNAL AUDIT

EXERCISE 6B

Should VW Deploy More Resources or Less Outside of the USA?

Purpose As indicated in ihe opening chapter boxed insert. VW receives more revenue from outside its home base of Europe than from inside Europe. This exercise gives you practice analyzing this domestic versus global revenue base so that more effective strategies can be formulated and implemented.

Instructions Step 1 Go the VW's website and review the company’s most recent Annual Report. Be careful to note

the financial, management, and marketing information available for each geographic region. Let all regions outside Europe, for purposes of this exercise, be referred to as Global, and Europe be referred to as domestic for VW.

Step 2 Go to www.finance.yahoo.com and review the last 45 days of Headlines for VW. Take note of public information related to VW as well as lo GM, Ford, Honda, and Toyota.

Step 3 Prepare a 3-page executive summary to reveal whether you feel VW should be placing more or less emphasis on operations outside of Europe. Provide supporting tables, #’s. ratios, and narrative.

EXERCISE 6C

Apply Breakeven Analysis Purpose Breakeven analysis is one of the simplest yet underused analytical tools in management. It helps to provide a dynamic view of the relationships between sales, costs and profits. A better understanding of breakeven analysis can enable an organization to formulate and implement strategies more effectively.

This exercise will show you how to calculate breakeven points mathematically. The formula for calculating breakeven point is BE Quantity = TFC/P - VC. In other words, the Quantity (Q) or units of product that need to be sold for a firm to breakeven is Total Fixed Costs divided by (Price per Unit 2 Variable Costs per Unit).

Instructions Step 1 l êts say an airplane company has Fixed Costs of $ 100 million and Variable Costs per Unit of $2

million. Planes sell for $3 million each. What is the company’s breakeven point in terms of the number of planes that need to be sold just to breakeven?

Step 2 If the airplane company wants to make a profit of $99 million annually, how many planes will it have to sell?

Step 3 If the company can sell 200 airplanes in a year, how much annual profit will ihe firm make?

EXERCISE 6D

Performing a Financial Ratio Analysis for adidas AG Purpose Financial ratio analysis is one of the best techniques for identifying and evaluating internal strengths and weaknesses. Potential investors and current shareholders look closely at firms’ financial ratios, making detailed comparisons to industry averages and to previous periods of time. Financial ratio analysis provides vital input information for developing an IFE Matrix.

Instructions Step 1 On a separate sheet of paper, write down numbers 1 to 20. Referring to adidas AG’s income

statement and balance sheet, calculate 20 financial ratios for 2013. Step 2 In a second column, indicate whether you consider each ratio to be a strength, weakness, or

neutral factor for adidas.

EXERCISE 6E

Constructing an IFE Matrix for adidas AG Purpose This exercise will give you experience developing an IFE Matrix. Identifying and prioritizing factors to include in an IFE Matrix fosters communication among functional and divisional managers.

CHAPTER 6 • THE INTERNAL AUDIT 223

Preparing an IFE Matrix allows human resource, marketing, production/operations, finance/ accounting. R&D. and management information systems managers to articulate their concerns and thoughts regarding the business condition of the firm. This results in an improved collective under­ standing of the business.

Instructions Step 1 Join with two other individuals to form a three-person team. Develop a IFE Matrix for adidas.

Be sure to include information on Reebok and TaylorMade. Step 2 Compare your team’s IFE Matrix to other teams’ IFE Matrices. Discuss any major differences. Step 3 What strategies do you think would allow adidas to capitalize on its major strengths? What

strategies would allow adidas to improve upon its major weaknesses?

EXERCISE 6F

Analyzing Your College or University's Internal Strategic Situation

Purpose This exercise is excellent for doing together as a class.

Instructions As a class, determine your college or university’s major internal strengths and weaknesses. List 10 strengths and 10 weaknesses. Then, get everyone in class to rank order their factors with 1 being most important and 10 being least important. Then, gather up everyone’s paper, count the numbers, and in that manner create a prioritized list of the key internal strengths and weaknesses facing your college.

Notes 1. Reprinted by permission of the publisher from "Integrating

Strength-Weakness Analysis into Strategic Planning,” by William King, Journal o f Business Research 2, no. 4: 481. Copyright 1983 by Elsevier Science Publishing Co., Inc.

2. Igor Ansoff, “Strategic Management of Technology” Journal o f Business Strategy 7, no. 3 (W'inter 1987): 38.

3. Claude George Jr., The History o f Management Thought. 2nd ed. (Upper Saddle River. ÑJ: Prentice-Hall. 1972), 174.

4. Robert Grant, “The Resource-Based Theory of Competitive Advantage: Implications for Strategy Formulation,” California Management Review, Spring 1991. 116.

5. J. B. Barney. “Firm Resources and Sustained Competitive Advantage,” Journal o f Management 17 (1991): 99-120; J. B. Barney, “The Resource-Based Theory of the Firm,” Organizational Science 7 (1996): 469; J. B. Barney, “Is the Resource-Based ‘View'’ a Useful Perspective for Strategic Management Research? Yes.” Academy o f Management Review 26, no. 1 (2001): 41-56.

6. Edgar Schein, Organizational Culture and Leadership (San Francisco: Jossey-Bass, 1985), 9.

7. John Lorsch, “Managing Culture: The Invisible Barrier to Strategic Change,” California Management Review 28. no. 2(1986): 95-109.

8. Y. Allarie and M. Firsirotu, “How- to Implement Radical Strategies in Large Organizations,” Sloan Management Review (Spring 1985): 19.

9. www.mindtools.com/plfailpl.html 10. Adam Smith. The Wealth o f Nations (New York: Modern

Library. 1937), 3-4. 11. Richard Daft. Management, 3rd ed. (Orlando, FL: Dryden

Press, 1993), 512.

12. Shelley Kirkpatrick and Edwin Locke, “Leadership: Do Traits Matter?" Academy o f Management Executive 5, no. 2 (May 1991): 48.

13. Peter Drucker, Management Tasks, Responsibilities, and Practice (New York: Harper & Row, 1973), 463.

14. Brian Dumaine, “What the Leaders of Tomorrow See,” Fortune. July 3, 1989. 51.

15. J. Evans and B. Bergman, Marketing (New York: Macmillan, 1982), 17.

16. Spencer Ante. “As Economy Cools, IBM Furthers Focus on Marketers,” Wall Street Journal (July 18, 2012): B3.

17. Brad Stone, “See Your Friends,” Bloomberg Businessweek (September 27-October 3, 2010): 65-69.

18. Quoted in Robert Waterman. Jr., “The Renewal Factor,” BusinessWeek, September 14, 1987, 108.

19. http://en.wikipedia.org/wiki/Cost-benefit_analysis 20. J. Van Horne. Financial Management and Policy (Upper

Saddle River. N.J.: Prentice-Hall, 1974), 10. 21. Matt Krantz, “Today's Fat Dividends are Getting Even

Heftier,” Wall Street Journal (August 6. 2012): 3B. 22. http://en.wikipedia.org/wiki/Break-even_(economics). 23. Andrew Peaple, “Fiat's Struggle With Italian Job Threatens

American Promise,” Wall Street Journal (September 28, 2012): CIO.

24. Philip Rousebl. Kamal Saad. and Tamara Erickson, “The Evolution of Third Generation R&D.” Planning Review 19. no. 2 (March-April 1991): 18-26.

25. Vida Scarpello, William Boulton, and Charles Hofer, “Reintegrating R&D into Business Strategy,” Journal o f Business Strategy 6. no. 4 (Spring 1986): 50-51.

26. http://en.wikipedia.org/wiki/Benchmarking.

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224

The External Audit

CHAPTER OBJECTIVES After studying this chapter, you should be able to do the following:

1. Discuss the nature and role of labor unions in the USA as a corporate strategic issue.

2. Describe how to conduct an external strategic-management audit. 3. Discuss 10 major external forces that affect organizations: economic, social,

cultural, demographic, environmental, political, governmental, legal, technological, and competitive.

4. Describe key sources of external information. 5. Discuss important forecasting tools used in strategic management. 6. Discuss the importance of monitoring external trends and events. 7. Explain how to develop an EFE Matrix. 8. Explain how to develop a Competitive Profile Matrix. 9. Discuss the importance of gathering competitive intelligence.

10. Discuss market commonality and resource similarity in relation to competitive analysis.

A S S U R A N C E O F L E A R N IN G EXERCISES The following exercises are found at the end of this chapter.

e x e r c i s e 7A Michelin and Africa: An External Assessment

e x e r c i s e 7B Preparing a CPM for M ichelin Based on Countries Rather than Companies

e x e r c i s e 7C Develop Divisional M ichelin EFE Matrices

e x e r c i s e 7D Developing an EFE Matrix for adidas AG

e x e r c i s e 7E The Externa] Assessment

e x e r c i s e 7F Developing a CPM for Michelin

e x e r c i s e 7G Developing a CPM for adidas AG

e x e r c i s e 7H Analyzing Your College or University’s External Strategic Situation

226 CHAPTER 7 • THE EXTERNAL AUDIT

This chapter examines the tools and concepts needed to conduct an external strategic management audit (sometimes called environmental scanning or industry analysis). An external audit focuses on identilying and evaluating trends and events beyond the con­ trol of a single firm, such as increased foreign competition, population shifts to coastal areas of the USA, an aging society, and taxing Internet sales. An external audit reveals key opportunities and threats confronting an organization so that managers can formulate strategies to take advan­ tage of the opportunities and avoid or reduce the impact of threats. This chapter presents a prac­ tical framework for gathering, assimilating, and analyzing external information. The Industrial Organization (I/O) view of strategic management is introduced.

The Chapter 7 boxed insert company pursuing strategies based on an excellent external strategic analysis is Michelin.

The Nature of an External Audit The purpose of an external audit is to develop a finite list of opportunities that could ben­ efit a firm and threats that should be avoided. As the term fin ite suggests, the external audit is not aimed at developing an exhaustive list of every possible factor that could influence the business; rather, it is aimed at identifying key variables that offer actionable responses. Firms should be able to respond either offensively or defensively to the factors by formu­ lating strategies that take advantage of external opportunities or that minimize the impact of potential threats. Figure 7-1 illustrates with white shading how the external audit fits into the strategic-management process.

EXCELLENT STRATEGIC MANAGEMENT SHOWCASED

Michelin Michelin is a huge tire manufacturer headquartered in Clemont- Ferrand in the Auvergne region of France. A major rival is Bridgestone. Michelin owns BFGoodrich, Kleber, Riken, Komoran, and the Uniroyal tire brands, as well as the Warrior brand in China. Michelin produces more than 175 million tires annually for all kinds of vehicles, supplying new and replacement tires to the passenger car and truck markets. The company is also a world leader in aircraft and earthmover tires. Additionally, Michelin is also known in the culinary world for its Red Guide reference books and restaurant star awards. The company publishes about 10 million maps and travel guides per year.

In 2014, Michelin will bring to market two new enduro bicycle tires, reentering the bike racing business. To provide mountain bike riders with high-performance tires, Michelin has partnered with two famous bikers: Fabien Barel, three-time world downhill champion, and Pierre Edouard Ferry, free ride champion. These two bikers have worked closely with Michelin Group engineers for two and a half years to design and develop the new Michelin bike tires.

In late 2013, production began on the new Porsche 918 Spyder. Michelin will be the only tire supplier for this new hybrid supercar, of which only 918 units are being produced. Michelin's new Pilot Sport Cup 2 is the only tire certified for two new high-powered sports cars- the Ferrari 458 Speciale and the Porsche 918 Spyder. Michelin's Pilot Sport 3 tires are equip the new Peugeot 308, making that car more energy efficient while delivering outstanding safety, handling and longevity. For the Peugeot 208 HYbrid FE, Michelin developed a

range of Tall and Narrow tires with a longer rim di­ ameter and better performance.

In late 2013, Kepler Cheuvreux, Jean-Dom inique Senard, Chief Executive Officer of Michelin, revealed the six ma­ jor Michelin Performance and Responsibility objectives for 2020 (paraphrased):

1. Increase durability and effectiveness of our products by at least 10% compared with 2010, while using fewer raw materials to produce.

2. Become more environmentally friendly by improving the energy efficiency of our plants and reducing our carbon footprint.

3. Annually deliver €1 billion in structural free cash flow per year and generate at least a 15% return on capital.

4. Develop and implement programs to improve employee engage­ ment, well-being and development.

5. Deploy employee-driven outreach programs and create local jobs to continuously improve our public relations in communities.

6. Develop and promote improved recycling solutions to the extent possible.

Source: Based on the company website and press releases.

CHAPTER 7 • THE EXTERNAL AUDIT 227

Strategy __ I Evaluation

I____________________ Strategy ________________________ I________ Strategy ________ Formulation I Implementation

FIGURE 7-1 A Comprehensive Strategie-Management Model

Source: Fred R. David, adapted from “How Companies Define Their Mission,” Long Range Planning 22. no. 3 (June 1988): 40. © Fred R. David.

Key External Forces External forces can be divided into five broad categories: (1) economic forces; (2) social, cultural, demographic, and natural environment forces; (3) political, governmental, and legal forces; (4) tech­ nological forces; and (5) competitive forces. Relationships among these forces and an organization are depicted in Figure 7-2. External trends and events, such as rising food prices and people in African countries coming online, significantly affect products, services, markets, and organizations world­ wide. IMPORTANT NOTE: WHEN IDENTIFYING AND PRIORITIZING KEY EXTERNAL FACTORS IN STRATEGIC PLANNING, MAKE SURE THE FACTORS SELECTED ARE SPECIFIC. IE QUANTIFIED TO THE EXTENT POSSIBLE; PERHAPS MORE IMPORTANTLY MAKE SURE THE FACTORS SELECTED ARE ACTIONABLE. IE MEANINGFUL IN TERMS OF HAVING STRATEGIC IMPLICATIONS. For example, regarding actionable, to say “the stock market is rising” is not actionable because there is no apparent strategy that the firm could formulate to capitalize on that factor. In contrast, a factor such as “the GDP of Brazil is 6.8 percent” is action­ able because the firm should perhaps open 100 new stores in Brazil. In other words, select factors that will be helpful in deciding what to recommend the firm to do, rather than selecting nebulous factors.

Changes in external forces translate into changes in consumer demand for both industrial and consumer products and services. External forces affect the types of products developed.

228 CHAPTER 7 • THE EXTERNAL AUDIT

FIGURE 7-2 Relationships Between Key External Forces and an Organization

the nature of positioning and market segmentation strategies, ihe type of services offered, and the choice of businesses to acquire or sell. External forces directly affect both suppliers and distributors. Identifying and evaluating external opportunities and threats enables organizations to develop a clear mission, to design strategies to achieve long-term objectives, and to develop policies to achieve annual objectives.

The increasing complexity of business today is evidenced by more countries developing the capacity and will to compete aggressively in world markets. Foreign businesses and countries are willing to learn, adapt, innovate, and invent to compete successfully in the marketplace. There are more competitive new technologies in Asia today than ever before, as recently intro­ duced for example by Lenovo in China and Samsung in South Korea.

The Process of Performing an External Audit The process of performing an external audit must involve as many managers and employees as possible. As emphasized in Chapter 1 and Chapter 5, involvement in the strategic-management process can lead to understanding and commitment from organizational members. Individuals appreciate having the opportunity to contribute ideas and to gain a better understanding of their firm's industry, competitors, and markets.

To perform an external audit, a company first must gather competitive intelligence and information about economic, social, cultural, demographic, environmental, political, govern­ mental, legal, and technological trends. Individuals can be asked to monitor various sources of information, such as key magazines, trade journals, and newspapers. These persons can submit periodic scanning reports to a committee of managers charged with performing the external audit. This approach provides a continuous stream of timely strategic information and involves many individuals in the external-audit process. The Internet provides another source for gather­ ing strategic information, as do corporate, university, and public libraries. Suppliers, distribu­ tors, salespersons, customers, and competitors represent other sources of vital information.

Once information is gathered, it should be assimilated and evaluated. A meeting or series of meetings of managers is needed to collectively identify the most important opportunities and threats facing the firm. These key external factors should be listed on flip charts or a chalk­ board. A prioritized list of these factors could be obtained by requesting that all managers rank the factors identified, from 1 for the most important opportunity or threat to 20 for the least important opportunity or threat. These key external factors can vary over time and by industry. Relationships with suppliers or distributors are often a critical success factor. Other variables commonly used include market share, breadth of competing products, world economies, for­ eign affiliates, proprietary and key account advantages, price competitiveness, technological advancements, population shifts, interest rates, and pollution abatement.

CHAPTER 7 • THE EXTERNAL AUDIT 229

Freund emphasized that these key external factors should be (a) important to achieving long-term and annual objectives, (b) measurable, (c) applicable to all competing firms, and (d) hierarchical in the sense that some will pertain to the overall company and others will be more narrowly focused on functional or divisional areas. A final list of the most important key exter­ nal factors should be communicated and distributed widely in the organization. Both opportuni­ ties and threats can be key external factors.1

The Industrial Organization (I/O) View The Industrial Organization (I/O) approach to competitive advantage advocates that external (industry) factors are more important than internal factors in a firm for achieving competitive advantage. Proponents of the I/O view, such as Michael Porter, contend that organizational performance will be primarily determined by industry forces. Porter’s Five-Forces Model, presented later in this chapter, is an example of the I/O perspective, which focuses on ana­ lyzing external forces and industry variables as a basis for getting and keeping competitive advantage. Competitive advantage is determined largely by competitive positioning within an industry, according to I/O advocates. Managing strategically from the I/O perspective entails firms striving to compete in attractive industries, avoiding weak or faltering industries, and gaining a full understanding of key external factor relationships within that attractive industry. I/O research provides important contributions to our understanding of how to gain competitive advantage.

I/O theorists contend that external factors and the industry in which a firm competes has a stronger influence on the firm’s performance than do the internal functional issues in marketing, finance, and the like. Firm performance, they contend, is based more on industry properties such as economies of scale, barriers to market entry, product differentiation, the economy, and level of competitiveness than on internal resources, capabilities, structure, and operations. The USA’s recent economic recovery having such a positive impact on both strong and weak firms adds credence to the notion that external forces are more important than internal.

The I/O view has enhanced the understanding of strategic management. However, it is not a question of whether external or internal factors are more important in gaining and maintaining competitive advantage. Effective integration and understanding o f both external and internal fac­ tors is the key to securing and keeping a competitive advantage. In fact, as discussed in Chapter 8. matching key external opportunities and threats with key internal strengths and weaknesses pro­ vides the basis for successful strategy formulation.

Economic Forces The lingering high underemployment rate in the USA bodes well for discount firms ranging from Dollar Tree to TJ Maxx to Walmart to Subway, but hurts thousands of traditional priced retailers in many industries. The Dow Jones Industrial Average is over 15,000, corporate profits are high, dividend increases are up sharply, and emerging markets are growing. Yet. job growth is still stymied, home prices remain low. and millions of people work for minimum wages or are either unemployed or underemployed. As a result of droughts, commodity prices are up sharply, especially food, which is contributing to rising inflation fears. Many firms are switching to the extent possible to part-time rather than full-time employees to avoid having to pay health ben­ efits. Consumer spending is rebounding. Much of Europe lingers in a recession.

Economic factors have a direct impact on the potential attractiveness of various strate­ gies. For example, with interest rates, funds needed for capital expansion are less costly. As interest rates rise, discretionary income declines, and the demand for discretionary goods falls. When stock prices increase, the desirability of equity as a source of capital for market development increases. When the market rises, consumer and business wealth expands. A summary of economic variables that often represent opportunities and threats for organiza­ tions is provided in Table 7-1.

To take advantage of Canada’s robust economy and eager-to-spend people, many firms are aggressively expanding operations into Canada, including TJX opening many Marshalls stores, Target opening stores, Walmart opening supercenters, and Tanger Outlet Factory Centers

230 CHAPTER 7 • THE EXTERNAL AUDIT

T A B LE 7-1 Key Economic Variables to Be Monitored

Shift to a service economy in the USA import/export factors Availability of credit Demand shifts for different categories of goods Level of disposable income and services Propensity of people to spend Income differences by region and consumer groups Interest rates Price fluctuations Inflation rates Export of labor and capital from the USA Money market rates Monetary policies Federal government budget deficits Fiscal policies Gross domestic product trend Tax rates Consumption patterns European Economic Community (EEC) policies Unemployment trends Organization of Petroleum Exporting Countries Worker productivity levels (OPEC) policies

Value of the dollar in world markets Coalitions of Lesser Developed Countries

Stock market trends (LDC) policies

Foreign countries7 economic conditions

opening new stores. “Canada is one of the most economically prosperous countries in the world,” said Howard Davidowitz, chairman of Davidowitz & Associates, a retail consultancy and investment banking firm. “It has a stable currency, it did not have a banking crisis and it did not spend itself into insanity.”

Trends in the dollar’s value have signilicant and unequal effects on companies in different industries and in different locations. For example, the pharmaceutical, tourism, entertainment, motor vehicle, aerospace, and forest products industries benefit greatly when the dollar falls against the yen and euro. Agricultural and petroleum industries are hurt by the dollar’s rise againsi the currencies of Mexico, Brazil, Venezuela, and Australia. Generally, a strong or high dollar makes U.S. goods more expensive in overseas markets. This worsens the U.S. trade defi­ cit. When the value of the dollar falls, tourism-oriented firms benefit because Americans do not travel abroad as much when the value of the dollar is low; rather, foreigners visit and vacation more in the United Stales.

A low value of the dollar means lower imports and higher exports; it helps U.S. companies’ competitiveness in world markets. A falling dollar makes U.S. goods cheaper to foreign consum­ ers and combats deflation by pushing up prices of imports. A low value of the dollar benefits the U.S. economy in many ways. First, it helps stave off the risks of deflation in the USA and also reduces the U.S. trade deficit. In addition, a low value of the dollar raises the foreign sales and profits of domestic firms, thanks to dollar-induced gains, and encourages foreign countries to low'er interest rates and loosen fiscal policy, which stimulates worldwide economic expansion. Some sectors, such as consumer staples, energy, materials, technology, and health care, especially benefit from a low value of the dollar. Manufacturers in many domestic industries in fact benefit because of a weak dollar, which forces foreign rivals to raise prices and extinguish discounts. Domestic firms w'ith big overseas sales, such as McDonald’s, greatly benefit from a weak dollar. Table 7-2 lists some advantages and disadvantages of a weak U.S. dollar for U.S. firms.

In contrast to rivals Nissan Motor and Honda Motor. Mazda Motor Corp. based in Hiroshima, Japan, has a strategy to produce more than 80 percent of its vehicles in Japan and export them rather than building manufacturing plants globally. Even if the value of the dollar weakens to 77 yen. Mazda says it can make a profit on its CX-5 vehicles. But with the dollar at 79 yen, Honda and Nissan say they must keep moving production abroad and will do so until or unless the dollar climbs back to at least 100 yen. Thus, value of the dollar versus the Japanese yen is an important factor in strategic planning among Japanese firms.

The value of the dollar changes some every day, but generally in 2012-2013 the value of the dollar was strong and thus profits of U.S. companies with revenue from abroad were lowered on average 6 to 7 percent. WThy the lowered profits? Because, for example. 100 euros earned in Europe, when translated back to U.S. dollars for reporting purposes, the 100 euros is worth

CHAPTER 7 • THE EXTERNAL AUDIT 231

T A B LE 7-2 Advantages and Disadvantages of a Weak Dollar for Domestic Firms

Advantages Disadvantages

1. Leads to more exports 1. Can lead to inflation 2. Leads to lower imports 2. Can cause rise in oil prices 3. Makes U.S. goods cheaper to foreign 3. Can weaken U.S. government

consumers 4. Makes it unattractive for Americans to travel 4. Combats deflation by pushing up prices globally

of imports 5. Can contribute to fall in stock prices 5. Can contribute to rise in stock prices in in long run

short run 6. Encourages foreign countries to lower

interest rates 7. Raises the revenues and profits of firms

that do business outside the USA 8. Forces foreign firms to raise prices 9. Reduces the U.S. trade deficit

10. Encourages firms to globalize 11. Encourages foreigners to visit the

United States

maybe $75. To combat ihis “loss,” some companies try to raise prices in their European or Mexican stores, but that carries a risk of alienating shoppers, angering retailers, and giving local competitors a price edge. Some advantages of a strong dollar however are that companies with substantial outside U.S. operations see their overseas expenses, such as salaries paid in euros, become cheaper. Another advantage of a strong dollar is that it gives U.S. companies greater firepower for international acquisitions. Another advantage of a strong dollar is that companies that import benefit from greater buying power because their dollars now go further overseas.

A recent Wall Street Journal article (l 2-4-12, B4) explains the unfavorable foreign- exchange rate environment plaguing U.S. firms. For example, the starch and sweetener maker Ingredion Inc.’s earnings were reduced by 20 cents per share recently by weakness in the Brazilian real, Argentine peso, British pound, and the euro. Similarly, General Motors reported that its third quarter 2012 sales were reduced by about $1.3 billion as a result of weakness in the European euro, Russian ruble, Hungarian forint, South Korean won. South African rand, Canadian dollar, and Mexican pesos.

Social, Cultural, Demographic, and Natural Environment Forces Asian Americans are now the best-educated, highest-earning, and fastest-growing racial group in the United States.2 The number of Asian Americans in the United States grew by 46 percent between 2000 and 2010, with Chinese Americans becoming by far the largest group. The me­ dian U.S. household income is $49.8K, with Asian American’s median being $66K, compared to whites S54K, Hispanics $40K, and African Americans $33.3K.3

The U.S. Fish and Wildlife Service reported in late 2012 that 11 percent more Americans (ages 16 and older) fished and 9 percent more hunted in 2011 than in 2006. The report also revealed that among children aged 6 to 15, 13 percent more hunted and 2 percent more fished during the same period. A variety of reasons account for the shift back to “doing outdoor things,” but this trend is excellent news for thousands of sporting goods companies.

Social, cultural, demographic, and environmental changes have a major impact on virtually all products, services, markets, and customers. Small, large, for-profit, and nonprofit organizations in all industries are being staggered and challenged by the opportunities and threats arising from changes in social, cultural, demographic, and environmental variables. In every way, the United States is much different today than it was yesterday, and tomorrow promises even greater changes.

232 CHAPTER 7 • THE EXTERNAL AUDIT

The USA is getting older and less white. The oldest among the 76 million baby boomers in the USA plan to retire soon, and this has lawmakers and younger taxpayers deeply concerned about who will pay their Social Security, Medicare, and Medicaid. Individuals age 65 and older in the USA as a percentage of the population, will rise to 18.5 percent by 2025. The oldest USA veteran is Richard Everton of East Austin. Texas, who is 108; the oldest USA woman is 114. Teralean Talley of Inkster, Michigan.

By 2075, the USA will have no racial or ethnic majority. This forecast is aggravating ten­ sions over issues such as immigration and affirmative action. Hawaii, California, and New Mexico already have no majority race or ethnic group

The population of the world recently surpassed 7 billion; the USA has slightly more than 310 million people. That leaves billions of people outside the USA who may be interested in the products and services produced through domestic firms. Remaining solely domestic is an increasingly risky strategy, especially as the world population continues to grow to an estimated 8 billion in 2028 and 9 billion in 2054.

Social, cultural, demographic, and environmental trends are shaping the way Americans live, work, produce, and consume. New trends are creating a different type of consumer and, consequently, a need for different products, different services, and different strategies. There are now more U.S. households with people living alone or with unrelated people than there are households consisting of married couples with children. U.S. households are making more and more purchases online.

The trend toward an older USA is good news for restaurants, hotels, airlines, cruise lines, tours, resorts, theme parks, luxury products and services, recreational vehicles, home builders, fur­ niture producers, computer manufacturers, travel services, pharmaceutical firms, automakers, and funeral homes. Older Americans are especially interested in health care, financial services, travel, crime prevention, and leisure. The world’s longest-living people are the Japanese, with Japanese women living to 86.3 years and men living to 80.1 years on average. By 2050, the Census Bureau projects that the number of Americans age 100 and older will increase to over 834,000 from just under 100,000 centenarians in the USA in 2000. Americans age 65 and over will increase from 12.6 percent of the U.S. population in 2000 to 20.0 percent by the year 2050. The aging U.S. popu­ lation affects the strategic orientation of nearly all organizations.

The historical trend of people moving from the Northeast and Midwest to the Sunbelt and West has dramatically slowed. Hard number data related to this trend can represent key oppor­ tunities for many firms and thus can be essential for successful strategy formulation, including where to locate new plants and distribution centers and where to focus marketing efforts.

A summary of important social, cultural, demographic, and environmental variables that represent opportunities or threats for virtually all organizations is given in Table 7-3.

Political, Governmental, and Legal Forces Figure 7-3 reveals the USA county-by-county presidential election results for the 2012 Barack Obama versus Mitt Romney election, with the red being Republican and the blue being Democratic. The red indicates counties that had a Republican majority vote result, but much of this land is sparsely inhabited. President Obama and the Democrats won both the popular vote and the Electoral College count. Various industries, such as aerospace, and all their supplier firms, typically support and lobby for Republicans, whereas other industries, such as automo­ tive and all their supplier firms, generally support Democrats. National, state, and local elections impact businesses, with ongoing healthy debate concerning the pros and cons of each party’s agenda for business. Should firms take stances on political issues?

Political issues and stances do matter for business, especially in today’s world of instant tweeting and e-mailing. For example. Starbucks’ recent support of same-sex marriage in its home state of Washington was praised by a number of prominent rights activists. Maine, Maryland, Minnesota, Washington, Massachusetts, New York. California, and a few other states all allow same-sex marriage. But the Seattle-based coffee chain’s outspoken oppo­ nents, such as the National Organization for Marriage (NOM), has vowed to make Starbucks (along with other companies that support same-sex marriage) pay a "price’' for this stance. “Middle Eastern countries are hostile to lesbian, gay. bisexual and transgender (LGBT)

CHAPTER 7 • THE EXTERNAL AUDIT 233

TA B LE 7-3 Key Social, Cultural, Demographic, and Natural Environment Variables

Childbearing rates Attitudes toward retirement Number of special-interest groups Attitudes toward leisure time Number of marriages Attitudes toward product quality Number of divorces Attitudes toward customer serv ice Number of births Pollution control Number of deaths Altitudes toward foreign peoples Immigration and emigration rates Energy conservation Social Security programs Social programs Life expectancy rates Number of churches Per capita income Number of church members Location of retailing, manufacturing. Social responsibility

and service businesses Attitudes toward careers Attitudes toward business Population changes by race, age, sex. Lifestyles and level of affluence Traffic congestion Attitudes toward authority Inner-city environments Population changes by city, county, Average disposable income state, region, and country Trust in government Value placed on leisure time Attitudes toward government Regional changes in tastes and preferences Attitudes toward work Number of women and minority workers Buying habits Number of high school and college Ethical concerns graduates by geographic area

Attitudes toward saving Recycling

Sex roles Waste management

Attitudes toward investing Air pollution

Racial equality Water pollution

Use of birth control Ozone depletion

Average level of education Endangered species

Government regulation

rights. So for example, in Qatar, in the Middle East, we've begun working to make sure that there’s some price to be paid for this,’’ Brian Brown of the NOM said. “These are not coun­ tries that look kindly on same-sex marriage. And this is where Starbucks wants to expand, as well as India.” In essence, the question needs to be asked, should firms take stances on contentious social issues?

Beginning in 2014, U.S. businesses will have to offer workers a minimum level in medi­ cal insurance or pay a penalty starting at S2,000 for each worker. This is part of the so-called Obamacare legislation. So, thousands of U.S. businesses, such as Pillar Hotels & Resorts, are transitioning to having a larger percentage of their workforce being comprised of part-time workers rather than full-time employees. Pillar Hotels owns Sheraton. Fairfield Inns, Hampton Inns, and Holiday Inns.

A political debate still rages in the USA regarding sales taxes on the Internet. Walmart, Target, and other large retailers are pressuring state governments to collect sales taxes from Amazon.com. Big brick-and-mortar retailers are backing a coalition called the Alliance for Main Street Fairness, which is leading political efforts to change sales-tax laws in more than a dozen states. Walmart’s executive Raul Vazquez says, “The rules today don't allow brick-and-mortar retailers to compete evenly with online retailers, and that needs to be addressed.”

Federal, state, local, and foreign governments are major regulators, deregulators, subsidizers, employers, and customers of organizations. Political, governmental, and legal factors, therefore, can represent key opportunities or threats for both small and large organizations. Political unrest in the Middle East threatens to raise oil prices globally, which could cause inflation. The political

234 CHAPTER 7 • THE EXTERNAL AUDIT

FIGURE 7-3 County-by County USA 2012 Presidential Results (red = Republican; blue = Democrat)

overthrow of monarchies in Egypt, Tunisia, Yemen, and Libya has spread to Syria and even Turkey because people in all nations desire liberty and freedom rather than oppression and suppression.

For industries and firms that depend heavily on government contracts or subsidies, political forecasts can be the most important part of an external audit. Changes in patent laws, antitrust legislation, tax rates, and lobbying activities can affect firms significantly. The increasing global interdependence among economies, markets, governments, and organizations makes it impera­ tive that firms consider the possible impact of political variables on the formulation and imple­ mentation of competitive strategies.

The Marketplace Fairness Act (MFA) in the U.S. Senate and the Marketplace Equity Act (MEA) in the U.S. House are likely to pass in 2013. basically reversing the 1992 Supreme Court decision exempting many online retailers from collecting state sales taxes unless they had a physical presence in the state, such as a warehouse. But as online sales boom, states continue to suffer severe budget shortfalls and brick-and-mortar companies cannot compete with online firms, so legislation to tax online sales is expected to pass soon.

Many countries worldwide are resorting to protectionism to safeguard their own industries. European Union (EU) nations, for example, have tightened their own trade rules and resumed subsidies for various of their own industries while barring imports from certain other countries. The EU recently restricted imports of U.S. chicken and beef. India is increasing tariffs on for­ eign steel. Russia perhaps has instituted the most protectionist measures by raising tariffs on most imports and subsidizing its own exports. Russia even imposed a new toll on trucks from the EU, Switzerland, and Turkmenistan. Despite these measures taken by other countries, the USA has largely refrained from "Buy American” policies and protectionist measures, although there are increased tariffs on French cheese and Italian water. Many economists say trade constraints will make it harder for global economic growth.

Labor Unions The extent that a state is unionized can be a significant political factor in strategic planning deci­ sions as related to manufacturing plant location and other operational matters. The size of U.S. labor unions has fallen sharply in the last decade as a result in large part of erosion of the U.S. manufacturing base.

CHAPTER 7 • THE EXTERNAL AUDIT 235

Huge declines of late in receipts of federal, state, and municipal governments has contrib­ uted to a sharp decline in the membership of public-sector unions. Organized public-sector labor issues are being debated in many state legislatures. State governments seek concessions, the most drastic of which may be the abolition of collective bargaining rights. Wisconsin recently passed a law eliminating most collective-bargaining rights for the state’s public-employee unions. That law sets a precedent that many other states may follow to curb union rights as a way to help state budgets become solvent. Ohio is close to passing a similar bill curbing union rights for 400,(XX) public workers.

According to the U.S. Bureau of Labor Statistics, the union membership rate (the percent of wage and salary workers who were members of a union) in the USA was 11.8 percent in 2011, down slightly from 11.9 percent the prior year. The number of wage and salary workers belong­ ing to unions, at 14.8 million, also showed little movement over the year. By comparison, in 1983, the union membership rate was 20.1 percent and there were 17.7 million union workers. Highlights from the Bureau’s 2011 data are as follows:

• Public-sector workers had a union membership rate (37.0 percent) more than five times higher than that of private-sector workers (6.9 percent).

• Workers in education, training, and library occupations had the highest unionization rate, at 36.8 percent, whereas the lowest rate occurred in sales and related occupations (3.0 percent).

• Black workers were more likely to be union members than were white, Asian, or Hispanic workers.

• Among states. New York continued to have the highest union membership rate (24.1 percent) and North Carolina again had the low'est rate (2.9 percent).

In Europe. German-based Lufthansa AG recently cancelled two-thirds of its airline flights as a result of an anticipated strike by its cabin crew. The union UFO represents 18,000 Lufthansa cabin-crew members who want higher wages, but Lufthansa says their average flight attendant’ salary is 52.492 euros compared with 23,680 euros at rival firm Air Berlin PLC. Similarly, British Airways recently was hammered by the cabin-crew union Unite, costing the airline about $250 million.

Local, state, and federal laws; regulatory agencies; and special-interest groups can have a major impact on the strategies of small, large, for-profit, and nonprofit organizations. Many companies have altered or abandoned strategies in the past because of political or governmental actions. In the academic world, as state budgets have dropped in recent years, so too has state sup­ port for colleges and universities. Resulting from the decline in monies received from the state, many institutions of higher learning are doing more fund-raising on their own—naming build­ ings and classrooms, for example, for donors. A summary of political, governmental, and legal variables that can represent key opportunities or threats to organizations is provided in Table 7-4.

TA B LE 7-4 Some Political, Governmental, and Legal Variables

Government regulations or deregulations Changes in tax laws Special tariffs Political action committees Voter participation rates Number, severity, and location of

government protests Number of patents Changes in patent laws Environmental protection laws Level of defense expenditures Legislation on equal employment Level of government subsidies Antitrust legislation

Sino American relationships Russian American relationships European American relationships African American relationships Import-export regulations

Government fiscal and monetary' policy changes Political conditions in foreign countries Special local, state, and federal laws Lobbying activities Size of government budgets World oil. currency, and labor markets Location and severity of terrorist activities Local, state, and national elections

236 CHAPTER 7 • THE EXTERNAL AUDIT

Technological Forces The Internet has changed the nature of opportunities and threats by altering the life cycles of products, increasing the speed of distribution, creating new products and services, erasing limitations of traditional geographic markets, and changing the historical trade-off between production standardization and flexibility. The Internet has lowered entry barriers and redefined the relationship between industries and various suppliers, creditors, customers, and competitors.

Papa John’s International a few years ago received more than 50 percent of all its pizza or­ ders through its website, up from 30 percent in 201 1 and far more than the industry average of 10 percent. Technology is a key to Papa John’s success as it strives to compete with Domino’s Pizza and Pi/./.a Hut. Papa John’s new website is interactive, where customers can see a pic­ ture of their pizza as they decide upon loppings. Papa John’s new loyalty program, called Papa Points, is promoted heavily through its new website.

Google’s Nexus 7 tablet computer and Apple’s iPhone 5 released in late 2012 worldwide provide a reminder of the kind of competition that has left Japan's consumer electronics makers struggling to survive. Japanese firms such as Sony Corp., Panasonic Corp. and Sharp Corp. once dominated the electronics business. Sharp’s new restructuring plan involves the firm cutting more than 10,000jobs, cutting wages, and selling plants in Mexico, China, and Malaysia.

According to media consultant BIA/Kelsey. small and midsize businesses in the USA spent about $1.3 billion in 2011 on online reputation management tools and services. Those figures grew to about $1.6 billion in 2012 and are expected to grow to $2.5 billion by 2016 according to the firm. Further, the firm says about 57 percent of small and midsize businesses in the USA monitor online content about their businesses, with 71 percent using free, do-ii- yourself software. In general, monitoring of online reviews about your business, large or small, has become a burdensome but an essential task, especially given emergence of social-media channels, such as Twitter, that empowers opinionated customers. Research is clear that benign neglect of a company’s online reputation could quickly hurl sales, especially given the new normal behavior of customers consulting their smartphones for even the smallest of purchases.

To effectively capitalize on e-commerce, a number of organizations are establishing two new positions in their firms: chief information officer (CIO) and chief technology officer (CTO). This trend reflects the growing importance of information technology (IT) in strategic management. A CIO and CTO work together to ensure that information needed to formulate, im­ plement, and evaluate strategies is available where and when ii is needed. These individuals are responsible for developing, maintaining, and updating a company’s information database. The CIO is more a manager, managing the firm’s relationship with stakeholders; the CTO is more a technician, focusing on technical issues such as data acquisition, data processing, decision- support systems, and software and hardware acquisition.

Technological forces represent major opportunities and threats that must be considered in for­ mulating strategies. Technological advancements can dramatically affect organizations' products, services, markets, suppliers, distributors, competitors, customers, manufacturing processes, market­ ing practices, and competitive position. Technological advancements can create new markets, result in a proliferation of new and improved products, change the relative competitive cost positions in an industry, and render existing products and services obsolete. Technological changes can reduce or eliminate cost barriers between businesses, create shorter production runs, create shortages in technical skills, and result in changing values and expectations of employees, managers, and cus­ tomers. Technological advancements can create new competitive advantages that are more powerful than existing advantages. No company or industry today is insulated against emerging technological developments. In high-tech industries, identification and evaluation of key technological opportuni­ ties and threats can be the most important part of the external strategic-management audit.

Organizations that traditionally have limited technology expenditures to what they can fund after meeting marketing and financial requirements urgently need a reversal in thinking. The pace of technological change is increasing and literally wiping out businesses every day. An emerging consensus holds that technology management is one of the key responsibilities of strategists. Firms should pursue strategies that take advantage of technological opportunities to achieve sustainable, competitive advantages in the marketplace.

In practice, critical decisions about technology too often are delegated to lower organizational levels or are made without an understanding of their strategic implications. Many strategists spend

CHAPTER 7 • THE EXTERNAL AUDIT 237

countless hours determining market share, positioning products in terms of features and price, forecasting sales and market size, and monitoring distributors; yet too often, technology does not receive the same respect.

Not all sectors of the economy are affected equally by technological developments. The communications, electronics, aeronautics, and pharmaceutical industries are much more volatile than the textile, forestry, and metals industries.

Competitive Forces An important part of an external audit is identifying rival firms and determining their strengths, weaknesses, capabilities, opportunities, threats, objectives, and strategies. George Salk said: "If you’re not faster than your competitor, you’re in a tenuous position, and if you’re only half as fast, you’re terminal."

Collecting and evaluating information on competitors is essential for successful strategy formulation. Identifying major competitors is not always easy because many firms have divi­ sions that compete in different industries. Many multidivisional firms do not provide sales and profit information on a divisional basis for competitive reasons. Also, privately-held firms do not publish any financial or marketing information. Addressing questions about competitors such as those presented in Table 7-5 is important in performing an external audit.

Competition in virtually all industries can be described as intense—and sometimes as cut­ throat. For example, Walgreens and CVS pharmacies are located generally across the street from each other and battle each other every day on price and customer service. Most automobile deal­ erships also are located close to each other. Dollar General, based in Goodlettsville. Tennessee, and Family Dollar, based in Matthews, North Carolina, compete intensely on price to attract customers away from each other and away from Walmart.

Seven characteristics describe the most competitive companies:

1. Strive to continually increase market share. 2. Use the vision/mission as a guide for all decisions. 3. Realize that the old adage "if it’s not broke, don't fix it” has been replaced by “whether

its broke or not. fix it;” in other words, continually strive to improve everything about the firm

4. Continually adapt, innovate, improve - especially when the firm is successful. 5. Strive to grow through acquisition whenever possible 6. Hire and retain the best employees and managers possible 7. Strive to stay cost-competitive on a global basis.5

TABLE 7-5 Key Questions About Competitors

1. What are the major competitors’ strengths? 2. What are the major competitors’ weaknesses? 3. What are the major competitors’ objectives and strategies? 4. How will the major competitors most likely respond to current economic, social, cultural,

demographic, environmental, political, governmental, legal, technological, and competitive trends affecting our industry?

5. How vulnerable arc the major competitors to our alternative company strategies? 6. How vulnerable are our alternative strategies to successful counterattack by our major

competitors? 7. How are our products or services positioned relative to major competitors? 8. To what extent are new firms entering and old firms leaving this industry? 9. What key factors have resulted in our present competitive position in this industry?

10. How have the sales and profit rankings of major competitors in the industry changed over recent years? Why have these rankings changed that way?

11. What is the nature of supplier and distributor relationships in this industry? 12. To what extent could substitute products or services be a threat to competitors in this industry?

238 CHAPTER 7 • THE EXTERNAL AUDIT

Competitive Intelligence Programs What is competitive intelligence? Competitive intelligence (Cl), as formally defined by the Society of Competitive Intelligence Professionals (SCIP), is a systematic and ethical process for gathering and analyzing information about the competition’s activities and general business trends to further a business’s own goals (SCIP website).

Good competitive intelligence in business, as in the military, is one of the keys to success. The more information and knowledge a firm can obtain about its competitors, the more likely it is that it can formulate and implement effective strategies. Major competitors’ weaknesses can represent external opportunities; major competitors’ strengths may represent key threats.

Various legal and ethical ways to obtain competitive intelligence include the following:

• Hire top executives from rival firms • Reverse engineer rival firms’ products • Use surveys and interviews of customers, suppliers, and distributors • Conduct drive by and on-site visits to rival firm operations • Search online databases • Contact government agencies for public information about rival firms • Systematically monitor relevant trade publications, magazines, and newspapers • Include gathering competitive intelligence in the job description of salespersons

Many U.S. executives grew up in times when U.S. firms dominated foreign competitors so much that gathering Cl did not seem worth the effort. Too many of these executives still cling to these attitudes—to the detriment of their organizations today. Even most MBA programs do not offer a course in competitive and business intelligence, thus reinforcing this attitude. As a consequence, three strong misperceptions about business intelligence prevail among U.S. executives today:

1. Running an intelligence program requires lots of people, computers, and other resources.

2. Collecting intelligence about competitors violates antitrust laws; business intelligence equals espionage.

3. Intelligence gathering is an unethical business practice.6

Any discussions with a competitor about price, market, or geography intentions could violate antitrust statutes. However, this fact must not lure a firm into underestimating the need for and benefits of systematically collecting information about competitors for strategic planning purposes. The Internet is an excellent medium for gathering Cl. Information gather­ ing from employees, managers, suppliers, distributors, customers, creditors, and consultants also can make the difference between having superior or just average intelligence and overall competitiveness.

Firms need an effective Cl program. The three basic objectives of a Cl program are (1) to pro­ vide a general understanding of an industry and its competitors, (2) to identify areas in which com­ petitors are vulnerable and to assess the impact strategic actions would have on competitors, and (3) to identify potential moves that a competitor might make that would endanger a firm’s position in the market.7 Competitive information is equally applicable for strategy formulation, implementa­ tion, and evaluation decisions. An effective Cl program allows all areas of a firm to access consistent and verifiable information in making decisions. All members of an organization—from the CEO to custodians—are valuable intelligence agents and should feel themselves to be a part of the Cl pro­ cess. Special characteristics of a successful Cl program include flexibility, usefulness, timeliness, and cross-functional cooperation.

The increasing emphasis on competitive analysis in the USA is evidenced by corpora­ tions putting this function on their organizational charts under job titles such as Director of Competitive Analysis, Competitive Strategy Manager, Director of Information Services, or Associate Director of Competitive Assessment. The responsibilities of a director of com­ petitive analysis include planning, collecting data, analyzing data, facilitating the process of gathering and analyzing data, disseminating intelligence on a timely basis, researching special issues, and recognizing what information is important and who needs to know. Cl is not corpo­ rate espionage because 95 percent of the information a company needs to make strategic deci­ sions is available and accessible to the public. Sources of competitive information include trade

CHAPTER 7 • THE EXTERNAL AUDIT 239

journals, want ads, newspaper articles, and government filings, as well as customers, suppliers, distributors, competitors themselves, and the Internet.

Unethical tactics such as bribery, wiretapping, and computer hacking should never be used to obtain information. All the information you could wish for can be collected without resorting to unethical tactics.

Market Commonality and Resource Similarity By definition, competitors are firms that offer similar products and services in the same market. Markets can be geographic or product areas or segments. For example, in the insurance industry the markets are broken down into commercial/consumer, health/life, or Europe/Asia. Researchers use the terms market commonality and resource similarity to study rivalry among competitors. Market commonality can be defined as the number and significance of markets that a firm com­ petes in with rivals.8 Resource similarity is the extent to which the type and amount of a firm’s internal resources are comparable to a rival.9 One way to analyze competitiveness between two or among several firms is to investigate market commonality and resource similarity issues while looking for areas of potential competitive advantage along each firm’s value chain.

Competitive Analysis: Porter’s Five-Forces Model Wayne Calloway said: '‘Nothing focuses the mind better than the constant sight of a competitor that wants to wipe you off the map.” As illustrated in Figure 7-4. Porter’s Five-Forces Model of com­ petitive analysis is a widely used approach for developing strategies in many industries. The inten­ sity of competition among firms varies widely across industries. Table 7-6 reveals the average gross profit margin and earnings per share for firms in different industries. Note the substantial variation among industries. For example, note that industry profit margins range from 20.5 to 2.3 percent, whereas industry return on equity (ROE) values range from 23.2 to 8.9. Note that bookstores have the lowest average profit margin (2.3). which implies fierce competition in that industry. Intensity of competition is highest in lower-retum industries. The collective impact of competitive forces is so brutal in some industries that the market is clearly “unattractive” from a profit-making standpoint. Rivalr> among existing firms is severe, new rivals can enter the industry' with relative ease, and both suppliers and customers can exercise considerable bargaining leverage. According to Porter, the na­ ture of competitiveness in a given industry can be viewed as a composite of five forces:

1. Rivalry among competing firms 2. Potential entry of new competitors 3. Potential development of substitute products 4. Bargaining power of suppliers 5. Bargaining power of consumers

Potential development of substitute products

Bargaining power o f suppliers Rivalry among competing firms Bargaining power of consumers

Potential entry o f new competitors

FIGURE 7-4 The Five-Forces Model of Competition

240 CHAPTER 7 • THE EXTERNAL AUDIT

T A B LE 7-6 Competitiveness Across a Few Industries (late 2013 data)

Profit Margin (%) EPS ($)

Pharmaceutical 20.5 20.3 Telecommunications 8.0 14.1 Fragrances/Cosmetics 9.8 22.6 Banking 16.1 8.9 Bookstores 2.3 10.5 Food Manufacturers 6.6 19.3 Oil and Gas 6.1 15.7 Airlines 2.5 23.2 Machinery/Construction 7.2 21.6 Paper Products 7.6 10.6

Source: Based on information at www.finance.yahoo.com retrieved on May 10, 2011.

The following three steps for using Porter’s Five-Forces Model can indicate whether com­ petition in a given industry is such that the firm can make an acceptable profit:

1. Identify key aspects or elements of each competitive force that impact the firm. 2. Evaluate how strong and important each element is for the firm. 3. Decide whether the collective strength of the elements is worth the firm entering or staying

in the industry.

Rivalry Among Competing Firms Rivalry among competing firms is usually the most powerful of the five competitive forces. The strategies pursued by one firm can be successful only to the extent that they provide competitive advantage over the strategies pursued by rival firms. Changes in strategy by one firm may be met with retaliatory countermoves, such as lowering prices, enhancing quality, adding features, providing services, extending warranties, and increasing advertising.

The intensity of rivalry among competing firms tends to increase as the number of com­ petitors increases, as competitors become more equal in size and capability, as demand for the industry’s products declines, and as price cutting becomes common. Rivalry also increases when consumers can switch brands easily; when barriers to leaving the market are high; when fixed costs are high; when the product is perishable; when consumer demand is growing slowly or de­ clines such that rivals have excess capacity or inventory; when the products being sold are com­ modities (not easily differentiated, such as gasoline); when rival firms are diverse in strategies, origins, and culture; and when mergers and acquisitions are common in the industry. As rivalry among competing firms intensifies, industry profits decline, in some cases to the point where an industry becomes inherently unattractive. When rival firms sense weakness, typically they will intensify both marketing and production efforts to capitalize on the “opportunity." Table 7-7 summarizes conditions that cause high rivalry among competing firms.

Potential Entry of New Competitors Whenever new firms can easily enter a particular industry, the intensity of competitiveness among firms increases. Barriers to entry, however, can include the need to gain economics of scale quickly, the need to gain technology and specialized know-how, the lack of experience, strong customer loyalty, strong brand preferences, large capital requirements, lack of adequate distribution channels, government regulatory policies, tariffs, lack of access to raw materials, possession of patents, undesirable locations, counterattack by entrenched firms, and potential saturation of the market.

Despite numerous barriers to entry, new firms sometimes enter industries with higher- quality products, lower prices, and substantial marketing resources. The strategist’s job. there­ fore, is to identify potential new firms entering the market, to monitor the new rival firms’ strategies, to counterattack as needed, and to capitalize on existing strengths and opportunities.

CHAPTER 7 • THE EXTERNAL AUDIT 241

1. High number of competing firms 2. Similar size of firms competing 3. Similar capability of firms competing 4. Falling demand for the industry’s products 5. Falling product or service prices in the industry

6. When consumers can switch brands easily 7. WTien barriers to leaving the market are high

8. When barriers to entering the market are low 9. When fixed costs are high among firms competing

10. When the product is perishable 11. When rivals have excess capacity 12. When consumer demand is falling 13. When rivals have excess inventory 14. When rivals sell similar products/services 15. When mergers are common in the industry

T A B LE 7-7 Conditions That Cause High Rivalry Am ong Competing Firms

When the threat of new firms entering the market is strong, incumbent firms generally fortify their positions and take actions to deter new entrants, such as lowering prices, extending warran­ ties, adding features, or offering financing specials.

Walt Disney is rapidly building its Shanghai Disneyland $4.4 billion complex set to open in China in 2016, complete with hotels, restaurants, retail shops and other amenities. However, a rival firm, DreamWorks Animation SKG, is now building a $3.1 billion entertainment district named Dream Center in Shanghai right beside Disneyland and says its facility will also open in 2016. Although expensive to build, theme parks are becoming more popular globally. Time Warner’s Warner Brothers is building Harry Potter attractions around the world, including a con­ verted movie studio outside London.

Potential Development of Substitute Products In many industries, firms are in close competition with producers of substitute products in other industries. Examples are plastic container producers competing with glass, paperboard, and alu­ minum can producers, and acetaminophen manufacturers competing with other manufacturers of pain and headache remedies. The presence of substitute products puts a ceiling on the price that can be charged before consumers will switch to the substitute product. Price ceilings equate to profit ceilings and more intense competition among rivals. Producers of eyeglasses and contact lenses, for example, face increasing competitive pressures from laser eye surgery. Producers of sugar face similar pressures from artificial sweeteners. Newspapers and magazines face substitute-product competitive pressures from the Internet and 24-hour cable television. The magniuide of competitive pressure derived from the development of substitute products is generally evidenced by rivals’ plans for expanding production capacity, as well as by their sales and profit growth numbers.

Competitive pressures arising from substitute products increase as the relative price of substitute products declines and as consumers’ costs of switching decrease. The competitive strength of substitute products is best measured by the inroads into the market share those prod­ ucts obtain, as well as those firms’ plans for increased capacity and market penetration.

For example, circulation of U.S. newspapers continues to drop drastically, with the excep­ tion of the Wall Street Journal, USA Today, and a few others. The growing popularity of free news on the web and more timely news online are two key factors negatively impacting tradi­ tional papers such as the New York Times, Los Angeles Times. and others.

Bargaining Power of Suppliers The bargaining power of suppliers affects the intensity of competition in an industry, especially when there are few suppliers, w'hen there are few good substitute raw materials, or when the cost of switching raw materials is especially high. It is often in the best interest of both suppliers and

242 CHAPTER 7 • THE EXTERNAL AUDIT

producers lo assist each other with reasonable prices, improved quality, development of new services, just-in-time deliveries, and reduced inventory costs, thus enhancing long-term profit­ ability for all concerned.

Firms may pursue a backward integration strategy to gain control or ownership of suppliers. This strategy is especially effective when suppliers are unreliable, too costly, or not capable of meet­ ing a firm's needs on a consistent basis. Firms generally can negotiate more favorable terms with suppliers when backward integration is a commonly used strategy among rival firms in an industry.

However, in many industries it is more economical to use outside suppliers of component parts than to self-manufacture the items. This is true, for example, in the outdoor power equip­ ment industry, where producers of lawn mowers, rotary tillers, leaf blowers, and edgers such as Murray generally obtain their small engines from outside manufacturers such as Briggs & Stratton that specialize in such engines and have huge economies of scale.

In more and more industries, sellers are forging strategic partnerships with select suppli­ ers in efforts to (a) reduce inventory and logistics costs (e.g., through just-in-time deliveries); (b) speed the availability of next-generation components; (c) enhance the quality of the parts and components being supplied and reduce defect rates; and (d) squeeze out important cost savings for both themselves and their suppliers.10

Bargaining Power of Consumers When customers are concentrated or large in number or buy in volume, their bargaining power represents a major force affecting the intensity of competition in an industry. Rival firms may offer extended warranties or special services to gain customer loyalty whenever the bargaining power of consumers is substantial. Bargaining power of consumers also is higher when the prod­ ucts being purchased are standard or undifferentiated. When this is the case, consumers often can negotiate selling price, warranty coverage, and accessory packages to a greater extent.

The bargaining power of consumers can be the most important force affecting competitive advantage. Consumers gain increasing bargaining power under the following circumstances:

1. If they can inexpensively switch to competing brands or substitutes 2. If they are particularly important to the seller 3. If sellers are struggling in the face of falling consumer demand 4. If they are informed about sellers’ products, prices, and costs 5. If they have discretion in whether and when they purchase the product11

Sources of External Information A wealth of strategic information is available to organizations from both published and unpub­ lished sources. Unpublished sources include customer surveys, market research, speeches at professional and shareholders’ meetings, television programs, interviews, and conversations with stakeholders. Published sources of strategic information include periodicals, journals, reports, gov­ ernment documents, abstracts, books, directories, newspapers, and manuals. A company website is usually an excellent place to start to find information about a firm, particularly on the Investor Relations web pages.

There are many excellent websites forgathering strategic information, but live that the author uses routinely are:

1. www.money.msn.com 2. http://finance.yahoo.com 3. www.hoovers.com 4. http://globaledge.msu.edu/industries/ 5. www.monrningstar.com

An excellent source of industry information is provided by Michigan State University at http:// globaledge.msu.edu/industries/. Industry Profiles provided at that site are an excellent source for information, news, events, and statistical data for any industry. In addition to a wealth of indices, risk assessments, and interactive trade information, a wide array of global resources are provided.

Most college libraries subscribe to Standard & Poor’s (S&P‘s) Industry Surveys. These documents are exceptionally up-to-date and give valuable information about many different

CHAPTER 7 • THE EXTERNAL AUDIT 243

industries. Each report is authored by a Standard & Poor’s industry research analyst and includes the following sections:

1. Current Environment 2. Industry Trends 3. How the Industry Operates 4. Key Industry Ratios and Statistics 5. How to Analyze a Company 6. Glossary of Industry Terms 7. Additional Industry Information 8. References 9. Comparative Company Financial Analysis

Forecasting Tools and Techniques Forecasts arc educated assumptions about future trends and events. Forecasting is a complex activity because of factors such as technological innovation, cultural changes, new products, improved services, stronger competitors, shifts in government priorities, changing social values, unstable economic conditions, and unforeseen events. Managers often must rely on published forecasts to effectively identify key external opportunities and threats.

A sense of the future permeates all action and underlies every decision a person makes. People eat expecting to be satisfied and nourished in the future. People sleep assuming that in the future they will feel rested. They invest energy, money, and time because they believe their efforts will be rewarded in the future. They build highways assuming that automobiles and trucks will need them in the future. Parents educate children on the basis of forecasts that they will need certain skills, attitudes, and knowledge when they grow up. The truth is we all make implicit forecasts throughout our daily lives. The question, therefore, is not whether we should forecast but rather how we can best forecast to enable us to move beyond our ordinarily unarticulated assumptions about the future. Can we obtain information and then make educated assumptions (forecasts) to better guide our current decisions to achieve a more desirable future state of affairs? Assumptions must be made based on facts, figures, trends, and research. Strive for the firm’s assumptions to be more accurate than rival firm’s assumptions.

Sometimes organizations must develop their own projections. Most organizations forecast (project) their own revenues and profits annually. Organizations sometimes forecast market share or customer loyalty in local areas. Because forecasting is so important in strategic manage­ ment and because the ability to forecast (in contrast to the ability to use a forecast) is essential, selected forecasting tools are examined further here.

Forecasting tools can be broadly categorized into two groups: quantitative techniques and qualitative techniques. Quantitative forecasts are most appropriate when historical data are avail­ able and when the relationships among key variables are expected to remain the same in the future. Linear regression, for example, is based on the assumption that the future will be just like the past—which, of course, it never is. As historical relationships become less stable, quan­ titative forecasts become less accurate.

No forecast is perfect, and some forecasts are even wildly inaccurate. This fact accents the need for strategists to devote sufficient time and effort to study the underlying bases for pub­ lished forecasts and to develop internal forecasts of their own. Key external opportunities and threats can be effectively identified only through good forecasts. Accurate forecasts can provide major competitive advantages for organizations. Accurate forecasts are vital to the strategic- management process and to the success of organizations.

Making Assumptions Planning would be impossible without assumptions. McConkey defines assumptions as the “best present estimates of the impact of major external factors, over which the manager has little if any control, but which may exert a significant impact on performance or the ability to achieve desired results."1- Strategists are faced with countless variables and imponderables that can be neither con­ trolled nor predicted with 100 percent accuracy. Wild guesses should never be made in formulating strategies, but reasonable assumptions based on available information must always be made.

244 CHAPTER 7 • THE EXTERNAL AUDIT

By identifying future occurrences that could have a major effect on the firm and by making reasonable assumptions about those factors, strategists can carry the strategic-management process forward. Assumptions are needed only for future trends and events that are most likely to have a significant effect on the company’s business. Based on the best information at the time, assumptions serve as checkpoints on the validity of strategies. If future occurrences deviate significantly from as­ sumptions, strategists know that corrective actions may be needed. Without reasonable assumptions, the strategy-formulation process could not proceed effectively. Firms that have the best information generally make the most accurate assumptions, which can lead to major competitive advantages.

Industry Analysis: The External Factor Evaluation Matrix An external factor evaluation (EFE) matrix allows strategists to summarize and evaluate eco­ nomic, social, cultural, demographic, environmental, political, governmental, legal, technological, and competitive information. Illustrated in Table 7-8, the EFE Matrix can be developed in five steps:

1. List key external factors as identified in the extemal-audit process. Include a total of 20 factors, including both opportunities and threats that affect the firm and its industry. List the opportunities first and then the threats. Be as specific as possible, using percentages, ratios, and comparative numbers whenever possible. Recall that Edward Deming said: "In God we trust. Everyone else bring data.” In addition, utilize "actionable" factors as defined earlier in this chapter.

2. Assign to each factor a weight that ranges from 0.0 (not important) to 1.0 (very important). The weight indicates the relative importance of that factor to being successful in the firm’s industry. Opportunities often receive higher weights than threats, but threats can receive high weights if they are especially severe or threatening. Appropriate weights can be determined by comparing successful with unsuccessful competitors or by discussing the factor and reaching a group consensus. The sum of all weights assigned to the factors must equal 1.0.

3. Assign a rating between I and 4 to each key external factor to indicate how effectively the firm's current strategies respond to the factor, where 4 = the response is superior. 3 = the response is above average, 2 = the response is average, and 1 — the response is poor. Ratings are based on effectiveness of the firm's strategies. Ratings are thus company-based, whereas the weights in Step 2 are industry-based. It is important to note that both threats and opportunities can receive a 1,2, 3. or 4.

4. Multiply each factor’s weight by its rating to determine a weighted score. 5. Sum the weighted scores for each variable to determine the total weighted score for the

organization.

Regardless of the number of key opportunities and threats included in an EFE Matrix, the highest possible total weighted score for an organization is 4.0 and the lowest possible total weighted score is 1.0. The average total weighted score is 2.5. A total weighted score of 4.0 indi­ cates that an organization is responding in an outstanding way to existing opportunities and threats in its industry. In other words, the firm’s strategies effectively take advantage of existing opportuni­ ties and minimize the potential adverse effects of external threats. A total score of 1.0 indicates that the firm’s strategies are not capitalizing on opportunities or avoiding external threats.

An example of an EFE Matrix is provided in Table 7-8 for a local 10-theater cinema complex. Note that the most important factor to being successful in this business is “Trend toward healthy eating eroding concession sales” as indicated by the 0.12 weight. Also note that the local cinema is doing excellent in regard to handling two factors, “TDB University is expanding 6 percent annually " and “Trend toward healthy eating eroding concession sales.” Perhaps the cinema is placing flyers on campus and also adding yogurt and healthy drinks to its concession menu. Note that you may have a 1. 2, 3, or 4 anywhere down the Rating column. Note also that the factors are stated in quantitative terms to the extent possible, rather than being stated in vague terms. Quantify the factors as much as possible in constructing an EFF Matrix. Note also that all the factors are “actionable” instead of be­ ing something like “the economy is bad.” Finally, note that the total weighted score of 2.58 is above the average (midpoint) of 2.5, so this cinema business is doing pretty well, taking advantage of the

CHAPTER 7 • THE EXTERNAL AUDIT 245

TA BLE 7-8 EFE Matrix for a Local 10-Theater Cinema Complex

Key External Factors Weight Rating Weighted

Score

Opportunities 1. Rowan County is growing 8 percent annually in population 0.05 3 0.15 2. TDB University is expanding 6 percent annually 0.08 4 0.32 3. Major competitor across town recently ceased operations 0.08 3 0.24 4. Demand for going to cinema growing 10 percent annually 0.07 2 0.14 5. Two new neighborhoods being developed within 3 miles 0.09 1 0.09 6. Disposable income among citizens grew 5 percent in prior year 0.06 3 0.18 7. Unemployment rate in county declined to 3.1 percent 0.03 2 0.06

Threats 8. Trend toward healthy eating eroding concession sales 0.12 4 0.48 9. Demand for online movies and DVDs growing 10 percent annually 0.06 2 0.12

10. Commercial property adjacent to cinemas for sale 0.06 3 0.18 11. TDB University installing an on-campus movie theater 0.04 3 0.12 12. County and city property taxes increasing 25 percent this year 0.08 2 0.16 13. Local religious groups object to R-rated movies being shown 0.04 3 0.12 14. Movies rented from local Blockbuster store up 12 percent 0.08 2 0.16 15. Movies rented last quarter from Time Warner up 15 percent 0.06 1 0.06

Total LOG 8

external opportunities and avoiding the threats facing the firm. There is definitely room for improve­ ment, though, because the highest total weighted score would be 4.0. As indicated by ratings of 1. this business needs to capitalize more on the "two new neighborhoods nearby" opportunity and the “movies rented from Time Warner” threat Note also that there are many percentage-based factors among the group. Be quantitative to the extent possible! Note also that the ratings range from 1 to 4 on both the opportunities and threats.

An EFE Matrix for Netflix is provided in Table 7-9. Note that the most important external factors for Netflix were the growth in Internet users globally as indicated by a weight of 0.08. Netflix’s total weighted score of 2.73 is good but not excellent.

The Competitive Profile Matrix The Competitive Profile Matrix (CPM) identifies a firm’s major competitors and its particular strengths and weaknesses in relation to a sample firm’s strategic position. The weights and total weighted scores in both a CPM and an EFE have the same meaning. However, critical suc­ cess factors in a CPM include both internal and external issues; therefore, the ratings refer to strengths and weaknesses, where 4 = major strength. 3 = minor strength, 2 — minor weakness, and I = major weakness. The critical success factors in a CPM are not grouped into opportu­ nities and threats as they are in an EFE. In a CPM, the ratings and total weighted scores for rival firms can be compared to the sample firm. This comparative analysis provides important internal strategic information. Avoid assigning the same rating to firms included in your CPM analysis.

A sample CPM is provided in Table 7-10. In this example, the two most important factors to being successful in the industry are “advertising” and “global expansion.” as indicated by- weights of 0.20. If there were no weight column in this analysis, note that each factor then would be equally important. Thus, having a weight column makes for a more robust analysis because it enables the analyst to assign higher and lower numbers to capture perceived or actual levels of importance. Note in Table 7-10 that Company I is strongest on “product quality,” as indicated by a rating of 4, whereas Company 2 is strongest on “advertising.” Overall. Company 1 is strongest, as indicated by the total weighted score of 3.15 and Company 3 is weakest.

246 CHAPTER 7 • THE EXTERNAL AUDIT

T A B LE 7-9 An Actual EFE Matrix for Netflix

Opportunities Weight Rating WScore

1. Netflix has 30 million members globally. Millions more would like Netflix.

0.07 2 .14

2. Movie ticket prices rose 3 percent in 2012. 0.04 2 .08 3. Blockbuster closed 30 percent of its stores in 2012. 0.06 4 .24

Number of Internet users globally increased from 2.4 billion in mid-2012 to over 3.0 billion in 2013.

0.08 4 .32

4. The introduction of smart TVs is enabling online content to be viewed faster and without gaming consoles.

0.06 3 .18

5. Average cable bills nationwide increased 5.8 percent. 0.05 2 .10 6. The average price of a DVD is S25 and rising. 0.04 2 .08 7. Percentage of Americans who play computer & video

games is 72 percent. 0.03 3 .09

8. Once you start a movie stream on Blockbuster, you only have 24 hours to watch as any number of times.

0.05 4 .20

9. Smartphone usage is growing 20 percent annually. Threats

0.02 3 .06

1. Unemployment exceeds 10 percent in many areas. 0.04 2 .08 2. Blockbuster has new movie and television titles available

28 days before Redbox and Netflix. 0.05 4 .20

3. Blockbuster offers disc-only plans, stream-only plans, and combination plans.

0.04 3 .12

4. Blockbuster offers unlimited rentals-by-mail and in-store exchanges.

0.06 2 .12

5. Redbox installed about 6.000 kiosks in Canada in 2012. 0.05 3 .15 6. Netflix’s streaming content licensing costs rose from

$180 million in 2010 to a huge $1.98 billion in 2012. 0.06 4 .24

7. Coinstar is partnering with Verizon to enter the streaming market.

0.07 2 .14

8. YouTube has an agreement with Paramount to stream movies through their website.

0.05 2 .10

9. Increase in online activity increases the threat of identity theft.

0.03 1 .04

10. Amazon, Apple, and Hulu enter the movie streaming business.

Total

0.05

1.00

3 .15

2JS

Other than the critical success factors listed in the example CPM, factors often included in this analysis include breadth of product line, effectiveness of sales distribution, proprietary or patent advantages, location of facilities, production capacity and efficiency, experience, union relations, technological advantages, and e-commerce expertise.

Just because one firm receives a 3.20 overall rating and another receives a 2.80 in a CPM, it does not necessarily follow that the first firm is precisely 14.3 percent better than the second, but it does suggest that the first firm is better in some areas. Regarding weights in a CPM. EFEM, or 1FEM. 0.08 is 33 percent higher than 0.06, so even small differences can reveal important perceptions regarding the relative importance ol various factors. The aim with numbers is to assimilate and evaluate information in a meaningful way that aids in decision-making.

Another CPM is provided in Table 7-11. Note that Company 2 has the best product quality and management experience: Company 3 has the best market share and inventory system; and Company 1 has the best price as indicated by the ratings. Again, avoid assigning duplicate rat­ ings on any row in a CPM.

CHAPTER 7 • THE EXTERNAL AUDIT 247

TA B LE 7-10 An Example Competitive Profile Matrix

Company 1 Company 2 Company 3

Critical Success Factors Weight Rating Score Rating Score Rating Score

Advertising 0.20 1 0.20 4 0.80 3 0.60 Product Quality 0.10 4 0.40 3 0.30 2 0.20 Price Competitiveness 0.10 3 0.30 2 0.20 1 0.10 Management 0.10 4 0.40 3 0.20 1 0.10 Financial Position 0.15 4 0.60 2 0.30 3 0.45 Customer Loyalty 0.10 4 0.40 3 0.30 2 0.20 Global Expansion 0.20 4 0.80 1 0.20 2 0.40 Market Share 0.05 1 0.05 4 0.20 3 0.15 Total 1.00 3.15 2.50 2.20

Note: The ratings values are as follows: I = m ajor weakness. 2 = minor weakness, 3 = minor strength. 4 = major strength. As indicated by the total weighted score of 2.50. Com petitor 2 is weakest. Only eight critical success factors are included for simplicity: this is too few in actuality.

An example CPM for Royal Caribbean Cruises (RCC) is provided in Table 7 -12. Note that RCC’s main rival is Carnival Corporation. Having 40 ships in its fleet, RCC is the world's second-largest cruise line operator, after Carnival, which has 100 ships. RCC owns Celebrity Cruises, Pullmantur Cruises, Azamara Club Cruises, and CDF Croisieres de France. Carnival recently ordered a brand new ship (being built by Fincantieri) to be the largest cruise ship ever built, having a passenger capacity of 4.000 and a tonnage of 135,000, and scheduled for delivery in 2016. Note in the CPM that Carnival has a much better financial position than RCC. but RCC has the nicest ships as of year 2013, led by its Oasis ship.

Special Note To Students In developing and presenting your external assessment for the firm, be mindful that gaining and sustaining competitive advantage is the overriding purpose of developing the opportunity and threat lists, value chain, EFFM, and CPM. During this section of your written or oral proj­ ect. emphasize how and why particular factors can yield competitive advantage for the firm. In

TA B LE 7-11 Another Example Competitive Profile Matrix

Company 1 Company 2 Company 3

Critical Success Factors Weight Rating

Weighted Score Rating

Weighted Score Rating

Weighted Score

Market Share 0.15 3 0.45 2 0.30 4 0.60 Inventory System 0.08 2 0.16 1 0.08 4 0.32 Financial Position 0.10 2 0.20 3 0.30 4 0.40 Product Quality 0.08 3 0.24 4 0.32 2 0.16 Consumer Loyalty 0.02 3 0.06 1 0.02 4 0.08 Sales Distribution 0.10 0.30 2 0.20 4 0.40 Global Expansion 0.15 3 0.45 2 0.30 4 0.60 Organization Structure 0.05 3 0.15 4 0.20 2 0.10 Production Capacity 0.04 3 0.12 2 0.08 4 0.16 E-commerce 0.10 3 0.30 1 0.10 4 0.40 Customer Service 0.10 3 0.30 2 0.20 4 0.40 Price Competitive 0.02 4 0.08 1 0.02 3 0.06 Management Experience 0.01 2 0.02 4 0.04 3 0.03 Total 1.00 2.83 2.16 3.69

248 CHAPTER 7 • THE EXTERNAL AUDIT

T A B LE 7-12 A Competitive Profile Matrix for Royal Caribbean Cruises

RCC Carnival Corp

Critical Success Factors Weight Rating Score Rating Score

Advertising 0.20 2 0.40 4 0.80 Quality of Ships 0.20 4 0.80 2 0.40 Price Competitiveness 0.15 3 0.45 4 0.60 Management 0.15 3 0.45 2 0.30 Financial Position 0.05 I 0.05 4 0.20 Customer Loyalty 0.15 2 0.30 4 0.60 Global Expansion 0.05 .15 3 0.15 Market Share 0.05 1 0.05 4 0.20 Total 1.00 2.65 3.25

other words, instead of robotically going through the weights and ratings (which by the way are critically important), highlight various factors in light of where you are leading the firm. Make it abundantly clear in your discussion how' your firm, with your suggestions, can subdue rival firms or at least profitably compete with them. Showcase during this section of your project the key underlying reasons how and why your firm can prosper among rivals. Remember to be prescriptive, rather than descriptive, in the manner that you present your entire project. If pre­ senting your project orally, be self-confident and passionate rather than timid and uninterested. Definitely “bring the data” throughout your project because “vagueness” is the most common downfall of students in case analyses.

Conclusion Increasing turbulence in markets and industries around the world means the external audit has become an explicit and vital pail of the strategic-managcment process. This chapter provides a framework for collecting and evaluating economic, social, cultural, demographic, environmen­ tal. political, governmental, legal, technological, and competitive information. Firms that do not mobilize and empower their managers and employees to identify, monitor, forecast, and evaluate key external forces may fail to anticipate emerging opportunities and threats and, consequently, may pursue ineffective strategies, miss opportunities, and invite organizational demise. Firms not taking advantage of e-commerce and social media networks are technologically falling behind.

A major responsibility of strategists is to ensure development of an effective extemal-audit system. This includes using information technology to devise a competitive intelligence system that works. The extemal-audit approach described in this chapter can be used effectively by any size or type of organization. Typically, the extemal-audit process is more informal in small firms, but the need to understand key trends and events is no less important for these firms. The EFE Matrix and Porter’s Five-Forces Model can help strategists evaluate the market and industry, but these tools must be accompanied by good intuitive judgment. Multinational firms especially need a systematic and effective extemal-audit system because external forces among foreign countries vary so greatly.

Key Terms and Concepts actionable factors (p. 227) chief information officer (CIO) (p. 236) chief technology officer (CTO) (p. 236)

competitive analysis (p. 238) competitive intelligence (Cl) (p. 238) competitive profile matrix (CPM) (p. 245)

CHAPTER 7 • THE EXTERNAL AUDIT 249

director of competitive analysis (p. 238) environmental scanning (p. 226) external audit (p. 226) external factor evaluation (EFE)

matrix (p. 244) external forces (p. 227) Industrial Organization (I/O) (p. 229)

Issues for Review and Discussion 7-1. Michelin has been very successful in the last decade.

In your opinion, what strategy changes would Michelin need in 2014?

7-2. Of the many competitors it has, which firm do you think worries Michelin most about? Why? Prepare a CPM that includes Michelin and the rival firm you identified.

7-3. A political debate, raging in the United States, concerns sales taxes on the Internet. Most states do not collect a sales tax. Brick and mortar businesses think this is unfair. How does the situation in Europe compare with the United States, in terms of sales tax on items purchased online? What is the strategic implication for companies?

7-4. The size of American labor unions have fallen sharply in the last decade, mostly due to the erosion of the U.S. manufacturing base. How does the situation in Europe compare to the United States in this regard? What is the strategic implication for companies?

7-5. List four reasons why some countries in Europe are struggling economically in comparison to Asian coun­ tries. What is the strategic implication for companies?

7-6. Does the Arab Spring—unfolding in the Middle East— represent more of an opportunity or threat to compa­ nies? Explain.

7-7. Identify two companies that you think would have a 1.5 total weighted score on their EFE Matrix. Why? Identify two companies that would have a 3.5 total weighted score on their EFE Matrix. Why?

7-8. Summarize what Chapter 7 says at the end, regarding competitive advantage whenever someone is presenting an EFE Matrix and CPM as part of a case analysis or strategic plan.

7-9. List the 10 key external forces that give rise to opportunities and threats. Give a specific example of each force, for your college or university.

7-10. Give four reasons why you agree or do not agree with I/O theorists.

7-11. Regarding economic variables, list in order of importance six specific factors that you feel greatly impact your college or university.

7-12. Explain why U.S.-based firms, such as McDonald’s, greatly benefit from a weak dollar.

7-13. Regarding social, cultural, demographic, and natural environment variables, list in order of importance six specific factors that you feel most greatly impact your college or university.

industry analysis (p. 226) information technology (IT) (p. 236) Internet (p. 236) linear regression (p. 243) market commonality (p. 239) Porter’s Five-Forces Model (p. 239) resource similarity (p. 239)

7-14. Regarding political, governmental, and legal variables, list in order of importance six specific factors that you feel most greatly impact your college or university.

7-15. Explain how wireless technology is impacting four industries.

7-16. Discuss the pros and cons of gathering and assimilating competitive intelligence.

7-17. Using Porter’s Five-Forces Model, explain competitive­ ness for a local fast food restaurant.

7-18. Identify an industry in which “bargaining power of suppliers” is the most important factor among Porter’s variables.

7-19. Develop an EFE Matrix for your college or university. 7-20. Distinguish between ratings and weights in an EFE

Matrix. 7-21. List 10 external trends or facts pertaining specifically to

your country that would impact companies in your city. 7-22. Develop a CPM for a company that you or your parents

have been employed. 7-23. Discuss the ethics of gathering competitive intelligence. 7-24. Discuss the ethics of cooperating with rival firms. 7-25. Contact your college library. Ask if they have the S&P

Industry Surveys in hardcopy in the library. If they do, print out the relevant report for a company that you familiar with.

7-26. Your boss develops an EFE Matrix that includes 54 factors. How would you suggest reducing the number of factors to 20?

7-27. List the 10 external areas that give rise to opportunities and threats. Give an example of each for IBM.

7-28. Compare the ratings in an EFE Matrix with those in a CPM in terms of meaning and definition.

7-29. Discuss the I/O view or approach to strategic planning. 7-30. List in order of importance what you feel are the six

major advantages of a weak dollar for a U.S.-based firm. 7-31. List in order of importance what you feel are the six

major advantages of a weak euro for a European-based firm headquartered in a country that has the euro as its currency.

7-32. Cooperating with competitors is becoming more common. What are the advantages and disadvantages of this for a company?

7-33. Regarding sources of external information, visit the www.finance.yahoo.com website and enter IBM; click on Headlines, and identify three major new initiatives the company has undertaken.

250 CHAPTER 7 • THE EXTERNAL AUDIT

7-34. Differentiate between making assumptions and making wild guesses about future opportunities, and threats lacing business firms.

7-35. Explain how the external assessment would, or should be different for non-profit organizations versus corporations.

7-36. Apply Porter’s Five-Forces Model to IBM. What strate­ gic implications arise in that analysis?

7-37. Compare and contrast competitive intelligence programs across several organizations that you are familiar with.

MyManagementLab® Go to m ym anagem entlab.com for the following Assisted-graded writing questions:

7-38. Describe the “process of performing an external audit” in 7-40. Mymanageinentlab Only—comprehensive writing an organization doing strategic planning for the first time. assignment for this chapter.

7-39. Compare and contrast the duties and responsibilities of a CIO with a CTO in a large firm.

Current Readings Allio, Robert J. and Liam Fahey. “Joan Magretta:

What Executives can Learn from Revisiting Michael Porter.” Strategy and Leadership 40, no. 3 (2012): 5-10.

Berchicci, Luca, Glen Dowell, and Andrew A. King. “Environmental Capabilities and Corporate Suategy: Exploring Acquisitions Among US Manufacturing Firms.” Strategic Management Journal 33, no. 9 (September 2012): 1053-1071.

Berman. Saul J. “Digital Transformation: Opportunities to Create New Business Models.” Strategy and Leadership 40, no. 3 (2012): 16-24.

Kim. Kwang-Ho and Wenpin Tsai. “Social Comparison Among Competing Firms.” Strategic Management Journal 33, no. 2 (February 2012): 115-136.

Pacheco-de-Almeida. Gon^alo and Peter B. Zemsky. “Some Like it Free: Innovators’ Strategic Use of Disclosure to Slow Down Competition.” Strategic Management Journal 33, no. 7 (July 2012): 773-793.

A SSU R A N CE OF LEARNING EX ER C IS ES EXERCISE 7A

Michelin and Africa: An External Assessment Purpose Michclin is featured in the opening chapter case as a firm that engages in excellent strategic planning. This exercise gives you practice conducting an external strategic management audit to determine if Africa is the new, best place for Michelin to produce and market products and services. For example, considerable underground mining occurs in much of Africa. The new MICHELIN XTXL tire is avail­ able in 25-inch for underground mining vehicles. The new tires offer enhanced safety and productivity and are available in sizes 26.5R25 and 29.5R25. Tests indicate that the new tires offer increases of 10 percent in longevity, 20 percent in puncture resistance, and 30 percent in load capacity.

Instructions Step 1 Research the business climate in 10 African countries. Step 2 Prepare an EFE Matrix for Michelin based solely on the opportunities and threats that

Michelin will face in doing business in the 10 African countries you chose. Step 3 Based on your research, list the 10 African countries you selected in rank order of attractive­

ness for Michelin to focus efforts upon. Give a one-sentence rationale for each country's ranking.

CHAPTER 7 • THE EXTERNAL AUDIT 251

Preparing a CPM for Michelin Based on Countries Rather than Companies

Purpose Countries are similar to companies in that they compete with each other for investment dollars and economic development.

Instructions Step 1 Revisit the research you collected and analyzed in the above exercise. Step 2 Prepare a CPM that reveals your assessment of 6 African countries in terms of their relative

strengths and weaknesses across what you deem to be the most critical success factors.

EXERCISE 7C Develop Divisional Michelin EFE Matrices

Purpose Michelin has five major geographic divisions: Europe, North America, Asia, South America, Africa/ India/Middle-East. The company faces fierce but different competitors in each segment.

The external opportunities and threats that Michelin faces are different in each geographic segment, so each segment prepares its own list of key external success factors. This external analysis is critically important in strategic planning because a firm needs to exploit opportunities and avoid or at least mitigate threats.

The purpose of this exercise is to develop divisional EFE Matrices that Michelin could use in developing an overall corporate EFE Matrix.

Instructions Step 1 Go to Michelin's website. Review the company’s most recent Annual Report. Step 2 Determine and review Michelin’s major geographic segments. Step 3 Conduct research to determine what you believe are the four major threats and the four major

opportunities critical to strategic planning within Michelin’s geographic segments. Review the relevant Standard and Poor's Industry Survey documents for each segment.

Step 4 Develop divisional EFE Matrices for Michelin. Work within a team of students if your instructor so requests but you will need an EFE Matrix for each segment.

Step 5 Prioritize the 20 threats and the 20 opportunities developed in the prior step so that corporate Michelin top executives can better develop a corporate EFE Matrix.

Step 6 Let's say Michelin has their operations segmented by Domestic versus Global. Based on your research, prepare an EFE Matrix for Michelin’s domestic operations and another EFE Matrix for Michelin’s Global Operations. Let Europe be Domestic and all other regions be Global.

EXERCISE 7D Developing an EFE Matrix for adidas AG

Purpose This exercise will provide practice developing an EFE Matrix. An EFE Matrix summarizes the results of an external audit. This is an important tool widely used by strategists.

Instructions Step 1 Join with two other students in class and jointly prepare an EFE Matrix for adidas AG. Refer

back to the Cohesion Case and to Exercise IB. if necessary, to identify external opportuni­ ties and threats. Use the information in the Standard and Poor's Industry Surveys that you copied as part of Assurance of Learning Exercise IB. Be sure not to include strategies as opportunities, but do include as many monetary amounts, percentages, numbers, and ratios as possible.

Step 2 All three-person teams participating in this exercise should record their EFE total weighted scores on the board. Put your initials after your score to identify it as your teams.

Step 3 Compare the total weighted scores. Which team’s score came closest to the instructor's answer? Discuss reasons for variation in the scores reported on the board.

EXERCISE 7B

252 CHAPTER 7 • THE EXTERNAL AUDIT

The External Assessment Purpose This exercise will help you become familiar with important sources of external information avail­ able in your college or university library. A key part of preparing an external audit is searching the Internet and examining published sources of information for relevant economic, social, cultural, demographic, environmental, political, governmental, legal, technological, and competitive trends and events. External opportunities and threats must be identified and evaluated before strategies can be formulated effectively.

Instructions Step 1 Select an American company or business where you recently purchased a product or

previously have worked. Conduct an external audit for this company. Find opportunities and threats in recent issues of newspapers and magazines. Search for information using the Internet. Use the following websites: http://marketwatch.multexinvestor.com; www .hoovers.com; http://moneycentral.msn.com; http://finance.yahoo.com; www.clearstation .com: https://us.etrade.eom/e/t/invest/markets

Step 2 On a separate sheet of paper. list 10 opportunities and 10 threats that face this company. Be specific in stating each factor.

Step 3 Include a bibliography to reveal where you found the information. Step 4 Write a three-page summary of your findings, and submit it to your instructor.

EXERCISE 7F Developing a CPM for Michelin

Purpose Monitoring competitors’ performance and strategies is a key aspect of an external audit. This exercise is designed to give you practice evaluating the competitive position of organizations in a given indus­ try and assimilating that information in the form of a CPM.

Instructions Step 1 Gather information about Michelin Corporation. Turn back to the opening chapter boxed

insert and review this information. Step 2 On a separate sheet of paper, prepare a CPM that includes Michelin and its two leading

competitors: Bridgestone Corporation, and Goodyear Tire and Rubber Company. Step 3 Turn in your CPM for a classwork grade.

EXERCISE 7G Developing a CPM for adidas AG

Purpose Monitoring competitors’ performance and strategies is a key aspect of an external audit. This exercise is designed to give you practice evaluating the competitive position of organizations in a given indus­ try and assimilating that information in the form of a CPM.

Instructions

Step 1 Gather information from Assurance of Learning Exercise 1B. Also, turn back to the Cohesion Case and review the section on competitors.

Step 2 On a separate sheet of paper, prepare a CPM that includes Nike. Puma, Under Armour, and Callaway Golf.

Step 3 Turn in your CPM for a classwork grade.

EXERCISE I E

CHAPTER 7 • THE EXTERNAL AUDIT 253

Analyzing Your College or University’s External Strategic Situation

Purpose This exercise is excellent for doing together as a class.

Instructions As a class, determine your college or university’s major external opportunities and threats. List 10 opportunities and 10 threats. Then, gel everyone in class to rank order their factors with 1 being most important and 10 being least important. Then, gather up everyone’s paper, count the numbers, and in that manner create a prioritized list o f the key external opportunities and threats facing your college.

EXERCISE 7H

Notes 1. York Freund, “Critical Success Factors,” Planning Review

16. no. 4 (July-A ugust 1988): 20.

2. Lee Siegel. “Rise o f the Tiger Nation.“ Wall Street Journal (O c tober27, 2012): C l.

3. Siegel. “Rise o f the Tiger Nation.”

4. Roger Yu, "Online Rep Crucial for Small Com panies,” USA Today (October 30, 2012): 5B.

5. Bill Saporito, “Com panies That Com pete Best,” Fortune, May 22, 1989, 36.

6 . Kenneth Sawka, “Dem ystifying Business Intelligence,” Management Review (October 1996): 49.

7. John Prescott and Daniel Smith, “The Largest Survey of ‘Leading-Edge’ Com petitor Intelligence M anagers,” Planning Review 17, no. 3 (M ay-June 1989): 6-13.

9. S. Jayachandran. J. G im eno, and P. R. Varadarajan. “Theory of M ultim arket Com petition: A Synthesis and Im plications for M arketing Strategy,” Journal o f Marketing 63. 3 ( 1999): 59; and M. J. Chen. “Com petitor A nalysis and Interfirm Rivalry: Toward a Theoretical Integration," Academy o f Management Review 21 (1996): 107-108.

10. A rthur Thom pson, Jr., A. J. Strickland III. and John G am ble, C rafting and Executing Strategy: Text and Readings (New York: M cG raw -H ill/Irw in, 2005), 63.

11. M ichael E. Porter. Com petitive Strategy: Techniques for Analyzing Industries and Com petitors (New York: Free Press, 1980), 24-27.

12. Dale McConkey, “Planning in a Changing Environment," Business Horizons 31. no. 5 (Septem ber- O ctober 1988): 67.

8. M. J. Chen. “Com petitor Analysis and Interfirm Rivalry: Toward a Theoretical Integration.” Academy o f Management Review 21 (1996): 106.

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254

Strategy Generation and Selection CHAPTER O BJECT IVES After studying this chapter, you should be able to do the following:

1. Describe a three-stage framework for choosing among alternative strategies.

2. Explain how to develop a Strengths-Weaknesses-Opportunities-Threats (SWOT) Matrix, Strategic Position and Action Evaluation (SPACE) Matrix, Boston Consulting Group (BCG) Matrix, Internal-External (IE) Matrix, and Quantitative Strategic Planning Matrix (QSPM).

3. Identify important behavioral, political, ethical, and social responsibility considerations in strategy analysis and choice.

4. Discuss the role of intuition in strategic analysis and choice. 5. Discuss the role of organizational culture in strategic analysis and choice. 6. Discuss the role of a board of directors in choosing among alternative strategies.

A S S U R A N C E OF L E A R N IN G E X E R C IS E S The following exercises are found at the end of this chapter.

E X E R C IS E 8A Should Unilever Penetrate Southeast Asia Further?

E X E R C IS E 8B Perform a SWOT Analysis for Unilever’s Global Operations

E X E R C IS E 8C Preparing a BCG Matrix for Unilever

E X E R C IS E 8D Developing a SWOT Matrix for adidas AG

E X E R C IS E 8E Developing a SPACE Matrix for adidas AG

E X E R C IS E 8F Developing a BCG Matrix for adidas AG

E X E R C IS E 8G Developing a QSPM for adidas AG

E X E R C IS E 8H Developing a SW'OT Matrix for Unilever

E X E R C IS E 81 Developing a SPACE Matrix for Unilever

E X E R C IS E 8J Developing a BCG Matrix for your College or University

E X E R C IS E 8K Developing a QSPM for a Company that You Are Familiar With

E X E R C IS E 8L Formulating Individual Strategies

E X E R C IS E 8M The Mach Test

256 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

Strategy analysis and choice largely involve m aking subjective decisions based on objective information. This chapter introduces important concepts that can help strategists generate feasible alternatives, evaluate those alternatives, and choose a specific course o f action. Behavioral aspects o f strategy formulation are described, including politics, culture, ethics, and social responsibility considerations. Modern tools for form ulating strategies are described, and the appropriate role o f a board o f directors is discussed. As showcased below, U nilever is an exam ple company pursuing an excellent strategic plan.

The Nature of Strategy Analysis and Choice As indicated by Figure 8-1 with white shading, this chapter focuses on generating and evaluat­ ing alternative strategies, as well as selecting strategies to pursue. Strategy analysis and choice seek to determ ine alternative courses o f action that could best enable the firm to achieve its mission and objectives. The firm ’s present strategies, objectives, vision, and mission, coupled w’ith the external and internal audit inform ation, provide a basis for generating and evaluat­ ing feasible alternative strategies. This system atic approach is the best way to avoid a crisis. R ud iirs Law states: “W hen a crisis forces choosing am ong alternatives, m ost people choose the worst possible one.’'

Unless a desperate situation confronts the firm, alternative strategies will likely represent incremental steps that move the firm from its present position to a desired future position. A lternative strategies do not com e out o f the wild blue yonder; they are derived from the firm 's vision, mission, objectives, external audit, and internal audit; they are consistent with, or build on. past strategies that have worked well.

The Process of Generating and Selecting Strategies Strategists never consider all feasible alternatives that could benefit the firm because there are an infinite number of possible actions and an infinite num ber o f ways to implement those actions. Therefore, a manageable set o f the most attractive alternative strategies must be developed. The advantages, disadvantages, trade-offs, costs, and benefits o f these strategies should be deter­ mined. This section discusses the process that many firms use to determ ine an appropriate set

mmn STRATEGIC MANAGEMENT Unilever Unilever, the world's third-largest consumer goods company behind Procter & Gamble and Nestle, is an Anglo-Dutch company whose products include foods, beverages, cleaning agents and personal care products. Unilever is a dual listed company consisting of Unilever N.V. based in Rotterdam, Netherlands, and Unilever PLC based in London - but both companies have the same directors and operate as a single business. Some of Unilever's best selling among its 450 brands are Aviance, Ben & Jerry's, Dove, Flora/Becel, Heartbrand ice creams, Hellmann's, Knorr, Lipton, Lux/Radox, Omo/Surf, Sunsilk, Toni & Guy, V05, and PG Tips. In December 2012, Unilever began phasing out by 2015 the use of microplastics in their personal care products.

In January 2013, Unilever divested its Skippy peanut butter brand, together with related manufacturing facilities in Little Rock, Arkansas, United States and Weifang, China, to Hormel Foods for approximately $700 million. In July 2013, Unilever increased its stake in its Indian unit, Hindustan Unilever, to 67 percent for around €2.45 billion.

In August 2013, Unilever signed an agreement for the sale of its Wish-Bone and Western dress­ ings brands to Pinnacle Foods Inc. for $580 million, subject to regulatory approval. In 2013, Fortune ranked Unilever as the 39th most admired company in the world outside the United States.

In September 2013, Unilever acquired T2, a premium Australian tea company that generated sales approaching AUSS57 million for the 12-month period ending June 30 2013. Unilever is the largest tea company in the world. T2 operates 40 stores and its range of fragrant teas and tea wares from around the world are also sold through some of the best restaurants in the country.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 257

Chapter 2: Outside-USA Strategic Planning

Types of Strategies Chapter 4

Strategy Monitoring Chapter 11

; Internal Audit lapter 6

Vision and Mission Analysis

Chapter 5

Strategy Generation

and Selection Chapter 8

Strategy Implementation

Chapter 9

The External Audit

Chapter 7

Chapter 3: Global/International Issues

Strategy _______________________ |_______ Strategy _________| _ Strategy __ | I Formulation I Implementation I Evaluation

FIGURE 8-1 A Comprehensive Strategie-Management Model

Source: Fred R. David, adapted from "How Companies Define Their Mission,” Long Range Planning 22. no. 3 (June 1988): 40, © Fred R. David.

of alternative strategies. Recom m endations (strategies selected to pursue) com e from alternative strategies formulated.

Identifying and evaluating alternative strategies should involve many o f the managers and em ployees who previously assem bled the organizational vision and m ission statements, perform ed the external audit, and conducted the internal audit. Representatives from each departm ent and division o f the firm should be included in this process, as was the case in previ­ ous strategy-form ulation activities. Recall that involvement provides the best opportunity for m anagers and em ployees to gain an understanding o f what the firm is doing and why and to becom e com m itted to helping the firm accom plish its objectives.

All participan ts in the strategy analysis and choice activity should have the firm ’s ex ternal and internal audit inform ation available. This inform ation, coupled w ith the firm 's m ission statem ent, will help participan ts crysta llize in their own m inds particu lar stra te­ gies that they believe could benefit the firm most. C reativ ity should be encouraged in this thought process.

Alternative strategies proposed by participants should be considered and discussed in a meeting or series o f meetings. Proposed strategies should be listed in writing. W hen all feasible strategies identified by participants are given and understood, the strategies should be ranked

258 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

in order o f attractiveness by all participants, with 1 = should not be implemented, 2 = possibly should be implemented, 3 = probably should be implemented, and 4 = definitely should be implemented. This process will result in a prioritized list o f best strategies that reflects the collective wisdom o f the group.

A Comprehensive Strategy-Formulation Analytical Framework Im portant strategy-form ulation techniques can be integrated into a three-stage dec ision­ m aking fram ework, as shown in Figure 8-2. The tools presented in this fram ew ork are applicable to all sizes and types o f organizations and can help strategists identify, evaluate, and select strategies.

Stage I o f the formulation framework consists o f the EFE M atrix, the IFE Matrix, and the Competitive Profile M atrix (CPM). Called the in p u t stage, Stage 1 sum m arizes the basic input information needed to formulate strategies. Stage 2, called the m atch ing stage, focuses on generating feasible alternative strategies by aligning key external and internal factors. Stage 2 techniques include the Strengths-W eaknesses-Opportunities-Threats (SW OT) Matrix, the Strategic Position and Action Evaluation (SPACE) Matrix, the Boston Consulting Group (BCG) Matrix, the Internal-External (IE) Matrix, and the Grand Strategy Matrix. Stage 3, called the decision stage, involves a single technique, the Quantitative Strategic Planning Matrix (QSPM ). A QSPM uses input information from Stage 1 to objectively evaluate feasible alternative strate­ gies identified in Stage 2. A QSPM reveals the relative attractiveness o f alternative strategies and thus provides objective basis for selecting specific strategies.

All nine techniques included in the stra tegy -fo rm u la tion fram ew ork require the integration o f intuition and analysis. Autonomous divisions in an organization com m only use strategy- formulation techniques to develop strategies and objectives. Divisional analyses provide a basis for identifying, evaluating, and selecting am ong alternative corporate-level strategies.

Strategists themselves, not analytic tools, are always responsible and accountable for strategic decisions. Lenz em phasized that the shift from a words-oriented to a numbers- oriented planning process can give rise to a false sense o f certainty; it can reduce dialogue, discussion, and argum ent as a means for exploring understandings, testing assum ptions, and fostering organizational learning .1 Strategists, therefore, must be wary o f this possibility and use analytical tools to facilitate, rather than to diminish, com m unication. W ithout objective information and analysis, personal biases, politics, em otions, personalities, and halo erro r (the tendency to put too much weight on a single factor) unfortunately may play a dom inant role in the strategy-form ulation process.

STAGE I : THE INPUT STAGE

External Factor Evaluation (EFE)

Matrix

Competitive Profile

Matrix (CPM)

Internal Factor Evaluation (IFE)

Matrix

STAGE 2: THE MATCHING STAGE

Strengths-Weaknesses- Opportunities-Threats

(SWOT) Matrix

Strategic Position and Action Evaluation (SPACE) Matrix

Boston Consulting Group (BCG)

Matrix

Internal-External (IE) Matrix

Grand Strategy Matrix

STAGE 3: THE DECISION STAGE

Quantitative Strategic Planning Matrix (QSPM)

FIGURE 8-2 The Strategy-Formulation Analytical Framework

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 259

The Input Stage Procedures for developing an EFE M atrix, an IFE M atrix, and a CPM were presented in Chapters 6 and 7. The inform ation derived from these three m atrices provides basic input information for the matching and decision stage matrices described later in this chapter.

The input tools require strategists to quantify subjectivity during early stages of the strategy-formulation process. M aking small decisions in the input matrices regarding the relative importance o f external and internal factors allows strategists to more effectively generate and evaluate alternative strategies. Good intuitive judgm ent is always needed in determ ining appropriate weights and ratings.

The Matching Stage Strategy is sometimes defined as the match an organization makes between its internal resources and skills and the opportunities and risks created by its external factors.2 The matching stage of the strategy-formulation framework consists o f five techniques that can be used in any sequence: the SW OT Matrix, the SPACE Matrix, the BCG M atrix, the IE Matrix, and the Grand Strategy Matrix. These tools rely on information derived from the input stage to match external opportu­ nities and threats with internal strengths and weaknesses. M atch ing external and internal critical success factors is the key to effectively generating feasible alternative strategies. For example, a firm with excess working capital (an internal strength) could take advantage o f the cell phone industry's 20 percent annual growth rate (an external opportunity) by acquiring Cellfone, Inc., a firm in the cell phone industry. This example portrays simple one-to-one matching. In most situations, external and internal relationships are more complex, and the matching requires multiple alignm ents for each strategy generated. Successful matching of key external and internal factors depends upon those underlying key factors being both specific and actionable. The basic concept of m atching is illustrated in Table 8-1.

Any organization, w hether military, product-oriented, service-oriented, governmental, or even athletic, must develop and execute good strategies to win. A good offense without a good defense, or vice versa, usually leads to defeat. Developing strategies that use strengths to capi­ talize on opportunities could be considered an offense, whereas strategies designed to improve on weaknesses while avoiding threats could be term ed defensive. Every organization has some external opportunities and threats and internal strengths and weaknesses that can be aligned to formulate feasible alternative strategies.

The SWOT Matrix The Strengths-VVeaknesses-Opportunities-Threats (SW OT) M atrix is an important matching tool that helps managers develop four types of strategies: SO (strengths-opportunities) strategies, WO (weaknesses-opportunities) strategies, ST (strengths-threats) strategies, and WT (weaknesses-threats) strategies.' Matching key external and internal factors is the most difficult part of developing a SWOT Matrix and requires good judgment— and there is no one best set of matches. Note in Table 8-1 that the first, second, third, and fourth strategies are SO, W'O, ST. and W T strategies, respectively.

TA BLE 8-1 Matching Key External and Internal Factors to Formulate Alternative Strategies

Key Internal Factor Key External Factor Resultant Strategy

Excess working capital (an internal strength) Insufficient capacity (an internal weakness) Strong research and development expertise (an internal strength) Poor employee morale (an internal weakness)

+ 20 percent annual growth in the cell phone industry (an external opportunity)

+ Exit of two major foreign competitors from the industry (an external opportunity)

+ Decreasing numbers of younger adults (an external threat)

+ Rising health-care costs (an external threat)

= Acquire Cellfone, Inc.

= Pursue horizontal integration by buying competitors' facilities

= Develop new products for older adults

= Develop a new wellness program

260 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

SO stra teg ics use a firm ’s internal strengths to take advantage o f external opportunities. All managers would like their organization to be in a position in which internal strengths can be used to take advantage of external trends and events. Organizations generally will pursue WO. ST. o r WT strategies to get into a situation in which they can apply SO strategies. W hen a firm has major weaknesses, it will strive to overcome them and make them strengths. When an orga­ nization faces m ajor threats, it will seek to avoid them to concentrate on opportunities.

W O stra teg ies aim at improving internal weaknesses by taking advantage of external opportunities. Sometimes key external opportunities exist, but a firm has internal weaknesses that prevent it from exploiting those opportunities. For example, there may be a high dem and for electronic devices to control the am ount and timing of fuel injection in autom obile engines (opportunity), but a certain auto part>> m anufacturer may lack the technology required for pro­ ducing these devices (weakness). One possible WO strategy would be to acquire this technology by forming a joint venture with a firm having com petency in this area. An alternative WO strat­ egy would be to hire and train people with the required technical capabilities.

ST strateg ies use a firm ’s strengths to avoid or reduce the impact o f external threats. This does not mean that a strong organization should always meet threats in the external environ­ ment head-on. An example ST strategy occurrcd when Texas Instruments used an excellent legal departm ent (a strength) to collect nearly $700 million in dam ages and royalties from nine Japanese and Korean firms that infringed on patents for sem iconductor memory chips (threat). Rival firms that copy ideas, innovations, and patented products are a m ajor threat in many indus­ tries. This is still a major problem for U.S. firms selling products in China.

W T stra teg ies are defensive tactics directed at reducing internal weakness and avoiding external threats. An organization faced with numerous external threats and internal weaknesses may indeed be in a precarious position. In fact, such a firm may have to fight for its survival, merge, retrench, declare bankruptcy, or choose liquidation.

A schematic representation of the SWOT Matrix is provided in Figure 8-3. Note that a SWOT Matrix is com posed of nine cells. As shown, there are four key factor cells, four strategy cells, and one cell that is always left blank (the upper-left cell). The four strategy cells, labeled SO. WO, ST. and VVT, are developed alter com pleting four key factor cells, labeled .S’, W. O. and T. There are eight steps involved in constructing a SW OT Matrix:

1. List the firm’s key external opportunities. 2. List the firm ’s key external threats. 3. List the firm 's key internal strengths. 4. List the firm ’s key internal weaknesses. 5. Match internal strengths with external opportunities, and record the resultant SO strategies

in the appropriate cell. 6. Match internal weaknesses with external opportunities, and record the resultant WO strategies. 7. Match internal strengths with external threats, and record the resultant ST strategies. 8 . Match internal weaknesses with external threats, and record the resultant W T strategies.

Some important aspects o f a SWOT M atrix are evidenced in Figure 8-3. For example, note that both the internal and external factors and the SO. ST, WO. and W T strategies are stated in quantitative terms to the extent possible. This is important. For example, regarding the second SO number-2 and ST number-1 strategies, if the analyst ju st said, “Add new repair and service persons." the reader might think that 20 new repair and service persons are needed. Actually only two are needed. Always be specific to the extent possible in stating factors and strategies.

It is also important to include the “S I, 0 2 ” type notation after each strategy in a SWOT Matrix. This notation reveals the rationale for each alternative strategy. Strategies do not rise out o f the blue. Note in Figure 8-3 how this notation reveals the internal and external factors that were matched to formulate desirable strategies. For example, note that this retail computer store business may need to “purchase land to build new store” because a new Highway 34 will make its location less desirable. The notation (W 2 ,0 2 ) and (S8. T3) in Figure 8-3 exemplifies this matching process.

The purpose o f each Stage 2 matching tool is to generate feasible alternative strategies, not to select or determ ine which strategies are best. Not all of the strategies developed in the SW OT Matrix, therefore, will be selected for implementation.

The strategy-formulation guidelines provided in Chapter 4 can enhance the process ol matching key external and internal factors. For exam ple, when an organization has both the

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 261

S trengths W eaknesses

1. Inventory turnover up 5.8 to 6.7 2. Average customer purchase up

$97 to SI28 3. Employee morale is excellent 4. In-store promotions = 20 percent

increase in sales 5. Newspaper advertising expenditures

down 10 percent 6. Revenues from repair and service

in store up 16 percent 7. In-store technical support persons

have MIS degrees 8. Store's debt-to-total-assets ratio down

34 percent

1. Software revenues in store down 12 percent

2. Location of store hurt by new Hwy 34 3. Carpet and paint in store in disrepair 4. Bathroom in store needs refurbishing 5. Total store revenues down 8 percent 6. Store has no website 7. Supplier on-time-delivery up to 2.4 days 8. Customer checkout process too slow 9. Revenues per employee up 19 percent

O pportun ities SO Strategies WO Strategies

1. Population of city growing 10 percent 2. Rival computer store opening one

mile away 3. Vehicle traffic passing store up

12 percent 4. Vendors average six new products a year 5. Senior citizen use of computers up

8 percent 6. Small business growth in area up

10 percent 7. Desire for websites up 18 percent by

realtors 8. Desire for websites up 12 percent by

small firms

1. Add four new in-store promotions monthly (S4. 03)

2. Add two new repair and service persons (S6. 05 )

3. Send flyer to all seniors over age 55 (S5, 05)

1. Purchase land to build new store (W2. 02 )

2. Install new carpet, paint, and bath <W3, W 4 .0 I)

3. Up website services by 50 percent (\V6, 07. 08)

4. Launch mailout to all realtors in city ( W5. 07)

Threats ST Strategies WT Strategies

1. Best Buy opening new store in one year nearby

2. Local university offers computer repair 3. New bypass Hwy 34 in 1 year will

divert traffic 4. New mall being built nearby 5. Gas prices up 14 percent 6. Vendors raising prices 8 percent

1. Hire two more repair persons and market these new services (S6. S7. T 1)

2. Purchase land to build new store (S8, T3)

3. Raise out-of-store service calls from $60 to $80 (S6, T5)

1. Hire two new cashiers (W8. T l. T4) 2. Install new carpet, paint, and bath

(W3. W4, T l)

FIGURE 8-3 A SWOT Matrix for a Retail Computer Store

capital and human resources needed to distribute its own products (internal strength) and distributors are unreliable, costly, or incapable of meeting the firm 's needs (external threat), forward integration can be an attractive ST strategy. When a firm has excess production capac­ ity (internal weakness) and its basic industry is experiencing declining annual sales and profits (external threat), related diversification can be an effective WT strategy.

Although the SWOT matrix is widely used in strategic planning, the analysis does have some lim itations.4 First, SW OT does not show how to achieve a com petitive advantage, so it must not he an end in itself. The matrix should be the starting point for a discussion on how proposed strategies could be im plem ented as well as cost-benefit considerations that ultimately could lead to competitive advantage. Second. SW OT is a static assessm ent (or snapshot) in time.

262 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

A SW OT matrix can be like studying a single frame o f a motion picture where you see the lead characters and the setting but have no clue as to the plot. As circum stances, capabilities, threats, and strategies change, the dynam ics o f a com petitive environm ent may not be revealed in a single matrix. Third, SW OT analysis may lead the firm to overem phasize a single internal or external factor in formulating strategies. There are interrelationships among the key internal and external factors that SW OT does not reveal that may be important in devising strategies.

The Strategic Position and Action Evaluation (SPACE) Matrix The S tra teg ic Position an d A ction E valuation (SPA C E ) M atrix , another important Stage 2 matching tool, is illustrated in Figure 8-4. Its four-quadrant fram ework indicates whether aggressive, conservative, defensive, or com petitive strategies are most appropriate for a given organization. The axes o f the SPACE Matrix represent two internal dimensions (financial position [FP] and com petitive position [CP]) and two external dim ensions (stability position [SP] and industry position [IP]). These four factors are perhaps the most important determ i­ nants of an organization’s overall strategic position .5

It is helpful here to elaborate upon the difference between the SP and IP axes. SP refers to the volatility of profits and revenues for firms in a given industry. SP volatility (stability) is based on the expected impact o f changes in core external factors such as technology, econ­ omy. dem ographic, seasonality, etc.) The higher frequency and magnitude o f the changes the more unstable on SP. An industry can be stable or unstable on SP, yet high or low on IP. The smartphone industry for example would be unstable on SP yet high growth on IF, whereas the carbonated beverage industry would be stable on SP yet low growth on IP.

FP +7 —

Conservative Aggressive • Market penetration +6 — • Backward, forward, horizontal • Market development integration • Product development +5 — • Market penetration • Related diversification • Market development

+4 — • Product development • Diversification (related or unrelated)

+3 —

+2 -

+1 —

i i i i i i i 0 I I ......................................

-7 -6 -5 -4 -3 -2 -1 0

1

+ 1 +2 +3 +4 +5 +6 +7

— 1

Defensive -2 — Competitive • Retrenchment • Backward, forward, horizontal • Divestiture _3 integration • Liquidation • Market penetration

-4 — • Market development • Product development

-5

-6 -

-7 —

SP FIGURE 8-4 The SPACE Matrix

Source: Based on H. Rowe. R. Mason, and K. Dickel, Strategic Management and Business Policy: A Methodological Approach (Reading. MA: Addison-Wesley Publishing Co. Inc., © 1982), 155.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 263

Depending on the type o f organization, numerous variables could make up each of the dim en­ sions represented on the axes of the SPACE Matrix. Factors that were included in the firm ’s EFE and IFE matrices should be considered in developing a SPACE Matrix. O ther variables commonly included are given in Table 8-2. For example, return on investment, leverage, liquidity, working capital, and cash How are commonly considered to be determining factors o f an organization's financial strength. Like the SWOT Matrix, the SPACE Matrix should be both tailored to the particular organization being studied and based on factual information as much as possible.

The steps required to develop a SPACE Matrix are as follows:

1. Select a set o f variables to define financial position (FP), com petitive position (CP), stability position (SP), and industry' position (IP).

2. Assign a numerical value ranging from +1 (worst) to +7 (best) to each of the variables that make up the FP and IP dimensions. Assign a numerical value ranging from -1 (best) to -7 (worst) to each of the variables that make up the SP and CP dimensions. On die FP and CP axes, make comparison to competitors. On the IP and SP axes, make comparison to other industries.

3. Com pute an average score for FP. CP. IP. and SP by summing the values given to the variables o f each dimension and then by dividing by the num ber o f variables included in the respective dimension.

4. Plot the average scores for FP, IP. SP, and CP on the appropriate axis in the SPACE Matrix. 5. Add the two scores on the jc-axis and plot the resultant point on X. Add the two scores on

the y-axis and plot the resultant point on Y. Plot the intersection o f the new xy point. 6 . Draw a d irec tiona l vector from the origin o f the SPACE Matrix through the new

intersection point. This vector reveals the type o f strategies recom m ended for the organization: aggressive, com petitive, defensive, or conservative.

Some examples o f strategy profiles that can emerge from a SPACE analysis are shown in Figure 8-5. The directional vector associated with each profile suggests the type of strategies to pur­ sue: aggressive, conservative, defensive, or competitive. When a firm’s directional vector is located in the aggressive q u ad ra n t (upper-right quadrant) of the SPACE Matrix, an organization is in an excellent position to use its internal strengths to (a) take advantage o f external opportunities, (b) overcome internal weaknesses, and (c) avoid external threats. Therefore, market penetration, market

TA B LE 8-2 Example Factors That Make Up the SPACE Matrix Axes

Internal Strategic Position External Strategic Position

Financial Position (FP) Stability Position (SP)

Return on investment Technological changes Leverage Rate of inflation Liquidity Demand variability Working capital Price range of competing products Cash flow Barriers to entry into market Inventory turnover Competitive pressure Earnings per share Ease of exit from market Price earnings ratio Price elasticity of demand

Risk involved in business Competitive Position (CP) Industry Position (IP)

Market share Growth potential Product quality Profit potential Product life cycle Financial stability Customer loyalty Extent leveraged Capacity utilization Resource utilization Technological know-how Ease of entry into market Control over suppliers and distributors Productivity, capacity utilization

Source: Based on H. Rowe. R. Mason, and K. Dickel. Strategic Management and Business Policy: A Methodological Approach (Reading, MA: Addison-Wesley Publishing Co. Inc., © 1982), 155-156.

264 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

FP

development, product development, backward integration, forward integration, horizontal integra­ tion, or diversification, can be feasible, depending on the specific circumstances that face the firm.

W hen a particular company is known, the analyst must be much more specific in terms of recommended strategies. For example, instead o f saying market penetration is a recommended

Aggressive Profiles

A financially strong firm that has achieved major competitive advantages in a growing and stable industiy

A firm whose financial strength is a dominating factor in the industry

Conservative Profiles

IP IP

SP

A firm that has achieved financial strength in a stable industry that is not growing; the firm has few competitive advantages

A firm that suffers from major competitive disadvantages in an industry that is technologically stable but declining in sales

FP Competitive Profiles

IP

A firm with major competitive advantages in a high-growth industry

An organization that is competing fairly well in an unstable industry

FP Defensive Profiles FP

IP IP

A firm that has a very weak competitive position in a negative growth, stable industry'

A financially troubled firm in a very unstable industry

FIGURE 8-5 Example Strategy Profiles

Source: Based on H. Rowe, R. Mason, and K. Dickel, Strategic Management and Business Policy: A Methodological Approach (Reading, MA: Addison-Wesley Publishing Co. Inc., © 1982), 155.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 265

strategy when your vector goes in the conservative quadrant, say that adding 34 new stores in India is a recommended strategy. This is an important point for students doing case analyses because a particular com pany is generally known, and terms such as market development are too vaaue to use. That term could refer to adding a m anufacturing plant in Thailand or M exico or South A frica— so students—be specific to the extent possible regarding implications o f all the matrices presented in this chapter. Not being specific can be disastrous in this course. Avoid terms like expand, increase, decrease, grow— be much more specific than that!

The directional vector may appear in the conservative q u a d ra n t (upper-left quadrant) o f the SPACE M atrix, which implies staying close to the firm ’s basic com petencies and not taking excessive risks. Conservative strategies most often include market penetration, market develop­ ment, product development, and related diversification. The directional vector may be located in the lower-left or defensive q u a d ra n t of the SPACE M atrix, which suggests that the firm should focus on rectifying internal w eaknesses and avoiding external threats. Defensive strategies include retrenchment, divestiture, liquidation, and related diversification. Finally, the directional vector may be located in the lower-right or com petitive q u a d ra n t o f the SPACE M atrix, indi­ cating com petitive strategies. Com petitive strategies include backward, forward, and horizontal integration; market penetration; market development; and product development.

A SPACE M atrix analysis for a bank is provided in Table 8 -3ế N ote that com petitive type strateg ies are recom m ended. A SPACE M atrix for H ew lett-Packard (HP) is given in

TA B LE 8-3 A SPACE Matrix for a Bank

Financial Position (FP) Ratings

The bank's primary capital ratio is 7.23 percent, which is 1.23 percentage points over the generally required ratio of 6 percent. 1.0 The bank’s return on assets is negative 0.77, compared to a bank industry average ratio of positive 0.70. 1.0 The bank’s net income was $183 million, down 9 percent from a year previously. 3.0 The bank’s revenues increased 7 percent to $3.46 billion. 4.0

9.0 Industry Position (IP)

Deregulation provides geographic and product freedom. 4.0 Deregulation increases competition in the banking industry. 2.0 Pennsylvania’s interstate banking law allows the bank to acquire other banks in New Jersey. Ohio, Kentucky, the District of 4.0 Columbia, and West Virginia.

10.0 Stability Position (SP)

Less-developed countries are experiencing high inflation and political instability. -4 .0 Headquartered in Pittsburgh, the bank historically has been heavily dependent on the steel, oil. and gas industries. These industries -5 .0 are depressed. Banking deregulation has created instability throughout the industry’. -4 .0

-13.0 Competitive Position (CP)

The bank provides data processing services for more than 450 institutions in 38 states. - 2.0 Superregional banks, international banks, and nonbanks are becoming increasingly competitive. -5 .0 The bank has a large customer base. - 2.0

-9.0 Conclusion

SP Average is -13.0 + 3 = -4.33 IP Average is +10.0 + 3 = 3.33 CP Average is —9.0 -j- 3 = —3.00 FP Average is +9.0 + 4 = 2.25 Directional Vector Coordinates: x-axis: -3 .00 + (+3.33) = +0.33

y-axis: -4.33 + (+2.25) = -2.08 The bank should pursue competitive strategies.

266 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

TA B LE 8-4 An Actual SPACE Matrix for Hewlett-Packard

In ternal Analysis External Analysis

Financial Position (FP) Stability Position (SI3) Return on Investment (ROl) I Rate of Inflation -2 Leverage 4 Technological Changes -6 Liquidity 2 Price Elasticity of Demand -3 Working Capital 1 Competitive Pressure -7 Cash Flow 2 Barriers to Entry into Market -4 Financial Position (FP) Average 2 Stability Position (SP) Average -4.4 Internal Analysis External Analysis

Competitive Position (CP) Industry Position (IP) Market Share -7 Growth Potential 6 Product Quality _2 Financial Stability 2 Customer Loyalty -3 Ease of Entry into Market 4 Technological Know-how -4 Resource Utilization I Control over Suppliers/Distributors -5 Profit Potential 2 Competitive Position (CP) Average -4.2 Industry Position (IP) Average 3.0

2.0 + (-4.4) = -2.4 y-axis 3 .0+ (-4.2) = -1.2 x-axis Coordinate (-1.2, -2.4) Conclusion: Vector points in defensive quadrant

Table 8-4 follow ed by the Krispy Kreme Donuts SPACE diagram in F igure 8-6 . N ote that HP is in a precarious defensive position , struggling to com pete against A pple, Dell, and Am azon.

x-axis = -1.2, y-axis = -2.4

SP

FIGURE 8-6 A SPACE Matrix for Krispy Kreme

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 267

The Boston Consulting Group (BCG) Matrix Based in Boston and having 1,713 employees, the Boston Consulting Group (BCG) is a large consulting firm that endured the recent economic downturn without laying off any em ployees and in 2010 hired the most new consultants ever. BCG ranks number 2 in Fortune's recent list o f the “ 100 Best Com panies To Work For.”

Autonomous divisions (or profit centers) o f an organization make up what is called a busi­ ness portfolio . When a firm ’s divisions com pete in different industries, a separate strategy often m ust be developed for each business. The Boston Consulting Group (BCG) Matrix and the Internal-External (IE) Matrix are designed specifically to enhance a multidivisional firm 's efforts to formulate strategies. (BCG is a private m anagement consulting firm based in Boston that currently em ploys about 4,400 consultants in 40 countries.)

In a Form !0K or Annual Report, some com panies do not disclose financial information by segment, in which case a BCG portfolio analysis may not be possible by persons external to the firm. Reasons to disclose by-division financial information in the author’s view, however, more than offset the reasons not to disclose, as indicated in Table 8-5.

The BCG M atrix graphically portrays differences am ong divisions in term s o f relative m arket share position and industry growth rate. The BCG M atrix allows a m ultidivisional organization to m anage its portfolio o f businesses by exam ining the relative m arket share position and the industry growth rate o f each division relative to all other d ivisions in the organization. R e la tive m a rk e t sh a re position is defined as the ratio o f a d iv ision 's own m arket share (or revenues) in a particular industry to the m arket share (or revenues) held by the largest rival firm in that industry. Note in Table 8-6 that other variables can be used in this analysis besides revenues. For exam ple, num ber o f stores, or num ber of restaurants, or in the airline industry num ber o f airplanes could be used for com parative purposes to deter­ m ine relative m arket share position . Relative market share position for Enterprise R ent-a-C ar based on num ber o f locations is 6 ,187/6,187 = 1.00 as indicated in Table 8-6 . E nterprise is the largest rental car com pany and its circle in a BCG M atrix would be som ew here along the far left axis.

Relative m arket share position is given on the Jt-axis o f the BCG M atrix. The m idpoint on the .v-axis usually is set at 0.50. corresponding to a division that has half the m arket share o f the leading firm in the industry. The y-axis represents the industry growth rate in sales, m easured in percentage term s. The growth rate percentages on the y-axis could range from - 2 0 to +20 percent, w ith 0.0 being the m idpoint. The average annual increase in revenues for several leading firm s in the industry w ould be a good estim ate o f the value. A lso, various sources such as the S&P Industry Survey w ould provide this value. These num erical ranges on the x- and y-axes are often used, but other num erical values could be

TA B LE 8-5 Reasons to (or Not to) Disclose Financial Information by Segment (by Division)

Reasons to Disclose Reasons Not to Disclose 1. Transparency is a good thing in today’s 1. Can become free competitive information

world of Sarbanes-Oxley for rival firms

2. Investors will better understand the firm. 2. Can hide performance failures which can lead to greater support 3. Can reduce rivalry among segments

3. Managers and employees will better understand the firm, which should lead to greater commitment

4. Disclosure enhances the communication process both within the firm and with outsiders

268 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

TA B LE 8-6 Market Share Data for Selected Industries

Hard Cider (consumption growing rapidly; has about 5 percent alcohol; consumed 50/50 by men/women versus 80/20 men/women for beer; sweeter than beer); WSJ, 8-15-12. B9—Top hard cider brands in the USA in millions of liters sold in 2011.

Brand Liters Owner

Woodchuck Cider 14.1 Vermont Hard Cider Strongbow Cider 6.9 Heinekcn NV Hornsby’s Cider 6.8 C&C Group PLC Magners 6.2 C&C Group PLC Ace Cider 2.1 California Cider Co. Crispin Cider 1.0 MillerCoors LLC Michelob Cider 1.0 Anheuser-Busch InBev NV Angry Orchard Cider 1.0 Boston Beer Co. (maker of Sam

Adams lager) Other Ciders 60.9

Total 100.0

USA Car Rental Industry (USA Today, 8-28-1 2. p. IB) Number of Airport Market

Brand Number of Cars Locations Share (%)

Enterprise 920K 6,187 34 Hertz/Advantage/ 438K 2.945 37 Dollar Thrifty Avis/Budget 285 K 2,300 26 Other I06K 978 03 TOTAL I.749K 2,410

Smartphones in the USA ( USA Today. 10-18-112, p. 4B)

Brand Market Share (%)

Apple 37.3 Samsung 27.0 LG 7.9 Motorola 6.7

Note: Ireland’s C&C Group PLC is trying to acquire Vermont Hard Cider, maker o f the best-selling Woodchuck eider. For many Americans until the mid-19th century, hard cider was the go-to alcoholic beverage, until drinkers turned to beer. Today in the USA. hard cider represents less than 0.5 percent of beer consumption, compared to the UK where it is eloser to 15 percent. But hard cider, which has an alcohol content o f about 5 percent like beer, is mounting a comeback in the USA.

established as deem ed appropriate for particular organizations, such as -10 to +10 percent on the y-axis.

The basic BCG Matrix appears in Figure 8-7. Each circle represents a separate division. The size o f the circle corresponds to the proportion o f corporate revenue generated by that business unit, and the pie slice indicates the proportion of corporate profits generated by that division. Divisions located in Quadrant 1 o f the BCG Matrix are called “Question M arks," those located in Quadrant 11 are called “Stars,” those locatcd in Quadranl 111 are called “Cash Cows,” and those divisions located in Quadrant IV are called “Dogs.”

• Question M arks— D ivisions in Q uadrant I have a low relative m arket share position, yet they com pete in a high-growth industry. G enerally these f irm s’ cash needs are high and the ir cash generation is low. These businesses are called q u es tio n m a rk s because the organization m ust decide w hether to strengthen them by pursu ing an intensive

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 269

High +20

Medium q

High

1.0

RELATIVE MARKET SHARE POSITION

Medium

.50

Low

0.0

-20

' • B a c k w a rd . F o rw a rd , o r H o r iz o n ta l In te g ra tio n

• M a rk e t Pe n e tratio n

• M a rk e t D e v e lo p m e n t

• P ro d u c t D e v e lo p m e n t

Stars v J P II

• M a rk e t P e n e tra tio n ^

• M a rk e t D e v e lo p m e n t

• P ro d u c t D e v e lo p m e n t

• D iv e s titu re

Q uestion Marks I

• P ro d u c t D e v e lo p m e n t

• D iv e rs if ic a tio n

• R e tre n c h m e n t

• D iv e s titu re

Cash Cows

I ' m

• R e tre n c h m e n t

• D iv e s titu re

• L iq u id a tio n

Dogs

' ' rLow FIGURE 8-7 The BCG Matrix

Source: Based on the BCG PoriI'olio Matrix from (he Product Portfolio Matrix, © 1970. The Boston Consulting Group.

strategy (m arket penetration , m arket developm ent, or product developm ent) or to sell them.

• Stars— Quadrant II businesses (stars) represent the organization’s best long-run opportunities for growth and profitability. Divisions with a high relative market share and a high industry growth rate should receive substantial investment to maintain or strengthen their dominant positions. Forward, backward, and horizontal integration; market penetration: market development; and product development are appropriate strategics for these divisions to consider, as indicated in Figure 8-7.

• Cash Cows— Divisions positioned in Quadrant III have a high relative market share position but com pete in a low-growth industry. Called cash cow's because they generate cash in excess o f their needs, they are often milked. Many o f today’s cash cows were yesterday’s stars. Cash cow divisions should be managed to maintain their strong position for as long as possible. Product development or diversification may be attractive strategies for strong cash cows. However, as a cash cow division becomes weak, retrenchm ent or divestiture can become more appropriate.

• Dogs— Quadrant IV divisions of the organization have a low relative market share posi­ tion and com pctc in a slow- or no-m arket-growth industry; they are dogs in the firm ’s portfolio. Because of their weak internal and external position, these businesses are of­ ten liquidated, divested, or trimmed down through retrenchm ent. W hen a division first becom es a dog, retrenchm ent can be the best strategy to pursue because many Dogs have bounced back, after strenuous asset and cost reduction, to becom e viable, profitable divisions.

The m ajor benefit o f the BCG M atrix is that it draws attention to the cash flow, invest­ ment characteristics, and needs of an organization’s various divisions. The divisions o f many firm s evolve over tim e: dogs becom e question marks, question marks becom e stars, stars becom e cash cows, and cash cows becom e dogs in an ongoing counterclockw ise m otion. Less frequently, stars becom e question marks, question m arks becom e dogs, dogs becom e cash cows, and cash cows becom c stars (in a clockw ise m otion). In some organizations, no cyclical m otion is apparent. Over tim e, organizations should strive to achieve a portfolio o f divisions that are stars.

An exam ple BCG Matrix is provided in Figure 8-8, which illustrates an organization com posed of five divisions with annual sales ranging from $5,000 to $60,000. Division 1 has

270 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

RELATIVE MARKET SHARE POSITION IN THE INDUSTRY

High 1.0

Medium .50

Low 0.0

INDUSTRY SALES GROWTH RATE (Percentage)

Medium 0

1

1 !. 39%

' --------1-----------------------------

20%

2 8%

3

4 3 31%

u. (

G K>

--- ---

--- ---

-1- ---

--- ---

--

Division Revenues

L .U Y V

Percent Revenues Profits Percent Profits Relative Market Share Industry Growth Rate {%)

1 560,000 37 $10,000 39 .80 + 15 2 40,000 24 5,000 20 .40 + 10 3 40,000 24 2,000 8 .10 + 1 4 20,000 12 8,000 31 .60 -20 5 5,000 3 500 2 .05 -10

Total SI 65,000 100 $25,500 100 — —

FIGURE 8-8 An Example BCG Matrix

the greatest sales volume, so the circle representing that division is the largest one in the matrix. The circle corresponding to Division 5 is the smallest because its sales volume ($5,000) is least among all the divisions. The pie slices within the circles reveal the percent o f corporate profits contributed by each division. As shown. Division 1 contributes the highest profit percentage, 39 percent, as indicated by 39 percent of the area within circle 1 being shaded. Notice in the diagram that Division I is considered a star, Division 2 is a question mark. Division 3 is also a question mark. Division 4 is a cash cow, and Division 5 is a dog.

The BCG Matrix, like all analytical techniques, has some lim itations. For example, viewing every business as a star, cash cow, dog, or question mark is an oversim plification; many businesses fall right in the middle o f the BCG Matrix and thus are not easily classified. Furthermore, the BCG Matrix does not reflect whether or not various divisions or their industries are growing over time; that is, the matrix has no temporal qualities, but rather it is a snapshot o f an organization at a given point in time. Finally, other variables besides relative market share position and industry growth rate in sales, such as size o f the market and com petitive advan­ tages, are important in making strategic decisions about various divisions.

An example BCG Matrix is provided in Figure 8-9. Note in Figure 8-9 that Division 5 had an operating loss o f $188 million. Take note how the percent profit column is still calculated because oftentimes a firm will have a division that incurs a loss for a year. In terms o f the pie slice in circle 5 o f the diagram, note that it is a different color from the positive profit segments in the other circles.

The Internal-External (IE) Matrix The In te rn a l-E x te rn a l (IE) M atrix positions an organization’s various divisions in a nine-cell display, illustrated in Figure 8-10. The IE Matrix is sim ilar to the BCG M atrix in that both tools involve plotting organization divisions in a schematic diagram; this is why they are both called “portfolio matrices.” Also, the size o f each circle represents the percentage sales contribution of each division, and pie slices reveal the percentage profit contribution o f each division in both the BCG and IE Matrix.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION

INDUSTRY SALES GROWTH RATE %

+20

+ 15

+ 10

+5

0 -5

-10

-15

-20

RELATIVE MARKET SHARE POSITION (RMSP)

.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.

---------- t----------1---------- 1---------- t---------

68%

---------- t----------\----------I---------- 1----------

, ( % 1.2% - 39.0% 3 Ç p \

4 c 0.1% 18.3%

5 ®

Division $ Sales (millions) % Sales $ Profits (millions) % Profits r m s p IG Rate %

1. $5,139 51.5 $799 68.0 0.8 10 2. 2,556 25.6 400 39.0 0.4 05 3. 1,749 17.5 12 1.2 0.2 00 4. 493 4.9 4 0.1 0.5 -05 5. 42 0.5 -188 (18.3) .02 -10 Total S9,979 100.0 $1,027 100.0

FIGURE 8-9 An Example BCG Matrix

Backward, Forward, or Horizontal Integration Market Penetration Market Development Product Development

Strong 3.0 to 4.0

THE IFE TOTAL WEIGHTED SCORES

Average Weak 2.0 to 2.99 1.0 to 1.99

FIGURE 8-10 The Internal-External (IE) Matrix

271

Source: Based on: The IE Matrix was developed from the General Electric (GE) Business Screen Matrix. For a description of the GE Matrix, see Michael Allen, “Diagramming GE's Planning for What’s WATT." in R. Allio and M. Pennington, eds.. Corporate Planning: Techniques and Applications I par; New York: AMACOM. 1979.

272 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

THE EFE TOTAL WEIGHTED SCORES

But there are some important differences between the BCG Matrix and the IE Matrix. First, die axes are different. Also, the IE Matrix requires more information about the divisions than the BCG Matrix. Furthermore, the strategic implications of each matrix are different. For these reasons, strate­ gists in multidivisional firms often develop both the BCG Matrix and the IE Matrix in formulating alternative strategies. A common practice is to develop a BCG Matrix and an IE Matrix for the pres­ ent and then develop projected matrices to reflect expectations o f the future. This before-and-al'ter analysis forecasts the expected effect o f strategic decisions on an organization’s portfolio of divisions.

The IE Matrix is based on two key dimensions: the IFE total weighted scores on the .x-axis and the EFE total weighted scores on the 3-axis. Recall that each division o f an organization should construct an IFE Matrix and an EFE Matrix for its part of the organization. The total weighted scores derived from the divisions allow construction o f the corporate-level IE Matrix. On the x-axis o f the IE Matrix, an IFE total weighted score o f 1.0 to 1.99 represents a weak internal position; a score o f 2.0 to 2.99 is considered average; and a score o f 3.0 to 4.0 is strong. Similarly, on the v-axis, an EFE total weighted score o f 1.0 to 1.99 is considered low; a score of 2.0 to 2.99 is medium; and a score o f 3.0 to 4.0 is high.

The IE Matrix can be divided into three major regions that have different strategy im plica­ tions. First, the prescription for divisions that fall into cells I. II. or IV can be described as grow and build. Intensive (market penetration, market development, and product development) or integrative (backward integration, forward integration, and horizontal integration) strategies can be most appropriate for these divisions. Second, divisions that fall into cells III. V, or VII can be managed best with hold and maintain strategies; market penetration and product development are two com monly employed strategies for these types o f divisions. Third, a com m on prescrip­ tion for divisions that fall into cells VI, VIII. or IX is harvest or divest. Successful organizations are able to achieve a portfolio of businesses positioned in or around cell I in the IE Matrix.

An example o f a completed IE Matrix is given in Figure 8-11, which depicts an organiza­ tion com posed o f four divisions. As indicated by the positioning of the circles, grow and build strategies are appropriate for Division 1, Division 2, and Division 3. Division 4 is a candidate for harvest or divest. Division 2 contributes the greatest percentage of com pany sales and thus is represented by the largest circle. Division 1 contributes the greatest proportion o f total profits: it has the largest-percentage pie slice.

THE IFE TOTAL WEIGHTED SCORES

High 3.0 to 4.0

Medium 2.0 to 2.99

Low 1.0 to 1.99

4.0

3.0

2.0

Strong 3.0 to 4.0

Average 2.0 to 2.99

3.0

Weak 1.0 to 1.99

2.0 1.0 1

50% 25%

3o 20% 40 5%

v

Division Sales Percent Sales Profits Percent Profits IFE Scores EFE Scores

1 $100 25.0 $10 50 3.6 3.2 2 200 50.0 5 25 2.1 3.5 3 50 12.5 4 20 3.1 2.1 4 50 12.5 1 5 1.8 2.5

Total S400 100.0 $20 100

FIGURE 8-11 An Example IE Matrix

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 273

THE IFE TOTAL WEIGHTED SCORES

THE EFE TOTAL WEIGHTED SCORES

FIGURE 8-12 The IE Matrix

Strotig 3.0 to 4.0

Average 2.0 to 2.99

Weak l.O to 1.99

High 3.0 to 4.0

Medium 2.0 to 2.99

Low 1.0 to 1.99

4.0

3.0

2.0

3.0 2.0

1.0

Grow and Build

1.0 I

16% /4

II

5

III

4%

IV

59% '

VI

K VII VIII ' 19% IX

Segments $ Revenue % Revenue S Profit % Profit EFE Scores IFE Scores

1. $7,868 71.5% $3,000 59% 2.5 3 2. 1,241 11.3% 1,000 19% 2 2 3. 1,578 14.3% 800 16% 3 3 4. 90 0.8% 100 2% 2.5 2.5 5. 223 2.1% 200 4% 3 2 Total $11,000 100% $5,100 100% — —

As indicated in Figure 8-12. the IE M atrix has five product segments. Note that Division 1 has the largest revenues (as indicated by the largest circle) and the largest profits (as indicated by the largest pie slice) in the matrix. It is com mon for organizations to develop both geographic and product-based IE M atrices to more effectively formulate strategies and allocate resources among divisions. In addition, firms often prepare an IE (or BCG) Matrix for competitors. Furthermore, firms will often prepare “before and after” IE (or BCG) M atrices to reveal the situation at present versus the expected situation after one year. This latter idea m inim izes the lim itation o f these m atrices being a “snapshot in time.” In perform ing case analysis, feel free to estim ate the IFE and EFE scores for the various divisions based upon your research into the com pany and industry— rather than preparing a separate IE Matrix for each division.

The Grand Strategy Matrix In addition to the SW OT M atrix, SPACE M atrix, BCG M atrix, and IE Matrix, the G ran d S tra tegy M atrix has become a popular tool for form ulating alternative strategies. All organiza­ tions can be positioned in one of the Grand Strategy M atrix’s four strategy quadrants. A firm ’s divisions likewise could be positioned. As illustrated in Figure 8-13, the Grand Strategy Matrix is based on two evaluative dimensions: competitive position and market (industry) growth. Any industry whose annual growth in sales exceeds 5 percent could be considered to have rapid growth. Appropriate strategies for an organization to consider are listed in sequential order of attractiveness in each quadrant o f the matrix.

Firms located in Quadrant I o f the Grand Strategy Matrix are in an excellent strategic posi­ tion. For these firms, continued concentration on current markets (market penetration and market development) and products (product development) is an appropriate strategy. It is unwise for a Quadrant I firm to shift notably from its established com petitive advantages. When a Quadrant I organization has excessive resources, then backward, forward, or horizontal integration may be effective strategies. W hen a Quadrant I firm is too heavily com mitted to a single product, then

274 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

RAPID MARKET GROWTH

WEAK COMPETITIVE

POSITION

Quadrant 11 1. Market development 2. Market penetration 3. Product development 4. Horizontal integration 5. Divestiture 6. Liquidation

Quadrant I 1. Market development 2. Market penetration 3. Product development 4. Forward integration 5. Backward integration 6. Horizontal integration 7. Related diversification

Quadrant 111 Quadrant IV I . Retrenchment 1. Related diversification 2. Related diversification 2. Unrelated diversification 3. Unrelated diversification 3 .Joint ventures 4. Divestiture 5. Liquidation

STRONG COMPETITIVE

POSITION

SLOW MARKET GROWTII

FIGURE 8-13 The Grand Strategy Matrix

Source: Based on Roland Christensen, Norman Berg, and Malcolm Salter. Policy Formulation and Administration (Homewood, IL: Richard D. Irwin. 1976), 16 - 18.

related diversification may reduce the risks associated with a narrow product line. Quadrant I firms can afford to take advantage o f external opportunities in several areas. They can take risks aggressively when necessary.

Firm s positioned in Quadrant ll need to evaluate their present approach to the marketplace seriously. Although their industry is growing, they are unable to com pete effectively, and they need to determine why the firm ’s current approach is ineffective and how the com pany can best change to improve its com petitiveness. Because Quadrant II firms are in a rapid-market-growth industry, an intensive strategy (as opposed to integrative or diversification) is usually the first option that should be considered. However, if the firm is lacking a distinctive competence or com petitive advantage, then horizontal integration is often a desirable alternative. As a last resort, divestiture or liquidation should be considered. Divestiture can provide funds needed to acquire other businesses or buy back shares o f stock.

Quadrant III organizations com pete in slow-growth industries and have weak com peti­ tive positions. These firms must make some drastic changes quickly to avoid further decline and possible liquidation. Extensive cost and asset reduction (retrenchm ent) should be pursued first. An alternative strategy is to shift resources away from the current business into different areas (diversify). If all else fails, the final options for Quadrant III businesses are divestiture or liquidation.

Finally. Quadrant IV businesses have a strong competitive position but are in a slow-growth industry. These firms have the strength to launch diversified program s into more promising growth areas: Quadrant IV firms have characteristically high cash-flow levels and limited inter­ nal growth needs and often can pursue related or unrelated diversification successfully. Quadrant IV firms also may pursue joint ventures.

Students: Even with the Grand Strategy Matrix, be sure to state your alternative strategies in specific terms whenever a particular com pany is known. Avoid using term s such as divestiture for example. Rather, specify the exact division to be sold. Also, be sure to use the free excel student template at www.strategyclub.com if you like.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 275

The Decision Stage Analysis and intuition provide a basis for making strategy-form ulation decisions. The matching techniques ju s t discussed reveal feasible alternative strategies. Many o f these strategies will likely have been proposed by managers and em ployees participating in the strategy analysis and choice activity. Any additional strategies resulting from the matching analyses could be discussed and added to the list o f feasible alternative options. As indicated previously in this chapter, participants could rate these strategies on a l-to-4-scale so that a prioritized list of the best strategies could be achieved.

The Quantitative Strategic Planning Matrix (QSPM) Other than ranking strategies to achieve the prioritized list, there is only one analytical technique in the literature designed to determ ine the relative attractiveness of feasible alternative actions. This technique is the Q u an tita tiv e S tra teg ic P lann ing M atrix (QSPM ), which com prises Stage 3 o f the strategy-form ulation analytical fram ework .6 This technique objectively indicates which alternative strategies are best. The QSPM uses input from Stage I analyses and matching results from Stage 2 analyses to decide objectively am ong alternative strategies. That is, the EFE Matrix, 1FE Matrix, and CPM that com prise Stage 1, coupled with the SWOT M atrix, SPACE M atrix, BCG Matrix, IE Matrix, and Grand Strategy Matrix that com prise Stage 2, provide the needed inform ation for setting up the QSPM (Stage 3). The QSPM is a tool that allows strate­ gists to evaluate alternative strategies objectively, based on previously identified external and internal key success factors. Like other strategy-form ulation analytical tools, the QSPM requires good intuitive judgm ent.

The basic form at o f the QSPM is illustrated in Table 8-7. Note that the left column o f a QSPM consists of key external and internal factors (from Stage I ), and the top row consists of feasible alternative strategies (from Stage 2). Specifically, the left column o f a QSPM consists o f inform ation obtained directly from the EFE Matrix and IFF M atrix. In a column adjacent to the key success factors, the respective weights received by each factor in the EFE Matrix and the IFE Matrix are recorded.

The top row o f a QSPM consists o f alternative strategies derived from the SW OT Matrix. SPACE Matrix, BCG Matrix, IE Matrix, and Grand Strategy Matrix. These matching tools usually generate sim ilar feasible alternatives. However, not every strategy suggested by the matching techniques has to be evaluated in a QSPM . Strategists should com pare several viable alternative strategies in a QSPM . Make sure your strategies are stated in specific terms, such

TA B LE 8-7 The Quantitative Strategic Planning Matrix—QSPM

Strategic A lternatives

Key Factors W eight S trategy 1 S trategy 2 S trategy 3

Key External Factors Economy

Pol i t ical/Legal/Govern men tal

Social/Cultural/Demographic/Environmental

Technological

Competitive

Key Internal Factors Management

Marketing

Finance/ Accounting

Production/Operations

Research and Development

Management Information Systems

276 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

as “Open 275 new stores in Indonesia” rather than ''Expand globally” or “Open new stores in Africa.” In Chapter 9. you will see that a dollar value m ust be established for each recom m ended strategy: it would be impossible to establish a dollar value for “expand globally.”

Conceptually, the QSPM determines the relative attractiveness o f various strategies based on the extent to which key external and internal critical success factors are capitalized on or improved. The relative attractiveness of each strategy within a set o f alternatives is com puted by determining the cumulative impact o f each external and internal critical success factor. Any number o f sets of alternative strategies can be included in the QSPM . and any num ber o f strate­ gies can make up a given set. but only strategies within a given set are evaluated relative to each other. For example, one set o f strategies may include diversification, whereas another set may include issuing stock and selling a division to raise needed capital. These two sets o f strategies are totally different, and the QSPM evaluates strategies only within sets. Note in Table 8-7 that three strategies are included, and they make up ju st one set.

A QSPM for a retail computer store is provided in Table 8-8. This example illustrates all the components o f the QSPM: strategic alternatives, key factors, weights, attractiveness scores (AS), total attractiveness scores (TAS), and the sum total attractiveness score. The three new terms just introduced— ( I ) attractiveness scores, (2) total attractiveness scores, and (3) the sum total attractive­ ness score— are defined and explained as the six steps required to develop a QSPM are discussed:

Step 1: Make a list o f the firm ’v key external opportunities and threats and internal strengths and weaknesses in the left column o f the QSPM. This information should be taken directly from the EFE Matrix and IFE Matrix. A minimum of 10 external key success factors and 10 internal key success factors should be included in the QSPM.

Step 2: Assign weights to each key external and internal factor. These weights are identical to those in the EFE Matrix and the IFE Matrix. The weights are presented in a straight column just to the right o f the external and internal critical success factors.

Step 3: Examine the Stage 2 (matching) matrices, and identify alternative strategies that the organization should consider implementing. Record these strategies in the top row of the QSPM. Group the strategies into mutually exclusive sets if possible.

Step 4: Determine the Attractiveness Scores (AS) defined as numerical values that indicate the relative attractiveness o f each strategy in a given set o f alternatives. A ttractiveness Scores (AS) are determined by examining each key external or internal factor, one at a time, and asking the question “Does this factor affect the choice o f strategies being made?” If the answer to this question is yes, then the strategies should be compared relative to that key factor. Specifically, AS should be assigned to each strategy to indicate the relative attractiveness of one strategy over others, considering the particular factor. The range for AS is 1 = not attractive. 2 = somewhat attractive. 3 = reasonably attractive, and 4 = highly attractive. By attractive, we mean the extent that one strategy, com pared to others, enables the firm to either capitalize on the strength, improve on the weakness, exploit the opportunity, or avoid the threat. Work row by row in developing a QSPM. If the answer to the previous question is no, indicating that the respective key factor has no effect upon the specific choice being made, then do not assign AS to the strate­ gies in that set. Use a dash to indicate that the key factor does not affect the choice being made. Note: If you assign an AS score to one strategy, then assign an AS score(s) to the other. In other words, if one strategy receives a dash, then all others must receive a dash in a given row.

Step 5: Compute the Total Attractiveness Scores. Total Attractiveness Scores (TAS) are defined as the product o f m ultiplying the weights (Step 2) by the AS (Step 4) in each row. The TAS indicate the relative attractiveness of each alternative strategy, considering only the impact o f the adjacent external or internal critical success factor. The higher the TAS. the more attractive the strategic alternative (considering only the adjacent critical success factor).

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 277

TA BLE 8-8 A QSPM for a Retail Computer Store

STRATEGIC ALTERNATIVES

1 2

Buy New Land and Fully Renovate Build New Larger Store Existing Store

Key Factors W eight 4S TAS ¿S TAS Opportunities 1. Population of city growing 10 percent 0.10 4 0.40 2 0.20 2. Rival computer store opening one mile away 0.10 2 0.20 4 0.40 3. Vehicle traffic passing store up 12 percent 0.08 1 0.08 4 0.32 4. Vendors average six new products/year 0.05 — —

5. Senior citizen use of computers up 8 percent 0.05 — — 6. Small business growth in area up 10 percent 0.10 — — 7. Desire for websites up 18 percent by realtors 0.06 — —

8. Desire for websites up 12 percent by small firms 0.06 — —

Threats 1. Best Buy opening new store nearby In one year 0.15 4 0.60 3 0.45 2. Local university offers computer repair 0.08 — —

3. New bypass for Hwy 34 in one year will divert traffic 0.12 4 0.48 1 0.12 4. New mall being built nearby 0.08 2 0.16 4 0.32 5. Gas prices up 14 percent 0.04 — — 6. Vendors raising prices 8 percent 0.03 — —

Total 1.00

Strengths

1. Inventory' turnover increased from 5.8 to 6.7 0.05 — —

2. Average customer purchase increased from $97 to $128 0.07 2 0.14 4 0.28 3. Employee morale is excellent 0.10 — — 4. In-store promotions resulted in 20 percent increase in sales 0.05 — —

5. Newspaper advertising expenditures increased 10 percent 0.02 — — 6. Revenues from repair/service segment of store up 16 percent 0.15 4 0.60 3 0.45 7. In-store technical support personnel have MIS college degrees 0.05 — — 8. Store’s debt-to-total-assets ratio declined to 34 percent 0.03 4 0.12 2 0.06 9. Revenues per employee up 19 percent 0.02 — —

Weaknesses

1. Revenues from software segment of store down 12 percent 0.10 — — 2. Location of store negatively impacted by new Hwy 34 0.15 4 0.60 1 0.15 3. Carpet and paint in store somewhat in disrepair 0.02 1 0.02 4 0.08 4. Bathroom in store needs refurbishing 0.02 1 0.02 4 0.08 5. Revenues from businesses down 8% 0.04 3 0.12 4 0.16 6. Store has no website 0.05 — — 7. Supplier on-time delivery increased to 2.4 days 0.03 — —

8. Often customers have to wait to check out 0.05 2 0.10 4 0.20 Total 1.00 3.64 3.27

278 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

S tep 6 : Compute the Sum Total Attractiveness Score. Add TAS in each strategy column o f the QSPM. The Sum Total A ttractiveness Scores (STAS) reveal which strategy is most attractive in each set of alternatives. Higher scores indicate more attractive strat­ egies, considering all the relevant external and internal factors that could affect the strategic decisions. The magnitude of the difference between the STAS in a given set of strategic alternatives indicates the relative desirability o f one strategy over another.

In Table 8-8, two alternative strategies— (1) buy new land and build new larger store and (2) fully renovate existing store— are being considered by a com puter retail store. Note by sum total attractiveness scores of 3.64 versus 3.27 that the analysis indicates the business should buy new land and build a new larger store. Note the use o f dashes to indicate which factors do not affect the strategy choice being considered. If a particular factor affects one strategy but not the other, it affects the choice being made, so AS should be recorded for both strategies. Never rate one strategy and not the other. Note also in Table 8-8 that there are no double I ’s, 2 ’s, 3 's. or 4 's in a row. Never duplicate scores in a row. Never work column by colum n; always prepare a QSPM working row by row. If you have more than one strategy in the QSPM . then let the AS scores range from 1 to “the number o f strategies being evaluated.’' This will enable you to have a different AS score for each strategy. These are all important guidelines to follow in developing a QSPM. In actual practice, the store did purchase the new land and build a new store; the business also did some minor refurbishing until the new store was operational.

There should be a rationale for each AS score assigned. Note in Table 8-8 in the first row that the “city population growing 10 percent annually” opportunity could be capitalized on best by Strategy 1, “building the new, larger store,” so an AS score of 4 was assigned to Strategy 1. AS scores, therefore, are not mere guesses; they should be rational, defensible, and reasonable.

An example QSPM is given in Table 8-9. Note in the actual QSPM for Starbucks in Table 8-9 that many rows are not rated, indicating that the particular factor does not significantly impact the choice to be made. This is good procedure. Also, notice in Table 8-9 that the 3 and 4 ratings given to the Strategy 2 “Open 400 Stores in the Middle East, Asia/Africa” versus Strategy 1 and indicate that Strategy 2 is a better choice given most o f the factors. Working row by row is also good procedure. In addition, notice in Table 8-9 that many rows are not rated at all, indicating the particular factor will not impact the choice between Strategy 1 and 2. Leaving perhaps half o f the rows blank in this manner is also good procedure. Finally, note in Table 8-9, that Strategy 2 is better for Starbucks as indicated by a STAS of 2.41.

TA BLE 8-9 An Actual QSPM for Starbucks (2013)

Strategy 1

Open 100 Stores on U.S. College Campuses

Strategy 2 Open 400 Stores in Middle East Asia/

Africa

WT. AS TAS AS TAS

Strengths 1. 22 percent of revenue comes from its international unit. 0.04 1 0.4 4 0.16 2. Net income grew to $333.1M for the recent quarter. 0.03 - - - - 3. Total revenue grew to S3.30B from S2.92B. 0.04 - - - - 4. Sales at global restaurants open at least 13 months rose 6 percent. 0.04 1 0.04 3 0.12 5. Starbucks earned a 1CK) percent HRC rating for the fourth consecutive year. 0.03 - - - - 6. Starbucks global comparable store sales also increased 6 percent. 0.04 1 0.04 3 0.12 7. Starbucks revenues reached $ I66.9M in the Asian-Pacific region for 201 l's last 0.04 1 0.04 4 0.16

quarter (up 38 percent from a year earlier). 8. Starbucks only buys coffee grown at elevations higher than 2.600 feet because 0.05 - - - -

those beans are of better quality. 9. Starbucks employs more than 650 people to provide technology solutions. 0.04 - - - -

10. Starbucks buys Evolution Fresh Inc. (a high end juice maker) for $30M. 0.05 - - - - 11. Starbucks market share is 32.6 percent. 0.04 - - - -

12. Starbucks sells 8.2 million coffee drinks on average each day in the United States. 0.04 4 0.16 1 0.04

(continued)

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 279

S tra tegy 1 Stra tegy 2

Open 400 Stores in O pen 100 Stores on U.S. M idd le East Asia/

College Cam puses A frica

WT. AS TAS AS TAS

Weaknesses 13. Starbucks rose prices in the Northeast and Sunbelt by about 1 percent. 0.04 3 0.12 1 0.04 14. Starbucks rose prices in 500 Chinese mainland stores. Coffee prices will increase 0.04 1 0.04 3 0.12

by 1 to 2 yuan f 16 to 32 U.S. cents). 15. Starbucks reward cardholders protest firm charging for soy milk and flavored 0.05 - - - -

symps. 16. Starbucks does not offer the same type and quality lea as would be served in India. 0.04 1 0.04 2 0.08 17. After 63 Starbucks were opened in France, the firm has never turned a profit there. 0.06 - - - - 18. Sales for Starbucks in Europe open at least 13 months only rose 2 percent 0.06 - - - -

whereas in the United States had a 9 percent and Asia had a 20 percent growth. 19. Starbucks reputation takes a big hit among British consumers after a report 0.03 - - - -

showed they paid no tax on sales of 1.2 billion pounds in years past after telling the taxman it made no profit but told investors it was a profitable unit.

20. Starbucks comes in second place lo Dunkin Donuts on Brand Keys 2012 0.04 - - - - Customer Loyalty Engagement Index.

Opportunities 21. 80 percent of U.S. adults are concerned about weight. 0.04 - - - - 22. 45 percent of cell phone users have a smart phone. 0.04 - - - - 23. China’s projected GDP is $7.9 trillion. 0.02 2 0.04 4 0.08 24. U.S. projected GDP is $15.6 trillion. 0.02 4 0.08 2 0.04 25. Arabica coffee’s futures price fell to a 17-month low after the likelihood of a re­ 0.04 2 0.08 3 0.12

cord global crop in 2012-2013. 26. Since 2005 China’s market for specialized coffee shops has tripled. 0.05 1 0.05 4 0.20 27. Tea is the second most consumed beverage in the world, behind bottled water. 0.04 1 0.04 4 0.16 28. India’s tea industry accounts for 31 percent of global production. 0.04 1 0.04 4 0.16 29. Dunkin' Donuts comparable stores sales growth was 5.1 percent in 2011 versus 0.02 - - - -

Starbucks 8 percent. 30. The domestic coffee market in India is growing by 25 percent annually. 0.02 - - - -

Threats 31. The European debt crisis causes the demand for coffee to falter in various coun­ 0.05 2 0.10 4 0.20

tries: down 6.7 percent. 2.6 percent, and 1.6 percent in Britain, Spain, and Italy. respectively.

32. Consumer confidence index fell to 60.6 in August from 65.4 in July. 0.03 3 0.09 1 0.03 33. China’s per capital GDP in 2011 was 55,184. 0.04 1 0.04 4 0.16 34. An estimated 30 to 50 million American adults are lactose intolerant. 0.04 - - - - 35. Dunkin’ Donuts opens outlets in the U.S. Northeast, South, and Mid-Atlantic at 0.03 4 0.12 1 0.03

10 college campuses. 36. Dunkin’ Donuts announces its company’s goal of doubling U.S. store presence 0.03 4 0.12 1 0.03

over 20 years. 37. McDonald's Asia/Pacific, Middle East and Africa division had a 1.4 percent in­ 0.04 1 0.04 4 0.16

crease in comparable sales. 38. McDonald's had total revenues of $27B for fiscal 2011 compared to Starbucks 0.04 2 0.08 3 0.12

S11.7B. 39. McDonald’s takes 7th place in Interbrand's Best Global Brands 2012 while 0.02 1 0.02 4 0.08

Starbucks comes in 88th place. 40. Select McDonald’s stores in the United States and Europe are providing iPads 0.04 - - - —

for customers to use while they are in the store. TOTAL 1.00 1.82 2.41

280 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

Positive Features and Limitations of the QSPM A positive feature o f the QSPM is that sets o f strategies can be exam ined sequentially or simultaneously. For example, corporate-level strategies could be evaluated first, followed by division-level strategies, and then function-level strategies. There is no limit to the number o f strategies that can be evaluated or the number of sets o f strategies that can be examined at once using the QSPM.

Another positive feature o f the QSPM is that it requires strategists to integrate pertinent external and internal factors into the decision process. Developing a QSPM makes it less likely that key factors will be overlooked or weighted inappropriately. A QSPM draws attention to important relationships that affect strategy decisions. Although developing a QSPM requires a number of subjective decisions, making small decisions along the way enhances the probability that the final strategic decisions will be best for the organization. A QSPM can be used by small and large, for-profit and nonprofit organizations.

The QSPM is not without some limitations. First, it always requires intuitive judgm ents and educated assumptions. The ratings and attractiveness scores require judgm ental decisions, even though they should be based 011 objective information. Discussion am ong strategists, managers, and em ployees throughout the strategy-formulation process, including development o f a QSPM, is constructive and improves strategic decisions. Constructive discussion during strategy analy­ sis and choice may arise because o f genuine differences of interpretation of inform ation and varying opinions. A nother limitation of the QSPM is that it can be only as good as the prerequi­ site information and matching analyses upon which it is based.

Cultural Aspects of Strategy Choice All organizations have a culture. C u ltu re includes the set o f shared values, beliefs, attitudes, customs, norms, personalities, heroes, and heroines that describe a firm. Culture is the unique way an organization does business. It is the human dimension that creates solidarity and meaning, and it inspires com mitm ent and productivity in an organization when strategy changes are made. All human beings have a basic need to make sense of the w'orld, to feel in control, and to make meaning. When events threaten meaning, individuals react defensively. M anagers and em ployees may even sabotage new strategies in an effort to recapture the status quo.

It is beneficial to view strategic managem ent from a cultural perspective because success often rests on the degree of support that strategies receive from a firm ’s culture. If a firm ’s strategies are supported by cultural products such as values, beliefs, rites, rituals, ceremonies, stories, symbols, language, heroes, and heroines, then managers often can im plem ent changes swiftly and easily. However, if a supportive culture does not exist and is not cultivated, then strategy changes may be ineffective or even counterproductive. A firm ’s culture can become antagonistic to new strategies, and the result o f that antagonism may be confusion and disarray.

Strategies that require fewer cultural changes may be more attractive because extensive changes can take considerable time and effort. W henever two firms merge, it becom es especially important to evaluate and consider culture-strategy linkages.

Culture provides an explanation for the difficulties a firm encounters when it attem pts to shift its strategic direction, as the following statement explains:

Not only has the “right" corporate culture become the essence and foundation o f corporate excellence, but success or failure o f needed corporate reform s hinges on m anagem ent's sagacity and ability to change the firm ’s driving culture in tim e and in tune with required changes in strategies.*

The Politics of Strategy Choice All organizations are political. Unless managed, political m aneuvering consum es valuable time, subverts organizational objectives, diverts human energy, and results in the loss o f som e valuable em ployees. Som etim es political biases and personal preferences get unduly em bed­ ded in strategy choice decisions. Internal politics affect the choice o f strategies in all organi­ zations. The hierarchy of com m and in an organization, com bined w ith the career aspirations

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 281

of different people and the need to allocate scarce resources, guarantees the form ation of coalitions o f individuals who strive to take care of them selves first and the organization sec­ ond, third, or fourth. C oalitions o f individuals often form around key strategy issues that face an enterprise. A m ajor responsibility o f strategists is to guide the developm ent o f coalitions, to nurture an overall team concept, and to gain the support o f key individuals and groups o f individuals.

In the absence o f objective analyses, strategy decisions too often are based on the politics o f the moment. With development o f improved strategy-form ation tools, political factors become less important in m aking strategic decisions. In the absence of objectivity, political factors som e­ tim es dictate strategies, and this is unfortunate. M anaging political relationships is an integral part o f building enthusiasm and esprit de corps in an organization.

A classic study of strategic management in nine large corporations examined the politi­ cal tactics o f successful and unsuccessful strategists.9 Successful strategists were found to let weakly supported ideas and proposals die through inaction and to establish additional hurdles or tests for strongly supported ideas considered unacceptable but not openly opposed. Successful strategists kept a low political profile on unacceptable proposals and strived to let most negative decisions com e from subordinates or a group consensus, thereby reserving their personal vetoes for big issues and crucial moments. Successful strategists did a lot o f chatting and informal questioning to stay abreast o f how things w-ere progressing and to know when to intervene. They led strategy but did not dictate it. They gave few orders, announced few decisions, depended heavily on informal questioning, and sought to probe and clarify until a consensus emerged.

Successful strategists generously and visibly rewarded key thrusts that succeeded. They assigned responsibility for m ajor new thrusts to cham pions, the individuals most strongly iden­ tified with the idea or product and whose futures were linked to its success. They stayed alert to the symbolic impact o f their own actions and statements so as not to send false signals that could stimulate movements in unwanted directions.

Successful strategists ensured that all major power bases within an organization were represented in, or had access to, top management. They interjected new faces and new views into considerations of major changes. This is important because new employees and managers gener­ ally have more enthusiasm and drive than employees who have been with the linn a long time. New employees do not see the w'orld the same old way; nor do they act as screens against changes. Successful strategists minimized their own political exposure on highly controversial issues and in circumstances in which major opposition from key power centers was likely. In combination, these findings provide a basis for managing political relationships in an organization.

Because strategies must be effective in the m arketplace and capable of gaining internal com m itm ent, the following tactics used by politicians for centuries can aid strategists:

1. Achieving desired results is more important that imposing a particular method, so consider various m ethods and choose, whenever possible, the one(s) that will afford the greatest com m itm ent from employees/managers.

2. Achieving satisfactory results with a popular strategy is generally better than trying to achieve optimal results with an unpopular strategy.

3. An effective way to gain com m itm ent and achieve desired results is oftentim es to shift from specific to general issues and concerns.

4. An effective way to gain com m itm ent and achieve desired results is oftentim es to shift from short-term to long-term issues and concerns.

5. Middle level managers must be genuinely involved in and supportive o f strategic decisions, because successful im plem entation will hinge on their support. 10

Governance Issues A “director," according to W ebster's Dictionary, is ‘“one o f a group o f persons entrusted with the overall direction of a corporate enterprise.” A board o f d irec to rs is a group of individuals who are elected by the ownership o f a corporation to have oversight and guidance over management and who look out for shareholders’ interests. The act o f oversight and direction is referred to as governance. The National Association of Corporate Directors defines governance as “the

282 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

characteristic o f ensuring that long-term strategic objectives and plans are established and that the proper m anagement structure is in place to achieve those objectives, while at the same time making sure that the structure functions to maintain the corporation’s integrity, reputation, and responsibility to its various constituencies.” Boards are being held accountable for the entire perform ance o f the firm. Boards of directors are increasingly sued by shareholders for m ism an­ aging their interests. New accounting rules in the USA and Europe now enhance corporate- govem ance codes and require much more extensive financial disclosure among publicly held firms. The roles and duties o f a board of directors can be divided into four broad categories, as indicated in Table 8-10.

Shareholders today are wary of boards o f directors. Shareholders o f hundreds o f firms are dem anding that their boards do a better job of governing corporate A m erica . 11 New com pen­ sation policies are needed as well as direct shareholder involvement in some director activi­ ties. For exam ple, boards could require CEOs to groom possible replacem ents from inside the firm because exorbitant com pensation is most often paid to new CEOs com ing from outside the firm.

M ost boards of directors globally have ended their image as rubber-stam ping friends o f CEOs. Boards are more autonomous than ever and continually mindful o f and responsive to legal and institutional-investor scrutiny. Boards are more cognizant o f auditing and com pliance issues and more reluctant to approve excessive com pensation and perks. Boards stay much more abreast today o f public scandals that attract shareholder and media attention. Increasingly,

TA B LE 8-10 Board of Director Duties and Responsibilities

1. CONTROL AND OVERSIGHT OVER MANAGEMENT a. Select the Chief Executive Officer (CEO). b. Sanction the CEO’s team. c. Provide the CEO with a forum. d. Ensure managerial competency. e. Evaluate management’s performance. f. Set management's salary levels, including fringe benefits. g. Guarantee managerial integrity through continuous auditing. h. Chart the corporate course. i. Devise and revise policies to be implemented by management.

2. ADHERENCE TO LEGAL PRESCRIPTIONS a. Keep abreast of new laws. b. Ensure the entire organization fulfills legal prescriptions. c. Pass bylaws and related resolutions. d. Select new directors. e. Approve capital budgets. f. Authorize borrowing, new stock issues, bonds, and so on.

3. CONSIDERATION OF STAKEHOLDERS' INTERESTS a. Monitor product quality. b. Facilitate upward progression in employee quality of work life. c. Review labor policies and practices. d. Improve the customer climate. e. Keep community relations at the highest level. f. Use influence to better governmental, professional association, and educational contacts. g. Maintain good public image.

4. ADVANCEMENT OF STOCKHOLDERS’ RIGHTS a. Preserve stockholders’ equity. b. Stimulate corporate growth so that the firm will survive and flourish. c. Guard against equity dilution. d. Ensure equitable stockholder representation. e. Inform stockholders through letters, reports, and meetings. f. Declare proper dividends. g. Guarantee corporate survival.

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boards of directors m onitor and review executive perform ance carefully without favoritism to executives, representing shareholders rather than the CEO. Boards are more proactive today, whereas in years past they were oftentimes merely reactive. These are all reasons why the chair o f the board o f directors should not also serve as the firm ’s C EO .12

Shareholders are also upset at boards for allow ing CEO s to receive huge end-of-year bonuses when the firm ’s stock price drops drastically during the year. 11 For exam ple, C hesapeake Energy Corp. and its board o f directors cam e under fire from shareholders for paying C hairm an and CEO A ubrey M cClendon $112 m illion as the firm ’s stock price p lum ­ meted. Investor Jeffrey B ronchick wrote in a letter to the C hesapeake board that the C E O ’s com pensation was a “near perfect illustration o f the com plete collapse o f appropriate corpo­ rate governance.”

Until recently, boards o f directors did m ost o f their work sitting around polished wooden tables. However, H ew lett-Packard’s d irectors, am ong many others, now log on to their own special board w ebsite tw ice a week and conduct business based on extensive confiden­ tial briefing inform ation posted there by the firm ’s top m anagem ent team. Then the board mem bers meet face-to-face and fully inform ed every two m onths to discuss the biggest issues facing the firm . Even the decision o f w hether to locate operations in countries with low corporate tax rates would be reviewed by a board o f directors. New board involvem ent policies are aim ed at curtailing lawsuits against board m em bers. For exam ple, there were 740 lawsuits filed in 2012 against directors regarding m erger deals. The Federal D eposit Insurance C orporation (FD IC) filed 23 law suits against directors in 2012, com pared to 16 in 2011 and ju st 2 in 2010 .

Today, boards o f directors are com posed mostly of outsiders who are becoming more involved in organizations’ strategic management. The trend in the USA is toward much greater board m em ber accountability with sm aller boards, now averaging 12 members rather than 18 as they did a few years ago. BusinessWeek recently evaluated the boards of most large U.S. com panies and provided the following “principles o f good governance” :

1. Never have more than two of the firm ’s executives (current or past) on the board. 2. Never allow a firm ’s executives to be the board’s audit, com pensation, or nom inating

committees. 3. Require all board m embers to own a large amount o f the firm ’s equity. 4. Require all board members to attend at least 75 percent o f all meetings. 5. Require the board to meet annually to evaluate its own perform ance, without the CEO,

COO, or top managem ent in attendance. 6 . Never allow the CEO to be Chairperson o f the Board. 7. Never allow interlocking directorships (where a director or CEO sits on another director’s

board).14

Jeff Sonnerfeld, associate dean o f the Yale School o f M anagement, says, “Boards of directors are now rolling up their sleeves and becom ing much more closely involved with management decision making.” Com pany CEOs and boards are required to personally certify financial statements; com pany loans to com pany executives and directors are illegal; and there is faster reporting of insider stock transactions.

Just as directors place more em phasis on staying informed about an organization’s health and operations, they are also taking a more active role in ensuring that publicly issued docum ents are accurate representations o f a firm 's status. Failure to accept responsibility for auditing or evaluating a firm ’s strategy is considered a serious breach o f a director’s duties. Stockholders, governm ent agencies, and custom ers are filing legal suits against directors for fraud, omissions, inaccurate disclosures, lack o f due diligence, and culpable ignorance about a firm ’s operations w'ith increasing frequency. Liability insurance for directors has become exceptionally expensive and has caused numerous directors to resign.

The Sarbanes-Oxley Act resulted in scores of boardroom overhauls among publicly traded com panies. The jobs o f chief executive and chairman are now held by separate persons, and board audit com m ittees must now have at least one financial expert as a member. Board audit com m ittees now meet 10 or more times per year, rather than three or four times as they did

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prior to the act. The act put an end to the “country club” atm osphere o f most boards and has shifted power from CEOs to directors. Although aimed at public com panies, the act has also had a sim ilar impact on privately owned com panies.1''

In Sweden, a new law requires 25 percent female representation in boardrooms. The Norwegian government has passed a sim ilar law that requires 40 percent o f corporate director seats to go to women. In the USA, women currently hold about 13 percent o f board seats at S&P 500 firms and 10 percent at S&P 1,500 firms. The Investor Responsibility Research Center in Washington, D.C., reports that minorities hold just 8.8 percent o f board seats o f S&P 1,500 companies. Progressive firms realize that women and m inorities ask different questions and make different suggestions in boardrooms than white men, which is helpful because women and minorities com prise much o f the consum er base everywhere.

The European Union (EU) Justice Com m issioner Viviane Reding introduced in late 2012 contentious legislation requiring publicly traded com panies across the EU to fill at least 40 percent of board positions with women by 2020, or be hit with sanctions to be decided by the EU countries.

A direct response to increased pressure on directors to stay informed and execute their responsibilities is that audit com mittees are becoming com monplace. A board o f directors should conduct an annual strategy audit in much the same fashion that it reviews the annual financial audit. In performing such an audit, a board could work jointly with operating management and/or seek outside counsel. Boards should play a role beyond that of perform ing a strategic audit. They should provide greater input and advice in the strategy-form ulation process to ensure that strategists are providing for the long-term needs o f the firm. This is being done through the formation o f three particular board committees: nominating com m ittees to propose candidates for the board and senior officers o f the firm; compensation com m ittees to evaluate the perform ance o f top executives and determ ine the terms and conditions of their em ploym ent; and audit committees to give board-level attention to com pany accounting and financial policies and performance.

Special Note to Students Your SWOT, SPACE, BCG, IE, Grand, and QSPM need to be developed accurately, but in covering those matrices in an oral presentation, focus more on the im plications o f those analy­ ses than the nuts-and-bolts calculations. In other words, as you go through those m atrices in a presentation, your goal is not to prove to the class that you did the calculations correctly. They expect accuracy and clarity and certainly you should have that covered. It is the im plications of each matrix that your audience will be most interested in, so use these m atrices to pave the way for your recommendations with costs, which generally com e just a page or two deeper into the project. A good rule o f thumb is to spend at least an equal amount o f tim e on the im plications as the actual calculations of each matrix when presented. This approach will improve the delivery aspect o f your presentation or paper by m aintaining the high interest level o f your audience. Focusing on im plications rather than calculations will also encourage questions from the audi­ ence when you finish. Questions on completion are a good thing. Silence on completion is a bad thing because silence could mean your audience was asleep, disinterested, or did not feel you did a good job. Also, utilize the free excel student template at www.strategyclub.com as needed.

Conclusion The essence o f strategy formulation is an assessment o f w hether an organization is doing the right things and how it can be more effective in what it does. Every organization should be wary o f becoming a prisoner o f its own strategy because even the best strategies become obso­ lete sooner or later. Regular reappraisal o f strategy helps m anagem ent avoid complacency. Objectives and strategies should be consciously developed and coordinated and should not merely evolve out o f day-to-day operating decisions.

An organization with no sense o f direction and no coherent strategy precipitates its own demise. When an organization does not know where it wants to go. it usually ends up some place it does not want to be. Ever}' organization needs to consciously establish and com municate clear objectives and strategies.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 285

M odern strategy-form ulation tools and concepts are described in this chapter and integrated into a practical three-stage framework. Tools such as the SW OT Matrix. SPACE M atrix, BCG M atrix. IE Matrix, and QSPM can significantly enhance the quality o f strategic decisions, but they should never be used to dictate the choice of strategies. Behavioral, cultural, and political aspects o f strategy generation and selection are always important to consider and manage. Because o f increased legal pressure from outside groups, boards o f directors are assum ing a more active role in strategy analysis and choice. This is a positive trend for organizations.

Key Terms and Concepts aggressive quadrant (p. 263) attractiveness scores (AS) (p. 276) board o f directors (p. 2 8 1 ) Boston Consulting G roup (BCG) matrix (p. 267) business portfolio (p. 267) cash cows (p. 269) cham pions (p. 281 ) com petitive position (CP) (p. 262) competitive quadrant (p. 265) conservative quadrant (p. 265) culture (p. 280) decision stage (p. 258) defensive quadrant (p. 265) directional vector (p. 263) dogs (p. 269) financial position (HP) (p. 262) governance (p. 281 ) Grand Strategy Matrix (p. 273) halo error (p. 258) industry position (IP) (p. 262)

input stage (p. 258) internal-external (IE) matrix (p. 270) matching (p. 259) matching stage (p. 258) Quantitative Strategic Planning M atrix (QSPM ) (p. 275) question marks (p. 268) relative market share position (p. 267) SO strategies (p. 260) stability position (SP) (p. 262) stars (p. 269) Strategic Position and Action Evaluation (SPACE)

M atrix (p. 262) strategy-form ulation analytical framework (p. 258) Strengths-W eaknesses O pportunities-Threats (SW'OT) Matrix

(p. 259) ST strategies (p. 260) Sum Total A ttractiveness Scores (STAS) (p. 278) Total A ttractiveness Scores (TAS) (p. 276) WO strategies (p. 260) W T strategies (p. 260)

Issues for Review and Discussion 8-1. Unilever has done really well for decades. How does

Unilever do so well? How can they continue to prosper? 8-2. Give an internal and external strength o f Unilever. Show

how those two factors are related to reveal a feasible alternative strategy.

8-3. W hat do you believe are the three major external opportunities that Unilever faces?

8-4. Develop a SPACE Matrix for Unilever. Explain the implications of your Matrix.

8-5. Develop a BCG Matrix for Unilever. Explain the im plications of your Matrix.

8 -6 . Develop a QSPM for U nilever that includes two strategies, six internal factors, and six external factors. W hat strategy appears to be best for Unilever to pursue?

8-7. Do a Google search using the key terms “boards of directors.” W hat new inform ation did you learn that was not given in the chapter?

8-8. In preparing a SPACE M atrix, which axis would the European political and econom ic unrest fall under?

8-9. In preparing a BCG Matrix, what would be the best range for the IGR axis as applied to the beverage industry?

286 CHAPTER 8 • STRATEGY GENERATION AND SELECTION

8-10. List four reasons why the IE Matrix is widely considered to be superior to the BCG Matrix.

8-11. Is there a limit to the number o f strategies that could be examined in a QSPM ? W hy?

8-12. Go to adidas* website and examine what you can find about the com pany’s board o f directors. Evaluate adidas’ board based on guidelines presented in the chapter.

8-13. Explain why the CEO o f a firm should not also be chairperson o f the board o f directors.

8-14. In preparing a QSPM , what should be done if the TAS for each strategy turn out to be identical?

8-15. Sum m arize in your own words the “Special Note to Students” section, given at the end o f the chapter.

8-16. Develop a Grand Strategy Matrix for Unilever and include one rival firm.

8-17. Explain what should be done if the SPACE vector coordinate point is (0 ,0).

8-18. On QSPM . why should you work row by row instead of column by colum n?

8-19. When constructing a SPACE Matrix, would it be appropriate to use a 1 to 10 scale for all axes?

8-20. If Unilever has the leading market share in Russia, w here along the top axis o f a BCG would their Russia O perations be plotted?

8-21. Develop a SW OT Matrix for yourself. 8-22. W hy is “m atching” internal with external factors such

an im portant strategic management activity? 8-23. Illustrate the strategy formulation framework that

includes three stages and nine analytical tools. W hich stage and tool do you feel is most important? Why?

8-24. Develop an example SW OT M atrix for your college or university with two items in each quadrant. Make sure your strategies clearly exemplify “matching” and show this with (S I, T2) type notation.

8-25. Develop an example SPACE Matrix for a global company that you are familiar with. Include two factors for each of the four axes (SP, IP. SP, and CP).

8-26. W'hat would be an appropriate SP rating for Unilever? 8-27. D iscuss the pros and cons of divulging divisional

inform ation to stakeholders. 8-28. Develop an exam ple BCG Matrix for a com pany that

has three divisions with revenues of 4. 8, and 12 and profits o f 5. 3, and 2, respectively.

8-29. Develop a SPACE Matrix for a firm that is a weak com petitor com peting in a slow growing and unstable industry. Label axes and quadrants clearly.

8-30. Discuss the lim itations o f a BCG analysis and the limitations o f a SPACE analysis.

8-31. Prepare an IE Matrix for a com pany with two divisions that have 30 and 60 in revenues to go with 10 and 15 in profits.

8-32. Develop a Grand Strategy Matrix with two example com panies in each quadrant, i.e., com panies that you know som ething about and that you would place in those quadrants.

8-33. Develop a QSPM for yourself— given two strate­ gies: I) go to graduate school or 2 ) begin w orking full-tim e.

8-34. W'ould a QSPM analysis be useful w ithout the weight colum n? Why or why not?

8-35. Discuss the characteristics o f successful strategists in terms of political factions within the firm.

8-36. In order o f attractiveness to you. rank the political tactics presented in Chapter 8 .

8-37. For a business in your city, list in order o f importance the top eight board-of-director duties and responsibili­ ties listed in the chapter.

8-38. Discuss the pros and cons o f Sw eden’s new board-of- director rule regarding women.

8-39. Develop a SPACE Matrix for your college or university.

8-40. Develop a BCG Matrix for your college or university. 8-41. Explain the lim itations o f the BCG, SPACE, and

SWOT. 8-42. Develop a QSPM for a local com pany that you are

familiar with. 8-43. W rite a short essay that reveals your recom m enda­

tions to firm s, regarding disclosure o f financial inform ation.

8-44. Explain why a before and after BCG and IE analysis can be useful in presenting a strategic plan for consideration.

8-45. Find an example o f a company, on the Internet, which has both a Cash Cow and a Question Mark division.

8-46. Regarding a Grand Strategy M atrix, identify two com ­ panies that would be located in your judgm ent in each quadrant— identify eight firms total.

8-47. For a non-profit com pany, list in o rder of im portance the top 10 board-of-d irector duties and responsibilities.

8-48. Regarding the principles o f good governance in the chapter, list in order o f im portance the top seven guidelines.

CHAPTER 8 • STRATEGY GENERATION AND SELECTION 287

MyManagementLab® Go to mymanagementlab.com for the following Assisted-graded writing questions:

8-49. Explain the steps involved in developing a QSPM. 8-51. M ym anagem entlab Only— com prehensive writing 8-50. How are the SW OT M atrix, SPACE Matrix. BCG assignm ent for this chapter.

Matrix, IE Matrix, and Grand Strategy Matrix similar? How are they different?

Current Readings Arms, Hanjo, M athias Wiecher, and Valeska Kleiderman.

"Dynam ic M odels for M anaging Big Decisions.’' Strategy and Leadership 40, no. 5 (2012): 39-46.

Blettner. Daniela P., Fernando R. Chaddad. and Richard A. Bettis. “The CEO Performance Effect: Statistical Issues and a Com plex Fit Perspective.” Strategic Management Journal 33, no. 8 (August 2012): 986-999.

Connelly, Brian L., and Erik J. Van Slyke. “The Power and Peril o f Board Interlocks.” Business Horizons 55, no. 5 (Septem ber 2012): 403-408.

Donaldson, Thomas. “The Epistem ic Fault Line in Corporate Governance’* The Academy o f Management Review 37 , no. 2 (April 2012): 256.

Fernhaber, Stephanie A., and Pankaj C. Patel. “How do young firms manage product portfolio complexity? The role of absorptive capacity and ambidexterity.” Strategic Management Journal 33, no. 13 (December 2012): 1516-1539.

He, Jinyu, and Zhi Huang. “Board Informal H ierarchy and Firm Financial Performance: Exploring a Tacit Structure

Guiding Boardroom Interactions.” The Academy o f Management Journal 54 , no. 6 (D ecem ber 2011): 1119.

Joseph, John, and W illiam Ocasio. “Architecture, Attention, and Adaptation in the M ultibusiness Firm: General Electric from 1951 to 2001.” Strategic Management Journal 33. no. 6 (June 2012): 633-660.

Kiron. David, Pamela Kirk Prentice, and Renee Boucher Ferguson. “Innovating Writh A naly tics” MITSIoan Management Review 54, no. 1 (Fall 2012): 47.

Walls, Judith L., Pascual Berrone, and Phillip H. Phan. “Corporate Governance and Environmental Performance: Is There Really a Link?” Strategic Management Journal 33, no. 8 (August 2012): 885-913.

Walter. Jorge, Fran/. W. Kellermanns, and Christoph Lechner. “Decision M aking Within and Between Organizations: Rationality, Politics and Alliance Performance.” Journal o f Management 38. no. 5 (Septem ber 2012): 1582.

A SSU R A N C E OF LEARNING EX ER C ISES EXERCISE 8A

Should Unilever Penetrate Southeast Asia Further? Purpose Unilever is featured in the opening chapter case as a firm that engages in excellent strategic planning. Unilever is the world’s third-largest consumer goods company (behind Procter & Gamble and Nestle). Some of Unilever’s best selling brands are Aviance. Ben & Jerry’s, Dove. Flora/Becel, Hellmann's, Knorr, Lipton. Lux/Radox, Omo/Surf, Sunsilk, Toni & Guy, V05, Wall’s, and PG Tips.

The purpose of this exercise is to give you experience investigating a particular region of the world to determine whether a linn should expand more deeply into that region of the world.

Unilever has recently began construction of a new factory in Yangon, Myanmar, and by 2015 expects to provide direct and indirect employment for over 2,000 people in Myanmar. The company currently employs close to 200 Myanmar employees at its factory in Thailand, of which a number are being moved back to Myanmar to help kick-start its operations in the country.

Instructions

Step I Go to Unilever’s corporate website and download the company’s most recent Annual Report. Examine the narrative and tables related to their operations in Southeast Asia.

Step 2 Research the competitive climate and business culture of Myanmar and two other countries in Southeast Asia as well as the operations of rival Nestle.

Step 3 Develop six recommendations for Unilever based on your assessment of their present and potential operations in Southeast Asia.

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EXERCISE 8B

Perform a SWOT Analysis for Unilever’s Global Operations

Purpose Unilever’s global and domestic business segments could be required annually to submit a SWOT analysis to corporate top executives who merge divisional analyses into an overall corporate analysis. This exercise will give you practice performing a SWOT analysis.

Instructions

Step 1 Review Unilever's global operations as described in the company’s most recent Annual Report. Unilever recently acquired 82 percent of the Russia-based beauty company Kalina.

Step 2 Review industry and competitive information pertaining to Unilever’s global operations. especially as compared to rival Procter & Gamble.

Step 3 Join with two other students in class. Together, develop a global SWOT Matrix for Unilever’s global business segment. Follow all the SWOT guidelines provided in the chapter, including (S4, T3)-type notation at die end of each strategy. Include three strategies in each of the four (SO. ST, WT, WO) quadrants. Avoid generic strategy terms such as Forward Integration.

Step 4 Turn in your team-developed SWOT Matrix to your professor for a classwork grade.

EXERCISE 8C

Preparing a BCG Matrix for Unilever Purpose This exercise will give you practice preparing both a by-product and a by-region -based BCG Matrix. Unilever has four major product segments of the company: Personal Care, Food. Refreshment, and Home Care. The company also has three major geographic segments: Europe, The Americas, and Asia/AMET/RUB.

Instructions

Step 1 Review Unilever’s global operations as described in the company’s most recent Annual Report and Form ¡OK.

Step 2 Prepare an up-to-date BCG matrices for Unilever’s 1) four product categories and 2) three geographic divisions.

Step 3 Write a two-page executive summary to reveal the strategic implications of your analyses.

EXERCISE 8D

Developing a SWOT Matrix for adidas AG Purpose The most widely used strategy formulation technique among firms worldwide is the SW'OT Matrix. This exercise requires development of a SWOT Matrix for adidas. Matching key external and internal factors in a SWOT Matrix requires good intuitive and conceptual skills. You will improve with prac­ tice in developing a SWOT Matrix.

Instructions Recall from Exercise IB that you already may have determined adidas’ external opportunities/threats and internal strengths/weaknesses. This information could be used to complete this exercise. Follow the steps outlined as follows:

Step 1 On a separate sheet of paper, construct a large nine-cell diagram that will represent your SWOT Matrix. Appropriately label the cells.

Step 2 Appropriately record adidas’ opportunities/threats and strengths/weaknesses in your diagram. Step 3 Match external and internal factors to generate feasible alternative strategies for adidas.

Record SO. WO, ST. and WT strategies in appropriate cells of the SWOT Matrix. Use the proper notation to indicate the rationale for the strategies. Try to include four strategies in each of the four strategy cells.

Step 4 Compare your SWOT Matrix to another students' SWOT Matrices. Discuss any major differences.

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EXERCISE 8E

Developing a SPACE Matrix for adidas AG Purpose Should adidas pursue aggressive, conservative, competitive, or defensive strategies? Develop a SPACE Matrix for adidas to answer this question. Elaborate on the strategic implications of your directional vector. Be specific in terms of strategies that could benefit adidas.

Instructions

Step I Join with two other persons in your class and develop a joint SPACE Matrix for adidas. Step 2 Diagram your SPACE Matrix on the board. Compare your Matrix with other teams' matrices. Step 3 Discuss the implications of your SPACE Matrix.

EXERCISE 8F

Developing a BCG Matrix for adidas AG Purpose Portfolio matrices are widely used by multidivisional organizations to help identify and select strate­ gies to pursue. A BCG analysis identifies particular divisions that should receive fewer resources than others. It may identify some divisions to be divested. This exercise can give you practice developing a BCG Matrix.

Instructions

Step 1 Place the following five column headings at the top of a separate sheet of paper: Divisions, Revenues, Profits, Relative Market Share Position, and Industry Growth Rate. Down the far left of your page, list adidas, Reebok, and TaylorMade. Turn back to the Cohesion Case and find information to fill in all the cells in your data table.

Step 2 Complete two BCG Matrices for adidas: 1) Include Reebok, TaylorMade, and adidas and 2) include Geographic Regions of the World.

Step 3 Compare your BCG Matrix to other students’ matrices. Discuss any major differences.

EXERCISE 8G

Developing a QSPM for adidas AG Purpose This exercise can give you practice developing a Quantitative Strategic Planning Matrix (QSPM) to determine the relative attractiveness of various strategic alternatives.

Instructions

Step 1 Join with two other students in class to develop a joint QSPM for adidas. Step 2 Go to the board and record your strategies and their Sum Total Attractiveness Scores.

Compare your team’s strategies and sum total attractiveness scores to those of other teams. Be sure not to assign the same AS score in a given row. Recall that dashes should be inserted all the way across a given row when used.

Step 3 Discuss any major differences.

EXERCISE 8H

Developing a SWOT Matrix for Unilever Purpose The most widely used strategy formulation technique among American firms is the SWOT Matrix. This exercise requires development of a SWOT Matrix for Unilever. Matching key external and internal factors in a SWOT Matrix requires good intuitive and conceptual skills. You will improve with practice in developing a SWOT Matrix.

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Instructions

Step 1 On a separate sheet of paper, construct a large nine-cell diagram that will represent your SWOT matrix. Appropriately label the cells.

Step 2 Determine six opportunities and six threats, and six strengths and six weaknesses for Unilever. Step 3 Match external and internal factors to generate feasible alternative strategies for Unilever.

Record SO. WO, ST, and WT strategies in appropriate cells of the SWOT Matrix. Use the proper notation to indicate the rationale for the strategies. Try to include two strategies in each of the four strategy cells. Compare your SWOT Matrix to another student’s SWOT Matrix. Discuss any major differences.

EXERCISE 81

Developing a SPACE Matrix for Unilever Purpose Should Unilever pursue aggressive, conservative, competitive, or defensive strategies? Develop a SPACE Matrix for Unilever to answer this question. Elaborate on the strategic implications of your directional vector. Be specific in terms of strategies that could benefit Unilever.

Instructions

Step 1 Join with two other persons in class and develop a joint SPACE Matrix for Unilever. Step 2 Diagram your SPACE Matrix on the board. Compare your matrix with other teams’ matrices. Step 3 Discuss the implications of your SPACE Matrix.

EXERCISE 8J

Developing a BCG Matrix for your College or University

Purpose Portfolio matrices are widely used by multidivisional organizations to help identify and select strate­ gies to pursue. A BCG analysis identifies particular divisions that should receive fewer resources than others; or it may identify some divisions to be divested. This exercise can give you practice develop­ ing a BCG Matrix for a college or university.

Instructions

Step 1 Place the following five column headings at the top of a separate sheet of paper: Divisions, Revenues, Profits, Relative Market Share Position, and Industry Growth Rate. Down the far left of your page, list Schools at your college.

Step 2 Complete two BCG Matrices for your college or university. Include the School of Business, the School of Education, and the School of Nursing—or any other three Schools.

Step 3 Compare your BCG Matrix to other students’ Matrices. Discuss any major differences.

EXERCISE 8K

Developing a QSPM for a Company that You Are Familiar With

Purpose This exercise can give you practice developing a Quantitative Strategic Planning Matrix (QSPM) to determine the relative attractiveness of various strategic alternatives.

Instructions

Step 1 Join with two other students in class to develop a joint QSPM for a company that all of you are familiar with.

Step 2 Record your strategies and their Sum Total Attractiveness Scores. Compare your team’s strategies and sum total attractiveness scores to those of other teams. Be sure not to assign the same AS score in a given row. Recall that dashes should be inserted all the way across a given row when used. Discuss any major differences.

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EXERCISE 8L

Formulating Individual Strategies Purpose Individuals and organizations are alike in many ways. Each has competitors, and each should plan for the future. Every individual and organization faces some external opportunities and threats and has some internal strengths and weaknesses. Both individuals and organizations establish objectives and allocate resources. These and other similarities make it possible for individuals to use many strategic- management concepts and tools. This exercise is designed to demonstrate how the SWOT Matrix can be used by individuals to plan their futures. As one nears completion of a college degree and begins interviewing for jobs, planning can be particularly important.

Instructions On a separate sheet of paper, construct a SWOT Matrix. Include what you consider to be your major external opportunities, your major external threats, your major strengths, and your major weaknesses. An internal weakness may be a low grade point average. An external opportunity may be that your university offers a graduate program that interests you. Match key external and internal factors by recording in the appropriate cell of the matrix alternative strategies or actions that would allow you to capitalize upon your strengths, overcome your weaknesses, take advantage of your external opportu­ nities, and minimize the impact of external threats. Be sure to use the appropriate matching notation in the strategy cells of the matrix. Because every individual (and organization) is unique, there is no one right answer to this exercise.

EXERCISE 8M

The Mach Test Purpose The purpose of this exercise is to enhance your understanding and awareness of the impact that behavioural and political factors can have on strategy analysis and choice.

Instructions

Step 1 On a separate sheet of paper, write down numbers 1 to 10. For each of the 10 statements given as follows, record a 1, 2, 3, 4. or 5 to indicate your attitude, where

1 = I disagree a lot. 2 = I disagree a little. 3 = My attitude is neutral. 4 = I agree a little. 5 = 1 agree a lot.

1. The best way to handle people is to tell them what they want to hear. 2. When you ask someone to do something for you, it is best to give the real reason for

wanting it, rather than a reason that might carry more weight. 3. Anyone who completely trusts anyone else is asking for trouble. 4. It is hard to get ahead without cutting comers here and there. 5. It is safest to assume that all people have a vicious streak, and it will come out when

they are given a chance. 6. One should take action only when it is morally right. 7. Most people are basically good and kind. 8. There is no excuse for lying to someone else. 9. Most people forget more easily the death of their father than the loss of their property.

10. Generally speaking, people won't work hard unless they're forced to do so. Step 2 Add up the numbers you recorded beside statements 1,3,4, 5.9. and 10. This sum is Subtotal

One. For the other four statements, reverse the numbers you recorded, so a 5 becomes a 1.4 becomes 2, 2 bccomes 4, I becomes 3. and 3 remains 3. Then add those four numbers to get Subtotal Two. Finally, add Subtotal One and Subtotal Two to get your Final Score.

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Your Final Score Your Final Score is your Machiavellian Score. Machiavellian principles are defined in a dictionary' as “manipulative, dishonest, deceiving, and favoring political expediency over morality." These tactics are not desirable, arc not ethical, and are not recommended in the strategic management process! You may, however, encounter some highly Machiavellian individuals in your career, so beware. It is important for strategists not to manipulate others in the pursuit of organizational objectives. Individuals today recog­ nize and resent manipulative tactics more than ever before. The National Opinion Research Center used this short quiz in a random sample of U.S. adults and found the national average Final Score to be 25.1 The higher your score, the more Machiavellian (manipulative) you tend to be. The following scale is descriptive of individual scores on this test:

• Below 16: Never uses manipulation as a tool. • 16 to 20: Rarely uses manipulation as a tool. • 21 to 25: Sometimes uses manipulation as a tool. • 26 to 30: Often uses manipulation as a tool. • Over 30: Always uses manipulation as a tool.

Test Development The Mach (Machiavellian) test was developed by Dr. Richard Christie, whose research suggests the following tendencies:

1. Men generally are more Machiavellian than women. 2. There is no significant difference between high Machs and low Machs on measures of

intelligence or ability. 3. Although high Machs are detached from others, they are detached in a pathological sense. 4. Machiavellian scores are not statistically related to authoritarian values. 5. High Machs tend to be in professions that emphasize the control and manipulation of

individuals—for example law, psychiatry, and behavioral science. 6. Machiavellianism is not significantly related to major demographic characteristics such as

educational level or marital status. 7. High Machs tend to come from a city or have urban backgrounds. 8. Older adults tend to have lower Mach scores than younger adults.2

Notes 1. Richard Christie and Florence Geis, Studies in Machiavellianism (Orlando, FL: Academic Press,

1970). Material in this exercise adapted with permission of the authors and Academic Press. 2. Ibid. 82-83.

Notes 1. R. T. Lenz. “M anaging the Evolution of the Strategic

Planning Process,” Business Horizons 30, no. 1 (January-February 1987): 37.

2. Roben Grant. "The Resource-Based Theory of Com petitive Advantage: Implications for Strategy Formulation," California Management Review, Spring 1991, 114.

3. Heinz W eihrich. “The TOWS Matrix: A Tool for Situational Analysis,” Long Range Flanning 15. no. 2

(April 1982): 61. Note: Although Dr. W eihrich first m odi­ fied SWOT analysis to form the TOW S matrix, the ac­ ronym SWOT is much more widely used than TOWS in practice.

4. Greg Dess, G. T. Lumpkin, and Alan Eisner, Strategic Management: Text and Cases (New York: M cGraw-Hill/ Irwin, 2006), 72.

5. Adapted from H. Rowe, R. M ason, and K. Dickel, Strategic Management and Business Policy:

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A Methodological Approach (Reading, MA: Addison- Wesley, 1982), 155-156.

6 . Fred David, “The Strategic Planning Matrix— A Quantitative Approach.” Long Range Planning 19. no. 5 (October 1986): 102; Andre Gib and Robert M argulies, “M aking Com petitive Intelligence Relevant to the User.” Planning Review 19, no. 3 (M ay-June 1991): 21.

7. Fred David, “Com puter-Assisted Strategic Planning in Small Businesses,’* Journal o f Systems Management 36, no. 7 (July 1985): 24-34.

8 . Y. Allarie and M. Firsirotu, “ How to Implement Radical Strategies in Large O rganizations" Sloan Management Review 26, no. 3 (Spring 1985): 19. Another excellent article is P. Shrivastava, “Integrating Strategy Formulation with Organizational Culture.” Journal o f Business Strategy 5, no. 3 (W inter 1985): 103-111.

9. Jam es Brian Quinn. Strategies fo r Changes: Logical Incrementalism (Hom ewood, IL: Richard D. Irwin, 1980), 128-145. These political tactics are

listed in A. Thom pson and A. Strickland, Strategic Management: Concepts and Cases (Plano, TX: Business Publications, 1984), 261.

10. William Guth and Ian MacMillan, “Strategy Implementation Versus Middle Management Self-Interest” Strategic Management Journal 7, no. 4 (July-August 1986): 321.

11. Joann Lublin, “Corporate D irectors ' Group Gives Repair Plan to Boards,” Wall Street Journal. M arch 24, 2009, B4.

12. http://www.usatoday.com /m oney/com panies/m anagem ent/ s to ry /2012-05-14/ceo-firings/54964476/1.

13. Phred Dvorak. “ Poor Year D oesn’t Stop CEO B onuses” Wall Street Journal. March 18. 2009. B 1.

14. Louis Lavelle, “The Best and W orst Boards,” BusinessWeek. O ctober 7, 2002, 104-110.

15. Matt Murray, “ Private Com panies Also Feel Pressure to Clean Up Acts.” Wall Street Journal, July 22, 2003. B 1.

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294

Strategy Implementation CHAPTER O BJECT IVES After studying this chapter, you should be able to do the following:

1. Develop effective perceptual maps to position rival firms.

2. Develop effective perceptual maps to identify market segments and demand voids.

3. Determine the cash worth of any business.

4. Explain market segmentation and product positioning as strategy-implementation tools.

5. Discuss procedures for determining the worth of a business.

6 . Develop projected financial statements to reveal the impact of strategy recommendations.

7. Perform EPS-EBIT analysis to evaluate the attractiveness of debt versus stock as a source of capital to implement strategies.

8. Discuss the nature and role of research and development in strategy implementation.

9. Explain how management information systems can determine the success of strategy-implementation efforts.

10. Explain business analytics and data mining.

A SS U R A N C E OF LE A R N IN G EXERC ISES

The following exercises are found at the end of this chapter.

Preparing an EPS/EBIT Analysis for Royal Dutch Shell pic

Developing a Product-Positioning Map for adidas AG

Performing an EPS/EBIT Analysis for adidas AG

Preparing Projected Financial Statements for adidas AG

Determining the Cash Value o f adidas AG

Developing a Product-Positioning Map for My College

Do Banks Require Projected Financial Statements?

E X E R C IS E 9A

E X E R C IS E 9B

E X E R C IS E 9C

E X E R C ISE 9D

E X E R C ISE 9E

E X E R C ISE 9F

E X E R C IS E 9G

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Strategies have no chance of being implemented successfully in organizations that do not market goods and services well, in firms that cannot raise needed working capital, in firms that produce technologically inferior products, or in firms that have a weak information system. This chapter examines marketing, finance and accounting, research and development (R&D), and management information systems (MIS) issues that are central to effective strategy implementation. Special topics include market segmentation, market positioning, evaluating the worth o f a business, determining to what extent debt or stock should be used as a source o f capi­ tal, developing projected financial statements, contracting R&D outside the firm, and creating an information support system. Manager and employee involvement and participation are essential for success in marketing, finance and accounting, R&D, and MIS activities.

The Nature of Strategy Implementation The quarterback can call the best play possible in the huddle, but that does not mean the play will go for a touchdown. The team may even lose yardage unless the play is executed (implemented) well. Less than 10 percent of strategies formulated are successfully implemented! There are many reasons for this low success rate, including failing to appropriately segm ent markets, paying too much for a new acquisition, and falling behind com petitors in R&D. Royal Dutch Shell imple­ ments strategies especially well.

Strategy implementation directly affects the lives o f plant managers, division managers, department managers, sales managers, product managers, project managers, personnel manag­ ers, staff managers, supervisors, and all employees. In some situations, individuals may not have participated in the strategy-formulation process at all and may not appreciate, understand, or even accept the work and thought that went into strategy formulation. There may even be foot dragging or resistance on their part. Managers and employees who do not understand the business and are not committed to the business may attempt to sabotage strategy-implementation efforts in hopes that the organization will return to its old ways. The strategy-implementation stage o f the strate- gic-management process is highlighted in Figure 9-1 as illustrated with white shading.

EXCELLENT STRATEGIC MANAGEMEN-

Royal Dutch Shell Royal Dutch Shell pic is the largest oil and gas company in the world and the largest firm globally. Fortune, in 2013, also ranked Shell as the 7th most profitable firm in the world. Incorporated in the United Kingdom but headquartered in the Netherlands, Shell has worldwide reserves of the equivalent of 14.2 billion barrels of oil. Most of Shell's crude oil is produced in Nigeria, Oman, and the UK, but Shell is also investing heavily in the Athabasca Oil Sands Project, which converts oil sands in Alberta to synthetic oil. Shell operates 44,000 gas stations, the world's largest retail fuel network, in more than 90 countries. Vertically integrated. Shell explores, produces, refines, transports, and sells oil related products and chemicals.

Shell's CEO, Peter Voser, is to retire at the end of March 2014, marking the end of 29 years with the Company. He is being replaced with Ben van Beurden, age 55, who has been Shell's Downstream Director since January 2013. Ben's promotion came after a compre­ hensive assessment and review of internal and external candidates led by the Board Nomination and Succession Committee. Ben joined Shell

in 1983 and has held a number of positions in both the Upstream and Downstream b u s i n e s s e s , working in the N e t h e r l a n d s , Africa, Malaysia, USA and, most recently, the UK. A Dutch national, Ben graduated with a Master's Degree in Chemical Engineering from Delft University of Technology, the Netherlands.

Royal Dutch Shell pic in September 2013 purchased as Treasury Stock 921,881 "B ” Shares of its own stock at a price of 2159.15 pence per share. Following the purchase, the remaining number of "A" Shares of Royal Dutch Shell pic was 3,821,611,712 and the remaining number of "B " Shares of Shell pic was 2,509,794,307.

CHAPTER 9 • STRATEGY IMPLEMENTATION 297

I___________________ Strategy _______________________ I_______ Strategy _________| _ Strategy __ I Formulation I Implementation I Evaluation I

FIGURE 9-1 A Comprehensive Strategie-Management Model

Source: Fred R. David, adapted from “How Companies Define Their Mission.” Long Range Planning 22, no. 3 (June 1988): 40, © Fred R. David.

Current Marketing Issues Countless marketing variables affect the success or failure of strategy implementation efforts. Some example marketing decisions that may require policies are as follows:

1. How to make advertisements more interactive to be more effective 2. How to best take advantage o f Facebook and Twitter conservations about the company and

industry 3. To use exclusive dealerships or multiple channels of distribution 4. To use heavy, light, or no TV advertising versus online advertising 5. To limit (or not) the share of business done with a single customer 6 . To be a price leader or a price follower 7. To offer a complete or limited warranty 8. To reward salespeople based on straight salary, straight commission, or a combination salary

and commission

M arketing is more about building a two-way relationship with consumers than just inform­ ing consumers about a product or service. M arketers today must get their customers involved in their com pany website and solicit suggestions from customers in terms o f product development,

298 CHAPTER 9 • 5TRATEGY IMPLEMENTATION

custom er service, and ideas. The online community is much quicker, cheaper, and effective than traditional focus groups and surveys.

Companies and organizations should encourage their employees to create wikis— websites that allow users to add, delete, and edit content regarding frequently asked questions and inform a­ tion across the firm’s whole value chain of activities. The most common wiki is Wikipedia, but wikis are user-generated content. Anyone can change the content in a wiki but the group and other editors can change the content submitted.

Firms should provide incentives to customers to share their thoughts, opinions, and experi­ ences on the company website. Encourage customers to network among themselves on topics o f their choosing on the company website. So the company website must not be all about the com ­ pany— it must be all about the customer too. Perhaps offer points or discounts for customers who provide ideas and suggestions. This practice will not only encourage participation but will allow both the company and other customers to interact with “experts."

New Principles of Marketing A business or organization’s website must provide clear and simple instructions for customers to set up a blog or contribute to a wiki. Customers trust each others' opinions more than a com ­ pany’s marketing pitch, and the more they talk freely, the more the firm can learn how to improve its product, service, and marketing. Marketers today monitor blogs daily to determine, evaluate, and influence opinions being formed by customers. Customers must not feel like they are a cap­ tive audience for advertising at a firm 's website. Table 9-1 provides new principles of marketing according to Parise, Guinan, and Weinberg.1

Wells Fargo and Bank of America tw eet customers, meaning they post messages o f 140 characters or less on Twitter.com to describe features o f bank products. Some banks are placing marketing videos on YouTube. UMB Financial o f Kansas City, Missouri, tweets about everything from the bank’s financial stability to the industry’s prospects. Steve Furman, D iscover's director o f e-commerce, says the appeal o f social networking is that it provides ' ‘pure, instant” com m uni­ cation with custom ers.2

PepsiCo recently established a “Mission Control” staffed with social marketing em ployees promoting the com pany’s long-time product Gatorade, which had been on a three-year sales slide. PepsiCo staffs Mission Control 24/7 to tweet encouragement to high-school athletes and respond to Facebook questions.3 W henever anybody uses Twitter or Facebook to com ment on Gatorade, that message pops up on a screen in Mission Control and a PepsiCo em ployee jo ins that person's social circle. PepsiCo is a leading company that tracks social media, tracks online-ad traffic, heads off potential crises, builds support for products, and monitors consum er behavior in depth. Gatorade is under intense pressure from Coca-Cola’s Powerade, whose sales are increasing in contrast to Gatorade’s sales decreasing.

Although the exponential increase in social networking and business online has created huge opportunities for marketers, it also has produced some severe threats. Perhaps the greatest threat is that any kind of negative publicity travels fast online. For example, Taco Bell suffered from its ads that featured asking 50 Cent (aka Curtis Jackson) if he would change his name to 79 Cent or 89 Cent for a day in exchange for a S I0.000 donation to charity. Seemingly minor ethical and

TA B LE 9-1 The New Principles of Marketing

1. Do not just talk at consumers—work with them throughout the marketing process. 2. Give consumers a reason to participate. 3. Listen to—and join—the conversation outside your company’s website. 4. Resist the temptation to sell. sell. sell. Instead attract, attract, attract. 5. Do not control online conversations; let it How freely. 6. Find a "marketing technologist,” a person who has three excellent skill sets (marketing,

technology, and social interaction). 7. Embrace instant messaging and chatting.

Source: Based on Salvatore Parise. Patricia Guinan, and Bruce Weinberg, “The Secrets of Marketing in a Web 2.0 World,” Wall Street Journal, December 15, 2008. R 1.

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questionable actions can catapult these days into huge public relations problems for companies as a result o f the monumental online social and business communications.

In increasing numbers, people living in underdeveloped and poor nations around the world have smartphones but no computers. This is opening up even larger markets to online marketing. People in remote parts o f Indonesia, Egypt, and Africa represent the fastest-growing customer base for Opera Software ASA, a Norwegian maker o f Internet browsers for mobile devices. Cell phones are widely used now for data transfer, not just for phone calls.4

People ages 18 to 27 spend more time weekly on the Internet than watching television, listen­ ing to the radio, or watching DVDs or VHS tapes. Companies are rapidly coming to the realiza­ tion that social networking sites and video sites are better means of reaching their customers than spending so many marketing dollars on traditional yellow pages or television, magazine, radio, or newspaper ads.

New companies such as Autonet Mobile based in San Francisco are selling new technology equipment for cars so that everyone in the vehicle can be online except, o f course, the driver. This technology is accelerating the movement from hard media to web-based media. With this technol­ ogy, when the vehicle drives into a new location, information on show's, museums, hotels, and other attractions in the location can be instantly downloaded.

Internet advertising is growing so rapidly that marketers are more and more allowed to create bigger, more intrusive ads that take up more space on the web page. Websites are allowing length­ ier ads to run before short video clips play. And blogs are creating more content that doubles also as an ad. Companies are also waiving minimum ad purchases. Companies are redesigning their websites to be much more interactive and are building new sponsorship programs and other enticements on their sites. Editorial content and advertising content are increasingly being mixed on blogs.

A recent report by BIA/Kelsey reveals that social media ad spending should double in the USA between 2012 and 2016 from $4.8 billion to $9.6+ billion by 2016. BIA/Kelsey says about one-third of that ad spending will be from local advertisers, with their ad spending in the USA growing from $ 1.2 billion in 2012 to $3.1 billion in 2016.

According to the Interactive Advertising Bureau and Pricewaterhouse Coopers, mobile advertising grew 95 percent in the first half o f 2012. The industry as a whole grew to an all-time high of $17 billion in revenues in the first half o f 2012, up 14 percent over the prior year. Another marketing sector that grew rapidly in the first half o f 2012 was digital video, a com ponent o f dis­ play advertising. Digital video grew 18 percent in 2012 from the prior year.

Google and Facebook are by far the dominant players in display advertising, together compris­ ing 30 percent o f the overall market in 2012. An eMarketer report predicts those two companies alone will sell 37 percent o f all display ads by the end of 2014. Google had 15.4 percent of the market in 2012 ($2.31 billion) compared to Facebook’s 14.4 percent (S2.I6 billion). Yahoo! once dominated the display ad market but is on the decline with 9.3 percent of the market ($1.39 billion).

Market Segmentation Two variables are of central importance to strategy implementation: m ark e t segm entation and p roduct positioning. Market segmentation and product positioning rank as marketing’s most important contributions to strategic management.

Market segmentation is widely used in implementing strategies, especially for small and specialized firms. Market segmentation can be defined as the subdividing of a market into distinct subsets of customers according to needs and buying habits.

EBay recently initiated a new market segmentation strategy to target consumers under 18 years old. "W e're definitely looking at ways to legitimately bring younger people in,’* said Devin Wenig at eBay. “We w on’t allow a 15-year-old unfettered access to the site. We would want a parent, an adult as a ride-along.” The under 18-age group are an increasingly savvy and desir­ able consum er segment for many businesses.

Market segmentation is an important variable in strategy implementation for at least three major reasons. First, strategies such as market development, product development, market penetration, and diversification require increased sales through new markets and products. To implement these strategies successfully, new or improved market-segmentation approaches are required. Second, market segmentation allows a firm to operate with limited resources because

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mass production, mass distribution, and mass advertising are not required. Market segmentation enables a small firm to compete successfully with a large firm by maximizing per-unit profits and per-segment sales. Finally, market segmentation decisions directly affect m arke ting mix v ari­ ables: product, place, promotion, and price, as indicated in Table 9-2.

Perhaps the most dramatic new market-segmentation strategy is the targeting of regional tastes. Firms from Pizza Hut to Honda Motors are increasingly modifying their products to meet different regional preferences o f customers around the world. Cam pbell’s has a spicier version o f its nacho cheese soup for the Southwest, and Burger King offers breakfast burritos in New Mexico but not in South Carolina. Geographic and demographic bases for segmenting mar­ kets are the most commonly employed, as illustrated in Table 9-3.

Evaluating potential market segments requires strategisLs to determine the characteristics and needs of consumers, to analyze consumer similarities and differences, and to develop consum er group profiles. Segmenting consum er markets is generally much simpler and easier than segm ent­ ing industrial markets, because industrial products, such as electronic circuits and forklifts, have multiple applications and appeal to diverse customer groups.

Segmentation is a key to matching supply and demand, which is one o f the thorniest prob­ lems in customer service. Segmentation often reveals that large, random fluctuations in demand actually consist o f several small, predictable, and manageable patterns. M atching supply and demand allows factories to produce desirable levels without extra shifts, overtime, and subcon­ tracting. Matching supply and demand also minimizes the number and severity o f stock-outs. The demand for hotel rooms, for example, can be dependent on foreign tourists, businesspersons, and vacationers. Focusing separately on these three market segments, however, can allow hotel firms to more effectively predict overall supply and demand.

Banks now are segmenting markets to increase effectiveness. “You're dead in the water if you aren’t segmenting the market,” says Anne Moore, president o f a bank consulting firm in Atlanta. The Internet makes market segmentation easier today because consumers naturally form “com­ munities" on the Web.

Retention-Based Segmentation To aid in more effective and efficient deployment o f marketing resources, com panies commonly tag each o f their active customers with three values:

Tag I: Is this custom er at high risk of canceling the com pany's service? One of the most common indicators o f high-risk customers is a drop off in usage o f the com pany’s service. For example, in the credit card industry this could be signaled through a custom er’s decline in spend­ ing on his or her card.

Tag 2: Is this customer worth retaining? This determination boils down to whether the postre­ tention profit generated from the customer is predicted to be greater than the cost incurred to retain the customer. Customers need to be managed as investments.

Tag 3: W hat retention tactics should be used to retain this custom er? For custom ers who are deemed “save-worthy,” it is essential for the company to know which save tactics are m ost likely

TA B LE 9-2 The Marketing Mix Component Variables

Product Place Promotion Price

Quality Distribution channels Advertising Level

Features and options Distribution coverage Personal selling Discounts and allowances

Style Outlet location Sales promotion Payment terms

Brand name Sales territories Publicity

Packaging Inventory levels and

Product line locations

Warranty Transportation carriers

Service level Other services

Source: Based on E. Jerome McCarthy, Basic Marketing: A Managerial Approach. 9th ed. (Homewood, IL: Richard D. Irwin. Inc.. 19X7), 37-44. Used with permission.

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TA B LE 9-3 Alternative Bases for Market Segmentation

Variable Typical Breakdow ns

Geographic Region Pacific, Mountain, West North Central, West South Central, East North Central, East South Central.

South Atlantic, Middle Atlantic, New England County Size A. B, C, D City Size Under 5.000: 5.000-20.000: 20,001-50,000: 50.001-100,000: 100.001-250.000: 250,001-500.000:

500.001-1.000,000: 1.000,001-4.000.000:4,000.001 or over Density Urban, suburban, rural Climate Northern, southern

Demographic Age Under 6, 6-11, 12-19, 20-34, 35-49, 50-64, 65+ Gender Male, female Family Size 1-2, 3-4,5+ Family Life Cycle Young, single; young, married, no children; young, married, youngest child under 6: young, married, youngest

child 6 or over; older, married, with children; older, married, no children under 18: older, single: other Income Under $10,000; $10,001-$15,000; S I5,001-$20,000: S20.001 -$30,000: $30,001-$50,000; $50,001-$70,000;

$70,001 -$ 100,000; over $ 100,000 Occupation Professional and technical: managers, officials, and proprietors; clerical and sales; craftspeople; foremen;

operatives; farmers: retirees: students: housewives; unemployed Education Grade school or less; some high school; high school graduate; some collcge; college graduate Religion Catholic. Protestant. Jewish, Islamic, other Race White, Asian, Hispanic, African American Nationality American. British, French. German, Scandinavian, Italian, Latin American, Middle Eastern. Japanese

Psychographic Social Class Lower lowers, upper lowers, lower middles, upper middles, lower uppers, upper uppers Personality Compulsive, gregarious, authoritarian, ambitious

Behavioral

Use Occasion Regular occasion, special occasion Benefits Sought Quality, service, economy User Status Nonuser, ex-user, potential user, first-lime user, regular user Usage Rate Light user, medium user, heavy user Loyalty Status None, medium, strong, absolute Readiness Stage Unaware, aware, informed, interested, desirous, intending to buy Attitude Toward Product Enthusiastic, positive, indifferent, negative, hostile

Source: Adapted from Philip Kotler, Marketing Management: Analysis. Planning and Control. © 1984: 256. Adapted by permission of Prentice-Hall, Inc., Upper Saddle River. New Jersey.

to be successful. Tactics com m only used range from providing “special” custom er discounts to sending custom ers com m unications that reinforce the value proposition o f the given serv ice?

The basic approach to tagging custom ers is to use historical retention data to make predic­ tions about active custom ers regarding:

• W hether they are at high risk o f canceling their service • W hether they are profitable to retain • W hat retention tactics are likely to be most effective

The idea with retention-based segmentation is to match up active customers with customers from historic retention data who share similar attributes. Using the theory that ‘‘birds o f a feather flock together” the approach is based on the assumption that active customers will have similar retention outcomes as those o f their comparable predecessor. This whole process is possible through business analytics or data mining (discussed later in this chapter).

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Does the Internet Make Market Segmentation Easier? Yes. The segments o f people whom marketers want to reach online are much more precisely delined than the segments o f people reached through traditional forms o f media, such as televi­ sion, radio, and magazines. People all over the world are congregating into virtual com munities on the web by becoming members, customers, and visitors o f websites that focus on an endless range o f topics. People in essence segment themselves by nature o f the websites that com prise their “favorite places," and many of these websites sell information regarding their “visitors.” Businesses and groups of individuals all over the world pool their purchasing power in websites to get volume discounts.

Through its Connect feature, Facebook recently introduced a type o f mobile advertising that targets consumers based on the apps they use from their phone. Connect lets users log into millions of websites and apps with their Facebook identity, so the com pany then targets ads based on that data. Facebook can also track what people do on their apps. Although Apple and Google also track users’ mobile apps, those two firms disclose to users in their privacy policy that they can target ads based on apps the person has downloaded from its App Store and iTunes. Facebook charges advertisers every time an app is installed on a users’ sm artphone .6 Privacy advocates contend that Facebook should provide ways for users to opt out o f the mobile ad targeting.

Product Positioning/Perceptual Mapping A fter m arkets have been segmented so that the firm can target particular custom er groups, the next step is to find out what custom ers want and expect. This takes analysis and research. A severe mistake is to assum e the firm knows what custom ers want and expect. Countless research studies reveal large differences between how custom ers deline service and rank the importance of different service activities and how producers view services. M any firms have become successful by filling the gap between what custom ers and producers see as good ser­ vice. W hat the custom er believes is good service is paramount, not w hat the producer believes service should be.

Identifying target custom ers on which to focus marketing efforts sets the stage for deciding how to m eet the needs and wants o f particular consum er groups. Product positioning is widely used for this purpose. Positioning entails developing schem atic representations that reflect how products or services com pare to com petitors' on dim ensions most im portant to success in the industry. The following steps are required in product positioning (som etim es called perceptual mapping):

1. Select key criteria that effectively differentiate products or services in the industry. 2. Diagram a two-dimensional product-positioning map with specified criteria on each axis. 3. Plot major com petitors' products or services in the resultant four-quadrant matrix. 4. Identify areas in the positioning map where the com pany’s products or services could be

most competitive in the given target market. Look for vacant areas (niches). 5. Develop a marketing plan to position the com pany’s products or services appropriately.

Because just two criteria can be examined on a single product-positioning (perceptual) map. multiple maps are often developed to assess various approaches to strategy implementation. M ultid im ensional scaling could be used to examine three or more criteria simultaneously, but ihis technique requires computer assistance and is beyond the scope of this text.

Some rules for using product positioning as a strategy-implementation tool are the following:

1. Look for the hole or vacan t niche. The best strategic opportunity might be an unserved segment.

2. Do not serve two segments with the same strategy. Usually, a strategy successful with one segment cannot be directly transferred to another segment.

3. Do not position yourself in the middle of the map. The middle usually means a strategy that is not clearly perceived to have any distinguishing characteristics. This rule can vary with the number o f competitors. For example, when there arc only tw o competitors, as in U.S. presidential elections, the middle becomes the preferred strategic position. '

CHAPTER 9 • STRATEGY IMPLEMENTATION 303

An effective product-positioning strategy meets two criteria: (1) it uniquely distinguishes a company from the competition, and (2 ) it leads customers to expect slightly less service than a company can deliver. Network Equipment Technology is an example o f a company that keeps custom er expectations slightly below perceived performance. This is a constant challenge for marketers. Firms need to inform customers about what to expect and then exceed the promise. Underpromise and then overdeliver is the key!

The product positioning map. or p e rcep tu a l m ap . in Figure 9-2, shows consum er percep­ tions o f various autom obiles on the two dim ensions o f sportiness and conservative and classy and affordable. This sam ple o f consum ers felt Porsche was the sportiest and classiest o f the cars in the study (top right corner). They felt Plym outh was m ost practical and conservative (bottom left corner). Car m anufacturers could focus their m arketing efforts on various target groups, or even redesign features in their vehicles, based on research and survey inform ation illustrated in perceptual maps. Perceptual maps can aid marketers in being more effective in spending money to prom ote products. Products, brands, or com panies positioned close to one another are perceived as sim ilar on the relevant dim ensions. For exam ple, in Figure 9-2, con­ sum ers see Buick, Chrysler, and O ldsm obile as similar. They are close com petitors and form a com petitive grouping. A com pany considering the introduction o f a new or im proved model may look for a vacant niche on a perceptual map. Some perceptual maps use different size circles to indicate the sales volume or m arket share of the various com peting products.

Perceptual maps may also display consum ers’ ideal points. These points reflect ideal com bi­ nations of the two dim ensions as seen by a consumer. Figure 9-3 reveals the results o f a study of consum ers’ ideal points in the alcohol and spirits product space. Each dot represents one respon­ dent's ideal com bination of the two dimensions. Areas where there is a cluster o f ideal points (such as A) indicates a m a rk e t segm ent. Areas without ideal points are sometimes referred to as dem and voids. A com pany considering introducing a new product will look for areas with a high density of ideal points. They will also look lor areas without competitive rivals (a vacant niche), perhaps best done by placing both the ( 1) ideal points and (2) com peting products on the same map.

Conservative

Lincoln Mercedes

Cadillac

Classy Distinctive

Porsche

Pontiac

w Nisan Toyota

vw

Practical Affordable

FIGURE 9-2 A Perceptual Map for the Automobile Industry

Source: Based on info at http://en.wikipedia.org/wiki/Perceptual_mappine.

304 CHAPTER 9 • STRATEGY IMPLEMENTATION

Quaintness

D

Social Appeal

Individual Appeal

Status FIGURE 9-3 A Perceptual Map for the Alcohol and Spirits Industry

Source: Based on info at hltp://en.wikipedia.org/wiki/Perceptual_mapping.

Finance and Accounting Issues In terms o f “Financial Soundness,” Fortune recently ranked the following companies as best in the world:

Rank Company 1 Apple 2 McDonald’s 3 Exxon Mobil 4 Philip Morris International 5 Intel 6 Google 7 GDF Suez 8 Procter & Gamble 9 Walmart Stores

10 Altria Group

Source: Based on http://money.cnn.com/magazincs/ fortune/mostadmired/2012/best_worst/best6.html.

Several finance and accounting concepts central to strategy implementation are acquiring needed capital, developing projected financial statements, preparing financial budgets, and evalu­ ating the worth o f a business. Some examples of decisions that may require finance and account­ ing policies are these:

1. To raise capital with short-term debt, long-term debt, preferred stock, or common stock 2. To lease or buy fixed assets 3. To determine an appropriate dividend payout ratio 4. To use last-in, first-out (LIFO), first-in, first-out (FIFO), or a market-value accounting

approach 5. To extend the time of accounts receivable 6 . To establish a certain percentage discount on accounts within a specified period of time 7. To determine the amount o f cash that should be kept on hand

CHAPTER 9 • STRATEGY IMPLEMENTATION 305

Acquiring Capital to Implement Strategies When students complete their recommendations page as part o f a case analysis, or in actual com ­ pany practice when a firm decides what strategies to pursue, it is necessary to address the ques­ tions: 1) Should the company obtain needed capital via stock or debt? 2) W hat would the firm ’s expected/projected EBIT values be given our recommendations?

Successful strategy implementation often requires additional capital. Besides net profit from operations and the sale o f assets, two basic sources of capital for an organization are debt and equity. Determining an appropriate mix of debt and equity in a firm 's capital structure can be vital to successful strategy implementation. An earn ings per share/earn ings before in terest and taxes (E P S /E B IT ) analysis is the most widely used technique for determining whether debt, stock, or a combination of debt and stock is the best alternative for raising capital to implement strategies. This technique involves an examination of the impact that debt versus stock financing has on earnings per share under various expectations for EBIT given specific recommendations (strate­ gies to be implemented).

Theoretically, an enterprise should have enough debt in its capital structure to boost its return on investment by applying debt to products and projects earning more than the cost of the debt. In low-earning periods, too much debt in the capital structure of an organization can endanger stockholders' returns and jeopardize company survival. Fixed debt obligations generally must be met, regardless o f circumstances. This does not mean that stock issuances are always belter than debt for raising capital. W'hen the cost o f capital (interest rates) is low. such as in 2012/2013. debt may be better than stock to obtain capital, but the analysis still must be performed because high stock prices usually accompany low interest rates, m aking stock issuances attractive for obtain­ ing capital. Some special concerns with stock issuances are dilution o f ownership, effect on stock price, and the need to share future earnings with all new shareholders. Facebook’s initial public offering in early 2012 was for $38 per share, but several months later the stock was selling for $21, so it is no guarantee even with an IPO that a firm ’s stock price will rise.

Another popular way for a company to raise capital is to issue corporate bonds, which is analogous to going to the bank and borrowing money, except that with bonds the company obtains the funds from investors rather than banks. Through the first seven months of 2012, companies sold almost S584 billion of bonds in the USA, according to Dealogic, up 6.5 percent from the same period in 2011.8 For example, Bristol-M yers Squibb, a company with single-A investment credit ratings, sold $2 billion of bonds that paid 3.35 percent interest. Many foreign companies also issue bonds in the USA as a way to raise capital. Especially when a com pany’s balance sheet is strong and its credit rating excellent, issuing bonds can be an effective, and certainly an alterna­ tive way to raise needed capital.

Before explaining EPS/EBIT analysis, it is important to know that EPS is earnings per share, which is net income divided by num ber of shares outstanding. Another term for shares outstand­ ing is shares issued. Also know that EBIT is earnings before interest and taxes. Another name for EBIT is operating income. EBT is earnings before tax. EAT is earnings after tax

The purpose o f EPS/EBIT analysis is to determine whether all debt, or all stock, or some combination of debt and stock yields the highest EPS values for the firm. EPS is perhaps the best measure o f success o f a company, so it is widely used in making the capital acquisition decision. EPS reflects the common “maximizing shareholders' wealth"’ overarching corporate objective. By chance if profit maximization is the com pany’s goal, then in performing an EPS/EBIT analysis, you may focus more on the EAT row more than the EPS row. Large companies may have millions o f shares outstanding, so even small differences in EPS across different financing options can equate to large sums of money saved by using that highest EPS value alternative. Any number of combination debt/stock (D/S) scenarios, such as 70/30 D/S or 30/70 D/S. may be examined in an EPS/EBIT analysis.

EPS/EBIT analysis may best be explained by working through an example for the XYZ Company, as provided in Table 9-4. Note that 100 percent stock is the best financing alternative as indicated by the EPS values o f 0.0279 and 0.056. An EPS/EBIT chart can be constructed to determine the break-even point, where one financing alternative becomes more attractive than another. Figure 9-4 reveals that issuing common stock is the best financing alternative for the XYZ Company. As noted in Figure 9-4, the top row (EBIT) on the x-axis is graphed with the bot­ tom row (EPS) on the v-axis, and the highest plotted line reveals the best method. Sometimes the

306 CHAPTER 9 • STRATEGY IMPLEMENTATION

T A B L E 9-4 EPS/EBiT Analysis for the X Y Z Company

Input Data The Number How Determined $Amount of Capital Needed EBIT Range

Interest Rate Tax Rate

Stock Price #Shares Outstanding

$100 million $20 to $40 million

5 percent 30 percent

$50 500 million

Estimated $cost of recommendations Estimate based on prior year EBIT and recommendations for the coming year(s) Estimate based on cost of capital Use prior year %: taxes divided by income before taxes, as given on income statement Use most recent stock price For the debt columns, enter the existing #shares outstanding. For stock columns, use the existing #shares outstanding + the #new shares that must be issued to raise the needed capital, i.e.. based on stock price. So divide the stock price into the Samount of capital needed.

100% Debt 100% Stock 50/50 Debt/Stock Combo $ EBIT 20,000,000 40,000,000 20,000,000 40.000,000 20.000,000 40,000.000 $ Interest 5.000,000 5,000.000 0 0 2,500.000 2.500.000 $ EBT 15,000,000 35,000.000 20,(MX),000 40.000.000 17,500,000 37,500,000 $ Taxes 4,500,000 10,500,000 6,000,000 12,000,000 5,250,000 11,250.000 $ EAT 10,500,000 24,500,000 14,000.000 28,000,000 12,250,000 26,250,000 # Shares 500.000,000 500,000.000 502.000.000 502,000,000 501,000,000 501,000,000 $ EPS 0.0210 0.049 0.0279 0.056 0.0245 0.0523

Conclusion—the best financing alternative is 100% stock because the EPS values are largest; the worst financing alternative is 100% debt because the EPS values are lowest.

plotted lines will interact, so a graph is especially helpful in making the capital acquisition deci­ sion, rather than solely relying on a table o f numbers.

It is important to note some limitations of EPS-EBIT analysis. First, llexibility is a lim ita­ tion. As an organization’s capital structure changes, so does its flexibility for considering future capital needs. Using all debt or all stock to raise capital in the present may impose fixed obli­ gations, restrictive covenants, or other constraints that could severely reduce a firm ’s ability to raise additional capital in the future. Second, control is a limitation. W hen additional stock is issued to finance strategy implementation, ownership and control o f the enterprise are diluted. This can be a serious concent in today’s business environment o f hostile takeovers, mergers, and acquisitions. Dilution o f ownership could be a problem, and if so, debt could be better than stock regardless o f determined EPS values in the analysis. Third, interest rates are a lim itation. If rates are expected to rise, as they are doing in 2013/2014, then debt could be better than stock, regard­ less of the determined EPS values in the analysis. Fourth, if the firm is already too highly lever­ aged vs. industry average ratios, then stock may be best regardless o f determ ined EPS values in the analysis. A fifth limitation is that the analysis assumes stock price, tax rate, and interest rates to be the same over all economic conditions. A sixth limitation is that the estim ated EBIT low and high values are based on the prior year plus the impact o f strategies to be implemented. But considering these six potential lim itations, unless you have a com pelling reason to overturn the highest last row EPS values dictating the EPS-EBIT analysis, then indeed those values should dictate the financing decision, because EPS is arguably the best measure of organizational perform ance.

IBM declared a third quarter 2012 cash dividend of $0.85 per com mon share, marking the third consecutive quarterly payout at that rate. IBM also authorized another $5 billion in addi­ tional funds to be used for its share repurchase program on top o f the $6.7 billion remaining available for buybacks. That was $11.7 billion for its stock repurchase program in total or about 5.3 percent o f its outstanding shares. IBM and thousands ol other firms lately have significantly increased their share repurchases.

CHAPTER 9 * STRATEGY IMPLEMENTATION 307

\

SF = Stock Financing DF = Debt Financing CF = 50/50 Combination (Debt/Stock) Financing

V_________________________________ ________________________________ )

FIGURE 9-4 An EPS/EBIT Chart for the XYZ Company

Lowe's Companies is aggressively buying its own stock, increasing its T reasury Stock on its balance sheets. Many analysts say stock buybacks reflect optimism among companies and say it is a good sign. However, other analysts argue that buybacks eat cash that a firm could better use to grow the firm. Intel in late 2012 borrowed S6 billion to buy back more of its ow'n stock. The low interest rate environment has spurred this activity. Even though Intel had the cash on its bal­ ance sheet to cover the transaction, the firm, like many large U.S. firms, have most o f their cash in overseas accounts (that is, a large percentage o f their revenues were derived in foreign countries). Many such firms prefer to leave their cash outside the USA because to use those funds to pay dividends or purchase treasury stock, for example, would trigger a big U.S. corporate income tax payment.

When using EPS/EBIT analysis, tim ing in relation to movements o f stock prices, interest rates, and bond prices becomes important. In times o f high stock prices, such as in 2013/2014, stock may prove to be the best alternative from both a cost and a demand standpoint. However, when cost of capital (interest rates) is low, debt is more attractive.

The USA has $9.7 trillion in outstanding debt, equal to 63 percent o f gross domestic product (GDP). Based on that percentage. S&P lowered the U.S.’s AAA credit rating. It is interesting, how­ ever, that 147 of the S&P 500 companies have total debt that is 63 percent or greater than the com ­ pany’s revenue. For example, GE, Lennar, and Harley-Davidson have debt that is 300, 131, and 116 percent greater than their revenues, respectively. A key difference of course is that companies generate money whereas governments consume money. The U.S. government pays $210 billion in interest annually, about 10 percent o f the $2.1 trillion it collects annually in taxes. Only 24 com pa­ nies in the S&P 500 however incur interest payments that total at least 10 percent of their revenue.

308 CHAPTER 9 • STRATEGY IMPLEMENTATION

Tables 9-5 and 9-6 provide EPS/EBIT analyses for two com panies—Gateway Com puters and Boeing. Notice in those analyses that the combination stock/debt options vary from 30/70 to 70/30. Any number of combinations could be explored. However, sometim es in preparing the EPS/EBIT graphs, the lines will intersect, thus revealing break-even points at which one financ­ ing alternative becomes more or less attractive than another. The slope o f these lines will be determined by a com bination o f factors including stock price, interest rate, num ber o f shares, and amount o f capital needed. Also, it should be noted here that the best financing alternatives are indicated by the highest EPS values. In Tables 9-5 and 9-6. note that the tax rates for the com pa­ nies vary considerably and should be computed from the respective income statements by divid­ ing taxes paid by income before taxes.

In Table 9-5. the higher EPS values indicate that Gateway should use stock to raise capital in recession or normal economic conditions but should use debt financing under boom condi­ tions. Stock is the best alternative for Gateway under all three conditions if EAT (profit m axim i­ zation) were the decision criteria, but EPS (maximize shareholders' wealth) is the better ratio to make this decision. Firms can do many things in the short run to maximize profits, so investors and creditors consider m aximizing shareholders’ wealth to be the better criteria for making financing decisions.

In Table 9-6, note that Boeing should use stock to raise capital in recession (see 0.92) or normal (see 2.29) economic conditions but should use debt financing under boom conditions (see 5.07). Let us calculate here the number of shares figure of 1014.68 given under Boeing’s stock alter­ native. Divide $10,000 M funds needed by the stock price of $53 = IKK.68 M new shares to be issued + the 826 M shares outstanding already = 1014.68 M shares under the stock scenario. Along the final row, EPS is the number of shares outstanding divided by EAT in all columns.

TA BLE 9-5 EPS/EBIT Analysis for Gateway (M = in millions)

Amount Needed: $1,000 M EBIT Range: - $500 M to + $ 100 M to + $500 M In terest Rate: 5% Tax Rate: 0% (because the firm has been incurring a loss annually) Stock Price: $6.00 # o f Shares Outstanding: 371 M

Com m on Stock Financing D ebt Financing

Recession Normal Boom Recession Normal Boom

EBIT (500.00) 100.00 500.00 (500.00) 1(X).()() 500.00 Interest 0.00 0.00 0.00 50.00 50.00 50.00 EBT (500.00) 100.00 500.00 (550.00) 50.00 450.00 Taxes 0.00 0.00 0.00 0.00 0.00 0.00 EAT (500.00) 100.00 500.00 (550.00) 50.00 450.00 #Shares 537.67 537.67 537.67 371.00 371.00 371.00

EPS (0.93) 0.19 0.93 (1.48) 0.13 1.21

70 Percent Stock—30 Percent D ebt 70 Percent D ebt—30 Percent Stock

Recession Normal Boom Recession Normal Boom

EBIT (500.00) 100.00 500.00 (500.00) 100.00 500.00 Interest 15.00 15.00 15.00 35.00 35.00 35.00

EBT (515.00) 85.00 485.00 (535.00) 65.00 465.00

Taxes 0.00 0.00 0.00 0.00 0.00 0.00 EAT (515.00) 85.00 485.00 (535.00) 65.00 465.00

#S hares 487.67 487.67 487.67 421.00 421.00 421.00

EPS (1.06) 0.17 0.99 (1.27) 0.15 1.10

CHAPTER 9 • STRATEGY IMPLEMENTATION 309

Conclusion: Gateway should use common stock to raise capital in recession or normal economic conditions hut should use debt financing under boom conditions. Note that stock is the best alternative under all three conditions according to EAT (profit maximization), but EPS (maximize shareholders' wealth) is the better ratio to make this decision.

TA B LE 9-6 EPS/EBIT Analysis for Boeing (M = in millions)

Amount Needed: $10,000 M Interest Rate: 5% Tax Rate: 7% Stock Price: $53.00 # of Shares Outstanding: 826 M

Com m on Stock Financing D ebt Financing

Recession Normal Boom Recession Normal Boom

EBIT 1.000.00 2,500.00 5,000.00 1.000.00 2,500.00 5.000.00 Interest 0.00 0.00 0.00 500.00 500.00 500.00 EBT 1,000.00 2.500.00 5,000.00 500.00 2,000.00 4,500.00 Taxes 70.00 175.00 350.00 35.00 140.00 315.00 EAT 930.00 2,325.00 4.650.00 465.00 1.860.00 4,185.00 # Shares 1,014.68 1.014.68 1.014.68 826.00 826.00 826.00 EPS 0.92 2.29 4.58 0.56 2.25 5.07

7 0 % Stock— 3 0 % Debt 7 0 % D ebt— 3 0 % Stock

Recession Normal Boom Recession Normal Boom

EBIT 1,000.00 2.500.00 5,000.00 1.000.00 2,500.00 5.000.00 Interest 150.00 150.00 150.00 350.00 350.00 350.00 EBT 850.00 2,350.00 4.850.00 650.00 2,150.00 4,650.00 Taxes 59.50 164.50 339.50 45.50 150.50 325.50 EAT 790.50 2.185.50 4,510.50 604.50 1.999.50 4,324.50 # Shares 958.08 958.08 958.08 882.60 882.60 882.60 EPS 0.83 2.28 4.71 0.68 2.27 4.90

310 CHAPTER 9 • STRATEGY IMPLEMENTATION

Conclusion: Boeing should use common stock to raise capital in recession (see 0.92) or normal (see 2.29) economic conditions but should use debt financing under boom conditions (see 5.07). Note that a dividends row is absent from this analysis. The more shares outstanding, the more dividends to be paid (if the firm pays dividends), which would lower the common stock EPS values.

Note in Table 9-5 and Table 9-6 that a dividends row is absent from both the Gateway and Boeing analyses. The more shares outstanding, the more dividends to be paid (if the firm indeed pays dividends). To consider dividends in an EPS/EBIT analysis, simply insert another row for “Dividends” right below the “EAT" row and then insert an “Earnings After Taxes and Dividends” row. Considering dividends would make the analysis more robust.

Note in both the Gateway and Boeing graphs, there is a breakeven point between the normal and boom range of EBIT where the debt option overtakes the 70/30 D/S option as the best financ­ ing alternative. A break-even point is where two lines cross each other. A break-even point is the EBIT level where various financing alternative represented by lines crossing are equally attractive in terms o f EPS. Both the Gateway and Boeing graphs indicate that EPS values are highest for the 100 percent debt option at high EBIT levels. The two graphs also reveal that the EPS values for 100 percent debt increase faster than the other financing options as EBIT levels increase beyond the break-even point. At low levels of EBIT however, both the Gateway and Boeing graphs indi­ cate that 100 percent stock is the best financing alternative because the EPS values are highest.

Projected Financial Statements Projected financial s ta tem en t analysis is a central strategy-implementation technique because it allows an organization to examine the expected results o f various actions and approaches. This type of analysis can be used to forecast the impact o f various implementation decisions (for example, to increase promotion expenditures by 50 percent to support a market-development strategy, to increase salaries by 25 percent to support a market-penetration strategy, to increase research and development expenditures by 70 percent to support product development, or to sell $1 million of common stock to raise capital for diversification). Nearly all financial institutions require at least three years of projected financial statements whenever a business seeks capital. A projected income statement and balance sheet allow an organization to compute projected financial ratios under various strategy-implementation scenarios. When com pared to prior years and to industry averages, financial ratios provide valuable insights into the feasibility of various strategy-implementation approaches.

Primarily as a result o f the Sarbanes-Oxlev Act, companies today are being much more diligent in preparing projected financial statements to “reasonably rather than too optim istically” project future expenses and earnings. There is much more care not to mislead shareholders and other constituencies.

A 2015 projected income statement and a balance sheet for the Litten Com pany are provided in Table 9-7. The projected statements for Litten are based on five assum ptions: (1) The company

CHAPTER 9 • STRATEGY IMPLEMENTATION 311

needs to raise S45 million to finance expansion into foreign markets; (2) $30 million of this total will be raised through increased debt and $15 million through com mon stock; (3) sales are expected to increase 50 percent; (4) three new facilities, costing a total o f $30 million, will be constructed in foreign markets; and (5) land for the new facilities is already owned by the com ­ pany. Note in Table 9-7 that Litten’s strategies and their implementation are expected to result in a sales increase from S100 million to $150 million and in a net increase in income from S6 million to $9.75 million in the forecasted year.

TA BLE 9-7 A Projected Income Statement and Balance Sheet for the Litten Company (in millions)

Prior Year 2014

Projected Year 2015 Remarks

PROJECTED INCOME STATEMENT Sales $100 $150.00 50% increase

Cost of Goods Sold 70 105.00 70% of sales Gross Margin 30 45.00

Selling Expense 10 15.00 10% of sales Administrative Expense 5 7.50 5% of sales

Earnings Before Interest and Taxes 15 22.50 Interest 3 3.00

Earnings Before Taxes 12 19.50 Taxes 6 9.75 50% rate

Net Income 6 9.75 Dividends 2 5.00

Retained Earnings 4 4.75 PROJECTED BALANCE SHEET Assets

Cash 5 7.75 Plug figure Accounts Receivable 2 4.00 100% increase Inventory 20 45.00 Total Current Assets 27 56.75 Land 15 15.00 Plant and Equipment 50 80.00 Add three new plants

at $10 million each Less Depreciation 10 20.00

Net Plant and Equipment 40 60.00 Total Fixed Assets 55 75.00 Total Assets 82 131.75 Liabilities

Accounts Payable 10 10.00 Notes Payable 10 10.00 Total Current Liabilities 20 20.00 Long-term Debt 40 70.00 Borrowed $30

million Additional Paid-in-Capital 20 35.00 Issued 100.000

shares at S150 each Retained Earnings 2 6.75 $2 + $4.75

Total Liabilities and Net Worth 82 131.75

312 CHAPTER 9 • STRATEGY IMPLEMENTATION

There are six steps in performing projected financial analysis:

1. Prepare the projected income statement before the balance sheet. Start by forecasting sales as accurately as possible. Be careful not to blindly push historical percentages into the future with regard to revenue (sales) increases. Be mindful o f what the firm did to achieve those past sales increases, which may not be appropriate for the future unless the firm takes similar or analogous actions (such as opening a similar number o f stores, for example). If dealing with a manufacturing firm, also be mindful that if the firm is operating at 100 percent capacity running three eight-hour shifts per day. then probably new manufacturing facilities (land, plant, and equipment) will be needed to increase sales further.

2. Use the percentage-of-sales method to project cost o f goods sold (CGS) and the expense items in the income statement. For example, if CGS is 70 percent o f sales in the prior year (as it is in Table 9-7), then use that same percentage to calculate CGS in the future year— unless there is a reason to use a different percentage. Items such as interest, dividends, and taxes must be treated independently and cannot be forecasted using the percentage-of-sales method.

3. Calculate the projected net income. 4. Subtract from the net income any dividends to be paid for that year. This remaining net

income is retained earnings (RE). Bring this retained earnings amount for that year (NI - DIV = RE) over to the balance sheet by adding it to the prior year’s RE shown on the balance sheet. In other words, every year a firm adds its RE for that particular year (from the income statement) to its historical RE total on the balance sheet. Therefore, the RE amount on the balance sheet is a cumulative number rather than money available for strat­ egy implementation! Note that RE is the first projected balance sheet item to be entered. As a result of this accounting procedure in developing projected financial statements, the RE amount on the balance sheet is usually a large number. However, it also can be a low or even negative number if the firm has been incurring losses. The only way for RE to decrease from one year to the next on the balance sheet is ( I ) if the firm incurred an earnings loss that year or (2) the firm had positive net income for the year but paid out dividends more than the net income. Be mindful that RE is the key link between a projected income statement and balance sheet, so be careful to make this calculation correctly.

5. Project the balance sheet items, beginning w'ith retained earnings and then forecasting stock­ holders’ equity, long-term liabilities, current liabilities, total liabilities, total assets, fixed assets, and current assets (in that order). Use the cash account as the plug figure— that is, use the cash account to make the assets total the liabilities and net worth. Then make appropriate adjustments. For example, if the cash needed to balance the statements is too small (or too large), make appropriate changes to borrow more (or less) money than planned.

6 . List com m ents (remarks) on the projected statements. Any time a significant change is made in an item from a prior year to the projected year, an explanation (remark) should be provided. Remarks are essential because otherwise pro form as are meaningless.

Projected Financial Statement Analysis for Whole Foods Market Because so many strategic management students have limited experience developing projected financial statements, let us apply the steps outlined on the previous pages to W hole Foods Market.

W hole Foods Market opened 16 stores in fiscal 2010. The projected statem ents given on the next page(s) are based on the following recommendations:

1. W hole Foods opens 40 new stores in 2011 and 60 new stores in 2012. 2. Whole Foods uses a 50/50 debt/stock com bination to finance the 100 new stores. 3. After paying almost no dividends in 2010, W hole Foods starts paying dividends at $1.00

per share in 2011 and 2012. 4. W hole Foods boosts its advertising expenses by $20 million per year. 5. W hole Foods installs a new inventory control system that increases the com pany's low-

gross margin from 34.8 percent to 40.0 percent. 6 . Whole Foods’ per store revenues will increase 10 percent annually in 2011-2013 resulting

from the new ad campaign and the im proving economy. 7. Total cost of recom m endations for tw'o years are $800 million = $200 million per year to

be raised through both debt and equity.

CHAPTER 9 • STRATEGY IMPLEMENTATION 313

W hole Foods' actual consolidated income statements and balance sheets are provided in Table 9-8 and Table 9-9, respectively. The projected statements, based on the aforementioned recom m endations, are provided in Table 9-10 and 9- l l , respectively. Read carefully the notes (a through f), which reveal the rationale for various changes and exemplify the pro forma pro­ cess. Note in Table 9-10 that W hole Foods’ operating margin with the proposed strategic plan increases from 4.9 percent in 2010 to 16.9 percent in 2012. Note in Table 9 - l l that W hole Foods' current ratio would be $3,580.3/$400 = 8.95, which is high. Thus, in 2 0 12 the com pany could better use that money to perhaps pay down some o f its $908 million in long-term debt.

The projected financial statem ents wrere prepared using the six steps outlined on prior pages and the above seven strategy statements. Note the cash account is used as the plug figure, and it is too high, so W hole Foods could reduce this num ber and concurrently reduce a liability or equity account the same am ount to keep the statement in balance. Rarely is the cash account perfect on ihc first pass through, so adjustm ents are needed and made. However, these adjust­ ments are not made on the projected statem ents given in Tables 9-10 and 9 -11, so that the five strategy statem ents can be more readily seen on respective rows. Note the author's com m ents on Tables 9-10 and 9 -1 1 that help explain changes in the numbers.

The U.S. Securities and Exchange Commission (SEC) conducts fraud investigations if pro­ jected numbers are misleading or if they omit information that’s important to investors. Projected statements must conform with generally accepted accounting principles (GAAP) and must not be designed to hide poor expected results. The Sarbanes-Oxley Act requires CEOs and CFOs o f cor­ porations to personally sign their firms' financial statements attesting to their accuracy. These exec­ utives could thus be held personally liable for misleading or inaccurate statements. The collapse of the Arthur Andersen accounting firm, along with its client Enron, fostered a “zero-tolerance” policy among auditors and shareholders with regard to a firm 's financial statements. But plenty o f firms still “ inflate” their financial projections and call them “pro formas,” so investors, shareholders, and other stakeholders must still be wary o f different com panies’ financial projections.9

On financial statements, different com panies use different terms for various items, such as revenues or sales used for the same item by different com panies. For net income, many firms use the term earnings, and many others use the term profits.

Financial Budgets A financia l budget is a docum ent that details how funds will be obtained and spent for a speci­ fied period o f time. Annual budgets are m ost com m on, although the period o f time for a budget can range from one day to more than 10 years. Fundamentally, financial budgeting is a method

TABLE 9-8 Actual Whole Foods Market Income Statements (in millions)

2010 2009

Revenue (a) $9,005.8 $8,031.6 Cost of Goods Sold 5,870.4 5,277.3 Gross Profit 3,135.4 2,754.3 Gross Profit Margin 34.8% 34.3% SG&A Expense 2,697.4 2,470.0 Depreciation & Amortization 275.6 266.7 Operating Income 438.0 284.3 Operating Margin 4.9% 3.5% Nonoperating Income 6.9 3.4 Nonoperating Expenses (33.0) (36.9) Income Before Taxes 411.8 250.9 Income Taxes (b) 165.9 104.1 Net Income After Taxes 245.8 146.8 Net Income $245.8 $146.8

(a) Note that the 16 news stores in 2010 resulted in (59.005.8 - 8,031.6 = 974.2 revenue increase = an average of $974.2 / 16 = $60.89) $60.89 million as the average revenue per new store. (b) Note Whole Foods’ effective tax rate is $165.9 / 411.8 = 40.3%.

314 CHAPTER 9 • STRATEGY IMPLEMENTATION

TA B LE 9-9 Actual Whole Foods Market Balance Sheets (in millions)

2010 2009

Assets

Current Assets

Cash $132.0 $430.1 Net Receivables 133.3 104.7 Inventories 323.5 310.6 Other Current Assets 572.7 209.9 Total Current Assets 1.161.5 1,055.4 Net Fixed Assets (a) 1,886.1 1.897.9 Other Noncurrent Assets 938.9 830.2 Total Assets 3,986.5 3,783.4

Liabilities

Current Liabilities

Accounts Payable 213.2 189.6 Short-Term Debt 0.4 0.4 Other Current Liabilities 534.3 494.0 Total Current Liabilities 747.9 684.0 Long-Term Debt 508.3 738.8 Other Noncurrent Liabilities 357.0 732.6 Total Liabilities 1,613.2 2,155.5

Shareholders’ Equity

Common Stock 500 400 Additional-paid-in-capital 1,274.7 869.7 Retained Earnings (b) 598.6 358.2 Total Shareholders’ Equity 2.373.3 1,627.9 Total Liabilities and SE $3,986.5 $3,783.4 Shares Outstanding (thou.) 172,033 140,542

(a) Since Whole Foods operated 300 stores in 2010. we can estimate cost per store = $ l .886 / 300 = $6.3 million and use that cost # for each new store to be built. (b) Note that Whole Foods reinvested back into the company $240.4 million of its total $245.8 million in net income, so in 2010 the company paid out only $5.4 million in dividends. We know that because $598.6 - $358.2 = $240.4.

for specifying what must be done to complete strategy implementation successfully. Financial budgeting should not be thought o f as a tool for limiting expenditures but rather as a method for obtaining the most productive and profitable use of an organization’s resources. Financial budgets can be viewed as the planned allocation of a firm ’s resources based on forecasts o f the future.

There are almost as many different types o f financial budgets as there are types o f organiza­ tions. Some com mon types of budgets include cash budgets, operating budgets, sales budgets, profit budgets, factory budgets, capital budgets, expense budgets, divisional budgets, variable budgets, flexible budgets, and fixed budgets. When an organization is experiencing financial d if­ ficulties, budgets are especially important in guiding strategy implementation.

Perhaps the most common type o f financial budget is the cash budget. The Financial Accounting Standards Board (FASB) has mandated that every publicly held com pany in the USA must issue an annual cash-flow statement in addition to the usual financial reports. The statement includes all receipts and disbursem ents of cash in operations, investments, and financing. It supplements the Statement on Changes in Financial Position formerly included in the annual reports o f all publicly held companies. A cash budget for the year 2 0 15 for the Toddler Toy Com pany is provided in Table 9 - 12. Note that Toddler is not expecting to have surplus cash until November 2015.

CHAPTER 9 • STRATEGY IMPLEMENTATION

TA B LE 9-10 Projected Whole Foods Market Income Statements (in millions)

2010 2011 2012

Revenue (a) $9,005.8 12,584.0 17.860.0 Cost of Goods Sold 5,870.4 7,550.0 10.716.0 Gross Profit 3.135.4 5,034.0 7,144.0 Gross Profit Margin (b) 34.8% 40% 40% SG&A Expense (c) 2.697.4 3,782.0 4,109.0 Depreciation & Amortization 275.6 290 310.0 Operating Income 438.0 1,252.0 3,035.0 Operating Margin 4.9% 9.9% 16.9% Nonoperating Income 6.9 0 0 Nonoperating Expenses (33.0) 0 0 Income Before Taxes 411.8 1,252.0 3.035.0 Income Taxes (d) 165.9 504.0 1,223.0 Net Income After Taxes 245.8 748.0 1.812.0 Net Income $245.8 748.0 1.812.0 Dividends 5.4 175.0 180.0 Retained Earnings $240.4 573.0 1,632.0

(a) $60.89 million per new store + 10% increase for all stores, so in 2011 we have S60.89 x 40 = $2,435 + 9.005 = $l l.440 + 10% = $12,584. In 2012 we have $60.89 x 60 = 3.653 + 12.584 = $16,237 + 10% = $17,860. (b) increases to 40% clue to better inventory control; note that 5.034/12,584 = 40% and 7,144/17,860 = 40%. (c) same 29.9% of revenue + $20 million per year, new ad campaign: note that $12,584 x .299 + $20 = $3,782. (d) same 40.3% rate as in 2010.

Financial budgets have some limitations. First, budgetary programs can become so detailed that they are cum bersom e and overly expensive. Overbudgeting or underbudgeting can cause problems. Second, financial budgets can become a substitute for objectives. A budget is a tool and not an end in itself. Third, budgets can hide inefficiencies if based solely on precedent rather than on periodic evaluation of circum stances and standards. Finally, budgets are som etim es used as instruments o f tyranny that result in frustration, resentment, absenteeism, and high turnover. To m inim ize the effect o f this last concern, managers should increase the participation o f subor­ dinates in preparing budgets.

Company Valuation Evaluating the worth o f a business is central to strategy im plementation because integrative, intensive, and diversification strategies are often implemented by acquiring other firms. O ther strategies, such as retrenchm ent and divestiture, may result in the sale o f a division o f an orga­ nization or o f the firm itself. Thousands o f transactions occur each year in which businesses are bought or sold in the USA. In all these cases, it is necessary to establish the financial worth or cash value o f a business to successfully implement strategies.

All the various methods for determ ining a business’s worth can be grouped into three main approaches: what a firm owns, what a firm earns, or what a firm will bring in the market. But it is important to realize that valuation is not an exact science. The valuation o f a firm ’s worth is based on financial facts, but com mon sense and intuitive judgm ent must enter into the process. It is difficult to assign a monetary value to some factors— such as a loyal custom er base, a his­ tory o f growth, legal suits pending, dedicated employees, a favorable lease, a bad credit rating, or good patents— that may not be reflected in a firm ’s financial statements. Also, different valu­ ation methods will yield different totals for a firm ’s worth, and no prescribed approach is best for a certain situation. Evaluating the worth o f a business truly requires both qualitative and quantitative skills.

316 CHAPTER 9 • STRATEGY IMPLEMENTATION

TA BLE 9-11 Projected Whole Foods Market Balance Sheets (in millions)

2010 2011 2012

Assets

Current Assets Cash $132.0 $1.55.3 $3,260.3 Net Receivables 133.3 140.0 160.0 Inventories 323.5 330.0 360.0 Other Current Assets 572.7 0 0 Total Current Assets 1,161.5 2,020.3 3.580.3 Net Fixed Assets (a) 1.886.1 2, 138.0 2,516.0 Other Noncurrent Assets 938.9 0 0 Total Assets $3,986.5 $4,159.3 $6,296.3

Liabilities

Current Liabilities

Accounts Payable 213.2 300.0 400.0 Short-Term Debt 0.4 0 0 Other Current Liabilities 534.3 0 0 Total Current Liabilities 747.9 300.0 400.0 Long-Term Debt (b) 508.3 708.0 908.0 Other Noncurrent Liabilities 357.0 0 0 Total Liabilities 1,613.2 1.008.0 1,308.0

Shareholders’ Equity

Common Stock (c) 500.0 505.0 510.0 Additional-paid-in-capital (d) 1,247.7 1,474.7 1,674.7 Retained Earnings (e) 598.6 1.171.6 2,803.6 Total Shareholders' Equity 2.373.3 3151.3 4.988.3 Total Liabilities and SE $3,986.5 $4,159.3 $6,296.3 Shares Outstanding (in thousands) (f) 172,033 177,033 182,033

(a) $6.3 M per store x 40 stores = 252 + l ,886 = 2 .138; 6.3 x 60 = 378 + 2 .139 = 2.516 (b) $200 M to be raised by debt annually (c) add 5 M new shares annually since $40 per share and need $200 M to be raised by equity annually (d) add $200 M annually thru stock issuance (e) $ 598.6 + $ 573.0 = $1,171.6 + 1,632.0 = $2,803.6 (f) stock price = $40, $200 M needed per year thru equity, so 5 M new shares to be issued annually; thus 172,033+ 5 M = 177,033

The first approach in evaluating the worth o f a business is determ ining its net worth or stockholders’ equity. Net w'orth represents the sum of com mon stock, additional paid-in capital, and retained earnings. After calculating net worth, subtract an appropriate amount for goodwill and intangibles. W hereas intangibles include copyrights, patents, and trademarks, goodwill arises only if a firm acquires another firm and pays more than the book value for that firm.

It should be noted that FASB Rule 142 requires com panies to adm it once a year if the premiums they paid for acquisitions, called goodwill, were a waste o f money. Goodwill is not a good thing to have on a balance sheet. Note in Table 9-13 that J.M . Sm ucker’s SGoodwill to STotal Assets is a really high 33.5 percent, indicating that a third o f the com pany's assets are “Goodwill,” which is not good.

The second approach to measuring the value of a firm grows out o f the belief that the worth o f any business should be based largely on the future benefits its owners may derive through net profits. A conservative rule o f thumb is to establish a business's worth as five tim es the firm 's current annual profit. A five-year average profit level could also be used. When using this approach, remember that firms normally suppress earnings in their financial statements to minimize taxes.

CHAPTER 9 ♦ STRATEGY IMPLEMENTATION 317

TA B LE 9-12 Six-Month Cash Budget for the Toddler Toy Company in 2015

Cash B udget (in thousands) July Aug. Sept. Oct. Nov. Dec. Jan.

Receipts

Collections $ 12,000 $21,000 $31,000 $35,000 $22,000 $18,000 $ 11,000 Payments

Purchases 14.000 21,000 28.000 14,000 14.000 7,000

Wages and Salaries 1,500 2,000 2,500 1,500 1,500 1,000

Rent 500 500 500 500 500 500

Other Expenses 200 300 400 200 — 100

Taxes — 8.000 — — — —

Payment on Machine — — 10,000 — — —

Total Payments $16,200 $31,800 $41,400 $16,200 $16,000 $8,600

Net Cash Gain (Loss) During Month -4,200 -10.800 -10.400 18,800 6.0(H) 9.400

Cash at Start of Month if No Borrowing Is Done

6,000 1.800 -9,000 -19,400 -600 5.400

Cumulative Cash (Cash at start plus gains 1,800 -9.000 -19,400 -600 5,400 14.800 or minus losses) Less Desired Level of Cash -5,000 -5,000 -5.000 -5,000 -5,000 -5,000

Total Loans Outstanding to Maintain $3,200 $14,000 $24,400 $5,600 $5,000 Cash Balance

Surplus Cash — — — — 400 9,800

TABLE 9-13 Company Worth Analysis for J.M. Smucker, Microsoft Corp., and Zale Corp. (in millions, except stock price and EPS)

Input Data J.M. Smucker M icrosoft Corp. Zale Corp.

$ Shareholders' Equity (SE) 5,163 66,363 178 S Net Income (Nl) 460 17.000 -27 S Stock Price (SPi 80 30 7 $ EPS 4.08 2.00 -.90 # of Shares Outstanding 109 8,330 32 $ Goodwill 3.050 13,542 100 $ Intangibles 3,190 3,170 0 $ Total Assets 9.115 121.271 1,171

Company Worth Analyses

1. SE Goodwill - Intangibles $977 $49,741 $78 2. Net Income x 5 2,300 85.000 0 3. (SP / EPS) x NI 9.019 225,000 0 4. # of Shares Out x Stock Price 8,720 251,400 224 5. Four Method Average $4,765 $161,285 $151 $ Goodwill / $ Total Assets 33.5% 11.1% 8.5%

The third approach is called the price-carnings ratio method. To use this method, divide the market price o f the firm ’s com m on stock by the annual earnings per share and multiply this num ber by the firm 's average net income for the past five years.

The fourth method can be called the outstanding shares method. To use this method, sim ­ ply multiply the number o f shares outstanding by the market price per share. If the purchase price

318 CHAPTER 9 • STRATEGY IMPLEMENTATION

is more than this amount, the additional dollars are called a premium. The outstanding shares method may be called the “market value” or “market capitalization” or “book value” of the firm. The premium is a per-share dollar amount that a person or firm is willing to pay beyond the book value o f the firm to control (acquire) the other company. Bristol-M yers Squibb recently offered $ 3 1 a share to acquire Am ylin Pharm aceuticals and that offer represented a 9.9 percent premium over A m ylin’s closing stock price the day of the offer. W ellPoint, the second-largest insurer in the USA, recently acquired Amerigroup for $92 per share in cash, which was a whop­ ping 43 percent premium to A m erigroup’s closing stock price of $64.34. A m erigroup’s stock soared 38 percent to S88.79 the day after the offer.

Table 9-13 provides the cash value analyses for three com panies— J.M. Smucker, M icrosoft Corp., and Zale Corp.— for fiscal year-end 2012. Notice that there is significant variation am ong the four methods used to determine cash value. For example, the worth o f J.M. Sm ucker ranged from minus $1,077 to $9,019 billion. Obviously, if you were selling your company, you would seek the larger values, whereas if purchasing a com pany you would seek the lower values. In practice, substantial negotiation takes place in reaching a final com prom ise (or averaged) amount. Also recognize that if a firm ’s net income is negative, theoretically the approaches involving that figure would result in a negative number, implying that the firm would pay you to acquire them. O f course, you obtain all o f the firm 's debt and liabilities in an acquisition, so theoretically this would be possible.

Hewlett-Packard, Boston Scientific, Frontier Com munications, and Republic Services (unfortunately for them) carry more goodwill on their balance sheet than their market (or book) value. This is a signal that their goodwill should be “written down,” which m eans “reduced and recorded as an expense on the income sta tem ent” Nasdaq OMX G roup’s $5.1 billion in good­ will exceeds its $3.9 billion market capitalization by a precarious 31 percent. Jack Ciesielski, publisher o f A nalyst's Accounting Observer, says: “W riting down goodwill is an adm ission that the company screwed up when it budgeted what an acquired firm is worth.” Som etim es it is OK to pay more for a company than its book value if the firm has technology or patents you need or economies o f scale you desire or even to reduce com petitive pricing pressure, but, like buying a house, paying a “prem ium ” for a com pany is almost always not a good thing. A cquiring at a “discount” is far better for shareholders.

Bccause goodwill write-down accounting rules involve projections and judgments, com panies have leeway for when to write down goodwill, and by how much. M icrosoft for example in 2012 wrote down (reduced) their goodwill $6.2 billion, basically adm itting that their previous acquisition of online-advertising firm aQuantive Inc. for $6.3 billion was ill advised— now recording that amount as an expense. Analysts expect Hewlett-Packard to soon write down some (or all) o f the $6.6 billion in goodwill among the $ 10.1 billion total that they recently paid for British software maker Autonomy PLC . 10

If the purchase price is less than the stock price tim es number of shares outstanding, rather than more, that difference is called a discount. For example, when Clayton D oubilier & Rice LLC recently acquired Emergency Medical Services (EM S) Corp. for $2.9 billion, a 9.4 percent discount below EM S’s stock price of $64.00.

Business evaluations are becoming routine in many situations. Businesses have many strategy-implementation reasons for determining their worth in addition to preparing to be sold or to buy other companies. Employee plans, taxes, retirement packages, mergers, acquisitions, expansion plans, banking relationships, death of a principal, divorce, partnership agreem ents, and IRS audits are other reasons for a periodic valuation. It is ju s t good business to have a reasonable understanding of what a firm is worth. This knowledge protects the interests o f all parties involved.

Ryan Brewer, an assistant professor o f finance at Indiana U niversity-P urdue U niversity Colum bus, recently calculated the m onetary value o f top college football team s. Brew er exam ined each program ’s revenues and expenses and made cash-flow adjustm ents, risk assessm ents and growth projections for each school. B rew er’s resu lts for 69 college pro­ gram s are provided in Table 9-14. Note that Texas was the m ost valuable college football program in 2012, followed by M ichigan. Interestingly, all o f these program s are “ non­ profit.” As a point o f reference, the NFL’s Jacksonville Jaguars sold in late 201 I for about $760 m illion.

CHAPTER 9 • STRATEGY IMPLEMENTATION 319

TA B LE 9-14 The Monetary Value of Various College Football Programs

Sticker Shock The value, in millions, of major-conference college-football programs, plus Notre Dame and BYU:

Rank SCHOOL VALUE Rank SCHOOL VALUE Rank SCHOOL VALUE Rank SCHOOL VALUE

1 Texas $761.7 19 Oregon $264.6 37 Virginia $146.3 55 Mississippi St. $99.3 2 Michigan $731.9 20 Washington $259.9 38 Purdue $145.1 56 Maryland $96.0 3 Florida $599.7 21 Michigan St. $224.8 39 N.C. State $143.0 57 California $92.6 4 Notre Dame $597.4 22 Texas Tech $211.0 40 Indiana $142.7 58 Syracuse $91.4 5 Ohio St. S586.6 23 Oklahoma St. $209.1 41 Iowa St. $140.3 59 Texas Christian $76.6 6 Auburn $508.1 24 Kansas St. $207.1 42 Minnesota $139.7 60 Louisville $75.4 7 Georeia $481.8 25 Colorado $202.9 43 BYU $136.1 61 Washington St. $73.4 8 Alabama $476.0 26 Kentucky $202.7 44 Arizona $126.8 62 Baylor $71.3 9 LSU $471.7 27 Clemson $201.8 45 UCLA $125.8 63 Rutgers $64.1

10 Oklahoma $454.7 28 use $197.8 46 Utah $119.7 64 Duke $62.0 11 Iowa $384.4 29 Georgia Tech $188.4 47 Oregon St. $118.8 65 Pittsburgh $59.6 12 Tennessee $364.6 30 Virginia Tech $171.5 48 Illinois $117.3 66 Vanderbilt $57Ễ3 13 Nebraska $360.1 31 Arizona St. $164.6 49 Mississippi $111.7 67 Missouri $56.4 14 Arkansas $332.0 32 West Virginia $159.4 50 Boston College $ 110.2 68 Cincinnati $48.9 15 S.Carolina $311.9 33 Florida St. $159.0 51 Kansas $103.4 69 Temple $46ỗ9 16 Penn St. $300.8 34 Miami(Fla.) $157.7 52 Connecticut $101.8 17 Wisconsin S296.1 35 Northwestern $148.8 53 South Florida $101.2 18 Texas A&M $278.5 36 Stanford $148.7 54 North Carolina $99.8

Source: Ryan Brewer, Indiana University-Purdue University Columbus. Note: Excludes Wake Forest; based on information at http://online.wsj.com/article/SB1000I424I2788732439l 104578225802183417888.html.

Deciding Whether to Go Public Hundreds o f com panies in 2012 held initial public offerings (IPOs) to move from being private to being public. These firms took advantage o f high stock market prices. For example, some recent IPOs include com puter-network-security firm Palo Alto Networks Inc., search engine Kayak Software Corp., guitar maker Fender M usical Instruments, discount retailer Five Below', and pharmaceutical developer D utata Therapeutics, health-food retailer Natural Grocers by vitam in Cottage, software firm E2open. and C huy’s Holdings, a U.S.-based operator o f M exican restaurants. MGM Holdings, parent o f the film studio M etro-Goldwyn-M ayer, just hired Goldman Sachs Group to develop a public stock offering for the company. MGM hopes its new “H obbit” and “Skyfall” movies will help its pending IPO.

Groupon, the firm that offers daily deals on services, went public in Novem ber 2011 at S20 per share or $13 billion in market capitalization, but less than a year later Groupon stock was selling for $6.00 per share and the com pany’s market capitalization had dropped to less than $5 billion. Zynga and Facebook’s recent IPO ’s also turned sour quite quickly.

G oing public m eans selling o ff a percentage o f a com pany to others to raise capital; consequently, it d ilutes the ow ners’ control o f the firm . G oing public is not recom m ended for com panies w ith less than $10 m illion in sales because the initial costs can be too high for the firm to generate sufficient cash flow to m ake going public w orthw hile. One do llar in four is the average total cost paid to lawyers, accountants, and underw riters when an initial stock issuance is under SI m illion; $1 in $20 w ill go to cover these costs for issuances over $20 m illion.

In addition to initial costs involved with a stock offering, there are costs and obligations associated with reporting and m anagem ent in a publicly held firm. For firms with more than $10 million in sales, going public can provide major advantages. It can allow the firm to raise capital to develop new products, build plants, expand, grow, and market products and services more effectively.

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Research and Development (R&D) Issues In terms of “Innovation,” Fortune recently ranked the following com panies as best in the world. Note that Apple retained its num ber-1 ranking from the prior year.

Rank Company

1 Apple 2 Sistema 3 GDF Suez 4 Limited Brands

5 Qualcomm

6* Enterprise Products Partners

6* Koc Holding

8 Amazon.com

9 Sealed Air

10 Nike

Source: Based on http://money.cnn.com/m agazines/fortune/ most-admired/2012/best_worst/best 1 .html.

Research and development (R&D) personnel can play an integral part in strategy implementation. These individuals are generally charged with developing new products and improving old products in a way that will allow effective strategy im plem entation. R&D em ployees and managers perform tasks that include transferring com plex technology, adjusting processes to local raw materials, adapting processes to local markets, and altering products to particular tastes and specifications. Strategies such as product development, market penetration, and related diversification require that new products be successfully developed and that old products be significantly improved.

Technological improvements that affect consum er and industrial products and services shorten product life cycles. Com panies in virtually every industry are relying on the developm ent o f new products and services to fuel profitability and growth. 11 Surveys suggest that the most successful organizations use an R&D strategy that ties external opportunities to internal strengths and is linked with objectives. W ell-formulated R&D policies match market opportunities with internal capabilities. R&D policies can enhance strategy implementation efforts to:

1. Emphasize product or process improvements. 2. Stress basic or applied research. 3. Be leaders or followers in R&D. 4. Develop robotics or manual-type processes. 5. Spend a high, average, or low am ount o f money on R&D. 6. Perform R&D within the firm or to contract R&D to outside firms. 7. Use university researchers or private-sector researchers.

R&D policy among rival firms often varies dramatically. For exam ple. Pfizer spends only about $5 billion annually on R&D even though the firm has about $70 billion in annual revenues, whereas rival Merck spends about $10 billion annually on R&D with annual revenue o f about $50 billion. Underlying this difference in strategy between the two pharm aceutical giants is a philosophical disagreement over the merits o f heavy investment to discover new drugs versus waiting for others to spend the money and discover and then follow up with similar products. Pfizer and M erck “are going in different directions,” said Les Funtleyder, portfolio manager of the Miller Tabak Health Care Transform ation mutual fund.

There m ust be effective interactions between R&D departm ents and other functional departm ents in implementing different types of generic business strategies. Conflicts between marketing, finance and accounting, R&D, and information system s departm ents can be m ini­ mized with clear policies and objectives. Table 9-15 gives some exam ples o f R&D activities that could be required for successful implementation o f various strategies. Many U.S. utility, energy, and automotive companies are employing their R&D departm ents to determ ine how the firm can effectively reduce its gas emissions.

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TA B LE 9-15 Research and Development Involvement in Selected Strategy-lmplementation Situations

Type of Organization Strategy Being Implemented R&D Activity

Pharmaceutical company Product development Test the effects of a new drug on different subgroups.

Boat manufacturer Related diversification Test the performance of various keel designs under various conditions.

Plastic container manufacturer Market penetration Develop a biodegradable container. Electronics company Market development Develop a telecommunications system in a

foreign country.

Many firms wrestle with the decision to acquire R&D expertise from external firms or to develop R&D expertise internally. The following guidelines can be used to help make this decision:

1. If the rate of technical progress is slow, the rate of market growth is moderate, and there are significant barriers to possible new entrants, then in-house R&D is the preferred solution. The reason is that R&D, if successful, will result in a temporary product or process monopoly that the com pany can exploit.

2. If technology is changing rapidly and the market is growing slowly, then a major effort in R&D may be risky because it may lead to the development o f an ultimately obsolete technology or one for which there is no market.

3. If technology is changing slowly but the market is growing quickly, there generally is not enough tim e for in-house development. The prescribed approach is to obtain R&D expertise on an exclusive or nonexclusive basis from an outside firm.

4. If both technical progress and market growth are fast, R&D expertise should be obtained through acquisition o f a well-established firm in the industry. 12

There are at least three major R&D approaches for implem enting strategies. The first strategy is to be the first firm to market new technological products. This is a glam orous and exciting strategy but also a dangerous one. Even Apple found this to be dangerous as per Samsung. Firms such as 3M and General Electric have been successful with this approach, but many other pioneering firms have fallen, with rival firms seizing the initiative.

A second R&D approach is to be an innovative imitator o f successful products, thus minimizing the risks and costs of start-up. This approach entails allowing a pioneer firm to develop the first version of the new product and to dem onstrate that a market exists. Then, laggard firms develop a sim ilar product. This strategy requires excellent R&D and marketing personnel.

A third R&D strategy is to be a low-cost producer by m ass-producing products sim ilar to but less expensive than products recently introduced. As a new product is accepted by cus­ tomers, price becom es increasingly im portant in the buying decision. Also, mass marketing replaces personal selling as the dom inant selling strategy. This R&D strategy requires substan­ tial investment in plant and equipm ent but fewer expenditures in R&D than the two approaches described previously. Dell and Lenovo have utilized this third approach to gain com petitive advantage.

R&D activities am ong U.S. firms need to be more closely aligned to business objec­ tives. There needs to be expanded com m unication between R&D managers and strategists. Corporations are experim enting with various methods to achieve this improved com m unication climate, including different roles and reporting arrangem ents for managers and new m ethods to reduce the time it takes research ideas to become reality.

Perhaps the most current trend in R&D m anagem ent has been lifting the veil of secrecy whereby firms, even m ajor com petitors, are joining forces to develop new- products. Collaboration is on the rise as a result o f new com petitive pressures, rising research costs, increasing regulatory issues, and accelerated product development schedules. Com panies not only are working more closely with each other on R&D, but they are also turning to consortia at universities for their R&D needs. More than 600 research consortia are now in operation in the USA.

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Management Information Systems (MIS) Issues Firms that gather, assimilate, and evaluate external and internal information most effectively are gaining com petitive advantages over other firms. Having an effective management information system (MIS) may be the most important factor in differentiating successful from unsuccessful firms. The process o f strategic management is facilitated im m ensely in firms that have an effec­ tive information system.

Information collection, retrieval, and storage can be used to create com petitive advantages in ways such as cross-selling to customers, monitoring suppliers, keeping managers and em ployees informed, coordinating activities among divisions, and managing funds. Like inventory and human resources, information is now recognized as a valuable organizational asset that can be controlled and managed. Firms that implement strategies using the best information will reap com petitive advantages in the twenty-first century.

A good information system can allow a firm to reduce costs. For example, online orders from salespersons to production facilities can shorten materials ordering tim e and reduce inventory costs. Direct com munications between suppliers, m anufacturers, marketers, and custom ers can link together elements o f the value chain as though they were one organization. Improved quality and service often result from an improved inform ation system.

Firms must increasingly be concerned about com puter hackers and take specific measures to secure and safeguard corporate com munications, files, orders, and business conducted over the Internet. Thousands of com panies today are plagued by com puter hackers who includc disgruntled em ployees, com petitors, bored teens, sociopaths, thieves, spies, and hired agents. Com puter vulnerability is a giant, expensive headache.

Headquartered in Short Hills, New Jersey, Dun & Bradstreet is an exam ple com pany that has an excellent inform ation system. Every D&B custom er and client in the world has a separate nine-digit number. The database o f more than 200 million businesses worldwide contains of information associated with each number. The D-U-N-S # has become so widely used that it is like a business Social Security number. D&B reaps great competitive advantages from its infor­ mation system.

In many firms, inform ation technology is doing away with the w orkplace and allowing em ployees to work at home or anywhere, anytime. The mobile concept o f work allows em ployees to work the traditional 9-to-5 workday across any of the 24 time zones around the globe. Affordable desktop videoconferencing software allows em ployees to “beam in” whenever needed. Any manager or em ployee who travels a lot away from the office is a good candidate for working at home rather than in an office provided by the firm. Salespersons or consultants are good examples, but any person whose job largely involves talking to others or handling inform a­ tion could easily operate at home with the proper M IS. 1'1

Business Analytics Business analytics is a MIS technique that involves using softw are to mine huge volum es o f data to help executives make decisions. Som etim es called predictive analytics, m achine learning, or data m ining, this softw are enables a researcher to assess and use the aggre­ gate experience o f an organization, a priceless strategic asset for a firm. The history o f a firm ’s interaction with its custom ers, suppliers, d istributors, em ployees, rival firm s, and more can all be tapped with data mining to generate predictive m odels. Business analytics is sim ilar to the actuarial m ethods used by insurance com panies to rate custom ers by the chance o f positive or negative outcom es. Every business is basically a risk m anagem ent endeavor! Therefore, like insurance com panies, all businesses can benefit from m easuring, tracking, and com puting the risk associated with hundreds o f strategic and tactical deci­ sions m ade everyday. Business analytics enables a com pany to benefit from m easuring and m anaging risk.

As more and more products become com moditized (so sim ilar as to be indistinguishable), competitive advantage more and more hinges on improvements to business processes. Business analytics can provide a firm with proprietary business intelligence regarding, for example, which segment(s) o f customers choose your firm versus those who defer, delay, or defect to a com peti­ tor and why. Business analytics can reveal where com petitors are weak so that marketing and sales activities can be directly targeted to take advantage o f resultant opportunities (knowledge).

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In addition to understanding consum er behavior better, which yields more effective and efficient marketing, business analytics also is being used to slash expenses by, for example, withholding retention offers from custom ers who are going to stay with the firm anyway, or m anaging fraud­ ulent transactions involving invoices, credit care purchases, tax returns insurance claims, mobile phone calls, online ad clicks, and more.

A key distinguishing feature of business analytics is that it is predictive rather than retro­ spective. in that it enables a lirm to learn from experience and to make current and future deci­ sions based on prior information. Deriving robust predictive models from data mining to support hundreds of com m only occurring business decisions is the essence o f learning from experience. The mathem atical models associated with business analytics can dramatically enhance deci­ sion m aking at all organizational levels and all stages o f strategic management. In a sense, art becom es science with business analytics resulting from the mathematical generalization of thousands, millions, or even billions o f prior data points to discover patterns of behavior for opti­ mizing the deploym ent o f resources.

IB M ’s form er CEO Samuel Palmisano announced that IBM is moving aggressively into business analytics, trying to overtake O racle’s market share lead. 14 IBM ’s annual business analytics revenues o f about S40 billion are growing about 15 percent every quarter com pared to the industry growing about 15 percent annually. IBM 's acquisition o f SPSS for $1.2 billion, am ong other recent acquisitions, launched the firm heavily into the business analytics consulting business. M icrosoft currently has a software program called PowerPivot that offers data-m ining capability in a spreadsheet-like way, but this is not nearly as powerful as business analytics software. IBM recently com pleted a business analytics project for the New York City Fire Department whereby buildings in the city were assessed for risk.

Special Note to Students Regardless of your business major, be sure to capitalize on that special knowledge in delivering your strategic managem ent case analysis. W henever the opportunity arises in your oral or written project, reveal how your firm can gain and sustain com petitive advantage using your m arketing, finance and accounting, or MIS recom m endations. Continuously com pare your firm to rivals and draw insights and conclusions so that your recom m endations com e across as well conceived. Never shy away from the EPS/EBIT or projected financial statem ent analyses because your audience must be convinced that what you recom m end is financially feasible and worth the dollars to be spent. Spend sufficient tim e on the nuts-and-bolts o f those analy­ ses, so fellow students (and your professor) will be assured that you did them correctly and reasonably. Too often, when students rush at the end. it means their financial statem ents are overly optim istic or incorrectly developed— so avoid that issue. The marketing, finance and accounting, and MIS aspects o f your recom m ended strategies must ultim ately work together to gain and sustain com petitive advantage for the firm— so point that out frequently. By the way, the free student excel tem plate at www.strategyclub.com can help imm ensely in perform ing EPS-EBIT analysis.

Conclusion Successful strategy implementation depends on cooperation among all functional and divisional managers in an organization. M arketing departm ents are com m only charged with im plem enting strategies that require significant increases in sales revenues in new areas and w'ith new or improved products. Finance and accounting managers must devise effective strategy-im plem entation approaches at low cost and minimum risk to that firm. R&D managers have to transfer complex technologies or develop new technologies to successfully implement strategies. Information systems m anagers are being called upon more and more to provide leadership and training for all individuals in the firm. The nature and role o f marketing, finance and accounting. R&D. and MIS activities, coupled with the m anagem ent activities described in Chapter 10, largely determine organizational success.

324 CHAPTER 9 • STRATEGY IMPLEMENTATION

Key Terms and Concepts book value (p. 318) business analytics (p. 322) cash budget (p. 314) data m ining (p. 322) dem and void (p. 303) discount (p. 318) EPS/EBIT analysis (p. 305) financial budget (p. 313) goodwill (p. 316) initial public offering (IPO) (p. 319) management inform ation system (MIS) (p. 322) market capitalization (p. 318) market segm ent (p. 303) market segm entation (p. 299)

market value (p. 318) marketing mix variables (p. 300) m ultidimensional scaling (p. 302) outstanding shares method (p. 317) perceptual mapping (p. 303) premium (p. 318) price-earnings ratio method (p. 317) product positioning (p. 299) projected financial statem ent analysis (p. 310) research and development (R&D) (p. 320) treasury stock (p. 307) tweet (p. 298) vacant niche (p. 302) wikis (p. 298)

Issues for Review and Discussion 9-1. Royal Dutch Shell pic has been successful for decades.

Analyze their year-end 2013 financials. List six points that best sum m arize Shell’s perform ance in 2013.

9-2. Explain how to develop an advertising strategy. 9-3. Illustrate a product-positioning map for Royal Dutch

Shell. Include three rival firms in your matrix. 9-4. Illustrate a product-positioning map for your college

or university. 9-5. List and explain the advantages and disadvantages of

using debt versus equity, as a means o f raising capital. 9-6. In order o f im portance, list the lim itations o f the EPS/

EB IT analysis. 9-7. C onsider the Cohesion Case on adidas AG. Calculate

that com pany’s tax rate, which is a common calculation needed in perform ing EPS/EBIT analysis.

9-8. Review the website o f a com pany that you are fam iliar with. Discuss the extent to which that organization has instituted the new principles o f m arketing according to Parise. Guinan. and Weinberg.

9-9. For com panies in general, identify and discuss three opportunities and three threats associated with social networking activities on the Internet.

9-10. Do you agree or disagree w ith the follow ing sta te­ m ent? Explain your reasoning. “Television view ers are passive viewers o f ads w hereas In ternet users take an active role in choosing w hat to look at— so custom ers on the Internet are tougher for m arketers to reach.”

9-11. How important or relevant do you believe purpose- based marketing is for organizations today?

CHAPTER 9 • STRATEGY IMPLEMENTATION 325

9-12. W hy is it essential for organizations to segm ent markets and target particular groups o f consum ers?

9-13. Explain how, and why the Internet makes market segm entation easier?

9-14. A product-positioning rule given in the chapter is that “when there are only two com petitors, the middle becomes the preferred strategic position.” Illustrate this for the cruise ship industry where two firms. Carnival and Royal Caribbean, dominate. Illustrate this for the com m ercial airliner building industry where Boeing and Airbus dominate.

9-15. How would dividends affect an EPS/EBIT analysis? Would it be correct to refer to “earnings after taxes, interest, and dividends" as retained earnings for a given year?

9-16. In perform ing an EPS/EBIT analysis, where does the first row of (EBIT) numbers come from?

9-17. In perform ing an EPS/EBIT analysis, where does the tax rate percentage com e from?

9-18. W hat am ount of dividends did Royal Dutch Shell pay in 2013? How much of 2013‘s earnings did Shell reinvest back into the com pany?

9-19. Show algebraically that the price earnings ratio formula is identical to the num ber of shares outstanding m ul­ tiplied by the stock price formula. W’hy are the values obtained from these two methods sometim es different?

9-20. In accounting terms, distinguish between intangibles and goodwill on a balance sheet. Why do these two items generally stay the sam e on projected financial statements?

9-21. W hat are the three m ajor R&D approaches to im ple­ m enting strategies? Wrhich approach would you prefer as owner of a small software com pany? W hy?

9-22. Explain in your own words the process o f developing projected financial statement analysis.

9-23. In developing projected financial statements, why should the preparer not use historical percentages too heavily?

9-24. Explain five methods for determ ining the cash value o f a company.

9-25. Given the seven R&D policies m entioned in the chapter, which four do you feel would be best for Audi to utilize? W hy?

9-26. Illustrate an EPS/EBIT chart that reflects negative EPS values.

9-27. Define a vacant niche using an example. 9-28. Define and give an exam ple o f w ikis and tweets. 9-29. List the m arketing mix variables. G ive an exam ple

o f each. 9-30. Show algebraically that the price earnings ratio method

o f calculating the cash value of a com pany is identical to the num ber of shares outstanding multiplied by the stock price method.

9-31. Define, and give an exam ple of, goodwill and intangibles.

9-32. Differentiate between capital surplus and additional paid in capital on a balance sheet.

9-33. W hat transaction is the link between the projected income statement and the projected balance sheet ?

9-34. Explain the benefits o f a before-and-after product-positioning map.

9-35. Explain how' HP should conduct m arket segm entation .

9-36. Determine the cash value of HP using the methods described in this chapter.

326 CHAPTER 9 • STRATEGY IMPLEMENTATION

MyManagementLab® Go to mymanagementlab.com for the following Assisted-graded writing questions:

9-37. Why is it essential for organizations to segment markets 9-39. M ymanagementlab Only— com prehensive writing and target particular groups o f consum ers? assignm ent for this chapter.

9-38. Explain how you would estim ate the total worth o f a business.

Current Readings Aaker, David A. “Win the Brand Relevance Battle and then

Build Com petitor Barriers.” California Management Review 54, no. 2 (W inter 2012): 43-57 .

Balmer, John M. T. “Corporate Brand M anagement im peratives: Custodianship. Credibility, and Calibration.” California Management Review 54, no. 3 (Spring 2012): 6 -33 .

Crittenden, Victoria L., W illiam F. Crittenden. “Strategic M arketing in a Changing World.” Business Horizons 55, no. 3 (May 2012): 215-217.

Denning, Stephen. “ From M axim izing Shareholder Value to Delighting the Customer." Strategy and Leadership 40, no. 4 (2012): 12-16.

Fox, Justin, and Jay W. Lorsch. “W hat Good Are Shareholders?” Harvard Business Review (July-August 2012): 48.

Guill&i, M auro F., and Esteban Garcia-Canal. “Execution as Strategy.” Harvard Business Review (October 2012): 103.

Kumar, V., and Rohan Mirchandani. “ Increasing the ROI of Social Media Marketing.” MIT Sloan Management Review 54, no. 1 (Fall 2012): 55.

Muller, Amy. Nate Hutchins, and Miguel Cardoso Pinto. “Applying Open Innovation W here Your Com pany Needs It Most.” Strategy and Leadership 40, no. 3 (2012): 35—42.

Quigley, Timothy J., and Donald C. Hambrick. “W'hen the Former CEO Stays on as Board Chair: Effects on Successor Discretion, Strategic Change, and Performance.” Strategic Management Journal 33, no. 7 (July 2012): 834-859.

A SSU R A N C E OF LEARNING E X ER C IS ES EXERCISE 9A Preparing an EPS/EBIT Analysis for Royal Dutch Shell pic

Purpose Shell is featured in the opening chapter case as a firm that engages in excellent strategic planning. Shell is both the largest oil and gas company in the world and the largest firm globally, according to Fortune, who in 2013 also ranked Shell as the 7th most profitable firm in the world. Incorporated in the United Kingdom but headquartered in the Netherlands, Shell has worldwide reserves of 14.2 billion barrels of oil equivalent.

An important part o f effective strategic management is wisely using debt versus equity for raising capital. This exercise gives you practice preparing an EPS/EBIT analysis for a company to determine whether debt versus equity or some combination of the two is best for the firm to expand and grow.

Instructions Step 1 Shell needs to raise SI billion to acquire a rival firm in Southeast Asia. Step 2 Prepare an EPS/EBIT analysis to determine whether Shell should use stock or debt to raise

the needed capital. Step 3 Prepare a two-page executive summary to provide justification for your financing decision.

CHAPTER 9 • STRATEGY IMPLEMENTATION 327

Developing a Product-Positioning Map for adidas AG Purpose Organizations continually monitor how their products and services are positioned relative to competi­ tors. This information is especially useful for marketing managers, but is also used by other managers and strategists.

Instructions Step 1 On a separate sheet of paper, develop two product-positioning maps that include Reebok,

adidas, Nike, Puma. Converse, and Under Armour. Let one map focus on athletic footwear and one map focus on apparel.

Step 2 At the board, diagram your product-positioning maps. Step 3 Compare your product-positioning maps with those diagrammed by other students. Discuss

any major differences.

EXERCISE 9B

EXERCISE 9C Performing an EPS/EBIT Analysis for adidas AG

Purpose An EPS/EBIT analysis is one of the most widely used techniques for determining the extent that debt and/or stock should be used to finance strategies to be implemented. This exercise can give you prac­ tice performing EPS/EBIT analysis.

Instructions In order to expand into Africa, adidas needs to raise SI billion. Determine whether adidas should use all debt, all stock, or a 50-50 combination of debt and stock to finance this market-development strategy. Assume a 20 percent tax rate, 5 percent interest rate, adidas stock price of $30 per share, and an annual dividend of $0.50 per share of common stock. The EBIT range for 2011 is between $1.0 billion and S2 billion. A total of 500 million shares of common stock are outstanding. Develop an EPS/EBIT chart to reflect your analysis.

EXERCISE 9D

Preparing Projected Financial Statements for adidas AG Purpose This exercise is designed to give you experience preparing projected financial statements. Pro forma analysis is a cenUal strategy-implementation technique because it allows managers to anticipate and evaluate the expected results of various strategy-implementation approaches.

Instructions

Step 1 Work with a classmate. Develop a 2014 projected income statement and balance sheet for adidas. Assume that adidas plans to raise $900 million in 2014 to begin serving Africa, and plans to obtain 50 percent financing from a bank and 50 percent financing from a stock issuance. Make other assumptions as needed, and state them clearly in written form. Use adidas’ website as needed.

Step 2 Compute adidas’ current ratio, debt-to-equity ratio, and return on investment for 2012 and 2013. How do your 2014 projected ratios compare to the 2012 and 2013 ratios? Why is it important to make this comparison?

Step 3 Bring your projected statements to class and discuss any problems or questions you encountered.

Step 4 Compare your projected statements to the statements of other students. What major differ­ ences exist between your analysis and the work of other students?

328 CHAPTER 9 • STRATEGY IMPLEMENTATION

EXERCISE 9E Determining the Cash Value of adidas AG

Purpose It is simply good business practice to periodically determine the financial worth or cash value of your company. This exercise gives you practice determining the total worth o f a company using several methods. Use data as given in the Cohesion Case or the data from the adidas website.

Instructions

Step 1 Calculate the financial worth of adidas based on four methods: 1) the net worth or stockholders’ equity. 2) the future value of adidas’ earnings, 3) the price-earnings ratio, and 4) the outstanding shares method. In dollars, how much is adidas worth?

Step 2 Compare your analyses and conclusions with those of other students.

EXERCISE 9F Developing a Product-Positioning Map for My College

Purpose Organizations continually monitor how their products and services are positioned relative to competitors. This information is especially useful for marketing managers, but is also used by other managers and strategists.

Instructions

Step 1 On a separate sheet of paper, develop a product-positioning map for your college or university. Step 2 At the board, diagram your product-positioning map. Compare your product-positioning

map with those diagrammed by other students. Discuss any major differences.

EXERCISE 9G Do Banks Require Projected Financial Statements?

Purpose This exercise will allow you to explore the practical importance and use of projected financial state­ ments among banks in your city.

Instructions Contact several local banks and ask managers about the nature and role of projected financial state­ ments in determining whether to make commercial loans to businesses. Report back to your class on your findings.

CHAPTER 9 • STRATEGY IMPLEMENTATION 329

Notes 1. Salvatore Parise, Patricia Guinan, and Bruce Weinberg,

“The Secrets o f M arketing in a Web 2.0 World,” Wall Street Journal, Decem ber 15, 2008, R 1.

2. Kathy Chu and Kim Thai, “Banks Jum p on Twitter W agon" USA Today, M ay 12, 2009, B l.

3. Valerie Bauerlein. “G atorade’s M ission: Sell More Drinks,” Wall Street Journal, Septem ber 14, 2010, B6 .

4. Susanne Vranica, “Veteran M arketer Promotes a New Kind of Selling.” Wall Street Journal, O ctober 31, 2008. B4.

5. Gupta, Sunil, and Donald R. Lehm ann, Managing Customers as Investments: The Strategic Value o f Customers in the Long Run (“Custom er Retention” section) (Upper Saddle River, NJ: Pearson Education/ W harton School Publishing. 2005).

6 . Shayndi Raice, “Facebook to Target Ads Based on App Usage,” Wall Street Journal (July 7. 2012): B3.

7. Ralph Biggadike. “The Contributions of Marketing to Strategic Management.” Academy o f Management Review 6 , no. 4 (October 1981): 627.

8. Patrick McGee, “Corporate Debt Has Allure.” Wall Street Journal (August 3, 2012): C 1.

9. M ichael Rapoport, “Pro Forma Is a Hard Habit to Break,” Wall Street Journal, Septem ber 18, 2003, B3A.

10. Scott Thurm , “Buyers Bew-are: The Goodwill Games,” Wall Street Journal (August 14, 2012): B l.

11. Amy M errick. “U.S. Research Spending to Rise Only 3.2 Percent,” Wall Street Journal, Decem ber 28, 2001, A2.

12. Pier Abetti. “Technology: A Key Strategic Resource,” Management Review 78. no. 2 (February 1989): 38.

13. Adapted from Edward Baig, “W elcome to the Officeless Office." Businessweek, June 26. 1995.

14. Spencer A nte. "IBM Ready for Close-Up,” Wall Street Journal. January 18, 2011, B4.

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Strategy Execution C H A P T E R O B JE C T IV E S After studying this chapter, you should be able to do the following:

1. Construct an effective organizational chart.

2. Explain why corporate wellness has become so important in strategic planning.

3. Explain why strategy implementation is more difficult than strategy formulation.

4. Discuss the importance of annual objectives and policies in achieving organizational commitment for strategies to be implemented.

5. Explain why organizational structure is so important in strategy implementation.

6. Compare and contrast restructuring and reengineering. 7. Describe the relationship between production/operations and strategy

implementation.

8. Explain how a firm can effectively link performance and pay to strategies. 9. Discuss employee stock ownership plans (ESOPs) as a strategic-management

concept.

10. Describe how to modify an organizational culture to support new strategies.

ASSURANCE OF LEARNING EXERCISES The following exercises are found at the end of this chapter.

Developing an Organizational Chart for Accenture pic

Assessing Accenture’s Philanthrophy Efforts

Revising adidas AG’s Organizational Chart

Exploring Objectives

Understanding My University’s Culture

E X E R C IS E 10A

E X E R C IS E 10B

E X E R C IS E 10C

E X E R C IS E 10D

E X E R C IS E 10E

332 CHAPTER 10 • STRATEGY EXECUTION

The strategic-m anagement process does not end on deciding what strategy or strategies to pursue. There must be a translation o f strategic thought into strategic action. This transla­tion is much easier if managers and em ployees o f the firm understand the business, feel a part o f the company, and through involvement in strategy-formillation activities have become com mitted to helping the organization succeed. W ithout understanding and com mitm ent, strategy-implementation efforts face m ajor problems. Vince Lombardi said: “The best game plan in the world never blocked or tackled anybody.”

Implementing strategy affects an organization from top to bottom, including all the func­ tional and divisional areas of a business. This chapter focuses on managem ent issues most central to implem enting strategies in 2014-2015 and Chapter 9 focuses on marketing, finance/ accounting. R&D, and m anagem ent information systems issues. Accenture is an example firm with excellent management practices.

Even the m ost technically perfect strategic plan will serve little purpose if it is not im plem ented. Many organizations tend to spend an inordinate am ount o f tim e, money, and effort on developing the strategic plan, treating the m eans and circum stances under which it will be im plem ented as afterthoughts! Change com es through im plem entation and evaluation, not through the plan. A technically im perfect plan that is im plem ented well will achieve more than the perfect plan that never gets o ff the paper on w hich it is typed.

The Nature of Strategy Implementation The strategy-im plem entation stage o f strategic m anagem ent is revealed in Figure 10-1, as illustrated with white shading. Successful strategy form ulation does not guarantee successful strategy im plem entation. It is always more difficult to do som ething (strategy im plem entation) than to say you are going to do it (strategy form ulation)! A lthough inextricably linked, strategy

STRATEGIC MANAGEMENT

Accenture Accenture pic, headquartered in Dublin, Ireland, is the world's largest consulting firm measured by revenues. As of August 2013, the company has approximately 266,000 employees serving clients in more than 120 countries. India is the single largest employee base for Accenture, with the headcount being close to 100,000, compared to about 50,000 in the United States.

In 2013, Fortune ranked Accenture as the 44'" most admired com­ pany in the world outside the United States. As most consulting firms, Accenture operates in a matrix structure. The first axis is dedicated to the operating groups, or industries of its clients. Accenture's has five Operating Groups that comprise 39 industry subgroups.

The five Operating Groups are:

• Communications, Media & Technology • Financial Services • Products • Resources • Health & Public Service.

In September 2013, Accenture acquired AMS Research headquar­ tered in Fairfax, Virginia. Accenture made the acquisition to strategically expand its U.S. defense business in the growing military health market, especially desiring to better serve the U.S. Department of Defense (DoD).

Accenture offers DoD extensive experience in providing elec­ tronic health records, health­ care integration, interoperability. AMS has more than three decades of government experience and expertise in healthcare IT, information solutions and services, data analyt es, cloud, data warehousing, human capital management and benefit solutions and agile software development.

Also in September 2013, YSPay, one of the leading payment services providers in China, began using a new mobile payments solution developed with Accenture. The new product allows YSPay customers - consumers, banks and merchants - to process payments with any type of mobile phone. YSPay is using the Accenture Mobility platform to connect with banks via China Union Pay - China's bank card association. Accenture is also providing application outsourcing services to YSPay, including the ongoing maintenance of the platform and any future enhancements agreed by both parties, allowing YSPay to keep its internal resources focused on core business activities.

CHAPTER 10 • STRATEGY EXECUTION 333

Chapter 2: Outside-USA Strategic Planning

Strategy Monitoring Chapter 11

The Internal Audit

Chapter 6

Vision and Mission Analysis

Chapter 5

m ? 1 Strategy

Generation Strategy

and Selection Chapter 8

Implementation . Chapter 9

L j*.

Strategy Execution

Chapter 10

u The External

Audit Chapter 7

Chapter 3: Ethics/Social Responsibility/Sustainability

Strategy _______________________ |_______ Strategy _________[ _ Strategy __ | I Formulation I Implementation I Evaluation

FIGURE 10-1 Comprehensive Strategie-Management Model

Source: Fred R. David, adapted from “How Companies Define Their Mission,” Long Range Planning 22. no. 3 (June 1988): 40, © Fred R. David.

im plem entation is fundam entally different from strategy form ulation. Strategy form ulation and im plem entation can be contrasted in the following ways:

• Strategy formulation is positioning forces before the action. • Strategy im plem entation is managing forces during the action. • Strategy formulation focuses on effectiveness. • Strategy implementation focuses on efficiency. • Strategy form ulation is primarily an intellectual process. • Strategy implementation is primarily an operational process. • Strategy form ulation requires good intuitive and analytical skills. • Strategy im plem entation requires special motivation and leadership skills. • Strategy formulation requires coordination among a few individuals. • Strategy implementation requires coordination among many individuals.

Strategy-form ulation concepts and tools do not differ greatly for small, large, for-profit, or nonprofit organizations. However, strategy im plem entation varies substantially am ong differ­ ent types and sizes o f organizations. Im plementing strategies requires such actions as altering

334 CHAPTER 10 • STRATEGY EXECUTION

sales territories, adding new departments, closing facilities, hiring new em ployees, changing an organization’s pricing strategy, developing financial budgets, developing new em ployee benefits, establishing cost-control procedures, changing advertising strategies, building new facilities, training new em ployees, transferring managers among divisions, and building a better manage­ ment information system. These types o f activities obviously differ greatly am ong m anufactur­ ing, service, and governmental organizations.

Management Perspectives In terms o f “Quality of M anagement." Fortune recently ranked the following com panies as best in the world:

Rank Company I Koc Holding 2 McDonald’s 3 Apple 4 Philip Morris International 5 Costco Wholesale 6 JP Morgan Chase 7 Wyndham Worldwide 8 Sysco 9 Walt Disney

10 TJX

Source: Based on: http://m oneyxnn.coni/m asa/ines/fortune/ m ostadm ired/2012/best_worst/best5.html.

In all but the smallest organizations, the transition from strategy formulation to strategy implementation requires a shift in responsibility from strategists to divisional and functional managers. Implementation problems can arise because of this shift in responsibility, especially if strategy-formulation decisions come as a surprise to middle- and lower-level m anagers. M anagers and em ployees are motivated more by perceived self-interests than by organizational interests, unless the two coincide. This is a primary reason why divisional and functional m anag­ ers should be involved as much as possible in strategy-formulation and strategy-im plem entation activities.

As indicated in Table 10-1, management issues central to strategy im plem entation include establishing annual objectives, devising policies, allocating resources, altering an existing organizational structure, restructuring and reengineering, revising reward and incentive plans,

TABLE 10-1 Some Management Issues Central to Strategy Implementation

Establish annual objectives Devise policies Allocate resources Alter an existing organizational structure Restructure and reengineer Revise reward and incentive plans Minimize resistance to change Match managers with strategy Develop a strategy-supportive culture Adapt production and operations processes Develop an effective human resources function Downsize and furlough as needed Link performance and pay to strategies

CHAPTER 10 • STRATEGY EXECUTION 335

minimizing resistance to change, matching managers with strategy, developing a strategy- supportive culture, adapting production and operations processes, developing an effective human resources function, and, if necessary, downsizing. M anagement changes are necessarily more extensive when strategies to be im plem ented move a firm in a major new direction.

M anagers and em ployees throughout an organization should participate early and directly in strategy-im plem entation decisions. Their role in strategy implementation should build on prior involvement in strategy-form ulation activities. Strategists’ genuine personal com m itm ent to im plem entation is a necessary and powerful motivational force for managers and employees. Too often, strategists are too busy to actively support strategy-implementation efforts, and their lack o f interest can be detrimental to organizational success. The rationale for objectives and strategies should be understood and clearly com m unicated throughout an organization. M ajor com petitors’ accom plishments, products, plans, actions, and performance should be apparent to all organizational members. M ajor external opportunities and threats should be clear, and m anagers’ and em ployees’ questions should be answered. Top-down flow o f com m unication is essential for developing bottom -up support.

Firms need to develop a com petitor focus at all hierarchical levels by gathering and widely distributing com petitive intelligence: every em ployee should be able to benchm ark her or his efforts against best-in-class com petitors so that the challenge becomes personal. For example, Starbucks Corp. recently instituted "lean production/operations” at its 11.000+ U.S. stores. This system elim inates idle employee time and unnecessary em ployee motions, such as walking, reaching, and bending. Starbucks says 30 percent o f em ployees' time is motion and the company wants to reduce that. They say “motion and work are two different things."

Annual Objectives E stab lish ing a n n u a l objectives is a decentralized activity that directly involves all managers in an organization. Active participation in establishing annual objectives can lead to acceptance and com mitm ent. A nnual objectives are essential for strategy implementation because they (a) represent the basis for allocating resources: (b) are a primary mechanism for evaluating m anag­ ers; (c) are the m ajor instrument for m onitoring progress toward achieving long-term objectives; and (d) establish organizational, divisional, and departmental priorities. Considerable time and effort should be devoted to ensuring that annual objectives are well conceived, consistent with long-term objectives, and supportive o f strategies to be implemented. Approving, revising, or rejecting annual objectives is much more than a rubber-stamp activity. The purpose of annual objectives can be summ arized as follows:

Annual objectives serve as guidelines for action, directing and channeling efforts and activities o f organization m embers. They provide a source o f legitim acy in an enter­ prise by justify ing activities to stakeholders. They serve as standards o f perform ance. They serve as an im portant source o f em ployee m otivation and identification. They give incentives for m anagers and em ployees to perform . They provide a basis for organiza­ tional design.2

Clearly stated and com m unicated objectives are critical to success in all types and sizes o f firm s. Annual objectives, stated in term s o f profitability , growth, and m arket share by business segm ent, geographic area, custom er groups, and product, are com m on in organ iza­ tions. F igure 10-2 illustrates how the Stam us C om pany could establish annual objectives based on long-term objectives. Table 10-2 reveals associated revenue figures that correspond to the objectives outlined in F igure 10-2. Note that, according to plan, the Stam us C om pany w ill slightly exceed its long-term objective o f doubling com pany revenues between 2012 and 2014.

Figure 10-2 also reflects how a hierarchy of annual objectives can be established based on an organization’s structure. O bjectives should be consistent across hierarchical levels and form a network o f supportive aims. H o rizo n ta l consistency o f objectives is as im portant as v e rtica l consistency o f objectives. For instance, it would not be effective for m anufacturing to achieve more than its annual objective o f units produced if marketing could not sell the additional units.

336 CHAPTER 10 • STRATEGY EXECUTION

R6-D annual objective

Develop two new products this year that are succesfully marketed.

Production annual objective

Increase production efficiency by 30% this year.

Marketing annual objective

Increase the number of salespeople by 40 this year.

Purchasing Shipping Quality Control

FIGURE 1 02 The Stamus Company's Hierarchy of Aims

Advertising Promotion Research Public Relations

Finance annual objective

Obtain long-term financing of $400,000 in the next six months.

Auditing Accounting Investments Collections Working Capital

Personnel annual objective

Reduce employee absenteeism from 10% to 5% this year.

Annual objectives should be measurable, consistent, reasonable, challenging, clear, com ­ municated throughout the organization, characterized by an appropriate time dim ension, and accom panied by com mensurate rewards and sanctions. Too often, objectives arc stated in gen­ eralities, with little operational usefulness. Annual objectives, such as “to improve com m unica­ tion” or “to improve performance,” are not clear, specific, or measurable. Objectives should state quantity, quality, cost, and tim e— and also be verifiable. Terms and phrases such as maximize, minimize, as soon as possible, and adequate should be avoided.

Annual objectives should be com patible with em ployees’ and m anagers’ values and sup­ ported by clearly stated policies. M ore o f som ething is not always better. Im proved quality or

CHAPTER 10 • STRATEGY EXECUTION 337

TABLE 10-2 The Stamus Company's Revenue Expectations (in Smillions)

2012 2013 2014

Division I Revenues 1.0 1.400 1.960 Division II Revenues 0.5 0.700 0.980 Division III Revenues 0.5 0.750 1.125 Total Company

Revenues 2.0 2.850 4.065

reduced cost may, for exam ple, be m ore im portant than quantity. It is im portant to tie rewards and sanctions to annual objectives so that em ployees and m anagers understand that achiev­ ing objectives is critical to successful strategy im plem entation. C lear annual objectives do not guarantee successful strategy im plem entation, but they do increase the likelihood that personal and organizational aim s can be accom plished. O verem phasis on achieving objec­ tives can result in undesirable conduct, such as faking the num bers, d istorting the records, and letting objectives becom e ends in them selves. M anagers m ust be alert to these potential problem s.

Policies Changes in a firm’s strategic direction do not occur automatically. On a day-to-day basis, poli­ cies are needed to make a strategy work. Policies facilitate solving recurring problem s and guide the im plementation o f strategy. Broadly defined, policy refers to specific guidelines, methods, procedures, rules, forms, and administrative practices established to support and encourage work toward stated goals. Policies are instruments for strategy im plementation. Policies set boundar­ ies, constraints, and limits on the kinds o f adm inistrative actions that can be taken to reward and sanction behavior; they clarify what can and cannot be done in pursuit o f an organization’s objectives. For example, Carnival’s Paradise ship has a no smoking policy anywhere, anytime aboard ship. It was the first cruise ship to ban smoking comprehensively. A nother example o f corporate policy relates to surfing the Web while at work. About 40 percent o f companies today do not have a formal policy preventing em ployees from surfing the Internet, but software is being marketed now that allows firms to monitor how, when, where, and how long various em ployees use the Internet at work.

Policies let both em ployees and managers know what is expected o f them, thereby increas­ ing the likelihood that strategies will be implemented successfully. They provide a basis for m anagem ent control, allow coordination across organizational units, and reduce the amount o f time managers spend making decisions. Policies also clarify what work is to be done and by whom. They promote delegation of decision making to appropriate managerial levels where various problem s usually arise. Many organizations have a policy manual that serves to guide and direct behavior. Walmart has a policy that it calls the “ 10 Foot” Rule, whereby customers can find assistance within 10 feet of anywhere in the store. This is a welcomed policy in Japan, where W almart is trying to gain a foothold: 58 percent o f all retailers in Japan are mom-and-pop stores and consumers historically have had to pay “top yen” rather than “discounted prices” for merchandise.

Policies can apply to all divisions and departm ents (for example, “We are an equal oppor­ tunity em ployer”). Some policies apply to a single departm ent (“Employees in this department must take at least one training and development course each year”). W hatever their scope and form, policies serve as a mechanism for im plem enting strategies and obtaining objectives. Policies should be stated in writing whenever possible. They represent the means for carrying out strategic decisions. Exam ples o f policies that support a com pany strategy, a divisional objective, and a departmental objective are given in Table 10-3.

Some example issues that may require a managem ent policy are provided in Table 10-4.

338 CHAPTER 10 • STRATEGY EXECUTION

TA B LE 10-3 A Hierarchy of Policies

Company Strategy Acquire a chain of retail stores to meet our sales growth and profitability objectives. Supporting Policies

1. “All stores will be open from 8 a.m. to S p.m. Monday through Saturday." (This policy could increase retail sales if stores currently are open only 40 hours a week.)

2. “All stores must submit a Monthly Control Data Report.” (This policy could reduce expense-to-sales ratios.) 3. “All stores must support company advertising by contributing 5 percent of their total monthly revenues for this purpose.” (This policy

could allow the company to establish a national reputation.) 4. "All stores must adhere to the uniform pricing guidelines set forth in the Company Handbook.” (This policy could help assure customers

that the company offers a consistent product in terms of price and quality in all its stores.)

Divisional Objective Increase the division's revenues from $10 million in 2014 to $15 million in 2015. Supporting Policies

1. "Beginning in January 2014, each one of this division’s salespersons must file a weekly activity report that includes the number of calls made, the number of miles traveled, the number of units sold, the dollar volume sold, and the number of new accounts opened." (This policy could ensure that salespersons do not place too great an emphasis in certain areas.)

2. “Beginning in January 2014. this division will return to its employees 5 percent of its gross revenues in the form of a Christmas bonus.” (This policy could increase employee productivity.)

3. "Beginning in January 2014, inventory levels carried in warehouses will be decreased by 30 percent in accordance with a just-in-time (JIT) manufacturing approach.” (This policy could reduce production expenses and thus free funds for increased marketing efforts.)

Production Department Objective Increase production from 20.000 units in 2014 to 30,000 units in 2015. Supporting Policies

1. “Beginning in January 2014, employees will have the option of working up to 20 hours of overtime per week.” (This policy could mini­ mize the need to hire additional employees.)

2. “Beginning in January 2014, pcrfect attendance awards in Ihe amount of $100 will be given to all employees who do not miss a workday in a given year.” (This policy could decrease absenteeism and increase productivity.)

3. "Beginning in January' 2014, new equipment must be leased rather than purchased." (This policy could reduce tax liabilities and thus al­ low more funds to be invested in modernizing production processes.)

TABLE 10-4 Some Issues That May Require a Management Policy

• To offer extensive or limited management development workshops and seminars • To centralize or decentralize employee-training activities • To recruit through employment agencies, college campuses, or newspapers • To promote from within or to hire from the outside • To promote on the basis of merit or on the basis of seniority • To tie executive compensation to long-term or annual objectives • To offer numerous or few employee benefits • To negotiate directly or indirectly with labor unions • To delegate authority for large expenditures or to centrally retain this authority • To allow much, some, or no overtime work • To establish a high- or low-safety stock of inventory • To use one or more suppliers • To buy, lease, or rent new production equipment • To greatly or somewhat stress quality control • To establish many or only a few production standards • To operate one, two. or three shifts • To discourage using insider information for personal gain • To discourage sexual harassment • To discourage smoking at work • To discourage insider trading • To discourage moonlighting

CHAPTER 10 • STRATEGY EXECUTION 339

Resource Allocation R esource allocation is a central management activity that allows for strategy execution. In orga­ nizations that do not use a strategic-m anagem ent approach to decision making, resource alloca­ tion is often based on political or personal factors. Strategic management enables resources to be allocated according to priorities established by annual objectives.

All organizations have at least four types o f resources that can be used to achieve desired objectives: financial resources, physical resources, human resources, and technologi­ cal resources. Allocating resources to particular divisions and departm ents does not mean that strategies will be successfully implemented. A num ber of factors com m only prohibit effective resource allocation, including an overprotection of resources, too great an emphasis on short-run financial criteria, organizational politics, vague strategy targets, a reluctance to take risks, and a lack o f sufficient knowledge.

Below the corporate level, there often exists an absence of system atic thinking about resources allocated and strategies o f the firm. Yavitz and Newman explain why:

M anagers normally have many more tasks than they can do. M anagers must allocate tim e and resources among these tasks. Pressure builds up. Expenses are too high. The CEO wants a good financial report for the third quarter. Strategy formulation and imple­ mentation activities often get deferred. Today’s problem s soak up available energies and resources. Scram bled accounts and budgets fail to reveal the shift in allocation away from strategic needs to currently squeaking w heels.3

The real value of any resource allocation program lies in the resulting accom plishm ent of an organization’s objectives. Effective resource allocation does not guarantee successful strategy im plem entation because program s, personnel, controls, and com m itm ent must breathe life into the resources provided. Strategic m anagem ent itself is som etim es referred to as a “resource allo­ cation process."

Managing Conflict Interdependency of objectives and competition for limited resources often leads to conflict. C onflict can be defined as a disagreement between two or more parties on one or more issues. Establishing annual objectives can lead to conflict because individuals have different expectations and perceptions, schedules create pressure, personalities are incompatible, and misunderstand­ ings between line managers (such as production supervisors) and staff managers (such as human resource specialists) occur. For example, a collection manager’s objective o f reducing bad debts by 50 percent in a given year may conflict with a divisional objective to increase sales by 20 percent.

Establishing objectives can lead to conflict because managers and strategists must make trade-offs, such as whether to em phasize short-term profits or long-term growth, profit margin or market share, market penetration or market development, growth or stability, high risk or low risk, and social responsiveness or profit maximization. Trade-offs are necessary because no firm has sufficient resources to pursue all strategies that would benefit the firm. Table 10-5 reveals som e im portant management trade-off decisions required in strategy implementation.

Conflict is unavoidable in organizations, so it is important that conflict be managed and resolved before dysfunctional consequences affect organizational perform ance. Conflict is not always bad. An absence of conflict can signal indifference and apathy. Conflict can serve to energize opposing groups into action and may help managers identify problems. General George Patton once said: ‘'If everyone is thinking alike, then som ebody isn 't thinking.”

Various approaches for m anaging and resolving conflict can be classified into three catego­ ries: avoidance, defusion, and confrontation. A voidance includes such actions as ignoring the problem in hopes that the conflict will resolve itself or physically separating the conflicting indi­ viduals (or groups). D efusion can include playing down differences between conflicting parties while accentuating sim ilarities and common interests, com prom ising so that there is neither a clear w inner nor loser, resorting to majority rule, appealing to a higher authority, or redesigning present positions. C onfron ta tion is exemplified by exchanging members o f conflicting parties so that each can gain an appreciation o f the other’s point o f view or holding a meeting at which conflicting parties present their views and work through their differences.

340 CHAPTER 10 • STRATEGY EXECUTION

TABLE 10-5 Some Management Trade-Off Decisions Required in Strategy Implementation

To emphasize short-term profits or long-term growth To emphasize profit margin or market share To emphasize market development or market penetration To lay oft' or furlough To seek growth or stability To take high risk or low risk To be more socially responsible or more profitable To outsource jobs or pay more to keep jobs at home To acquire externally or to build internally To restructure or reengineer To use leverage or equity to raise funds To use part-time or full-time employees

Matching Structure with Strategy Changes in strategy often require changes in the way an organization is structured, for two m ajor reasons. First, structure largely dictates how objectives and policies will be established. For exam ple, objectives and policies established under a geographic organizational structure are couched in geographic terms. O bjectives and policies are stated largely in term s o f prod­ ucts in an organization whose structure is based on product groups. The structural form al for developing objectives and policies can significantly impact all other strategy-im plem entation activities.

The second major reason why changes in strategy often require changes in structure is that stm cture dictates how resources will be allocated. If an organization’s structure is based on custom er groups, then resources will be allocated in that manner. Similarly, if an organization’s structure is set up along functional business lines, then resources are allocated by functional areas. Unless new or revised strategies place em phasis in the same areas as old strategies, struc­ tural reorientation commonly becomes a part o f strategy implementation.

Alfred Chandler promoted the notion that ‘‘changes in strategy lead to changes in organi­ zational structure.” Structure should be designed to facilitate the strategic pursuit o f a firm and, therefore, follow strategy. W ithout a strategy or reasons for being (m ission), com panies find it difficult to design an effective structure. Chandler found a particular structure sequence to be repeated often as organizations grow and change strategy over time.

There is no one optimal organizational design or structure for a given strategy or type of organization. W hat is appropriate for one organization may not be appropriate for a sim ilar firm, although successful firms in a given industry do tend to organize them selves in a sim ilar way. For example, consum er goods com panies tend to em ulate the divisional structure-by-product form o f organization. Small firms tend to be functionally structured (centralized). M edium-sized firms tend to be divisionally structured (decentralized). Large firms tend lo use a strateg ic busi­ ness un it (SBU) s tru c tu re or matrix structure. As organizations grow, their structures generally change from simple to complex as a result o f concatenation, or the linking together o f several basic strategies.

Numerous external and internal forces affect an organization; no firm could change its structure in response to every one o f these forces because to do so would lead to chaos. However, when a firm changes its strategy, the existing organizational structure may become ineffective. As indicated in Table 10-6. symptoms of an ineffective organizational structure include too many levels o f management, too many meetings attended by too many people, too much atten­ tion being directed toward solving interdepartm ental conflicts, too large a span o f control, and too many unachieved objectives. Changes in structure can facilitate strategy-im plem entation efforts, but changes in structure should not be expected to make a bad strategy good, to make bad managers good, or to make bad products sell.

CHAPTER 10 • STRATEGY EXECUTION 341

1. Too many levels of management 2. Too many meetings attended by too many people 3. Too much attention being directed toward solving interdepartmental conflicts 4. Too large a span of control 5. Too many unachieved objectives 6. Declining corporate or business performance 7. Losing ground to rival firms 8. Revenue or earnings divided by number of employees or number of managers is low compared to

rival firms

TA B LE 10-6 Symptoms of an Ineffective Organizational Structure

Structure undeniably can and does influence strategy. Strategies formulated must be work­ able, so if a certain new strategy required massive structural changes it would not be an attractive choice. In this way, structure can shape the choice o f strategies. But a more important concern is determ ining what types of structural changes are needed to implement new strategies and how these changes can best be accomplished. There are seven basic types of organizational structure: functional, divisional by geographic area, divisional by product, divisional by customer, divi­ sional process, strategic business unit (SBU), and matrix.

The Functional structure The most widely used structure is the functional or centralized type because this structure is the sim plest and least expensive of the seven alternatives. A functional s tru c tu re groups tasks and activities by business function, such as production and operations, marketing, finance and accounting, research and development, and m anagem ent inform ation systems. A university may structure its activities by major functions that include academic affairs, student services, alumni relations, athletics, m aintenance, and accounting. Besides being simple and inexpensive, a functional structure also promotes specialization o f labor, encourages efficient use of m anage­ rial and technical talent, minimizes the need for an elaborate control system, and allows rapid decision making.

Some disadvantages o f a functional structure are that it forces accountability to the top, m inim izes career development opportunities, and is som etim es characterized by low employee morale, line or staff conflicts, poor delegation of authority, and inadequate planning for products and markets.

A functional structure often leads to short-term and narrow thinking that may undermine what is best for the firm as a whole. For example, the research and developm ent department may strive to overdesion products and com ponents to achieve technical eleaance. whereas m anufacturing may argue for low-frills products that can be mass produced m ore easily. Thus, com m unication is often not as good in a functional structure. Schein cives an exam ple o f a com ­ munication problem in a functional structure:

The word “m arketing” will mean product developm ent to the engineer, studying custom ers through m arket research to the product m anager, m erchandisins to the salesperson, and constant change in design to the m anufacturing m anager. Then when these m anagers try to work together, they often attribute d isagreem ents to personalities and fail to notice the deeper, shared assum ptions that vary and dictate how each func­ tion th inks.4

M ost large com panies have abandoned the functional structure in favor o f decentralization and improved accountability. However, a large com pany that still operates from a functional type organizational design is Southwest Airlines, headquartered in Dallas, Texas. As illustrated in Figure 10-3, Southwest has only five top executives and no divisions, even thoush the firm operates 700 aircraft serving 72 cities in 37 states.

Table 10-7 summ arizes the advantages and disadvantages o f a functional organizational structure.

342 CHAPTER 10 • STRATEGY EXECUTION

FIGURE 10-3 Southwest Airlines' Functional Organizational Chart

Source: Based on company documents.

The Divisional Structure The divisional s tru c tu re or decentra lized s tru c tu re is the second most common type used by U.S. businesses. As a small organization grows, it has more difficulty managing different products and services in different markets. Some form o f divisional structure generally becomes necessary to motivate em ployees, control operations, and compete successfully in diverse locations. The divisional structure can be organized in one of four ways: by geographic area, by­ product or service, by customer, or by process. With a divisional structure, functional activities are performed both centrally and in each separate division.

Sun M icrosystem s recently reduced the number of its business units from seven to four. Kodak recently reduced its number of business units from seven by-custom er divisions to five by-product divisions. As consumption patterns becom e increasingly sim ilar worldwide, a by-product structure is becoming more effective than a by-custom er or a by-geographic type divisional structure. In the restructuring, Kodak eliminated its global operations division and distributed those responsibilities across the new by-product divisions.

A divisional structure has some clear advantages. First and perhaps foremost, accountability is clear. That is, divisional managers can be held responsible for sales and profit levels. Because a divisional structure is based on extensive delegation o f authority, managers and em ployees can easily see the results o f their good or bad performances. As a result, em ployee morale is generally higher in a divisional structure than it is in a centralized structure. O ther advantages of the divisional design are that it creates career development opportunities for managers, allows local control o f situations, leads to a competitive climate within an organization, and allows new businesses and products to be added easily.

The divisional design is not without some limitations, however. Perhaps the most important limitation is that a divisional structure is costly, for a num ber o f reasons. First, each division requires functional specialists who m ust be paid. Second, there exists som e duplication o f staff

TABLE 10-7 Advantages and Disadvantages of a Functional Organizational Structure

Advantages Disadvantages

l. Simple and inexpensive l. Accountability forced to the top 2. Capitalizes on specialization of business 2. Delegation of authority and responsibility

activities such as marketing and finance not encouraged 3. Minimizes need for elaborate control system 3. Minimizes career development 4. Allows for rapid decision making 4. Low employee and manager murale

5. Inadequate planning for products and markets

6. Leads to short-term, narrow thinking 7. Leads to communication problems

CHAPTER 10 • STRATEGY EXECUTION 343

TABLE 10-8 Advantages and Disadvantages of a Divisional Organizational Structure

Advantages Disadvantages l . Accountability is clear l . Can be costly 2. Allows local control of local situations 2. Duplication of functional activities 3. Creates career development chances 3. Requires a skilled management force 4. Promotes delegation of authority 4. Requires an elaborate control system 5. Leads to competitive climate internally 5. Competition among divisions can become so 6. Allows easy adding of new products or intense as to be dysfunctional

regions 6. Can lead to limited sharing of ideas and 7. Allows strict control and attention to resources

products, customers, or regions 7. Some regions, products, or customers may receive special treatment

services, facilities, and personnel; for instance, functional specialists are also needed centrally (at headquarters) to coordinate divisional activities. Third, managers must be well qualified because the divisional design forces delegation o f authority; better-qualified individuals require higher salaries. A divisional structure can also be costly because it requires an elaborate, head­ quarters-driven control system. Fourth, com petition between divisions may become so intense that it is dysfunctional and leads to limited sharing o f ideas and resources for the com mon good o f the firm. Table 10-8 sum m arizes the advantages and disadvantages o f divisional organiza­ tional structure.

Ghoshal and Bartlett, two leading scholars in strategic management, note the following:

As their label clearly warns, divisions divide. The divisional model fragments com pa­ nies’ resources; it creates vertical com m unication channels that insulate business units and prevents them from sharing their strengths with one another. Consequently, the whole of the corporation is often less than the sum of its parts. A final lim itation o f the divisional design is that certain regions, products, or custom ers may som etim es receive special treatment, and it may be difficult to maintain consistent, com panywide practices. Nonetheless, for most large organizations and many small firms, the advantages o f a divisional structure more than offset the potential lim itations.''

A divisional structure by geographic area is appropriate for organizations whose strate­ gies need to be tailored to fit the particular needs and characteristics o f custom ers in different geographic areas. This type o f structure can be most appropriate for organizations that have sim ilar branch facilities located in widely dispersed areas. A divisional structure by geographic area allows local participation in decision making and improved coordination w ithin a region. Hershey Foods is an example com pany organized using the divisional-by-region type o f struc­ ture, as illustrated in Figure 10-4. Analysts contend that this type o f structure may not be best for Hershey because consum ption patterns for candy are quite sim ilar worldwide. An alternative— and perhaps better— type o f structure for Hershey would be divisional by product because the com pany produces, and sells three types o f products worldwide: ( l ) chocolate, (2 ) nonchocolate, and (3) grocery.

The divisional structure by product (or sendees) is most effective for implementing strategies when specific products or services need special emphasis. Also, this type o f structure is widely used when an organization offers only a few products or services or when an organi­ zation 's products or services differ substantially. The divisional structure allows strict control over and attention to product lines, but it may also require a more skilled management force and rcduced top m anagem ent control. General Motors, DuPont, M icrosoft, and Procter & Gamble use a divisional structure by product to implement strategies. M icrosoft introduced its new Surface Tablet for $499 in late 2 0 12. The Surface is being sold online and in M icrosoft retail stores, but not in stores such as Best Buy or W almart. or even Amazon. M icrosoft’s divisional- by-product organizational structure is illustrated in Figure 10-5.

344 CHAPTER 10 • STRATEGY EXECUTION

FIGURE 10-4 Hershey Foods' Divisional-by-Region Organizational Chart

Source: Based on company documents.

Steve Ballmer, Chief Executive Officer

B. Kevin Turner, C hief Operating

Officer

Peter Klein, C hief Financial

Officer

Lisa Brummel, C hief People

Officer

Craig Mundie, C hief Research and

Strategy Officer

Brad Sm ith, General Counsel

Eric Rudder, C hief Technical Strategy Officer

FIGURE 10-5 Microsoft's Divisional-by-Product Organizational Structure

Source: Based on company documents.

Sat va Nadella,

President, Server &

Tools Business

\ ______________)

f M Kirill Tatarinov, President, M icrosoft Business Solutions Division

When a few m ajor custom ers are o f paramount importance and many different services are provided to these customers, then a divisional structure by customer can be the m ost effec­ tive way to implement strategies. This structure allows an organization to cater effectively to the requirements of clearly defined custom er groups. For example, book publishing com panies often organize their activities around custom er groups, such as colleges, secondary schools, and private commercial schools. Some airline com panies have two m ajor custom er divisions: pas­ sengers and freight or cargo services. Utility com panies often use (1) com m ercial. (2) residen­ tial, and (3) industrial as their divisions by customer.

CHAPTER 10 • STRATEGY EXECUTION 345

A divisional structure by process is sim ilar to a functional structure, because activities are organized according to the way work is actually performed. However, a key difference between these two designs is that functional departm ents are not accountable for profits or revenues, whereas divisional process departm ents are evaluated on these criteria. An exam ple o f a divi­ sional structure by process is a m anufacturing business organized into six divisions: electrical work, glass cutting, welding, grinding, painting, and foundry work. In this case, all operations related to these specific processes would be grouped under the separate divisions. Each process (division) would be responsible for generating revenues and profits. The divisional structure by process can be particularly effective in achieving objectives when distinct production processes represent the thrust o f com petitiveness in an industry. H alliburton's organizational chart illustrated on the next page features aspects o f the division-by-process design.

The Strategic Business Unit (SBU) Structure As the number, size, and diversity o f divisions in an organization increase, controlling and evaluating divisional operations become increasingly difficult for strategists. Increases in sales often are not accom panied by sim ilar increases in profitability. The span o f control becomes too large at top levels o f the firm. For example, in a large conglomerate organization com posed of 90 divisions, such as ConAgra, the chief executive officer could have difficulty even rem em bering the first names o f divisional presidents. In multidivisional organizations, an SBU structure can greatly facilitate strategy-im plem entation efforts. ConAgra has put its many divisions into three primary SBUs: (1) food service (restaurants), (2) retail (grocery stores), and (3) agricultural products.

The SBU structure groups sim ilar divisions into SBUs and delegates authority and responsi­ bility for each unit to a senior executive who reports directly to the chief executive officer. This change in structure can facilitate strategy im plem entation by improving coordination between sim ilar divisions and channeling accountability to distinct business units. In a 100-division conglomerate, the divisions could perhaps be regrouped into 10 SBUs according to certain com mon characteristics, such as com peting in the same industry, being located in the same area, or having the same customers.

Two disadvantages o f an SBU structure are that it requires an additional layer o f manage­ ment, which increases salary expenses. Also, the role of the group vice president is often am big­ uous. However, these lim itations often do not outweigh the advantages o f improved coordination and accountability. A nother advantage o f the SBU structure is that it makes the tasks of planning and control by the corporate office more manageable.

News Corp. recently reorganized its operations into two SBUs: (1) Entertainment, which includes 20th Century Fox, Fox Broadcast News, and the Fox News Channel, and (2) Publishing, which includes The Wall Street Journal. Times o f London, The Sun newspaper. The Australian newspaper, and HarperCollins book publishing. News C orp /s Chairman and CEO, Rupert Murdoch, is retaining his fam ily’s 40 percent voting stake in what may result in two separate com panies. Estimated 2014 revenue in billions o f dollars by division within the Publishing SBU is as follows:

Australia newspapers (2.19)

Dow Jones (2.07)

U.K. newspapers ( 1.34)

Book publishing (1.25)

M arketing sendees (0.97)

Fox Sports (0.62)

REA Group (0.37)

NY Post, other (0.30)

Education business (0.12)

Apparently to groom a new CEO, Coca-Cola recently streamlined its organizational structure by converting to three SBUs: (1) The Americas Beverages headed by Cahillane, (2) O utside-The-Am ericas Beverages headed by Bozer. and (3) Outside-The-Americas Bottlers headed by Finan. Coke CEO M uhtar Kent said “Consolidating leadership under the three groups

346 CHAPTER 10 • STRATEGY EXECUTION

FIGURE 10-6 Halliburton Company's SBU Organizational Chart

Source: Based on http://www.halliburton.com/AboutUs/default.aspx?pageid=2458&navid=966ệ

will streamline reporting lines and intensify our focus on key markets." Either Mr. Cahillane and Mr. Bozer are expected to replace Mr. Kent as CEO sometim e in the future, although Mr. Kent says: “As long as I 'm having fun, my health allows me to conlinuc and I ’m generating good returns for our shareholders, and im portantly as long as I’m smiling, which is im portant in any­ thing you do. then I will continue."6

An excellent example of an SBƯ organizational chart is the one posted at the Halliburton Company website and shown in Figure 10-6. Note that six division executives report to the Drilling and Evaluation top executive, whereas five division heads report to the Com pletion and Production top executive. It is interesting and somewhat unusual that the 11 Halliburton divi­ sions are organized by process rather than by geographic region or product.

The Matrix structure A m atrix s tru c tu re is the most complex o f all designs because it depends on both vertical and horizontal flows o f authority and communication (hence the term matrix). In contrast, functional and divisional structures depend primarily on vertical flows o f authority and com munication. A matrix structure can result in higher overhead because it creates more management positions. Other disadvantages o f a matrix structure that contribute to overall com plexity include dual lines o f budget authority (a violation o f the unity-of-command principle), dual sources o f reward and punishm ent, shared authority, dual reporting channels, and a need for an extensive and effective com munication system.

D espite its complexity, the matrix structure is widely used in many industries, including construction, health care, research, and defense. As indicated in Table 10-9. som e advantages of a

CHAPTER 10 • STRATEGY EXECUTION 347

TA B LE 10-9 Advantages and Disadvantages of a Matrix Structure

A dvantages D isadvantages

1. Project objectives are clear 1. Requires excellent vertical and horizontal 2. Employees can clearly see results of their flows of communication

work 2. Costly because creates more manager 3. Shutting down a project is easily positions

accomplished 3. Violates unity of command principle 4. Facilitates uses of special equipment, person- 4. Creates dual lines of budget authority

nel. and facilities 5. Creates dual sources of reward and 5. Functional resources are shared instead of punishment

duplicated as in a divisional structure 6. Creates shared authority and reporting 7. Requires mutual trust and understanding

matrix structure are that project objectives are clear, there are many channels o f com m unication, workers can see the visible results of their work, and shutting down a project can be accom ­ plished relatively easily. Another advantage o f a matrix structure is that it facilitates the use o f specialized personnel, equipm ent, and facilities. Functional resources are shared in a matrix structure, rather than duplicated as in a divisional structure. Individuals with a high degree of expertise can divide their time as needed among projects, and they in turn develop their own skills and com petencies more than in other structures.

A typical matrix structure is illustrated in Figure 10-7. Note that the letters (A through Z4) refer to managers. For example, if you were manager A, you would be responsible for financial aspects o f Project l . and you would have two bosses: the Project l Manager on site and the CFO off site.

For a matrix structure to be effective, organizations need participative planning, training, clear mutual understanding of roles and responsibilities, excellent internal com munication, and mutual trust and confidence. The matrix structure is being used more frequently by U.S. businesses because firms are pursuing strategies that add new products, custom er groups, and technology to their range of activities. Out o f these changes are com ing product managers, func­ tional managers, and geographic-area managers, all o f whom have important strategic respon­ sibilities. When several variables, such as product, customer, technology, geography, functional area, and line of business, have roughly equal strategic priorities, a matrix organization can be an effective structural form.

^Chief Executive Officerj

Chief Strategy

»'Officer (CSOj,

Chief Finance

Officer (CFO)

Chief Operating

Officer (COO)

Chief Information Officer (CIO)

VP of Human

Resources

VP of Marketing

[^Industrial Products SBU [ Consumer Products SBU

Adhesive Packaging Division

Tubes/ Cores

Division

Reels Division

FIGURE 10-7 An Example Matrix Structure

348 CHAPTER 10 • STRATEGY EXECUTION

Some Do's and Don'ts in Developing Organizational Charts Students analyzing strategic-m anagem ent cases are often asked to revise and develop a firm 's organizational structure. This section provides some basic guidelines for this endeavor. There are some basic do’s and don 'ts in regard to devising or constructing organizational charts, espe­ cially for midsize to large firms. First o f all. reserve the title CEO for the top executive o f the firm. D on 't use the title “president” for the top person; use it for the division top managers if there are divisions within the firm. Also, do not use the title “president” for functional business executives. They should have the title “chief,” or “ vice president.” or “manager,” or “officer." such as “C hief Information Officer,” or “VP of Human Resources.” Further, do not recommend a dual title (such as “CEO and president” ) for ju st one executive. Do not let a single individual be both chairman of the board, although Pfizer's CEO, Ian Read, is also chairm an of the board. And Comverse Technology recently nam ed Charles Burdick its president, ch ief executive officer, and chairman o f the board. Actually, “chairperson” is much better than “chairm an” for this title.

A signilicant movement among corporate America is to split the chairperson o f the board and the CEO positions in publicly held companies. The movement includes asking the New York Stock Exchange and Nasdaq to adopt listing rules that would require separate positions. About 50 percent of com panies in the S&P 500 stock index have separate positions, up from 22 percent in 2002, but this still leaves plenty o f room for improvement. Among European and Asian com panies, the split in these two positions is much more com mon. For exam ple, 79 percent o f British com panies split the positions, and all German and Dutch com panies split the position. South Korea’s Samsung Electronics in mid-2013 dissolved its COO position in favor o f dual C EO 's— but this practice in not com mon or popular in the USA.

Directly below the CEO, it is best to have a COO (chief operating officer) with any division presidents reporting directly to the COO. On the same level as the COO and also reporting to the CEO, draw in your functional business executives, such as a CFO (chief financial officer), VP o f human resources, a CSO (chief strategy officer), a CIO (chief inform ation officer), a CM O (chief marketing officer), a VP of R&D. a VP of legal affairs, an investment relations officer, maintenance officer, and so on. Note in Figure 10-8 that these positions are labeled and placed appropriately. Note that a controller or treasurer would normally report to the CFO.

In developing an organizational chart, avoid having a particular person reporting to more than one person in the chain of com mand. This would violate the unity-of-com m and principle of management that “every em ployee should have just one boss." Also, do not have the CFO, CIO, CSO, human resource officer, or other functional positions report to the COO. All these posi­ tions report directly to the CEO.

A key consideration in devising an organizational structure concerns the divisions. Note whether the divisions (if any) of a firm presently are established based on geography, customer, product, or process. If the firm ’s organizational chart is not available, you often can devise a chart based on the titles o f executives. An im portant case analysis activity is for you to decide how the divisions of a firm should be organized for maximum effectiveness. Even if the firm presently has no divisions, determine whether the firm would operate better with divisions. In other words, which type of divisional breakdown do you (or your group or team) feel would be best for the firm in allocating resources, establishing objectives, and devising compensation incentives? This important strategic decision faces many midsize and large firms (and teams o f students analyzing a strategic-m anagem ent case).

As consumption patterns become more and more sim ilar worldwide, the divisional-by- product form of structure is increasingly the most effective. Be mindful that all firms have functional staff below their top executive and often readily provide this information, so be wary o f concluding prematurely that a particular firm uses a functional structure. If you see the word president in the titles of executives, coupled with financial-reporting segments, such as by product or geographic region, then the firm is divisionally structured.

If the firm is large with numerous divisions, decide whether an SBU type o f structure would be more appropriate to reduce the span of control reporting to the COO. One never knows for sure if a proposed or actual structure is indeed most effective for a particular firm. Declining financial perform ance signals a need for altering the structure.

Some important guidelines to follow in devising organizational charts for com panies are provided in Table 10-10.

CHAPTER 10 • STRATEGY EXECUTION 349

Note: Titles spelled out as follows. Chief Executive Officer (CEO) Chief Finance Officer (CFO) Chief Strategy Officer (CSO) Chief Information Officer (CIO) Human Resources Manager (HRM) Chief Operating Officer (COO) Chief Legal Officer (CLO) Research & Development Officer (R&D) Chief Marketing Officer (CMO) Chief Technology Officer (CTO) Competitive Intelligence Officer (CIO) Maintenance Officer (MO)

FIGURE 10-8 Typical Top Managers of a Large Firm

TABLE 10-10 Fifteen Guidelines for Developing an Organizational Chart

1. Instead of chairman of the board, make it chairperson of the board. 2. Make sure the board of directors reveals diversity in race, ethnicity, gender, and age. 3. Make sure the chair of the board is not also the CEO or president of the company. 4. Make sure the CEO of the firm does not also carry the title president. 5. Reserve the title president for the division heads of the firm. 6. Make sure the firm has a COO. 7. Make sure only presidents of divisions report to the COO. 8. Make sure functional executives such as CFO. CIO, CMO, CSO, R&D, CLO. CTO, and HRM report to the CEO, not the COO. 9. Make sure every executive has one boss, so lines in the chart should be drawn accordingly, assuring unity of command.

10. Make sure span of control is reasonable, probably no more than 10 persons reporting to any other person. 11. Make sure diversity in race, ethnicity, gender, and age is well represented among corporate executives. 12. Avoid a functional type structure for all but the smallest firms. 13. Decentral i/e, using some form of divisional structure, whenever possible. 14. Use an SBU type structure for large, multidivisional firms. 15. Make sure executive titles match product names as best possible in division-by-product and SBU-designated firms.

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Restructuring Restructuring and reengineering are becom ing com m onplace on the corporate landscape across the USA and Europe. R estruc tu ring— also called dow nsizing, rightsizing, or delayering— involves reducing the size of the firm in terms o f num ber o f em ployees, num ber o f divisions or units, and number o f hierarchical levels in the firm ’s organizational structure. This reduction in size is intended to improve both efficiency and effectiveness. Restructuring is concerned primarily with shareholder well-being rather than em ployee well-being.

The lingering recession in Europe has forced many com panies there to downsize, laying off m anagers and employees. This practice was historically rare in Europe because labor unions and laws required lengthy negotiations or huge severance checks before workers could be term i­ nated. In contrast to the USA, labor union executives of large European firms sit on most boards of directors.

Job security in European com panies is slowly moving toward a U.S. scenario, in which firms lay off almost at will. From banks in Milan to factories in M annheim. European employers are starting to show people the door in an effort to stream line operations, increase efficiency, and com pete against already slim and trim U.S. firms. Massive U .S.-style layoffs are still rare in Europe, but unemployment rates throughout the continent are rising quite rapidly. European firms still prefer to downsize by attrition and retirem ent rather than by blanket layoffs because of culture, laws, and unions.

In contrast, reengineering is concerned more with em ployee and custom er well-being than shareholder well-being. R eengineering— also called process management, process innovation. or process redesign— involves reconfiguring or redesigning work, jobs, and processes for the purpose o f improving cost, quality, service, and speed. Reengineering does not usually affect the organizational structure or chart, nor does it imply job loss or em ployee layoffs. W hereas restructuring is concerned with elim inating or establishing, shrinking or enlarging, and moving organizational departments and divisions, the focus of reengineering is changing the way work is actually carried out. Reengineering is characterized by many tactical (short-term , business- function-specific) decisions, whereas restructuring is characterized by strategic (long-term, affecting all business functions) decisions.

Developed by M otorola in 1986 and made famous by CEO Jack W elch at General E lectric and more recently by Robert Nardelli, form er CEO o f Home Depot, Six S igm a is a quality- boosting process im provem ent technique that entails training several key persons in the firm in the techniques to monitor, m easure, and improve processes and elim inate defects. Six Sigm a has been widely applied across industries from retailing to financial services. C FO Dave Cote at Honeywell and CEO Jeff Immelt at General E lectric spurred acceptance of Six Sigma, which aims to improve work processes and elim inate w aste by training “select" em ployees who are given judo titles such as M aster Black Belts, Black Belts, and Green Belts. Target Corp. claim s more than $100 million in savings over the past six years resulting from its Six S igm a program.

Six Sigma was criticized in a Wall Street Journal article that cited many exam ple firms whose stock price fell for a number o f years after adoption of Six Sigma. The technique's reliance on the special group o f trained employees is problem atic and its use within retail firms such as Home Depot has not been as successful as in m anufacturing firm s.K

Restructuring Firms often employ restructuring when various ratios appear out o f line with competitors as determined through benchmarking exercises. Recall that b en ch m ark in g simply involves com paring a firm against the best firms in the industry on a wide variety of perform ance-related criteria. Some benchmarking ratios commonly used in rationalizing the need for restructuring are headcount-to-sales-volum e, or corporate-staff-to-operating-em ployees, or span-of-control figures.

The primary benefit sought from restructuring is cost reduction. For some highly bureau­ cratic firms, restructuring can actually rescue the firm from global com petition and demise. But the downside of restructuring can be reduced em ployee com m itm ent, creativity, and innovation that accom panies the uncertainty and traum a associated with pending and actual employee layoffs. Avon Products recently restructured partly as a result o f corruption investigations in its

CHAPTER 10 • STRATEGY EXECUTION 351

Russia and Brazil operations. The com pany reduced its six com mercial business units down to two— (1) Developed Markets and (2) Developing M arkets— in essence going to a divisional by geographic region type structure. Avon has been reporting lower sales and profits amid missteps in key markets. Form er CEO Andrea Jung installed five new regional heads and new presidents in Avon’s U.S. and Russia markets.

Employers today are looking fo r people who can do things, not fo r people who make other people do things. Restructuring in many firms has made a m anager’s job an invisible, thankless role. M ore workers today are self-managed, entrepreneurs, interpreneurs, or team-managed. M anagers today need to be counselors, motivators, financial advisors, and psychologists. They also run the risk o f becoming technologically behind in their areas of expertise. “D ilbert” cartoons sometimes portray managers as enem ies or as morons.

Linking Performance and Pay to Strategies With so many people out o f work and executive salaries so large, politicians are more and more giving shareholders greater control over executive pay. The Dodd-Frank Wall Street Reform and Consum er Protection Act grants shareholders advisory votes on com pensation. A recent Bloomberg Businessweek article says com panies should install five policies to improve their com pensation practices:

1. Provide full transparency to all stakeholders. Novartis does an excellent job on this. 2. Reward long-term perform ance with long-term pay, rather than annual incentives.

ExxonM obil does an excellent job on this. 3. Base executive com pensation on actual company perform ance, rather than on stock price.

Target, for example, bases executive pay on sam e-store sales growth rather than stock price.

4. Extend the tim e-horizon for bonuses. Replace short-term with long-term incentives. Goldman Sachs does an excellent job on this.

5. Increase equity between workers and executives. Delete many special perks and benefits for executives. Be more consistent across levels, although em ployees with greater responsi­ bility must receive greater com pensation. 10

As firms acquire other firms in other countries, these pay differences can cause resentment and even turmoil. Larger pay packages o f U.S. CEOs are socially less acceptable in many other countries. For example, in Japan, seniority rather than perform ance is the key factor in determ in­ ing pay, and harmony among m anagers is em phasized over individual excellence.

How can an organization’s reward system be more closely linked to strategic perform ance? How can decisions on salary increases, promotions, merit pay, and bonuses be more closely aligned to support the long-term strategic objectives of the organization? There are no widely accepted answers to these questions, but a dual bonus system based on both annual objectives and long-term objectives is becoming com mon. The percentage o f a m anager’s annual bonus attributable to short-term versus long-term results should vary by hierarchical level in the orga­ nization. It is important that bonuses not be based solely on short-term results because such a system ignores long-term com pany strategies and objectives.

M any com panies have recently instituted policies to allow their shareholders to vote on executive com pensation policies. Aflac was the first U.S. corporation to voluntarily give share­ holders an advisory vote on executive compensation. Aflac did this back in 2007. Apple did this in 2008, as did H&R Block. Several com panies that instituted say-on-pay policies more recently were Ingersoll-Rand, Verizon, M otorola, Occidental Petroleum, and Hewlett-Packard. These new policies underscore how the financial crisis and shareholder outrage about top executive pay has affected com pensation practice. None o f the shareholder votes are binding on the com panies, however, at least not so far. The U.S. House o f Representatives recently passed a bill to form alize this shareholder tactic, which is gaining steam across the country as a means to com bat exorbitant executive pay.

In an effort to cut costs and increase productivity, more and more Japanese com panies are sw itching from seniority-based pay to perform ance-based approaches. Toyota has switched to a full merit system for 20,000 o f its 70,000 white-collar workers. Fujitsu, Sony. M atsushita

352 CHAPTER 10 • STRATEGY EXECUTION

Electric Industrial, and Kao also have switched to merit pay systems. This sw itching is hurting morale at some Japanese com panies, which have trained workers for decades to cooperate rather than to compete and to work in groups rather than individually.

Richard Brown. CEO of Electronic Data System s (EDS), once said.

You have to start with an appraisal system that gives genuine feedback and differentiates performance. Some call it ranking people. That seems a little harsh. But you can’t have a manager checking a box that says you’re either stupendous, m agnificent, very good, good, or average. Concise, constructive feedback is the fuel workers use to get better. A com ­ pany that doesn’t differentiate perform ance risks losing its best people. 11

P rofit sh a rin g is another widely used form o f incentive com pensation. More than 30 percent o f U.S. com panies have profit-sharing plans, but critics em phasize that too many factors affect profits for this to be a good criterion. Taxes, pricing, or an acquisition would wipe out profits, for example. Also, firms try to minimize profits in a sense to reduce taxes.

For em ployee (rather than executive) bonuses and incentives, only 16 percent o f U.S. com ­ panies are now using stock price, down from 29 percent in 2009 .12 Instead, com panies are using profit in order to more closely link em ployees’ incentives to spending and budget decisions. PepsiCo, for example, recently began using profit and cash flow instead o f stock price to focus managers on profit and cash-flow targets. PepsiCo’s CFO, Hugh Johnston, said: ‘T h e change allows our em ployees to make decisions about spending and profit trade-offs them selves, rather than simply being handed a budget to follow; it’s something they can wrap their arms around and say, ‘Now I understand how I can impact PepsiC o’s stock price.’” PepsiC o’s new com pensation system based on profit enabled the company to lower its capital spending to 4.5 percent o f sales in 2012, down from an historical average o f about 5.5 percent. For upper-level executives, stock price is still the major variable used for com pensation incentives, but for m id-and-low er level managers and em ployees, stock price is dependent on too many extraneous variables for it to be an effective com pensation variable.

The good news for shareholders is that in 2013, over 50 percent of CEO com pensation was directly associated with the perform ance o f the firm, rather than salary— up from 35 percent in 2009 (WSJ, 3-21-13, p. B l). Note below that Indra Nooyi o f PepsiCo was the third highest paid women CEO in 2012 in the USA:

1. Irene Rosenfeld at Kraft ($21.9M) 2. Debra Cafaro at Ventas ($ 18.5M) 3. Indra Nooyi at PepsiCo ($ 17.1M) 4. Meg W hitman at HP (S16.5M) 5. Ellen Kullman at DuPont ($15.9M) 6 . Angela Braly at WellPoint ($13.3M )

Still another criterion w-idely used to link performance and pay to strategies is gain sharing. G ain sh a rin g requires employees or departments to establish perform ance targets; if actual results exceed objectives, all members get bonuses. More than 26 percent o f U.S. com panies use some form of gain sharing; about 75 percent o f gain-sharing plans have been adopted since 1980. Carrier, a subsidiary of United Technologies, has had excellent success with gain sharing in its six plants in Syracuse, New York; Firestone’s tire plant in W ilson, North Carolina, has experienced sim ilar success with gain sharing.

Criteria such as sales, profit, production efficiency, quality, and safety could also serve as bases for an effective bonus system . If an organization meets certain understood, agreed-on profit objectives, every member o f the enterprise should share in the harvest. A bonus system can be an effective tool for motivating individuals to support strategy-im plem entation efforts. BankAmerica, for example, recently overhauled its incentive system to link pay to sales o f the bank’s most profitable products and services. Branch managers receive a base salary plus a bonus based both on the num ber o f new custom ers and on sales o f bank products. Every em ployee in each branch is also eligible for a bonus if the branch exceeds its goals. Thomas Peterson, a top BankAm erica executive, says, “We want to make people responsible for meeting their goals, so we pay incentives on sales, not on controlling costs or on being sure the parking lot is sw'ept.”

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Five tests are often used to determ ine whether a perform ance-pay plan will benefit an organization:

1. Does the plan capture attention? Are people talking more about their activities and taking pride in early successes under the plan?

2. Do employees understand the plan? Can participants explain how it works and what they need to do to earn the incentive?

3. Is the plan improving communication? Do em ployees know more than they used to about the com pany’s m ission, plans, and objectives?

4. Does the plan pay out when it should? Are incentives being paid for desired results— and being withheld when objectives are not met?

5. Is the company or unit performing better? Are profits up? Has market share grown? Have gains resulted in part from the incentives? 13

In addition to a dual bonus system , a com bination o f reward strategy incentives, such as salary raises, stock options, fringe benefits, prom otions, praise, recognition, criticism , fear, increased jo b autonomy, and awards, can be used to encourage m anagers and em ployees to push hard for successful strategic im plem entation. The range o f options for getting people, departm ents, and divisions to actively support strategy-im plem entation activities in a par­ ticular organization is alm ost lim itless. M erck, for exam ple, recently gave each o f its 37,000 em ployees a 10-year option to buy 100 shares o f M erck stock at a set price o f $127. Steven Darien. M erck’s vice president o f hum an resources, says, “We needed to find ways to get everyone in the w orkforce on board in term s o f our goals and objectives. Com pany executives will begin m eeting with all M erck w orkers to explore ways in which em ployees can contribute more.”

Managing Resistance to Change No organization or individual can escape change. But the thought of change raises anxieties because people fear econom ic loss, inconvenience, uncertainty, and a break in normal social patterns. Almost any change in structure, technology, people, or strategies has the potential to disrupt com fortable interaction patterns. For this reason, people resist change. The strategic- managem ent process itself can impose m ajor changes on individuals and processes. Reorienting an organization to get people to think and act strategically is not an easy task.

R esistance to change can be considered the single greatest threat to successful strategy im plementation. Resistance regularly occurs in organizations in the form of sabotaging produc­ tion machines, absenteeism , filing unfounded grievances, and an unwillingness to cooperate. People often resist strategy im plem entation because they do not understand w hat is happening or why changes are taking place. In that case, em ployees may simply need accurate inform ation. Successful strategy im plem entation hinges on m anagers’ ability to develop an organizational climate conducive to change. Change m ust be viewed as an opportunity rather than as a threat by managers and em ployees.

Resistance to change can em erge at any stage or level o f the strategy-im plem entation process. Although there are various approaches for implementing changes, three com m only used strategies are a force change strategy, an educative change strategy, and a rational or self-interest change strategy. A force change stra tegy involves giving orders and enforcing those orders; this strategy has the advantage of being fast, but it is plagued by low com m itm ent and high resistance. The educative change stra tegy is one that presents information to convince people o f the need for change; the disadvantage of an educative change strategy is that im plem enta­ tion becomes slow and difficult. However, this type o f strategy evokes greater com m itm ent and less resistance than does the force change strategy. Finally, a ra tio n a l change s tra teg y or self- in te rest change stra tegy is one that attem pts to convince individuals that the change is to their personal advantage. When this appeal is successful, strategy implementation can be relatively easy. However, implementation changes are seldom to everyone’s advantage.

The rational change strategy is the most desirable, so this approach is examined a bit further. M anagers can improve the likelihood of successfully implementing change by carefully designing change efforts. Jack Duncan described a rational or self-interest change strategy as

354 CHAPTER 10 • STRATEGY EXECUTION

consisting o f four steps. First, employees are invited to participate in the process of change and in the details o f transition; participation allows everyone to give opinions, to feel a part o f the change process, and to identify their own self-interests regarding the recommended change. Second, some motivation or incentive to change is required; self-interest can be the most important motivator. Third, com munication is needed so that people can understand the purpose for the changes. Giving and receiving feedback is the fourth step: everyone enjoys knowing how things are going and how much progress is being m ade. 14

Because of diverse external and internal forces, change is a fact o f life in organizations. The rate, speed, magnitude, and direction o f changes vary over tim e by industry and organi­ zation. Strategists should strive to create a work environm ent in which change is recognized as necessary and beneficial so that individuals can more easily adapt to change. Adopting a strategic-m anagem ent approach to decision making can itself require m ajor changes in the philosophy and operations o f a firm.

Strategists can take a number of positive actions to minimize managers* and em ployees' resistance to change. For example, individuals who will be affected by a change should be involved in the decision to make the change and in decisions about how to im plem ent the change. Strategists should anticipate changes and develop and offer training and developm ent workshops so that managers and em ployees can adapt to those changes. They also need to effectively com ­ municate the need for changes. The strategic-m anagement process can be described as a process o f managing change.

Organizational change should be viewed today as a continuous process rather than as a project or event. The most successful organizations today continuously adapt to changes in the competitive environm ent, which themselves continue to change at an accelerating rate. It is not sufficient today to simply react to change. M anagers need to anticipate change and ideally be the creator o f change. Viewing change as a continuous process is in stark contrast to an old m an­ agement doctrine regarding change, which was to unfreeze behavior, change the behavior, and then rcfreeze the new behavior. The new “continuous organizational change” philosophy should mirror the popular “continuous quality improvement philosophy.”

Creating a Strategy-Supportive Culture Strategists should strive to preserve, em phasize, and build 011 aspects o f an existing cu ltu re that support proposed new strategies. Aspects o f an existing culture that are antagonistic to a proposed strategy should be identified and changed. Substantial research indicates that new strategies are often market-driven and dictated by competitive forces. For this reason, chang­ ing a firm 's culture to lit a new strategy is usually more effective than changing a strategy to fit an existing culture. As indicated in Table 10-11, numerous techniques are available to alter

TABLE 10-11 Ways and Means for Altering an Organization's Culture

1. Recruitment 2. Training 3. Transfer 4. Promotion 5. Restructuring 6. Reengineering 7. Role modeling 8. Positive reinforcement 9. Mentoring

10. Revising vision and/or mission 11. Redesigning physical spaces/facades 12. Altering reward system 13. Altering organizational policies, procedures, and practices

CHAPTER 10 • STRATEGY EXECUTION 355

an organization’s culture, including recruitment, training, transfer, promotion, restructure of an organization’s design, role modeling, positive reinforcem ent, and mentoring.

Schein indicated that the following elements are most useful in linking culture to strategy:

1. Formal statem ents o f organizational philosophy, charters, creeds, materials used for recruitm ent and selection, and socialization

2. D esigning o f physical spaces, facades, and buildings 3. Deliberate role modeling, teaching, and coaching by leaders 4. Explicit reward and status system and promotion criteria 5. Stories, legends, myths, and parables about key people and events 6 . W hat leaders pay attention to, measure, and control 7. Leader reactions to critical incidents and organizational crises 8. How the organization is designed and structured 9. Organizational systems and procedures

10. Criteria used for recruitment, selection, promotion, leveling off, retirement, and “excom ­ m unication” o f people1 ^

W hen Volkswagen AG acquired Porsche in late 2012. there was concern that the 75-year- old Volkswagen Chairman and patriarch, Ferdinand P iech’s autocratic style would be at odds with Porsche’s corporate culture. Porsche had for a long time placed a premium on individual effort am ong its engineers and designers, often encouraging com petition among groups to come up with new design ideas and innovations. Time will tell if Volkswagen and Porsche can meld their cultures into a com petitive advantage.

In the personal and religious side o f life, the impact o f loss and change is easy to see .1<s M emories o f loss and change often haunt individuals and organizations for years. Ibsen wrote, “Rob the average man of his life illusion and you rob him of his happiness at the same stroke.” 1' W hen attachm ents to a culture are severed in an organization’s attempt to change direction, em ployees and m anagers often experience deep feelings o f grief. This phenom enon commonly occurs when external conditions dictate the need for a new strategy. M anagers and employees often struggle to find m eaning in a situation that changed many years before. Some people find com fort in memories; others find solace in the present. Weak linkages between strategic m anagem ent and organizational culture can jeopardize perform ance and success. Deal and Kennedy em phasized that making strategic changes in an organization always threatens a culture:

People form strong attachm ents to heroes, legends, the rituals of daily life, the hoopla of extravaganza and cerem onies, and all the symbols o f the workplace. Change strips rela­ tionships and leaves employees confused, insecure, and often angry. Unless something can be done to provide support for transitions from old to new, the force o f a culture can neutralize and em asculate strategy changes. 18

Production and Operations Concerns When Implementing Strategies Apple employs thousands of its own workers in China, but about 700,000 assembly workers at manufacturing contractors like Foxconn put together Apple products. It would be almost impossible to bring those jobs to the USA for at least three reasons. First o f all, Foxconn— China’s largest private em ployer and the manufacturer of an estimated 40 percent o f the w orld 's consumer electronic devices— pays its assembly workers far less than U.S. labor laws would allow. A typical salary is about S 18 a day. Secondly, unlike U.S. plants, Foxconn and other Chinese manufacturing operations house employees in dormitories and can send hundreds o f thousands of workers to the assembly lines at a m om ent’s notice. On the lines, workers are subjected to what most Americans would consider unbearable long hours and tough working conditions. That system gives tech com panies the efficiency needed to race products out the door, so speed is a bigger factor than pay. Finally, most of the component suppliers for Apple and other technology giants are also

356 CHAPTER 10 • STRATEGY EXECUTION

TA BLE 10-12 Production Management and Strategy Implementation

Type of Organization Strategy Being Implemented Production System Adjustments

I lospital Adding a cancer center (Product Purchase specialized equipment Development) and add specialized people.

Bank Adding 10 new branches (Market Development)

Perform site location analysis.

Beer brewery Purchasing a barley farm operation Revise the inventory control (Backward Integration) system.

Steel manufacturer Acquiring a fast-food chain (Unrelated Diversification)

Improve the quality control system.

Computer company Purchasing a retail distribution Alter the shipping, packaging, and chain (Forward Integration) transportation systems.

in China or other Asian countries. That geographic clustering gives com panies the flexibility to change a product design at the last m inute and still ship on time.

Production and operations capabilities, lim itations, and policies can significantly enhance or inhibit the attainm ent o f objectives. Production processes typically constitute more than 70 percent o f a firm ’s total assets. A major part o f the strategy-iinplem entation process takes place at the production site. Production-related decisions on plant si/e , plant location, prod­ uct design, choice o f equipment, kind of tooling, size o f inventory, inventory control, quality control, cost control, use of standards, job specialization, em ployee training, equipm ent and resource utilization, shipping and packaging, and technological innovation can have a dram atic impact on the success or failure of strategy-implementation efforts.

Exam ples o f adjustments in production systems that could be required to implement various strategies are provided in Table 10-12 for both for-profit and nonprofit organizations. For instance, note that when a bank form ulates and selects a strategy to add I0 new branches, a production-related implementation concern is site location. The largest bicycle com pany in the USA, Huffy, recently ended its own production o f bikes and now contracts out those services to Asian and Mexican manufacturers. Huffy focuses instead on the design, marketing, and distribu­ tion o f bikes, but it no longer produces bikes itself. The Dayton, Ohio, com pany closed its plants in Ohio, Missouri, and Mississippi.

Ju st-in -tim e (J IT ) production approaches have withstood the test o f time. JIT significantly reduces the costs o f implementing strategies. With JIT. parts and materials are delivered to a pro­ duction site just as they are needed, rather than being stockpiled as a hedge against later deliver­ ies. Harley-Davidson reports that at one plant alone, JIT freed $22 million previously tied up in inventory and greatly reduced reorder lead time.

Factors that should be studied before locating production facilities include the availability o f major resources, the prevailing wage rates in the area, transportation costs related to shipping and receiving, the location of major markets, political risks in the area or country, and the avail­ ability o f trainable employees. Some o f these factors explain why many manufacturing opera­ tions in China are moving back to Mexico, or to Vietnam, or even back to the USA.

Human Resource Concerns When Implementing Strategies More and more com panies are instituting furloughs to cut costs as an alternative to laying off em ployees. F u rloughs are temporary layoffs and even w hite-collar m anagers are being given furloughs, once confined to blue-collar workers. A few organizations furloughing professional workers include Gulfstream Aerospace, Media General, Gannett, the University of M aryland. Clemson University, and Spansion. Most com panies are still using tem porary and part-tim e workers rather than hiring full-time em ployees, which suggests that high unem ploym ent rates may be a long-term trend. More and more com panies may follow H arley-D avidson’s lead

CHAPTER 10 • STRATEGY EXECUTION 357

Salary freeze Hiring freeze Salary reductions Reduce employee benefits Raise employee contribution to health-care premiums Reduce employee 40l(k)/403(b) match Reduce employee workweek Mandatory furlough Voluntary furlough Hire temporary instead of full-time employees Hire contract employees instead of full-time employees Volunteer buyouts (Walt Disney is doing this) Halt production for three days a week (Toyota Motor is doing this) Layoffs Early retirement Reducing or eliminating bonuses

Source: Based on Dana Mattioli, “Employers Make Cuts Despite Belief Upturn Is Near," Wall Street Journal. April 23, 2009, B4.

TA B LE 10-13 Labor Cost-Saving Tactics

when that firm signed a new union contract recently that creates a tier o f “casual workers” with no benefits and no minimum num ber o f hours, allowing Harley to call up workers only as needed.20 Table 10 - 13 lists ways that com panies today are reducing labor costs to stay finan­ cially sound.

A well-designed strategic-m anagem ent system can fail if insufficient attention is given to the human resource dimension. Human resource problems that arise when businesses implement strategies can usually be traced to one of three causes: ( l) disruption of social and political struc­ tures, (2) failure to match individuals’ aptitudes with implementation tasks, and (3) inadequate top managem ent support for implementation activities 21

Strategy implementation poses a threat to many managers and em ployees in an organization. New power and status relationships are anticipated and realized. New formal and informal groups' values, beliefs, and priorities may be largely unknown. M anagers and em ployees may become engaged in resistance behavior as their roles, prerogatives, and power in the firm change. Disruption of social and political structures that accom pany strategy execution m ust be anticipated and considered during strategy formulation and managed during strategy implementation.

A concern in matching managers with strategy is that jobs have specific and relatively static responsibilities, although people are dynam ic in their personal development. Com monly used methods that match managers with strategies to be implemented include transferring m anagers, developing leadership workshops, offering career development activities, prom otions, job enlargem ent, and job enrichment.

A num ber o f other guidelines can help ensure that human relationships facilitate rather than disrupt strategy-im plem entation efforts. Specifically, managers should do a lot o f chatting and informal questioning to stay abreast of how things are progressing and to know when to intervene. M anagers can build support for strategy-im plem entation efforts by giving few orders, announcing few' decisions, depending heavily on informal questioning, and seeking to probe and clarify until a consensus em erges. Key thrusts that succeed should be rewarded generously and visibly.

Perhaps the best method for preventing and overcoming human resource problem s in strategic managem ent is to actively involve as many managers and em ployees as possible in the process. Although time consuming, this approach builds understanding, trust, com mitm ent, and ownership and reduces resentment and hostility. The true potential o f strategy formulation and im plem entation resides in people.

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Employee Stock Ownership Plans (ESOPs) An ESOP is a tax-qualified, defined-contribution, em ployee-benefit plan whereby em ployees purchase stock o f the com pany through borrowed money or cash contributions. ESOPs em power em ployees to work as owners; this is a primary reason why the num ber o f ESOPs have grown dramatically to more than 10,000 firms covering more than 14 million employees. ESOPs now control more than $600 billion in corporate stock in the USA.

Some ESOP com panies include:

• W. L. Gore & Associates— m aker o f medical and industrial products as well as Gore-Tex • Herman Miller— famous for making innovative office furniture • KCI— a civil engineering firm • HCSS— a software m anufacturer for the heavy construction industry

Besides reducing worker alienation and stim ulating productivity, ESOPs allow firms other benefits, such as substantial tax savings. Principal, interest, and dividend paym ents on ESOP- funded debt are tax deductible. Banks lend money to ESOPs at interest rales below prime. This money can be repaid in pretax dollars, lowering the debt service as much as 30 percent in some cases. “The ownership culture really makes a difference, when m anagement is a facilitator, not a dictator,” says Corey Rosen, executive director of the National Center for Employee Ownership. Fifteen employee-owned com panies are listed in Table 10-14.

If an ESOP owns more than 50 percent of the firm, those who lend money to the ESOP arc taxed on only 50 percent o f the income received on the loans. ESOPs are not for every firm, however, because the initial legal, accounting, actuarial, and appraisal fees to set up an ESOP are about $50,000 for a small or midsized firm, with annual adm inistration expenses o f about $15,000. Analysts say ESOPs also do not work well in firms that have fluctuating payrolls and profits. Human resource managers in many firms conduct preliminary research to determ ine the desirability o f an ESOP, and then they facilitate its establishm ent and adm inistration if benefits outweigh the costs.

Wyatt Cafeterias, a southwestern U.S. operator o f 120 cafeterias, also adopted the ESOP concept to prevent a hostile takeover. Employee productivity at Wyatt greatly increased since the ESOP began, as illustrated in the following quote:

The key em ployee in our entire organization is the person serving the custom er on the cafeteria line. We now tell the tea cart server, “D on’t wait for the m anager to tell you how to do your job better or how to provide better service. You take care o f it." Sure.

TABLE 10-14 Fourteen Example ESOP Firms

Firm Headquarters Location

Publix Supermarkets Florida Tribune Company Illinois Lifctouch Minnesota John Lewis Partnership United Kingdom Mondragon Cooperative Spain Houchens Industries Kentucky Amsted Industries Illinois Mast General Store North Carolina

HDR, Inc. Nebraska

Yoke’s Fresh Market Washington SPARTA. Inc. California

Hy-Vee Iowa Bi-Mart Washington Ferrellgas Partners Kansas

CHAPTER 10 • STRATEGY EXECUTION 359

w e're looking for productivity increases, but since we began pushing decisions down to the level o f people who deal directly with custom ers, w e’ve discovered an awesom e side effect— suddenly the work crews have this “happy to be here” attitude that the custom ers really love.22

Balancing Work Life and Home Life More women earn both undergraduate and graduate degrees in the USA than men, but a wage disparity still persists between men and women at all education levels.23 Women on average make 25 percent less than men. The average age today for women to get married in the USA is 30 for those with a college degree, and 26 for those with just a high school degree. About 29 percent o f both men and women in the USA today have a college degree, whereas in 1970 only 8 percent o f women and 14 percent o f men had college degrees.

A recent article in Wall Street Journal (12-5-12, A3) revealed that in the USA, women now hold 33.4 percent o f legal jo b s, including lawyers, judges, m agistrates, and other jud ic ia l em ployees, up from 29.2 percent in 2000. A lso, the percentage o f women physi­ cians and surgeons rose to 32.4 percent from 26.8 percent during that tim e. This is great news; however, the bad news is that the m edian salary for wom en lawyers is $90,000 versus $ 122,000 for men, and the m edian salary for fem ale physicians is $112,128 versus $186,916 for men.

Globally, it is widely acknow ledged that the best countries for working women are Norway, Sweden, Finland, and Denmark— that often rate above the USA. A ccording to the World Econom ic Forum 's 2012 report on the global gender gap overall, the USA ranked num ber 22 overall, and on wage equality, the USA ranked num ber 61 behind M adagascar, Cam bodia, and Guyana. In that report, women in the USA make on average 67 percent o f what men make, com pared, for exam ple, to 73 percent in Canada. Unm arried women in fact make more than men in many countries. M arried women with children, however, usually make con­ siderably lower than men.

Work and family strategies have become so popular among com panies today that the strat­ egies now represent a com petitive advantage for those firms that offer such benefits as elder care assistance, flexible scheduling, jo b sharing, adoption benefits, an on-site sum m er camp, em ployee help lines, pet care, and even lawn service referrals. New corporate titles such as work and life coordinator and director o f diversity are becoming common.

Working Mother magazine annually published its listing o f “The 100 Best Com panies for W orking M others” (w w w.workingm other.com ). Three especially important variables used in the ranking were availability of flextime, advancem ent opportunities, and equitable distribution of benefits am ong com panies. O ther important criteria are com pressed weeks, telecommuting, job sharing, childcare facilities, maternity leave for both parents, mentoring, career development, and promotion for women. Working M other’s top 10 best com panies for working women in 2012 are provided in Table 10-15. Working Mother also conducts extensive research to determine the best U.S. firms for women of color.

A corporate objective to become more lean and mean must today include consideration for the fact that a good home life contributes im m ensely to a good work life. The work and family issue is no longer ju s t a w om en's issue. Some specific measures that firms are taking to address this issue are providing spouse relocation assistance as an em ployee benefit; providing com pany resources for family recreational and educational use; establishing em ployee country clubs, such as those at IBM and Bethlehem Steel; and creating family and work interaction opportu­ nities. A study by Joseph Fleck o f W heaton College found that in com panies that do not offer paternity leave for fathers as a benefit, most men take short, informal paternity leaves anyway by com bining vacation time and sick days.

Some organizations have developed family days, when family members are invited into the workplace, taken on plant or office tours, dined by management, and given a chance to see exactly what other family m embers do each day. Family days are inexpensive and increase the em ployee’s pride in working for the organization. Flexible working hours during the week are another human resource response to the need for individuals to balance work life and home life. The work and family topic is being made part of the agenda at meetings and thus is being discussed in many organizations.

360 CHAPTER 10 • STRATEGY EXECUTION

1. Bank of America—allows employees to define how they work. 2. Deloitte—grants employees four unpaid weeks off annually. 3. Ernst & Young (E&Y)— up to 75 percent of its employees work outside E&Y offices.

Breastfeeding moms may rely on lactation rooms at most sites. 4. General Mills— women head five of the seven U.S. retail divisions. 5. Grant Thornton—offers 8 weeks of paid maternity leave and numerous flexible work options. 6. IBM—offers outstanding assistance to children of employees through its Special Care for Children

program. 7. KPMG—employees may take 26 (job guaranteed, partially paid) weeks off following the birth or

adoption of a child. 8. Procter & Gamble (P&G)—all P&G office employees may adjust the times that they start or finish

work by two hours either way; 47 percent of all P&G hires in 2011 were women. Breastfeeding moms may rely on lactation rooms at most sites.

9. PricewaterhouseCoopers— many female partners go through the Breakthrough Leadership Development Program and achieve top executive positions.

10. WellStar Health System—has an in-house concierge service to help moms get things done.

Source: Based on 2012: http://www.workingmother.com/best-company-list/l29l 10/7271.

There is great room for improvement in removing the glass ceiling dom estically, especially considering that women make up 47 percent o f the U.S. labor force. G lass ceiling refers to the invisible barrier in many firms that bars women and minorities from top-level m anagem ent posi­ tions. The USA is a leader globally in promoting women and m inorities into mid- and top-level managerial positions in business. Only 4.0 percent o f Fortune 500 firms have a woman CEO. Table 10-16 gives the 2 1 Fortune 500 Women CEOs in 2 0 13. These women are w onderful role models for women around the world.

TABLE 10-16 Fortune 500 Women CEOs in 2013

TA B LE 10-15 Top Ten Companies for Working Women

CEO Company

Angela Braly WellPoint Patricia Woertz Archer Daniels Midland

Marissa Mayer Yahoo! Indra Nooyi PepsiCo Irene Rosenfeld Kraft Foods Carol Meyrowitz TJX Virginia Rometty IBM Debra Reed Sempra Energy Deanna Mulligan Guardian Life Insurance

Sherilyn McCoy Avon Products

Denise Morrison Campbell Soup

Maggie Wilderotter Frontier Communications

Meg Whitman Hewlett-Packard

llene Gordon Corn Products

Heather Bresch Mylan

Gracia Martore Gannett

Ellen Kullman DuPont

Ursula Bums Xerox Kathleen Mazzarella Gravbar Electric

Beth Mooney Key Corp

Marillyn Hewson Lockheed Martin Corp

CHAPTER 10 • STRATEGY EXECUTION 361

Benefits of a Diverse Workforce CEO Rosalind Brewer, the first African American and first woman to lead a W almart business unit, is turning W alm art’s SA M ’s Club into a $ 100 billion business. After taking over o f SAM 'S in 2012. Brewer says SA M ’s is raising m em bership fees, building stores in m etropolitan areas instead o f rural towns, adding brands like Eddie Bauer, Nautica, and Lucky Brand Jeans that differential SA M ’s from W almart and other discount retailers. Brewer is also opening SAM ’s stores earlier to capture small businesspersons who buy the morning of their day’s business. CEO Brewer is doing a great job trying to gain ground on Costco W holesale, which logged nearly double the sales o f SA M ’s Club in 2 0 12.

In late 2 0 12, when CEO Chris Kubasik at Lockheed Martin was fired for having an “im proper” relationship with a fellow em ployee, a long-tim e Lockheed Martin female execu­ tive, M arillyn Hewson. was appointed as the com pany’s new CEO. Three o f the six largest Pentagon contractors now have female C E O ’s. Lockheed M artin is the w orld’s largest defense contractor.

A dvertising agencies are an exam ple industry transitioning from being specialist H ispanic, African A m erican, and Asian agencies to becom ing m ulticultural, generalist agen­ cies. Leading executives o f culturally specialized agencies are defecting in large num bers to generalist agencies as com panies increasingly em brace m ulticultural m arketing using m ulti­ cultural ad agencies. Com panies such as Burger King are shifting their H ispanic and African A m erican ad agencies to generalist firms such as Crispin. C hurch’s Chicken says pooling everything at a generalist agency helps reinforce the m ulticultural com ponent o f its overall m arket strategy.24

In Latin and South America, the num ber o f women in high office has increased dramatically in recent years. Brazil recently elected its first woman president. D ilma Rouseff. Both Argentina and Chile already have a woman president. Cristina Kirchner and M ichelle Bachelet, respec­ tively. Regarding the percent o f national congressional seats held by women, Argentina has 38.3 percent followed by Honduras with 23.4 percent, as com pared to Europe with 20.0 percent. Nordic countries at 4 1.6 percent, and Arab states at l l . l percent.“'' Women now make up 53 percent o f the work force in Latin and South America.

A recent study by M cKinsey & Co. in Asia revealed that Asian com panies’ average return on equity improves from 15 percent to 22 percent when more and more women hold high-level positions.26 Wang Jin at McKinsey says: “Women tend to be stronger in terms o f collaboration and people development, while men tend to be stronger in individual decision making. By having more women at the senior level, com panies are helping to improve organizational health as well as financial perform ance.”27 The percentage o f women on corporate boards in Australia increased from 8.3 in 2010 to 14 percent in 20 1 2 .28 M alaysia and South Korea are also making excellent progress integrating women into upper levels o f m anagem ent and subsidizing com panies that build child-care facilities and help women juggle work and family life. In con­ trast, women in India still are expected to care for their family and extended family; also in India women often unfortunately have an abortion if they know their fetus is a girl. Overall in Asia, women com prise only 6 percent of corporate board seats, com pared to 17 percent in Europe and 15 percent in the USA.

An organization can perhaps be most effective when its w orkforce m irrors the diversity o f its custom ers. For global com panies, this goal can be optim istic, but it is a w orthw hile goal.

Corporate Wellness Programs Recent articles detail how com panies such as Johnson & Johnson (J&J), Low e’s Home- Improvement, the superm arket chain H-E-B, and Healthwise report impressive returns on investment o f com prehensive, well-run em ployee wellness programs, sometim es as high as six to one.29 A recent study by Fidelity Investments and the National Business Group on Health reports that nearly 90 percent o f em ployers today offer some kind o f wellness incentives or prizes to em ployees who “get healthier,” up from 59 percent in 2009. For example, JetBlue Airways offers em ployees money— $25 for teeth cleanings and S400 for com pleting an Ironman triathlon, etc. Furniture company, KI, has all its em ployees divided into four groups based on

362 CHAPTER 10 • STRATEGY EXECUTION

“healthiness” with the most-healthy people paying $ 1,000 less on health insurance premiums than the least-healthy employees.

A ccording to the 2013 N ational Survey o f E m ployer-Sponsored Health P lans, the percentage o f large em ployers (500+ em ployees) that offer low er health insurance prem ium s to nonsm okers increased from 9 percent in 2009 to 15 percent in 2012 (WSJ, 2 -I0 -R 5 ). In addition, 42 percent o f large firms now offer onsite exercise or yoga classes, and 35 percent offer onsite W eight W atchers program s. J&J estim ates that w ellness program s have cum u­ latively saved the com pany $250 m illion on health-care costs over the past decade. All J&J facilities around the world are tobacco free. At the softw are firm SAS Institute head­ quartered in Cary, North C arolina, voluntary turnover o f em ployees has dropped to ju st 4 percent, largely, the firm says, due to its effective w ellness program . On the SAS main cam pus, 70 percent o f em ployees use the recreation cen ter at least tw ice a week. SAS is num ber 3 am ong Fortune's “ 100 Best Com panies to Work For.” At H ealthw ise, CEO Don K em per’s personal com m itm ent to w ellness perm eates the entire culture o f the firm , from m onthly staff m eetings to an annual W ellness Day. L ow e’s offers em ployees a m onthly $50 discount on m edical insurance if they pledge that they and covered dependents will not use any tobacco products.

Chevron is also a model corporate wellness com pany that sponsors many internal and external wellness activities. Chevron and other com panies such as Biltm ore that provide exem ­ plary wellness programs think beyond diet and exercise and focus also on stress m anagem ent by assisting em ployees with such issues as divorce, serious illness, death and grief recovery, child rearing, and care o f aging parents. B iltm ore’s two-day health fairs twice a year focus on physi­ cal, financial, and spiritual wellness. At Lowe’s headquarters, an impressive spiral staircase in the lobby makes climbing the stairs more appealing than riding the elevator. Such practices as “providing abundant bicycle racks,” “conducting walking meetings,” and “offering five m inute stress breaks” are becoming com mon at com panies to promote a corporate wellness culture.

Whole Foods Market headquartered in Austin, Texas, is another outstanding corporate wellness com pany with their em ployees receiving a 30 percent discount card on all products sold in their stores “ if they maintain and docum ent a healthy lifestyle.” In addition, W egm an’s Food Markets, headquartered in Rochester, New York, is another superm arket chain with an excellent corporate wellness program. More than 11,000 o f W egman’s 39,000 em ployees recently took part in a challenge to eat five cups of fruit and vegetables and walk up to 10,000 steps a day for eight weeks. Wegman recently ranked num ber 4 am ong Fortune's “ 100 Best Com panies to Work For.”

Firms are striving to lower the accelerating costs o f em ployees’ health-care insurance premiums. Many firms such as Scotts M iracle-Gro Company (based in M arysville, Ohio), IBM. and M icrosoft are implementing wellness programs, requiring em ployees to get healthier or pay higher insurance premiums. Employees that do get healthier win bonuses, free trips, and pay lower premiums; nonconforming em ployees pay higher prem ium s and receive no “healthy” benefits. W ellness o f employees has becom e a strategic issue for many firms. Most firms require a health examination as a part o f an em ployment application, and healthiness is more and more becoming a hiring factor. Michael Porter, coauthor o f Redefining Health Care, says. “We have this notion that you can gorge on hot dogs, be in a pie-eating contest, and drink every day, and society will take care o f you. We can’t afford to let individuals drive up com pany costs because they’re not willing to address their own health problems.”

W ellness program s provide counseling to em ployees and seek lifestyle changes to achieve healthier living. For exam ple, trans fats are a m ajor cause o f heart disease. N ear elim ination o f trans fats in one’s diet will reduce one’s risk for heart attack. Saturated fats are also bad. so one should avoid eating too much red meat and dairy products, which are high in saturated fats. Seven key lifesty le habits listed in Table 10-17 m ay significantly im prove health and longevity. Boston M arket recently removed all salt shakers o ff tables in its 476 restaurants. The com pany is also reducing salt by 20 percent in its rô tisserie chicken, m aca­ roni and cheese, and m ashed potatoes. CEO George M ichel says Boston M arket will reduce salt levels by 15 percent m enu-w ide by the end of 2014. Pepper shakers rem ain on tables at Boston M arket.

CHAPTER 10 • STRATEGY EXECUTION 363

TABLE 10-17 The Key to Staying Healthy, Living to 100, and Being a "Well" Employee

1. Eat nutritiously—cat a variety of fruits and vegetables daily because they have ingredients that the body uses to repair and strengthen itself.

2. Stay hydrated—drink plenty of water to aid the body in eliminating toxins and to enable body organs to function efficiently; the body is mostly water.

3. Get plenty of rest—the body repairs itself during rest, so get at least seven hours of sleep nightly, preferably eight hours. 4. Get plenty of exercise—exercise vigorously at least 30 minutes daily so the body can release toxins and strengthen vital organs. 5. Reduce stress—the body’s immune system is weakened when one is under stress, making the body vulnerable to many ailments, so keep

stress to a minimum. 6. Do not smoke—smoking kills, no doubt about it anymore. 7. Take vitamin supplements—consult your physician, but because it is difficult for diet alone to supply all the nutrients and vitamins

needed, supplements can be helpful in achieving good health and longevity.

Source: Based on Lauren Etter. “Trans Fats: Will They Get Shelved?” Wall Street Journal. December 8, 2006, A6; Joel Fuhrman. MD. Eat to Live (Boston: Lillie, Brown. 2003).

Special Note to Students An integral part o f managing a firm is continually and system atically seeking to gain and sustain com petitive advantage through effective planning, organizing, motivating, staffing, and controlling. Rival firm s engage in these same activities, so em phasize in your strategic- m anagem ent case analysis how your firm im plem enting your recom m endations will outper­ form rival firms. Rem em ber to be prescriptive rather than descriptive on every page or slide in your project, m eaning to be insightful, forw ard-looking, and analytical rather than ju st describing operations. It is easy to describe a com pany but is difficult to analyze a company. S trategic-m anagem ent case analysis is about analyzing a com pany and its industry, uncovering ways and m eans for the firm to best gain and sustain com petitive advantage. So com m unicate throughout your project how your firm, and especially your recom m endations, will lead to improved growth and profitability versus rival firms. Avoid vagueness and generalities throughout your project, as your audience or reader seeks great ideas backed up by great analyses. Be analytical and prescriptive rather than vague and descriptive in highlighting every slide you show an audience.

Conclusion Successful strategy formulation does not at all guarantee successful strategy implementation. Although inextricably interdependent, strategy formulation and strategy im plementation are characteristically different. In a single word, strategy implementation means change. It is widely agreed that “the real work begins after strategies arc formulated.” Successful strategy im plem en­ tation requires the support of, as well as discipline and hard work, from motivated managers and employees. It is som etim es frightening to think that a single individual can irreparably sabotage strategy-im plem entation efforts.

Formulating the right strategies is not enough because managers and em ployees must be motivated to implement those strategies. M anagement issues considered central to strategy im plementation include matching organizational structure with strategy, linking perform ance and pay to strategies, creating an organizational clim ate conducive to change, m anaging political relationships, creating a strategy-supportive culture, adapting production and operations pro­ cesses, and m anaging human resources. Establishing annual objectives, devising policies, and allocating resources are central strategy-im plem entation activities com mon to all organizations. Depending on the size and type o f the organization, other management issues could be equally important to successful strategy im plementation.

364 CHAPTER 10 • STRATEGY EXECUTION

Key Terms and Concepts annual objectives (p. 335) avoidance (p. 339) benchm arking (p. 350) bonus system (p. 352) conflict (p. 339) confrontation (p. 339) culture (p. 354) decentralized structure (p. 342) defusion (p. 339) delayering (p. 350) divisional structure by geographic area, product, customer, or

process (p. 342) downsizing (p. 350) educative change strategy (p. 353) em ployee stock ownership plans (ESOP) (p. 358) establishing annual objectives (p. 335) force change strategy (p. 353) functional structure (p. 341)

furloughs (p. 356) gain sharing (p. 352) glass ceiling (p. 360) horizontal consistency of objectives (p. 335) just-in-tim e (JIT) (p. 356) matrix structure (p. 346) policy (p. 337) profit sharing (p. 352) rational change strategy (p. 353) reengineering (p. 350) resistance to change (p. 353) resource allocation (p. 339) restructuring (p. 350) rightsizing (p. 350) self-interest change strategy (p. 353) Six Sigma (p. 350) strategic business unit (SBU) structure (p. 340) vertical consistency o f objectives (p. 335)

Issues for Review and Discussion 10-1. A ccenture is a strong firm, globally. W hat are the

three major threats you see that face Accenture in your country?

10-2. In order o f im portance, list the six m anagement issues you feel are m ost central to strategy implementation. Briefly explain your answer.

10-3. List the five m ajor benefits o f a firm that has clearly defined its annual objectives.

10-4. W hich approach to conflict resolution would you use to resolve a disagreem ent between top-level managers, regarding a firm ’s strategic plan?

10-5. Illustrate a functional organizational chart. 10-6. Create a diagram for a divisional organizational chart. 10-7. Draw a strategic business unit organizational chart. 10-8. Illustrate a matrix organizational chart. 10-9. List ten “d o ’s and d o n 'ts” regarding developm ent

o f organizational charts.

10-10. Com pare and contrast restructuring and reengineering. 10-11. Describe five ways a firm could link perform ance and

pay, to strategies. 10-12. List, in order o f im portance, eight ways and means

for altering an organization’s culture. Explain your answer.

10-13. Why are so many firms today installing corporate wellness program s?

10-14. Discuss how business attitudes towards “balancing work life and home life" vary across three countries that you are fam iliar with.

10-15. Discuss the glass ceiling in your country versus the United States.

10-16. Discuss ESOPs in your country com pared to the United States.

10-17. In order o f importance, in your opinion, list six advantages o f a matrix organizational structure.

CHAPTER 10 • STRATEGY EXECUTION 365

10-18. Determine whether your college or university has a corporate wellness program. Provide examples o f poli­ cies that could be used to implement such a program.

10-19. Do you think horizontal consistency o f objectives is as important as vertical consistency? Explain using an example.

10-20. Define policies. Give four exam ples o f policies for a bank.

10-21. Discuss your preference on each o f the trade-off decisions required for strategy implementation. Explain why.

10-22. List three categories or approaches for conflict resolu­ tion. Which approach would you use for a salesperson who has had a disagreem ent with a client, regarding value of a property to be listed for sale?

10-23. In order o f importance, list six sym ptom s o f an ineffective organizational structure.

10-24. Explain why the functional organizational structure is the m ost widely used around the world.

10-25. List the advantages and disadvantages of a functional versus divisional structure.

10-26. How should a firm decide between a divisional-by- product versus divisional-by-geographic region type organizational chart?

10-27. A divisional-structure-by-process organizational chart is quite uncommon. Give two exam ples of the type of com panies where this would be appropriate.

10-28. Illustrate a matrix-type structure fo ra hospital. 10-29. Com pare and contrast restructuring with reengineering. 10-30. Explain why it is so important to link perform ance and

pay to strategies.

10-31. Describe five tests that are often used to determine whether a perform ance-pay plan will benefit an organization.

10-32. Describe three com monly used strategies to minimize employee resistance to change. W hich approach would you most often use? W hy?

10-33. Give a hypothetical example of each labor cost-saving tactic listed in the chapter.

10-34. Use the Internet to find five com panies in your country, which operate based on an ESOP. Present your list to the class.

10-35. Provide the advantages and disadvantages o f a firm operating based on an ESOP.

10-36. Visit www.workingmother.com and find five exam ples of firms, which are best suited for working m others, and that have business locations in your city.

10-37. There were only 12 Fortune 500 women CEOs in 2009. Conduct an Internet research to identify five com panies in your country that have women CEOs. Why arc there so few women CEOs?

10-38. List four benefits o f having a diverse workforce. 10-39. Explain why corporate wellness program s are becoming

increasingly popular. I(M 0. Define and give an exam ple o f Six Sigma. 10-41. Define a glass ceiling. Provide an example. 10-42. How many divisions would a firm have to have for you

to recommend an SBU type structure? Why? 10-43. Explain when a matrix type structure may be the most

effective for an organization. 1(1-44. How would you link com pensation of your em ployees

to perform ance o f your business?

MyManagementLab® Go to mymanagementlab.com for the following Assisted-graded writing questions: 10-45. What are the two major disadvantages of an SBU-type 10-47. M ymanagementlab Only— com prehensive writing

organizational structure? W hat arc the two major assignment for this chapter, advantages? At what point in a firm ’s growth do you feel the advantages offset the disadvantages? Explain.

10-46. Would you recommend a divisional structure by geographic area, product, customer, or process for a medium-sized bank in your local area? W hy?

366 CHAPTER 10 • STRATEGY EXECUTION

Current Readings Allio, M ichael K. “Strategic Dashboards: Designing and

Deploying Them to Improve Implementation." Strategy and Leadership 40, no. 5 (2012): 24-31.

Beeson, John, and Anna M arie Valerio. "The Executive Leadership Imperative: A New Perspective on How Com panies and Executives Can Accelerate the Development o f Women Leaders.” Business Horizons 55, no. 5 (Septem ber 2012): 417-425.

Cam pbell, Benjamin A. Campbell. Russell Coff, and David Kryscynski. “Rethinking Sustained Com petitive Advantage from Human Capital.” The Academy o f Management Review 37, no. 3 (July 2012): 376.

Csaszar, Felipe A. “Organizational Structure as a Determinant o f Performance: Evidence from Mutual Funds.” Strategic Management Journal 33, no. 6 (June 2012): 611-632.

Chng. Daniel Han Ming, M atthew S. Rodgers. Eric Shih. and Xiao-Bing Song. “When does incentive com pensation motivate managerial behaviors? An experimental investigation of the fit between incentive com pensation, executive core self-evaluation, and firm performance.” Strategic Management Journal 33. no. 12 (Decem ber 2012): 1343-1362.

Davis, Paul .1. "A Model for Strategy Implementation and Conflict Resolution in the Franchise Business.” Strategy and Leadership 40, no. 5 (2012): 32-38.

Denning. Stephen. “Gary Hamel: M anaging While Under the Inllucnce o f Innovation.” Strategy and Leadership 40, no. 5 (2012): 12-18.

Dezso, Cristian L., and David Gaddis Ross. “Does Female Representation in Top M anagement Improve Firm Performance? A Panel Data Investigation.” Strategic Management Journal 33, no. 9 (Septem ber 2012): 1072-1089.

Fulmer, C. Ashley, and M ichele J. Gelfand. “At What Level (and in W hom) We Trust: Trust Across M ultiple Organization Levels.” Journal o f Management 38. no. 4 (July 2012): 1167.

Gulati, Ranjay, Phanish Puranam, and Michael Tushman. "M eta-Organization Design: Rethinking Design in

Interorganizational and Com munity Contexts.” Strategic Management Journal 33, no. 6 (June 2012): 571-586.

Karim, Samina, and Charles Williams. “Structural Knowledge: How Executive Experience with Structural Composition Affects Intrafirm Mobility and Unit Reconfiguration.” Strategic Management Journal 33. no. 6 (June 2012): 681-709.

Katzenbach, Jon R., Ilona Steffen, and Caroline Kronley. “Cultural Change That Sticks.” Harvard Business Review (July-August 2012): 110.

King, Eden B.. Jeremy F. Dawson, M ichael A. West, Veronica L. G ilrane, Chad I. Peddie, and Lucy Bastin. “Why Organizational and Com m unity Diversity Matter: Representativeness and the Emergence o f Incivility and Organizational Performance.” The Academy o f Management Journal 54 , no. 6 (Decem ber 201 1): 1103.

Larkin, Ian. Lam ar Pierce, and Francesca Gino. “The Psychological Costs o f Pay-for-Perform ance: Implications for the Strategic Com pensation o f Employees.“ Strategic Management Journal 33, no. 10 (October 2012): 1194-1214.

Lechner, Christoph, and Steven W. Floyd. “G roup Influence Activities and the Performance o f Strategic Initiatives.” Strategic Management Journal 33, no. 5 (May 2012): 478-495.

Prats, Julia, M arc Sosna, and S. R am akrishna Velamuri. “M anaging in D ifferent G row th C ontexts.” California Management Review 54, no. 4 (Sum m er 2012): 118-142.

Puranam, Phanish, M ario Raveendran. and Thorbjorn Knudsen. “Organization Design: The Epistem ic Interdependence Perspective.” The Academy o f Management Review 37, no. 3 (July 2012): 419.

Wulf, Julie. “The Flattened Firm: Not as Advertised.” Inside CMR 55. no. 1 (Fall 2012): 5.

A SSU R A N CE OF LEARNING EX ER C ISES EXERCISE 10A

Developing an Organizational Chart for Accenture pic Purpose Accenture is featured in the opening chapter case as a firm that engages in excellent strategic plan­ ning. Accenture pic. headquartered in Dublin, Ireland, is the world’s largest consulting firm measured by revenues. As of August 20 13. the company has approximately 266.000 employees serving clients in more than 120 countries. India is the single largest employee base for Accenture, with the head­ count being close to 100,000, compared to about 50,000 in the United States.

This exercise gives you practice developing an organizational chart.

CHAPTER 10 • STRATEGY EXECUTION 367

Instructions Step 1 Visit Accenture’s website. Review the company’s most recent Annual Report. Note the list

of top managers of the firm. Step 2 Develop an organizational chart for Accenture based on the titles of their top executives. Step 3 Develop a recommended organizational chart for Accenture based on the guidelines

presented in Chapter 10.

EXERCISE 10B

Assessing Accenture’s Philanthrophy Efforts Purpose Accenture recently awarded Quest Alliance India an additional grant of US$623,000 to help Quest provide approximately 3.000 disadvantaged young people with career and workplace skills. The grant brings Accenture's direct support to Quest Alliance India to more than US$950,000 since 2009. This exercise gives you practice comparing a company’s philanthrophy efforts vs its major rivals.

Instructions Step I Visit Accenture’s website and click on the Citizenship and Values hotlink. Review Accenture’s

sustainability efforts. Step 2 Identify Accenture’s major competitors. Step 3 Compare and contrast Accenture’s sustainability efforts versus its two major competitors.

EXERCISE 10C

Revising adidas AG’s Organizational Chart Purpose Developing and altering organizational charts is an important skill for strategists to possess. This exercise can improve your skill in altering an organization’s hierarchical structure in response to new strategies being formed.

Instructions Step 1 Develop an organizational chart for adidas. On a separate sheet of paper, answer the

following questions: 1. What type of organizational chart have you illustrated for adidas? 2. What improvements could you recommend for the adidas organizational chart?

Give your reasoning for each suggestion. Step 2 Now consider the following:

1. What aspects of your adidas chart do you especially like? 2. What type of organizational chart do you believe would best suit adidas? Why?

EXERCISE 10D

Exploring Objectives Purpose The purpose of this exercise is to bridge the gap between key topics in Chapter 10 versus what com­ panies are doing in your area with regard to having clearly defined objectives.

Instructions Do sufficient research to discover five businesses in your local area that have clearly defined objec­ tives. Discuss the nature and role of objectives in these firms.

368 CHAPTER 10 • STRATEGY EXECUTION

Understanding My University’s Culture Purpose It is something of an art to uncover the basic values and beliefs that are buried deeply in an organiza­ tion’s rich collection of stories, language, heroes, heroines, and rituals. Yet culture can be the most important factor in implementing strategies.

Instructions Step l On a separate sheet of paper, list the following terms: hero/heroine, belief, metaphor, language,

value, symbol, story, legend, saga, folktale, myth, ceremony, rite, and ritual. Step 2 For your college or university, give examples of each term. If necessary, speak with faculty,

staff, alumni, administration, or fellow students of the institution to identify examples of each term.

Step 3 Report your findings to the class. Tell the class how you feci regarding cultural products being consciously used to help implement strategies.

EXERCISE 10E

Notes 1. Dale McConkey. "Planning in a Changing Environment,”

Business Horizons. Septem ber-O ctober 1988. 66 .

2. A. G. Bedeian, and W. F. Glueck, Management, 3rd ed. (Chicago: The Dryden Press, 1983), 212.

3. Boris Yavitz and William Newman, Strategy in Action: The Execution, Politics, and Payoff o f Business Planning (New York: The Free Press, 1982), 195.

4. E. H. Schein. “Three Cultures o f M anagement: The Key to Organizational Learning,” Sloan Management Review 38. 1 (1996): 9-20.

5. S. Ghoshal, and C. A. Bartlett, “Changing the Role of M anagement: Beyond Structure to Processes.” Harvard Business Review 73. 1 (1995): 88 .

6 . Mike Ester, “Coca-Cola Starts a Horse Race for Next CEO,” Wall Street Journal (July 31. 2 0 12): B 1.

7. Joann Lublin, “Chairm an-CEO Split Gains Allies,” Wall Street Journal, March 30, 2009. B4.

8. Karen Richardson, “The ‘Six S igm a’ Factor for Home Depot ” Wall Street Journal, January 4. 2007, C3.

9. “Want to Be a M anager? Many People Say No, Calling Job M iserable,” Wall Street Journal, April 4, 1997, 1;

Stephanie Armour. "M anagem ent Loses Its Allure,” USA Today. October 10, 1997, IB.

10. Bill George, “Executive Pay: Rebuilding Trust in an Era of Rage,” Bloomberg Businessweek. Septem ber 13-19, 2010. 56.

11. Richard Brown, “Outsider CEO: Inspiring Change with Force and G race” USA Today (July 19, 1999): 3B.

12. Emily Chasan, “Stock Loses Some Sway on Pay,” Wall Street Journal (October 30, 2012): B4.

13. Yavitz and Newman. 58.

14. Jack Duncan, Management (New York: Random House, 1983): 381-390.

15. E. H. Schein, “The Role o f the Founder in Creating Organizational Culture ” Organizational Dynamics (Sum m er 1983): 13-28.

16. T. Deal and A. Kennedy, “Culture: A New Look Through Old Lenses.” Journal o f Applied Behavioral Science 19. no. 4 (1983): 498-504.

17. H. Ibsen, “The Wild Duck,” in O. G. Brochett and L. Brochett (eds.), Plays fo r the Theater (New York: Holt, Rinehart & W inston, 1967); R. Pascale, “The Paradox

CHAPTER 10 • STRATEGY EXECUTION 369

o f ‘Corporate Culture’: Reconciling Ourselves to Socialization,” California Management Review 28. no. 2(1985): 26, 37-40.

18. T. Deal and A. Kennedy, Corporate Cultures: The Rites and Rituals o f Corporate Life (Reading, MA: Addison- Wesley, 1982): 256.

19. Robert Stobaugh, and Piero Telesio, “Match M anufacturing Policies and Product Strategy." Harvard Business Review 61. no. 2 (M arch-A pril 1983): 113.

20. Sudeep Reddy, “Em ployers Increasingly Rely on Tem ps. Part-T im ers.” Wall Street Journal, O ctober 1 1. 2010, A4.

21. R. T. Lenz and M arjorie Lyles, “M anaging Human Resource Problems in Strategy Planning Systems,” Journal o f Business Strategy 60. no. 4 (Spring 1986): 58.

22. J. Warren Henry, “ESOPs with Productivity Payoffs,” Journal o f Business Strategy (Ju ly-A ugust 1989): 33.

23. Conor Dougherty, “Strides by Women, Still a Wage Gap,” Wall Street Journal, March 1, 201 L A3. Also, David Jackson and Mimi Hall, “W omen Gain in Education and Longevity,” USA Today, M arch 2, 2011, 5A.

24. Suzanne Vranica, “Ad Firms Heed Diversity,” Wall Street Journal, November 29, 2010, B7.

25. Paulo Prada, “Women Ascend in Latin America," Wall Street Journal, December 24, 2010, A 10.

26. Kathy Chu, “Asian Women Fight Barriers,” Wall Street Journal (July 2, 2012): B4.

27. Ibid.

28. Ibid.

29. Berry, Leonard L„ Ann M irabito, and W illiam Baun, “W hat’s The Hard Return On Em ployee W ellness Program s?” Harvard Business Review, D ecem ber 2010, 104-1 12. Also, Jen Wieczner. “Your Com pany Wants to Make You Healthy.'" Wall Street Journal, April 9. 2013, R6 ,

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370

Strategy Monitoring CHAPTER OBJECTIVES After studying this chapter, you should be able to do the following:

1. Describe a practical framework for evaluating strategies.

2. Explain why strategy evaluation is complex, sensitive, and yet essential for organizational success.

3. Discuss the importance of contingency planning in strategy evaluation.

4. Explain the role of auditing in strategy evaluation.

5. Describe and develop a Balanced Scorecard.

6. Discuss three 21st-century challenges in strategic management.

ASSURANCE OF LEARNING EXERCISES The following exercises are found at the end of this chapter.

e x e r c is e 11 a Evaluating BHP B illito n ’s Strategies

e x e r c is e 11 b Preparing a Strategy-Evaluation Report for adidas AG

e x e r c is e 11 c Preparing a Balanced Scorecard for adidas AG e x e r c is e 11 d Evaluate My University’s Strategies

372 CHAPTER 11 • STRATEGY MONITORING

The best formulated and best implemented strategies become obsolete as a firm ’s exter­nal and internal environm ents change. It is essential, therefore, that strategists system ­atically review, evaluate, and control the execution o f strategies. This chapter presents a framework that can guide m anagers’ efforts to evaluate strategic-m anagem ent activities, to make sure they arc working, and to make timely changes. Guidelines arc presented for form u­ lating, implementing, and evaluating strategies. BHP Billiton is an example company that has reinvented itself a number of times by continually evaluating its strategies and taking bold cor­ rective actions to continue growing.

The Nature of Strategy Evaluation The strategic-management process results in decisions that can have significant, long-lasting consequences. Erroneous strategic decisions can inflict severe penalties and can be exceedingly difficult, if not impossible, to reverse. Most strategists agree, therefore, that strategy evaluation is vital to an organization’s well-being; timely evaluations can alert management to problems or potential problems before a situation becomes critical. Strategy evaluation includes three basic activities: ( 1) examining the underlying bases of a firm’s strategy, (2 ) com paring expected results with actual results, and (3) taking corrective actions to ensure that performance conforms to plans. The strategy-evaluation stage of the strategic-management process is illustrated in Figure I 1 - 1 with white shading.

Adequate and timely feedback is the cornerstone of effective strategy evaluation. Strategy evaluation can be no better than the information on which it is based. Too much pressure from top managers may result in lower managers contriving numbers they think will be satisfactory.

Strategy evaluation can be a com plex and sensitive undertaking. Too much em phasis on evaluating strategies may be expensive and counterproductive. No one likes to be evaluated too closely! The more managers attempt to evaluate the behavior o f others, the less control they have. Yet too little or no evaluation can create even worse problems. Strategy evaluation is essen­ tial to ensure that stated objectives arc being achieved.

I STRATEGIC MANAGEMENT

BHP Billiton

SHOWCASED

BHP Billiton is a large Australian multinational mining and petroleum company headquartered in Melbourne. BHP has major offices in London. BHP is arguably the world's largest mining company and among the top ten largest companies in the world measured by market capitalization. Fortune in 2013 ranked BHP as the 115th largest company in the world and the 20,ri most profitable. The Melbourne side of the firm is BHP Billiton Limited: the London side is BHP Billiton Pic.

BHP is among the world's top producers of iron ore, coal, aluminum, copper, manganese, nickel, silver, uranium, and potash. BHP also has crude oil and natural gas holdings. BHP may soon divest its diamond assets. BHP recently paid $4.75 billion in cash to Chesapeake Energy for all of the company's shale assets and 487,000 acres (1,970 km2) of mineral rights leases and 420 miles (680 km) of pipeline located in north central Arkansas in the USA. The wells on the mineral leases are producing about 415 million cubic feet of natural gas per day. BHP plans to spend $800 million to $1 billion a year over 10 years to develop the field and triple production.

BHP recently acquired Petrohawk Energy in the USA for $12.1 billion in cash, considerably expanding its shale natural gas resources.

In 2012, BHP ceased operations at its $20 billion Olympic Dam cop­ per and uranium mine expansion project in South Australia, as a result of falling commodity prices and slowing global economic growth. The company just sold its Yeelirrie Uranium Project to Canadian Cameco for about $430 million as part of a broader move to step away from resource expansion in Australia.

In August 2013, BHP announced the vesting outcomes for the five-year long-term incentive plan (LTIP) awards for their top execu­ tives. For awards to be granted, BHP had to deliver a total shareholder return (TSR) that exceeded the TSR of a group of peer companies by an average of 5.5 percent per year for five years, or 30.7 percent in total compounded over a five year performance period. For the perfor­ mance period that ended June 30, 2013, the TSR for peer companies was negative 44.0 percent, compared to BHP's negative 9.4 percent. Thus, BHP top executives received the awards.

■■■

CHAPTER 11 • STRATEGY MONITORING 373

I___________________ Strategy _______________________ I_______ Strategy _________Strategy ______ I Formulation I Implementation I Evaluation

FIGURE 11-1 A Comprehensive Strategic-Management Model

Source: Fred R. David, adapted from “How Companies Define Their Mission” Long Range Planning 22. no. 3 (June 1988): 40. © Fred R. David.

In many organizations, strategy evaluation is sim ply an appraisal o f how well an organization has performed. Have the firm 's assets increased? Has there been an increase in profitability? Have sales increased? Have productivity levels increased? Have profit margin, return on invest­ ment, and earnings-per-share ratios increased? Some firms argue that their strategy m ust have been correct if the answers to these types o f questions are affirmative. Well, the strategy or strategies may have been correct, but this type of reasoning can be misleading because strategy evaluation m ust have both a long-run and short-run focus. Strategies often do not affect short­ term operating results until it is too late to make needed changes.

It is impossible to dem onstrate conclusively that a particular strategy is optimal or even to guarantee that it will work. One can, however, evaluate it for critical flaws. Richard Rumek offered tour criteria that could be used to evaluate a strategy: consistency, consonance, feasibil­ ity. and advantage. Described in Table 11- 1, consonance and ad v a n ta g e are mostly based on a firm ’s external assessment, whereas consistency and feasibility are largely based on an internal assessment.

Strategy evaluation is important because organizations face dynam ic environm ents in which key external and internal factors often change quickly and dramatically. Success today is no guarantee of success tomorrow! Joseph Stalin was a ruthless leader (from 1928 on) and premier

374 CHAPTER 11 • STRATEGY MONITORING

TA BLE 11-1 Rumelt's Criteria for Evaluating Strategies

Consistency

A strategy should not present inconsistent goals and policies. Organizational conflict and interdepartmental bickering are often symptoms of managerial disorder, but these problems may also be a sign of strategic inconsistency. Three guidelines help determine if organizational problems are the result of inconsistencies in strategy: • If managerial problems continue despite changes in personnel and if they tend to be issue-based rather than people-based, then strategies

may be inconsistent. • If success for one organizational department means, or is interpreted to mean, failure for another department, then strategies may be

inconsistent. • If policy problems and issues continue to be brought to the lop for resolution, then strategies may be inconsistent.

Consonance

Consonance refers to the need for strategists to examine sets o f trends, as well as individual trends, in evaluating strategies. A strategy must represent an adaptive response to the external environment and to the critical changes occurring within it. One difficulty in matching a firm’s key internal and external factors in the formulation of strategy is that most trends are the result of interactions among other trends. For example, the daycare explosion came about as a combined result of many trends that included a rise in the average level of education, increased inflation, and an increase in women in the workforce. Although single economic or demographic trends might appear steady for many years, there are waves of change going on at the interaction level.

Feasibility

A strategy must neither overtax available resources nor create unsolvable subproblems. The final broad test of strategy is its feasibility; that is, can the strategy be attempted within the physical, human, and financial resources of the enterprise? The financial resources of a business are the easiest to quantify and are normally the first limitation against which strategy is evaluated. It is sometimes forgotten, however, that innovative approaches to financing are often possible. Devices, such as captive subsidiaries, sale-leaseback arrangements, and tying plant mortgages to long-term contracts, have all been used effectively to help win key positions in suddenly expanding industries. A less quantifiable, but actually more rigid, limitation on strategic choice is that imposed by individual and organizational capabilities. In evaluating a strategy, it is important to examine whether an organization has demonstrated in the past that it possesses the abilities, competencies, skills, and talents needed to carry out a given strategy.

Advantage

A strategy must provide for the creation or maintenance of a competitive advantage in a selected area of activity. Competitive advantages normally are the result of superiority in one of three areas: ( l ) resources, (2) skills, or (3) position. The idea that the positioning of one's resources can enhance their combined effectiveness is familiar to military theorists, chess players, and diplomats. Position can also play a crucial role in an organization’s strategy. Once gained, a good position is defensible—meaning that it is so costly to capture that rivals arc deterred from full-scale attacks. Positional advantage tends to be self-sustaining as long as the key internal and environmental factors that underlie it remain stable. This is why entrenched firms can be almost impossible to unseat, even if their raw skill levels are only average. Although not all positional advantages are associated with size, it is true that larger organizations tend to operate in markets and use procedures that turn their size into advantage, whereas smaller firms seek product or market positions that exploit other types of advantage. The principal characteristic of good position is that it permits the firm to obtain advantage from policies that would not similarly benefit rivals without the same position. Therefore, in evaluating strategy, organizations should examine the nature of positional advantages associated with a given strategy.

Source: Adapted from Richard Rumelt. "The Evaluation of Business Strategy,” in W. F. Glueck (ed.). Business Policy and Strategic Management (New York: McGraw-Hill, 1980), 359-367. Used with permission.

(from 1941 on) o f the Soviet Union until his death in 1953. A fam ous quote from Stalin was: History shows that there are no invincible armies. This quote reveals that even the mightiest, most successful firms must continually evaluate their strategies and be wary o f rival firms. An organization should never be lulled into com placency with success. Countless firms have thrived one year only to struggle for survival the following year. Peter Drucker said: Unless strategy evaluation is performed seriously and systematically, and unless strategists are willing to act on the results, energy will be used up defending yesterday.”

Demise can come quickly. For example, the large clothing retailer J.C. Penney, based in Plano. Texas, was profitable and fine, until they hired CEO Ron Johnson in November 20 1 1. Johnson implemented a new strategic plan at Penney’s that included doing away with coupons, promo­ tions, and discounting in favor of his “ fair and square pricing1' policy, building branded boutiques stores-within stores, replacing their chief marketing officer, Michael Francis, with himself, adding more celebrity brands and high-tech features to attract younger customers, exiting from the outlet

CHAPTER 11 • STRATEGY MONITORING 375

business, and extensive, expensive remodeling. Johnson envisioned all Penney stores to have tables with iPads for customers to use, and activities for kids such as making greeting cards, and even Pilates and yoga classes within stores.1 M oody’s Investors Service downgraded Penney's long­ term debt two notches to Ba3 from Bal in August 2012; Penney’s is still unprofitable in late 2013.

Another exam ple o f quick dem ise is Hewlett-Packard, which delivered an $8.9 billion loss in its fiscal third quarter o f 2012 as the firm ’s revenue dropped to $29.7 billion. Consum ers are Hocking in the millions to tablets and away from desktop and laptop com puters, crushing HP who had not anticipated such as swift switch in consum er preferences. This consum er trend is also crushing another U.S. icon company. Intel, which reported a 14-percent drop in third-quarter 2012 profits.

Strategy evaluation is becoming increasingly difficult with the passage o f time, for many reasons. Domestic and world econom ies were more stable in years past, product life cycles were longer, product development cycles were longer, technological advancement was slower, change occurred less frequently, there were fewer com petitors, foreign com panies were weak, and there were more regulated industries. O ther reasons why strategy evaluation is more difficult today include the following trends:

1. A dram atic increase in the environm ent’s complexity 2. The increasing difficulty o f predicting the future with accuracy 3. The increasing number of variables 4. The rapid rate o f obsolescence o f even the best plans 5. The increase in the num ber of both dom estic and world events affecting organizations 6. The decreasing tim e span for which planning can be done with any degree o f certainty2

A fundamental problem facing managers today is how to control em ployees effectively in light o f modern organizational dem ands for greater Hexibility, innovation, creativity, and initiative from em ployees. ' How can managers today ensure that empowered em ployees acting in an entrepreneurial m anner do not put the well-being of the business at risk? The potential costs to com panies in term s o f dam aged reputations, fines, m issed opportunities, and diversion o f m anagem ent’s attention are enormous.

When em powered em ployees are held accountable for and pressured to achieve specific goals and are given wide latitude in their actions to achieve them, there can be dysfunctional behavior. For example, Nordstrom , the upscale fashion retailer known for outstanding custom er service, wras subjected to lawsuits and fines when em ployees underreported hours worked to increase their sales per hour— the com pany’s primary perform ance criterion.

The Process of Evaluating Strategies Strategy evaluation is necessary for all sizes and kinds o f organizations. Strategy evalua­ tion should initiate managerial questioning of expectations and assumptions, should trigger a review o f objectives and values, and should stimulate creativity in generating alternatives and formulating criteria o f evaluation.4 Regardless o f the size of the organization, a certain am ount of management by wandering around at all levels is essential to effective strategy evaluation. Strategy-evaluation activities should be perform ed on a continuing basis, rather than at the end o f specified periods o f lime or ju st after problem s occur. W aiting until the end o f the year, for example, could result in a firm closing the barn door after the horses have already escaped.

Evaluating strategies on a continuous rather than on a periodic basis allows benchmarks of progress to be established and more effectively monitored. Some strategies take years to im ple­ ment; consequently, associated results may not become apparent for years. Successful strategies com bine patience with a w illingness to promptly take corrective actions when necessary. There always com es a time when corrective actions are needed in an organization! Centuries ago, a w riter ( perhaps Solom on) made the following observations about change:

There is a time for everything,

A time to be born and a time to die.

A time to plant and a time to uproot,

A tim e to kill and a time to heal,

A time to tear down and a time to build.

376 CHAPTER 11 • STRATEGY MONITORING

A time to weep and a time to laugh,

A time to mourn and a time to dance,

A time to scatter stones and a time to gather them,

A time to em brace and a time to refrain,

A time to search and a time to give up,

A time to keep and a time to throw away,

A time to tear and a time to mend,

A time to be silent and a time to speak,

A time to love and a tim e to hate,

A tim e for war and a time for peace.5

M anagers and employees of the firm should be continually aware o f progress being made toward achieving the firm ’s objectives. As key success factors change, organizational members should be involved in determining appropriate corrective actions. If assum ptions and expecta­ tions deviate significantly from forecasts, then the firm should renew stratcgy-formulation activities, perhaps sooner than planned. In strategy evaluation, like strategy formulation and strategy im plementation, people make the difference. Through involvement in the process of evaluating strategies, managers and em ployees become com m itted to keeping the firm moving steadily toward achieving objectives.

A Strategy-Evaluation Framework Table 11-2 summ arizes strategy-evaluation activities in terms o f key questions that should be addressed, alternative answers to those questions, and appropriate actions for an organization to take. Notice that corrective actions are almost always needed except when (1) external and inter­ nal factors have not significantly changed and (2) the firm is progressing satisfactorily toward achieving stated objectives. Relationships among strategy-evaluation activities are illustrated in Figure 11-2.

Reviewing Bases of Strategy As shown in Figure 11-2, reviewing the underlying bases of an organization’s strategy could be approached by developing a revised EFE Matrix and IFE Matrix. A revised IFE Matrix should focus on changes in the organization’s management, marketing, finance and accounting, production and operations, research and development (R&D), and management information systems (MIS) strengths and weaknesses. A revised EFE Matrix should indicate how effective

TA BLE 11-2 A Strategy-Evaluation Assessment Matrix

Have Major Changes Occurred

in the Firm's Internal Strategic

Position?

Have Major Changes Occurred

in the Firm's External Strategic

Position?

Has the Firm Progressed

Satisfactorily Toward Achieving Its Stated

Objectives? Result

No No No Take corrective actions

Yes Yes Yes Take corrective actions

Yes Yes No Take corrective actions

Yes No Yes Take corrective actions

Yes No No Take corrective actions

No Yes Yes Take corrective actions

No Yes No Take corrective actions

No No Yes Continue present strategic course

CHAPTER 11 • STRATEGY MONITORING 377

ACTIVITY ONE: REVIEW UNDERLYING BASES OF STRATEGY

Prepare revised Internal Factor Evaluation (IFE) Matrix

Compare revised to existing Internal Factor Evaluation (IFE) Matrix

Prepare revised External Factor Evaluation (EFE) Matrix

Compare revised to existing External Factor Evaluation (EFE) Matrix

Do significant differences occur?

r

ACTIVITY TWO: MEASURE ORGANIZATIONAL PERFORMANCE

Compare planned to actual progress toward meeting stated objectives

r a Do significant differences occur?

V J

ACTIVITY THREE: TAKE CORRECTIVE ACTIONS

V

Continue present course J FIGURE 11-2

A Strategy-Evaluation Framework

a firm 's strategies have been in response to key opportunities and threats. This analysis could also address such questions as the following:

1. How have com petitors reacted to our strategies? 2. How have com petitors’ strategies changed? 3. Have m ajor com petitors’ strengths and weaknesses changed? 4. W hy are com petitors m aking certain strategic changes? 5. WThy are some com petitors’ strategies more successful than others? 6. How satisfied are our com petitors w ith their present market positions and profitability? 7. How far can our major com petitors be pushed before retaliating? 8. How could we more effectively cooperate with our com petitors?

378 CHAPTER 11 • STRATEGY MONITORING

Numerous external and internal factors can prevent linns from achieving long-term and annual objectives. Externally, actions by com petitors, changes in dem and, changes in technology, economic changes, dem ographic shifts, and governm ental actions may prevent objectives from being accomplished. Internally, ineffective strategics may have been chosen or im plementation activities may have been poor. Objectives may have been too optim istic. Thus, failure to achieve objectives may not be the result o f unsatisfactory work by managers and e m p lo y e e s . All organizational m embers need to know this to encourage their support for strategy-evaluation activities. Organizations desperately need to know as soon as possible when their strategies are not effective. Som etim es managers and em ployees on the front lines discover this well before strategists.

External opportunities and threats and internal strengths and weaknesses that represent the bases o f current strategies should continually be monitored for change. It is not really a question o f whether these factors will change but rather when they will change and in w hat ways. Here are some key questions to address in evaluating strategies:

1. Are our internal strengths still strengths? 2. Have we added other internal strengths? If so, what are they? 3. Are our internal weaknesses still weaknesses? 4. Do we now have other internal weaknesses? If so, what are they? 5. Are our external opportunities still opportunities? 6. Are there now other external opportunities? If so, what are they? 7. Are our external threats still threats? 8. Are there now other external threats? If so, what are they? 9. Are we vulnerable to a hostile takeover?

Measuring Organizational Performance Another important strategy-evaluation activity is m easuring o rgan izational perform ance. This activity includes com paring expected results to actual results, investigating deviations from plans, evaluating individual perform ance, and exam ining progress being made toward meeting stated objectives. Both long-term and annual objectives are com m only used in this process. Criteria for evaluating strategies should be measurable and easily verifiable. C riteria that predict results may be more important than those that reveal what already has happened. For example, rather than simply being informed that sales in the last quarter were 20 percent under what was expected, strategists need to know that sales in the next quarter may be 20 percent below standard unless some action is taken to counter the trend. Really effective control requires accu­ rate forecasting.

Failure to make satisfactory progress toward accom plishing long-term or annual objectives signals a need for corrective actions. Many factors, such as unreasonable policies, unexpected turns in the economy, unreliable suppliers or distributors, or ineffective strategies, can result in unsatisfactory progress toward meeting objectives. Problems can result from ineffectiveness (not doing the right things) or inefficiency (poorly doing the right things).

Many variables can and should be included in measuring organizational perform ance. As indicated in Table 11-3. typically a favorable or unfavorable variance is recorded monthly, quarterly, and annually, and resultant actions needed arc then determined.

Determining which objectives are m ost important in the evaluation o f strategies can be difficult. Strategy evaluation is based on both quantitative and qualitative criteria. Selecting the exact set o f criteria for evaluating strategies depends on a particular organization’s size, industry, strategies, and management philosophy. An organization pursuing a retrenchm ent strategy, for example, could have an entirely different set o f evaluative criteria from an organization pursuing a market-development strategy. Quantitative criteria commonly used to evaluate strategies are financial ratios, often monitored for each segment of the firm. Strategists use ratios to make three critical comparisons: (1) com paring the firm ’s perform ance over different time periods. (2) com paring the firm ’s performance to com petitors', and (3) com paring the firm 's performance to industry averages.

Some potential problem s are associated with using only quantitative criteria for evaluating strategies. First, m ost quantitative criteria are geared to annual objectives rather than long-term objectives. Also, different accounting m ethods can provide different results on

CHAPTER 11 • STRATEGY MONITORING 379

Factor Actual Result Expected Result Variance Action Needed

Corporate Revenues

Corporate Profits

Corporate ROI

Region I Revenues

Region I Profits

Region I ROI

Region 2 Revenues

Region 2 Profits

Region 2 ROI

Product l Revenues Product l Profits

Product l ROI Product 2 Revenues

Product 2 Profits

Product 2 ROI

ROI. return on investment.

TABLE 11-3 A Sample Framework for Measuring Organizational Performance

many quantitative criteria. Third, intuitive judgm ents are almost always involved in deriving quantitative criteria. Thus, qualitative criteria arc also im portant in evaluating strategies. Human factors such as high absenteeism and turnover rates, poor production quality and quantity rates, or low em ployee satisfaction can be underlying causes of declining performance. M arketing, finance and accounting, R&D. or MIS factors can also cause financial problems.

Some additional key questions that reveal the need for qualitative or intuitive judgm ents in strategy evaluation are as follows:

1. How good is the firm ’s balance o f investments between high-risk and low-risk projects? 2. How good is the firm 's balance o f investments between long-term and short-term projects? 3. How good is the firm 's balance o f investments between slow-growing m arkets and fast-

growing m arkets? 4. How good is the firm 's balance o f investments among different divisions? 5. To what extent are the firm ’s alternative strategies socially responsible? 6. W hat are the relationships am ong the firm ’s key internal and external strategic factors? 7. How are m ajor com petitors likely to respond to particular strategies?

Taking Corrective Actions The final strategy-evaluation activity, tak in g corrective actions, requires making changes to com petitively reposition a firm for the future. As indicated in Table 11-4, examples of changes that may be needed are altering an organization’s structure, replacing one or more key individu­ als, selling a division, or revising a business mission. O ther changes could include establishing or revising objectives, devising new policies, issuing stock to raise capital, adding additional salespersons, differently allocating resources, or developing new perform ance incentives. Taking corrective actions does not necessarily mean that existing strategies will be abandoned or even that new strategies must be formulated.

The probabilities and possibilities for incorrect or inappropriate actions increase geom etri­ cally with an arithm etic increase in personnel. Any person directing an overall undertaking must check on the actions o f the participants as well as the results that they have achieved. If either the actions or results do not comply with preconceived or planned achievements, then corrective actions are needed.6

380 CHAPTER 11 • STRATEGY MONITORING

TA BLE 11-4 Corrective Actions Possibly Needed to Correct Unfavorable Variances

1. Alter the firm's structure 2. Replace one or more key individuals 3. Divest a division 4. Alter the firm’s vision or mission 5. Revise objectives 6. A lte r s tra teg ies

7. Devise new policies 8. Insinll new performance incentives 9. Raise capital with stock or debt

10. Add or terminate salespersons, employees, or managers 11. Allocate resources differently 12. Outsource (or rein in) business functions

The largest office-supplies chain in the USA with 2,295 stores globally and 1,500 in the USA, Staples, is taking corrective actions to try to survive in the big-box oflice-supply store business. Many analysts say it is too little too late, but Staples is reducing its U.S. store space by 15 percent between 2013 and 2015 and is opening sm aller stores more focused on mobile applications. Especially hurting Staples (and OfficeMax and Office Depot) are trends such as: (a) consumers prefer to purchase office supplies online (cheaper) from rivals such as Amazon, and (b) there is falling demand for office supplies since handheld devices such as the iPad have reduced demand for personal com puters, printers, and even paper. Staples does own a fleet of vehicles that can deliver orders for free the next day, as com pared to Amazon that only offers free two-day deliveries to members paying $79 a year to be part o f Amazon Prime.

No organization can survive as an island; no organization can escape change. Taking corrective actions is necessary to keep an organization on track toward achieving stated objec­ tives. In his thought-provoking books ¡'inure Shock and The Third Wave, Alvin Toffler argued that business environm ents are becoming so dynam ic and complex that they threaten people and organizations with fu tu re shock, which occurs when the nature, types, and speed of changes overpower an individual’s or organization’s ability and capacity to adapt. Strategy evaluation enhances an organization’s ability to adapt successfully to changing circum stances.

Taking corrective actions raises em ployees’ and m anagers’ anxieties. Research suggests that participation in strategy-evaluation activities is one o f the best ways to overcom e individu­ als’ resistance to change. According to Erez and Kanfer, individuals accept change best when they have a cognitive understanding of the changes, a sense of control over the situation, and an awareness that necessary actions are going to be taken to implement the changes.7

Strategy evaluation can lead to strategy-formulation changes, strategy-im plem entation changes, both formulation and implementation changes, or no changes at all. Strategists cannot escape having to revise strategies and implementation approaches sooner or later. Hussey and Langham offered the following insight on taking corrective actions:

Resistance to change is often em otionally based and not easily overcome by rational argument. Resistance may be based on such feelings as loss o f status, implied criticism of present com petence, fear o f failure in the new situation, annoyance at not being consulted, lack of understanding o f the need for change, or insecurity in changing from well-known and fixed methods. It is necessary, therefore, to overcome such resistance by creating situations o f participation and full explanation when changes are envisaged.8

Corrective actions should place an organization in a better position to capitalize on internal strengths; to take advantage of key external opportunities: to avoid, reduce, or mitigate exter­ nal threats; and to improve internal weaknesses. Corrective actions should have a proper time horizon and an appropriate am ount o f risk. They should be internally consistent and socially responsible. Perhaps most important, corrective actions strengthen an organization’s competitive

CHAPTER 11 • STRATEGY MONITORING 381

position in its basic industry. Continuous strategy evaluation keeps strategists close to the pulse of an organization and provides information needed for an effective strategic-m anagement system. Carter Bayles described the benefits o f strategy evaluation as follows:

Evaluation activities may renew confidence in the current business strategy or point to the need for actions to correct some weaknesses, such as erosion of product superiority or technological edge. In many cases, the benefits of strategy evaluation are much more far-reaching, for the outcome of the process may be a fundamentally new strategy that will lead, even in a business that is already turning a respectable profit, to substantially increased earnings. It is this possibility that justifies strategy evaluation, for the payoff can be very large.9

The Balanced Scorecard Developed in 1993 by Harvard Business School professors Robert Kaplan and David Norton, and refined continually through today, the Balanced Scorecard is a strategy evaluation and control technique. B alanced Scorecard derives its name from the perceived need o f firms to “balance" financial m easures that are oftentim es used exclusively in strategy evaluation and control with nontlnancial measures such as product quality and custom er service. An effective Balanced Scorecard contains a carefully chosen combination o f strategic and financial objectives tailored to the com pany's business.

As a tool to manage and evaluate strategy, the Balanced Scorecard is currently in use at Sears, United Parcel Service, 3M Corporation, Heinz, and hundreds o f other firms. For example, 3M Corporation has a financial objective to achieve annual growth in earnings per share of 10 percent or better, as well as a strategic objective to have at least 30 percent o f sales come from products introduced in the past four years. The overall aim o f the Balanced Scorecard is to “balance” shareholder objectives with custom er and operational objectives. Obviously, these sets o f objectives interrelate and many even conflict. For example, custom ers want low price and high service, which may conflict with shareholders' desire for a high return on their investment. The Balanced Scorecard concept is consistent with the notions of continuous improvement in management (CIM ) and total quality m anagem ent (TQM).

The Balanced Scorecard basic premise is that firms should establish objectives and evaluate strategies on criteria other than financial measures. Financial measures and ratios are vitally impor­ tant in strategic planning, but o f equal importance are factors such as customer service, employee morale, product quality, pollution abatement, business ethics, social responsibility, community involvement, and other such items. In conjunction with financial measures, these “softer" factors comprise an integral part o f both the objective-setting process and the strategy-evaluation process. A Balanced Scorecard for a firm is simply a listing of all key objectives to work toward, along with an associated time dimension of when each objective is to be accomplished, as well as a primary responsibility or contact person, department, or division for each objective.

The Balanced Scorecard is an important strategy-evaluation tool. It is a process that allows firms to evaluate strategies from four perspectives: financial perform ance, custom er knowledge, internal business processes, and learning and growth. The Balanced Scorecard analysis requires that firms seek answers to the following questions and use that information, in conjunction with financial measures, to adequately and more effectively evaluate strategies being implemented:

1. How well is the firm continually improving and creating value along measures such as innovation, technological leadership, product quality, operational process efficiencies, and so on?

2. How well is the firm sustaining and even improving on its core com petencies and com petitive advantages?

3. How satisfied are the firm 's custom ers?

A sample Balanced Scorecard is provided in Table 11-5. Notice that the firm examines six key issues in evaluating its strategies: (1) Customers, (2) Managers/Employees, (3) Operations/ Processes, (4) Community/Social Responsibility, (5) Business Ethics/Natural Environment, and (6) Financial. The basic form of a Balanced Scorecard may differ for different organizations. The Balanced Scorecard approach to strategy evaluation aims to balance long-term with short-term concerns, to balance financial with nonfinancial concerns, and to balance internal

382 CHAPTER 11 • STRATEGY MONITORING

TABLE 11-5 An Example Balanced Scorecard

Area of Objectives Measure or Target Time Expectation Primary Responsibility Customers

l.

2.

3.

4.

Managers/Employees

l. 2. 3.

4.

Operations/Processes

1. 2.

3.

4.

Communi ty/Soc i al Respon s i bi l i ty

l. 2.

3.

4.

Business Ethics/Natural Environment

l.

2.

3. 4

Financial

l.

2.

3.

4.

with external concerns. The Balanced Scorecard would be constructed differently, that is, adapted to particular firms in various industries with the underlying theme or thrust being the same, which is to evaluate the firm’s strategies based on both key quantitative and qualitative measures.

The Balanced Scorecard Institute has a Certification Program that includes two levels o f certification: Balanced Scorecard M aster Professional (BSM P) and Balanced Scorecard Professional (BSP), both of which are offered in association with George Washington University and are achievable through public workshop participation. The website for this program is http://www.balancedscorecard.org/.

Published Sources of Strategy-Evaluation Information A number of publications are helpful in evaluating a firm ’s strategies. For example, Fortune annually identifies and evaluates the Fortune l .000 (the largest m anufacturers) and the Fortune 50 (the largest retailers, transportation com panies, utilities, banks, insurance com ­ panies. and diversified financial corporations in the USA). Fortune ranks the best and worst

CHAPTER 11 • STRATEGY MONITORING 383

TA BLE 11-6 The Most and Least Admired Companies in Management Quality in Various Industries in 2012

Most Admired Least Admired

Koc Holding Sears Holdings McDonald’s China South Industries Group Apple MF Global Holdings Philip Morris International NewPage Holding Costco Wholesale Gas Natural Fenosa J.p. Morgan Chase Yahoo! Wyndham Worldwide AMR Sysco GDF Suez Walt Disney Dongfeng MG

China FAW Group

Source: Based on information accessed November I, 2012 at http://money.cnn.com/magazines/ fortune/most-admired/2012/best_worst/best5.html.

perform ers on various factors, such as return on investment, sales volume, and profitability. Fortune annually publishes its strategy-evaluation research in an article titled “W orld’s Most Adm ired Com panies.” Nine key attributes serve as evaluative criteria: people management; innovativeness; products quality; financial soundness; social responsibility; use o f assets; long­ term investment; global com petitiveness; and quality of management. Fortune's 2012 evaluation in Table 11-6 reveals the firms most adm ired (best m anaged) in their industry.

Businessweek, Industry Week. and Dun's Business Month periodically publish detailed evaluations o f U.S. businesses and industries. Although published sources o f strategy-evaluation information focus primarily on large, publicly held businesses, the com parative ratios and related information are widely used to evaluate small businesses and privately owned firms as well.

Characteristics of an Effective Evaluation System Strategy evaluation m ust meet several basic requirem ents to be effective. First, strategy- evaluation activities must be economical; too much inform ation can be just as bad as too little information, and too many controls can do more harm than good. Strategy-evaluation activities also should be m eaningful; they should specifically relate to a firm ’s objectives. They should provide managers with useful information about tasks over which they have control and influence. Strategy-evaluation activities should provide timely information; on occasion and in some areas, managers may daily need information. For example, when a firm has diversified by acquiring another firm, evaluative information may be needed frequently. However, in an R&D department, daily or even weekly evaluative information could be dysfunctional. Approximate information that is timely is generally more desirable as a basis for strategy evaluation than accurate information that does not depict the present. Frequent measurem ent and rapid report­ ing may frustrate control rather than give better control. The time dimension of control must coincide with the tim e span o f the event being measured.

Strategy evaluation should be designed to provide a true picture o f what is happening. For example, in a severe economic downturn, productivity and profitability ratios may drop alarmingly, although em ployees and managers are actually working harder. Strategy evaluations should fairly portray this type o f situation. Information derived from the strategy-evaluation process should facilitate action and should be directed to those individuals in the organization who need to take action based on it. M anagers com monly ignore evaluative reports that are provided only for informational purposes; not all m anagers need to receive all reports. Controls need to be action-oriented rather than inform ation-oriented.

The strategy-evaluation process should not dom inate decisions; it should foster mutual understanding, trust, and com m on sense. No departm ent should fail to cooperate with another in evaluating strategies. Strategy evaluations should be sim ple, not too cum bersom e, and not too

384 CHAPTER 11 • STRATEGY MONITORING

restrictive. Com plex strategy-evaluation systems often confuse people and accom plish little. The test of an effective evaluation system is its usefulness, not its complexity.

Large organizations require a more elaborate and detailed strategy-evaluation system because it is more difficult to coordinate efforts am ong different divisions and functional areas. Managers in small com panies often com m unicate daily with each other and their em ployees and do not need extensive evaluative reporting systems. Familiarity with local environm ents usually makes gathering and evaluating information much easier for small organizations than for large businesses. But the key to an effective strategy-evaluation system may be the ability to convince participants that failure to accomplish certain objectives within a prescribed time is not necessar­ ily a reflection of their performance.

There is no one ideal strategy-evaluation system. The unique characteristics o f an organiza­ tion, including its size, management style, purpose, problem s, and strengths, can determ ine a strategy-evaluation and control system ’s final design. Robert W aterman offered the following observation about successful organizations' strategy-evaluation and control systems:

Successful com panies treat facts as friends and controls as liberating. M organ Guaranty and Wells Fargo not only survive but thrive in the troubled waters o f bank deregulation, because their strategy evaluation and control systems are sound, their risk is contained, and they know themselves and the com petitive situation so well. Successful com panies have a voracious hunger for facts. They see information where others see only data. Successful com panies maintain tight, accurate financial controls. Their people don’t regard controls as an imposition o f autocracy but as the benign checks and balances that allow them to be creative and free .10

Contingency Planning A basic premise o f good strategic management is that firms plan ways to deal with unfavorable and favorable events before they occur. Too many organizations prepare contingency plans just for unfavorable events; this is a mistake, because both minimizing threats and capitalizing on opportunities can improve a firm ’s com petitive position.

Regardless o f how carefully strategies are formulated, im plem ented, and evaluated, unforeseen events, such as strikes, boycotts, natural disasters, arrival o f foreign com petitors, and government actions, can make a strategy obsolete. To minimize the impact o f potential threats, organizations should develop contingency plans as part o f their strategy-evaluation process. C ontingency p lans can be defined as alternative plans that can be put into effect if certain key events do not occur as expected. Only high-priority areas require the insurance of contin­ gency plans. Strategists cannot and should not try to cover all bases by planning for all possible contingencies. But in any case, contingency plans should be as simple as possible.

Some contingency plans commonly established by firms include the following:

1. If a major com petitor withdraws from particular markets as intelligence reports indicate, what actions should our firm take?

2. If our sales objectives are not reached, what actions should our firm take to avoid profit losses?

3. If demand for our new product exceeds plans, what actions should our firm take to meet the higher dem and?

4. If certain disasters occur— such as loss o f com puter capabilities; a hostile takeover attempt; loss o f patent protection; or destruction of manufacturing facilities because of earthquakes, tornadoes, or hurricanes— what actions should our firm take?

5. If a new technological advancem ent makes our new product obsolete sooner than expected, what actions should our firm take?

Too many organizations discard alternative strategies not selected for implementation although the work devoted to analyzing these options would render valuable information. Alternative strategies not selected for implementation can serve as contingency plans in case the strategy or strategies selected do not work. U.S. companies and governments are increasingly considering nuclear-generated electricity as the most efficient means o f power generation. Many contingency plans certainly call for nuclear power rather than for coal- and gas-derived electricity.

CHAPTER 11 • STRATEGY MONITORING 385

When strategy-evaluation activities reveal the need for a major change quickly, an appropriate contingency plan can be executed in a timely way. Contingency plans can promote a strategist’s ability to respond quickly to key changes in the internal and external bases of an organization’s current strategy. For example, if underlying assumptions about the economy turn out to be wrong and contingency plans are ready, then managers can make appropriate changes promptly.

In some cases, external or internal conditions present unexpected opportunities. W hen such opportunities occur, contingency plans could allow an organization to quickly capitalize on them. Linneman and Chandran reported that contingency planning gave users, such as DuPont, Dow Chemical. Consolidated Foods, and Emerson Electric, three m ajor benefits: (1) It permitted quick response to change, (2) it prevented panic in crisis situations, and (3) it made managers more adaptable by encouraging them to appreciate just how variable the future can be. They suggested that effective contingency planning involves a five-step process:

1. Identify both good and bad events that could jeopardize strategies. 2. Determine when the good and bad events are likely to occur. 3. Determine the expected pros and cons of each contingency event. 4. Develop contingency plans for key contingency events. 5. Determ ine early warning trigger points key contingency events.11

Auditing A frequently used tool in strategy evaluation is the audit. A ud iting is defined by the American Accounting Association (AAA) as “a systematic process of objectively obtaining and evaluat­ ing evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria, and com m unicating the results to interested users.” 12

Auditors examine the financial statement o f firms to determine whether they have been prepared according to generally accepted accounting principles (G A A P) and whether they fairly represent the activities o f the firm. Independent auditors use a set o f standards called generally accepted auditing standards (GAAS). Public accounting firms often have a consulting arm that provides strategy-evaluation services.

The new era of international financial reporting standards (IF R S ) appears unstoppable, and businesses need to go ahead and get ready to use IFRS. Many U.S. com panies now report their finances using both the old GAAP and the new IFRS. “If com panies don’t prepare, if they don’t start three years in advance,” warns business professor Donna Street at the University of Dayton, “they’re going to be in big trouble.” GAAP standards com prised 25,000 pages, whereas IFRS com prises only 5,000 pages, so in that sense IFRS is less cumbersome.

This accounting switch from GAAP to IFRS in the United States is going to cost businesses m illions o f dollars in fees and upgraded software systems and training. U.S. CPAs need to study global accounting principles intensely, and business schools should go ahead and begin teaching students the new accounting standards. M ost large accounting firms and multinational firms favor the switch to IFRS saying it will simplify accounting, make it easier for investors to com pare firms across countries, and make it easier to raise capital globally. But many smaller firms oppose the upcom ing change say it will be too costly; some firms are uneasy about the idea of giving an international body the authority to write accounting rules for the USA. Some firms also would pay higher taxes because last in, first out (LIFO) inventor)’ methods are not allowed under IFR S.1'1 The International Accounting Standards Board (IASB) has publicly expressed ’‘regret” over the USA's slowness in adopting IFRS.

The U.S. Chamber o f Commerce supports a change, saying it will lead to much more cross-border commerce and will help the USA compete in the world economy. Already the European Union and 113 nations have adopted or soon plan to use international rules, including Australia, China, India, Mexico, and Canada. So the USA likely will also adopt IFRS rules, but this switch could unleash a legal and regulatory nightmare. A few U.S. multinational firms already use IFRS for their foreign subsidiaries, such as United Technologies (UT). UT derives more than 60 percent o f its revenues from abroad and is already training its entire staff to use IFRS.

M ovem ent to IFRS from GAAP encom passes a com pany’s entire operations, includ­ ing auditing, oversight, cash management, taxes, technology, software, investing, acquiring,

386 CHAPTER 11 • STRATEGY MONITORING

merging, importing, exporting, pension planning, and partnering. Switching from GAAP to IFRS is also likely to be plagued by gaping differences in business custom s, financial regulations, tax laws, politics, and other factors. One critic o f the upcom ing switch is Charles N iem eier o f the Public Company Accounting Oversight Board, who says the switch “has the potential to be a Tower of Babel,” costing firms m illions when they do not even have thousands to spend.

Others say the switch will help U.S. com panies raise capital abroad and do business with firms abroad. Perhaps ihe biggest upside of the switch is that IFRS rules are more streamlined and less complex than GAAP. Lenovo is a big advocate o f IFRS as they desire to be a world company rather than a U.S. or Chinese company, so the faster the switch to IFRS, the better for them. The bottom line is that IFRS is com ing to the United States, sooner rather than later, so we all need to gear up for this switch as soon as possible.

21st-Century Challenges in Strategic Management Three particular challenges or decisions that face all strategists today are (1) deciding whether the process should be more an art or a science, (2) deciding whether strategies should be visible or hidden from stakeholders, and (3) deciding whether the process should be more top-down or bottom -up in their firm .14

The Art or Science Issue This textbook is consistent with most o f the strategy literature in advocating that strategic management be viewed more as a science than an art. This perspective contends that firms need to systematically assess their external and internal environments, conduct research, carefully evaluate the pros and cons o f various alternatives, perform analyses, and then decide on a particular course of action. In contrast. Mintzberg's notion of “crafting” strategies embodies the artistic model, which suggests that strategic decision making be based primarily on holistic thinking, intuition, creativity, and imagination.1̂ Mintzberg and his followers reject strategies that result from objective analysis, preferring instead subjective imagination. “Strategy scientists’* reject strategies that emerge from emotion, hunch, creativity, and politics. Proponents o f the artistic view often consider strategic plan­ ning exercises to be time poorly spent. The Mintzberg philosophy insists on informality, whereas strategy scientists (and this text) insist on more formality. Mintzberg refers to strategic planning as an “emergent” process whereas strategy scientists use the term deliberate process.16

The answer to the art-versus-science question is one that strategists must decide for themselves, and certainly the two approaches are not mutually exclusive. In deciding which approach is more effective, however, consider that the business world today has become increas­ ingly complex and more intensely competitive. There is less room for error in strategic planning. Recall that Chapter I discussed the importance o f intuition, experience, and subjectivity in strategic planning, and even the weights and ratings discussed in Chapters 6, 7, and 8 certainly require good judgm ent. But the idea of deciding on strategies for any firm without thorough research and analysis, at least in the mind o f these authors, is unwise. Certainly, in sm aller firms there can be more informality in the process com pared to larger firms, but even for sm aller firms, a wealth of competitive information is available on the Internet and elsewhere and should be collected, assimilated, and evaluated before deciding on a course o f action on which survival o f the firm may hinge. The livelihood o f countless em ployees and shareholders may hinge on the effectiveness of strategies selected. Too much is at stake to be less than thorough in formulating strategies. It is not wise for a strategist to rely too heavily on gut feeling and opinion instead o f research data, competitive intelligence, and analysis in formulating strategies.

The Visible or Hidden Issue An interesting aspect of any competitive analysis discussion is whether strategies themselves should be secret or open within firms. The Chinese warrior Sun T/,u and military leaders today strive to keep strategies secret because war is based on deception. However, for a business organization, secrecy may not be best. Keeping strategies secret from employees and stakeholders at large could severely inhibit employee and stakeholder communication, understanding, and commitment and also forgo valuable input that these persons could have regarding formulation or implementation of that strategy. Thus, strategists in a particular firm must decide for themselves whether the risk o f rival firms easily knowing and exploiting a firm’s strategies is worth the benefit o f improved employee

CHAPTER 11 • STRATEGY MONITORING 387

and stakeholder motivation and input. Most executives agree that some strategic information should remain confidential to top managers, and that steps should be taken to ensure that such information is not disseminated beyond the inner circle. For a firm that you may own or manage, would you advocate openness or secrecy in regard to strategies being formulated and implemented?

There are certainly good reasons to keep the strategy process and strategies themselves visible and open rather than hidden and secret. There are also good reasons to keep strategies hidden from all but top-level executives. Strategists must decide for themselves what is best for their firms. This text comes down largely on the side of being visible and open, but certainly this may not be best for all strategists and all firms. As pointed out in Chapter I , Sun Tzu argued that all war is based on deception and that the best maneuvers are those not easily predicted by rivals. Business and war are analogous.

Some reasons to be completely open with the strategy process and resultant decisions are these:

1. M anagers, em ployees, and other stakeholders can readily contribute to the process. They often have excellent ideas. Secrecy would forgo many excellent ideas.

2. Investors, creditors, and other stakeholders have greater basis for supporting a firm when they know what the firm is doing and where the firm is going.

3. Visibility prom otes democracy, whereas secrecy promotes autocracy. Domestic firms and most foreign firms prefer democracy over autocracy as a management style.

4. Participation and openness enhance understanding, com mitm ent, and communication within the firm.

Reasons why some firms prefer to conduct strategic planning in secret and keep strategies hidden from all but the highest-level executives are as follows:

1. Free dissem ination o f a firm ’s strategies may easily translate into competitive intelligence for rival firms who could exploit the firm given that information.

2. Secrecy limits criticism , second guessing, and hindsight. 3. Participants in a visible strategy process becom e more attractive to rival firms who may

lure them away. 4. Secrecy limits rival firms from imitating or duplicating the firm ’s strategies and

undermining the firm.

The obvious benefits o f the visible versus hidden extremes suggest that a working balance must be sought between the apparent contradictions. Parnell says that in a perfect world all key individuals both inside and outside the firm should be involved in strategic planning, but in practice particularly sensitive and confidential information should always remain strictly confidential to top m anagers.! This balancing act is difficult but essential for survival o f the firm.

The Top-Down or Bottom-Up Approach Proponents o f the top-down approach contend that top executives are the only persons in the linn with the collective experience, acumen, and fiduciary responsibility to make key strategy decisions. In contrast, bottom-up advocates argue that lower- and middle-level managers and employees who will be implementing the strategies need to be actively involved in the process o f formulating the strategies to ensure their support and commitment. Recent strategy research and this textbook emphasize the bottom-up approach, but earlier work by Schendel and Hofer stressed the need for firms to rely on perceptions o f their top managers in sUategic planning.18 Strategists must reach a working balance of the two approaches in a manner deemed best for their firms at a particular time, while cognizant of the fact that current research supports the bottom-up approach, at least among U.S. firms. Increased education and diversity of the workforce at all levels are reasons why iniddle- and lower-level managers— and even nonmanagers— should be invited to participate in the firm 's strategic planning process, at least to the extent that they are willing and able to contribute.

Special Note to Students Just Google the words balanced scorecard images and you will see more than 100 actual Balanced Scorecards being used as a tool by various organizations to gain and sustain com peti­ tive advantage. Note the variation in format. In perfonning your case analysis, develop and pres­ ent a Balanced Scorecard that you recommend to help your firm m onitor and evaluate progress

388 CHAPTER 11 • STRATEGY MONITORING

toward stated objectives. Effective, timely evaluation of strategies can enable a firm to adapt quickly to changing conditions, and a Balanced Scorecard can assist in this endeavor. Couch your discussion of the Balanced Scorecard in terms of com petitive advantage versus rival firms.

This chapter presents a strategy-evaluation framework that can facilitate accomplishment of annual and long-term objectives. Effective strategy evaluation allows an organization to capitalize on internal strengths as they develop, to exploit external opportunities as they emerge, to recognize and defend against threats, and to mitigate internal weaknesses before they become detrimental.

Strategists in successful organizations take the time to formulate, implement, and then evaluate strategies deliberately and systematically. Good strategists move their organization for­ ward with purpose and direction, continually evaluating and im proving the firm 's external and internal strategic positions. Strategy evaluation allows an organization to shape its own future rather than allowing it to be constantly shaped by remote forces that have little or no vested interest in the well-being o f the enterprise.

Although not a guarantee for success, strategic management allows organizations to make effective long-term decisions, to execute those decisions efficiently, and to take corrective actions as needed to ensure success. Computer networks and the Internet help to coordinate strategic- management activities and to ensure that decisions are based on good information. A key to effective strategy evaluation and to successful strategic management is an integration o f intuition and analysis:

A potentially fatal problem is the tendency for analytical and intuitive issues to polarize. This polarization leads to strategy evaluation that is dominated by either analysis or intuition, or to strategy evaluation that is discontinuous, with a lack o f coordination among analytical and intuitive issues.19

Strategists in successful organizations realize that strategic managem ent is first and fore­ most a people process. It is an excellent vehicle for fostering organizational com munication. People are what make the difference in organizations.

The real key to effective strategic management is to accept the prem ise that the planning process is more important than the written plan, that the manager is continuously planning and does not stop planning when the written plan is finished. The written plan is only a snapshot as o f the moment it is approved. If the manager is not planning on a continuous basis— planning, measuring, and revising— the written plan can become obsolete the day it is finished. This obso­ lescence becomes more o f a certainty as the increasingly rapid rate o f change makes the business

. 1() environm ent more uncertain.-

Conclusion

Key Terms and Concepts advantage (p. 373) auditing (p. 385) Balanced Scorecard (p. 381) consistency (p. 373) consonance (p. 373) contingency plans (p. 384) feasibility (p. 373) future shock (p. 380)

strategy (p. 376) revised EFE Matrix (p. 376) revised IFE Matrix (p. 376) taking corrective actions (p. 379)

GAAS, GAAP, and IFRS (p. 385) m anagement by wandering around (p. 375) measuring organizational perform ance (p. 378) reviewing the underlying bases o f an organization’s

CHAPTER 11 • STRATEGY MONITORING 389

Issues for Review and Discussion 11-1.

11-2.

11-3.

11-4.

11-5.

11-6.

11-7.

11-8.

11-9.

11- 10 ,

BHP Billiton has been very successful in the last 11-11. decade. W hat is the major reason for its success? Visit BHP Billiton’s website and evaluate the firm’s strategies, which are currently being implemented. 11-12. Discuss the nature and implications of the upcoming 11-13. accounting switch from GAAP to IFRS, in the United States. 11-14. Ask the following question to an accounting professor 11-15. at your college or university, and report your findings back to the class— “To what extent would my learning 11-16. the IFRS standards, on my own, give me a competitive advantage in the job m arket?” 11-17. Give an exam ple of “consonance,” other than the one provided by Rum elt in this Chapter. 11-18. “Evaluating strategies on a continuous rather than a periodic basis is desired.” Discuss the pros and cons 11-19. o f this statement. How often should an organization’s vision or mission be 11-20. changed, in light o f strategy evaluation activities? Com pare M intzberg’s notion o f “crafting” strategies with the notion o f “gathering and assim ilating informa­ tion” to formulate strategies, mentioned in this book. 11-21. Do you believe strategic management is more of an art or science? Explain. Do you feel strategic management should be more 11-22. a top-down or bottom-up process in a firm? Briefly explain your answer.

Do you think strategic m anagem ent should be more visible or hidden, as a process in a firm? Explain. Develop a balanced scorecard for BHP Billiton. Create a balanced scorecard for your college or university. Discuss contingency planning. Identify some important financial ratios, which are useful in evaluating a firm ’s strategies. How often should a firm form ally evaluate its strategies? Under what conditions are corrective actions not required in the strategy-evaluation process? Define and discuss auditing, as it relates to strategy- evaluation. List 10 characteristics of an effective evaluation system . Go to Fortune m agazine’s w ebsite and identify several firm s in your city, w hich are listed am ong the m ost adm ired com panies in the w orld according to Fortune. Ask the dean of your school to describe how their departm ent evaluates strategies. Present your findings to the class. Identify four firms that provide their strategic plans on their websites, and four that do not. Should firms do this? Explain your answer.

MyManagementLab® Go to m ym anagem entlab.com for the following Assisted-graded writing questions:

11-23. Why is the Balanced Scorecard an important topic both 11-25. M ym anagem entlab Only—com prehensive writing in devising objectives and in evaluating strategies? assignm ent for this chapter.

11-24. Do you believe strategic m anagem ent should be more visible or hidden as a process in a firm? Explain.

Current Readings Aguinis, Herman. Ryan K. Gottfredson, and Harry Joo.

“Delivering Effective Performance Feedback: The Strengths-Based Approach.” Business Horizons 55. no. 2 (March 2012): 105-111.

Lafley, A.G., Roger L. Martin, Jan W. Rivkin, and Nicolaj Siggelkow. “ Bringing Science to the Art o f Strategy.” Harvard Business Review (Septem ber 2012): 56.

Lux, Sean, T. Russell Crook, and Terry' Leap. “Corporate Political Activity: The Good, the Bad, and the Ugly.” Business Horizons 55, no. 3 (M ay 2012): 307—31^2.

Kahane, Adam. ‘T ransform ative Scenario Planning: Changing the Future by Exploring Alternatives."

Strategy and Leadership 40. no. 5 (2012): 19-23.’

M auboussin. Michael J. “The True M easures o f Success.” Harvard Business Review (October 2012): 46.

Peltola, Soili. “Can an Old Firm Learn New Tricks? A Corporate Entrepreneurship Approach to Organizational Renewal.” Business Horizons 55, no. 1 (January 2012): 4 3 -5 1.

Stieger, Daniel, Kurt Matzler, Sayan Chatterjee, and Florian Ladstaetter-Fussenegger. “Dem ocratizing Strategy: How Crowdsourcing Can Be Used For Strategy Dialogues.” California Management Review 54, no. 4 (Summ er 2012): 44-68.

390 CHAPTER 11 • STRATEGY MONITORING

A SSU R A N CE OF LEARN IN G EX ER C ISES EX ER C IS E 11A

Evaluating BHP Billiton’s Strategies Purpose BHP Billiton is featured in the opening chapter example as a firm that engages in excellent strategic plan­ ning. BHP is a large Australian multinational mining and petroleum company headquartered in Melbourne, Australia. BHP also has major offices in London. BHP is arguably the world’s largest mining company and among the top ten largest companies in the world measured by market capitalization. Fortune in 2013 ranked BHP as the 115lh largest company in the world and the 20,h most profitable. BHP is among the world's top producers of iron ore, coal, aluminum, copper, manganese, nickel, silver, uranium, and potash. BHP also has crude oil and natural gas holdings. BHP may soon divest its diamond assets.

This exercise can give you practice evaluating a company’s strategies.

Instructions Step 1 Go to BHP Billiton’s corporate website and navigate to the Investors & Media section.

Review recent news releases for BHP Billiton. Step 2 Determine what new strategies BHP is pursuing. Step 3 Evaluate BHP’s newest strategies based on concepts presented in Chapter 11. Step 4 Prepare a strategy evaluation report for BHP.

EX ER C IS E 11B

Preparing a Strategy-Evaluation Report for adidas AG Purpose This exercise can give you experience locating strategy-evaluation information. Use of the Internet coupled with published sources of information can significantly enhance the strategy-evaluation process. Performance information on competitors, for example, can help put into perspective a firm 's own performance.

Instructions Step 1 Search the Internet for information on adidas. Prepare a strategy-evaluation report for your

instructor. Include in your report a summary of adidas’ strategies and performance in 2013 and a summary of your conclusions regarding the effectiveness of adidas' strategies.

Step 2 Based on your analysis, do you feel that adidas is pursuing effective strategies? What recom­ mendations would you offer to adidas’ chief executive officer?

EX ER C IS E 11C

Preparing a Balanced Scorecard for adidas AG Purpose This exercise can give you experience developing a Balanced Scorecard for a corporation.

Instructions Step 1 Compile all information that you have collected on adidas. Step 2 Join with three other students in class. Jointly develop a 20-item Balanced Scorecard for

the company. Step 3 Appoint a spokesperson for your team to give a three-minute overview to the class regarding

the substance of your Balanced Scorecard.

CHAPTER 11 • STRATEGY MONITORING 391

Evaluate My University’s Strategies Purpose An important part of evaluating strategies is determining the nature and extent of changes in an organi­ zation’s external opportunities/threats and internal strengths/weaknesses. Changes in these underlying critical success factors can indicate a need to change or modify the linn’s strategies.

Instructions As a class, discuss positive and negative changes in your university’s external and internal factors during your college career. Begin by listing on the board new or emerging opportunities and threats. Then identify strengths and weaknesses that have changed significantly during your college career. In light of the external and internal changes that were identified, discuss whether your university’s strategies need modifying. Are there any new strategies that you would recommend? Make a list to recommend to your department chair, dean, president, or chancellor.

EXERCISE 11D

Notes 1. Karen Talley, “Sales Plunge A nother 23% at Penney,”

Wall Street Journal (August 11—12): B3.

2. Dale McConkey, “Planning in a Changing Environment,” Business Horizons, Septem ber-O ctober 1988, 64.

3. Robert Simons, “Control in an Age of Empowerment,” Harvard Business Review, M arch-A pril 1995, 80.

4. Dale Zand, “Reviewing the Policy Process,” California Management Review 2 1, no. I (Fall 1978): 37.

5. Eccles. 3:1-8 .

6. C laude George Jr., The History o f Management Thought (Upper Saddle River. New Jersey: Prentice Hall, 1968), 16 5 - 166.

7. M. Erez and F. Kanfer, “The Role of Goal Acceptance in Goal Setting and Task Performance,” Academy o f Management Review 8. no. 3 (July 1983): 457.

8. D. Hussey and M. Langham. Corporate Planning: The Human Factor (Oxford, England: Pergamon Press, 1979), 138.

9. Carter Bayles, “Strategic Control: The President’s Paradox,” Business Horizons 20, no. 4 (August 1977): 18.

10. Robert W aterman, Jr., “How the Best Get Better,” BusinessWeek. Septem ber 14, 1987, 105.

11. Robert Linneman and Rajan Chandran, “Contingency Planning: A Key to Swift M anagerial Action in the

Uncertain Tomorrow,” Managerial Planning 29, no. 4 (January-February 1981): 23-27.

12. American Accounting Association, Report o f Committee on Basic Auditing Concepts, 1971, 15-74.

13. M ichael Rapoport. “Delay Seen (Again) For New’ Rules on A ccounting,” Wall Street Journal (July 6. 2012): C l ; M ichael Rapoport, “A ccounting Panel Expresses 'R eg re t' O ver U.S. Stance,” Wall Street Journal (Ju ly 16, 2012): C5.

14. John Parnell. “Five Critical Challenges in Strategy M aking,” SAM Advanced Management Journal 68, no. 2 (Spring 2003): 15-22.

15. Henry M intzberg, “Crafting Strategy,” Harvard Business Review, Ju ly-A ugust 1987, 66-75.

16. Henry' Mintzberg and J. Waters, “O f Strategies, Deliberate and Emergent,'’ Strategic Management Journal 6, no. 2: 257-272.

17. Parnell, 15-22.

18. D. E. Schendel and C. W. Hofer (Eds.), Strategic Management (Boston: Little, Brown. 1979).

19. Michael M cGinnis, “The Key to Strategic Planning: Integrating Analysis and Intuition,” Sloan Management Review 26, no. 1 (Fall 1984): 49.

20. McConkey, 72.

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APPENDIX 1

GUIDELINES FOR CASE ANALYSIS

MyManagementLab® Improve Your Grade! Over 10 million students improved their results using the Pearson MyLabs. Visit m ym anagem entlab.com for simulations, tutorials, and end-of-chapter problems.

392

Guidelines for Case Analysis C H A P TER O B JE C T IV E S After studying this chapter, you should be able to do the following:

1. Describe the case method for learning strategic-management concepts.

2. Identify the steps in preparing a comprehensive written case analysis.

3. Describe how to give an effective oral case analysis presentation.

4. Discuss special tips for doing a case analysis.

A SS U R A N C E O F LEA R N IN G E X E R C ISE S The following exercises are found at the end of this chapter.

Oral Presentation— Step l Introduction (2 minutes)

Oral Presentation— Step 2 Mission and Vision (4 minutes)

Oral Presentation— Step 3 Internal Assessment (8 minutes)

Oral Presentation— Step 4 External Assessment (8 minutes)

Oral Presentation— Step 5 Strategy Formulation (14 minutes)

Oral Presentation— Step 6 Strategy Implementation (8 minutes)

Oral Presentation— Step 7 Strategy Evaluation (2 minutes)

Oral Presentation— Step 8 Conclusion (4 minutes)

394 APPEN DIX 1 • GUIDELIN ES FOR CASE ANALYSIS

The purpose o f this section is to help you analyze strategic-m anagem ent cases. Guidelines for preparing written and oral case analyses are given, and suggestions for preparing cases for class discussion are presented. Steps to follow in preparing case analyses are provided. Guidelines for making an oral presentation are described.

What Is a Strategic-Management Case? A strategic-management case describes an organization’s external and internal conditions and raises issues concerning the firm’s mission, strategies, objectives, and policies. M ost o f the information in a strategic-m anagement case is established fact, but some inform ation may be opinions, judgm ents, and beliefs. Strategic-m anagem ent cases are more com prehensive than those you may have studied in other courses. They generally include a description o f related management, marketing, finance and accounting, production and operations, research and development (R&D), management information systems (M IS), and natural environm ent issues. A strategic-m anagement case puts the reader at the scene of the action by describing a firm ’s situation at some point in time. Strategic-managem ent cases arc written to give you practice applying strategic-m anagem ent concepts. The case method for studying strategic managem ent is often called learning by doing.

Guidelines for Preparing Case Analyses The Need for Practicality There is no such thing as a com plete case, and no case ever gives you all the information you need to conduct analyses and make recommendations. Likewise, in the business world, strategists never have all the information they need to make decisions: information may be unavailable or too costly to obtain, or it may take too much time to obtain. So in analyzing strategic-m anagement cases, do what strategists do every day— make reasonable assumptions about unknowns, clearly state assumptions, perform appropriate analyses, and make decisions. Be practical For example, in perform ing a projected financial analysis, make reasonable assumptions, appropriately state them, and proceed to show what impact your recommendations are expected to have on the orga­ nization’s financial position. Avoid saying, “I don 't have enough information.” Always supple­ ment the information provided in a case with Internet and library research.

The Need for Justification The most important part o f analyzing cases is not what strategies you recom m end but rather how you support your decisions and how you propose that they be implemented. There is no single best solution or one right answer to a case, so give ample justification for your recom m enda­ tions. This is important. In the business world, strategists usually do not know if their decisions arc right until resources have been allocated and consumed. Then it is often too late to reverse a decision. This cold fact accents the need for careful integration o f intuition and analysis in pre­ paring strategic management case analyses.

The Need for Realism Avoid recommending a course of action beyond an organization’s means. Be realistic. No organiza­ tion can possibly pursue all the strategies that could potentially benefit the firm. Estimate how much capital will be required to implement what you recommended. Determine whether debt, stock, or a combination of debt and stock could be used to obtain the capital. Make sure your recommendations are feasible. Do not prepare a case analysis that omits all arguments and information not supportive o f your recommendations. Rather, present the major advantages and disadvantages o f several feasi­ ble alternatives. Try not to exaggerate, stereotype, prejudge, or overdramatize. Strive to demonstrate that your interpretation of the evidence is reasonable and objective.

The Need for Specificity Do not make broad generalizations such as “The com pany should pursue a market penetration strategy.” Be specific by telling what, why, when, how, where, and who. Failure to use specif­ ics is the single m ajor shortcom ing of most oral and written case analyses. For exam ple, in

APPEN DIX 1 • GUIDELINES FOR CASE ANALYSIS 3 9 5

an internal audit say, "The firm ’s current ratio fell from 2.2 in 2013 to 1.3 in 2014, and this is considered to be a major weakness,” instead o f “The firm ’s financial condition is bad.’* But recall from the chapters that selected external and internal factors need to be “actionable” to the extent possible, and financial ratios in general are not actionable. Rather than concluding from a Strategic Position and Action Evaluation (SPACE) M atrix that a firm should be defensive, be more specific, saying, “The firm should consider closing three plants, laying off 280 em ployees, and divesting itself o f its chem ical division, for a net savings o f $20.2 million in 2014.” Use ratios, percentages, numbers, and dollar estimates. Businesspeople dislike generali­ ties and vagueness.

The Need for Originality Do not necessarily recom m end the course o f action that the firm plans to take or actually undertook, even if those actions resulted in improved revenues and earnings. The aim of case analysis is for you to consider all the facts and information relevant to the organization at the time, to generate feasible alternative strategies, to choose among those alternatives, and to defend your recom m endations. Put yourself back in time to the point when strategic decisions were being made by the firm 's strategists. Based on the information available then, what would you have done? Support your position with charts, graphs, ratios, analyses, and the like— not a revelation from the library. You can become a good strategist by thinking through situations, making management assessm ents, and proposing plans yourself. Be original. Com pare and con­ trast what you recom m end versus what the com pany plans to do or did.

The Need to Contribute Strategy form ulation, im plementation, and evaluation decisions are commonly made by a group o f individuals rather than by a single person. Therefore, your professor may divide the class into three- or four-person teams and ask you to prepare written or oral case analyses. M embers o f a strategic-m anagem ent team, in class or in the business world, differ on their aversion to risk, their concern for short-run versus long-run benefits, their attitudes toward social responsibility, and their views concerning globalization. There are no perfect people, so there are no perfect strategies. Be open-m inded to others' views. Be a good listener and a good contributor.

Preparing a Case for Class Discussion Your professor may ask you to prepare a case for class discussion. Preparing a case for class discussion means that you need to read the case before class, make notes regarding the organization’s external opportunities and threats and internal strengths and weaknesses, perform appropriate analyses, and come to class prepared to offer and defend some specific recom m endations.

The Case Method versus Lecture Approach The case method o f teaching is radically different from the traditional lecture approach, in which little or no preparation is needed by students before class. The case method involves a classroom situation in which students do most o f the talking; your professor facilitates discussion by asking questions and encouraging student interaction regarding ideas, analyses, and recommendations. Be prepared for a discussion along the lines o f “W hat would you do, why would you do it, when would you do it. and how would you do it?” Prepare answers to the following types o f questions:

• W hat are the firm ’s most important external opportunities and threats? • W hat are the organization’s major strengths and weaknesses? • How would you describe the organization’s financial condition? • W hat are the firm ’s existing strategies and objectives? • W ho are the firm ’s competitors, and what are their strategies? • W hat objectives and strategies do you recommend for this organization? Explain your

reasoning. How does what you recommend com pare to what the com pany plans? • How could the organization best implement what you recom m end? W hat implementation

problem s do you envision? How could the firm avoid or solve those problem s?

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The Cross-Examination Do not hesitate to take a stand on the issues and to support your position w ith objective analyses and outside research. Strive to apply strategic-m anagem ent concepts and tools in preparing your case for class discussion. Seek defensible argum ents and positions. Support opinions and judgm ents with facts, reasons, and evidence. C runch the num bers before class! Be w illing to describe your recom m endations to the class w ithout fear o f disapproval. Respect the ideas o f others, but be w illing to go against the m ajority opinion when you can justify a better position.

Strategic-managem ent case analysis gives you the opportunity to learn more about yourself, your colleagues, strategic managem ent, and the decision-m aking process in organizations. The rewards o f this experience will depend on the effort you put forth, so do a good job. Discussing business policy cases in class is exciting and challenging. Expect views counter to those you present. Different students will place em phasis on different aspects o f an organization’s situation and subm it different recom m endations for scrutiny and rebuttal. Cross-exam ination discussions com m only arise, just as they occur in a real business organization. Avoid being a silent observer.

Preparing a Written Case Analysis In addition to asking you to prepare a case for class discussion, your professor may ask you to prepare a written case analysis. Preparing a written case analysis is sim ilar to preparing a case for class discussion, except written reports are generally more structured and more detailed. There is no ironclad procedure for preparing a written case analysis because cases differ in focus; the type, size, and com plexity o f the organizations being analyzed also vary.

When writing a strategic-m anagem ent report or case analysis, avoid using jargon, vague or redundant words, acronyms, abbreviations, sexist language, and ethnic or racial slurs. And watch your spelling! Use short sentences and paragraphs and simple words and phrases. Use quite a few subheadings. Arrange issues and ideas from the most important to the least important. Arrange recom m endations from the least controversial to the most controversial. Use the active voice rather than the passive voice for all verbs; for example, say “O ur team recom m ends that the company diversify” rather than “It is recommended by our team to diversify.” Use many examples to add specificity and clarity. Tables, figures, pic charts, bar charts, tim elines, and other kinds o f exhibits help com m unicate important points and ideas. Som etim es a picture is worth a thousand words.

The Executive Summary Your professor may ask you to focus the written case analysis on a particular aspect o f the strategic-m anagement process, such as (1) to identify and evaluate the organization's existing vision, mission, objectives, and strategies: or (2) to propose and defend specific recom m enda­ tions for the com pany; or (3) to develop an industry analysis by describing the com petitors, products, selling techniques, and market conditions in a given industry. These types o f written reports are som etim es called executive summaries. An executive summary usually ranges from three to five pages of text in length, plus exhibits.

The Comprehensive Written Analysis Your professor may ask you to prepare a comprehensive written analysis. This assignm ent requires you to apply the entire strategic-m anagem ent process to the particular organization. When preparing a com prehensive written analysis, picture yourself as a consultant who has been asked by a com pany to conduct a study o f its external and internal environm ent and to make specific recom m endations for its future. Prepare exhibits to support your recom m enda­ tions. H ighlight exhibits w ith some discussion in the paper. Com prehensive written analyses are usually about 10 pages in length, plus exhibits. Throughout your w ritten analysis, em phasize how your proposed strategies will enable the firm to gain and sustain com petitive advantage. Visit www.strategyclub.com for examples.

APPEN DIX 1 • GUIDELIN ES FOR CASE ANALYSIS 397

Steps in Preparing a Comprehensive Written Analysis In preparing a written case analysis, you could follow the steps outlined here, which correlate to the stages in the strategic-m anagem ent process and the chapters in this text. (Note— The steps in presenting an oral case analysis are given on pages 401-403 , are more detailed, and could be used here).

S te p 1 Identify the firm 's existing vision, mission, objectives, and strategies.

S te p 2 Develop vision and mission statements for the organization.

S te p 3 Identify the organization’s external opportunities and threats.

S te p 4 Construct a Competitive Profile M atrix (CPM).

S te p 5 Construct an External Factor Evaluation (EFE) M atrix.

S te p 6 Identify the organization’s internal strengths and weaknesses.

S te p 7 Construct an Internal Factor Evaluation (IFE) Matrix.

S te p 8 Prepare a Strengths-W eaknesses-Opportunities-Threats (SW OT) Matrix, Strategic Position and Action Evaluation (SPACE) Matrix. Boston Consulting Group (BCG) M atrix, Internal-External (IE) M atrix, Grand Strategy Matrix, and Quantitative Strategic Planning Matrix (QSPM ) as appropriate. Give advantages and disadvantages o f alternative strategies.

S te p 9 Recom mend specific strategies and long-term objectives. Show how much your recom m endations will cost. Clearly itemize these costs for each projected year. Com pare your recom m endations to actual strategies planned by the company.

S te p 10 Specify how your recom m endations can be implemented and what results you can expect. Prepare forecasted ratios and projected financial statements. Present a tim etable or agenda for action.

S te p 11 Recom mend specific annual objectives and policies.

S te p 12 Recom mend procedures for strategy review and evaluation.

Making an Oral Presentation Your professor may ask you to prepare a strategic-m anagem ent case analysis, individually or as a group, and present your analysis to the class. Oral presentations are usually graded on two parts: content and delivery. Content refers to the quality, quantity, correctness, and appropriate­ ness o f analyses presented, including such dimensions as logical flow through the presentation, coverage of major issues, use of specifics, avoidance of generalities, absence o f mistakes, and feasibility o f recommendations. Delivery includes such dim ensions as audience attentive­ ness, clarity o f visual aids, appropriate dress, persuasiveness of arguments, tone o f voice, eye contact, and posture. Great ideas are o f no value unless others can be convinced of their merit through clear com m unication. The guidelines presented here can help you make an effective oral presentation.

Organizing the Presentation Begin your presentation by introducing yourself and giving a clear outline of topics to be covered. If a team is presenting, specify the sequence o f speakers and the areas each person will address. At the beginning of an oral presentation, try to capture your audience’s interest and attention. You could do this by displaying some products made by the company, telling an interesting short story about the company, or sharing an experience you had that is related to the company, its products, or its services. You could develop or obtain a video to show at the beginning of class; you could visit a local distributor o f the firm ’s products and tape a personal interview with the business owner or manager. A light or humorous introduction can be effective at the beginning of a presentation.

Be sure the setting of your presentation is well organized, with seats for attendees, flip charts, a transparency projector, and whatever else you plan to use. Arrive at the classroom at least 15 m inutes early to organize the setting, and be sure your materials are ready to go. M ake sure everyone can see your visual aids well.

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Controlling Your Voice An effective rate o f speaking ranges from 100 to 125 words per minute. Practice your presenta­ tion aloud to determine if you are going too fast. Individuals com m only speak too fast when nervous. Breathe deeply before and during the presentation to help yourself slow down. Have a cup o f water available; pausing to take a drink will wet your throat, give you tim e to collect your thoughts, control your nervousness, slow you down, and signal to the audience a change in topic.

Avoid a monotone voice by placing emphasis on different words or sentences. Speak loudly and clearly, but do not shout. Silence can be used effectively to break a monotone voice. Stop at the end o f each sentence, rather than running sentences together with and or uh.

Managing Body Language Be sure not to fold your arms, lean on the podium, put your hands in your pockets, or put your hands behind you. Keep a straight posture, with one foot slightly in front o f the other. Do not turn your back to the audience; doing so is not only rude, but it also prevents your voice from projecting well. Avoid using too many hand gestures. On occasion, leave the podium or table and walk toward your audience, but do not walk around loo much. Never block the audience’s view of your visual aids.

Maintain good eye contact throughout the presentation. This is the best way to persuade your audience. There is nothing more reassuring to a speaker than to see members o f the audience nod in agreement or smile. Try to look everyone in the eye at least once during your presentation, but focus more on individuals who look interested than on those who seem bored. To stay in touch with your audience, use humor and smiles as appropriate throughout your presentation. A presentation should never be dull!

Speaking from Notes Be sure not to read to your audience because reading puts people to sleep. Perhaps worse than reading is merely reciting what you have memorized. Do not try to m em orize anything. Rather, practice unobtrusively using notes. M ake sure your notes are written clearly so you will not flounder when trying to read your own writing. Include only main ideas on your note cards. Keep note cards on a podium or table if possible so that you will not drop them or get them out o f order; walking with note cards tends to be distracting.

Constructing Visual Aids Make sure your visual aids are legible to individuals in the back of the room. Use color to high­ light special items. Avoid putting com plete sentences on visual aids; rather, use short phrases and then orally elaborate on issues as you make your presentation. Generally, there should be no more than four to six lines o f text on each visual aid. Use clear headings and subheadings. Be careful about spelling and grammar; use a consistent style o f lettering. Use m asking tape or an easel for posters— do not hold posters in your hand. Transparencies and handouts are excellent aids; however, be careful not to use too many handouts or your audience may concentrate on them instead of you during the presentation.

Answering Questions It is best to field questions at the end of your presentation, rather than during the presentation itself. Encourage questions, and take your time to respond to each one. Answering questions can be persuasive because it involves you with the audience. If a team is giving the presentation, the audience should direct questions to a specific person. During the question-and-answ er period, be polite, confident, and courteous. Avoid verbose responses. Do not get defensive with your answers, even if a hostile or confrontational question is asked. Staying calm during potentially disruptive situations, such as a cross-examination, reflects self-confidence, maturity, poise, and command of the particular company and its industry. Stand up throughout the question-and- answer period.

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Tips for Success in Case Analysis Strategic-m anagem ent students who have used this text over 14 editions offer you the following tips for success in doing case analysis. The tips are grouped into two basic sections: (1) Content Tips and (2) Process Tips. Content tips relate especially to the content o f your case analysis, whereas the Process tips relate mostly to the process that you and your group mates undergo in preparing and delivering your case analysis/presentation.

Content Tips 1. Use the www.strategyclub.com w ebsite resources. The free excel student template

provided there is especially useful as are the sample PowerPoint case analyses on a couple of com panies.

2. In preparing your external assessment, use the S&P Industry Survey material in your college library.

3. Go to http://finance.yahoo.com or http://money.m sn.com and enter your com pany's stock symbol.

4. View your case analysis and presentation as a product that m ust have some competitive factor to favorably differentiate it from the case analyses o f other students.

5. Develop a mind-set o f why, continually questioning your ow'n and others' assumptions and assertions.

6. Because strategic m anagem ent is a capstone course, seek the help o f professors in other specialty areas when necessary.

7. Read your case frequently as work progresses so you do not overlook details. 8. At the end o f each group session, assign each member o f the group a task to be completed

for the next meeting. 9. Becom e friends with the library and the Internet.

10. Be creative and innovative throughout the case analysis process. 11. A goal o f case analysis is to improve your ability to think clearly in am biguous and

confusing situations: do not get frustrated that there is no single best answer. 12. Do not confuse sym ptom s with causes; do not develop conclusions and solutions

prem aturely; recognize that inform ation may be misleading, conflicting, or wrong. 13. Work hard to develop the ability to form ulate reasonable, consistent, and creative plans: put

yourself in the strategist’s position. 14. Develop confidence in using quantitative tools for analysis. They are not inherently

difficult; it is ju st practice and fam iliarity you need. 15. Strive for excellence in writing and in the technical preparation o f your case. Prepare nice

charts, tables, diagrams, and graphs. Use color and unique pictures. No messy exhibits! Use PowerPoint.

16. Do not forget that the objective is to learn: explore areas w ith which you are not familiar. 17. Pay attention to detail. 18. Think through alternative im plications fully and realistically. The consequences

of decisions are not always apparent. They often affect many different aspects o f a firm ’s operations.

19. Provide answers to such fundamental questions as what, when, where, why, who. and how. 20. Do not merely recite ratios or present figures. Rather, develop ideas and conclusions

concerning the possible trends. Show the importance of these figures to the corporation. 21. Support reasoning and judgm ent with factual data whenever possible. 22. Your analysis should be as detailed and specific as possible. 23. A picture speaks a thousand words, and a creative picture gets you an A in many classes. 24. Emphasize the Recom m endations and Strategy Implementation sections. A common

mistake is to spend too much time on the external or internal analysis parts of your paper or presentation. The recom m endations and implementation sections are the most important part.

25. Throughout your case analysis, em phasize how your proposed strategic plan will enable the firm to gain and sustain com petitive advantage.

400 APPENDIX 1 • GUIDELIN ES FOR CASE ANALYSIS

Process Tips 1. W hen working as a team, encourage most o f the work to be done individually. Use team

meetings mostly to assimilate work. This approach is most efficient. 2. If allowed to do so, invite questions throughout your presentation. 3. During the presentation, keep good posture, eye contact, and voice tone, and project

confidence. Do not get defensive under any conditions or with any questions. 4. Prepare your case analysis in advance o f the due date to allow time for reflection and

practice. Do not procrastinate. 5. M aintain a positive attitude about the class, working with problems rather than against them. 6. Keep in tune with your professor, and understand his or her values and expectations. 7. O ther students will have strengths in functional areas that will com plem ent your

weaknesses, so develop a cooperative spirit that moderates com petitiveness in group work. 8. When preparing a case analysis as a group, divide into separate teams to work on the

external analysis and internal analysis. 9. Have a good sense o f humor.

10. Capitalize on the strengths of each m em ber of the group; volunteer your services in your areas o f strength.

11. Set goals for yourself and your team; budget your time to attain them. 12. Foster attitudes that encourage group participation and interaction. Do not be hasty to

judge group members. 13. Be prepared to work. There will be times when you will have to do more than your share.

Accept it, and do what you have to do to move the team forward. 14. Think of your case analysis as if it were really happening: do not reduce case analysis to a

mechanical process. 15. To uncover flaws in your analysis and to prepare the group for questions during an oral

presentation, assign one person in the group to actively play the devil’s advocate. 16. Do not schedule excessively long group meetings; two-hour sessions are about right. 17. Push your ideas hard enough to get them listened to, but then let up; listen to others and

try to follow their lines o f thinking; follow the flow o f group discussion, recognizing when you need to get back on track; do not repeat yourself or others unless clarity or progress dem ands repetition.

18. Develop a case-presentation style that is direct, assertive, and convincing; be concise, precise, fluent, and correct.

19. Have fun when at all possible. Preparing a case is frustrating at times, but enjoy it while you can; it may be several years before you are playing CEO again.

20. In group cases, do not allow personality differences to interfere. W hen they occur, they must be understood for what they are— and then put aside.

21. Get things written down (drafts) as soon as possible. 22. Read everything that other group members write, and com ment on it in writing. This

allows group input into all aspects o f case preparation. 23. Adaptation and flexibility are keys to success; be creative and innovative. 24. Neatness is a real plus: your case analysis should look professional. 25. Let someone else read and critique your presentation several days before you present it. 26. Make special efforts to get to know your group members. This leads to more openness in

the group and allows for more interchange o f ideas. Put in the tim e and effort necessary to develop these relationships.

27. Be constructively critical of your group m em bers’ work. Do not dom inate group discussions. Be a good listener and contributor.

28. Learn from past mistakes and deficiencies. Improve on weak aspects o f other case presentations.

29. Learn from the positive approaches and accom plishm ents o f classm ates.

Sample Case Analysis Outline There are musicians who play wonderfully without notes and there are chefs who cook wonder­ fully without recipes, but most of us prefer a more orderly cookbook approach, at least in the first attempt at doing something new. Therefore the following eight steps may serve as a basic

APPEN DIX 1 • GUIDELINES FOR CASE ANALYSIS 401

outline for you in presenting a strategic plan for your firm 's future. This outline is not the only approach used in business and industry for com m unicating a strategic plan, but this approach is tim e-tested, it does work, and it does cover all o f the basics. You may am end the content, tools, and concepts given to suit your own company, audience, assignment, and circum stances, but it helps to know and understand the rules before you start breaking them.

Depending on whether your class is 50 m inutes or 75 minutes and how much time your prolessor allows for your case presentation, the following outlines what generally needs to be covered. A recom m ended time (in minutes) as part o f the presentation is given for an overall 50-m inute event. Even if you do not have time to cover all areas in your oral presentation, you may be asked to prepare these areas and give them to your professor as a written case analysis. Be sure in an oral presentation to manage lime knowing that your recom m endations and asso­ ciated costs are the most important part. You should go to www.strategyclub.com and use that information and software in preparing your case analysis. Good luck.

Current Readings Kearney, Eric, Dicther Gebert, and Sven Voelpel. “W hen M em bers’ Need for Cognition.” Academy o f Management

Diversity Benefits Teams: The Importance o f Team Journal, June 2009, 581-598.

STEPS IN PR ESEN TIN G AN O RAL CA SE AN ALYSIS ORAL PRESENTATION— STEP 1

Introduction (2 minutes) a. Introduce yourselves by name and major. Establish the time setting of your case and analysis.

Prepare your strategic plan for the three years 2014-2016. b. Introduce your company and its products or services: capture interest. c. Show the outline of your presentation and tell who is doing what parts. d. Let your audience know that the primary motivation, rationale, or intent of every slide is to

reveal how the firm can best gain and sustain competitive advantage.

ORAL PRESENTATION— STEP 2

Mission and Vision (4 minutes) a. Show existing mission and vision statements if available from the firm’s website, annual report,

or elsewhere. b. Show your “improved” mission and vision and tell why it is improved. c. Compare your mission and vision to a leading competitor's statements. d. Comment on your vision and mission in terms of how they support the strategies you envision

for your firm.

ORAL PRESENTATION— STEP 3

Internal Assessment (8 minutes) a. Give your financial ratio analysis. Highlight especially good and bad ratios. Do not give

definitions of the ratios and do not highlight all the ratios. b. Show the firm’s organizational chart found or “created based on executive titles.” Identify the

type of chart as well as good and bad aspects. Unless all white males comprise the chart, peoples’ names are generally not important because positions reveal structure as people come and go.

c. Present your improved or recommended organizational chart. Tell why you feel it is improved over the existing chart.

d. Show a market positioning map with firm and competitors. Discuss the map in light of strategies you envision for firm versus competitors’ strategies.

e. Identify the marketing strategy of the firm in terms of good and bad points versus competitors and in light of strategies you envision for the firm.

402 APPENDIX 1 • GUIDELIN ES FOR CASE ANALYSIS

f. Show a map locating the firm’s operations. Discuss in light of strategies you envision. Also, perhaps show a value chain analysis chart.

g. Discuss (and perhaps show) the firm’s website and Facebook page in terms of good and bad points compared to rival firms.

h. Show your “value of the firm” analysis. i. List 20 of the firm’s strengths and weaknesses. Go over each one listed without “reading”

them verbatim. j. Show and explain your Internal Factor Evaluation (IFE) Matrix.

ORAL PRESENTATION— STEP 4

External Assessment (8 minutes) a. Identify and discuss major competitors. Use pie charts, maps, tables, or figures to show the

intensity of competition in the industry’. b. Show your Competitive Profile Matrix. Include at least 12 factors and two competitors. c. Summarize key industry trends citing Standard & Poor's Industry Survey or Chamber of

Commerce statistics, and so on. Highlight key external trends as they impact the firm, including trends that are economic, social, cultural, demographic, geographic, technological, political, legal, governmental, and to do with the natural environment.

d. List 20 of the firm’s opportunities and threats. Make sure your opportunities are not stated as strategies. Go over each one listed without “reading” them verbatim.

e. Show and explain your External Factor Evaluation (EFE) Matrix.

ORAL PRESENTATION— STEP 5

Strategy Formulation (14 minutes) a. Show and explain your SWOT Matrix, highlighting each of your strategies listed. b. Show and explain your SPACE Matrix, using half of your “space time” on calculations and the

other half on implications of those numbers. Strategy implications must be specific rather than generic. In other words, use of a term such as market penetration is not satisfactory alone as a strategy implication.

c. Show your Boston Consulting Group (BCG) Matrix. Again focus on both the numbers and the strategy implications. Do multiple BCG Matrices if possible, including domestic versus global, or another geographic breakdown. Develop a product BCG if at all possible. Comment on changes to this matrix as per strategies you envision. Develop this matrix even if you do not know the profits per division and even if you have to estimate the axes information. However, make no wild guesses on axes or revenue/profit information.

d. Show your Internal-External (IE) Matrix. Because this analysis is similar to the BCG. see the preceding comments.

e. Show your Grand Strategy Matrix. Again focus on implications after giving the quadrant selection. Reminder: Use of a term such as market penetration is not satisfactory alone as a strategy implication. Be more specific. Elaborate.

f. Show your Quantitative Strategic Planning Matrix (QSPM). Be sure to explain your strategies to start with here. Do not go back over the internal and external factors. Avoid having more than one 4. 3, 2, or 1 in a row. If you rate one strategy, you need to rate the other because that particular factor is affecting the choice. Work row by row rather than column by column on preparing the QSPM.

g. Present your recommendations page. This is the most important page in your presentation. Be specific in terms of both strategies and estimated costs of those strategies. Total your estimated costs. You should have 10 or more strategies. Divide your strategies into two groups: (1) Existing Strategies to Be Continued and (2) New Strategies to Be Started.

ORAL PRESENTATION— STEP 6

Strategy Implementation (8 minutes) a. Show and explain your earnings per share/earnings before interest and taxes (EPS/

EBIT) analysis to reveal whether stock, debt, or a combination is best to finance your recommendations. Graph the analysis. Decide which approach to use if there are any given limitations of the analysis.

APPEN DIX 1 • GUIDELINES FOR CASE ANALYSIS 403

b. Show your projected income statement. Relate changes in the items to your recommendations rather than blindly going with historical percentage changes.

c. Show your projected balance sheet. Relate changes in your items to your recommendations. Be sure to show the retained earnings calculation and the results of your EPS/EBIT decision.

d. Show your projected financial ratios and highlight several key ratios to show the benefits of your strategic plan.

ORAL PRESENTATION— STEP 7

Strategy Evaluation (2 minutes) a. Prepare a Balanced Scorecard to show your expected financial and nonfinancial objectives

recommended for the firm.

ORAL PRESENTATION— STEP 8

Conclusion (4 minutes) a. Compare and contrast your strategic plan versus the company's own plans for the future. b. Thank audience members for their attention. Genuinely seek and gladly answer questions.

Strategie Management Jases

406 STRATEGIC M AN AGEM EN T CASES

Ryanair Holdings, pic — 2011

Charles M. Byles Virginia Commonwealth University

RYAAY http://www.ryanair.ie In O ctober 2011, Ryanair began "Child Free” nights in response to a Europe-wide passenger survey showing that over half would pay higher fares to avoid other people’s children. R yanair’s director o f com munications, Stephen McNamara, stated, “W hen it com es to children, we all love our own but would clearly prefer to avoid other people’s little monsters while traveling.” According to M cNamara, it was not operationally possible to divide the cabins into “adult” and “fam ily” areas as some o f the survey respondents had suggested. The child-free flights would be on high-frequency routes only.

Ryanair recently proposed removing rows o f seats to be replaced by 15 rows o f vertical seats. At the time. Stephen M cNamara invoked a poll o f 120.000 passengers, 80,000 of whom responded they would opt for “standing room” if the tickets were free, while 40 percent would opt for the service for half-price tickets. An earlier proposal would remove two toilets on short- haul aircraft and charge passengers one Euro for using the rem aining third toilet. Even more sur­ prising was CEO O 'L eary ’s proposal that one o f the two pilots on Ryanair aircraft be replaced by a com puter and one member o f the cabin crew on all flights be trained to land the plane. But, despite frequent, seemingly ludicrous suggestions, the airline outperform s its com petitors, and many actions that appeared risky or foolhardy at the time (such as ordering new planes when the market collapsed after the 9/11 attacks) later turned out to be quite astute.

History Ryanair was founded in 1985 and has its headquarters at the Dublin Airport in Ireland. Flights began between Ireland and the United Kingdom in 1986 as the new airline 's Dublin-London route challenged the British A irways-Aer Lingus duopoly. After severe financial losses in 1990. Ryanair restructured, adopting the Southwest Airlines business model, and became the pioneer o f the low-fares model in Europe. The next years showed growth from 745,000 passengers in 1990 to 72.1 million as o f March 31, 2 0 1 1. Ryanair Holdings was incorporated in 1996 as a holding company for Ryanair Limited. Today, Ryanair operates more than 1.500 flights per day from 44 bases and across 27 countries, connecting 160 destinations throughout Europe and Morocco.

Ryanair grew from 51 em ployees in 1985 to more than 8,(XX) em ployees today. Based on passengers carried, Ryanair is Europe’s largest low-cost carrier and second-largest airline. Ii is also the w orld’s largest carrier o f international passengers and the fifth-largest carrier o f both international and domestic passengers. As it continues to grow, Ryanair faces challenges in its use of ancillary fees as a means of maintaining revenue growth while keeping ticket prices low. Externally, increasing legislation and financial distress in Europe threaten lo adversely affect its business model and raise the cost o f operations.

Throughout this case. “ Ryanair” refers to both Ryanair Holdings and Ryanair Limited, which are managed as an integrated unit with the same board of directors and executive officers. The fiscal year for the company means the 12 month period ending on March 31. The Annual Report refers to Form 20F filed with the Securities and Exchange Com m ission and covers the fiscal year ending M arch 31. 2010. Updated financial and operating information is given in Ryanair Full Year Results 2011, which contains data for the fiscal year ending March 31. 201 I (preliminary and unaudited).

CASE 1 • RYANAIR HOLDINGS, PLC — 2011 407

Internal Factors Mission and Vision R yanair has no published m ission or vision statem ent, but its Annual Report and w ebsite statem ents im ply a vision and m ission. A vision statem ent is w hat a com pany w ants to becom e, w hich for R yanair is to “firm ly establish itself as E urope 's leading scheduled pas­ senger a irline through continued im provem ents and expanded offerings o f its low -fares service.”

A m ission statement answers the question “W hat is our business?” Ryanair answers by stating that "R yanair seeks to offer low fares that generate increased passenger traffic while m aintaining a continuous focus on cost-containm ent and operating efficiencies.” The extensive statem ents o f its strategy (Exhibit l ) and its charter (Exhibit 2) explain the main elements o f its business model and its relationship with customers.

EXHIBIT 1 Key Elements of Ryanair's Strategy

1. Low Fares—targets fare-conscious leisure and business travelers who might otherwise use a substitute form of transportation

2. Customer Service—emphasis on better punctuality, fewer lost bags, and fewer cancellations than rivals

3. Frequent Point-to-Point Short-Haul—secondary airports near major metropolitan areas with “no-frills”

4. Low Operating Cost—use of single aircraft type, productive work force, use of contractors, choice of airports with competitive costs

5. Use o fthe Internet—all ticket purchases and check-in via Internet 6. Commitment to Safety and Quality—low-cost operating strategy does not extend to safety,

maintenance, or quality assurance 7. Ancillary Services—revenues are enhanced with hotel bookings, car rentals, and other nonticket

revenues as well as baggage and other charges 8. Focused Criteria for Growth—growth based on an explicit plan with a focus in Europe 9. Responding to C urrent Challenges—responses to increasing fuel costs and reduced economic

growth

Source: Annual Report, Ryanair Holdings PLC (Form 20F filed with U.S. Securities and Exchange Commission), July 20. 2010. http://www.ryanair.com/doc/invcstor/20l0/20F_20l0.pdf.

EXHIBIT 2 Ryanair Passenger Fares, Punctuality, and Service Commitment (Charter)

1. Offer the lowest fares at all times on all routes. 2. No fuel surcharge imposed on any fare. 3. Honor the agreed fare after payment. 4. Notify passengers of known delays, cancellations, and diversions. 5. Minimize the number of passengers facing delays. 6. Allow reservation changes. 7. Respond quickly to passenger complaints and provide prompt refunds. 8. Take measures to speed up check-in. 9. Minimize the number of passengers who are involuntarily denied boarding.

10. Provide passenger information through its website. 11. Provide the following information at the time of booking: scheduled departure and arrival

time, airport/terminal of departure/arrival, and the terms and conditions attached to the fare to be paid.

Source: "Ryanair Passenger Charter." Ryanair website, http://www.ryanair.com/en/about/passenger-charter.

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Code of Ethics Ryanair’s "Code o f Business Conduct & Ethics 2010” gives ethical guidelines about the com ­ pany's work environment, business activities, financial reporting, com pany property, conflict o f interest, law and regulations, disciplinary- action, and reporting procedures. The code is sum m arized as follows:

Ryanair is com mitted to conducting business in an ethical fashion that com plies with all laws and regulations in the countries in which Ryanair operates. As em ployees and repre­ sentatives of Ryanair, we must consider how our actions affect the integrity and credibility o f the Company as a whole. This Code o f Business Conduct & Ethics sets out the prin­ ciples that constitute our way o f doing business.

O ver the years. Ryanair has been accused o f questionable practices, particularly its use of con­ troversial or m isleading advertisem ents that appear to violate its ethics code, specifically its statem ent o f “Fair Dealing" (below), which is part o f that code.

Ryanair does not seek com petitive advantage through illegal or unethical business practices. All em ployees/directors should endeavour to deal fairly with customers, com ­ petitors and employees. No em ployee/director should take unfair advantage of anyone through manipulation, concealment, abuse o f privileged information, m isrepresentation of material facts, or any unfair dealing practice.

Several com plaints have been filed against Ryanair with the Advertising Standards Authority (ASA), the U.K.’s independent regulator o f advertising. BBC News reported that in 2008, Ryanair faced an ASA probe asserting that it made exaggerated claim s about the avail­ ability o f flights at advertised prices that did not include taxes and fees. O ther allegations were that Ryanair:

• Claim ed that its flight from London to Brussels was faster and cheaper than traveling by the Eurostar train.

• Played down the effect o f aviation on the environm ent by claim ing that the industry accounts for just 2 percent o f carbon dioxide em issions (its code o f ethics stales that the airline will do business in an environmentally responsible way).

• Suggested that people buying tickets via online agent Lastminute.com were being ripped off. • Used a model in schoolgirl-style clothes with the headline “hottest back to school fares.”

Even Ryanair acknowledges its controversial advertisements by its website statement that it engages in “punchy advertising that sometim es gets us in trouble.” In 2011, the ASA criticized a Ryanair advertisement featuring a bikini-clad woman promoting trips to a “place in the sun.” The ASA argued that some o f these places had as little as three hours o f sunshine per day. Would these advertisements be appropriate given Ryanair’s own policy against “m isrepresentation of the facts?”

Top Management There are 10 directors o f Ryanair, including CEO Michael O ’Leary. N ine directors arc indepen­ dent under the standards set forth in the NASDAQ rules. Essentially, an independent director has no material interest in the company (for example, being an em ployee or m anager in that company, or having any direct business relationship with the com pany such as being a custom er or supplier).

There are nine executive officers as illustrated in Exhibit 3. Mr. O ’Leary has served as a director since November 1988. deputy chief executive from 1991 to 1994, and CEO since January 1, 1994. O ’Leary restructured Ryanair around the Southwest A irlines model. In 1991. he went to Dallas to meet Southwest executives and took the lessons back to Ryanair. W hile he embraced a few central aspects o f Southw est’s model (a single aircraft, secondary airports), he went much further with the constant drive to keep costs down. In particular, the extensive use of ancillary fees to balance the low ticket prices became a trademark o f Ryanair and now forms a core elem ent of its low-cost strategy.

CASE 1 • RYANAIR HOLDINGS, PLC — 2011 409

EXHIBIT 3 Ryanair's Executive Officers

M ichael O ’Leary (49) C h ie f Executive O fficer

M ichael Cawley (56)

Deputy' Chief Executive; Chief

O perating Officer

Ray Conway (55)

Chief Pilot

Caroline Green (46)

D irector o f C ustom er

Service

Michael Hickey (47)

D irector o f Engineering

Juliusz Komorek (32)

D irector o f Legal & Regulatory

Affairs; C om pany Secretary

Howard Millar (49)

D eputy Chief Executive;

Chief Financial Officer

David O 'Brien (46)

Director o f Flight O perations and

G round O perations

Edward W ilson (46)

D irector o f Personnel

and In-flight

Source: Annual Report. Ryanair Holdings PLC (Form 20F filed with U.S. Securities and Exchange Commission), July 20. 2010. http://www.ryanair.com/doc/ investor/2010/20F_2010.pdf.

O ’Leary is known for his aggressiveness, outrageous public statem ents, and insults to almost any group or individual who gets in the way o f Ryanair, including custom ers who com ­ plain about poor service. He has been accused o f making outlandish suggestions (for example, to have standing passengers on aircraft or to replace one o f the pilots with a com puter) to gain publicity. But, despite giving the impression o f being a loose cannon, industry experts say he is an astute strategist who has created a singular focus on cost control that com petitors have been unable to imitate. He leads by exam ple— stays in budget motels, has no Blackberry, and flies on Ryanair. His office is sparse and the com pany headquarters in Dublin is a drab 15,000-square- foot building. Prior to becom ing CEO, O ’Leary was a conventional dresser who avoided the limelight. On becom ing CEO. however, he changed his wardrobe to jeans and became more outspoken and flamboyant.

O ’L eary's gross salary in 2010 was €595,000 plus a bonus payment of €241.000. O ’Leary's contract may be term inated by either party with 12 months notice.

Strategy Ryanair’s primary means of achieving its objective to become Europe’s leading scheduled passenger airline is to offer lower fares than com petitors. The nine elements o f its strategy are shown in Exhibit 1. W hile Ryanair’s leading strategy is lower cost (through its operations), it also seeks to differentiate itself (through certain aspects o f custom er service) and raise revenues on nonticket items (through ancillary services) as a means of offsetting the lower fares. Its strat­ egy has generated some controversy, especially with respect to ancillary fees (which the airline has been accused o f concealing) and custom er service (which has been reduced in some areas, or which may only be available for a fee).

Five key value chain activities make up the main elements o f strategy: 1) operations, 2) human resource management, 3) customer service, 4) use of the Internet, and 5) ancillary revenues. These value chain activities show how Ryanair organizes its internal activities to implement its strategy.

Operations The primary method o f cost control is the use of a single model o f aircraft (the Boeing 737- 800), which allows m inim ization of training and maintenance costs, efficient management o f spare parts inventory, and more flexible scheduling o f flight crews. Because this model aircraft is widely used, flight crews are m ore readily available for hire. In addition, because Ryanair purchases a large num ber o f aircraft from Boeing, it can negotiate price concessions.

O ther cost saving aspects o f operations are the use o f secondary and regional airports that offer com petitive prices, the use of outdoor boarding stairs instead o f jetw ays, having all passengers check in on the Internet, and the introduction of a checked-bag fee. which reduces the num ber o f bags carried by passengers, handling costs, and the number o f check-in desks. Ryanair frequently has agreements with secondary' and regional airports that its fees be based on traffic volume. Airports are chosen because o f low costs o f operating out of that airport rather than for market reasons.

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Ryanair’s short-haul focus also enhances the low-cost strategy as it allows flights to he conducted without meals, movies, and other in-flight services that would be expected on longer flights. W hile some aspects o f operations have a negative effect on custom er service (e.g., the distance o f the secondary airport from the main cities and the cost o f checked baggage), there are positive aspects such as less congested regional airports, which permit more frequent on-time arrivals, quicker turnarounds, and more frequent on-time departures. Quicker turnarounds and more frequent on-time departures are also enhanced because the airline offers neither connecting flights nor the transfer o f baggage to other flights, whether operated by Ryanair or not.

Human Resource Management A second activity contributing to lower costs is the productivity-based incentive system. Flight attendants receive commissions for onboard sales and, along with pilots, payments based on the number o f hours or sectors flown. For the 2 0 10 fiscal year, productivity-based incentives accounted for approximately 39 percent o f a typical flight attendant's total earnings and 37 percent o f a typical pilot’s total compensation. The cost o f customer service is reduced by outsourcing tick­ eting and other services at airports. For these services. Ryanair has been successful in negotiating fixed-price, multi-year contracts.

Under the Irish Aviation Authority (IAA) rules, pilots are lim ited to 100 flight-hours per 28-day cycle, 300 flight-hours every three months, and 900 flight-hours per fiscal year. For fis­ cal 2010, the average flight-hours for Ryanair's pilots were approxim ately 64 hours per month and approxim ately 758 for the com plete year. There is a risk to the productivity-based incentive system if these standards are made more stringent (i.e.. if the allowed flight hours are reduced).

Most Ryanair employees are represented by unions, and the company currently has a negoti­ ated pay freeze for fiscal 2 0 11 affecting all employee groups. In addition, certain positions may be eliminated in the future, which could lead to deterioration in labor relations and affect the airline’s operations.

Customer Service Ryanair’s stated approach to customer service is the deliberate reduction o f services in some areas (e.g., free checked bags, meals, flights to major airports) while raising it in others (e.g.. on-time departures and arrivals, fewer lost bags). Ryanair claims on its website and in its Annual Report that, according to the Association of European airlines, it has better punctuality, fewer lost bags, and fewer cancellations than its peer group in Europe. This achievement is attributed to Ryanair's focus on these services and its operations from uncongested secondary airports. The airline believes that customers prefer fewer services plus extra fees as needed for meals and other items in exchange for low fares. Exhibit 2 summarizes the "Ryanair Passenger Fares. Punctuality, and Service Commitment” (Charter) published on its website.

The Air Transport Users’ Council, however, claims that in 2009. Easy Jet and Ryanair had the most com plaints o f any major European airline and cancellations, missing bags, and denied boarding were top com plaints. In addition, other observers view Ryanair's custom er service as poor. For example, in a recent Businessweek article entitled “R yanair's O 'Leary: The Duke of D iscom fort” even CEO O 'Leary suggests that custom er service is poor:

In exchange for cheap fares, he |0 'L e a ry | says, passengers will put up with just about anything. On Ryanair, that can include high luggage fees, relentless in-flight sales pitches for sm okeless cigarettes and scratch-off lottery games: minimal custom er service: bad. expensive food: cramped seats; and flights to secondary city airports that are sometim es hours from the actual city.

In the same article. O ’Leary criticizes com petitors for treating budget travelers with a level of courtesy that they do not receive elsewhere, nor expect when traveling. O ’Leary believes that customers will endure discom fort and indignity as long as they get to their destination cheaply and with their suitcases.

Ancillary Revenues The em phasis on ancillary revenues sets Ryanair's strategy apart from other low-cost carriers. It is central to the low-cost strategy as it allows the airline to make up the revenues lost through

CASE 1 • RYANAIR HOLDINGS, PLC — 2011 411

lower ticket prices. Ancillary revenues are defined as revenues beyond the sale o f a ticket and include sales o f related items such as hotel reservations or car rental, as well as charges for food, checked baggage, priority boarding, and other items. Ryanair has been particularly creative in com ing up with new means o f generating ancillary revenues. For example, in 2009. the company announced the sale o f smokeless cigarettes to ensure that passengers get their “fix” o f nicotine without lighting up.

The com pany’s website contains offers for car hire, travel insurance, hotels, airport transfer, credit cards, hostels and bed and breakfasts, cruise holidays, villas and apartments, campsite holidays, and others. Ryanair has contracts with com panies to handle the sendees marketed on the website and receives a fee from these com panies. For example, in the contract with Hertz Corporation, Hertz handles all rentals marketed through Ryanair’s website in exchange for a per- passenger fee paid to Ryanair. Recently. Ryanair teamed up with a travel-m edia com pany to sell targeted advertising that will appear on its boarding passes.

Ancillary revenues are also generated by charging fees for just about anything. For example, there are fees for priority boarding, reserved seats, for airport boarding card reissue, checked baggage, excess baggage, infant equipm ent, sports equipm ent, musical instrum ents, and many others. A recent new fee is a £2 charge to cover the cost o f cancellations and delays in 2 0 10 such as the Icelandic volcanic ash. heavy snow, and strikes in Spain and France. One controversial fee is the boarding pass reissue fee (charging €40/£40 for a passenger who fails to print out his boarding pass), which has been ruled illegal by a judge in Barcelona. W ithout the charge, Ryanair argues that it would have to em ploy num erous handling agents to reissue boarding passes.

The 20 JO Amadeus Guide to Ancillary Revenue categorizes Ryanair as one of the “Ancillary Revenue C ham ps” and estim ates that for 2 0 10, worldwide ancillary revenues would be $22.6 billion. The Irish Examiner newspaper reported that Ryanair’s ancillary revenues for 2009 were €663 million, more than any European airline, and in the top five ranking of airlines around the world (the top three are United, American, and Delta). Ryanair’s ancillary revenues grew by 21 percent to €802 million for fiscal 201 1.

Use of the Internet— Booking, Check-In, and Boarding Passengers must book and pay for fares on the Ryanair website or call center. An adm inistrative fee applies to all bookings made through the call center and also to web bookings made without using Ryanair’s free paym ent method (M asterCard Prepaid Debit Card). Flights are booked one-way only and tickets may be changed for a fee but cannot be cancelled. Passengers must check in online from 15 days before the flight up to four hours before departure time. An online check-in fee applies to all tickets booked (€6/£6 for flights booked online and € 12/£ 12 for those made via the call center or at the airport). A fter checking in, the boarding pass must be printed and presented at boarding. No changes can be made to passenger name(s), flight dates, times, or route once the check-in is com pleted. Seating is not assigned unless “Reserved Seating” has been purchased (on the website) or where passengers have indicated that they need special assis­ tance. Passengers who have purchased “Priority Boarding” (also from the website) may board before others provided they arrive at the gate no later than 30 minutes before boarding. Refunds are possible only in the event o f a flight cancellation or the death o f an im m ediate family m em ­ ber (within 14 days of the travel date).

Fleet— Environmental Issues and Safety Ryanair has a fleet o f 272 B oeing 737-800 je ts . It is one o f the youngest fleets, w ith an average age o f 2.94 years and none o lder than 8 years (as o f M arch 31, 2010). Each aircraft has a capacity o f 189 passengers, is capable o f longer flights, and has m ore sophisticated avion ics than the previous 737-200 aircraft. W inglets are installed w ingtips to reduce fuel consum ption . The com pany has orders for 56 new aircraft expected to be delivered over the next tw o years.

Ryanair boasts that its modern fleet contributes to less fuel use, pollution, and noise, and the airline is strongly opposed to a charge on emissions. The airline believes that a charge on em issions will increase air fares, reduce com petition, and help the larger carriers, which have less efficient aircraft and fly into more congested airports (which have longer taxiing tim es and holding o f flights), which contribute to fuel waste and pollution.

412 STRATEGIC M AN AGEM ENT CASES

There have been no passenger or flight crew fatalities in 25 years o f operation. The com pany's board has an air safety committee to oversee safety practices. The airline trains its flight crews using programs approved by the Irish Aviation Authority. Each Boeing 737-800 is equipped with an Operational Flight Data Monitoring system, which provides reports on deviations from normal operating procedures on any flight.

Operating Performance Revenue Passenger Miles (RPMs) is the total number o f passengers multiplied by the miles flown and is a useful measure o f an airline’s market share. Ryanair’s RPMs increased 14.4 percent from 39,202.3 million in the 2009 fiscal year to 44 ,841 .1 million in the 2010 fiscal year.

Available Seat Miles (ASM s) is the number o f seats in the active fleet multiplied bv the number o f miles flown and is a capacity measure. ASM s are a function o f the fleet size, mix of seats (first, business, and econom y seats), the average length of flights, and the turnaround time of the aircraft. Ryanair’s ASM s increased 13.5 percent from 47.102.5 million in the 2009 fiscal year to 53.469.6 million in the 2010 fiscal year.

The load factor is RPM divided by ASM and m easures the percentage o f available capacity that is taken by revenue paying passengers. Once the load factor exceeds the break-even point (which varies by airline), the airline becom es profitable. R yanair’s load factor for fiscal 2009 was 81 percent (break-even 79 percent), and for fiscal 2010 was 82 percent (break-even 73 percent).

Average yield per RPM (frequently referred to as just “yield") is the average passenger revenue received for each revenue passenger flown. Airlines should only be compared on the basis of yields if their mix of flights is similar. International flights tend to have lower yields but tend to be more profitable (because o f lower costs), while domestic flights might have higher yields but be less prof­ itable (because costs are higher). Also, airlines with a higher proportion of first class and business seats will have higher yields than a low-cost carrier, which will tend to have only one seat class. For Ryanair, yield decreased from €0.060 in 2009 to €0.052 in 2010, attributable to an increase in seat capacity, poor economic conditions, increased price promotions, and the adverse strengthening of the U.K. pound sterling against the Euro.

Cost per Available Seat Mile (CASM ) is expressed as the num ber o f cents to operate each ASM (operating costs divided by ASMs) and is frequently used to com pare costs across airlines. For Ryanair, CASM was €0.058 for fiscal 2009 and €0.047 for fiscal 2010.

Finally, the average booked passenger fare was €40.02 in 2009 and €34.95 in 2010. Ancillary revenues per booked passenger were €10.21 in 2009 and €9.98 in 2010.

Financial Performance Balance sheets and income statements for the last two years are given in Exhibits 4 and 5. Note that for the year ended M arch 31. 2011, Ryanair reported a 26 percent increase in profits to €400.7 million, com pared to €318.8 million in the year ended March 31, 2010. Total operating revenues increased by 21 percent to €3,629.5 million, primarily due to a 12 percent increase in average fares, an 8 percent increase in passenger numbers, and a 21 percent increase in ancillary fees. Gross cash increased by €127.2 million to €2,940.6 million. Adjusted basic EPS rose to 26.97 from 2 1.59 as of M arch 31, 2 0 10.

E X H IB IT 4 Ryanair Holdings pic and Subsidiaries Condensed Consolidated Prelim inary Balance Sheet as of March 31, 2011 (000,000 om itted)

Mar. 31, 2011 Mar. 31, 2010

€ €

Noncurrent assets Property, plant and equipment 4,933.7 4.314.2

Intangible assets 46.8 46.8

Available for sale financial assets 114.0 1 16.2

Derivative financial instruments 23.9 22.8

Total noncurrcnt assets 5,118.4 4,500.0

CASE 1 • RYANAIR HOLDINGS, PLC — 2011 413

EXHIBIT 4 Continued

Mar. 31, 2011 Mar. 31, 2010 € €

Current assets Inventories 2.7 2.5 Other assets 99.4 80.6 Current tax 0.5 - Trade receivables 50.6 44.3 Derivative financial instruments 383.8 122.6 Restricted cash 42.9 67.8 Financial assets: cash > 3 months 869.4 1.267.7 Cash and cash equivalents 2.028.3 1.477.9 Total current assets 3.477.6 3.063.4 Total assets 8.596.0 7,563.4 C urrent liabilities Trade payables 150.8 154.0 Accrued expenses and other liabilities 1,217.0 1,088.2 Current maturities of debt 333.8 265.5 Current tax - 0.9 Derivative financial instruments 125.4 41.0 Total current liabilities 1,827.0 1.549.6 Noncurrent liabilities Provisions 96.9 102.9 Derivative financial instruments 8.3 35.4 Deferred tax 267.7 199.6 Other creditors 126.6 136.6 Noncurrent maturities of debt 3,315.6 2,690.7 Total noncurrent liabilities 3,815.1 3,165.2 Shareholders’ equity Issued share capital 9.5 9.4 Share premium account 659.3 631.9 Capital redemption reserve 0.5 0.5 Retained earnings 1,967.6 2.083.5 Other reserves 317.0 123.3 Shareholders’ equity 2,953.9 2,848.6 Total liabilities and shareholders' equity 8,596.0 7,563.4

Source: “Ryanair Full Year Results 2011 .” Ryanair website, http://www.ryanair.com/doc/investor/20l 1/ q4_201 l_doc.pdf.

E X H IB IT 5 Ryanair Holdings pic and Subsidiaries Condensed Consolidated Prelim inary Income Statem ent for the Year Ended March 31, 2011 (000,000 om itted)

Mar. 31, 2011 Mar. 31, 2010

€ €

Operating revenues Scheduled revenues 2,827.9 2,324.5 Ancillary revenues 801.6 663.6

Total operating revenues - continuing operations 3,629.5 2.988.1

(Continued)

414 STRATEGIC M AN AGEM ENT CASES

EXHIBIT 5 Continued

Mar. 31, 2011 Mar. 31, 2010

€ €

Operating expenses Staff costs 371.5 335.0 Depreciation 273.0 235.4 Fuel & oil 1.226.7 893.9 Maintenance, materials, & repairs 93.9 86.0 Aircraft rentals 95.2 95.5 Route charges 410.5 336.3 Airport & handling charges 490.9 459.1 Marketing, distribution, & other 151.6 144.8 Icelandic ash-related cost - -

Total operating expenses 3,113.3 2.586.0 Operating profit - continuing operations 516.2 402.1

Other income/(expenses) Finance income 27.2 23.5 Finance expense (92.2) (72.1) Foreign exchange loss (0.6) (1.0) Loss on impairment of available for sale financial asset _ Gain on disposal of property, plant. & equipment - 2.0

Total other expenses (65.6) (47.6) Profit before tax 450.6 354.5

Tax on profit on ordinary activities (49.9) (35.7) Profit for the year - all attributable to equity holders of parent 400.7 318.8

Earnings per ordinary share (in € ccnt) Basic- 26.97 21.59

Diluted 26.89 21.52 Weighted average no. of ordinary shares (in Ms) Basic 1.485.7 1.476.4

Diluted 1.490.1 1,481.7

Source: “Ryanair Full Year Results 2011.” Ryanair website, http://www.ryanair.com/doc/investor/20l I/ q4_2011 _doc.pdf.

Total operating expenses rose by 20 percent to €3,113.3 million, primarily as a result o f increased fuel prices but also because o f increased hours flown. Fuel costs (39 percent o f total operating costs) increased by 37 percent to €1,226.7 million. Unit costs excluding fuel increased by 3 percent and including fuel rose by 11 percent. The operating margin rose 1 percent to 14 percent, while operating profit increased by 28 percent to €516.2 million. The income state­ ment (Exhibit 5) shows all operating expenses for the airline.

These figures represent unaudited consolidated financial inform ation prepared in accordance with International Financial Reporting Standards (IFRS) principles. The figures exclude exceptional items o f €29.7 m illion (pretax) reflecting the closure o f airspace in April and May 2010 because of the volcanic eruptions in Iceland. The exceptional item s for the year ended March 31, 2011, am ounted to €13.5 m illion, reflecting the im pairm ent o f the Aer Lingus shareholding. For this reason, the incom e statem ent is labeled “ Pre Exceptional R esults” in accordance with the way in which R yanair presented its operating and financial results.

CASE 1 • RYANAIR HOLDINGS, PLC — 2011 415

External Factors Government Regulation COMMISSION FOR AVIATION REGULATION (CAR) The CAR is responsible for issuing operators licenses subject to EU law, and the CAR may revoke licenses. Ryanair’s current operator’s license becam e effective on Decem ber 1, 1993. The CAR is also responsible for deciding whether an airport should be "fully coordinated,” effectively granting it control over the issuing of slots (a time reserved for arrival and departure o f a particular airline flight). Ryanair has in the past challenged the C A R 's decision to designate Dublin Airport as fully slot-coordinated.

IRISH AVIATION AUTHORITY (IAA) The 1AA is responsible for overseeing the safety and technical aspects o f aviation in Ireland and issuing operator’s certificates to carriers. The IA A s regulatory authority includes the following: air safety: aircraft certification; personnel licensing and training: maintenance, m anufacture, repair, air w orthiness, and operation o f aircraft; im plem entation o f EU legislation; aircraft noise; and ground services. Each o f Ryanair’s aircraft must have a Certificate o f A irworthiness issued by the IAA, and this certificate may be am ended or withdrawn if the airline fails to com ply with statutes, rules, and regulations relevant to the industry.

DEPARTMENT OF TRANSPORTATION (DOT) The DOT is responsible for im plementation of EU and Irish legislation and international standards relating to air transportation. O f importance to Ryanair, in 2005 the DOT enacted legislation in response to EU legislation requiring com pensation and assistance to passengers in the event of denied boarding, flight cancellation, and long delays (EU 261).

Ryanair views the EU 261 regulations as “unfair and discrim inatory” because they force airlines to pay com pensation to passengers as well as cover other costs in circum stances beyond the control o f the airline, such as air traffic control strikes or failure by airports to clear snow from runways. Ryanair argues that com pensation in such circumstances should be limited to the ticket price paid as is required for train, coach, and ferry operations. (The regulation itself states that airlines are not responsible for passenger com pensation forevents beyond the airline’s control.) In the case of denied boarding, cancellation, or long delay (which is deemed the same as a cancellation), short-haul airlines such as Ryanair would be required to pay €250 per pas­ senger (for inconvenience to that passenger). Airlines arc also required to reroute or refund the ticket and may be required to provide meals, accom m odation, and other am enities to passengers. Ryanair has already paid out claim s o f £88 million related to the above events last year and ju sti­ fies its added £2 fee by the costs associated with EU 261. The airline, however, stands to earn up to £150 million per year from this fee, nearly twice the £88 million already paid out.

Fuel Fuel represented 34.1 percent o f total operating expenses for fiscal 2010 (43.8 percent in 2009). Ryanair actively engages in fuel hedging (for example, purchasing future fuel supplies at a set price to minimize losses should prices increase). It is limited in its ability to pass on fuel increases to passengers and has made a com m itm ent in its charter not to impose a fuel surcharge on any fare.

Ryanair is 90 percent hedged for fiscal year 2012 at S820 per metric ton ( 1.000 kilograms or 2,204.62 lb.), or about $82 per barrel. This represents a 12 percent price increase over last year but is below current prices. The airline anticipates higher oil prices next w inter coupled with the refusal of some airports to offer lower charges. This may result in the grounding o f aircraft rather than risk financial losses. Although Ryanair expects traffic to grow overall in fiscal 2012, it does anticipate a reduction in the winter. It expects its full year fuel costs to increase by approxim ately €350 million.

Airline Industry and Competition The European airline industry is highly competitive with a number of low-fare (e.g.. easyJet, Air Berlin, and Germanwings), traditional (e.g., British Airways, Lufthansa, and Air France), and charter airlines (e.g.. Monarch Airlines and Titan Airways). Charter flights are offered by low-fare as well as traditional airlines, and some charter airlines (e.g., Monarch) offer scheduled services. Airlines compete on fares, time and frequency o f services, service quality (e.g., number o f on-time

416 STRATEGIC M AN AGEM EN T CASES

departures and arrivals, frequency of lost baggage, and frequency of involuntary denied boardings), amenities such as frequent flyer programs, and reputation. Ryanair believes that state-owned com ­ petitors have advantages because of subsidies and other state aid provided to them. In addition, the EU-U.S. Open Skies Agreement that took effect in 2008 allows U.S. carriers to offer services in the intra-EU market, which results in increased competition.

Although Ryanair boasts having the lowest fares, a survey in May 2 0 11 by The Telegraph showed how the cost o f a flight on a low-cost carrier can escalate when all fees are added and make prices on a traditional carrier such as British Airways more com petitive. The survey was of return flights for a family o f four from London to Madrid traveling on the same dates in August with two checked bags, golf clubs, and a cot. and paying with a debit card. The fares were as follows: Ryanair £271.92; easyJet £275.92; and British Airways £476.20. W hile Ryanair had the lowest fare, the costs went up substantially once all lees were added. To Ryanair’s ticket cost would be added an online check-in fee (£48), luggage fees (£80 plus £80 for golf clubs and £20 for the travel cot), adm inistration fees (£48). and the new delay/cancellation fee (£16) for a total cost o f £563.92, the highest o f the three carriers.

Exhibit 6 gives the full breakdown of all costs. While this survey represents a snapshot of a particular trip and m ight not be applicable to all trips, it makes the point that Ryanair is not always the cheapest way to travel and passengers must consider the added fees before m aking the ticket purchase. To the extent that passengers become more familiar with the complex Ryanair fee structure, it may place Ryanair at a disadvantage compared to low-fare and traditional airlines, as illustrated in this survey.

Airlines face competition from ground transportation such as high-speed rail systems that are quite extensive in Europe and sea transportation (which in Ryanair’s case would be more relevant to travel between Britain, Ireland, and continental Europe, as well as travel to Morocco).

The Single European Sky proposal (SES) launched by the European Commission in 1999 could have broad effects on the European airline industry. According to The Wall Street Journal, in 39 European countries there ate 39 national agencies plus Eurocontrol, with 64 control centers. The European system has twice as many bureaucrats and support staff than in the United States and operating costs are 75 percent higher than the FAA's, largely because o f labor costs. Ryanair's £2 fee that was recently added was in part to cover costs that it incurred because o f a strike in 2010 by Spanish air traffic controllers. These controllers were earning an average of half a million dollars and went on strike after an attempt by the Spanish government to cut those salaries to below $300,000. Resistance to a Europe-wide system similar to the FAA in the United States is in part explained by the desire to protect pay systems such as in Spain. EU officials state that the SES will end such pay abuses, cut delays, and reduce fuel consumption and pollution.

EXHIBIT 6 Cost Comparison of Ryanair, easyJet, and British Airways for Family of Four, London to Madrid, in August 2011

Cost Item British Airways Ryanair easyJet

Ticket price £479.20 £271.92 £275.92

Online check-in n/a £48 n/a

Delay /cancellation* n/a £16 n/a

Administration fee n/a £48** £8 Two checked bags free up to 23kg £80 up to 15kg £44 up to 20kg

Travel cot free £20 free

Golf clubs free £80 £50

Total cost of trip £479.20 £563.92 £387.17

*£2 fee per passenger per flight added to compensate claims for last year's flight delays and cancellations due to volcanic ash, heavy snow, and ATC strikes **Avoidable if use MasterCard Prepaid Booking Card otherwise £6 per passenger per flight (Ryanair), avoidable for easyJet if use Visa Electron Source: Oliver Smith, “Ryanair to earn £l .25 billion from extra charges,” The Telegraph. May 6. 2011. http://www.telegraph.co.uk/travel/travelnews/8497343/Ryanair-to-eam-l.25bn-from-extra-charges.html.

CASE 1 • RYANAIR HOLDINGS, PLC — 2011 417

On M ay 23, 2 0 1 l, the airline released the Ryanair Full Year's Results 2011 , in which CEO Michael O ’Leary pointed out the following highlights:

• Profits rose 26 percent to €401 million • Traffic grew 8 percent to 72 million • 40 new aircraft (year-end fleet was 272 aircraft) • 8 new bases: El Prat. Gran Canaria, Kaunas, Lanzarote, Malta, Seville, Tenerife, Valencia

(total 44 bases) • 328 new routes (total o f over 1,300 routes) • Custom er service further improved (num ber one on-time airline) • D ividend of €500 million paid to shareholders (€846 million returned to shareholders over

the last three years)

The highlights show an airline that has grown, been profitable, and made returns to its share­ holders. But. are there risks associated with rapid growth? If passenger numbers do not m aterial­ ize to keep up with the fleet expansion. Ryanair could experience overcapacity and be forced to lower its prices to attract more passengers. It would also face difficulties to pay for its expanded fleet o f aircraft. Fuel prices are expected to rise in 2012. Increasing legislation, in particular EU 261, could have continuing adverse effects on Ryanair. One new piece o f legislation taking effect in January 2012 is the European U nion’s emissions trading scheme. Under this requirement, airlines must pay for the carbon dioxide they emit. Estim ates are that airlines are likely to pay about €1.4 billion for carbon permits in 2012. rising to €7 billion by 2020. A certain number of permits will be issued free to each airline, but they will have to buy permits on the open market for emission beyond the allowed amount. O ther challenges faced by Ryanair are:

1. How sustainable is the strategy of low ticket price plus extensive fees as consumers become more educated about Ryanair's lee structure?

2. Will custom ers continue to put up with the poor overall custom er service in exchange for lower ticket prices, faster turnarounds, and a higher percentage o f on-time departures and arrivals?

3. Will increasing custom er com plains about the airline’s services and advertising bring more restrictive legislation for the airline?

4. Does Ryanair’s strategy provide an opportunity for a “differentiated” low-cost entrant, perhaps a low-fare carrier with a softer touch?

On May 24, 2011, Ryanair deliberately flew an aircraft (without passengers) through Scottish airspace that was closed because o f a recent volcanic eruption in Iceland. R yanair’s reason was to dem onstrate that there was no safety threat to aircraft in this area and the designa­ tion o f it as a "'red zone” by the U .K.’s Civil Aviation Office was flawed. In response, the U.K.’s transportation secretary stated that radar tracking of the aircraft showed that it did not fly though any part o f the designated red zone. Is this another in a series o f publicity stunts by Ryanair, or does it have a point that the flight restrictions were unnecessary?

Prepare a three-year strategic plan for CEO O’Leary at Ryanair.

The Future

418 STRATEGIC M AN AGEM EN T CASES

The Emirates Group, 2014

www.theemiratesgroup.com

Based in Dubai, United Arab Emirates (UAE), Emirates Group (Em irates) includes (a) Emirates (the airlines) and (b) Dnata. a company specializing in aviation ground-handling services and operating at 20 airports. The largest airline in the Middle East, Em irates flies to more than 130 destinations in 70 countries on six continents and offers direct flights from Dubai to Washington. DC, San Francisco, Los Angeles, and Seattle. Emirates services the world from Beijing to San Francisco and more than 100 markets in between. More than 1,200 Emirates flights depart Dubai each week, accounting for about 40 percent o f all air traffic out o f Dubai international Airport.

Emirates carries 40 million passengers and 2.0 million tons o f cargo annually, using a fleet o f more than 170 aircraft. The company has another 230 aircraft on order (worth about $84 billion) and is the w orld’s largest operator o f both the Airbus 380 and Boeing 777. Using large planes such as the Airbus 380 and Boeing 777 provides extra space and luxury for wealthy and business passengers alike. Most o f the com pany’s planes even include spacious private suites, and some planes provide a spa with showers. Emirates is well known for providing ex­ cellent service for high-end passengers in first class, but it also provides excellent service in business class and economy class. Econom y-class customers receive w ell-thought-out meals consisting o f many courses, e-mail, SMS services, telephone, and personal TV monitors with more than 1.400 channel options. Singapore Air is considered the closest com petitor based on overall business model o f top service at a premium price and markets served.

Emirates has more than 67.000 em ployees and annual revenues o f more than 73.1 billion Dirham (the United Arab Emirates currency). The Dirham is pegged to the U.S. dollar so cur­ rency fluctuations are not significant. Emirates is owned by the government o f Dubai operating under the Investment Corporation of Dubai name, but the company and the governm ent o f Dubai are quick to point out the airline has grown in scale not by way of protectionism but through competition. The government of Dubai treats Emirates as a wholly independent business entity on its own and attributes this to the firm ’s success. Dubai has an open-skies policy and more than 60 percent o f all flights in Dubai are by com panies other than Emirates.

In August 2013, Emirates became the first airline in the M iddle East to provide Google Now cards for their passengers who book via Emirates.com. A feature o f the Google Search app, Google Now is available and fully integrated for Android (devices running Android 4 .1 and above) and iOS (iPhones and iPads). This new product enables Em irates’ custom ers to see and monitor their upcoming flight, providing flight times and departure terminal. G oogle Now gives passengers relevant information on their destination (for exam ple weather conditions locally, currency, local landmarks, accom modations, and attractions).

Copyright by Fred David Rooks LLC. (Written by Forest R. David)

History Dubai is a city-state in the UAE, located within the em irate o f the sam e nam e, one o f the seven em irates that make up the UAE. Dubai has the largest population in the UAE (2,104.895) and the second-largest land territory by area (4,114 k n r ) after Abu Dhabi. Dubai and Abu Dhabi, the national capital, are the only two em irates to have veto power over critical matters o f national im portance in Lhe UAE legislature. The city o f Dubai is located on the em irate’s northern coast­ line and is often misperceived as a country or city-state and, in some cases, the UAE as a whole has been described as Dubai.

When the British pulled out o f Dubai in the late 1950s, Sheikh Saeed bin M aktoum (the current CEO of Emirates) decreed open-seas, open-skies, and open-trade policies to develop the country. He also required that all government agencies make a profit. Dubai was aiming to elim inate its dependence on its finite oil reserves within 50 years and thus has operated under a free market society for decades. Emirates Group started in 1959 as the Dubai National A ir

CASE 2 • THE EMIRATES GROUP, 2014 419

Transport Association (Dnata), with Dnata airport operations, Dnata cargo, and Dnata agencies as segments. After G ulf A ir began cutting back service to Dubai in the 1980s, D ubai’s royal family provided funding for Dnata to obtain two planes and the com pany became known as Emirates Group. The com pany’s lirst flight was in 1985 on a leased Airbus plane. After being in operation for four years. Emeritus was serving 12 destinations, and by 1994 the airline was serving 32 destinations but still only operated 15 aircraft and was the sixth largest airline in the M iddle East. During this time. 92 rival firms were serving Dubai Airport, which provided intense com petition for Emirates.

The late 1990s was a time o f rapid expansion for Emirates; it ordered 16 Airbus 330-200s at a cost o f $2 billion, and in 1997, it ordered an additional six Boeing 777-200s. The company followed that by opening a $65-million training center with simulators for training pilots and crew. The com pany continued to expand, ordering an additional 22 Airbus A380s, the largest plane in the world, and six additional Boeing 777s in 2001. The 2000s saw considerable expan­ sion in the num ber o f planes operated and destinations served, including new flights being added every month to various places around the world. Emirates received 22 new aircraft in fiscal year 2012, the most ever obtained in a single year by the company. Emirates is perhaps the world’s fastest growing and most profitable airline in the industry.

Dubai is one of the fastest-growing countries in the world because thousands of people migrate to Dubai monthly, often because there is no tax on the personal wages in Dubai. The living standard is great, the climate is great, the infrastructure is impressive, business is grow­ ing leaps and bounds, and the schools in Dubai are international and provide a great learning environm ent for kids o f all nationalities. However, an expatriate (foreigner) may work in Dubai only if sponsored by an employer.

Internal Issues Mission and Vision Em irates’ m ission is ‘'to become one of the top lifestyle brands in the world.”

Organizational Structure As indicated in Exhibit 1, Emirates operates from a divisional-by-product organizational design. Note that no women are among the com pany’s top management team, which com es as no sur­ prise given M iddle Eastern culture. However, Emirates could set an exam ple soon by promoting

EXH IBIT 1 Emirates' Organizational Structure

Source: Based on company documents.

420 STRATEGIC M AN AGEM ENT CASES

one or more women to top management, to exem plify that women are as capable as men to manage business operations. The Executive Vice Chairman position perhaps is analogous to the traditional C hief Operations Officer.

Emirates Luxury F irst-class passengers on Em irates flights enjoy the ir own private suites on A irbus 380. A irbus 350, and Boeing 777 planes. The Em irates first-c lass experience starts w ith a per­ sonal chauffeur p ick ing up a passenger and driv ing him or her to the airport for a seam less check in. C ustom ers are then able to enjoy the first-c lass lounge w hile they w ait for the plane to arrive before the boarding process begins. F irst-c lass passengers have an a llow ­ ance for two carry on item s to taling 25 pounds com bined and unlim ited checked bags up to 170 pounds total w eight. O nce on board, the custom er enjoys su ites that include a personal m ini-bar, vanity table, m irror, w ardrobe, 23-inch TV with m ore than 1.400 chan ­ nels including the latest m ovies, slid ing door for extra privacy, SM S, Internet, and m uch m ore. If desired , the flight crew can covert the seat to a fully Hat bed w ith m attress. To com plem ent the bed, pajam as, slippers, and to iletries w ith Bulgari lo tions are provided. F irst-class custom ers have exquisite free food and drink op tions, including D om Perignon, m artinis, Iranian caviar, stir-fried lobster, glazed duck breast, A rabic m ezze (appetizers), and much more. F irst-c lass custom ers have access to the firs t-c lass lounge to m ingle w ith o ther first-c lass passengers and enjoy hors d ’oeuvres prepared by som e o f the w o rld 's best chefs. F irst-c lass custom ers can enjoy one o f the two onboard show er spas as part o f their experience on the Em irates A irbus 380. The spas are m arketed as having w alnut and m arble designs w ith fine linens and provide com plim entary m assages in addition to a shower. The price in 2009 for a first-c lass ticket from Dubai to M elbourne, A ustra lia w as around $16,000.

Business-class travel on Em irates is possibly the best in the world. Business-class pas­ sengers enjoy many am enities, such as seats turning into a 79-inch flat bed at the push o f a button, power supply for laptops, extra large tables, large screen TVs w ith m ore than 1.400 channels, SM S, Internet, m ini-bar built into every seat, and privacy dividers. These am enities are provided on A380 and most Boeing 777 aircraft. B usiness-class passengers also enjoy delicious food and many drink options. Com plim entary cham pagne and vintage wines are the norm, and all food is presented on Royal Doulton fm e-bone china. Business-class custom ers also have access to the business-class lounge on the second level o f all A380 aircraft where chefs fix snacks and hors d ’oeuvres. Em irates’ econom y-class custom ers enjoy m ore than 1,400 channels on their personal TV, meals, and Internet, phone, and SM S capabilities at their seats.

Finance Em irates’ fiscal year ends on March 3 1 si. and all financial statem ents are prepared in accordance with the International Financial Reporting Standards (IFRS) and are reviewed by an unaffiliated institution as any publicly traded company would be subject to. Em irates reported a profit for the 25th consecutive year in fiscal year 2013 with revenues up 17.4 percent from the previous year, and the best year ever for Dnata, which had revenues of 6.62 million AED. Rising fuel prices hurt overall profits because fuel accounts for more than 40 percent o f all costs for Emirates. The Arab Spring and the instability in Africa also hurt profits, but the com pany’s net profit for fiscal year 2013 was 7.83 billion AED, up 57 percent from the previous year. Em irates increased total passenger volume by 15.9 percent in fiscal year 2013 and maintained a passenger seal factor of 80 percent.

Em irates’ recent income statements and balance sheets are provided in Exhibits 2 and 3. respectively. Note the strong financial position of this company.

Segments The Emirates Group has two primary divisions, Emirates and Dnata. Em irates is the airline, whereas Dnata includes (a) cargo and ground handing, (b) travel services, (c) catering, and (d) freight forwarding.

CASE 2 « THE EMIRATES GROUP, 2014 421

EXHIBIT 2 Emirates' Income Statement (in millions of AED)

2013 2012 2011 AED m AED m AED m

Revenue 71,159 61,508 52,945 Other operating income 1,954 779 1.286 Operating costs (70.274) (60,474) (48.788) Operating profit 2,839 1,813 5,443 Other gains and losses — — (4) Finance income 406 414 521 Finance costs (900) (657) (506) Share of results in associates and joint 127 103 91

ventures Profit before income tax 2,472 1,673 5,545 Income tax expense (64) (53) (78) Profit for the year 2,408 1,620 5,467 Profit attributable to non-controlling 125 118 92

interests Profit attributable to Emirates’ owner 2,283 1,502 5,375 Profit for the year 2,408 1,620 5,467 Currency translation differences 9 (9) 38 Cash flow hedges 56 (259) (282) Actuarial losses on retirement benefit (70) (116) (57)

obligations Other comprehensive income (5) (384) (301) Total comprehensive income for the year 2,403 1,236 5,166 Total comprehensive income attributable 125 118 92

to non-controlling interests Total comprehensive income attributable 2.278 1,118 5,074

to Emirates’ Owner

Source: Based on page 8, 2013 Annual Report.

EXHIBIT 3 Emirates' Balance Sheets (in millions of AED)

2013 2012 2011 AED m AED m AED m

ASSETS Non-current assets Property, plant and equipment 57,039 49,198 39,848 Intangible assets 910 902 901 Investments in associates and joint 485 430 386

ventures Advance lease rentals 807 370 384 Loans and other receivables 508 917 1,704 Derivative financial instruments 92 69 — Deferred income tax asset 15 10 —

51,896 43,223 Current assets Inventories 1,564 1,469 1,290 Trade and other receivables 8,744 8,126 6,481 Derivative financial instruments 67 8 123 Short term bank deposits 18,048 8.055 3,777 Cash and cash equivalents 6,524 7,532 10,196

34,447 25,190 21,867 Total assets 94,803 77.086 65,090

(continued)

422 STRATEGIC M AN AGEM ENT CASES

EXHIBIT 3 Continued

2013 AED m

2012 AED m

2011 AED m

EQUITY AND LIABILITIES C apital and reserves Capital 17 801 801 Retained earnings 22,729 21.256 20,370 Other reserves (768) (833) (565) Attributable to Emirates’ owner 22,762 21,224 20,606 Non-controlling interests 270 242 207 Total equity 23,032 21,466 20,813 Non-current liabilities Borrowings and lease liabilities 35,752 26,843 20.502 Retirement benefit obligations — 631 479 Deferred revenue 1,460 1,074 930 Deferred credits 294 350 401 Deferred income tax liability — — 2 Trade and other payables — — 31 Derivative financial instruments 1,016 957 642

29,855 22,987 Current liabilities Trade and other payables 25,013 20.601 17,551 Income tax liabilities 24 36 22 Borrowings and lease liabilities 5,042 4,037 2,728 Deferred revenue 1.147 915 792 Deferred credits 87 136 136 Derivative financial instruments 6 40 61

31,319 25,765 21,290 Total liabilities 71,771 55,620 44,277 Total equity and liabilities 94,803 77,086 65,090

Source: Based on page 9, 2013, Annual Report.

Emirates Passenger revenue is the largest overall revenue generator as revealed in Exhibit 4. Substantial revenue also is derived from cargo, which produces 15 percent o f the segm ent’s total revenue. whereas sale o f goods produces 3 percent. All other sources contribute less than 1 percent o f the segm ent’s revenues. This segment includes several maritim e and mercantile holdings,

EXHIBIT 4 Emirates Revenues by Segment (in millions of AED)

REVENUE

2013 2011-12 2010-11 AED m AED m AED m

Passenger 57,477 48,950 41,415 Cargo 10.346 9,546 8,803 Excess baggage 388 332 293 Other 767 Transport revenue 68,978 58,828 50,511 Sale of goods 1,196 2,017 1,774 Food 502 245 226 Other 483 418 434

Total 71,159 61.508 52,945

Source: Page 13, 2013. Annual Report.

CASE 2 • THE EMIRATES GROUP, 2014 423

a 49 percent ownership in a wine and spirit business in Thailand, and hotels in UAE, Australia, and Seychelles.

This segment operates more than 180 aircraft with approxim ately 120 on operating lease, 55 on financial lease, and 6 being fully owned by Emirates. Out o f the 180 planes the company operates, 98 are Boeing’s 777, one o f Boeing’s largest planes and the largest tw in-engine plane in the world. An additional 21 aircraft are Airbus 380s, the four-engine double-decker plane that is the largest in the w'orld. Emirates is the largest operator o f Airbus 380 aircraft in the world. The com pany has on order 223 additional aircraft broken down to 84 Boeing 777s, 69 Airbus 380s, and 70 Airbus 350-900s. The Airbus 350s are wide-bodied, long-range planes designed to com pete with Boeing’s Dreamliner. Although the 350s are considered large capacity, they hold significantly less passengers than the 777 and 380 models. On average, Emirates wide-body planes are 77 months old com pared to the industry average of 136 months. With 223 new planes on order, the average age o f planes in the fleet should drop substantially.

More than 40 percent of all expenses are related to je t fuel. Employment expenses account for 13 percent of revenue and operating leases account for 8 percent. Maybe surprising to some, aircraft maintenance only amounted for AED 1,296 million or 2 percent of total revenues, about the same as parking and landing fees. Exhibit 4 details a revenue breakdown within the Emirates segment.

Exhibit 5 reveals the geographic breakdown of Em irates’ flights. No single market accounts for more than 30 percent o f revenues, creating a well-diversified com pany with respect to regions served. The Americas market grew at the highest rate in the most recent fiscal year, but East Asia and Australasia regions had the largest overall AED growth. Note that the Americas segm ent grew from last place to fourth place.

Dnata D nata’s profits and revenues for fiscal year-end March 31, 2013 were at all time records of 6.5 billion AED and 815 million AED respectively, as revealed in Exhibit 6. M uch o f the rev­ enue growth can be attributed to recent acquisitions Dnata made including Travel Republic Ltd., the largest privately-held online travel company in the United Kingdom, in 2011.

EXHIBIT 5 Geographic Breakdown of Emirates' Revenues (in millions of AED)

East Asia and

Year Australasia Europe

West Asia and

Indian Ocean Americas

Middle East Africa Total

2012-2013 20,884 20,140 8,031 8,275 7,117 6,712 71,159 2011-12 18,227 17,058 7,083 6,696 6,314 6,130 61,508 2010-11 15,503 14,433 6,405 5,518 5,488 5,598 52,945

Source: Page 14, 2012-2013 Annual Report.

EXHIBIT 6 Dnata's Revenues by Segment (in millions of AED)

Revenue

2012-2013 2011-12 2010-11 % change AED m AED m AED m

In-flight Catering 1.686 2,452 576 325.7 Airport operations 2,474 2,321 1,980 17.2 Cargo 1,077 993 882 12.6 Information 755 649 546 18.9 Technology Travel services 544 319 243 31.3 Other — 173 100 73.0 Total 6,536 6.907 4,327 59.6

Source: Based on company documents.

424 STRATEGIC M AN AGEM ENT CASES

EXHIBIT 7 Geographical Revenue in Percent

2011-2012 2010-2011 2009-2010

UAE 77% 62% 45% International 23% 38% 55%

Source: Based on page 54. 2012 Annual Report.

In late 2010, Dnata acquired Alpha Flight G roup’s in-flight catering business. This is why the segm ent’s revenues increased so much in 2011-2012 because Travel R epublic’s revenues first appeared on the income statement.

In-flight catering was both the largest revenue gainer and the largest revenue percent increase by 325 percent; however, the 2010-2011 fiscal year represents only three months of providing this service in house, resulting in the large percent increase. In-flight catering through the acquisition o f Alpha Flight Group provided more than 48 million meals to custom ers in fis­ cal year 2012. Note all revenue streams in the Dnata segment experienced significant increases over the two years reported. Exhibit 7 provides a breakdown of Dnata services in UAE and inter­ nationally. For the first time ever, revenues in international markets were greater than dom estic revenues.

Competition Factors impacting the airline industry include global unrest, volatility o f fuel prices, mergers and acquisitions, strategic alliances, video conferencing, and entry of discount airlines such as Ryanair. More than 100 different airlines provide service to Dubai International Airport, which is projected to become the w orld 's busiest airport by 2016. Opening for passenger travel by the end o f 2013 will be the new A1 M aktoum Airport in Dubai. In fiscal year 2012 alone, Emirates started long-haul flights to Seattle. D allas-Fort Worth, Rio de Janeiro, Buenos Aries. W ashington DC, Geneva, Baghdad, and St. Petersburg (Russia), am ong others. Em irates’ larg­ est direct com petitors are Singapore Airlines. British Airways, Delta. Middle East Airlines, and flydubai. Dubai is located eight hours by air from 75 percent o f the w orld’s population.

Singapore Airlines Group Singapore Air dates back to 1947 when the company was known as M alayan Airways Limited, operating flights to cities in and around Singapore. But in 1971 M alayan Airways split into Singapore Airlines and Malaysian Airline System, and the Singapore Airlines brand took off. Singapore Air now operates 101 planes that average six years and seven months and have 30 more planes on order. Like Emirates, Singapore Air operates the A irbus 380 (19 in operation) and the Boeing 777 (58 in operation). The Group operates 20 subsidiaries within the air travel industry, including SIA Cargo, SIA Engineering Company, Silk.Air, Scoot, and Tradewinds Tours and Travel. Both SilkAir and Scoot are airlines that com plim ent the service o f Singapore Air. Singapore Air predominantly serves Europe, Asia, and Australia, but it also flies to four cities in the United States and three in Africa.

Singapore Airline Group’s fiscal year, like Em irates’, ends on March 31. For fiscal year 2012, the com pany’s profits were down $756 million to $336 million or 69 percent reduction, whereas revenues grew by S333 million to S14.8 billion, up 2 percent from the previous year. Both Singapore Air and Emirates are luxury airlines using Suites (separate from first class), first class, business class, and economy class. First-class passengers can enjoy 23-inch TVs, dining with food served on tableware designed by Givenchy, wines, and cham pagne. Singapore Air mar­ kets that they are the only airline to offer a stand-alone bed, not a converted seat. To complement the stand-alone bed, a sleeper suit, bedroom slippers, and linens also designed by Givenchy are provided. Soft lighting options and premium skin care products and toiletries are also provided.

Custom ers in first, business, and economy classes also enjoy am enities that exceed most all com peting airlines. Hot. moist, hand towels are provided after meals to custom ers, even those in econom y class. Serving all passengers since 1972 is the distinguished “Singapore Girl" that according to the company “is an enduring symbol o f our im peccable service standards."

CASE 2 • THE EMIRATES GROUP, 2014 425

flydubai flydubai was started by the government o f Dubai in 2008 and was supported by Em irates during the firm 's establishing phase, but flydubai is not part o f the Emirates Group. With the backing o f the Dubai government, flydubai ordered 50 Boeing 737-80ŨS at a total price o f $3.74 billion. The first planes were delivered in 2009. and flydubai was air bound for Beirut, the first market served. The com pany quickly grew as additional planes on order arrived. As o f early 2013, the com pany served 52 markets, mostly in the M iddle East but also a few select markets in Eastern Europe and India. In contrast to Emirates, flydubai is a discount airline provider much like a Spirit Airlines or AirTran in the USA or Ryanair or easyJet in Europe, flydubai operates 28 planes and 800 flights per week. The average age o f aircraft is less than two years. The com­ pany does not currently provide financial information to the public.

Middle East Airlines Middle East Airlines (M EA) began in 1945 in Beirut and served cities in Syria, Cyprus, Egypt, and later Saudi Arabia. The airline provides a local alternative for customers in the Middle East. In 1963, MEA merged with Air Liban and added destinations in the M iddle East, West Africa, and Europe. In 2010, MEA accepted delivery o f two new Airbus 320 aircrafts and resumed flights to Berlin and Brussels. In 2012. MEA joined Sky Team and currently serves Europe, Persian Gulf, M iddle East, and Africa. Notable destinations include four flights a day to Paris, London. Frankfurt, and Brussels; they also have flights to Rome, M ilan, Athens, Geneva, Istanbul, and others in Europe and flights to several cities in Saudi Arabia, Amman. Iraq. Cairo, and Sharm el Sheikh. In total, MEA operates 19 aircraft w ith an average age of less than four years, has 10 planes on order, and serves 31 markets. The com pany offers Cedar C lass (first class) and econ­ omy class. In 2011, MEA had revenues of $637 million with profits o f $62 million.

British Airways British Airways is a member of the Oneworld Alliance and is the largest carrier based on fleet size in the United Kingdom. The airline currently operates more than 250 aircraft with 50 more on order and serves the entire world. The airline has alliances with several airlines including Comair o f South Africa and Sun Air o f Scandinavia. The company had revenues of $14.8 billion in 2011. British Airways offers economy class, premium-econom y class, business clas, and first class.

Delta Headquartered in Atlanta and a member o f the Sky Team Alliance, Delta is a major U.S. air­ line. Delta has hubs in several U.S. cities as well as in Amsterdam. Tokyo, and Paris. Operating more than 5.000 flishts a day and an additional 2,500 flights through Delta Connection, Delta is one o f the largest airlines in the world, and one of only a select few to provide service to all six inhabited continents. The airline provides business elite, first class, economy com fort, and economy class. Delta reported revenues o f $14 billion and net income of $854 million in 201 l ẻ

Strategic Alliances Airlines started forming strategic alliances in the 1990s to better com pete with rival firms. Historically, if an airline did not serve a select market, a custom er would either find an airline that did or be forced to purchase two separate tickets. A lliances largely resolve this problem because airlines can jointly benefit having a com petitor (now also an alliance member) provide service for that leg o f the flight. Other benefits o f alliances are more efficient marketing and advertising exposure and frequent-flier program s, which attem pt to hook passengers on to one particular airline for all their flying needs.

Three o f the largest alliances in the world are SkyTeam, Star Alliance, and Oneworld. SkyTeam is based out o f Amsterdam and was created in 2000 by founding members: Delta, Air France, Aerom exico, and Korean Air. The Sky Team Alliance consists o f 19 carriers from five continents and carries more than 550 million passengers each year. Based out o f New York City, Oneworld was formed in 1999 with founding members: American Airlines, British Airways, Canadian Airlines, Cathay Pacific, and Qantas. Today, 11 airlines operate within the Oneworld alliance and carry more than 335 million passengers annually. The Star A lliance was founded in 1997 by Air Canada, Lufthansa, Scandinavian Airlines, Thai Airways International, and United Airlines.

426 STRATEGIC M AN AGEM ENT CASES

Based in Frankfurt, Germany, the Star Alliance has 28 m em ber airlines and serves 193 different countries with annual passenger numbers more than 670 million, making Star Alliance the larg­ est alliance in terms of passengers served.

Alliance with Quantas Emirates is not a m em ber o f any airline alliance, whereas Quantas is a m em ber of Oneworld. However in January 2013, Emirates and Quantas, two rival firms, formally entered into a partnership allowing Quantas Airbus 380 customers to depart from Concourse A at Dubai Airport, the w orld’s only concourse designed for the Airbus 380. Quantas custom ers can enjoy the concourse, while waiting lor their connecting flights to Europe. In exchange, Quantas moved their hub for European flights from Singapore to Dubai. Neither airline owns shines o f the other, but they work together to better coordinate price, sales, and schedules. Q uantas CEO Alan Joyce believes the partnership is a first o f its kind and different from traditional alliances.

Dubai Business Culture To be successful in business in Dubai, their culture and religion m ust be respected and rules must be followed. For example, a colleague should never be em barrassed or criticized in public. Women in Dubai should dress conservatively. Alcohol should never be consum ed on the street, and it should be taken home only if one has a license to purchase it. Singles o f the opposite sex may not live together in Dubai; gay marriages and relationships are not accepted in Dubai. If an unmarried woman becomes pregnant, then she must leave the country immediately. O ther im­ portant rules to follow in Dubai include: do not cross your legs in front o f someone of higher au­ thority because it is seen as disrespectful; do not hold onto a handshake for a long time because it signifies a brotherly bond instead of a friendly gesture; do not use your left hand because it is considered dirty so use only the right hand to offer drinks, food, and so on; do not turn down a drink offer because it might insult the host; do not engage in friendly talk in pubic with any fe­ males; do not shake hands with women unless they com e forward to do so; do not flirt, hug, and have other physical contact with a member of the opposite sex; do not make eye contact with women; do not ask a male Arab about any female because that is bad manners; do not point the soles o f shoes at an Arab because the soles are dirty; do not refuse any gifts (if offered) but open them in private not in public; do not express a desire to com m unicate with any member o f the opposite sex.

In Dubai, the workday starts at 8 a .m . until I p .m ., but em ployees return at 7 p .m . to work more. During the Muslim Festival Ramadan, working hours in offices becom e shorter by two hours. In Arab cultures, clothes should be worn on all body parts including limbs. On Friday, M uslims pray and rest, so business should not be conducted on that day. During the month o f Ramadan, M uslims avoid eating, smoking, and drinking during daylight.

The Future Ironically for Emirates, the flydubai discount airline may pose the largest threat to the firm because demand for low price flights is growing rapidly globally. Flying with Em irates is high dollar, and com petitors see great potential to take market share from Emirates with lower prices. It is important, therefore, for Em irates’ Chairman and CEO, Sheikh Ahmed bin Saeed A1 M aktoum, to have a clear strategic plan for the next three years.

Design a business strategy for the Emirates Group for the next three years.

CASE 3 • UNITED PARCEL SERVICE, INC., 2013 427

United Parcel Service, Inc., 2013

www.ups.com, UPS Headquartered in Atlanta, Georgia, United Parcel Service (UPS) is the largest logistics com pany in the world based on revenue and package volume. Operating in the air delivery and freight services industry, UPS delivers packages up to 150 pounds across the USA and to 220 countries worldwide. Serving custom ers since 1907, UPS operates a fleet o f more than 100.000 cars, vans, trucks, tractors, and motorcycles and more than 530 aircraft and uses 35.000 transport cargo containers. In addition, UPS has 39,100 drop boxes, 2,100 custom er centers, 4,700 independently owned UPS stores, and perhaps most importantly, 83,900 drivers.

U PS's Q2 of 2013 revenue increased 1.2 percent as the com pany’s daily international package volume improved 5 percent and domestic volume grew 1.9 percent from the prior year. For Q2, UPS delivered 15.7 million packages per day, an increase of 2.3 percent over the prior-year period. The com pany’s domestic Q2 revenue improved to $8.24 billion, up 2.3 percent; domestic revenue per piece was up 0.3 percent. The com pany’s daily package volume improved 1.9 percent, com pared to the same period last year, driven by residential shipm ents from e-com m erce customers. Declining letter volume led to a 1.5 percent drop in Next Day Air. For Q2 of 2013, U PS 's international daily package volume grew 5.0 percent and revenue increased 1.6 percent to $3.06 billion. Daily Export shipm ents increased 5.0 percent, led by Europe and Asia. Custom ers globally continue to trade down to slower moving solutions, resulting in a 3.4 percent decline in U PS’s export revenue per piece.

UPS global air network is headquartered in Louisville, Kentucky, where the com pany can process 416.000 packages per hour! UPS has numerous other airport hubs across the USA and in Germany, Canada, Hong Kong. Singapore, Taiwan, and China. A m em ber of both the Dow Jones 30 Com posite and Dow Transportation indexes, UPS em ploys 399,000 full-tim e em ployees (323.000 in the USA and 76,000 outside of the USA). A total o f 349,000 of these em ployees were m embers o f a union. UPS operates under three principle segments: (1) U.S. Domestic Package, (2) International Package, and the newer and much sm aller (3) Supply Chain and Freight segment. U PS’s major com petitors are FedEx and the United States Postal Service.

Although U PS’s primary business is the timely delivery o f packages and docum ents, the com pany has extended its capabilities in recent years to encom pass the broader spectrum of services known as supply chain solutions, such as freight forwarding, custom s brokerage, fulfillment, returns, financial transaction, and even repairs. UPS is also a leading provider o f less-than-truckload transportation services.

Copy right by Fred David Books LLC. (Written by Forest R. David)

History UPS was founded in 1907 by teenagers Claude Ryan and Jim Casey as the American M essenger Company in Seattle, Washington. The teenagers saw an opportunity with the limited telephone and autom obile options to run errands, carry notes, and make hom e deliveries for drugstores. The early strategy o f UPS was to com pete on cost by offering the best prices while maintaining dependable and courtesy service.

By 1913, the telephone was m ore com m on, reducing the need for m essenger services, so the American M essenger Com pany changed its name to M erchant’s Parcel Delivery and merged with Evert M cCabe’s to focus almost exclusively on package delivery o f drugstore and grocery store packages to people’s homes. The acquisition o f Evert M cCabe’s added m otorcycles and a single Ford Motel T to the business, so by 1916 “UPS” had an expanding fleet o f delivery vehicles. Soon the company expanded its business to also deliver departm ent store packages to homes in the Seattle area.

428 STRATEGIC M AN AGEM ENT CASES

Geographic expansion continued throughout the 1920s, including air service, and the company expanded into cities along the entire Pacific coast. The com pany changed its nam e to United Parcel Service and moved its headquarters to New York. UPS continued to grow over the years, and in 1975 the com pany began serving Toronto. Canada, marking the first time UPS served customers outside the USA. The following year, UPS began operations in Germany, and then in 1989, with the purchase of a British docum ent company, UPS was serving custom ers virtually worldwide.

The 1990s saw UPS adapt well to the growing presence o f electronic data and package tracking. The com pany moved its headquarters to Atlanta, G eorgia, in 1994. Operating as a private com pany for the first 90 years, UPS offered 10 percent o f its stock to the public in 1999, giving the com pany the ability to raise capital through equity and make acquisitions more easily.

UPS’s 1999 acquisitions of Challenge A ir resulted in UPS becoming the largest air cargo carrier in Latin America. Other acquisitions in the United Kingdom and Poland expanded U PS’s global reach throughout Europe. UPS has to date acquired more than 40 com panies ranging from shipping and trucking to finance and international trade services.

UPS’s supply chain solutions capabilities are available to clients in over 220 countries and territories. U PS's 2012 revenues increased 1.9 percent to S54.1 billion, but net income decreased 78.8 percent to $807 million. The com pany’s 2012 return on assets (ROA) dropped to 2.2 percent, from 11.1 percent the prior year. In 2013. UPS is trying to close on its acquisition of the European firm, TNT Express, for $6.8 billion, which will expand its presence in the European and Asian markets.

Internal Issues Vision and Mission The UPS vision is provided on the com pany website, as follows:

Our goal is to synchronize the world of com m erce by developing business solutions that create value and competitive advantages for our customers.

The company provides the following mission statement on its website:

Mission: What We Seek to Achieve

• Grow our global business by serving the logistics needs of custom ers, offering excellence and value in all that we do.

• Maintain a financially strong com pany— with broad em ployee ownership— that provides a long-term competitive return to our shareowners.

• Inspire our people and business partners to do their best, offering opportunities for personal development and success.

• Lead by example as a responsible, caring, and sustainable company m aking a difference in the com m unities we serve.

UPS describes the nature of its business in the following way:

As the w orld’s largest package delivery company and a leading global provider o f specialized transportation and logistics services. UPS continues to develop the frontiers ot logistics, supply chain management, and e-Com merce ... com bining the flows o f goods, information, and funds.

Sustainability UPS provides an elaborate Sustainability Report on its website, after giving the following sustainability statement:

UPS is committed to operating our business in a socially, environm entally and economically responsible manner. We publish annual programs on goal attainment.

CASE 3 • UNITED PARCEL SERVICE, INC., 2013 429

UPS was recently recognized as one o f only 10 U.S. corporations to receive an A+ for superior transparency from com panies registered with the Global Reporting Initiative (GRI). “One o f the guiding principles to U PS ’s sustainability strategy is our com m itm ent to transparency,” UPS Chairm an and CEO Scott Davis w rote in the organization’s 201 1 Sustainability Report. “We are disclosing more inform ation than e v e r___We have reported our five-year progress, successes and challenges. Now, we are focused ahead.” C hief Sustainability O fficer Scott W'icker reported that UPS now uses a “m ateriality m atrix” to track how the com pany’s in terests m atch or d iffer from those o f o ther stakeholders. A recent GRI report recognized UPS for (a) driving 85 m illion fewer m iles, saving 8.4 million gallons o f fuel and 83.000 m etric tons o f carbon dioxide em issions using advanced route-planning technology, (b) expanding telem atics technology to elim inate m ore than 98 m illion m inutes o f engine idling tim e, saving 653,000 gallons o f fuel, and (c) earning the highest Carbon D isclosure Project score am ong all U.S. com panies, and tying with three others for the top score in the world.

Speaking at Fortune's Brainstorm Green 2012, UPS C hief Operations Officer (COO) David Abney said: “Sustainability is a way of life. It’s always high on our radar screen.” The UPS Foundation, the charitable arm of the firm, recently started a long-term effort to support em ployee volunteer activities to plant more than I million trees around the world, beginning with tree-planting initiatives in China. Canada. Haiti, the Netherlands, Norway. Russia. Uganda, and the United States by the end of 2013. UPS was rated #1 in Fortune M agazine’s 2012 “W orld’s Most A dm ired” for the Delivery Industry.

Culture and Ethics The com pany code o f ethics is provided at on the UPS website under Governance Documents (http://www.investors.ups.com /phoenix.zhtm l?c=62900& p=irol-govhighlights).

Additionally, UPS has what it refers to on its website as a “distinctive culture.” The statement reads as follows:

We believe that the dedication of our em ployees results in large part from our distinctive “em ployee-owner” concept. Our em ployee stock ownership tradition dates from 1927. when our founders, who believed that em ployee stock ownership was a vital foundation for successful business, first offered stock to employees. To facilitate em ployee stock ownership, we maintain several stock-based com pensation programs.

The com pany’s brown-clothed drivers and em ployees and brown trucks symbolize the firm ’s com m itm ent to a distinctive culture, anchored by em ployee ownership o f a large part of the firm. UPS is highly unionized.

A fter donating S I50.000 to the Irving-based Boy Scouts of America, UPS announced recently that the com pany will no longer fund them, until gay scouts and leaders are allowed to be members. The Atlanta Business Chronicle reported that the Gay & Lesbian Alliance Against Defamation (GLADD) said it was told by UPS that under revised guidelines o f The UPS Foundation, it will not support organizations that are unable to attest to having a policy that aligns with the foundation’s nondiscrimination policy.

Organizational Structure Among U PS’s top eight corporate executives, there are two women and one African American. Exhibit I reveals U PS's current organizational chart. Note the com pany uses a divisional- by-geographic region structure.

Strategy During ca lendar 2012, UPS opened 12 new dedicated health care fac ilities on four con ti­ nents. bringing the com pany total to 37. UPS strives daily to provide custom ers com peti­ tive prices and excellent services w orldw ide. UPS benefits from several key trends in the m arketplace, including (a) expansion o f global trade, (b) grow th in em erging m arkets.

430 STRATEGIC M AN AGEM EN T CASES

EXHIBIT 1 UPS's Organizational Structure

Senior Vice-president,

Chief Information

Officer

V__________)

f UPS Chairman and ] Chief Fxecutive Office!

r Chief Financial

Officer

Chief Operations

Officer

y

Vice-president, Legal

Compliance

Senior Vice-presidenl,

Hum an Resource and

Labor Relations

Senior Vice-president,

Com m unications and Brand

Management

President, UPS

International

r President,

U.S. Operations

Source: Based on information on the company’s website.

(c) outsourcing, (d) retail com m ercial grow th, and (e) increasing trade across borders. These are reasons why UPS recently acquired Italy-based Pieffe G roup, a pharm aceutical logistics com pany that helps enhance the trust that E uropean-based pharm aceutical and biotech com panies have for UPS to handle the delivery o f its products and services. U P S ’s principle strategy is to identify successful businesses outside the USA and form alliances with them in the hope o f eventually acquiring them. China rem ains the key em erging m arket w ith air hubs in Shanghai and Shenzhen. Recent UPS C hinese investm ents include adding intra-A sia and around-the-w orld flight frequencies, striving to serve custom ers m ore e f­ ficiently in A sia, Europe, and around the w orld. UPS already serv ices m ore than 40 Asian nations through more than 20 alliances. In V ietnam alone, since a 2 0 10 alliance, U PS’s vo l­ ume in that country has doubled.

UPS plans to increase its m arket share in Europe, where half o f all its international revenue derives from; strong growth is expected to continue in Germany, the United Kingdom. France, Italy, Spain, and the Netherlands. Despite lingering economic troubles in Europe. UPS is ex­ panding its European Air hub in Cologne, Germany, by 70 percent to a total capacity o f 190,000 packages per hour. For reference, this is still well short o f the hub in Louisville, Kentucky, that processes more than 400,000 packages per hour. The expansion o f the Cologne hub was com pleted in 2013. In addition, the 2012 acquisition o f Belgium -based Kiala S.A. enables e- com merce retailers to offer its custom ers timely delivery to retail locations or people’s homes.

UPS’s 2009 acquisition of Turkey-based Unsped Paket Servisi has led to double-digit growth to and from that country. South and Central Am erica econom ies are growing along with Mexico, and UPS is currently well positioned in those countries as well.

Effective December 31, 2012. UPS instituted a 4.5 percent rate increase for UPS Air and U.S.-originating International Services shipments. UPS breaks the rate increase into two parts: a 6.5 percent base rate on UPS Air and International Services m inus a two percentage point reduction in fuel surcharges on such shipments. UPS Ground base rates also increased on that date, by 5.9 percent, mitigated by a single percentage point reduction in the fuel surcharge, resulting in an average 4.9 percent price hike. UPS Next Day A ir Freight, Second Day Air Freight, and Three-Day Freight rates for shipm ents among U.S., Canadian, and Puerto Rican locations also rose by 4.9 percent.

CASE 3 • UNITED PARCEL SERVICE, INC., 2013 431

UPS recently closed on its $6.58 billion deal to acquire TNT Express N.V., an international courier deli very-services com pany with headquarters in Hoofddorp, Netherlands. Com peting primarily with FedEx and DHL. TN T Express has fully owned operations in 65 countries and delivers docum ents, parcels, and pieces of freight to more than 200 countries. The com pany recorded sales o f more than €7.2 billion in 2 0 11. As part o f the deal. UPS is seeking to avoid concessions that would hinder the com pany's plan to double its operations in Europe through the acquisition of TN T whose air operations were at issue because com panies outside the European Union cannot hold stakes of more than 49 percent in airlines. The TN T Express deal will mark the largest acquisition ever for UPS.

To expand its global healthcare distribution facility network in the Asia Pacific region. UPS recently opened new facilities in Hangzhou and Shanghai, China, and Sydney, Australia. These openings bring the total num ber o f UPS dedicated healthcare facilities around the globe to 36, encom passing more than a half-m illion square meters o f space. The UPS strategy is to invest in its global healthcare network to become the largest medical products transporter in the world. Increased globalization and growing healthcare consumption in em erging markets are the impetus for this strategy. The new distribution centers serve multinational and regional healthcare m anufacturers across the Asia Pacific region.

Segments U PS 's top 20 custom ers account for less than 10 percent o f the com pany 's revenue. UPS has m ajor air hubs in H artford, CN; Ontario, CA; Philidalphia, PA; Rockford, IL and outside o f the United States in Ham ilton, Ontario; Cologne, Germ any; Shanghai China; Shenzhen, China; Raipei. Taiwan; Incheon, South Korea; Hong Kong, and Singapore. UPS reports revenues and operating profits in three different segments: ( l ) U.S. Dom estic Package, (2) International Package, and (3) Supply Chain and Freight. Exhibit 2 reveals that U PS 's Supply Chain and Freight division accounts for about 17 percent o f all revenue and 10 percent o f all operating profits. A lso note that more than half o f U PS’s profits com e from its U.S. op­ erations, so there is a lot o f room for growth globally, which is another reason for the TN T Express acquisition. But South A m erica, A ustralia, and to a lesser degree, Asia, are not UPS strongholds to say the least.

EXH IBIT 2 Selected Income Statement Data

Years Ended D ecem ber 31,

2012 2011 2010 2009 2008

Revenue:

U.S. Domestic Package $ 32,856 $ 31,717 $ 29.742 $28,158 S 31,278 International Package 12,124 12,249 11,133 9,699 11,293 Supply Chain & Freight 9,147 9,139 8,670 7.440 8,915 Total revenue 54,127 53,105 49,545 45,297 51.486

Operating expenses:

Compensation and benefits 33,102 27,575 26,557 25,933 29.826 Other 19,682 19,450 17.347 15,856 20.041 Total operating expenses 52,784 47.025 43,904 41,789 49,867

Operating profit (loss):

U.S. Domestic Package 459 3,764 3,238 1,919 823 International Package 869 1,709 1,831 1,279 1.246 Supply Chain and Freight 15 607 572 310 (450) Total operating profit 1,343 6.080 5,641 3,508 1,619

Source: 2012 Form 10K. p. 21.

432 STRATEGIC M AN AGEM ENT CASES

EXHIBIT 3 U.S. Domestic Package Operations

Year Ended December 31, % Change

2012 2011 2010 2012/2011

Average Daily Package Volume (in thousands): Next Day Air 1,277 1,206 1,205 5.9% Deferred 1,031 975 941 5.7% Ground 11,588 11,230 11,140 3.2%

Total Avg. Daily Package Volume 13,896 13,411 13.286 3.6% Average Revenue Per Piece:

Next Day Air $ 19.93 S 20.33 $ 19.14 (2.0)% Deferred 13.06 13.32 12.50 (2.0)% Ground 7.89 7.78 7.43 1.4%

Total Avg. Revenue Per Piece $9.38 $9.31 $ 8.85 0.8% Operating Days in Period 252 254 253

Revenue (in millions):

Next Day Air $6,412 $ 6,229 $ 5.835 2.9% Deferred 3,392 3,299 2.975 2.8% Ground 23,052 22,189 20.932 3.9%

Total Revenue $ 32,856 $31,717 $ 29,742 3.6%

Source: UPS 2012 Form I OK p. 24.

U.S. Domestic Package Segment U PS's U.S. Domestic Package division reported revenues o f $32.8 billion in 2012, up from $31.7 billion in 2011, a 3.6 percent increase. Operating profits decreased around 87.8 percent during this same time period. This division of UPS focuses on timely delivery o f small packages across the USA offers custom ers same-, next-, two-, and three-day alternatives or standard ship­ ping depending on how fast the delivery is needed. UPS delivers more than 11 million packages daily in the USA with most being delivered between one to three business days. Within this segment, UPS has an alliance with the United States Postal Service (USPS) called SurePost, a service for customers who are sending or receiving nonurgent lightweight shipm ents in which UPS handles the long haul ground transportation and USPS makes the final home delivery. Note in Exhibit 3, U PS 's ‘‘Next Day Air" and their ■‘Deferred” business reported declines in business in 2012 versus 2011. Note in Exhibit 2 the 88 percent drop in U PS’s 2012 operating profit in their domestic segment.

International Package Segment U PS 's International Package Reporting Segm ent includes all package operations outside the USA. This segm ent offers a wide selection o f price and delivery options, such as Express Plus, Express, and Express Saver for urgent shipm ents. M ore traditional shipm ents that do not require express service can use UPS W orldwide. In addition, custom ers in the USA, M exico, Canada, and Europe can use UPS T ransborder S tandard delivery services for its shipm ents.

Am ong the international regions served. Europe is the largest UPS custom er and ac­ counts for around half o f the com pany’s international revenue. UPS expects Europe to continue being a large revenue source in the future because o f the fragm ented nature of the m arket in Europe and the fact that exports make up a large part o f E urope 's gross dom estic product (GDP). Additionally, U PS 's TN T Express acquisition will nearly double U PS 's busi­ ness in Europe.

Asia is somewhat o f a new frontier for UPS, but that continent offers the fastest growth opportunities. Note in Exhibit 4 that UPS’s international segm ent reported quite a few negative numbers in 2012 versus 2011.

CASE 3 • UNITED PARCEL SERVICE, INC., 2013 433

EXHIBIT 4 International Package Operations

Year Ended December 31, % Change

2012 2011 2010 2012/2011

Average Daily Package Volume (In Thousands): Domestic 1,427 1.444 1.403 (1.2)% Export 972 942 885 3.2%

Total Avg. Daily Package Volume 2,399 2,386 2,288 0.5% Average Revenue Per Piece:

Domestic $7.04 $7.17 $6.66 (1.8)% Export 36.88 37.85 36.77 (2.6)%

Total Avg. Revenue Per Piece $ 19.13 $ 19.28 $ 18.31 (0.8)% Operating Days in Period 252 254 253

Revenue (In Millions):

Domestic $2,531 $ 2,628 $ 2.365 (3.7)% Export 9,033 9,056 8.234 (0.3)% Cargo 560 565 534 (0.9)%

Total Revenue $12,124 $12,249 $11,133 (1.0)% Operating Expenses (In Millions):

Operating Expenses $11,255 $10,540 $ 9,302 6.8% Defined Benefit Plan Mark-to-Market Charge (941) (171) (42)

Adjusted Operating Expenses $10,314 $10,369 $ 9,260 (0.5)% Operating Profit (In Millions) and Operating Margin:

Operating Profit $869 $ 1,709 $ 1,831 (49.2)%

Source: UPS's 2012 Form J0K, p. 28.

Supply Chain and Freight U PS’s Supply Chain and Freight segm ent includes logistics services, UPS freight business, and financial offerings through UPS Capital. As o f D ecem ber 2012, UPS m anaged supply chains in more than 195 countries and territories w ith more than 35 m illion square feet o f distribution space. Because o f the com plex nature o f supply chains, UPS offers the following services: freight forw arding, custom s brokerage, logistics and distribution, UPS freight, and UPS capital.

UPS is the second-largest freight forwarding com pany in the USA and is among the top six internationally. A freight forwarder or forwarding agent is a person or company that organizes shipments for individuals or com panies to get large orders from the m anufacturer to market or final point o f distribution. A forwarder is not typically a carrier but is an expert in supply chain management. In other words, a freight forwarder is a “travel agent” for the cargo industry, or a third-party logistics provider. Thus, instead of transporting cargo, UPS oftentim es just facilitates the movement o f cargo ranging from raw agricultural products to m anufactured goods. Cargo can travel on a variety o f carrier types, including ships, airplanes, trucks, railroads, or all o f these modes, and oftentim es not on UPS-owned assets.

UPS Freight is the long-haul segment of UPS providing long distance transportation of packages in all 50 states, several U.S. territories, and Mexico. UPS Capital aids customers in export and import financing, as well as protecting goods and paym ent solutions.

Finance For calendar 2012, U PS’s overall volume grew 2.8 percent. The com pany’s business-to-business volume showed no growth, partly due to the increasing migration of traditional retail to on­ line retail. U PS’s income statements are provided in Exhibit 5. Balance sheets are provided in Exhibit 6.

434 STRATEGIC M AN AGEM ENT CASES

EXHIBIT 5 UPS's Income Statements (in millions, except per share amounts)

Years Ended December 31,

2012 2011 2010

Revenue 5 54,127 $53,105 $ 49,545 Operating Expenses:

Compensation and benefits 33,102 27,575 26.557 Repairs and maintenance 1,228 1,286 1,131 Depreciation and amortization 1,858 1,782 1,792 Purchased transportation 7,354 7,232 6,640 Fuel 4,090 4,046 2,972 Other occupancy 902 943 939 Other expenses 4,250 4,161 3,873

Total Operating Expenses 52,784 47,025 43,904 Operating Profit 1,343 6,080 5,641 Other Income and (Expense):

Investment income 24 44 3 Interest expense (393) (348) (354)

Total Other Income and (369) (304) (351) (Expense) Income Before Income Taxes 974 5.776 5.290 Incomc Tax Expense 167 1,972 1,952 Net Income $807 $ 3,804 $ 3,338 Basic Earnings Per Share $0.84 $3.88 $ 3.36 Diluted Earnings Per Share $0.83 $3.84 $ 3.33

Source: UPS’s 2012 Form I0K. p. 58.

EXHIBIT 6 UPS's Balance Sheets (in millions)

December 31, 2012 2011

ASSETS Current Assets:

Cash and cash equivalents S 7,327 $ 3,034

Marketable securities 597 1,241

Accounts receivable, net 6,111 6,246

Deferred income tax assets 583 611

Other current assets 973 1,152

Total Current Assets 15.591 12,284

Property, Plant and Equipment, Net 17,894 17,621

Goodwill 2,173 2.101

Intangible Assets, Net 603 585

Investments and Restricted Cash 307 303

Derivative Assets 535 483

Deferred Income Tax Assets 684 118

Other Non-Current Assets 1,076 1,206

Total Assets $ 38.863 $ 34,701

CASE 3 • UNITED PARCEL SERVICE, INC., 2013 435

EXHIBIT 6 Continued

December 31, 2012 2011

LIABILITIES AND SHAREOWNERS’ EQUITY Currenl Liabilities:

Current maturities of long-term debt and $ 1,781 S 33 commercial paper Accounts payable 2,278 2,300 Accrued wages and withholdings 1,927 1,843 Self-insurance reserves 763 781 Other current liabilities 1,641 1,557

Total Current Liabilities 8,390 6,514 Long-Term Debt 11,089 11.095 Pension and Postretirement Benefit Obligations 11,068 5,505 Deferred Income Tax Liabilities 48 1.900 Self-Insurance Reserves 1,980 1.806 Other Non-Current Liabilities 1,555 773 Shareowners' Equity:

Class A common stock (225 and 240 shares issued 3 3 in 2012 and 2011) Class B common stock (729 and 725 shares issued 7 7 in 2012 and 2011) Additional paid-in capital — — Retained earnings 7,997 10,128 Accumulated other comprehensive loss (3,354) (3,103) Deferred compensation obligations 78 88 Less: Treasury stock (1 and 2 shares in 2012 (78) (88)

and 2011) Total Equity for Controlling Interests 4.653 7,035

Noncontrolling Interests 80 73 Total Shareowners’ Equity 4,733 7,108 Total Liabilities and Shareowners’ Equity S 38,863 5 34,701

Source: UPS’s 2012 Form ¡OK. p. 57.

External Issues Changing Consumer Behavior M ore and more people are no longer willing to pay more for an overnight delivery service. They would rather wait another day for the goods to be delivered, instead o f paying a premium for quicker delivery. This change in custom er preferences and attitude appears to be permanent, regardless of the economy.

Companies Exporting More UPS anticipates that most high-tech com panies expect to export more cell phones, tablets, and other electronics over the next several years to growing m iddle-class populations in developing nations. The Barack Obama adm inistration has a goal to double exports by 2015. Scott Davis, UPS chief executive officer, is on the President’s Export Council and has touted free trade agreem ents as critical for boosting U.S. exports and the economy. A free trade agreem ent between the USA and Panama will soon go into effect, following on the heels o f such agreem ents with Colom bia and South Korea. Some analysts expect that high-tech product sales and shipm ents are expected to grow by 22 percent in India, the M iddle East, and Africa

436 STRATEGIC M AN AGEM ENT CASES

over ihe next three to live years. Those same analysts expect such sales increases to range from 18 percent in Brazil and 19 percent in the rest o f South Am erica to 15 percent in Eastern Europe, 13 percent in Korea, and 8 percent in China and in other Asian nations.

M any executives are planning to modify its distribution networks to handle m ore volume at East Coast ports once a wider Panama Canal is opened to bigger ships around 2015. Quite a few com panies plan to shift from air to ocean freight when that happens, so many East Coast ports are heavily investing in dredging and other projects to be able to accept higger ships. Both FedEx and UPS have already seen a shift in dem and for shipping products cheaper, such as by sea, rather than premium-priced express air serv ices, because of the weakening global economy.

Internet and Catalog Purchasing About 40 percent o f total UPS shipm ents are from businesses-to-consum ers, com pared with about one-third from a few years ago. It expects these shipm ents, typically from large catalog or Internet retailers, to grow to half o f all packages during the holiday season. Consum ers are expected to do more and more online shopping. UPS and its sm aller rival FedEx can benefit twice when consumers shop online: UPS ships the gift to the receiver, and it also ships the unwanted presents that are later returned. Online sales are expected to grow at four tim es the pace o f traditional retail sales in 2012. This trend is helping U PS’s earnings despite weakness in trade between businesses. Business-to-business shipm ents are typically between a m anufacturer and a retailer, and are closely tied to industrial production.

Competitors As indicated in Exhibit 7. UPS com petes with USPS and FedEx. Another large com petitor is DHL International. Exhibit 6 reveals that UPS generates more revenue per em ployee than either the USPS or FedEx. Note how low the USPS is on revenue per employee.

USPS USPS incurred a record loss o f $15.9 billion for its fiscal year 2012, which it blamed primarily on a mandate to set aside billions o f dollars for a retirement heath fund. The USPS loss included SI 1.1 billion in defaulted payments it owes to “prefund" health benefits for future retirees. Postal officials have com plained for years about these prepayments, which are required by Congress, to pay for future retirees. The USPS points out that other federal agencies do not have sim ilar mandates for prefunding.

The S15.9 billion loss was more than triple the $ 5 .1 billion in loss the USPS posted in the prior year. Fredric Rolando, president of the National Association of Letter Carriers, recently blamed the congressionally mandated prefunding for the bulk o f U SPS’s financial woes. The USPS is highly unionized.

USPS has been struggling with declines in mail revenue for a variety o f reasons, including everyone's transition to e-mail. To combat massive losses, USPS plans to cut 150,000 workers through 2015. reduce existing staffers’ work hours and hike the price on first-class stamps by 3 cents to 49 cents. USPS officials are considering a scale back o f delivery service to five days, ceasing its low-volume, low-revenue. Saturday service. The notion of five-day service however is intensely unpopular in Congress and unlikely to prevail.

EXHIBIT 7 Comparing UPS to Rivals

USPS UPS FedEx

Number of Employees 551K 222K 230K

Net Income ($) — 3.26B 2.02B

Revenue ($) 65.7 B 53.66B 42.95B

Revenue ($)/Employee 119K 241K 187K

EPS Ratio (S) — 3.38 6.40

Market Capitalization — 66.8B 27. IB

EPS. earnings per share.

CASE 3 • UNITED PARCEL SERVICE, INC., 2013 437

Unlike other federal agencies, the USPS does not technically receive taxpayer support, though it has borrowed $15 billion from the U.S. Treasury.

FedEx Headquartered in Memphis. Tennessee, FedEx is the w orld’s num ber-1 express transportation provider, delivering about 3.5 million packages daily to more than 220 countries and territories from about 2.000 FedEx Office shops. FedEx owns and operates a fleet o f about 690 aircraft and more than 50,000 motor vehicles and trailers. To com plem ent its express delivery business, FedEx Ground provides small-package ground delivery in North America, and less-than-truckload (LTL) carrier FedEx Freight hauls larger shipments. FedEx Office Stores offer a variety of document-related and other business services and serve as retail hubs for other FedEx units.

FedEx is spending $100 million to build a new 134.000-square-m eter international express and cargo hub. to be up and running at the airport in Pudong, China, by 2017. FedEx said it will be capable of handling 36.000 parcels and docum ents per hour. The new facility 's annual sorting capacity may reach more than 90 million items, m eeting the dem and in the next 20 years.

Shanghai is forecast to become the w orld’s top air cargo hub by 2015, with a throughput of more than more than 5 million tons. Major dom estic airlines have based 80 percent o f its freight capacities at the Pudong airport, which now ranks num ber 3 by cargo turnover, after Hong Kong and Memphis.

FedEx is expanding its services across the USA, Canada, and Mexico. The company is expanding its Priority next-day services in its FedEx Freight segment by opening a new service center in Rochester, New York, that will cater to 13 U.S. and Canadian m arkets dealing in cross-border shipm ents to and from Toronto and M ontreal. In Mexico, FedEx recently added two new service centers— one each in Culiacan and Silao— to strengthen its freight network in northwestern and north central part o f Mexico. FedEx is building a new hub in Guangzhou. China, for catering to 100 new Chinese cities within the next five years.

As for acquisitions. FedEx completed the take over of Polish courier company, Opek Sp. z o.o., and French B2B Express transportation company, TATEX, both in mid-2012. Then FedEx acquired Rapidao Cometa, a Brazilian transportation and logistics company. These acquisitions should provide FedEx greater operational efficiencies, provide a competitive edge, generate significant long-term synergies, support international business growth, and drive higher profitability.

DHL Headquartered in Germany and privately held. DHL is a gigantic package delivery company that constitutes the express delivery and logistics business segments o f its parent, Deutsche Post. DHL is a leader in the worldwide market for express delivery services, operating through four divisions: Express, Global Forwarding and Freight Forwarding, Mail, and Supply Chain. (Mail service in Germany is handled by the Deutsche Post brand; DHL handles all o f the Global Mail business). DHL's Express courier service network spans more than 220 countries and territories using a fleet o f 32,000 vehicles and about 250 aircraft. DHL’s supply chain division maintains some 23 million square meters (almost 250 million square feet) o f warehouse space.

The Future UPS is on ihe hunt for businesses sim ilar to TNT Express in Europe that it recently acquired. Sim ilar businesses in Asia, Australia, South America, and Africa would enable UPS to extend its services globally. M ore than half o f U PS's revenues still com es from the USA, yet 95 percent o f the w orld’s population lives outside the USA. M ore and more people are buying and selling online, which is a key positive trend for UPS in the future. A key threat however is that rival FedEx is aggressive and savvy and also on the hunt to make acquisitions. FedEx does not like being num ber 2 in the global packaging business.

UPS needs a clear strategic plan going forward.

438 STRATEGIC M AN AGEM ENT CASES

Amazon.com, Inc. — 2011

M. Jill Austin and Ralph I. Williams Jr. Middle Tennessee State University

AMZN http://www.amazon.com Tw enty-six-year-old Am anda Hocking grew tired o f trying to find a traditional publisher for her young adult paranorm al novels, so she began self-publishing her novels and selling them as e-books or print on demand books through Amazon.com and Barnesandnoble.com. She sold 164,000 downloads in 2010, and by January 2011, Hocking had sold more than 450.000 copies (99 percent were e-books). A m anda’s e-book prices range from 99 cents to $2.99 (paperbacks cost $8.99) and she keeps 70 percent o f what she sells o f $2.99 books and 30 percent lor each 99 cent book sold. Hocking changed her self-publishing strategy in April 201 I when she agreed to sell her books through a traditional book publishing company. She signed a $2 million deal with St. M artin’s Press to publish four of her novels. Amazon.com was am ong six bidders for Ms. H ocking’s books, the first time Amazon entered the bidding against traditional book publishing com panies for an author’s work. Some insiders say Amazon actually bid more than St. M artin's for Hockings work, but stipulated that all e-book sales m ust be through Kindle. St. M artin’s Press will make deals with all e-book sellers, giving Hocking a larger audience for her e-books. Russ Grandinetti, the Kindle Content VP for Amazon, says of H ocking's success: ‘"Digital pub­ lishing gives a chance to a great book that otherwise might have been overlooked." These are just two examples of a world drastically changed by the way consum ers choose to read books. The stories also illustrate A m azon's power in the m arketplace and its com petitive business approach.

Based in Seattle, W ashington, Amazon continues to change the landscape of online selling in general and book selling in particular. Amazon for 2010 was named the w orld’s top brand ahead o f com mon names like Coca-Cola. M icrosoft, and M cDonalds. A m azon’s revenue in­ creased to more than $34 billion in 2010 with income of $1.15 billion. Nearly 80 million people visit Amazon.com every month. The com pany’s two m ost recent services launched in 2011 are its controversial cloud technology that allows custom ers to store and access music and its entry into the Netflix world of movie streaming.

Amazon added 13 new fulfillment centers in 2010 and another 15 new centers in the first six months o f 2011 to total 52 centers. A m azon’s sales reached $9.91 billion in the 2nd quarter of 2011, a 51 percent increase from 2010 ’s 2nd quarter sales of $6.5 billion. The increasing avail­ ability o f the Internet to people globally has changed the way consum ers purchase products and the way consumers receive information about products. The United States has more than half of the world’s Internet users. The portion o f U.S. households connected to the Internet is expected to increase to 80 percent in 2013. In the five-year period between 2010 and 2014. online sales are expected to grow 10 percent per year. Online consumer sales will likely total $249 billion by the end o f 2014. It is expected that information gathered from the Internet will influence 53 percent o f all U.S. retail purchases by 2014. Amazon is positioned perfectly to capitalize on all these trends.

A m azon’s manufacturing partner Quanta Computer, expects to ship 3 million new Amazon tablet com puters in the 3rd of 2011. A m azon’s new 10.1-inch “H ollyw ood” tablet may become a major com petition to A pple’s table computers.

History— 1995 to 2011 W hile Jeff Bezos worked for Shaw & Co. from 1990 to 1994. he was asked to investigate Internet business opportunities. Bezos recommended that Shaw & Co. enter the business of sell­ ing books online, but his idea was rejected by com pany management. Bezos decided to resign from the com pany and pursue the idea on his own under the com pany name of Cadabra, Inc.

CASE 4 • AMAZON.COM, IN C .— 2011 439

Bezos quickly renamed the new venture Amazon, after the largest river in the world, the Amazon River. The Amazon logo has an arrow pointing from the first “A” to the “Z,” indicative of the wide scope of materials available from Amazon.com, everything from A to Z.

Amazon.com opened for business in July 1995. and went public in May o f 1997 with an ini­ tial public offering o f three million shares (S I8 each). In 1996. the company first exceeded $ 1 () million in book sales. However. Amazon did not make a profit until 2003. The first decade of operations did not always run smoothly, and industry critics predicted several times that Amazon would fail, especially during the dot-com industry collapse in the late 1990s. By the end of 1997. Am azon had served more than 1.5 million custom ers (a 738 percent increase from the 180,000 custom ers served the year before). That same year, the com pany also established long-term re­ lationships with strategic partners such as Yahoo!. Prodigy, America Online, Excite, Alta Vista, and Netscape.

In 1998, Am azon.com acquired Internet M ovie Database, a British-based source o f in­ form ation on m ovies and entertainm ent program s dating from 1892 to the present. This was A m azon’s first step toward selling videos online and was a major entry into the international market. Shop the Web. a service that linked other retailers to the Amazon site and allowed Am azon to act as a m iddlem an, was introduced in 1998. A fter only 45 days o f sales o f DVDs and videos. Am azon becam e the num ber one video reta iler online at the end o f 1998. Am azon acquired several com panies in 1998 (Internet M ovie Database, Bookpages, Telebook, Junglee. and PlanetA ll).

Electronics were introduced for sale on the com pany website in 1999 and later become one o f the com pany’s largest businesses. However, even with this new successful product line, Amazon had two challenging years in 2000 and 2001. Shortly after being nam ed Time m aga­ zine's “Person of the Year” on Decem ber 27, 1999. Bezos laid-off 150 workers and reported a larger than expected $323 million loss for the holiday season. Losses were $1.4 billion in 2000, but by the end of 2001. the firm had generated a $5 million profit.

Through its approach to operations, Am azon revolutionized the book selling industry by providing sales rankings o f books that were previously guarded by publishers and by provid­ ing readers' com m ents to a wide audience so custom ers do not have to rely on book critics for reviews. During the last several years, Amazon m anagers have continued to expand the num ber o f products offered on their websites, develop new services, and expand into new markets. During 2006, Amazon announced the opening o f the Emergency Preparedness Store (within the Tools & Hardware Store). This store offers checklists for both preparation and recovery from natural disasters and one-stop shopping for tools, first aid supplies, com m unication de­ vices, and safety equipm ent. Custom ers can also find resources from the National W eather Service, National Hurricane Center, Federal Emergency M anagem ent Agency, and American Red Cross on the store site. Amazon launched its Grocery Store as a market test in May 2006 and officially launched the business in July 2006. The store offers more than 1,200 brands (Kashi. Nestle, Kellogg, Kraft, Procter & Gamble) o f non-perishable items. A bout half o f the current product selection is natural and organic products such as W ild Oats, N ew m an's Own. and N ature 's Gate.

The Toy and Baby Store opened in July 2006. A baby registry is available so custom ers can purchase the perfect gifts for their friends' babies. The products offered at this store are available from com panies such as Target, eToys, D iscovery Channel Store, and Babystyle. The grand opening of the Automotive Parts and Accessories Store was held in October 2006. The Automotive Store offers more than a million parts from 250 leading parts and accessories retail­ ers such as Auto Barn, HorsepowerFreaks, and Sum m it Racing Equipment. Some of the brands offered through the site include: Fram, Holley, Lund. Raybestos, and Schumacher. A service called Part Finder allows custom ers lo find the correct parts to lit their vehicles (for approxi­ mately 10,000 different American cars or trucks).

Amazon introduced the Kindle, a wireless reading device, for use in the United Stales in 2007. Custom ers download books, magazines, and newspapers to read on Kindle, and they can store these downloaded materials on other devices such as the iPad. M ost Kindle books cost between $9.99 and $12.99, but other books are much less expensive (less than $5, and some are free). Amazon began offering Kindle International in more than 100 countries in October o f 2009. Amazon reported in 2010 that custom ers were buying more Kindle books than hardcover books, even as hardcover books sales ai Amazon continued to grow. By January 2011, Kindle

440 STRATEGIC M AN AGEM ENT CASES

book sales were greater than the com pany’s paperback book sales. The Kindle does face strong com petition from multi-functional devices such as A pple’s iPad and other book readers such as Nook, a Barnes and Noble product. By 2011. Amazon completed agreem ents so Kindle books can be loaned from libraries to Kindle owners.

Amazon continues to expand into new product and service areas. In 2009, Amazon an­ nounced a strategic alliance with textbook publisher M cGraw-Hill to target sales in the higher education market. M cGraw-Hill distributes hundreds o f Kindles in colleges and universities, exposing a new generation to wireless reading devices.

Some other new services/products offered include: shoes/apparel (through Zappos. which was purchased in 2009 for $1.1 billion); the Denim Shop (2010), and web services such as Amazon Relational Database Services, Elastic M apReduce, and Virtual Private Cloud. Perhaps the most talked about new service is the music cloud service that was started in 2011. Users can upload music to Amazon data storage systems on the web and play them back on any PC or Apple computer. The music can also be accessed by cell phones and tablet com puters through the Android operating system. Customers can purchase space on the web for $20 a year after they have used the free 5 gigabytes of storage (about 1,200 songs). Bill Carr. A m azon’s VP for M usic and Movies, said that with the service custom ers can “store it 1 music] in the cloud and play it anywhere.” There are possible legal issues with this new service. Record label managers want music services to negotiate licenses with record com panies to store and make digital music available, while Amazon managers believe that additional licensing is not necessary. Amazon says their Cloud Player/Cloud Drive technology is not unlike Google Docs or M icrosoft's Windows M edia Player.

A m azon’s strength in selling consum er products was dem onstrated in its 2009 jew elry sales. As expected, given the sluggish U.S. economy, the majority o f jewelry retailers saw their sales drop. However, while Neiman M arcus and J.C. Penney were experiencing jew elry sales drops in excess o f 20 percent, Amazon increased its jewelry sales by 13 percent. Quidsi, a com pany that sells bulk consum er items over two websites (diapers.com and soap.com) was acquired in 2010. This acquisition allows Amazon to increase its presence in a new custom er category. Amazon anticipates the custom ers who make frequent website visits to buy consum er staples could be enticed through promotion to buy higher margin goods.

Mission The mission ofA m azon.com is:

to be the Earth 's most customer-centric company, where custom ers can find and discover anything they might want to buy online, and endeavor to offer custom ers the lowest possible prices.

Competition Direct com petitors for Amazon include: brick-and-m oitar retailers; online e-com m erce websites; book publishers; and distributors, manufacturers, and producers o f products sold by Am azon. M ajor brick-and-m ortar retailers include stores such as Best Buy, Wal-Mart, Target, Sears, and Office Depot. Hybrid retailers’ success in the e-com m erce market is dem onstrated by the 8 per­ cent reduction o f pure e-tailers' share o f total online sales between 2004 and 2010. Researchers sight consum ers' inherent trust in a brick-and-m ortar physical presence as an advantage hybrid retailers have over pure e-tailers.

Internationally, com panies are being founded based on business models sim ilar to that of Amazon. Chinese companies are positioning themselves to com pete for the m ore than 400 mil­ lion Chinese Internet users (more than any other nation). The Chinese com pany 360buy.com was founded in 2004 and expects to report 2010 revenues in excess o f $1.5 billion as it sells a wide range of products. In 2010, Wal-Mart invested more than $500 million in 360buy.com. Another Chinese web-based retailer, China Dangdang, Inc, raised $272 million through a 2010 public stock offering and plans to use the proceeds to upgrade and enhance both its technology and ful­ fillment. Beirut based neelwafurat.com was launched in 1998 and sells books, music, and DVDs to the Middle Eastern world.

CASE 4 • AMAZON.COM, IN C .— 2011 441

Amazon also has a number o f indirect com petitors, including com panies that provide e-com m erce services such as website development, third-party fulfillment com panies, and custom er-service com panies that provide infrastructure web services. O ther indirect com peti­ tors are m edia com panies, com parison shopping websites, and web search engines. Examples of e-com m erce com petitors include eBay.com. Toysrus.com, and Target.com. Download ser­ vice com petitors include Apple Computer. Google.com . and other DVD rental services such as Netflix and Blockbuster that provide video downloading.

The major com petitors in the book sales market that was revolutionized by Amazon include Barnes & Noble, Borders, and Books-A-M illion. Information about these com panies is provided in the following sections.

Barnes & Noble The typical Barnes & Noble store offers 60,000 to 200.000 titles, and m ost stores have Starbucks cafes and music departm ents that sell more than 30,000 m usic titles. Barnes & Noble is the nation's largest brick-and-m ortar bookseller with 1,357 total stores operating in 50 states, includ­ ing 720 Barnes & Noble superstores and 637 B & N College Booksellers on college campuses. These bookstores serve approxim ately four million students and faculty. Only 10 percent o f sales were made by custom ers online in 2010, while college sales were more than 14 percent o f sales. About 90 stores were closed from 2007 to 201 I, and the company expects more consolidation in the future. The com pany invests heavily in its version o f the e-reader (launched in 2009), called Nook, that com petes with A m azon’s Kindle and A pple's iPad. The com pany announced in 201 1 that Nook will be sold in Staples stores in an attem pt to get the device into more custom ers' hands; Nook is also sold at Best Buy and Wal-Mart. In D ecem ber 2010, the company pul itself on the market to be sold, but no buyers have shown interest. Financial information for Barnes & Noble is shown in Exhibit 1.

Borders Group Borders is the number two U.S. bookseller and offers up to 170.000 book, music, and movie titles for sale in its stores. Most stores also have a Seattle's Best coffee shop. In 2010. the company had 511 Borders stores in 45 states and Puerto Rico and 175 smaller stores with the names Waldenbooks, Borders Express, or Borders Outlets. The company also had 29 Borders aiiport stores in 2010. In February 2011. unable to gain traction in the digital book market, and after having three CEOs in three years, Borders filed Chapter 11 bankruptcy. Borders plans to close 226 superstores in 2011 and is likely to close more. The company received S505 million from GE Capital for its reorganiza­ tion and has also negotiated rent reductions o f more than S30 million with some landlords. A new Borders strategy is to stock more nonbook items such as games and stationery, and company man­ agers are considering selling food items from local sources and wine in Borders cafes. Managers hope that through reorganization and closing o f some stores, the company can be profitable again. Financial information for Borders Group is shown in Exhibit 2.

EXHIBIT 1 Financial Information for Barnes & Noble ($ in millions)

Fiscal 2010 Thirteen Weeks

Ended May 2, 2009 Fiscal 2008

Net Sales $5,810.56 $1,105.12 $5,121.80 Operating Income 73.25 (3.24) 143.33 Net Earnings 36.64 (2.72) 75.89

May 1, 2010 May 2, 2009 January 2009

Total Assets 3,706.68 2,664.28 2.877.86 Long-Term Debt 260.40 - - Stockholders’ Equity 903.37 911.82 923.23

Note: Barnes & Noble, Inc. changed its fiscal year-end from January to April effective on September 30, 2009. (The year 2009 is a 13-week transition period ended May 2, 2009.) Source: Barnes & Noble. 2010, Form ¡OK.

442 STRATEGIC M AN AGEM ENT CASES

EXHIBIT 2 Financial Information for Borders Group (S in millions)

2010 2009 2008

Net Sales $2,791.1 $3,242.1 $3,555.1 Operating Income (94.9) (149.2) 4.1 Net Earnings (109.4) (186.7) (157.4) Total Assets 1,425.2 1,609.0 2,147.1 Long-Term Debt 4.8 6.6 5.6 Stockholders’ Equity 158.3 263.1 479.1

Source: Borders Group. 2010, Form I OK, p. 20.

Books-A-Million Books-A-M illion was founded in 1917 as a street-corner newsstand in Florence, A labama, and is currently the third-largest book retailing chain in the United States. The com pany has 223 stores that are located in 22 states and W ashington, DC. The com pany offers two retail store formats: Books-A-M illion superstores with over 20,000 square feel (named Books-A-M illion or Book & Co.) and traditional bookstores with 3.500 to 4.000 square feet (called Books-A-M illion or Bookland). Books-A-Million also has a wholesale and distribution division, an e-com m erce division, and an Internet development and services company called Net Central that is located in Nashville, Tennessee. Although Books-A-M illion suffered a 7.5 percent reduction in sales in the years from 2007 through 2010. the company has remained profitable. Financial inform ation for Books-A-M illion is shown in Exhibit 3.

Internal Issues By-Segment Finances Amazon considers its business as two geographic segments. North A merica and International. In 2010, North America sales produced approxim ately 55 percent o f the com pany's total revenue, and approximately 45 percent came from international sales. O ver the last three years, net sales have increased more in North America than in international m arkets, as indicated in Exhibit 4. More than 50 percent o f Amazon sales are made in North America.

A m azon’s mix o f products tails into three categories: media, electronics and other general merchandise, and other services. O ther services include nonretail activities, such as Amazon Web Services, other seller sites, and co-branded credit card agreements. E lectronics/other general m erchandise and other sales have increased significantly from 2009 to 2010 in both the North Am erica and International segments, while media sales have either decreased (in International segment) or increased by only a few percentage points (North Am erica). M edia makes up 43 percent of all net sales in 2010, while electronics is 54 percent, and “other" is only 3 percent o f net sales. Overall, media sales declined from 2009 to 2010. while sales o f electron­ ics and other general merchandise increased, as indicated in Exhibit 5.

Marketing Amazon's marketing strategy is designed to increase customer traffic on the com pany’s websites, to promote repeat purchases, to build awareness of products and services that are available, and to

EXHIBIT 3 Financial Information for Books-A-Million (S in thousands)

2010 2009 2008

Net Sales $508,667 $515,357 $536,054

Operating Income $21,677 18,890 27.420

Net Earnings $13,836 10,574 16.522

Total Assets $273,498 279,292 284,833

Long-Term Debt $6,360 6.720 6.975

Stockholders’ Equity $114,708 104,484 99.051

Source: 2010 Annual Report, http://www.booksamillion.com.

CASE 4 • AMAZON.COM, INC. — 2011 443

EXHIBIT 4 Amazon.com Net Sales by Geographic Area (in millions)

Year Ended December 31

2010 2009 2008

Net Sales North America $18,707 $12,828 $10,228 International 15,497 11,681 8,938 Consolidated 534,204 $24,509 519,166

Year-Over-Year Percentage Growth North America 46% 25% 26% International 33 31 33 Consolidated 40 28 29

Year-Over-Year Percentage Growth. Excluding Effect of Exchange Rates

North America 46% 26% 26% International 34 33 31 Consolidated 40 29 28 Net Sales Mix North America 55% 52% 53% International 45 48 47 Consolidated 100% 100% 100%

Source: Amazon.com. 2010. Form I OK.

EXHIBIT 5 Amazon.com Net Sales by Geographic Area and Product Type (in millions)

Amazon.com Inc.