need report based on 7 and 8 chapters only

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GREGORY G. DESS University of Texas at Dallas

GERRY McNAMARA Michigan State University

ALAN B. EISNER Pace University

SEUNG-HYUN (SEAN) LEE University of Texas at Dallas

text & cases

ninth edition

STRATEGIC MANAGEMENT

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STRATEGIC MANAGEMENT: TEXT AND CASES, NINTH EDITION

Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2019 by McGraw- Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2016, 2014, and 2012. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

1 2 3 4 5 6 7 8 9 0 LWI 21 20 19 18

ISBN 978-1-259-81395-5 (bound edition) MHID 1-259-81395-9 (bound edition)

ISBN 978-1-259-89997-3 (loose-leaf edition) MHID 1-259-89997-7 (loose-leaf edition)

ISBN 978-1-259-89994-2 (instructor’s edition) MHID 1-259-89994-2 (instructor’s edition)

Portfolio Director: Michael Ablassmeir Lead Product Developer: Kelly Delso Product Developer: Anne Ehrenworth Executive Marketing Manager: Debbie Clare Content Project Managers: Harvey Yep (Core), Bruce Gin (Assessment) Buyer: Susan K. Culbertson Design: Matt Diamond Content Licensing Specialists: DeAnna Dausener (Image and Text) Cover Image: ©Anatoli Styf/Shutterstock Compositor: SPi Global

All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.

Library of Congress Cataloging-in-Publication Data

Names: Dess, Gregory G., author. | McNamara, Gerry, author. | Eisner, Alan B., author. Title: Strategic management : text and cases / Gregory G. Dess, University of Texas at Dallas, Gerry McNamara, Michigan State University, Alan B. Eisner, Pace University. Description: Ninth edition. | New York, NY : McGraw-Hill Education, [2019] Identifiers: LCCN 2017052281 | ISBN 9781259813955 (alk. paper) Subjects: LCSH: Strategic planning. Classification: LCC HD30.28 .D4746 2019 | DDC 658.4/012—dc23 LC record available at https://lccn.loc.gov/2017052281

The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

mheducation.com/highered

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To my family, Margie and Taylor and my parents, the late Bill and Mary Dess; and Michael Wood

To my first two academic mentors—Charles Burden and Les Rue (of Georgia State University)

–Greg

To my wonderful wife, Gaelen, my children, Megan and AJ; and my parents, Gene and Jane

–Gerry

To my family, Helaine, Rachel, and Jacob

–Alan

To my family, Hannah, Paul and Stephen; and my parents, Kenny and Inkyung.

–Sean

DEDICATION

dedication

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Gregory G. Dess is the Andrew R. Cecil Endowed Chair in Management at the University of Texas at Dallas. His primary research interests are in strategic management, organization- environment relationships, and knowledge management. He has published numerous articles on these subjects in both academic and practitioner-oriented journals. He also serves on the editorial boards of a wide range of practitioner-oriented and academic journals. In August 2000, he was inducted into the Academy of Management Journal’s Hall of Fame as one of its charter members. Professor Dess has conducted executive programs in the United States, Europe, Africa, Hong Kong, and Australia. During 1994 he was a Fulbright Scholar in Oporto, Portugal. In 2009, he received an honorary doctorate from the University of Bern (Switzerland). He received his PhD in Business Administration from the University of Washington (Seattle) and a BIE degree from Georgia Tech.

Gerry McNamara is the Eli Broad Professor of Management at Michigan State University. His research draws on cognitive and behavioral theories to explain strategic phenomena, including strategic decision making, mergers and acquisitions, and environmental assessments. His research has been published in the Academy of Management Journal, the Strategic Management Journal, Organization Science, Organizational Behavior and Human Decision Processes, the Journal of Applied Psychology, the Journal of Management, and the Journal of International Business Studies. Gerry’s research has also been abstracted in the Wall Street Journal, Harvard Business Review, New York Times, Bloomberg Businessweek, the Economist, and Financial Week. He serves as an Associate Editor for the Strategic Management Journal and previously served as an Associate Editor for the Academy of Management Journal. He received his PhD from the University of Minnesota.

ABOUT THE AUTHORS

about the authors

©He GaoPhoto provided by the author

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Alan B. Eisner is Professor of Management and Department Chair, Management and Management Science Department, at the Lubin School of Business, Pace University. He received his PhD in management from the Stern School of Business, New York University. His primary research interests are in strategic management, technology management, organizational learning, and managerial decision making. He has published research articles and cases in journals such as Advances in Strategic Management, International Journal of Electronic Commerce, International Journal of Technology Management, American Business Review, Journal of Behavioral and Applied Management, and Journal of the International Academy for Case Studies. He is the former Associate Editor of the Case Association’s peer-reviewed journal, The CASE Journal.

Seung-Hyun Lee is a Professor of strategic management and international business and the Area Coordinator of the Organization, Strategy, and International Management area at the Jindal School of Business, University of Texas at Dallas. His primary research interests lie on the intersection between strategic management and international business spanning from foreign direct investment to issues of microfinance and corruption. He has published in numerous journals including Academy of Management Review, Journal of Business Ethics, Journal of International Business Studies, Journal of Business Venturing, and Strategic Management Journal. He received his MBA and PhD from the Ohio State University.

©Seung-Hyun Lee©Alan B. Eisner

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PREFACE

Welcome to the Ninth Edition of Strategic Management: Text and Cases! As noted on the cover, we are happy to introduce Seung- Hyun Lee to the author team. Greg has known Seung since we both joined the faculty at the University of Texas at Dallas in 2002. Seung has developed a very distinguished publication record in both strategic management and international business/international management and he has made many important contributions in these areas in the present edition. In particular, his international expertise has been particularly valuable in further “globalizing” our book.

We appreciate the constructive and positive feedback that we have received on our work. Here’s some of the encouraging feedback we have received from our reviewers:

The Dess book comprehensively covers the fundamentals of strategy and supports concepts with research and managerial insights.

Joshua J. Daspit, Mississippi State University

Very engaging. Students will want to read it and find it hard to put down.

Amy Grescock, University of Michigan, Flint

Very easy for students to understand. Great use of business examples throughout the text.

Debbie Gilliard, Metropolitan State University, Denver

I use Strategic Management in a capstone course required of all business majors, and students appreciate the book because it synergizes all their business education into a meaningful and understandable whole. My students enjoy the book’s readability and tight organization, as well as the contemporary examples, case studies, discussion questions, and exercises.

William Sannwald, San Diego State University

The Dess book overcomes many of the limitations of the last book I used in many ways: (a) presents content in a very interesting and engrossing manner without compromising the depth and comprehensiveness, (b) inclusion of timely and interesting illustrative examples, and (c) EOC exercises do an excellent job of complementing the chapter content.

Sucheta Nadkami, University of Cambridge

The content is current and my students would find the real-world examples to be extremely interesting. My colleagues would want to know about it and I would make extensive use of the following features: “Learning from Mistakes,” “Strategy Spotlights,” and “Issues for Debate.” I especially like the “Reflecting on Career Implications” feature. Bottom line: the authors do a great job of explaining complex material and at the same time their use of up-to-date examples promotes learning.

Jeffrey Richard Nystrom, University of Colorado at Denver

We always strive to improve our work and we are most appreciative of the extensive and thoughtful feedback that many strategy professionals have graciously given us. We endeavored to incorporate their ideas into the Ninth Edition—and we acknowledge them by name later in the Preface.

We believe we have made valuable improvements throughout our many revised editions of Strategic Management. At the same time, we strive to be consistent and “true” to our original overriding objective: a book that satisfies three R’s—rigor, relevance, and readable. And we are

preface

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pleased that we have received feedback (such as the comments on the previous page) that is consistent with what we are trying to accomplish.

What are some of the features in Strategic Management that reinforce the 3 R’s? First, we build in rigor by drawing on the latest research by management scholars and insights from management consultants to offer a current a current and comprehensive view of strategic issues. We reinforce this rigor with our “Issues for Debate” and “Reflecting on Career Implications. . .” that require students to develop insights on how to address complex issues and understand how strategy concepts can enhance their career success. Second, to enhance relevance, we provide numerous examples from management practice in the text and “Strategy Spotlights” (sidebars). We also increase relevance by relating course topic and examples to current business and societal themes, including environmental sustainability, ethics, globalization, entrepreneurship, and data analytics. Third, we stress readability with an engaging writing style with minimal jargon to ensure an effective learning experience. This is most clearly evident in the conversational presentations of chapter opening “Learning from Mistakes” and chapter ending “Issues for Debate.”

Unlike other strategy texts, we provide three separate chapters that address timely topics about which business students should have a solid understanding. These are the role of intellectual assets in value creation (Chapter 4), entrepreneurial strategy and competitive dynamics (Chapter 8), and fostering entrepreneurship in established organizations (Chapter 12). We also provide an excellent and thorough chapter on how to analyze strategic management cases.

In developing Strategic Management: Text and Cases, we certainly didn’t forget the instructors. As we all know, you have a most challenging (but rewarding) job. We did our best to help you. We provide a variety of supplementary materials that should help you in class preparation and delivery. For example, our chapter notes do not simply summarize the material in the text. Rather (and consistent with the concept of strategy), we ask ourselves: “How can we add value?” Thus, for each chapter, we provide numerous questions to pose to help guide class discussion, at least 12 boxed examples to supplement chapter material, and three detailed “teaching tips” to further engage students. For example, we provide several useful insights on strategic leadership from one of Greg’s colleagues, Charles Hazzard (formerly Executive Vice President, Occidental Chemical). Also, we completed the chapter notes—along with the entire test bank—ourselves. That is, unlike many of our rivals, we didn’t simply farm the work out to others. Instead, we felt that such efforts help to enhance quality and consistency—as well as demonstrate our personal commitment to provide a top-quality total package to strategy instructors. With the Ninth Edition, we also benefited from valued input by our strategy colleagues to further improve our work.

Let’s now address some of the key substantive changes in the Ninth Edition. Then we will cover some of the major features that we have had in previous editions.

WHAT’S NEW? HIGHLIGHTS OF THE NINTH EDITION We have endeavored to add new material to the chapters that reflects the feedback we have received from our reviewers as well as the challenges today’s managers face. Thus, we all invested an extensive amount of time carefully reviewing a wide variety of books, academic and practitioner journals, and the business press.

We also worked hard to develop more concise and tightly written chapters. Based on feedback from some of the reviewers, we have tightened our writing style, tried to eliminate redundant examples, and focused more directly on what we feel is the most important content in each chapter for our audience. The overall result is that we were able to update our material, add valuable new content, and—at the same time—shorten the length of the chapters.

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Here are some of the major changes and improvements in the Ninth Edition:

· Big Data/Data Analysis. A central theme of the Ninth Edition, it has become a leading and highly visible component of a broader technological phenomena—the emergence of digital technology. Such initiatives have the potential to enable firms to better customize their product and service offerings to customers while more efficiently and fully using the resources of the company. Throughout the text, we provide examples from a wide range of industries and government. This includes discussions of how Coca Cola uses data analytics to produce consistent orange juice, IBM’s leveraging of big data to become a healthcare solution firm, Caterpillar’s use of data analytics to improve machine reliability and to identify needed service before major machine failures, and Digital Reasoning’s efforts to use data analytics to enhance the ability of firms to control employees and avoid illegal and unethical behavior.

· Greater coverage of international business/international management (IB/IM from new co-author). As we noted at the beginning of the Preface, we have invited Seung-Hyun Lee, an outstanding IB/IM scholar, to join the author team and we are very pleased that he has accepted! Throughout the book we have included many concepts and examples of IB/IM that reflects the growing role of international operations for a wide range of industries and firms. We discuss how differences in national culture impact the negotiation of contracts and whether or not to adapt human resource practices when organizations cross national boundaries. We also include a discussion of how corporate governance practices differ across countries and discuss in depth how Japan is striving to develop balanced governance practices that incorporate elements of U.S. practices while retaining, at its core, elements of traditional Japanese practices. Additionally, we discuss why conglomerate firms thrive in Asian markets even as this form of organization has gone out of favor in the United States and Europe. Finally, we discuss research that suggests that firms in transition economies can improve their innovative performance by focusing on learning across boundaries within the firm compared to learning from outside partners.

· “Executive Insights: The Strategic Management Process.” Here, we introduce a nationally recognized leader and explore several key issues related to strategic management. The executive is William H. McRaven, a retired four-star admiral who leads the nation’s second largest system of higher education. As chief executive officer of the UT System, he oversees 14 institutions that educate 217,000 students and employ 20,000 faculty and more than 70,000 health care professionals, researchers, and staff. He is perhaps best known for his involvement in Operation Neptune Spear, in which he commanded the U.S. Navy Special Forces who located and killed al Qaeda leader Osama bin Laden. We are very grateful for his valuable contribution!

· Half of the 12 opening “Learning from Mistakes” vignettes that lead off each chapter are totally new. Unique to this text, they are all examples of what can go wrong, and they serve as an excellent vehicle for clarifying and reinforcing strategy concepts. After all, what can be learned if one simply admires perfection?

· Over half of our “Strategy Spotlights” (sidebar examples) are brand new, and many of the others have been thoroughly updated. Although we have reduced the number of Spotlights from the previous edition to conserve space, we still have a total of 64—by far the most in the strategy market. We focus on bringing the most important strategy concepts to life in a concise and highly readable manner. And we work hard to eliminate unnecessary detail that detracts from the main point we are trying to make. Also, consistent with our previous edition, many of the Spotlights focus on two

PREFACE

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“hot” issues that are critical in leading today’s organizations: ethics and environmental sustainability—as well as data analytics in this edition.

Key content changes for the chapters include:

· Chapter 1 addresses three challenges for executives who are often faced with similar sets of opposing goals which can polarize their organizations. These challenges, or paradoxes, are called (1) the innovation paradox, the tension between existing products and new ones—stability and change; (2) the globalization paradox, the tension between global connectedness and local needs; and, (3) the obligation paradox, the tension between maximizing shareholder returns and creating benefits for a wide range of stakeholders— employees, customers, society, etc. We also discuss three theaters of practice that managers need to recognize in order to optimize the positive impact of the corporate social responsibility (CSR) initiatives. These are (1) Focusing on philanthropy, (2) Improving operational effectiveness, and (3) Transforming the business model.

· Chapter 2 introduces the concept of big data/data analytics—a technology that affects multiple segments of the general environment. A highly visible component of the digital economy, such technologies are altering the way business is conducted in a wide variety of sectors—government, industry, and commerce. We provide a detailed example of how it has been used to monitor the expenditures of federal, state, and local governments.

· Chapter 3 includes a discussion on program hiring to build human capital. With program hiring, firms offer employment to promising graduates without knowing which specific job the employee will fill. Firms employing this tactic believe it allows them to meet changing market conditions by hiring flexible employees who desire a dynamic setting. We also include a discussion of how Coca Cola is leveraging data analytics to produce orange juice that is consistent over time and can be tailored to meet local market tastes.

· Chapter 4 discusses research that has found that millennials have a different definition of diversity and inclusion than prior generations. That is, millennials look upon diversity as the blending of different backgrounds, experiences, and perspectives within a team, i.e., cognitive diversity. Earlier generations—the X-Generation and the Boomer Generation— tended to view diversity as a representation of fairness and protection for all regardless of gender, race, religion, etc. An important implication is that while many millennials believe that differences of opinion enable teams to excel, relatively few of them feel that their leaders share this perspective. The chapter also provides a detailed example of how data analytics can increase employee retention.

· Chapter 5 examines how firms can create strong competitive positions in platform markets. In platform markets, firms act as intermediaries between buyers and sellers. Success is largely based on the ability of the firm to be the de facto provider of this matching process. We discuss several actions firms can take to stake out a leadership position in these markets. In addition, we include a discussion of research outlining how firms can develop organizational structures and policies to draw on customer interactions to improve their innovativeness. The key finding from this research is that it is critical for firms to empower and incent front line employees to look for and share innovative insights they take away from customer interactions.

· Chapter 6 includes a section on different forms of strategic alliances and when they are most appropriate. In discussing the differences between contractual alliances, equity alliances, and joint ventures, students can better understand the range of options they

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have to build cooperative arrangements with other firms and the factors that influence the choice among these options.

· Chapter 7 explains two important areas in which culture can play a key role in managing organizations across national boundaries. First, we discuss situations in which it is best to not adapt one’s company culture—even if it conflicts with the culture country in which the firm operates. We provide the example of Google’s human resource policy of providing employees with lots of positive feedback during performance reviews. Why? Google feels that this is a key reason for its outstanding success in product innovation. Second, we address some of the challenges that managers encounter when they negotiate contracts across national boundaries. We discuss research that identifies several elements of negotiating behaviors that help to identify cultural differences.

· Chapter 8 identifies factors investors can examine when evaluating the risk of crowdfunded ventures. When firms raise funds through crowdfunding, they often have limited business and financial histories and haven’t yet built up a clear reputation. This raises the risks investors face. We identify some factors investors can look into to clarify the worthiness and risk of firms who are raising financial resources through crowdfunding.

· Chapter 9 discusses the increasingly important role that activist investors have in the corporate governance of publicly-traded firms. Activist investors are investors who take small but significant ownership stakes in large firms, typically 5 to 10 percent ownership, and push for major strategic changes in the firm. These activist investors are often successful, winning 70 percent of the shareholder votes they champion and have forced the exit of leaders of several large firms. Additionally, we discuss a corner of Wall Street where women dominate, as corporate governance heads at major institutional investors. These institutional investors hold large blocks of stock in all major corporations. As a result, these female leaders are in a position to push for governance changes in these corporations to make them more responsive to the concerns of investors, such as increasing opportunities for female corporate leaders.

· Chapter 10 discusses how firms can organize to improve their innovativeness. Often managers look to outside partners to learn new skills and access new knowledge to improve their innovative performance. We discuss research that suggests that efforts to look to create novel combinations of knowledge within the firm offer greater potential to generate stronger innovation performance. The key advantage of internal knowledge is that it is proprietary and potentially more applicable to the firm’s innovation efforts.

· Chapter 11 includes discussions of multiple firms that have changed their leadership and control systems to respond to challenges they’ve faced. This includes Marvin Ellison’s efforts to revive JC Penney after prior bad leadership, Target’s efforts to change its supply chain system to meet changing customer demands, and the decision procedures JC Johnson Inc. has put in place to improve its ability to lead its industry in sustainability efforts.

· Chapter 12 highlights the potential to learn from innovation failures. Too often, firms become risk averse in their behavior in order to avoid failure. We discuss how this can result in missing truly innovative opportunities. Drawing off research by Julian Birkinshaw, we discuss the need for firms to get their employees to take bold innovation actions and steps firms can take to learn from failed innovation efforts to be more effective in future innovation efforts. We also discuss research on the consequences of losing star innovation employees. Firms worry about the loss of key innovation personnel, but research shows that while there are costs associated with the loss of star

PREFACE

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innovators, there are also potential benefits. Firms that lose key innovators typically experience a loss in exploitation-oriented innovation, but they also often see an increase in exploration-oriented innovation.

· Chapter 13 provides an example of how the College of Business Administration at Towson University successfully introduced a “live” business case completion across all of it strategic management sections. The “description” and the “case completion checklist” includes many of the elements of the analysis-decision-action cycle in case analysis that we address in the chapter.

· Chapter 13 updates our Appendix: Sources of Company and Industry Information. Here, we owe a big debt to Ruthie Brock and Carol Byrne, library professionals at the University of Texas at Arlington. These ladies have provided us with comprehensive and updated information for the Ninth Edition that is organized in a range of issues. These include competitive intelligence, annual report collections, company rankings, business websites, and strategic and competitive analysis. Such information is invaluable in analyzing companies and industries. We are always amazed by the diligence, competence—and good cheer—that Ruthie and Carol demonstrate when we impose on them every two years!

· We have worked hard to further enhance our excellent case package with a major focus on fresh and current cases on familiar firms. · More than half of our cases are author-written (much more than the competition). · We have updated our users favorite cases, creating fresh stories about familiar

companies to minimize instructor preparation time and “maximize freshness” of he content.

· We have added several exciting new cases to the lineup including Blackberry and Ascena (the successor company to Ann Talyor).

· We have also extensively updated 28 familiar cases with the latest news. · Our cases are familiar yet fresh with new data and problems to solve.

WHAT REMAINS THE SAME: KEY FEATURES OF EARLIER EDITIONS Let’s now briefly address some of the exciting features that remain from the earlier editions.

· Traditional organizing framework with three other chapters on timely topics. Crisply written chapters cover all of the strategy bases and address contemporary topics. First, the chapters are divided logically into the traditional sequence: strategy analysis, strategy formulation, and strategy implementation. Second, we include three chapters on such timely topics as intellectual capital/knowledge management, entrepreneurial strategy and competitive dynamics, and fostering corporate entrepreneurship and new ventures.

· “Learning from Mistakes” chapter-opening cases. To enhance student interest, we begin each chapter with a case that depicts an organization that has suffered a dramatic performance drop, or outright failure, by failing to adhere to sound strategic management concepts and principles. We believe that this feature serves to underpin the value of the concepts in the course and that it is a preferred teaching approach to merely providing examples of outstanding companies that always seem to get it right. After all, isn’t it better (and more challenging) to diagnose problems than admire perfection? As Dartmouth’s Sydney Finkelstein, author of Why Smart Executives Fail,

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PREFACE

notes: “We live in a world where success is revered, and failure is quickly pushed to the side. However, some of the greatest opportunities to learn—for both individuals and organizations—come from studying what goes wrong.”* We’ll see how, for example, why Frederica Marchionni, the CEO that Land’s End hired in 2015, failed to spearhead the revival of the brand. Her initiatives geared toward taking the brand upscale turned out to be too much of a shock to the firm’s customer base as well as the firm’s family culture and wholesome style. As noted by a former executive, “It doesn’t look like Land’s End anymore. There was never the implication that if you wore Lands’ End you’d be on the beach on Nantucket living the perfect life.” We’ll also explore the bankruptcy of storied law firm Dewey & LeBoeuf LLP. Their failure can be attributed to three major issues: a reliance on borrowed money, making large promises about compensation to incoming partners (which didn’t sit well with their existing partners!), and a lack of transparency about the firm’s financials.

· “Issue for Debate” at the end of each chapter. We find that students become very engaged (and often animated!) in discussing an issue that has viable alternate points of view. It is an exciting way to drive home key strategy concepts. For example, in Chapter 1, Seventh Generation is faced with a dilemma that confronts their values and they must decide whether or not to provide their products to some of their largest customers. At issue: While they sympathize (and their values are consistent) with the striking workers at the large grocery chains, should they cross the picket lines? In Chapter 4, we discuss an issue that can be quite controversial: Does offering financial incentives to employees to lose weight actually work? We will explain a study by professors and medical professionals who conducted a test to explore this issue. And, in Chapter 7, we address Medtronic’s decision to acquire Covidien, an Irish-based medical equipment manufacturer for $43 billion. Its primary motive: Lower its taxes by moving its legal home to Ireland—a country that has lower rates of taxation on corporations. Some critics may see such a move as unethical and unpatriotic. Others would argue that it will help the firm save on taxes and benefit their shareholders.

· “Insights from Research.” We include six of this feature in the Ninth Edition—and half of them are entirely new. Here, we summarize key research findings on a variety of issues and, more importantly, address their relevance for making organizations (and managers!) more effective. For example, in Chapter 2 we discuss findings from a meta- analysis (research combining many individual studies) to debunk several myths about older workers—a topic of increasing importance, given the changing demographics in many developed countries. In Chapter 4, we address a study that explored the viability of re-hiring employees who had previously left the organizations. Such employees, called “boomerangs” may leave an organization for several reasons and such reasons may strongly influence their willingness to return to the organization. In Chapter 5, we summarize a study that looked at how firms can improve their innovativeness by drawing on interactions with customers but only if the firm empowers front line employees to lead innovative efforts and provides incentives to motivate employees to do so. In Chapter 10, we discuss research on firms in transition economies that found firms which learn from both external partners and by spanning boundaries within the firm can improve their innovation. However, learning between units within the firm produced higher innovation performance.

*Personal Communication, June 20, 2005.

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· “Reflecting on Career Implications. . .” We provide insights that are closely aligned with and directed to three distinct issues faced by our readers: prepare them for a job interview (e.g., industry analysis), help them with current employers or their career in general, or help them find potential employers and decide where to work. We believe this will be very valuable to students’ professional development.

· Consistent chapter format and features to reinforce learning. We have included several features in each chapter to add value and create an enhanced learning experience. First, each chapter begins with an overview and a list of key learning objectives. Second, as previously noted, the opening case describes a situation in which a company’s performance eroded because of a lack of proper application of strategy concepts. Third, at the end of each chapter there are four different types of questions/exercises that should help students assess their understanding and application of material:

1. Summary review questions. 2. Experiential exercises. 3. Application questions and exercises. 4. Ethics questions.

Given the centrality of online systems to business today, each chapter contains at least one exercise that allows students to explore the use of the web in implementing a firm’s strategy.

· Key Terms. Approximately a dozen key terms for each chapter are identified in the margins of the pages. This addition was made in response to reviewer feedback and improves students’ understanding of core strategy concepts.

· Clear articulation and illustration of key concepts. Key strategy concepts are introduced in a clear and concise manner and are followed by timely and interesting examples from business practice. Such concepts include value-chain analysis, the resource- based view of the firm, Porter’s five-forces model, competitive advantage boundaryless organizational designs, digital strategies, corporate governance, ethics, data analytics, and entrepreneurship.

· Extensive use of sidebars. We include 64 sidebars (or about five per chapter) called “Strategy Spotlights.” The Strategy Spotlights not only illustrate key points but also increase the readability and excitement of new strategy concepts.

· Integrative themes. The text provides a solid grounding in ethics, globalization, environmental substainability, and technology. These topics are central themes throughout the book and form the basis for many of the Strategy Spotlights.

· Implications of concepts for small businesses. Many of the key concepts are applied to start-up firms and smaller businesses, which is particularly important since many students have professional plans to work in such firms.

· Not just a textbook but an entire package. Strategic Management features the best chapter teaching notes available today. Rather than merely summarizing the key points in each chapter, we focus on value-added material to enhance the teaching (and learning) experience. Each chapter includes dozens of questions to spur discussion, teaching tips, in-class group exercises, and about a dozen detailed examples from business practice to provide further illustrations of key concepts.

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PREFACE

TEACHING RESOURCES Instructor’s Manual (IM) Prepared by the textbook authors, along with valued input from our strategy colleagues, the accompanying IM contains summary/objectives, lecture/discussion outlines, discussion questions, extra examples not included in the text, teaching tips, reflecting on career implications, experiential exercises, and more.

Test Bank Revised by Christine Pence of the University of California-Riverside, the test bank contains more than 1,000 true/false, multiple-choice, and essay questions. It is tagged with learning objectives as well as Bloom’s Taxonomy and AACSB criteria.

· Assurance of Learning Ready. Assurance of Learning is an important element of many accreditation standards. Dess 9e is designed specifically to support your Assurance of Learning initiatives. Each chapter in the book begins with a list of numbered learning objectives that appear throughout the chapter. Every test bank question is also linked to one of these objectives, in addition to level of difficulty, topic area, Bloom’s Taxonomy level, and AACSB skill area. EZ Test, McGraw-Hill’s easy-to-use test bank software, can search the test bank by these and other categories, providing an engine for targeted Assurance of Learning analysis and assessment.

· AACSB Statement. The McGraw-Hill Companies is a proud corporate member of AACSB International. Understanding the importance and value of AACSB accreditation, Dess 9e has sought to recognize the curricula guidelines detailed in the AACSB standards for business accreditation by connecting selected questions in Dess 9e and the test bank to the general knowledge and skill guidelines found in the AACSB standards. The statements contained in Dess 9e are provided only as a guide for the users of this text. The AACSB leaves content coverage and assessment within the purview of individual schools, the mission of the school, and the faculty. While Dess 9e and the teaching package make no claim of any specific AACSB qualification or evaluation, we have labeled selected questions within Dess 9e according to the six general knowledge and skills areas.

· Computerized Test Bank Online. A comprehensive bank of test questions is provided within a computerized test bank powered by McGraw-Hill’s flexible electronic testing program, EZ Test Online (www.eztestonline.com). EZ Test Online allows you to create paper and online tests or quizzes in this easy-to-use program. Imagine being able to create and access your test or quiz anywhere, at any time, without installing the testing software! Now, with EZ Test Online, instructors can select questions from multiple McGraw-Hill test banks or author their own and then either print the test for paper distribution or give it online.

· Test Creation. · Author/edit questions online using the 14 different question-type templates. · Create printed tests or deliver online to get instant scoring and feedback. · Create question pools to offer multiple versions online—great for practice. · Export your tests for use in WebCT, Blackboard, and Apple’s iQuiz. · Compatible with EZ Test Desktop tests you’ve already created. · Sharing tests with colleagues, adjuncts, TAs is easy.

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· Online Test Management. · Set availability dates and time limits for your quiz or test. · Control how your test will be presented. · Assign points by question or question type with drop-down menu. · Provide immediate feedback to students or delay until all finish the test. · Create practice tests online to enable student mastery. · Your roster can be uploaded to enable student self-registration.

· Online Scoring and Reporting. · Automated scoring for most of EZ Test’s numerous question types. · Allows manual scoring for essay and other open response questions. · Manual rescoring and feedback are also available. · EZ Test’s grade book is designed to easily export to your grade book. · View basic statistical reports.

· Support and Help. · User’s guide and built-in page-specific help. · Flash tutorials for getting started on the support site. · Support website: www.mhhe.com/eztest. · Product specialist available at 1-800-331-5094. · Online training: http://auth.mhhe.com/mpss/workshops/.

PowerPoint Presentation Prepared by Pauline Assenza of Western Connecticut State University, it consists of more than 400 slides incorporating an outline for the chapters tied to learning objectives. Also included are instructor notes, multiple-choice questions that can be used as Classroom Performance System (CPS) questions, and additional examples outside the text to promote class discussion.

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PREFACE

The Business Strategy Game and GLO-BUS Online Simulations Both allow teams of students to manage companies in a head-to-head contest for global market leadership. These simulations give students the immediate opportunity to experiment with various strategy options and to gain proficiency in applying the concepts and tools they have been reading about in the chapters. To find out more or to register, please visit www.mhhe.com/ thompsonsims.

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right in Blackboard. Whether you’re choosing a book for your course or building Connect assignments, all the tools you need are right where you want them—inside Blackboard.

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ACKNOWLEDGMENTS Strategic Management represents far more than just the joint efforts of the three co-authors. Rather, it is the product of the collaborative input of many people. Some of these individuals are academic colleagues, others are the outstanding team of professionals at McGraw-Hill, and still others are those who are closest to us—our families. It is time to express our sincere gratitude.

First, we’d like to acknowledge the dedicated instructors who have graciously provided their insights since the inception of the text. Their input has been very helpful in both pointing out errors in the manuscript and suggesting areas that needed further development as additional topics. We sincerely believe that the incorporation of their ideas has been critical to improving the final product. These professionals and their affiliations are:

The Reviewer Hall of Fame Moses Acquaah, University of North Carolina-Greensboro Todd Alessandri, Northeastern University Larry Alexander, Virginia Polytechnic Institute Thomas H. Allison, Washington State University Brent B. Allred, College of William & Mary

Allen C. Amason, Georgia Southern University Kathy Anders, Arizona State University Jonathan Anderson, University of West Georgia Peter H. Antoniou, California State University- San Marcos Dave Arnott, Dallas Baptist University

Marne L. Arthaud-Day, Kansas State University Dr. Bindu Arya, University of Missouri— St. Louis Jay A. Azriel, York College of Pennsylvania Jeffrey J. Bailey, University of Idaho David L. Baker, PhD, John Carroll University

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PREFACE

Dennis R. Balch, University of North Alabama Bruce Barringer, University of Central Florida Barbara R. Bartkus, Old Dominion University Barry Bayon, Bryant University Brent D. Beal, Louisiana State University Dr. Patricia Beckenholdt, Business and Professional Programs, University of Maryland, University College Joyce Beggs, University of North Carolina-Charlotte Michael Behnam, Suffolk University Kristen Bell DeTienne, Brigham Young University Eldon Bernstein, Lynn University Lyda Bigelow, University of Utah David Blair, University of Nebraska at Omaha Daniela Blettner, Tilburg University Dusty Bodie, Boise State University William Bogner, Georgia State University David S. Boss, PhD, Ohio University Scott Browne, Chapman University Jon Bryan, Bridgewater State College

Charles M. Byles, Virginia Commonwealth University

Mikelle A. Calhoun, Valparaiso University

Thomas J. Callahan, University of Michigan–Dearborn

Samuel D. Cappel, Southeastern Louisiana State University

Gary Carini, Baylor University

Shawn M. Carraher, University of Texas–Dallas

Tim Carroll, University of South Carolina Don Caruth, Amberton University

Maureen Casile, Bowling Green State University

Gary J. Castrogiovanni, Florida Atlantic University

Radha Chaganti, Rider University

Erick PC Chang, Arkansas State University

Tuhin Chaturvedi, Joseph M. Katz Graduate School of Business, University of Pittsburgh

Jianhong Chen, University of New Hampshire

Tianxu Chen, Oakland University

Andy Y. Chiou, SUNY Farmingdale State College

Theresa Cho, Rutgers University

Timothy S. Clark, Northern Arizona University

Bruce Clemens, Western New England College

Betty S. Coffey, Appalachian State University

Wade Coggins, Webster University-Fort Smith Metro Campus

Susan Cohen, University of Pittsburgh

George S. Cole, Shippensburg University

Joseph Coombs, Virginia Commonwealth University

Christine Cope Pence, University of California-Riverside

James J. Cordeiro, SUNY Brockport Stephen E. Courter, University of Texas at Austin

Jeffrey Covin, Indiana University

Keith Credo, Auburn University

Joshua J. Daspit, PhD, Mississippi State University

Deepak Datta, University of Texas at Arlington James Davis, Utah State University Justin L. Davis, University of West Florida David Dawley, West Virginia University Daniel DeGravel, California State University Northridge, David Nazarian College of Business and Economics

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Helen Deresky, State University of New York-Plattsburgh Rocki-Lee DeWitt, University of Vermont Jay Dial, Ohio State University Michael E. Dobbs, Arkansas State University Jonathan Doh, Villanova University Dr. John Donnellan, NJCU School of Business Tom Douglas, Clemson University Jon Down, Oregon State University Meredith Downes, Illinois State University Alan E. Ellstrand, University of Arkansas Dean S. Elmuti, Eastern Illinois University Clare Engle, Concordia University Mehmet Erdem Genc, Baruch College, CUNY Tracy Ethridge, Tri-County Technical College William A. Evans, Troy State University-Dothan Frances H. Fabian, University of Memphis Angelo Fanelli, Warrington College of Business Michael Fathi, Georgia Southwestern University Carolyn J. Fausnaugh, Florida Institute of Technology

Tamela D. Ferguson, University of Louisiana at Lafayette

David Flanagan, Western Michigan University

Kelly Flis, The Art Institutes

Karen Ford-Eickhoff, University of North Carolina Charlotte

Dave Foster, Montana State University

Isaac Fox, University of Minnesota

Charla S. Fraley, Columbus State Community College–Columbus, Ohio

Deborah Francis, Brevard College

Steven A. Frankforter, Winthrop University

Vance Fried, Oklahoma State University

Karen Froelich, North Dakota State University

Naomi A. Gardberg, Baruch College, CUNY

Joe Gerard, Western New England University

J. Michael Geringer, Ohio University

Diana L. Gilbertson, California State University–Fresno

Matt Gilley, St. Mary’s University

Debbie Gilliard, Metropolitan State College-Denver

Yezdi H. Godiwalla, University of Wisconsin–Whitewater

Sanjay Goel, University of Minnesota-Duluth

Sandy Gough, Boise State University

Amy Gresock, PhD The University of Michigan, Flint

Vishal K. Gupta, The University of Mississippi

Dr. Susan Hansen, University of Wisconsin–Platteville

Allen Harmon, University of Minnesota–Duluth

Niran Harrison, University of Oregon

Paula Harveston, Berry College

Ahmad Hassan, Morehead State University

Donald Hatfield, Virginia Polytechnic Institute

Kim Hester, Arkansas State University

Scott Hicks, Liberty University

John Hironaka, California State University–Sacramento

Anne Kelly Hoel, University of Wisconsin– Stout

Alan Hoffman, Bentley College

Gordon Holbein, University of Kentucky

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PREFACE

Stephen V. Horner, Pittsburg State University Jill Hough, University of Tulsa John Humphreys, Eastern New Mexico University James G. Ibe, Morris College Jay J. Janney, University of Dayton Lawrence Jauch, University of Louisiana-Monroe Dana M. Johnson, Michigan Technical University Homer Johnson, Loyola University, Chicago Marilyn R. Kaplan, Naveen Jindal School of Management, University of Texas–Dallas James Katzenstein, California State University– Dominguez Hills Joseph Kavanaugh, Sam Houston State University Franz Kellermanns, University of Tennessee Craig Kelley, California State University-Sacramento Donna Kelley, Babson College Dave Ketchen, Auburn University John A. Kilpatrick, Idaho State University Dr. Jaemin Kim, Stockton University Brent H. Kinghorn, Emporia State University

Helaine J. Korn, Baruch College, CUNY Stan Kowalczyk, San Francisco State University Daniel Kraska, North Central State College Donald E. Kreps, Kutztown University Jim Kroeger, Cleveland State University Subdoh P. Kulkarni, Howard University Ron Lambert, Faulkner University Theresa Lant, New York University Jai Joon Lee, California State University Sacramento Ted Legatski, Texas Christian University David J. Lemak, Washington State University–Tri-Cities Cynthia Lengnick-Hall, University of Texas at San Antonio Donald L. Lester, Arkansas State University Wanda Lester, North Carolina A&T State University Krista B. Lewellyn, University of Wyoming Benyamin Lichtenstein, University of Massachusetts at Boston Jun Lin, SUNY at New Paltz Zhiang (John) Lin, University of Texas at Dallas

Dan Lockhart, University of Kentucky John Logan, University of South Carolina Franz T. Lohrke, Samford University Kevin B. Lowe, Graduate School of Management, University of Auckland Leyland M. Lucas, Morgan State University Doug Lyon, Fort Lewis College Rickey Madden, PhD, Presbyterian College James Maddox, Friends University Ravi Madhavan, University of Pittsburgh Paul Mallette, Colorado State University Santo D. Marabella, Moravian College Catherine Maritan, Syracuse University Daniel Marrone, Farmingdale State College, SUNY Sarah Marsh, Northern Illinois University Jim Martin, Washburn University John R. Massaua, University of Southern Maine Hao Ma, Bryant College Larry McDaniel, Alabama A&M University Jean McGuire, Louisiana State University

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Abagail McWilliams, University of Illinois-Chicago Ofer Meilich, California State University– San Marcos

John E. Merchant, California State University–Sacramento

John M. Mezias, University of Miami

Michael Michalisin, Southern Illinois University at Carbondale

Doug Moesel, University of Missouri-Columbia

Fatma Mohamed, Morehead State University

Mike Montalbano, Bentley University

Debra Moody, University of North Carolina–Charlotte

Gregory A. Moore, Middle Tennessee State University

James R. Morgan, Dominican University and UC Berkeley Extension

Ken Morlino, Wilmington University

Sara A. Morris, Old Dominion University

Todd W. Moss, PhD, Syracuse University

Carolyn Mu, Baylor University

Stephen Mueller, Northern Kentucky University

John Mullane, Middle Tennessee State University

Chandran Mylvaganam, Northwood University Sucheta Nadkarni, Cambridge University Anil Nair, Old Dominion University V.K. Narayanan, Drexel University Maria L. Nathan, Lynchburg College Louise Nemanich, Arizona State University Charles Newman, University of Maryland, University College Stephanie Newport, Austin Peay State University Gerry Nkombo Muuka, Murray State University Bill Norton, University of Louisville Dr. Jill E. Novak Texas A&M University Roman Nowacki, Northern Illinois University Yusuf A. Nur, SUNY Brockport Jeffrey Richard Nystrom, University of Colorado– Denver William Ross O’Brien, Dallas Baptist University d.t. ogilvie, Rutgers University Floyd Ormsbee, Clarkson University Dr. Mine Ozer, SUNY-Oneonta Dr. Eren Ozgen, Troy University-Dothan Campus

Karen L. Page, University of Wyoming Jacquelyn W. Palmer, University of Cincinnati Julie Palmer, University of Missouri–Columbia Daewoo Park, Xavier University Gerald Parker, Saint Louis University Ralph Parrish, University of Central Oklahoma Amy Patrick, Wilmington University John Pepper, The University of Kansas Douglas K. Peterson, Indiana State University Edward Petkus, Mary Baldwin College Michael C. Pickett, National University Peter Ping Li, California State University-Stanislaus Michael W. Pitts, Virginia Commonwealth University Laura Poppo, Virginia Tech Steve Porth, Saint Joseph’s University Jodi A. Potter, Robert Morris University Scott A. Quatro, Grand Canyon University Nandini Rajagopalan, University of Southern California

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PREFACE

Annette L. Ranft, North Carolina State University Abdul Rasheed, University of Texas at Arlington Devaki Rau, Northern Illinois University George Redmond, Franklin University Kira Reed, Syracuse University Clint Relyea, Arkansas State University Barbara Ribbens, Western Illinois University Maurice Rice, University of Washington Violina P. Rindova, University of Texas–Austin Ron Rivas, Canisius College David Robinson, Indiana State University–Terre Haute Kenneth Robinson, Kennesaw State University Simon Rodan, San Jose State University Patrick R. Rogers, North Carolina A&T State University John K. Ross III, Texas State University–San Marcos Robert Rottman, Kentucky State University Matthew R. Rutherford, Gonzaga University Carol M. Sanchez, Grand Valley State University Doug Sanford, Towson University

William W. Sannwald, San Diego State University Yolanda Sarason, Colorado State University Marguerite Schneider, New Jersey Institute of Technology Roger R. Schnorbus, University of Richmond Terry Sebora, University of Nebraska–Lincoln John Seeger, Bentley College Jamal Shamsie, Michigan State University Mark Shanley, University of Illinois at Chicago Ali Shahzad, James Madison University Lois Shelton, California State University–Northridge Herbert Sherman, Long Island University Weilei Shi, Baruch College, CUNY Chris Shook, Auburn University Jeremy Short, University of Oklahoma Mark Simon, Oakland University– Michigan Rob Singh, Morgan State University Bruce Skaggs, University of Massachusetts Lise Anne D. Slattern, University of Louisiana at Lafayette

Wayne Smeltz, Rider University Anne Smith, University of Tennessee Andrew Spicer, University of South Carolina James D. Spina, University of Maryland John Stanbury, George Mason University & Inter-University Institute of Macau, SAR China Timothy Stearns, California State University–Fresno Elton Stephen, Austin State University Charles E. Stevens, University of Wyoming Alice Stewart, Ohio State University Mohan Subramaniam, Carroll School of Management Boston College Ram Subramanian, Grand Valley State University Roy Suddaby, University of Iowa Michael Sullivan, UC Berkeley Extension Marta Szabo White, Georgia State University Stephen Takach, University of Texas at San Antonio Justin Tan, York University, Canada Qingjiu Tao, PhD, James Madison University Renata A. Tarasievich, University of Illinois at Chicago

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Linda Teagarden, Virginia Tech Bing-Sheng Teng, George Washington University Alan Theriault, University of California–Riverside Tracy Thompson, University of Washington–Tacoma Karen Torres, Angelo State University Mary Trottier, Associate Professor of Management, Nichols College Robert Trumble, Virginia Commonwealth University Francis D. (Doug) Tuggle, Chapman University K.J. Tullis, University of Central Oklahoma Craig A. Turner, PhD, East Tennessee State University Beverly Tyler, North Carolina State University

Rajaram Veliyath, Kennesaw State University S. Stephen Vitucci, Tarleton State University– Central Texas Jay A. Vora, St. Cloud State University Valerie Wallingford, Ph.D., Bemidji State University Jorge Walter, Portland State University Bruce Walters, Louisiana Tech University Edward Ward, St. Cloud State University N. Wasilewski, Pepperdine University Andrew Watson, Northeastern University Larry Watts, Stephen F. Austin University Marlene E. Weaver, American Public University System Paula S. Weber, St. Cloud State University Kenneth E. A. Wendeln, Indiana University

Robert R. Wharton, Western Kentucky University Laura Whitcomb, California State University-Los Angeles Scott Williams, Wright State University Ross A. Wirth, Franklin University Gary Wishniewsky, California State University East Bay Diana Wong, Bowling Green State University Beth Woodard, Belmont University John E. Wroblewski, State University of New York-Fredonia Anne York, University of Nebraska- Omaha Michael Zhang, Sacred Heart University Monica Zimmerman, Temple University

Second, we would like to thank the people who have made our two important “features” possible. The information found in our six “Insights from Research” was provided courtesy of www.businessminded.com, an organization founded by K. Matthew Gilley, PhD (St. Mary’s University) that transforms empirical management research into actionable insights for business leaders. We appreciate Matt’s graciousness and kindness in helping us out. And, of course, our “Executive Insights: The Strategic Management Process” would not have been possible without the gracious participation of Admiral William H. McRaven, Retired who is presently Chancellor of the University of Texas System, and Jana Pankratz, Executive Director.

Third, the authors would like to thank several faculty colleagues who were particularly helpful in the review, critique, and development of the book and supplementary materials. Greg’s and Sean’s colleagues at the University of Texas at Dallas also have been helpful and supportive. These individuals include Mike Peng, Joe Picken, Kumar Nair, John Lin, Larry

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PREFACE

Chasteen, Tev Dalgic, and Livia Markoczy. His administrative assistant, Shalonda Hill, has been extremely helpful. Four doctoral students, Brian Pinkham, Steve Sauerwald, Kyun Kim, and Canan Mutlu, have provided many useful inputs and ideas. He also appreciates the support of his dean and associate dean, Hasan Pirkul and Varghese Jacob, respectively. Greg wishes to thank a special colleague, Abdul Rasheed at the University of Texas at Arlington, who certainly has been a valued source of friendship and ideas for us for many years. He provided many valuable contributions to the Ninth Edition. Gerry thanks all of his colleagues at Michigan State University for their help and support over the years. He also thanks his mentor, Phil Bromiley, as well as the students and former students he has had the pleasure of working with, including Cindy Devers, Federico Aime, Mike Mannor, Bernadine Dykes, Mathias Arrfelt, Kalin Kolev, Seungho Choi, Danny Gamache, and Adam Steinbach. Alan thanks his colleagues at Pace University and the Case Association for their support in developing these fine case selections. Special thanks go to Jamal Shamsie at Michigan State University for his support in developing the case selections for this edition.

Fourth, we would like to thank the team at McGraw-Hill for their outstanding support throughout the entire process. As we work on the book through the various editions, we always appreciate their hard work and recognize how so many people “add value” to our final package. This began with John Biernat, formerly publisher, who signed us to our original contract. He was always available to us and provided a great deal of support and valued input throughout several editions. Presently, in editorial, Susan Gouijnstook, managing director, director Mike Ablassmeir, senior product developers Anne Ehrenworth and Katharine Glynn (of Piper Editorial) kept things on track, responded quickly to our seemingly endless needs and requests, and offered insights and encouragement. We appreciate their expertise—as well as their patience! Once the manuscript was completed and revised, content project manager Harvey Yep expertly guided it through the content and assessment production process. Matt Diamond provided excellent design and artwork guidance. We also appreciate executive marketing manager Debbie Clare and marketing coordinator Brittany Berholdt for their energetic, competent, and thorough marketing efforts. Last, but certainly not least, we thank MHE’s 70-plus outstanding book reps—who serve on the “front lines”—as well as many in-house sales professionals based in Dubuque, Iowa. Clearly, they deserve a lot of credit (even though not mentioned by name) for our success.

Fifth, we acknowledge the valuable contributions of many of our strategy colleagues for their excellent contributions to our supplementary and digital materials. Such content really adds a lot of value to our entire package! We are grateful to Pauline Assenza at Western Connecticut State University for her superb work on case teaching notes as well as chapter and case PowerPoints. Justin Davis, University of West Florida, along with Noushi Rahman, Pace University, deserve our thanks for their hard work in developing excellent digital materials for Connect. Thanks also goes to Noushi Rahman for developing the Connect IM that accompanies this edition of the text. And, finally, we thank Christine Pence, University of California-Riverside, for her important contributions in revising our test bank and chapter quizzes, and Todd Moss, Oregon State University, for his hard work in putting together an excellent set of videos online, along with the video grid that links videos to chapter material.

Finally, we would like to thank our families. For Greg this includes his parents, William and Mary Dess, who have always been there for him. His wife, Margie, and daughter, Taylor, have been a constant source of love and companionship. His father, a career U. S. Air Force pilot took his “final flight” on May 22, 2015. Truly a member of Tom Brokaw’s “Greatest Generation,” he completed flight school before his 21st birthday and flew nearly 30 missions over Japan in World War II as a B-29 bomber pilot before he turned 23. His wife, five children, and several

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grandchildren truly miss him. Gerry thanks his wife, Gaelen, for her love, support, and friendship; and his children, Megan and AJ, for their love and the joy they bring to his life. He also thanks his current and former PhD students who regularly inspire and challenge him. Alan thanks his family—his wife, Helaine, and his children, Rachel and Jacob—for their love and support. He also thanks his parents, Gail Eisner and the late Marvin Eisner, for their support and encouragement. Sean thanks his wife, Hannah, and his two boys, Paul and Stephen, for their unceasing love and care. He also thanks his parents, Kenny and Inkyung Lee for being there whenever needed.

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A GUIDED TOUR

LEARNING OBJECTIVES Learning Objectives numbered L05.1, L05.2, L05.3, etc., with corresponding icons in the margins to indicate where learning objectives are covered in the text.

LEARNING FROM MISTAKES Learning from Mistakes vignettes are examples of where things went wrong. Failures are not only interesting but also sometimes easier to learn from. And students realize strategy is notjustabout “right or wrong” answers, but requires critical thinking.

STRATEGY SPOTLIGHT These boxes weave themes of ethics, globalization, and technology into every chapter of the text, providing students with a thorough grounding necessary for understanding strategic management. Select boxes incorporate crowdsourcing, environmental sustainability, and ethical themes.

a guided

tour

chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

1 LO1-1 The definition of strategic management and its four key attributes. LO1-2 The strategic management process and its three interrelated and principal

activities.

LO1-3 The vital role of corporate governance and stakeholder management, as well as how “symbiosis” can be achieved among an organization’s stakeholders.

LO1-4 The importance of social responsibility, including environmental sustainability, and how it can enhance a corporation’s innovation strategy.

LO1-5 The need for greater empowerment throughout the organization. LO1-6 How an awareness of a hierarchy of strategic goals can help an

organization achieve coherence in its strategic direction.

Strategic Management Creating Competitive Advantages

©Anatoli Styf/Getty Images

What makes the study of strategic management so interesting? Things can change so rapidly! Some start-ups can disrupt industries and become globally recognized names in just a few years. The rankings of the world’s most valuable firms can dramatically change in a rather brief period of time. On the other hand, many impressive, high-flying firms can struggle to reclaim past glory or even fail. Recall just four that begin with the letter “b”—Blackberry, Blockbuster, Borders, and Barings. As colorfully (and ironically!) noted by Arthur Martinez, Sears’s former Chairman: “Today’s peacock is tomorrow’s feather duster.”1

Consider the following:2

• At the beginning of 2007, the three firms in the world with the highest market values were Exxon Mobil, General Electric, and Gazprom (a Russian natural gas firm). By early 2017, three high tech firms headed the list—Apple, Alphabet (parent of Google), and Microsoft.

• Only 74 of the original 500 companies in the S&P index were still around 40 years later. And McKinsey notes that the average company tenure on the S&P 500 list has fallen from 61 years in 1958 to about 20 in 2016.

• With the dramatic increase of the digital economy, new entrants are shaking up long-standing industries. Note that Alibaba is the world’s most valuable retailer—but holds no inventory; Airbnb is the world’s largest provider of accommodations—but owns no real estate; and Uber is the world’s largest car service but owns no cars.

• A quarter century ago, how many would have predicted that a South Korean firm would be a global car giant, than an Indian firm would be one of the world’s largest technology firms, and a huge Chinese Internet company would list on an American stock exchange?

• Fortune magazine’s annual list of the 500 biggest companies now features 156 emerging- market firms. This compares with only 18 in 1995!

To remain competitive, companies often must bring in “new blood” and make significant changes in their strategies. But sometimes a new CEO’s initiatives makes things worse. Let’s take a look at Lands’ End, an American clothing retailer.3

Lands’ End was founded in 1963 as a mail order supplier of sailboat equipment by Gary Comer. As business picked up, he expanded the business into clothing and home furnishings and moved the company to Dodgeville, Wisconsin, in 1978 where he was its CEO until he stepped down in 1990. The firm was acquired by Sears in 2002, but later spun off in 2013. A year later it commenced trading on the NASDAQ stock exchange.

Targeting Middle America, companies like Lands’ End, the GAP Inc., and J. C. Penney have had a hard time in recent years positioning themselves in the hotly contested clothing industry. They are squeezed on the high end by brands like Michael Kors Holdings Ltd. and Coach, Inc. On the lower end, fast-fashion retailers including H&M operator Hennes & Mauritz AB are applying pressure by churning out inexpensive, runway-inspired styles.

LEARNING FROM MISTAKES

4.3 STRATEGY SPOTLIGHT MILLENNIALS HAVE A DIFFERENT DEFINITION OF DIVERSITY AND INCLUSION THAN PRIOR GENERATIONS A recent study by Deloitte and the Billie Jean King Leadership Initiative (BJKLI) shows that, in general, Millennials see the con- cepts of diversity and inclusion through a vastly different lens. The study analyzed the responses of 3,726 individuals who came from a wide variety of backgrounds with representation across gender, race/ethnicity, sexual orientation, national sta- tus, veteran status, disabilities, level within an organization, and tenure with an organization. The respondents were asked 62 questions about diversity and inclusion and the findings demon- strated a snapshot of shifting generational mindsets.

Millennials (born between 1977 to 1995) look upon diver- sity as the blending of different backgrounds, experiences, and perspectives within a team—which is known as cognitive diver- sity. They use this word to describe the mix of unique traits that help to overcome challenges and attain business objectives. For Millennials, inclusion is the support for a collaborative environ- ment, and leadership at such an organization must be transpar- ent, communicative, and engaging. According to the study, when defining diversity, Millennials are 35 percent more likely to focus on unique experiences, whereas 21 percent of non-Millennials are more likely to focus on representation.

The X-generation (born between 1965 and 1976) and Boomer generation (born between 1946 and 1964) have a different take.

These generations view diversity as a representation of fairness and protection for all—regardless of gender, race, religion, ethnic- ity, or sexual orientation. Here, inclusion is the integration of indi- viduals of all demographics into one workplace. It is the right thing to do, that is, a moral and legal imperative to achieve compliance and equality—regardless of whether it benefits the business. The study found that when asked about the business impact on diver- sity, Millennials are 71 percent more likely to focus on teamwork. In contrast, 28 percent of non-Millennials are more likely to focus on fairness of opportunity.

The study’s authors contend that the disconnect between the traditional definitions of diversity and inclusion and those of Millennials can create problems for businesses. For example, clashes may occur when managers do not permit Millennials to express themselves freely. The study found that while 86 percent of Millennials feel that differences of opinion allow teams to excel, only 59 percent believe that their leaders share this perspective.

The study suggests that a company with an inclusive culture promotes innovation. And it cites research by IBM and Morgan Stanley that shows that companies with high levels of innovation achieve the quickest growth in profits and that radical innova- tion outstrips incremental change by generating 10 times more shareholder value.

Sources: Dishman, L. 2015. Millennials have a different definition of diversity and inclusion. fastcompany.com, May 18: np; and Anonymous. 2015. For millennials inclusion goes beyond checking traditional boxes, according to a new Deloitte-- Billie Jean King Leadership Initiative Study. prnewswire.com, May 13: np.

11.2 ENVIRONMENTAL SUSTAINABILITY, ETHICSSTRATEGY SPOTLIGHT FAMILY LEADERSHIP SUSTAINS THE CULTURE OF SC JOHNSON SC Johnson, the maker of Windex, Ziploc bags, and Glade Air Fresheners, is known as one of the most environmentally con- scious consumer products companies. The family-owned company is run by Fisk Johnson, the fifth generation of the family to serve as firm CEO. It is the 35th largest privately owned firm, with 13,000 employees and nearly $10 billion in sales. Over the decades, the firm has built and reinforced its reputation for environmental con- sciousness. Being privately owned by the Johnson family is part of it. Fisk Johnson put it this way, “Wall Street rewards that short- termism. . . . We are in a very fortunate situation to not have to worry about those things, and we’re very fortunate that we have a family that is principled and has been very principled.”

Fisk uses the benefits of dedicated family ownership to work in both substantive and symbolic ways. On the substantive side, he has implemented systems in place to improve its environ- mental performance. For example, with its Greenlist process, the firm rates the ingredients it uses or is considering using. It then rates each ingredient on several criteria, including biodegrad- ability and human toxicity, and gives the ingredient a score rang-

3 (better or best) from about 20 percent to over 50 percent from 2001 to 2016.

Fisk uses stories from decisions in the past as it acts to sustain its culture of environmental consciousness. In using stories to rein- force the environmental focus within the firm and to explain it to external stakeholders, Fisk Johnson draws on stories relating to decisions his father made as well as ones he’s made. Most promi- nently, he uses a story about a decision his father made to stop using chlorofluorocarbons in the firm’s aerosol products. “Our first decision to unilaterally remove a major chemical occurred in 1975, when research began suggesting that chlorofluorocar- bons (CFCs) in aerosols might harm Earth’s ozone layer. My father was CEO at the time, and he decided to ban them from all the company’s aerosol products worldwide. He did so several years before the government played catch-up and banned the use of CFCs from everyone’s products.” He goes on to say, “You look back on that decision today, in light of the strong laws that came in, and that was a very prescient decision.” This story is especially effective since it highlights his father’s willingness and ability to take actions that can lead both the government and industry rivals to change. A second story outlines the firm’s decision to remove chlorine as an ingredient in its Saran Wrap. In the late 1990s, regu-

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EXHIBITS Both new and improved exhibits in every chapter provide visual presentations of the most complex concepts covered to support student comprehension.

REFLECTING ON CAREER IMPLICATIONS This section before the summary of every chapter consists of examples on how understanding of key concepts helps business students early in their careers.

INSIGHTS The “Insights” feature is new to this edition. “Insights from Executives” spotlight interviews with executives from worldwide organizations about current issues salient to strategic management. “Insights from Research” summarize key research findings relevant to maintaining the effectiveness of an organization and its management.

industries? There are several reasons. With regard to the collection period, grocery stores operate mostly on a cash basis, hence a very short collection period. Semiconductor manu- facturers sell their output to other manufacturers (e.g., computer makers) on terms such as 2/15 net 45, which means they give a 2 percent discount on bills paid within 15 days and start charging interest after 45 days. Skilled-nursing facilities also have a longer collection period than grocery stores because they typically rely on payments from insurance companies.

The industry norms for return on sales also highlight differences among these industries. Grocers, with very slim margins, have a lower return on sales than either skilled-nursing facil- ities or semiconductor manufacturers. But how might we explain the differences between

Financial Ratio Semiconductors Grocery Stores Skilled-Nursing Facilities

Quick ratio (times) 1.9 0.6 1.3

Current ratio (times) 3.6 1.7 1.7

Total liabilities to net worth (%) 35.1 72.7 82.5

Collection period (days) 48.6 3.3 36.5

Assets to sales (%) 131.7 22.1 58.3

Return on sales (%)  24   1.1 3.1

Source: Dun & Bradstreet. Industry Norms and Key Business Ratios, 2010–2011. One Year Edition, SIC #3600–3699 (Semiconductors); SIC #5400–5499 (Grocery Stores); SIC #8000–8099 (Skilled-Nursing Facilities). New York: Dun & Bradstreet Credit Services.

EXHIBIT 3.10 How Financial Ratios Differ across Industries

Admiral William H. McRaven, Retired Chancellor, University of Texas System

BIOSKETCH University of Texas Chancellor William H. McRaven, a retired four-star admiral, leads the nation’s second largest system of higher education. As chief executive officer of the UT System since January 2015, he oversees 14 institutions that educate 217,000 students and employ 20,000 faculty and more than 70,000 health care professionals, researchers, and staff.

Prior to becoming chancellor, McRaven, a Navy SEAL, was the commander of U.S. Special Operations Command during which time he led a force of 69,000 men and women and was responsible for conducting counter-terrorism operations world- wide. McRaven is also a recognized national authority on U.S. foreign policy and has advised presidents George W. Bush and Barack Obama and other U.S. leaders on defense issues. His acclaimed book, Spec. Ops: Case Studies in Special Operations Warfare: Theory and Practice, has been published in several lan-

SEAL—helps young people move past self-imposed limits of physical and mental endurance and build confidence in themselves to lead others. The result is a person who is capable of leading in an environment of constant stress, chaos, failure and hardships. In fact, to me, basic SEAL training was a lifetime sampling of micro-challenges I would later face while leading people and organizations all crammed into six months.

Question 2. In leading Neptune Spear, what were the key leadership decisions you made to build an organization to accomplish this task?

The majority of the key leadership decisions that in past enabled us to accomplish this task began before I took command of the organization—but as a member of the

organization and its number 2 leader over a period of years, I had been an engaged student in the trial, error, and the ulti- mate development of what my old boss, General Stan McChrystal, called a “team of teams.” You see, our operational envi- ronment was changing at an incredibly rapid pace. Unlike any time in our history the rate of change was—and is—no longer

INSIGHTS from executives1.1

THE STRATEGIC MANAGEMENT PROCESS

Overview People often think that older workers are less motivated and less healthy, resist change and are less trusting, and have more trouble balancing work and family. It turns out these assumptions just aren’t true. By challenging these stereotypes in your organization, you can keep your employees working.

What the Research Shows In a 2012 paper published by Personnel Psychology, research- ers from the University of Hong Kong and the University of Georgia examined 418 studies of workers’ ages and stereotypes. A meta-analysis—a study of studies—was conducted to find out if any of the six following stereotypes about older workers—as compared with younger workers—was actually true:

• They are less motivated. • They are less willing to participate in training and

career development. • They are more resistant to change. • They are less trusting. • They are less healthy. • They are more vulnerable to work-family imbalance.

retain, and encourage mature employees’ continued involve- ment in workplaces because they have much to offer in the ways of wisdom, experience, and institutional knowledge. The alternative is to miss out on a growing pool of valuable human capital.

How can you deal with age stereotypes to keep older workers engaged? The authors suggest three effective ways:

• Provide more opportunities for younger and older workers to work together.

• Promote positive attributes of older workers, like experience, carefulness, and punctuality.

• Engage employees in open discussions about stereotypes.

Adam Bradshaw of the DeGarmo Group Inc. has sum- marized research on addressing age stereotypes in the workplace and offers practical advice. For instance, make sure hiring practices identify factors important to the job other than age. Managers can be trained in how to spot age stereotypes and can point out to employees why the stereo- types are often untrue by using examples of effective older workers. Realize that older workers can offer a competitive advantage because of skills they possess that competitors

INSIGHTS from Research2.1

NEW TRICKS: RESEARCH DEBUNKS MYTHS ABOUT OLDER WORKERS

Reflecting on Career Implications . . . This chapter discusses both the long-term focus of strategy and the need for coherence in strategic direction. The following questions extend these themes by asking students to consider their own strategic goals and how they fit with the goals of the firms in which they work or would seek employment.

Attributes of Strategic Management: The attributes of strategic management described in this chapter are applicable to your personal careers as well. What are your overall goals and objectives? Who are the stakeholders you have to consider in making your career decisions (family, community, etc.)? What trade- offs do you see between your long-term and short-term goals?

Intended versus Emergent Strategies: While you may have planned your career trajectory carefully, don’t be too tied to it. Strive to take advantage of new opportunities as they arise. Many promising career opportunities may “emerge” that were not part of your intended career strategy or your specific job assignment. Take initiative by pursuing opportunities to get additional training (e.g., learn a software or a statistical package), volunteering for a short-term overseas assignment, etc. You may be in a better position to take advantage of such emergent opportunities if you take the effort to prepare for

them. For example, learning a foreign language may position you better for an overseas opportunity.

Ambidexterity: In Strategy Spotlight 1.1, we discussed the four most important traits of ambidextrous individuals. These include looking for opportunities beyond the description of one’s job, seeking out opportunities to collaborate with others, building internal networks, and multitasking. Evaluate yourself along each of these criteria. If you score low, think of ways in which you can improve your ambidexterity.

Strategic Coherence: What is the mission of your organization? What are the strategic objectives of the department or unit you are working for? In what ways does your own role contribute to the mission and objectives? What can you do differently in order to help the organization attain its mission and strategic objectives?

Strategic Coherence: Setting strategic objectives is important in your personal career as well. Identify and write down three or four important strategic objectives you want to accomplish in the next few years (finish your degree, find a better-paying job, etc.). Are you allocating your resources (time, money, etc.) to enable you to achieve these objectives? Are your objectives measurable, timely, realistic, specific, and appropriate?

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PART 1 STRATEGIC ANALYSIS 1 Strategic Management: Creating Competitive Advantages 2

2 Analyzing the External Environment of the Firm: Creating Competitive Advantages 34

3 Assessing the Internal Environment of the Firm 70

4 Recognizing a Firm’s Intellectual Assets: Moving beyond a Firm’s Tangible Resources 102

PART 2 STRATEGIC FORMULATION 5 Business-Level Strategy: Creating and Sustaining Competitive

Advantages 138

6 Corporate-Level Strategy: Creating Value through Diversification 172

7 International Strategy: Creating Value in Global Markets 202

8 Entrepreneurial Strategy and Competitive Dynamics 236

PART 3 STRATEGIC IMPLEMENTATION 9 Strategic Control and Corporate Governance 266

10 Creating Effective Organizational Designs 300

11 Strategic Leadership: Creating a Learning Organization and an Ethical Organization 332

12 Managing Innovation and Fostering Corporate Entrepreneurship 360

PART 4 CASE ANALYSIS 13 Analyzing Strategic Management Cases 392

Cases C-1

Indexes I-1

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PART 1 STRATEGIC ANALYSIS

CHAPTER 1 Strategic Management: Creating Competitive Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

What Is Strategic Management? . . . . . . . . . . . . . . . . . 6 Defining Strategic Management . . . . . . . . . . . . . . . . . . . . . . 6 The Four Key Attributes of Strategic Management . . . . . . . 7

1.1 STRATEGY SPOTLIGHT

Ambidextrous Behaviors: Combining Alignment and Adaptability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

The Strategic Management Process . . . . . . . . . . . . . . 9 Intended versus Realized Strategies . . . . . . . . . . . . . . . . . . . 10 Strategy Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Strategy Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Strategy Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1.1 INSIGHTS FROM EXECUTIVES

The Strategic Management Process . . . . . . . . . . . . . . . . . . . . .14

The Role of Corporate Governance and Stakeholder Management . . . . . . . . . . . . . . . . . . 16 Alternative Perspectives of Stakeholder Management . . . . .17 Social Responsibility and Environmental Sustainability:

Moving beyond the Immediate Stakeholders . . . . . . . . . 18 1.2 STRATEGY SPOTLIGHT

How Walmart Deploys Green Energy on an Industrial Scale—And Makes Money at It . . . . . . . . . . . . . . . . . . . . . .21

The Strategic Management Perspective: An Imperative Throughout the Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

1.3 STRATEGY SPOTLIGHT

Strategy and the Value of Inexperience . . . . . . . . . . . . . . . . . 23

Ensuring Coherence in Strategic Direction . . . . . . . . 23 Organizational Vision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Mission Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Strategic Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

1.4 STRATEGY SPOTLIGHT

How Perceptual Limited Succeeded by Rallying Around the Founder’s Original Mission . . . . . . . . . . . . . . . . . . . . 27

Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . . 29 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . . 30 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

CHAPTER 2 Analyzing the External Environment of the Firm: Creating Competitive Advantages . . . . . . . . . . . . .34

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Enhancing Awareness of the External Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 The Role of Scanning, Monitoring, Competitive

Intelligence, and Forecasting . . . . . . . . . . . . . . . . . . . . . 37 2.1 STRATEGY SPOTLIGHT Ethics

Ethical Guidelines on Competitive Intelligence: United Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

SWOT Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

The General Environment . . . . . . . . . . . . . . . . . . . . . . 41 The Demographic Segment . . . . . . . . . . . . . . . . . . . . . . . . . 43 The Sociocultural Segment . . . . . . . . . . . . . . . . . . . . . . . . . 43 The Political/Legal Segment . . . . . . . . . . . . . . . . . . . . . . . . 43

2.1 INSIGHTS FROM RESEARCH

New Tricks: Research Debunks Myths about Older Workers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

The Technological Segment . . . . . . . . . . . . . . . . . . . . . . . . . 45 2.2 STRATEGY SPOTLIGHT Ethics

The Conflict Minerals Legislation: Implications for Supply Chain Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

The Economic Segment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 The Global Segment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

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Relationships among Elements of the General Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Data Analytics: A Technology That Affects Multiple Segments of the General Environment . . . . . . . . . . . . . 47 2.3 STRATEGY SPOTLIGHT Data Analytics

How Big Data Can Monitor Federal, State, and Local Government Expenditures . . . . . . . . . . . . . . . . . . . . . . . . 49

The Competitive Environment . . . . . . . . . . . . . . . . . . 50 Porter’s Five Forces Model of Industry Competition . . . . . 50

2.4 STRATEGY SPOTLIGHT

Apple Flexes Its Muscle When It Comes to Negotiating Rental Rates for Its Stores in Malls . . . . . . . . . . . . . . . . . . . 53

How the Internet and Digital Technologies Are Affecting the Five Competitive Forces . . . . . . . . . . . . . . . . . . . . . . 55 2.5 STRATEGY SPOTLIGHT

Buyer Power in Legal Services: The Role of the Internet . . . . 58

Using Industry Analysis: A Few Caveats . . . . . . . . . . . . . . . 59 Strategic Groups within Industries . . . . . . . . . . . . . . . . . . . .61 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . . 64 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . . 66 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

CHAPTER 3 Assessing the Internal Environment of the Firm . . .70

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71

Value-Chain Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Primary Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

3.1 STRATEGY SPOTLIGHT

Chipotle’s Efficient Operations . . . . . . . . . . . . . . . . . . . . . . . . .74

Support Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 3.2 STRATEGY SPOTLIGHT Data

The Algorithm for Orange Juice . . . . . . . . . . . . . . . . . . . . . . . 77

3.3 STRATEGY SPOTLIGHT

Schmitz Cargobull: Adding Value to Customers via IT . . . . . . 78

Interrelationships among Value-Chain Activities within and across Organizations . . . . . . . . . . . . . . . . . . . . . . . . 78

Integrating Customers into the Value Chain . . . . . . . . . . . . 78 Applying the Value Chain to Service Organizations . . . . . . 80

Resource-Based View of the Firm . . . . . . . . . . . . . . . 81 Types of Firm Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . .81 Firm Resources and Sustainable Competitive

Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 3.4 STRATEGY SPOTLIGHT

Printed in Taiwan: Path Dependence in 3D Printing . . . . . . . 85

3.5 STRATEGY SPOTLIGHT

Amazon Prime: Very Difficult for Rivals to Copy . . . . . . . . . . 86

The Generation and Distribution of a Firm’s Profits: Extending the Resource-Based View of the Firm . . . . . 88

Evaluating Firm Performance: Two Approaches . . . 90 Financial Ratio Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Integrating Financial Analysis and Stakeholder

Perspectives: The Balanced Scorecard . . . . . . . . . . . . . . 93 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . . 96 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . . 98 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

CHAPTER 4 Recognizing a Firm’s Intellectual Assets: Moving beyond a Firm’s Tangible Resources . . . .102

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

The Central Role of Knowledge in Today’s Economy . . . . . . . . . . . . . . . . . . . . . . . . . . 104 Human Capital: The Foundation of Intellectual Capital . . . . . . . . . . . . . . . . . . . . . . . . . . 107

4.1 STRATEGY SPOTLIGHT Environmental Sustainability

Can Green Strategies Attract and Retain Talent? . . . . . . . . . . 108

Attracting Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . 108 Developing Human Capital . . . . . . . . . . . . . . . . . . . . . . . . .110

4.1 INSIGHTS FROM RESEARCH

Welcome Back! Recruiting Boomerang Employees . . . . . . . . . 111

Retaining Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . .114

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CONTENTS

Enhancing Human Capital: Redefining Jobs and Managing Diversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115 4.2 STRATEGY SPOTLIGHT

Want to Increase Employee Retention? Try Data Analytics . . 116

4.3 STRATEGY SPOTLIGHT

Millennials Have a Different Definition of Diversity and Inclusion than Prior Generations . . . . . . . . . . . . . . . . . . . 118

The Vital Role of Social Capital . . . . . . . . . . . . . . . . 118 How Social Capital Helps Attract and Retain Talent . . . . .119 Social Networks: Implications for Knowledge

Management and Career Success . . . . . . . . . . . . . . . . . .119 4.4 STRATEGY SPOTLIGHT

Picasso versus Van Gogh: Who Was More Successful and Why? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122

The Potential Downside of Social Capital . . . . . . . . . . . . . 123

Using Technology to Leverage Human Capital and Knowledge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 Using Networks to Share Information . . . . . . . . . . . . . . . . 124 Electronic Teams: Using Technology to Enhance

Collaboration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 Codifying Knowledge for Competitive Advantage . . . . . . 126

4.5 STRATEGY SPOTLIGHT

How SAP Taps Knowledge Well Beyond Its Boundaries . . . . .127

Protecting the Intellectual Assets of the Organization: Intellectual Property and Dynamic Capabilities . . . 128 Intellectual Property Rights . . . . . . . . . . . . . . . . . . . . . . . . 129 Dynamic Capabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . . 131 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . .132 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133

PART 2 STRATEGIC FORMULATION

CHAPTER 5 Business-Level Strategy: Creating and Sustaining Competitive Advantages . . . . . . . . . . 138

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139

Types of Competitive Advantage and Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 Overall Cost Leadership. . . . . . . . . . . . . . . . . . . . . . . . . . . .141

5.1 STRATEGY SPOTLIGHT Environmental Sustainability Primark Strives to Balance Low Costs with Environmental

Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .143 Differentiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

5.1 INSIGHTS FROM RESEARCH Linking Customer Interactions to Innovation: The Role

of the Organizational Practices. . . . . . . . . . . . . . . . . . . . .147 5.2 STRATEGY SPOTLIGHT Data Analytics Caterpillar Digs into the Data to Differentiate Itself . . . . . . . .148

Focus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 5.3 STRATEGY SPOTLIGHT Data Analytics Luxury in the E-Commerce World . . . . . . . . . . . . . . . . . . . . . 151

Combination Strategies: Integrating Overall Low Cost and Differentiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 5.4 STRATEGY SPOTLIGHT Expanding the Profit Pool in the Sky . . . . . . . . . . . . . . . . . . .153

Can Competitive Strategies Be Sustained? Integrating and Applying Strategic Management Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155 Atlas Door: A Case Example . . . . . . . . . . . . . . . . . . . . . . . 155 Are Atlas Door’s Competitive Advantages Sustainable? . . .156 Strategies for Platform Markets . . . . . . . . . . . . . . . . . . . . . 158

Industry Life-Cycle Stages: Strategic Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 Strategies in the Introduction Stage . . . . . . . . . . . . . . . . . . .161 Strategies in the Growth Stage . . . . . . . . . . . . . . . . . . . . . . .161 Strategies in the Maturity Stage . . . . . . . . . . . . . . . . . . . . . 162 Strategies in the Decline Stage. . . . . . . . . . . . . . . . . . . . . . 163 Turnaround Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

5.5 STRATEGY SPOTLIGHT How Mindy Grossman Led HSN’s Remarkable

Turnaround . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . .166 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . .168 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168

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CHAPTER 6 Corporate-Level Strategy: Creating Value through Diversification . . . . . . . . . . . . . . . . . . . . 172

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Making Diversification Work: An Overview . . . . . . . 174 Related Diversification: Economies of Scope and Revenue Enhancement . . . . . . . . . . . . . . . . . . . . . . . 175 Leveraging Core Competencies . . . . . . . . . . . . . . . . . . . . . .175

6.1 STRATEGY SPOTLIGHT Data Analytics

IBM: The New Health Care Expert . . . . . . . . . . . . . . . . . . . .177

Sharing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178

Enhancing Revenue and Differentiation . . . . . . . . . 178 Related Diversification: Market Power . . . . . . . . . . 179 Pooled Negotiating Power . . . . . . . . . . . . . . . . . . . . . . . . . 179 Vertical Integration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

6.2 STRATEGY SPOTLIGHT Environmental Sustainability

Tesla Breaks Industry Norms by Vertically Integrating . . . . .180

Unrelated Diversification: Financial Synergies and Parenting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 Corporate Parenting and Restructuring . . . . . . . . . . . . . . 182 Portfolio Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183 Caveat: Is Risk Reduction a Viable Goal of

Diversification? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

The Means to Achieve Diversification . . . . . . . . . . . 186 Mergers and Acquisitions. . . . . . . . . . . . . . . . . . . . . . . . . . 186

6.3 STRATEGY SPOTLIGHT Ethics

Valeant Pharmaceuticals Jacks Up Prices after Acquisitions but Loses in the End. . . . . . . . . . . . . . . . . . . . . . . . . . . . .189

6.4 STRATEGY SPOTLIGHT

The Wisdom of Crowds: When Do Investors See Value in Acquisitions?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .190

Strategic Alliances and Joint Ventures . . . . . . . . . . . . . . . 192 6.5 STRATEGY SPOTLIGHT

Ericsson and Cisco Join Forces to Respond to the Changing Telecommunications Market . . . . . . . . . . . . . . . . . . . . . . . 193

Internal Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

How Managerial Motives Can Erode Value Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194 Growth for Growth’s Sake . . . . . . . . . . . . . . . . . . . . . . . . . 194 Egotism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 Antitakeover Tactics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . .197 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .197 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .198 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .198 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . .198 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .198 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .198

CHAPTER 7 International Strategy: Creating Value in Global Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

The Global Economy: A Brief Overview . . . . . . . . . . 204 Factors Affecting a Nation’s Competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Factor Endowments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Demand Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Related and Supporting Industries . . . . . . . . . . . . . . . . . . 206 Firm Strategy, Structure, and Rivalry . . . . . . . . . . . . . . . . 206 Concluding Comment on Factors Affecting a Nation’s

Competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206 7.1 STRATEGY SPOTLIGHT

India and the Diamond of National Advantage . . . . . . . . . . 207

International Expansion: A Company’s Motivations and Risks . . . . . . . . . . . . . . . . . . . . . . . . 208 Motivations for International Expansion . . . . . . . . . . . . . 208 Potential Risks of International Expansion . . . . . . . . . . . . .210

7.2 STRATEGY SPOTLIGHT Ethics

Counterfeit Drugs: A Dangerous and Growing Problem . . . . 213 7.3 STRATEGY SPOTLIGHT

When to Not Adapt Your Company’s Culture—Even If It Conflicts with the Local Culture . . . . . . . . . . . . . . . . . . . . 214

Global Dispersion of Value Chains: Outsourcing and Offshoring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .214

Achieving Competitive Advantage in Global Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216 Two Opposing Pressures: Reducing Costs and Adapting

to Local Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .216 International Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .217 Global Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .219 Multidomestic Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . 220

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CONTENTS

7.4 STRATEGY SPOTLIGHT

Challenges Involving Cultural Differences That Managers May Encounter When Negotiating Contracts across National Boundaries . . . . . . . . . . . . . . . . . . . . . . . . . . . .221

Transnational Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 7.5 STRATEGY SPOTLIGHT

Panasonic’s China Experience Shows the Benefits of Being a Transnational . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

Global or Regional? A Second Look at Globalization . . . 224

Entry Modes of International Expansion . . . . . . . . . 226 Exporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226 Licensing and Franchising . . . . . . . . . . . . . . . . . . . . . . . . . 227 Strategic Alliances and Joint Ventures . . . . . . . . . . . . . . . 228 Wholly Owned Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . 229 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . .231 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .231 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . 232 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233

CHAPTER 8 Entrepreneurial Strategy and Competitive Dynamics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

Recognizing Entrepreneurial Opportunities . . . . . . 238 Entrepreneurial Opportunities . . . . . . . . . . . . . . . . . . . . . . 239

8.1 STRATEGY SPOTLIGHT

Seeing Opportunity in the Bright Side . . . . . . . . . . . . . . . . . 240

8.2 STRATEGY SPOTLIGHT Environmental Sustainability

mOasis Leverages Technology to Improve Water Efficiency for Farmers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241

Entrepreneurial Resources . . . . . . . . . . . . . . . . . . . . . . . . . 242 Entrepreneurial Leadership . . . . . . . . . . . . . . . . . . . . . . . . 246

Entrepreneurial Strategy . . . . . . . . . . . . . . . . . . . . . 247 Entry Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

8.3 STRATEGY SPOTLIGHT

Casper Sleep Aims to Be the Warby Parker of Mattresses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249

Generic Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

8.4 STRATEGY SPOTLIGHT

Shakespeare & Co.: Using Technology to Create a New Local Bookstore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252

Combination Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . 252

Competitive Dynamics . . . . . . . . . . . . . . . . . . . . . . . 253 New Competitive Action . . . . . . . . . . . . . . . . . . . . . . . . . . 253 Threat Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254 Motivation and Capability to Respond . . . . . . . . . . . . . . . 256 Types of Competitive Actions . . . . . . . . . . . . . . . . . . . . . . 256 Likelihood of Competitive Reaction . . . . . . . . . . . . . . . . . 258

8.5 STRATEGY SPOTLIGHT Ethics

Cleaning Up in the Soap Business . . . . . . . . . . . . . . . . . . . . 259

Choosing Not to React: Forbearance and Co-opetition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259

Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . .261 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .261 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . 262 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263

PART 3 STRATEGIC IMPLEMENTATION CHAPTER 9 Strategic Control and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 266

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .267

Ensuring Informational Control: Responding Effectively to Environmental Change . . . . . . . . . . . 268 A Traditional Approach to Strategic Control . . . . . . . . . . 268 A Contemporary Approach to Strategic Control . . . . . . . 269

Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries . . . . . . . . . . . . . . . . . . . . . 270 Building a Strong and Effective Culture . . . . . . . . . . . . . . 270 Motivating with Rewards and Incentives . . . . . . . . . . . . . . .271

9.1 STRATEGY SPOTLIGHT

Using Pictures and Stories to Build a Customer-Oriented Culture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .272

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9.1 INSIGHTS FROM RESEARCH

Inspire Passion—Motivate Top Performance . . . . . . . . . . . . . .274

Setting Boundaries and Constraints . . . . . . . . . . . . . . . . . .275 Behavioral Control in Organizations: Situational

Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276 9.2 STRATEGY SPOTLIGHT Data Analytics

Using Data Analytics to Enhance Organizational Control . . .277

Evolving from Boundaries to Rewards and Culture . . . . . 277

The Role of Corporate Governance . . . . . . . . . . . . . 278 The Modern Corporation: The Separation of Owners

(Shareholders) and Management . . . . . . . . . . . . . . . . . 279 Governance Mechanisms: Aligning the Interests of

Owners and Managers . . . . . . . . . . . . . . . . . . . . . . . . . 280 9.3 STRATEGY SPOTLIGHT Ethics

How Women Have Come to Dominate a Corner of Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284

CEO Duality: Is It Good or Bad? . . . . . . . . . . . . . . . . . . . 285 External Governance Control Mechanisms . . . . . . . . . . . 286

9.4 STRATEGY SPOTLIGHT

The Rise of the Privately Owned Firm . . . . . . . . . . . . . . . . . 288

9.5 STRATEGY SPOTLIGHT Ethics

Japanese Government Pushes for Governance Reform . . . . . 289

Corporate Governance: An International Perspective . . . 290 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . 293 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . 294 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

CHAPTER 10 Creating Effective Organizational Designs . . . . . 300

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .301

Traditional Forms of Organizational Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302 Patterns of Growth of Large Corporations: Strategy-

Structure Relationships . . . . . . . . . . . . . . . . . . . . . . . . 302 Simple Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304 Functional Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304 Divisional Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306

10.1 STRATEGY SPOTLIGHT

Whole Foods Centralizes to Improve Efficiency . . . . . . . . . . 307

Matrix Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308 10.2 STRATEGY SPOTLIGHT

Where Conglomerates Prosper . . . . . . . . . . . . . . . . . . . . . . . 309

International Operations: Implications for Organizational Structure . . . . . . . . . . . . . . . . . . . . . . . .310

Global Start-Ups: A Recent Phenomenon . . . . . . . . . . . . .312 10.3 STRATEGY SPOTLIGHT

Global Start-Up, BRCK, Works to Bring Reliable Internet Connectivity to the World . . . . . . . . . . . . . . . . . . . . . . . . . 313

How an Organization’s Structure Can Influence Strategy Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . .313

Boundaryless Organizational Designs . . . . . . . . . . 314 The Barrier-Free Organization . . . . . . . . . . . . . . . . . . . . . . .314

10.4 STRATEGY SPOTLIGHT Environmental Sustainability

The Business Roundtable: A Forum for Sharing Best Environmental Sustainability Practices . . . . . . . . . . . . . .316

10.1 INSIGHTS FROM RESEARCH

Where Employees Learn Affects Financial Performance . . . . 317

10.5 STRATEGY SPOTLIGHT

Cloudflare Sees the Need for Structure . . . . . . . . . . . . . . . . .318

The Modular Organization . . . . . . . . . . . . . . . . . . . . . . . . .318 The Virtual Organization . . . . . . . . . . . . . . . . . . . . . . . . . . 320 Boundaryless Organizations: Making Them Work . . . . . . 321

Creating Ambidextrous Organizational Designs . . 324 Ambidextrous Organizations: Key Design Attributes . . . . 325 Why Was the Ambidextrous Organization the Most

Effective Structure? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 325 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . .327 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .327 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . 328 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

CHAPTER 11 Strategic Leadership: Creating a Learning Organization and an Ethical Organization . . . . . 332

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333

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Leadership: Three Interdependent Activities . . . . . 334 Setting a Direction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335 Designing the Organization . . . . . . . . . . . . . . . . . . . . . . . . 335

11.1 STRATEGY SPOTLIGHT

Marvin Ellison Attempts to Turn JC Penney Co. Inc. Around . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 336

Nurturing a Culture Committed to Excellence and Ethical Behavior . . . . . . . . . . . . . . . . . . . . . . . . . . 336 11.2 STRATEGY SPOTLIGHT Environmental Sustainability,

Ethics

Family Leadership Sustains the Culture of SC Johnson . . . . 337

Getting Things Done: Overcoming Barriers and Using Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338 Overcoming Barriers to Change . . . . . . . . . . . . . . . . . . . . 338

11.3 STRATEGY SPOTLIGHT

Overcoming Supply Chain Limitations at Target . . . . . . . . . 339

Using Power Effectively . . . . . . . . . . . . . . . . . . . . . . . . . . . 339 11.4 STRATEGY SPOTLIGHT

The Use of “Soft” Power at Siemens . . . . . . . . . . . . . . . . . . . .341

Emotional Intelligence: A Key Leadership Trait . . . 341 Self-Awareness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 342 Self-Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 342 Motivation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 Empathy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 Social Skill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 Emotional Intelligence: Some Potential Drawbacks and

Cautionary Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344

Creating a Learning Organization . . . . . . . . . . . . . . 344 Inspiring and Motivating People with a Mission

or Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345 Empowering Employees at All Levels . . . . . . . . . . . . . . . . 345 Accumulating and Sharing Internal Knowledge . . . . . . . . 346 Gathering and Integrating External Information . . . . . . . 346 Challenging the Status Quo and Enabling Creativity . . . . 347

Creating an Ethical Organization . . . . . . . . . . . . . . . 348 Individual Ethics versus Organizational Ethics . . . . . . . . . 348

11.5 STRATEGY SPOTLIGHT Environmental Sustainability, Ethics

Green Energy: Real or Just a Marketing Ploy? . . . . . . . . . . . 349

Integrity-Based versus Compliance-Based Approaches to Organizational Ethics . . . . . . . . . . . . . . . . . . . . . . . . 350

Role Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351

Corporate Credos and Codes of Conduct . . . . . . . . . . . . . 352 Reward and Evaluation Systems . . . . . . . . . . . . . . . . . . . . 352 Policies and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . 353 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 353 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . 354 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . 356 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356

CHAPTER 12 Managing Innovation and Fostering Corporate Entrepreneurship . . . . . . . . . . . . . . . . . . . . . . . . . 360

Learning from Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .361

Managing Innovation . . . . . . . . . . . . . . . . . . . . . . . . 362 Types of Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 362

12.1 STRATEGY SPOTLIGHT

MiO Drops Change the Beverage Game . . . . . . . . . . . . . . . . 363

Challenges of Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . 364 Cultivating Innovation Skills . . . . . . . . . . . . . . . . . . . . . . . 365

12.2 STRATEGY SPOTLIGHT

Procter & Gamble Strives to Remain Innovative. . . . . . . . . . 366

12.3 STRATEGY SPOTLIGHT Environmental Sustainability

Fair Oaks Farms Sees the Power of Waste . . . . . . . . . . . . . . 368

Defining the Scope of Innovation . . . . . . . . . . . . . . . . . . . 368 Managing the Pace of Innovation . . . . . . . . . . . . . . . . . . . 369 Staffing to Capture Value from Innovation . . . . . . . . . . . . 369 Collaborating with Innovation Partners . . . . . . . . . . . . . . 370 The Value of Unsuccessful Innovation . . . . . . . . . . . . . . . 370

12.1 INSIGHTS FROM RESEARCH

You Can Adapt to the Loss of a Star Employee . . . . . . . . . . .371

Corporate Entrepreneurship . . . . . . . . . . . . . . . . . . . 373 Focused Approaches to Corporate Entrepreneurship . . . .374

12.4 STRATEGY SPOTLIGHT

Big Firms Use NVGs and Business Incubators to Trigger Creativity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .375

Dispersed Approaches to Corporate Entrepreneurship . . .375 Measuring the Success of Corporate Entrepreneurship

Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377

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Real Options Analysis: A Useful Tool . . . . . . . . . . . . 378 Applications of Real Options Analysis to Strategic

Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379 12.5 STRATEGY SPOTLIGHT

Saving Millions with Real Options at Intel . . . . . . . . . . . . . . 380

Potential Pitfalls of Real Options Analysis . . . . . . . . . . . . 380

Entrepreneurial Orientation . . . . . . . . . . . . . . . . . . . 381 Autonomy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381 Innovativeness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382 Proactiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383 Competitive Aggressiveness . . . . . . . . . . . . . . . . . . . . . . . . 384 Risk Taking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384 Issue for Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 385 Reflecting on Career Implications . . . . . . . . . . . . . . . . . . . . 386 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 386 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387 Experiential Exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387 Application Questions & Exercises . . . . . . . . . . . . . . . . . . . . 387 Ethics Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388

PART 4 Case Analysis CHAPTER 13 Analyzing Strategic Management Cases . . . . . . 392

Why Analyze Strategic Management Cases? . . . . . . . . . . . . 393 13.1 STRATEGY SPOTLIGHT

Analysis, Decision Making, and Change at Sapient Health Network . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395

How to Conduct a Case Analysis . . . . . . . . . . . . . . . 395 Become Familiar with the Material . . . . . . . . . . . . . . . . . . 396

13.2 STRATEGY SPOTLIGHT

Using a Business Plan Framework to Analyze Strategic Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397

Identify Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397 Conduct Strategic Analyses . . . . . . . . . . . . . . . . . . . . . . . . 398 Propose Alternative Solutions . . . . . . . . . . . . . . . . . . . . . . 400 Make Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . 400

How to Get the Most from Case Analysis . . . . . . . . 401 Useful Decision-Making Techniques in Case Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404 Integrative Thinking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404 Asking Heretical Questions . . . . . . . . . . . . . . . . . . . . . . . . 406

13.3 STRATEGY SPOTLIGHT

Integrative Thinking at Red Hat, Inc. . . . . . . . . . . . . . . . . . 406

Conflict-Inducing Techniques . . . . . . . . . . . . . . . . . . . . . . 407 13.4 STRATEGY SPOTLIGHT

Making Case Analysis Teams More Effective . . . . . . . . . . . . 408

Following the Analysis-Decision-Action Cycle in Case Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411

13.5 STRATEGY SPOTLIGHT

Case Competition Assignment . . . . . . . . . . . . . . . . . . . . . . . .416

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 417 Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 417 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 417 Appendix 1 to Chapter 13: Financial Ratio Analysis . . . . . . . 418 Appendix 2 to Chapter 13: Sources of Company and

Industry Information . . . . . . . . . . . . . . . . . . . . . . . . . . . .427

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CASES

1 ROBIN HOOD Hypothetical/Classic Robin Hood and his Merrymen are in trouble, as wealthy travelers are avoiding Sherwood Forest. This classic case is an excellent introduction to strategic management using a nonbusiness context. . . . . . . . . . C2

2 THE GLOBAL CASINO INDUSTRY IN 2017 Casino Industry The dominance of Las Vegas and Atlantic City in the global market has been challenged by the development of several casinos along a strip in the former Portuguese colony of Macau. More recently, this growth of casinos has spread to other locations across Asia-Pacific. All of these new locations are hoping to grab a share of the gambling revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . C3

3 MCDONALD’S IN 2017 Restaurant Change is in the air at the world’s largest burger chain. Only 20% of millennials have even tried a Big Mac and McDonald’s is worried. It has removed high fructose corn syrup from its buns, changed from the use of liquid margarine to real butter, decided to use chicken that has been raised without antibiotics, and switched to cage- free eggs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C7

4 ZYNGA: IS THE GAME OVER? Mutimedia & Online Games Zynga not only struggled to remain relevant in the gaming industry but also fought to seem attractive to investors. During the past four years, the company had a new CEO almost every year. . . . . . . . . . . . . . . . . . . . C13

5 QVC Retail QVC is finally beginning to see cracks emerge in a business model that has relied on impulsive purchases

by television viewers. The home shopping channel’s U.S. sales fell 6% during the last part of 2016, the first drop in seven years on its home turf. It was especially troubling that this decline extended into the crucial year-end holiday period. . . . . . . . . . . . . . . . . . . . . . . . C19

6 MICROFINANCE: GOING GLOBAL . . . AND GOING PUBLIC?

Finance With the global success of the microfinance concept, the number of private microfinance institutions exploded and the initial public offerings for these institutions was on the rise. This transfer of control to public buyers creates a fiduciary duty of the bank’s management to maximize shareholder value. Will this be a good thing for these typically “do good” banks? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C24

7 WORLD WRESTLING ENTERTAINMENT Entertainment 2017 offered new challenges for WWE’s potent mix of shaved, pierced, and pumped-up muscled hunks; buxom, scantily clad, and sometimes cosmetically enhanced beauties; and body-bashing clashes of good versus evil that had resulted in an empire that claimed over 35 million fans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C27

8 GREENWOOD RESOURCES: A GLOBAL SUSTAINABLE VENTURE IN THE MAKING

Natural Resources GreenWood manager Jeff Nuss narrowed the field from 20 possible investment sites to two strategic alternatives. Which tree plantation investment in rural China should Jeff proceed with? . . . . . . . . . . . . . . . . . . . . . . . . . . . C32

9 FRESHDIRECT: HOW FRESH IS IT? Grocery FreshDirect, a New York City–based online grocer, claimed, “Our food is fresh, our customers are spoiled.” Recently, however, many consumers questioned the freshness of the food delivered. . . . . . . . . . . . . . . . . . C46

10 DIPPIN’ DOTS: IS THE FUTURE FROZEN? Ice Cream Dippin’ Dots Ice Cream is faced with mounting competition for its flagship tiny beads of ice cream that are made and served at super-cold temperatures. Will their new distribution partners bring them in from the cold?. . . . C58

cases

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11 KICKSTARTER AND CROWDFUNDING Crowdfunding Crowdfunding allows ventures to draw on relatively small contributions from a relatively large number of individuals using the Internet, without standard financial intermediaries. KickStarter offers a platform for crowdfunding of new ventures, but the field is crowded. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C68

12 EMIRATES AIRLINE IN 2017 Airlines Emirates faced its biggest challenge from the drop in oil prices and the growth in terrorist attacks that have led to a decline in demand. Many companies, particularly in the Middle East, have been cutting back on travel for their employees, reducing the premium revenue that Emirates has been generating from first and business class passengers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C75

13 CIRQUE DU SOLEIL Entertainment Cirque du Soleil’s business triumphs mirrored its high- flying aerial stunts, but poorly received shows over the last few years and a decline in profits have caused executives at Cirque to announce restructuring and refocusing efforts—shifting some of the attention away from their string of successful shows toward several other potential business ventures. . . . . . . . . . . . . . . . C82

14 PIXAR Movies Disney CEO Bob Iger worked hard to clinch the deal to acquire Pixar, whose track record has made it one of the world’s most successful animation companies. Iger realized, however, that he must try to protect Pixar’s creative culture while also trying to carry that culture over to some of Disney’s animation efforts. . . . . . . . C86

15 CAMPBELL: HOW TO KEEP THE SOUP SIMMERING

Processed and Packaged Goods In 2017, Campbell Soup neared the boiling point with numerous challenges, the most important to remain attractive to health-conscious consumers. CEO Denise Morrison tried to turn the company focus toward fresh food categories, with its fresh food division called “Campbell Fresh.” However, the company still failed to accomplish an impressive comeback. . . . . . . . . . . . . C91

16 HEINEKEN Beer Heineken can lay claim to a brand that may be the closest thing to a global beer brand. But in the United States and Europe sales are relatively flat. Heineken owns more than 175 smaller or regional brands of beer. Would the move to launch Bintang, which is its biggest selling beer brand in Indonesia, into the UK and select European markets be successful? . . . . . . . . . . . . . . C102

17 FORD: NO LONGER JUST AN AUTO COMPANY?

Automotive Ford’s new CEO Mark Fields announced that Ford would focus not only on advanced new vehicles but on changing the way the world moves by solving today’s growing global transportation challenges. Are Fields and Ford up to the challenge? . . . . . . . . . . . . . . . . . C107

18 GENERAL MOTORS IN 2017 Automotive GM has fallen from its dominant position in the domestic auto business, is dismantling operations in Russia, and is selling off its Opel unit in Europe to Peugeot. Will CEO Mary Barra be able to bring back the glory with a series of new investments such as in electric vehicles, ride sharing fleets, and driverless cars? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C120

19 JOHNSON & JOHNSON Pharmaceuticals, Personal Care Products, Medical Devices CEO Alex Gorsky has been growing J&J by acquisition, while granting autonomy to the firms that it absorbs. While independence cultivates an entrepreneurial attitude, the units are not pursuing collaborative opportunities across units. How can J&J combine collaboration and autonomy without unraveling the J&J entrepreneurial spirit? . . . . . . . . . . . . . . . . . . . . C128

20 AVON: A NEW ERA? Cosmetics Rookie CEO Shari McCoy spun off 80% of Avon’s domestic business in an attempt save the firm. Can McCoy save the remaining business and return the iconic, direct selling company to profitable growth?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C133

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CASES

21 THE BOSTON BEER COMPANY: POISED FOR GROWTH

Beer The Boston Beer Company was facing a difficult competitive environment with direct competition from both larger and smaller breweries and from premium imported beers. While further growth would be beneficial in terms of revenue, growing too large could negatively affect the company’s status as a craft brewery and the perceptions of its customers. . . . . . . . . . . . C144

22 NINTENDO’S SWITCH Video Games In 2017 Nintendo launched a new gaming console system named Nintendo Switch. Would the new Joy- Con Controllers and flexible play features be enough to boost consumer numbers and investors’ confidence? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C154

23 TATA STARBUCKS: HOW TO BREW A SUSTAINABLE BLEND FOR INDIA

Coffee Would Starbucks and Tata under new CEO Sumi Ghosh’s leadership finally be able to brew a new blend of success in the competitive and complex Indian café market? While management appeared proud of the joint venture’s early performance, some critical strategic choices would need to be made to ensure the long-term success of Starbucks in India. . . . . . . . . . . . . . . . . . C165

24 WEIGHT WATCHERS INTERNATIONAL INC. Weight Loss Weight Watchers was reinventing weight loss for a new generation and hoping profits would jump off the scale. A new “Beyond the Scale” advertising campaign that featured the entrepreneur and talk show host, Oprah Winfrey, claiming that she had lost 40 pounds by using Weight Watchers program. . . . . . . . . . . . . . . . . . . . C173

25 SAMSUNG ELECTRONICS 2017 Consumer Electronics Samsung rushed the Note 7 to market ahead of Apple’s anticipated iPhone 7. The tendency of the Note 7 to burst into flames from a poor battery design subsequently led Samsung to engage in one of its most extensive and costly recalls and to eventually kill the new product. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C184

26 PROCTER & GAMBLE Consumer Products Procter & Gamble was the world’s largest consumer products conglomerate, with billion-dollar brands such as Tide, Crest, Pampers, Gillette, Right Guard, and Duracell. However, sales were down as consumers were coping with the economic downturn by switching to P&G’s lower-priced brands. . . . . . . . . . . . . . . . . . . . C189

27 APPLE INC.: IS THE INNOVATION OVER? Computers, Consumer Electronics CEO Tim Cook had driven the stock price up 175% since the death of founder Steve Jobs. Yet Cook was criticized for being too cautious about entering new product categories, pursuing acquisitions, and driving employees to achieve stretch goals. Would Apple be able to innovative without Jobs? . . . . . . . . . . . . . . . . . . . C195

28 JETBLUE AIRLINES: GETTING OVER THE “BLUES”?

Airline This airline’s start-up success story is facing new challenges as operational problems have surfaced and another new pilot is in the CEO’s seat. . . . . . . . . . . C208

29 UNITED WAY WORLDWIDE Nonprofit As a nonprofit organization, it was imperative for United Way Worldwide to get the necessary support at the local level in order to achieve its stated organizational goals. Would Gallagher’s various strategies be successfully implemented, or was the nonprofit’s very mission perhaps no longer relevant? . . . . . . . . . . . . . . . . . . . .C218

30 EBAY Internet The online auction pioneer was entering a critical period. There were questions of what was right for the company to increase shareholder value over the long term, as well as operational issues related to search engine optimization and online security. . . . . . . . . C227

31 JAMBA JUICE: MIXING IT UP & STARTING AFRESH

Smoothies/QSR After years of same-store declines, activist investors were pressuring CEO Dave Pace for a turnaround.

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Jamba has gradually expanded its product line over the past several years to appeal to a broader palate, but was the company biting off more than it could chew? . . C241

32 BLACKBERRY LIMITED: IS THERE A PATH TO RECOVERY?

Mobile Phones, Software Blackberry CEO John Chen was hired to get the former dominating smartphone producer back to profitability. However, Blackberry stock was trading for less than $7 a share, that is, only a fraction of the $139 price in 2008. Chen has to navigate the rumors of a sale to Samsung and hostile takeovers, while refocusing the firm. Will Chen and Blackberry survive? . . . . . . . . C250

33 ASCENA: ODDS OF SURVIVAL IN SPECIALTY RETAIL?

Retail, Women’s Fashion Ascena was just starting to digest Ann Taylor, its most recent acquisition in women’s apparel. However, 2017

was shaping up to be the worst year in apparel retail in a decade as ten major apparel retailers filed for bankruptcy and many others teetered on the brink. Could Ascena transcend the industry and drive sales forward or was this one acquisition too many? . . . . C263

Indexes

Company I-1

Name I-11

Subject I-27

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des13959_ch01_001-033.indd 1 01/04/18 10:03 AM

Chapter 1 Introduction

and Analyzing Goals and Objectives

Chapter 4 Assessing Intellectual

Capital

Chapter 2 Analyzing

the External Environment

Chapter 3 Analyzing

the Internal Environment

Chapter 13 Case

Analysis

Case Analysis

Strategy Formulation Strategy Implementation

Strategy Analysis

Chapter 5 Formulating

Business-Level Strategies

Chapter 8 Entrepreneurial

Strategy and Competitive

Dynamics

Chapter 6 Formulating Corporate-

Level Strategies

Chapter 7 Formulating International

Strategies

Chapter 9 Strategic

Control and Corporate

Governance

Chapter 12 Fostering Corporate

Entrepreneur- ship

Chapter 10 Creating Effective

Organizational Designs

Chapter 11 Strategic Lead-

ership Excel- lence, Ethics, and Change

The Strategic Management Process

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

1 LO1-1 The definition of strategic management and its four key attributes. LO1-2 The strategic management process and its three interrelated and principal

activities.

LO1-3 The vital role of corporate governance and stakeholder management, as well as how “symbiosis” can be achieved among an organization’s stakeholders.

LO1-4 The importance of social responsibility, including environmental sustainability, and how it can enhance a corporation’s innovation strategy.

LO1-5 The need for greater empowerment throughout the organization. LO1-6 How an awareness of a hierarchy of strategic goals can help an

organization achieve coherence in its strategic direction.

Strategic Management Creating Competitive Advantages

©Anatoli Styf/Shutterstock

PART 1: STRATEGIC ANALYSIS

What makes the study of strategic management so interesting? Things can change so rapidly! Some start-ups can disrupt industries and become globally recognized names in just a few years. The rankings of the world’s most valuable firms can dramatically change in a rather brief period of time. On the other hand, many impressive, high-flying firms can struggle to reclaim past glory or even fail. Recall just four that begin with the letter “b”—Blackberry, Blockbuster, Borders, and Barings. As colorfully (and ironically!) noted by Arthur Martinez, Sears’s former Chairman: “Today’s peacock is tomorrow’s feather duster.”1

Consider the following:2

• At the beginning of 2007, the three firms in the world with the highest market values were Exxon Mobil, General Electric, and Gazprom (a Russian natural gas firm). By early 2017, three high tech firms headed the list—Apple, Alphabet (parent of Google), and Microsoft.

• Only 74 of the original 500 companies in the S&P index were still around 40 years later. And McKinsey notes that the average company tenure on the S&P 500 list has fallen from 61 years in 1958 to about 20 in 2016.

• With the dramatic increase of the digital economy, new entrants are shaking up long-standing industries. Note that Alibaba is the world’s most valuable retailer—but holds no inventory; Airbnb is the world’s largest provider of accommodations—but owns no real estate; and Uber is the world’s largest car service but owns no cars.

• A quarter century ago, how many would have predicted that a South Korean firm would be a global car giant, than an Indian firm would be one of the world’s largest technology firms, and a huge Chinese Internet company would list on an American stock exchange?

• Fortune magazine’s annual list of the 500 biggest companies now features 156 emerging- market firms. This compares with only 18 in 1995!

To remain competitive, companies often must bring in “new blood” and make significant changes in their strategies. But sometimes a new CEO’s initiatives makes things worse. Let’s take a look at Lands’ End, an American clothing retailer.3

Lands’ End was founded in 1963 as a mail order supplier of sailboat equipment by Gary Comer. As business picked up, he expanded the business into clothing and home furnishings and moved the company to Dodgeville, Wisconsin, in 1978 where he was its CEO until he stepped down in 1990. The firm was acquired by Sears in 2002, but later spun off in 2013. A year later it commenced trading on the NASDAQ stock exchange.

Targeting Middle America, companies like Lands’ End, the GAP Inc., and J. C. Penney have had a hard time in recent years positioning themselves in the hotly contested clothing industry. They are squeezed on the high end by brands like Michael Kors Holdings Ltd. and Coach, Inc. On the lower end, fast-fashion retailers including H&M operator Hennes & Mauritz AB are applying pressure by churning out inexpensive, runway-inspired styles.

To spearhead a revival of the brand, Lands’ End hired a new CEO, Frederica Marchionni, in February 2015. However, since her arrival, the firm’s stock price has suffered, same store sales declined for all six quarters of her tenure, and the firm kept losing money. It reported a loss of $19.5 million for the year ending January 29, 2016—compared to a $73.8 million profit for the previous year. (And, things didn’t get better—it lost another $7.7 million in the first half of 2016.)

LEARNING FROM MISTAKES

PART 1: STRATEGIC ANALYSIS

4 PART 1 :: STRATEGIC ANALYSIS

So, what went wrong? Lands’ End was always known for its wholesome style and corporate culture. Its founder, Gary Comer, who liked to dress casually in jeans and sweaters, had fostered a familial culture. However, things dramatically changed when Ms. Marchionni arrived. Prior to taking the position, she had struck a deal to only spend one week a month in Dodgeville—preferring instead to spend most of her time in an office in New York’s garment district. Also, unlike her predecessors, she had private bathrooms in both of her offices—such perks didn’t seem to fit well with the firm’s culture.

Given Marchionni’s background at high-end names like Ferrari and Dolce & Gabbana, she tried to inject more style into the maker of outdoorsy, casual clothes. She added slimmer-fits, stiletto heels and a new line of activewear. In presentations, according to those attending, she derided the company’s boxy sweaters and baggy pants as “ugly,” asking “Who would wear that?” A photo shoot for a line took place in the Marshall Islands—a very costly location, according to people familiar with the situation. She overhauled the catalog, hired celebrity photographers, and hired a Vogue stylist for input. She also added new price points—including the Canvas line which sells for as much as 30 percent more than the traditional Lands’ End collection.

At the end of the day, it appeared that Ms. Marchionni was never able to get Lands’ End employees to buy into her vision. And as losses piled up quickly, the board became concerned that she was trying to make too many changes too quickly. Perhaps, she was not given enough time to turn things around—but her approach to re-invent the apparel brand may have been too much of a shock for its customer base as well as the firm’s family culture and wholesome style. Maybe Lee Eisenberg, the firm’s former creative director, said it best: “It doesn’t look like Lands’ End anymore. There was never the implication that if you wore Lands’ End you’d be on a beach on Nantucket living the perfect life.” Marchionni resigned on September 26, 2016—underscoring, as noted by Fortune.com, how futile it must be to take such a Middle American brand upscale.

Discussion Questions 1. What actions could Ms. Marchionni have taken to improve Lands’ End’s prospects for success

in the marketplace? 2. Did Lands’ End make the right choice in selecting her for the CEO position? Why? Why not?

Today’s leaders face a large number of complex challenges in the global marketplace. In considering how much credit (or blame) they deserve, two perspectives of leadership come immediately to mind: the “romantic” and “external control” perspectives.4 First, let’s look at the romantic view of leadership. Here, the implicit assumption is that the leader is the key force in determining an organization’s success—or lack thereof.5 This view dominates the popular press in business magazines such as Fortune, Bloomberg Businessweek, and Forbes, wherein the CEO is either lauded for his or her firm’s success or chided for the organiza- tion’s demise.6 Consider, for example, the credit that has been bestowed on leaders such as Jack Welch, Andrew Grove, and Herb Kelleher for the tremendous accomplishments when they led their firms, General Electric, Intel, and Southwest Airlines, respectively.

Similarly, Apple’s success in the last decade has been attributed almost entirely to the late Steve Jobs, its former CEO, who died on October 5, 2011.7 Apple’s string of hit products, such as iMac computers, iPods, iPhones, and iPads, is a testament to his genius for devel- oping innovative, user-friendly, and aesthetically pleasing products. In addition to being a

romantic view of leadership situations in which the leader is the key force determining the organization’s success—or lack thereof.

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perfectionist in product design, Jobs was a master showman with a cult following. During his time as CEO between 1997 and 2011, Apple’s market value soared by over $300 billion!

On the other hand, when things don’t go well, much of the failure of an organization can also, rightfully, be attributed to the leader.8 Clearly, actions undertaken by Ms. Marchionni to move Lands’ End upscale backfired and hampered its performance. In contrast, Apple fully capitalized on emerging technology trends with a variety of products, including sophis- ticated smartphones.

The effect—for good or for bad—that top executives can have on a firm’s market value can be reflected in what happens when one of them leaves their firm.9 For example, look what occurred when Kasper Rorsted stepped down as CEO of the German packaged-goods firm Henkel in January, 2016 to become CEO of Adidas: Henkel immediately lost $2 billion in market capitalization, and Adidas gained $1 billion. On the other hand, when Viacom announced that executive chairman Sumner Redstone was stepping down, the firm gained $1.1 billion of market valuation in 30 minutes!

However, such an emphasis on the leader reflects only part of the picture. Consider another perspective, called the external control view of leadership. Here, rather than making the implicit assumption that the leader is the most important factor in determining organi- zational outcomes, the focus is on external factors that may positively (or negatively) affect a firm’s success. We don’t have to look far to support this perspective. Developments in the general environment, such as economic downturns, new technologies, governmental legisla- tion, or an outbreak of major internal conflict or war, can greatly restrict the choices that are available to a firm’s executives. For example, several book retailers, such as Borders and Waldenbooks, found the consumer shift away from brick-and-mortar bookstores to online book buying (e.g., Amazon) and digital books an overwhelming environmental force against which they had few defenses.

Looking back at the opening Lands’ End case, it was clear that Ms. Marchionni faced challenges in the external environment over which she had relatively little control. As noted, chains targeting Middle America such as Lands’ End were squeezed on both the higher end by brands such as Coach Inc. and on the lower end by Hennes & Mauritz AB. And as noted by an analyst, her potential for success was adversely affected by “the worst consumer soft goods market in eight years.”10

Before moving on, it is important to point out that successful executives are often able to navigate around the difficult circumstances that they face. At times it can be refreshing to see the optimistic position they take when they encounter seemingly insurmountable odds. Of course, that’s not to say that one should be naive or Pollyannaish. Consider, for example, how one CEO, discussed next, is handling trying times.11

Name a general economic woe, and chances are that Charles Needham, CEO of Metorex, is dealing with it.

• Market turmoil has knocked 80 percent off the shares of South Africa’s Metorex, the mining company that he heads.

• The plunge in global commodities is slamming prices for the copper, cobalt, and other minerals Metorex unearths across Africa. The credit crisis makes it harder to raise money.

• Fighting has again broken out in the Democratic Republic of Congo, where Metorex has a mine and several projects in development.

Such problems might send many executives to the window ledge. Yet Needham appears unruffled as he sits down at a conference table in the company’s modest offices in a Johannesburg suburb. The combat in northeast Congo, he notes, is far from Metorex’s mine. Commodity prices are still high, in historical terms. And Needham is confident he can raise enough capital, drawing on relationships with South African banks. “These are the kinds of things you deal with, doing business in Africa,” he says.

external control view of leadership situations in which external forces—where the leader has limited influence—determine the organization’s success.

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WHAT IS STRATEGIC MANAGEMENT? Given the many challenges and opportunities in the global marketplace, today’s managers must do more than set long-term strategies and hope for the best.12 They must go beyond what some have called “incremental management,” whereby they view their job as making a series of small, minor changes to improve the efficiency of their firm’s operations.13 Rather than seeing their role as merely custodians of the status quo, today’s leaders must be proac- tive, anticipate change, and continually refine and, when necessary, make dramatic changes to their strategies. The strategic management of the organization must become both a pro- cess and a way of thinking throughout the organization.

Defining Strategic Management Strategic management consists of the analyses, decisions, and actions an organization undertakes in order to create and sustain competitive advantages. This definition captures two main elements that go to the heart of the field of strategic management.

First, the strategic management of an organization entails three ongoing processes: analyses, decisions, and actions. Strategic management is concerned with the analysis of strategic goals (vision, mission, and strategic objectives) along with the analysis of the internal and external environments of the organization. Next, leaders must make strategic decisions. These decisions, broadly speaking, address two basic questions: What industries should we compete in? How should we compete in those industries? These questions also often involve an organization’s domestic and international operations. And last are the actions that must be taken. Decisions are of little use, of course, unless they are acted on. Firms must take the necessary actions to implement their strategies. This requires leaders to allocate the necessary resources and to design the organization to bring the intended strategies to reality.

Second, the essence of strategic management is the study of why some firms outperform others.14 Thus, managers need to determine how a firm is to compete so that it can obtain advantages that are sustainable over a lengthy period of time. That means focusing on two fundamental questions:

• How should we compete in order to create competitive advantages in the marketplace? Managers need to determine if the firm should position itself as the low-cost producer or develop products and services that are unique and will enable the firm to charge premium prices. Or should they do some combination of both?

• How can we create competitive advantages in the marketplace that are unique, valuable, and difficult for rivals to copy or substitute? That is, managers need to make such advantages sustainable, instead of temporary.

Sustainable competitive advantage cannot be achieved through operational effective- ness alone.15 The popular management innovations of the last two decades—total qual- ity, just-in-time, benchmarking, business process reengineering, outsourcing—are all about operational effectiveness. Operational effectiveness means performing similar activities better than rivals. Each of these innovations is important, but none lead to sustainable competitive advantage because everyone is doing them. Strategy is all about being differ- ent. Sustainable competitive advantage is possible only by performing different activities from rivals or performing similar activities in different ways. Companies such as Walmart, Southwest Airlines, and IKEA have developed unique, internally consistent, and difficult- to-imitate activity systems that have provided them with sustained competitive advan- tages. A company with a good strategy must make clear choices about what it wants to accomplish. Trying to do everything that your rivals do eventually leads to mutually destructive price competition, not long-term advantage.

strategic management the analyses, decisions, and actions an organization undertakes in order to create and sustain competitive advantages.

strategy the ideas, decisions, and actions that enable a firm to succeed.

competitive advantage a firm’s resources and capabilities that enable it to overcome the competitive forces in its industry(ies).

operational effectiveness performing similar activities better than rivals.

LO 1-1 The definition of strategic management and its four key attributes.

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The Four Key Attributes of Strategic Management Before discussing the strategic management process, let’s briefly talk about four attri- butes of strategic management.16 It should become clear how this course differs from other courses that you have had in functional areas, such as accounting, marketing, opera- tions, and finance. Exhibit 1.1 provides a definition and the four attributes of strategic management.

First, strategic management is directed toward overall organizational goals and objectives. That is, effort must be directed at what is best for the total organization, not just a single functional area. Some authors have referred to this perspective as “organizational versus individual rationality.”17 That is, what might look “rational” or ideal for one functional area, such as operations, may not be in the best interest of the overall firm. For example, opera- tions may decide to schedule long production runs of similar products to lower unit costs. However, the standardized output may be counter to what the marketing department needs to appeal to a demanding target market. Similarly, research and development may “overen- gineer” the product to develop a far superior offering, but the design may make the product so expensive that market demand is minimal.

As noted by David Novak, CEO of Yum Brands:18

I tell people that once you get a job you should act like you run the place. Not in terms of ego, but in terms of how you think about the business. Don’t just think about your piece of the business. Think about your piece of the business and the total business. This way, you’ll always have a broader perspective.

Second, strategic management includes multiple stakeholders in decision making.19 Stakeholders are those individuals, groups, and organizations that have a “stake” in the suc- cess of the organization, including owners (shareholders in a publicly held corporation), employees, customers, suppliers, the community at large, and so on. (We’ll discuss this in more detail later in this chapter.) Managers will not be successful if they focus on a single stakeholder. For example, if the overwhelming emphasis is on generating profits for the owners, employees may become alienated, customer service may suffer, and the suppliers may resent demands for pricing concessions.

Third, strategic management requires incorporating both short-term and long-term perspec- tives.20 Peter Senge, a leading strategic management author, has referred to this need as a “creative tension.”21 That is, managers must maintain both a vision for the future of the organization and a focus on its present operating needs. However, financial markets can exert significant pressures on executives to meet short-term performance targets. Studies have shown that corporate leaders often take a short-term approach to the detriment of creating long-term shareholder value.

Andrew Winston addresses this issue in his recent book, The Big Pivot:22

Consider the following scenario: You are close to the end of the quarter and you are faced with a project that you are certain will make money. That is, it has a guaranteed positive net present value (NPV). But, it will reduce your earnings for this quarter. Do you invest?

stakeholders individuals, groups, and organizations that have a stake in the success of the organization. These include owners (shareholders in a publicly held corporation), employees, customers, suppliers, and the community at large.

EXHIBIT 1.1 Strategic Management Concepts

Definition: Strategic management consists of the analyses, decisions, and actions an organization undertakes in order to create and sustain competitive advantages.

Key Attributes of Strategic Management

• Directs the organization toward overall goals and objectives. • Includes multiple stakeholders in decision making. • Needs to incorporate short-term and long-term perspectives. • Recognizes trade-offs between efficiency and effectiveness.

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A research study posed this question to 400 CFOs and a majority said they would not do it. Further, 80 percent of the executives would decrease R&D spending, advertising, and general maintenance. So, what occurs when you cut back on these investments to prop up short-term earnings every quarter? Logically, you don’t invest in projects with favorable paybacks and you underspend on initiatives that build longer-term value. Thus, your earnings targets in the future quarters actually get more difficult to hit.

Fourth, strategic management involves the recognition of trade-offs between effectiveness and efficiency. Some authors have referred to this as the difference between “doing the right thing” (effectiveness) and “doing things right” (efficiency).23 While managers must allocate and use resources wisely, they must still direct their efforts toward the attainment of overall organizational objectives. As noted by Meg Whitman, Hewlett-Packard’s CEO, “Less than perfect strategy execution against the right strategy will probably work. A 100% execution against the wrong strategy won’t.” 24

Successful managers must make many trade-offs. It is central to the practice of strategic management. At times, managers must focus on the short term and efficiency; at other times, the emphasis is on the long term and expanding a firm’s product-market scope in order to anticipate opportunities in the competitive environment.

To summarize, leaders typically face many difficult and challenging decisions. In a 2016 article in the Harvard Business Review, Wendy Smith and her colleagues provide some valu- able insights in addressing such situations.25 The author team studied corporations over many years and found that senior executives are often faced with similar sets of opposing goals, which can polarize their organizations. Such tensions or paradoxes fall into three cate- gories, which may be related to three questions that many leaders view as “either/or” choices.

• Do we manage for today or for tomorrow? A firm’s long-term survival requires taking risks and learning from failure in the pursuit of new products and services. However, companies also need consistency in their products and services. This depicts the tension between existing products and new ones, stability and change. This is the innovation paradox. For example, in the late 1990s, IBM’s senior leaders saw the Internet wave and felt the need to harness the new technology. However, the firm also needed to sustain its traditional strength in client-server markets. Each strategy required different structures, cultures, rewards, and metrics—which could not easily be executed in tandem.

• Do we stick to boundaries or cross them? Global supply chains can be very effective, but they may also lack flexibility. New ideas can emerge from innovation activities that are dispersed throughout the world. However, not having all the talent and brains in one location can be costly. This is the tension between global connectedness and local needs, the globalization paradox. In 2009, NASA’s director of human health and performance started an initiative geared toward generating new knowledge through collaborative cross-firm and cross-disciplinary work. Not too surprisingly, he faced strong pushback from scientists interested in protecting their turf and their identities as independent experts. Although both collaboration and independent work were required to generate new innovations, they posed organizational and cultural challenges.

• Whom do we focus on, shareholders or stakeholders? Clearly, companies exist to create value. But managers are often faced with the choice between maximizing shareholder gains while trying to create benefits for a wide range of stakeholders— employees, customers, society, etc. However, being socially responsible may bring down a firm’s share price, and prioritizing employees may conflict with short-term shareholders’ or customers’ needs. This is the obligation paradox. Paul Polman, Unilever’s CEO, launched the Unilever Sustainable Living Plan in 2010. The goal was to double the size of the business over 10 years, improve the health and well-being of more than a billion people, and cut the firm’s environmental impact in half. He

effectiveness tailoring actions to the needs of an organization rather than wasting effort, or “doing the right thing.”

efficiency performing actions at a low cost relative to a benchmark, or “doing things right.”

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LO 1-2 The strategic management process and its three interrelated and principal activities.

1.1 STRATEGY SPOTLIGHT AMBIDEXTROUS BEHAVIORS: COMBINING ALIGNMENT AND ADAPTABILITY A study involving 41 business units in 10 multinational compa- nies identified four ambidextrous behaviors in individuals. Such behaviors are the essence of ambidexterity, and they illustrate how a dual capacity for alignment and adaptability can be woven into the fabric of an organization at the individual level.

They take time and are alert to opportunities beyond the confines of their own jobs. A large computer company’s sales manager became aware of a need for a new software module that nobody currently offered. Instead of selling the customer something else, he worked up a business case for the new module. With man- agement’s approval, he began working full time on its development.

They are cooperative and seek out opportunities to com- bine their efforts with others. A marketing manager for Italy was responsible for supporting a newly acquired subsidiary. When frustrated about the limited amount of contact she had with her peers in other countries, she began discussions with them. This led to the creation of a European marketing forum that meets quarterly to discuss issues, share best practices, and collaborate on marketing plans.

They are brokers, always looking to build internal net- works. When visiting the head office in St. Louis, a Canadian plant manager heard about plans for a $10 million investment for a new tape manufacturing plant. After inquiring further about the plans and returning to Canada, he contacted a regional man- ager in Manitoba, who he knew was looking for ways to build his business. With some generous support from the Manitoba government, the regional manager bid for, and ultimately won, the $10 million investment.

They are multitaskers who are comfortable wearing more than one hat. Although an operations manager for a major cof- fee and tea distributor was charged with running his plant as effi- ciently as possible, he took it upon himself to identify value-added services for his clients. By developing a dual role, he was able to manage operations and develop a promising electronic module that automatically reported impending problems inside a coffee vending machine. With corporate funding, he found a subcontrac- tor to develop the software, and he then piloted the module in his own operations. It was so successful that it was eventually adopted by operations managers in several other countries.

A recent Harvard Business Review article provides some useful insights on how one can become a more ambidextrous leader. Consider the following questions:

• Do you meet your numbers? • Do you help others? • What do you do for your peers? Are you just their

in-house competitor? • When you manage up, do you bring problems—or

problems with possible solutions? • Are you transparent? Managers who get a reputation

for spinning events gradually lose the trust of peers and superiors.

• Are you developing a group of senior-managers who know you and are willing to back your original ideas with resources?

Sources: Birkinshaw, J. & Gibson, C. 2004. Building ambidexterity into an organization. MIT Sloan Management Review, 45(4): 47–55; and Bower, J. L. 2007. Solve the succession crisis by growing inside-out leaders. Harvard Business Review, 85(11): 90–99.

argued that such investments would lead to greater profits over the long term; whereas a singular focus on short-term profits would have adverse effects on society and the environment. His arguments were persuasive to many; however, there have been many challenges in implementing the plan. Not surprisingly, it has caused uncertainty among senior executives that has led to anxiety and fights over resource allocation.

Some authors have developed the concept of “ambidexterity” (similar to the aforemen- tioned “innovation paradox”), which refers to a manager’s challenge to both align resources to take advantage of existing product markets and proactively explore new opportuni- ties.26 Strategy Spotlight 1.1 discusses ambidextrous behaviors that are essential for success in today’s challenging marketplace.

THE STRATEGIC MANAGEMENT PROCESS We’ve identified three ongoing processes—analyses, decisions, and actions—that are central to strategic management. In practice, these three processes—often referred to as strategy analysis, strategy formulation, and strategy implementation—are highly interdependent and do not take place one after the other in a sequential fashion in most companies.

ambidexterity the challenge managers face of both aligning resources to take advantage of existing product markets and proactively exploring new opportunities.

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EXHIBIT 1.2 Realized Strategy and Intended Strategy: Usually Not the Same Realized Strategy

Emergent Strategy

Unrealized Strategy

D el

ib er

at e

St ra

te gy

Intended Strategy

Intended versus Realized Strategies Henry Mintzberg, a management scholar at McGill University, argues that viewing the strategic management process as one in which analysis is followed by optimal decisions and their subsequent meticulous implementation neither describes the strategic management process accurately nor prescribes ideal practice.27 He sees the business environment as far from predictable, thus limiting our ability for analysis. Further, decisions are seldom based on optimal rationality alone, given the political processes that occur in all organizations.28

Taking into consideration the limitations discussed above, Mintzberg proposed an alter- native model. As depicted in Exhibit 1.2, decisions following from analysis, in this model, constitute the intended strategy of the firm. For a variety of reasons, the intended strategy rarely survives in its original form. Unforeseen environmental developments, unanticipated resource constraints, or changes in managerial preferences may result in at least some parts of the intended strategy remaining unrealized.

Consider an important trend affecting law firms:

Many of the leading corporations have reduced their need for outside legal services by increasingly expanding their in-house legal departments.29 For example, companies and financial institutions spent an estimated $41 billion on their internal lawyers in 2014, a 22 percent increase since 2011. And a survey of 1,200 chief legal officers found that 63 percent of respondents are now “in-sourcing” legal work they used to send out to law firms or other service providers. In response, many large law firms have been forced to move away from commodity practices such as basic commercial contracts to more specialized areas like cross-border transactions and global regulatory issues.

Thus, the final realized strategy of any firm is a combination of deliberate and emergent strategies.

Next, we will address each of the three key strategic management processes—strategy analysis, strategy formulation, and strategy implementation—and provide a brief overview of the chapters.

Exhibit 1.3 depicts the strategic management process and indicates how it ties into the chapters in the book. Consistent with our discussion above, we use two-way arrows to con- vey the interactive nature of the processes.

strategic management process strategy analysis, strategy formulation, and strategy implementation.

intended strategy strategy in which organizational decisions are determined only by analysis.

realized strategy strategy in which organizational decisions are determined by both analysis and unforeseen environmental developments, unanticipated resource constraints, and/or changes in managerial preferences.

Source: Adapted from Mintzberg, H. & Waters, J. A., “Of Strategies: Deliberate and Emergent,” Strategic Management Journal, Vol. 6, 1985, pp. 257–272.

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EXHIBIT 1.3 The Strategic Management Process

Chapter 1 Introduction

and Analyzing Goals and Objectives

Chapter 4 Assessing Intellectual

Capital

Chapter 2 Analyzing

the External Environment

Chapter 3 Analyzing

the Internal Environment

Chapter 13 Case

Analysis

Case Analysis

Strategy Formulation Strategy Implementation

Strategy Analysis

Chapter 5 Formulating

Business-Level Strategies

Chapter 8 Entrepreneurial

Strategy and Competitive

Dynamics

Chapter 6 Formulating Corporate-

Level Strategies

Chapter 7 Formulating International

Strategies

Chapter 9 Strategic

Control and Corporate

Governance

Chapter 12 Fostering Corporate

Entrepreneur- ship

Chapter 10 Creating Effective

Organizational Designs

Chapter 11 Strategic Lead-

ership Excel- lence, Ethics, and Change

Before moving on, we point out that analyzing the environment and formulating strategies are, of course, important activities in the strategic management process. However, nothing happens until resources are allocated and effective strategies are successfully implemented. Rick Spielman, General Manager of the Minnesota Vikings (of the National Football League), provides valuable insight on this issue.30 He recalls the many quarterbacks that he has inter- viewed over the past 25 years and notes that many of them can effectively draw up plays on the whiteboard and “you sit there and it’s like listening to an offensive coordinator.” However, that is not enough. He points out, “Now can he translate that and make those same decisions and those same type of reads in the two and a half seconds he has to get rid of the ball?”

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Strategy Analysis

We measure, study, quantify, analyze every single piece of our business. . . . But then you’ve got to be able to take all that data and information and transform it into change in the organization and improvements in the organization and the formalization of the business strategy.

—Richard Anderson, CEO of Delta Air Lines31

Strategy analysis may be looked upon as the starting point of the strategic management pro- cess. It consists of the “advance work” that must be done in order to effectively formulate and implement strategies. Many strategies fail because managers may want to formulate and implement strategies without a careful analysis of the overarching goals of the organization and without a thorough analysis of its external and internal environments.

Analyzing Organizational Goals and Objectives (Chapter 1) A firm’s vision, mission, and strategic objectives form a hierarchy of goals that range from broad statements of intent and bases for competitive advantage to specific, measurable strategic objectives.

Analyzing the External Environment of the Firm (Chapter 2) Managers must monitor and scan the environment as well as analyze competitors. Two frameworks are provided: (1) The general environment consists of several elements, such as demographic and economic seg- ments, and (2) the industry environment consists of competitors and other organizations that may threaten the success of a firm’s products and services.

Assessing the Internal Environment of the Firm (Chapter 3) Analyzing the strengths and relationships among the activities that constitute a firm’s value chain (e.g., operations, mar- keting and sales, and human resource management) can be a means of uncovering potential sources of competitive advantage for the firm.32

Assessing a Firm’s Intellectual Assets (Chapter 4) The knowledge worker and a firm’s other intellectual assets (e.g., patents) are important drivers of competitive advantages and wealth creation. We also assess how well the organization creates networks and relation- ships as well as how technology can enhance collaboration among employees and provide a means of accumulating and storing knowledge.33

Strategy Formulation

“You can have the best operations. You can be the most adept at whatever it is that you’re doing. But, if you have a bad strategy, it’s all for naught.”

—Fred Smith, CEO of FedEx34

Strategy formulation is developed at several levels. First, business-level strategy addresses the issue of how to compete in a given business to attain competitive advantage. Second, corporate-level strategy focuses on two issues: (a) what businesses to compete in and (b) how businesses can be managed to achieve synergy; that is, they create more value by work- ing together than by operating as standalone businesses. Third, a firm must develop inter- national strategies as it ventures beyond its national boundaries. Fourth, managers must formulate effective entrepreneurial initiatives.

Formulating Business-Level Strategy (Chapter 5) The question of how firms compete and outperform their rivals and how they achieve and sustain competitive advantages goes to the heart of strategic management. Successful firms strive to develop bases for competitive advantage, which can be achieved through cost leadership and/or differentiation as well as by focusing on a narrow or industrywide market segment.35

Formulating Corporate-Level Strategy (Chapter 6) Corporate-level strategy addresses a firm’s portfolio (or group) of businesses. It asks: (1) What business (or businesses) should

strategy analysis study of firms’ external and internal environments, and their fit with organizational vision and goals.

strategy formulation decisions made by firms regarding investments, commitments, and other aspects of operations that create and sustain competitive advantage.

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we compete in? and (2) How can we manage this portfolio of businesses to create synergies among the businesses?

Formulating International Strategy (Chapter 7) When firms enter foreign markets, they face both opportunities and pitfalls.36 Managers must decide not only on the most appro- priate entry strategy but also how they will go about attaining competitive advantages in international markets.37

Entrepreneurial Strategy and Competitive Dynamics (Chapter 8) Entrepreneurial activity aimed at new value creation is a major engine for economic growth. For entrepreneurial initiatives to succeed, viable opportunities must be recognized and effective strategies must be formulated.

Strategy Implementation

“We could leave our strategic plan on an airplane, and it wouldn’t matter. It’s all about execution.”

—John Stumpf, CEO of Wells Fargo38

Clearly, sound strategies are of no value if they are not properly implemented.39 Strategy implementation involves ensuring proper strategic controls and organizational designs, which includes establishing effective means to coordinate and integrate activities within the firm as well as with its suppliers, customers, and alliance partners.40 Leadership plays a central role to ensure that the organization is committed to excellence and ethical behavior. It also promotes learning and continuous improvement and acts entrepreneurially in creating new opportunities.

Strategic Control and Corporate Governance (Chapter 9) Firms must exercise two types of strategic control. First, informational control requires that organizations continually moni- tor and scan the environment and respond to threats and opportunities. Second, behavioral control involves the proper balance of rewards and incentives as well as cultures and bound- aries (or constraints). Further, successful firms (those that are incorporated) practice effec- tive corporate governance.

Creating Effective Organizational Designs (Chapter 10) Firms must have organizational structures and designs that are consistent with their strategy. In today’s rapidly changing competitive environments, firms must ensure that their organizational boundaries—those internal to the firm and external—are more flexible and permeable.41 Often, organizations develop strategic alliances to capitalize on the capabilities of other organizations.

Creating a Learning Organization and an Ethical Organization (Chapter 11) Effective lead- ers set a direction, design the organization, and develop an organization that is committed to excellence and ethical behavior. In addition, given rapid and unpredictable change, lead- ers must create a “learning organization” so that the entire organization can benefit from individual and collective talents.

Fostering Corporate Entrepreneurship (Chapter 12) Firms must continually improve and grow as well as find new ways to renew their organizations. Corporate entrepreneurship and innovation provide firms with new opportunities, and strategies should be formulated that enhance a firm’s innovative capacity.

Chapter 13, “Analyzing Strategic Management Cases,” provides guidelines and sugges- tions on how to evaluate cases in this course. Thus, the concepts and techniques discussed in the first 12 chapters can be applied to real-world organizations.

In the “Executive Insights: The Strategic Management Process” sidebar we include an interview that the authors conducted with Admiral William H. McRaven, Retired. His distinguished career includes being commander of the U.S. Special Operations Command, and he led Operation Neptune Spear that led to the demise of al Qaeda’s leader, Osama bin

strategy implementation actions made by firms that carry out the formulated strategy, including strategic controls, organizational design, and leadership.

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Admiral William H. McRaven, Retired Chancellor, University of Texas System

BIOSKETCH University of Texas Chancellor William H. McRaven, a retired four-star admiral, leads the nation’s second largest system of higher education. As chief executive officer of the UT System since January 2015, he oversees 14 institutions that educate 217,000 students and employ 20,000 faculty and more than 70,000 health care professionals, researchers, and staff.

Prior to becoming chancellor, McRaven, a Navy SEAL, was the commander of U.S. Special Operations Command during which time he led a force of 69,000 men and women and was responsible for conducting counter-terrorism operations world- wide. McRaven is also a recognized national authority on U.S. foreign policy and has advised presidents George W. Bush and Barack Obama and other U.S. leaders on defense issues. His acclaimed book, Spec. Ops: Case Studies in Special Operations Warfare: Theory and Practice, has been published in several lan- guages. He is noted for his involvement in Operation Neptune Spear, in which he commanded the U.S. Navy Special forces who located and killed al Qaeda leader Osama bin Laden.

McRaven has been recognized for his leadership numerous times by national and international publications and organizations. In 2011, he was the first runner-up for Time magazine’s Person of the Year. In 2012, Foreign Policy magazine named McRaven one of the nation’s Top 10 Foreign Policy Experts and one of the Top 100 Global Thinkers. And in 2014, Politico named McRaven one of the Politico 50, citing his leadership as instrumental in cutting through Washington bureaucracy.

McRaven graduated from the University of Texas at Austin in 1977 with a degree in journalism and received his master’s degree from the Naval Postgraduate School in Monterey in 1991. In 2012, the Texas Exes honored McRaven with a Distinguished Alumnus Award. Source: www.utsystem.edu/chancellor/biography

Question 1. What leadership lessons did you take away from SEAL training and leadership of SEAL Team 3?

The foundation of effective leadership is being able to lead yourself. This may sound strange, but it is true. Most initial military training—perhaps no more note- worthy than in that training crucible to become a Navy

SEAL—helps young people move past self-imposed limits of physical and mental endurance and build confidence in themselves to lead others. The result is a person who is capable of leading in an environment of constant stress, chaos, failure and hardships. In fact, to me, basic SEAL training was a lifetime sampling of micro-challenges I would later face while leading people and organizations all crammed into six months.

Question 2. In leading Neptune Spear, what were the key leadership decisions you made to build an organization to accomplish this task?

The majority of the key leadership decisions that in past enabled us to accomplish this task began before I took command of the organization—but as a member of the

organization and its number 2 leader over a period of years, I had been an engaged student in the trial, error, and the ulti- mate development of what my old boss, General Stan McChrystal, called a “team of teams.” You see, our operational envi- ronment was changing at an incredibly rapid pace. Unlike any time in our history the rate of change was—and is—no longer linear, it is exponential.

The enemy I faced in Iraq, Afghanistan, Africa, Asia and across the world adapted quickly to our methods of warfare. Using technology, social media and global transportation, they presented tactical and operational problems that today’s special operations forces had never seen before. Consequently, our organizations

had to adapt to this rapidly changing threat. We had to build a flat chain of command that empowered the lead- ers below us. We had to reduce our own bureaucracy so we could make timely decisions. We had to constantly communicate so everyone understood the commander’s intent and the strategic direction in which we were head- ing. We had to collaborate in ways that had never been done in the history of special operations warfare. The team of teams we built enabled all of our organizations to derive strength from each other and work together to be successful. It required us to break away from the hierarchical structure—the command structure—that had defined the American military for hundreds of years.

We formed a formal and informal network of subject mat- ter experts bound together by a common mission, using technology to partner in new ways, brought together through operational incentives, and a bottom-up desire with top-down support to solve the most complex prob- lems facing our nation. Essentially, we structured our

INSIGHTS from executives1.1

THE STRATEGIC MANAGEMENT PROCESS

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organization and our processes to use our size, our talent and our operational diversity to achieve an unparalleled level of collaboration in pursuit of common goals.

Though leadership, effective processes, and a trust-based organizational culture had significant parts to play in the success of Neptune Spear, no one should forget it was the actions of well-trained, committed, confident and fiercely determined young Americans who were responsible for the positive outcome of that operation.

Question 3. What lessons have you taken from your military career as you lead a very different type of organization as Chancellor of the University of Texas?

Actually, the duties, responsibilities and organizational relationships are remarkably similar. I am still a servant leader, but instead of serving my country at the national level, I serve the people of Texas. For years as a flag offi- cer I had a frequent and direct relationship with the U.S. Congress; I now have a similar responsibility to inform and respond to the Texas Legislature. Instead of the Secretary of Defense and his staff, and the Chairman of the Joint Chiefs and his staff, providing oversight and guidance, I have the Board of Regents. And the four- teen institutions for which I feel directly responsible are led by very mature professionals who expect a high level of empowerment and autonomy—much like the mature professionals of the large and diverse organizations I commanded over the last decade.

This does not mean, of course, that I approach situa- tions or lead our incredible System the exact same way as I led Special Operations Command—it simply means that I have a comfortable context for the relationships I must build and sustain. The lessons I bring from the military feed off of that—I may have context for these relationships, but I also realize this is a different environ- ment and I must first understand the conditions of the higher education environment before I go about making changes. Understanding the environment—specifically, conducting a strategic assessment—was the focus of my effort for the second half of my first year in office. I knew as the senior leader, I first needed to learn and appreciate the conditions under which we were operat- ing. Another lesson I brought was the importance of establishing relationships early by getting out as much as possible and seeing and listening to others—inside my organization primarily, but also reaching out to stake- holders who lie outside the System. Additionally, I knew from my time in the military that communication and

collaboration—and an organizational culture that rein- forces both those things—are critical keys to success.

The aforementioned concept of a “team of teams” was probably the single most valuable organizational change in the history of the modern military, and it continues and matures even today. Navy SEALs work with the Army Special Forces. The Special Forces work with the conven- tional infantry. The infantry work with the naval aviators. The pilots and crews work with the logisticians. We all work with the intelligence and law enforcement communi- ties and the locals on the ground. And every day we talk. We would look at a problem, and we were finding solu- tions at a speed unheard of in the past. In other words, everyone has to contribute their ideas—not just listen.

Here at the University of Texas System, I believe we can build our own “team of teams” and we are in the process of doing so. We will use our size, our talent and our diversity to collaborate on difficult issues, and in an environment of competing demands, we will prioritize our objectives so we do not waste effort on inconsequential goals. As the second largest university system in the United States we must apply our resources to those priorities and cut away where we are not effective. And much like my last organization, our rapidly changing environment requires us to constantly innovate to get ahead of our problems while never losing sight of our mission and our objectives.

Question 4. How did you see personal integrity and organizational ethics play out in your military career? Can you provide some examples of actions you took to build or sustain an ethical organization?

You always have to reinforce three main principles of a good organization. That is, all your actions must be moral, legal, and ethical. If you fail to comply with those foundational elements, you and your organiza- tion will fail. It all starts with your personal integrity. Maintaining your personal integrity is hard. Being good all the time is difficult. Making the right decisions in the face of temptation is challenging, but you quickly learn that bad decisions have consequences, consequences that are rarely worth the momentary lapse in judgment.

If you do the right thing, particularly when no one is watch- ing, you will be rewarded many times over. The only way to build and sustain an ethical organization is for you, the leader, to demonstrate the qualities you want the organi- zation to uphold. Everyone is watching you—whether you know it or not. The littlest actions and the smallest deci- sions are all closely observed. The culture begins at the top.

Laden. He recently became Chancellor of the University of Texas System. His experience as an effective leader in both military and university organizations provides valuable insights into the strategic management processes: analysis, formulation, and implementation.

Let’s now address two concepts—corporate governance and stakeholder management— that are critical to the strategic management process.

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THE ROLE OF CORPORATE GOVERNANCE AND STAKEHOLDER MANAGEMENT Most business enterprises that employ more than a few dozen people are organized as cor- porations. As you recall from your finance classes, the overall purpose of a corporation is to maximize the long-term return to the owners (shareholders). Thus, we may ask: Who is really responsible for fulfilling this purpose? Robert Monks and Neil Minow provide a useful definition of corporate governance as “the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the chief executive officer), and (3) the board of directors.”42 This relationship is illustrated in Exhibit 1.4.

The board of directors (BOD) are the elected representatives of the shareholders charged with ensuring that the interests and motives of management are aligned with those of the owners (i.e., shareholders). In many cases, the BOD is diligent in fulfilling its purpose. For example, Intel Corporation, the giant $58 billion maker of microprocessor chips, practices sound governance. Its BOD follows guidelines to ensure that its members are independent (i.e., are not members of the executive management team and do not have close personal ties to top executives) so that they can provide proper oversight; it has explicit guidelines on the selection of director candidates (to avoid “cronyism”). It provides detailed procedures for formal evaluations of directors and the firm’s top officers.43 Such guidelines serve to ensure that management is acting in the best interests of shareholders.44

Recently, there has been much criticism as well as cynicism by both citizens and the business press about the poor job that management and the BODs of large corporations are doing. We only have to look at the scandals at firms such as Arthur Andersen, Best Buy, Olympus, Enron, Volkswagen, and Wells Fargo.45 Such malfeasance has led to an erosion of the public’s trust in corporations. For example, according to the 2014 CNBC/Burson- Marsteller Corporation Perception Indicator, a global survey of 25,000 individuals, only 52 percent of the public in developed markets has a favorable view of corporations.46 Forty- five percent felt corporations have “too much influence over the government.” More than half of the U.S. public said “strong and influential” corporations are “bad” even if they are promoting innovation and growth, and only 9 percent of the public in the United States says corporate CEOs are “among the most respected” in society.

Perhaps, part of the responsibility—or blame—lies with boards of directors who are often not delivering on their core mission: providing strong oversight and strategic support for management’s efforts to create long-term value.47 In a 2013 study by McKinsey & Co., only

corporate governance the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the chief executive officer), and (3) the board of directors.

LO 1-3 The vital role of corporate governance and stakeholder management, as well as how “symbiosis” can be achieved among an organization’s stakeholders.

EXHIBIT 1.4 The Key Elements of Corporate Governance Management

(Headed by the chief executive officer)

Shareholders (Owners)

Board of Directors (Elected by the shareholders to represent their interests)

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34 percent of 772 directors agreed that the boards on which they served fully comprehended their firm’s strategies. And only 22 percent claimed their boards were completely aware of how their firms created value. Finally, a mere 16 percent claimed their boards had a strong understanding of the dynamics of their firms’ industries.

One area in which public anger is most pronounced is the excessive compensation of the top executives of well-known firms. It is now clear that much of the bonus pay awarded to executives on Wall Street in the past was richly undeserved.48 Case in point, 2011 was a poor year for financial stocks: 35 of the 50 largest financial company stocks fell that year. The sector lost 17 percent—compared to flat performance for the Standard & Poor’s 500. However, even as the sector struggled, the average pay of finance company CEOs rose 20.4 percent. For example, JPMorgan CEO Jamie Dimon was the highest-paid banker—with $23.1 million in compensation, an 11 percent increase from the previous year. The firm’s shareholders didn’t do as well—the stock fell 20 percent.49

Of course, executive pay is not restricted to financial institutions. A study released in 2016 entitled “The 100 Most Overpaid CEOs” addressed what it viewed as the “fundamen- tal disconnect between CEO pay and performance.”50 It found that CEO pay grew 997 percent over the most recent 36-year period—a rate that outpaced the growth in the cost of living, the productivity of the economy, and the stock market. The lead author, Rosanna Weaver, argues that the latter point disproves “the claim that the growth in CEO pay reflects the ‘performance’ of the company, the value of its stock, or the ability of the CEO to do anything but disproportionately raise the amount of his pay.” And, a regression analysis con- ducted by HIP Investor that considered environmental, social, and governance factors came to a similar conclusion: 17 CEOs made at least $20 million more in 2014 than they would have if their pay had been tied to performance.

Clearly, there is a strong need for improved corporate governance, and we will address this topic in Chapter 9.51 We focus on three important mechanisms to ensure effective cor- porate governance: an effective and engaged board of directors, shareholder activism, and proper managerial rewards and incentives.52 In addition to these internal controls, a key role is played by various external control mechanisms.53 These include the auditors, banks, analysts, an active financial press, and the threat of hostile takeovers.

Alternative Perspectives of Stakeholder Management Generating long-term returns for the shareholders is the primary goal of a publicly held corporation.54 As noted by former Chrysler vice chairman Robert Lutz, “We are here to serve the shareholder and create shareholder value. I insist that the only person who owns the company is the person who paid good money for it.”55

Despite the primacy of generating shareholder value, managers who focus solely on the interests of the owners of the business will often make poor decisions that lead to negative, unanticipated outcomes.56 For example, decisions such as mass layoffs to increase profits, ignoring issues related to conservation of the natural environment to save money, and exert- ing excessive pressure on suppliers to lower prices can harm the firm in the long run. Such actions would likely lead to negative outcomes such as alienated employees, increased gov- ernmental oversight and fines, and disloyal suppliers.

Clearly, in addition to shareholders, there are other stakeholders (e.g., suppliers, custom- ers) who must be taken into account in the strategic management process.57 A stakeholder can be defined as an individual or group, inside or outside the company, that has a stake in and can influence an organization’s performance. Each stakeholder group makes various claims on the company.58 Exhibit 1.5 provides a list of major stakeholder groups and the nature of their claims on the company.

Zero Sum or Symbiosis? There are two opposing ways of looking at the role of stakeholder management.59 The first one can be termed “zero sum.” Here, the various stakeholders

stakeholder management a firm’s strategy for recognizing and responding to the interests of all its salient stakeholders.

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compete for the organization’s resources: the gain of one individual or group is the loss of another individual or group. For example, employees want higher wages (which drive down profits), suppliers want higher prices for their inputs and slower, more flexible delivery times (which drive up costs), customers want fast deliveries and higher quality (which drive up costs), the community at large wants charitable contributions (which take money from company goals), and so on. This zero-sum thinking is rooted, in part, in the traditional con- flict between workers and management, leading to the formation of unions and sometimes ending in adversarial union–management negotiations and long, bitter strikes.

Consider, for example, the many stakeholder challenges facing Walmart, the world’s larg- est retailer.

Walmart strives to ramp up growth while many stakeholders are watching nervously: employees and trade unions; shareholders, investors, and creditors; suppliers and joint venture partners; the governments of the United States and other nations where the retailer operates; and customers. In addition many non-governmental organizations (NGOs), particularly in countries where the retailer buys its products, are closely monitoring Walmart. Walmart’s stakeholders have different interests, and not all of them share the firm’s goals.

There will always be conflicting demands on organizations. However, organizations can achieve mutual benefit through stakeholder symbiosis, which recognizes that stakehold- ers are dependent upon each other for their success and well-being.60 Consider Procter & Gamble’s “laundry detergent compaction,” a technique for compressing even more cleaning power into ever smaller concentrations.

P&G perfected a technique that could compact two or three times as much cleaning powder into a liquid concentration. This remarkable breakthrough has led to not only a change in consumer shopping habits but also a revolution in industry supply chain econom- ics. Here’s how several key stakeholders are affected:

Consumers love concentrated liquids because they are easier to carry, pour, and store. Retailers, meanwhile, prefer them because they take up less floor and shelf space, which leads to higher sales-per-square-foot—a big deal for Walmart, Target, and other big retailers. Shipping and wholesalers, meanwhile, prefer reduced-sized products because smaller bottles translate into reduced fuel consumption and improved warehouse space utilization. And, finally, environmentalists favor such products because they use less packaging and produce less waste than conventional products.61

Social Responsibility and Environmental Sustainability: Moving beyond the Immediate Stakeholders Organizations cannot ignore the interests and demands of stakeholders such as citizens and society in general that are beyond its immediate constituencies—customers, owners, suppliers, and employees. The realization that firms have multiple stakeholders and that

Stakeholder Group Nature of Claim

Stockholders Dividends, capital appreciation

Employees Wages, benefits, safe working environment, job security

Suppliers Payment on time, assurance of continued relationship

Creditors Payment of interest, repayment of principal

Customers Value, warranties

Government Taxes, compliance with regulations

Communities Good citizenship behavior such as charities, employment, not polluting the environment

EXHIBIT 1.5 An Organization’s Key Stakeholders and the Nature of Their Claims

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evaluating their performance must go beyond analyzing their financial results has led to a new way of thinking about businesses and their relationship to society.

First, social responsibility recognizes that businesses must respond to society’s expectations regarding their obligations to society. Second, the triple bottom line approach evaluates a firm’s performance. This perspective takes into account financial, social, and environmental perfor- mance. Third, making the case for sustainability initiatives addresses some of the challenges managers face in obtaining approvals for such projects—and how to overcome them.

Social Responsibility Social responsibility is the expectation that businesses or individuals will strive to improve the overall welfare of society.62 From the perspective of a business, this means that managers must take active steps to make society better by virtue of the business being in existence.63 What constitutes socially responsible behavior changes over time. In the 1970s affirmative action was a high priority; during the 1990s and up to the present time, the public has been concerned about environmental quality. Many firms have responded to this by engaging in recycling and reducing waste. And in the wake of terrorist attacks on New York City and the Pentagon, as well as the continuing threat from terrorists worldwide, a new kind of priority has arisen: the need to be vigilant concerning public safety.

In order to maximize the positive impact of corporate social responsibility (CSR) initia- tives, firms need to create coherent strategies.64 Research has shown that companies’ CSR activities are generally divided across three theaters of practice and assigning the activities accordingly is an important initial step.

• Theater one: Focusing on philanthropy. Here, programs are not designed to increase profits or revenues. Examples include financial contributions to civic and charity organizations as well as the participation and engagement of employees in community programs.

• Theater two: Improving operational effectiveness. Initiatives in this theater function within existing business models to provide social or environmental benefits and support a company’s value creating activities in order to enhance efficiency and effectiveness. They typically can increase revenue or decrease costs—or both. Examples include sustainability initiatives that can reduce the use of resources, waste, or emissions—to cut costs. Or, firms can invest in employee health care and working conditions to enhance retention and productivity—as well as a firm’s reputation.

• Theater three: Transforming the business model. Improved business performance is a requirement of programs in this theater and is predicated on social and environmental challenges and results. An example would be Hindustan Unilever’s Project Shakti in India. Rather than use the typical wholesaler-retailer distribution model to reach remote villages, the firm recruited village women who were provided with training and microfinance loans in order to sell soaps, detergents, and other products door-to-door. More than 65,000 women were recruited and not only were they able to typically double their household’s income but it also contributed to public health via access to hygiene products. The project attained more than $100 million in revenues and has led the firm to roll out similar programs in other countries.

A key stakeholder group that appears to be particularly susceptible to corporate social respon- sibility (CSR) initiatives is customers.65 Surveys indicate a strong positive relationship between CSR behaviors and consumers’ reactions to a firm’s products and services.66 For example:

• Corporate Citizenship’s poll conducted by Cone Communications found that “84 percent of Americans say they would be likely to switch brands to one associated with a good cause, if price and quality are similar.”67

• Hill & Knowlton/Harris’s Interactive poll reveals that “79 percent of Americans take corporate citizenship into account when deciding whether to buy a particular company’s product and 37 percent consider corporate citizenship an important factor when making purchasing decisions.”68

social responsibility the expectation that businesses or individuals will strive to improve the overall welfare of society.

LO 1-4 The importance of social responsibility, including environmental sustainability, and how it can enhance a corporation’s innovation strategy.

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Such findings are consistent with a large body of research that confirms the positive influ- ence of CSR on consumers’ company evaluations and product purchase intentions across a broad range of product categories.

The Triple Bottom Line: Incorporating Financial as Well as Environmental and Social Costs  Many companies are now measuring what has been called a “triple bottom line.” This involves assessing financial, social, and environmental performance. Shell, NEC, Procter & Gamble, and others have recognized that failing to account for the environmental and social costs of doing business poses risks to the company and its community.69

Social and environmental issues can ultimately become financial issues. According to Lars Sorensen, CEO of Novo Nordisk, a $16 billion global pharmaceutical firm based in Denmark:70

If we keep polluting, stricter regulations will be imposed, and energy consumption will become more costly. The same thing applies to the social side. If we don’t treat employees well, if we don’t behave as good corporate citizens in our local communities, and if we don’t provide inexpensive products for poorer countries, governments will impose regulations on us that will end up being very costly.

The environmental revolution has been almost four decades in the making.71 In the 1960s and 1970s, companies were in a state of denial regarding their firms’ impact on the natural environment. However, a series of visible ecological problems created a groundswell for strict governmental regulation. In the United States, Lake Erie was “dead,” and in Japan, people died of mercury poisoning. More recently, Japan’s horrific tsunami that took place on March 11, 2011, and Hurricane Sandy’s devastation on the East Coast of the United States in late October 2012 have raised alarms.

Environmental sustainability is now a value embraced by the most competitive and suc- cessful multinational companies.72 The McKinsey & Company’s survey of more than 400 senior executives of companies around the world found that 92 percent agreed with former Sony president Akio Morita’s contention that the environmental challenge will be one of the central issues in the 21st century.73 Virtually all executives acknowledged their firms’ responsibility to control pollution, and 83 percent agreed that corporations have an environ- mental responsibility for their products even after they are sold.

For many successful firms, environmental values are now becoming a central part of their cultures and management processes.74 And, as noted earlier, environmental impacts are being audited and accounted for as the “third bottom line.” According to a recent corporate report, “If we aren’t good corporate citizens as reflected in a Triple Bottom Line that takes into account social and environmental responsibilities along with financial ones—eventually our stock price, our profits, and our entire business could suffer.”75 Also, a CEO survey on sustainability by Accenture debunks the notion that sustainability and profitability are mutually exclusive corporate goals. The study found that sustainability is being increasingly recognized as a source of cost efficiencies and revenue growth. In many companies, sustain- ability activities have led to increases in revenue and profits. As Jeff Immelt, the CEO of General Electric, puts it, “Green is green.”76 Strategy Spotlight 1.2 shows how Walmart is able to dramatically increase its use of renewable energy—and make money on it, as well.

Many firms have profited by investing in socially responsible behavior, including those activities that enhance environmental sustainability. However, how do such “socially respon- sible” companies fare in terms of shareholder returns compared to benchmarks such as the Standard & Poor’s 500 Index? Let’s look at some of the evidence.

SRI (socially responsible investing) is a broad-based approach to investing that now encompasses an estimated $3.7 trillion, or $1 out of every $9 under professional management in the United States.77 SRI recognizes that corporate responsibility and societal concerns are considerations in investment decisions. With SRI, investors have the opportunity to put

triple bottom line assessment of a firm’s financial, social, and environmental performance.

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1.2 ENVIRONMENTAL SUSTAINABILITYSTRATEGY SPOTLIGHT HOW WALMART DEPLOYS GREEN ENERGY ON AN INDUSTRIAL SCALE—AND MAKES MONEY AT IT. During a visit to Walmart’s store in Mountain View, California, then- President Barack Obama said, “More and more companies like Walmart are realizing that wasting less energy isn’t just good for the planet, it’s good for business. It’s good for the bottom line.”

Despite the good public relations that Walmart got from the visit, the $480 billion company is far too savvy to lose money on its renewable energy initiatives. Instead, the retailer has off-loaded its capital investment, along with all of the risk, onto partners such as SolarCity. This minimizes their exposure by benefiting from the federal government’s generous subsidies for alternative energy investments.

Walmart has installed 105 megawatts of solar panels on the roofs of 327 stores and distribution centers. That is about 6 percent of their locations and represents enough energy to power 20,000 houses. It has become the nation’s largest commercial solar genera- tor and it plans to double its number of panels by 2020.

How has Walmart cut its costs? The way it usually does— by using its tremendous power over its suppliers to risk their own capital in order to get what it wants. For example, it pro- vides  access to its roof space to SolarCity, or other installers, who install the panels (at a cost of about $1.2 million for the average store array). The supplier then sells the power gener- ated to Walmart under a long-term deal—at a price that is typi- cally cheaper than what the local electric utility would charge. Claims David Ozment, Walmart’s energy chief, “The value propo- sition is obvious. Why put up our own capital?”

As of 2015, Walmart was getting 26 percent of its worldwide power from green sources—including wind, solar, fuel cells and hydropower. Walmart’s longer-term goal is to use a combination of energy-efficient measures to source half of the company’s energy needs from renewable sources by 2025. This will also result in an estimated 18 percent emissions reduction from its operations.

Sources: Helman, C. 2015. Everyday renewable energy. Forbes. November 23: 66, 68; and Makower, J. 2016. Insider Walmart’s 2025 sustainability goals. www. greenbiz.com. November 4: np.

their money to work to build a more sustainable world while earning competitive returns both today and over time.

And, as the saying goes, nice guys don’t have to finish last. The ING SRI Index Fund, which tracks the stocks of 50 companies, enjoyed a 47.4 percent return in a recent year. That easily beat the 2.65 percent gain of the Standard & Poor’s 500 stock index. A review of the 145 socially responsible equity mutual and exchange-traded funds tracked by Morningstar also shows that 65 percent of them outperformed the S&P 500.78

Making the Business Case for Sustainability Initiatives We mentioned many financial and nonfinancial benefits associated with sustainability initiatives in the previous section. However, in practice, such initiatives often have difficulty making it through the conven- tional approval process within corporations. This is primarily because, before companies make investments in projects, managers want to know their return on investment.79

The ROIs on sustainability projects are often very difficult to quantify for a number of reasons. Among these are:

1. The data necessary to calculate ROI accurately are often not available when it comes to sustainability projects. However, sustainability programs may often find their success beyond company boundaries, so internal systems and process metrics can’t capture all the relevant numbers.

2. Many of the benefits from such projects are intangible. Traditional financial models are built around relatively easy-to-measure, monetized results. Yet many of the benefits of sustainability projects involve fuzzy intangibles, such as the goodwill that can enhance a firm’s brand equity.

3. The payback period is on a different time frame. Even when their future benefits can be forecast, sustainability projects often require longer-term payback windows.

Clearly, the case for sustainability projects needs to be made on the basis of a more holistic and comprehensive understanding of all the tangible and intangible benefits rather than whether or not they meet existing hurdle rates for traditional investment projects.

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For example, 3M uses a lower hurdle rate for pollution prevention projects. When it comes to environmental projects, IKEA allows a 10- to 15-year payback period, considerably longer than it allows for other types of investment. And Diversey, a cleaning products company, has employed a portfolio approach. It has established two hurdles for projects in its carbon reduc- tion plan: a three-year payback and a cost per megaton of carbon avoided. Out of 120 possible projects ranging from lighting retrofits to solar photovoltaic systems, only 30 cleared both hurdles. Although about 60 of the other ideas could reach one, an expanded 90-project portfo- lio, all added together, met the double hurdle. Subsequently, Diversey was able to increase its carbon reduction goal from 8 to 25 percent and generated a higher net present value.

Such approaches are the result of the recognition that the intangible benefits of sustain- ability projects—such as reducing risks, staying ahead of regulations, pleasing communities, and enhancing employee morale—are substantial even when they are difficult to quantify. Just as companies spend large fortunes on launching advertising campaigns or initiating R&D projects without a clear quantification of financial returns, sustainability investments are necessary even when it is difficult to calculate the ROI of such investments. The alterna- tive of not making these investments is often no longer feasible.

THE STRATEGIC MANAGEMENT PERSPECTIVE: AN IMPERATIVE THROUGHOUT THE ORGANIZATION Strategic management requires managers to take an integrative view of the organization and assess how all of the functional areas and activities fit together to help an organization achieve its goals and objectives. This cannot be accomplished if only the top managers in the organization take an integrative, strategic perspective of issues facing the firm and everyone else “fends for themselves” in their independent, isolated functional areas. Instead, people throughout the organization must strive toward overall goals.

The need for such a perspective is accelerating in today’s increasingly complex, intercon- nected, ever-changing, global economy. As noted by Peter Senge of MIT, the days when Henry Ford, Alfred Sloan, and Tom Watson (top executives at Ford, General Motors, and IBM, respectively) “learned for the organization are gone.”80

To develop and mobilize people and other assets, leaders are needed throughout the organization.81 No longer can organizations be effective if the top “does the thinking” and the rest of the organization “does the work.” Everyone must be involved in the strategic management process. There is a critical need for three types of leaders:

• Local line leaders who have significant profit-and-loss responsibility. • Executive leaders who champion and guide ideas, create a learning infrastructure,

and establish a domain for taking action. • Internal networkers who, although they have little positional power and formal

authority, generate their power through the conviction and clarity of their ideas.82

Top-level executives are key in setting the tone for the empowerment of employees. Consider Richard Branson, founder of the Virgin Group, whose core businesses include retail operations, hotels, communications, and an airline. He is well known for creating a culture and an informal structure where anybody in the organization can be involved in generating and acting upon new business ideas. In an interview, he stated: “If someone has an idea, they can pick up the phone and talk to me. I can vote, ‘Done, let’s do it.’ Or, better still, they can just go ahead and do it. They know that they are not going to get a mouthful from me if they make a mistake.”83

To inculcate a strategic management perspective, managers must create management processes to foster change. This involves planning, leading, and holding people accountable. At Netflix, leading people is not based on one’s position in the hierarchy, nor an individual

LO 1-5 The need for greater empowerment throughout the organization.

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1.3 STRATEGY SPOTLIGHT STRATEGY AND THE VALUE OF INEXPERIENCE Peter Gruber, chairman of Mandalay Entertainment, discovered that great ideas can come from the least expected sources. During the filming of the movie Gorillas in the Mist, his produc- tion company faced many problems. Rwanda—the site of the filming—was on the verge of revolution, the film needed to use 200 animals, and the screenplay required the gorillas to follow a script, that is, do what the script called for and “act.” If that failed, the fallback position was to use dwarfs in gorilla suits on a soundstage—a strategy that usually failed.

Gruber explains how the “day was saved” by someone with very limited experience:

We called an emergency meeting to solve these problems. In the middle of it, a young intern asked, “What if you let the gorillas write the story?” Everyone laughed and wondered what she was doing in the

meeting with experienced filmmakers. Hours later, someone casually asked her what she had meant. She said, “What if you send a really good cinematog- rapher into the jungle with a ton of film to shoot the gorillas, then you could write a story around what the gorillas did on film.” It was a brilliant idea. And we did exactly what she suggested: We sent Alan Root, an Academy Award–nominated cinematographer into the jungle for three weeks. He came back with phenomenal footage that practically wrote the story for us.

The upshot? The film cost $20 million to shoot—half the origi- nal budget. And it was nominated for five Academy Awards— including Sigourney Weaver for best actress—and it won two Golden Globe Awards.

Source: Gruber, P. 1998. My greatest lesson. Fast Company, 14: 88–90; and imdb.com.

LO 1-6 How an awareness of a hierarchy of strategic goals can help an organization achieve coherence in its strategic direction.

trait that is taught to people identified as “high potentials.”84 The expectation is that anyone can take initiative, make decisions, and influence others consistent with the firm’s strat- egy. Everyone gets—and receives—feedback from team members, supervisors, managers, and customers. As part of the overall system that emphasizes transparency, there is the shared belief at Netflix that good results depend on people providing their insights and perspec- tives. Getting alignment, direction, and obtaining results the right way is essential. Those who fail to achieve this are asked to leave the firm.

We’d like to close with our favorite example of how inexperience can be a virtue. It fur- ther reinforces the benefits of having broad involvement throughout the organization in the strategic management process (see Strategy Spotlight 1.3).

ENSURING COHERENCE IN STRATEGIC DIRECTION Employees and managers must strive toward common goals and objectives.85 By specifying desired results, it becomes much easier to move forward. Otherwise, when no one knows what the firm is striving to accomplish, individuals have no idea of what to work toward. Alan Mulally, former CEO at Ford Motor Company, stressed the importance of perspective in creating a sense of mission: “What are we? What is our real purpose? And then, how do you include everybody so you know where you are on that plan, so you can work on areas that need special attention.” 86

Organizations express priorities best through stated goals and objectives that form a hierarchy of goals, which includes the firm’s vision, mission, and strategic objectives.87 What visions may lack in specificity, they make up for in their ability to evoke power- ful and compelling mental images. On the other hand, strategic objectives tend to be more specific and provide a more direct means of determining if the organization is mov- ing toward broader, overall goals.88 Visions, as one would expect, also have longer time horizons than either mission statements or strategic objectives. Exhibit 1.6 depicts the hierarchy of goals and its relationship to two attributes: general versus specific and time horizon.

hierarchy of goals organizational goals ranging from, at the top, those that are less specific yet able to evoke powerful and compelling mental images, to, at the bottom, those that are more specific and measurable.

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Organizational Vision A vision is a goal that is “massively inspiring, overarching, and long term.”89 It represents a destination that is driven by and evokes passion. For example, Wendy Kopp, founder of Teach for America, notes that her vision for the organization, which strives to improve the quality of inner-city schools, draws many applicants: “We’re looking for people who are magnetized to this notion, this vision, that one day all children in our nation should have the opportunity to attain an excellent education.” 90

Leaders must develop and implement a vision. A vision may or may not succeed; it depends on whether or not everything else happens according to an organization’s strategy. As Mark Hurd, Hewlett-Packard’s former CEO, humorously points out: “Without execu- tion, vision is just another word for hallucination.”91

In a survey of executives from 20 different countries, respondents were asked what they believed were a leader’s key traits.92 Ninety-eight percent responded that “a strong sense of vision” was the most important. Similarly, when asked about the critical knowledge skills, the leaders cited “strategy formulation to achieve a vision” as the most important skill. In other words, managers need to have not only a vision but also a plan to implement it. Regretfully, 90 percent reported a lack of confidence in their own skills and ability to conceive a vision. For example, T. J. Rogers, CEO of Cypress Semiconductor, an electronic- chip maker that faced some difficulties in 1992, lamented that his own shortsightedness caused the danger: “I did not have the 50,000-foot view, and got caught.”93

One of the most famous examples of a vision is Disneyland’s: “To be the happiest place on earth.” Other examples are:

• “Restoring patients to full life.” (Medtronic) • “Our vision is to be the world’s best quick service restaurant.” (McDonald’s) • “To organize the world’s information and make it universally accessible and useful.”

(Google) • “To give everyone in the world the power to share and make the world more open

and connected” (Facebook)

Although such visions cannot be accurately measured by a specific indicator of how well they are being achieved, they do provide a fundamental statement of an organization’s values, aspirations, and goals. Such visions go well beyond narrow financial objectives, of course, and strive to capture both the minds and hearts of employees.

The vision statement may also contain a slogan, diagram, or picture—whatever grabs attention.94 The aim is to capture the essence of the more formal parts of the vision in a few words that are easily remembered, yet that evoke the spirit of the entire vision statement. In its 20-year battle with Xerox, Canon’s slogan, or battle cry, was “Beat Xerox.” Motorola’s slogan is “Total Customer Satisfaction.” Outboard Marine Corporation’s slogan is “To Take the World Boating.”

vision organizational goal(s) that evoke(s) powerful and compelling mental images.

EXHIBIT 1.6 A Hierarchy of Goals

Vision

Mission Statement

Strategic Objectives

General

Specific

Long Time Horizon

Short Time Horizon

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Clearly, vision statements are not a cure-all. Sometimes they backfire and erode a com- pany’s credibility. Visions fail for many reasons, including the following:95

The Walk Doesn’t Match the Talk An idealistic vision can arouse employee enthusiasm. However, that same enthusiasm can be quickly dashed if employees find that senior manage- ment’s behavior is not consistent with the vision. Often, vision is a sloganeering campaign of new buzzwords and empty platitudes like “devotion to the customer,” “teamwork,” or “total quality” that aren’t consistently backed by management’s action.

Irrelevance Visions created in a vacuum—unrelated to environmental threats or opportuni- ties or an organization’s resources and capabilities—often ignore the needs of those who are expected to buy into them. Employees reject visions that are not anchored in reality.

Not the Holy Grail Managers often search continually for the one elusive solution that will solve their firm’s problems—that is, the next “holy grail” of management. They may have tried other management fads only to find that they fell short of their expectations. However, they remain convinced that one exists. A vision simply cannot be viewed as a magic cure for an organization’s illness.

Too Much Focus Leads to Missed Opportunities The downside of too much focus is that in directing people and resources toward a grandiose vision, losses can be significant. It is analo- gous to focusing your eyes on a small point on a wall. Clearly, you would not have very much peripheral vision. Similarly, organizations must strive to be aware of unfolding events in both their external and internal environment when formulating and implementing strategies.

An Ideal Future Irreconciled with the Present Although visions are not designed to mir- ror reality, they must be anchored somehow in it. People have difficulty identifying with a vision that paints a rosy picture of the future but does not account for the often hostile environment in which the firm competes or that ignores some of the firm’s weaknesses.

Mission Statements A company’s mission statement differs from its vision in that it encompasses both the pur- pose of the company and the basis of competition and competitive advantage.

Exhibit 1.7 contains the vision statement and mission statement of WellPoint Health Network (renamed Anthem, Inc., in December 2014), a giant $79 billion managed health care organization. Note that while the vision statement is broad-based, the mission state- ment is more specific and focused on the means by which the firm will compete.

Effective mission statements incorporate the concept of stakeholder management, suggest- ing that organizations must respond to multiple constituencies. Customers, employees, sup- pliers, and owners are the primary stakeholders, but others may also play an important role. Mission statements also have the greatest impact when they reflect an organization’s enduring,

mission statement a set of organizational goals that identifies the purpose of the organization, its basis of competition, and competitive advantage.

Vision

WellPoint will redefine our industry: Through a new generation of consumer-friendly products that put individuals back in control of their future.

Mission

The WellPoint companies provide health security by offering a choice of quality branded health and related financial services designed to meet the changing expectations of individuals, families, and their sponsors throughout a lifelong relationship.

Source: WellPoint Health Network company records.

EXHIBIT 1.7 Comparing WellPoint Health Network’s Vision and Mission

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overarching strategic priorities and competitive positioning. Mission statements also can vary in length and specificity. The three mission statements below illustrate these issues.

• “To produce superior financial returns for our shareholders as we serve our customers with the highest quality transportation, logistics, and e-commerce.” (Federal Express)

• “Build the best product, cause no unnecessary harm, use business to inspire and implement solutions to the environmental crisis.” (Patagonia)

• “To be the very best in the business. Our game plan is status go . . . we are constantly looking ahead, building on our strengths, and reaching for new goals. In our quest of these goals, we look at the three stars of the Brinker logo and are reminded of the basic values that are the strength of this company . . . People, Quality and Profitability. Everything we do at Brinker must support these core values. We also look at the eight golden flames depicted in our logo, and are reminded of the fire that ignites our mission and makes up the heart and soul of this incredible company. These flames are: Customers, Food, Team, Concepts, Culture, Partners, Community, and Shareholders. As keeper of these flames, we will continue to build on our strengths and work together to be the best in the business.” (Brinker International, whose restaurant chains include Chili’s and On the Border)96

Few mission statements identify profit or any other financial indicator as the sole purpose of the firm. Indeed, many do not even mention profit or shareholder return.97 Employees of organizations or departments are usually the mission’s most important audi- ence. For them, the mission should help to build a common understanding of purpose and commitment to nurture.

A good mission statement, by addressing each principal theme, must communicate why an organization is special and different. Two studies that linked corporate values and mis- sion statements with financial performance found that the most successful firms mentioned values other than profits. The less successful firms focused almost entirely on profitability.98 In essence, profit is the metaphorical equivalent of oxygen, food, and water that the body requires. They are not the point of life, but without them, there is no life.

Vision statements tend to be quite enduring and seldom change. However, a firm’s mis- sion can and should change when competitive conditions dramatically change or the firm is faced with new threats or opportunities.

Sometimes a firm needs to shrink significantly. Such initiatives can enable a firm to regroup, redeploy, and restart profitable growth. Strategy Spotlight 1.4 explains how Perceptual Limited, an Australian investment and trustee group, recovered from financial decline by reducing oper- ating costs, eliminating noncore businesses, and rallying around its founder’s original mission.

Strategic Objectives Strategic objectives are used to operationalize the mission statement.99 That is, they help to provide guidance on how the organization can fulfill or move toward the “higher goals” in the goal hierarchy—the mission and vision. Thus, they are more specific and cover a more well-defined time frame. Setting objectives demands a yardstick to measure the fulfillment of the objectives.100

Exhibit 1.8 lists several firms’ strategic objectives—both financial and nonfinancial. While most of them are directed toward generating greater profits and returns for the own- ers of the business, others are directed at customers or society at large.

For objectives to be meaningful, they need to satisfy several criteria. An objective must be:

• Measurable. There must be at least one indicator (or yardstick) that measures progress against fulfilling the objective.

• Specific. This provides a clear message as to what needs to be accomplished. • Appropriate. It must be consistent with the organization’s vision and mission.

strategic objectives a set of organizational goals that are used to put into practice the mission statement and that are specific and cover a well- defined time frame.

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1.4 STRATEGY SPOTLIGHT HOW PERCEPTUAL LIMITED SUCCEEDED BY RALLYING AROUND THE FOUNDER’S ORIGINAL MISSION Perceptual Limited has enjoyed a long and storied history. It was established in 1886 to manage the trusts and estates of Australia’s wealthy families and led the market for most of its history. However, as it grew it lost its focus and began diversifying into several new business areas. By 2011, the firm was struggling—its share price had slid from a high of $84 to $24 in four years and profits were down almost 70 percent. Not surprisingly, shareholders were call- ing publicly for new leadership and a major repositioning of the firm. Enter Geoff Lloyd, Perceptual’s third CEO in twelve months.

Lloyd discovered that the firm had become internally com- petitive and had grown incredibly complex over time by entering many new businesses—and did not hold leadership positions in most of them. He was convinced that he needed to restore the company to its original core mission: the protection of Australia’s wealth. To do this, he realized he would need to make the firm “faster, more confident, and, above all, simpler.”

He quickly made many changes. He replaced 10 of 11 members of the management team with people who had no vested interest in the past decisions. He launched Transformation 2015—which

included several initiatives directed toward reducing complexity at all levels. These included: (1) reducing the number of businesses from 11 to three—asset management, high net worth advisory and trustee services, and corporate fiduciary services (after all, just two businesses were responsible for 95 percent of the profits!), (2) reducing real estate holdings by half, and (3) reducing headquar- ters staff by 50 percent. His team also found that Perceptual was using more than 3,000 computer systems and applications.

Along with all of the cutbacks, Lloyd and his management team focused on a plan to gain market share by investing in the firm’s core. He led town hall meetings to explain the company’s situation and to ignite interest for its core values. Key among his efforts was to get employees to refocus on the founding princi- ples of the company. During the process, Lloyd found something remarkable: Perceptual’s original trust business was so strong that it still had its first customer—125 years later.

Efforts by Lloyd and his management team led to a dramatic turnaround. Its stock price more than doubled within four years; employee engagement has significantly increased; the firm is gaining market share in its core markets; and net profits have increased over 16 percent each year from 2011 to 2015. Sources: Zook, C. & Allen, J. Reigniting growth. Harvard Business Review. 94(3): 70-76; www.perceptual2015. reportonline.com.au; and, www.perceptual.com.au.

Strategic Objectives (Financial)

• Increase sales growth 6 percent to 8 percent and accelerate core net earnings growth from 13 percent to 15 percent per share in each of the next 5 years. (Procter & Gamble)

• Generate Internet-related revenue of $1.5 billion. (AutoNation) • Increase the contribution of Banking Group earnings from investments, brokerage, and insurance from

16 percent to 25 percent. (Wells Fargo) • Cut corporate overhead costs by $30 million per year. (Fortune Brands)

Strategic Objectives (Nonfinancial)

• We want a majority of our customers, when surveyed, to say they consider Wells Fargo the best financial institution in the community. (Wells Fargo)

• Reduce volatile air emissions 15 percent by 2015 from 2010 base year, indexed to net sales. (3M) • Our goal is to help save 100,000 more lives each year. (Varian Medical Systems) • We want to be the top-ranked supplier to our customers. (PPG)

Sources: Company documents and annual reports.

EXHIBIT 1.8 Strategic Objectives

• Realistic. It must be an achievable target given the organization’s capabilities and opportunities in the environment. In essence, it must be challenging but doable.

• Timely. There must be a time frame for achieving the objective. As the economist John Maynard Keynes once said, “In the long run, we are all dead!”

When objectives satisfy the above criteria, there are many benefits. First, they help to channel all employees’ efforts toward common goals. This helps the organization concen- trate and conserve valuable resources and work collectively in a timely manner.

Second, challenging objectives can help to motivate and inspire employees to higher levels of commitment and effort. Much research has supported the notion that people work

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ISSUE FOR DEBATE

Seventh Generation’s Decision Dilemma A strike idled 67,300 workers of the United Food and Commercial Workers (UFCW) who worked at Albertsons, Ralphs, and Vons—all large grocery store chains. These stores sold natural home products made by Seventh Generation, a socially conscious company. Interestingly, the inspiration for its name came from the Great Law of the Haudenosaunee. (This Law of Peace of the Iroquois Confederacy in North America has its roots in the 14th century.) The law states that “in our every deliberation we must consider the impact of our decisions on the next seven generations.” Accordingly, the company’s mission is “To inspire a revolution that nurtures the health of the next seven generations,” and its values are to “care wholeheartedly, collaborate deliberately, nurture nature, innovate disruptively, and be a trusted brand.”

Clearly, Seventh Generation faced a dilemma: On the one hand, it believed that the strikers had a just cause. However, if it honored the strikers by not crossing the picket lines, the firm would lose the shelf space for its products in the stores it had worked so hard to secure. Honoring the strikers would also erode its trust with the large grocery stores. On the other hand, if Seventh Generation ignored the strikers and proceeded to send its products to the stores, it would be compromising its values and thereby losing trust and credibility with several stakeholders—its customers, distributors, and employees.

Discussion Questions 1. How important should the Seventh Generation values be considered when deciding what to do? 2. How can Seventh Generation solve this dilemma?

Sources: Russo, M. V. 2010. Companies on a mission: Entrepreneurial strategies for growing sustainably, responsibly, and profitably. Stanford: Stanford University Press: 94–96; Seventh Generation. 2012. Seventh generation’s mission—Corporate social responsibility. www.seventhgeneration.com, np; Foster, A. C. 2004. Major work stoppage in 2003. U.S. Bureau of Labor and Statistics. Compensation and Working Conditions. www.bls.gov, November 23: np; Fast Company. 2008. 45 social entrepreneurs who are changing the world. Profits with purpose: Seventh Generation. www.fastcompany, np; and Ratical. Undated. The six nations: Oldest living participatory democracy on earth. www.ratical.org, np.

harder when they are striving toward specific goals instead of being asked simply to “do their best.”

Third, as we noted earlier in the chapter, there is always the potential for different parts of an organization to pursue their own goals rather than overall company goals. Although well intentioned, these may work at cross-purposes to the organization as a whole. Meaningful objectives thus help to resolve conflicts when they arise.

Finally, proper objectives provide a yardstick for rewards and incentives. They will ensure a greater sense of equity or fairness when rewards are allocated.

A caveat: When formulating strategic objectives, managers need to remember that too many objectives can result in a lack of focus and diminished results:

A few years ago CEO Tony Petrucciani and his team at Single Source Systems, a software firm in Fishers, Indiana, set 15 annual objectives, such as automating some of its software functions. However, the firm, which got distracted by having so many items on its objective list, missed its $8.1 million revenue benchmark by 11 percent. “Nobody focused on any one thing,” he says. Going forward, Petrucciani decided to set just a few key priorities. This helped the company to meet its goal of $10 million in sales. Sometimes, less is more!101

In addition to the above, organizations have lower-level objectives that are more spe- cific than strategic objectives. These are often referred to as short-term objectives—essential components of a firm’s “action plan” that are critical in implementing the firm’s chosen strategy. We discuss these issues in detail in Chapter 9.

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Reflecting on Career Implications . . . This chapter discusses both the long-term focus of strategy and the need for coherence in strategic direction. The following questions extend these themes by asking students to consider their own strategic goals and how they fit with the goals of the firms in which they work or would seek employment.

Attributes of Strategic Management: The attributes of strategic management described in this chapter are applicable to your personal careers as well. What are your overall goals and objectives? Who are the stakeholders you have to consider in making your career decisions (family, community, etc.)? What trade- offs do you see between your long-term and short-term goals?

Intended versus Emergent Strategies: While you may have planned your career trajectory carefully, don’t be too tied to it. Strive to take advantage of new opportunities as they arise. Many promising career opportunities may “emerge” that were not part of your intended career strategy or your specific job assignment. Take initiative by pursuing opportunities to get additional training (e.g., learn a software or a statistical package), volunteering for a short-term overseas assignment, etc. You may be in a better position to take advantage of such emergent opportunities if you take the effort to prepare for

them. For example, learning a foreign language may position you better for an overseas opportunity.

Ambidexterity: In Strategy Spotlight 1.1, we discussed the four most important traits of ambidextrous individuals. These include looking for opportunities beyond the description of one’s job, seeking out opportunities to collaborate with others, building internal networks, and multitasking. Evaluate yourself along each of these criteria. If you score low, think of ways in which you can improve your ambidexterity.

Strategic Coherence: What is the mission of your organization? What are the strategic objectives of the department or unit you are working for? In what ways does your own role contribute to the mission and objectives? What can you do differently in order to help the organization attain its mission and strategic objectives?

Strategic Coherence: Setting strategic objectives is important in your personal career as well. Identify and write down three or four important strategic objectives you want to accomplish in the next few years (finish your degree, find a better-paying job, etc.). Are you allocating your resources (time, money, etc.) to enable you to achieve these objectives? Are your objectives measurable, timely, realistic, specific, and appropriate?

We began this introductory chapter by defining strategic management and articulating some of its key attributes. Strategic management is defined as “consisting of the analyses, decisions, and actions an organization undertakes

to create and sustain competitive advantages.” The issue of how and why some firms outperform others in the marketplace is central to the study of strategic management. Strategic management has four key attributes: It is directed at overall organizational goals, includes multiple stakeholders, incorporates both short-term and long-term perspectives, and incorporates trade-offs between efficiency and effectiveness.

The second section discussed the strategic management process. Here, we paralleled the above definition of strategic management and focused on three core activities in the strategic management process—strategy analysis, strategy formulation, and strategy implementation. We noted how each of these activities is highly interrelated to and interdependent on the others. We also discussed how each of the first 12 chapters in this text fits into the three core activities.

Next, we introduced two important concepts—corporate governance and stakeholder management—which must be taken into account throughout the strategic management process. Governance mechanisms can be broadly divided into two groups: internal and external. Internal governance mechanisms include shareholders (owners), management (led by the chief executive officer), and the board of directors. External control is exercised by auditors, banks,

analysts, and an active business press as well as the threat of takeovers. We identified five key stakeholders in all organizations: owners, customers, suppliers, employees, and society at large. Successful firms go beyond an overriding focus on satisfying solely the interests of owners. Rather, they recognize the inherent conflicts that arise among the demands of the various stakeholders as well as the need to endeavor to attain “symbiosis”—that is, interdependence and mutual benefit—among the various stakeholder groups. Managers must also recognize the need to act in a socially responsible manner which, if done effectively, can enhance a firm’s innovativeness. The “shared value” approach represents an innovative perspective on creating value for the firm and society at the same time. The managers also should recognize and incorporate issues related to environmental sustainability in their strategic actions.

In the fourth section, we discussed factors that have accelerated the rate of unpredictable change that managers face today. Such factors, and the combination of them, have increased the need for managers and employees throughout the organization to have a strategic management perspective and to become more empowered.

The final section addressed the need for consistency among a firm’s vision, mission, and strategic objectives. Collectively, they form an organization’s hierarchy of goals. Visions should evoke powerful and compelling mental images. However, they are not very specific. Strategic objectives, on the other hand, are much more specific and are vital to ensuring that the organization is striving toward fulfilling its vision and mission.

summary

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romantic view of leadership 4 external control view of leadership 5 strategic management 6 strategy 6 competitive advantage 6 operational effectiveness 6 stakeholders 7 effectiveness 8 efficiency 8

ambidexterity 9 strategic management process 10 intended strategy 10 realized strategy 10 strategy analysis 12 strategy formulation 12 strategy implementation 13 corporate governance 16 stakeholder management 17 social responsibility 19 triple bottom line 20 hierarchy of goals 23 vision 24 mission statement 25 strategic objectives 26

key terms

APPLICATION QUESTIONS & EXERCISES 1. Go to the Internet and look up one of these company

sites: www.walmart.com, www.ge.com, or www.fordmotor. com. What are some of the key events that would represent the “romantic” perspective of leadership? What are some of the key events that depict the “external control” perspective of leadership?

2. Select a company that competes in an industry in which you are interested. What are some of the recent demands that stakeholders have placed on this company? Can you find examples of how the company is trying to develop “symbiosis” (interdependence and mutual benefit) among its stakeholders? (Use the Internet and library resources.)

3. Provide examples of companies that are actively trying to increase the amount of empowerment in the strategic management process throughout the organization. Do these companies seem to be having positive outcomes? Why? Why not?

4. Look up the vision statements and/or mission statements for a few companies. Do you feel that they are constructive and useful as a means of motivating employees and providing a strong strategic direction? Why? Why not? (Note: Annual reports, along with the Internet, may be good sources of information.)

EXPERIENTIAL EXERCISE Using the Internet or library sources, select four organizations— two in the private sector and two in the public sector. Find their mission statements. Complete the following exhibit by identifying the stakeholders that are mentioned. Evaluate the differences between firms in the private sector and those in the public sector.

Organization Name

Mission Statement

Stakeholders (√ = mentioned)

1. Customers

2. Suppliers

3. Managers/employees

4. Community-at-large

5. Owners

6. Others?

7. Others?

SUMMARY REVIEW QUESTIONS 1. How is “strategic management” defined in the text,

and what are its four key attributes? 2. Briefly discuss the three key activities in the strategic

management process. Why is it important for managers to recognize the interdependent nature of these activities?

3. Explain the concept of “stakeholder management.” Why shouldn’t managers be solely interested in stockholder management, that is, maximizing the returns for owners of the firm—its shareholders?

4. What is “corporate governance”? What are its three key elements, and how can it be improved?

5. How can “symbiosis” (interdependence, mutual benefit) be achieved among a firm’s stakeholders?

6. Why do firms need to have a greater strategic management perspective and empowerment in the strategic management process throughout the organization?

7. What is meant by a “hierarchy of goals”? What are the main components of it, and why must consistency be achieved among them?

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ETHICS QUESTIONS 1. A company focuses solely on short-term profits to provide the greatest return to the owners of the business (i.e., the

shareholders in a publicly held firm). What ethical issues could this raise? 2. A firm has spent some time—with input from managers at all levels—on developing a vision statement and a mission

statement. Over time, however, the behavior of some executives is contrary to these statements. Could this raise some ethical issues?

1. Gunther, M. 2010. Fallen angels. Fortune, November 1: 75–78.

2. Colvin, G. 2015. The 21st century corporation. Fortune, November 1: 103–112; and, Anonymous. 2016. The rise of superstars. The Economist, September 17: 3– 16.

3. Kapner, S. & Lublin, J. S. 2016. Lands’ end CEO is pushed out after 19 months. The Wall Street Journal, September 27: B1; Anonymous. 2016. Lands’ End CEO Marchionni out after failing to take brand upscale. Fortune.com, September 26: np; and, Kapner, S. 2016. New Lands’ End CEO delivers high fashion—and a culture clash. www. wsj.com, May 6: np.

4. For a discussion of the “romantic” versus “external control” perspective, refer to Meindl, J. R. 1987. The romance of leadership and the evaluation of organizational performance. Academy of Management Journal, 30: 92–109; and Pfeffer, J. & Salancik, G. R. 1978. The external control of organizations: A resource dependence perspective. New York: Harper & Row.

5. A recent perspective on the “romantic view” of leadership is provided by Mintzberg, H. 2004. Leadership and management development: An afterword. Academy of Management Executive, 18(3): 140– 142.

6. For a discussion of the best and worst managers for 2008, read Anonymous. 2009. The best managers. BusinessWeek, January 19: 40–41; and The worst managers. On page 42 in the same issue.

7. Burrows, P. 2009. Apple without its core? BusinessWeek, January 26/ February 2: 31.

8. For a study on the effects of CEOs on firm performance, refer to Kor, Y. Y. & Misangyi, V. F. 2008. Strategic Management Journal, 29(11):1357–1368.

9. Colvin, G. 2016. Developing an internal market for talent. Fortune. March 1: 22.

10. Kapner, S. & Lublin, op. cit.

11. Ewing, J. 2008. South Africa emerges from the shadows. BusinessWeek, December 15: 52–56.

12. For an interesting perspective on the need for strategists to maintain a global mind-set, refer to Begley, T. M. & Boyd, D. P. 2003. The need for a global mind-set. MIT Sloan Management Review, 44(2): 25–32.

13. Porter, M. E. 1996. What is strategy? Harvard Business Review, 74(6): 61–78.

14. See, for example, Barney, J. B. & Arikan, A. M. 2001. The resource- based view: Origins and implications. In Hitt, M. A., Freeman, R. E., & Harrison, J. S. (Eds.), Handbook of strategic management: 124– 189. Malden, MA: Blackwell.

15. Porter, M. E. 1996. What is strategy? Harvard Business Review, 74(6): 61–78; and Hammonds, K. H. 2001. Michael Porter’s big ideas. Fast Company, March: 55–56.

16. This section draws upon Dess, G. G. & Miller, A. 1993. Strategic management. New York: McGraw-Hill.

17. See, for example, Hrebiniak, L. G. & Joyce, W. F. 1986. The strategic importance of managing myopia. Sloan Management Review, 28(1): 5–14.

18. Bryant, A. 2011. The corner office. New York: Times Books.

19. For an insightful discussion on how to manage diverse stakeholder groups, refer to Rondinelli, D. A. & London, T. 2003. How corporations and environmental groups cooperate: Assessing cross-sector alliances and collaborations. Academy of Management Executive, 17(1): 61–76.

20. Some dangers of a short-term perspective are addressed in Van Buren, M. E. & Safferstone, T. 2009. The quick wins paradox. Harvard Business Review, 67(1): 54–61.

21. Senge, P. 1996. Leading learning organizations: The bold, the powerful, and the invisible. In Hesselbein, F., Goldsmith, M., & Beckhard, R. (Eds.), The leader of

the future: 41–58. San Francisco: Jossey-Bass.

22. Winston, A. S. 2014. The big pivot. Boston: Harvard Business Review.

23. Loeb, M. 1994. Where leaders come from. Fortune, September 19: 241 (quoting Warren Bennis).

24. Ignatius, A. 2016. The HBR Interview: Hewlett Packard Enterprise CEO Meg Whitman. Harvard Business Review, 94(5): 100.

25. This section draws on: Smith, W., Lewis, M., & Tushman, M. 2016. “Both/and” leadership. Harvard Business Review, 94(5): 63–70.

26. New perspectives on “management models” are addressed in Birkinshaw, J. & Goddard, J. 2009. What is your management model? MIT Sloan Management Review, 50(2): 81–90.

27. Mintzberg, H. 1985. Of strategies: Deliberate and emergent. Strategic Management Journal, 6: 257–272.

28. Some interesting insights on decision- making processes are found in Nutt, P. C. 2008. Investigating the success of decision making processes. Journal of Management Studies, 45(2): 425–455.

29. Smith, J. 2014. Go-to lawyers are in-house. The Wall Street Journal, September 15: B6.

30. Machota, J. 2016. Job description varies for NFL QBs,” The Dallas Morning News. March 20: 4C.

31. Bryant, A. 2009. The corner office. nytimes.com, April 25: np.

32. A study investigating the sustainability of competitive advantage is Newbert, S. L. 2008. Value, rareness, competitive advantages, and performance: A conceptual-level empirical investigation of the resource- based view of the firm. Strategic Management Journal, 29(7): 745–768.

33. Good insights on mentoring are addressed in DeLong, T. J., Gabarro, J. J., & Lees, R. J. 2008. Why mentoring matters in a hypercompetitive world. Harvard Business Review, 66(1): 115–121.

REFERENCES

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34. Karlgaard, R. 2014. The soft edge. San Francisco: Jossey-Bass.

35. A unique perspective on differentiation strategies is Austin, R. D. 2008. High margins and the quest for aesthetic coherence. Harvard Business Review, 86(1): 18–19.

36. Some insights on partnering in the global area are discussed in MacCormack, A. & Forbath, T. 2008. Harvard Business Review, 66(1): 24, 26.

37. For insights on how firms can be successful in entering new markets in emerging economies, refer to Eyring, M. J., Johnson, M. W., & Nair, H. 2011. New business models in emerging markets. Harvard Business Review, 89(1/2): 88–95.

38. Fortune. 2012. December 3: 6. 39. An interesting discussion of the

challenges of strategy implementation is Neilson, G. L., Martin, K. L., & Powers, E. 2008. The secrets of strategy execution. Harvard Business Review, 86(6): 61–70.

40. Interesting perspectives on strategy execution involving the link between strategy and operations are addressed in Kaplan, R. S. & Norton, D. P. 2008. Mastering the management system. Harvard Business Review, 66(1): 62–77.

41. An innovative perspective on organizational design is found in Garvin, D. A. & Levesque, L. C. 2008. The multiunit enterprise. Harvard Business Review, 86(6): 106–117.

42. Monks, R. & Minow, N. 2001. Corporate governance (2nd ed.). Malden, MA: Blackwell.

43. Intel Corp. 2007. Intel corporation board of directors guidelines on significant corporate governance issues. www.intel.com

44. Jones, T. J., Felps, W., & Bigley, G. A. 2007. Ethical theory and stakeholder- related decisions: The role of stakeholder culture. Academy of Management Review, 32(1): 137– 155.

45. For example, see: The best (& worst) managers of the year, 2003. BusinessWeek, January 13: 58–92; and Lavelle, M. 2003. Rogues of the year. Time, January 6: 33–45.

46. Baer, D. A. 2014. The West’s bruised confidence in capitalism. The Wall Street Journal, September 22: A17; and Miller, D. 2014. Greatness is gone. Dallas Morning News, October 26: 1 D.

47. Barton, D. & Wiseman, M. 2015. Where boards fall short. Harvard Business Review, 93(1/2): 100.

48. Hessel, E. & Woolley, S. 2008. Your money or your life. Forbes, October 27: 52.

49. Task, A. 2012. Finance CEO pay rose 20% in 2011, even as stocks stumbled. www.finance.yahoo.com, June 5: np.

50. Rosenberg, Y. 2016. This CEO got $142 million more than he deserved. finance.yahoo.com: February 17: np.

51. Some interesting insights on the role of activist investors can be found in Greenwood, R. & Schol, M. 2008. When (not) to listen to activist investors. Harvard Business Review, 66(1): 23–24.

52. For an interesting perspective on the changing role of boards of directors, refer to Lawler, E. & Finegold, D. 2005. Rethinking governance. MIT Sloan Management Review, 46(2): 67–70.

53. Benz, M. & Frey, B. S. 2007. Corporate governance: What can we learn from public governance? Academy of Management Review, 32(1): 92– 104.

54. The salience of shareholder value is addressed in Carrott, G. T. & Jackson, S. E. 2009. Shareholder value must top the CEO’s agenda. Harvard Business Review, 67(1): 22–24.

55. Stakeholder symbiosis. 1998. Fortune, March 30: S2.

56. An excellent review of stakeholder management theory can be found in Laplume, A. O., Sonpar, K., & Litz, R. A. 2008. Stakeholder theory: Reviewing a theory that moves us. Journal of Management, 34(6): 1152– 1189.

57. For a definitive, recent discussion of the stakeholder concept, refer to Freeman, R. E. & McVae, J. 2001. A stakeholder approach to strategic management. In Hitt, M. A., Freeman, R. E., & Harrison, J. S. (Eds.), Handbook of strategic management: 189–207. Malden, MA: Blackwell.

58. Harrison, J. S., Bosse, D. A., & Phillips, R. A. 2010. Managing for stakeholders, stakeholder utility functions, and competitive advantage. Strategic Management Journal, 31(1): 58–74.

59. For an insightful discussion on the role of business in society, refer to Handy, op. cit.

60. Stakeholder symbiosis. op. cit., p. S3. The Walmart example draws on: Camillus, J. 2008. Strategy as a wicked problem. Harvard Business Review, 86(5): 100– 101.

61. Sidhu, I. 2010. Doing both. Upper Saddle River, NJ: FT Press, 7–8.

62. Thomas, J. G. 2000. Macroenvironmetal forces. In Helms, M. M. (Ed.), Encyclopedia

of management (4th ed.): 516–520. Farmington Hills, MI: Gale Group.

63. For a strong advocacy position on the need for corporate values and social responsibility, read Hollender, J. 2004. What matters most: Corporate values and social responsibility. California Management Review, 46(4): 111–119.

64. Rangan, K., Chase, L., & Karim, S. 2015. The truth about CSR. Harvard Business Review, 93(1/2): 41–49.

65. Bhattacharya, C. B. & Sen, S. 2004, Doing better at doing good: When, why, and how consumers respond to corporate social initiatives. California Management Review, 47(1): 9–24.

66. For some findings on the relationship between corporate social responsibility and firm performance, see Margolis, J. D. & Elfenbein, H. A. 2008. Harvard Business Review, 86(1): 19–20.

67. Cone Corporate Citizenship Study, 2002, www.coneinc.com.

68. Refer to www.bsr.org. 69. For an insightful discussion of the

risks and opportunities associated with global warming, refer to Lash, J. & Wellington, F. 2007. Competitive advantage on a warming planet. Harvard Business Review, 85(3): 94– 102.

70. Ignatius, A. 2015. Leadership with a conscience. Harvard Business Review, 93(11): 50–63.

71. This section draws on Hart, S. L. 1997. Beyond greening: Strategies for a sustainable world. Harvard Business Review, 75(1): 66–76; and Berry, M. A. & Rondinelli, D. A. 1998. Proactive corporate environmental management: A new industrial revolution. Academy of Management Executive, 12(2): 38–50.

72. For a creative perspective on environmental sustainability and competitive advantage as well as ethical implications, read Ehrenfeld, J. R. 2005. The roots of sustainability. MIT Sloan Management Review, 46(2): 23–25.

73. McKinsey & Company. 1991. The corporate response to the environmental challenge. Summary Report. Amsterdam: McKinsey & Company.

74. Delmas, M. A. & Montes-Sancho, M. J. 2010. Voluntary agreements to improve environmental quality: Symbolic and substantive cooperation. Strategic Management Journal, 31(6): 575–601.

75. Vogel, D. J. 2005. Is there a market for virtue? The business case for corporate social responsibility. California Management Review, 47(4): 19–36.

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76. Esty, D. C. & Charnovitz, S. 2012. Green rules to drive innovation. Harvard Business Review, 90(3): 120– 123.

77. Chamberlain, M. 2013. Socially responsible investing: What you need to know. Forbes.com, April 24: np.

78. Kaahwarski, T. 2010. It pays to be good. Bloomberg Businessweek, February 1 to February 8: 69.

79. This discussion draws on Kuehn, K. & McIntire, L. 2014. Sustainability a CFO can love. Harvard Business Review, 92(4): 66–74; and Esty, D. C. & Winston, A. S. 2009. Green to gold. Hoboken, NJ: Wiley.

80. Senge, P. M. 1990. The leader’s new work: Building learning organizations. Sloan Management Review, 32(1): 7–23.

81. For an interesting perspective on the role of middle managers in the strategic management process, refer to Huy, Q. H. 2001. In praise of middle managers. Harvard Business Review, 79(8): 72–81.

82. Senge, 1996, op. cit., pp. 41–58. 83. Kets de Vries, M. F. R. 1998.

Charisma in action: The transformational abilities of Virgin’s Richard Branson and ABB’s Percy

Barnevik. Organizational Dynamics, 26(3): 7–21.

84. Worley, C. G., Williams, T. & Lawler, E. E. III. 2016. Creating management processes built for change. MIT Sloan Management Review, 58(1): 77–82.

85. An interesting discussion on how to translate top management’s goals into concrete actions is found in Bungay, S. 2011. How to make the most of your company’s strategy. Harvard Business Review, 89(1/2): 132– 140.

86. Bryant, A. 2011. The corner office. New York: St. Martin’s/Griffin, 171.

87. An insightful discussion about the role of vision, mission, and strategic objectives can be found in Collis, D. J. & Rukstad, M. G. 2008. Can you say what your strategy is? Harvard Business Review, 66(4): 82–90.

88. Our discussion draws on a variety of sources. These include Lipton, M. 1996. Demystifying the development of an organizational vision. Sloan Management Review, 37(4): 83–92; Bart, C. K. 2000. Lasting inspiration. CA Magazine, May: 49–50; and Quigley, J. V. 1994. Vision: How leaders develop it, share it, and sustain it. Business Horizons, September–October: 37–40.

89. Lipton, op. cit.

90. Bryant, A. 2011. The corner office. New York: St. Martin’s/Griffin, 34.

91. Hardy, Q. 2007. The uncarly. Forbes, March 12: 82–90.

92. Some interesting perspectives on gender differences in organizational vision are discussed in Ibarra, H. & Obodaru, O. 2009. Women and the vision thing. Harvard Business Review, 67(1): 62–70.

93. Quigley, op. cit. 94. Ibid. 95. Lipton, op. cit. Additional pitfalls are

addressed in this article. 96. Company records. 97. Lipton, op. cit. 98. Sexton, D. A. & Van Aukun, P. M.

1985. A longitudinal study of small business strategic planning. Journal of Small Business Management, January: 8–15, cited in Lipton, op. cit.

99. For an insightful perspective on the use of strategic objectives, refer to Chatterjee, S. 2005. Core objectives: Clarity in designing strategy. California Management Review, 47(2): 33–49.

100. Ibid. 101. Harnish, V. 2011. Five ways to

get your strategy right. Fortune, April 11: 42.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

2 LO2-1 The importance of developing forecasts of the business environment. LO2-2 Why environmental scanning, environmental monitoring, and collecting

competitive intelligence are critical inputs to forecasting.

LO2-3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.

LO2-4 The impact of the general environment on a firm’s strategies and performance.

LO2-5 How forces in the competitive environment can affect profitability, and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.

LO2-6 How the Internet and digitally based capabilities are affecting the five competitive forces and industry profitability.

LO2-7 The concept of strategic groups and their strategy and performance implications.

Analyzing the External Environment of the Firm Creating Competitive Advantages

©Anatoli Styf/Shutterstock

PART 1: STRATEGIC ANALYSIS

Analyzing the external environment is a critical step in recognizing and understanding the opportunities and threats that organizations face. And here is where some companies fail to do a good job. The fact is that few things really “sell themselves”—especially if they are new to the market. According to Booz & Company, 66 percent of new products fail within two years, and, according to the Doblin Group, an astonishing 96 percent of all innovations fail to deliver any return on a company’s investment.1

Consider the example of Salemi Industries and the launch of its product, Cell Zone, in 2005. Although it tried to carefully analyze its potential market, it misread the market’s demand for the product and paid a steep price for its mistake.2 Mobile phone usage was sharply increasing, and its founder observed that patrons in places such as restaurants would be annoyed by the chatter of a nearby guest having a private (but loud!) conversation. Salemi Industries interpreted this observation as an opportunity to create the Cell Zone: a “commercial sound resistant cell phone booth that provides a convenient and disturbance-free environment to place and receive phone calls . . . with a design feature to promote product or service on its curvilinear outer shell,” according to the firm’s website.

Salemi Industries’ key error was that it failed to take into consideration an emerging technology— the increasing popularity of text messaging and other nonvoice communication technology applications and how that would affect the sales of its product. In addition to this technology shift, the target locations (restaurants) thought the price ($3,500) was too steep, and they were not interested in or willing to give up productive square footage for patrons to hold private conversations. Not surprisingly, the firm has sold only 300 units (100 of them in college libraries), and Salemi Industries has lost over $650,000 to date.

Discussion Questions 1. What is the biggest stumbling block for Cell Zone? 2. Are there other market segments where Cell Zone might work?

“We built a better mousetrap but there were no mice” (commenting on his firm’s development of blue windshield glass for the automobile industry).3

Gary W. Weber, PPG Industries

Successful managers must recognize opportunities and threats in their firm’s external envi- ronment. They must be aware of what’s going on outside their company. If they focus exclu- sively on the efficiency of internal operations, the firm may degenerate into the world’s most efficient producer of buggy whips, typewriters, or carbon paper. But if they miscalcu- late the market, opportunities will be lost—hardly an enviable position for their firm. As we saw from the Cell Zone example, misreading the market can lead to negative consequences.

In Competing for the Future, Gary Hamel and C. K. Prahalad suggest that “every man- ager carries around in his or her head a set of biases, assumptions, and presuppositions about the structure of the relevant ‘industry,’ about how one makes money in the industry, about who the competition is and isn’t, about who the customers are and aren’t, and so

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on.”4 Environmental analysis requires you to continually question such assumptions. Peter Drucker, considered the father of modern management, labeled these interrelated sets of assumptions the “theory of the business.”5 One could attribute much of the failure of Ms. Marchionni’s tenure at Lands’ End to her efforts to re-invent the apparel brand in a way that was in conflict with both its customer base as well as the firm’s family culture and whole- some style—as we discussed in in the opening case in Chapter 1.

A firm’s strategy may be good at one point in time, but it may go astray when man- agement’s frame of reference gets out of touch with the realities of the actual business situation. This results when management’s assumptions, premises, or beliefs are incorrect or when internal inconsistencies among them render the overall “theory of the business” invalid. As Warren Buffett, investor extraordinaire, colorfully notes, “Beware of past per- formance ‘proofs.’ If history books were the key to riches, the Forbes 400 would consist of librarians.”

In the business world, many once-successful firms have fallen. Today we may wonder who will be the next Blockbuster, Borders, Circuit City, or Radio Shack.

ENHANCING AWARENESS OF THE EXTERNAL ENVIRONMENT So how do managers become environmentally aware?6 Ram Charan, an adviser to many Fortune 500 CEOs, provides some useful insights with his concept of perceptual acuity.7 He defines it as “the ability to sense what is coming before the fog clears.” He draws on Ted Turner as an example: Turner saw the potential of 24-hour news before anyone else did. All the ingredients were there, but no others connected them until he created CNN. Like Turner, the best CEOs are compulsively tuned to the external environment and seem to have a sixth sense that picks up anomalies and detects early warning signals which may represent key threats or opportunities.

How can perceptual acuity be improved? Although many CEOs may complain that the top job is a lonely one, they can’t do it effectively by sitting alone in their office. Instead, high-performing CEOs are constantly meeting with people and searching out information. Charan provides three examples:

• One CEO gets together with his critical people for half a day every eight weeks to discuss what’s new and what’s going on in the world. The setting is informal, and outsiders often attend. The participants look beyond the lens of their industry because some trends that affect one industry may impact others later on.

• Another CEO meets four times a year with about four other CEOs of large, but noncompeting, diverse global companies. Examining the world from multiple perspectives, they share their thinking about how different trends may develop. The CEO then goes back to his own weekly management meeting and throws out “a bunch of hand grenades to shake up people’s thinking.”

• Two companies ask outsiders to critique strategy during their board’s strategy sessions. Such input typically leads to spirited discussions that provide valued input on the hinge assumptions and options that are under consideration. Once, the focus was on pinpointing the risk inherent in a certain strategy. Now, discussions have led to finding that the company was missing a valuable opportunity.

We will now address three important processes—scanning, monitoring, and gathering competitive intelligence—used to develop forecasts.8 Exhibit 2.1 illustrates relationships among these important activities. We also discuss the importance of scenario planning in anticipating major future changes in the external environment and the role of SWOT analysis.9

LO 2-1 The importance of developing forecasts of the business environment.

perceptual acuity the ability to sense what is coming before the fog clears.

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The Role of Scanning, Monitoring, Competitive Intelligence, and Forecasting Environmental Scanning Environmental scanning involves surveillance of a firm’s external environment to predict environmental changes and detect changes already underway.10,11 This alerts the organization to critical trends and events before changes develop a discern- ible pattern and before competitors recognize them.12 Otherwise, the firm may be forced into a reactive mode.13

Experts agree that spotting key trends requires a combination of knowing your business and your customer as well as keeping an eye on what’s happening around you. Such a big- picture/small-picture view enables you to better identify the emerging trends that will affect your business.

Leading firms in an industry can also be a key indicator of emerging trends.14 For exam- ple, with its wide range of household goods, Procter & Gamble is a barometer for consumer spending. Any sign that it can sell more of its premium products without cutting prices sharply indicates that shoppers may finally be becoming less price-sensitive with everyday purchases. In particular, investors will examine the performance of beauty products like Olay moisturizers and CoverGirl cosmetics for evidence that spending on small, discretion- ary pick-me-ups is improving.

Environmental Monitoring Environmental monitoring tracks the evolution of environmen- tal trends, sequences of events, or streams of activities. They may be trends that the firm came across by accident or ones that were brought to its attention from outside the organi- zation.15 Monitoring enables firms to evaluate how dramatically environmental trends are changing the competitive landscape.

One of the authors of this text has conducted on-site interviews with executives from sev- eral industries to identify indicators that firms monitor as inputs to their strategy process. Examples of such indicators included:

• A Motel 6 executive. The number of rooms in the budget segment of the industry in the United States and the difference between the average daily room rate and the consumer price index (CPI).

• A Pier 1 Imports executive. Net disposable income (NDI), consumer confidence index, and housing starts.

• A Johnson & Johnson medical products executive. Percentage of gross domestic product (GDP) spent on health care, number of active hospital beds, and the size and power of purchasing agents (indicates the concentration of buyers).

Such indices are critical for managers in determining a firm’s strategic direction and resource allocation.

environmental scanning surveillance of a firm’s external environment to predict environmental changes and detect changes already under way.

environmental monitoring a firm’s analysis of the external environment that tracks the evolution of environmental trends, sequences of events, or streams of activities.

EXHIBIT 2.1 Inputs to Forecasting

Forecasts

Environmental scanning

Environmental monitoring

Competitive intelligence

LO 2-2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting.

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Competitive Intelligence Competitive intelligence (CI) helps firms define and understand their industry and identify rivals’ strengths and weaknesses.16 This includes the intelligence gathering associated with collecting data on competitors and interpreting such data. Done properly, competitive intelligence helps a company avoid surprises by anticipating competi- tors’ moves and decreasing response time.17

Examples of competitive analysis are evident in daily newspapers and periodicals such as The Wall Street Journal, Bloomberg Businessweek, and Fortune. For example, banks con- tinually track home loan, auto loan, and certificate of deposit (CD) interest rates charged by rivals. Major airlines change hundreds of fares daily in response to competitors’ tactics. Car manufacturers are keenly aware of announced cuts or increases in rivals’ production volume, sales, and sales incentives (e.g., rebates and low interest rates on financing). This information is used in their marketing, pricing, and production strategies.

Keeping track of competitors has become easier today with the amount of information that is available on the Internet. The following are examples of some websites that compa- nies routinely use for competitive intelligence gathering.18

• Slideshare. A website for publicly sharing PowerPoint presentations. Marketing teams have embraced the platform and often post detail-rich presentations about their firms and products.

• Quora. A question-and-answer site popular among industry insiders who embrace the free flow of information about technical questions.

• Ispionage. A site that reveals the ad words that companies are buying, which can often shed light on new campaigns being launched.

• YouTube. Great for finding interviews with executives at trade shows.

At times, a firm’s aggressive efforts to gather competitive intelligence may lead to unethi- cal or illegal behaviors.19 Strategy Spotlight 2.1 provides an example of a company, United Technologies, that has set clear guidelines to help prevent unethical behavior.

A word of caution: Executives must be careful to avoid spending so much time and effort tracking the actions of traditional competitors that they ignore new competitors. Further, broad environmental changes and events may have a dramatic impact on a firm’s viability. Peter Drucker, wrote:

Increasingly, a winning strategy will require information about events and conditions outside the institution: noncustomers, technologies other than those currently used by the company and its present competitors, markets not currently served, and so on.20

Consider the failure of specialized medical lab Sleep HealthCenters.21 Until recently, patients suffering from sleep disorders, such as apnea, were forced to undergo expensive overnight visits to sleep clinics, including Sleep HealthCenters, to diagnose their ailments. The firm was launched in 1997 and quickly expanded to over two dozen locations. Revenue soared from nearly $10 million in 1997 to $30 million in 2010.

However, the rapid improvements in the price and performance of wearable monitoring devices changed the business, gradually at first and then suddenly. For one thing, the more comfortable home setting produced more effective measurements. And the quick declines in the cost of wearable monitoring meant patients could get the same results at one-third the price of an overnight stay at a clinic. By 2011, Sleep HealthCenters’ revenue began to decline, and the firm closed 20 percent of its locations. In 2012, its death knells sounded: Insurance companies decided to cover the less expensive option. Sleep HealthCenters abruptly closed its doors.

Environmental Forecasting Environmental scanning, monitoring, and competitive intel- ligence are important inputs for analyzing the external environment. Environmental forecasting involves the development of plausible projections about the direction, scope,

competitive intelligence a firm’s activities of collecting and interpreting data on competitors, defining and understanding the industry, and identifying competitors’ strengths and weaknesses.

environmental forecasting the development of plausible projections about the direction, scope, speed, and intensity of environmental change.

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2.1 ETHICSSTRATEGY SPOTLIGHT ETHICAL GUIDELINES ON COMPETITIVE INTELLIGENCE: UNITED TECHNOLOGIES United Technologies (UT) is a $65 billion global conglomer- ate composed of world-leading businesses with rich histories of technological pioneering, such as Otis Elevator, Carrier Air Conditioning, and Sikorsky (helicopters). UT believes strongly in a robust code of ethics. One such document is the Code of Ethics Guide on Competitive Intelligence. This encourages managers and workers to ask themselves these five questions whenever they have ethical concerns.

1. Have I done anything that coerced somebody to share this information? Have I, for example, threatened a supplier by indicating that future business opportunities will be influenced by the receipt of information with respect to a competitor?

2. Am I in a place where I should not be? If, for example, I am a field representative with privileges to move around

in a customer’s facility, have I gone outside the areas permitted? Have I misled anybody in order to gain access?

3. Is the contemplated technique for gathering information evasive, such as sifting through trash or setting up an electronic “snooping” device directed at a competitor’s facility from across the street?

4. Have I misled somebody in a way that the person believed sharing information with me was required or would be protected by a confidentiality agreement? Have I, for example, called and misrepresented myself as a government official who was seeking some information for some official purpose?

5. Have I done something to evade or circumvent a system intended to secure or protect information?

Sources: Nelson, B. 2003. The thinker. Forbes, March 3: 62–64; The Fuld war room—Survival kit 010. Code of ethics (printed 2/26/01); and www.yahoo.com.

speed, and intensity of environmental change.22 Its purpose is to predict change.23 It asks: How long will it take a new technology to reach the marketplace? Will the present social con- cern about an issue result in new legislation? Are current lifestyle trends likely to continue?

Some forecasting issues are much more specific to a particular firm and the industry in which it competes. Consider how important it is for Motel 6 to predict future indicators, such as the number of rooms, in the budget segment of the industry. If its predictions are low, it will build too many units, creating a surplus of room capacity that would drive down room rates.

A danger of forecasting is that managers may view uncertainty as black and white and ignore important gray areas.24 The problem is that underestimating uncertainty can lead to strategies that neither defend against threats nor take advantage of opportunities.

In 1977 one of the colossal underestimations in business history occurred when Kenneth H. Olsen, president of Digital Equipment Corp., announced, “There is no reason for indi- viduals to have a computer in their home.” The explosion in the personal computer market was not easy to detect in 1977, but it was clearly within the range of possibilities at the time. And, historically, there have been underestimates of the growth potential of new telecom- munication services. The electric telegraph was derided by Ralph Waldo Emerson, and the telephone had its skeptics. More recently, an “infamous” McKinsey study in the early 1980s predicted fewer than 1 million cellular users in the United States by 2000. Actually, there were nearly 100 million.25

Obviously, poor predictions about technology change never go out of vogue. Consider some other “gems”—predicted by very knowledgeable people: 26

• (1981) “Cellular phones will absolutely not replace local wire systems.” Inventor Marty Cooper

• (1995) “I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.” Robert Metcalfe, founder of 3Com

• (1997) “Apple is already dead.” Former Microsoft CTO Nathan Myhrvold. • (2005) “There’s just not that many videos I want to watch.” Steve Chen, CTO and

co-founder of YouTube, expressing concerns about the firm’s long-term viability.

LO 2-3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.

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• (2006) “Everyone’s always asking me when Apple will come out with a cell phone. My answer is ‘Probably never.’” David Pogue, The New York Times

• (2007) “There’s no chance that the iPhone is going to get significant market share.” Steve Ballmer, Microsoft

Jason Zweig, an editor at The Wall Street Journal, provides an important cautionary note (and rather colorful example!) regarding the need to question the reliability of forecasts: “Humans don’t want accuracy; they want assurance . . . people can’t stand ignoring all pre- dictions; admitting that the future is unknowable is just too frightening.”27

The Nobel laureate and the late Stanford University economist Kenneth Arrow did a tour of duty as a weather forecaster for the U.S. Air Force during World War II. Ordered to evaluate mathematical models for predicting the weather one month ahead, he found that they were worthless. Informed of that, his superiors sent back another order: “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.”

Scenario Analysis Scenario analysis is a more in-depth approach to forecasting. It draws on a range of disciplines and interests, among them economics, psychology, sociology, and demo- graphics. It usually begins with a discussion of participants’ thoughts on ways in which societal trends, economics, politics, and technology may affect an issue.28 Scenario analysis involves the projection of future possible events. It does not rely on extrapolation of historical trends. Rather, it seeks to explore possible developments that may only be connected to the past. That is, several scenarios are considered in a scenario analysis in order to envision possible future outcomes.

Consider PPG Industries.29 The Pittsburgh-based producer of paints, coatings, specialty materials, chemicals, glass, and fiberglass has paid dividends each year since 1899. One of the key tools it uses today in its strategic planning is scenario analysis.

PPG has developed four alternative futures based on differing assumptions about two key variables: the cost of energy (because its manufacturing operations are energy-intensive) and the extent of opportunity for growth in emerging markets. In the most favorable scenario, cost of energy will stay both moderate and stable and opportunities for growth and differentiation will be fast and strong. In this scenario, PPG determined that its success will depend on having the resources to pursue new opportunities. On the other hand, in the worst case scenario, the cost of energy will be high and opportunities for growth will be weak and slow. Such a scenario would call for a complete change in strategic direction.

Between these two extremes lies the possibility of two mixed scenarios. First, opportunity for growth in emerging markets may be high, but the cost of energy may be volatile. In this scenario, the company’s success will depend on coming up with more efficient processes. Second, cost of energy may remain moderate and stable, but opportunities for growth in emerging markets may remain weak and slow. In this situation, the most viable strategy may be one of capturing market share with new products.

Developing strategies based on possible future scenarios seems to be paying off for PPG Industries. For the five years ending in 2016, PPG’s stock has enjoyed a compounded growth rate exceeding 17 percent.

SWOT Analysis To understand the business environment of a particular firm, you need to analyze both the general environment and the firm’s industry and competitive environment. Generally, firms compete with other firms in the same industry. An industry is composed of a set of firms that produce similar products or services, sell to similar customers, and use similar methods of production. Gathering industry information and understanding competitive dynamics among the different companies in your industry is key to successful strategic management.

One of the most basic techniques for analyzing firm and industry conditions is SWOT analysis. SWOT stands for strengths, weaknesses, opportunities, and threats. It provides “raw material”—a basic listing of conditions both inside and surrounding your company.

scenario analysis an in-depth approach to environmental forecasting that involves experts’ detailed assessments of societal trends, economics, politics, technology, or other dimensions of the external environment.

SWOT analysis a framework for analyzing a company’s internal and external environments and that stands for strengths, weaknesses, opportunities, and threats.

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The Strengths and Weaknesses refer to the internal conditions of the firm—where your firm excels (strengths) and where it may be lacking relative to competitors (weaknesses). Opportunities and Threats are environmental conditions external to the firm. These could be factors in either the general or the competitive environment. In the general environ- ment, one might experience developments that are beneficial for most companies, such as improving economic conditions that lower borrowing costs, or trends that benefit some companies and harm others. An example is the heightened concern with fitness, which is a threat to some companies (e.g., tobacco) and an opportunity to others (e.g., health clubs). Opportunities and threats are also present in the competitive environment among firms competing for the same customers.

The general idea of SWOT analysis is that a firm’s strategy must:

• Build on its strengths. • Remedy the weaknesses or work around them. • Take advantage of the opportunities presented by the environment. • Protect the firm from the threats.

Despite its apparent simplicity, the SWOT approach has been very popular. First, it forces managers to consider both internal and external factors simultaneously. Second, its emphasis on identifying opportunities and threats makes firms act proactively rather than reactively. Third, it raises awareness about the role of strategy in creating a match between the environmental conditions and the firm’s internal strengths and weaknesses. Finally, its conceptual simplicity is achieved without sacrificing analytical rigor.

While analysis is necessary, it is also equally important to recognize the role played by intuition and judgment. Steve Jobs, the legendary former chairman of Apple, took a very different approach in determining what customers really wanted:30

Steve Jobs was convinced market research and focus groups limited one’s ability to innovate. When asked how much research was done to guide Apple when he introduced the iPad, Jobs famously quipped: “None. It isn’t the consumers’ job to know what they want. It’s hard for (consumers) to tell you what they want when they’ve never seen anything remotely like it.”

Jobs relied on his own intuition—his radarlike feel for emerging technologies and how they could be brought together to create, in his words “insanely great products, that ultimately made the difference.” For Jobs, who died in 2011 at the age of 56, intuition was no mere gut call. It was, as he put it in his often-quoted commencement speech at Stanford, about “connecting the dots, glimpsing the relationships among wildly disparate life experiences and changes in technologies.”

THE GENERAL ENVIRONMENT The general environment is composed of factors that can have dramatic effects on firm strat- egy.31 We divide the general environment into six segments: demographic, sociocultural, political/legal, technological, economic, and global. Exhibit 2.2 provides examples of key trends and events in each of the six segments of the general environment.

Before addressing each of the six segments in turn, consider Dominic Barton’s insights in response to a question posed to him by an editor of Fortune magazine: What are your client’s wor- ries right now? (Barton is global managing director of McKinsey, the giant consulting firm.)32

“They’re pretty consistent around the world. The big one now is geopolitics. Whether you’re in Russia, China, anywhere the assumed stability that was there for the past 20 or so years—it’s not there. The second is technology, which is moving two to three times faster than management. Most CEOs I talk to are excited and paranoid at the same time. Related to that is cyber security: the amount of time and effort to protect systems and look at vulnerabilities is big.

LO 2-4 The impact of the general environment on a firm’s strategies and performance.

general environment factors external to an industry, and usually beyond a firm’s control, that affect a firm’s strategy.

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EXHIBIT 2.2 General Environment: Key Trends and Events

Demographic

• Aging population • Rising affluence • Changes in ethnic composition • Geographic distribution of population • Greater disparities in income levels

Sociocultural

• More women in the workforce • Increase in temporary workers • Greater concern for fitness • Greater concern for environment • Postponement of family formation

Political/Legal

• Tort reform • Americans with Disabilities Act (ADA) of 1990 • Deregulation of utility and other industries • Increases in federally mandated minimum wages • Taxation at local, state, federal levels • Legislation on corporate governance reforms in bookkeeping, stock options, etc. (Sarbanes-Oxley Act of

2002) • Affordable Care Act (Obamacare)

Technological

• Genetic engineering • Three-dimensional (3D) printing • Computer-aided design/computer-aided manufacturing systems (CAD/CAM) • Research in synthetic and exotic materials • Pollution/global warming • Miniaturization of computing technologies • Wireless communications • Nanotechnology • Big Data/Data Analysis

Economic

• Interest rates • Unemployment rates • Consumer price index • Trends in GDP • Changes in stock market valuations

Global

• Increasing global trade • Currency exchange rates • Emergence of the Indian and Chinese economies • Trade agreements among regional blocs (e.g., NAFTA, EU, ASEAN) • Creation of WTO (leading to decreasing tariffs/free trade in services) • Increased risks associated with terrorism

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“A fourth trend is the shift in economic power, with 2.2 billion new middle-class consumers in the next 15 years, and it’s moving to Asia and Africa. Do you have the right type of people in your top 100? Are you in those markets? Those are the four big ones we see everywhere.”

The Demographic Segment Demographics are the most easily understood and quantifiable elements of the general envi- ronment. They are at the root of many changes in society. Demographics include elements such as the aging population,33 rising or declining affluence, changes in ethnic composition, geographic distribution of the population, and disparities in income level.34

The impact of a demographic trend, like all segments of the general environment, varies across industries. Rising levels of affluence in many developed countries bode well for bro- kerage services as well as for upscale pets and supplies. However, this trend may adversely affect fast-food restaurants because people can afford to dine at higher-priced restaurants. Fast-food restaurants depend on minimum-wage employees to operate efficiently, but the competition for labor intensifies as more attractive employment opportunities become prev- alent, thus threatening the employment base for restaurants. Let’s look at the details of one of these trends.

The aging population in the United States and other developed countries has important implications. Although the percentage of those 65 and over in the U.S. workforce bottomed in the 1990s, it has been rising ever since.35 According to the Bureau of Labor Statistics, 59 percent of workers 65 and older were putting in full-time hours in 2013, a percentage that has increased steadily over the past decade. And, according to a 2014 study by Merrill Lynch and the Age Wave Consulting firm, 72 percent of preretirees aged 50 and over wanted to work during their retirement. “Older workers are to the first half of the 21st century what women were to the last half of the 20th century,” says Eugene Steuerle, an economist at the Urban Institute.

There are a number of misconceptions about the quality and value of older workers. The Insights from Research box on pages 44 and 45, however, debunks many of these myths.

The Sociocultural Segment Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples include a higher percentage of women in the workforce, dual-income families, increases in the number of temporary workers, greater concern for healthy diets and physical fit- ness, greater interest in the environment, and postponement of having children. Such forces enhance sales of products and services in many industries but depress sales in others. The increased number of women in the workforce has increased the need for business clothing merchandise but decreased the demand for baking product staples (since people would have less time to cook from scratch). The health and fitness trend has helped industries that manufacture exercise equipment and healthful foods but harmed industries that produce unhealthful foods.

Increased educational attainment by women in the workplace has led to more women in upper-management positions.36 Given such educational attainment, it is hardly surprising that companies owned by women have been one of the driving forces of the U.S. econ- omy; these companies (now more than 9 million in number) account for 40 percent of all U.S. businesses and have generated more than $3.6 trillion in annual revenue. In addition, women have a tremendous impact on consumer spending decisions. Not surprisingly, many companies have focused their advertising and promotion efforts on female consumers.

The Political/Legal Segment Political processes and legislation influence environmental regulations with which indus- tries must comply.37,38 Some important elements of the political/legal arena include tort

demographic segment of the general environment genetic and observable characteristics of a population, including the levels and growth of age, density, sex, race, ethnicity, education, geographic region, and income.

sociocultural segment of the general environment the values, beliefs, and lifestyles of a society.

political/legal segment of the general environment how a society creates and exercises power, including rules, laws, and taxation policies.

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Overview People often think that older workers are less motivated and less healthy, resist change and are less trusting, and have more trouble balancing work and family. It turns out these assumptions just aren’t true. By challenging these stereotypes in your organization, you can keep your employees working.

What the Research Shows In a 2012 paper published by Personnel Psychology, research- ers from the University of Hong Kong and the University of Georgia examined 418 studies of workers’ ages and stereotypes. A meta-analysis—a study of studies—was conducted to find out if any of the six following stereotypes about older workers—as compared with younger workers—was actually true:

• They are less motivated. • They are less willing to participate in training and

career development. • They are more resistant to change. • They are less trusting. • They are less healthy. • They are more vulnerable to work-family imbalance.

After an exhaustive search of studies dealing with these issues, the investigators’ meta-analytic techniques turned up some interesting results. Older workers’ motivation and job involvement are actually slightly higher than those of younger workers. Older workers are slightly more willing to implement organizational changes, are not less trusting, and are not less healthy than younger workers. Moreover, they’re not more likely to have issues with work-family imbalance. Of the six investigated, the only stereotype sup- ported was that older workers are less willing to participate in training and career development.

Why This Matters Business leaders must pay attention to the circumstances of older workers. According to the U.S. Bureau of Labor Statistics, 19.5 percent of American workers were 55 and older in 2010, but by 2020 25.2 percent will be 55 and older. Workers aged 25 to 44 should drop from 66.9 to 63.7 percent of the workforce during the same period. These statistics make clear that recruiting and training older workers remain critical.

When the findings of the meta-analysis are considered, the challenge of integrating older workers into the work- place becomes acute. The stereotypes held about older workers don’t hold water, but when older workers are sub- jected to them, they are more likely to retire and experi- ence a lower quality of life. Business leaders should attract,

retain, and encourage mature employees’ continued involve- ment in workplaces because they have much to offer in the ways of wisdom, experience, and institutional knowledge. The alternative is to miss out on a growing pool of valuable human capital.

How can you deal with age stereotypes to keep older workers engaged? The authors suggest three effective ways:

• Provide more opportunities for younger and older workers to work together.

• Promote positive attributes of older workers, like experience, carefulness, and punctuality.

• Engage employees in open discussions about stereotypes.

Adam Bradshaw of the DeGarmo Group Inc. has sum- marized research on addressing age stereotypes in the workplace and offers practical advice. For instance, make sure hiring practices identify factors important to the job other than age. Managers can be trained in how to spot age stereotypes and can point out to employees why the stereo- types are often untrue by using examples of effective older workers. Realize that older workers can offer a competitive advantage because of skills they possess that competitors may overlook.

Professor Tamara Erickson, who was named one of the top 50 global business thinkers in 2011, points out that mem- bers of different generations bring different experiences, assumptions, and benefits to the workforce. Companies can gain a great deal from creating a culture that welcomes workers of all ages and in which leaders address biases.

Key Takeaways • The percentage of American workers 55 years old

and older is expected to increase from 19.5 percent in 2010 to 25.2 percent in 2020.

• Many stereotypes exist about older workers. A review of 418 studies reveals these stereotypes are largely unfounded.

• Older workers subjected to negative stereotypes are more likely to retire and more likely to report lower quality of life and poorer health.

• When business leaders accept stereotypes about older workers, they lose out on these workers’ wisdom and experience. And by 2020 employers may have a smaller pool of younger workers than they do today.

• Solutions include creating opportunities for younger and older workers to work together and having frank, open discussions about stereotypes.

INSIGHTS from Research2.1

NEW TRICKS: RESEARCH DEBUNKS MYTHS ABOUT OLDER WORKERS

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Apply This Today The stereotypes people often hold about older workers are largely unfounded. Let’s face it: The labor force is aging, and astute companies can gain a great deal by attracting and retain- ing these valuable employees. Train your employees to accept colleagues of all ages—and the entire organization will benefit.

Research Reviewed Ng, T. W. H. & Feldman, D. C. 2012. Evaluating six com- mon stereotypes about older workers with meta-analytical data. Personnel Psychology, 65: 821–858. We thank Matthew Gilley, PhD, of businessminded.com for contributing this research brief.

reform, the Americans with Disabilities Act (ADA) of 1990, the repeal of the Glass-Steagall Act in 1999 (banks may now offer brokerage services), deregulation of utilities and other industries, and increases in the federally mandated minimum wage.39

Government legislation can also have a significant impact on the governance of corpora- tions. The U.S. Congress passed the Sarbanes-Oxley Act in 2002, which greatly increases the accountability of auditors, executives, and corporate lawyers. This act responded to the widespread perception that existing governance mechanisms failed to protect the interests of shareholders, employees, and creditors. Clearly, Sarbanes-Oxley has also created a tre- mendous demand for professional accounting services.

Legislation can also affect firms in the high-tech sector of the economy by expanding the number of temporary visas available for highly skilled foreign professionals.40 For example, a bill passed by the U.S. Congress in October 2000 allowed 195,000 H-1B visas for each of the following three years—up from a cap of 115,000. However, beginning in 2006 and continuing through 2015, the annual cap on H-1B visas has shrunk to only 65,000—with an additional 20,000 visas available for foreigners with a master’s or higher degree from a U.S. institution. Many of the visas are for professionals from India with computer and soft- ware expertise. In 2014, companies applied for 172,500 H-1B visas. This means that at least 87,500 engineers, developers, and others couldn’t take jobs in the United States.41 As one would expect, this is a political “hot potato” for industry executives as well as U.S. labor and workers’ rights groups. The key arguments against H-1B visas are that H-1B workers drive down wages and take jobs from Americans.

Strategy Spotlight 2.2 discusses recent U.S. legislation that requires companies to dis- close metals in their supply chain that are connected to war-torn regions.

The Technological Segment Developments in technology lead to new products and services and improve how they are produced and delivered to the end user.42 Innovations can create entirely new industries and alter the boundaries of existing industries.43 Technological developments and trends include genetic engineering, Internet technology, computer-aided design/computer-aided manufac- turing (CAD/CAM), research in artificial and exotic materials, and, on the downside, pollu- tion and global warming.44 Petroleum and primary metals industries spend significantly to reduce their pollution. Engineering and consulting firms that work with polluting industries derive financial benefits from solving such problems.

Nanotechnology is becoming a very promising area of research with many potentially useful applications.45 Nanotechnology takes place at industry’s tiniest stage: one-billionth of a meter. Remarkably, this is the size of 10 hydrogen atoms in a row. Matter at such a tiny scale behaves very differently. Familiar materials—from gold to carbon soot—display star- tling and useful new properties. Some transmit light or electricity. Others become harder than diamonds or turn into potent chemical catalysts. What’s more, researchers have found that a tiny dose of nanoparticles can transform the chemistry and nature of far bigger things.

technological segment of the general environment innovation and state of knowledge in industrial arts, engineering, applied sciences, and pure science; and their interaction with society.

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2.2 ETHICSSTRATEGY SPOTLIGHT THE CONFLICT MINERALS LEGISLATION: IMPLICATIONS FOR SUPPLY CHAIN MANAGEMENT In 2010, the United States Congress enacted Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The law requires companies to disclose whether any tin, tantalum, tungsten, or gold in their supply chain is connected to violent militia groups in the Congo or nine surrounding coun- tries, including Angola, Rwanda, and Sudan.

In a recent year, U.S. companies spent about $700 million and 6 million staff hours in efforts to comply with the rules to disclose “conflict minerals” in their supply chains, according to a study by Tulane University and Assent Compliance, a New York consulting firm. And, as of 2015, companies were required to hire outside auditors to evaluate their results.

With huge financial resources and manpower to conduct thorough examinations of their supply chains, several major technology firms including Microsoft, Apple, and Intel topped the list in terms of compliance with the law and in providing addi- tional information on their processes. But even Microsoft and Apple stated that they were “conflict indeterminable” last year. Intel claimed that its products were “conflict free”—and sent

employees to 90 mineral smelters around the world to gather that information.

Consider challenges associated with tracking tantalum—the hard blue-gray metal that is essential to firms’ ability to build smaller and lighter cellphones, laptops, hard drives and other devices. According to the U.S. Geological Survey, 12 percent of the world’s supply is in the Congo. However, to track the origin of the mineral, companies often have to dig four or five layers deep into their supply chain, as the mineral travels across the globe to various parts manufacturers.

The difficulty in complying with the legislation is further (and colorfully!) depicted by Chris Bayer, a consultant who studied recent reports filed with the SEC. Think about the challenges associated with tracking materials from more than 2 million small-scale or “subsistence” miners in the Eastern Congo who smelt small amounts of metals—and determining their links to guerrilla operations! He asserts, “It’s a herculean task [like trying to] apply modern supply-chain logistics to the equivalent of the 1849 California gold rush.”

Sources: Chasan, E. 2015. U.S. firms struggle to trace “conflict minerals.” www. wsj.com, August 3: np; Browning, L. 2015. Companies struggle to comply with rules on conflict materials. www.nytimes.com; and Shirodkar, S. M. & Ritter, S. E. 2016. Supply chain management and the conflict materials rules—action items for 2016. www.dlapiper.com, February 16: np.

Another emerging technology is physioletics, which is the practice of linking wearable computing devices with data analysis and quantified feedback to improve performance.46 An example is sensors in shoes (such as Nike+, used by runners to track distance, speed, and other metrics). Another application focuses on people’s movements in various work settings. Tesco’s employees, for instance, wear armbands at a distribution center in Ireland to track the goods they are gathering. The devices free up time that employees would oth- erwise spend marking clipboards. The armband also allots tasks to the wearer, forecasts his or her completion time, and quantifies the wearer’s precise movements among the facility’s 9.6 miles of shelving and 111 loading bays.

The Economic Segment The economy affects all industries, from suppliers of raw materials to manufacturers of finished goods and services, as well as all organizations in the service, wholesale, retail, government, and nonprofit sectors.47 Key economic indicators include interest rates, unem- ployment rates, the consumer price index, the gross domestic product, and net disposable income.48 Interest rate increases have a negative impact on the residential home construc- tion industry but a negligible (or neutral) effect on industries that produce consumer neces- sities such as prescription drugs or common grocery items.

Other economic indicators are associated with equity markets. Perhaps the most watched is the Dow Jones Industrial Average (DJIA), which is composed of 30 large industrial firms. When stock market indexes increase, consumers’ discretionary income rises and there is often an increased demand for luxury items such as jewelry and automobiles. But when stock valuations decrease, demand for these items shrinks.

economic segment of the general environment characteristics of the economy, including national income and monetary conditions.

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The Global Segment More firms are expanding their operations and market reach beyond the borders of their “home” country. Globalization provides both opportunities to access larger potential mar- kets and a broad base of production factors such as raw materials, labor, skilled managers, and technical professionals. However, such endeavors also carry many political, social, and economic risks.49

Examples of key elements include currency exchange rates, increasing global trade, the economic emergence of China, trade agreements among regional blocs (e.g., North American Free Trade Agreement, European Union), and the General Agreement on Tariffs and Trade (GATT) (lowering of tariffs).50 Increases in trade across national boundaries also provide benefits to air cargo and shipping industries but have a minimal impact on service industries such as bookkeeping and routine medical services.

A key factor in the global economy is the rapid rise of the middle class in emerging coun- tries. The number of consumers in Asia’s middle class is rapidly approaching the number in Europe and North America combined. An important implication of this trend is the dramatic change in hiring practices of U.S. multinationals. Consider:

Thirty-five U.S.-based multinational firms have recently added jobs faster than other U.S. employers, but nearly three-fourths of those jobs were overseas, according to a Wall Street Journal analysis. Those companies, which include Wal-Mart Stores Inc., International Paper Co., Honeywell International, Inc., and United Parcel Service, boosted their employment at home by 3.1 percent, or 113,000 jobs, at roughly the same rate of increase as the nation’s other employers. However, they also added more than 333,000 jobs in their far-flung—and faster growing—foreign operations.51

Relationships among Elements of the General Environment In our discussion of the general environment, we see many relationships among the vari- ous elements.52 For example, a demographic trend in the United States, the aging of the population, has important implications for the economic segment (in terms of tax policies to provide benefits to increasing numbers of older citizens). Another example is the emer- gence of information technology as a means to increase the rate of productivity gains in the United States and other developed countries. Such use of IT results in lower inflation (an important element of the economic segment) and helps offset costs associated with higher labor rates.

The effects of a trend or event in the general environment vary across industries. Governmental legislation (political/legal) to permit the importation of prescription drugs from foreign countries is a very positive development for drugstores but a very negative event for U.S. drug manufacturers. Exhibit 2.3 provides other examples of how the impact of trends or events in the general environment can vary across industries.

Data Analytics: A Technology That Affects Multiple Segments of the General Environment Before moving on, let’s consider Data Analytics (or, alternatively “Big Data”). Data analytics has been a leading and highly visible component of a broader technological phenomenon— the emergence of digital technology.53 Such technologies are altering the way business is being conducted in a broad variety of sectors—government, industry, academia, and commerce.

Corporations are increasingly collecting and analyzing data on their customers, includ- ing data on customer characteristics, purchasing patterns, employee productivity, and physi- cal asset utilization. These efforts, commonly referred to as “Big Data,” have the potential

data analytics The process of examining large data sets to uncover hidden patterns, market trends, and customer preferences.

global segment of the general environment influences from foreign countries, including foreign market opportunities, foreign- based competition, and expanded capital markets.

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Segment/Trends and Events Industry Positive Neutral Negative

Demographic

Aging population Health care ✓

Baby products ✓

Rising affluence Brokerage services ✓

Fast foods ✓

Upscale pets and supplies ✓

Sociocultural

More women in the workforce

Clothing ✓

Baking products (staples) ✓

Greater concern for health and fitness

Home exercise equipment ✓

Meat products ✓

Political/legal

Tort reform Legal services ✓

Auto manufacturing ✓

Americans with Disabilities Act (ADA)

Retail ✓

Manufacturers of elevators, escalators, and ramps

✓

Technological

Genetic engineering Pharmaceutical ✓

Publishing ✓

Pollution/global warming Engineering services ✓

Petroleum ✓

Economic

Interest rate decreases Residential construction ✓

Most common grocery products

✓

Global

Increasing global trade Shipping ✓

Personal service ✓

Emergence of China as an economic power

Soft drinks ✓

Defense ✓

EXHIBIT 2.3 The Impact of General Environmental Trends on Various Industries

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2.3 STRATEGY SPOTLIGHT HOW BIG DATA CAN MONITOR FEDERAL, STATE, AND LOCAL GOVERNMENT EXPENDITURES Open The Books is a new initiative that uses big data to make the work of city, state, and the federal government more trans- parent. It was founded in Illinois by Adam Andrzejewski, a big- data expert. He and his team have amassed the computing power to capture a great share of the federal checkbook’s ven- dor spending in the United States, as well as more than 48 states and many local governments.

Open The Books can also trace public salaries, pensions, and donations to political campaigns. Perhaps not too surprisingly, donors and subsidy recipients frequently turn out to be one of the same! Open The Books has created an app that can be quite revealing—the beauty school that receives more than 100 times in grants and student loans what it charges in tuition, and the $1.67 million in federally guaranteed loans received by the brother of a former Illinois director of agriculture.

Let’s take a closer look to see what Andrzejewski has uncovered in his study of expenditures by the state of Illinois. He found that it has been two years since Illinois state govern- ment had a full-year budget and more than 70,000 vendors are owed $8.2 billion. However, despite a deadlock by the legisla- ture and apparent fiscal insolvency, more than $50 billion has

been paid to providers and other entities during the 2016 fiscal year. Who are some of these recipients?

• Comptroller Leslie Munger paid a lobbyist $50,000 out of her budget. The lobbyist, Shea, Paige and Rogal, has garnered more than $370,000 in payments since 2009. A key executive is the chairman emeritus of the Republican Party.

• Since 2005, J. Walter Thompson (JWT), one of the world’s largest advertising agencies, has received $178.1 million.

• The Illinois Department of Transportation (IDOT) employs 1,133 civil engineers and 1,155 engineering technicians. Given this bank of talent, one might question why civil engineering firms such as ESI Consultants were paid $3.7 million, as well as other firms at large hourly rates.

• One could claim that IDOT engages in political patronage. On August 31, 2016, Munger paid $4.1 million in “performance bonuses” to 1,230 IDOT employees— members of the Teamsters. However, it may hardly be called a “performance bonus” because one of every two employees qualified for the pay enhancement.

As noted by Andrzejewski, “The Illinois credit ranking is the lowest of all 50 states. But the public patronage machine rolls on.”

Sources: Shales, A. 2015. Pulling down state credit ratings. Forbes, November 2: 52; and Andrzejewski, A. 2016. The $50 billion Illinois favor factory hums along. www.forbes.com, August 31: np.

to enable firms to better customize their product and service offerings to customers while more efficiently and fully using the resources of the company. For example, Pepsi used data analytics to develop an algorithm that lowers the rate of inventory stockouts and has shared the algorithm with its partners and retailers. Similarly, Kaiser Permanente collects petabytes of data on the health treatments of its 8 million health care members. This has allowed Kaiser to develop insights on the cost, efficacy, and safety of the treatments pro- vided by doctors and procedures in hospitals.

A recent survey by consultants NewVantage Partners has found that the number of U.S. firms using big data in the past three years has jumped to 63 percent. And 70 percent of firms now say that big data is of critical importance to their firms, a huge increase from 21 percent in 2012. Clearly, this is one of the fastest tech-adoption rates in history. Meanwhile, the title of chief data officer (the C-Suite executive of big data) did not exist until recently. Now, it is found in 54 percent of the firms that were surveyed.

Companies that are taking the lead in the analytics revolution see it as an important source of competitive differentiation. Recently, the MIT Center for Digital Business, along with research sponsor Capgemini Consulting, completed a two-year study. More than 400 compa- nies participated with the goal of determining which companies were attaining a “digital advan- tage” over industry peers with their use of analytics, social media, and mobile and embedded devices. The study found that companies that do more with digital technologies—and support such investments with leadership and governance mechanisms—are 26 percent more profitable than their industry peers, and outperform average industry performance by 6 to 9 percent.

Spotlight 2.3 is an example of how data analytics can play a key role in monitoring spend- ing in the public sector of the economy.

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THE COMPETITIVE ENVIRONMENT Managers must consider the competitive environment (also sometimes referred to as the task or industry environment). The nature of competition in an industry, as well as the profitability of a firm, is often directly influenced by developments in the competitive environment.

The competitive environment consists of many factors that are particularly relevant to a firm’s strategy. These include competitors (existing or potential), customers, and suppliers. Potential competitors may include a supplier considering forward integration, such as an automobile manufacturer acquiring a rental car company, or a firm in an entirely new indus- try introducing a similar product that uses a more efficient technology.

Next, we will discuss key concepts and analytical techniques that managers should use to assess their competitive environments. First, we examine Michael Porter’s five-forces model that illustrates how these forces can be used to explain an industry’s profitability.54 Second, we discuss how the five forces are being affected by the capabilities provided by Internet technologies. Third, we address some of the limitations, or “caveats,” that managers should be familiar with when conducting industry analysis. Finally, we address the concept of stra- tegic groups, because even within an industry it is often useful to group firms on the basis of similarities of their strategies. As we will see, competition tends to be more intense among firms within a strategic group than between strategic groups.

Porter’s Five Forces Model of Industry Competition The “five forces” model developed by Michael E. Porter has been the most commonly used analytical tool for examining the competitive environment. It describes the competitive envi- ronment in terms of five basic competitive forces:55

1. The threat of new entrants. 2. The bargaining power of buyers. 3. The bargaining power of suppliers. 4. The threat of substitute products and services. 5. The intensity of rivalry among competitors in an industry.

Each of these forces affects a firm’s ability to compete in a given market. Together, they determine the profit potential for a particular industry. The model is shown in Exhibit 2.4. A manager should be familiar with the five forces model for several reasons. It helps you decide whether your firm should remain in or exit an industry. It provides the rationale for increasing or decreasing resource commitments. The model helps you assess how to improve your firm’s competitive position with regard to each of the five forces.56 For example, you can use insights provided by the five forces model to understand how higher entry barriers discourage new rivals from competing with you.57 Or you can see how to develop strong relationships with your distribution channels. You may decide to find suppliers who satisfy the price/performance criteria needed to make your product or service a top performer.

Consider, for example, some of the competitive forces affecting the hotel industry.58 Airbnb, a room-sharing site, offers more rooms than even Marriott. Online travel agencies take a hefty cut of hotel bookings; and price-comparison sites make it difficult to raise room rates. Growing supply may make it harder still. Steven Kent of Goldman Sachs expects that the supply of new rooms in the next two years will outpace the previous five. Already, the previous growth of American occupancy rates has begun to slow.

The Threat of New Entrants The threat of new entrants refers to the possibility that the profits of established firms in the industry may be eroded by new competitors.59 The extent of the threat depends on existing barriers to entry and the combined reactions from existing

Porter’s five forces model of industry competition a tool for examining the industry-level competitive environment, especially the ability of firms in that industry to set prices and minimize costs.

LO 2-5 How forces in the competitive environment can affect profitability, and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.

competitive environment factors that pertain to an industry and affect a firm’s strategies.

industry a group of firms that produce similar goods or services.

threat of new entrants the possibility that the profits of established firms in the industry may be eroded by new competitors.

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competitors.60 If entry barriers are high and/or the newcomer can anticipate a sharp retali- ation from established competitors, the threat of entry is low. These circumstances discour- age new competitors. There are six major sources of entry barriers.

Economies of Scale Economies of scale refers to spreading the costs of production over the number of units produced. The cost of a product per unit declines as the absolute volume per period increases. This deters entry by forcing the entrant to come in at a large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disad- vantage. Both are undesirable options.

Product Differentiation When existing competitors have strong brand identification and customer loyalty, product differentiation creates a barrier to entry by forcing entrants to spend heavily to overcome existing customer loyalties.

Capital Requirements The need to invest large financial resources to compete creates a barrier to entry, especially if the capital is required for risky or unrecoverable up-front adver- tising or research and development (R&D).

Switching Costs A barrier to entry is created by the existence of one-time costs that the buyer faces when switching from one supplier’s product or service to another.

Access to Distribution Channels The new entrant’s need to secure distribution for its prod- uct can create a barrier to entry.

Cost Disadvantages Independent of Scale Some existing competitors may have advantages that are independent of size or economies of scale. These derive from:

• Proprietary products • Favorable access to raw materials • Government subsidies • Favorable government policies

economies of scale decreases in cost per unit as absolute output per period increases.

product differentiation the degree to which a product has strong brand loyalty or customer loyalty.

switching costs one-time costs that a buyer/supplier faces when switching from one supplier/buyer to another.

Sources: From Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Special Issue on HBS Centennial. Harvard Business Review 86, No. 1 (January 2008), 78–93. Reprinted with permission of Michael E. Porter.

EXHIBIT 2.4 Porter’s Five Forces Model of Industry Competition

Threat of substitute products

or services

Threat of new entrants

Bargaining power of buyers

Bargaining power of suppliers INDUSTRY

COMPETITORS

Rivalry among Existing Firms

SUPPLIERS

SUBSTITUTES

BUYERS

POTENTIAL ENTRANTS

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Managers often tend to overestimate the barriers of entry in many industries. There are any number of cases where new entrants found innovative ways to enter industries by clev- erly mixing and matching existing technologies. For example, companies, medical research- ers, governments, and others are creating breakthrough technology products without having to create any new technology.61 Geoff Colvin, a senior editor at Fortune, calls this “the era of Lego Innovation,” in which significant and valuable advances in technology can be achieved by imaginatively combining components and software available to everyone. Such a trend serves to reduce entry barriers in many industries because state-of-the-art technology does not have to be developed internally—rather, it is widely available and, Colvin asserts, “we all have access to a really big box of plastic bricks.” Consider a few examples:

MIT’s Media Lab has created robots powered by Android smartphones. After all, those devices can see, hear, recognize speech, and talk; they know where they are, how they’re oriented, and how fast they’re moving. And, through apps and an Internet connection, they can do a nearly infinite number of other tasks, such as recognize faces and translate languages. Similarly, teams at the University of South Carolina combined off-the-shelf eye- tracking technology with simple software they wrote to detect whether a driver was getting drowsy; any modern car has enough computing power to handle this job easily.

The Bargaining Power of Buyers Buyers threaten an industry by forcing down prices, bar- gaining for higher quality or more services, and playing competitors against each other. These actions erode industry profitability.62 The power of each large buyer group depends on attributes of the market situation and the importance of purchases from that group com- pared with the industry’s overall business. A buyer group is powerful when:

• It is concentrated or purchases large volumes relative to seller sales. If a large percentage of a supplier’s sales are purchased by a single buyer, the importance of the buyer’s business to the supplier increases. Large-volume buyers also are powerful in industries with high fixed costs (e.g., steel manufacturing).

• The products it purchases from the industry are standard or undifferentiated. Confident they can always find alternative suppliers, buyers play one company against the other, as in commodity grain products.

• The buyer faces few switching costs. Switching costs lock the buyer to particular sellers. Conversely, the buyer’s power is enhanced if the seller faces high switching costs.

• It earns low profits. Low profits create incentives to lower purchasing costs. On the other hand, highly profitable buyers are generally less price-sensitive.

• The buyers pose a credible threat of backward integration. If buyers either are partially integrated or pose a credible threat of backward integration, they are typically able to secure bargaining concessions.

• The industry’s product is unimportant to the quality of the buyer’s products or services. When the quality of the buyer’s products is not affected by the industry’s product, the buyer is more price-sensitive.

At times, a firm or set of firms in an industry may increase its buyer power by using the services of a third party. FreeMarkets Online is one such third party.63 Pittsburgh-based FreeMarkets has developed software enabling large industrial buyers to organize online auc- tions for qualified suppliers of semistandard parts such as fabricated components, packag- ing materials, metal stampings, and services. By aggregating buyers, FreeMarkets increases the buyers’ bargaining power. The results are impressive. In its first 48 auctions, most par- ticipating companies saved over 15 percent; some saved as much as 50 percent.

Strategy Spotlight 2.4 discusses why Apple, Inc., has such powerful bargaining power when they negotiate rental space in malls.

bargaining power of buyers the threat that buyers may force down prices, bargain for higher quality or more services, and play competitors against each other.

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2.4 STRATEGY SPOTLIGHT APPLE FLEXES ITS MUSCLE WHEN IT COMES TO NEGOTIATING RENTAL RATES FOR ITS STORES IN MALLS Not all stores in a mall are created equal. Apple’s enormous gravitational pull on mall traffic distorts the market for mall rents and helps win the iPhone maker sweetheart deals. Apple draws in so many shoppers that its stores can single-handedly lift sales by 10 percent at the malls in which they operate, according to Green Street Advisors, a real estate research firm. In fact, Apple accounts for as much as 33 percent of total sales in some of the New England malls in which it operates.

Apple has used its bargaining power to pay no more than 2 percent of its sales a square foot in rent. That compares very favorably with a typical tenant, which pays as much as 15 percent, according to industry executives. In addition to paying a lower

percentage of sales for rent, Apple does not pay additional rent if their sales exceed a particular level—a luxury not afforded other retail tenants.

Apple opened its first two retail stores in 2001 at Tysons Corner Center in McClean, Virginia, and in the Glendale Galleria in Glendale, California. As of 2016, it had more than 450 stores in the United States and more than 18 other countries. In addi- tion, it plans to open 25 new stores in China by 2017, bring- ing its total to 40 in that country. Although the stores account for about only 12 percent of Apple’s total revenues, they draw about 1 million visitors a day. Fun fact: That is more than all of the Disney theme parks in the world combined!

Sources: Kapner, S. 2015. Apple stores upend the mall business. The Wall Street Journal, March 11: B1 and B4; and Farfan, B. 2016. Apple computer retail stores global locations. www.the balance.com, October 12: np.

The Bargaining Power of Suppliers Suppliers can exert bargaining power by threatening to raise prices or reduce the quality of purchased goods and services. Powerful suppliers can squeeze the profitability of firms so far that they can’t recover the costs of raw material inputs.64 The factors that make suppliers powerful tend to mirror those that make buyers powerful. A supplier group will be powerful when:

• The supplier group is dominated by a few companies and is more concentrated (few firms dominate the industry) than the industry it sells to. Suppliers selling to fragmented industries influence prices, quality, and terms.

• The supplier group is not obliged to contend with substitute products for sale to the industry. The power of even large, powerful suppliers can be checked if they compete with substitutes.

• The industry is not an important customer of the supplier group. When suppliers sell to several industries and a particular industry does not represent a significant fraction of its sales, suppliers are more prone to exert power.

• The supplier’s product is an important input to the buyer’s business. When such inputs are important to the success of the buyer’s manufacturing process or product quality, the bargaining power of suppliers is high.

• The supplier group’s products are differentiated, or it has built up switching costs for the buyer. Differentiation or switching costs facing the buyers cut off their options to play one supplier against another.

• The supplier group poses a credible threat of forward integration. This provides a check against the industry’s ability to improve the terms by which it purchases.

The formation of Delta Pride Catfish is an example of the power a group of suppliers can attain if they exercise the threat of forward integration.65 Catfish farmers in Mississippi historically supplied their harvest to processing plants run by large agribusiness firms such as ConAgra and Farm Fresh. When the farmers increased their production of catfish in response to growing demand, they found, much to their chagrin, that processors were holding back on their plans to increase their processing capabilities in hopes of higher retail prices for catfish.

bargaining power of suppliers the threat that suppliers may raise prices or reduce the quality of purchased goods and services.

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What action did the farmers take? About 120 of them banded together and formed a cooperative, raised $4.5 million, and constructed their own processing plant, which they supplied themselves. ConAgra’s market share quickly dropped from 35 percent to 11 percent, and Farm Fresh’s market share fell by over 20 percent. Within 10 years, Delta Pride controlled over 40 percent of the U.S. catfish market. Recently, Delta Pride changed its ownership structure and became a closely-held corporation. In 2014, it had revenues of $80 million, employed 600 people, and processed 80 million pounds of catfish.

The Threat of Substitute Products and Services All firms within an industry compete with industries producing substitute products and services.66 Substitutes limit the potential returns of an industry by placing a ceiling on the prices that firms in that industry can prof- itably charge. The more attractive the price/performance ratio of substitute products, the tighter the lid on an industry’s profits.

Identifying substitute products involves searching for other products or services that can perform the same function as the industry’s offerings. This may lead a manager into busi- nesses seemingly far removed from the industry. For example, the airline industry might not consider video cameras much of a threat. But as digital technology has improved and wire- less and other forms of telecommunication have become more efficient, teleconferencing has become a viable substitute for business travel. That is, the rate of improvement in the price–performance relationship of the substitute product (or service) is high.

Consider the case of hybrid cars as a substitute for gasoline-powered cars.67 Hybrid cars, such as the Toyota Prius, have seen tremendous success since the first hybrids were introduced in the late 1990s. Yet the market share of hybrid cars has been consistently low—reaching 2.4 percent in 2009, rising to 3.3 percent (the peak) in 2013, and declining to only 2 percent in 2016. Such results are even more surprising given that the number of models more than doubled between 2009 and 2014—24 to 51. That’s more choices, but fewer takers. While some may believe the hybrid car industry feels pressure from other novel car segments such as electric cars (e.g., Nissan Leaf), the primary competition comes from an unusual suspect: plain old gas combustion cars.

The primary reason many environmental and cost-conscious consumers prefer gasoline- powered over hybrid cars is rather simple. Engines of gasoline-powered cars have increasingly challenged the key selling attribute of hybrid cars: fuel economy. While hybrid cars still slightly outcompete modern gasoline cars in terms of fuel economy, consumers increasingly don’t see the value of paying as much as $6,000 extra for a hybrid car when they can get around 40 mpg in a gasoline car such as the Chevrolet Cruz or Hyundai Elantra.

The Intensity of Rivalry among Competitors in an Industry Firms use tactics like price competition, advertising battles, product introductions, and increased customer service or warranties. Rivalry occurs when competitors sense the pressure or act on an opportunity to improve their position.68

Some forms of competition, such as price competition, are typically highly destabilizing and are likely to erode the average level of profitability in an industry.69 Rivals easily match price cuts, an action that lowers profits for all firms. On the other hand, advertising bat- tles expand overall demand or enhance the level of product differentiation for the benefit of all firms in the industry. Rivalry, of course, differs across industries. In some instances it is characterized as warlike, bitter, or cutthroat, whereas in other industries it is referred to as polite and gentlemanly. Intense rivalry is the result of several interacting factors, including the following:

• Numerous or equally balanced competitors. When there are many firms in an industry, the likelihood of mavericks is great. Some firms believe they can make moves without being noticed. Even when there are relatively few firms, and they are nearly equal in size and resources, instability results from fighting among companies having the resources for sustained and vigorous retaliation.

threat of substitute products and services the threat of limiting the potential returns of an industry by placing a ceiling on the prices that firms in that industry can profitably charge without losing too many customers to substitute products.

intensity of rivalry among competitors in an industry the threat that customers will switch their business to competitors within the industry.

substitute products and services products and services outside the industry that serve the same customer needs as the industry’s products and services.

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• Slow industry growth. Slow industry growth turns competition into a fight for market share, since firms seek to expand their sales.

• High fixed or storage costs. High fixed costs create strong pressures for all firms to increase capacity. Excess capacity often leads to escalating price cutting.

• Lack of differentiation or switching costs. Where the product or service is perceived as a commodity or near commodity, the buyer’s choice is typically based on price and service, resulting in pressures for intense price and service competition. Lack of switching costs, described earlier, has the same effect.

• Capacity augmented in large increments. Where economies of scale require that capacity must be added in large increments, capacity additions can be very disruptive to the industry supply/demand balance.

• High exit barriers. Exit barriers are economic, strategic, and emotional factors that keep firms competing even though they may be earning low or negative returns on their investments. Some exit barriers are specialized assets, fixed costs of exit, strategic interrelationships (e.g., relationships between the business units and others within a company in terms of image, marketing, shared facilities, and so on), emotional barriers, and government and social pressures (e.g., governmental discouragement of exit out of concern for job loss).

Rivalry between firms is often based solely on price, but it can involve other factors. Consider, for example, the intense competition between Uber Technologies Inc. and Lyft Inc., which are engaged in a fierce, ongoing battle in the taxi industry:70

The bitter war between Uber and Lyft has spilled into dozens of cities where they are racing to provide the default app for summoning a ride within minutes. The two rivals are busy undercutting each other’s prices, poaching drivers, and co-opting innovations. These actions have increasingly blurred the lines between the two services.

The potential market for these firms may stretch far beyond rides. Investors who have bid up the value of Uber to over $69 billion in August 2016 are betting that it can expand into becoming the backbone of a logistics and delivery network for various services—a type of FedEx for cities.

The recruitment of drivers is the lifeblood for the services as they attempt to build the largest networks with the fastest pickup times. For example, many Uber drivers are motivated to poach Lyft’s drivers in order to get a bounty—$500 for referring a Lyft driver and $1,000 for referring a Lyft “mentor,” an experienced Lyft contractor who helps train new drivers.

In June 2014, another shot over the bow took place when both companies unveiled similar carpooling services within hours of each other. Lyft Line and Uber Pool let passengers ride with strangers and split the bill—lowering the cost of regular commutes. Lyft claims that it had been developing the carpooling model for several years and acquired a team to lead the effort months ago, according to John Zimmer, Lyft’s president. He adds, “I think it’s flattering when other companies look at how we’re innovating and want to do similar things.”

Exhibit 2.5 summarizes our discussion of industry five-forces analysis. It points out how various factors, such as economies of scale and capital requirements, affect each “force.”

How the Internet and Digital Technologies Are Affecting the Five Competitive Forces The Internet is having a significant impact on nearly every industry. Internet-based and digi- tal technologies have fundamentally changed the ways businesses interact with each other and with consumers. In most cases, these changes have affected industry forces in ways that have created many new strategic challenges. In this section, we will evaluate Michael Porter’s five-forces model in terms of the actual use of the Internet and the new technologi- cal capabilities that it makes possible.

The Threat of New Entrants In most industries, the threat of new entrants has increased because digital and Internet-based technologies lower barriers to entry. For example,

LO 2-6 How the Internet and digitally based capabilities are affecting the five competitive forces and industry profitability.

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Threat of New Entrants Is High When: High Low

Economies of scale are X

Product differentiation is X

Capital requirements are X

Switching costs are X

Incumbent’s control of distribution channels is

X

Incumbent’s proprietary knowledge is

X

Incumbent’s access to raw materials is

X

Incumbent’s access to government subsidies is

X

Power of Buyers Is High When: High Low

Concentration of buyers relative to suppliers is

X

Switching costs are X

Product differentiation of suppliers is

X

Threat of backward integration by buyers is

X

Extent of buyer’s profits is X

Importance of the supplier’s input to quality of buyer’s final product is

X

Power of Suppliers Is High When: High Low

Concentration relative to buyer industry is

X

Availability of substitute products is

X

Importance of customer to the supplier is

X

Differentiation of the supplier’s products and services is

X

Switching costs of the buyer are X

Threat of forward integration by the supplier is

X

Threat of Substitute Products Is High When: High Low

Differentiation of the substitute product is

X

Rate of improvement in price– performance relationship of substitute product is

X

Intensity of Competitive Rivalry Is High When: High Low

Number of competitors is X

Industry growth rate is X

Fixed costs are X

Storage costs are X

Product differentiation is X

Switching costs are X

Exit barriers are X

Strategic stakes are X

EXHIBIT 2.5 Competitive Analysis Checklist

businesses that reach customers primarily through the Internet may enjoy savings on other traditional expenses such as office rent, sales-force salaries, printing, and postage. This may encourage more entrants who, because of the lower start-up expenses, see an opportunity to capture market share by offering a product or performing a service more efficiently than existing competitors. Thus, a new cyber entrant can use the savings provided by the Internet to charge lower prices and compete on price despite the incumbent’s scale advantages.

Alternatively, because digital technologies often make it possible for young firms to pro- vide services that are equivalent or superior to an incumbent, a new entrant may be able to serve a market more effectively, with more personalized services and greater attention to

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product details. A new firm may be able to build a reputation in its niche and charge premium prices. By so doing, it can capture part of an incumbent’s business and erode profitability.

Another potential benefit of web-based business is access to distribution channels. Manufacturers or distributors that can reach potential outlets for their products more effi- ciently by means of the Internet may enter markets that were previously closed to them. Access is not guaranteed, however, because strong barriers to entry exist in certain industries.71

The Bargaining Power of Buyers The Internet and wireless technologies may increase buyer power by providing consumers with more information to make buying decisions and by lowering switching costs. But these technologies may also suppress the power of tradi- tional buyer channels that have concentrated buying power in the hands of a few, giving buy- ers new ways to access sellers. To sort out these differences, let’s first distinguish between two types of buyers: end users and buyer channel intermediaries.

End users are the final customers in a distribution channel. Internet sales activity that is labeled “B2C”—that is, business-to-consumer—is concerned with end users. The Internet is likely to increase the power of these buyers for several reasons. First, the Internet provides large amounts of consumer information. This gives end users the information they need to shop for quality merchandise and bargain for price concessions. Second, an end user’s switching costs are potentially much lower because of the Internet. Switching may involve only a few clicks of the mouse to find and view a competing product or service online.

In contrast, the bargaining power of distribution channel buyers may decrease because of the Internet. Buyer channel intermediaries are the wholesalers, distributors, and retailers who serve as intermediaries between manufacturers and end users. In some industries, they are dominated by powerful players that control who gains access to the latest goods or the best merchandise. The Internet and wireless communications, however, make it much easier and less expensive for businesses to reach customers directly. Thus, the Internet may increase the power of incumbent firms relative to that of traditional buyer channels. Strategy Spotlight 2.5 illustrates some of the changes brought on by the Internet that have affected the legal services industry.

The Bargaining Power of Suppliers Use of the Internet and digital technologies to speed up and streamline the process of acquiring supplies is already benefiting many sectors of the economy. But the net effect of the Internet on supplier power will depend on the nature of competition in a given industry. As with buyer power, the extent to which the Internet is a benefit or a detriment also hinges on the supplier’s position along the supply chain.

The role of suppliers involves providing products or services to other businesses. The term “B2B”—that is, business-to-business—often refers to businesses that supply or sell to other businesses. The effect of the Internet on the bargaining power of suppliers is a double-edged sword. On the one hand, suppliers may find it difficult to hold on to customers because buyers can do comparative shopping and price negotiations so much faster on the Internet.

On the other hand, several factors may also contribute to stronger supplier power. First, the growth of new web-based business may create more downstream outlets for suppliers to sell to. Second, suppliers may be able to create web-based purchasing arrangements that make purchasing easier and discourage their customers from switching. Online procure- ment systems directly link suppliers and customers, reducing transaction costs and paper- work.72 Third, the use of proprietary software that links buyers to a supplier’s website may create a rapid, low-cost ordering capability that discourages the buyer from seeking other sources of supply. Amazon.com, for example, created and patented One-Click purchasing technology that speeds up the ordering process for customers who enroll in the service.73

Finally, suppliers will have greater power to the extent that they can reach end users directly without intermediaries. Previously, suppliers often had to work through intermediaries who brought their products or services to market for a fee. But a process known as disinterme- diation is removing the organizations or business process layers responsible for intermediary

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58 PART 1 :: STRATEGIC ANALYSIS

2.5 STRATEGY SPOTLIGHT BUYER POWER IN LEGAL SERVICES: THE ROLE OF THE INTERNET The $276 billion U.S. legal services industry, which includes about 180,000 firms, historically was a classic example of an industry that leaves buyers at a bargaining disadvantage. One of the key reasons for the strong bargaining position of law firms is high information asymmetry between lawyers and consumers, meaning that highly trained and experienced legal professionals know more about legal matters than the average consumer of legal services.

The Internet provides an excellent example of how unequal bargaining power can be reduced by decreasing information asymmetry. A new class of Internet legal services providers tries to accomplish just that and is challenging traditional law services along the way. For instance, LawPivot.com, a recent start-up backed by Google Ventures and cofounded by a former

top Apple Inc. lawyer, allows consumers to interact with law- yers on a social networking site. This service allows customers to get a better picture of a lawyer’s legal skills before opening their wallets. As a result, information asymmetry between law- yers and consumers is reduced and customers find themselves in a better bargaining position. Another example is LegalZoom. com, a service that helps consumers to create legal docu- ments. Customers familiar with LegalZoom.com may use their knowledge of the time and effort required to create legal docu- ments to challenge a lawyer’s fees for custom-crafted legal documents.

Sources: Anonymous. 2016. The size of the U.S. legal market: Shrinking piece of a bigger pie: An LEI Graphic. www.legalexecutiveinstitute.com, January 11: np; Jacobs, D. L. 2011. Google takes aim at lawyers. Forbes, August 8: np; Anonymous. 2011. Alternative law firms: Bargain briefs. The Economist, August 13: 64; and Anonymous. 2014. Legal services industry profile. First Research, August 25: np.

steps in the value chain of many industries.74 Just as the Internet is eliminating some business functions, it is creating an opening for new functions. These new activities are entering the value chain by a process known as reintermediation—the introduction of new types of inter- mediaries. Many of these new functions are affecting traditional supply chains. For example, delivery services are enjoying a boom because of the Internet. Many more consumers are choosing to have products delivered to their door rather than going out to pick them up.

The Threat of Substitutes Along with traditional marketplaces, the Internet has created a new marketplace and a new channel. In general, therefore, the threat of substitutes is height- ened because the Internet introduces new ways to accomplish the same tasks.

Consumers will generally choose to use a product or service until a substitute that meets the same need becomes available at a lower cost. The economies created by Internet technologies have led to the development of numerous substitutes for traditional ways of doing business.

Another example of substitution is in the realm of electronic storage. With expanded desktop computing, the need to store information electronically has increased dramatically. Until recently, the trend has been to create increasingly larger desktop storage capabilities and techniques for compressing information that create storage efficiencies. But a viable substitute has emerged: storing information digitally on the Internet. Companies such as Dropbox and Amazon Web Services are providing web-based storage that firms can access simply by leasing space online. Since these storage places are virtual, they can be accessed anywhere the web can be accessed. Travelers can access important documents and files without transporting them physically from place to place.

The Intensity of Competitive Rivalry Because the Internet creates more tools and means for competing, rivalry among competitors is likely to be more intense. Only those competi- tors that can use digital technologies and the web to give themselves a distinct image, create unique product offerings, or provide “faster, smarter, cheaper” services are likely to capture greater profitability with the new technology.

Rivalry is more intense when switching costs are low and product or service differen- tiation is minimized. Because the Internet makes it possible to shop around, it has “com- moditized” products that might previously have been regarded as rare or unique. Since the Internet reduces the importance of location, products that previously had to be sought out

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in geographically distant outlets are now readily available online. This makes competitors in cyberspace seem more equally balanced, thus intensifying rivalry.

The problem is made worse for marketers by the presence of shopping robots (“bots”) and infomediaries that search the web for the best possible prices. Consumer websites like mySimon seek out all the web locations that sell similar products and provide price com- parisons.75 Obviously, this focuses the consumer exclusively on price. Some shopping info- mediaries, such as CNET, not only search for the lowest prices on many different products but also rank the customer service quality of different sites that sell similarly priced items.76 Such infomediary services are good for consumers because they give them the chance to compare services as well as price. For businesses, however, they increase rivalry by consoli- dating the marketing message that consumers use to make a purchase decision into a few key pieces of information over which the selling company has little control.

Using Industry Analysis: A Few Caveats For industry analysis to be valuable, a company must collect and evaluate a wide variety of information. As the trend toward globalization accelerates, information on foreign markets as well as on a wider variety of competitors, suppliers, customers, substitutes, and potential new entrants becomes more critical. Industry analysis helps a firm not only to evaluate the profit potential of an industry but also to consider various ways to strengthen its position vis-à-vis the five forces. However, we’d like to address a few caveats.

First, managers must not always avoid low-profit industries (or low-profit segments in profitable industries).77 Such industries can still yield high returns for some players who pursue sound strategies. As an example, consider WellPoint Health Network (now Anthem, Inc.), a huge health care insurer:78

In 1986, WellPoint Health Network (when it was known as Blue Cross of California) suffered a loss of $160 million. That year, Leonard Schaeffer became CEO and challenged the conventional wisdom that individuals and small firms were money losers. (This was certainly “heresy” at the time—the firm was losing $5 million a year insuring 65,000 individuals!) However, by the early 1990s, the health insurer was leading the industry in profitability. The firm has continued to grow and outperform its rivals even during economic downturns. By 2016, its revenues and profits were over $80 billion and $2.5 billion, respectively.

Second, five-forces analysis implicitly assumes a zero-sum game, determining how a firm can enhance its position relative to the forces. Yet such an approach can often be shortsighted; that is, it can overlook the many potential benefits of developing constructive win–win relationships with suppliers and customers. Establishing long-term mutually beneficial rela- tionships with suppliers improves a firm’s ability to implement just-in-time (JIT) inventory systems, which let it manage inventories better and respond quickly to market demands. A recent study found that if a company exploits its powerful position against a supplier, that action may come back to haunt the company.79 Consider, for example, General Motors’ heavy-handed dealings with its suppliers:80

In 2014, GM was already locked in a public relations nightmare as a deadly ignition defect triggered the recall of over 2.5 million vehicles.81 At the same time, it was faced with another perception problem: poor supplier relations. GM is now considered the worst big automaker to deal with, according to a new survey of top suppliers in the car industry in the United States.

The annual survey, conducted by the automotive consultant group Planning Perspectives Inc., asks the industry’s biggest suppliers to rate the relationships with the six automakers that account for more than 85 percent of all cars and light trucks in the U.S. Those so-called “Tier 1” suppliers say GM is their least favorite big customer—less popular than even Chrysler, the unit of Fiat Chrysler Automobiles that had “earned” the dubious distinction since 2008.

The suppliers gave GM low marks on all kinds of measures, including its overall trustworthiness, its communication skills, and its protection of intellectual property. The suppliers also said that GM was the automaker least likely to allow them to raise prices to

zero-sum game a situation in which multiple players interact, and winners win only by taking from other players.

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recoup unexpected materials cost increases. In return, parts executives have said they tend to bring hot new technology to other carmakers first—certainly something that makes it more difficult for GM to compete in this hotly contested industry.

Third, the five-forces analysis also has been criticized for being essentially a static analy- sis. External forces as well as strategies of individual firms are continually changing the structure of all industries. The search for a dynamic theory of strategy has led to greater use of game theory in industrial organization economics research and strategy research.

Based on game-theoretic considerations, Brandenburger and Nalebuff recently introduced the concept of the value net,82 which in many ways is an extension of the five-forces analysis. It is illustrated in Exhibit 2.6. The value net represents all the players in the game and analyzes how their interactions affect a firm’s ability to generate and appropriate value. The vertical dimension of the net includes suppliers and customers. The firm has direct transactions with them. On the horizontal dimension are substitutes and complements, players with whom a firm interacts but may not necessarily transact. The concept of complementors is perhaps the single most important contribution of value net analysis and is explained in more detail below.

Complements typically are products or services that have a potential impact on the value of a firm’s own products or services. Those who produce complements are usually referred to as complementors.83 Powerful hardware is of no value to a user unless there is software that runs on it. Similarly, new and better software is possible only if the hardware on which it can be run is available. This is equally true in the video game industry, where the sales of game consoles and video games complement each other. Nintendo’s success in the early 1990s was a result of its ability to manage its relationship with its complementors. Nintendo built a security chip into the hardware and then licensed the right to develop games to outside firms. These firms paid a royalty to Nintendo for each copy of the game sold. The royalty revenue enabled Nintendo to sell game consoles at close to their cost, thereby increasing their market share, which, in turn, caused more games to be sold and more royalties to be generated.84

We would like to close this section with some recent insights from Michael Porter, the orig- inator of the five-forces analysis.85 He addresses two critical issues in conducting a good indus- try analysis, which will yield an improved understanding of the root causes of profitability: (1) choosing the appropriate time frame and (2) a rigorous quantification of the five forces.

complements products or services that have an impact on the value of a firm’s products or services.

EXHIBIT 2.6 The Value Net

SUBSTITUTORS

SUPPLIERS

CUSTOMERS

THE COMPANY COMPLEMENTORS Interactions between

players on the horizontal axis

Transactions between players on the vertical axis

Source: Adapted from “The Right Game: Use Game Theory Shape Strategy,” by A. Brandenburger and B. J. Nalebuff, Harvard Business Review July–August 1995.

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• Good industry analysis looks rigorously at the structural underpinnings of profitability. A first step is to understand the time horizon. One of the essential tasks in industry analysis is to distinguish short-term fluctuations from structural changes. A good guideline for the appropriate time horizon is the full business cycle for the particular industry. For most industries, a three- to five-year horizon is appropriate. However, for some industries with long lead times, such as mining, the appropriate horizon may be a decade or more. It is average profitability over this period, not profitability in any particular year, which should be the focus of analysis.

• The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability. As much as possible, analysts should look at industry structure quantitatively, rather than be satisfied with lists of qualitative factors. Many elements of five forces can be quantified: the percentage of the buyer’s total cost accounted for by the industry’s product (to understand buyer price sensitivity); the percentage of industry sales required to fill a plant or operate a logistical network to efficient scale (to help assess barriers to entry); and the buyer’s switching cost (determining the inducement an entrant or rival must offer customers).

Strategic Groups within Industries In an industry analysis, two assumptions are unassailable: (1) No two firms are totally dif- ferent, and (2) no two firms are exactly the same. The issue becomes one of identifying groups of firms that are more similar to each other than firms that are not, otherwise known as strategic groups.86 This is important because rivalry tends to be greater among firms that are alike. Strategic groups are clusters of firms that share similar strategies. After all, is Target more concerned about Nordstrom or Walmart? Is Mercedes more concerned about Hyundai or BMW? The answers are straightforward.87

These examples are not meant to trivialize the strategic groups concept.88 Classifying an industry into strategic groups involves judgment. If it is useful as an analytical tool, we must exercise caution in deciding what dimensions to use to map these firms. Dimensions include breadth of product and geographic scope, price/quality, degree of vertical integration, type of distribution (e.g., dealers, mass merchandisers, private label), and so on. Dimensions should also be selected to reflect the variety of strategic combinations in an industry. For example, if all firms in an industry have roughly the same level of product differentiation (or R&D intensity), this would not be a good dimension to select.

What value is the strategic groups concept as an analytical tool? First, strategic groupings help a firm identify barriers to mobility that protect a group from attacks by other groups.89 Mobility bar- riers are factors that deter the movement of firms from one strategic position to another. For example, in the chainsaw industry, the major barriers protecting the high-quality/dealer-oriented group are technology, brand image, and an established network of servicing dealers.

The second value of strategic grouping is that it helps a firm identify groups whose com- petitive position may be marginal or tenuous. We may anticipate that these competitors may exit the industry or try to move into another group. In recent years in the retail department store industry, firms such as JCPenney and Sears have experienced extremely difficult times because they were stuck in the middle, neither an aggressive discount player like Walmart nor a prestigious upscale player like Neiman Marcus.

Third, strategic groupings help chart the future directions of firms’ strategies. Arrows ema- nating from each strategic group can represent the direction in which the group (or a firm within the group) seems to be moving. If all strategic groups are moving in a similar direc- tion, this could indicate a high degree of future volatility and intensity of competition. In the automobile industry, for example, the competition in the minivan and sport utility segments has intensified in recent years as many firms have entered those product segments.

LO 2-7 The concept of strategic groups and their strategy and performance implications.

strategic groups clusters of firms that share similar strategies.

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Fourth, strategic groups are helpful in thinking through the implications of each industry trend for the strategic group as a whole. Is the trend decreasing the viability of a group? If so, in what direction should the strategic group move? Is the trend increasing or decreasing entry barriers? Will the trend decrease the ability of one group to separate itself from other groups? Such analysis can help in making predictions about industry evolution. A sharp increase in interest rates, for example, tends to have less impact on providers of higher- priced goods (e.g., Porsches) than on providers of lower-priced goods (e.g., Chevrolet Cobalt), whose customer base is much more price-sensitive.

Exhibit 2.7 provides a strategic grouping of the worldwide automobile industry.90 The firms in each group are representative; not all firms are included in the mapping. We have identified five strategic groups. In the top left-hand corner are high-end luxury automakers that focus on a very narrow product market. Most of the cars produced by the members of this group cost well over $100,000. Some cost over twice that amount. The 2017 Ferrari California T starts at $210,843, and the 2017 Lamborghini Huracan will set you back $210,000 (in case you were wondering how to spend your employment signing bonus). Players in this market have a very exclusive clientele and face little rivalry from other strategic groups. At the other extreme, in the lower left-hand corner is a strategic group that has low-price/quality attributes and targets a narrow market. These players, Hyundai and Kia, limit competition from other strategic groups by pricing their products very low. The third group (near the middle) consists of firms high in product pricing/quality and average in their product-line breadth. The final group (at the far right) consists of firms with a broad range of products and multiple price points. These firms have entries that compete at both the lower end of the market (e.g., the Ford Focus) and the higher end (e.g., Chevrolet Corvette).

The auto market has been very dynamic and competition has intensified in recent years.91 For example, some players are going more upscale with their product offerings. In 2009, Hyundai introduced its Genesis, starting at $33,000. This brings Hyundai into direct competition with entries from other strategic groups such as Toyota’s Camry and Honda’s Accord. And, in 2010, Hyundai introduced the Equus model. It was priced at about $60,000 to compete directly with the Lexus 460 on price. To further intensify competition, some upscale brands are increasingly entering lower-priced segments. In 2014, Audi introduced

Note: Members of each strategic group are not exhaustive, only illustrative.

EXHIBIT 2.7 The World Automobile Industry: Strategic Groups

Chery Geely

Tata Motors

Hyundai Kia

HighLow

High

Low

Ferrari Lamborghini

Porsche

Mercedes BMW Audi

Toyota Ford

General Motors Chrysler Honda Nissan

Breadth of Product Line

Price

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ISSUE FOR DEBATE

Purdue University’s Innovative Idea: Income Share Agreements During the past decade, the cost of higher education in the United States has outpaced growth in personal income as well as cost of living increases. This has resulted in a rapid rise in student indebtedness, which many experts view as a looming crisis. Purdue University has responded to this crisis in an innovative way—allowing students to enroll in return for a fixed percentage of their future income.

Purdue University rolled out the “Back a Boiler” program in 2016, using a concept known as an income-share agreement, or ISA, that is available to rising juniors and seniors. The awards will begin at $5,000 and take into consideration a student’s cumulative debt. It is different from a typical loan because students would repay the debt based on a fixed rate linked to their expected income. In a sense, it may be viewed as a gamble that could save them thousands of dollars as compared to traditional loans. But it could also cost them far more if they land high-paying jobs.

To illustrate, a senior majoring in chemical engineering could sign a contract for $10,000 and pay 2.68 percent of her income over seven years, according to Purdue’s online calculator. On the other hand, a student planning to work in a less lucrative field such as comparative literature would shell out a larger portion of her paycheck with contracts lasting no longer than nine years. This is shorter than the federal-aid 10-year repayment plan that stretches out much longer if a borrower falls behind. And Purdue caps repayment at 2.5 times the value of the contract with the objective to plow returns into helping future students. As noted by Purdue University’s President Mitch Daniels, “Clearly there is an explosion in student debt and the default rate is a concern. That got me seriously thinking about this, not as replacement (for federal loans) but as a new option.”

A concern might be that only poor performing students would be more likely to be interested. However, Purdue’s plan to offer contracts tailored to individuals will help the school recoup the investment. Another issue is whether ISAs can compete with federal programs such as Pell Grants. One potential positive outcome: If the program takes off, students looking at contracts would see data on predicted earnings—thus, they may be inclined to choose majors that tend to produce more value.

Purdue structured the income shares to be similar to other forms of unsecured consumer debt. However, it has the added protection that has been extremely difficult to obtain with student loans: bankruptcy discharge. The foundation has put protections in place to account for hardship such as not requiring payments for graduates who earn less than $20,000 a year. However, if someone makes about that amount but fails to make payments—they will be pursued through debt collection.

Discussion Questions 1. Would you be interested in taking out an ISA? Why? Why not? 2. In general, what do you see as the main advantage (or disadvantage) of such a program? 3. Do you think it will become successful? And, if so, do you foresee a market for truly private

ISAs in the future?

Sources: Anonymous. 2016. The other debt-free college idea. The Wall Street Journal, April 17: np; Douglas-Gabriel, D. 2016. At Purdue, student aid based on future earnings could revolutionize college debt. www.washingtonpost.com, April: np; Belkin, D. 2015. Seeking options, college students sell their futures. Dallas Morning News, August 6: A3; and Anonymous. Income share agreements. www.purdue.edu undated.

the Q3 SUV at a base price of only $32,500. And BMW, with its 1-series, is another well- known example. Such cars, priced in the low $30,000s, compete more directly with prod- ucts from broad-line manufacturers like Ford, General Motors, and Toyota. This suggests that members of a strategic group can overcome mobility barriers and migrate to other groups that they find attractive if they are willing to commit time and resources.

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64 PART 1 :: STRATEGIC ANALYSIS

Our discussion would not be complete, of course, without paying some attention to recent entries in the automobile industry that will likely lead to the formation of a new stra- tegic group—placed at the bottom left corner of the grid in Exhibit 2.7. Three firms—China’s Zhejiang Geely Holding Company, China’s Chery Automobile Company, and India’s Tata Motors—have introduced models that bring new meaning to the term “subcompact.”92 Let’s take a look at these econoboxes.

Chery’s 2013 QQ model sells for between $6,083 and $8,170 in the Chinese market and sports horsepower in the range of only 51 to 74. Geely’s best-selling four-door sedan, the Free Cruiser, retails from $5,440 to $7,046. The firm has gone more upscale with some offerings, such as the GX7, a sports utility vehicle with a price starting at $14,910.

For low price-points, India’s Tata Motors has everyone beat by the proverbial mile. In January 2008, it introduced the Nano as the “World’s Cheapest Car,” with an astonishing retail price of only $2,500. It is a four-door, five-seat hatchback that gets 54 miles to the gallon (but this economy originally came with a 30 horsepower motor). Initially, it was a big hit in India. However, after sales peaked at about 80,000 units in 2011–2012, they crashed to only 21,000 units in 2013–2014. As noted by Girish Wagh, the man behind the Nano, “People started looking at Nano not as a low-cost innovation, but as a cheap car. This, among other factors, also hurt the chances.” Needless to say, Tata has made many attempts to make the car more upscale, with a correspondingly higher price.

Not surprisingly, some automakers have recently entered the Indian market with more desirable offerings. Several have offerings that are called compact sedans, but they are actually hatchbacks with a tiny trunk tacked on. These models include Suzuki’s Dzire, Honda’s Amaze, and Hyundai’s Xcent. Prices start at around $8,000, and with the added cachet of a sedan silhouette that adds only a few hundred dollars, these models have become very popular with Indian buyers. This niche is one of the few car segments that soared, while the country’s overall car market shrunk.

Reflecting on Career Implications . . . This chapter addresses the importance of the external environment for strategic managers. As a strategic manager, you should strive in your career to benefit from enhancing your awareness of your external environment. The questions below focus on these issues.

Creating the Environmentally Aware Organization: Advancing your career requires constant scanning, monitoring, and intelligence gathering not only to find future job opportunities but also to understand how employers’ expectations are changing. Consider using websites such as LinkedIn to find opportunities. Merely posting your résumé on a site such as LinkedIn may not be enough. Instead, consider in what ways you can use such sites for scanning, monitoring, and intelligence gathering.

SWOT Analysis: As an analytical method, SWOT analysis is applicable for individuals as it is for firms. It is important for you to periodically evaluate your strengths and weaknesses as well as potential opportunities and threats to your career. Such analysis should be followed by efforts

to address your weaknesses by improving your skills and capabilities.

General Environment: The general environment consists of several segments, such as the demographic, sociocultural, political/legal, technological, economic, and global environments. It would be useful to evaluate how each of these segments can affect your career opportunities. Identify two or three specific trends (e.g., rapid technological change, aging of the population, increase in minimum wages) and their impact on your choice of careers. These also provide possibilities for you to add value for your organization.

Five-Forces Analysis: Before you go for a job interview, consider the five forces affecting the industry within which the firm competes. This will help you to appear knowledgeable about the industry and increase your odds of landing the job. It also can help you to decide if you want to work for that organization. If the “forces” are unfavorable, the long-term profit potential of the industry may be unattractive, leading to fewer resources available and—all other things being equal— fewer career opportunities.

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Managers must analyze the external environment to minimize or eliminate threats and exploit opportunities. This involves a continuous process of environ- mental scanning and monitoring as well as obtaining competitive intelli gence on

present and potential rivals. These activities provide valuable inputs for developing forecasts. In addition, many firms use scenario planning to anticipate and respond to volatile and disruptive environmental changes.

We identified two types of environments: the general environment and the competitive environment. The six segments of the general environment are demographic, sociocultural, political/legal, technological, economic, and global. Trends and events occurring in these segments, such as the aging of the population, higher percentages of women in the workplace, governmental legislation, and increasing (or decreasing) interest rates, can have a dramatic effect on a firm. A given trend or event may have a positive impact on some industries and a negative, a neutral, or no impact on others.

The competitive environment consists of industry- related factors and has a more direct impact than the general environment. Porter’s five-forces model of industry analysis includes the threat of new entrants, buyer power, supplier power, threat of substitutes, and rivalry among competitors. The intensity of these factors determines, in large part, the average expected level of profitability in an industry. A sound awareness of such factors, both individually and in combination, is beneficial not only for deciding what industries to enter but also for assessing how a firm can improve its competitive position. We discuss how many of the changes brought about by the digital economy can be understood in the context of five-forces analysis. The limitations of five-forces analysis include its static nature and its inability to acknowledge the role of complementors. Although we addressed the general environment and competitive environment in separate sections, they are quite

interdependent. A given environmental trend or event, such as changes in the ethnic composition of a population or a technological innovation, typically has a much greater impact on some industries than on others.

The concept of strategic groups is also important to the external environment of a firm. No two organizations are completely different nor are they exactly the same. The question is how to group firms in an industry on the basis of similarities in their resources and strategies. The strategic groups concept is valuable for determining mobility barriers across groups, identifying groups with marginal competitive positions, charting the future directions of firm strategies, and assessing the implications of industry trends for the strategic group as a whole.

SUMMARY REVIEW QUESTIONS 1. Why must managers be aware of a firm’s external

environment? 2. What is gathering and analyzing competitive

intelligence, and why is it important for firms to engage in it?

3. Discuss and describe the six elements of the external environment.

4. Select one of these elements and describe some changes relating to it in an industry that interests you.

5. Describe how the five forces can be used to determine the average expected profitability in an industry.

6. What are some of the limitations (or caveats) in using five-forces analysis?

7. Explain how the general environment and industry environment are highly related. How can such interrelationships affect the profitability of a firm or industry?

8. Explain the concept of strategic groups. What are the performance implications?

summary

perceptual acuity 36 environmental scanning 37 environmental monitoring 37 competitive intelligence 38 environmental forecasting 38 scenario analysis 40

SWOT analysis 40 general environment 41 demographic segment of the general environment 43 sociocultural segment of the general environment 43 political/legal segment of the general environment 43 technological segment of the general environment 45 economic segment of the general environment 46

key terms

global segment of the general environment 47 data analytics 47 industry 50 competitive environment 50 Porter’s five-forces model of industry competition 50 threat of new entrants 50 economies of scale 51 product differentiation 51 switching cost 51 bargaining power of buyers 52

bargaining power of suppliers 53 threat of substitute products and services 54 substitute products and services 54 intensity of rivalry among competitors in an industry 54 zero-sum game 59 complements 60 strategic groups 61

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EXPERIENTIAL EXERCISE Select one of the following industries: personal computers, airlines, or automobiles. For this industry, evaluate the strength of each of Porter’s five forces as well as complementors.

Industry Force High? Medium? Low? Why?

1. Threat of new entrants

2. Power of buyers

3. Power of suppliers

4. Power of substitutes

5. Rivalry among competitors

6. Complementors

APPLICATION QUESTIONS & EXERCISES 1. Imagine yourself as the CEO of a large firm in an

industry in which you are interested. Please (1) identify major trends in the general environment, (2) analyze their impact on the firm, and (3) identify major sources of information to monitor these trends. (Use Internet and library resources.)

2. Analyze movements across the strategic groups in the U.S. retail industry. How do these movements within this industry change the nature of competition?

3. What are the major trends in the general environment that have impacted the U.S. pharmaceutical industry?

4. Go to the Internet and look up www.kroger.com. What are some of the five forces driving industry competition that are affecting the profitability of this firm?

ETHICS QUESTIONS 1. What are some of the legal and ethical issues involved

in collecting competitor intelligence in the following situations?

a. Hotel A sends an employee posing as a potential client to Hotel B to find out who Hotel B’s major corporate customers are.

b. A firm hires an MBA student to collect information directly from a competitor while claiming the information is for a course project.

c. A firm advertises a nonexistent position and interviews a rival’s employees with the intention of obtaining competitor information.

2. What are some of the ethical implications that arise when a firm tries to exploit its power over a supplier?

1. Nanton, N. & Dicks, J. W. 2013. Every entrepreneur’s biggest mistake (and how to avoid it!). www.fastcompany.com. May 21: np.

2. Schneider, J. & Hall, J. 2011. Can you hear me now? Harvard Business Review, 89(4): 23; Hornigan, J. 2009. Wireless Internet use—Mobile access to data and information. www.pewinternet.org, July 22: np; and Salemi Industries. 2012. Home page. www.salemiindustries.com, December 20: np.

3. Weber, G. W. 1995. A new paint job at PPG. BusinessWeek. November 13: 74-75.

4. Hamel, G. & Prahalad, C. K. 1994. Competing for the future. Boston: Harvard Business School Press.

5. Drucker, P. F. 1994. Theory of the business. Harvard Business Review, 72: 95–104.

6. For an insightful discussion on managers’ assessment of the external environment, refer to Sutcliffe, K. M. & Weber, K. 2003. The high cost of accurate knowledge. Harvard Business Review, 81(5): 74–86.

7. Merino, M. 2013. You can’t be a wimp: Making the tough calls. Harvard Business Review, 91(11): 73–78.

8. For insights on recognizing and acting on environmental opportunities, refer to Alvarez, S. A. & Barney, J. B. 2008. Opportunities, organizations, and entrepreneurship: Theory and debate. Strategic Entrepreneurship Journal, 2(3): entire issue.

9. Charitou, C. D. & Markides, C. C. 2003. Responses to disruptive strategic innovation. MIT Sloan Management Review, 44(2): 55–64.

10. Our discussion of scanning, monitoring, competitive intelligence, and forecasting concepts draws on several sources. These include Fahey, L. & Narayanan, V. K. 1983. Macroenvironmental analysis for strategic management. St. Paul, MN: West; Lorange, P., Scott, F. S., & Ghoshal, S. 1986. Strategic control. St. Paul, MN: West; Ansoff, H. I. 1984. Implementing strategic management. Englewood Cliffs, NJ: Prentice Hall; and Schreyogg, G. & Stienmann, H. 1987. Strategic control: A new perspective. Academy of Management Review, 12: 91–103.

11. An insightful discussion on how leaders can develop “peripheral vision” in environmental scanning is found in Day, G. S. & Schoemaker, P. J. H. 2008. Are you a “vigilant leader”? MIT Sloan Management Review, 49(3): 43–51.

REFERENCES

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12. Elenkov, D. S. 1997. Strategic uncertainty and environmental scanning: The case for institutional influences on scanning behavior. Strategic Management Journal, 18: 287–302.

13. For an interesting perspective on environmental scanning in emerging economies, see May, R. C., Stewart, W. H., & Sweo, R. 2000. Environmental scanning behavior in a transitional economy, Evidence from Russia. Academy of Management Journal, 43(3): 403–427.

14. Bryon, E. 2010. For insight into P&G, check Olay numbers. Wall Street Journal, October 27: C1.

15. Tang, J. 2010. How entrepreneurs discover opportunities in China: An institutional view. Asia Pacific Journal of Management, 27(3): 461–480.

16. Walters, B. A. & Priem, R. L. 1999. Business strategy and CEO intelligence acquisition. Competitive Intelligence Review, 10(2): 15–22.

17. Prior, V. 1999. The language of competitive intelligence, Part 4. Competitive Intelligence Review, 10(1): 84–87.

18. Hill, K. 2011. The spy who liked me. Forbes, November 21: 56–57.

19. Wolfenson, J. 1999. The world in 1999: A battle for corporate honesty. The Economist, 38: 13–30.

20. Drucker, P. F. 1997. The future that has already happened. Harvard Business Review, 75(6): 22.

21. Downes, L. & Nunes, P. 2014. Big bang disruption. New York: Penguin.

22. Fahey & Narayanan, op. cit., p. 41.

23. Insights on how to improve predictions can be found in Cross, R., Thomas, R. J., & Light, D. A. 2009. The prediction lover’s handbook. MIT Sloan Management Review, 50(2): 32–34.

24. Courtney, H., Kirkland, J., & Viguerie, P. 1997. Strategy under uncertainty. Harvard Business Review, 75(6): 66–79.

25. Odlyzko, A. 2003. False hopes. Red Herring, March: 31.

26. Szczerba, R. J. 2015. 15 Worst tech predictions of all time. www.forbes. com. January 5: np; and, Dunn, M. 2016. Here are 20 of the worst predictions ever made about the future of tech. www.news.com.au. March 8: np.

27. Zweig, J. 2014. Lessons Learned from the year of shock. The Wall Street Journal, December 31: C1–C2.

28. For an interesting perspective on how Accenture practices and has developed its approach to scenario planning, refer to Ferguson, G., Mathur, S., & Shah, B. 2005. Evolving from information to insight. MIT Sloan Management Review, 46(2): 51–58.

29. The PPG example draws on: Camillus, J. C. 2008. Strategy as a wicked problem. Harvard Business Review, 86(5): 98-106; www.ppg.com; and, finance.yahoo.com.

30. Byrne, J. 2012. Great ideas are hard to come by. Fortune, April 7: 69 ff.

31. Dean, T. J., Brown, R. L., & Bamford, C. E. 1998. Differences in large and small firm responses to environmental context: Strategic implications from a comparative analysis of business formations. Strategic Management Journal, 19: 709–728.

32. Colvin, G. 2014. Four things that worry business. Fortune, October 27: 32.

33. Colvin, G. 1997. How to beat the boomer rush. Fortune, August 18: 59–63.

34. Porter, M. E. 2010. Discovering—and lowering—the real costs of health care. Harvard Business Review, 89(1/2): 49–50.

35. Farrell, C. 2014. Baby boomers’ latest revolution: Unretirement. Dallas Morning News, October 19: 4P.

36. Challenger, J. 2000. Women’s corporate rise has reduced relocations. Lexington (KY) Herald- Leader, October 29: D1.

37. Watkins, M. D. 2003. Government games. MIT Sloan Management Review, 44(2): 91–95.

38. A discussion of the political issues surrounding caloric content on meals is in Orey, M. 2008. A food fight over calorie counts. BusinessWeek, February 11: 36.

39. For a discussion of the linkage between copyright law and innovation, read Guterman, J. 2009. Does copyright law hinder innovation? MIT Sloan Management Review, 50(2): 14–15.

40. Davies, A. 2000. The welcome mat is out for nerds. BusinessWeek, May 21: 17; Broache, A. 2007. Annual H-1B visa cap met—already. news.cnet. com, April 3: np; and Anonymous.

Undated. Cap count for H-1B and H-2B workers for fiscal year 2009. www.uscis.gov: np.

41. Weise, K. 2014. How to hack the visa limit. Bloomberg Businessweek, May 26–June 1: 39–40.

42. Hout, T. M. & Ghemawat, P. 2010. China vs. the world: Whose technology is it? Harvard Business Review, 88(12): 94–103.

43. Business ready for Internet revolution. 1999. Financial Times, May 21: 17.

44. A discussion of an alternate energy— marine energy—is the topic of Boyle, M. 2008. Scottish power. Fortune, March 17: 28.

45. Baker, S. & Aston, A. 2005. The business of nanotech. BusinessWeek, February 14: 64–71.

46. Wilson, H. J. 2013. Wearables in the workplace. Harvard Business Review, 91(9): 22–25.

47. For an insightful discussion of the causes of the global financial crisis, read Johnson, S. 2009. The global financial crisis—What really precipitated it? MIT Sloan Management Review, 50(2): 16–18.

48. Tyson, L. D. 2011. A better stimulus for the U.S. economy. Harvard Business Review, 89(1/2): 53.

49. An interesting and balanced discussion on the merits of multinationals to the U.S. economy is found in Mandel, M. 2008. Multinationals: Are they good for America? BusinessWeek, March 10: 41–64.

50. Insights on risk perception across countries are addressed in Purda, L. D. 2008. Risk perception and the financial system. Journal of International Business Studies, 39(7): 1178–1196.

51. Thurm, S. 2012. U.S. firms add jobs, but mostly overseas. wsj.com, April 27: np.

52. Goll, I. & Rasheed, M. A. 1997. Rational decision-making and firm performance: The moderating role of environment. Strategic Management Journal, 18: 583–591.

53. Our discussion of data analytics draws on a variety of sources. These include: Kiron, D. 2013. From value to vision: Reimagining the possible with data analytics. MIT Sloan Management Review (Research Report), Spring: 3–19; Malone, M. S. 2016. The big-data future has arrived. The Wall Street Journal, February 23: A17; and Porter, M. E. &

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Heppelmann, J. E. 2015. How smart, connected products are transforming companies. Harvard Business Review, 93(10): 96– 114.

54. This discussion draws heavily on Porter, M. E. 1980. Competitive strategy: chap. 1. New York: Free Press.

55. Ibid. 56. Rivalry in the airline industry is

discussed in Foust, D. 2009. Which airlines will disappear in 2009? BusinessWeek, January 19: 46–47.

57. Fryer, B. 2001. Leading through rough times: An interview with Novell’s Eric Schmidt. Harvard Business Review, 78(5): 117–123.

58. Anonymous. 2015. No reservations. The Economist. November 21: 63.

59. For a discussion on the importance of barriers to entry within industries, read Greenwald, B. & Kahn, J. 2005. Competition demystified: A radically simplified approach to business strategy. East Rutherford, NJ: Portfolio.

60. A discussion of how the medical industry has erected entry barriers that have resulted in lawsuits is found in Whelan, D. 2008. Bad medicine. BusinessWeek, March 10: 86–98.

61. Colvin, G. 2014. Welcome to the era of Lego innovations (some assembly required). Fortune, April 14: 52.

62. Wise, R. & Baumgarter, P. 1999. Go downstream: The new profit imperative in manufacturing. Harvard Business Review, 77(5): 133–141.

63. Salman, W. A. 2000. The new economy is stronger than you think. Harvard Business Review, 77(6): 99– 106.

64. Mudambi, R. & Helper, S. 1998. The “close but adversarial” model of supplier relations in the U.S. auto industry. Strategic Management Journal, 19: 775–792.

65. Stevens, D. (vice president of Delta Pride Catfish, Inc.). 2014. personal communication: October 16; and Fritz, M. 1988. Agribusiness: Catfish story. Forbes, December 12: 37.

66. Trends in the solar industry are discussed in Carey, J. 2009. Solar: The sun will come out tomorrow. BusinessWeek, January 12: 51.

67. Edelstein, S. 2014. Could U.S. hybrid car sales be peaking already—and if so, why? greencarreports.com, June 16: np; Naughton, K. 2012. Hybrids’ unlikely rival: plain old cars. Bloomberg Businessweek, February 2: 23–24; Cobb, J. 2016. April 2016 dash board. www.hybridcars.com, May 4: np.

68. An interesting analysis of self- regulation in an industry (chemical) is in Barnett, M. L. & King, A. A. 2008. Good fences make good neighbors: A longitudinal analysis of an industry self-regulatory institution. Academy of Management Journal, 51(6): 1053–1078.

69. For an interesting perspective on the intensity of competition in the supermarket industry, refer to Anonymous. 2005. Warfare in the aisles. The Economist, April 2: 6–8.

70. Macmillan, D. 2014. Tech’s fiercest rivalry: Uber vs. Lyft. online.wsj.com, August 11: np; Divine, J. 2016. Uber IPO: Losing luster after a $1.2 billion loss. www.usnews.com, August 29: np.

71. For an interesting perspective on changing features of firm boundaries, refer to Afuah, A. 2003. Redefining firm boundaries in the face of the Internet: Are firms really shrinking? Academy of Management Review, 28(1): 34–53.

72. Time to rebuild. 2001. The Economist, May 19: 55–56.

73. www.amazon.com. 74. For more on the role of the Internet

as an electronic intermediary, refer to Carr, N. G. 2000. Hypermediation: Commerce as clickstream. Harvard Business Review, 78(1): 46–48.

75. www.mysimon.com; and www. pricescan.com.

76. www.cnet.com; and www.bizrate.com. 77. For insights into strategies in a low-

profit industry, refer to Hopkins, M. S. 2008. The management lessons of a beleaguered industry. MIT Sloan Management Review, 50(1): 25–31.

78. Foust, D. 2007. The best performers. BusinessWeek, March 26: 58–95; Rosenblum, D., Tomlinson, D., & Scott, L. 2003. Bottom-feeding for blockbuster businesses. Harvard Business Review, 81(3): 52–59; Paychex 2006 Annual Report; and WellPoint Health Network 2005 Annual Report.

79. Kumar, N. 1996. The power of trust in manufacturer-retailer relationship. Harvard Business Review, 74(6): 92–110.

80. Welch, D. 2006. Renault-Nissan: Say hello to Bo. BusinessWeek, July 31: 56–57.

81. Kelleher, J. B. 2014. GM ranked worst automaker by U.S. suppliers— survey. finance.yahoo.com, May 12: np; and Welch, D. 2006. Renault-Nissan: Say hello to Bo. BusinessWeek, July 31: 56–57.

82. Brandenburger, A. & Nalebuff, B. J. 1995. The right game: Use game theory to shape strategy. Harvard Business Review, 73(4): 57–71.

83. For a scholarly discussion of complementary assets and their relationship to competitive advantage, refer to Stieglitz, N. & Heine, K. 2007. Innovations and the role of complementarities in a strategic theory of the firm. Strategic Management Journal, 28(1): 1–15.

84. A useful framework for the analysis of industry evolution has been proposed by Professor Anita McGahan of Boston University. Her analysis is based on the identification of the core activities and the core assets of an industry and the threats they face. She suggests that an industry may follow one of four possible evolutionary trajectories— radical change, creative change, intermediating change, or progressive change—based on these two types of threats of obsolescence. Refer to McGahan, A. M. 2004. How industries change. Harvard Business Review, 82(10): 87–94.

85. Porter, M. I. 2008. The five competitive forces that shape strategy. Harvard Business Review, 86(1): 79–93.

86. Peteraf, M. & Shanley, M. 1997. Getting to know you: A theory of strategic group identity. Strategic Management Journal, 18 (Special Issue): 165–186.

87. An interesting scholarly perspective on strategic groups may be found in Dranove, D., Perteraf, M., & Shanley, M. 1998. Do strategic groups exist? An economic framework for analysis. Strategic Management Journal, 19(11): 1029– 1044.

88. For an empirical study on strategic groups and predictors of performance, refer to Short, J. C., Ketchen, D. J., Jr., Palmer, T. B., & Hult, T. M. 2007. Firm, strategic group, and industry influences on performance. Strategic Management Journal, 28(2): 147–167.

89. This section draws on several sources, including Kerwin, K. R. & Haughton, K. 1997. Can Detroit make cars that baby boomers like? BusinessWeek, December 1: 134–148; and Taylor, A., III. 1994. The new golden age of autos. Fortune, April 4: 50–66.

90. Csere, C. 2001. Supercar supermarket. Car and Driver, January: 118– 127.

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91. For a discussion of the extent of overcapacity in the worldwide automobile industry, read Roberts, D., Matlack, C., Busyh, J., & Rowley, I. 2009. A hundred factories too many. BusinessWeek, January 19: 42–43.

92. McLain, S. 2014. India’s middle class embraces minicars. The Wall Street

Journal, October 9: B2; Anonymous. 2014. Geely GX7 launched after upgrading: Making versatile and comfortable SUV. www.globaltimes. ch, April 18: np; Anonymous. 2014. Adequate Guiyang Geely Free Cruiser higher offer 1,000 yuan now. www.wantinews.com, February 20: np; Anonymous. 2013. Restyled Chery

QQ hit showrooms with a US$6,083 starting price. www.chinaautoweb. com, March 4: np; and Doval, P. 2014. Cheapest car tag hit Tata Nano: Creator. economictimes.indiatimes. com, August 21: np.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

3 LO3-1 The primary and support activities of a firm’s value chain. LO3-2 How value-chain analysis can help managers create value by investigating

relationships among activities within the firm and between the firm and its customers and suppliers.

LO3-3 The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities.

LO3-4 The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers.

LO3-5 The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms.

LO3-6 The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated.

Assessing the Internal Environment of the Firm

©Anatoli Styf/Shutterstock

PART 1: STRATEGIC ANALYSIS

When Twitter first burst upon the scene in 2006, there was almost immediate buzz about the firm and its platform. Having the ability to send out text messages to a circle of friends or followers seemed like a great idea. At the same time, in the words of Evan Williams, one of Twitter’s creators, “With Twitter, it wasn’t clear what it was. They called it a social network, they called it microblogging, but it was hard to define, because it didn’t replace anything. There was this path of discovery with something like that, where over time you figure out what it is.” Still, it took off. Growing from only 16,000 users at the end of 2006 to 4 million in 2008 and to 54 million by the end of 2010, it seemed to be on the path to great success.

But the situation has changed since then. Twitter’s growth quickly flattened out. The number of users hit 284 million in the third quarter of 2014 but had only grown to 317 million two years later. In fact, the firm experienced a decline in the number of users in the United States in late 2015. Twitter’s growth pales in comparison to some of its closest rivals. Over the same two-year period, Snapchat saw its user base grow by 154 percent, while Instagram jumped by a whopping 284 percent. With its flat growth, investors have become quite pessimistic about the firm’s value. Its stock price declined by 59 percent from December 2014 to 2016.1

Why the quick decline in growth? There just isn’t anything terribly unique about Twitter and its core products are not difficult to copy. Facebook created a similar messaging app and has seen its user base grow to 1 billion individuals. WhatsApp, which is owned by Facebook, has also grown to 1 billion users. Instagram has over 500 million users. Twitter also faces strong competition as it tries to expand its global reach since messaging apps that focus on specific geographic regions have also popped up. For example, the Japanese chat app, Line, has 220 million users.

It is unclear whether Twitter can turn it around in this increasingly competitive messaging app market as a standalone firm. The firm appeared to be open to being acquired by a firm that could integrate its messaging app into a larger platform of services. While rumors swirled that Salesforce, Disney, or Alphabet, the parent company of Google, might be interested in buying Twitter in the fall of 2016, no formal offers came. Apparently, these firms just didn’t see much value in Twitter. As Marc Benioff, the CEO of Salesforce, stated, “We walked away. It wasn’t the right fit for us.” Thus, the future for Twitter is unclear.

Discussion Questions 1. Why did Twitter go from an exciting, growing firm to a firm with a flat user base so quickly? 2. What could the firm have done to avoid this situation? 3. What options does the firm have to get back on a path to success?

LEARNING FROM MISTAKES

In this chapter we will place heavy emphasis on the value-chain concept. That is, we focus on the key value-creating activities (e.g., operations, marketing and sales, and procurement) that a firm must effectively manage and integrate in order to attain competitive advantages in the marketplace. However, firms not only must pay close attention to their own value- creating activities but also must maintain close and effective relationships with key orga- nizations outside the firm boundaries, such as suppliers, customers, and alliance partners.

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Although Twitter experienced tremendous growth early, it was quickly challenged by other applications that effectively mimicked what Twitter offered. Twitter’s resource set and market positioning just was not very difficult to copy.

We will begin our discussion of the firm’s internal environment by looking at a value- chain analysis. This analysis gives us insight into a firm’s operations and how the firm cre- ates economic value.

VALUE-CHAIN ANALYSIS Value-chain analysis views the organization as a sequential process of value-creating activities. The approach is useful for understanding the building blocks of competitive advantage and was described in Michael Porter’s seminal book Competitive Advantage.2 Value is the amount that buyers are willing to pay for what a firm provides them and is measured by total revenue, a ref lection of the price a firm’s product commands and the quantity it can sell. A firm is profitable when the value it receives exceeds the total costs involved in creating its product or service. Creating value for buyers that exceeds the costs of production (i.e., margin) is a key concept used in analyzing a firm’s com- petitive position.

Porter described two different categories of activities. First, five primary activities—inbound logistics, operations, outbound logistics, marketing and sales, and service— contribute to the physical creation of the product or service, its sale and transfer to the buyer, and its ser- vice after the sale. Second, support activities—procurement, technology development, human resource management, and general administration—either add value by themselves or add value through important relationships with both primary activities and other support activi- ties. Exhibit 3.1 illustrates Porter’s value chain.

To get the most out of value-chain analysis, view the concept in its broadest context, without regard to the boundaries of your own organization. That is, place your organization within a more encompassing value chain that includes your firm’s suppliers, customers, and alliance partners. Thus, in addition to thoroughly understanding how value is created within the organization, be aware of how value is created for other organizations in the overall sup- ply chain or distribution channel.3

Next, we’ll describe and provide examples of each of the primary and support activities. Then we’ll provide examples of how companies add value by means of relationships among activities within the organization as well as activities outside the organization, such as those activities associated with customers and suppliers.4

LO 3-1 The primary and support activities of a firm’s value chain.

EXHIBIT 3.1 The Value Chain: Primary and Support Activities

Inbound Logistics

Operations Outbound Logistics

Marketing and Sales

Service

Primary Activities

• General Administration

• Human Resource Management

• Technology Development

• Procurement

Support Activities

Adapted from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter, 1985, 1998, Free Press.

value-chain analysis a strategic analysis of an organization that uses value-creating activities

primary activities sequential activities of the value chain that refer to the physical creation of the product or service, its sale and transfer to the buyer, and its service after sale, including inbound logistics, operations, outbound logistics, marketing and sales, and service.

support activities activities of the value chain that either add value by themselves or add value through important relationships with both primary activities and other support activities, including procurement, technology development, human resource management, and general administration.

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Primary Activities Five generic categories of primary activities are involved in competing in any industry, as shown in Exhibit 3.2. Each category is divisible into a number of distinct activities that depend on the particular industry and the firm’s strategy.5

Inbound Logistics Inbound logistics is primarily associated with receiving, storing, and distributing inputs to the product. It includes material handling, warehousing, inventory control, vehicle scheduling, and returns to suppliers.

Just-in-time (JIT) inventory systems, for example, were designed to achieve efficient inbound logistics. In essence, Toyota epitomizes JIT inventory systems, in which parts deliv- eries arrive at the assembly plants only hours before they are needed. JIT systems will play a vital role in fulfilling Toyota’s commitment to fill a buyer’s new-car order in just five days.6 This standard is in sharp contrast to most competitors that require approximately 30 days’ notice to build vehicles. Toyota’s standard is three times faster than even Honda Motors, considered to be the industry’s most efficient in order follow-through. The five days repre- sent the time from the company’s receipt of an order to the time the car leaves the assembly plant. Actual delivery may take longer, depending on where a customer lives.

Operations Operations include all activities associated with transforming inputs into the final product form, such as machining, packaging, assembly, testing, printing, and facility operations.

Creating environmentally friendly manufacturing is one way to use operations to achieve competitive advantage. Shaw Industries (now part of Berkshire Hathaway), a world-class competitor in the floor-covering industry, is well known for its concern for the environ- ment.7 It has been successful in reducing the expenses associated with the disposal of dangerous chemicals and other waste products from its manufacturing operations. Its envi- ronmental endeavors have multiple payoffs. Shaw has received many awards for its recycling efforts—awards that enhance its reputation.

LO 3-1 The primary and support activities of a firm’s value chain.

inbound logistics receiving, storing, and distributing inputs of a product.

operations all activities associated with transforming inputs into the final product form.

EXHIBIT 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

Inbound Logistics

• Location of distribution facilities to minimize shipping times. • Warehouse layout and designs to increase efficiency of operations for incoming materials.

Operations

• Efficient plant operations to minimize costs. • Efficient plant layout and workflow design. • Incorporation of appropriate process technology.

Outbound Logistics

• Effective shipping processes to provide quick delivery and minimize damages. • Shipping of goods in large lot sizes to minimize transportation costs.

Marketing and Sales

• Innovative approaches to promotion and advertising. • Proper identification of customer segments and needs.

Service

• Quick response to customer needs and emergencies. • Quality of service personnel and ongoing training.

Source: Adapted from Porter, M. E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press.

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74 PART 1 :: STRATEGIC ANALYSIS

3.1 STRATEGY SPOTLIGHT CHIPOTLE’S EFFICIENT OPERATIONS Peak hours at restaurants create real challenges that must be addressed. Otherwise, business may be lost and, worse yet, custom- ers may never come back. Lines snaking out the doors have long been a bottleneck to growth at U.S. burrito chain Chipotle. However, the company has a plan—actually a four-step plan, to be exact.

The chain managed to accelerate service by six transactions per hour at peak times during a recent quarter (which is a signifi- cant increase over the mere two transactions per hour the previ- ous quarter). “We achieved our fastest throughput ever,” claims Steve Ells, co-CEO. However, some of Chipotle’s fastest restau- rants run more than 350 transactions per hour at lunchtime— more than three times the chainwide average.

How are such remarkable increases in productivity attained? By what the company calls “the four pillars of great throughput.” These are:

• Expediters. An expediter is the extra person between the one who rolls your burrito and the one who rings up your order. The expediter’s job? Getting your drink, asking if your order is “to go,” and bagging your food.

• Linebackers. These are people who patrol the countertops, serving-ware, and bins of food, so the ones who are actually serving customers never turn their backs on them.

• Mise en place. In other restaurants, this means setting out ingredients and utensils ready for use. In Chipotle’s case, it means zero tolerance for not having absolutely everything in place ahead of lunch and dinner rush hours.

• Aces in their places. This refers to a commitment to having what each branch considers its top servers in the most important positions at peak times. Thus, there are no trainees working at burrito rush hour.

Although sales for the firm dropped in late 2015 in response to food safety concerns, its long-term performance has been very impressive. From its founding in 1993, Chipotle has grown to be the largest Mexican quick service restaurant chain in the world.

Sources: Ferdman, R. A. 2014. How Chipotle is going to serve burritos faster, and faster, and faster. www.qz.com, January 31: np; Zillman, C. 2014. 2014’s top people in business. Fortune, December 1: 156; and statista.com.

Efficient operations can also provide a firm with many benefits in virtually any industry— including restaurants. Strategy Spotlight 3.1 discusses Chipotle’s rather novel approach to improving its operations.

Outbound Logistics Outbound logistics is associated with collecting, storing, and distribut- ing the product or service to buyers. These activities include finished goods, warehousing, material handling, delivery vehicle operation, order processing, and scheduling.

Campbell Soup uses an electronic network to facilitate its continuous-replenishment program with its most progressive retailers.8 Each morning, retailers electronically inform Campbell of their product needs and of the level of inventories in their distribution centers. Campbell uses that information to forecast future demand and to determine which prod- ucts require replenishment (based on the inventory limits previously established with each retailer). Trucks leave Campbell’s shipping plant that afternoon and arrive at the retailers’ distribution centers the same day. The program cuts the inventories of participating retail- ers from about a four- to a two-weeks’ supply. Campbell Soup achieved this improvement because it slashed delivery time and because it knows the inventories of key retailers and can deploy supplies when they are most needed.

The Campbell Soup example also illustrates the win–win benefits of exemplary value- chain activities. Both the supplier (Campbell) and its buyers (retailers) come out ahead. Since the retailer makes more money on Campbell products delivered through continuous replenishment, it has an incentive to carry a broader line and give the company greater shelf space. After Campbell introduced the program, sales of its products grew twice as fast through participating retailers as through all other retailers. Not surprisingly, supermarket chains love such programs.

Marketing and Sales Marketing and sales activities are associated with purchases of prod- ucts and services by end users and the inducements used to get them to make purchases.9

outbound logistics collecting, storing, and distributing the product or service to buyers.

marketing and sales activities associated with purchases of products and services by end users and the inducements used to get them to make purchases.

CHAPTER 3 :: ASSESSING THE INTERNAL ENVIRONMENT OF THE FIRM 75

They include advertising, promotion, sales force, quoting, channel selection, channel rela- tions, and pricing.10,11

Consider product placement. This is a marketing strategy that many firms are increas- ingly adopting to reach customers who are not swayed by traditional advertising. Mercedes- Benz is a firm that has aggressively pushed for product placement in Hollywood movies. In 2015, Mercedes products appeared in nine of the top 31 blockbuster movies. For example, when the villains in the James Bond movie, Spectre, showed up in the desert to pick up Bond, they arrived in a fleet of Mercedes AMGs.12

Service The service primary activity includes all actions associated with providing service to enhance or maintain the value of the product, such as installation, repair, training, parts supply, and product adjustment.

Let’s see how two retailers are providing exemplary customer service. At Sephora.com, a customer service representative taking a phone call from a repeat customer has instant access to what shade of lipstick she likes best. This will help the rep cross-sell by suggesting a match- ing shade of lip gloss. Such personalization is expected to build loyalty and boost sales per cus- tomer. Nordstrom, the Seattle-based department store chain, goes even a step further. It offers a cyber-assist: A service rep can take control of a customer’s web browser and literally lead her to just the silk scarf that she is looking for. CEO Dan Nordstrom believes that such a capabil- ity will close enough additional purchases to pay for the $1 million investment in software.

Support Activities Support activities in the value chain can be divided into four generic categories, as shown in Exhibit 3.3. Each category of the support activity is divisible into a number of distinct value activities that are specific to a particular industry. For example, technology development’s dis- crete activities may include component design, feature design, field testing, process engineer- ing, and technology selection. Similarly, procurement may include activities such as qualifying new suppliers, purchasing different groups of inputs, and monitoring supplier performance.

service actions associated with providing service to enhance or maintain the value of the product.

General Administration

• Effective planning systems to attain overall goals and objectives. • Excellent relationships with diverse stakeholder groups. • Effective information technology to integrate value-creating activities.

Human Resource Management

• Effective recruiting, development, and retention mechanisms for employees. • Quality relations with trade unions. • Reward and incentive programs to motivate all employees.

Technology Development

• Effective R&D activities for process and product initiatives. • Positive collaborative relationships between R&D and other departments. • Excellent professional qualifications of personnel. • Data analytics

Procurement

• Procurement of raw material inputs to optimize quality and speed and to minimize the associated costs. • Development of collaborative win–win relationships with suppliers. • Analysis and selection of alternative sources of inputs to minimize dependence on one supplier.

Source: Adapted from Porter, M.E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press.

EXHIBIT 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

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Procurement Procurement refers to the function of purchasing inputs used in the firm’s value chain, not to the purchased inputs themselves.13 Purchased inputs include raw materi- als, supplies, and other consumable items as well as assets such as machinery, laboratory equipment, office equipment, and buildings.14,15

Microsoft has improved its procurement process (and the quality of its suppliers) by pro- viding formal reviews of its suppliers. One of Microsoft’s divisions has extended the review process used for employees to its outside suppliers.16 The employee services group, which is responsible for everything from travel to 401(k) programs to the on-site library, outsources more than 60 percent of the services it provides. Unfortunately, the employee services group was not providing suppliers with enough feedback. This was feedback that the suppliers wanted to get and that Microsoft wanted to give.

The evaluation system that Microsoft developed helped clarify its expectations to suppli- ers. An executive noted: “We had one supplier—this was before the new system—that would have scored a 1.2 out of 5. After we started giving this feedback, and the supplier understood our expectations, its performance improved dramatically. Within six months, it scored a 4. If you’d asked me before we began the feedback system, I would have said that was impossible.”17

Technology Development Every value activity embodies technology.18 The array of technol- ogies employed in most firms is very broad, ranging from technologies used to prepare doc- uments and transport goods to those embodied in processes and equipment or the product itself.19 Technology development related to the product and its features supports the entire value chain, while other technology development is associated with particular primary or support activities.

Techniq, headquartered in Paris, France, with 40,000 employees in 48 countries, is a world leader in project management, engineering, and construction for the energy industry.20 Its manufacturing plant in Normandy, France, has developed innovative ways to add value for its customers. This division, Subsea Infrastructure, produces subsea flexible pipes for the oil and gas industry. Its technology innovations have added significant value for its customers and has led to operating margins 50 percent higher than those for the company overall.

Its traditional services include installing, inspecting, maintaining, and repairing pipes in locations around the world, from the Arctic to the Arabian Gulf. However, the company now goes much further. In collaboration with oil services giant Schlumberger, Techniq has developed intelligent pipes that can monitor and regulate the temperature throughout an oil pipeline—important value-added activities for its customers, large oil producers. Fluctuating temperatures pose a major problem—they cause changes in pipe diameter, which makes the flow of oil more variable. This compromises drilling efficiency and is a significant source of costs for Techniq’s customers. Using intelligent pipes not only keeps temperatures steadier but also reduces the complexity of subsea drilling layouts and shortens pipe installation times.

Strategy Spotlight 3.2 discusses how Coca-Cola has developed data analytic technologies to produce orange juice that meets the taste demands of a global customer base.

Human Resource Management Human resource management consists of activities involved in the recruiting, hiring, training, development, and compensation of all types of person- nel.21 It supports both individual primary and support activities (e.g., hiring of engineers and scientists) and the entire value chain (e.g., negotiations with labor unions).22

Like all great service companies, JetBlue Airways Corporation is obsessed with hiring superior employees.23 But the company found it difficult to attract college graduates to commit to careers as flight attendants. JetBlue developed a highly innovative recruitment program for flight attendants—a one-year contract that gives them a chance to travel, meet lots of people, and then decide what else they might like to do. It also introduced the idea of training a friend and employee together so that they could share a job. With such employee- friendly initiatives, JetBlue has been very successful in attracting talent.

procurement the function of purchasing inputs used in the firm’s value chain, including raw materials, supplies, and other consumable items as well as assets such as machinery, laboratory equipment, office equipment, and buildings.

technology development activities associated with the development of new knowledge that is applied to the firm’s operations.

human resource management activities involved in the recruiting, hiring, training, development, and compensation of all types of personnel.

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3.2 STRATEGY SPOTLIGHT THE ALGORITHM FOR ORANGE JUICE Making orange juice sounds simple enough. Squeeze the juice out of some oranges, and there you have it. But making orange juice is not so simple if you are Coca-Cola. The firm is the largest orange juice producer in the world, accounting for 17 percent of the juice sold in the world’s top 22 markets, producing under the Minute Maid, Simply Orange, and Del Valle brands. Staying on top is a challenge since the firm has to respond to a range of variables, including weather conditions, differing customer preferences across markets, the flow of product over 12 months when the prime growing season lasts three months, and volatil- ity in demand.

To meet customer expectations on a daily basis and continue to lead the market, Coke has turned to data analytics. As a first step in the process, Coke leverages an algorithm it has devel- oped, called Black Box. Black Box contains detailed data on more than 600 flavors that can be used to make the orange juice customers expect to taste. Coke then matches the characteris- tics of each batch of raw juice to the algorithm to determine how

to mix together different batches of juice to produce the exact taste it wants to produce. Black Box considers multiple attributes of each batch of juice, including sweetness, acidity, and other taste attributes. Coke also uses the algorithm to evaluate sat- ellite imagery of growing regions. The algorithm allows Coke to consider other factors, such as current demand and prices, weather patterns, and crop yields to maximize the efficiency of the process while producing the quantity and taste of juice to meet the market needs. But if conditions change, such as the emergence of a hurricane or the threat of a freeze in a growing region, Coke can go back to the algorithm and produce a new plan in five to ten minutes. Bob Cross, a consultant who helped Coke develop Black Box, commented that it “is definitely one of the most complex applications of business analytics. It requires analyzing up to one quintillion decision variables to consistently deliver the optimal blend, despite the whims of Mother Nature.”

Sources: Sanders, N. 2016. How to use big data to drive your supply chain. California Management Review. Spring: 26–48; Stanford, D. 2016. Coke engineers its orange juice–with an algorithm. bloomberg.com. January 31: np.

In their efforts to attract high-potential college graduates, some firms have turned to “program hiring.” Facebook, Intuit, AB InBev, and others empower their recruiters to make offers on the spot when they interview college students, without knowing what specific position they will fill. These firms search for candidates with attributes such as being a self- starter and a problem-solver, and make quick offers to preempt the market. Later, the new employees have matching interviews with various units in the firm to find the right initial position. The firms may lose out with some candidates who dislike the uncertainty of what their role will be, but they believe the candidates who are open to this type of hiring will be a better fit in a dynamic, creative workplace.24

General Administration General administration consists of a number of activities, includ- ing general management, planning, finance, accounting, legal and government affairs, quality management, and information systems. Administration (unlike the other support activities) typically supports the entire value chain and not individual activities.25

Although general administration is sometimes viewed only as overhead, it can be a pow- erful source of competitive advantage. In a telephone operating company, for example, negotiating and maintaining ongoing relations with regulatory bodies can be among the most important activities for competitive advantage. Also, in some industries top manage- ment plays a vital role in dealing with important buyers.26

The strong and effective leadership of top executives can also make a significant contri- bution to an organization’s success. As we discussed in Chapter 1, chief executive officers (CEOs) such as Jack Ma and Mark Zuckerberg have been credited with playing critical roles in the success of Alibaba and Facebook.

Information technology (IT) can also play a key role in enhancing the value that a com- pany can provide its customers and, in turn, increasing its own revenues and profits. Strategy Spotlight 3.3 describes how Schmitz Cargobull, a German truck and trailer manufacturer, uses IT to further its competitive position.

general administration general management, planning, finance, accounting, legal and government affairs, quality management, and information systems; activities that support the entire value chain and not individual activities.

LO 3-2 How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers.

DATA

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3.3 STRATEGY SPOTLIGHT SCHMITZ CARGOBULL: ADDING VALUE TO CUSTOMERS VIA IT Germany’s truck and trailer manufacturer, Schmitz Cargobull, mainly serves customers that are operators of truck or trailer fleets. Like its rivals, the company derives a growing share of revenue from support services such as financing, full-service contracts for breakdowns and regular maintenance, and spare-parts supplies.

What sets the company apart is its expertise in telematics (the integrated application of telecommunications data) to moni- tor the current state of any Schmitz Cargobull–produced trailer. Through telematics, key information is continually available to the driver, the freight agent, and the customer. They can track, for instance, when maintenance is done, how much weight has been loaded, the current cargo temperature, and where the vehicle is on its route. Therefore, Schmitz Cargobull custom- ers can better manage their trailer use and minimize the risk of breakdowns. The decision to introduce telematics, not surpris- ingly, derived from management’s belief that real-time sharing of data would bind the company more closely to customers.

In applying its telematic tools in its products, Schmitz Cargobull is providing clear, tangible benefits. It uses informa- tion technology only where it makes sense. On the production line, for example, workers implement statistical quality controls manually, rather than rely on an automated system, because the company found manual control improves engagement and job performance.

That strategy has helped Schmitz Cargobull become an industry leader. In 2013, the company controlled 82 percent of the sales of semitrailer reefers (refrigerated trailers) in Germany, and its market share in Europe was about 50 percent. Further, its results for the fiscal year ending March 2014 are most impres- sive: sales increased by 7.5 percent and pretax profit soared 66 percent.

Sources: Anonymous. 2014. Schmitz Cargobull AG announces earnings and production results for the year ending March 2014. www.investing.businessweek. com, July 31: np; Anonymous. 2014. Premiere at the IAA Show 2014: Increased I-beam stability and payload. www.cargobull.com, September: np; and Chick, S. E., Huchzermeier, A., & Netessine, S. 2014. Europe’s solution factories. Harvard Business Review, 92(4): 11–115.

Interrelationships among Value-Chain Activities within and across Organizations We have defined each of the value-chain activities separately for clarity of presentation. Managers must not ignore, however, the importance of relationships among value-chain activities.27 There are two levels: (1) interrelationships among activities within the firm and (2) relationships among activities within the firm and with other stakeholders (e.g., custom- ers and suppliers) that are part of the firm’s expanded value chain.28

With regard to the first level, Lise Saari, former Director of Global Employee Research at IBM, provided an example by commenting on how human resources needs to be inte- grated with the other functional areas of the firm. She put it this way: “HR [must be] a true partner of the business, with a deep and up-to-date understanding of business realities and objectives, and, in turn, [must ensure] HR initiatives fully support them at all points of the value chain.”

With regard to the second level, Campbell Soup’s use of electronic networks enabled it to improve the efficiency of outbound logistics.29 However, it also helped Campbell manage the ordering of raw materials more effectively, improve its production scheduling, and help its customers better manage their inbound logistics operations.

Integrating Customers into the Value Chain When addressing the value-chain concept, it is important to focus on the interrelationship between the organization and its most important stakeholder—its customers. Some firms find great value by directly incorporating their customers into the value creation process. Firms can do this in one of two ways.

First, they can employ the “prosumer” concept and directly team up with customers to design and build products to satisfy their particular needs. Working directly with custom- ers in this process provides multiple potential benefits for the firm. As the firm develops

interrelationships collaborative and strategic exchange relationships between value-chain activities either (a) within firms or (b) between firms. Strategic exchange relationships involve exchange of resources such as information, people, technology, or money that contribute to the success of the firm.

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individualized products and relationship marketing, it can benefit from greater customer satisfaction and loyalty. Additionally, the interactions with customers can generate insights that lead to cost-saving initiatives and more innovative ideas for the producing firm. In dis- cussing this concept, Hartmut Jenner, CEO of Alfred Karcher, a German manufacturing firm, stated:

In the future, we will be talking more and more about the “prosumer”—a customer/producer who is even more extensively integrated into the value chain. As a consequence, production processes will be customized more precisely and individually.30

Second, firms can leverage the power of crowdsourcing. As introduced in Chapter 2, crowdsourcing occurs when firms tap into the knowledge and ideas of a large number of customers and other stakeholders, typically through online forums. The rise of social media has generated tremendous opportunities for firms to engage with customers.31 In contrast to prosumer interactions, which allow the firm to gain insights on the needs of a particular customer, crowdsourcing offers the opportunity to leverage the wisdom of a larger crowd. Many companies have encouraged customers to participate in value-creating activities, such as brainstorming advertising taglines or product ideas. These activities not only enable firms to innovate at low cost but also engage customers. Clearly, a marketer’s dream! At the same time, crowdsourcing has some significant risks.

Understanding the Perils of Crowdsourcing  While crowdsourcing offers great promise, in practice such programs are difficult to run. At times, customers can “hijack” them. Instead of offering constructive ideas, customers jump at the chance to raise concerns and even ridi- cule the company. Such hijacking is one of the biggest challenges companies face. Research has shown about half of such campaigns fail. Consider the following marketing-focused crowdsourcing examples:

• In 2006, General Motors tried a “fun” experiment, one of the first attempts to use user-generated advertising. The company asked the public to create commercials for the Chevy Tahoe—ads the company hoped would go viral. Unfortunately, some of the ads did go viral! These include: “Like this snowy wilderness. Better get your fill of it now. Then say hello to global warming. Chevy Tahoe” and “$70 to fill up the tank, which will last less than 400 miles. Chevy Tahoe.”

• McDonald’s set up a Twitter campaign to promote positive word of mouth. But this initiative became a platform for people looking to bash the chain. Tweets such as the following certainly didn’t help the firm’s cause: “I lost 50 lbs in 6 months after I quit working and eating at McDonalds” and “The McRib contains the same chemicals used to make yoga mats, mmmmm.”

Research has identified three areas of particular concern:

• Strong brand reputation. Companies with strong brands need to protect them. After all, they have the most to lose. They must be aware such efforts provide consumers the opportunity to tarnish the brand. Strong brands are typically built through consistent, effective marketing, and companies need to weigh the potential for misbehaving customers to thwart their careful efforts.

• High demand uncertainty. Firms are generally more likely to ask for customer input when market conditions are changing. However, this often backfires when demand is highly uncertain, because customers in such markets often don’t know what they want or what they will like. For example, Porsche received a lot of negative feedback when it announced plans to release an SUV, but it went ahead anyway, and the Porsche Cayenne was a great success.

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• Too many initiatives. Firms typically benefit from working repeatedly with the same customers. Often, the quality, quantity, and variety of inputs decrease as the frequency of engagement increases. A study of the Dell IdeaStorm program (in which customers were encouraged to submit product or service ideas) discovered that the same people submitted ideas repeatedly—including submitting ones for things the company already provided. And customers whose ideas were implemented tended to return with additional ideas that were quite similar to their initial suggestions.

Applying the Value Chain to Service Organizations The concepts of inbound logistics, operations, and outbound logistics suggest managing the raw materials that might be manufactured into finished products and delivered to custom- ers. However, these three steps do not apply only to manufacturing. They correspond to any transformation process in which inputs are converted through a work process into outputs that add value. For example, accounting is a sort of transformation process that converts daily records of individual transactions into monthly financial reports. In this example, the transaction records are the inputs, accounting is the operation that adds value, and financial statements are the outputs.

What are the “operations,” or transformation processes, of service organizations? At times, the difference between manufacturing and service is in providing a customized solu- tion rather than mass production as is common in manufacturing. For example, a travel agent adds value by creating an itinerary that includes transportation, accommodations, and activities that are customized to your budget and travel dates. A law firm renders ser- vices that are specific to a client’s needs and circumstances. In both cases, the work process (operation) involves the application of specialized knowledge based on the specifics of a situation (inputs) and the outcome that the client desires (outputs).

The application of the value chain to service organizations suggests that the value-adding process may be configured differently depending on the type of business a firm is engaged in. As the preceding discussion on support activities suggests, activities such as procurement and legal services are critical for adding value. Indeed, the activities that may provide support only to one company may be critical to the primary value-adding activity of another firm.

Exhibit 3.4 provides two models of how the value chain might look in service industries. In the retail industry, there are no manufacturing operations. A firm such as Nordstrom adds value by developing expertise in the procurement of finished goods and by displaying

EXHIBIT 3.4 Some Examples of Value Chains in Service Industries Retail: Primary Value-Chain Activities

Engineering Services: Primary Value-Chain Activities

Partnering with

vendors

Purchasing goods

Managing and distributing inventory

Operating stores

Research and development

Engineering Designs

and solutions

Marketing and sales

Marketing and

selling

Service

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them in its stores in a way that enhances sales. Thus, the value chain makes procurement activities (i.e., partnering with vendors and purchasing goods) a primary rather than a sup- port activity. Operations refer to the task of operating Nordstrom’s stores.

For an engineering services firm, research and development provides inputs, the trans- formation process is the engineering itself, and innovative designs and practical solutions are the outputs. The Beca Group, for example, is a large consulting firm with about 3,000 employees, based in 17 offices throughout the Asia Pacific region. In its technology and innovation management practice, Beca strives to make the best use of the science, tech- nology, and knowledge resources available to create value for a wide range of industries and client sectors. This involves activities associated with research and development, engi- neering, and creating solutions as well as downstream activities such as marketing, sales, and service. How the primary and support activities of a given firm are configured and deployed will often depend on industry conditions and whether the company is service- and/or manufacturing-oriented.

RESOURCE-BASED VIEW OF THE FIRM The resource-based view (RBV) of the firm combines two perspectives: (1) the internal analy- sis of phenomena within a company and (2) an external analysis of the industry and its competitive environment.32 It goes beyond the traditional SWOT (strengths, weaknesses, opportunities, threats) analysis by integrating internal and external perspectives. The abil- ity of a firm’s resources to confer competitive advantage(s) cannot be determined with- out taking into consideration the broader competitive context. A firm’s resources must be evaluated in terms of how valuable, rare, and hard they are for competitors to duplicate. Otherwise, the firm attains only competitive parity.

A firm’s strengths and capabilities—no matter how unique or impressive—do not neces- sarily lead to competitive advantages in the marketplace. The criteria for whether advan- tages are created and whether or not they can be sustained over time will be addressed later in this section. Thus, the RBV is a very useful framework for gaining insights as to why some competitors are more profitable than others. As we will see later in the book, the RBV is also helpful in developing strategies for individual businesses and diversified firms by reveal- ing how core competencies embedded in a firm can help it exploit new product and market opportunities.

In the two sections that follow, we will discuss the three key types of resources that firms possess (summarized in Exhibit 3.5): tangible resources, intangible resources, and orga- nizational capabilities. Then we will address the conditions under which such assets and capabilities can enable a firm to attain a sustainable competitive advantage.33

Types of Firm Resources Firm resources are all assets, capabilities, organizational processes, information, knowledge, and so forth, controlled by a firm that enable it to develop and implement value-creating strategies.

Tangible Resources Tangible resources are assets that are relatively easy to identify. They include the physical and financial assets that an organization uses to create value for its customers. Among them are financial resource (e.g., a firm’s cash, accounts receivable, and its ability to borrow funds); physical resources (e.g., the company’s plant, equipment, and machinery as well as its proximity to customers and suppliers); organizational resources (e.g., the company’s strategic planning process and its employee development, evalua- tion, and reward systems); and technological resources (e.g., trade secrets, patents, and copyrights).

LO 3-3 The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities.

resource-based view (RBV) of the firm perspective that firms’ competitive advantages are due to their endowment of strategic resources that are valuable, rare, costly to imitate, and costly to substitute.

tangible resources organizational assets that are relatively easy to identify, including physical assets, financial resources, organizational resources, and technological resources.

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Tangible Resources

Financial • Firm’s cash account and cash equivalents. • Firm’s capacity to raise equity. • Firm’s borrowing capacity.

Physical • Modern plant and facilities. • Favorable manufacturing locations. • State-of-the-art machinery and equipment.

Technological • Trade secrets. • Innovative production processes. • Patents, copyrights, trademarks.

Organizational • Effective strategic planning processes. • Excellent evaluation and control systems.

Intangible Resources

Human • Experience and capabilities of employees. • Trust. • Managerial skills. • Firm-specific practices and procedures.

Innovation and creativity • Technical and scientific skills. • Innovation capacities.

Reputation • Brand name. • Reputation with customers for quality and reliability. • Reputation with suppliers for fairness, non–zero-

sum relationships.

Organizational Capabilities

• Firm competencies or skills the firm employs to transfer inputs to outputs. • Capacity to combine tangible and intangible resources, using organizational processes to attain

desired end.

EXAMPLES:

• Outstanding customer service. • Excellent product development capabilities. • Innovativeness of products and services. • Ability to hire, motivate, and retain human capital.

Sources: Adapted from Barney, J. B. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management, 17: 101; Grant, R. M. 1991. Contemporary Strategy Analysis: 100–102. Cambridge, England: Blackwell Business; and Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. 2001. Strategic Management: Competitiveness and Globalization (4th ed.). Cincinnati: South- Western College Publishing.

EXHIBIT 3.5 The Resource-Based View of the Firm: Resources and Capabilities

Many firms are finding that high-tech, computerized training has dual benefits: It devel- ops more-effective employees and reduces costs at the same time. Employees at FedEx take computer-based job competency tests every 6 to 12 months.34 The 90-minute computer- based tests identify areas of individual weakness and provide input to a computer database of employee skills—information the firm uses in promotion decisions.

Intangible Resources Much more difficult for competitors (and, for that matter, a firm’s own managers) to account for or imitate are intangible resources, which are typically embed- ded in unique routines and practices that have evolved and accumulated over time. These include human resources (e.g., experience and capability of employees, trust, effectiveness

intangible resources organizational assets that are difficult to identify and account for and are typically embedded in unique routines and practices, including human resources, innovation resources, and reputation resources.

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of work teams, managerial skills), innovation resources (e.g., technical and scientific exper- tise, ideas), and reputation resources (e.g., brand name, reputation with suppliers for fair- ness and with customers for reliability and product quality).35 A firm’s culture may also be a resource that provides competitive advantage.36

As an example of how a firm can leverage the value of intangible resources, we turn to Harley-Davidson. You might not think that motorcycles, clothes, toys, and restaurants have much in common. Yet Harley-Davidson has entered all of these product and service markets by capitalizing on its strong brand image—a valuable intangible resource.37 It has used that image to sell accessories, clothing, and toys, and it has licensed the Harley-Davidson Café in New York City to provide further exposure for its brand name and products.

Social networking sites have the potential to play havoc with a firm’s reputation. Consider the unfortunate situation Comcast faced when one of its repairmen fell asleep on the job—and it went viral:

Ben Finkelstein, a law student, had trouble with the cable modem in his home. A Comcast cable repairman arrived to fix the problem. However, when the technician had to call the home office for a key piece of information, he was put on hold for so long that he fell asleep on Finkelstein’s couch. Outraged, Finkelstein made a video of the sleeping technician and posted it on YouTube. The clip became a hit—with more than a million viewings. And, for a long time, it undermined Comcast’s efforts to improve its reputation for customer service.38

Organizational Capabilities Organizational capabilities are not specific tangible or intangi- ble assets, but rather the competencies or skills that a firm employs to transform inputs into outputs.39 In short, they refer to an organization’s capacity to deploy tangible and intangible resources over time and generally in combination and to leverage those capabilities to bring about a desired end.40 Examples of organizational capabilities are outstanding customer service, excellent product development capabilities, superb innovation processes, and flex- ibility in manufacturing processes.41

In the case of Apple, the majority of components used in its products can be characterized as proven technology, such as touch-screen and MP3-player functionality.42 However, Apple com- bines and packages these in new and innovative ways while also seeking to integrate the value chain. This is the case with iTunes, for example, where suppliers of downloadable music are a vital component of the success Apple has enjoyed with its iPod series of MP3 players. Thus, Apple draws on proven technologies and its ability to offer innovative combinations of them.

Firm Resources and Sustainable Competitive Advantages As we have mentioned, resources alone are not a basis for competitive advantages, nor are advantages sustainable over time.43 In some cases, a resource or capability helps a firm to increase its revenues or to lower costs but the firm derives only a temporary advantage because competitors quickly imitate or substitute for it.44

For a resource to provide a firm with the potential for a sustainable competitive advantage, it must have four attributes.45 First, the resource must be valuable in the sense that it exploits opportunities and/or neutralizes threats in the firm’s environment. Second, it must be rare among the firm’s current and potential competitors. Third, the resource must be difficult for competitors to imitate. Fourth, the resource must have no strategically equivalent substi- tutes. These criteria are summarized in Exhibit 3.6. We will now discuss each of these crite- ria. Then we will examine how Blockbuster’s competitive advantage, which seemed secure a decade ago, subsequently eroded, causing the company to file for bankruptcy in 2011.

Is the Resource Valuable? Organizational resources can be a source of competitive advan- tage only when they are valuable. Resources are valuable when they enable a firm to for- mulate and implement strategies that improve its efficiency or effectiveness. The SWOT framework suggests that firms improve their performance only when they exploit opportuni- ties or neutralize (or minimize) threats.

organizational capabilities the competencies and skills that a firm employs to transform inputs into outputs.

LO 3-4 The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers.

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Is the resource or capability . . . Implications

Valuable? • Neutralize threats and exploit opportunities

Rare? • Not many firms possess

Difficult to imitate? • Physically unique • Path dependency (how accumulated over time) • Causal ambiguity (difficult to disentangle what it is or

how it could be re-created) • Social complexity (trust, interpersonal relationships,

culture, reputation)

Difficult to substitute? • No equivalent strategic resources or capabilities

EXHIBIT 3.6 Four Criteria for Assessing Sustainability of Resources and Capabilities

The fact that firm attributes must be valuable in order to be considered resources (as well as potential sources of competitive advantage) reveals an important complemen- tary relationship among environmental models (e.g., SWOT and five-forces analyses) and the resource-based model. Environmental models isolate those firm attributes that exploit opportunities and/or neutralize threats. Thus, they specify what firm attributes may be con- sidered as resources. The resource-based model then suggests what additional characteris- tics these resources must possess if they are to develop a sustained competitive advantage.

Is the Resource Rare? If competitors or potential competitors also possess the same valu- able resource, it is not a source of a competitive advantage because all of these firms have the capability to exploit that resource in the same way. Common strategies based on such a resource would give no one firm an advantage. For a resource to provide competitive advan- tages, it must be uncommon, that is, rare relative to other competitors.

This argument can apply to bundles of valuable firm resources that are used to formulate and develop strategies. Some strategies require a mix of multiple types of resources— tangible assets, intangible assets, and organizational capabilities. If a particular bundle of firm resources is not rare, then relatively large numbers of firms will be able to conceive of and implement the strategies in question. Thus, such strategies will not be a source of competi- tive advantage, even if the resource in question is valuable.

Can the Resource Be Imitated Easily? Inimitability (difficulty in imitating) is a key to value creation because it constrains competition.46 If a resource is inimitable, then any prof- its generated are more likely to be sustainable.47 Having a resource that competitors can easily copy generates only temporary value.48 This has important implications. Since man- agers often fail to apply this test, they tend to base long-term strategies on resources that are imitable. IBP (Iowa Beef Processors) became the first meatpacking company in the United States to modernize by building a set of assets (automated plants located in cattle-producing states) and capabilities (low-cost “disassembly” of carcasses) that earned returns on assets of 1.3 percent in the 1970s. By the late 1980s, however, ConAgra and Cargill had imitated these resources, and IBP’s profitability fell by nearly 70 percent, to 0.4 percent.

Groupon is a more recent example of a firm that has suffered because rivals have been able to imitate its strategy rather easily:

Groupon, which offers online coupons for bargains at local shops and restaurants, created a new market.49 Although it was initially a boon to consumers, it offers no lasting “first-mover” advantage. Its business model is not patentable and is easy to replicate. Not surprisingly, there are many copycats. For example, there was a tremendous amount of churn in the industry in 2012. The number of daily deal sites in the United States rose by almost 8 percent (142 sites), according to Daily Deal Media, which tracks the industry. Meanwhile, globally, 560 daily deal sites closed over the same period!

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3.4 STRATEGY SPOTLIGHT PRINTED IN TAIWAN: PATH DEPENDENCE IN 3D PRINTING The world’s largest producer of 3D printers for consumers in 2016 wasn’t HP, Canon, Brother, or any other widely known printer manufacturer. It was XYZprinting, a Taiwan-based computer com- ponent manufacturer. XYZprinting, a subsidiary of the New Kinpo Group, produced 19 percent of the 3D printers sold in 2016. While the 3D printer market is just emerging, Simon Shen, New Kinpo Group’s CEO, aims to draw on the firm’s infrastructure and experi- ence to build a dominant position as the low-cost leader in the 3D printer market. The firm’s da Vinci printer, which can be found in BestBuy, in Toys R Us, and on Amazon.com was honored with the 2016 Editors’ Choice Award at the Consumer Electronics Show.

Shen sees three key resources the firm can draw on to build a sustainable advantage. First, the firm has built an efficient supply chain and manufacturing system to produce a range of electronic products that can be leveraged to build 3D printers. Second, it has developed internal control systems to minimize cost in order to thrive in Taiwan’s notoriously thin-margin elec- tronics industry. Third, the firm has developed competencies in the R&D of electronic products. Their R&D knowledge and manufacturing skills apply directly to 3D printing since, while the

firm is not well known, it is actually one of the world’s largest producers of 2D printers, producing them as a contract manu- facturer to the world’s leading printer companies. With their own manufacturing capabilities and supply chain connections along with their mechanical engineering experience, XYZprinting was able to introduce some of the lowest priced systems on the mar- ket. As Wendy Mok, an analyst with IDC, stated, “they have the manufacturing background, they know the difficulty of R&D.”

Shen sees all of this providing a set of competencies that later movers will find hard to imitate. In his words, “If you don’t have a 2D background, it’s difficult to catch up.” They are also looking to expand their competencies by extending into more expensive industrial machines to meet specific needs. For exam- ple, they are working with a local university to develop the ability to print dental implants. As the market matures, Shen believes they are developing a set of resources and competencies that late movers will find hard to match.

Sources: Einhorn, B. 2016. Made-in-Taiwan used to mean PC, now it’s 3D. bloomberg.com. April 27: np; Molitch-Hou, M. 2016. How XYZprinting is conquering 3D printing & why you might move to Taiwan. 3dprintingindustry.com. January 5: np; Anonymous. 2016. XYZprinting forms several new retail partnerships to offer 3D printing solutions to consumers nationwide. prnewswire.com. December 6: np; Connery, C. 2016. 3D printers: Desktop market still growing but metal printers prop up struggling industrial segment in 1H. 2016. tctmagazine.com. December 6: np.

Clearly, an advantage based on inimitability won’t last forever. Competitors will eventu- ally discover a way to copy most valuable resources. However, managers can forestall them and sustain profits for a while by developing strategies around resources that have at least one of the following four characteristics.50

Physical Uniqueness The first source of inimitability is physical uniqueness, which by defi- nition is inherently difficult to copy. A beautiful resort location, mineral rights, or Pfizer’s pharmaceutical patents simply cannot be imitated. Many managers believe that several of their resources may fall into this category, but on close inspection, few do.

Path Dependency A greater number of resources cannot be imitated because of what economists refer to as path dependency. This simply means that resources are unique and therefore scarce because of all that has happened along the path followed in their develop- ment and/or accumulation. Competitors cannot go out and buy these resources quickly and easily; they must be built up over time in ways that are difficult to accelerate.

The Gerber Products Co. brand name for baby food is an example of a resource that is poten- tially inimitable. Re-creating Gerber’s brand loyalty would be a time-consuming process that competitors could not expedite, even with expensive marketing campaigns. Ashley furniture has found that controlling all steps of its distribution system has allowed it to develop specific com- petencies that are difficult to match. It has developed specially designed racks in its distribution centers and proprietary inventory management systems that would take time to match. It has also tasked its truck drivers to be “Ashley Ambassadors,” building relationships with furniture store managers and employees. Both these operational and relational resources have built up over time and can’t be imitated overnight.51 Also, a crash R&D program generally cannot rep- licate a successful technology when research findings cumulate. Strategy Spotlight 3.4 outlines how XYZprinting is using its R&D and manufacturing experience to build a path-dependent

path dependency a characteristic of resources that is developed and/or accumulated through a unique series of events.

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3.5 STRATEGY SPOTLIGHT AMAZON PRIME: VERY DIFFICULT FOR RIVALS TO COPY Amazon Prime, introduced in 2004, is a free-shipping service that guarantees delivery of products within two days for an annual fee of $79. According to Bloomberg Businessweek, it may be the most ingenious and effective customer loyalty pro- gram in all of e-commerce, if not retail in general. It converts casual shoppers into Amazon addicts who gorge on the gratifi- cation of having purchases reliably appear two days after they order. Analysts describe Prime as one of the main factors driving Amazon’s stock price up nearly 300 percent from 2008 to 2010. Also, it is one of the main reasons why Amazon’s sales grew 30 percent during the recession, while other retailers suffered.

By the end of 2015, Amazon had an estimated 60 to 80 million Prime members globally, up from 5 million three years earlier. They are practically addicted to using Amazon—and certainly don’t seem to mind the annual membership price boost to $99. Scot Wingo of Channel Advisor, a company that helps online sell- ers, estimates that people with Prime spend about four times what others do and account for half of all spending at Amazon.

Amazon Prime has proven to be extremely hard for rivals to copy. Why? It enables Amazon to exploit its wide selection, low prices, network of third-party merchants, and finely tuned distribution system. All that while also keying off that faintly irra- tional human need to maximize the benefits of a club that you have already paid to join. Yet Amazon’s success also leads to increased pressure from both public and private entities. For a long time, Amazon was able to avoid collecting local sales taxes because Amazon did not have a local sales presence in many

states. This practice distorts competition and strains already tight state coffers. Some states have used a combination of leg- islation and litigation to convince Amazon to collect sales taxes.

Moreover, rivals—both online and off—have realized the increasing threat posed by Prime and are rushing to respond. For example, in October 2010, a consortium of over 100 retail- ers, including Staples, Eddie Bauer, and Kay Jewelers, banded together to offer their own copycat $79, two-day shipping pro- gram, ShopRunner, which applies to products across their web- sites. As noted by Fiona Dias, the executive who administers the program, “As Amazon added more merchandising categories to Prime, retailers started feeling the pain. They have finally come to understand that Amazon is an existential threat and that Prime is the fuel of the engine.”

Finally, Prime members also gain access to thousands of movies, video games, ebooks, and HBO programming. Prime members may soon also be able to gain access to watch major sports through their Prime membership. As annoying as this might be to Netflix, it is not intended primarily as an assault on Netflix. Rather, CEO Jeff Bezos is willing to lose money on ship- ping and services in exchange for loyalty.

Sources: Anonymous. 2014. Relentless.com. The Economist, June 21: 23–26; McCorvey, J. J. 2013. The race has just begun. Fast Company, September: 66–76; Stone, B. 2010. What’s in the box? Instant gratification. Bloomberg Businessweek, November 29–December 5: 39–40; Kaplan, M. 2011. Amazon Prime: 5 million members, 20 percent growth. www.practicalcommerce.com, September 16: np; Fowler, G. A. 2010. Retailers team up against Amazon. www.wsj.com, October 6: np; Halkias, M. 2012. Amazon to collect sales tax in Texas. Dallas Morning News, April 28: 4A. Kim, E. 2015. These numbers explain why Amazon wants to give so much free stuff to Prime members. finance.yahoo.com. October 21: np; and Ramachandran, S. 2016. Amazon explores possible premium sports package with prime membership. wsj.com. November 22: np.

advantage in the 3D printing market. Clearly, these path-dependent conditions build protection for the original resource. The benefits from experience and learning through trial and error can- not be duplicated overnight.

Causal Ambiguity The third source of inimitability is termed causal ambiguity. This means that would-be competitors may be thwarted because it is impossible to disentangle the causes (or possible explanations) of either what the valuable resource is or how it can be re-created. What is the root of 3M’s innovation process? You can study it and draw up a list of possible factors. But it is a complex, unfolding (or folding) process that is hard to under- stand and would be hard to imitate.

Often, causally ambiguous resources are organizational capabilities, involving a complex web of social interactions that may even depend on particular individuals. When trying to compete with Google, many competitors, such as Yahoo and Twitter, have found it hard to match Google’s ability to innovate and launch new products. Most acknowledge this is tied to Google’s ability to hire the best talent and the culture of creativity within the firm, but firms find it very challenging to identify the specific set of actions Google took to build its image and culture or how to match it.

Strategy Spotlight 3.5 describes Amazon’s continued success as the world’s largest online marketplace. Competitors recently tried to imitate Amazon’s free-shipping strategy, but with

causal ambiguity a characteristic of a firm’s resources that is costly to imitate because a competitor cannot determine what the resource is and/or how it can be re-created.

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limited success. The reason is that Amazon has developed an array of interrelated elements of strategy which their rivals find too difficult to imitate.

Social Complexity A firm’s resources may be imperfectly inimitable because they reflect a high level of social complexity. Such phenomena are typically beyond the ability of firms to systematically manage or influence. When competitive advantages are based on social complexity, it is difficult for other firms to imitate them.

A wide variety of firm resources may be considered socially complex. Examples include interpersonal relations among the managers in a firm, its culture, and its reputation with its suppliers and customers. In many of these cases, it is easy to specify how these socially com- plex resources add value to a firm. Hence, there is little or no causal ambiguity surrounding the link between them and competitive advantage.

The Edelman Trust Barometer, a comprehensive survey of public trust, has found that trust and transparency are more critical than ever.52 For the first time in the survey’s history, Edelman found in its 2014 survey that impressions of openness, sincerity, and authenticity were more important to corporate reputation in the United States than the quality of prod- ucts and services. This means trust affects tangible things such as supply chain partnerships and long-term customer loyalty. People want to partner with you because they have heard you are a credible company built through a culture of trust. In a sense, being a great com- pany to work for also makes you a great company to work with.

Are Substitutes Readily Available? The fourth requirement for a firm resource to be a source of sustainable competitive advantage is that there must be no strategically equivalent valuable resources that are themselves not rare or inimitable. Two valuable firm resources (or two bundles of resources) are strategically equivalent when each one can be exploited separately to implement the same strategies.

Substitutability may take at least two forms. First, though it may be impossible for a firm to imitate exactly another firm’s resource, it may be able to substitute a similar resource that enables it to develop and implement the same strategy. Clearly, a firm seeking to imitate another firm’s high-quality top management team would be unable to copy the team exactly. However, it might be able to develop its own unique management team. Though these two teams would have different ages, functional backgrounds, experience, and so on, they could be strategically equivalent and thus substitutes for one another.

Second, very different firm resources can become strategic substitutes. For example, Internet booksellers such as Amazon.com compete as substitutes for brick-and-mortar booksellers such as Barnes & Noble. The result is that resources such as premier retail loca- tions become less valuable. In a similar vein, several pharmaceutical firms have seen the value of patent protection erode in the face of new drugs that are based on different produc- tion processes and act in different ways, but can be used in similar treatment regimes. The coming years will likely see even more radical change in the pharmaceutical industry as the substitution of genetic therapies eliminates certain uses of chemotherapy.53

To recap this section, recall that resources and capabilities must be rare and valuable as well as difficult to imitate or substitute in order for a firm to attain competitive advantages that are sustainable over time.54 Exhibit 3.7 illustrates the relationship among the four crite- ria of sustainability and shows the competitive implications.

In firms represented by the first row of Exhibit 3.7, managers are in a difficult situation. When their resources and capabilities do not meet any of the four criteria, it would be dif- ficult to develop any type of competitive advantage, in the short or long term. The resources and capabilities they possess enable the firm neither to exploit environmental opportunities nor to neutralize environmental threats. In the second and third rows, firms have resources and capabilities that are valuable as well as rare, respectively. However, in both cases the resources and capabilities are not difficult for competitors to imitate or substitute. Here, the

social complexity a characteristic of a firm’s resources that is costly to imitate because the social engineering required is beyond the capability of competitors, including interpersonal relations among managers, organizational culture, and reputation with suppliers and customers.

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Is a Resource or Capability . . .

Valuable? Rare? Difficult to Imitate?

Without Substitutes?

Implication for Competitiveness

No No No No Competitive disadvantage

Yes No No No Competitive parity

Yes Yes No No Temporary competitive advantage

Yes Yes Yes Yes Sustainable competitive advantage

Source: Adapted from Barney, J. B. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management, 17: 99–120.

EXHIBIT 3.7 Criteria for Sustainable Competitive Advantage and Strategic Implications

firms could attain some level of competitive parity. They could perform on par with equally endowed rivals or attain a temporary competitive advantage. But their advantages would be easy for competitors to match. It is only in the fourth row, where all four criteria are satis- fied, that competitive advantages can be sustained over time. Next, let’s look at Blockbuster and see how its competitive advantage, which seemed to be sustainable for a rather long period of time, eventually eroded, leading to the company’s bankruptcy in 2011.

Blockbuster Inc.: From Sustainable (?) Advantage to Bankruptcy Blockbuster Video failed to recognize in time the threat posed to its brick-and-mortar business by virtual services such as Netflix.55 At the time, few thought that consumers would trade the convenience of picking up their videos to waiting for them to arrive in the mail. Interestingly, Blockbuster had the chance to buy Netflix for $50 million in 2000 but turned down the opportunity. Barry McCarthy, Netflix’s former chief financial officer, recalls the conversation during a meeting with Blockbuster’s top executives: Reed Hastings, Netflix’s cofounder, “had the chutzpah to propose to them that we run their brand online and that they run (our) brand in the stores and they just about laughed us out of the office. At least initially, they thought we were a very small niche business.”

Users, of course, embraced the automated self-service of Netflix’s web-based interface technology that positioned the start-up to transition from mailing DVDs to streaming con- tent over the Internet. As technologies improved broadband speed, reliability, and adoption, Netflix transitioned in just a few years to a cloud-based service.

Blockbuster tried to follow each of Netflix’s strategic moves. However, it remained a perennial second in the winner-take-all market for new ways to distribute entertainment content. Blockbuster continued to lag, weighed down by the high labor costs and real estate costs of its once-dominant locations—assets that became liabilities. In 2011, after closing some 900 stores, the company declared bankruptcy.

In the end, Blockbuster’s assets were acquired for only $320 million by satellite television maverick Dish Networks, which was mainly interested in Blockbuster’s online channel and 3.3 million customers. Had Blockbuster sold out earlier, or found a way to shed the physical assets sooner, that price could have been much higher. In 1999, the year Netflix launched its online subscription service, Blockbuster was valued at nearly $3 billion—nearly 10 times what Dish ultimately paid. Netflix, on the other hand, had a market cap of $21 billion by the end of 2014.

The Generation and Distribution of a Firm’s Profits: Extending the Resource-Based View of the Firm The resource-based view of the firm is useful in determining when firms will create competi- tive advantages and enjoy high levels of profitability. However, it has not been developed to

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address how a firm’s profits (often referred to as “rents” by economists) will be distributed to a firm’s management and employees or other stakeholders such as customers, suppliers, or governments.56 This is an important issue because firms may be successful in creating competitive advantages that can be sustainable for a period of time. However, much of the profits can be retained (or “appropriated”) by a firm’s employees and managers or other stakeholders instead of flowing to the firm’s owners (i.e., the stockholders).*

Consider Viewpoint DataLabs, a subsidiary of software giant Computer Associates, that makes sophisticated three-dimensional models and textures for film production houses, video games, and car manufacturers. This example will help to show how employees are often able to obtain (or “appropriate”) a high proportion of a firm’s profits:

Walter Noot, head of production, was having trouble keeping his highly skilled Generation X employees happy with their compensation. Each time one of them was lured away for more money, everyone would want a raise. “We were having to give out raises every six months—30 to 40 percent—then six months later they’d expect the same. It was a big struggle to keep people happy.”57

Here, much of the profits is being generated by the highly skilled professionals working together. They are able to exercise their power by successfully demanding more financial compensation. In part, management has responded favorably because they are united in their demands and their work involves a certain amount of social complexity and causal ambiguity—given the complex, coordinated efforts that their work entails.

Four factors help explain the extent to which employees and managers will be able to obtain a proportionately high level of the profits that they generate:58

• Employee bargaining power. If employees are vital to forming a firm’s unique capability, they will earn disproportionately high wages. For example, marketing professionals may have access to valuable information that helps them to understand the intricacies of customer demands and expectations, or engineers may understand unique technical aspects of the products or services. Additionally, in some industries such as consulting, advertising, and tax preparation, clients tend to be very loyal to individual professionals employed by the firm, instead of to the firm itself. This enables them to “take the clients with them” if they leave. This enhances their bargaining power.

• Employee replacement cost. If employees’ skills are idiosyncratic and rare (a source of resource-based advantages), they should have high bargaining power based on the high cost required by the firm to replace them. For example, Raymond Ozzie, the software designer who was critical in the development of Lotus Notes, was able to dictate the terms under which IBM acquired Lotus.

• Employee exit costs. This factor may tend to reduce an employee’s bargaining power. An individual may face high personal costs when leaving the organization. Thus, that individual’s threat of leaving may not be credible. In addition, an employee’s expertise may be firm-specific and of limited value to other firms.

• Manager bargaining power. Managers’ power is based on how well they create resource-based advantages. They are generally charged with creating value through the process of organizing, coordinating, and leveraging employees as well as other forms of capital such as plant, equipment, and financial capital (addressed further in Chapter 4). Such activities provide managers with sources of information that may not be readily available to others.

Chapter 9 addresses the conditions under which top-level managers (such as CEOs) of large corporations have been, at times, able to obtain levels of total compensation that

* Economists define rents as profits (or prices) in excess of what is required to provide a normal return.

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would appear to be significantly disproportionate to their contributions to wealth genera- tion as well as to top executives in peer organizations. Here, corporate governance becomes a critical control mechanism. Consider shareholders’ reaction, in April 2012, to Citigroup’s proposed $15 million pay package for then-CEO Vikram Pandit.59 It was not positive, to say the least. After all, they had suffered a 92 percent decline in the stock’s price under Pandit’s five-year reign. They rejected the bank’s compensation proposal. In October 2012, the board ousted Pandit after the New York–based firm failed to secure Federal Reserve approval to increase its shareholder payouts and Moody’s Investors Service cut the bank’s credit rating two levels.

Such diversion of profits from the owners of the business to top management is far less likely when the board members are truly independent outsiders (i.e., they do not have close ties to management). In general, given the external market for top talent, the level of com- pensation that executives receive is based on factors similar to the ones just discussed that determine the level of their bargaining power.60

In addition to employees and managers, other stakeholder groups can also appropriate a portion of the rents generated by a firm. If, for example, a critical input is controlled by a monopoly supplier or if a single buyer accounts for most of a firm’s sales, this supplier’s or buyer’s bargaining power can greatly erode the potential profits of a firm. Similarly, exces- sive taxation by governments can also reduce what is available to a firm’s stockholders.

EVALUATING FIRM PERFORMANCE: TWO APPROACHES This section addresses two approaches to use when evaluating a firm’s performance. The first is financial ratio analysis, which, generally speaking, identifies how a firm is perform- ing according to its balance sheet, income statement, and market valuation. As we will discuss, when performing a financial ratio analysis, you must take into account the firm’s performance from a historical perspective (not just at one point in time) as well as how it compares with both industry norms and key competitors.61

The second perspective takes a broader stakeholder view. Firms must satisfy a broad range of stakeholders, including employees, customers, and owners, to ensure their long- term viability. Central to our discussion will be a well-known approach—the balanced scorecard—that has been popularized by Robert Kaplan and David Norton.62

Financial Ratio Analysis The beginning point in analyzing the financial position of a firm is to compute and analyze five different types of financial ratios:

• Short-term solvency or liquidity • Long-term solvency measures • Asset management (or turnover) • Profitability • Market value

Exhibit 3.8 summarizes each of these five ratios. Appendix 1 to Chapter 13 (the Case Analysis chapter) provides detailed definitions for and

discussions of each of these types of ratios as well as examples of how each is calculated. Refer to pages 418 to 427.

A meaningful ratio analysis must go beyond the calculation and interpretation of finan- cial ratios.63 It must include how ratios change over time as well as how they are interrelated. For example, a firm that takes on too much long-term debt to finance operations will see an immediate impact on its indicators of long-term financial leverage. The additional debt will negatively affect the firm’s short-term liquidity ratio (i.e., current and quick ratios) since

financial ratio analysis a method of evaluating a company’s performance and financial well- being through ratios of accounting values, including short-term solvency, long-term solvency, asset utilization, profitability, and market value ratios.

LO 3-5 The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms.

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EXHIBIT 3.8 A Summary of Five Types of Financial Ratios

I. Short-term solvency, or liquidity, ratios

Current ratio =  Current assets _______________ Current liabilities

Quick ratio =  Current assets – Inventory ______________________ Current liabilities

Cash ratio =  Cash _______________ Current liabilities

II. Long-term solvency, or financial leverage, ratios

Total debt ratio =  Total assets – Total equity _____________________ Total assets

Debt-equity ratio = Total debt/Total equity

Equity multiplier = Total assets/Total equity

Times interest earned ratio =  EBIT _______ Interest

Cash coverage ratio =  EBIT + Depreciation _________________ Interest

III. Asset utilization, or turnover, ratios

Inventory turnover =  Cost of goods sold _______________ Inventory

Days’ sales in inventory =  365 days ________________ Inventory turnover

Receivables turnover =  Sales _________________ Accounts receivable

Days’ sales in receivables =  365 days _________________ Receivables turnover

Total asset turnover =  Sales __________ Total assets

Capital intensity =  Total assets __________ Sales

IV. Profitability ratios

Profit margin =  Net income __________ Sales

Return on assets (ROA) =  Net income __________ Total assets

Return on equity (ROE) =  Net income __________ Total equity

ROE =  Net income __________ Sales

× Sales ______ Assets

× Assets ______ Equity

V. Market value ratios

Price-earnings ratio =  Price per share ________________ Earnings per share

Market-to-book ratio =  Market value per share ___________________ Book value per share

the firm must pay interest and principal on the additional debt each year until it is retired. Additionally, the interest expenses deducted from revenues reduce the firm’s profitability.

A firm’s financial position should not be analyzed in isolation. Important reference points are needed. We will address some issues that must be taken into account to make financial analysis more meaningful: historical comparisons, comparisons with industry norms, and comparisons with key competitors.

Historical Comparisons When you evaluate a firm’s financial performance, it is very use- ful to compare its financial position over time. This provides a means of evaluating trends. For example, Apple Inc. reported revenues of $234 billion and net income of $53 billion in 2015. Virtually all firms would be very happy with such remarkable financial success. These figures represent a stunning annual growth in revenue and net income of 28 percent and 33 percent, respectively, over Apple’s 2014 figures. Had Apple’s revenues and net income in 2015 been $150 billion and $30 billion, respectively, it would still be a very large and highly profitable enterprise. However, such performance would have significantly damaged Apple’s market valuation and reputation as well as the careers of many of its executives.

Exhibit 3.9 illustrates a 10-year period of return on sales (ROS) for a hypothetical com- pany. As indicated by the dotted trend lines, the rate of growth (or decline) differs substan- tially over time periods.

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EXHIBIT 3.9 Historical Trends: Return on Sales (ROS) for a Hypothetical Company

20%

10%

20172008 2009 2010 2011 2012 2013 2014 2015 2016

Years 1, 2, 3

Yea rs 4

, 5, 6

Years 8 , 9, 10

Years 6, 7, 8, 9, 10

Year

Re tu

rn o

n Sa

le s

Years 6, 7, 8

Comparison with Industry Norms When you are evaluating a firm’s financial performance, remember also to compare it with industry norms. A firm’s current ratio or profitability may appear impressive at first glance. However, it may pale when compared with industry standards or norms.

Comparing your firm with all other firms in your industry assesses relative performance. Banks often use such comparisons when evaluating a firm’s creditworthiness. Exhibit 3.10 includes a variety of financial ratios for three industries: semiconductors, grocery stores, and skilled-nursing facilities. Why is there such variation among the financial ratios for these three industries? There are several reasons. With regard to the collection period, grocery stores operate mostly on a cash basis, hence a very short collection period. Semiconductor manu- facturers sell their output to other manufacturers (e.g., computer makers) on terms such as 2/15 net 45, which means they give a 2 percent discount on bills paid within 15 days and start charging interest after 45 days. Skilled-nursing facilities also have a longer collection period than grocery stores because they typically rely on payments from insurance companies.

The industry norms for return on sales also highlight differences among these industries. Grocers, with very slim margins, have a lower return on sales than either skilled-nursing facil- ities or semiconductor manufacturers. But how might we explain the differences between

Financial Ratio Semiconductors Grocery Stores Skilled-Nursing Facilities

Quick ratio (times) 1.9 0.6 1.3

Current ratio (times) 3.6 1.7 1.7

Total liabilities to net worth (%) 35.1 72.7 82.5

Collection period (days) 48.6 3.3 36.5

Assets to sales (%) 131.7 22.1 58.3

Return on sales (%)  24   1.1 3.1

Source: Dun & Bradstreet. Industry Norms and Key Business Ratios, 2010–2011. One Year Edition, SIC #3600–3699 (Semiconductors); SIC #5400–5499 (Grocery Stores); SIC #8000–8099 (Skilled-Nursing Facilities). New York: Dun & Bradstreet Credit Services.

EXHIBIT 3.10 How Financial Ratios Differ across Industries

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skilled-nursing facilities and semiconductor manufacturers? Health care facilities, in general, are limited in their pricing structures by Medicare/Medicaid regulations and by insurance reimbursement limits, but semiconductor producers have pricing structures determined by the market. If their products have superior performance, semiconductor manufacturers can charge premium prices.

Comparison with Key Competitors Recall from Chapter 2 that firms with similar strate- gies are members of a strategic group in an industry. Furthermore, competition is more intense among competitors within groups than across groups. Thus, you can gain valuable insights into a firm’s financial and competitive position if you make comparisons between a firm and its most direct rivals. Consider a firm trying to diversify into the highly profitable pharmaceutical industry. Even if it was willing to invest several hundred million dollars, it would be virtually impossible to compete effectively against industry giants such as Pfizer and Merck. These two firms had 2015 revenues of $49 billion and $39 billion, respectively, and both had R&D budgets of over $6.5 billion.64

Integrating Financial Analysis and Stakeholder Perspectives: The Balanced Scorecard It is useful to see how a firm performs over time in terms of several ratios. However, such traditional approaches can be a double-edged sword.65 Many important transactions— investments in research and development, employee training and development, and adver- tising and promotion of key brands—may greatly expand a firm’s market potential and create significant long-term shareholder value. But such critical investments are not reflected posi- tively in short-term financial reports. Financial reports typically measure expenses, not the value created. Thus, managers may be penalized for spending money in the short term to improve their firm’s long-term competitive viability!

Now consider the other side of the coin. A manager may destroy the firm’s future value by dissatisfying customers, depleting the firm’s stock of good products coming out of R&D, or damaging the morale of valued employees. Such budget cuts, however, may lead to very good short-term financials. The manager may look good in the short run and even receive credit for improving the firm’s performance. In essence, such a manager has mastered “denominator management,” whereby decreasing investments makes the return on investment (ROI) ratio larger, even though the actual return remains constant or shrinks.

The Balanced Scorecard: Description and Benefits To provide a meaningful integration of the many issues that come into evaluating a firm’s performance, Kaplan and Norton devel- oped a “balanced scorecard.”66 This provides top managers with a fast but comprehensive view of the business. In a nutshell, it includes financial measures that reflect the results of actions already taken, but it complements these indicators with measures of customer satis- faction, internal processes, and the organization’s innovation and improvement activities— operational measures that drive future financial performance.

The balanced scorecard enables managers to consider their business from four key perspectives: customer, internal, innovation and learning, and financial. These are briefly described in Exhibit 3.11.

Customer Perspective Clearly, how a company is performing from its customers’ perspec- tive is a top priority for management. The balanced scorecard requires that managers trans- late their general mission statements on customer service into specific measures that reflect the factors that really matter to customers. For the balanced scorecard to work, managers must articulate goals for four key categories of customer concerns: time, quality, perfor- mance and service, and cost.

LO 3-6 The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated.

balanced scorecard a method of evaluating a firm’s performance using performance measures from the customer, internal, innovation and learning, and financial perspectives.

customer perspective measures of firm performance that indicate how well firms are satisfying customers’ expectations.

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Internal Business Perspective Customer-based measures are important. However, they must be translated into indicators of what the firm must do internally to meet customers’ expecta- tions. Excellent customer performance results from processes, decisions, and actions that occur throughout organizations in a coordinated fashion, and managers must focus on those critical internal operations that enable them to satisfy customer needs. The internal measures should reflect business processes that have the greatest impact on customer satisfaction. These include factors that affect cycle time, quality, employee skills, and productivity.

Innovation and Learning Perspective Given the rapid rate of markets, technologies, and global competition, the criteria for success are constantly changing. To survive and prosper, managers must make frequent changes to existing products and services as well as introduce entirely new products with expanded capabilities. A firm’s ability to do well from an innova- tion and learning perspective is more dependent on its intangible than tangible assets. Three categories of intangible assets are critically important: human capital (skills, talent, and knowledge), information capital (information systems, networks), and organization capital (culture, leadership).

Financial Perspective Measures of financial performance indicate whether the company’s strategy, implementation, and execution are indeed contributing to bottom-line improve- ment. Typical financial goals include profitability, growth, and shareholder value. Periodic financial statements remind managers that improved quality, response time, productivity, and innovative products benefit the firm only when they result in improved sales, increased market share, reduced operating expenses, or higher asset turnover.67

A key implication is that managers do not need to look at their job as balancing stake- holder demands. They must avoid the following mind-set: “How many units in employee satisfaction do I have to give up to get some additional units of customer satisfaction or profits?” Instead, the balanced scorecard provides a win–win approach—increasing satis- faction among a wide variety of organizational stakeholders, including employees (at all levels), customers, and stockholders.

Limitations and Potential Downsides of the Balanced Scorecard There is general agreement that there is nothing inherently wrong with the concept of the balanced scorecard.68 The key limitation is that some executives may view it as a “quick fix” that can be easily installed. If managers do not recognize this from the beginning and fail to commit to it long term, the organization will be disappointed. Poor execution becomes the cause of such performance outcomes. And organizational scorecards must be aligned with individuals’ scorecards to turn the balanced scorecards into a powerful tool for sustained performance.

In a study of 50 Canadian medium-size and large organizations, the number of users expressing skepticism about scorecard performance was much greater than the num- ber claiming positive results. A large number of respondents agreed with the statement “Balanced scorecards don’t really work.” Some representative comments included: “It became just a number-crunching exercise by accountants after the first year,” “It is just the latest management fad and is already dropping lower on management’s list of priorities as all fads eventually do,” and “If scorecards are supposed to be a measurement tool, why is it so hard to measure their results?” There is much work to do before scorecards can become a viable framework to measure sustained strategic performance.

internal business perspective measures of firm performance that indicate how well firms’ internal processes, decisions, and actions are contributing to customer satisfaction.

innovation and learning perspective measures of firm performance that indicate how well firms are changing their product and service offerings to adapt to changes in the internal and external environments.

financial perspective measures of firms’ financial performance that indicate how well strategy, implementation, and execution are contributing to bottom-line improvement.

EXHIBIT 3.11 The Balanced Scorecard’s Four Perspectives

• How do customers see us? (customer perspective) • What must we excel at? (internal business perspective) • Can we continue to improve and create value? (innovation and learning perspective) • How do we look to shareholders? (financial perspective)

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ISSUE FOR DEBATE

Even as malls around the country see store after store closing, online retailers, both large and small, have started exploring opening brick-and-mortar stores. Amazon has opened a physical bookstore in Seattle’s University Village and has plans to open 200 stores. Fabletics, an online athletic clothing retailer, opened six physical stores in the second half of 2016. Birchbox, an online beauty supply store, opened its first brick-and-mortar store in the trendy Soho District of New York City.

There are both potential benefits and pitfalls in opening these physical stores. These online firms are striving to grow the awareness of their brand and build their market position with these stores. They can leverage their customer databases to identify the markets with the greatest potential. Online retailers collect an enormous amount of data about their customers and can base their physical stores in areas where the local demographics suggest there is the greatest density of potential customers. Opening physical stores also offers them the potential to offer a richer experience to their customers. In stores, customers can try on or test the retailer’s products and can be brought in for promotional events and seminars related to the firm’s products—things that are much more difficult in the online space. Some online retailers, such as Bonobos and Blue Nile, use their stores solely as showrooms where customers try on clothing or jewelry and then order whatever they want online for home delivery. Finally, opening physical stores allows the firm to attract a new set of customers, those who do not regularly shop online.

There are also new challenges in opening physical stores. First, having physical stores requires a significant financial investment. The cost to rent and physically set up store locations can be quite steep, especially in high traffic areas such as New York City and Chicago—the most common targets for initial locations. Second, it can reduce the flexibility of the firm. Store leases typically last several years, leaving firms stuck if the location turns out to be less successful than expected. Also, housing inventory in a range of locations requires longer planning and greater investment than having an online-only model. Third, online store operators have to learn new competencies to compete with physical stores. Online retailers typically have limited experience in predicting consumer demand months ahead of time, a foremost skill needed by brick-and-mortar retailers to be able to stock products in stores. They also don’t have experience in staffing, training, and compensating the personnel needed in a physical store. In physical stores, the sales associate is a key asset, but online retailers are more adept at hiring and organizing work for IT, web- marketing, and logistics personnel. Fourth, the legal requirements for running physical stores are more complex. This can include taxation and permitting laws, but the most complex may be the myriad of employment and labor laws that retailers face when they operate in different cities or states.

Problems often occur in the balanced scorecard implementation efforts when the commitment to learning is insufficient and employees’ personal ambitions are included. Without a set of rules for employees that address continuous process improvement and the personal improvement of individual employees, there will be limited employee buy-in and insufficient cultural change. Thus, many improvements may be temporary and superficial. Often, scorecards that failed to attain alignment and improvements dissipated very quickly. And, in many cases, management’s efforts to improve performance were seen as divisive and were viewed by employees as aimed at benefiting senior management compensation. This fostered a “what’s in it for me?” attitude.

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Reflecting on Career Implications . . . The Value Chain: It is important that you develop an

understanding of your firm’s value chain. What activities are most critical for attaining competitive advantage? Think of ways in which you can add value in your firm’s value chain. How might your firm’s support activities (e.g., information technology, human resource practices) help you accomplish your assigned tasks more effectively? How will you bring your value-added contribution to the attention of your superiors?

The Value Chain: Consider the most important linkages between the activities you perform in your organization with other activities both within your firm and between your firm and its suppliers, customers, and alliance partners. Understanding and strengthening these linkages can

contribute greatly to your career advancement within your current organization.

Resource-Based View of the Firm: Are your skills and talents rare, valuable, and difficult to imitate, and do they have few substitutes? If so, you are in the better position to add value for your firm—and earn rewards and incentives. How can your skills and talents be enhanced to help satisfy these criteria to a greater extent? Get more training? Change positions within the firm? Consider career options at other organizations?

Balanced Scorecard: Can you design a balanced scorecard for your life? What perspectives would you include in it? In what ways would such a balanced scorecard help you attain success in life?

In the traditional approaches to assessing a firm’s internal environment, the primary goal of managers would be to determine their firm’s relative strengths and weaknesses. Such is the role of SWOT analysis, wherein managers

analyze their firm’s strengths and weaknesses as well as the opportunities and threats in the external environment. In this chapter, we discussed why this may be a good starting point but hardly the best approach to take in performing a sound analysis. There are many limitations to SWOT analysis, including its static perspective, its potential to overemphasize a single dimension of a firm’s strategy, and the likelihood that a firm’s strengths do not necessarily help the firm create value or competitive advantages.

We identified two frameworks that serve to complement SWOT analysis in assessing a firm’s internal environment: value-chain analysis and the resource-based view of the firm. In conducting a value-chain analysis, first divide the firm into a series of value-creating activities. These include primary activities such as inbound logistics, operations, and service as well as support activities such as procurement and human resource management. Then analyze how each activity adds value as well as how interrelationships among value activities

in the firm and among the firm and its customers and suppliers add value. Thus, instead of merely determining a firm’s strengths and weaknesses per se, you analyze them in the overall context of the firm and its relationships with customers and suppliers—the value system.

The resource-based view of the firm considers the firm as a bundle of resources: tangible resources, intangible resources, and organizational capabilities. Competitive advantages that are sustainable over time generally arise from the creation of bundles of resources and capabilities. For advantages to be sustainable, four criteria must be satisfied: value, rarity, difficulty in imitation, and difficulty in substitution. Such an evaluation requires a sound knowledge of the competitive context in which the firm exists. The owners of a business may not capture all of the value created by the firm. The appropriation of value created by a firm between the owners and employees is determined by four factors: employee bargaining power, replacement cost, employee exit costs, and manager bargaining power.

An internal analysis of the firm would not be complete unless you evaluate its performance and make the appropriate comparisons. Determining a firm’s performance requires an analysis of its financial situation as well as a review of how well it is satisfying a broad range of stakeholders, including

summary

Discussion Questions 1. Will online retailers, in general, experience a positive outcome in opening physical stores? 2. For what types of online retailers does opening stores make the most sense? Why? 3. Is it more challenging for traditional retailers to build an online space, or for online retailers

to build a physical store presence? Sources: Briggs, F. 2015. Shift of online brands to bricks & mortar stores set to create omni-channel experience for malls. forbes.com. August 11: np; Walsh, M. 2016. The future of e-commerce: bricks and mortar. theguardian.com. January 30: np; and Bensinger, G. & Kapner, S. 2016. Online stores embrace bricks. wsj.com. February 5: np.

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customers, employees, and stockholders. We discussed the concept of the balanced scorecard, in which four perspectives must be addressed: customer, internal business, innovation and learning, and financial. Central to this concept is the idea that the interests of various stakeholders can be interrelated. We provide examples of how indicators of employee satisfaction lead to higher levels of customer satisfaction, which in turn lead to higher levels of financial performance. Thus, improving a firm’s performance does not need to involve making trade- offs among different stakeholders. Assessing the firm’s performance is also more useful if it is evaluated in terms of how it changes over time, compares with industry norms, and compares with key competitors.

SUMMARY REVIEW QUESTIONS 1. SWOT analysis is a technique to analyze the internal

and external environments of a firm. What are its advantages and disadvantages?

2. Briefly describe the primary and support activities in a firm’s value chain.

3. How can managers create value by establishing important relationships among the value-chain activities both within their firm and between the firm and its customers and suppliers?

4. Briefly explain the four criteria for sustainability of competitive advantages.

5. Under what conditions are employees and managers able to appropriate some of the value created by their firm?

6. What are the advantages and disadvantages of conducting a financial ratio analysis of a firm?

7. Summarize the concept of the balanced scorecard. What are its main advantages?

value-chain analysis 72 primary activities 72 support activities 72 inbound logistics 73 operations 73 outbound logistics 74 marketing and sales 74 service 75 procurement 76 technology development 76 human resource management 76 general administration 77

interrelationships 78 resource-based view of the firm 81 tangible resources 81 intangible resources 82 organizational capabilities 83 path dependency 85 causal ambiguity 86 social complexity 87 financial ratio analysis 90 balanced scorecard 93 customer perspective 93 internal business perspective 94 innovation and learning perspective 94 financial perspective 94

key terms

EXPERIENTIAL EXERCISE Caterpillar is a leading firm in the construction and mining equipment industry with extensive global operations. It has approximately 114,000 employees, and its revenues were $47 billion in 2015. In addition to its manufacturing and logistics operations, Caterpillar is well known for its superb service and parts supply, and it provides retail financing for its equipment.

Below, we address several questions that focus on Caterpillar’s value-chain activities and the interrelationships among them as well as whether or not the firm is able to attain sustainable competitive advantage(s).

Value-Chain Activity Yes/No How Does Caterpillar Create Value for the Customer?

Primary:

Inbound logistics

Operations

Outbound logistics

Marketing and sales

Service

Support:

Procurement

Technology development

Human resource management

General administration

1. Where in Caterpillar’s value chain is the firm creating value for its customers?

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2. What are the important relationships among Caterpillar’s value-chain activities? What are the important interdependencies? For each activity, identify the relationships and interdependencies.

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Resource/Activity Is It Valuable? Is It Rare? Are There Few Substitutes? Is It Difficult to Make?

Inbound logistics

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Outbound logistics

Marketing and sales

Service

Procurement

Technology development

Human resource management

General administration

3. What resources, activities, and relationships enable Caterpillar to achieve a sustainable competitive advantage?

APPLICATION QUESTIONS & EXERCISES 1. Using published reports, select two CEOs who have

recently made public statements regarding a major change in their firm’s strategy. Discuss how the successful implementation of such strategies requires changes in the firm’s primary and support activities.

2. Select a firm that competes in an industry in which you are interested. Drawing upon published financial reports, complete a financial ratio analysis. Based on changes over time and a comparison with industry norms, evaluate the firm’s strengths and weaknesses in terms of its financial position.

3. How might exemplary human resource practices enhance and strengthen a firm’s value-chain activities?

4. Using the Internet, look up your university or college. What are some of its key value-creating activities that provide competitive advantages? Why?

ETHICS QUESTIONS 1. What are some of the ethical issues that arise when

a firm becomes overly zealous in advertising its products?

2. What are some of the ethical issues that may arise from a firm’s procurement activities? Are you aware of any of these issues from your personal experience or businesses you are familiar with?

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1. Lapowski, I. 2013. Ev Williams on Twitter’s early years, inc.com. October 4: np; Shen, L. 2016. Here’s why Twitter’s stock is plunging. fortune. com. October 15: np; Luckerson, V. 2016. This one chart explains why Twitter is in trouble. time.com. February 10: np; Covert, J. 2016. Twitter tanks as company struggles to find a buyer. nypost.com. October 10: np; Thomas, L. 2016. Twitter struggles to lure advertisers despite user growth. cnbc.com. July 26: np; statista.com.

2. Our discussion of the value chain will draw on Porter, M. E. 1985. Competitive advantage: chap. 2. New York: Free Press.

3. Dyer, J. H. 1996. Specialized supplier networks as a source of competitive advantage: Evidence from the auto industry. Strategic Management Journal, 17: 271–291.

4. For an insightful perspective on value- chain analysis, refer to Stabell, C. B. & Fjeldstad, O. D. 1998. Configuring value for competitive advantage: On chains, shops, and networks. Strategic Management Journal, 19: 413–437. The authors develop concepts of value chains, value shops, and value networks to extend the value- creation logic across a broad range of industries. Their work builds on the seminal contributions of Porter, 1985, op. cit., and others who have addressed how firms create value through key interrelationships among value-creating activities.

5. Ibid. 6. Maynard, M. 1999. Toyota promises

custom order in 5 days. USA Today, August 6: B1.

7. Shaw Industries. 1999. Annual report: 14– 15.

8. Fisher, M. L. 1997. What is the right supply chain for your product? Harvard Business Review, 75(2): 105– 116.

9. Jackson, M. 2001. Bringing a dying brand back to life. Harvard Business Review, 79(5): 53–61.

10. Anderson, J. C. & Nmarus, J. A. 2003. Selectively pursuing more of your customer’s business. MIT Sloan Management Review, 44(3): 42–50.

11. Insights on advertising are addressed in Rayport, J. F. 2008. Where is advertising going? Into ‘stitials. Harvard Business Review, 66(5): 18–20.

12. Sauer, A. 2016. Announcing the 2016 brandcameo product placement awards. brandchannel.com. February 24: np.

13. For a scholarly discussion on the procurement of technology components, read Hoetker, G. 2005. How much you know versus how well I know you: Selecting a supplier for a technically innovative component. Strategic Management Journal, 26(1): 75–96.

14. For a discussion on criteria to use when screening suppliers for back- office functions, read Feeny, D., Lacity, M., & Willcocks, L. P. 2005. Taking the measure of outsourcing providers. MIT Sloan Management Review, 46(3): 41–48.

15. For a study investigating sourcing practices, refer to Safizadeh, M. H., Field, J. M., & Ritzman, L. P. 2008. Sourcing practices and boundaries of the firm in the financial services industry. Strategic Management Journal, 29(1): 79–92.

16. Imperato, G. 1998. How to give good feedback. Fast Company, September: 144– 156.

17. Imperato, G., “How Microsoft Reviews Suppliers,” Fast Company, September 1998.

18. Bensaou, B. M. & Earl, M. 1998. The right mindset for managing information technology. Harvard Business Review, 96(5): 118– 128.

19. A discussion of R&D in the pharmaceutical industry is in Garnier, J-P. 2008. Rebuilding the R&D engine in big pharma. Harvard Business Review, 66(5): 68–76.

20. Chick, S. E., Huchzermeier, A., & Netessine, S. 2014. Europe’s solution factories. Harvard Business Review, 92(4): 111–115.

21. Ulrich, D. 1998. A new mandate for human resources. Harvard Business Review, 96(1): 124– 134.

22. A study of human resource management in China is Li, J., Lam, K., Sun, J. J. M., & Liu, S. X. Y. 2008. Strategic resource management, institutionalization, and employment modes: An empirical study in China. Strategic Management Journal, 29(3): 337–342.

23. Wood, J. 2003. Sharing jobs and working from home: The new face of the airline industry. AviationCareer. net: February 21.

24. Gellman, L. 2015. When a job offer comes without a job. Wall Street Journal. December 2: B1, B7.

25. For insights on the role of information systems integration in fostering innovation, refer to Cash, J. I. Jr., Earl, M. J., & Morison, R.

2008. Teaming up to crack innovation and enterprise integration. Harvard Business Review, 66(11): 90–100.

26. For a cautionary note on the use of IT, refer to McAfee, A. 2003. When too much IT knowledge is a dangerous thing. MIT Sloan Management Review, 44(2): 83–90.

27. For an interesting perspective on some of the potential downsides of close customer and supplier relationships, refer to Anderson, E. & Jap, S. D. 2005. The dark side of close relationships. MIT Sloan Management Review, 46(3): 75–82.

28. Day, G. S. 2003. Creating a superior customer-relating capability. MIT Sloan Management Review, 44(3): 77–82.

29. To gain insights on the role of electronic technologies in enhancing a firm’s connections to outside suppliers and customers, refer to Lawrence, T. B., Morse, E. A., & Fowler, S. W. 2005. Managing your portfolio of connections. MIT Sloan Management Review, 46(2): 59–66.

30. IBM Global CEO Study, p. 27. 31. Verhoef, P. C., Beckers, S. F. M.,

& van Doorn, J. 2013. Understand the perils of co-creation. Harvard Business Review, 91(9): 28; and Winston, A. S. 2014. The big pivot. Boston: Harvard Business Review Press.

32. Collis, D. J. & Montgomery, C. A. 1995. Competing on resources: Strategy in the 1990’s. Harvard Business Review, 73(4): 119– 128; and Barney, J. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17(1): 99– 120.

33. For critiques of the resource-based view of the firm, refer to Sirmon, D. G., Hitt, M. A., & Ireland, R. D. 2007. Managing firm resources in dynamic environments to create value: Looking inside the black box. Academy of Management Review, 32(1): 273–292; and Newbert, S. L. 2007. Empirical research on the resource-based view of the firm: An assessment and suggestions for future research. Strategic Management Journal, 28(2): 121–146.

34. Henkoff, R. 1993. Companies that train the best. Fortune, March 22: 83; and Dess & Picken, Beyond productivity, p. 98.

35. Gaines-Ross, L. 2010. Reputation warfare. Harvard Business Review, 88(12): 70–76.

36. Barney, J. B. 1986. Types of competition and the theory of

REFERENCES

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strategy: Towards an integrative framework. Academy of Management Review, 11(4): 791–800.

37. Harley-Davidson. 1993. Annual report.

38. Stetler, B. 2008. Griping online? Comcast hears and talks back. nytimes.com, July 25: np.

39. For a rigorous, academic treatment of the origin of capabilities, refer to Ethiraj, S. K., Kale, P., Krishnan, M. S., & Singh, J. V. 2005. Where do capabilities come from and how do they matter? A study of the software services industry. Strategic Management Journal, 26(1): 25–46.

40. For an academic discussion on methods associated with organizational capabilities, refer to Dutta, S., Narasimhan, O., & Rajiv, S. 2005. Conceptualizing and measuring capabilities: Methodology and empirical application. Strategic Management Journal, 26(3): 277–286.

41. Lorenzoni, G. & Lipparini, A. 1999. The leveraging of interfirm relationships as a distinctive organizational capability: A longitudinal study. Strategic Management Journal, 20: 317–338.

42. Andersen, M. M. op. cit, p. 209. 43. A study investigating the

sustainability of competitive advantage is Newbert, S. L. 2008. Value, rareness, competitive advantages, and performance: A conceptual-level empirical investigation of the resource- based view of the firm. Strategic Management Journal, 29(7): 745–768.

44. Arikan, A. M. & McGahan, A. M. 2010. The development of capabilities in new firms. Strategic Management Journal, 31(1): 1–18.

45. Barney, J. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17(1): 99–120.

46. Barney, 1986, op. cit. Our discussion of inimitability and substitution draws upon this source.

47. A study that investigates the performance implications of imitation is Ethiraj, S. K. & Zhu, D. H. 2008. Performance effects of imitative entry. Strategic Management Journal, 29(8): 797–818.

48. Sirmon, D. G., Hitt, M. A., Arregale, J.-L. & Campbell, J. T. 2010. The dynamic interplay of capability strengths and weaknesses: Investigating the bases of temporary competitive advantage. Strategic Management Journal, 31(13): 1386– 1409.

49. Scherzer, L. 2012. Groupon and deal sites see skepticism replacing promise. finance.yahoo.com, November 30: np; The dismal scoop on Groupon. 2011. The Economist, October 22: 81; Slater, D. 2012. Are daily deals done? Fast Company; and Danna, D. 2012. Groupon & daily deals competition. beta.fool.com, June 15: np.

50. Deephouse, D. L. 1999. To be different, or to be the same? It’s a question (and theory) of strategic balance. Strategic Management Journal, 20: 147–166.

51. Hagerty, J. 2015. A radical idea: Own your supply chain. Wall Street Journal. April 30: B1-B2.

52. Karlgaard, R. 2014. The soft edge. San Francisco: Jossey-Bass.

53. Yeoh, P. L. & Roth, K. 1999. An empirical analysis of sustained advantage in the U.S. pharmaceutical industry: Impact of firm resources and capabilities. Strategic Management Journal, 20: 637–653.

54. Robins, J. A. & Wiersema, M. F. 2000. Strategies for unstructured competitive environments: Using scarce resources to create new markets. In Bresser, R. F., et al. (Eds.), Winning strategies in a deconstructing world: 201–220. New York: Wiley.

55. Graser, M. 2013. Blockbuster chiefs lacked the vision to see how the industry was shifting under the video rental chain’s feet. www.variety.com, November 12: np; Kellmurray, B. 2013. Learning from Blockbuster’s failure to adapt. www.abovethefoldmag. com, November 13: np; and Downes, L. & Nunes, P. 2014. Big bang disruption. New York: Penguin.

56. Amit, R. & Schoemaker, J. H. 1993. Strategic assets and organizational rent. Strategic Management Journal, 14(1): 33–46; Collis, D. J. & Montgomery, C. A. 1995. Competing on resources: Strategy in the 1990’s. Harvard Business Review, 73(4):

118–128; Coff, R. W. 1999. When competitive advantage doesn’t lead to performance: The resource-based view and stakeholder bargaining power. Organization Science, 10(2): 119–133; and Blyler, M. & Coff, R. W. 2003. Dynamic capabilities, social capital, and rent appropriation: Ties that split pies. Strategic Management Journal, 24: 677–686.

57. Munk, N. 1998. The new organization man. Fortune, March 16: 62–74.

58. Coff, op. cit. 59. Anonymous. 2013. “All of them are

overpaid”: Bank CEOs got average 7.7% raise. www.moneynews.com, June 3: np.

60. We have focused our discussion on how internal stakeholders (e.g., employees, managers, and top executives) may appropriate a firm’s profits (or rents). For an interesting discussion of how a firm’s innovations may be appropriated by external stakeholders (e.g., customers, suppliers) as well as competitors, refer to Grant, R. M. 2002. Contemporary strategy analysis (4th ed.): 335–340. Malden, MA: Blackwell.

61. Luehrman, T. A. 1997. What’s it worth? A general manager’s guide to valuation. Harvard Business Review, 45(3): 132–142.

62. See, for example, Kaplan, R. S. & Norton, D. P. 1992. The balanced scorecard: Measures that drive performance. Harvard Business Review, 69(1): 71–79.

63. Hitt, M. A., Ireland, R. D., & Stadter, G. 1982. Functional importance of company performance: Moderating effects of grand strategy and industry type. Strategic Management Journal, 3: 315–330.

64. finance.yahoo.com. 65. Kaplan & Norton, op. cit. 66. Ibid. 67. For a discussion of the relative value

of growth versus increasing margins, read Mass, N. J. 2005. The relative value of growth. Harvard Business Review, 83(4): 102–112.

68. Our discussion draws upon: Angel, R. & Rampersad, H. 2005. Do scorecards add up? camagazine.com. May: np.; and Niven, P. 2002. Balanced scorecard step by step: Maximizing performance and maintaining results. New York: John Wiley & Sons.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

4 LO4-1 Why the management of knowledge professionals and knowledge itself

are so critical in today’s organizations.

LO4-2 The importance of recognizing the interdependence of attracting, developing, and retaining human capital.

LO4-3 The key role of social capital in leveraging human capital within and across the firm.

LO4-4 The importance of social networks in knowledge management and in promoting career success.

LO4-5 The vital role of technology in leveraging knowledge and human capital. LO4-6 Why “electronic” or “virtual” teams are critical in combining and

leveraging knowledge in organizations and how they can be made more effective.

LO4-7 The challenge of protecting intellectual property and the importance of a firm’s dynamic capabilities.

Recognizing a Firm’s Intellectual Assets Moving beyond a Firm’s Tangible Resources

©Anatoli Styf/Shutterstock

PART 1: STRATEGIC ANALYSIS

The 2012 bankruptcy of storied law firm Dewey & LeBoeuf LLP illustrates how even well- established firms can fail because of ineffective management of their talent. The failure of the firm is attributable to three major issues: a reliance on borrowed money, making large promises about compensation to incoming (called “lateral”) partners, and a lack of transparency about the firm’s financials.

Partnership in a major law firm, considered the brass ring in a legal career, once came with lifetime security, prestige, and entry into the 1 percent—and at times, the one-tenth of the 1 percent. However, the collapse of Dewey & LeBoeuf laid bare the increasingly Darwinian competition for lucrative clients that has afflicted even the highest ranks of the profession. Here was a firm that traced its roots to the 19th century and bore the name of a former Republican presidential candidate and New York governor, Thomas E. Dewey. The New York–based law firm once had 1,300 lawyers but filed for bankruptcy amid a huge exodus of talent and mounting debt. Few firms borrowed as much money as Dewey & LeBoeuf did—its credit line included a private bond placement of $125 million in 2010. And transparency did not seem to be one of Dewey’s strengths: Some only learned about this transaction when it surfaced in a news report. One former partner said: “I read about it in the papers. And I certainly didn’t sign off on it.”

In 2007, Dewey & LeBoeuf was formed in a widely hailed merger of insurance-and-energy- focused LeBoeuf, Lamb, Greene & McRae LLP, and Dewey Ballantine LLP. However, things soured quickly. The newly merged firm grew aggressively by making promises it ultimately couldn’t honor—guaranteeing new partners huge salaries, sometimes over $5 million a year. Legacy partners were definitely not happy that new hires were being treated better than they were and, of course, demanded pay pacts of their own. By the fall of 2011, roughly a third of the firm’s 300 partners had salary guarantees.

Large law firms sometimes woo big stars by promising to pay them a fixed amount for a year or two—regardless of the firm’s or their own financial performance. But most firms use such guarantees very sparingly. By all accounts, Dewey took this practice to an extreme and made compensation guarantees for multiple years. To make matters worse, it offered guarantees to lawyers who did not prove to be rainmakers. News of the widespread guarantees angered the rank-and-file partners at Dewey, many of whom left the firm. Dewey’s performance continued to suffer and after a round of failed merger attempts, the firm liquidated. This left thousands of staff and junior lawyers unemployed, and it became the largest law firm failure in U.S. history.

Elizabeth Sharrer, the chairwoman of 500-lawyer Holland and Hart LLP, said, “Leaders hopefully have learned a lesson that if you’re making someone a compensation deal you have to hide from our partners, it’s not a good deal.” Law firms can dissolve within weeks if spooked partners bail. Sharrer notes, “You can circle the drain really, really quickly.” Interviews with former partners, consultants, and others in the industry depict Dewey as a firm run by an insular coterie of attorneys and administrators who often withheld critical information from their partners, undermining their own credibility in the process. When the Great Recession of 2008 and 2009 hit and deep problems came to the surface, a sense of shared sacrifice and loyalty was in short supply!

LEARNING FROM MISTAKES

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Managers are always looking for stellar professionals who can take their organizations to the next level. However, attracting talent is a necessary but not sufficient condition for suc- cess. In today’s knowledge economy, it does not matter how big your stock of resources is—whether it be top talent, physical resources, or financial capital. Rather, the question becomes: How good is the organization at attracting top talent and leveraging that talent to produce a stream of products and services valued by the marketplace?

Clearly, Dewey & LeBoeuf failed in retaining top talent. The firm lacked transpar- ency and its partners were very resentful when they discovered that newly hired part- ners were provided with huge guaranteed pay packages. And, as noted, when major problems arose at the firm, there was very little goodwill among the legacy partners. Not surprisingly, many of them bolted and, as is frequently the case, took many of their clients with them.

In this chapter, we also address how human capital can be leveraged in an organization. We point out the important roles of social capital and technology.

THE CENTRAL ROLE OF KNOWLEDGE IN TODAY’S ECONOMY Central to our discussion is an enormous change that has accelerated over the past few decades and its implications for the strategic management of organizations.1 For most of the 20th century, managers focused on tangible resources such as land, equipment, and money as well as intangibles such as brands, image, and customer loyalty. Efforts were directed more toward the efficient allocation of labor and capital—the two traditional fac- tors of production.

How times have changed. In the last quarter century, employment in the manufacturing sector declined at a significant rate. Today only 9 percent of the U.S. workforce is employed in this sector, compared to 21 percent in 1980.2 In contrast, the service sector grew from 73 percent of the workforce in 1980 to 86 percent by 2012.

The knowledge-worker segment, in particular, is growing dramatically. Using a broad def- inition, it is estimated that knowledge workers currently outnumber other types of workers in the United States by at least four to one—they represent between a quarter and a half of all workers in advanced economies. Recent popular press has gone so far as to suggest that, due to the increased speed and competitiveness of modern business, all modern employees are knowledge workers.

In the knowledge economy, wealth is increasingly created by effective management of knowledge workers instead of by the efficient control of physical and financial assets. The growing importance of knowledge, coupled with the move by labor markets to reward knowledge work, tells us that investing in a company is, in essence, buying a set of talents, capabilities, skills, and ideas—intellectual capital—not physical and financial resources.3

LO 4-1 Why the management of knowledge professionals and knowledge itself are so critical in today’s organizations.

knowledge economy an economy where wealth is created through the effective management of knowledge workers instead of by the efficient control of physical and financial assets.

Discussion Questions 1. How could these problems have been avoided at Dewey & LeBoeuf? 2. What practices should firms such as Dewey & LeBoeuf implement to attract and retain top

talent?

Sources: Randazzo, S. 2015. Lessons from the Dewey debacle. The Wall Street Journal. October 20: B2; Stewart, J. B. 2014. The rise and fall of a rainmaker. nytimes.com. December 12: np; Longstreth, A. & Raymond, N. 2012. The Dewey chronicles: The rise and fall of a legal titan, reuters.com. May 11: np; and Frank, A. D. 2012. The end of an era. fortune.com. May 29: np.

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EXHIBIT 4.1 Ratio of Market Value to Book Value for Selected Companies

Company Annual Sales

($ billions) Market Value

($ billions) Book Value ($ billions)

Ratio of Market to Book Value

Microsoft 85.3 486.8 72.0 6.8

Apple 215.6 627.0 128.3 4.9

Alphabet (parent of Google) 75.0 564.9 120.3 4.7

Oracle 37.0 160.8 47.3 3.4

Intel 55.4 174.0 61.1 2.8

Nucor 16.4 19.3 7.4 2.6

General Motors 152.4 57.2 39.9 1.4

Note: The data on market valuations are as of January 13, 2017. All other financial data are based on the most recently available balance sheets and income statements.

Source: finance.yahoo.com.

Human capital is growing more valuable in virtually every business.4 This trend has been going on for decades as ever fewer workers function as low-maintenance machines— for example, turning a wrench in a factory—and more become thinkers and creators. Intangible assets, mostly derived from human capital, have soared from 17 percent of the S&P 500’s market value in 1975 to 84 percent in 2015, according to the advisory firm Ocean Tomo. Even a manufacturer such as Stryker gets 70 percent of its value from intan- gibles; it makes replacement knees, hips, and other joints that are, in essence, loaded with intellectual capital.

To apply some numbers to our arguments, let’s ask, Whats a company worth?5 Start with the “big three” financial statements: income statement, balance sheet, and statement of cash flow. If these statements tell a story that investors find useful, then a company’s market value* should roughly (but not precisely, because the market looks forward and the books look backward) be the same as the value that accountants ascribe to it—the book value of the firm. However, this is not the case. A study compared the market value with the book value of 3,500 U.S. companies over a period of two decades. In 1978 the two were similar: Book value was 95 percent of market value. However, market values and book values have diverged significantly. By January 2017, the S&P industrials were—on average—trading at 2.96 times book value.6 Robert A. Howell, an expert on the changing role of finance and accounting, muses, “The big three financial statements . . . are about as useful as an 80-year- old Los Angeles road map.”

The gap between a firms market value and book value is far greater for knowledge- intensive corporations than for firms with strategies based primarily on tangible assets.7 Exhibit 4.1 shows the ratio of market-to-book value for some well-known companies. In firms where knowledge and the management of knowledge workers are relatively important contributors to developing products and services—and physical resources are less critical— the ratio of market-to-book value tends to be much higher.

As shown in Exhibit 4.1, firms such as Apple, Alphabet (parent of Google), Microsoft, and Oracle have very high market value to book value ratios because of their high investment in knowledge resources and technological expertise. In contrast, firms in more traditional industry sectors such as Nucor and Southwest Airlines have relatively low market-to-book

* The market value of a firm is equal to the value of a share of its common stock times the number of shares outstanding. The book value of a firm is primarily a measure of the value of its tangible assets. It can be calculated by the formula Total assets – Total liabilities.

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ratios. This reflects their greater investment in physical resources and lower investment in knowledge resources. A firm like Intel has a market-to-book value ratio that falls between the above two groups of firms. This is because its high level of investment in knowledge resources is matched by a correspondingly huge investment in plant and equipment. For example, Intel invested $3 billion to build a fabrication facility in Chandler, Arizona.8

Many writers have defined intellectual capital as the difference between a firms market value and book value—that is, a measure of the value of a firm’s intangible assets.9 This broad definition includes assets such as reputation, employee loyalty and commitment, cus- tomer relationships, company values, brand names, and the experience and skills of employ- ees.10 Thus, simplifying, we have:

Intellectual capital = Market value of firm – Book value of firm How do companies create value in the knowledge-intensive economy? The general

answer is to attract and leverage human capital effectively through mechanisms that create products and services of value over time.

First, human capital is the “individual capabilities, knowledge, skills, and experience of the company’s employees and managers.”11 This knowledge is relevant to the task at hand, as well as the capacity to add to this reservoir of knowledge, skills, and experience through learning.12

Second, social capital is “the network of relationships that individuals have throughout the organization.” Relationships are critical in sharing and leveraging knowledge and in acquiring resources.13 Social capital can extend beyond the organizational boundaries to include relationships between the firm and its suppliers, customers, and alliance partners.14

Third is the concept of “knowledge,” which comes in two different forms. First, there is explicit knowledge that is codified, documented, easily reproduced, and widely distributed, such as engineering drawings, software code, and patents.15 The other type of knowledge is tacit knowledge. That is in the minds of employees and is based on their experiences and back- grounds.16 Tacit knowledge is shared only with the consent and participation of the individual.

New knowledge is constantly created through the continual interaction of explicit and tacit knowledge. Consider two software engineers working together on a computer code. The computer code is the explicit knowledge. By sharing ideas based on each individual’s experience—that is, their tacit knowledge—they create new knowledge when they modify the code. Another important issue is the role of “socially complex processes,” which include leadership, culture, and trust.17 These processes play a central role in the creation of knowl- edge.18 They represent the “glue” that holds the organization together and helps to create a working environment where individuals are more willing to share their ideas, work in teams, and, in the end, create products and services of value.19

Numerous books have been written on the subject of knowledge management and the central role that it has played in creating wealth in organizations and countries throughout the developed world.20 Here, we focus on some of the key issues that organizations must address to compete through knowledge.

We will now turn our discussion to the central resource itself—human capital—and some guidelines on how it can be attracted/selected, developed, and retained.21 Tom Stewart, former editor of the Harvard Business Review, noted that organizations must also undergo significant efforts to protect their human capital. A firm may “diversify the ownership of vital knowledge by emphasizing teamwork, guard against obsolescence by developing learning programs, and shackle key people with golden handcuffs.”22 In addition, people are less likely to leave an organization if there are effective structures to promote teamwork and information sharing, strong leadership that encourages innovation, and cultures that demand excellence and ethical behavior. Such issues are central to this chapter. Although we touch on these issues through- out this chapter, we provide more detail in later chapters. We discuss organizational controls (culture, rewards, and boundaries) in Chapter 9, organization structure and design in Chapter 10, and a variety of leadership and entrepreneurship topics in Chapters 11 and 12.

intellectual capital the difference between the market value of the firm and the book value of the firm, including assets such as reputation, employee loyalty and commitment, customer relationships, company values, brand names, and the experience and skills of employees.

human capital the individual capabilities, knowledge, skills, and experience of a company’s employees and managers.

social capital the network of friendships and working relationships between talented people both inside and outside the organization.

explicit knowledge knowledge that is codified, documented, easily reproduced, and widely distributed.

tacit knowledge knowledge that is in the minds of employees and is based on their experiences and backgrounds.

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HUMAN CAPITAL: THE FOUNDATION OF INTELLECTUAL CAPITAL

Take away my people, but leave my factories and soon grass will grow on the factory floors. . . . . Take away my factories, but leave my people and soon we will have a new and better factory.23

—Andrew Carnegie, Steel industry legend

The importance of talent to organization success is hardly new. Organizations must recruit talented people—employees at all levels with the proper sets of skills and capabilities coupled with the right values and attitudes. Such skills and attitudes must be continually developed, strengthened, and reinforced, and each employee must be motivated and his or her efforts focused on the organization’s goals and objectives.24

The rise to prominence of knowledge workers as a vital source of competitive advantage is changing the balance of power in today’s organization.25 Knowledge workers place profes- sional development and personal enrichment (financial and otherwise) above company loyalty. Attracting, recruiting, and hiring the “best and the brightest” is a critical first step in the process of building intellectual capital. As noted by law professor Orly Lobel, talent wants to be free:26

Companies like Microsoft, Google, and Facebook are so hungry for talent that they acquire (or, as the tech-buzz is now calling it, acq-hire) entire start-ups only to discard the product and keep the teams, founders, and engineers.

Hiring is only the first of three processes in which all successful organizations must engage to build and leverage their human capital. Firms must also develop employees to ful- fill their full potential to maximize their joint contributions.27 Finally, the first two processes are for naught if firms can’t provide the working environment and intrinsic and extrinsic rewards to engage their best and brightest.28 Interestingly, a recent Gallup study showed that companies whose workers are the most engaged outperform those with the least engaged by a significant amount: 16 percent higher profitability, 18 percent higher productivity, and 25 to 49 percent lower turnover (depending on the industry).29 The last benefit can really be significant: Software leader SAP calculated that “for each percentage point that our reten- tion rate goes up or down, the impact on our operating profit is approximately $81 million.”

These activities are highly interrelated. We would like to suggest the imagery of a three- legged stool (see Exhibit 4.2).30 If one leg is weak or broken, the stool collapses.

To illustrate such interdependence, poor hiring impedes the effectiveness of develop- ment and retention processes. In a similar vein, ineffective retention efforts place additional

LO 4-2 The importance of recognizing the interdependence of attracting, developing, and retaining human capital.

EXHIBIT 4.2 Human Capital: Three Interdependent Activities

Attracting Human Capital

Developing Human Capital

Retaining Human Capital

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4.1 ENVIRONMENTAL SUSTAINABILITYSTRATEGY SPOTLIGHT CAN GREEN STRATEGIES ATTRACT AND RETAIN TALENT? Competing successfully for top talent and retaining high- performing employees are critical factors in an organization’s success. Employee recruiting and turnover are, of course, very costly. Losing and replacing a top talent can cost companies up to 200 percent of an employee’s annual salary, according to Engaged! Outbehave Your Competition to Create Customers for Life.

Today, some 40 percent of job seekers read a company’s sustainability report, according to a survey commissioned by the Global Reporting Initiative (GRI). Prospective employees can also riffle through Google in seconds and unearth a myriad of sustainability news and accolades, including an Interbrand “Top 50 Global Green Brand” ranking. Further, a 2014 study by the nonprofit group Net Impact found that business school gradu- ates would take a 15 percent pay cut to:

• Have a job that seeks to make a social or environmental difference in the world (83%)

• Have a job in a company committed to corporate and environmental responsibility (71%)

Below, we discuss an example of a green initiative by a well- known company that helps attract and retain talent: • Intel’s “Green Intel” intranet portal, environmental

sustainability network, and environmental excellence awards are beginning to yield benefits for the company. “Intel’s employee engagement has resulted in increased employee loyalty, more company pride, and improved morale,” according to Carrie Freeman, a sustainability strategist at the firm. Intel managers expect the next organizational health survey will show increased levels of employee pride and satisfaction with their work, which are considered to be good predictors of employee retention.

Sources: Anonymous. 2015. Why a commitment to sustainability can attract and retain the best talent. grantthornton.com. April 30: np; Earley, K. 2014. Sustainabilty gives HR teams an edge in attracting and retaining talent. www. theguardian.com, February 20: np; Anonymous. 2010. The business case for environmental and sustainability employee education. National Environmental Education Foundation, November: np; Mattioli, D. 2007. How going green draws talent, cuts costs. Wall Street Journal, November 13: B10; and Lederman, G. 2013. Engaged! Outbehave your competition to create customers for life. Ashland, OR: Evolve.

burdens on hiring and development. Consider the following anecdote, provided by Jeffrey Pfeffer of the Stanford University Graduate School of Business:

Not long ago, I went to a large, fancy San Francisco law firm—where they treat their associates like dog doo and where the turnover is very high. I asked the managing partner about the turnover rate. He said, “A few years ago, it was 25 percent, and now we’re up to 30 percent.” I asked him how the firm had responded to that trend. He said, “We increased our recruiting.” So I asked him, “What kind of doctor would you be if your patient was bleeding faster and faster, and your only response was to increase the speed of the transfusion?”31

Clearly, stepped-up recruiting is a poor substitute for weak retention.32 Although there are no simple, easy-to-apply answers, we can learn from what leading-edge firms are doing to attract, develop, and retain human capital in today’s highly competitive marketplace.33 Before moving on, Strategy Spotlight 4.1 addresses the importance of a firm’s “green” or environmental sustainability strategy in attracting young talent.

Attracting Human Capital

In today’s world, talent is so critical to the success of what you’re doing—their core competencies and how well they fit into your office culture. The combination can be, well, extraordinary. But only if you bring in the right people.34

—Mindy Grossman, CEO of HSN (Home Shopping Network)

The first step in the process of building superior human capital is input control: attracting and selecting the right person.35 Human resource professionals often approach employee selection from a “lock and key” mentality—that is, fit a key (a job candidate) into a lock (the job). Such an approach involves a thorough analysis of the person and the job. Only then can the right decision be made as to how well the two will fit together. How can you fail, the

CHAPTER 4 :: RECOGNIZING A FIRM’S INTELLECTUAL ASSETS 109

theory goes, if you get a precise match of knowledge, ability, and skill profiles? Frequently, however, the precise matching approach places its emphasis on task-specific skills (e.g., motor skills, specific information processing capabilities, and communication skills) and puts less emphasis on the broad general knowledge and experience, social skills, values, beliefs, and attitudes of employees.36

Many have questioned the precise matching approach. They argue that firms can identify top performers by focusing on key employee mind-sets, attitudes, social skills, and general orientations. If they get these elements right, the task-specific skills can be learned quickly. (This does not imply, however, that task-specific skills are unimportant; rather, it suggests that the requisite skill sets must be viewed as a necessary but not sufficient condition.) This leads us to a popular phrase today that serves as the title of the next subsection.

“Hire for Attitude, Train for Skill” Organizations are increasingly emphasizing gen- eral knowledge and experience, social skills, values, beliefs, and attitudes of employees.37 Consider Southwest Airlines’ hiring practices, which focus on employee values and atti- tudes. Given its strong team orientation, Southwest uses an “indirect” approach. For exam- ple, the interviewing team asks a group of employees to prepare a five-minute presentation about themselves. During the presentations, interviewers observe which candidates enthu- siastically support their peers and which candidates focus on polishing their own presenta- tions while the others are presenting.38 The former are, of course, favored.

Alan Cooper, president of Cooper Software, Inc., in Palo Alto, California, goes further. He cleverly uses technology to hone in on the problem-solving ability of his applicants and their attitudes before an interview even takes place. He has devised a “Bozo Filter,” an online test that can be applied to any industry. Before you spend time on whether job can- didates will work out satisfactorily, find out how their minds work. Cooper advised, “Hiring was a black hole. I don’t talk to bozos anymore, because 90 percent of them turn away when they see our test. It’s a self-administering bozo filter.”39 How does it work?

The online test asks questions designed to see how prospective employees approach problem-solving tasks. For example, one key question asks software engineer applicants to design a table-creation software program for Microsoft Word. Candidates provide pencil sketches and a description of the new user interface. Another question used for design communicators asks them to develop a marketing strategy for a new touch-tone phone—directed at consumers in the year 1850. Candidates e-mail their answers back to the company, and the answers are circulated around the firm to solicit feedback. Only candidates with the highest marks get interviews.

Sound Recruiting Approaches and Networking Companies that take hiring seriously must also take recruiting seriously. The number of jobs that successful knowledge-intensive companies must fill is astonishing. Ironically, many companies still have no shortage of applicants. For example, Google, which ranked first on Fortune’s 2012 and 2013 “100 Best Companies to Work For,” is planning to hire thousands of employees—even though its hir- ing rate has slowed.40 The challenge becomes having the right job candidates, not the great- est number of them.

GE Medical Systems, which builds CT scanners and magnetic resonance imaging (MRI) systems, relies extensively on networking. GE has found that current employees are the best source for new ones. Stephen Patscot, VP, human resources, made a few simple changes to double the number of referrals. First, he simplified the process—no complex forms, no bureaucracy, and so on. Second, he increased incentives. Everyone referring a qualified candidate receives a gift certificate from Sears. For referrals who are hired, the “bounty” increases to $2,000. Although this may sound like a lot of money, it is “peanuts” compared to the $15,000 to $20,000 fees that GE typically pays to headhunters for each person hired.41 Also, when someone refers a former colleague or friend for a job, his or her credibility is on

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the line. Thus, employees will be careful in recommending people for employment unless they are reasonably confident that these people are good candidates.

Attracting Millennials The Millennial generation has also been termed “Generation Y” or “Echo Boom” and includes people who were born after 1982. Many call them impatient, demanding, or entitled. However, if employers don’t provide incentives to attract and retain young workers, somebody else will. Thus, they will be at a competitive disadvantage.42

Why? Demographics are on the Millennials’ side—within a few years they will outnumber any other generation. The U.S. Bureau of Labor Statistics projects that by 2020 Millennials will make up 40 percent of the workforce. Baby boomers are retiring, and Millennials will be working for the next several decades. Additionally, they have many of the requisite skills to succeed in the future workplace—tech-savviness and the ability to innovate—and they are more racially diverse than any prior generation. Thus, they are better able to relate rapidly to different customs and cultures.

A study from the Center for Work-Life Policy sums this issue up rather well: Instead of the traditional plums of prestigious title, powerful position, and concomitant compensation, Millennials value challenging and diverse job opportunities, stimulating colleagues, a well- designed communal workspace, and flexible work options. In fact, 89 percent of Millennials say that flexible work options are an important consideration in choosing an employer.

Organizations often miss out on a potential source of talent—former employees! Not everyone who leaves an organization does so because they are unhappy or dissatisfied. Instead, many leave for what they think they believe is a new opportunity. The accompany- ing “Insights from Research” text box addresses the benefits of hiring former employees (called “boomerangs”) who are willing to come back.

Developing Human Capital It is not enough to hire top-level talent and expect that the skills and capabilities of those employees remain current throughout the duration of their employment. Rather, training and development must take place at all levels of the organization.43 For example, Solectron assembles printed circuit boards and other components for its Silicon Valley clients.44 Its employees receive an average of 95 hours of company-provided training each year. Chairman Winston Chen observed, “Technology changes so fast that we estimate 20 percent of an engi- neer’s knowledge becomes obsolete each year. Training is an obligation we owe to our employ- ees. If you want high growth and high quality, then training is a big part of the equation.”

Leaders who are committed to developing the people who work for them in order to bring out their strengths and enhance their careers will have committed followers. According to James Rogers, CEO of Duke Energy: “One of the biggest things I find in organizations is that people tend to limit their perceptions of themselves and their capabilities, and one of my challenges is to open them up to the possibilities. I have this belief that anybody can do almost anything in the right context.”45

In addition to training and developing human capital, firms must encourage widespread involvement, monitor and track employee development, and evaluate human capital.46

Encouraging Widespread Involvement Developing human capital requires the active involvement of leaders at all levels. It won’t be successful if it is viewed only as the respon- sibility of the human resource department. Each year at General Electric, 200 facilitators, 30 officers, 30 human resource executives, and many young managers actively participate in GE’s orientation program at Crotonville, its training center outside New York City. Topics include global competition, winning on the global playing field, and personal exam- ination of the new employee’s core values vis-à-vis GE’s values. As a senior manager once commented, “There is nothing like teaching Sunday school to force you to confront your own values.”

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Overview The common assumption is that turnover creates vacancy problems and expenses to be avoided at all costs. However, sometimes turnover just can’t be prevented. Employees who leave an organization aren’t always unhappy—some might be willing to come back if given the opportunity. Consider “boomerang” employees as a key recruiting pool to save time and money.

What the Research Shows Researchers at Texas Christian University, the University of Cincinnati, the University of Illinois, and the University of North Carolina recently published a study in Personnel Psychology that examines why employees leave an organiza- tion and why they may be willing to return. Using a sample of 452 employees who left and returned for employment, called “boomerangs,” and 1,187 who left but had no desire to return, known as “alumni,” the authors examined these employees’ motives.

Traditional thinking about employment views employee turnover as an end state, where those who leave never want to return. However, this study suggests that this needn’t be the case. There may be value in keeping in touch with employees who leave. These findings indicate that employ- ees’ willingness to return in the future is influenced by the reasons they left in the first place: Boomerangs were statis- tically more likely to leave initially for two main reasons. First, they experienced a negative life event, such as taking care of a sick parent that necessitated a change in employ- ment. Second, they received an alternate job offer deemed too good to turn down. The research did find, however, that boomerangs are more likely to accept those alternate jobs in the same industry. Alumni, on the other hand, were sta- tistically more likely to leave because they were dissatisfied with their jobs or because they wanted to change industries.

Not all employee turnover is bad. In fact, if business leaders understand the motivations for departures, turnover may create opportunities to bring valued employees back.

Why This Matters Employee turnover is expensive. Business leaders appropri- ate considerable resources trying to minimize employee turn- over. Despite best efforts, valued employees still leave the organization. It’s an inevitable part of working life. So, what can be done about it? This study indicates that understand- ing the reasons why employees leave might be beneficial in luring them back.

Boomerang employees are appealing because the train- ing and socialization required for them is quite less than

that of other newly hired employees. The implications of this research are that not all employee turnover is bad. In fact, if business leaders understand the motives for departure, turnover may create opportunities to bring valued employ- ees back. This research underscores the essential need for an exit-interview process with all departing employees. Whether conducted in person, online, or on the phone, the interview should assess why an employee is leaving and whether he or she would be willing to return in the future. Ideally, data from the exit interview would connect to a human resource management system with performance information, to allow for easy identification of those high performers leaving for reasons other than dissatisfaction who could be recruited as boomerang employees in the future. Maintaining an active alumni program and asking current managers to identify past employees who would be on their top 10 “hire-back” list are other ways to cultivate a worthy talent pool.

Understanding why employees leave could save your organization money in the long run by broadening the pool of potential hires for future job openings. However, this is not to suggest that you should give up trying to retain val- ued employees from the start. Maintaining and fostering employee satisfaction remains crucial for reducing turnover caused by dissatisfaction. As a manager, take the initiative to monitor and address employee satisfaction levels so you can prevent your top talent from leaving in the first place.

Key Takeaways Understanding why employees leave is essential information for company recruiting strategies. Employees are more likely to return and be productive assets if they leave for reasons other than dissatisfaction. Because unhappy employees are more likely to leave and never return, you should monitor and address employee satisfaction levels on an ongoing basis.

Rehiring former employees can save money and time. Make sure your company has exit interviews and alumni programs that track potential boomerang employees.

Apply This Today Employees are going to leave your organization—that’s a fact. Understanding why they leave, though, should be a top prior- ity. By determining the reasons for departure, managers may find that valuable employees are willing to return in the future.

Research Reviewed Shipp, A. J., Furst-Holloway, S., Harris, T. B., & Rosen, B. 2014. Gone today but here tomorrow: Extending the unfold- ing model of turnover to consider boomerang employees. Personnel Psychology, 67(2): 421–462.

INSIGHTS from Research4.1

WELCOME BACK! RECRUITING BOOMERANG EMPLOYEES

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Similarly, A. G. Lafley, Procter & Gamble’s former CEO, claimed that he spent 40 per- cent of his time on personnel.47 Andy Grove, who was previously Intel’s CEO, required all senior people, including himself, to spend at least a week a year teaching high flyers. And Nitin Paranjpe, CEO of Hindustan Unilever, recruits people from campuses and regularly visits high-potential employees in their offices.

Mentoring Mentoring is most often a formal or informal relationship between two people—a senior mentor and a junior protégé.48 Mentoring can potentially be a valuable influence in professional development in both the public and private sectors. The war for tal- ent is creating challenges within organizations to recruit new talent as well as retain talent.

Mentoring can provide many benefits—to the organization as well as the individual.49 For the organization, it can help to recruit qualified managers, decrease turnover, fill senior- level positions with qualified professionals, enhance diversity initiatives with senior-level management, and facilitate organizational change efforts. Individuals can also benefit from effective mentoring programs. These benefits include helping newer employees transition into the organization, helping developmental relationships for people who lack access to informal mentoring relationships, and providing support and challenge to people on an organization’s “fast track” to positions of higher responsibility.

Mentoring is traditionally viewed as a program to transfer knowledge and experience from more senior managers to up-and-comers. However, many organizations have rein- vented it to fit today’s highly competitive, knowledge-intensive industries. For example, con- sider Intel:

Intel matches people not by job title and years of experience but by specific skills that are in demand. Lory Lanese, Intel’s mentor champion at its huge New Mexico plant (with 5,500 employees), states, “This is definitely not a special program for special people.” Instead, Intel’s program uses an intranet and email to perform the matchmaking, creating relationships that stretch across state lines and national boundaries. Such an approach enables Intel to spread best practices quickly throughout the far-flung organization. Finally, Intel relies on written contracts and tight deadlines to make sure that its mentoring program gets results—and fast.50

Intel has also initiated a mentoring program involving its technical assistants (TAs) who work with senior executives. This concept is sometimes referred to as “reverse mentoring” because senior executives benefit from the insights of professionals who have more updated technical skills—but rank lower in the organizational hierarchy. And, not surprisingly, the TAs stand to benefit quite a bit as well. Here are some insights offered by Andy Grove (for- merly Intel’s CEO):51

In the 1980s I had a marketing manager named Dennis Carter. I probably learned more from him than anyone in my career. He is a genius. He taught me what brands are. I had no idea—I thought a brand was the name on the box. He showed me the connection of brands to strategies. Dennis went on to be Chief Marketing Officer. He was the person responsible for the Pentium name, “Intel Inside”; he came up with all my good ideas.

Monitoring Progress and Tracking Development Whether a firm uses on-site formal train- ing, off-site training (e.g., universities), or on-the-job training, tracking individual progress— and sharing this knowledge with both the employee and key managers—becomes essential. Like many leading-edge firms, GlaxoSmithKline (GSK) places strong emphasis on broader experiences over longer time periods. Dan Phelan, senior vice president and director of human resources, explained, “We ideally follow a two-plus-two-plus-two formula in develop- ing people for top management positions.” This reflects the belief that GSK’s best people should gain experience in two business units, two functional units (such as finance and marketing), and two countries.

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Other companies may take a less formal approach.52 Alcoa CEO Klaus Kleinfeld says that he brings “the whole executive team into a room for two days to discuss succession planning and the talent that should be developed. We call it Talent Marketplace. In reality it is a fight for great talent.” Executives discuss the best employees and candidates for impor- tant positions and decide who goes where. “It is not rare that you say, ‘Well, that person is ready to develop,’ and people are scribbling it down,” claims Kleinfeld. “You can bet that when you’re not looking, they’re already sending notes to the person: ‘Hey, we need to talk.’”

Evaluating Human Capital In today’s competitive environment, collaboration and inter- dependence are vital to organizational success. Individuals must share their knowledge and work constructively to achieve collective, not just individual, goals. However, traditional systems evaluate performance from a single perspective (i.e., “top down”) and generally don’t address the “softer” dimensions of communications and social skills, values, beliefs, and attitudes.53

To address the limitations of the traditional approach, many organizations use 360-degree evaluation and feedback systems.54 Here, superiors, direct reports, colleagues, and even internal and external customers rate a person’s performance.55 Managers rate themselves to have a personal benchmark. The 360-degree feedback system complements teamwork, employee involvement, and organizational flattening. As organizations continue to push responsibility downward, traditional top-down appraisal systems become insufficient.56 For example, a manager who previously managed the performance of three supervisors might now be responsible for 10 and is less likely to have the in-depth knowledge needed to appraise and develop them adequately. Exhibit 4.3 provides a portion of GE’s 360-degree leadership assessment chart.

360-degree evaluation and feedback systems superiors, direct reports, colleagues, and even external and internal customers rate a person’s performance.

Vision • Has developed and communicated a clear, simple, customer-focused vision/direction for the organization.

• Forward-thinking, stretches horizons, challenges imaginations. • Inspires and energizes others to commit to Vision. Captures minds. Leads by example. • As appropriate, updates Vision to reflect constant and accelerating change affecting the

business.

Customer/Quality Focus

Integrity

Accountability/Commitment

Communication/Influence

Shared Ownership/Boundaryless

Team Builder/Empowerment

Knowledge/Expertise/Intellect

Initiative/Speed

Global Mind-Set

Note: This evaluation system consists of 10 “characteristics”—Vision, Customer/Quality Focus, Integrity, and so on. Each of these characteristics has four “performance criteria.” For illustrative purposes, the four performance criteria of “Vision” are included.

Source: Adapted from Slater, R. 1994. Get Better or Get Beaten: 152–155. Burr Ridge, IL: Irwin Professional Publishing.

EXHIBIT 4.3 An Excerpt from General Electric’s 360-Degree Leadership Assessment Chart

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At times, a firm’s performance assessment methods may get in the way of team success.57 Microsoft is an example. For many years, the software giant employed a “stack ranking” sys- tem as part of its performance evaluation model. With this system, a certain percentage of any team’s members would be rated “top performers,” “good,” “average,” “below average,” and “poor,” regardless of the team’s overall performance. Perhaps, in some situations, this type of forced ranking works. However, in Microsoft’s case, it had (not too surprisingly!) unintended consequences. Over time, according to inside reports, the stack ranking created a culture in which employees competed with one another rather than against the firm’s rivals. And “A” players rarely liked to join groups with other “A” players, because they feared they might be seen as weaker members of the team.

Retaining Human Capital It has been said that talented employees are like “frogs in a wheelbarrow.”58 They can jump out at any time! By analogy, the organization can either try to force employees to stay in the firm or try to keep them from jumping out by creating incentives.59 In other words, either today’s leaders can provide the challenges, work environment, and incentives to keep pro- ductive employees and management from wanting to bail out, or they can use legal means such as employment contracts and noncompete clauses.60 Firms must prevent the transfer of valuable and sensitive information outside the organization. Failure to do so would be the neglect of a leader’s fiduciary responsibility to shareholders. However, greater efforts should be directed at the former (e.g., challenges, good work environment, and incentives), but, as we all know, the latter (e.g., employment contracts and noncompete clauses) have their place.61

Gary Burnison, CEO of Korn/Ferry International, the world’s largest executive search firm, provides an insight on the importance of employee retention:62

How do you extend the life of an employee? This is not an environment where you work for an organization for 20 years. But if you can extend it from three years to six years, that has an enormous impact. Turnover is a huge hidden cost in a profit-and-loss statement that nobody ever focuses on. If there was a line item that showed that, I guarantee you’d have the attention of a CEO.

Identifying with an Organization’s Mission and Values People who identify with and are more committed to the core mission and values of the organization are less likely to stray or bolt to the competition. For example, take the perspective of the late Steve Jobs, Apple’s widely admired former CEO:63

When I hire somebody really senior, competence is the ante. They have to be really smart. But the real issue for me is: Are they going to fall in love with Apple? Because if they fall in love with Apple, everything else will take care of itself. They’ll want to do what’s best for Apple, not what’s best for them, what’s best for Steve, or anyone else.

“Tribal loyalty” is another key factor that links people to the organization.64 A tribe is not the organization as a whole (unless it is very small). Rather, it is teams, communities of practice, and other groups within an organization or occupation.

Brian Hall, CEO of Values Technology in Santa Cruz, California, documented a shift in people’s emotional expectations from work. From the 1950s on, a “task-first” relationship— “Tell me what the job is, and let’s get on with it”—dominated employee attitudes. Emotions and personal life were checked at the door. In the past few years, a “relationship-first” set of values has challenged the task orientation. Hall believes that it will become dominant. Employees want to share attitudes and beliefs as well as workspace.

Challenging Work and a Stimulating Environment Arthur Schawlow, winner of the 1981 Nobel Prize in physics, was asked what made the difference between highly creative and less

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creative scientists. His reply: “The labor of love aspect is very important. The most success- ful scientists often are not the most talented.65 But they are the ones impelled by curiosity. They’ve got to know what the answer is.”66 Such insights highlight the importance of intrin- sic motivation: the motivation to work on something because it is exciting, satisfying, or personally challenging.67 As noted by Jeff Immelt, former chairman and CEO of General Electric, “You want people with the self-confidence to leave, but you want them to stay. That puts pressure on you to keep work interesting.”68

Lars Sorensen, CEO of Novo Nordisk, the huge Danish pharmaceutical firm, provides a poignant perspective on how to keep employees engaged: “. . . we bring patients to see employees. We illuminate the big difference we are making. Without our medication, 24 million people would suffer. There is nothing more motivating for people than to go to work and save people’s lives.”69

Firms can also keep highly mobile employees motivated and challenged through oppor- tunities that lower barriers to an employee’s mobility within a company. For example, Shell Oil Company has created an “open sourcing” model for talent. Jobs are listed on its intranet, and, with a two-month notice, employees can go to work on anything that interests them.

Financial and Nonfinancial Rewards and Incentives Financial rewards are a vital organiza- tional control mechanism (as we will discuss in Chapter 9). Money—whether in the form of salary, bonus, stock options, and so forth—can mean many different things to people. It might mean security, recognition, or a sense of freedom and independence.

Paying people more is seldom the most important factor in attracting and retaining human capital.70 Most surveys show that money is not the most important reason why peo- ple take or leave jobs and that money, in some surveys, is not even in the top 10. Consistent with these findings, Tandem Computers (part of Hewlett-Packard) typically doesn’t tell peo- ple being recruited what their salaries would be. People who asked were told that Tandem’s salaries were competitive. If they persisted along this line of questioning, they would not be offered a position. Why? Tandem realized a rather simple idea: People who come for money will leave for money.

Another nonfinancial reward is accommodating working families with children. Balancing demands of family and work is a problem at some point for virtually all employees.

Below we discuss how Google attracts and retains talent through financial and nonfi- nancial incentives. Its unique “Google culture,” a huge attraction to potential employees, transforms a traditional workspace into a fun, feel-at-home, and flexible place to work.71

Googlers do not merely work but have a great time doing it. The Mountain View, California, headquarters includes on-site medical and dental facilities, oil change and bike repair, foosball, pool tables, volleyball courts, and free breakfast, lunch, and dinner on a daily basis at 11 gourmet restaurants. Googlers have access to training programs and receive tuition reimbursement while they take a leave of absence to pursue higher education. Google states on its website, “Though Google has grown a lot since it opened in 1998, we still maintain a small company feel.”

Our discussion of employee retention would not be complete unless we discussed some of the innovations in data analytics that have provided significant benefits to many compa- nies. We address this issue in Strategy Spotlight 4.2.

Enhancing Human Capital: Redefining Jobs and Managing Diversity Before moving on to our discussion of social capital, it is important to point out that com- panies are increasingly realizing that the payoff from enhancing their human capital can be substantial. Firms have found that redefining jobs and leveraging the benefits of a diverse workforce can go a long way in improving their performance.

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4.2 STRATEGY SPOTLIGHT WANT TO INCREASE EMPLOYEE RETENTION? TRY DATA ANALYTICS We have all heard about management by the book. Perhaps, we should consider management by the algorithm. “People analytics” is rapidly emerging as an important tool in the perpet- ual war to attract and retain talent. Companies have begun hiring data scientists as well as building or buying software that helps predict who will leave and who will make the best vice president.

According to Josh Bersin, principal at Bersin by Deloitte, the HR group at the consulting giant, “It’s like Moneyball for HR, letting you make better decisions and this year it has really peaked.” He states that the percentage of firms using predictive HR analytics has doubled from 4 percent to 8 percent and last year investors poured $2 billion in companies making apps for hiring, performance management, and wellness programs.

Several companies such as Intel Corp., Twitter, and IBM are now using sentiment-analysis software to assess how employ- ees feel about everything from diversity efforts to their prospects for promotion. Such tools enable managers to analyze text such as internal comments on blog posts or responses to open-ended questions on surveys. The goal is to automatically sort through

hundreds or thousands of comments to get a feel of where man- agement can make changes that will improve the chances that employees will remain enthusiastic about the company—and ultimately stay there.

McKinsey & Company claims that one company reduced its retention bonuses by $20 million—and employee attrition by half!—because of its use of predictive behavioral analytics. Contrary to expectations, the company discovered that limited investment in management and employee training, and inad- equate recognition, were the main drivers of staff defections. In contrast, expensive retention bonuses, which the company had turned to in desperation, turned out to be an ineffective Band-Aid.

A key advantage of the new analytics techniques over tradi- tional approaches (such as exit interviews with departing employ- ees) is that they are predictive, rather than reactive. And they definitely provide more objective information than the more qual- itative findings that one would get with a one-on-one discussion.

Sources: Alsever, J. 2016. Is software better at managing people than you are? Fortune. March 15: 41-42; King, R. 2015. Companies want to know: How do workers feel? The Wall Street Journal. October 14: R3; and, Fecheyr-Lippens, B., Schaninger, B., & Tanner, K. 2015. Power to the new people analytics. mckinsey.com. March: np.

Enhancing Human Capital: Redefining Jobs Recent research by McKinsey Global Institute suggests that by 2020, the worldwide shortage of highly skilled, college-educated workers could reach 38 to 40 million, or about 13 percent of demand.72 In response, some firms are taking steps to expand their talent pool, for example, by investing in apprenticeships and other training programs. However, some are going further: They are redefining the jobs of their experts and transferring some of their tasks to lower-skilled people inside or outside their companies, as well as outsourcing work that requires less scarce skills and is not as strategically important. Redefining high-value knowledge jobs not only can help organiza- tions address skill shortages but also can lower costs and enhance job satisfaction.

Consider the following examples:

• Orrick, Herrington & Sutcliffe, a San Francisco–based law firm with nine U.S. offices, shifted routine discovery work previously performed by partners and partner-tracked associates to a new service center in West Virginia staffed by lower-paid attorneys.

• In the United Kingdom, a growing number of public schools are relieving head teachers (or principals) of administrative tasks such as budgeting, facilities maintenance, human resources, and community relations so that they can devote more time to developing teachers.

• The Narayana Hrudayalaya Heart Hospital in Bangalore has junior surgeons, nurses, and technicians handle routine tasks such as preparing the patient for surgery and closing the chest after surgery. Senior cardiac surgeons arrive at the operating room only when the patient’s chest is open and the heart is ready to be operated on. Such an approach helps the hospital lower the cost to a fraction of the cost of U.S. providers while maintaining U.S.-level mortality and infection rates.

Breaking high-end knowledge work into highly specialized pieces involves several processes. These include identifying the gap between the talent your firm has and what it requires; creating

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narrower, more-focused job descriptions in areas where talent is scarce; selecting from various options to fill the skills gap; and rewiring processes for talent and knowledge management.

Enhancing Human Capital: Managing Diversity A combination of demographic trends and accelerating globalization of business have made the management of cultural differ- ences a critical issue.73 Workforces, which reflect demographic changes in the overall popu- lation, will be increasingly heterogeneous along dimensions such as gender, race, ethnicity, and nationality.74 Demographic trends in the United States indicate a growth in Hispanic Americans from 6.9 million in 1960 to over 35 million in 2000, with an expected increase to over 59 million by 2020 and 102 million by 2050. Similarly, the Asian American population should grow to 20 million in 2020 from 12 million in 2000 and only 1.5 million in 1970. And the African American population is expected to increase from 12.8 percent of the U.S. population in 2000 to 14.2 percent by 2025.75

Such demographic changes have implications not only for the labor pool but also for cus- tomer bases, which are also becoming more diverse.76 This creates important organizational challenges and opportunities.

The effective management of diversity can enhance the social responsibility goals of an organization.77 However, there are many other benefits as well. Six other areas where sound management of diverse workforces can improve an organization’s effectiveness and competitive advantages are (1) cost, (2) resource acquisition, (3) marketing, (4) creativity, (5) problem solving, and (6) organizational flexibility.

• Cost argument. As organizations become more diverse, firms effective in managing diversity will have a cost advantage over those that are not.

• Resource acquisition argument. Firms with excellent reputations as prospective employers for women and ethnic minorities will have an advantage in the competition for top talent. As labor pools shrink and change in composition, such advantages will become even more important.

• Marketing argument. For multinational firms, the insight and cultural sensitivity that members with roots in other countries bring to marketing efforts will be very useful. A similar rationale applies to subpopulations within domestic operations.

• Creativity argument. Less emphasis on conformity to norms of the past and a diversity of perspectives will improve the level of creativity.

• Problem-solving argument. Heterogeneity in decision-making and problem-solving groups typically produces better decisions because of a wider range of perspectives as well as more thorough analysis. Jim Schiro, former CEO of PricewaterhouseCoopers, explains, “When you make a genuine commitment to diversity, you bring a greater diversity of ideas, approaches, and experiences and abilities that can be applied to client problems. After all, six people with different perspectives have a better shot at solving complex problems than sixty people who all think alike.”78

• Organizational flexibility argument. With effective programs to enhance workplace diversity, systems become less determinant, less standardized, and therefore more fluid. Such fluidity should lead to greater flexibility to react to environmental changes. Reactions should be faster and less costly.

Most managers accept that employers benefit from a diverse workforce. However, this notion can often be very difficult to prove or quantify, particularly when it comes to deter- mining how diversity affects a firm’s ability to innovate.79

New research provides compelling evidence that diversity enhances innovation and drives market growth. This finding should intensify efforts to ensure that organizations both embody and embrace the power of differences.

Strategy Spotlight 4.3 contrasts the views that Millennials have of diversity with those of other generations, and the implications of such differences for organizations.

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4.3 STRATEGY SPOTLIGHT MILLENNIALS HAVE A DIFFERENT DEFINITION OF DIVERSITY AND INCLUSION THAN PRIOR GENERATIONS A recent study by Deloitte and the Billie Jean King Leadership Initiative (BJKLI) shows that, in general, Millennials see the con- cepts of diversity and inclusion through a vastly different lens. The study analyzed the responses of 3,726 individuals who came from a wide variety of backgrounds with representation across gender, race/ethnicity, sexual orientation, national sta- tus, veteran status, disabilities, level within an organization, and tenure with an organization. The respondents were asked 62 questions about diversity and inclusion and the findings demon- strated a snapshot of shifting generational mindsets.

Millennials (born between 1977 to 1995) look upon diver- sity as the blending of different backgrounds, experiences, and perspectives within a team—which is known as cognitive diver- sity. They use this word to describe the mix of unique traits that help to overcome challenges and attain business objectives. For Millennials, inclusion is the support for a collaborative environ- ment, and leadership at such an organization must be transpar- ent, communicative, and engaging. According to the study, when defining diversity, Millennials are 35 percent more likely to focus on unique experiences, whereas 21 percent of non-Millennials are more likely to focus on representation.

The X-generation (born between 1965 and 1976) and Boomer generation (born between 1946 and 1964) have a different take.

These generations view diversity as a representation of fairness and protection for all—regardless of gender, race, religion, ethnic- ity, or sexual orientation. Here, inclusion is the integration of indi- viduals of all demographics into one workplace. It is the right thing to do, that is, a moral and legal imperative to achieve compliance and equality—regardless of whether it benefits the business. The study found that when asked about the business impact on diver- sity, Millennials are 71 percent more likely to focus on teamwork. In contrast, 28 percent of non-Millennials are more likely to focus on fairness of opportunity.

The study’s authors contend that the disconnect between the traditional definitions of diversity and inclusion and those of Millennials can create problems for businesses. For example, clashes may occur when managers do not permit Millennials to express themselves freely. The study found that while 86 percent of Millennials feel that differences of opinion allow teams to excel, only 59 percent believe that their leaders share this perspective.

The study suggests that a company with an inclusive culture promotes innovation. And it cites research by IBM and Morgan Stanley that shows that companies with high levels of innovation achieve the quickest growth in profits and that radical innova- tion outstrips incremental change by generating 10 times more shareholder value.

Sources: Dishman, L. 2015. Millennials have a different definition of diversity and inclusion. fastcompany.com, May 18: np; and Anonymous. 2015. For millennials inclusion goes beyond checking traditional boxes, according to a new Deloitte-- Billie Jean King Leadership Initiative Study. prnewswire.com, May 13: np.

THE VITAL ROLE OF SOCIAL CAPITAL Successful firms are well aware that the attraction, development, and retention of talent is a necessary but not sufficient condition for creating competitive advantages.80 In the knowledge economy, it is not the stock of human capital that is important, but the extent to which it is combined and leveraged.81 In a sense, developing and retaining human capital becomes less important as key players (talented professionals, in particular) take the role of “free agents” and bring with them the requisite skill in many cases. Rather, the development of social capital (that is, the friendships and working relationships among talented individuals) gains importance, because it helps tie knowledge workers to a given firm.82 Knowledge workers often exhibit greater loyalties to their colleagues and their profession than their employing organization, which may be “an amorphous, distant, and sometimes threatening entity.”83 Thus, a firm must find ways to create “ties” among its knowledge workers.

Let’s look at a hypothetical example. Two pharmaceutical firms are fortunate enough to hire Nobel Prize–winning scientists.84 In one case, the scientist is offered a very attrac- tive salary, outstanding facilities and equipment, and told to “go to it!” In the second case, the scientist is offered approximately the same salary, facilities, and equipment plus one additional ingredient: working in a laboratory with 10 highly skilled and enthusiastic scien- tists. Part of the job is to collaborate with these peers and jointly develop promising drug compounds. There is little doubt as to which scenario will lead to a higher probability of retaining the scientist. The interaction, sharing, and collaboration will create a situation in

LO 4-3 The key role of social capital in leveraging human capital within and across the firm.

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which the scientist will develop firm-specific ties and be less likely to “bolt” for a higher salary offer. Such ties are critical because knowledge-based resources tend to be more tacit in nature, as we mentioned early in this chapter. Therefore, they are much more difficult to protect against loss (i.e., the individual quitting the organization) than other types of capi- tal, such as equipment, machinery, and land.

Another way to view this situation is in terms of the resource-based view of the firm that we discussed in Chapter 3. That is, competitive advantages tend to be harder for competi- tors to copy if they are based on “unique bundles” of resources.85 So, if employees are work- ing effectively in teams and sharing their knowledge and learning from each other, not only will they be more likely to add value to the firm, but they also will be less likely to leave the organization, because of the loyalties and social ties that they develop over time.

How Social Capital Helps Attract and Retain Talent The importance of social ties among talented professionals creates a significant challenge (and opportunity) for organizations. In The Wall Street Journal, Bernard Wysocki described the increase in a type of “Pied Piper effect,” in which teams or networks of people are leav- ing one company for another.86 The trend is to recruit job candidates at the crux of social relationships in organizations, particularly if they are seen as having the potential to bring with them valuable colleagues.87 This is a process that is referred to as “hiring via personal networks.” Let’s look at one instance of this practice.

Gerald Eickhoff, founder of an electronic commerce company called Third Millennium Communications, tried for 15 years to hire Michael Reene. Why? Mr. Eickhoff says that he has “these Pied Piper skills.” Mr. Reene was a star at Andersen Consulting in the 1980s and at IBM in the 1990s. He built his businesses and kept turning down overtures from Mr. Eickhoff.

However, later he joined Third Millennium as chief executive officer, with a salary of just $120,000 but with a 20 percent stake in the firm. Since then, he has brought in a raft of former IBM colleagues and Andersen subordinates. One protégé from his time at Andersen, Mary Goode, was brought on board as executive vice president. She promptly tapped her own network and brought along former colleagues.

Wysocki considers the Pied Piper effect one of the underappreciated factors in the war for talent today. This is because one of the myths of the New Economy is rampant individualism, wherein individuals find jobs on the Internet career sites and go to work for complete strangers. Perhaps, instead of Me Inc., the truth is closer to We Inc.88

Another example of social relationships causing human capital mobility is the emigra- tion of talent from an organization to form start-up ventures. Microsoft is perhaps the best- known example of this phenomenon.89 Professionals frequently leave Microsoft en masse to form venture capital and technology start-ups, called “Baby Bills,” built around teams of software developers. For example, Ignition Corporation, of Bellevue, Washington, was formed by Brad Silverberg, a former Microsoft senior vice president. Eight former Microsoft executives, among others, founded the company.

Social Networks: Implications for Knowledge Management and Career Success Managers face many challenges driven by such factors as rapid changes in globalization and technology. Leading a successful company is more than a one-person job. As Tom Malone put it in The Future of Work, “As managers, we need to shift our thinking from command and control to coordinate and cultivate—the best way to gain power is sometimes to give it away.”90 The move away from top-down bureaucratic control to more open, decentralized network models makes it more difficult for managers to understand how work is actually getting done, who is interacting with whom both within and outside the organization, and the consequences of these interactions for the long-term health of the organization.91

LO 4-4 The importance of social networks in knowledge management and in promoting career success.

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Malcolm Gladwell, in his best-selling book The Tipping Point, used the term connector to describe people who have used many ties to different social worlds.92 It’s not the number of people that connectors know that makes them significant. Rather, it is their ability to link people, ideas, and resources that wouldn’t normally bump into one another. In business, connectors are critical facilitators for collaboration and integration. David Kenny, president of Akamai Technologies, believes that being a connector is one of the most important ways in which he adds value:

Kenny spends much of his time traveling around the world to meet with employees, partners, and customers. He states, “I spend time with media owners to hear what they think about digital platforms, Facebook, and new pricing models, and with Microsoft leaders to get their views on cloud computing. I’m interested in hearing how our clients feel about macroeconomic issues, the G20, and how debt will affect future generations.” These conversations lead to new strategic insights and relationships and help Akamai develop critical external partnerships.

Social networks can also help one bring about important change in an organization—or simply get things done! Consider a change initiative undertaken at the United Kingdom’s National Health Care Service—a huge, government-run institution that employs about a mil- lion people in hundreds of units and divisions with deeply rooted, bureaucratic, hierarchical systems. This is certainly an organization in which you can’t rely solely on your “position power”:93

John wanted to set up a nurse-led preoperative assessment service intended to free up time for the doctors who previously led the assessments, reduce cancelled operations (and costs), and improve patient care. Sounds easy enough . . . after all, John was a senior doctor and near the top of the hospital’s formal hierarchy. However, he had only recently joined the organization and was not well connected internally.

As he began talking to other doctors and to nurses about the change, he was met with a lot of resistance. He was about to give up when Carol, a well-respected nurse, offered to help. She had even less seniority than John, but many colleagues relied on her advice about navigating hospital politics. She knew many of the people whose support John needed and she eventually converted them to the change.

Social network analysis depicts the pattern of interactions among individuals and helps to diagnose effective and ineffective patterns.94 It helps identify groups or clusters of indi- viduals that comprise the network, individuals who link the clusters, and other network members. It helps diagnose communication patterns and, consequently, communication effectiveness.95 Such analysis of communication patterns is helpful because the configura- tion of group members’ social ties within and outside the group affects the extent to which members connect to individuals who:

• Convey needed resources. • Have the opportunity to exchange information and support. • Have the motivation to treat each other in positive ways. • Have the time to develop trusting relationships that might improve the groups’

effectiveness.

However, such relationships don’t “just happen.”96 Developing social capital requires interdependence among group members. Social capital erodes when people in the network become independent. And increased interactions between members aid in the develop- ment and maintenance of mutual obligations in a social network.97 Social networks such as Facebook may facilitate increased interactions between members in a social network via Internet-based communications.

Let’s take a brief look at a simplified network analysis to get a grasp of the key ideas. In Exhibit 4.4, the links depict informal relationships among individuals, such as

social network analysis analysis of the pattern of social interactions among individuals.

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communication flows, personal support, and advice networks. There may be some individu- als with literally no linkages, such as Fred. These individuals are typically labeled “isolates.” However, most people do have some linkages with others.

To simplify, there are two primary types of mechanisms through which social capital will flow: closure relationships (depicted by Bill, Frank, George, and Susan) and bridging relationships (depicted by Mary). As we can see, in the former relationships one mem- ber is central to the communication flows in a group. In contrast, in the latter relation- ships, one person “bridges” or brings together groups that would have been otherwise unconnected.

Both closure and bridging relationships have important implications for the effective flow of information in organizations and for the management of knowledge. We will now briefly discuss each of these types of relationships. We will also address some of the implica- tions that understanding social networks has for one’s career success.

Closure With closure, many members have relationships (or ties) with other members. As indicated in Exhibit 4.4, Bill’s group would have a higher level of closure than Frank’s Susan’s, or George’s groups because more group members are connected to each other. Through closure, group members develop strong relationships with each other, high levels of trust, and greater solidarity. High levels of trust help to ensure that informal norms in the group are easily enforced and there is less “free riding.” Social pressure will prevent people from withholding effort or shirking their responsibilities. In addition, people in the network are more willing to extend favors and “go the extra mile” on a colleague’s behalf because they are confident that their efforts will be reciprocated by another member in their group. Another benefit of a network with closure is the high level of emotional sup- port. This becomes particularly valuable when setbacks occur that may destroy morale or an unexpected tragedy happens that might cause the group to lose its focus. Social support helps the group to rebound from misfortune and get back on track.

But high levels of closure often come with a price. Groups that become too closed can become insular. They cut themselves off from the rest of the organization and fail to share what they are learning from people outside their group. Research shows that while managers need to encourage closure up to a point, if there is too much closure, they need to encourage people to open up their groups and infuse new ideas through bridging relationships.98

closure the degree to which all members of a social network have relationships (or ties) with other group members.

EXHIBIT 4.4 A Simplified Social Network

Bill

Frank

Fred

Susan

George

Mary

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4.4 STRATEGY SPOTLIGHT PICASSO VERSUS VAN GOGH: WHO WAS MORE SUCCESSFUL AND WHY? Vincent van Gogh and Pablo Picasso are two of the most iconoclastic—and famous—artists of modern times. Paintings by both of them have fetched over $100 million. And both of them were responsible for some of the most iconic images in the art world: Van Gogh’s Self-Portrait (the one sans the earlobe) and Starry Night and Picasso’s The Old Guitarist and Guernica. However, there is an important difference between van Gogh and Picasso. Van Gogh died penniless. Picasso’s estate was estimated at $750 million when he died in 1973. What was the difference?

Van Gogh’s primary connection to the art world was through his brother. Unfortunately, this connection didn’t feed directly into the money that could have turned him into a living suc- cess. In contrast, Picasso’s myriad connections provided him with access to commercial riches. As noted by Gregory Berns in his book Iconoclast: A Neuroscientist Reveals How to Think Differently, “Picasso’s wide ranging social network, which

included artists, writers, and politicians, meant that he was never more than a few people away from anyone of importance in the world.”*

In effect, van Gogh was a loner, and the charismatic Picasso was an active member of multiple social circles. In social net- working terms, van Gogh was a solitary “node” who had few connections. Picasso, on the other hand, was a “hub” who embedded himself in a vast network that stretched across various social lines. Where Picasso smoothly navigated multiple social circles, van Gogh had to struggle just to maintain con- nections with even those closest to him. Van Gogh inhabited an alien world, whereas Picasso was a social magnet. And because he knew so many people, the world was at Picasso’s fingertips. From his perspective, the world was smaller.

* Berns, G., Iconoclast: A Neuroscientist Reveals How to Think Differently. Boston, MA: Harvard Business Review Press, 2008.

Sources: Hayashi, A. M. 2008. Why Picasso out earned van Gogh. MIT Sloan Management Review, 50(1): 11–12; and Berns, G. 2008. Icononclast: A Neuroscientist Reveals How to Think Differently. Boston: Harvard Business Press.

Bridging Relationships The closure perspective rests on an assumption that there is a high level of similarity among group members. However, members can be quite heterogeneous with regard to their positions in either the formal or informal structures of the group or the organization. Such heterogeneity exists because of, for example, vertical boundaries (differ- ent levels in the hierarchy) and horizontal boundaries (different functional areas).

Bridging relationships, in contrast to closure, stress the importance of ties connecting people. Employees who bridge disconnected people tend to receive timely, diverse informa- tion because of their access to a wide range of heterogeneous information flows. Such bridg- ing relationships span a number of different types of boundaries.

The University of Chicago’s Ron Burt originally coined the term “structural holes” to refer to the social gap between two groups. Structural holes are common in organizations. When they occur in business, managers typically refer to them as “silos” or “stovepipes.” Sales and engineering are a classic example of two groups whose members traditionally interact with their peers rather than across groups.

A study that Burt conducted at Raytheon, a $25 billion U.S. electronics company and military contractor, provides further insight into the benefits of bridging.99

Burt studied several hundred managers in Raytheon’s supply chain group and asked them to write down ideas to improve the company’s supply chain management. Then he asked two Raytheon executives to rate the ideas. The conclusion: The best suggestions consistently came from managers who discussed ideas outside their regular work group.

Burt found that Raytheon managers were good at thinking of ideas but bad at developing them. Too often, Burt said, the managers discussed their ideas with colleagues already in their informal discussion network. Instead, he said, they should have had discussions outside their typical contacts, particularly with an informal boss, or someone with enough power to be an ally but not an actual supervisor.

Implications for Career Success Let’s go back in time in order to illustrate the value of social networks in one’s career success. Consider two of the most celebrated artists of all time: Vincent van Gogh and Pablo Picasso. Strategy Spotlight 4.4 points out why these two artists enjoyed sharply contrasting levels of success during their lifetimes.

bridging relationships relationships in a social network that connect otherwise disconnected people.

structural holes social gaps between groups in a social network where there are few relationships bridging the groups.

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Effective social networks provide many advantages for the firm.100 They can play a key role in an individual’s career advancement and success. One’s social network potentially can provide three unique advantages: private information, access to diverse skill sets, and power.101 Managers see these advantages at work every day but might not consider how their networks regulate them.

Private Information We make judgments using both public and private informa- tion. Today, public information is available from many sources, including the Internet. However, since it is so accessible, public information offers less competitive advantage than it used to.

In contrast, private information from personal contacts can offer something not found in publicly available sources, such as the release date of a new product or knowledge about what a particular interviewer looks for in candidates. Private information can give managers an edge, though it is more subjective than public information since it cannot be easily veri- fied by independent sources, such as Dun & Bradstreet. Consequently the value of your private information to others—and the value of others’ private information to you—depends on how much trust exists in the network of relationships.

Access to Diverse Skill Sets Linus Pauling, one of only two people to win a Nobel Prize in two different areas and considered one of the towering geniuses of the 20th century, attrib- uted his creative success not to his immense brainpower or luck but to his diverse contacts. He said, “The best way to have a good idea is to have a lot of ideas.”

While expertise has become more specialized during the past few decades, organiza- tional, product, and marketing issues have become more interdisciplinary. This means that success is tied to the ability to transcend natural skill limitations through others. Highly diverse network relationships, therefore, can help you develop more complete, creative, and unbiased perspectives on issues. Trading information or skills with people whose experi- ences differ from your own provides you with unique, exceptionally valuable resources. It is common for people in relationships to share their problems. If you know enough people, you will begin to see how the problems that another person is struggling with can be solved by the solutions being developed by others. If you can bring together problems and solu- tions, it will greatly benefit your career.

Power Traditionally, a manager’s power was embedded in a firm’s hierarchy. But when corporate organizations became flatter, more like pancakes than pyramids, that power was repositioned in the network’s brokers (people who bridged multiple networks), who could adapt to changes in the organization, develop clients, and synthesize opposing points of view. Such brokers weren’t necessarily at the top of the hierarchy or experts in their fields, but they linked specialists in the firm with trustworthy and informative relationships.102

Most personal networks are highly clustered; that is, an individual’s friends are likely to be friends with one another as well. Most corporate networks are made up of several clus- ters that have few links between them. Brokers are especially powerful because they connect separate clusters, thus stimulating collaboration among otherwise independent specialists.

The Potential Downside of Social Capital We’d like to close our discussion of social capital by addressing some of its limitations. First, some firms have been adversely affected by very high levels of social capital because it may breed “groupthink”—a tendency not to question shared beliefs.103 Such think- ing may occur in networks with high levels of closure where there is little input from people outside the network. In effect, too many warm and fuzzy feelings among group members prevent people from rigorously challenging each other. People are discouraged

groupthink a tendency in an organization for individuals not to question shared beliefs.

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from engaging in the “creative abrasion” that Dorothy Leonard of Harvard University describes as a key source of innovation.104 Two firms that were well known for their colle- giality, strong sense of employee membership, and humane treatment—Digital Equipment (now part of Hewlett-Packard) and Polaroid—suffered greatly from market misjudgments and strategic errors. The aforementioned aspects of their culture contributed to their problems.

Second, if there are deep-rooted mind-sets, there would be a tendency to develop dys- functional human resource practices. That is, the organization (or group) would continue to hire, reward, and promote like-minded people who tend to further intensify organizational inertia and erode innovation. Such homogeneity would increase over time and decrease the effectiveness of decision-making processes.

Third, the socialization processes (orientation, training, etc.) can be expensive in terms of both financial resources and managerial commitment. Such investments can represent a significant opportunity cost that should be evaluated in terms of the intended benefits. If such expenses become excessive, profitability would be adversely affected.

Finally, individuals may use the contacts they develop to pursue their own interests and agendas, which may be inconsistent with the organization’s goals and objectives. Thus, they may distort or selectively use information to favor their preferred courses of action or with- hold information in their own self-interest to enhance their power to the detriment of the common good. Drawing on our discussion of social networks, this is particularly true in an organization that has too many bridging relationships but not enough closure relationships. In high-closure groups, it is easier to watch each other to ensure that illegal or unethical acts don’t occur. By contrast, bridging relationships make it easier for a person to play one group or individual off another, with no one being the wiser.105 We will discuss some behavioral control mechanisms in Chapter 9 (rewards, control, boundaries) that reduce such dysfunc- tional behaviors and actions.106

USING TECHNOLOGY TO LEVERAGE HUMAN CAPITAL AND KNOWLEDGE Sharing knowledge and information throughout the organization can be a means of con- serving resources, developing products and services, and creating new opportunities. In this section we will discuss how technology can be used to leverage human capital and knowl- edge within organizations as well as with customers and suppliers beyond their boundaries.

Using Networks to Share Information As we all know, email is an effective means of communicating a wide variety of information. It is quick, easy, and almost costless. Of course, it can become a problem when employees use it extensively for personal reasons. And we all know how fast jokes or rumors can spread within and across organizations!

Email can also cause embarrassment, or worse, if one is not careful. Consider the plight of a potential CEO—as recalled by Marshall Goldsmith, a well-known executive coach:107

I witnessed a series of e-mails between a potential CEO and a friend inside the company. The first e-mail to the friend provided an elaborate description of “why the current CEO is an idiot.” The friend sent a reply. Several rounds of e-mails followed. Then the friend sent an e-mail containing a funny joke. The potential CEO decided that the current CEO would love this joke and forwarded it to him. You can guess what happened next. The CEO scrolled down the e-mail chain and found the “idiot” message. The heir apparent was gone in a week.

LO 4-5 The vital role of technology in leveraging knowledge and human capital.

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Email can, however, be a means for top executives to communicate information effi- ciently. For example, Martin Sorrell, chairman of WPP Group PLC, the huge $15 billion advertising and public relations firm, is a strong believer in the use of email.108 He emails all of his employees once a month to discuss how the company is doing, address specific issues, and offer his perspectives on hot issues, such as new business models for the Internet. He believes that it keeps people abreast of what he is working on.

Technology can also enable much more sophisticated forms of communication in addi- tion to knowledge sharing. Cisco, for example, launched Integrated Workforce Experience (IWE) in 2010.109 It is a social business platform designed to facilitate internal and exter- nal collaboration and decentralize decision making. It functions much like a Facebook “wall”: A real-time news feed provides updates on employees’ status and activities as well as information about relevant communities, business projects, and customer and partner interactions. One manager likens it to Amazon. “It makes recommendations based on what you are doing, the role you are in, and the choices of other people like you. We are taking that to the enterprise level and basically allowing appropriate information to find you,” he says.

Electronic Teams: Using Technology to Enhance Collaboration Technology enables professionals to work as part of electronic, or virtual, teams to enhance the speed and effectiveness with which products are developed. For example, Microsoft has concentrated much of its development on electronic teams (or e-teams) that are networked together.110 This helps to accelerate design and testing of new soft- ware modules that use the Windows-based framework as their central architecture. Microsoft is able to foster specialized technical expertise while sharing knowledge rap- idly throughout the firm. This helps the firm learn how its new technologies can be applied rapidly to new business ventures such as cable television, broadcasting, travel services, and financial services.

What are electronic teams (or e-teams)? There are two key differences between e-teams and more traditional teams:111

• E-team members either work in geographically separated workplaces or may work in the same space but at different times. E-teams may have members working in different spaces and time zones, as is the case with many multinational teams.

• Most of the interactions among members of e-teams occur through electronic communication channels such as fax machines and groupware tools such as email, bulletin boards, chat, and videoconferencing.

E-teams have expanded exponentially in recent years.112 Organizations face increasingly high levels of complex and dynamic change. E-teams are also effective in helping businesses cope with global challenges. Most e-teams perform very complex tasks and most knowledge- based teams are charged with developing new products, improving organizational processes, and satisfying challenging customer problems. For example, Hewlett-Packard’s e-teams solve clients’ computing problems, and Sun Microsystems’ (part of Oracle) e-teams gener- ate new business models.

Advantages There are multiple advantages of e-teams.113 In addition to the rather obvious use of technology to facilitate communications, the potential benefits parallel the other two major sections in this chapter—human capital and social capital.

First, e-teams are less restricted by the geographic constraints that are placed on face- to-face teams. Thus, e-teams have the potential to acquire a broader range of “human capital,” or the skills and capacities that are necessary to complete complex assignments. So e-team leaders can draw upon a greater pool of talent to address a wider range of

LO 4-6 Why “electronic” or “virtual” teams are critical in combining and leveraging knowledge in organizations and how they can be made more effective.

electronic teams a team of individuals that completes tasks primarily through email communication.

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problems since they are not constrained by geographic space. Once formed, e-teams can be more flexible in responding to unanticipated work challenges and opportunities because team members can be rotated out of projects when demands and contingencies alter the team’s objectives.

Second, e-teams can be very effective in generating “social capital”—the quality of rela- tionships and networks that form. Such capital is a key lubricant in work transactions and operations. Given the broader boundaries associated with e-teams, members and leaders generally have access to a wider range of social contacts than would be typically available in more traditional face-to-face teams. Such contacts are often connected to a broader scope of clients, customers, constituents, and other key stakeholders.

Challenges However, there are challenges associated with making e-teams effective. Successful action by both traditional teams and e-teams requires that:

• Members identify who among them can provide the most appropriate knowledge and resources.

• E-team leaders and key members know how to combine individual contributions in the most effective manner for a coordinated and appropriate response.

Group psychologists have termed such activities “identification and combination” activities, and teams that fail to perform them face a “process loss.”114 Process losses prevent teams from reaching high levels of performance because of inefficient interaction dynamics among team members. Such poor dynamics require that some collective energy, time, and effort be devoted to dealing with team inefficiencies, thus diverting the team away from its objectives. For example, if a team member fails to communicate important information at critical phases of a project, other members may waste time and energy. This can lead to conflict and resentment as well as to decreased motivation to work hard to complete tasks.

The potential for process losses tends to be more prevalent in e-teams than in traditional teams because the geographic dispersion of members increases the complexity of establish- ing effective interaction and exchanges. Generally, teams suffer process loss because of low cohesion, low trust among members, a lack of appropriate norms or standard operating procedures, or a lack of shared understanding among team members about their tasks. With e-teams, members are more geographically or temporally dispersed, and the team becomes more susceptible to the risk factors that can create process loss. Such problems can be exacerbated when team members have less than ideal competencies and social skills. This can erode problem-solving capabilities as well as the effective functioning of the group as a social unit.

A variety of technologies, from email and Internet groups to Skype have facilitated the formation and effective functioning of e-teams as well as a wide range of collaborations within companies. Such technologies greatly enhance the collaborative abilities of employ- ees and managers within a company at a reasonable cost—despite the distances that sepa- rate them.

Codifying Knowledge for Competitive Advantage There are two different kinds of knowledge. Tacit knowledge is embedded in personal experience and shared only with the consent and participation of the individual. Explicit (or codified) knowledge, on the other hand, is knowledge that can be documented, widely distributed, and easily replicated. One of the challenges of knowledge-intensive organiza- tions is to capture and codify the knowledge and experience that, in effect, resides in the heads of its employees. Otherwise, they will have to constantly “reinvent the wheel,” which

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4.5 STRATEGY SPOTLIGHT HOW SAP TAPS KNOWLEDGE WELL BEYOND ITS BOUNDARIES Traditionally, organizations built and protected their knowledge stocks—proprietary resources that no one else could access. However, the more the business environment changes, the faster the value of what you know at any point in time dimin- ishes. In today’s world, success hinges on the ability to access a growing variety of knowledge flows in order to rapidly replenish the firm’s knowledge stocks. For example, when an organization tries to improve cycle times in a manufacturing process, it finds far more value in problem solving shaped by the diverse experi- ences, perspectives, and learning of a tightly knit team (shared through knowledge flows) than in a training manual (knowledge stocks) alone.

Knowledge flows can help companies gain competitive advantage in an age of near-constant disruption. The software company SAP, for example, routinely taps the nearly 3 million participants in its Community Network, which extends well beyond the boundaries of the firm. By providing a virtual plat- form for customers, developers, system integrators, and service

vendors to create and exchange knowledge, SAP has signifi- cantly increased the productivity of all the participants in its ecosystem.

According to Mark Yolton, senior vice president of SAP Communications and Social Media, “It’s a very robust com- munity with a great deal of activity. We see about 1.2 million unique visitors every month. Hundreds of millions of pages are viewed every year. There are 4,000 discussion forum posts every single day, 365 days a year, and about 115 blogs every day, 365 days a year, from any of the nearly 3 million members.”

The site is open to everyone, regardless of whether you are a SAP customer, partner, or newcomer who needs to work with SAP technology. The site offers technical articles, web-based training, code samples, evaluation systems, discussion forums, and excellent blogs for community experts.

Sources: Yolton, M. 2012. SAP: Using social media for building, selling and supporting. sloanreview.mit.edu, August 7: np; Hagel, J., III., Brown, J. S., & Davison, L. 2009. The big shift: Measuring the forces of change. Harvard Business Review, 87(4): 87; and Anonymous. Undated. SAP developer network. sap.sys-con.com: np.

is both expensive and inefficient. Also, the “new wheel” may not necessarily be superior to the “old wheel.”115

Once a knowledge asset (e.g., a software code or a process) is developed and paid for, it can be reused many times at very low cost, assuming that it doesn’t have to be substantially modified each time. For example, Access Health, a call-in medical center, uses technology to capture and share knowledge. When someone calls the center, a registered nurse uses the company’s “clinical decision architecture” to assess the caller’s symptoms, rule out pos- sible conditions, and recommend a home remedy, doctor’s visit, or trip to the emergency room. The company’s knowledge repository contains algorithms of the symptoms of more than 500 illnesses. According to CEO Joseph Tallman, “We are not inventing a new way to cure disease. We are taking available knowledge and inventing processes to put it to better use.” The software algorithms were very expensive to develop, but the investment has been repaid many times over. The first 300 algorithms that Access Health developed have each been used an average of 8,000 times a year. Further, the company’s paying customers— insurance companies and provider groups—save money because many callers would have made expensive trips to the emergency room or the doctor’s office had they not been diag- nosed over the phone.

The user community can be a major source of knowledge creation for a firm. Strategy Spotlight 4.5 highlights how SAP has been able to leverage the expertise and involvement of its users to develop new knowledge and transmit it to SAP’s entire user community.

We close this section with a series of questions managers should consider in determin- ing (1) how effective their organization is in attracting, developing, and retaining human capital and (2) how effective they are in leveraging human capital through social capital and technology. These questions, included in Exhibit 4.5, summarize some of the key issues addressed in this chapter.

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Human Capital

Recruiting “Top-Notch” Human Capital

• Does the organization assess attitude and “general makeup” instead of focusing primarily on skills and background in selecting employees at all levels?

• How important are creativity and problem-solving ability? Are they properly considered in hiring decisions? • Do people throughout the organization engage in effective networking activities to obtain a broad pool of worthy potential employees?

Is the organization creative in such endeavors?

Enhancing Human Capital through Employee Development

• Does the development and training process inculcate an “organizationwide” perspective? • Is there widespread involvement, including top executives, in the preparation and delivery of training and development programs? • Is the development of human capital effectively tracked and monitored? • Are there effective programs for succession at all levels of the organization, especially at the topmost levels? • Does the firm effectively evaluate its human capital? Is a 360-degree evaluation used? Why? Why not? • Are mechanisms in place to ensure that a manager’s success does not come at the cost of compromising the organization’s core

values?

Retaining the Best Employees

• Are there appropriate financial rewards to motivate employees at all levels? • Do people throughout the organization strongly identify with the organization’s mission? • Are employees provided with a stimulating and challenging work environment that fosters professional growth? • Are valued amenities provided (e.g., flextime, child care facilities, telecommuting) that are appropriate given the organization’s

mission, its strategy, and how work is accomplished? • Is the organization continually devising strategies and mechanisms to retain top performers?

Social Capital

• Are there positive personal and professional relationships among employees? • Is the organization benefiting (or being penalized) by hiring (or by voluntary turnover) en masse? • Does an environment of caring and encouragement rather than competition enhance team performance? • Do the social networks within the organization have the appropriate levels of closure and bridging relationships? • Does the organization minimize the adverse effects of excessive social capital, such as excessive costs and “groupthink”?

Technology

• Has the organization used technologies such as email and networks to develop products and services? • Does the organization effectively use technology to transfer best practices across the organization? • Does the organization use technology to leverage human capital and knowledge both within the boundaries of the organization and

among its suppliers and customers? • Has the organization effectively used technology to codify knowledge for competitive advantage? • Does the organization try to retain some of the knowledge of employees when they decide to leave the firm?

Source: Adapted from Dess, G. G., & Picken, J. C. 1999. Beyond Productivity: 63–64. New York: AMACON.

EXHIBIT 4.5 Issues to Consider in Creating Value through Human Capital, Social Capital, and Technology

PROTECTING THE INTELLECTUAL ASSETS OF THE ORGANIZATION: INTELLECTUAL PROPERTY AND DYNAMIC CAPABILITIES In today’s dynamic and turbulent world, unpredictability and fast change dominate the busi- ness environment. Firms can use technology, attract human capital, or tap into research and design networks to get access to pretty much the same information as their competitors.

LO 4-7 The challenge of protecting intellectual property and the importance of a firm’s dynamic capabilities.

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So what would give firms a sustainable competitive advantage?116 Protecting a firm’s intel- lectual property requires a concerted effort on the part of the company. After all, employ- ees become disgruntled and patents expire. The management of intellectual property (IP) involves, besides patents, contracts with confidentiality and noncompete clauses, copy- rights, and the development of trademarks. Moreover, developing dynamic capabilities is the only avenue providing firms with the ability to reconfigure their knowledge and activi- ties to achieve a sustainable competitive advantage.

Intellectual Property Rights Intellectual property rights are more difficult to define and protect than property rights for physical assets (e.g., plant, equipment, and land). However, if intellectual property rights are not reliably protected by the state, there will be no incentive to develop new products and services. Property rights have been enshrined in constitutions and rules of law in many countries. In the information era, though, adjustments need to be made to accommodate the new realities of knowledge. Knowledge and information are fundamentally different assets from the physical ones that property rights have been designed to protect.

The protection of intellectual rights raises unique issues, compared to physical property rights. IP is characterized by significant development costs and very low marginal costs. Indeed, it may take a substantial investment to develop a software program, an idea, or a digital music tune. Once developed, though, its reproduction and distribution cost may be almost zero, espe- cially if the Internet is used. Effective protection of intellectual property is necessary before any investor will finance such an undertaking. Appropriation of investors’ returns is harder to police since possession and deployment are not as readily observable. Unlike physical assets, intellectual property can be stolen by simply broadcasting it. Recall Napster and MP3 as well as the debates about counterfeit software, music CDs, and DVDs coming from developing countries such as China. Part of the problem is that using an idea does not prevent others from simultaneously using it for their own benefit, which is typically impossible with physical assets. Moreover, new ideas are frequently built on old ideas and are not easily traceable.

Given these unique challenges in protecting IP, it comes as no surprise that legal battles over patents become commonplace in IP-heavy industries such as telecommunications. Take the recent patent battles Apple has been fighting against smartphone makers running Android, Google’s mobile operating system.117

In 2012, Apple and HTC, a Taiwanese smartphone maker, agreed to dismiss a series of lawsuits filed against each other after Apple accused HTC of copying the iPhone. While this settlement may be a sign that Apple’s new CEO, Timothy Cook, is eager to end the distractions caused by IP-related litigation, other patent battles continue, including one between Apple and Samsung, the largest maker of Android phones. This legal battle involves much higher stakes, because Samsung shipped almost eight times as many Android smartphones as HTC in the third quarter of 2012. However, Apple’s new leadership seems to be more pragmatic about this issue. In Mr. Cook’s words, “It is awkward. I hate litigation. I absolutely hate it,” suggesting that he is not as enthusiastic a combatant in the patent wars as was his predecessor, Steve Jobs, who famously promised to “destroy Android, because it’s a stolen product.”

Countries are attempting to pass new legislation to cope with developments in new phar- maceutical compounds, stem cell research, and biotechnology. However, a firm that is faced with this challenge today cannot wait for the legislation to catch up. New technological developments, software solutions, electronic games, online services, and other products and services contribute to our economic prosperity and the creation of wealth for those entre- preneurs who have the idea first and risk bringing it to the market.

Dynamic Capabilities Dynamic capabilities entail the capacity to build and protect a competitive advan- tage.118 This rests on knowledge, assets, competencies, and complementary assets and

intellectual property rights intangible property owned by a firm in the forms of patents, copyrights, trademarks, or trade secrets.

dynamic capabilities a firm’s capacity to build and protect a competitive advantage, which rests on knowledge, assets, competencies, complementary assets, and technologies. Dynamic capabilities include the ability to sense and seize new opportunities, generate new knowledge, and reconfigure existing assets and capabilities.

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technologies as well as the ability to sense and seize new opportunities, generate new knowledge, and reconfigure existing assets and capabilities.119 According to David Teece, an economist at the University of California at Berkeley, dynamic capabilities are related to the entrepreneurial side of the firm and are built within a firm through its environmen- tal and technological “sensing” apparatus, its choices of organizational form, and its col- lective ability to strategize. Dynamic capabilities are about the ability of an organization to challenge the conventional wisdom within its industry and market, learn and innovate, adapt to the changing world, and continuously adopt new ways to serve the evolving needs of the market.120

Examples of dynamic capabilities include product development, strategic decision mak- ing, alliances, and acquisitions.121 Some firms have clearly developed internal processes and routines that make them superior in such activities. For example, 3M and Apple are ahead of their competitors in product development. Cisco Systems has made numerous acquisi- tions over the years. Cisco seems to have developed the capability to identify and evaluate potential acquisition candidates and seamlessly integrate them once the acquisition is com- pleted. Other organizations can try to copy Cisco’s practices. However, Cisco’s combina- tion of the resources of the acquired companies and their reconfiguration that Cisco has already achieved places it well ahead of its competitors. As markets become increasingly dynamic, traditional sources of long-term competitive advantage become less relevant. In such markets, all that a firm can strive for are a series of temporary advantages. Dynamic capabilities allow a firm to create this series of temporary advantages through new resource configurations.122

ISSUE FOR DEBATE

Does Providing Financial Incentives to Employees to Lose Weight Actually Work? Assume your employer offered each of its staff $550 to lose weight, an amount that would be subtracted from their health insurance premiums the following year. Do you think it would work? Would it provide enough incentive for some of the employees to shed the pounds?

Approximately four out of five large employers in the United States now offer some type of financial incentive for employees to improve their health. And the Affordable Care Act has encouraged such programs by significantly increasing the amount of money, in the form of a percentage of insurance premiums, that employers can reward (or take away) to improve health factors such as body mass index, blood pressure and cholesterol, as well as for ending the use of tobacco.

Several professors and medical professionals decided to test whether or not incentives actually work. Employees were randomly assigned to two conditions: one group in which employees were offered the $550 incentive and another group—the control group—in which no incentive was offered. After one year the results were reported in the journal Health Affairs. The result: Employees assigned to the control group that received no financial incentive had no change in their weight. However, employees who were offered the $550 incentive also didn’t lose weight.

Discussion Questions 1. Why do you think the $550 incentive did not result in people losing weight? 2. Can you think of how incentives could have been structured to be more successful?

Source: Patel, M. S., Asch, D. A., & Volpp, K. G. 2016. Does paying employees to lose weight work? Dallas Morning News, March 20: 1P, 5P.

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Reflecting on Career Implications . . . This chapter focuses on the growing importance of intellectual assets in the valuation of firms. Since improved organizational performance occurs when firms effectively combine human capital, social capital, and technology, the following questions help students to consider how they can leverage their talents though relationships and technology.

Human Capital: Identify specific steps taken by your organization to effectively attract, develop, and retain talent. If you cannot identify such steps, you may have fewer career opportunities to develop your human capital at your organization. Do you take advantage of your organization’s human resource programs, such as tuition reimbursement, mentoring, and so forth?

Human Capital: As workplaces become more diverse, it is important to reflect on whether your organization values diversity. What kinds of diversity seem to be encouraged (e.g., age-based or ethnicity-based)? In what ways are your colleagues different from and similar to you? If your firm has a homogeneous workforce, there may be limited perspectives

on strategic and operational issues and a career at this organization may be less attractive to you.

Social Capital: Does your organization have strong social capital? What is the basis of your conclusion that it has strong or weak social capital? What specific programs are in place to build and develop social capital? What is the impact of social capital on employee turnover in your organization? Alternatively, is social capital so strong that you see effects such as “groupthink”? From your perspective, how might you better leverage social capital toward pursuing other career opportunities?

Social Capital: Are you actively working to build a strong social network at your work organization? To advance your career, strive to build a broad network that gives you access to diverse information.

Technology: Does your organization provide and effectively use technology (e.g., groupware, knowledge management systems) to help you leverage your talents and expand your knowledge base? If your organization does a poor job in this regard, what can you do on your own to expand your knowledge base using technology available outside the organization?

Firms throughout the industrial world are recognizing that the knowledge worker is the key to success in the marketplace. However, they also recognize that human capital, although vital, is still only a necessary, but not a sufficient,

condition for creating value. We began the first section of the chapter by addressing the importance of human capital and how it can be attracted, developed, and retained. Then we discussed the role of social capital and technology in leveraging human capital for competitive success. We pointed out that intellectual capital—the difference between a firm’s market value and its book value—has increased significantly over the past few decades. This is particularly true for firms in knowledge-intensive industries, especially where there are relatively few tangible assets, such as software development.

The second section of the chapter addressed the attraction, development, and retention of human capital. We viewed these three activities as a “three-legged stool”— that is, it is difficult for firms to be successful if they ignore or are unsuccessful in any one of these activities. Among the issues we discussed in attracting human capital were “hiring for attitude, training for skill” and the value of using social networks to attract human capital. In particular, it is important to attract employees who can collaborate with others, given the importance of collective efforts such as teams and task forces. With regard to developing human capital, we discussed the need to encourage widespread involvement throughout the organization, monitor progress and track the development of human capital, and evaluate

human capital. Among the issues that are widely practiced in evaluating human capital is the 360-degree evaluation system. Employees are evaluated by their superiors, peers, direct reports, and even internal and external customers. We also addressed the value of maintaining a diverse workforce. Finally, some mechanisms for retaining human capital are employees’ identification with the organization’s mission and values, providing challenging work and a stimulating environment, the importance of financial and nonfinancial rewards and incentives, and providing flexibility and amenities. A key issue here is that a firm should not overemphasize financial rewards. After all, if individuals join an organization for money, they also are likely to leave for money. With money as the primary motivator, there is little chance that employees will develop firm-specific ties to keep them with the organization.

The third section of the chapter discussed the importance of social capital in leveraging human capital. Social capital refers to the network of relationships that individuals have throughout the organization as well as with customers and suppliers. Such ties can be critical in obtaining both information and resources. With regard to recruiting, for example, we saw how some firms are able to hire en masse groups of individuals who are part of social networks. Social relationships can also be very important in the effective functioning of groups. Finally, we discussed some of the potential downsides of social capital. These include the expenses that firms may bear when promoting social and working relationships among individuals as well as the potential for “groupthink,” wherein individuals are reluctant to express divergent (or opposing) views on

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an issue because of social pressures to conform. We also introduced the concept of social networks. The relative advantages of being central in a network versus bridging multiple networks was discussed. We addressed the key role that social networks can play in both improving knowledge management and promoting career success.

The fourth section addressed the role of technology in leveraging human capital. We discussed relatively simple means of using technology, such as email and networks where individuals can collaborate by way of personal computers. We provided suggestions and guidelines on how electronic teams can be effectively managed. We also addressed more sophisticated uses of technology, such as sophisticated management systems. Here, knowledge can be codified and reused at very low cost, as we saw in the examples of firms in the consulting, health care, and high- technology industries.

In the last section we discussed the increasing importance of protecting a firm’s intellectual property. Although traditional approaches such as patents, copyrights, and trademarks are important, the development of dynamic capabilities may be the best protection in the long run.

SUMMARY REVIEW QUESTIONS 1. Explain the role of knowledge in today’s competitive

environment. 2. Why is it important for managers to recognize the

interdependence in the attraction, development, and retention of talented professionals?

3. What are some of the potential downsides for firms that engage in a “war for talent”?

4. Discuss the need for managers to use social capital in leveraging their human capital both within and across their firm.

5. Discuss the key role of technology in leveraging knowledge and human capital.

EXPERIENTIAL EXERCISE Pfizer, a leading health care firm with $52 billion in revenues, is often rated as one of Fortune’s “Most Admired Firms.” It is also considered an excellent place to work and has generated high return to shareholders. Clearly, Pfizer values its human capital. Using the Internet and/or library resources, identify some of the actions/strategies Pfizer has taken to attract, develop, and retain human capital. What are their implications? (Fill in the table at bottom of the page.)

knowledge economy 104 intellectual capital 106 human capital 106

social capital 106 explicit knowledge 106 tacit knowledge 106 360-degree evaluation and

feedback systems 113 social network analysis 120 closure 121 bridging relationships 122

key terms

Activity Actions/Strategies Implications

Attracting human capital

Developing human capital

Retaining human capital

APPLICATION QUESTIONS & EXERCISES 1. Look up successful firms in a high-technology

industry as well as two successful firms in more traditional industries such as automobile manufacturing and retailing. Compare their market values and book values. What are some implications of these differences?

2. Select a firm for which you believe its social capital— both within the firm and among its suppliers and customers—is vital to its competitive advantage. Support your arguments.

3. Choose a company with which you are familiar. What are some of the ways in which it uses technology to leverage its human capital?

4. Using the Internet, look up a company with which you are familiar. What are some of the policies and procedures that it uses to enhance the firm’s human and social capital?

ETHICS QUESTIONS 1. Recall an example of a firm that recently faced

an ethical crisis. How do you feel the crisis and management’s handling of it affected the firm’s human capital and social capital?

2. Based on your experiences or what you have learned in your previous classes, are you familiar with any companies that used unethical practices to attract talented professionals? What do you feel were the short-term and long-term consequences of such practices?

structural holes 122 groupthink 123 electronic teams 125

intellectual property rights 129

dynamic capabilities 129

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1. Parts of this chapter draw upon some of the ideas and examples from Dess, G. G. & Picken, J. C. 1999. Beyond productivity. New York: AMACOM.

2. Dekas, K. H., et al. 2013. Organizational citizenship behavior, version 2.0: A review and qualitative investigation of OCBs for knowledge workers at Google and beyond. Academy of Management Perspectives, 27(3): 219–237.

3. Stewart, T. A. 1997. Intellectual capital: The new wealth of organizations. New York: Doubleday/Currency.

4. Colvin, G. 2015. The 100 best companies to work for. Fortune. March 15: 109.

5. Stewart, T. A. 2001. Accounting gets radical. Fortune, April 16: 184–194.

6. Adams, S. & Kichen, S. 2008. Ben Graham then and now. Forbes, www. multpl.com/s-p-500-price-to-book, November 10: 56.

7. An interesting discussion of Steve Jobs’s impact on Apple’s valuation is in Lashinsky, A. 2009. Steve’s leave— what does it really mean? Fortune, February 2: 96–102.

8. Anonymous. 2007. Intel opens first high volume 45 nm microprocessor manufacturing factory. www.intel.com, October 25: np.

9. Thomas Stewart has suggested this formula in his book Intellectual capital. He provides an insightful discussion on pages 224–225, including some of the limitations of this approach to measuring intellectual capital. We recognize, of course, that during the late 1990s and in early 2000, there were some excessive market valuations of high- technology and Internet firms. For an interesting discussion of the extraordinary market valuation of Yahoo!, an Internet company, refer to Perkins, A. B. 2001. The Internet bubble encapsulated: Yahoo! Red Herring, April 15: 17–18.

10. Roberts, P. W. & Dowling, G. R. 2002. Corporate reputation and sustained superior financial performance. Strategic Management Journal, 23(12): 1077–1095.

11. For a study on the relationships between human capital, learning, and sustainable competitive advantage, read Hatch, N. W. & Dyer, J. H. 2005. Human capital and learning as a source of sustainable competitive advantage. Strategic Management Journal, 25: 1155–1178.

12. One of the seminal contributions on knowledge management is Becker, G.

S. 1993. Human capital: A theoretical and empirical analysis with special reference to education (3rd ed.). Chicago: University of Chicago Press.

13. For an excellent overview of the topic of social capital, read Baron, R. A. 2005. Social capital. In Hitt, M. A. & Ireland, R. D. (Eds.), The Blackwell encyclopedia of management (2nd ed.): 224–226. Malden, MA: Blackwell.

14. For an excellent discussion of social capital and its impact on organizational performance, refer to Nahapiet, J. & Ghoshal, S. 1998. Social capital, intellectual capital, and the organizational advantage. Academy of Management Review, 23: 242–266.

15. An interesting discussion of how knowledge management (patents) can enhance organizational performance can be found in Bogner, W. C. & Bansal, P. 2007. Knowledge management as the basis of sustained high performance. Journal of Management Studies, 44(1): 165–188.

16. Polanyi, M. 1967. The tacit dimension. Garden City, NY: Anchor.

17. Barney, J. B. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17: 99–120.

18. For an interesting perspective of empirical research on how knowledge can adversely affect performance, read Haas, M. R. & Hansen, M. T. 2005. When using knowledge can hurt performance: The value of organizational capabilities in a management consulting company. Strategic Management Journal, 26(1): 1–24.

19. New insights on managing talent are provided in Cappelli, P. 2008. Talent management for the twenty-first century. Harvard Business Review, 66(3): 74–81.

20. Some of the notable books on this topic include Edvisson & Malone, op. cit.; Stewart, op. cit.; and Nonaka, I. & Takeuchi, I. 1995. The knowledge creating company. New York: Oxford University Press.

21. Segalla, M. & Felton, N. 2010. Find the real power in your organization. Harvard Business Review, 88(5): 34–35.

22. Stewart, T. A. 2000. Taking risk to the marketplace. Fortune, March 6: 424.

23. Lobel, O. 2014. Talent wants to be free. New Haven, CT: Yale University Press.

24. Insights on Generation X’s perspective on the workplace are in Erickson, T. J. 2008. Task, not time: Profile of a Gen Y job. Harvard Business Review, 86(2): 19.

25. Pfeffer, J. 2010. Building sustainable organizations: The human factor. Academy of Management Perspectives, 24(1): 34–45.

26. Lobel, op. cit. 27. Some workplace implications for the

aging workforce are addressed in Strack, R., Baier, J., & Fahlander, A. 2008. Managing demographic risk. Harvard Business Review, 66(2): 119–128.

28. For a discussion of attracting, developing, and retaining top talent, refer to Goffee, R. & Jones, G. 2007. Leading clever people. Harvard Business Review, 85(3): 72–89.

29. Winston, A. S. 2014. The big pivot. Boston: Harvard Business Review Press.

30. Dess & Picken, op. cit., p. 34. 31. Webber, A. M. 1998. Danger: Toxic

company. Fast Company, November: 152–161.

32. Martin, J. & Schmidt, C. 2010. How to keep your top talent. Harvard Business Review, 88(5): 54–61.

33. Some interesting insights on why home-grown American talent is going abroad are found in Saffo, P. 2009. A looming American diaspora. Harvard Business Review, 87(2): 27.

34. Grossman, M. 2012. The best advice I ever got. Fortune, May 12: 119.

35. Davenport, T. H., Harris, J., & Shapiro, J. 2010. Competing on talent analytics. Harvard Business Review, 88(10): 62–69.

36. Ployhart, R. E. & Moliterno, T. P. 2011. Emergence of the human capital resource: A multilevel model. Academy of Management Review, 36(1): 127–150.

37. For insights on management development and firm performance in several countries, refer to Mabey, C. 2008. Management development and firm performance in Germany, Norway, Spain, and the UK. Journal of International Business Studies, 39(8): 1327–1342.

38. Martin, J. 1998. So, you want to work for the best. . . . Fortune, January 12: 77.

39. Cardin, R. 1997. Make your own Bozo Filter. Fast Company, October– November: 56.

40. Anonymous. 100 best companies to work for. money.cnn.com, undated: np.

41. Martin, op. cit.; Henkoff, R. 1993. Companies that train best. Fortune, March 22: 53–60.

42. This section draws on: Garg, V. 2012. Here’s why companies should give Millennial workers everything they ask for. buisnessinsider.com,

REFERENCES

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August 23: np; worklifepolicy.com; and Gerdes, L. 2006. The top 50 employers for new college grads. BusinessWeek, September 18: 64–81.

43. An interesting perspective on developing new talent rapidly when they join an organization can be found in Rollag, K., Parise, S., & Cross, R. 2005. Getting new hires up to speed quickly. MIT Sloan Management Review, 46(2): 35–41.

44. Stewart, T. A. 1998. Gray flannel suit? Moi? Fortune, March 18: 80–82.

45. Bryant, A. 2011. The corner office. New York: St. Martin’s Griffin, 227.

46. An interesting perspective on how Cisco Systems develops its talent can be found in Chatman, J., O’Reilly, C., & Chang, V. 2005. Cisco Systems: Developing a human capital strategy. California Management Review, 47(2): 137–166.

47. Anonymous. 2011. Schumpeter: The tussle for talent. The Economist, January 8: 68.

48. Training and development policy: Mentoring. opm.gov: undated, np.

49. Douglas, C. A. 1997. Formal mentoring programs in organizations. centerforcreativeleadership.org: np.

50. Warner, F. 2002. Inside Intel’s mentoring movement. fastcompany. com, March 31: np.

51. Grove, A. 2011. Be a mentor. Bloomberg Businessweek, September 21: 80.

52. Colvin, G. 2016. Developing an internal market for talent. Fortune. March 1: 22.

53. For an innovative perspective on the appropriateness of alternate approaches to evaluation and rewards, refer to Seijts, G. H. & Lathan, G. P. 2005. Learning versus performance goals: When should each be used? Academy of Management Executive, 19(1): 124–132.

54. The discussion of the 360-degree feedback system draws on the article UPS. 1997. 360-degree feedback: Coming from all sides. Vision (a UPS Corporation internal company publication), March: 3; Slater, R. 1994. Get better or get beaten: Thirty- one leadership secrets from Jack Welch. Burr Ridge, IL: Irwin; Nexon, M. 1997. General Electric: The secrets of the finest company in the world. L’Expansion, July 23: 18–30; and Smith, D. 1996. Bold new directions for human resources. Merck World (internal company publication), October: 8.

55. Interesting insights on 360-degree evaluation systems are discussed in Barwise, P. & Meehan, Sean. 2008.

So you think you’re a good listener. Harvard Business Review, 66(4): 22–23.

56. Insights into the use of 360-degree evaluation are in Kaplan, R. E. & Kaiser, R. B. 2009. Stop overdoing your strengths. Harvard Business Review, 87(2): 100–103.

57. Mankins, M., Bird, A., & Root, J. 2013. Making star teams out of star players. Harvard Business Review, 91(1/2): 74–78.

58. Kets de Vries, M. F. R. 1998. Charisma in action: The transformational abilities of Virgin’s Richard Branson and ABB’s Percy Barnevik. Organizational Dynamics, Winter: 20.

59. For an interesting discussion on how organizational culture has helped Zappos become number one in Fortune’s 2009 survey of the best companies to work for, see O’Brien, J. M. 2009. Zappos knows how to kick it. Fortune, February 2: 54–58.

60. We have only to consider the most celebrated case of industrial espionage in recent years, wherein José Ignacio Lopez was indicted in a German court for stealing sensitive product planning documents from his former employer, General Motors, and sharing them with his executive colleagues at Volkswagen. The lawsuit was dismissed by the German courts, but Lopez and his colleagues were investigated by the U.S. Justice Department. Also consider the recent litigation involving noncompete employment contracts and confidentiality clauses of International Paper v. Louisiana- Pacific, Campbell Soup v. H. J. Heinz Co., and PepsiCo v. Quaker Oats’s Gatorade. In addition to retaining valuable human resources and often their valuable network of customers, firms must also protect proprietary information and knowledge. For interesting insights, refer to Carley, W. M. 1998. CEO gets hard lesson in how not to keep his lieutenants. The Wall Street Journal, February 11: A1, A10; and Lenzner, R. & Shook, C. 1998. Whose Rolodex is it, anyway? Forbes, February 23: 100–103.

61. For an insightful discussion of retention of knowledge workers in today’s economy, read Davenport, T. H. 2005. The care and feeding of the knowledge worker. Boston, MA: Harvard Business School Press.

62. Weber, L. 2014. Here’s what boards want in executives. The Wall Street Journal, December 10: B5.

63. Fisher, A. 2008. America’s most admired companies. Fortune, March 17: 74.

64. Stewart, T. A. 2001. The wealth of knowledge, New York: Currency.

65. For insights on fulfilling one’s potential, refer to Kaplan, R. S. 2008. Reaching your potential. Harvard Business Review, 66(7/8): 45–57.

66. Amabile, T. M. 1997. Motivating creativity in organizations: On doing what you love and loving what you do. California Management Review, Fall: 39–58.

67. For an insightful perspective on alternate types of employee–employer relationships, read Erickson, T. J. & Gratton, L. 2007. What it means to work here. Harvard Business Review, 85(3): 104–112.

68. Little, L. 2016. Leadership innovation. Baylor Magazine. Winter: 31.

69. Ignatius, A. & McGinn, D. 2015. The best performing CEOs in the world. Harvard Business Review, 93(11): 63.

70. Pfeffer, J. 2001. Fighting the war for talent is hazardous to your organization’s health. Organizational Dynamics, 29(4): 248–259.

71. Best companies to work for 2011. 2011. finance.yahoo.com, January 20: np.

72. This section draws on Dewhurst, M., Hancock, B., & Ellsworth, D. 2013. Redesigning knowledge work. Harvard Business Review, 91 (1/2): 58–64.

73. Cox, T. L. 1991. The multinational organization. Academy of Management Executive, 5(2): 34–47. Without doubt, a great deal has been written on the topic of creating and maintaining an effective diverse workforce. Some excellent, recent books include Harvey, C. P. & Allard, M. J. 2005. Understanding and managing diversity: Readings, cases, and exercises (3rd ed.). Upper Saddle River, NJ: Pearson Prentice-Hall; Miller, F. A. & Katz, J. H. 2002. The inclusion breakthrough: Unleashing the real power of diversity. San Francisco: Berrett Koehler; and Williams, M. A. 2001. The 10 lenses: Your guide to living and working in a multicultural world. Sterling, VA: Capital Books.

74. For an interesting perspective on benefits and downsides of diversity in global consulting firms, refer to Mors, M. L. 2010. Innovation in a global consulting firm: When the problem is too much diversity. Strategic Management Journal, 31(8): 841–872.

75. Day, J. C. Undated. National population projections. cps.ipums.org: np.

76. Hewlett, S. A. & Rashid, R. 2010. The battle for female talent in emerging markets. Harvard Business Review, 88(5): 101–107.

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77. This section, including the six potential benefits of a diverse workforce, draws on Cox, T. H. & Blake, S. 1991. Managing cultural diversity: Implications for organizational competitiveness. Academy of Management Executive, 5(3): 45–56.

78. www.pwcglobal.com/us/eng/careers/ diversity/index.html.

79. Hewlett, S. A., Marshall, M., & Sherbin, L. 2013. How diversity can drive innovation. Harvard Business Review, 91(12): 30.

80. This discussion draws on Dess, G. G. & Lumpkin, G. T. 2001. Emerging issues in strategy process research. In Hitt, M. A., Freeman, R. E., & Harrison, J. S. (Eds.), Handbook of strategic management: 3–34. Malden, MA: Blackwell.

81. Wong, S.-S. & Boh, W. F. 2010. Leveraging the ties of others to build a reputation for trustworthiness among peers. Academy of Management Journal, 53(1): 129–148.

82. Adler, P. S. & Kwon, S. W. 2002. Social capital: Prospects for a new concept. Academy of Management Review, 27(1): 17–40.

83. Capelli, P. 2000. A market-driven approach to retaining talent. Harvard Business Review, 78(1): 103–113.

84. This hypothetical example draws on Peteraf, M. 1993. The cornerstones of competitive advantage. Strategic Management Journal, 14: 179–191.

85. Wernerfelt, B. 1984. A resource- based view of the firm. Strategic Management Journal, 5: 171–180.

86. Wysocki, B., Jr. 2000. Yet another hazard of the new economy: The Pied Piper effect. The Wall Street Journal, March 20: A1–A16.

87. Ideas on how managers can more effectively use their social network are addressed in McGrath, C. & Zell, D. 2009. Profiles of trust: Who to turn to, and for what. MIT Sloan Management Review, 50(2): 75–80.

88. Ibid. 89. Buckman, R. C. 2000. Tech defectors

from Microsoft resettle together. The Wall Street Journal, October: B1–B6.

90. Malone, T., The Future of Work. Boston, MA: Harvard Business School Press, April 2004.

91. Aime, F., Johnson, S., Ridge, J. W., & Hill, A. D. 2010. The routine may be stable but the advantage is not: Competitive implications of key employee mobility. Strategic Management Journal, 31(1): 75–87.

92. Ibarra, H. & Hansen, M. T. 2011. Are you a collaborative leader? Harvard Business Review, 89(7/8): 68–74.

93. Battilana, J. & Casciaro, T. 2013. The network secrets of great change agents. Harvard Business Review, 91(7/8): 62–68.

94. There has been a tremendous amount of theory building and empirical research in recent years in the area of social network analysis. Unquestionably, two of the major contributors to this domain have been Ronald Burt and J. S. Coleman. For excellent background discussions, refer to Burt, R. S. 1992. Structural holes: The social structure of competition. Cambridge, MA: Harvard University Press; Coleman, J. S. 1990. Foundations of social theory. Cambridge, MA: Harvard University Press; and Coleman, J. S. 1988. Social capital in the creation of human capital. American Journal of Sociology, 94: S95–S120. For a more recent review and integration of current thought on social network theory, consider Burt, R. S. 2005. Brokerage & closure: An introduction to social capital. New York: Oxford Press.

95. Our discussion draws on the concepts developed by Burt, 1992, op. cit.; Coleman, 1990, op. cit.; Coleman, 1988, op. cit.; and Oh, H., Chung, M., & Labianca, G. 2004. Group social capital and group effectiveness: The role of informal socializing ties. Academy of Management Journal, 47(6): 860–875. We would like to thank Joe Labianca (University of Kentucky) for his helpful feedback and ideas in our discussion of social networks.

96. Arregle, J. L., Hitt, M. A., Sirmon, D. G., & Very, P. 2007. The development of organizational social capital: Attributes of family firms. Journal of Management Studies, 44(1): 73–95.

97. A novel perspective on social networks is in Pentland, A. 2009. How social networks network best. Harvard Business Review, 87(2): 37.

98. Oh et al., op. cit. 99. Hoppe, B. 2004. Good ideas at

Raytheon and big holes in our own backyard. connectedness.blogspot.com, July 8: np.

100. Perspectives on how to use and develop decision networks are discussed in Cross, R., Thomas, R. J., & Light, D. A. 2009. How “who you know” affects what you decide. MIT Sloan Management Review, 50(2): 35–42.

101. Our discussion of the three advantages of social networks draws

on Uzzi, B. & Dunlap. S. 2005. How to build your network. Harvard Business Review, 83(12): 53–60. For an excellent review on the research exploring the relationship between social capital and managerial performance, read Moran, P. 2005. Structural vs. relational embeddedness: Social capital and managerial performance. Strategic Management Journal, 26(12): 1129–1151.

102. A perspective on personal influence is in Christakis, N. A. 2009. The dynamics of personal influence. Harvard Business Review, 87(2): 31.

103. Prusak, L. & Cohen, D. 2001. How to invest in social capital. Harvard Business Review, 79(6): 86–93.

104. Leonard, D. & Straus, S. 1997. Putting your company’s whole brain to work. Harvard Business Review, 75(4): 110–122.

105. For an excellent discussion of public (i.e., the organization) versus private (i.e., the individual manager) benefits of social capital, refer to Leana, C. R. & Van Buren, H. J. 1999. Organizational social capital and employment practices. Academy of Management Review, 24(3): 538–555.

106. The authors would like to thank Joe Labianca, University of Kentucky, and John Lin, University of Texas at Dallas, for their very helpful input in our discussion of social network theory and its practical implications.

107. Goldsmith, M. 2009. How not to lose the top job. Harvard Business Review, 87(1): 74.

108. Taylor, W. C. 1999. Whatever happened to globalization? Fast Company, December: 228–236.

109. Wilson, H. J., Guinan, P. J., Paris, S., & Weinberg, D. 2011. What’s your social media strategy? Harvard Business Review, 89(7/8): 23–25.

110. Lei, D., Slocum, J., & Pitts, R. A. 1999. Designing organizations for competitive advantage: The power of unlearning and learning. Organizational Dynamics, Winter: 24–38.

111. This section draws upon Zaccaro, S. J. & Bader, P. 2002. E-leadership and the challenges of leading e-teams: Minimizing the bad and maximizing the good. Organizational Dynamics, 31(4): 377–387.

112. Kirkman, B. L., Rosen, B., Tesluk, P. E., & Gibson, C. B. 2004. The impact of team empowerment on virtual team performance: The moderating role of face-to-face interaction. Academy of Management Journal, 47(2): 175–192.

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113. The discussion of the advantages and challenges associated with e-teams draws on Zaccaro & Bader, op. cit.

114. For a study exploring the relationship between team empowerment, face-to- face interaction, and performance in virtual teams, read Kirkman, Rosen, Tesluk, & Gibson, op. cit.

115. For an innovative study on how firms share knowledge with competitors and the performance implications, read Spencer, J. W. 2003. Firms’ knowledge sharing strategies in the global innovation system: Empirical evidence from the flat panel display industry. Strategic Management Journal, 24(3): 217–235.

116. This discussion draws on Conley, J. G. 2005. Intellectual capital management. Kellogg School of Management and Schulich School of Business, York University, Toronto, ON; Conley, J. G. & Szobocsan, J.

2001. Snow White shows the way. Managing Intellectual P02roperty, June: 15–25; Greenspan, A. 2004. Intellectual property rights. Federal Reserve Board, Remarks by the chairman, February 27; and Teece, D. J. 1998. Capturing value from knowledge assets. California Management Review, 40(3): 54–79. The authors would like to thank Professor Theo Peridis, York University, for his contribution to this section.

117. Wingfield, N. 2012. As Apple and HTC end lawsuits, smartphone patent battles continue. New York Times, www.nytimes.com, November 11: 57–63; and Tyrangiel, J. 2012. Tim Cook’s freshman year: The Apple CEO speaks. Bloomberg Businessweek, December 6: 62–76.

118. E. Danneels. 2011. Trying to become a different type of company: Dynamic

capability at Smith Corona. Strategic Management Journal, 32(1): 1–31.

119. A study of the relationship between dynamic capabilities and related diversification is Doving, E. & Gooderham, P. N. 2008. Strategic Management Journal, 29(8): 841–858.

120. A perspective on strategy in turbulent markets is in Sull, D. 2009. How to thrive in turbulent markets. Harvard Business Review, 87(2): 78–88.

121. Lee, G. K. 2008. Relevance of organizational capabilities and its dynamics: What to learn from entrants’ product portfolios about the determinants of entry timing. Strategic Management Journal, 29(12): 1257–1280.

122. Eisenhardt, K. M. & Martin, J. E. 2000. Dynamic capabilities: What are they? Strategic Management Journal, 21: 1105–1121.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

5 LO5-1 The central role of competitive advantage in the study of strategic

management and the three generic strategies: overall cost leadership, differentiation, and focus.

LO5-2 How the successful attainment of generic strategies can improve a firm’s relative power vis-à-vis the five forces that determine an industry’s average profitability.

LO5-3 The pitfalls managers must avoid in striving to attain generic strategies. LO5-4 How firms can effectively combine the generic strategies of overall cost

leadership and differentiation.

LO5-5 What factors determine the sustainability of a firm’s competitive advantage. LO5-6 The importance of considering the industry life cycle to determine a

firm’s business-level strategy and its relative emphasis on functional area strategies and value-creating activities.

LO5-7 The need for turnaround strategies that enable a firm to reposition its competitive position in an industry.

Business-Level Strategy Creating and Sustaining Competitive Advantages

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PART 2: STRATEGIC FORMULATION

A&P was the first traditional supermarket operator in the United States, with its roots going back to 1859. In its heyday, the firm operated over 4,200 stores. During the period from 1915 to 1975, A&P was the largest grocery retailer in the country. However it suffered a long, painful decline that led to multiple reorganization efforts as well as bankruptcies. In 2015, the long struggle to revive the firm came to an end when, as part of a bankruptcy filing, A&P sold off or closed its final 256 stores.1

What happened to this retailing icon? They were simply stuck in the middle. When it was on top, A&P provided a clear value proposition for its customers. It was one of the most cost-efficient retailers in the market while providing a wide array of products for its customers. As a result, it had both cost and differentiation advantages over its rivals. However, things started to turn in the 1950s. Rather than invest in, expand, and modernize its stores, its controlling owners distributed most of its profits to shareholders through large dividends. At the same time, new and aggressive competitors started to enter the market, and these competitors eroded A&P’s distinctive positioning. In the battle to win the business of cost-conscious customers, A&P faced stiff competition from massive general market retailers, most notably Walmart, as well as focused discounters, such as dollar stores and discount grocers, including Aldi. Customers looking for a higher level of service and specialty foods gravitated to grocery retailers that offered a higher level of service in larger stores, such as Wegmans, and newer high-end providers, such as Whole Foods, that offered gourmet foods and wider organic food product lines.

A&P was initially slow to respond to these challenges. When they finally did respond, as Jim Hertel, a grocery industry consultant stated, “They got caught in a downward spiral of sales declines that forced them to cut costs.” This resulted in challenges of hiring enough qualified staff and limited funds to update or upgrade stores. Even so, they were still at a cost disadvantage to both Walmart and Aldi. This left A&P with both higher prices than Walmart and other discounters and stores that felt old and dirty. In other words, the firm offered little in terms of value for its customers. After its initial bankruptcy, A&P attempted to modernize its stores and rebrand itself as a more upscale grocery retailer but lacked the financial resources to follow through on the change.

Discussion Questions 1. What decisions did A&P make when it was successful that led to its later failure? 2. How should the firm have responded to the new competitive challenges it faced? 3. What firm do you see today that faces similar challenges? How should this firm respond and

act to reinforce its strategic position?

LEARNING FROM MISTAKES

In order to create and sustain a competitive advantage, companies need to stay focused on their customers’ evolving wants and needs and not sacrifice their strategic position as they mature and the market around them evolves. Since A&P failed to invest in and reinforce its market position as the grocery industry matured and new entrants came into the market, it is not surprising that its market leadership eroded, and it was forced out of the market.

business-level strategy a strategy designed for a firm or a division of a firm that competes within a single business.

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TYPES OF COMPETITIVE ADVANTAGE AND SUSTAINABILITY

Michael Porter presented three generic strategies that a firm can use to overcome the five forces and achieve competitive advantage.2 Each of Porter’s generic strategies has the poten- tial to allow a firm to outperform rivals in their industry. The first, overall cost leadership, is based on creating a low-cost position. Here, a firm must manage the relationships through- out the value chain and lower costs throughout the entire chain. Second, differentiation requires a firm to create products and/or services that are unique and valued. Here, the pri- mary emphasis is on “nonprice” attributes for which customers will gladly pay a premium.3 Third, a focus strategy directs attention (or “focus”) toward narrow product lines, buyer segments, or targeted geographic markets, and they must attain advantages through either differentiation or cost leadership.4 Whereas the overall cost leadership and differentiation strategies strive to attain advantages industrywide, focusers have a narrow target market in mind. Exhibit 5.1 illustrates these three strategies on two dimensions: competitive advan- tage and markets served.

Both casual observation and research support the notion that firms that identify with one or more of the forms of competitive advantage outperform those that do not.5 There has been a rich history of strategic management research addressing this topic. One study analyzed 1,789 strategic business units and found that businesses combining multiple forms of competitive advantage (differentiation and overall cost leadership) outperformed busi- nesses that used only a single form. The lowest performers were those that did not identify with any type of advantage. They were classified as “stuck in the middle.” Results of this study are presented in Exhibit 5.2.6

For an example of the dangers of being stuck in the middle, consider the traditional supermarket.7 The major supermarket chains, such as Food Lion and Albertsons, used to be the main source of groceries for consumers. However, they find themselves in a situation today where affluent customers are going upmarket to get their organic and gourmet foods at retailers like Whole Foods Market and budget-conscious consumers are drifting to dis- count chains such as Walmart, Aldi, and Dollar General.

LO 5-1 The central role of competitive advantage in the study of strategic management and the three generic strategies: overall cost leadership, differentiation, and focus.

generic strategies basic types of business- level strategies based on breadth of target market (industrywide versus narrow market segment) and type of competitive advantage (low cost versus uniqueness).

EXHIBIT 5.1 Three Generic Strategies Competitive Advantage

Low Cost Position

M ar

ke ts

S er

ve d

Broad Target Market

Narrow Target Markets

Overall Cost Leadership

Cost Focus

Broad Differentiation

Differentiation Focus

Superior Perceived Value by Customer

Source: Adapted from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter, 1980, 1998, Free Press.

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Overall Cost Leadership The first generic strategy is overall cost leadership. Overall cost leadership requires a tight set of interrelated tactics that include:

• Aggressive construction of efficient-scale facilities. • Vigorous pursuit of cost reductions from experience. • Tight cost and overhead control. • Avoidance of marginal customer accounts. • Cost minimization in all activities in the firm’s value chain, such as R&D, service,

sales force, and advertising.

Exhibit 5.3 draws on the value-chain concept (see Chapter 3) to provide examples of how a firm can attain an overall cost leadership strategy in its primary and support activities.

One factor often central to an overall cost leadership strategy is the experience curve, which refers to how business “learns” to lower costs as it gains experience with production processes. With experience, unit costs of production decline as output increases in most industries. The experience curve, developed by the Boston Consulting Group in 1968, is a way of looking at efficiency gains that come with experience. For a range of products, as cumulative experience doubles, costs and labor hours needed to produce a unit of product decline by 10 to 30 percent. There are a number of reasons why we find this effect. Among the most common factors are workers getting better at what they do, product designs being simplified as the product matures, and production processes being automated and stream- lined. However, experience curve gains will be the foundation for a cost advantage only if the firm knows the source of the cost reduction and can keep these gains proprietary.

To generate above-average performance, a firm following an overall cost leadership posi- tion must attain competitive parity on the basis of differentiation relative to competitors.8 In other words, a firm achieving parity is similar to its competitors, or “on par,” with respect to differentiated products.9 Competitive parity on the basis of differentiation permits a cost leader to translate cost advantages directly into higher profits than competitors. Thus, the cost leader earns above-average returns.10

The failure to attain parity on the basis of differentiation can be illustrated with an exam- ple from the automobile industry—the Tata Nano. Tata, an Indian conglomerate, developed the Nano to be the cheapest car in the world. At a price of about $2,000, the Nano was expected to draw in middle-class customers in India and developing markets as well as bud- get conscious customers in Europe and North America. However, it hasn‘t caught on in either market. The Nano doesn’t have some of the basic features expected with cars, such as

overall cost leadership a firm’s generic strategy based on appeal to the industrywide market using a competitive advantage based on low cost.

experience curve the decline in unit costs of production as cumulative output increases.

competitive parity a firm’s achievement of similarity, or being “on par,” with competitors with respect to low cost, differentiation, or other strategic product characteristic.

Competitive Advantage

Differentiation and Cost Differentiation Cost

Differentiation and Focus Cost and Focus

Stuck in the Middle

Performance

Return on investment (%)

35.5 32.9 30.2 17.0 23.7 17.8

Sales growth (%) 15.1 13.5 13.5 16.4 17.5 12.2

Gain in market share (%)

5.3 5.3 5.5 6.1 6.3 4.4

Sample size 123 160 100 141 86 105

EXHIBIT 5.2 Competitive Advantage and Business Performance

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Support Activities

Firm Infrastructure

• Few management layers to reduce overhead costs. • Standardized accounting practices to minimize personnel required.

Human Resource Management

• Minimize costs associated with employee turnover through effective policies. • Effective orientation and training programs to maximize employee productivity.

Technology Development

• Effective use of automated technology to reduce scrappage rates. • Expertise in process engineering to reduce manufacturing costs.

Procurement

• Effective policy guidelines to ensure low-cost raw materials (with acceptable quality levels). • Shared purchasing operations with other business units.

Primary Activities

Inbound Logistics

• Effective layout of receiving dock operations.

Operations

• Effective use of quality control inspectors to minimize rework.

Outbound Logistics

• Effective utilization of delivery fleets.

Marketing and Sales

• Purchase of media in large blocks. • Sales-force utilization is maximized by territory management.

Service

• Thorough service repair guidelines to minimize repeat maintenance calls. • Use of single type of vehicle to minimize repair costs.

Source: Adapted from Porter, M. E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press.

EXHIBIT 5.3 Value-Chain Activities: Examples of Overall Cost Leadership

power steering and a passenger side mirror. It also faces concerns about safety. In crash tests, the Nano received zero stars for adult protection and didn’t meet basic UN safety require- ments. Also, there were numerous reports of Nanos catching fire. Due to all of these factors, the Nano has simply been seen by customers as offering a lousy value proposition.11

The lesson is simple. Price is just one component of value. No matter how good the price, the most cost-sensitive consumer won’t buy a bad product.

Gordon Bethune, the former CEO of Continental Airlines, summed up the need to pro- vide good products or services when employing a low-cost strategy this way: “You can make a pizza so cheap, nobody will buy it.”12

Next, we discuss two examples of firms that have built a cost leadership position. Aldi, a discount supermarket retailer, has grown from its German base to the rest of Europe,

Australia, and the United States by replicating a simple business format. Aldi limits the num- ber of products (SKUs in the grocery business) in each category to ensure product turn, to

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5.1 ENVIRONMENTAL SUSTAINABILITYSTRATEGY SPOTLIGHT PRIMARK STRIVES TO BALANCE LOW COSTS WITH ENVIRONMENTAL SUSTAINABILITY Primark may be the most successful brand most Americans have never heard of. Though it didn’t open its first U.S. store until 2015, it has been one of the fastest growing fashion retailers in the world over the last several years—growing by 150 percent between 2008 and 2014. Though its growth slowed to 9 percent in 2016, it continues to expand into new markets and expects its growth to accelerate in 2017. The Irish-based retailer focuses on selling trendy clothes at astonishingly low prices. It emphasizes keeping its cost structure lower than any of its rivals by leverag- ing streamlined logistics, a very low marketing budget, and its large scale that helps it get bargain prices from its suppliers. It also marks its prices up above cost less than its major rivals. As a result, the average selling price of an article of women’s clothing at Primark was 60 percent less than H&M, one of its major rivals, in Britain. It aims to make up for low margins by selling at a higher volume than its rivals. For example, for every square foot, Primark generates 55 percent greater sales annually than H&M. Primark’s customers often buy a series of outfits, wear them a

few times, and then come back for a fresh set of outfits. Primark appears to be benefiting from the “Instagram effect,” where young fashion-conscious consumers feel the need to regularly post selfies of new outfits they just bought.

While it strives for low costs, the firm also tries to balance this with the need for sustainability. Primark developed the Primark Sustainable Cotton Program in partnership with the Self-Employed Women’s Association (SEWA) and social busi- ness CottonConnect. In this effort, they promote sustainable farming methods to female smallholder cotton farmers in India that provide economic opportunities for women; reduce the use of fertilizer, pesticides and water; and improve cotton yields. As a result of its efforts, Primark has been honored by Greenpeace with a Detox Leader Award and by the Chartered Institute of Procurement with a Best Contribution to Corporate Responsibility Award.

Sources: Anonymous, 2015. Faster, cheaper fashion. economist.com. September 5: np; Doshi, V. 2016. Primark tackles fast fashion critics with cotton farmer project in India. theguardian.com. September 30: np; McGregor, L. 2016. Can Primark really claim to be sustainable? sourcingjournalonline.com. October 17: np; Percival, G. 2016. Irish arm helps to drive 9% sales growth at Primark. irishexaminer.com. September 13: np.

ease stocking shelves, and to increase its power over suppliers. It also sells mostly private-label products to minimize cost. It has small, efficient, and simply designed stores. It offers limited services and expects customers to bring their own bags and bag their own groceries. As a result, Aldi can offer its products at prices 40 percent lower than competing supermarkets.13

Zulily, an online retailer, has built its business model around lower-cost operations in order to carve out a unique position relative to Amazon and other online retailers. Zulily keeps very little inventory and typically orders products from vendors only when custom- ers purchase the product. It also has developed a bare-bones distribution system. Together, these actions result in deliveries that take an average of 11.5 days to get to customers and can sometimes stretch out to several weeks. Due to its reduced operational costs, Zulily is able to offer attractive prices to customers who are willing to wait.14

A business that strives for a low-cost advantage must attain an absolute cost advantage relative to its rivals.15 This is typically accomplished by offering a no-frills product or ser- vice to a broad target market using standardization to derive the greatest benefits from economies of scale and experience. However, such a strategy may fail if a firm is unable to attain parity on important dimensions of differentiation such as quick responses to cus- tomer requests for services or design changes. Strategy Spotlight 5.1 discusses how Primark, an Irish clothing retailer, has built a low-cost strategy while also being seen as effectively addressing concerns about environmental sustainability.

Overall Cost Leadership: Improving Competitive Position vis-à-vis the Five Forces An over- all low-cost position enables a firm to achieve above-average returns despite strong competi- tion. It protects a firm against rivalry from competitors, because lower costs allow a firm to earn returns even if its competitors eroded their profits through intense rivalry. A low-cost position also protects firms against powerful buyers. Buyers can exert power to drive down prices only to the level of the next most efficient producer. Also, a low-cost position provides

LO 5-2 How the successful attainment of generic strategies can improve a firm’s relative power vis- à-vis the five forces that determine an industry’s average profitability.

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more flexibility to cope with demands from powerful suppliers for input cost increases. The factors that lead to a low-cost position also provide a substantial entry barriers position with respect to substitute products introduced by new and existing competitors.16

A few examples will illustrate these points. Zulily’s close attention to costs helps to protect the company from buyer power and intense rivalry from competitors. Thus, Zulily is able to drive down costs and reduce the bargaining power of its customers. By cutting costs lower than other discount clothing retailers, Primark both lessens the degree of rivalry it faces and increases entry barriers for new entrants. Aldi’s extreme focus on minimizing costs across its operations makes it less vulnerable to substitutes, such as discount retailers like Walmart and dollar stores.

Potential Pitfalls of Overall Cost Leadership Strategies Potential pitfalls of an overall cost leadership strategy include:

• Too much focus on one or a few value-chain activities. Would you consider a person to be astute if he canceled his newspaper subscription and quit eating out to save money but then “maxed out” several credit cards, requiring him to pay hundreds of dollars a month in interest charges? Of course not. Similarly, firms need to pay attention to all activities in the value chain.17 Too often managers make big cuts in operating expenses but don’t question year-to-year spending on capital projects. Or managers may decide to cut selling and marketing expenses but ignore manufacturing expenses. Managers should explore all value-chain activities, including relationships among them, as candidates for cost reductions.

• Increase in the cost of the inputs on which the advantage is based. Firms can be vulnerable to price increases in the factors of production. For example, consider manufacturing firms based in China that rely on low labor costs. Due to demographic factors, the supply of workers 16 to 24 years old has peaked and will drop by a third in the next 12 years, thanks to stringent family-planning policies that have sharply reduced China’s population growth.18 This is leading to upward pressure on labor costs in Chinese factories, undercutting the cost advantage of firms producing there.

• A strategy that can be imitated too easily. One of the common pitfalls of a cost leadership strategy is that a firm’s strategy may consist of value-creating activities that are easy to imitate.19 Such has been the case with online brokers in recent years.20 As of early 2015, there were over 200 online brokers listed on allstocks.com, hardly symbolic of an industry where imitation is extremely difficult. And according to Henry McVey, financial services analyst at Morgan Stanley, “We think you need five to ten” online brokers.

• A lack of parity on differentiation. As noted earlier, firms striving to attain cost leadership advantages must obtain a level of parity on differentiation.21 Firms providing online degree programs may offer low prices. However, they may not be successful unless they can offer instruction that is perceived as comparable to traditional providers. For them, parity can be achieved on differentiation dimensions such as reputation and quality and through signaling mechanisms such as accreditation agencies.

• Reduced flexibility. Building up a low-cost advantage often requires significant investments in plant and equipment, distribution systems, and large, economically scaled operations. As a result, firms often find that these investments limit their flexibility, leading to great difficulty responding to changes in the environment. For example, Coors Brewing developed a highly efficient, large-scale brewery in Golden, Colorado. Coors was one of the most efficient brewers in the world, but its plant was designed to mass-produce one or two types of beer. When the craft brewing craze started to grow, the plant was not well equipped to produce smaller batches of craft beer, and Coors found it difficult to meet this opportunity. Ultimately, Coors had to buy its way into this movement by acquiring small craft breweries.22

LO 5-3 The pitfalls managers must avoid in striving to attain generic strategies.

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• Obsolescence of the basis of cost advantage. Ultimately, the foundation of a firm’s cost advantage may become obsolete. In such circumstances, other firms develop new ways of cutting costs, leaving the old cost leaders at a significant disadvantage. The older cost leaders are often locked into their way of competing and are unable to respond to the newer, lower-cost means of competing. This is the position that discount investment advisors now find themselves. Charles Schwab and TD Ameritrade challenged traditional brokers with lower cost business models. Now, they find themselves having to respond to a new class of robo-advisor firms, such as Betterment, that offer even lower cost investment advice using automated data analytic-based computer systems.

Differentiation As the name implies, a differentiation strategy consists of creating differences in the firm’s product or service offering by creating something that is perceived industrywide as unique and valued by customers.23 Differentiation can take many forms:

• Prestige or brand image (Hotel Monaco, BMW automobiles).24

• Quality (Apple, Ruth’s Chris steak houses, Michelin tires). • Technology (Martin guitars, North Face camping equipment). • Innovation (Medtronic medical equipment, Tesla Motors). • Features (Cannondale mountain bikes, Ducati motorcycles). • Customer service (Nordstrom department stores, USAA financial services). • Dealer network (Lexus automobiles, Caterpillar earthmoving equipment).

Exhibit 5.4 draws on the concept of the value chain as an example of how firms may dif- ferentiate themselves in primary and support activities.

Firms may differentiate themselves along several different dimensions at once.25 For exam- ple, the Cheesecake Factory, an upscale casual restaurant, differentiates itself by offering high- quality food, the widest and deepest menu in its class of restaurants, and premium locations.26

Firms achieve and sustain differentiation advantages and attain above-average perfor- mance when their price premiums exceed the extra costs incurred in being unique.27 For example, the Cheesecake Factory must increase consumer prices to offset the higher cost of premium real estate and producing such a wide menu. Thus, a differentiator will always seek out ways of distinguishing itself from similar competitors to justify price premiums greater than the costs incurred by differentiating.28 Clearly, a differentiator cannot ignore costs. After all, its premium prices would be eroded by a markedly inferior cost position. Therefore, it must attain a level of cost parity relative to competitors. Differentiators can do this by reducing costs in all areas that do not affect differentiation. Porsche, for exam- ple, invests heavily in engine design—an area in which its customers demand excellence— but it is less concerned and spends fewer resources in the design of the instrument panel or the arrangement of switches on the radio.29 Although a differentiation firm needs to be mindful of costs, it must also regularly and consistently reinforce the foundations of its differentiation advantage. In doing so, the firm builds a stronger reputation for differentia- tion, and this reputation can be an enduring source of advantage in its market.30

Many companies successfully follow a differentiation strategy. For example, Zappos may sell shoes, but it sees the core element of its differentiation advantage as service. Zappos CEO Tony Hsieh puts it this way:31

We hope that 10 years from now people won’t even realize that we started out selling shoes online, and that when you say “Zappos,” they’ll think, “Oh, that’s the place with the absolute best customer service.” And that doesn’t even have to be limited to being an online experience. We’ve had customers email us and ask us if we would please start an airline, or run the IRS.

differentiation strategy a firm’s generic strategy based on creating differences in the firm’s product or service offering by creating something that is perceived industrywide as unique and valued by customers.

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Support Activities

Firm Infrastructure

• Superior MIS—to integrate value-creating activities to improve quality. • Facilities that promote firm image. • Widely respected CEO who enhances firm reputation.

Human Resource Management

• Programs to attract talented engineers and scientists. • Provision of training and incentives to ensure a strong customer service orientation.

Technology Development

• Superior material handling and sorting technology. • Excellent applications engineering support.

Procurement

• Purchase of high-quality components to enhance product image. • Use of most-prestigious outlets.

Primary Activities

Inbound Logistics

• Superior material handling operations to minimize damage. • Quick transfer of inputs to manufacturing process.

Operations

• Flexibility and speed in responding to changes in manufacturing specifications. • Low defect rates to improve quality.

Outbound Logistics

• Accurate and responsive order processing. • Effective product replenishment to reduce customer inventory.

Marketing and Sales

• Creative and innovative advertising programs. • Fostering of personal relationship with key customers.

Service

• Rapid response to customer service requests. • Complete inventory of replacement parts and supplies.

Source: Adapted from Porter, M. E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press.

EXHIBIT 5.4 Value-Chain Activities: Examples of Differentiation

This emphasis on service has led to great success. Growing from an idea to a billion- dollar company in only a dozen years, Zappos is seeing the benefits of providing exemplary service. In Insights from Research, we see that firms are better able to improve their inno- vativeness when they leverage the value of customer interactions by providing incentives for employees to generate new ideas, build strong networks to share ideas and questions across organizational boundaries, and empower personnel to make bold decisions.

Strategy Spotlight 5.2 discusses how Caterpillar is using data analytics to differentiate the firm and sell new services.

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Overview Business leaders have many reasons to want to be innovative. Research has shown customer interactions are important to innovation, but the study discussed below proves that is not enough. Business leaders must organize all employees to leverage customer interaction via particular incentives, com- munication patterns, and empowerment efforts.

What the Research Shows Researchers from the Copenhagen Business School pub- lished a paper in Organization Science describing ways that companies use customer interactions to improve their inno- vation performance. The researchers used data from surveys of chief executive officers and other top managers in 169 of the largest Danish companies to determine the factors that improve innovation. The authors argue that merely inter- acting with customers isn’t enough; business leaders must organize employees in certain ways internally to impact inno- vation performance.

The researchers found that companies whose employees had high customer interaction—those who collaborated with customers on projects and communicated intensely with customers—had better innovation performance and profit- ability. They found that the more a company’s employees interacted with customers, the more its leaders delegated responsibility. As a result, in such companies, employees influenced their own jobs and often worked in teams.

Additionally, the researchers found that the more busi- ness leaders delegated responsibility, the more the compa- nies used knowledge incentives. That is, employees’ salaries were linked to improvement in skills as well as sharing and upgrading knowledge. This resulted in more communica- tion between functional departments and between manage- ment and employees.

The bottom line of this research is this: The link between interaction with customers and innovation perfor- mance is indirect, but is related to organizational practices that trigger individual knowledge growth and cross-unit communication.

Why This Matters It was already known that when employees interact with their users and customers, innovation often increases. But innova- tion doesn’t just happen. Specific organizational practices are necessary to make it happen. The way leaders leverage their employees’ customer interactions is through policies

about communication, incentives, and empowerment. For example, communication should be encouraged across departments and between managers and employees. Also, rewards for sharing ideas and knowledge should be in place. Finally, employees should be given leeway to make decisions on their own rather than having to deal with red tape.

When these practices are in place, customer interactions are more likely to lead to innovation. But some companies are more equipped than others to receive helpful feedback from their customers. The software company SAP provides an excellent example of how to benefit from customers’ ideas. The organization routinely taps more than 1.5 million participants in its Developer Network to post questions and receive quick responses on its virtual platform. Customers, developers, system integrators, and vendors help SAP increase productivity for all participants.

Key Takeaways • Innovative companies often have higher profits,

market values, market share, and credit ratings—and are more likely to survive.

• Interacting with customers can lead to innovation; in fact, many innovations are initiated by customers rather than manufacturers.

• This research also shows that customer interaction is not enough. To have these interactions spur innovative actions requires corporate leaders to enact specific organizational practices.

• Important practices for innovation include incentives to seek and share knowledge, the delegation of responsibility, and internal communication across departments and between managers and employees.

Apply This Today Employees’ interactions with customers have become vital to increasing innovative performance, but it is not enough. Communication between management and employees as well as across departments, incentives to get and share knowledge, and the delegation of responsibility can unleash the creativity of your workforce.

Research Reviewed Foss, N., Laursen, K., & Pederson, T. 2011. Linking cus- tomer interaction and innovation: The mediating role of new organizational practices. Organization Science, 22: 980–999.

INSIGHTS from Research5.1

LINKING CUSTOMER INTERACTIONS TO INNOVATION: THE ROLE OF THE ORGANIZATIONAL PRACTICES

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5.2 DATA ANALYTICSSTRATEGY SPOTLIGHT CATERPILLAR DIGS INTO THE DATA TO DIFFERENTIATE ITSELF When most people think about the Caterpillar Corporation, they think of big yellow tractors and heavy equipment used in construc- tion and mining. They don’t often think of technology and data ana- lytics. But this is an increasing emphasis in the firm. Caterpillar has been adding high-tech tools to its products for years. Cat excava- tors have been equipped with GPS and laser technology to help the driver set and maintain level digging and grading slopes. Cat has also built in systems to diagnose the ongoing health of the machine.

More recently, Caterpillar has looked to big data to help it grow its business. In an alliance with Uptake, a data analytics firm, they are now building systems to transmit data from machines to the cloud. This will allow Caterpillar to see how its machines are most commonly used, the tasks the machines struggle with, what triggers breakdowns, and when customers are likely to need to replace their machines. Cat itself can use this data to help it develop the next generation of machines—to assess the most common uses for its machines, to build better products, and

to predict customer needs. The plan is to use the data to bet- ter differentiate its products. But the company can also use the data to sell differentiated services to its business partners. For example, dealers could use the results of Cat’s data collection to predict upcoming repairs and parts needs. End customers would likely value data on machine usage to see if operators are sit- ting idle too much or if they are improperly using machines. End customers could also benefit from early predictions of possible failures and recommendations for preventative maintenance. For example, in a study of one malfunctioning machine owned by a large mining company, Cat concluded that the firm’s new tech- nology would have reduced repair costs from the $650,000 the mining company incurred to $12,000 by identifying an emerging problem before it did serious damage. Thus, Cat sees this tech- nology as allowing it to better serve both its customers and deal- ers, resulting in new sources of income for Cat as customers see value in buying ongoing data-access and software subscriptions. Sources: Mehta, S. 2013. Where brains meet brawn. Fortune. October 28: 72; Whipp, L. 2016. Caterpillar explores data mining with Uptake. ft.com. August 21: np.

Differentiation: Improving Competitive Position vis-à-vis the Five Forces Differentiation pro- vides protection against rivalry since brand loyalty lowers customer sensitivity to price and raises customer switching costs.32 By increasing a firm’s margins, differentiation also avoids the need for a low-cost position. Higher entry barriers result because of customer loyalty and the firm’s ability to provide uniqueness in its products or services.33 Differentiation also provides higher margins that enable a firm to deal with supplier power. And it reduces buyer power, because buyers lack comparable alternatives and are therefore less price-sensitive.34 Supplier power is also decreased because there is a certain amount of prestige associated with being the supplier to a producer of highly differentiated products and services. Last, differentiation enhances customer loyalty, thus reducing the threat from substitutes.35

Our examples illustrate these points. Porsche has enjoyed enhanced power over buyers because its strong reputation makes buyers more willing to pay a premium price. This less- ens rivalry, since buyers become less price-sensitive. The prestige associated with its brand name also lowers supplier power since margins are high. Suppliers would probably desire to be associated with prestige brands, thus lessening their incentives to drive up prices. Finally, the loyalty and “peace of mind” associated with a service provider such as Zappos makes such firms less vulnerable to rivalry or substitute products and services.

Potential Pitfalls of Differentiation Strategies Potential pitfalls of a differentiation strategy include:

• Uniqueness that is not valuable. A differentiation strategy must provide unique bundles of products and/or services that customers value highly. It’s not enough just to be “different.” An example is Gibson’s Dobro bass guitar. Gibson came up with a unique idea: Design and build an acoustic bass guitar with sufficient sound volume so that amplification wasn’t necessary. The problem with other acoustic bass guitars was that they did not project enough volume because of the low-frequency bass notes. By adding a resonator plate on the body of the traditional acoustic bass,

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Gibson increased the sound volume. Gibson believed this product would serve a particular niche market—bluegrass and folk artists who played in small group “jams” with other acoustic musicians. Unfortunately, Gibson soon discovered that its targeted market was content with the existing options: an upright bass amplified with a microphone or an acoustic electric guitar. Thus, Gibson developed a unique product, but it was not perceived as valuable by its potential customers.36

• Too much differentiation. Firms may strive for quality or service that is higher than customers desire.37 Thus, they become vulnerable to competitors that provide an appropriate level of quality at a lower price. For example, consider the expensive Mercedes-Benz S-Class, which ranged in price between $93,650 and $138,000 for the 2011 models.38 Consumer Reports described it as “sumptuous,” “quiet and luxurious,” and a “delight to drive.” The magazine also considered it to be the least reliable sedan available in the United States. According to David Champion, who runs the testing program, the problems are electronic. “The engineers have gone a little wild,” he says. “They’ve put every bell and whistle that they think of, and sometimes they don’t have the attention to detail to make these systems work.” Some features include a computer-driven suspension that reduces body roll as the vehicle whips around a corner; cruise control that automatically slows the car down if it gets too close to another car; and seats that are adjustable 14 ways and are ventilated by a system that uses eight fans.

• Too high a price premium. This pitfall is quite similar to too much differentiation. Customers may desire the product, but they are repelled by the price premium. For example, Duracell was told by the market that it charged too much for batteries.39 The firm tried to sell consumers on its superior-quality products, but the mass market wasn’t convinced. Why? The price differential was simply too high. At one CVS drugstore, a four-pack of Energizer AA batteries was on sale at $2.99 compared with a Duracell four-pack at $4.59. Duracell’s market share dropped 2 percent in a recent two-year period, and its profits declined over 30 percent. Clearly, the price/ performance proposition Duracell offered customers was not accepted.

• Differentiation that is easily imitated. As we noted in Chapter 3, resources that are easily imitated cannot lead to sustainable advantages. Similarly, firms may strive for, and even attain, a differentiation strategy that is successful for a time. However, the advantages are eroded through imitation. Consider Cereality’s innovative differentiation strategy of stores that offer a wide variety of cereals and toppings for around $4.40 As one would expect, once the idea proved successful, competitors entered the market because much of the initial risk had already been taken. These new competitors included stores with the following names: the Cereal Cabinet, The Cereal Bowl, and Bowls: A Cereal Joint. Says David Roth, one of Cereality’s founders: “With any good business idea, you’re faced with people who see you’ve cracked the code and who try to cash in on it.”

• Dilution of brand identification through product-line extensions. Firms may erode their quality brand image by adding products or services with lower prices and less quality. Although this can increase short-term revenues, it may be detrimental in the long run. Consider Gucci.41 In the 1980s Gucci wanted to capitalize on its prestigious brand name by launching an aggressive strategy of revenue growth. It added a set of lower- priced canvas goods to its product line. It also pushed goods heavily into department stores and duty-free channels and allowed its name to appear on a host of licensed items such as watches, eyeglasses, and perfumes. In the short term, this strategy worked. Sales soared. However, the strategy carried a high price. Gucci’s indiscriminate approach to expanding its products and channels tarnished its sterling brand. Sales of its high-end goods (with higher profit margins) fell, causing profits to decline.

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• Perceptions of differentiation that vary between buyers and sellers. The issue here is that “beauty is in the eye of the beholder.” Companies must realize that although they may perceive their products and services as differentiated, their customers may view them as commodities. Indeed, in today’s marketplace, many products and services have been reduced to commodities.42 Thus, a firm could overprice its offerings and lose margins altogether if it has to lower prices to reflect market realities.

Exhibit 5.5 summarizes the pitfalls of over- all cost leadership and differentiation strate- gies. In addressing the pitfalls associated with

Overall Cost Leadership

• Too much focus on one or a few value-chain activities. • Increase in the cost of the inputs on which the advantage is based. • A strategy that can be imitated too easily. • A lack of parity on differentiation. • Reduced flexibility. • Obsolescence of the basis of cost advantage.

Differentiation

• Uniqueness that is not valuable. • Too much differentiation. • A price premium that is too high. • Differentiation that is easily imitated. • Dilution of brand identification through product-line extensions. • Perceptions of differentiation that vary between buyers and sellers.

EXHIBIT 5.5 Potential Pitfalls of Overall Cost Leadership and Differentiation Strategies

these two generic strategies, there is one common, underlying theme: Managers must be aware of the dangers associated with concentrating so much on one strategy that they fail to attain parity on the other.

Focus A focus strategy is based on the choice of a narrow competitive scope within an industry. A firm following this strategy selects a segment or group of segments and tailors its strategy to serve them. The essence of focus is the exploitation of a particular market niche. As you might expect, narrow focus itself (like merely “being different” as a differentiator) is simply not sufficient for above-average performance.

The focus strategy, as indicated in Exhibit 5.1, has two variants. In a cost focus, a firm strives to create a cost advantage in its target segment. In a differentiation focus, a firm seeks to differentiate in its target market. Both variants of the focus strategy rely on provid- ing better service than broad-based competitors that are trying to serve the focuser’s target segment. Cost focus exploits differences in cost behavior in some segments, while differen- tiation focus exploits the special needs of buyers in other segments.

Let’s look at examples of two firms that have successfully implemented focus strategies. LinkedIn has staked out a position as the business social media site of choice. Rather than compete with Facebook head on, LinkedIn created a strategy that focuses on individuals who wish to share their business experience and make connections with individuals with whom they share or could potentially share business ties. In doing so, it has created an extremely strong business model. LinkedIn monetizes its user information in three ways: subscription fees from some users, advertising fees, and recruiter fees. The first two are fairly standard for social media sites, but the advertising fees are higher for LinkedIn since the ads can be more effectively targeted as a result of LinkedIn’s focus. The third income source is fairly unique for LinkedIn. Headhunters and human resource departments pay significant user fees, up to $8,200 a year, to have access to LinkedIn’s recruiting search engine, which can sift through LinkedIn profiles to identify individuals with desired skills and experiences. The power of this business model can be seen in the difference in user value for LinkedIn when compared to Facebook. For every hour that a user spends on the site, LinkedIn generates $1.30 in income. For Facebook, it is a paltry 6.2 cents.43

Marlin Steel Wire Products, a Baltimore-based manufacturing company, has also seen great benefit from developing a niche-differentiator strategy. Marlin, a manufacturer of commodity wire products, faced stiff and ever-increasing competition from rivals based in China and other

focus strategy a firm’s generic strategy based on appeal to a narrow market segment within an industry.

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5.3 DATA ANALYTICSSTRATEGY SPOTLIGHT LUXURY IN THE E-COMMERCE WORLD Traditionally, luxury retailers have relied on high levels of per- sonal touch in their stores as well as a sense of exclusivity in order to differentiate themselves from the mass retail markets. As a result, many luxury retailers have looked on the Internet retail market skeptically, thinking it didn’t fit their products and the needs of their customers. Rather than offering an indulgent and exclusive retail experience, the Internet promotes accessi- bility and efficiency. Yoox, an Italian firm, appears to have solved the mystery of how to turn e-commerce into a luxury experience. Yoox designs and manages online stores for nearly 40 luxury brands, including Armani, Diesel, Emilio Pucci, and Brunello Cucinelli. In 2015, the firm booked orders in 100 countries, gen- erating over $1 billion in sales and $19 million in net income.

How has Yoox translated the luxury retail experience to the online world? Its expertise at creating the right experi- ence cuts across the value chain. First, Yoox views itself as a craftsperson, designing each website specifically to the brand. Second, it focuses on the details. This includes training its

60 photographers to create images for each product that match the specific guidelines of each brand. For one clothing retailer, this included using flamenco dancers in its designer images, rather than fashion models. The attention to detail flows through to the packaging. Packers at Yoox’s five fulfillment centers are trained on the specific angle of the ribbons for a box contain- ing an Alexander Wang dress versus one containing a Bottega Veneta bag. Third, Yoox has developed innovative algorithms to predict which products will sell at which times and in which geo- graphic regions, allowing effective stocking to meet the needs of customers and providing guidance to retailers on optimal pric- ing. Finally, Yoox has insisted on exclusive contracts with luxury brands to ensure that it can control the brands’ images in the online retail space. These luxury brands have grown reliant on Yoox. About one-third of Yoox’s revenue derives from the cre- ation and management of the luxury brands’ websites, while the remainder comes from its order-fulfillment services. Sources: Fairchild, C. 2014. A luxe look for e-commerce. Fortune, June 16: 83–84; and Clark, N. 2014. Success draws competition for luxury e-retailer Yoox. nytimes.com, December 6: np.

emerging markets. These rivals had labor-based cost advantages that Marlin found hard to counter. Marlin responded by changing the game it played. Drew Greenblatt, Marlin’s presi- dent, decided to go upmarket, automating his production and specializing in high-end prod- ucts. For example, Marlin produces antimicrobial baskets for restaurant kitchens and exports its products globally. Marlin provides products to customers in 36 countries and, in 2012, was listed as the 162nd fastest-growing private manufacturing company in the United States.44

Strategy Spotlight 5.3 illustrates how Yoox has carved out a profitable niche in the online retailing world as a luxury goods provider.

Focus: Improving Competitive Position vis-à-vis the Five Forces Focus requires that a firm have either a low-cost position with its strategic target, high differentiation, or both. As we discussed with regard to cost and differentiation strategies, these positions provide defenses against each competitive force. Focus is also used to select niches that are least vulnerable to substitutes or where competitors are weakest.

Let’s look at our examples to illustrate some of these points. First, by providing a platform for a targeted customer group, businesspeople, to share key work information, LinkedIn insulated itself from rivalrous pressure from existing social networks, such as Facebook. It also felt little threat from new generalist social networks, such as Google +. Similarly, the new focus of Marlin Steel lessened the power of buyers since the company provides special- ized products. Also, it is insulated from competitors, which manufacture the commodity products Marlin used to produce.

Potential Pitfalls of Focus Strategies Potential pitfalls of focus strategies include:

• Cost advantages may erode within the narrow segment. The advantages of a cost focus strategy may be fleeting if the cost advantages are eroded over time. For example, early pioneers in online education, such as the University of Phoenix, have faced increasing challenges as traditional universities have entered with their own online programs that allow them to match the cost benefits associated with online delivery

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systems. Similarly, other firms have seen their profit margins drop as competitors enter their product segment.

• Even product and service offerings that are highly focused are subject to competition from new entrants and from imitation. Some firms adopting a focus strategy may enjoy temporary advantages because they select a small niche with few rivals. However, their advantages may be short-lived. A notable example is the multitude of dot-com firms that specialize in very narrow segments such as pet supplies, ethnic foods, and vintage automobile accessories. The entry barriers tend to be low, there is little buyer loyalty, and competition becomes intense. And since the marketing strategies and technologies employed by most rivals are largely nonproprietary, imitation is easy. Over time, revenues fall, profits margins are squeezed, and only the strongest players survive the shakeout.

• Focusers can become too focused to satisfy buyer needs. Some firms attempting to attain advantages through a focus strategy may have too narrow a product or service. Consider many retail firms. Hardware chains such as Ace and True Value are losing market share to rivals such as Lowe’s and Home Depot that offer a full line of home and garden equipment and accessories. And given the enormous purchasing power of the national chains, it would be difficult for such specialty retailers to attain parity on costs.

Combination Strategies: Integrating Overall Low Cost and Differentiation Perhaps the primary benefit to firms that integrate low-cost and differentiation strategies is the difficulty for rivals to duplicate or imitate.45 This strategy enables a firm to provide two types of value to customers: differentiated attributes (e.g., high quality, brand identification, reputation) and lower prices (because of the firm’s lower costs in value-creating activities). The goal is thus to provide unique value to customers in an efficient manner.46 Some firms are able to attain both types of advantages simultaneously.47 For example, superior quality can lead to lower costs because of less need for rework in manufacturing, fewer warranty claims, a reduced need for customer service personnel to resolve customer complaints, and so forth. Thus, the benefits of combining advantages can be additive, instead of merely involving trade- offs. Next, we consider four approaches to combining overall low cost and differentiation.

Adopting Automated and Flexible Manufacturing Systems Given the advances in manufactur- ing technologies such as CAD/CAM (computer aided design and computer aided manufactur- ing) as well as information technologies, many firms have been able to manufacture unique products in relatively small quantities at lower costs—a concept known as mass customization.48

Let’s consider Andersen Windows of Bayport, Minnesota—a $2.3 billion manufacturer of windows for the building industry.49 Until about 20 years ago, Andersen was a mass producer, in small batches, of a variety of standard windows. However, to meet changing customer needs, Andersen kept adding to its product line. The result was catalogs of ever-increasing size and a bewildering set of choices for both homeowners and contractors. Over a six-year period, the number of products tripled, price quotes took several hours, and the error rate increased. This not only damaged the company’s reputation but also added to its manufacturing expenses.

To bring about a major change, Andersen developed an interactive computer version of its paper catalogs that it sold to distributors and retailers. Salespersons can now customize each window to meet the customer’s needs, check the design for structural soundness, and provide a price quote. The system is virtually error-free, customers get exactly what they want, and the time to develop the design and furnish a quotation has been cut by 75 percent. Each showroom computer is connected to the factory, and customers are assigned a code number that permits them to track the order. The manufacturing system has been developed to use some common finished parts, but it also allows considerable variation in the final

combination strategies firms’ integrations of various strategies to provide multiple types of value to customers.

LO 5-4 How firms can effectively combine the generic strategies of overall cost leadership and differentiation.

mass customization a firm’s ability to manufacture unique products in small quantities at low cost.

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5.4 STRATEGY SPOTLIGHT EXPANDING THE PROFIT POOL IN THE SKY Commercial airlines find themselves in a very competitive market, facing a number of competitors, having high fixed costs, and expe- riencing demand that is largely driven by economic conditions. As a result, profits in the airline industry are typically fairly low and often negative. The challenges in this industry are evident in the 23 separate bankruptcies that have occurred in the U.S. airline industry since 2000. However, as anyone who has flown in recent years can attest, airlines have found new sources of profit to aug- ment their income beyond what customers are willing to pay when purchasing a ticket. The fees airlines have added on for ancillary services accounted for $36.7 billion in additional revenue for global airlines in 2015, up from a paltry $2.5 billion in 2008.

The range of revenue sources has expanded in recent years. The most obvious source of service revenue is baggage fees. However, airlines also generate revenue by charging book- ing fees and by selling premium economy seating, the right to assigned seats, exit-row seating, guarantees that family members can all sit together, earlier boarding of flights, pre- mium meals, pillow and blanket sets, Internet access on board, and the right to hold a reservation before making a purchase

commitment. Outside the flight experience itself, airlines are generating revenue by charging fees for credit cards, frequent- flyer programs, and access to airport lounges. The importance of these fees is staggering for some airlines. While Emirates Air relies on these service fees for less than 1 percent of its rev- enue, 22 percent of Ryanair’s revenue and 38 percent of Spirit Airlines’ revenue is accounted for by these fees.

By separating the value of the actual flight from the services associated with flying, airlines have greatly expanded the profit pool associated with flying. They have found that flyers may be very price-conscious when purchasing tickets but are willing to shell out more for a range of services. While this does increase their revenue, it may also provide benefits for at least some cus- tomers. As Jay Sorensen, CEO of IdeaWorks, notes, “It offers the potential for an airline to better tailor service to the needs of indi- vidual customers. They can click and buy the amenities they want rather than the airline deciding what is bundled in the base fare.”

Sources: Akasie, J. 2013. With a fee for everything, airlines jet toward a new business model. minyanville.com, October 1: np; Perera, J. 2014. Looking at airline fees in 2008 compared to 2014. chron.com, November 25: np; and Garcia, M. 2015. Airline fee revenue expected to reach nearly $60 billion in 2015. skift. com, November 10: np.

products. Despite its huge investment, Andersen has been able to lower costs, enhance qual- ity and variety, and improve its response time to customers.

Using Data Analytics As initially discussed in Chapter 2, corporations are increasingly collecting and analyzing data on their customers, including data on customer characteris- tics, purchasing patterns, employee productivity, and physical asset utilization. These efforts have the potential to allow firms to better customize their product and service offerings to customers while more efficiently and fully using the resources of the company. For example, Caterpillar collects and analyzes large volumes of data about how customers use their trac- tors. Since this data helps Cat better assess the uses and limitations of their current tractors, the firm can use data analytics to employ more focused and timely product improvement efforts. This allows the firm to simultaneously reduce the cost of new product development efforts and better differentiate their products.50

Exploiting the Profit Pool Concept for Competitive Advantage A profit pool is defined as the total profits in an industry at all points along the industry’s value chain.51 Although the concept is relatively straightforward, the structure of the profit pool can be complex.52 The potential pool of profits will be deeper in some segments of the value chain than in others, and the depths will vary within an individual segment. Segment profitability may vary widely by customer group, product category, geographic market, or distribution chan- nel. Additionally, the pattern of profit concentration in an industry is very often different from the pattern of revenue generation. Strategy Spotlight 5.4 outlines how airlines have expanded the profit pools of their market by adding fees for a variety of services.

Coordinating the “Extended” Value Chain by Way of Information Technology Many firms have achieved success by integrating activities throughout the “extended value chain” by using information technology to link their own value chain with the value chains of their

profit pool the total profits in an industry at all points along the industry’s value chain.

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customers and suppliers. As noted in Chapter 3, this approach enables a firm to add value not only through its own value-creating activities but also for its customers and suppliers.

Such a strategy often necessitates redefining the industry’s value chain. A number of years ago, Walmart took a close look at its industry’s value chain and decided to reframe the competitive challenge. Although its competitors were primarily focused on retailing— merchandising and promotion—Walmart determined that it was not so much in the retailing industry as in the transportation logistics and communications industries. Here, linkages in the extended value chain became central. That became Walmart’s chosen battleground. By redefining the rules of competition that played to its strengths, Walmart has attained com- petitive advantages and dominates its industry.

Integrated Overall Low-Cost and Differentiation Strategies: Improving Competitive Position vis-à-vis the Five Forces Firms that successfully integrate both differentiation and cost advantages create an enviable position. For example, Walmart’s integration of information systems, logistics, and transportation helps it to drive down costs and provide outstanding product selection. This dominant competitive position serves to erect high entry barriers to potential competitors that have neither the financial nor physical resources to compete head-to-head. Walmart’s size—with over $482 million in sales in 2016—provides the chain with enormous bargaining power over suppliers. Its low pricing and wide selection reduce the power of buyers (its customers), because there are relatively few competitors that can provide a comparable cost/value proposition. This reduces the possibility of intense head- to-head rivalry, such as protracted price wars. Finally, Walmart’s overall value proposition makes potential substitute products (e.g., Internet competitors) a less viable threat.

Pitfalls of Integrated Overall Cost Leadership and Differentiation Strategies The pitfalls of integrated overall cost leadership and differentiation include:

• Failing to attain both strategies and possibly ending up with neither, leaving the firm “stuck in the middle.” A key issue in strategic management is the creation of competitive advantages that enable a firm to enjoy above-average returns. Some firms may become stuck in the middle if they try to attain both cost and differentiation advantages. As mentioned earlier in this chapter, mainline supermarket chains find themselves stuck in the middle as their cost structure is higher than discount retailers offering groceries and their products and services are not seen by consumers as being as valuable as those of high-end grocery chains, such as Whole Foods.

• Underestimating the challenges and expenses associated with coordinating value-creating activities in the extended value chain. Integrating activities across a firm’s value chain with the value chain of suppliers and customers involves a significant investment in financial and human resources. Firms must consider the expenses linked to technology investment, managerial time and commitment, and the involvement and investment required by the firm’s customers and suppliers. The firm must be confident that it can generate a sufficient scale of operations and revenues to justify all associated expenses.

• Miscalculating sources of revenue and profit pools in the firm’s industry. Firms may fail to accurately assess sources of revenue and profits in their value chain. This can occur for several reasons. For example, a manager may be biased due to his or her functional area background, work experiences, and educational background. If the manager’s background is in engineering, he or she might perceive that proportionately greater revenue and margins were being created in manufacturing, product, and process design than a person whose background is in a “downstream” value-chain activity such as marketing and sales. Or politics could make managers “fudge” the numbers to favor their area of operations. This would make them responsible for a greater proportion of the firm’s profits, thus improving their bargaining position.

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A related problem is directing an overwhelming amount of managerial time, attention, and resources to value-creating activities that produce the greatest margins—to the detri- ment of other important, albeit less profitable, activities. For example, a car manufacturer may focus too much on downstream activities, such as warranty fulfillment and financing operations, to the detriment of differentiation and cost of the cars themselves.

CAN COMPETITIVE STRATEGIES BE SUSTAINED? INTEGRATING AND APPLYING STRATEGIC MANAGEMENT CONCEPTS Thus far this chapter has addressed how firms can attain competitive advantages in the mar- ketplace. We discussed the three generic strategies—overall cost leadership, differentiation, and focus—as well as combination strategies. Next we discussed the importance of linking value-chain activities (both those within the firm and those linkages between the firm’s sup- pliers and customers) to attain such advantages. We also showed how successful competi- tive strategies enable firms to strengthen their position vis-à-vis the five forces of industry competition as well as how to avoid the pitfalls associated with the strategies.

Competitive advantages are, however, often short-lived. As we discussed in the beginning of Chapter 1, the composition of the firms that constitute the Fortune 500 list has experi- enced significant turnover in its membership over the years—reflecting the temporary nature of competitive advantages. Consider BlackBerry’s fall from grace. BlackBerry initially domi- nated the smartphone market. BlackBerry held 20 percent of the cell phone market in 2009, and its users were addicted to BlackBerry’s products, leading some to refer to them as crack- berrys. However, the firm’s market share quickly eroded with the introduction of touch screen smartphones from Apple, Samsung, and others. BlackBerry was slow to move away from its physical keyboards and saw its market share fall to 0.1 percent by 2016.53

Clearly, “nothing is forever” when it comes to competitive advantages. Rapid changes in technology, globalization, and actions by rivals from within—as well as outside—the industry can quickly erode a firm’s advantages. It is becoming increasingly important to recognize that the duration of competitive advantages is declining, especially in technology-intensive industries.54 Even in industries that are normally viewed as “low tech,” the increasing use of technology has suddenly made competitive advantages less sustainable.55 Amazon’s success in book retailing at the cost of Barnes & Noble, the former industry leader, as well as cable TV’s difficulties in responding to streaming services providers like Netflix and Hulu, serve to illustrate how difficult it has become for industry leaders to sustain competitive advan- tages that they once thought would last forever.

In this section, we will discuss some factors that help determine whether a strategy is sus- tainable over a long period of time. We will draw on some strategic management concepts from the first five chapters. To illustrate our points, we will look at a company, Atlas Door, which created an innovative strategy in its industry and enjoyed superior performance for several years. Our discussion of Atlas Door draws on a Harvard Business Review article by George Stalk, Jr.56 It was published some time ago (1988), which provides us the benefit of hindsight to make our points about the sustainability of competitive advantage. After all, the strategic management concepts we have been addressing in the text are quite timeless in their relevance to practice. A brief summary follows.

Atlas Door: A Case Example Atlas Door, a U.S.-based company, has enjoyed remarkable success. It has grown at an average annual rate of 15 percent in an industry with an overall annual growth rate of less than 5 percent. Recently, its pretax earnings were 20 percent of sales—about five times the

LO 5-5 What factors determine the sustainability of a firm’s competitive advantage.

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industry average. Atlas is debt-free, and by its 10th year, the company had achieved the number-one competitive position in its industry.

Atlas produces industrial doors—a product with almost infinite variety, involving limit- less choices of width and height and material. Given the importance of product variety, inventory is almost useless in meeting customer orders. Instead, most doors can be manu- factured only after the order has been placed.

How Did Atlas Door Create Its Competitive Advantages in the Marketplace? First, Atlas built just-in-time factories. Although simple in concept, they require extra tooling and machinery to reduce changeover times. Further, the manufacturing process must be organized by product and scheduled to start and complete with all of the parts available at the same time.

Second, Atlas reduced the time to receive and process an order. Traditionally, when cus- tomers, distributors, or salespeople called a door manufacturer with a request for price and delivery, they would have to wait more than one week for a response. In contrast, Atlas first streamlined and then automated its entire order-entry, engineering, pricing, and scheduling process. Atlas can price and schedule 95 percent of its incoming orders while the callers are still on the telephone. It can quickly engineer new special orders because it has preserved on computer the design and production data of all previous special orders—which drastically reduces the amount of reengineering necessary.

Third, Atlas tightly controlled logistics so that it always shipped only fully complete orders to construction sites. Orders require many components, and gathering all of them at the factory and making sure that they are with the correct order can be a time-consuming task. Of course, it is even more time-consuming to get the correct parts to the job site after the order has been shipped! Atlas developed a system to track the parts in production and the purchased parts for each order. This helped to ensure the arrival of all necessary parts at the shipping dock in time—a just-in-time logistics operation.

The Result? When Atlas began operations, distributors had little interest in its product. The established distributors already carried the door line of a much larger competitor and saw little to no reason to switch suppliers except, perhaps, for a major price concession. But as a start-up, Atlas was too small to compete on price alone. Instead, it positioned itself as the door supplier of last resort—the company people came to if the established supplier could not deliver or missed a key date.

Of course, with an average industry order-fulfillment time of almost four months, some calls inevitably came to Atlas. And when it did get the call, Atlas commanded a higher price because of its faster delivery. Atlas not only got a higher price, but its effective integration of value-creating activities saved time and lowered costs. Thus, it enjoyed the best of both worlds.

In 10 short years, the company replaced the leading door suppliers in 80 percent of the distributors in the United States. With its strategic advantage, the company could be selective—becoming the supplier for only the strongest distributors.

Are Atlas Door’s Competitive Advantages Sustainable? We will now take both the “pro” and “con” positions as to whether or not Atlas Door’s com- petitive advantages will be sustainable for a very long time. It is important, of course, to assume that Atlas Door’s strategy is unique in the industry, and the central issue becomes whether or not rivals will be able to easily imitate its strategy or create a viable substitute strategy.

“Pro” Position: The Strategy Is Highly Sustainable Drawing on Chapter 2, it is quite evi- dent that Atlas Door has attained a very favorable position vis-à-vis the five forces of indus- try competition. For example, it is able to exert power over its customers ( distributors) because of its ability to deliver a quality product in a short period of time. Also, its domi- nance in the industry creates high entry barriers for new entrants. It is also quite evident

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that Atlas Door has been able to successfully integrate many value-chain activities within the firm—a fact that is integral to its just-in-time strategy. As noted in Chapter 3, such integration of activities provides a strong basis for sustainability, because rivals would have difficulty in imitating this strategy due to causal ambiguity and path dependency (i.e., it is difficult to build up in a short period of time the resources that Atlas Door has accumulated and developed as well as disentangle the causes of what the valuable resources are or how they can be re-created). Further, as noted in Chapter 4, Atlas Door benefits from the social capital that it has developed with a wide range of key stakehold- ers (Chapter 1). These would include customers, employees, and managers (a reasonable assumption, given how smoothly the internal operations flow and the company’s long- term relationships with distributors). It would be very difficult for a rival to replace Atlas Door as the supplier of last resort—given the reputation that it has earned over time for “coming through in the clutch” on time-sensitive orders. Finally, we can conclude that Atlas Door has created competitive advantages in both overall low cost and differentia- tion (Chapter 5). Its strong linkages among value-chain activities—a requirement for its just-in-time operations—not only lower costs but enable the company to respond quickly to customer orders. As noted in Exhibit 5.4, many of the value-chain activities associated with a differentiation strategy reflect the element of speed or quick response.

“Con” Position: The Strategy Can Be Easily Imitated or Substituted An argument could be made that much of Atlas Door’s strategy relies on technologies that are rather well known and nonproprietary. Over time, a well-financed rival could imitate its strategy (via trial and error), achieve a tight integration among its value-creating activities, and implement a just- in-time manufacturing process. Because human capital is highly mobile (Chapter 4), a rival could hire away Atlas Door’s talent, and these individuals could aid the rival in transferring Atlas Door’s best practices. A new rival could also enter the industry with a large resource base, which might enable it to price its doors well under Atlas Door to build market share (but this would likely involve pricing below cost and would be a risky and nonsustainable strategy). Finally, a rival could potentially “leapfrog” the technologies and processes that Atlas Door has employed and achieve competitive superiority. With the benefit of hindsight, it could use the Internet to further speed up the linkages among its value-creating activities and the order-entry processes with its customers and suppliers. (But even this could prove to be a temporary advantage, since rivals could relatively easily do the same thing.)

What Is the Verdict? Both positions have merit. Over time, it would be rather easy to see how a new rival could achieve parity with Atlas Door—or even create a superior competi- tive position with new technologies or innovative processes. However, two factors make it extremely difficult for a rival to challenge Atlas Door in the short term: (1) The success that Atlas Door has enjoyed with its just-in-time scheduling and production systems—which involve the successful integration of many value-creating activities—helps the firm not only lower costs but also respond quickly to customer needs, and (2) the strong, positive repu- tational effects that it has earned with its customers increases their loyalty and would take significant time for rivals to match.

Finally, it is important to also understand that it is Atlas Door’s ability to appropriate most of the profits generated by its competitive advantages that make it a highly successful company. As we discussed in Chapter 3, profits generated by resources can be appropriated by a number of stakeholders such as suppliers, customers, employees, or rivals. The struc- ture of the industrial door industry makes such value appropriation difficult: The suppliers provide generic parts, no one buyer is big enough to dictate prices, the tacit nature of the knowledge makes imitation difficult, and individual employees may be easily replaceable. Still, even with the advantages that Atlas Door enjoys, it needs to avoid becoming compla- cent or it will suffer the same fate as the dominant firm it replaced.

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Strategies for Platform Markets Before moving on to our discussion of industry life-cycle stages and competitive strategy, we introduce and discuss an emerging trend: two-sided or platform markets. In these markets, firms act as intermediaries between two sets of platform users: buyers and sellers. Firms that thrive in these markets often do not produce a product themselves. Instead, successful platform firms create a business that attracts a large range of suppliers and a wide popula- tion of customers, becoming the go-to clearinghouse that both suppliers and customers turn to in order to facilitate a transaction. In doing so, they typically successfully combine ele- ments of both cost and differentiation advantages.

These types of markets have been in existence for a long period of time. For example, VISA became the largest credit card company by signing up both the most merchants and the most customers in their card network. Retailers and restaurants now perceive the need to accept VISA credit and debit cards because millions of customers carry them. On the other side, when considering which credit card(s) to carry, most customers feel the need to carry a VISA card since it is accepted by so many merchants. As the VISA example illus- trates, the sheer number of buyers and sellers using a given platform provides the platform firm with a differentiated market position while simultaneously allowing it to become a cost leader due to the economies of scale it accrues as it becomes the largest platform.

While these types of markets have existed for decades, they have become increasingly com- mon in the 21st century. Whether it is Amazon in retailing, Facebook in social networks, Airbnb in short-term housing rentals, Uber in driver services, Spotify in streaming services, or Etsy in craft products, platform businesses have taken on increasing prominence in the economy.

But how do firms position themselves to succeed in these two-sided markets? It involves a combination of actions to build a strong position and facilitate optimal interactions between suppliers and users. In doing so, these firms strive to simultaneously limit costs to users and also provide differentiated service. The issues platform businesses need to master to suc- ceed include the following.57

• Draw in users. The key to success in platform models is to generate the best (and often biggest) base of suppliers and customers. Thus, firms must develop effective pricing and incentives for users to attract and retain them. This typically involves subsidizing early and price-sensitive users. For example, Adobe was able to emerge as the dominant pdf software partly because it allowed users to read and print documents for free. As it established itself as “the” pdf reader software, producers of documents and those who wished to edit documents became increasingly willing to purchase software from Adobe. Thus, Adobe provided the product at no cost to some users while differentiating itself in the eyes of other users. Successful platform providers also find ways to attract and retain “marquee” users. YouTube has done this by allowing users to set up their own channel and compensate them for the volume of traffic they bring in.

• Create easy and informative customer interfaces. Platform business providers need to make it easy for users to plug into the platform. For example, Quicken Loans strives to differentiate itself with its Rocket Mortgage product, arguing it is the easiest and quickest system for applying for a home mortgage—typically taking less than 10 minutes to complete the application. By developing an easy to use app that requires no lending officer interaction, Quicken Loans was also able to build a more cost-efficient lending system than traditional loan brokers. Uber similarly worked to differentiate itself with a simple app for users to connect with a driver and by providing updated information on the expected arrival time of the driver. On the supplier side, Apple strives to ease the process for software developers by providing the operating system and underlying library codes needed to develop new software.

• Facilitate the best connections between suppliers and customers. Platform businesses can learn a great deal about their suppliers and customers by observing their search

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and usage patterns. Successful platform firms leverage this data to figure out how to best fill their matchmaking role in bringing together suppliers and users. Google is notable in its ability to tailor advertising to the search patterns of its users in order to increase the success rates for its advertising. Similarly, Airbnb has worked to create systems that increase the likelihood that hosts will agree to offers from potential renters. The firm realizes that renters get frustrated if their rental offers are declined. Additionally, hosts will be dissatisfied if offers come from undesirable renters. Using data analytics, Airbnb analyzed when specific hosts accepted and declined offers and their satisfaction ratings of renters to develop profiles of preferred renter characteristics. Using the resulting algorithm for matching renter characteristics and host preferences, the company saw a 4 percent increase in its rate of converting offers into accepted rental matches.

• Sequencing the growth of the business. To maximize the chance of success, platform firms must consciously plan out the sequence of their businesses. This involves thinking in terms of both geographic and product market expansion. In planning out its geographic market expansion, Uber analyzed the supply and demand of the taxi markets in cities across the country and first entered cities with the greatest shortage of taxis. Since it started in markets with unmet demand, Uber was able to expand quickly in these markets to be as cost efficient as possible. It also heavily advertised its business in settings where taxis were likely to be in short supply, such as sporting events and concerts. Once Uber established itself in these markets and developed a brand image, it expanded into other markets. Platform firms also need to consider both the need and opportunity of expanding their product scope. For example, Facebook has looked to continually extend its differentiation by expanding the range of services it offers, and as a result, has been able to put the squeeze on narrow platform providers, such as Twitter. Similarly, Spotify expanded from music to video streaming services in a quest to be a more complete service provider.

If successful, a platform provider becomes the dominant player linking suppliers and cus- tomers. This success offers the firm great flexibility in pricing its services as the firm gains a near monopoly in its market.

INDUSTRY LIFE-CYCLE STAGES: STRATEGIC IMPLICATIONS The industry life cycle refers to the stages of introduction, growth, maturity, and decline that occur over the life of an industry. In considering the industry life cycle, it is useful to think in terms of broad product lines such as personal computers, photocopiers, or long-distance telephone service. Yet the industry life-cycle concept can be explored from several levels, from the life cycle of an entire industry to the life cycle of a single variation or model of a specific product or service.

Why are industry life cycles important?58 The emphasis on various generic strate- gies, functional areas, value-creating activities, and overall objectives varies over the course of an industry life cycle. Managers must become even more aware of their firm’s strengths and weaknesses in many areas to attain competitive advantages. For example, firms depend on their research and development (R&D) activities in the introductory stage. R&D is the source of new products and features that everyone hopes will appeal to customers. Firms develop products and services to stimulate consumer demand. Later, during the maturity phase, the functions of the product have been defined, more competi- tors have entered the market, and competition is intense. Managers then place greater emphasis on production efficiencies and process (as opposed to the product) engineering

LO 5-6 The importance of considering the industry life cycle to determine a firm’s business-level strategy and its relative emphasis on functional area strategies and value-creating activities.

industry life cycle the stages of introduction, growth, maturity, and decline that typically occur over the life of an industry.

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in order to lower manufacturing costs. This helps to protect the firm’s market position and to extend the product life cycle because the firm’s lower costs can be passed on to consumers in the form of lower prices, and price-sensitive customers will find the product more appealing.

Exhibit 5.6 illustrates the four stages of the industry life cycle and how factors such as generic strategies, market growth rate, intensity of competition, and overall objectives change over time. Managers must strive to emphasize the key functional areas during each of the four stages and to attain a level of parity in all functional areas and value-creating activities. For example, although controlling production costs may be a primary concern during the maturity stage, managers should not totally ignore other functions such as marketing and R&D. If they do, they can become so focused on lowering costs that they miss market trends or fail to incorporate important product or process designs. Thus, the firm may attain low-cost products that have limited market appeal.

EXHIBIT 5.6 Stages of the Industry Life Cycle

Unit Sales

Time

Sales/ Profits

Profits

Generic strategies

Market growth rate

Number of segments

Intensity of competition

Emphasis on product design

Emphasis on process design

Major functional area(s) of concern

Overall objective

Differentiation

Low

Very few

Low

Very high

Low

Research and development

Increase market awareness

Differentiation

Very large

Some

Increasing

High

Low to moderate

Sales and marketing

Create consumer demand

Differentiation Overall cost leadership

Low to moderate

Many

Very intense

High

Low to moderate

Production

Defend market share and extend product life cycles

Overall cost leadership Focus

Negative

Few

Changing

Low

Low

General management and finance

Consolidate, maintain, harvest, or exit

Stage

Factor Introduction Growth Maturity Decline

Time

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It is important to point out a caveat. While the life-cycle idea is analogous to a living organ- ism (i.e., birth, growth, maturity, and death), the comparison has limitations.59 Products and services go through many cycles of innovation and renewal. Typically, only fad products have a single life cycle. Maturity stages of an industry can be “transformed” or followed by a stage of rapid growth if consumer tastes change, technological innovations take place, or new develop- ments occur. The cereal industry is a good example. When medical research indicated that oat consumption reduced a person’s cholesterol, sales of Quaker Oats increased dramatically.60

Strategies in the Introduction Stage In the introduction stage, products are unfamiliar to consumers.61 Market segments are not well defined, and product features are not clearly specified. The early development of an industry typically involves low sales growth, rapid technological change, operating losses, and the need for strong sources of cash to finance operations. Since there are few players and not much growth, competition tends to be limited.

Success requires an emphasis on research and development and marketing activities to enhance awareness. The challenge becomes one of (1) developing the product and finding a way to get users to try it and (2) generating enough exposure so the product emerges as the “standard” by which all other rivals’ products are evaluated.

There’s an advantage to being the “first mover” in a market.62 It led to Coca-Cola’s suc- cess in becoming the first soft-drink company to build a recognizable global brand and enabled Caterpillar to get a lock on overseas sales channels and service capabilities.

However, there can also be a benefit to being a “late mover.” Target carefully considered its decision to delay its Internet strategy. Compared to its competitors Walmart and Kmart, Target was definitely an industry laggard. But things certainly turned out well:63

By waiting, Target gained a late-mover advantage. The store was able to use competitors’ mistakes as its own learning curve. This saved money, and customers didn’t seem to mind the wait: When Target finally opened its website, it quickly captured market share from both Kmart and Walmart Internet shoppers. Forrester Research Internet analyst Stephen Zrike commented, “There’s no question, in our mind, that Target has a far better understanding of how consumers buy online.”

Examples of products currently in the introductory stages of the industry life cycle include electric vehicles and space tourism.

Strategies in the Growth Stage The growth stage is characterized by strong increases in sales. Such potential attracts other rivals. In the growth stage, the primary key to success is to build consumer prefer- ences for specific brands. This requires strong brand recognition, differentiated products, and the financial resources to support a variety of value-chain activities such as marketing and sales, and research and development. Whereas marketing and sales initiatives were mainly directed at spurring aggregate demand—that is, demand for all such products in the introduction stage—efforts in the growth stage are directed toward stimulating selective demand, in which a firm’s product offerings are chosen instead of a rival’s.

Revenues increase at an accelerating rate because (1) new consumers are trying the product and (2) a growing proportion of satisfied consumers are making repeat purchases.64 In gen- eral, as a product moves through its life cycle, the proportion of repeat buyers to new pur- chasers increases. Conversely, new products and services often fail if there are relatively few repeat purchases. For example, Alberto-Culver introduced Mr. Culver’s Sparklers, which were solid air fresheners that looked like stained glass. Although the product quickly went from the introductory to the growth stage, sales collapsed. Why? Unfortunately, there were few repeat purchasers because buyers treated them as inexpensive window decorations, left them there, and felt little need to purchase new ones. Examples of products currently in the growth stage include cloud computing data storage services and ultra-high-definition television (UHD TV).

introduction stage the first stage of the industry life cycle, characterized by (1) new products that are not known to customers, (2) poorly defined market segments, (3) unspecified product features, (4) low sales growth, (5) rapid technological change, (6) operating losses, and (7) a need for financial support.

growth stage the second stage of the product life cycle, characterized by (1) strong increases in sales; (2) growing competition; (3) developing brand recognition; and (4) a need for financing complementary value- chain activities such as marketing, sales, customer service, and research and development.

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Strategies in the Maturity Stage In the maturity stage aggregate industry demand softens. As markets become saturated, there are few new adopters. It’s no longer possible to “grow around” the competition, so direct competition becomes predominant.65 With few attractive prospects, marginal competitors exit the market. At the same time, rivalry among existing rivals intensifies because of fierce price competition at the same time that expenses associated with attracting new buyers are rising. Advantages based on efficient manufacturing operations and process engineering become more important for keeping costs low as customers become more price-sensitive. It also becomes more difficult for firms to differentiate their offerings, because users have a greater understanding of products and services.

An article in Fortune magazine that addressed the intensity of rivalry in mature markets was aptly titled “A Game of Inches.” It stated, “Battling for market share in a slowing indus- try can be a mighty dirty business. Just ask laundry soap archrivals Unilever and Procter & Gamble.”66 These two firms have been locked in a battle for market share since 1965. Why is the competition so intense? There is not much territory to gain and industry sales were flat. An analyst noted, “People aren’t getting any dirtier.” Thus, the only way to win is to take market share from the competition. To increase its share, Procter & Gamble (P&G) spends $100 million a year promoting its Tide brand on television, billboards, buses, magazines, and the Internet. But Unilever isn’t standing still. Armed with an $80 million budget, it launched a soap tablet product named Wisk Dual Action Tablets. For example, it delivered samples of this product to 24 million U.S. homes in Sunday newspapers, followed by a series of TV ads. P&G launched a counteroffensive with Tide Rapid Action Tablets ads showed in side- by-side comparisons of the two products dropped into beakers of water. In the promotion, P&G claimed that its product is superior because it dissolves faster than Unilever’s product.

Although this is only one example, many product classes and industries, including con- sumer products such as beer, automobiles, and athletic shoes, are in maturity.

Firms do not need to be “held hostage” to the life-cycle curve. By positioning or reposi- tioning their products in unexpected ways, firms can change how customers mentally cat- egorize them. Thus, firms are able to rescue products floundering in the maturity phase of their life cycles and return them to the growth phase.

Two positioning strategies that managers can use to affect consumers’ mental shifts are reverse positioning, which strips away “sacred” product attributes while adding new ones, and breakaway positioning, which associates the product with a radically different category.67

Reverse Positioning This strategy assumes that although customers may desire more than the baseline product, they don’t necessarily want an endless list of features. With reverse position- ing, companies make the creative decision to step off the augmentation treadmill and shed prod- uct attributes that the rest of the industry considers sacred. Then, once a product is returned to its baseline state, the stripped-down product adds one or more carefully selected attributes that would usually be found only in a highly augmented product. Such an unconventional combina- tion of attributes allows the product to assume a new competitive position within the category and move backward from maturity into a growth position on the life-cycle curve.

Breakaway Positioning As noted above, with reverse positioning, a product establishes a unique position in its category but retains a clear category membership. However, with break- away positioning, a product escapes its category by deliberately associating with a different one. Thus, managers leverage the new category’s conventions to change both how products are consumed and with whom they compete. Instead of merely seeing the breakaway product as simply an alternative to others in its category, consumers perceive it as altogether different.

When a breakaway product is successful in leaving its category and joining a new one, it is able to redefine its competition. Similar to reverse positioning, this strategy permits the product to shift backward on the life-cycle curve, moving from the rather dismal maturity phase to a thriving growth opportunity.

maturity stage the third stage of the product life cycle, characterized by (1) slowing demand growth, (2) saturated markets, (3) direct competition, (4) price competition, and (5) strategic emphasis on efficient operations.

breakaway positioning a break in the industry tendency to incrementally improve products along specific dimensions, characteristic of the product life cycle, by offering products that are still in the industry but are perceived by customers as being different.

reverse positioning a break in the industry tendency to continuously augment products, characteristic of the product life cycle, by offering products with fewer product attributes and lower prices.

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Strategies in the Decline Stage Although all decisions in the phases of an industry life cycle are important, they become par- ticularly difficult in the decline stage. Firms must face up to the fundamental strategic choices of either exiting or staying and attempting to consolidate their position in the industry.68

The decline stage occurs when industry sales and profits begin to fall. Typically, changes in the business environment are at the root of an industry or product group entering this stage.69 Changes in consumer tastes or a technological innovation can push a product into decline. For example, the advent of online news services pushed the print newspaper and news magazine businesses into a rapid decline.

Products in the decline stage often consume a large share of management time and finan- cial resources relative to their potential worth. Sales and profits decline. Also, competitors may start drastically cutting their prices to raise cash and remain solvent. The situation is further aggravated by the liquidation of assets, including inventory, of some of the competi- tors that have failed. This further intensifies price competition.

In the decline stage, a firm’s strategic options become dependent on the actions of rivals. If many competitors leave the market, sales and profit opportunities increase. On the other hand, prospects are limited if all competitors remain.70 If some competitors merge, their increased market power may erode the opportunities for the remaining players. Managers must carefully monitor the actions and intentions of competitors before deciding on a course of action.

Four basic strategies are available in the decline phase: maintaining, harvesting, exiting, and consolidating.71

• Maintaining refers to keeping a product going without significantly reducing marketing support, technological development, or other investments, in the hope that competitors will eventually exit the market. For example, even though most documents are sent digitally, there is still a significant market for fax machines since many legal and investment documents must still be signed and sent using a fax. This mode of transmission is still seen as more secure than other means of transmission. Thus, there may still be the potential for revenues and profits.

• Harvesting involves obtaining as much profit as possible and requires that costs be reduced quickly. Managers should consider the firm’s value-creating activities and cut associated budgets. Value-chain activities to consider are primary (e.g., operations, sales and marketing) and support (e.g., procurement, technology development). The objective is to wring out as much profit as possible.

• Exiting the market involves dropping the product from a firm’s portfolio. Since a residual core of consumers exist, eliminating it should be carefully considered. If the firm’s exit involves product markets that affect important relationships with other product markets in the corporation’s overall portfolio, an exit could have repercussions for the whole corporation. For example, it may involve the loss of valuable brand names or human capital with a broad variety of expertise in many value-creating activities such as marketing, technology, and operations.

• Consolidation involves one firm acquiring at a reasonable price the best of the surviving firms in an industry. This enables firms to enhance market power and acquire valuable assets. One example of a consolidation strategy took place in the defense industry in the early 1990s. As the cliché suggests, “peace broke out” at the end of the Cold War and overall U.S. defense spending levels plummeted.72 Many companies that make up the defense industry saw more than 50 percent of their market disappear. Only one-quarter of the 120,000 companies that once supplied the Department of Defense still serve in that capacity; the others have shut down their defense business or dissolved altogether. But one key player, Lockheed Martin, became a dominant rival by pursuing an aggressive strategy of consolidation. During the 1990s, it purchased 17 independent entities, including General Dynamics’

decline stage the fourth stage of the product life cycle, characterized by (1) falling sales and profits, (2) increasing price competition, and (3) industry consolidation.

harvesting strategy a strategy of wringing as much profit as possible out of a business in the short to medium term by reducing costs.

consolidation strategy a firm’s acquiring or merging with other firms in an industry in order to enhance market power and gain valuable assets.

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tactical aircraft and space systems divisions, GE Aerospace, Goodyear Aerospace, and Honeywell Electro-Optics. These combinations enabled Lockheed Martin to emerge as the top provider to three governmental customers: the Department of Defense, the Department of Energy, and NASA.

Examples of products currently in the decline stage of the industry life cycle include the video-rental business (being replaced by video on demand), hard disk drives (being replaced by solid-state memory and cloud storage), and desktop computers (being replaced by note- book and tablet computers).

The introduction of new technologies and associated products does not always mean that old technologies quickly fade away. Research shows that in a number of cases, old tech- nologies actually enjoy a very profitable “last gasp.”73 Examples include personal computers (versus tablet computers and other mobile devices), coronary artery bypass graft surgery (versus angioplasty), and vinyl records (versus CDs and digital downloads of music). In each case, the advent of new technology prompted predictions of the demise of the older technology, but each of these has proved to be a resilient survivor. What accounts for their continued profitability and survival?

Retreating to more defensible ground is one strategy that firms specializing in technologies threatened with rapid obsolescence have followed. For example, while angioplasty may be appropriate for relatively healthier patients with blocked arteries, sicker, higher-risk patients seem to benefit more from coronary artery bypass graft surgery. This enabled the surgeons to concentrate on the more difficult cases and improve the technology itself. The advent of television unseated the radio as the major source of entertainment from American homes. However, the radio has survived and even thrived in venues where people are also engaged in other activities, such as driving.

Using the new to improve the old is a second approach. Microsoft has integrated ele- ments of mobile technology into the Windows operating system to address the challenge of Google’s Android and Apple’s iOS.

Improving the price-performance trade-off is a third approach. IBM continues to make money selling mainframes long after their obituary was written. It retooled the technology using low- cost microprocessors and cut their prices drastically. Further, it invested and updated the software, enabling it to offer clients such as banks better performance and lower costs.

Turnaround Strategies A turnaround strategy involves reversing performance decline and reinvigorating growth toward profitability.74 A need for turnaround may occur at any stage in the life cycle but is more likely to occur during maturity or decline.

Most turnarounds require a firm to carefully analyze the external and internal envi- ronments.75 The external analysis leads to identification of market segments or customer groups that may still find the product attractive.76 Internal analysis results in actions aimed at reduced costs and higher efficiency. A firm needs to undertake a mix of both internally and externally oriented actions to effect a turnaround.77 In effect, the cliché “You can’t shrink yourself to greatness” applies.

A study of 260 mature businesses in need of a turnaround identified three strategies used by successful companies.78

• Asset and cost surgery. Very often, mature firms tend to have assets that do not produce any returns. These include real estate, buildings, and so on. Outright sales or sale and leaseback free up considerable cash and improve returns. Investment in new plants and equipment can be deferred. Firms in turnaround situations try to aggressively cut administrative expenses and inventories and speed up collection of receivables. Costs also can be reduced by outsourcing production of various inputs for which market prices may be cheaper than in-house production costs.

turnaround strategy a strategy that reverses a firm’s decline in performance and returns it to growth and profitability.

LO 5-7 The need for turnaround strategies that enable a firm to reposition its competitive position in an industry.

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• Selective product and market pruning. Most mature or declining firms have many product lines that are losing money or are only marginally profitable. One strategy is to discontinue such product lines and focus all resources on a few core profitable areas. For example, in 2014, Procter & Gamble announced that it would sell off or close down up to 100 of its brands, allowing the firm to improve its efficiency and its innovativeness as it focused on its core brands. The remaining 70 to 80 “core” brands accounted for 90 percent of the firm’s sales.

• Piecemeal productivity improvements. There are many ways in which a firm can eliminate costs and improve productivity. Although individually these are small gains, they cumulate over a period of time to substantial gains. Improving business processes by reengineering them, benchmarking specific activities against industry leaders, encouraging employee input to identify excess costs, increasing capacity utilization, and improving employee productivity lead to a significant overall gain.

Strategy Spotlight 5.5 provides an illustration of a turnaround effort by focusing on the dramatic strategic realignment that Mindy Grossman undertook at HSN (formerly the Home Shopping Network).

5.5 STRATEGY SPOTLIGHT HOW MINDY GROSSMAN LED HSN’S REMARKABLE TURNAROUND Mindy Grossman took over the helm of HSN, formerly known as the Home Shopping Network, in 2008, at a very trying time. The Home Shopping Network was falling behind the times as retailing technology changed rapidly in the digital age, and it was saddled with the reputation of being the home for C-list celebrities hawking relatively low-grade jewelry, fashion, and health and beauty prod- ucts to couch potatoes. The firm had experienced significant lead- ership turmoil, with seven CEOs in the prior 10 years. It was also facing some of the worst economic conditions since the 1930s. Not surprisingly, the firm experienced a multibillion-dollar loss in 2008.

However, things have changed dramatically since those dark days. HSN generated 169 million in profit on $3.7 billion in sales in 2015. The firm’s stock price, which traded as low as $1.42 in 2008, was trading at over $34 a share in late 2016.

At the center of HSN’s turnaround is Mindy Grossman, the firm’s CEO. She came to HSN after working for a number of clothing manufacturers, including Ralph Lauren, Tommy Hilfiger, and, most recently, Nike. Her recipe for the turnaround reflects a mix of hard business acumen combined with an ability to engage stakeholders in the firm to move the turnaround forward. With her changes, she’s moved HSN from being a dowdy cable TV channel to a retailer that meets the needs of busy women by providing them a place to shop wherever they are—at home through their TVs or while traveling for work or at their kids’ soccer games through their phones or tablets.

What are Grossman’s lessons for managing a turnaround? First, she found value in engaging with employees. Her first day at HSN, she chose to go through the same new-employee orienta- tion that all employees go through. She felt this humanized her in the minds of other employees. On her second day, she held a town-hall meeting so that she could directly introduce herself and

set the tone that she was accessible and that all employees were valued and could have a future at HSN. She also set up a policy to regularly have breakfasts and lunches with employees and says, “I learn more from those than from reading any report.”

Second, she got the lineup of employees right. She cat- egorizes workers into three categories. “Evangelists” are the employees who are truly enthusiastic about the company and try to rally others. The “Interested” are those who are invested in the firm’s success but have something of a wait-and-see atti- tude. The “Blockers” are toxic and work to limit the firm’s ability to change. She saw the need to rid the company of toxicity and pushed out the Blockers quickly. This allowed her to develop a management team, which largely stayed intact for several years, that reflected the strong skills and commitment she desired.

She tailored the company’s offerings to meet the changing needs of her customer base. In the deep days of the recession in 2008–2009, this meant shifting from offering high-priced jewelry and fashions to providing products and services that helped HSN’s customers save time and money. Later, this meant dramatically growing the company’s mobile platforms. Today, over half the new customers come to HSN through their mobile phones. One of the new services attracting them is HSN’s online arcade, where cus- tomers can play games that allow them to win HSN merchandise, which generated over 100 million plays in its first year.

Key to it all is staying focused on what HSN’s strategy is and who its customers are. In the words of Grossman, “We’re not trying to be Amazon, all things to all people. We have a highly specialized customer and want to give her the best experience somewhere she can trust.”

Sources: Goudreau, J. 2012. How Mindy Grossman is transforming HSN. forbes. com, August 29: np; Banjo, S. 2013. HSN enjoys a mobile-shopping rebirth in the digital age. wsj.com, July 5: np; and Snyder, B. 2014. How Mindy Grossman turned around HSN. gsb.stanford.edu/insights, June 5: np.

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ISSUE FOR DEBATE

Issue for Debate Shazz Lewis is aiming to shake up the beer business by entering with a brew aimed specifically at women. On its website, Chick beer is described as “the only beer brand designed for women, who drink 25 percent of all beer sold in the U.S.” Shazz got the inspiration for Chick beer when she was looking over the more than 400 beers sold in the liquor store that she and her husband owned. She concluded, “there was nothing that shouted out female.” Since women consume 700 million cases of beer a year, she saw this as a market that hasn’t received enough focus.

To best reach her target market of 21 to 35-year-old women, she crafted it to be low in calories (only 97) and have a “very mellow beer flavor” with a little less carbonation “so it doesn’t make you burp.” Still, she says this is not a weak beer. “It needed to be a stand-up beer—not fruity-flavored, as full-bodied as a light beer could be.” Turning to the look of the product, she designed the packaging to highlight the brand’s image. The cardboard carrier is hot pink and black in the image of a purse and includes the tagline “witness the chickness.” The bottle labels show the image of a little black dress on a hot pink background. This all has led Megan Gibson, a correspondent for Time magazine, to call the brand “patronizing.” Jennifer Litz, editor of Craft Business daily, commented that some beer drinkers may believe “it’s a bit too obviously pandering to create a beer specifically geared toward women.” When Lewis was questioned on the brand name and the packaging, she commented, “I happen to think all things chick are terrific. I came up with a slogan that was a little in your face. It was empowering to turn it on its head.”

Discussion Questions 1. Is the name and packaging of Chick beer patronizing to women, or is it empowering to turn

what has been, at times, a derogatory term on its head? 2. How effectively does Chick beer create differentiation to draw in female beer drinkers? How

successful do you think the brand could be? 3. What recommendations would you have for Shazz Lewis to enhance her chances of success

in the beer market?

Sources: Shockey, L. 2011. Chick beer founder Shazz Lewis dishes on making girly beer. villagevoice.com, September 1: np; Gibson, M. 2011. New ‘Chick’ beer is a lady-catered brew in a girly, pink package. newsfeed.time.com, September 7: np; Snider, M. 2016. Women to get their own beer. lsj.com, May 29: np.

Reflecting on Career Implications . . . This chapter discusses how firms build competitive advantage in the marketplace. The following questions ask you to consider how you can contribute to the competitive advantage of firms you work at as well as how you can develop your own differentiated set of skills and enhance the growth phase of your career.

Types of Competitive Advantage: Are you aware of your organization’s business-level strategy? What do you do to help your firm either increase differentiation or lower costs? Can you demonstrate to your superiors how you have contributed to the firm’s chosen business-level strategy?

Types of Competitive Advantage: What is your own competitive advantage? What opportunities does your current job provide to enhance your competitive advantage? Are you making the best use of your competitive advantage? If not, what organizations might provide you with better opportunities for doing so? Does your résumé clearly reflect your competitive advantage? Or are you “stuck in the middle”?

Understanding Your Differentiation: When looking for a new job or for advancement in your current firm, be conscious of being able to identify what differentiates you from other applicants. Consider the items in Exhibit 5.4 as you work to identify what distinguishes you from others.

CHAPTER 5 :: BUSINESS-LEVEL STRATEGY 167

Industry Life Cycle: Before you go for a job interview, identify the life-cycle stage of the industry within which your firm is located. You are more likely to have greater opportunities for career advancement in an industry in the growth stage than one in the decline stage.

Industry Life Cycle: If you sense that your career is maturing (or in the decline phase!), what actions can you take to restore career growth and momentum (e.g., training, mentoring, professional networking)? Should you actively consider professional opportunities in other industries?

How and why firms outperform each other goes to the heart of strategic management. In this chapter, we identified three generic strategies and discussed how firms are able not only to attain advantages over competitors

but also to sustain such advantages over time. Why do some advantages become long-lasting while others are quickly imitated by competitors?

The three generic strategies—overall cost leadership, differentiation, and focus—form the core of this chapter. We began by providing a brief description of each generic strategy (or competitive advantage) and furnished examples of firms that have successfully implemented these strategies. Successful generic strategies invariably enhance a firm’s position vis-à- vis the five forces of that industry—a point that we stressed and illustrated with examples. However, as we pointed out, there are pitfalls to each of the generic strategies. Thus, the sustainability of a firm’s advantage is always challenged because of imitation or substitution by new or existing rivals. Such competitor moves erode a firm’s advantage over time.

We also discussed the viability of combining (or integrating) overall cost leadership and generic differentiation strategies. If successful, such integration can enable a firm to enjoy superior performance and improve its competitive position. However, this is challenging, and managers must be aware of the potential downside risks associated with such an initiative.

We addressed the challenges inherent in determining the sustainability of competitive advantages. Drawing on an example from a manufacturing industry, we discussed both the “pro” and “con” positions as to why competitive advantages are sustainable over a long period of time.

The concept of the industry life cycle is a critical contingency that managers must take into account in striving to create and sustain competitive advantages. We identified the four stages of the industry life cycle— introduction, growth, maturity, and decline—and suggested how these stages can play a role in decisions that managers must make at the business level. These include overall strategies as well as the relative emphasis on functional areas and value-creating activities.

When a firm’s performance severely erodes, turnaround strategies are needed to reverse its situation and enhance its

summary

competitive position. We have discussed three approaches— asset cost surgery, selective product and market pruning, and piecemeal productivity improvements.

SUMMARY REVIEW QUESTIONS 1. Explain why the concept of competitive advantage is

central to the study of strategic management. 2. Briefly describe the three generic strategies—overall

cost leadership, differentiation, and focus. 3. Explain the relationship between the three generic

strategies and the five forces that determine the average profitability within an industry.

4. What are some of the ways in which a firm can attain a successful turnaround strategy?

5. Describe some of the pitfalls associated with each of the three generic strategies.

6. Can firms combine the generic strategies of overall cost leadership and differentiation? Why or why not?

7. Explain why the industry life-cycle concept is an important factor in determining a firm’s business- level strategy.

business-level strategy 139 generic strategies 140 overall cost leadership 141 experience curve 141 competitive parity 141 differentiation strategy 145 focus strategy 150 combination strategies 152

mass customization 152 profit pool 153 industry life cycle 159 introduction stage 161 growth stage 161 maturity stage 162 reverse positioning 162 breakaway

positioning 162 decline stage 163 harvesting strategy 163 consolidation strategy 163 turnaround strategy 164

key terms

EXPERIENTIAL EXERCISE What are some examples of primary and support activities that enable Nucor, a $19 billion steel manufacturer, to achieve a low-cost strategy? (Fill in the following table.)

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Value-Chain Activity Yes/No How Does Nucor Create Value for the Customer?

Primary:

Inbound logistics

Operations

Outbound logistics

Marketing and sales

Service

Support:

Procurement

Technology development

Human resource management

General administration

APPLICATION QUESTIONS & EXERCISES 1. Research Amazon. How has this firm been able to

combine overall cost leadership and differentiation strategies?

2. Choose a firm with which you are familiar in your local business community. Is the firm successful in following one (or more) generic strategies? Why or why not? What do you think are some of the challenges it faces in implementing these strategies in an effective manner?

3. Think of a firm that has attained a differentiation focus or cost focus strategy. Are its advantages sustainable? Why? Why not? (Hint: Consider its position vis-à-vis Porter’s five forces.)

4. Think of a firm that successfully achieved a combination overall cost leadership and

differentiation strategy. What can be learned from this example? Are the advantages sustainable? Why? Why not? (Hint: Consider its competitive position vis- à-vis Porter’s five forces.)

ETHICS QUESTIONS 1. Can you think of a company that suffered ethical

consequences as a result of an overemphasis on a cost leadership strategy? What do you think were the financial and nonfinancial implications?

2. In the introductory stage of the product life cycle, what are some of the unethical practices that managers could engage in to enhance their firm’s market position? What could be some of the long- term implications of such actions?

1. Gasparro, A. & Checkler, J. 2015. A&P bankruptcy filing indicates likely demise. wsj.com. July 20: np; Bomey, N. & Nguyen, H. 2015. A&P grocery chain files bankruptcy again. usatoday.com. July 20: np.

2. For a perspective by Porter on competitive strategy, refer to Porter, M. E. 1996. What is strategy? Harvard Business Review, 74(6): 61–78.

3. For insights into how a start-up is using solar technology, see Gimbel, B. 2009. Plastic power. Fortune, February 2: 34.

4. Useful insights on strategy in an economic downturn are in Rhodes,

D. & Stelter, D. 2009. Seize advantage in a downturn. Harvard Business Review, 87(2): 50–58.

5. Some useful ideas on maintaining competitive advantages can be found in Ma, H. & Karri, R. 2005. Leaders beware: Some sure ways to lose your competitive advantage. Organizational Dynamics, 343(1): 63–76.

6. Miller, A. & Dess, G. G. 1993. Assessing Porter’s model in terms of its generalizability, accuracy, and simplicity. Journal of Management Studies, 30(4): 553–585.

7. Gasparro, A. & Martin, T. 2012. What’s wrong with America’s supermarkets? wsj.com, July 12: np.

8. For insights on how discounting can erode a firm’s performance, read Stibel, J. M. & Delgrosso, P. 2008. Discounts can be dangerous. Harvard Business Review, 66(12): 31.

9. For a scholarly discussion and analysis of the concept of competitive parity, refer to Powell, T. C. 2003. Varieties of competitive parity. Strategic Management Journal, 24(1): 61–86.

10. Rao, A. R., Bergen, M. E., & Davis, S. 2000. How to fight a price war. Harvard Business Review, 78(2): 107–120.

11. Oltermann, P. & McClanahan, P. 2014. Tata Nano safety under scrutiny after dire crash test results. guardian. com. January 31: np.

REFERENCES

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12. Burrus, D. 2011. Flash foresight: How to see the invisible and do the impossible. New York: HarperCollins.

13. Corstjens, M. & Lal, R. 2012. Retail doesn’t cross borders. Harvard Business Review, April: 104–110.

14. Ng, S. 2014. Zulily customers play the waiting game. wsj.com, May 4: np.

15. Interesting insights on Walmart’s effective cost leadership strategy are found in Palmeri, C. 2008. Wal-Mart is up for this downturn. BusinessWeek, November 6: 34.

16. An interesting perspective on the dangers of price discounting is Mohammed, R. 2011. Ditch the discounts. Harvard Business Review, 89(1/2): 23–25.

17. Dholakia, U. M. 2011. Why employees can wreck promotional offers. Harvard Business Review, 89(1/2): 28.

18. Jacobs, A. 2010. Workers in China voting with their feet. International Herald Tribune, July 13: 1, 14.

19. For a perspective on the sustainability of competitive advantages, refer to Barney, J. 1995. Looking inside for competitive advantage. Academy of Management Executive, 9(4): 49–61.

20. Thornton, E. 2001. Why e-brokers are broker and broker. BusinessWeek, January 22: 94.

21. Mohammed, R. 2011. Ditch the discounts. Harvard Business Review, 89(1/2): 23–25.

22. Wilson, D. 2012. Big Beer dresses up in craft brewers’ clothing. Fortune. com, November 15: np.

23. For an “ultimate” in differentiated services, consider time-shares in exotic automobiles such as Lamborghinis and Bentleys. Refer to Stead, D. 2008. My Lamborghini— today, anyway. BusinessWeek, January 18:17.

24. For an interesting perspective on the value of corporate brands and how they may be leveraged, refer to Aaker, D. A. 2004, California Management Review, 46(3): 6–18.

25. A unique perspective on differentiation strategies is Austin, R. D. 2008. High margins and the quest for aesthetic coherence. Harvard Business Review, 86(1): 18–19.

26. Eng, D. 2011. Cheesecake Factory’s winning formula. Fortune, May 2: 19–20.

27. For a discussion on quality in terms of a company’s software and information systems, refer to Prahalad, C. K. & Krishnan, M. S. 1999. The new meaning of quality in the information age. Harvard Business Review, 77(5): 109–118.

28. The role of design in achieving differentiation is addressed in Brown, T. 2008. Design thinking. Harvard Business Review, 86(6): 84–92.

29. Taylor, A., III. 2001. Can you believe Porsche is putting its badge on this car? Fortune, February 19: 168–172.

30. Roberts, P. & Dowling, G. 2008. Corporate reputation and sustained superior financial performance. Strategic Management Journal, 23: 1077–1093.

31. Mann, J. 2010. The best service in the world. Networking Times, January: np.

32. Bonnabeau, E., Bodick, N., & Armstrong, R. W. 2008. A more rational approach to new-product development. Harvard Business Review, 66(3): 96–102.

33. Insights on Google’s innovation are in Iyer, B. & Davenport, T. H. 2008. Reverse engineering Google’s innovation machine. Harvard Business Review, 66(4): 58–68.

34. A discussion of how a firm used technology to create product differentiation is in Mehta, S. N. 2009. Under Armour reboots. Fortune, February 2: 29–33 (5).

35. Bertini, M. & Wathieu, L. 2010. How to stop customers from fixating on price. Harvard Business Review, 88(5): 84–91.

36. The authors would like to thank Scott Droege, a faculty member at Western Kentucky University, for providing this example.

37. Dixon, M., Freeman, K., & Toman, N. 2010. Stop trying to delight your customers. Harvard Business Review, 88(7/8).

38. Flint, J. 2004. Stop the nerds. Forbes, July 5: 80; and Fahey, E. 2004. Over- engineering 101. Forbes, December 13: 62.

39. Symonds, W. C. 2000. Can Gillette regain its voltage? BusinessWeek, October 16: 102–104.

40. Caplan, J. 2006. In a real crunch. Inside Business, July: A37–A38.

41. Gadiesh, O. & Gilbert, J. L. 1998. Profit pools: A fresh look at strategy. Harvard Business Review, 76(3): 139–158.

42. Colvin, G. 2000. Beware: You could soon be selling soybeans. Fortune, November 13: 80.

43. Anders, G. 2012. How LinkedIn has turned your resume into a cash machine. Forbes.com, July 16: np.

44. Burrus, D. 2011. Flash foresight: How to see the invisible and do the impossible. New York: HarperCollins.

45. Hall, W. K. 1980. Survival strategies in a hostile environment, Harvard Business Review, 58: 75–87; on

the paint and allied products industry, see Dess, G. G. & Davis, P. S. 1984. Porter’s (1980) generic strategies as determinants of strategic group membership and organizational performance. Academy of Management Journal, 27: 467–488; for the Korean electronics industry, see Kim, L. & Lim, Y. 1988. Environment, generic strategies, and performance in a rapidly developing country: A taxonomic approach. Academy of Management Journal, 31: 802–827; Wright, P., Hotard, D., Kroll, M., Chan, P., & Tanner, J. 1990. Performance and multiple strategies in a firm: Evidence from the apparel industry. In Dean, B. V. & Cassidy, J. C. (Eds.), Strategic management: Methods and studies: 93–110. Amsterdam: Elsevier-North Holland; and Wright, P., Kroll, M., Tu, H., & Helms, M. 1991. Generic strategies and business performance: An empirical study of the screw machine products industry. British Journal of Management, 2: 1–9.

46. Gilmore, J. H. & Pine, B. J., II. 1997. The four faces of customization. Harvard Business Review, 75(1): 91–101.

47. Heracleous, L. & Wirtz, J. 2010. Singapore Airlines’ balancing act. Harvard Business Review, 88(7/8): 145–149.

48. Gilmore & Pine, op. cit. For interesting insights on mass customization, refer to Cattani, K., Dahan, E., & Schmidt, G. 2005. Offshoring versus “spackling.” MIT Sloan Management Review, 46(3): 6–7.

49. Goodstein, L. D. & Butz, H. E. 1998. Customer value: The linchpin of organizational change. Organizational Dynamics, Summer: 21–34.

50. Kiron, D. 2013. From value to vision: Reimagining the possible with data analytics. MIT Sloan Management Review Research Report, Spring: 1–19.

51. Gadiesh & Gilbert, op. cit., pp. 139–158.

52. Insights on the profit pool concept are addressed in Reinartz, W. & Ulaga, W. 2008. How to sell services more profitably. Harvard Business Review, 66(5): 90–96.

53. statista.com/statistics/263439/ global-market-share-held-by-rim- smartphones/.

54. For an insightful, recent discussion on the difficulties and challenges associated with creating advantages that are sustainable for any reasonable period of time and suggested strategies, refer to D’Aveni, R. A., Dagnino, G. B., & Smith,

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K. G. 2010. The age of temporary advantage. Strategic Management Journal, 31(13): 1371–1385. This is the lead article in a special issue of this journal that provides many ideas that are useful to both academics and practicing managers. For an additional examination of declining advantage in technologically intensive industries, see Vaaler, P. M. & McNamara, G. 2010. Are technology-intensive industries more dynamically competitive? No and yes. Organization Science, 21: 271–289.

55. Rita McGrath provides some interesting ideas on possible strategies for firms facing highly uncertain competitive environments: McGrath, R. G. 2011. When your business model is in trouble. Harvard Business Review, 89(1/2): 96–98.

56. The Atlas Door example draws on Stalk, G., Jr. 1988. Time—the next source of competitive advantage. Harvard Business Review, 66(4): 41–51.

57. Eisenmann, T., Parker, G., & Van Alstyne, M. 2006. Strategies for two-sided markets. hbr.org. October: np; Bonchek, M. & Choudary, S. 2013. Three elements of a successful platform strategy. hbr.org. January 31: np; Anonymous. 2016. How Uber, Airbnb and Etsy attracted their first 1,000 customers. horbes. com. July 13: np; Ifrach, B. 2015. How Airbnb uses machine learning to detect host preferences. nerds. airbnb.com. April 14: np.

58. For an interesting perspective on the influence of the product life cycle and rate of technological change on competitive strategy, refer to Lei, D. & Slocum, J. W., Jr. 2005. Strategic and organizational requirements for competitive advantage. Academy of Management Executive, 19(1): 31–45.

59. Dickson, P. R. 1994. Marketing management: 293. Fort Worth, TX: Dryden Press; Day, G. S. 1981. The product life cycle: Analysis and application. Journal of Marketing Research, 45: 60–67.

60. Bearden, W. O., Ingram, T. N., & LaForge, R. W. 1995. Marketing principles and practices. Burr Ridge, IL: Irwin.

61. MacMillan, I. C. 1985. Preemptive strategies. In Guth, W. D. (Ed.), Handbook of business strategy: 9-1–9-22. Boston: Warren, Gorham & Lamont; Pearce, J. A. & Robinson, R. B. 2000. Strategic management (7th ed.). New York: McGraw-Hill; and Dickson, op. cit., pp. 295–296.

62. Bartlett, C. A. & Ghoshal, S. 2000. Going global: Lessons for late movers. Harvard Business Review, 78(2): 132–142.

63. Neuborne, E. 2000. E-tailers hit the relaunch key. BusinessWeek, October 17: 62.

64. Berkowitz, E. N., Kerin, R. A., & Hartley, S. W. 2000. Marketing (6th ed.). New York: McGraw-Hill.

65. MacMillan, op. cit. 66. Brooker, K. 2001. A game of inches.

Fortune, February 5: 98–100. 67. Our discussion of reverse and

breakaway positioning draws on Moon, Y. 2005. Break free from the product life cycle. Harvard Business Review, 83(5): 87–94. This article also discusses stealth positioning as a means of overcoming consumer resistance and advancing a product from the introduction to the growth phase.

68. MacMillan, op. cit. 69. Berkowitz et al., op. cit. 70. Bearden et al., op. cit. 71. The discussion of these four

strategies draws on MacMillan, op. cit.; Berkowitz et al., op. cit.; and Bearden et al., op. cit.

72. Augustine, N. R. 1997. Reshaping an industry: Lockheed Martin’s survival story. Harvard Business Review, 75(3): 83–94.

73. Snow, D. C. 2008. Beware of old technologies’ last gasps. Harvard Business Review, January: 17–18; Lohr, S. 2008. Why old technologies are still kicking. New York Times, March 23: np; and McGrath, R. G. 2008. Innovation and the last gasps of dying technologies. ritamcgrath. com, March 18: np.

74. Coyne, K. P., Coyne, S. T., & Coyne, E. J., Sr. 2010. When you’ve got to cut costs—now. Harvard Business Review, 88(5): 74–83.

75. A study that draws on the resource- based view of the firm to investigate successful turnaround strategies is Morrow, J. S., Sirmon, D. G., Hitt, M. A., & Holcomb, T. R. 2007. Creating value in the face of declining performance: Firm strategies and organizational recovery. Strategic Management Journal, 28(3): 271–284.

76. For a study investigating the relationship between organizational restructuring and acquisition performance, refer to Barkema, H. G. & Schijven, M. Toward unlocking the full potential of acquisitions: The role of organizational restructuring. Academy of Management Journal, 51(4): 696–722.

77. For some useful ideas on effective turnarounds and handling downsizings, refer to Marks, M. S. & De Meuse, K. P. 2005. Resizing the organization: Maximizing the gain while minimizing the pain of layoffs, divestitures and closings. Organizational Dynamics, 34(1): 19–36.

78. Hambrick, D. C. & Schecter, S. M. 1983. Turnaround strategies for mature industrial product business units. Academy of Management Journal, 26(2): 231–248.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

6 LO6-1 The reasons for the failure of many diversification efforts. LO6-2 How managers can create value through diversification initiatives. LO6-3 How corporations can use related diversification to achieve synergistic

benefits through economies of scope and market power.

LO6-4 How corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis.

LO6-5 The various means of engaging in diversification—mergers and acquisitions, joint ventures/strategic alliances, and internal development.

LO6-6 Managerial behaviors that can erode the creation of value.

Corporate-Level Strategy Creating Value through Diversification

©Anatoli Styf/Shutterstock

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For decades, Coca-Cola used independent bottlers to distribute Coke products to stores and restaurants. Coke would manufacture the concentrate used to make its soft drinks, but the actual bottling of the product and distribution to end retailers was handled by about 70 regional bottling firms. In 2010, Coca-Cola undertook a major initiative to buy its bottlers and create a national vertically integrated business operation, where Coke would not only manufacture the concentrate but also own its bottling and distribution system. The firm spent $12.3 billion to acquire Coca-Cola Enterprises, its largest bottling partner. Coke believed it could improve the operations of the bottling network by closing some bottling plants, modernizing others, and creating an integrated national manufacturing system. In doing so, the firm could achieve $350 million in annual cost savings while allowing the firm to nationally roll out new products more quickly. Coke could then also negotiate directly with large, national retailers. In short, the firm would be more efficient and more responsive to customer needs.

However, under pressure from investors, Coca-Cola reversed course in 2015—announcing that it would sell off all of its bottling operations. In the first step of this process, it agreed to sell nine production facilities to three bottling companies for $380 million. Additionally, Coke announced it would complete the process of selling off its remaining bottling plants and distribution facilities by the end of 2017.1

What happened to trigger this rapid change? Coke found that being in the bottling business didn’t help its financial performance. In the words of Jack Russo, an analyst at Edward Jones Investing, “bottling is a low margin, capital-intensive business.” Coke also found upgrading and streamlining its bottling networks was harder and was taking more time than expected. While it initially estimated it could close about one- third of its bottling plants to improve efficiencies, it ended up closing only one-tenth of the plants. As a result, Coke saw its operating margins fall from 20.7 percent in 2009 to 11.4 percent in 2014. Divesting the bottling operations allows Coke to again focus on the more profitable business of selling concentrates and syrups to independent companies that bottle and can drinks and then package and distribute them to stores and restaurants. Analysts expect the firm’s operating margins will rise by 50 percent.  Returning management of bottling and distribution to local partners will also allow bottling operations to better meet local market needs. Ultimately, Coke’s management came to the realization that running a capital- intensive manufacturing business didn’t really fit the capabilities of the firm. CEO Muhtar Kent told industry analysts that Coke could now focus on developing and managing brands: “That’s what we’re best at.”

Discussion Questions 1. What are the pros and cons of Coca-Cola owning its bottlers? 2. Why didn’t Coca-Cola’s acquisition of its bottlers lead to the improvements the firm expected? 3. Will this latest move serve as a clear strategy that will lead to long-term profitability, or is it just

a reaction to outside pressures the firm faced?

LEARNING FROM MISTAKES

Coca-Cola’s experience with its purchase of its bottlers is more the rule than the excep- tion. Research shows that a majority of acquisitions of public corporations result in value destruction rather than value creation. Many other large multinational firms have also failed to effectively integrate their acquisitions, paid too high a premium for the target’s common stock, or were unable to understand how the acquired firm’s assets would fit with their own

LO 6-1 The reasons for the failure of many diversification efforts.

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lines of business.2 And, at times, top executives may not have acted in the best interests of shareholders. That is, the motive for the acquisition may have been to enhance the execu- tives’ power and prestige rather than to improve shareholder returns. At times, the only other people who may have benefited were the shareholders of the acquired firms—or the investment bankers who advise the acquiring firm, because they collect huge fees up front regardless of what happens afterward!3

Academic research has found that acquisitions, in general, do not lead to benefits for shareholders. A review paper that looked at over 100 studies on mergers and acquisitions con- cluded that research has found that acquisitions, on average, do not create shareholder value.4

Exhibit 6.1 lists some well-known examples of failed acquisitions and mergers. Many acquisitions ultimately result in divestiture—an admission that things didn’t work

out as planned. In fact, some years ago, a writer for Fortune magazine lamented, “Studies show that 33 percent to 50 percent of acquisitions are later divested, giving corporate mar- riages a divorce rate roughly comparable to that of men and women.”5

Admittedly, we have been rather pessimistic so far.6 Clearly, many diversification efforts have worked out very well—whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development. We will discuss many success stories through- out this chapter. Next, we will discuss the primary rationales for diversification.

MAKING DIVERSIFICATION WORK: AN OVERVIEW Clearly, not all diversification moves, including those involving mergers and acquisitions, erode performance. For example, acquisitions in the oil industry, such as British Petroleum’s purchases of Amoco and Arco, performed well, as did the Exxon-Mobil merger. MetLife was able to dramatically expand its global footprint by acquiring Alico, a global player in the insurance business, from AIG in 2010 when AIG was in financial distress. Since AIG was desperate to sell assets, MetLife was able to acquire this business at an attractive price. With this acquisition, MetLife expanded its global reach from 17 to 64 countries and increased its non-U.S. revenue from 15 to 40 percent.7 Many leading high-tech firms such as Google, Apple, and Intel have dramatically enhanced their revenues, profits, and market values through a wide variety of diversification initiatives, including acquisitions, strategic alliances, and joint ventures, as well as internal development.

LO 6-2 How managers can create value through diversification initiatives.

diversification the process of firms expanding their operations by entering new businesses.

EXHIBIT 6.1 Some Well-Known M&A Blunders

Examples of Some Very Expensive Blunders

• Sprint and Nextel merged in 2005. On January 31, 2008, the firm announced a merger-related charge of $31 billion. Its stock had lost 76 percent of its value by late 2012 when it was announced that Sprint Nextel would be purchased by SoftBank, a Japanese telecommunications and Internet firm. SoftBank’s stock price dropped 20 percent in the week after announcing it would acquire Sprint.

• AOL paid $114 billion to acquire Time Warner in 2001. Over the next two years, AOL Time Warner lost $150 billion in market valuation. • In 2012, Hewlett-Packard wrote off $9 billion of the $11 billion it paid for Autonomy, a software company that it purchased one year

earlier. After the purchase, HP realized that Autonomy’s accounting statements were not accurate, resulting in a nearly 80 percent drop in the value of Autonomy once those accounting irregularities were corrected.

• Similarly, in 2012, Microsoft admitted to a major acquisition mistake when it wrote off essentially the entire $6.2 billion it paid for a digital advertising firm, aQuantive, that it purchased in 2007.

• Yahoo purchased Tumblr for $1.1 billion in 2013 but had written off over 80 percent of this value by the middle of 2016. Commentators have noted that Yahoo’s repeated failures to extract value from acquisitions is one of the key reasons it was unable to survive as an independent firm.

Sources: Ante, S. E. 2008. Sprint’s wake-up call. businessweek.com, February 21: np; Tully, S. 2006. The (second) worst deal ever. Fortune, October 16: 102–119; Wakabayashi, D., Troianovski, A., & Ante, S. 2012. Bravado behind Softbank’s Sprint deal. wsj.com, October 16: np; and Kim, E. 2016.Yahoo just wrote down another $482 million from Tumblr, the company it bought for $1 billion. businessinsider.com, July 18: np.

corporate-level strategy a strategy that focuses on gaining long-term revenue, profits, and market value through managing operations in multiple businesses.

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So the question becomes: Why do some diversification efforts pay off and others pro- duce poor results? This chapter addresses two related issues: (1) What businesses should a corporation compete in? and (2) How should these businesses be managed to jointly create more value than if they were freestanding units?

Diversification initiatives—whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development—must be justified by the creation of value for shareholders.8 But this is not always the case.9 Acquiring firms typically pay high premiums when they acquire a target firm. For example, in 2016, Microsoft offered to buy LinkedIn for $26.2 billion, 50 percent higher than LinkedIn’s value the day before. In contrast, you and I, as private investors, can diversify our portfolio of stocks very cheaply. With an intensely competitive online brokerage industry, we can acquire hundreds (or thousands) of shares for a transaction fee of as little as $10 or less—a far cry from the 30 to 40 percent (or higher) premiums that corporations typically must pay to acquire companies.

Given the seemingly high inherent downside risks and uncertainties, one might ask: Why should companies even bother with diversification initiatives? The answer, in a word, is syn- ergy, derived from the Greek word synergos, which means “working together.” This can have two different, but not mutually exclusive, meanings.

First, a firm may diversify into related businesses. Here, the primary potential benefits to be derived come from horizontal relationships, that is, businesses sharing intangible resources (e.g., core competencies such as marketing) and tangible resources (e.g., pro- duction facilities, distribution channels).10 Firms can also enhance their market power via pooled negotiating power and vertical integration. For example, Procter & Gamble enjoys many synergies from having businesses that share distribution resources.

Second, a corporation may diversify into unrelated businesses.11 Here, the primary potential benefits are derived largely from hierarchical relationships, that is, value creation derived from the corporate office. Examples of the latter would include leveraging some of the support activities in the value chain that we discussed in Chapter 3, such as information systems or human resource practices.

Please note that such benefits derived from horizontal (related diversification) and hier- archical (unrelated diversification) relationships are not mutually exclusive. Many firms that diversify into related areas benefit from information technology expertise in the corpo- rate office. Similarly, unrelated diversifiers often benefit from the “best practices” of sister businesses even though their products, markets, and technologies may differ dramatically.

Exhibit 6.2 provides an overview of how we will address the various means by which firms create value through both related and unrelated diversification and also includes a summary of some examples that we will address in this chapter.12

RELATED DIVERSIFICATION: ECONOMIES OF SCOPE AND REVENUE ENHANCEMENT Related diversification enables a firm to benefit from horizontal relationships across differ- ent businesses in the diversified corporation by leveraging core competencies and sharing activities (e.g., production and distribution facilities). This enables a corporation to benefit from economies of scope. Economies of scope refers to cost savings from leveraging core competencies or sharing related activities among businesses in the corporation. A firm can also enjoy greater revenues if two businesses attain higher levels of sales growth combined than either company could attain independently.

Leveraging Core Competencies The concept of core competencies can be illustrated by the imagery of the diversified corpo- ration as a tree.13 The trunk and major limbs represent core products; the smaller branches

LO 6-3 How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power.

economies of scope cost savings from leveraging core competencies or sharing related activities among businesses in a corporation.

related diversification a firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power.

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EXHIBIT 6.2 Creating Value through Related and Unrelated Diversification

Related Diversification: Economies of Scope

Leveraging core competencies • 3M leverages its competencies in adhesives technologies to many industries, including automotive,

construction, and telecommunications.

Sharing activities • Polaris, a manufacturer of snowmobiles, motorcycles, watercraft, and off-road vehicles, shares

manufacturing operations across its businesses. It also has a corporate R&D facility and staff departments that support all of Polaris’s operating divisions.

Related Diversification: Market Power

Pooled negotiating power • ConAgra, a diversified food producer, increases its power over suppliers by centrally purchasing huge

quantities of packaging materials for all of its food divisions.

Vertical integration • Shaw Industries, a giant carpet manufacturer, increases its control over raw materials by producing much

of its own polypropylene fiber, a key input to its manufacturing process.

Unrelated Diversification: Parenting, Restructuring, and Financial Synergies

Corporate restructuring and parenting • The corporate office of Cooper Industries adds value to its acquired businesses by performing such

activities as auditing their manufacturing operations, improving their accounting activities, and centralizing union negotiations.

Portfolio management • Novartis, formerly Ciba-Geigy, uses portfolio management to improve many key activities, including

resource allocation and reward and evaluation systems.

are business units; and the leaves, flowers, and fruit are end products. The core compe- tencies are represented by the root system, which provides nourishment, sustenance, and stability. Managers often misread the strength of competitors by looking only at their end products, just as we can fail to appreciate the strength of a tree by looking only at its leaves. Core competencies may also be viewed as the “glue” that binds existing businesses together or as the engine that fuels new business growth.

Core competencies reflect the collective learning in organizations—how to coordinate diverse production skills, integrate multiple streams of technologies, and market diverse products and services.14 Casio, a giant electronic products producer, synthesizes its abilities in miniatur- ization, microprocessor design, material science, and ultrathin precision castings to produce digital watches. These are the same skills it applies to design and produce its miniature card calculators, digital cameras, pocket electronic dictionaries, and other small electronics.

For a core competence to create value and provide a viable basis for synergy among the businesses in a corporation, it must meet three criteria:15

• The core competence must enhance competitive advantage(s) by creating superior customer value. Every value-chain activity has the potential to provide a viable basis for building on a core competence.16 At Gillette, for example, scientists have developed a series of successful new razors, including the Sensor, Fusion, Mach 3, and ProGlide, building on a thorough understanding of several phenomena that underlie shaving. These include the physiology of facial hair and skin, the metallurgy of blade strength and sharpness, the dynamics of a cartridge moving across skin, and the physics of a razor blade severing hair. Such innovations are possible only with an understanding of such phenomena and the ability to combine such technologies

core competencies a firm’s strategic resources that reflect the collective learning in the organization.

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6.1 DATA ANALYTICSSTRATEGY SPOTLIGHT IBM: THE NEW HEALTH CARE EXPERT Watson, the supercomputer IBM used to win a competition against the best players on the quiz show Jeopardy! is now working toward becoming Dr. Watson. Over the decades, IBM has developed strong competencies in raw computing power. With Watson, a computer named after IBM founder Thomas J. Watson, IBM engineers and scientists set out to extend IBM’s competencies by building a computing system that can process natural language. Their goal was to build a system that could rival a human’s ability to answer questions posed in natural language with speed, accuracy, and confidence. They took four years to develop the system and demonstrated its capabilities in beating two of the greatest champions of Jeopardy! in 2011.

Now IBM is aiming to leverage its competencies in the health care arena. In 2013, IBM introduced three applications, one which recommends cancer treatment options and two for reviewing and authorizing treatments and related insurance claims. IBM developed the cancer treatment application with Memorial Sloan-Kettering, one of the world’s premier cancer treatment clinics. IBM chose to work on cancer treatment since the volume of research on cancer doubles every five years. As a result, oncologists, the doctors treating cancer, can easily fall behind the cutting edge of research. As Dr. Mark Kris, chief of Memorial Sloan Kettering’s Thoracic Oncology Service, stated, “There has been an explosion in medical research, and doctors

can’t possibly keep up.” That is not a problem for Watson. IBM sees this massive volume of research as an opportunity to crowdsource knowledge to develop new, integrated insights. IBM regularly feeds massive amounts of data from medical stud- ies into Watson. In a one-year period, Watson absorbed and ana- lyzed more than 600,000 pieces of medical data and 2 million pages of text from 42 medical journals and clinical trials of can- cer treatments. IBM then adds the individual patient’s health history and current symptoms to the system. With its natural- language capabilities, Watson can easily process and codify all of the information fed into it. Doctors access the system, using an iPad, enter the patient’s symptoms, and within three seconds receive a personalized diagnosis and a prioritized list of recom- mended tests and treatment options.

While oncology was the first medical specialty for Watson, IBM has expanded the approach and is also providing guidance for the treatment of diabetes, kidney disease, heart disease, and many other areas of medicine. It has even created an entirely new business unit, IBM Watson Health, a cloud-based service selling diagnostic expertise to doctors, hospitals, and insurers.

Sources: Frier, S. 2012. IBM wants to put a Watson in your pocket. Bloomberg Businessweek, September 17: 41–42; Groenfeldt, T. 2012. IBM’s Watson, Cedars- Sinai and WellPoint take on cancer. forbes.com, February 1: np; Henschen, D. 2013. IBM’s Watson could be healthcare game changer. informationweek.com, February 3: np; ibm.com; and Claney, H. 2015. IBM’s new health care prescription: A standalone business unit. fortune.com, April 13: np..

into innovative products. Customers are willing to pay more for such technologically differentiated products.

• Different businesses in the corporation must be similar in at least one important way related to the core competence. It is not essential that the products or services themselves be similar. Rather, at least one element in the value chain must require similar skills in creating competitive advantage if the corporation is to capitalize on its core competence. For example, while we might think that film technology and beauty products have little in common, Fujifilm has found a link it could exploit. Fuji took expertise it had developed with collagen, a major component of both photo film and human skin, and used it to develop a new skin care product line, Astalift—a product line that produces over $80 million in sales.17 Similarly, as discussed in Strategy Spotlight 6.1, IBM is combining its competencies in computing technology with crowdsourced medical research knowledge to provide health care services.

• The core competencies must be difficult for competitors to imitate or find substitutes for. As we discussed in Chapter 5, competitive advantages will not be sustainable if the competition can easily imitate or substitute them. Similarly, if the skills associated with a firm’s core competencies are easily imitated or replicated, they are not a sound basis for sustainable advantages.

Consider Amazon’s retailing operations. Amazon developed strong competencies in Internet retailing, website infrastructure, warehousing, and order fulfillment to dominate the online book industry. It used these competencies along with its brand name to expand

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into a range of online retail businesses. Competitors in these other market areas have had great difficulty imitating Amazon’s competencies, and many have simply stopped trying. Instead, they have partnered with Amazon and contracted with Amazon to provide these services for them.18

Sharing Activities As we saw previously, leveraging core competencies involves transferring accumulated skills and expertise across business units in a corporation. Corporations also can achieve synergy by sharing activities across their business units. These include value-creating activities such as com- mon manufacturing facilities, distribution channels, and sales forces. As we will see, sharing activities can potentially provide two primary payoffs: cost savings and revenue enhancements.

Deriving Cost Savings Typically, this is the most common type of synergy and the easiest to estimate. Peter Shaw, head of mergers and acquisitions at the British chemical and phar- maceutical company ICI, refers to cost savings as “hard synergies” and contends that the level of certainty of their achievement is quite high. Cost savings come from many sources, including from the elimination of jobs, facilities, and related expenses that are no longer needed when functions are consolidated and from economies of scale in purchasing. Cost savings are generally highest when one company acquires another from the same industry in the same country. Shaw Industries, a division of Berkshire Hathaway, is the nation’s larg- est carpet producer. Over the years, it has dominated the competition through a strategy of acquisition that has enabled Shaw, among other things, to consolidate its manufacturing operations in a few, highly efficient plants and to lower costs through higher capacity utili- zation. Honda benefits by sharing small engine development and manufacturing across the more than 15 different types of power equipment it produces. Similarly, General Motors uses a shared engineering group and shared vehicle platforms across its Chevrolet, Buick, and GMC brands.

Sharing activities inevitably involve costs that the benefits must outweigh such as the greater coordination required to manage a shared activity. Even more important is the need to compromise on the design or performance of an activity so that it can be shared. For example, a salesperson handling the products of two business units must operate in a way that is usually not what either unit would choose if it were independent. If the compromise erodes the unit’s effectiveness, then sharing may reduce rather than enhance competitive advantage.

ENHANCING REVENUE AND DIFFERENTIATION Often an acquiring firm and its target may achieve a higher level of sales growth together than either company could on its own. For example, Starbucks has acquired a number of small firms, including La Boulange, a small bakery chain; Teavana, a tea producer; and Evolution Fresh, a juice company. Starbucks can add value to all of these firms by expanding their market exposure as Starbucks offers these products for sale in its national retail chain.19

Firms also can enhance the effectiveness of their differentiation strategies by means of sharing activities among business units. A shared order-processing system, for example, may permit new features and services that a buyer will value. As another example, financial ser- vice providers strive to provide differentiated bundles of services to customers. By having a single point of contact where customers can manage their checking accounts, investment accounts, insurance policies, bill-payment services, mortgages, and many other services, they create value for their customers.

As a cautionary note, managers must keep in mind that sharing activities among busi- nesses in a corporation can have a negative effect on a given business’s differentiation. For example, when Ford owned Jaguar, customers had lower perceived value of Jaguar

sharing activities having activities of two or more businesses’ value chains done by one of the businesses.

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automobiles when they learned that the entry-level Jaguar shared its basic design with and was manufactured in the same production plant as the Ford Mondeo, a European midsize car. Perhaps it is not too surprising that Jaguar was divested by Ford in 2008.

RELATED DIVERSIFICATION: MARKET POWER We now discuss how companies achieve related diversification through market power. We also address the two principal means by which firms achieve synergy through market power: pooled negotiating power and vertical integration. Managers do, however, have limits on their ability to use market power for diversification, because government regulations can sometimes restrict the ability of a business to gain very large shares of a particular market. For example, in 2016, in order to approve Anheuser-Busch InBev’s planned purchase of SABMiller, the Federal Trade Commission required InBev to divest all of SABMiller’s U.S. operations to keep InBev from getting too much market power in the U.S. beer market.

Pooled Negotiating Power Similar businesses working together or the affiliation of a business with a strong parent can strengthen an organization’s bargaining position relative to suppliers and customers and enhance its position vis-à-vis competitors. Compare, for example, the position of an independent food manufacturer with that of the same business within Nestlé. Being part of Nestlé provides the business with significant clout—greater bargaining power with sup- pliers and customers—since it is part of a firm that makes large purchases from suppliers and provides a wide variety of products. Access to the parent’s deep pockets increases the business’s strength, and the Nestlé unit enjoys greater protection from substitutes and new entrants. Not only would rivals perceive the unit as a more formidable opponent, but the unit’s association with Nestlé would also provide greater visibility and improved image.

When acquiring related businesses, a firm’s potential for pooled negotiating power vis- à-vis its customers and suppliers can be very enticing. However, managers must carefully evaluate how the combined businesses may affect relationships with actual and potential customers, suppliers, and competitors. For example, when PepsiCo diversified into the fast-food industry with its acquisitions of Kentucky Fried Chicken, Taco Bell, and Pizza Hut (now part of Yum! Brands), it clearly benefited from its position over these units that served as a captive market for its soft-drink products. However, many competitors, such as McDonald’s, refused to consider PepsiCo as a supplier of its own soft-drink needs because of competition with Pepsi’s divisions in the fast-food industry. Simply put, McDonald’s did not want to subsidize the enemy! Thus, although acquiring related businesses can enhance a corporation’s bargaining power, it must be aware of the potential for retaliation.

Vertical Integration Vertical integration occurs when a firm becomes its own supplier or distributor. That is, it represents an expansion or extension of the firm by integrating preceding or successive production processes.20 The firm incorporates more processes toward the original source of raw materials (backward integration) or toward the ultimate consumer (forward integra- tion). For example, an oil refinery might secure land leases and develop its own drilling capacity to ensure a constant supply of crude oil. Or it could expand into retail operations by owning or licensing gasoline stations to guarantee customers for its petroleum products.

Vertical integration can be a viable strategy for many firms. Strategy Spotlight 6.2 dis- cusses how Tesla is vertically integrating into battery production to ensure it has an ade- quate supply of batteries as it expands its production of vehicles.

Benefits and Risks of Vertical Integration Vertical integration is a means for an organi- zation to reduce its dependence on suppliers or its channels of distribution to end users.

market power firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment.

pooled negotiating power the improvement in bargaining position relative to suppliers and customers.

vertical integration an expansion or extension of the firm by integrating preceding or successive production processes.

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6.2 ENVIRONMENTAL SUSTAINABILITYSTRATEGY SPOTLIGHT TESLA BREAKS INDUSTRY NORMS BY VERTICALLY INTEGRATING For decades, auto manufacturers vertically integrated and con- trolled all stages of the manufacturing process. By manufac- turing their own components, the auto firms could coordinate design of parts, ensure the quality of components, and also ensure that there was adequate production of the parts they needed. However, in recent decades, auto firms have sold off most of their suppliers. By allowing outside suppliers to compete for contracts, the auto firms found they were able to buy compo- nents for lower cost than if they had built them in-house.

In contrast to the direction the major auto firms have gone, Tesla is going all in on building a vertically integrated business model. In 2015, Tesla announced that it was building a “gigafac- tory” to supply all of the batteries they will need for their cars. Tesla sees at least three benefits from making its own batteries.

First, by taking on the $5 billion cost to build the factory, it is maximizing scale efficiencies in battery manufacturing that could result in a per unit cost reduction of 30 percent. Second, Tesla believes it will be able to better coordinate battery technol- ogy development as a vertically integrated firm. Third, if demand for electric vehicles takes off as Tesla expects, it will benefit from having an in-house supplier that can provide a steady supply of batteries rather than having to compete to buy batteries from outside suppliers. There simply isn’t enough battery production capacity in the world to provide the batteries needed for Tesla to hit its goal of selling 500,000 vehicles per year. But it is a big bet that will be very costly to Tesla if demand doesn’t grow as it expects or if new battery technology makes Tesla’s lithium-ion batteries obsolete. Sources: Gorzelany, J. 2014. Why Tesla’s vertical manufacturing move could prove essential to its success. forbes.com, February 27: np.; and Randall, T. 2017. Tesla flips the switch on the gigafactory. bloomberg.com, January 4.

However, the benefits associated with vertical integration—backward or forward—must be carefully weighed against the risks.21 The primary benefits and risks of vertical integration are listed in Exhibit 6.3.

Winnebago, the leader in the market for drivable recreational vehicles, with a 33.9 percent market share, illustrates some of vertical integration’s benefits.22 The word Winnebago means “big RV” to most Americans. And the firm has a sterling reputation for great quality. The firm’s huge northern Iowa factories do everything from extruding aluminum for body parts to molding plastics for water and holding tanks to dashboards. Such vertical integra- tion at the factory may appear to be outdated and expensive, but it guarantees excellent quality. The Recreational Vehicle Dealer Association started giving a quality award in 1996, and Winnebago has won it 20 out of 21 years since.

In making vertical integration decisions, five issues should be considered:23

1. Is the company satisfied with the quality of the value that its present suppliers and distributors are providing? If the performance of organizations in the vertical chain— both suppliers and distributors—is satisfactory, it may not, in general, be appropriate

Benefits

• A secure source of raw materials or distribution channels. • Protection of and control over valuable assets. • Proprietary access to new technologies developed by the unit. • Simplified procurement and administrative procedures.

Risks

• Costs and expenses associated with increased overhead and capital expenditures. • Loss of flexibility resulting from large investments. • Problems associated with unbalanced capacities along the value chain. (For example, the in-house

supplier has to be larger than your needs in order to benefit from economies of scale in that market.) • Additional administrative costs associated with managing a more complex set of activities.

EXHIBIT 6.3 Benefits and Risks of Vertical Integration

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for a company to perform these activities itself. But if firms are not happy with their current suppliers, they may want to backward integrate. For example, Kaiser Permanente, a health provider with 10.6 million subscribers, launched its own medical school to better train physicians to provide the integrated style of care Kaiser is striving to provide.24

2. Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits? Even if a firm is outsourcing value-chain activities to companies that are doing a credible job, it may be missing out on substantial profit opportunities. Consider Best Buy. When it realized that the profit potential of providing installation and service was substantial, Best Buy forward integrated into this area by acquiring Geek Squad.

3. Is there a high level of stability in the demand for the organization’s products? High demand or sales volatility is not conducive to vertical integration. With the high level of fixed costs in plant and equipment as well as operating costs that accompany endeavors toward vertical integration, widely fluctuating sales demand can either strain resources (in times of high demand) or result in unused capacity (in times of low demand). The cycles of “boom and bust” in the automobile industry are a key reason why the manufacturers have increased the amount of outsourced inputs.

4. Does the company have the necessary competencies to execute the vertical integration strategies? As many companies would attest, successfully executing strategies of vertical integration can be very difficult. For example, Boise Cascade, a lumber firm, once forward integrated into the home-building industry but found that it didn’t have the design and marketing competencies needed to compete in this market.

5. Will the vertical integration initiative have potential negative impacts on the firm’s stakeholders? Managers must carefully consider the impact that vertical integration may have on existing and future customers, suppliers, and competitors. After Lockheed Martin, a dominant defense contractor, acquired Loral Corporation, an electronics supplier, for $9.1 billion, it had an unpleasant and unanticipated surprise. Loral, as a subsidiary of Lockheed, was viewed as a rival by many of its previous customers. Thus, while Lockheed Martin may have seen benefits by being able to coordinate operations with Loral as a captive supplier, it also saw a decline in business for Loral with other defense contractors.

Analyzing Vertical Integration: The Transaction Cost Perspective Another approach that has proved very useful in understanding vertical integration is the transaction cost perspec- tive.25 According to this perspective, every market transaction involves some transaction costs. First, a decision to purchase an input from an outside source leads to search costs (i.e., the cost to find where it is available, the level of quality, etc.). Second, there are costs associated with negotiating. Third, a contract needs to be written spelling out future possible contingencies. Fourth, parties in a contract have to monitor each other. Finally, if a party does not comply with the terms of the contract, there are enforcement costs. Transaction costs are thus the sum of search costs, negotiation costs, contracting costs, monitoring costs, and enforcement costs. These transaction costs can be avoided by internalizing the activity, in other words, by producing the input in-house.

A related problem with purchasing a specialized input from outside is the issue of t ransaction-specific investments. For example, when an automobile company needs an input specifically designed for a particular car model, the supplier may be unwilling to make the investments in plant and machinery necessary to produce that component for two reasons. First, the investment may take many years to recover but there is no guarantee the automo- bile company will continue to buy from the supplier after the contract expires, typically in one year. Second, once the investment is made, the supplier has no bargaining power. That is, the buyer knows that the supplier has no option but to supply at ever-lower prices because

transaction cost perspective a perspective that the choice of a transaction’s governance structure, such as vertical integration or market transaction, is influenced by transaction costs, including search, negotiating, contracting, monitoring, and enforcement costs, associated with each choice.

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the investments were so specific that they cannot be used to produce alternative products. In such circumstances, again, vertical integration may be the only option.

Vertical integration, however, gives rise to a different set of costs. These costs are referred to as administrative costs. Coordinating different stages of the value chain now internalized within the firm causes administrative costs to go up. Decisions about vertical integration are, therefore, based on a comparison of transaction costs and administrative costs. If trans- action costs are lower than administrative costs, it is best to resort to market transactions and avoid vertical integration. For example, McDonald’s may be the world’s biggest buyer of beef, but it does not raise cattle. The market for beef has low transaction costs and requires no transaction-specific investments. On the other hand, if transaction costs are higher than administrative costs, vertical integration becomes an attractive strategy. Most automobile manufacturers produce their own engines because the market for engines involves high transaction costs and transaction-specific investments.

UNRELATED DIVERSIFICATION: FINANCIAL SYNERGIES AND PARENTING With unrelated diversification, unlike related diversification, few benefits are derived from horizontal relationships—that is, the leveraging of core competencies or the sharing of activ- ities across business units within a corporation. Instead, potential benefits can be gained from vertical (or hierarchical) relationships—the creation of synergies from the interaction of the corporate office with the individual business units. There are two main sources of such synergies. First, the corporate office can contribute to “parenting” and restructuring of (often acquired) businesses. Second, the corporate office can add value by viewing the entire corporation as a family or “portfolio” of businesses and allocating resources to opti- mize corporate goals of profitability, cash flow, and growth. Additionally, the corporate office enhances value by establishing appropriate human resource practices and financial controls for each of its business units.

Corporate Parenting and Restructuring We have discussed how firms can add value through related diversification by exploring sources of synergy across business units. Now, we discuss how value can be created within business units as a result of the expertise and support provided by the corporate office.

Parenting The positive contributions of the corporate office are called the “parenting advan- tage.”26 Many firms have successfully diversified their holdings without strong evidence of the more traditional sources of synergy (i.e., horizontally across business units). Diversified public corporations such as Berkshire Hathaway and Virgin Group and leveraged buyout firms such as KKR and Clayton, Dubilier & Rice are a few examples.27 These parent compa- nies create value through management expertise. How? They improve plans and budgets and provide especially competent central functions such as legal, financial, human resource man- agement, procurement, and the like. They also help subsidiaries make wise choices in their own acquisitions, divestitures, and new internal development decisions. Such contributions often help business units to substantially increase their revenues and profits. For example, KKR, a private equity firm, has a team of parenting experts, called KKR Capstone, that works with newly acquired firms for 12 to 24 months to enhance the acquired firm’s value. The team works to improve a range of operating activities, such as new product development processes, sales force activities, quality improvement, and supply chain management.

Restructuring Restructuring is another means by which the corporate office can add value to a business.28 The central idea can be captured in the real estate phrase “Buy low and sell

LO 6-4 How corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis.

unrelated diversification a firm entering a different business that has little horizontal interaction with other businesses of a firm.

parenting advantage the positive contributions of the corporate office to a new business as a result of expertise and support provided and not as a result of substantial changes in assets, capital structure, or management.

restructuring the intervention of the corporate office in a new business that substantially changes the assets, capital structure, and/or management, including selling off parts of the business, changing the management, reducing payroll and unnecessary sources of expenses, changing strategies, and infusing the new business with new technologies, processes, and reward systems.

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high.” Here, the corporate office tries to find either poorly performing firms with unreal- ized potential or firms in industries on the threshold of significant, positive change. The par- ent intervenes, often selling off parts of the business; changing the management; reducing payroll and unnecessary sources of expenses; changing strategies; and infusing the company with new technologies, processes, reward systems, and so forth. When the restructuring is complete, the firm can either “sell high” and capture the added value or keep the business and enjoy financial and competitive benefits.29

For the restructuring strategy to work, the corporate management must have the insight to detect undervalued companies (otherwise, the cost of acquisition would be too high) or businesses competing in industries with a high potential for transformation.30 Additionally, of course, it must have the requisite skills and resources to turn the businesses around, even if they may be in new and unfamiliar industries.

Restructuring can involve changes in assets, capital structure, or management.

• Asset restructuring involves the sale of unproductive assets, or even whole lines of businesses, that are peripheral. In some cases, it may even involve acquisitions that strengthen the core business.

• Capital restructuring involves changing the debt-equity mix, or the mix between different classes of debt or equity. Although the substitution of equity with debt is more common in buyout situations, occasionally the parent may provide additional equity capital.

• Management restructuring typically involves changes in the composition of the top management team, organizational structure, and reporting relationships. Tight financial control, rewards based strictly on meeting short- to medium-term performance goals, and reduction in the number of middle-level managers are common steps in management restructuring. In some cases, parental intervention may even result in changes in strategy as well as infusion of new technologies and processes.

Portfolio Management During the 1970s and early 1980s, several leading consulting firms developed the concept of portfolio management to achieve a better understanding of the competitive position of an overall portfolio (or family) of businesses, to suggest strategic alternatives for each of the businesses, and to identify priorities for the allocation of resources. Several studies have reported widespread use of these techniques among American firms.31

While portfolio management tools have been widely used in corporations, research on their use has offered mixed support. However, recent research has suggested that strategi- cally channeling resources to units with the most promising prospects can lead to corpo- rate advantage. Research suggests that many firms do not adjust their capital allocations in response to changes in the performance of units or the attractiveness of the markets in which units of the corporation compete. Instead, allocations are fairly consistent from year to year. However, firms that assess the attractiveness of markets in which the firm competes and the capabilities of each division and then choose allocations of corporate resources based on these assessments exhibit higher levels of corporate survival, overall corporate performance, stock market performance, and the performance of individual business units within the corporation. These effects have also been shown to be stronger when firms com- pete in more competitive markets and in times of economic distress.32 These findings have shown that the ability to effectively allocate financial capital is a key competence of high- performance diversified firms.

Description and Potential Benefits The key purpose of portfolio models is to assist a firm in achieving a balanced portfolio of businesses.33 This consists of businesses whose prof- itability, growth, and cash flow characteristics complement each other and adds up to a

portfolio management a method of (a) assessing the competitive position of a portfolio of businesses within a corporation, (b) suggesting strategic alternatives for each business, and (c) identifying priorities for the allocation of resources across the businesses.

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satisfactory overall corporate performance. Imbalance, for example, could be caused either by excessive cash generation with too few growth opportunities or by insufficient cash gen- eration to fund the growth requirements in the portfolio.

The Boston Consulting Group’s (BCG’s) growth/share matrix is among the best known of these approaches.34 In the BCG approach, each of the firm’s strategic business units (SBUs) is plotted on a two-dimensional grid in which the axes are relative market share and industry growth rate. The grid is broken into four quadrants. Exhibit 6.4 depicts the BCG matrix. Following are a few clarifications:

1. Each circle represents one of the corporation’s business units. The size of the circle represents the relative size of the business unit in terms of revenues.

2. Relative market share, measured by the ratio of the business unit’s size to that of its largest competitor, is plotted along the horizontal axis.

3. Market share is central to the BCG matrix. This is because high relative market share leads to unit cost reduction due to experience and learning curve effects and, consequently, superior competitive position.

Each of the four quadrants of the grid has different implications for the SBUs that fall into the category:

• Stars are SBUs competing in high-growth industries with relatively high market shares. These firms have long-term growth potential and should continue to receive substantial investment funding.

• Question marks are SBUs competing in high-growth industries but having relatively weak market shares. Resources should be invested in them to enhance their competitive positions.

• Cash cows are SBUs with high market shares in low-growth industries. These units have limited long-run potential but represent a source of current cash flows to fund investments in “stars” and “question marks.”

• Dogs are SBUs with weak market shares in low-growth industries. Because they have weak positions and limited potential, most analysts recommend that they be divested.

EXHIBIT 6.4 The Boston Consulting Group (BCG) Portfolio Matrix

22%

20%

18%

16%

14%

12%

10%

8%

6%

4%

2%

0

10 X 4X 2X

Stars Question Marks

Cash Cows

In du

st ry

G ro

w th

R at

e

Dogs

1. 5X 1X

0. 5X

0. 4X

0. 3X

0. 2X

0. 1X

Relative Market Share

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In using portfolio strategy approaches, a corporation tries to create shareholder value in a number of ways.35 First, portfolio analysis provides a snapshot of the businesses in a cor- poration’s portfolio. Therefore, the corporation is in a better position to allocate resources among the business units according to prescribed criteria (e.g., use cash flows from the cash cows to fund promising stars). Second, the expertise and analytical resources in the corporate office provide guidance in determining what firms may be attractive (or unat- tractive) acquisitions. Third, the corporate office is able to provide financial resources to the business units on favorable terms that reflect the corporation’s overall ability to raise funds. Fourth, the corporate office can provide high-quality review and coaching for the individual businesses. Fifth, portfolio analysis provides a basis for developing strategic goals and reward/evaluation systems for business managers. For example, managers of cash cows would have lower targets for revenue growth than managers of stars, but the former would have higher threshold levels of profit targets on proposed projects than the managers of star businesses. Compensation systems would also reflect such realities. Managers of cash cows understandably would be rewarded more on the basis of cash that their businesses generate than would managers of star businesses. Similarly, managers of star businesses would be held to higher standards for revenue growth than managers of cash cow businesses.

Limitations Despite the potential benefits of portfolio models, there are also some nota- ble downsides. First, they compare SBUs on only two dimensions, making the implicit but erroneous assumption that (1) those are the only factors that really matter and (2) every unit can be accurately compared on that basis. Second, the approach views each SBU as a stand-alone entity, ignoring common core business practices and value-creating activities that may hold promise for synergies across business units. Third, unless care is exercised, the process becomes largely mechanical, substituting an oversimplified graphical model for the important contributions of the CEO’s (and other corporate managers’) experience and judgment. Fourth, the reliance on “strict rules” regarding resource allocation across SBUs can be detrimental to a firm’s long-term viability. Finally, while colorful and easy to compre- hend, the imagery of the BCG matrix can lead to some troublesome and overly simplistic prescriptions. For example, division managers are likely to want to jump ship as soon as their division is labeled a “dog.”

To see what can go wrong, consider Cabot Corporation.

Cabot Corporation supplies carbon black for the rubber, electronics, and plastics industries. Following the BCG matrix, Cabot moved away from its cash cow, carbon black, and diversified into stars such as ceramics and semiconductors in a seemingly overaggressive effort to create more revenue growth for the corporation. Predictably, Cabot’s return on assets declined as the firm shifted away from its core competence to unrelated areas. The portfolio model failed by pointing the company in the wrong direction in an effort to spur growth—away from its core business. Recognizing its mistake, Cabot Corporation returned to its mainstay carbon black manufacturing and divested unrelated businesses. Today the company is a leader in its field with $2.4 billion in revenues in 2016.36

Caveat: Is Risk Reduction a Viable Goal of Diversification? One of the purposes of diversification is to reduce the risk that is inherent in a firm’s vari- ability in revenues and profits over time. That is, if a firm enters new products or markets that are affected differently by seasonal or economic cycles, its performance over time will be more stable. For example, a firm manufacturing lawn mowers may diversify into snow- blowers to even out its annual sales. Or a firm manufacturing a luxury line of household furniture may introduce a lower-priced line since affluent and lower-income customers are affected differently by economic cycles.

At first glance the above reasoning may make sense, but there are some problems with it. First, a firm’s stockholders can diversify their portfolios at a much lower cost than a

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corporation, and they don’t have to worry about integrating the acquisition into their port- folio. Second, economic cycles as well as their impact on a given industry (or firm) are dif- ficult to predict with any degree of accuracy.

Notwithstanding the above, some firms have benefited from diversification by lowering the variability (or risk) in their performance over time. Consider GE, a firm that manu- factures a wide range of products, including aircraft engines, power-generation equipment, locomotive trains, large appliances, healthcare equipment, lighting, water treatment equip- ment, oil well drilling equipment, and many other products. Offering such a wide range of products has allowed GE to generate stable earnings and a low-risk profile. Due to its earn- ing stability, GE is able to borrow money at favorable rates which it then uses to invest in its own operations and to extend its portfolio even further by acquiring other manufacturers.

Risk reduction in and of itself is rarely viable as a means to create shareholder value. It must be undertaken with a view of a firm’s overall diversification strategy.

THE MEANS TO ACHIEVE DIVERSIFICATION We have addressed the types of diversification (e.g., related and unrelated) that a firm may undertake to achieve synergies and create value for its shareholders. Now, we address the means by which a firm can go about achieving these desired benefits.

There are three basic means. First, through acquisitions or mergers, corporations can directly acquire a firm’s assets and competencies. Although the terms mergers and acquisi- tions are used quite interchangeably, there are some key differences. With acquisitions, one firm buys another through a stock purchase, cash, or the issuance of debt.37 Mergers, on the other hand, entail a combination or consolidation of two firms to form a new legal entity. Mergers are relatively rare and entail a transaction among two firms on a relatively equal basis. Despite such differences, we consider both mergers and acquisitions to be quite simi- lar in terms of their implications for a firm’s corporate-level strategy.38

Second, corporations may agree to pool the resources of other companies with their resource base, commonly known as a joint venture or strategic alliance. Although these two forms of partnerships are similar in many ways, there is an important difference. Joint ventures involve the formation of a third-party legal entity where the two (or more) firms each contribute equity, whereas strategic alliances do not.

Third, corporations may diversify into new products, markets, and technologies through internal development. Called corporate entrepreneurship, it involves the leveraging and combining of a firm’s own resources and competencies to create synergies and enhance shareholder value. We address this subject in greater length in Chapter 12.

Mergers and Acquisitions The most visible and often costly means to diversify is through acquisitions. Over the past several years, several large acquisitions were announced. These include:39

• InBev’s acquisition of Anheuser-Busch for $52 billion. • AT&T’s acquisition of DirecTV for $67 billion. • Facebook’s acquisition of WhatsApp for $19.4 billion. • Marriott International’s purchase of Starwood Hotels for $13.6 billion. • Shire Pharmaceutical’s $32 billion acquisition of Baxalta.

Exhibit 6.5 illustrates the volatility in worldwide M&A activity over the last several years. Several factors influence M&A activity. Julia Coronado, the chief economist at the invest- ment bank BNP Paribas, highlights two of the key determinants, stating, “When mergers and acquisitions pick up, that’s a good sign that businesses are feeling confident enough about the future that they’re willing to become aggressive, look for deals, look for ways to

LO 6-5 The various means of engaging in diversification—mergers and acquisitions, joint ventures/strategic alliances, and internal development.

acquisitions the incorporation of one firm into another through purchase.

mergers the combining of two or more firms into one new legal entity.

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grow and expand their operations. And it’s also an indication that markets are willing to finance these transactions. So it’s optimism from the markets and from the businesses them- selves.”40 Thus, the general economic conditions and level of optimism about the future influence managers’ willingness to take on the risk of acquisitions. Additionally, the avail- ability of financing can influence acquisition activity. During boom periods, financing is typically widely available. In contrast, during recessionary periods, potential acquirers typi- cally find it difficult to borrow money to finance acquisitions.

Governmental policies such as regulatory actions and tax policies can also make the M&A environment more or less favorable. For example, increased antitrust enforcement will decrease the ability of firms to acquire their competitors or possibly firms in closely related markets. In contrast, increased regulatory pressures for good corporate governance may leave boards of directors more open to acquisition offers.

Finally, currency fluctuations can influence the rate of cross-border acquisitions, with firms in countries with stronger currencies being in a stronger position to acquire. For example, the U.S. dollar has increased in value from .72 to .95 euro from early 2014 to late 2016, making it relatively cheaper for U.S. firms to acquire European firms.

Motives and Benefits Growth through mergers and acquisitions has played a critical role in the success of many corporations in a wide variety of high-technology and knowledge-intensive industries. Here, market and technology changes can occur very quickly and unpredictably.41 Speed—speed to market, speed to positioning, and speed to becoming a viable company—is criti- cal in such industries. For example, in 2010, Apple acquired Siri Inc. so that it could quickly fully integrate Siri’s natural-language voice recognition software into iOS, Apple’s operating system.

Mergers and acquisitions also can be a means of obtaining valuable resources that can help an organization expand its product offerings and services. Cisco Systems, a computer networking firm, has undertaken over 80 acquisitions in the last decade. Cisco uses these acquisitions to quickly add new technology to its product offerings to meet changing cus- tomer needs. Then it uses its excellent sales force to market the new technology to its cor- porate customers. Cisco also provides strong incentives to the staff of acquired companies to stay on. To realize the greatest value from its acquisitions, Cisco also has learned to integrate acquired companies efficiently and effectively.42

Acquiring firms often use acquisitions to acquire critical human capital. These acquisi- tions have been referred to as acq-hires. In an acq-hire, the acquiring firm believes it needs the specific technical knowledge or the social network contacts of individuals in the target

EXHIBIT 6.5 Global Value of Mergers and Acquisitions ($ trillions)

0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

1

2

3

4

5

6

$ Tr

ill iio

n

Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis.

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firm. This is especially important in settings where the technology or consumer preferences are highly dynamic. For example, in 2014, Apple purchased Beats Electronics for $3 billion. While Apple valued the product portfolio of Beats, its primary aim was to pull the found- ers of Beats, Jimmy Iovine and Dr. Dre (aka Andrew Young), into the Apple family. With Apple’s iTunes business having hit a wall in growth, experiencing a 1 percent decline in 2013, Apple wanted to acquire new management talent to turn this business around. In addi- tion to their experience at Beats, Iovine and Dr. Dre both have over 20 years of experience in the music industry, with Iovine founding and heading InterScope Records and Dr. Dre being a hip-hop pioneer and music producer. With this acquisition, Apple believes it brought in a wealth of knowledge about the music business, the ability to identify music trends, up-and- coming talent, and industry contacts needed to rejuvenate Apple’s music business.43

Mergers and acquisitions also can provide the opportunity for firms to attain the three bases of synergy—leveraging core competencies, sharing activities, and building market power. Consider some of eBay’s acquisitions. eBay has purchased a range of businesses in related product markets, such as GSI Commerce, a company that designs and runs online shopping sites for brick-and-mortar retailers, and StubHub, an online ticket broker. Additionally, it has purchased Korean online auction company Gmarket to expand its geographic scope. Finally, it has pur- chased firms providing related services, such as Shutl, a rapid-order-fulfillment service provider.

These acquisitions offer the opportunity to leverage eBay’s competencies.44 For example, with the acquisition of GSI, eBay saw opportunities to leverage its core competencies in online systems as well as its reputation to strengthen GSI while also expanding eBay’s abil- ity to work with medium to large merchants and brands. eBay can also benefit from these acquisitions by sharing activities. In acquiring firms in related product markets and in new geographic markets, eBay has built a set of businesses that can share in the development of e-commerce and mobile commerce systems. Finally, by expanding into new geographic markets and offering a wider range of services, eBay can build market power as one of the few online retailer systems that provide a full set of services on a global platform. Strategy Spotlight 6.3 highlights how Valeant Pharmaceuticals tried to leverage market power ben- efits from acquisitions but found the benefits both controversial and short-lived.

Merger and acquisition activity also can lead to consolidation within an industry and can force other players to merge.45 The airline industry has seen a great deal of consolidation in the last several years. With a number of large-scale acquisitions, including Delta’s acquisition of Northwest Airlines in 2008, United’s acquisition of Continental in 2010, and American’s purchase of US Airways in 2013, the U.S. airlines industry has been left with only four major players. In combining, these airlines are both seeking greater efficiencies by combining their networks and hoping that consolidation will dampen the rivalry in the industry.46

Corporations can also enter new market segments by way of acquisitions. As mentioned above, eBay, a firm that specialized in providing services to individuals and small busi- nesses, moved into providing online retail systems for large merchants with its acquisition of GSI Commerce. Similarly, one of the reasons Fiat acquired Chrysler was to gain access to the U.S. auto market. Exhibit 6.6 summarizes the benefits of mergers and acquisitions.

Potential Limitations As noted in the previous section, mergers and acquisitions provide a firm with many potential benefits. However, at the same time, there are many potential drawbacks or limitations to such corporate activity.47

• Obtain valuable resources, such as critical human capital, that can help an organization expand its product offerings.

• Provide the opportunity for firms to attain three bases of synergy: leveraging core competencies, sharing activities, and building market power.

• Lead to consolidation within an industry and force other players to merge. • Enter new market segments.

EXHIBIT 6.6 Benefits of Mergers and Acquisitions

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6.3 ETHICSSTRATEGY SPOTLIGHT VALEANT PHARMACEUTICALS JACKS UP PRICES AFTER ACQUISITIONS BUT LOSES IN THE END Valeant Pharmaceuticals figured it had found a way to improve its profit margins. Rather than emphasizing drug development, the firm undertook a series of acquisitions where it bought up existing drugs it believed were underpriced and then dramati- cally raised the prices of those drugs. For example, in February 2015, Valeant announced it was buying the rights to two life- saving heart drugs and immediately increased the list prices for the drugs—one by 212 percent and the other by 525 percent. Similarly, after it purchased Salix Pharmaceuticals, Valeant increased the price of a diabetes drug Salix produced, Glumetza, by about 800 percent. J. Michael Pearson, Valeant’s CEO, justi- fied the firm’s actions that they were just working to maximize shareholder value when he stated if “products are sort of mis- priced and there’s an opportunity, we will act appropriately in terms of doing what I assume our shareholders would like us to do.” Further, in a statement, Valeant defended its pricing actions, stating it “prices its treatments based on a range of factors,

including clinical benefits and the value they bring to patients, payers, and society.”

The strategy paid off for Valeant for quite a while. Its stock price rose from $15 a share in early 2010 to over $250 a share in July of 2015, but then it all crashed down. Its price increase triggered a great deal of scrutiny from regulators, and generic manufacturers jumped to create cheaper competitors to Valeant’s drugs, many of which either no longer had patent protection or were soon to lose patent protection. Thus, its ability to sustain high drug price rev- enue appeared questionable. Additionally, the firm had taken on $30 billion in debt to finance its acquisitions and would be unable to meet its debt obligations if it had to cut the prices of its drugs. Coupled with questions about the firm’s accounting practices, these concerns led investors to bail out, pushing the stock’s price down to $14 a share in December 2016. The turn in events also cost Mr. Pearson his position as firm CEO in April 2016.

Sources: Rockoff, J. & Silverman E. 2015. Pharmaceutical companies buy rivals’ drugs, then jack up the prices. wsj.com, April 27: np; Pollack, A. & Tavernise, S. 2015. Valeant’s drug price strategy enriches it, but infuriates patients and lawmakers. nytimes.com, October 4: np; and Vardi, N. 2016. Valeant Pharmaceuticals’ prescription for disaster. forbes.com, April 13: np.

First, the takeover premium that is paid for an acquisition typically is very high. Two times out of three, the stock price of the acquiring company falls once the deal is made public. Since the acquiring firm often pays a 30 percent or higher premium for the target company, the acquirer must create synergies and scale economies that result in sales and market gains exceeding the premium price. Firms paying higher premiums set the performance hurdle even higher. For example, Household International paid an 82 percent premium to buy Beneficial, and Conseco paid an 83 percent premium to acquire Green Tree Financial. Historically, paying a high premium over the stock price has been a poor strategy.

Second, competing firms often can imitate any advantages realized or copy synergies that result from the M&A.48 Thus, a firm can often see its advantages quickly erode. Unless the advantages are sustainable and difficult to copy, investors will not be willing to pay a high premium for the stock. Similarly, the time value of money must be factored into the stock price. M&A costs are paid up front. Conversely, firms pay for R&D, ongoing marketing, and capacity expansion over time. This stretches out the payments needed to gain new competencies. The M&A argument is that a large initial investment is worthwhile because it creates long-term advantages. However, stock analysts want to see immediate results from such a large cash outlay. If the acquired firm does not produce results quickly, investors often divest the stock, driving the price down.

Third, managers’ credibility and ego can sometimes get in the way of sound business deci- sions. If the M&A does not perform as planned, managers who pushed for the deal find their reputation tarnished. This can lead them to protect their credibility by funneling more money, or escalating their commitment, into an inevitably doomed operation. Further, when a merger fails and a firm tries to unload the acquisition, the firm often must sell at a huge discount. These problems further compound the costs and erode the stock price.

Fourth, there can be many cultural issues that may doom the intended benefits from M&A endeavors. Consider the insights of Joanne Lawrence, who played an important role in the merger between SmithKline and the Beecham Group.49

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• Takeover premiums paid for acquisitions are typically very high. • Competing firms often can imitate any advantages or copy synergies that result from the merger or acquisition. • Managers’ egos sometimes get in the way of sound business decisions. • Cultural issues may doom the intended benefits from M&A endeavors.

EXHIBIT 6.7 Limitations of Mergers and Acquisitions

6.4 STRATEGY SPOTLIGHT THE WISDOM OF CROWDS: WHEN DO INVESTORS SEE VALUE IN ACQUISITIONS? By some estimates, 70 to 90 percent of acquisitions destroy shareholder value. But investors do see value in some acquisi- tions. The question is, When does the wisdom of the investment crowd indicate there is value with acquisitions? Recent research suggests it rests in both the characteristics of the deal and the motivation of the acquiring firm.

The Characteristics of the Deal Research has identified several deal characteristics that lead to positive investor reactions. Not surprisingly, investors see greater value in acquisitions when the acquiring and the acquired (target) firm are in the same or closely related industries. This is consistent with there being greater potential for synergies when the firms are in similar markets. Second, investors see greater value potential when acquiring managers are seen as responding quickly to new opportunities, such as those provided by the emergence of new technologies or market deregulation. Third, investors have a more positive reaction when the acquiring firm used cash to buy the target, as opposed to giving the target shareholders stock in the combined firm. Acquiring firms often use stock to finance acquisi- tions when they think their own stock is overvalued. Thus, the use of cash signals that the acquiring firm’s managers have confidence in the value of the deal. Fourth, the less the acquiring firm relies on outside advisers, such as investment banks, the more investors see value in the deal. As with the use of cash, managers who rely

primarily on their own knowledge and abilities to manage deals are seen as more confident. Finally, when the target firm tries to avoid the acquisition, investors see less value potential. Defense actions by targets are seen as signals that the target firm will not be open to easy integration with the acquiring firm. Thus, it may be difficult to leverage synergies.

The Motivation of the Acquirer How much value investors see in the deal is also affected by the motivation of the acquirer. Interestingly, if the acquiring firm is highly profitable, investors see less value in the acquisition. The concern here is that strong performance likely leads managers to become overconfident and more likely to undertake “empire building” acquisitions as opposed to acquisitions that generate shareholder value. Second, if the acquiring firm is highly leveraged, having a high debt-equity ratio, investors see more value in the acquisition. Since the acquiring firm is at a higher risk of bankruptcy, managers of highly leveraged firms are likely to undertake acquisitions only if they are low risk and likely to generate synergistic benefits.

In total, the stock investors look to logical clues about the potential value of the deal and the motives of the acquiring firm managers to assess the value they see. Thus, there appears to be simple but logical wisdom in the crowd. Sources: McNamara, G., Haleblian, J., & Dykes, B. 2008. Performance implications of participating in an acquisition wave: Early mover advantages, bandwagon effects, and the moderating influence of industry characteristics and acquirer tactics. Academy of Management Journal, 51: 113–130; and Schijven, M. & Hitt, M. 2012. The vicarious wisdom of crowds: Toward a behavioral perspective on investor reactions to acquisition announcements. Strategic Management Journal, 33: 1247–1268.

The key to a strategic merger is to create a new culture. This was a mammoth challenge during the SmithKline Beecham merger. We were working at so many different cultural levels, it was dizzying. We had two national cultures to blend—American and British—that compounded the challenge of selling the merger in two different markets with two different shareholder bases. There were also two different business cultures: One was very strong, scientific, and academic; the other was much more commercially oriented. And then we had to consider within both companies the individual businesses, each of which has its own little culture.

Exhibit 6.7 summarizes the limitations of mergers and acquisitions. Strategy Spotlight 6.4 discusses the characteristics of acquisitions that lead investors to

see greater value in the combinations. Divestment: The Other Side of the “M&A Coin” When firms acquire other businesses,

it typically generates quite a bit of “press” in business publications such as The Wall Street Journal, Bloomberg Businessweek, and Fortune. It makes for exciting news, and one thing is for sure—large acquiring firms automatically improve their standing in the Fortune 500 rankings (since it is based solely on total revenues). However, managers must also carefully consider the strategic implications of exiting businesses.

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Divestments, the exit of a business from a firm’s portfolio, are quite common. One study found that large, prestigious U.S. companies divested more acquisitions than they kept.50

Divesting a business can accomplish many different objectives.* It can be used to help a firm reverse an earlier acquisition that didn’t work out as planned. Often, this is simply to help “cut their losses.” Other objectives include (1) enabling managers to focus their efforts more directly on the firm’s core businesses,51 (2) providing the firm with more resources to spend on more attractive alternatives, and (3) raising cash to help fund existing businesses.

Divesting can enhance a firm’s competitive position only to the extent that it reduces its tangible (e.g., maintenance, investments, etc.) or intangible (e.g., opportunity costs, man- agerial attention) costs without sacrificing a current competitive advantage or the seeds of future advantages.52 To be effective, divesting requires a thorough understanding of a business unit’s current ability and future potential to contribute to a firm’s value creation. However, since such decisions involve a great deal of uncertainty, it is very difficult to make such evaluations. In addition, because of managerial self-interests and organizational iner- tia, firms often delay divestments of underperforming businesses.

The Boston Consulting Group has identified seven principles for successful divestiture.53

1. Remove the emotion from the decision. Managers need to consider objectively the prospects for each unit in the firm and how this unit fits with the firm’s overall strategy. Issues related to personal relationships with the managers of the unit, the length of time the unit has been part of the company, and other emotional elements should not be considered in the decision.54

2. Know the value of the business you are selling. Divesting firms can generate greater interest in and higher bids for units they are divesting if they can clearly articulate the strategic value of the unit.

3. Time the deal right. This involves both internal timing, whereby the firm regularly evaluates all its units so that it can divest units when they are no longer highly valued in the firm but will still be of value to the outside market, and external timing, being ready to sell when the market conditions are right.

4. Maintain a sizable pool of potential buyers. Divesting firms should not focus on a single potential buyer. Instead, they should discuss possible deals with several hand- picked potential bidders.

5. Tell a story about the deal. For each potential bidder it talks with, the divesting firm should develop a narrative about how the unit it is interested in selling will create value for that buyer.

6. Run divestitures systematically through a project office. Firms should look at developing the ability to divest units as a distinct form of corporate competencies. While many firms have acquisition units, they often don’t have divesting units even though there is significant potential value in divestitures.

7. Communicate clearly and frequently. Corporate managers need to clearly communicate to internal stakeholders, such as employees, and external stakeholders, such as customers and stockholders, what their goals are with divestment activity, how it will create value, and how the firm is moving forward strategically with these decisions.

divestment the exit of a business from a firm’s portfolio.

* Firms can divest their businesses in a number of ways. Sell-offs, spin-offs, equity carve-outs, asset sales/dissolution, and split- ups are some such modes of divestment. In a sell-off, the divesting firm privately negotiates with a third party to divest a unit/ subsidiary for cash/stock. In a spin-off, a parent company distributes shares of the unit/subsidiary being divested pro rata to its existing shareholders and a new company is formed. Equity carve-outs are similar to spin-offs except that shares in the unit/ subsidiary being divested are offered to new shareholders. Dissolution involves sale of redundant assets, not necessarily as an entire unit/subsidiary as in sell-offs but a few bits at a time. A split-up, on the other hand, is an instance of divestiture where by the parent company is split into two or more new companies and the parent ceases to exist. Shares in the parent company are exchanged for shares in new companies, and the exact distribution varies case by case.

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Strategic Alliances and Joint Ventures A strategic alliance is a cooperative relationship between two (or more) firms.55 Alliances can exist in multiple forms. Contractual alliances are simply based on written contracts between firms. Contractual alliances are typically used for fairly simple alliance agreements, such as supplier, marketing, or distribution relationships that don’t require a great deal of integration or technology sharing between firms and have a finite, identifiable end time period. If the terms of the agreement can be clearly laid out in contracts, then contracts can be a complete and effective basis for the agreement. However, when there is uncertainty about how the alli- ance will proceed and evolve over time or if one firm is much larger than the other, firms will often form equity alliances. In an equity alliance, at least one firm purchases a minority owner- ship stake in the other. Equity ownership in alliances helps align the interest of the two firms since the firm that buys the ownership stake benefits both from increases in its own value and the value of the partner it now owns a part of. This can reduce concerns that one firm will benefit more from the alliance than the partner firm or take advantage of the partner firm as the alliance evolves. This can be an especially large concern when a very large firm allies with a small firm. By taking an equity stake in the smaller firm, the larger firm signals that it is link- ing its own money into the success of the smaller firm. Joint ventures represent a special case of alliances, wherein two (or more) firms contribute equity to form a new legal entity.

Strategic alliances and joint ventures are assuming an increasingly prominent role in the strategy of leading firms, both large and small.56 Such cooperative relationships have many potential advantages.57 Among these are entering new markets, reducing manufacturing (or other) costs in the value chain, and developing and diffusing new technologies.58

Entering New Markets Often a company that has a successful product or service wants to introduce it into a new market. However, it may not have the financial resources or the requisite marketing expertise because it does not understand customer needs, know how to promote the product, or have access to the proper distribution channels.59

Zara, a Spanish clothing company, operates stores in over 70 countries. Still, when enter- ing markets very distant from its home markets, Zara often uses local alliance partners to help it negotiate the different cultural and regulatory environments. For example, when Zara expanded into India in 2010, it did it in cooperation with Tata, an Indian conglomerate.60

Alliances can also be used to enter new product markets. For example, Lego has expanded its product portfolio by licensing the right to develop products built around characters and brands, such as Star Wars and Harry Potter. It also allied with the digital animation firm Animal Logic Pty Ltd and Warner Bros. to develop the Lego Movie.61

Reducing Manufacturing (or Other) Costs in the Value Chain Strategic alliances (or joint ventures) often enable firms to pool capital, value-creating activities, or facilities in order to reduce costs. For example, the PGA and LPGA tours joined together in a strategic alliance that allows them to save costs by jointly marketing golf, develop a shared digital media plat- form, and jointly negotiate domestic television contracts.62

Developing and Diffusing New Technologies Strategic alliances also may be used to build jointly on the technological expertise of two or more companies. This may enable them to develop products technologically beyond the capability of the companies acting indepen- dently.63 The alliance between Ericsson and Cisco discussed in Strategy Spotlight 6.5 aims to allow the two firms to jointly develop new, integrated telecommunication equipment to meet the evolving needs of firms like Verizon and Vodafone.

Potential Downsides Despite their promise, many alliances and joint ventures fail to meet expectations for a variety of reasons.64 First, without the proper partner, a firm should never consider undertaking an alliance, even for the best of reasons.65 Each partner should bring the desired complementary strengths to the partnership. Ideally, the strengths contributed

strategic alliance a cooperative relationship between two or more firms.

joint ventures new entities formed within a strategic alliance in which two or more firms, the parents, contribute equity to form the new legal entity.

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6.5 STRATEGY SPOTLIGHT ERICSSON AND CISCO JOIN FORCES TO RESPOND TO THE CHANGING TELECOMMUNICATIONS MARKET Ericsson AB and Cisco Systems are both giants in providing equip- ment for the telecommunications and Internet markets. Ericsson, a Swedish firm, is one of the world’s leading manufacturers of wireless equipment with $26 billion in sales. Cisco, based in the United States, has revenue of $49 billion and is the world’s larg- est manufacturer of Internet backbone gear. Even with their size and large market presence, they are facing strong challenges. First, they are finding that their telecommunications customers, such as Verizon and AT&T, are looking for complete solutions as they upgrade their technology to launch 5G networks. As part of this, these customers are replacing some special-purpose wireless and network equipment with computers equipped with software. This requires integrating technology that has been sold separately by firms like Ericsson and Cisco. Second, they are fac- ing stronger competition from rivals who can provide these inte- grated solutions. Chinese system provider Huawei has expertise in both the wireless and Internet equipment arenas and is pro- viding complete solutions for telecom firms. Additionally, Nokia, another leading wireless equipment provider, extended its ability to provide integrated systems when it acquired Alcatel-Lucent, an Internet equipment firm, in early 2016.

Rather than have one of the firms acquire the other, Ericsson and Cisco decided to address these competitive challenges by

allying with each other. They initially will work to integrate exist- ing equipment to provide complete solutions to telecom firms. As part of this, they will combine some sales and consulting efforts. As they move forward, they will jointly develop new hard- ware and services. Since technology is evolving so rapidly, the ultimate scope of the alliance remains somewhat unclear. The complexity of it all took a while to work through— negotiations about the alliance took 13 months, but they have signed a flex- ible agreement about sharing patented technologies and have a high degree of trust that this is the right course.

Why choose an alliance over the acquisition route that Nokia and Alcatel pursued? Chuck Robbins, Cisco’s CEO, made the case for avoiding an acquisition stating that “Neither Ericsson or Cisco really believe that these large mergers typically work.” Since the two companies come from different countries and are both large with strong corporate cultures, a full integration would have been a great challenge. Also, an acquisition of firms so large would likely have triggered significant anti-trust con- cerns and regulatory scrutiny. Hans Vestberg, Ericsson’s CEO, made an affirmative case for the alliance, stating, “This is a much more agile and efficient choice. We can start already tomorrow.” The firms anticipate that the alliance should increase sales by each firm by at least $1 billion annually.

Sources: Clark, D. & Hansegard, J. 2015. Ericsson, Cisco pool telecom, Internet savvy in wide-reaching alliance. wsj.com, November 9: np.; and Higginbotham, S. 2015. Why Cisco and Ericsson are teaming up for future growth. fortune.com, November 9: np.

by the partners are unique; thus synergies created can be more easily sustained and defended over the longer term. The goal must be to develop synergies between the contributions of the partners, resulting in a win–win situation. Moreover, the partners must be compatible and willing to trust each other.66 Unfortunately, often little attention is given to nurturing the close working relationships and interpersonal connections that bring together the part- nering organizations.67

Internal Development Firms can also diversify by means of corporate entrepreneurship and new venture develop- ment. In today’s economy, internal development is such an important means by which com- panies expand their businesses that we have devoted a whole chapter to it (see Chapter 12). Sony and the Minnesota Mining & Manufacturing Co. (3M), for example, are known for their dedication to innovation, R&D, and cutting-edge technologies. For example, 3M has developed its entire corporate culture to support its ongoing policy of generating at least 25 percent of total sales from products created within the most recent four-year period. While 3M exceeded this goal for decades, a push for improved efficiency that began in the early 2000s resulted in a drop to generating only 21 percent of sales from newer products in 2005. By refocusing on innovation, 3M raised that value back up to 33 percent in 2016.

Biocon, the largest Indian biotechnology firm, shows the power of internal development. Kiran Mazumdar-Shaw, the firm’s founder, took the knowledge she learned while studying malting and brewing in college to start a small firm that produced enzymes for the beer

internal development entering a new business through investment in new facilities, often called corporate enterpreneurship and new venture development.

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industry in her Bangalore garage in 1978. The firm first expanded into providing enzymes for other food and textile industries. From there, Biocon expanded on to producing generic drugs and is now the largest producer of insulin in Asia.68

Compared to mergers and acquisitions, firms that engage in internal development cap- ture the value created by their own innovative activities without having to “share the wealth” with alliance partners or face the difficulties associated with combining activities across the value chains of several firms or merging corporate cultures.69 Also, firms can often develop new products or services at a relatively lower cost and thus rely on their own resources rather than turning to external funding.70

There are also potential disadvantages. It may be time-consuming; thus, firms may forfeit the benefits of speed that growth through mergers or acquisitions can provide. This may be especially important among high-tech or knowledge-based organizations in fast-paced environments where being an early mover is critical. Thus, firms that choose to diversify through internal development must develop capabilities that allow them to move quickly from initial opportunity recognition to market introduction.

HOW MANAGERIAL MOTIVES CAN ERODE VALUE CREATION Thus far in the chapter, we have implicitly assumed that CEOs and top executives are “ratio- nal beings”; that is, they act in the best interests of shareholders to maximize long-term shareholder value. In the real world, however, they may often act in their own self-interest. We now address some managerial motives that can serve to erode, rather than enhance, value creation. These include “growth for growth’s sake,” excessive egotism, and the cre- ation of a wide variety of antitakeover tactics.

Growth for Growth’s Sake There are huge incentives for executives to increase the size of their firm. And these are not consistent with increasing shareholder wealth. Top managers, including the CEO, of larger firms typically enjoy more prestige, higher rankings for their firms on the Fortune 500 list (based on revenues, not profits), greater incomes, more job security, and so on. There is also the excitement and associated recognition of making a major acquisition. As noted by Harvard’s Michael Porter, “There’s a tremendous allure to mergers and acquisitions. It’s the big play, the dramatic gesture. With one stroke of the pen you can add billions to size, get a front-page story, and create excitement in markets.”71

In recent years many high-tech firms have suffered from the negative impact of their uncontrolled growth. Consider, for example, Priceline.com’s ill-fated venture into an online service to offer groceries and gasoline.72 A myriad of problems—perhaps most importantly, a lack of participation by manufacturers—caused the firm to lose more than $5 million a week prior to abandoning these ventures. Such initiatives are often little more than desperate moves by top managers to satisfy investor demands for accelerating revenues. Unfortunately, the increased revenues often fail to materialize into a corresponding hike in earnings.

At times, executives’ overemphasis on growth can result in a plethora of ethical lapses, which can have disastrous outcomes for their companies. A good example (of bad practice) is Joseph Berardino’s leadership at Andersen Worldwide. Berardino had a chance early on to take a hard line on ethics and quality in the wake of earlier scandals at clients such as Waste Management and Sunbeam. Instead, according to former executives, he put too much emphasis on revenue growth. Consequently, the firm’s reputation quickly eroded when it audited and signed off on the highly flawed financial statements of such infamous firms as Enron, Global Crossing, and WorldCom. Berardino ultimately resigned in disgrace in March 2002, and his firm was dissolved later that year.73

LO 6-6 Managerial behaviors that can erode the creation of value.

managerial motives managers acting in their own self-interest rather than to maximize long- term shareholder value.

growth for growth’s sake managers’ actions to grow the size of their firms not to increase long-term profitability but to serve managerial self-interest.

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Egotism A healthy ego helps make a leader confident, clearheaded, and able to cope with change. CEOs, by their very nature, are intensely competitive people in the office as well as on the tennis court or golf course. But sometimes when pride is at stake, individuals will go to great lengths to win.

Egos can get in the way of a “synergistic” corporate marriage. Few executives (or lower- level managers) are exempt from the potential downside of excessive egos. Consider, for example, the reflections of General Electric’s former CEO Jack Welch, considered by many to be the world’s most admired executive. He admitted to a regrettable decision: “My hubris got in the way in the Kidder Peabody deal. [He was referring to GE’s buyout of the soon- to-be-troubled Wall Street firm.] I got wise advice from Walter Wriston and other directors who said, ‘Jack, don’t do this.’ But I was bully enough and on a run to do it. And I got whacked right in the head.”74 In addition to poor financial results, Kidder Peabody was wracked by a widely publicized trading scandal that tarnished the reputations of both GE and Kidder Peabody. Welch ended up selling Kidder.

The business press has included many stories of how egotism and greed have infiltrated organizations.75 For example, consider Merrill Lynch’s former CEO, John Thain.76 On January 22, 2009, he was ousted as head of Merrill Lynch by Bank of America’s CEO, Ken Lewis:

Thain embarrassingly doled out $4 billion in discretionary year-end bonuses to favored employees just before Bank of America’s rescue purchase of failing Merrill. The bonuses amounted to about 10 percent of Merrill’s 2008 losses.

Obviously, John Thain believed that he was entitled. When he took over ailing Merrill in early 2008, he began planning major cuts, but he also ordered that his office be redecorated. He spent $1.22 million of company funds to make it “livable,” which, in part, included $87,000 for a rug, $87,000 for a pair of guest chairs, $68,000 for a 19th-century credenza, and (what really got the attention of the press) $35,000 for a “commode with legs.”

He later agreed to repay the decorating costs. However, one might still ask: What kind of person treats other people’s money like this? And who needs a commode that costs as much as a new Lexus? Finally, a comment by Bob O’Brien, stock editor at Barrons.com, clearly applies: “The sense of entitlement that’s been engendered in this group of people has clearly not been beaten out of them by the brutal performance of the financial sector over the course of the last year.”

Antitakeover Tactics Unfriendly or hostile takeovers can occur when a company’s stock becomes undervalued. A com- peting organization can buy the outstanding stock of a takeover candidate in sufficient quantity to become a large shareholder. Then it makes a tender offer to gain full control of the company. If the shareholders accept the offer, the hostile firm buys the target company and either fires the target firm’s management team or strips the team members of their power. Thus, antitakeover tactics are common, including greenmail, golden parachutes, and poison pills.77

The first, greenmail, is an effort by the target firm to prevent an impending takeover. When a hostile firm buys a large block of outstanding target company stock and the tar- get firm’s management feels that a tender offer is impending, it offers to buy the stock back from the hostile company at a higher price than the unfriendly company paid for it. Although this often prevents a hostile takeover, the same price is not offered to preexisting shareholders. However, it protects the jobs of the target firm’s management.

Second, a golden parachute is a prearranged contract with managers specifying that, in the event of a hostile takeover, the target firm’s managers will be paid a significant severance package. Although top managers lose their jobs, the golden parachute provisions protect their income.

Third, poison pills are used by a company to give shareholders certain rights in the event of a takeover by another firm. They are also known as shareholder rights plans.

Clearly, antitakeover tactics can often raise some interesting ethical—and legal—issues.

egotism managers’ actions to shape their firms’ strategies to serve their selfish interests rather than to maximize long- term shareholder value.

antitakeover tactics managers’ actions to avoid losing wealth or power as a result of a hostile takeover.

greenmail a payment by a firm to a hostile party for the firm’s stock at a premium, made when the firm’s management feels that the hostile party is about to make a tender offer.

golden parachute a prearranged contract with managers specifying that, in the event of a hostile takeover, the target firm’s managers will be paid a significant severance package.

poison pill used by a company to give shareholders certain rights in the event of takeover by another firm.

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ISSUE FOR DEBATE

Starbucks Moves Far Outside the Coffeehouse When you say Starbucks, most people instantly think of coffee, specifically coffee prepared by a barista just the way you want it—once you get the Starbucks lingo down. Starbucks is available in over 20,000 coffeehouses in more than 60 countries. Starbucks has experienced amazing growth over the last 30 years as it moved from a small chain of coffeehouses in Seattle to the global powerhouse that it is now. However, the firm faces more limited prospects for growth in its coffee business from this point forward. The coffee market is fairly mature, and Starbucks sees a limited number of new markets in which to expand.

In recent years, Starbucks has diversified into a number of new products and distribution channels to stoke up its growth potential. This has included diversifying into new products to sell through its cafes. Starbucks purchased La Boulange Bakery and now produces baked goods to sell in its cafes. Similarly, it purchased Teavana and is adding tea bars to its cafes. It also purchased Evolution Fresh juice company and now supplies the juices it sells in Starbucks coffeehouses. It is also test marketing additional new products in its cafes—beer and wine in Starbucks Evening concept stores and carbonated beverages in several markets. Starbucks is also making a major push in the grocery aisle. The firm has developed a “signature aisle” which features wood shelving that reflects the appearance of a Starbucks Café. The aisle’s desirable end cap (the high-traffic shelf area at the end of an aisle) attracts shoppers’ attention to products such as Starbucks’ bagged coffee, its single-serve K-cups, and its Via brand instant coffee. But selling coffee in grocery stores is just the first step. Starbucks aims to also distribute its La Boulange bakery products, Teavana teas, and Evolution Fresh juices in grocery stores. It has even been looking further afield as it developed Evolution Harvest snack bars for the grocery aisle and also crafted an alliance with Danone to produce and sell Evolution Fresh yogurt products in grocery stores. The grocery aisle business now accounts for about 7 percent of Starbucks’ business, but CEO Howard Schultz envisions the grocery aisle business producing half of the company’s sales.

While the growth potential is enticing, there are some potential pitfalls associated with Starbucks’ push into new arenas. The perceived differentiation of its coffee products could erode as they become a grocery aisle staple. Also, the growth of grocery sales could cannibalize the sales at cafes as people simply brew their K-cup coffee at home rather than swinging through the Starbucks drive-through on the way to work. In moving into noncoffee products, the question becomes whether or not Starbucks has the competencies to manage other businesses well. While Starbucks has mastered the management of the coffee supply chain and developed a distinctive product, it is not clear that the company has the competencies to produce bakery products, juice, tea, beer, and wine better than outside suppliers. Finally, managing all of these new businesses may distract Starbucks from its core coffee cafe business. The challenge for Starbucks is to know what its core competencies are and to focus on markets that allow it to best exploit those competencies.

Discussion Questions 1. What are Starbucks’ core competencies? Do the new businesses allow Starbucks to leverage

those competencies? 2. Do Starbucks’ diversification efforts appear to be primarily about increasing growth or

increasing shareholder value by sharing activities, building market power, and/or leveraging core competencies?

3. Where do you think Starbucks should draw boundaries on what businesses to compete in? Should it keep the new products in the corporate family? Should it continue to move into the grocery retailing space?

Sources: Levine-Weinberg, A. 2014. Starbucks has decades of growth ahead. money.cnn.com, November 19: np; Kowitt, B. 2013. Starbucks’ grocery gambit. Fortune, December 23: np; Strom, S. 2013. Starbucks aims to move beyond beans. nytimes.com, October 8: np; and starbucks.com.

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Reflecting on Career Implications . . . This chapter focuses on how firms can create value through diversification. The following questions lead you to consider how you can develop core competencies that apply in different settings and how you can leverage those skills in different value chain activities or units in your firms.

Corporate-Level Strategy: Is your current employer a single business firm or a diversified firm? If it is diversified, does it pursue related or unrelated diversification? Does its diversification provide you with career opportunities, especially lateral moves? What organizational policies are in place to either encourage or discourage you from moving from one business unit to another?

Core Competencies: What do you see as your core competencies? How can you leverage them

within your business unit as well as across other business units?

Sharing Infrastructures: Identify what infrastructure activities and resources (e.g., information systems, legal) are available in the corporate office that are shared by various business units in the firm. How often do you take advantage of these shared resources? Identify ways in which you can enhance your performance by taking advantage of these shared infrastructure resources.

Diversification: From your career perspective, what actions can you take to diversify your employment risk (e.g., doing coursework at a local university, obtaining professional certification such as a CPA, networking through professional affiliation, etc.)? In periods of retrenchment, such actions will provide you with a greater number of career options.

A key challenge for today’s managers is to create “synergy” when engaging in diversification activities. As we discussed in this chapter, corporate managers do not, in general, have a very good track record in creating value in

such endeavors when it comes to mergers and acquisitions. Among the factors that serve to erode shareholder values are paying an excessive premium for the target firm, failing to integrate the activities of the newly acquired businesses into the corporate family, and undertaking diversification initiatives that are too easily imitated by the competition.

We addressed two major types of corporate-level strategy: related and unrelated diversification. With related diversification the corporation strives to enter into areas in which key resources and capabilities of the corporation can be shared or leveraged. Synergies come from horizontal relationships between business units. Cost savings and enhanced revenues can be derived from two major sources. First, economies of scope can be achieved from the leveraging of core competencies and the sharing of activities. Second, market power can be attained from greater, or pooled, negotiating power and from vertical integration.

When firms undergo unrelated diversification, they enter product markets that are dissimilar to their present businesses. Thus, there is generally little opportunity to either leverage core competencies or share activities across business units. Here, synergies are created from vertical relationships between the corporate office and the individual business units. With unrelated diversification, the primary ways to create value are corporate restructuring and parenting, as well as the use of portfolio analysis techniques.

Corporations have three primary means of diversifying their product markets—mergers and acquisitions, joint ventures/strategic alliances, and internal development. There are key trade-offs associated with each of these. For example, mergers and acquisitions are typically the quickest means to enter new markets and provide the corporation with a high level of control over the acquired business. However, with the expensive premiums that often need to be paid to the shareholders of the target firm and the challenges associated with integrating acquisitions, they can also be quite expensive. Not surprisingly, many poorly performing acquisitions are subsequently divested. At times, however, divestitures can help firms refocus their efforts and generate resources. Strategic alliances and joint ventures between two or more firms, on the other hand, may be a means of reducing risk since they involve the sharing and combining of resources. But such joint initiatives also provide a firm with less control (than it would have with an acquisition) since governance is shared between two independent entities. Also, there is a limit to the potential upside for each partner because returns must be shared as well. Finally, with internal development, a firm is able to capture all of the value from its initiatives (as opposed to sharing it with a merger or alliance partner). However, diversification by means of internal development can be very time-consuming—a disadvantage that becomes even more important in fast-paced competitive environments.

Finally, some managerial behaviors may serve to erode shareholder returns. Among these are “growth for growth’s sake,” egotism, and antitakeover tactics. As we discussed, some of these issues—particularly antitakeover tactics—raise ethical considerations because the managers of the firm are not acting in the best interests of the shareholders.

summary

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EXPERIENTIAL EXERCISE AT&T is a firm that follows a strategy of related diversification. Evaluate its success (or lack thereof) with regard to how well it has (1) built on core competencies, (2) shared infrastructures, and (3) increased market power. (Fill answers in table below.)

SUMMARY REVIEW QUESTIONS 1. Discuss how managers can create value for their firm

through diversification efforts. 2. What are some of the reasons that many diversification

efforts fail to achieve desired outcomes? 3. How can companies benefit from related diversification?

Unrelated diversification? What are some of the key concepts that can explain such success?

4. What are some of the important ways in which a firm can restructure a business?

5. Discuss some of the various means that firms can use to diversify. What are the pros and cons associated with each of these?

6. Discuss some of the actions that managers may engage in to erode shareholder value.

corporate-level strategy 172 diversification 174 related diversification 175 economies of scope 175 core competencies 176 sharing activities 178 market power 179

pooled negotiating power 179 vertical integration 179 transaction cost perspective 181 unrelated diversification 182 parenting advantage 182 restructuring 182 portfolio management 183 acquisitions 186 mergers 186 divestment 191 strategic alliance 192 joint ventures 192

key terms

APPLICATION QUESTIONS & EXERCISES 1. What were some of the largest mergers and

acquisitions over the last two years? What was the rationale for these actions? Do you think they will be successful? Explain.

2. Discuss some examples from business practice in which an executive’s actions appear to be in his or her self-interest rather than the corporation’s well-being.

3. Discuss some of the challenges that managers must overcome in making strategic alliances successful. What are some strategic alliances with which you are familiar? Were they successful or not? Explain.

4. Use the Internet and select a company that has recently undertaken diversification into new product markets. What do you feel were some of the reasons for this diversification (e.g., leveraging core competencies, sharing infrastructures)?

Rationale for Related Diversification Successful/Unsuccessful? Why?

1. Build on core competencies

2. Share infrastructures

3. Increase market power

internal development 193 managerial motives 194 growth for growth’s sake 194 egotism 195

antitakeover tactics 195 greenmail 195 golden parachute 195 poison pill 195

ETHICS QUESTIONS 1. It is not uncommon for corporations to undertake

downsizing and layoffs. Do you feel that such actions raise ethical considerations? Why or why not?

2. What are some of the ethical issues that arise when managers act in a manner that is counter to their firm’s best interests? What are the long-term implications for both the firms and the managers themselves?

1. Kaplan, J. 2015. Coca-Cola to sell nine U.S. facilities to bottling companies. bloomberg.com, September 24: np; Esterl, M. 2016. Coke to step up North American restructuring. wsj.com, February 9: np; and Esterl, M. 2016. Coke tweaks its business model again. wsj.com, March 23: np.

2. Insights on measuring M&A performance are addressed in Zollo, M. & Meier, D. 2008. What is M&A performance? BusinessWeek, 22(3): 55–77.

3. Insights on how and why firms may overpay for acquisitions are addressed in Malhotra, D., Ku, G.,

& Murnighan, J. K. 2008. When winning is everything. Harvard Business Review, 66(5): 78–86.

4. Haleblian, J., Devers, C., McNamara, G., Carpenter, M., & Davison, R. 2009. Taking stock of what we know about mergers and acquisitions: A review and research

REFERENCES

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agenda. Journal of Management, 35: 469–502.

5. Pare, T. P. 1994. The new merger boom. Fortune, November 28: 96.

6. A discussion of the effects of director experience and acquisition performance is in McDonald, M. L. & Westphal, J. D. 2008. What do they know? The effects of outside director acquisition experience on firm acquisition performance. Strategic Management Journal, 29(11): 1155–1177.

7. Finance and economics: Snoopy sniffs an opportunity; MetLife buys Alico. 2010. Economist.com, March 13: np.

8. For a study that investigates several predictors of corporate diversification, read Wiersema, M. F. & Bowen, H. P. 2008. Corporate diversification: The impact of foreign competition, industry globalization, and product diversification. Strategic Management Journal, 29(2): 114–132.

9. Kumar, M. V. S. 2011. Are joint ventures positive sum games? The relative effects of cooperative and non-cooperative behavior. Strategic Management Journal, 32(1): 32–54.

10. Makri, M., Hitt, M. A., & Lane, P. J. 2010. Complementary technologies, knowledge relatedness, and invention outcomes in high technology mergers and acquisitions. Strategic Management Journal, 31(6): 602–628.

11. A discussion of Tyco’s unrelated diversification strategy is in Hindo, B. 2008. Solving Tyco’s identity crisis. BusinessWeek, February 18: 62.

12. Our framework draws upon a variety of sources, including Goold, M. & Campbell, A. 1998. Desperately seeking synergy. Harvard Business Review, 76(5): 131–143; Porter, M. E. 1987. From advantage to corporate strategy. Harvard Business Review, 65(3): 43–59; and Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. 2001. Strategic management: Competitiveness and globalization (4th ed.). Cincinnati, OH: South-Western.

13. This imagery of the corporation as a tree and related discussion draws on Prahalad, C. K. & Hamel, G. 1990. The core competence of the corporation. Harvard Business Review, 68(3): 79–91. Parts of this section also draw on Picken, J. C. & Dess, G. G. 1997. Mission critical: chap. 5. Burr Ridge, IL: Irwin Professional.

14. Graebner, M. E., Eisenhardt, K. M., & Roundy, P. T. 2010. Success and failure in technology acquisitions: Lessons for buyers and sellers.

Academy of Management Perspectives, 24(3): 73–92.

15. This section draws on Prahalad & Hamel, op. cit.; and Porter, op. cit.

16. A study that investigates the relationship between a firm’s technology resources, diversification, and performance can be found in Miller, D. J. 2004. Firms’ technological resources and the performance effects of diversification. A longitudinal study. Strategic Management Journal, 25: 1097–1119.

17. Khan, N. & Matsuda, K. 2015. Fujifilm shifts focus to stem cells and ebola drugs. bloomberg.com, August 17: np.

18. Chesbrough, H. 2011. Bringing open innovation to services. MIT Sloan Management Review, 52(2): 85–90.

19. Levine-Weinberg, A. 2014. Starbucks has decades of growth ahead. money. cnn.com, November 19: np.

20. This section draws on Hrebiniak, L. G. & Joyce, W. F. 1984. Implementing strategy. New York: Macmillan; and Oster, S. M. 1994. Modern competitive analysis. New York: Oxford University Press.

21. The discussion of the benefits and costs of vertical integration draws on Hax, A. C. & Majluf, N. S. 1991. The strategy concept and process: A pragmatic approach: 139. Englewood Cliffs, NJ: Prentice Hall.

22. Fahey, J. 2005. Gray winds. Forbes, January 10: 143.

23. This discussion draws on Oster, op. cit.; and Harrigan, K. 1986. Matching vertical integration strategies to competitive conditions. Strategic Management Journal, 7(6): 535–556.

24. Mathews, A. 2015. Kaiser Permanente to launch medical school. wsj.com, December 18: np.

25. For a scholarly explanation on how transaction costs determine the boundaries of a firm, see Oliver E. Williamson’s pioneering books Markets and hierarchies: Analysis and antitrust implications (New York: Free Press, 1975) and The economic institutions of capitalism (New York: Free Press, 1985).

26. Campbell, A., Goold, M., & Alexander, M. 1995. Corporate strategy: The quest for parenting advantage. Harvard Business Review, 73(2): 120–132; and Picken & Dess, op. cit.

27. Anslinger, P. A. & Copeland, T. E. 1996. Growth through acquisition: A fresh look. Harvard Business Review, 74(1): 126–135.

28. This section draws on Porter, op. cit.; and Hambrick, D. C. 1985. Turnaround strategies. In Guth, W. D. (Ed.), Handbook of business strategy: 10-1–10-32. Boston: Warren, Gorham & Lamont.

29. There is an important delineation between companies that are operated for a long-term profit and those that are bought and sold for short-term gains. The latter are sometimes referred to as “holding companies” and are generally more concerned about financial issues than strategic issues.

30. Casico, W. F. 2002. Strategies for responsible restructuring. Academy of Management Executive, 16(3): 80–91; and Singh, H. 1993. Challenges in researching corporate restructuring. Journal of Management Studies, 30(1): 147–172.

31. Hax & Majluf, op. cit. By 1979, 45 percent of Fortune 500 companies employed some form of portfolio analysis, according to Haspelagh, P. 1982. Portfolio planning: Uses and limits. Harvard Business Review, 60: 58–73. A later study conducted in 1993 found that over 40 percent of the respondents used portfolio analysis techniques, but the level of usage was expected to increase to more than 60 percent in the near future: Rigby, D. K. 1994. Managing the management tools. Planning Review, September–October: 20–24.

32. Fruk, M., Hall, S., & Mittal, D. 2013. Never let a good crisis go to waste. mckinsey.com, October: np; and Arrfelt, M., Wiseman, R., McNamara, G., & Hult, T., 2015. Examining a key corporate role: The influence of capital allocation competency on business unit performance. Strategic Management Journal, in press.

33. Goold, M. & Luchs, K. 1993. Why diversify? Four decades of management thinking. Academy of Management Executive, 7(3): 7–25.

34. Other approaches include the industry attractiveness–business strength matrix developed jointly by General Electric and McKinsey and Company, the life-cycle matrix developed by Arthur D. Little, and the profitability matrix proposed by Marakon. For an extensive review, refer to Hax & Majluf, op. cit.: 182–194.

35. Porter, op. cit.: 49–52. 36. Picken & Dess, op. cit.; Cabot

Corporation. 2001. 10-Q filing, Securities and Exchange Commission, May 14.

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37. Insights on the performance of serial acquirers is found in Laamanen, T. & Keil, T. 2008. Performance of serial acquirers: Toward an acquisition program perspective. Strategic Management Journal, 29(6): 663–672.

38. Some insights from Lazard’s CEO on mergers and acquisitions are addressed in Stewart, T. A. & Morse, G. 2008. Giving great advice. Harvard Business Review, 66(1): 106–113.

39. Coy, P., Thornton, E., Arndt, M., & Grow, B. 2005. Shake, rattle, and merge. BusinessWeek, January 10: 32–35; and Anonymous. 2005. Love is in the air. The Economist, February 5: 9.

40. Hill, A. 2011. Mergers indicate market optimism. www.marketplace. org, March 21: np.

41. For an interesting study of the relationship between mergers and a firm’s product-market strategies, refer to Krishnan, R. A., Joshi, S., & Krishnan, H. 2004. The influence of mergers on firms’ product-mix strategies. Strategic Management Journal, 25: 587–611.

42. Like many high-tech firms during the economic slump that began in mid-2000, Cisco Systems experienced declining performance. On April 16, 2001, it announced that its revenues for the quarter closing April 30 would drop 5 percent from a year earlier— and a stunning 30 percent from the previous three months—to about $4.7 billion. Furthermore, Cisco announced that it would lay off 8,500 employees and take an enormous $2.5 billion charge to write down inventory. By late October 2002, its stock was trading at around $10, down significantly from its 52-week high of $70. Elstrom, op. cit.: 39.

43. Sisario, B. 2014. Jimmy Iovine, a master of Beats, lends Apple a skilled ear. nytimes.com, May 28: np; and Dickey, M. 2014. Meet the executives Apple is paying $3 billion to get. businessinsider.com, May 28: np.

44. Ignatius, A. 2011. How eBay developed a culture of experimentation. Harvard Business Review, 89(3): 92–97.

45. For a discussion of the trend toward consolidation of the steel industry and how Lakshmi Mittal is becoming a dominant player, read Reed, S. & Arndt, M. 2004. The raja of steel. BusinessWeek, December 20: 50–52.

46. Colvin, G. 2011. Airline king. Fortune, May 2: 50–57.

47. This discussion draws upon Rappaport, A. & Sirower, M. L.

1999. Stock or cash? The trade-offs for buyers and sellers in mergers and acquisitions. Harvard Business Review, 77(6): 147–158; and Lipin, S. & Deogun, N. 2000. Big mergers of 90s prove disappointing to shareholders. The Wall Street Journal, October 30: C1.

48. The downside of mergers in the airline industry is found in Gimbel, B. 2008. Why airline mergers don’t fly. BusinessWeek, March 17: 26.

49. Mouio, A. (Ed.). 1998. Unit of one. Fast Company, September: 82.

50. Porter, M. E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3): 43.

51. The divestiture of a business that is undertaken in order to enable managers to better focus on its core business has been termed “downscoping.” Refer to Hitt, M. A., Harrison, J. S., & Ireland, R. D. 2001. Mergers and acquisitions: A guide to creating value for stakeholders. New York: Oxford University Press.

52. Sirmon, D. G., Hitt, M. A., & Ireland, R. D. 2007. Managing firm resources in dynamic environments to create value: Looking inside the black box. Academy of Management Review, 32(1): 273–292.

53. Kengelbach, J., Klemmer, D., & Roos, A. 2012. Plant and prune: How M&A can grow portfolio value. BCG Report, September: 1–38.

54. Berry, J., Brigham, B., Bynum, A., Leu, C., & McLaughlin, R. 2012. Creating value through divestitures— Deans Foods: Theory in practice. Unpublished manuscript.

55. A study that investigates alliance performance is Lunnan, R. & Haugland, S. A. 2008. Predicting and measuring alliance performance: A multidimensional analysis. Strategic Management Journal, 29(5): 545–556.

56. For scholarly perspectives on the role of learning in creating value in strategic alliances, refer to Anard, B. N. & Khanna, T. 2000. Do firms learn to create value? Strategic Management Journal, 12(3): 295–317; and Vermeulen, F. & Barkema, H. P. 2001. Learning through acquisitions. Academy of Management Journal, 44(3): 457–476.

57. For a detailed discussion of transaction cost economics in strategic alliances, read Reuer, J. J. & Arno, A. 2007. Strategic alliance contracts: Dimensions and determinants of contractual complexity. Strategic Management Journal, 28(3): 313–330.

58. This section draws on Hutt, M. D., Stafford, E. R., Walker, B. A., & Reingen, P. H. 2000. Case study: Defining the strategic alliance. Sloan Management Review, 41(2): 51–62; and Walters, B. A., Peters, S., & Dess, G. G. 1994. Strategic alliances and joint ventures: Making them work. Business Horizons, 4: 5–10.

59. A study that investigates strategic alliances and networks is Tiwana, A. 2008. Do bridging ties complement strong ties? An empirical examination of alliance ambidexterity. Strategic Management Journal, 29(3): 251–272.

60. Fashion chain Zara opens its first Indian store. 2010. bbc.co.uk/news/, May 31: np.

61. Hoang, H. & Rothaermel, F. 2016. How to manage alliances strategically. Sloan Management Review, 76 (Fall): 69–73.

62. Anonymous. 2016. PGA TOUR and LPGA announce strategic alliance agreement. lpga.com, March 4: np.

63. Phelps, C. 2010. A longitudinal study of the influence of alliance network structure and composition on firm exploratory innovation. Academy of Management Journal, 53(4): 890–913.

64. For an institutional theory perspective on strategic alliances, read Dacin, M. T., Oliver, C., & Roy, J. P. 2007. The legitimacy of strategic alliances: An institutional perspective. Strategic Management Journal, 28(2): 169–187.

65. A study investigating factors that determine partner selection in strategic alliances is found in Shah, R. H. & Swaminathan, V. 2008. Strategic Management Journal, 29(5): 471–494.

66. Arino, A. & Ring, P. S. 2010. The role of fairness in alliance formation. Strategic Management Journal, 31(6): 1054–1087.

67. Greve, H. R., Baum, J. A. C., Mitsuhashi, H. & Rowley, T. J. 2010. Built to last but falling apart: Cohesion, friction, and withdrawal from interfirm alliances. Academy of Management Journal, 53(4): 302–322.

68. Narayan, A. 2011. From brewing, an Indian biotech is born. Bloomberg Businessweek, February 28: 19–20.

69. For an insightful perspective on how to manage conflict between innovation and ongoing operations in an organization, read Govindarajan, V. & Trimble, C. 2010. The other side of innovation: Solving the execution

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challenge. Boston: Harvard Business School Press.

70. Dunlap-Hinkler, D., Kotabe, M., & Mudambi, R. 2010. A story of breakthrough versus incremental innovation: Corporate entrepreneurship in the global pharmaceutical industry. Strategic Entrepreneurship Journal, 4(2): 106–127.

71. Porter, op. cit.: 43–59. 72. Angwin, J. S. & Wingfield, N. 2000.

How Jay Walker built WebHouse on

a theory that he couldn’t prove. The Wall Street Journal, October 16: A1, A8.

73. The fallen. 2003. BusinessWeek, January 13: 80–82.

74. The Jack Welch example draws upon Sellers, P. 2001. Get over yourself. Fortune, April 30: 76–88.

75. Li, J. & Tang, Y. 2010. CEO hubris and firm risk taking in China: The moderating role of managerial discretion. Academy of Management Journal, 53(1): 45–68.

76. John Thain and his golden commode. 2009. Editorial. Dallasnews.com, January 26: np; Task, A. 2009. Wall Street’s $18.4B bonus: The sense of entitlement has not been beaten out. finance.yahoo.com, January 29: np; and Exit Thain. 2009. Newsfinancialcareers. com, January 22: np.

77. This section draws on Weston, J. F., Besley, S., & Brigham, E. F. 1996. Essentials of managerial finance (11th ed.): 18–20. Fort Worth, TX: Dryden Press, Harcourt Brace.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

7 LO7-1 The importance of international expansion as a viable diversification

strategy.

LO7-2 The sources of national advantage; that is, why an industry in a given country is more (or less) successful than the same industry in another country.

LO7-3 The motivations (or benefits) and the risks associated with international expansion, including the emerging trend for greater offshoring and outsourcing activity.

LO7-4 The two opposing forces—cost reduction and adaptation to local markets—that firms face when entering international markets.

LO7-5 The advantages and disadvantages associated with each of the four basic strategies: international, global, multidomestic, and transnational.

LO7-6 The difference between regional companies and truly global companies. LO7-7 The four basic types of entry strategies and the relative benefits and risks

associated with each of them.

International Strategy Creating Value in Global Markets

©Anatoli Styf/Shutterstock

PART 2: STRATEGIC FORMULATION

What was supposed to be one of India’s hottest new shopping centers didn’t turn out that way. Dreams Mall, located in a Mumbai suburb, was built by Housing Development & Infrastructure Ltd. (an Indian real estate development company) to cater to the growing middle class of the world’s second-most populous nation. But four years after its grand opening, the “dream” has become, in essence, a retail nightmare. Now, the mall consists of a smattering of struggling stores on the ground floor along with a maze of dark hallways with mostly empty shops. Space that was intended for retailers is used by call centers. And abandoned corridors are rented out for wedding receptions.

Across India, many of the country’s more than 300 malls have suffered weak sales and high vacancy rates. This was not anticipated. Developers over the past decade have built more than 250 shopping centers to tap into India’s rapidly expanding consumer culture. Some analysts had estimated that India’s middle class would grow to more than 400 million people. However, only a sliver of them (less than 10 million by McKinsey & Company’s estimates) have sufficient disposable income to make them steady mall customers.

India did not get its first mall until the late 1990s. Developers started building many others after Spencer Plaza in Chennai and a few others were so successful. Some construction companies began building three or more malls right next to each other in some neighborhoods in New Delhi and Mumbai. As noted by Benu Sehgal, vice president at DLF Ltd., a big developer, “Everyone jumped into the mall business with little understanding of who they were actually targeting.” Govind Shrikhande, chief executive of one of India’s largest retailers, said, “Everyone was opening malls left, right, and center. The consumer was never at the center of the planning process.”

Even with high vacancy rates, some Indian malls are doing very well. For example, Select CITYWALK Mall in South Delhi is considered “India’s No. 1 mall.” Others that are highly successful in India’s highly competitive market include DLF Promenade, Ambience Palladium, Phoenix, Inorbit, and Marketcity. What makes these malls successful? They win in the marketplace because they have a sound knowledge of the market and make informed decisions at the right time. For example, Select CITYWALK focused on what is considered “premium” in its positioning in the market: a level lower than affordable luxury. Today the mall is moving toward the affordable luxury category. Also, Select CITYWALK has a nice collection of retailers, such as Zara, Nike, and H&M, a multiplex theater, and great food. As noted by Yogeshwar Sharma, chief executive of Select CITYWALK, “Mall operation is one of the easiest things, given you know the job. Every game has its own rules. If you follow the rules, you are successful, if you don’t you fail.”

Discussion Questions 1. What lessons can other multinational companies learn from the boom and bust of shopping

centers in India? 2. How can foreign retailers be successful in a country in which shopping centers are not attract-

ing enough customers?

Sources: Kulshrestha, A. 2016. India may attract $80 million PE investment in retail real estate, say JLL. artices. economictimes.indiatimes.com. April 14: np.; Rana, P. 2015. Empty dream at India’s malls. the Wall Street Journal. June 17: C1, C8; and, Batra, A. 2015. What makes Select CITYWALK India’s successful mall, reveals Yogeshwar Sharma. retail. economictimes.indiatimes.com. March 20: np.

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In this chapter we discuss how firms create value and achieve competitive advantage in the global marketplace. Multinational firms are constantly faced with many important decisions. These include entry strategies; the dilemma of choosing between local adaptation (in prod- uct offerings, locations, advertising, and pricing) and global integration; and others. We will address how firms can avoid pitfalls by developing a better understanding of the business environments of different countries as illustrated by the lukewarm response of Indian con- sumers to the new malls discussed previously. In addition, we address factors that can influence a nation’s success in a particular industry. In our view, this is an important context in determin- ing how well firms eventually do when they compete beyond their nation’s boundaries.

THE GLOBAL ECONOMY: A BRIEF OVERVIEW Managers face many opportunities and risks when they diversify abroad.1 The trade among nations has increased dramatically in recent years, and it is estimated that recently the trade across nations exceeded the trade within nations. In a variety of industries such as semicon- ductors, automobiles, commercial aircraft, telecommunications, computers, and consumer electronics, it is almost impossible to survive unless firms scan the world for competitors, customers, human resources, suppliers, and technology.2

GE’s wind energy business benefits by tapping into talent around the world. The firm has built research centers in China, Germany, India, and the United States “We did it,” says CEO Jeffrey Immelt, “to access the best brains everywhere in the world.” All four centers have played a key role in GE’s development of huge 92-ton turbines:3

• Chinese researchers in Shanghai designed the microprocessors that control the pitch of the blade.

• Mechanical engineers from India (Bangalore) devised mathematical models to maximize the efficiency of materials in the turbine.

• Power-systems experts in the United States (Niskayuna, New York), which has researchers from 55 countries, do the design work.

• Technicians in Munich, Germany, have created a “smart” turbine that can calculate wind speeds and signal sensors in other turbines to produce maximum electricity.

The rise of globalization—meaning the rise of market capitalism around the world—has undeniably created tremendous business opportunities for multinational corporations. For example, while smartphone sales declined in Western Europe in the third quarter of 2014, they grew at a 50 percent rate in Eastern Europe, the Middle East, and Africa.4

This rapid rise in global capitalism has had dramatic effects on the growth in different economic zones. For example, Fortune magazine’s annual list of the world’s 500 biggest companies included 156 firms from emerging markets in 2015, compared to only 18 in 1995.5 McKinsey & Company predicts that by 2025 about 45 percent of the Fortune Global 500 will be based in emerging economies, which are now producing world-class companies with huge domestic markets and a commitment to invest in innovation.

Over half the world’s output now comes from emerging markets. This is leading to a convergence of living standards across the globe and is changing the face of business. One example of this is the shift in the global automobile market. China supplanted the United States as the largest market for automobiles in 2009.

One of the challenges with globalization is determining how to meet the needs of custom- ers at very different income levels. In many developing economies, distributions of income remain much wider than they do in the developed world, leaving many impoverished even as the economies grow. The challenge for multinational firms is to tailor their products and services to meet the needs of the “bottom of the pyramid.” Global corporations are increas- ingly changing their product offerings to meet the needs of the nearly 5 billion poor people

LO 7-1 The importance of international expansion as a viable diversification strategy.

globalization a term that has two meanings: (1) the increase in international exchange, including trade in goods and services as well as exchange of money, ideas, and information; (2) the growing similarity of laws, rules, norms, values, and ideas across countries.

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in the world who inhabit developing countries. Collectively, this represents a very large market with $14 trillion in purchasing power.

Next, we will address in more detail the question of why some nations and their industries are more competitive.6 This establishes an important context or setting for the remainder of the chapter. After we discuss why some nations and their industries outperform others, we will be better able to address the various strategies that firms can take to create competitive advantage when they expand internationally.

FACTORS AFFECTING A NATION’S COMPETITIVENESS Michael Porter of Harvard University conducted a four-year study in which he and a team of 30 researchers looked at the patterns of competitive success in 10 leading trading nations. He concluded that there are four broad attributes of nations that individually, and as a sys- tem, constitute what is termed the diamond of national advantage. In effect, these attributes jointly determine the playing field that each nation establishes and operates for its indus- tries. These factors are:

• Factor endowments. The nation’s position in factors of production, such as skilled labor or infrastructure, necessary to compete in a given industry.

• Demand conditions. The nature of home-market demand for the industry’s product or service.

• Related and supporting industries. The presence or absence in the nation of supplier industries and other related industries that are internationally competitive.

• Firm strategy, structure, and rivalry. The conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry.

Factor Endowments7,8

Classical economics suggests that factors of production such as land, labor, and capital are the building blocks that create usable consumer goods and services.9 However, companies in advanced nations seeking competitive advantage over firms in other nations create many of the factors of production. For example, a country or industry dependent on scientific innovation must have a skilled human resource pool to draw upon. This resource pool is not inherited; it is created through investment in industry-specific knowledge and talent. The supporting infrastructure of a country—that is, its transportation and communication systems as well as its banking system—is also critical.

Factors of production must be developed that are industry- and firm-specific. In addi- tion, the pool of resources is less important than the speed and efficiency with which these resources are deployed. Thus, firm-specific knowledge and skills created within a country that are rare, valuable, difficult to imitate, and rapidly and efficiently deployed are the fac- tors of production that ultimately lead to a nation’s competitive advantage.

For example, the island nation of Japan has little landmass, making the warehouse space needed to store inventory prohibitively expensive. But by pioneering just-in-time inventory management, Japanese companies managed to create a resource from which they gained advantage over companies in other nations that spent large sums to warehouse inventory.

Demand Conditions Demand conditions refer to the demands that consumers place on an industry for goods and services. Consumers who demand highly specific, sophisticated products and services force firms to create innovative, advanced products and services to meet the demand. This consumer pressure presents challenges to a country’s industries. But in response to these challenges, improvements to existing goods and services often result, creating conditions necessary for competitive advantage over firms in other countries.

diamond of national advantage a framework for explaining why countries foster successful multinational corporations; consists of four factors—factor endowments; demand conditions; related and supporting industries; and firm strategy, structure, and rivalry.

factor endowments (national advantage) a nation’s position in factors of production.

LO 7-2 The sources of national advantage; that is, why an industry in a given country is more (or less) successful than the same industry in another country.

demand conditions (national advantage) the nature of home-market demand for the industry’s product or service.

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Countries with demanding consumers drive firms in that country to meet high stan- dards, upgrade existing products and services, and create innovative products and services. The conditions of consumer demand influence how firms view a market. This, in turn, helps a nation’s industries to better anticipate future global demand conditions and proactively respond to product and service requirements.

Denmark, for instance, is known for its environmental awareness. Demand from con- sumers for environmentally safe products has spurred Danish manufacturers to become leaders in water pollution control equipment—products it has successfully exported.

Related and Supporting Industries Related and supporting industries enable firms to manage inputs more effectively. For example, countries with a strong supplier base benefit by adding efficiency to downstream activities. A competitive supplier base helps a firm obtain inputs using cost-effective, timely methods, thus reducing manufacturing costs. Also, close working relationships with sup- pliers provide the potential to develop competitive advantages through joint research and development and the ongoing exchange of knowledge.

Related industries offer similar opportunities through joint efforts among firms. In addi- tion, related industries create the probability that new companies will enter the market, increasing competition and forcing existing firms to become more competitive through efforts such as cost control, product innovation, and novel approaches to distribution. Combined, these give the home country’s industries a source of competitive advantage.

In the Italian footwear industry the supporting industries enhance national competitive advantage. In Italy, shoe manufacturers are geographically located near their suppliers. The manufacturers have ongoing interactions with leather suppliers and learn about new tex- tures, colors, and manufacturing techniques while a shoe is still in the prototype stage. The manufacturers are able to project future demand and gear their factories for new products long before companies in other nations become aware of the new styles.

Firm Strategy, Structure, and Rivalry Rivalry is particularly intense in nations with conditions of strong consumer demand, strong supplier bases, and high new-entrant potential from related industries. This competi- tive rivalry in turn increases the efficiency with which firms develop, market, and distribute products and services within the home country. Domestic rivalry thus provides a strong impetus for firms to innovate and find new sources of competitive advantage.

This intense rivalry forces firms to look outside their national boundaries for new mar- kets, setting up the conditions necessary for global competitiveness. Among all the points on Porter’s diamond of national advantage, domestic rivalry is perhaps the strongest indicator of global competitive success. Firms that have experienced intense domestic competition are more likely to have designed strategies and structures that allow them to successfully compete in world markets.

In the European grocery retail industry, intense rivalry has led firms such as Aldi and Tesco to tighten their supply chains and improve store efficiency. Thus, it is no surprise that these firms are also strong global players.

The Indian software industry offers a clear example of how the attributes in Porter’s “diamond” interact to lead to the conditions for a strong industry to grow. Exhibit 7.1 illus- trates India’s “software diamond,” and Strategy Spotlight 7.1 further discusses the mutually reinforcing elements at work in this market.

Concluding Comment on Factors Affecting a Nation’s Competitiveness Porter drew his conclusions based on case histories of firms in more than 100 industries. Despite the differences in strategies employed by successful global competitors, a common

related and supporting industries (national advantage) the presence, absence, and quality in the nation of supplier industries and other related industries that supply services, support, or technology to firms in the industry value chain.

firm strategy, structure, and rivalry (national advantage) the conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry.

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EXHIBIT 7.1 India’s Software Diamond

Domestic rivalry

No regulatory barriers to entry or start-up; 800 firms, mostly small, in fierce rivalry; growing number of MNC software- development centers in India.

Large network of public and private educational institutions; weak but rapidly improving communications infrastructure; duty-free access to imported computers and software, following economic liberalization.

Large, growing market; sophisticated customers; cutting-edge applications.

Large pool of skilled labor; low salaries; English-language capability.

Related and supporting industries

Factor endowments

Domestic demand

conditions

U.S. demand

conditions

Dashed lines represent weaker interactions.

Source: From Kampur D. and Ramamurti R., “India’s Emerging Competition Advantage in Services,” Academy of Management Executive: The Thinking Manager’s Source. Copyright © 2001 by Academy of Management.

7.1 STRATEGY SPOTLIGHT INDIA AND THE DIAMOND OF NATIONAL ADVANTAGE The Indian software industry has become one of the leading global markets for software. The industry has grown to about $110 billion (in export) in 2016 and Indian IT firms provide soft- ware and services to over half the Fortune 500 firms. What are the factors driving this success? Porter’s diamond of national advantage helps clarify this question. See Exhibit 7.1.

First, factor endowments are conducive to the rise of India’s software industry. Through investment in human resource devel- opment with a focus on industry-specific knowledge, India’s uni- versities and software firms have literally created this essential factor of production. For example, India produces the second- largest annual output of scientists and engineers in the world, behind only the United States. In a knowledge-intensive industry such as software, development of human resources is funda- mental to both domestic and global success.

Second, demand conditions require that software firms stay on the cutting edge of technological innovation. India has already moved toward globalization of its software industry; consumer demand conditions in developed nations such as Germany, Denmark, parts of Southeast Asia, and the United

States created the consumer demand necessary to propel India’s software makers toward sophisticated software solutions.*

Third, India has the supplier base as well as the related industries needed to drive competitive rivalry and enhance competitiveness. In particular, information technology (IT) hard- ware prices declined rapidly in the 1990s. Furthermore, rapid technological change in IT hardware meant that latecomers like India were not locked into older-generation technologies. Thus, both the IT hardware and software industries could “leapfrog” older technologies. In addition, relationships among knowledge workers in these IT hardware and software industries offer the social structure for ongoing knowledge exchange, promoting further enhancement of existing products. Further infrastructure improvements are occurring rapidly.

Fourth, with over 800 firms in the software services indus- try in India, intense rivalry forces firms to develop competitive strategies and structures. Although firms like TCS, Infosys, and

*Although India’s success cannot be explained in terms of its home-market demand (according to Porter’s model), the nature of the industry enables software to be transferred among different locations simultaneously by way of communications links. Thus, competitiveness of markets outside India can be enhanced without a physical presence in those markets.

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Wipro have become large, they still face strong competition from dozens of small and midsize companies aspiring to catch them. This intense rivalry is one of the primary factors driving Indian software firms to develop overseas distribution channels, as pre- dicted by Porter’s diamond of national advantage.

Sources: Pai M. 2016. No, India’s software industry did not die on Friday. www .ndtv.com. October 16:np; Sachitanand, R. 2010. The new face of IT. Business Today, 19: 62; Anonymous. 2010. Training to lead. www.Dqindia.com, October 5:

np; Nagaraju, B. 2011. India’s software exports seen up 16–18 pct. in Fy12. www. reuters.com, February 2: np; Ghemawat, P. & Hout, T. 2008. Tomorrow’s global giants. Harvard Business Review, 86(11): 80–88; Mathur, S. K. 2007. Indian IT industry: A performance analysis and a model for possible adoption. ideas. repec.org, January 1: np; Kripalani, M. 2002. Calling Bangalore: Multinationals are making it a hub for high-tech research BusinessWeek, November 25: 52–54; Kapur, D. & Ramamurti, R. 2001. India’s emerging competitive advantage in services. 2001. Academy of Management Executive, 15(2): 20–33; World Bank. 2001 World Development Report: 6. New York: Oxford University Press; and Reuters. 2001. Oracle in India push, taps software talent. Washington Post Online, July 3.

continued

theme emerged: Firms that succeeded in global markets had first succeeded in intensely competitive home markets. We can conclude that competitive advantage for global firms typically grows out of relentless, continuing improvement, and innovation.10

INTERNATIONAL EXPANSION: A COMPANY’S MOTIVATIONS AND RISKS

Motivations for International Expansion Increase Market Size There are many motivations for a company to pursue international expansion. The most obvious one is to increase the size of potential markets for a firm’s prod- ucts and services.11 The world’s population exceeded 7.6 billion in early 2018, with the U.S. representing less than 5 percent.

Many multinational firms are intensifying their efforts to market their products and ser- vices to countries such as India and China as the ranks of their middle class have increased over the past decade. The potential is great. An OECD study predicts that consumption by middle-class consumers in Asian markets will grow from $4.9 trillion in 2009 to over $30 trillion by 2020. At that point, Asia will make up 60 percent of global middle-class con- sumption, up from 20 percent in 2009.12

Expanding a firm’s global presence also automatically increases its scale of operations, pro- viding it with a larger revenue and asset base.13 As we noted in Chapter 5 in discussing overall cost leadership strategies, such an increase in revenues and asset base potentially enables a firm to attain economies of scale. This provides multiple benefits. One advantage is the spread- ing of fixed costs such as R&D over a larger volume of production. Examples include the sale of Boeing’s commercial aircraft and Microsoft’s operating systems in many foreign countries.

Filmmaking is another industry in which international sales can help amortize huge developmental costs.14 For example, 77 percent of the $1.1 billion box-office take for Transformers: Age of Extinction came from overseas moviegoers. Similarly, the market for kids’ movies is largely outside the U.S., with 70 percent of Frozen’s $1.3 billion in box-office take coming from overseas.

Take Advantage of Arbitrage Taking advantage of arbitrage opportunities is a second advan- tage of international expansion. In its simplest form, arbitrage involves buying something where it is cheap and selling it where it commands a higher price. A big part of Walmart’s suc- cess can be attributed to the company’s expertise in arbitrage. The possibilities for arbitrage are not necessarily confined to simple trading opportunities. It can be applied to virtually any factor of production and every stage of the value chain. For example, a firm may locate its call centers in India, its manufacturing plants in China or Vietnam, and its R&D in Europe, where

LO 7-3 The motivations (or benefits) and the risks associated with international expansion, including the emerging trend for greater offshoring and outsourcing activity.

multinational firms firms that manage operations in more than one country.

arbitrage opportunities an opportunity to profit by buying and selling the same good in different markets.

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the specific types of talented personnel may be available at the lowest possible cost. In today’s integrated global financial markets, a firm can borrow anywhere in the world where capital is cheap and use it to fund a project in a country where capital is expensive. Such arbitrage opportunities are even more attractive to global corporations because their larger size enables them to buy in huge volume, thus increasing their bargaining power with suppliers.

Enhancing a Product’s Growth Potential Enhancing the growth rate of a product that is in its maturity stage in a firm’s home country but that has greater demand potential elsewhere is another benefit of international expansion. As we noted in Chapter 5, products (and industries) generally go through a four-stage life cycle of introduction, growth, maturity, and decline. In recent decades, U.S. soft-drink producers such as Coca-Cola and PepsiCo have aggressively pursued international markets to attain levels of growth that simply would not be available in the United States. The differences in market growth potential have even led some firms to restructure their operations. For example, Procter & Gamble relocated its global skin, cosmetics, and personal care unit headquarters from Cincinnati to Singapore to be closer to the fast-growing Asian market.15

Optimize the Location of Value-Chain Activities Optimizing the physical location for every activity in the firm’s value chain is another benefit. Recall from our discussions in Chapters 3 and 5 that the value chain represents the various activities in which all firms must engage to produce products and services. It includes primary activities, such as inbound logistics, operations, and marketing, as well as support activities, such as procurement, R&D, and human resource management. All firms have to make critical decisions as to where each activity will take place.16 Optimizing the location for every activity in the value chain can yield one or more of three strategic advantages: performance enhancement, cost reduction, and risk reduction. We will now discuss each of these.

Performance Enhancement Microsoft’s decision to establish a corporate research labora- tory in Cambridge, England, is an example of a location decision that was guided mainly by the goal of building and sustaining world-class excellence in selected value-creating activi- ties.17 This strategic decision provided Microsoft with access to outstanding technical and professional talent. Location decisions can affect the quality with which any activity is per- formed in terms of the availability of needed talent, speed of learning, and the quality of external and internal coordination.

Strategy&, the consulting unit of PWC, the giant accounting firm, produces an annual survey of the world’s 1000 most innovative companies.18 It found that in 2015, firms that spent 60 percent or more of their R&D budgets overseas enjoyed significantly higher operat- ing margins and return on assets, as well as faster growth in operating income, than their more domestically oriented rivals.

Cost Reduction Two location decisions founded largely on cost-reduction considerations are (1) Nike’s decision to source the manufacture of athletic shoes from Asian countries such as China, Vietnam, and Indonesia and (2) the decision of Volkswagen to locate a new auto produc- tion plant in Chattanooga, Tennessee, to leverage the relatively low labor costs in the area as well as low shipping costs due to Chattanooga’s close proximity to both rail and river transportation. Such location decisions can affect the cost structure in terms of local manpower and other resources, transportation and logistics, and government incentives and the local tax structure

Performance enhancement and cost-reduction benefits parallel the business-level strate- gies (discussed in Chapter 5) of differentiation and overall cost leadership. They can at times be attained simultaneously. Consider our example in the previous section on the Indian software industry. When Oracle set up a development operation in that country, the company benefited both from lower labor costs and operational expenses and from perfor- mance enhancements realized through the hiring of superbly talented professionals.

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Risk Reduction Given the erratic swings in the exchange ratios between the U.S. dollar and the Japanese yen (in relation to each other and to other major currencies), an impor- tant basis for cost competition between Ford and Toyota has been their relative ingenuity at managing currency risks. One way for such rivals to manage currency risks has been to spread the high-cost elements of their manufacturing operations across a few select and carefully chosen locations around the world. Location decisions such as these can affect the overall risk profile of the firm with respect to currency, economic, and political risks.19

Learning Opportunities By expanding into new markets, corporations expose themselves to differing market demands, R&D capabilities, functional skills, organizational processes, and managerial practices. This provides opportunities for managers to transfer the knowl- edge that results from these exposures back to their home office and to other divisions in the firm. Thus, expansion into new markets provides a range of learning opportunities. For example, when L’Oréal, a French personal care product manufacturer, acquired two U.S. firms that developed and sold hair care products to African-American customers, L’Oréal gained knowledge on what is referred to in the industry as “ethnic hair care.” It then took this knowledge and built a new ethnic hair care division in Europe and later began making inroads in African markets. More generally, research suggests that overseas expansion leads to valuable learning at home. One study found that, rather than distracting the firm in its efforts in its home market, overseas acquisitions led to substantial performance improve- ments, an average of a 12 percent increase, in home markets.20

Explore Reverse Innovation Finally, exploring possibilities for reverse innovation has become a major motivation for international expansion. Many leading companies are discovering that developing products specifically for emerging markets can pay off in a big way. In the past, multinational companies typically developed products for their rich home markets and then tried to sell them in developing countries with minor adaptations. However, as growth slows in rich nations and demand grows rapidly in developing countries such as India and China, this approach becomes increasingly inadequate. Instead, companies like GE have committed significant resources to developing products that meet the needs of developing nations, products that deliver adequate functionality at a fraction of the cost. Interestingly, these products have subsequently found considerable success in value segments in wealthy countries as well. Hence, this process is referred to as reverse innovation, a new motivation for international expansion.

As $3,000 cars, $300 computers, and $30 mobile phones bring what were previously considered as luxuries within the reach of the middle class of emerging markets, it is impor- tant to understand the motivations and implications of reverse innovation. First, it is impos- sible to sell first-world versions of products with minor adaptations in countries where the average annual income per person is between $1,000 and $4,000, as is the case in most developing countries. To sell in these markets, entirely new products must be designed and developed by local technical talent and manufactured with local components. Second, although these countries are relatively poor, they are growing rapidly. Third, if the innova- tion does not come from first-world multinationals, there are any number of local firms that are ready to grab the market with low-cost products. Fourth, as the consumers and govern- ments of many first-world countries are rediscovering the virtues of frugality and are trying to cut down expenses, these products and services originally developed for the first world may gain significant market shares in developing countries as well.

Potential Risks of International Expansion When a company expands its international operations, it does so to increase its profits or revenues. As with any other investment, however, there are also potential risks.21 To help companies assess the risk of entering foreign markets, rating systems have been developed to evaluate political and economic, as well as financial and credit, risks.22

reverse innovation new products developed by developed-country multinational firms for emerging markets that have adequate functionality at a low cost.

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Euromoney magazine publishes a semiannual “Country Risk Rating” that evaluates politi- cal, economic, and other risks that entrants potentially face.23 Exhibit 7.2 presents a sample of country risk ratings, published by AM Best. Note that the overall ratings range from 1 to 5, with higher risk receiving the higher score.

Next we will discuss the four main types of risk: political risk, economic risk, currency risk, and management risk.

Political and Economic Risk Generally speaking, the business climate in the United States is very favorable. However, some countries around the globe may be hazardous to the health of corporate initiatives because of political risk.24 Forces such as social unrest, military turmoil, demonstrations, and even violent conflict and terrorism can pose serious threats.25 Consider, for example, the ongoing tension and violence in the Middle East associated with the revolutions and civil wars in Egypt, Libya, Syria, and other countries. Such conditions increase the likelihood of destruction of property and disruption of operations as well as nonpayment for goods and services. Thus, countries that are viewed as high risk are less attractive for most types of business.26

Another source of political risk in many countries is the absence of the rule of law. The absence of rules or the lack of uniform enforcement of existing rules leads to what might often seem to be arbitrary and inconsistent decisions by government officials. This can make it difficult for foreign firms to conduct business.

For example, consider Renault’s experience in Russia. Renault paid $1 billion to acquire a 25 percent ownership stake in the Russian automaker AvtoVAZ in 2008. Just one year later, Russian Prime Minister Vladimir Putin threatened to dilute Renault’s ownership stake unless it contributed more money to prop up AvtoVAZ, which was then experiencing a significant slide in sales. Renault realized its ownership claim may not have held up in the corrupt Russian court system. Therefore, it was forced to negotiate and eventually agreed to transfer over $300 million in technology and expertise to the Russian firm to ensure its ownership stake would stay at 25 percent.27

political risk potential threat to a firm’s operations in a country due to ineffectiveness of the domestic political system.

rule of law a characteristic of legal systems whereby behavior is governed by rules that are uniformly enforced.

EXHIBIT 7.2 A Sample of Country Risk Ratings, August 22, 2017

Country Score Overall Country Rating Economic Risk Political Risk Financial System Risk

Norway 1 2 1 1

Canada 1 1 1 1

United States 1 2 1 1

Singapore 1 2 2 1

Hong Kong 2 2 2 1

South Korea 2 1 2 2

South Africa 4 3 4 3

China 3 2 3 3

Bahrain 4 4 3 3

Kazakhstan 4 3 3 4

Colombia 4 3 4 3

Russia 4 3 4 4

Argentina 5 3 4 5

Libya 5 4 5 5

Source: A.M. Best Company - Used by permission.

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Interestingly, while corporations have historically been concerned about rule-of-law issues in developing markets, such issues have also become a significant concern in devel- oped markets, most critically in the United States. In a 2012 World Economic Forum Global Competitive Report that examined the quality of governmental institutions and the rule of law, the United States fared poorly. Starkly, the United States was ranked among the top 20 countries on only 1 of the 22 measures of institutional quality the survey included. In line with these findings, the International Finance Corporation (IFC) found that governmental hurdles businesses face have become a greater challenge in the United States in recent years. The IFC compiles data annually on the burdens of doing business that are put in place by governments and found that the United States is one of only a few countries surveyed in which doing business has become more burdensome. In nearly 90 percent of countries, gov- ernmental burdens have eased since 2006, but the United States has bucked that trend and become a more difficult location in which to operate. As institutions deteriorate, the United States loses its luster as a place to base operations. This sentiment was reflected in a survey of business executives who are alumni of the Harvard Business School. When asked whether they had recently favored basing new operations in the United States or in a foreign location, an overwhelming majority, 84 percent, responded that they had chosen the foreign location. Thus, advanced economies, such as the United States, risk losing out to other countries if they fail to reinforce and strengthen their legal and political institutions.28

The laws, and the enforcement of laws, associated with the protection of intellec- tual property rights can be a major potential economic risk in entering new countries.29 Microsoft, for example, has lost billions of dollars in potential revenue through piracy of its software products in many countries, including China. Other areas of the globe, such as the former Soviet Union and some eastern European nations, have piracy prob- lems as well.30 Firms rich in intellectual property have encountered financial losses as imitations of their products have grown due to a lack of law enforcement of intellectual property rights.31

Counterfeiting, a direct form of theft of intellectual property rights, is a significant and growing problem. The International Chamber of Commerce estimated that the value of counterfeit goods exceeded $1.7 trillion in 2015, over 2 percent of the world’s total economic output. “The whole business has just exploded,” said Jeffrey Hardy, head of the anticoun- terfeiting program at ICC. “And it goes way beyond music and Gucci bags.” Counterfeiting has moved well beyond handbags and shoes to include chemicals, pharmaceuticals, and aircraft parts. According to a University of Florida study, 25 percent of the pesticide market in some parts of Europe is estimated to be counterfeit. This is especially troubling since these chemicals are often toxic.32 In Strategy Spotlight 7.2, we discuss the challenge of fight- ing counterfeiting in the pharmaceutical business and how Pfizer is attempting to fight this threat to its business.

Currency Risks Currency fluctuations can pose substantial risks. A company with opera- tions in several countries must constantly monitor the exchange rate between its own cur- rency and that of the host country to minimize currency risks. Even a small change in the exchange rate can result in a significant difference in the cost of production or net profit when doing business overseas. When the U.S. dollar appreciates against other cur- rencies, for example, U.S. goods can be more expensive to consumers in foreign countries. At the same time, however, appreciation of the U.S. dollar can have negative implications for American companies that have branch operations overseas. The reason for this is that prof- its from abroad must be exchanged for dollars at a more expensive rate of exchange, reduc- ing the amount of profit when measured in dollars. For example, consider an American firm doing business in Italy. If this firm had a 20 percent profit in euros at its Italian center of operations, this profit would be totally wiped out when converted into U.S. dollars if the euro had depreciated 20 percent against the U.S. dollar. (U.S. multinationals typically

economic risk potential threat to a firm’s operations in a country due to economic policies and conditions, including property rights laws and enforcement of those laws.

counterfeiting selling of trademarked goods without the consent of the trademark holder.

currency risk potential threat to a firm’s operations in a country due to fluctuations in the local currency’s exchange rate.

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7.2  ETHICSSTRATEGY SPOTLIGHT COUNTERFEIT DRUGS: A DANGEROUS AND GROWING PROBLEM Brian Donnelly has an interesting background. He’s both a cop and a pharmacist. He worked as a special agent for the FBI for 21 years, but he also has a PhD in pharmacology. Now he’s on the front lines of an important fight: keeping counterfeit drugs from the market. He works as an investigator for Pfizer, one of the world’s largest pharmaceutical companies, putting both his pharmacology and law enforcement skills at work to blunt the growing flow of counterfeit drugs. He is one of a small army of former law enforcement officers employed by the pharmaceuti- cal companies working for the same aim.

This is an important fight for two reasons. First, it is of economic consequence for the pharmaceutical companies. Counterfeit drugs are big business. In the United States alone, counterfeit drugs generated around $200 billion in revenue in 2015. They are enticing to customers. For example, while Pfizer’s erectile dysfunction pill, Viagra, sells for $15 per tab- let, fake versions sold online can be gotten for as little as $1 a pill. The sales of counterfeit drugs cut into the sales and prof- its of Pfizer and the other pharmaceutical firms. Second and more importantly, these fake drugs are potentially dangerous. The danger comes from both what they contain and what they don’t contain. Fake pills have been found to contain chalk, brick dust, paint, and even pesticides. Thus, they may be toxic, and ingesting them may cause significant health problems. On the other side, they may not contain the correct dose or even any of the active ingredients they are supposed to have. This may lead to severe health consequences. For example,

fake Zithromax, an antibiotic, may contain none of the neces- sary chemical components, leaving the patient unable to fight the infection. According to one estimate, counterfeit drugs contribute to the death of upward of 200,000 people a year globally.

The pharmaceutical firms are fighting back with Donnelly and his colleagues. They use a common law enforcement technique. The fake drugs are sold by local dealers in the United States, who typically sell through websites. These local dealers, called drop dealers, are the easiest to catch. From there, the investiga- tors try to gain information on the major dealers from whom the drop dealers order. If they can get to these folks, they try to take it back to the kingpins manufacturing the drugs. This typically takes them through multiple law enforcement agencies in mul- tiple countries, often back to manufacturing plants in China and India. To find the source, the pharmaceutical companies also use advanced technology. They determine the chemical composition of fake drugs they seize to search for common chemical signa- tures that point to the possible sourcing plant.

Pfizer is also fighting the fight from another angle. It is now tagging every bottle of Viagra and many other pharmaceuticals with radio-frequency identification (RFID) tags. Pharmacies can read these tags and input the data into Pfizer’s system to confirm that these bottles are legitimate Pfizer drugs. This won’t stop shady websites from delivering counterfeit drugs, but it will help keep the counterfeits out of legitimate pharmacies.

Sources: McLauglin, J. 2015. The United States isn’t immune to counterfeit drugs. lawstreetmedia.com, May 8: np; O’Connor, M. 2006. Pfizer using RFID to fight fake Viagra. RFIDjournal.com, January 6: np; and Gillette, F. 2013. Inside Pfizer’s fight against counterfeit drugs. Bloomberg Businessweek, January 17: np.

engage in sophisticated “hedging strategies” to minimize currency risk. The discussion of this is beyond the scope of this section.)

Below, we discuss how Israel’s strong currency—the shekel—forced a firm to reevaluate its strategy.

For years O.R.T. Technologies resisted moving any operations outside Israel. However, when faced with a sharp rise in the value of the shekel, the maker of specialized software for managing gas stations froze all local hiring and decided to transfer some developmental work to Eastern Europe. Laments CEO Alex Milner, “I never thought I’d see the day when we would have to move R&D outside of Israel, but the strong shekel has forced us to do so.”33

Management Risks Management risks may be considered the challenges and risks that managers face when they must respond to the inevitable differences that they encounter in foreign markets. These take a variety of forms: culture, customs, language, income levels, customer preferences, distribution systems, and so on.34 As we will note later in the chap- ter, even in the case of apparently standard products, some degree of local adaptation will become necessary.35

Differences in cultures across countries can also pose unique challenges for managers.36 Cultural symbols can evoke deep feelings.37 For example, in a series of advertisements aimed at Italian vacationers, Coca-Cola executives turned the Eiffel Tower, Empire State Building,

management risk potential threat to a firm’s operations in a country due to the problems that managers have making decisions in the context of foreign markets.

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and Tower of Pisa into the familiar Coke bottle. So far, so good. However, when the white marble columns of the Parthenon that crowns the Acropolis in Athens were turned into Coke bottles, the Greeks became outraged. Why? Greeks refer to the Acropolis as the “holy rock,” and a government official said the Parthenon is an “international symbol of excellence” and that “whoever insults the Parthenon insults international culture.” Coca-Cola apologized.

An important management challenge involves adapting to different cultures when a firm crosses national boundaries. As we discuss in Strategy Spotlight 7.3, however, if a firm’s culture is a key driver of its success, it should maintain and reinforce that corporate culture across different locations—even if it conflicts with local practice.

Global Dispersion of Value Chains: Outsourcing and Offshoring A major recent trend has been the dispersion of the value chains of multinational corpora- tions across different countries; that is, the various activities that constitute the value chain of a firm are now spread across several countries and continents. Such dispersion of value occurs mainly through increasing offshoring and outsourcing.

A report issued by the World Trade Organization described the production of a particu- lar U.S. car as follows: “30 percent of the car’s value goes to Korea for assembly, 17.5 per- cent to Japan for components and advanced technology, 7.5 percent to Germany for design, 4 percent to Taiwan and Singapore for minor parts, 2.5 percent to U.K. for advertising and marketing services, and 1.5 percent to Ireland and Barbados for data processing. This means

7.3 STRATEGY SPOTLIGHT WHEN TO NOT ADAPT YOUR COMPANY’S CULTURE—EVEN IF IT CONFLICTS WITH THE LOCAL CULTURE When companies instill a company culture that includes how people communicate, evaluate each other, and so on, they may often run into problems when they expand internationally. For example, the Dutch shipping company TNT has long emphasized task-oriented efficiency and egalitarian management. However, when it commenced operations in China, neither of those values fit with local norms. As expected, it began to conduct business in a more relationship-oriented and hierarchical manner, as its managers in Asia adapted their styles to attract local clients and motivate their employees.

The problem with such adaptation is that a company’s cul- ture can sometimes be a key driver of its success. That is, if you believe that your corporate culture is what made the com- pany great, you should consider maintaining it in all of your offices—even when it conflicts with local practice. This approach becomes particularly relevant for firms with a highly innovative product offering and relatively little local competition. If your cul- ture has led to significant innovation and there is not a strong imperative to understand local consumers, it may be best to ignore the local culture to help maintain the organizational core.

Consider Google. It believes that its culture is a key rea- son for its outstanding success. Part of this involves providing employees with lots of positive feedback, and the company’s performance review begins by instructing managers to “List

the things that this employee did reasonably well.” Only then does it state, “List one thing this person could do to have a big- ger impact.” At Google, products are always considered to be in Beta—and mistakes are praised. For example, before she became COO of Facebook, Sheryl Sandberg was a vice presi- dent at Google and her responsibilities included managing their automated advertising system. When she made a mistake that cost Google several million dollars, she admitted her error to co-founder Larry Page. His response was, “I’m so glad that you made this mistake because I want to run a company where we are moving too quickly and doing too much, not being cautious and doing too little. If we don’t have any of these mistakes, we’re just not taking enough risk.”

However, when Google moved into France, it found that positive words were used sparingly and criticism was provided more strongly. A French manager said, “The first time I used the Google form to give a performance review, I was confused. Where was the section to talk about problem areas? ‘What did this employee do really well?’ The positive wording seemed over the top.” However, Google’s strong corporate culture typi- cally supersedes local preferences. The French manager contin- ued, “After five years at Google France, I can tell you we are now a group of French people who give negative feedback in a very un-French way.”

Sources: Meyer, E. 2015. When culture doesn’t translate. Harvard Business Review 93(10): 66–72; Meyer, E. 2014. Navigating the cultural minefield. Harvard Business Review 92(5): 119–123; and Kim, J. 2013. 7 secrets of Google’s epic organizational culture. officevibe.com, September 30: np.

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that only 37 percent of the production value is generated in the U.S.”38 In today’s economy, we are increasingly witnessing two interrelated trends: outsourcing and offshoring.

Outsourcing occurs when a firm decides to utilize other firms to perform value-creating activities that were previously performed in-house.39 It may be a new activity that the firm is perfectly capable of doing but chooses to have someone else perform for cost or quality reasons. Outsourcing can be to either a domestic or foreign firm.

Offshoring takes place when a firm decides to shift an activity that it was performing in a domestic location to a foreign location.40 For example, both Microsoft and Intel now have R&D facilities in India, employing a large number of Indian scientists and engineers. Often, offshoring and outsourcing go together; that is, a firm may outsource an activity to a foreign supplier, thereby causing the work to be offshored as well.41

The recent explosion in the volume of outsourcing and offshoring is due to a variety of factors. Up until the 1960s, for most companies, the entire value chain was in one location. Further, the production took place close to where the customers were in order to keep trans- portation costs under control. In the case of service industries, it was generally believed that offshoring was not possible because the producer and consumer had to be present at the same place at the same time. After all, a haircut could not be performed if the barber and the client were separated!

For manufacturing industries, the rapid decline in transportation and coordination costs has enabled firms to disperse their value chains over different locations. For example, Nike’s R&D takes place in the United States, raw materials are procured from a multitude of countries, actual manufacturing takes place in China, Indonesia, or Vietnam, advertising is produced in the United States, and sales and service take place in practically all the coun- tries. Each value-creating activity is performed in the location where the cost is the lowest or the quality is the best. Without finding optimal locations for each activity, Nike could not have attained its position as the world’s largest shoe company.

The experience of the manufacturing sector was also repeated in the service sector by the mid-1990s. A trend that began with the outsourcing of low-level programming and data entry work to countries such as India and Ireland suddenly grew manyfold, encompassing a variety of white-collar and professional activities ranging from call centers to R&D.

Bangalore, India, in recent years, has emerged as a location where more and more U.S. tax returns are prepared. In India, U.S.-trained and licensed radiologists interpret chest x-rays and CT scans from U.S. hospitals for half the cost. The advantages from offshoring go beyond mere cost savings today. In many specialized occupations in science and engineer- ing, there is a shortage of qualified professionals in developed countries, whereas countries like India, China, and Singapore have what seems like an inexhaustible supply.42

While offshoring offers the potential to cut costs in corporations across a wide range of industries, many firms are finding the benefits of offshoring to be more elusive and the costs greater than they anticipated.43 A study by AMR Research found that 56 percent of companies moving production offshore experienced an increase in total costs, contrary to their expectations of cost savings. In a more focused study, 70 percent of managers said sourcing in China is more costly than they initially estimated.

The cause of this contrary outcome is actually not all that surprising. Common savings from offshoring, such as lower wages, benefits, energy costs, regulatory costs, and taxes, are all easily visible and immediate. In contrast, there are a host of hidden costs that arise over time and often overwhelm the cost savings of offshoring. These hidden costs include:

• Total wage costs. Labor cost per hour may be significantly lower in developing markets, but this may not translate into lower overall costs. If workers in these markets are less productive or less skilled, firms end up with a higher number of hours needed to produce the same quantity of product. This necessitates hiring more workers and having employees work longer hours.

outsourcing using other firms to perform value-creating activities that were previously performed in-house.

offshoring shifting a value-creating activity from a domestic location to a foreign location.

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• Indirect costs. In addition to higher labor costs, there are also a number of indirect costs that pop up. If there are problems with the skill level of workers, the firm will find the need for more training and supervision of workers, more raw material and greater scrap due to the lower skill level, and greater rework to fix quality problems. The firm may also experience greater need for security staff in its facilities.

• Increased inventory. Due to the longer delivery times, firms often need to tie up more capital in work in progress and inventory.

• Reduced market responsiveness. The long supply lines from low-cost countries may leave firms less responsive to shifts in customer demands. This may damage their brand image and also increase product obsolescence costs, as they may have to scrap or sell at a steep discount products that fail to meet quickly changing technology standards or customer tastes.

• Coordination costs. Coordinating product development and manufacturing can be difficult with operations undertaking different tasks in different countries. This may hamper innovation. It may also trigger unexpected costs, such as paying overtime in some markets so that staff across multiple time zones can meet to coordinate their activities.

• Intellectual property rights. Firms operating in countries with weak IP protection can wind up losing their trade secrets or taking costly measures to protect these secrets.

• Wage inflation. In moving overseas, firms often assume some level of wage stability, but wages in developing markets can be volatile and spike dramatically. For example, minimum wages set by provinces in China increased at an average of 18 percent per year in the 2010–2014 period.44 As Roger Meiners, chairman of the Department of Economics at the University of Texas at Arlington, stated, “The U.S. is more competitive on a wage basis because average wages have come down, especially for entry-level workers, and wages in China have been increasing.”

Firms need to take into account all of these costs in determining whether or not to move their operations offshore.

ACHIEVING COMPETITIVE ADVANTAGE IN GLOBAL MARKETS We now discuss the two opposing forces that firms face when they expand into global mar- kets: cost reduction and adaptation to local markets. Then we address the four basic types of international strategies that they may pursue: international, global, multidomestic, and transnational. The selection of one of these four types of strategies is largely dependent on a firm’s relative pressure to address each of the two forces.

Two Opposing Pressures: Reducing Costs and Adapting to Local Markets Many years ago, the famed marketing strategist Theodore Levitt advocated strategies that favored global products and brands. He suggested that firms should standardize all of their products and services for all of their worldwide markets. Such an approach would help a firm lower its overall costs by spreading its investments over as large a market as possible. Levitt’s approach rested on three key assumptions:

1. Customer needs and interests are becoming increasingly homogeneous worldwide. 2. People around the world are willing to sacrifice preferences in product features,

functions, design, and the like for lower prices at high quality. 3. Substantial economies of scale in production and marketing can be achieved through

supplying global markets.45

LO 7-4 The two opposing forces—cost reduction and adaptation to local markets—that firms face when entering international markets.

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However, there is ample evidence to refute these assumptions.46 Regarding the first assumption—the increasing worldwide homogeneity of customer needs and interests— consider the number of product markets, ranging from watches and handbags to soft drinks and fast foods. Companies have identified global customer segments and developed global products and brands targeted to those segments. Also, many other companies adapt lines to idiosyncratic country preferences and develop local brands targeted to local market segments. For example, Nestlé’s line of pizzas marketed in the United Kingdom includes cheese with ham and pineapple topping on a French bread crust. Similarly, Coca-Cola in Japan markets Georgia (a tonic drink) as well as Classic Coke and Hi-C.

Consider the second assumption—the sacrifice of product attributes for lower prices. While there is invariably a price-sensitive segment in many product markets, there is no indication that this is increasing. In contrast, in many product and service markets—ranging from watches, personal computers, and household appliances to banking and insurance— there is a growing interest in multiple product features, product quality, and service.

Finally, the third assumption is that significant economies of scale in production and marketing could be achieved for global products and services. Although standardization may lower manufacturing costs, such a perspective does not consider three critical and interrelated points. First, as we discussed in Chapter 5, technological developments in flex- ible factory automation enable economies of scale to be attained at lower levels of output and do not require production of a single standardized product. Second, the cost of produc- tion is only one component, and often not the critical one, in determining the total cost of a product. Third, a firm’s strategy should not be product-driven. It should also consider other activities in the firm’s value chain, such as marketing, sales, and distribution.

Based on the above, we would have a hard time arguing that it is wise to develop the same product or service for all markets throughout the world. While there are some exceptions, such as Boeing airplanes and some of Coca-Cola’s soft-drink products, managers must also strive to tailor their products to the culture of the country in which they are attempting to do business. Few would argue that “one size fits all” generally applies.

The opposing pressures that managers face place conflicting demands on firms as they strive to be competitive.47 On the one hand, competitive pressures require that firms do what they can to lower unit costs so that consumers will not perceive their product and service offerings as too expensive. This may lead them to consider locating manufacturing facilities where labor costs are low and developing products that are highly standardized across multiple countries.

In addition to responding to pressures to lower costs, managers must strive to be respon- sive to local pressures in order to tailor their products to the demand of the local market in which they do business. This requires differentiating their offerings and strategies from country to country to reflect consumer tastes and preferences and making changes to reflect differences in distribution channels, human resource practices, and governmental regulations. However, since the strategies and tactics to differentiate products and services to local markets can involve additional expenses, a firm’s costs will tend to rise.

The two opposing pressures result in four different basic strategies that companies can use to compete in the global marketplace: international, global, multidomestic, and trans- national. The strategy that a firm selects depends on the degree of pressure that it is facing for cost reductions and the importance of adapting to local markets. Exhibit 7.3 shows the conditions under which each of these strategies would be most appropriate.

It is important to note that we consider these four strategies to be “basic” or “pure”; that is, in practice, all firms will tend to have some elements of each strategy.

International Strategy There are a small number of industries in which pressures for both local adaptation and lowering costs are rather low. An extreme example of such an industry is the “orphan” drug industry. These are medicines for diseases that are severe but affect only a small

LO 7-5 The advantages and disadvantages associated with each of the four basic strategies: international, global, multidomestic, and transnational.

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number of people. Diseases such as Gaucher disease and Fabry disease fit into this cat- egory. Companies such as Genzyme and Oxford GlycoSciences are active in this segment of the drug industry. There is virtually no need to adapt their products to the local mar- kets. And the pressures to reduce costs are low; even though only a few thousand patients are affected, the revenues and margins are significant, because patients are charged up to $100,000 per year.

An international strategy is based on diffusion and adaptation of the parent company’s knowledge and expertise to foreign markets. Country units are allowed to make some minor adaptations to products and ideas coming from the head office, but they have far less independence and autonomy compared to multidomestic companies. The primary goal of the strategy is worldwide exploitation of the parent firm’s knowledge and capabilities. All sources of core competencies are centralized.

The majority of large U.S. multinationals pursued the international strategy in the decades following World War II. These companies centralized R&D and product develop- ment but established manufacturing facilities as well as marketing organizations abroad. Companies such as McDonald’s and Kellogg are examples of firms following such a strat- egy. Although these companies do make some local adaptations, they are of a very lim- ited nature. With increasing pressures to reduce costs due to global competition, especially from low-cost countries, opportunities to successfully employ an international strategy are becoming more limited. This strategy is most suitable in situations where a firm has distinc- tive competencies that local companies in foreign markets lack.

Risks and Challenges Below are some of the risks and challenges associated with an inter- national strategy.

• Different activities in the value chain typically have different optimal locations. That is, R&D may be optimally located in a country with an abundant supply of scientists and engineers, whereas assembly may be better conducted in a low- cost location. Nike, for example, designs its shoes in the United States, but all the manufacturing is done in countries like China or Thailand. The international

international strategy a strategy based on firms’ diffusion and adaptation of the parent companies’ knowledge and expertise to foreign markets; used in industries where the pressures for both local adaptation and lowering costs are low.

EXHIBIT 7.3 Opposing Pressures and Four Strategies

HighLow

High

Low

Pressures for Local Adaptation

Pr es

su re

s to

L ow

er C

os ts

Global strategy

International strategy

Transnational strategy

Multidomestic strategy

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strategy, with its tendency to concentrate most of its activities in one location, fails to take advantage of the benefits of an optimally distributed value chain.

• The lack of local responsiveness may result in the alienation of local customers. Worse still, the firm’s inability to be receptive to new ideas and innovation from its foreign subsidiaries may lead to missed opportunities.

Exhibit 7.4 summarizes the strengths and limitations of international strategies in the global marketplace.

Global Strategy As indicated in Exhibit 7.3, a firm whose emphasis is on lowering costs tends to follow a global strategy. Competitive strategy is centralized and controlled to a large extent by the corporate office. Since the primary emphasis is on controlling costs, the corporate office strives to achieve a strong level of coordination and integration across the various busi- nesses.48 Firms following a global strategy strive to offer standardized products and services as well as to locate manufacturing, R&D, and marketing activities in only a few locations.49

A global strategy emphasizes economies of scale due to the standardization of products and services and the centralization of operations in a few locations. As such, one advantage may be that innovations that come about through efforts of either a business unit or the corporate office can be transferred more easily to other locations. Although costs may be lower, the firm following a global strategy may, in general, have to forgo opportunities for revenue growth since it does not invest extensive resources in adapting product offerings from one market to another.

A global strategy is most appropriate when there are strong pressures for reducing costs and comparatively weak pressures for adaptation to local markets. Economies of scale become an important consideration.50 Advantages to increased volume may come from larger production plants or runs as well as from more efficient logistics and distribution net- works. Worldwide volume is also especially important in supporting high levels of investment in research and development. As we would expect, many industries requiring high levels of R&D, such as pharmaceuticals, semiconductors, and jet aircraft, follow global strategies.

Another advantage of a global strategy is that it can enable a firm to create a standard level of quality throughout the world. Let’s look at what Tom Siebel, former chairman of Siebel Systems (now part of Oracle), a developer of e-business application software, said about global standardization:

Our customers—global companies like IBM, Zurich Financial Services, and Citicorp—expect the same high level of service and quality, and the same licensing policies, no matter where we do business with them around the world. Our human resources and legal departments help us create policies that respect local cultures and requirements worldwide, while at the same time maintaining the highest standards.51

Risks and Challenges There are, of course, some risks associated with a global strategy:52

• A firm can enjoy scale economies only by concentrating scale-sensitive resources and activities in one or few locations. Such concentration, however, becomes a “double-edged sword.” For example, if a firm has only one manufacturing facility, it must export its output (e.g., components, subsystems, or finished products) to other

global strategy a strategy based on firms’ centralization and control by the corporate office, with the primary emphasis on controlling costs; used in industries where the pressure for local adaptation is low and the pressure for lowering costs is high.

Strengths Limitations

• Leverage and diffusion of a parent firm’s knowledge and core competencies.

• Lower costs because of less need to tailor products and services.

• Limited ability to adapt to local markets. • Inability to take advantage of new ideas and innovations

occurring in local markets.

EXHIBIT 7.4 Strengths and Limitations of International Strategies in the Global Marketplace

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markets, some of which may be a great distance from the operation. Thus, decisions about locating facilities must weigh the potential benefits from concentrating operations in a single location against the higher transportation and tariff costs that result from such concentration.

• The geographic concentration of any activity may also tend to isolate that activity from the targeted markets. Such isolation may be risky since it may hamper the facility’s ability to quickly respond to changes in market conditions and needs.

• Concentrating an activity in a single location also makes the rest of the firm dependent on that location. Such dependency implies that, unless the location has world-class competencies, the firm’s competitive position can be eroded if problems arise. A European Ford executive, reflecting on the firm’s concentration of activities during a global integration program in the mid-1990s, lamented, “Now if you misjudge the market, you are wrong in 15 countries rather than only one.”

Exhibit 7.5 summarizes the strengths and limitations of global strategies.

Multidomestic Strategy According to Exhibit 7.3, a firm whose emphasis is on differentiating its product and service offerings to adapt to local markets follows a multidomestic strategy.53 Decisions evolving from a multidomestic strategy tend to be decentralized to permit the firm to tailor its prod- ucts and respond rapidly to changes in demand. This enables a firm to expand its market and to charge different prices in different markets. For firms following this strategy, differ- ences in language, culture, income levels, customer preferences, and distribution systems are only a few of the many factors that must be considered. Even in the case of relatively standardized products, at least some level of local adaptation is often necessary.

Consider, for example, the Oreo cookie.54 Kraft has tailored the iconic cookie to better meet the tastes and preferences in different markets. For example, Kraft has created green tea Oreos in China, chocolate and peanut butter Oreos for Indonesia, and banana and dulce de leche Oreos for Argentina. Kraft has also lowered the sweetness of the cookie for China and reduced the bitterness of the cookie for India. The shape is also on the table for change. Kraft has even created wafer-stick-style Oreos.

Kraft has tailored other products to meet local market needs. For example, with its Tang drink product, it developed local flavors, such as a lime and cinnamon flavor for Mexico and mango Tang for the Philippines. It also looked to the nutritional needs in different countries. True to the heritage of the brand, Kraft has kept the theme that Tang is a good source of vitamin C. But in Brazil, where children often have iron deficiencies, it added iron as well as other vitamins and minerals. The local-focus strategy has worked well, with Tang’s sales almost doubling in five years.

To meet the needs of local markets, companies need to go beyond just product designs. One of the simple ways firms have worked to meet market needs is by finding appropriate names for their products. For example, in China, the names of products imbue them with strong meanings and can be significant drivers of their success. As a result, firms have been careful with how they translate their brands. For example, Reebok became Rui bu, which

multidomestic strategy a strategy based on firms’ differentiating their products and services to adapt to local markets; used in industries where the pressure for local adaptation is high and the pressure for lowering costs is low.

Strengths Limitations

• Strong integration occurs across various businesses. • Standardization leads to higher economies of scale,

which lower costs. • Creation of uniform standards of quality throughout the

world is facilitated.

• Limited ability exists to adapt to local markets. • Concentration of activities may increase dependence on a

single facility. • Single locations may lead to higher tariffs and

transportation costs.

EXHIBIT 7.5 Strengths and Limitations of Global Strategies

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7.4 STRATEGY SPOTLIGHT CHALLENGES INVOLVING CULTURAL DIFFERENCES THAT MANAGERS MAY ENCOUNTER WHEN NEGOTIATING CONTRACTS ACROSS NATIONAL BOUNDARIES When international companies cross borders, they often must deal with cultural differences. And culture has a strong influence on how one thinks, communicates, and acts. It also affects the types of transactions firms make as well as the negotiation pro- cess. Cultural differences, for example, between a Chinese pub- lic sector plant manager in Shanghai and the head of a Canadian division of a family company in Toronto can create barriers that may impede or completely disrupt the negotiating process.

Let’s look at an example that Erin Meyer provided in a recent Harvard Business Review article. An American working for a defense company located in the midwestern United States was well trained in basic negotiating techniques such as: Separate people from the process, focus on interests not positions, define your BATNA (best alternative to a negotiated agreement), and so on. He believed that his telephone call to Saudi Arabia was proceeding according to plan. After he had steered his would- be customer to accept the deal, he felt he had reached his goal. But then he made a fatal mistake: He then reviewed the agreement with the client in detail on who had agreed to what. Unfortunately, a soft but firm voice said, “I told you I would do it. You think I don’t keep my promises? That I am not good on my word?” Clearly, that was the end of the discussion—and the deal.

Research has shown that there are several elements of negotiating behavior that help to identify cultural differences that often arise during negotiations. The findings are based on a study of 400 people from twelve nationalities. An understanding of such differences can help managers understand their coun- terparts and anticipate possible misunderstandings. Three of these elements are summarized as follows.

First, negotiators from different cultures tend to view the purpose of the negotiation quite differently. Some look upon the goal as a signed contract, others view it as the development of a relationship. The survey found that 74 percent of Spanish respon- dents stated that their goal was a contract, while only 33 percent of Indian executives felt this way. Such a cultural difference may explain why Asian negotiators tend to give more time and effort to preliminaries, while North Americans typically want to rush through this first phase of deal making. Although the initial part of a negotiation can be critical in getting to know one another, it would seem less important if the goal is just to get a contract.

Second, based on cultural differences, some people appear to approach deal making with either a process in which both can gain (win-win) or a contest in which one side wins and the other side loses (win-lose). That is, the former sees it as a collabora- tive process and the other side sees it as confrontational. In the survey, 100 percent of the Japanese respondents stated that they viewed negotiations as a win-win process, whereas only 33 percent of the Spanish executives held that view.

Third, cultural factors can influence the sort of written agreement that is preferred. Americans prefer highly detailed contracts that serve to anticipate many possible circumstances that may arise, no matter how likely they may be. In contrast, Chinese respondents preferred a contract in the form of general principles instead of detailed rules because they believed that if unexpected circumstances arose, the parties should draw on the relationship, not the contract, to resolve differences. Among all the respondents in the survey, 78 percent preferred specific agreements, while only 22 percent desired general agreements. And as expected, there was considerable variation among respondents: While only 11 percent of the English respondents favored general agreements, 45.5 percent of the Japanese and the Germans claimed to do so.

As a cautionary note, one must recognize that cultural differ- ences often arise because when addressing cultural differences, managers frequently rely on stereotypes that can often be pejo- rative (for example, Portuguese are always running late). Such an attitude can distort expectations about one’s counterpart’s behavior as well as lead to costly misinterpretations.

Rather than rely on stereotypes, one should focus on prototypes—cultural averages on various dimensions of values and behaviors. For example, Japanese negotiators typically have more silent periods during negotiations compared to Brazilians. However, there remains a good deal of variation within each culture— meaning that some Brazilians speak less than some Japanese do. Therefore, it would be a mistake to expect a Japanese negotiator who you have never met to be reserved. However, if it turns out a negotiator is very quiet, you should consider her behavior in light of the prototype. Further, such awareness of your own cultural pro- totypes would aid you in anticipating how your counterpart would interpret your own bargaining behavior.

Sources: Shonk, K. 2016. How to resolve cultural conflict: Overcoming cultural barriers at the negotiation table. pon.harvard.edu, August 25: np; Meyer, E. 2015. Getting to Si, Ja, Hai, and Da. Harvard Business Review, 93(12): 74–80; Salacuse, J. W. 2004. Negotiating: The top ten ways that culture can affect your negotiation. iveybusinessjournal.com, October: np; and Livermore, D. 2015. 10 tips for managing across cultures. management-issues.com, May 11: np.

means “quick steps.” Lay’s snack foods became Le shi, which means “happy things.” And Coca-Cola’s Chinese name, Ke Kou Ke Le, translates to “tasty fun.”

When companies cross national borders, they typically encounter different cultures. Strategy Spotlight 7.4 addresses some of the challenges that managers may encounter when negotiating contracts and how they may be resolved—or, at least minimized.

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Risks and Challenges As you might expect, there are some risks associated with a multido- mestic strategy. Among these are the following:

• Typically, local adaptation of products and services will increase a company’s cost structure. In many industries, competition is so intense that most firms can ill afford any competitive disadvantages on the dimension of cost. A key challenge of managers is to determine the trade-off between local adaptation and its cost structure. For example, cost considerations led Procter & Gamble to standardize its diaper design across all European markets. This was done despite research data indicating that Italian mothers, unlike those in other countries, preferred diapers that covered the baby’s navel. Later, however, P&G recognized that this feature was critical to these mothers, so the company decided to incorporate this feature for the Italian market despite its adverse cost implications.

• At times, local adaptations, even when well intentioned, may backfire. When the American restaurant chain TGI Fridays entered the South Korean market, it purposely incorporated many local dishes, such as kimchi (hot, spicy cabbage), in its menu. This responsiveness, however, was not well received. Company analysis of the weak market acceptance indicated that Korean customers anticipated a visit to TGI Fridays as a visit to America. Thus, finding Korean dishes was inconsistent with their expectations.

• The optimal degree of local adaptation evolves over time. In many industry segments, a variety of factors, such as the inf luence of global media, greater international travel, and declining income disparities across countries, may lead to increasing global standardization. On the other hand, in other industry segments, especially where the product or service can be delivered over the Internet (such as music), the need for even greater customization and local adaptation may increase over time. Firms must recalibrate the need for local adaptation on an ongoing basis; excessive adaptation extracts a price as surely as underadaptation.

Exhibit 7.6 summarizes the strengths and limitations of multidomestic strategies.

Transnational Strategy A transnational strategy strives to optimize the trade-offs associated with efficiency, local adaptation, and learning.55 It seeks efficiency not for its own sake but as a means to achieve global competitiveness.56 It recognizes the importance of local responsiveness as a tool for flexibility in international operations.57 Innovations are regarded as an out- come of a larger process of organizational learning that includes the contributions of everyone in the firm.58 Also, a core tenet of the transnational model is that a firm’s assets and capabilities are dispersed according to the most beneficial location for each activity. Thus, managers avoid the tendency to either concentrate activities in a central location (a global strategy) or disperse them across many locations to enhance adaptation

transnational strategy a strategy based on firms’ optimizing the trade-offs associated with efficiency, local adaptation, and learning; used in industries where the pressures for both local adaptation and lowering costs are high.

Strengths Limitations

• Ability to adapt products and services to local market conditions. • Ability to detect potential opportunities for attractive niches in a

given market, enhancing revenue.

• Decreased ability to realize cost savings through scale economies. • Greater difficulty in transferring knowledge across countries. • Possibility of leading to “overadaptation” as conditions change.

EXHIBIT 7.6 Strengths and Limitations of Multidomestic Strategies

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(a multidomestic strategy). Peter Brabeck, former chairman of Nestlé, the giant food com- pany, provides such a perspective:

The closer we come to the consumer, in branding, pricing, communication, and product adaptation, the more we decentralize. The more we are dealing with production, logistics, and supply-chain management, the more centralized decision making becomes. After all, we want to leverage Nestlé’s size, not be hampered by it.59

The Nestlé example illustrates a common approach in determining whether or not to centralize or decentralize a value-chain activity. Typically, primary activities that are “down- stream” (e.g., marketing and sales, and service), or closer to the customer, tend to require more decentralization in order to adapt to local market conditions. On the other hand, pri- mary activities that are “upstream” (e.g., logistics and operations), or further away from the customer, tend to be centralized. This is because there is less need for adapting these activi- ties to local markets and the firm can benefit from economies of scale. Additionally, many support activities, such as information systems and procurement, tend to be centralized in order to increase the potential for economies of scale.

A central philosophy of the transnational organization is enhanced adaptation to all competitive situations as well as flexibility by capitalizing on communication and knowl- edge flows throughout the organization.60 A principal characteristic is the integration of unique contributions of all units into worldwide operations. Thus, a joint innovation by headquarters and by one of the overseas units can lead potentially to the development of relatively standardized and yet flexible products and services that are suitable for multiple markets. Strategy Spotlight 7.5 discusses how Panasonic benefited from moving from a global to a transnational strategy.

Risks and Challenges As with the other strategies, there are some unique risks and chal- lenges associated with a transnational strategy:

• The choice of a seemingly optimal location cannot guarantee that the quality and cost of factor inputs (i.e., labor, materials) will be optimal. Managers must ensure that the relative advantage of a location is actually realized, not squandered because of weaknesses in productivity and the quality of internal operations. Ford Motor Co., for example, has benefited from having some of its manufacturing operations in Mexico. While some have argued that the benefits of lower wage rates will be partly offset by lower productivity, this does not always have to be the case. Since unemployment in Mexico is higher than in the United States, Ford can be more selective in its hiring practices for its Mexican operations. And given the lower turnover among its Mexican employees, Ford can justify a high level of investment in training and development. Thus, the net result can be not only lower wage rates but also higher productivity than in the United States.

• Although knowledge transfer can be a key source of competitive advantage, it does not take place “automatically.” For knowledge transfer to take place from one subsidiary to another, it is important for the source of the knowledge, the target units, and the corporate headquarters to recognize the potential value of such unique know-how. Given that there can be significant geographic, linguistic, and cultural distances that typically separate subsidiaries, the potential for knowledge transfer can become very difficult to realize. Firms must create mechanisms to systematically and routinely uncover the opportunities for knowledge transfer.

Exhibit 7.7 summarizes the relative advantages and disadvantages of transnational strategies.

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7.5 STRATEGY SPOTLIGHT PANASONIC’S CHINA EXPERIENCE SHOWS THE BENEFITS OF BEING A TRANSNATIONAL Panasonic moved into China in the late 1980s, seeing it as a low-cost region in which to manufacture its products. Traditionally, Panasonic had used a global strategy in its opera- tions. It designed standardized products in Japan, manufac- tured them in low-cost markets, and sold its products primarily in developed markets. China simply served as a manufacturing location.

This worked well until the Chinese economy started to grow and mature. As the Chinese middle class began to emerge, local competitors, such as Haier, quickly jumped in with products designed for the Chinese market and outcompeted Panasonic in the growing market. This led Panasonic to radically change its way of competing in the global market.

Panasonic embraced the need to balance global inte- gration with local adaptation. It set up a Lifestyle Research Center in China. In this center, marketing and product devel- opment staff compiled and interpreted data on customer wants and needs. Their charge was to uncover hidden needs in the Chinese market and design products to meet those needs. At the same time, country managers emphasized the need for the center staff to design products that benefited from global integration. For example, staff members were told to regularly work with engineers in Japan to ensure that product designs used standard global parts in the Panasonic system and also leveraged technologies being developed in Japan. Over time, this built trust with the Japanese engineers, who began to discuss how to draw on their knowledge to help design products that could be sold in other markets. Thus, knowledge flowed in both directions: from Japan to China and from China to Japan and, by extension, the rest of the world. The system has worked so well in China that Panasonic has expanded its policies and built lifestyle research centers in Europe and India.

There are five key elements of Panasonic’s transnational ini- tiatives. Each allows Panasonic to manage the tension for global integration and local adaptation.

• Establish a dedicated unit. One organization should be devoted to embracing the tension. The aim of Panasonic’s China Lifestyle Research Center was to both understand Chinese consumers and draw on Panasonic Japan’s R&D capabilities.

• Create an on-the-ground mission. The unit’s mission should state explicitly how local adaptation and cross- border integration support company strategy. The lifestyle center’s mission was “data interpretation,” not just data collection, to ensure that insights led to viable product proposals that leveraged Panasonic’s technology assets.

• Develop core local staff. The unit should develop local staff who can engage in both localization and integration activities. At the lifestyle center, each staff member spent a year getting training and extensive coaching in fieldwork and proposal writing for products that leverage Panasonic’s technology to meet local needs.

• Extend the reach. The unit must constantly push to expand its influence. The lifestyle center’s leader ratcheted up communication and interaction between the center and engineers at Panasonic’s headquarters to broaden the organization’s scope and influence.

• Strengthen local authority. Sufficient authority should be given to overseas subsidiaries to enhance their autonomy while ensuring sound global integration. Seeing the early successes of the lifestyle center, Panasonic gave increasing authority to its Chinese operations for deeper local adaptation while also maintaining integrated working relationships between Japan and China.

Sources: Wakayama, T., Shintaku, J., & Amano, T. 2012. What Panasonic learned in China. Harvard Business Review, December: 109–113; and Osawa, J. 2012. Panasonic pins hopes on home appliances. wsj.com, March 25: np.

EXHIBIT 7.7 Strengths and Limitations of Transnational Strategies

Strengths Limitations

• Ability to attain economies of scale. • Ability to adapt to local markets. • Ability to locate activities in optimal locations. • Ability to increase knowledge flows and learning.

• Unique challenges in determining optimal locations of activities to ensure cost and quality.

• Unique managerial challenges in fostering knowledge transfer.

Global or Regional? A Second Look at Globalization Thus far, we have suggested four possible strategies from which a firm must choose once it has decided to compete in the global marketplace. In recent years, many writ- ers have asserted that the process of globalization has caused national borders to

LO 7-6 The difference between regional companies and truly global companies.

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become increasingly irrelevant.61 However, some scholars have questioned this per- spective, and they have argued that it is unwise for companies to rush into full-scale globalization.62

Before answering questions about the extent of firms’ globalization, let’s try to clarify what “globalization” means. Traditionally, a firm’s globalization is measured in terms of its foreign sales as a percentage of total sales. However, this measure can be misleading. For example, consider a U.S. firm that has expanded its activities into Canada. Clearly, this initiative is qualitatively different from achieving the same sales volume in a distant country such as China. Similarly, if a Malaysian firm expands into Singapore or a German firm starts selling its products in Austria, this would repre- sent an expansion into a geographically adjacent country. Such nearby countries would often share many common characteristics in terms of language, culture, infrastruc- ture, and customer preferences. In other words, this is more a case of regionalization than globalization.

Extensive analysis of the distribution data of sales across different countries and regions led Alan Rugman and Alain Verbeke to conclude that there is a stronger case to be made in favor of regionalization than globalization. According to their study, a company would have to have at least 20 percent of its sales in each of the three major economic regions—North America, Europe, and Asia—to be considered a global firm. However, they found that only 9 of the world’s 500 largest firms met this standard! Even when they relaxed the criterion to 20 percent of sales each in at least two of the three regions, the number only increased to 25. Thus, most companies are regional or, at best, biregional—not global—even today.

In a world of instant communication, rapid transportation, and governments that are increasingly willing to open up their markets to trade and investment, why are so few firms “global”? The most obvious answer is that distance still matters. After all, it is easier to do business in a neighboring country than in a faraway country, all else being equal. Distance, in the final analysis, may be viewed as a concept with many dimensions, not just a measure of geographic distance. For example, both Canada and Mexico are the same distance from the United States However, U.S. companies find it easier to expand operations into Canada than into Mexico. Why? Canada and the United States share many commonalities in terms of lan- guage, culture, economic development, legal and political systems, and infrastructure devel- opment. Thus, if we view distance as having many dimensions, the United States and Canada are very close, whereas there is greater distance between the United States and Mexico. Similarly, when we look at what we might call the “true” distance between the United States and China, the effects of geographic distance are multiplied by distance in terms of culture, language, religion, and legal and political systems between the two countries. On the other hand, although the United States and Australia are geographically distant, the “true” dis- tance is somewhat less when one considers distance along the other dimensions.

Another reason for regional expansion is the rise of trading blocs and free trade zones. A number of regional agreements have been created that facilitate the growth of busi- ness within these regions by easing trade restrictions and taxes and tariffs. These have included the European Union (EU), North American Free Trade Agreement (NAFTA), Association of Southeast Asian Nations (ASEAN), and MERCOSUR (a South American trading block).

Regional economic integration has progressed at a faster pace than global economic integration, and the trade and investment patterns of the largest companies reflect this reality. After all, regions represent the outcomes of centuries of political and cultural his- tory that results in not only commonalities but also mutual affinity. For example, stretch- ing from Algeria and Morocco in the West to Oman and Yemen in the East, more than 30 countries share the Arabic language and the Muslim religion, making these countries a natural regional bloc. Similarly, the countries of South and Central America share the

regionalization increasing international exchange of goods, services, money, people, ideas, and information; and the increasing similarity of culture, laws, rules, and norms within a region such as Europe, North America, or Asia.

trading blocs groups of countries agreeing to increase trade between them by lowering trade barriers.

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Spanish language (except Brazil), the Catholic religion, and a history of Spanish colonial- ism. No wonder firms find it easier and less risky to expand within their region than to other regions.

ENTRY MODES OF INTERNATIONAL EXPANSION A firm has many options available to it when it decides to expand into international mar- kets. Given the challenges associated with such entry, many firms first start on a small scale and then increase their level of investment and risk as they gain greater experience with the overseas market in question.63

Exhibit 7.8 illustrates a wide variety of modes of foreign entry, including exporting, licensing, franchising, joint ventures, strategic alliances, and wholly owned subsidiaries.64 As the exhibit indicates, the various types of entry form a continuum ranging from export- ing (low investment and risk, low control) to a wholly owned subsidiary (high investment and risk, high control).65

There can be frustrations and setbacks as a firm evolves its international entry strategy from exporting to more expensive types, including wholly owned subsidiaries. For example, according to the CEO of a large U.S. specialty chemical company:

In the end, we always do a better job with our own subsidiaries; sales improve, and we have greater control over the business. But we still need local distributors for entry, and we are still searching for strategies to get us through the transitions without battles over control and performance.66

Exporting Exporting consists of producing goods in one country to sell in another.67 This entry strat- egy enables a firm to invest the least amount of resources in terms of its product, its orga- nization, and its overall corporate strategy. Many host countries dislike this entry strategy because it provides less local employment than other modes of entry.68

Multinationals often stumble onto a stepwise strategy for penetrating markets, begin- ning with the exporting of products. This often results in a series of unplanned actions to

LO 7-7 The four basic types of entry strategies and the relative benefits and risks associated with each of them.

exporting producing goods in one country to sell to residents of another country.

EXHIBIT 7.8 Entry Modes for International Expansion

HighLow

High

Low

Degree of Ownership and Control

Ex te

nt o

f I nv

es tm

en t a

nd R

is k

Exporting

Licensing

Franchising

Strategic Alliance

Joint Venture

Wholly Owned Subsidiary

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increase sales revenues. As the pattern recurs with entries into subsequent markets, this approach, named a “beachhead strategy,” often becomes official policy.69

Benefits Such an approach definitely has its advantages. After all, firms start from scratch in sales and distribution when they enter new markets. Because many foreign markets are nationally regulated and dominated by networks of local intermediaries, firms need to part- ner with local distributors to benefit from their valuable expertise and knowledge of their own markets. Multinationals, after all, recognize that they cannot master local business practices, meet regulatory requirements, hire and manage local personnel, or gain access to potential customers without some form of local partnership.

Multinationals also want to minimize their own risk. They do this by hiring local dis- tributors and investing very little in the undertaking. In essence, the firm gives up control of strategic marketing decisions to the local partners—much more control than they would be willing to give up in their home market.

Risks and Limitations Exporting is a relatively inexpensive way to enter foreign mar- kets. However, it can still have significant downsides. Most centrally, the ability to tailor the firm’s products to meet local market needs is typically very limited. In a study of 250 instances in which multinational firms used local distributors to implement their exporting entry strategy, the results were dismal. In the vast majority of the cases, the distributors were bought (to increase control) by the multinational firm or were fired. In contrast, successful distributors shared two common characteristics:

• They carried product lines that complemented, rather than competed with, the multinational’s products.

• They behaved as if they were business partners with the multinationals. They shared market information with the corporations, they initiated projects with distributors in neighboring countries, and they suggested initiatives in their own or nearby markets. Additionally, these distributors took on risk themselves by investing in areas such as training, information systems, and advertising and promotion in order to increase the business of their multinational partners.

The key point is the importance of developing collaborative, win–win relationships. To ensure more control over operations without incurring significant risks, many firms

have used licensing and franchising as a mode of entry. Let’s now discuss these and their relative advantages and disadvantages.

Licensing and Franchising Licensing and franchising are both forms of contractual arrangements. Licensing enables a company to receive a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable item of intellectual property.70

Franchising contracts generally include a broader range of factors in an operation and have a longer time period during which the agreement is in effect. Franchising remains a primary form of American business. According to a survey, more than 400 U.S. franchisers have international exposure.71 This is greater than the combined totals of the next four larg- est franchiser home countries—France, the United Kingdom, Mexico, and Austria.

Benefits In international markets, an advantage of licensing is that the firm granting a license incurs little risk, since it does not have to invest any significant resources into the country itself. In turn, the licensee (the firm receiving the license) gains access to the trade- mark, patent, and so on, and is able to potentially create competitive advantages. In many cases, the country also benefits from the product being manufactured locally. For example,

licensing a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable intellectual property.

franchising a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its intellectual property; franchising usually involves a longer time period than licensing and includes other factors, such as monitoring of operations, training, and advertising.

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Yoplait yogurt is licensed by General Mills from Sodima, a French cooperative, for sale in the United States. The logos of college and professional athletic teams in the United States are another source of trademarks that generate significant royalty income domestically and internationally.

Franchising has the advantage of limiting the risk exposure that a firm has in overseas markets. At the same time, the firm is able to expand the revenue base of the company.

Risks and Limitations The licensor gives up control of its product and forgoes potential revenues and profits. Furthermore, the licensee may eventually become so familiar with the patent and trade secrets that it may become a competitor; that is, the licensee may make some modifications to the product and manufacture and sell it independently of the licen- sor without having to pay a royalty fee. This potential situation is aggravated in countries that have relatively weak laws to protect intellectual property. Additionally, if the licensee selected by the multinational firm turns out to be a poor choice, the brand name and reputa- tion of the product may be tarnished.72

With franchising, the multinational firm receives only a portion of the revenues, in the form of franchise fees. Had the firm set up the operation itself (e.g., a restaurant through direct investment), it would have had the entire revenue to itself.

Companies often desire a closer collaboration with other firms in order to increase rev- enue, reduce costs, and enhance their learning—often through the diffusion of technology. To achieve such objectives, they enter into strategic alliances or joint ventures, two entry modes we will discuss next.

Strategic Alliances and Joint Ventures Joint ventures and strategic alliances have recently become increasingly popular.73 These two forms of partnership differ in that joint ventures entail the creation of a third-party legal entity, whereas strategic alliances do not. In addition, strategic alliances generally focus on initiatives that are smaller in scope than joint ventures.74

Benefits As we discussed in Chapter 6, these strategies have been effective in helping firms increase revenues and reduce costs as well as enhance learning and diffuse technolo- gies.75 These partnerships enable firms to share the risks as well as the potential revenues and profits. Also, by gaining exposure to new sources of knowledge and technologies, such partnerships can help firms develop core competencies that can lead to competitive advan- tages in the marketplace.76 Finally, entering into partnerships with host-country firms can provide very useful information on local market tastes, competitive conditions, legal mat- ters, and cultural nuances.77

Risks and Limitations Managers must be aware of the risks associated with strategic alliances and joint ventures and how they can be minimized.78 First, there needs to be a clearly defined strategy that is strongly supported by the organizations that are party to the partnership. Otherwise, the firms may work at cross-purposes and not achieve any of their goals. Second, and closely allied to the first issue, there must be a clear understanding of capabilities and resources that will be central to the partnership. Without such clari- fication, there will be fewer opportunities for learning and developing competencies that could lead to competitive advantages. Third, trust is a vital element. Phasing in the relation- ship between alliance partners permits them to get to know each other better and develop trust. Without trust, one party may take advantage of the other by, for example, withholding its fair share of resources and gaining access to privileged information through unethical (or illegal) means. Fourth, cultural issues that can potentially lead to conflict and dysfunc- tional behaviors need to be addressed. An organization’s culture is the set of values, beliefs, and attitudes that influence the behavior and goals of its employees.79 Thus, recognizing

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cultural differences, as well as striving to develop elements of a “common culture” for the partnership, is vital. Without a unifying culture, it will become difficult to combine and leverage resources that are increasingly important in knowledge-intensive organizations (dis- cussed in Chapter 4).80

Finally, the success of a firm’s alliance should not be left to chance.81 To improve their odds of success, many companies have carefully documented alliance-management knowledge by creating guidelines and manuals to help them manage specific aspects of the entire alliance life cycle (e.g., partner selection and alliance negotiation and con- tracting). For example, Hewlett-Packard developed 60 different tools and templates, which it placed in a 300-page manual for guiding decision making. The manual included such tools as a template for making the business case for an alliance, a partner evalu- ation form, a negotiation template outlining the roles and responsibilities of different departments, a list of the ways to measure alliance performance, and an alliance termi- nation checklist.

When a firm desires the highest level of control, it develops wholly owned subsidiaries. Although wholly owned subsidiaries can generate the greatest returns, they also have the highest levels of investment and risk. We will now discuss them.

Wholly Owned Subsidiaries A wholly owned subsidiary is a business in which a multinational company owns 100 percent of the stock. Two ways a firm can establish a wholly owned subsidiary are to (1) acquire an existing company in the home country or (2) develop a totally new operation (often referred to as a “greenfield venture”).

Benefits Establishing a wholly owned subsidiary is the most expensive and risky of the various entry modes. However, it can also yield the highest returns. In addition, it provides the multinational company with the greatest degree of control of all activities, including manufacturing, marketing, distribution, and technology development.82

Wholly owned subsidiaries are most appropriate where a firm already has the appro- priate knowledge and capabilities that it can leverage rather easily through multiple loca- tions. Examples range from restaurants to semiconductor manufacturers. To lower costs, for example, Intel Corporation builds semiconductor plants throughout the world—all of which use virtually the same blueprint. Knowledge can be further leveraged by hiring managers and professionals from the firm’s home country, often through hiring talent from competitors.

Risks and Limitations As noted, wholly owned subsidiaries are typically the most expen- sive and risky entry mode. With franchising, joint ventures, or strategic alliances, the risk is shared with the firm’s partners. With wholly owned subsidiaries, the entire risk is assumed by the parent company. The risks associated with doing business in a new country (e.g., political, cultural, and legal) can be lessened by hiring local talent.

For example, Wendy’s avoided committing two blunders in Germany by hiring locals to its advertising staff.83 In one case, the firm wanted to promote its “old-fashioned” qualities. However, a literal translation would have resulted in the company promoting itself as “out- dated.” In another situation, Wendy’s wanted to emphasize that its hamburgers could be prepared 256 ways. The problem? The German word that Wendy’s wanted to use for “ways” usually meant “highways” or “roads.” Although such errors may sometimes be entertaining to the public, it is certainly preferable to catch these mistakes before they confuse the con- sumer or embarrass the company.

We have addressed entry strategies as a progression from exporting to the creation of wholly owned subsidiaries. However, we must point out that many firms do not follow such an evolutionary approach.

wholly owned subsidiary a business in which a multinational company owns 100 percent of the stock.

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ISSUE FOR DEBATE

The Ethicality of Tax Inversions In June 2014, Medtronic, a Minneapolis-based medical device manufacturer, announced that it would join the tax-inversion acquisition parade. A tax-inversion acquisition occurs when a corporation acquires a target firm based in a lower-tax country and, as part of the transaction, moves its legal headquarters to the target firm’s nation. After making this move, the combined corporation’s taxes are based on the lower rate of its new home country. This move is perfectly legal according to U.S. law as long as the target firm’s shareholders own at least 20 percent of the combined firm. About 50 U.S. corporations have undertaken tax inversions over the last 10 years, but the rate of occurrence appears to be increasing.

Medtronic acquired Covidien, an Irish-based medical equipment manufacturer, in January 2015 for $49.9 billion, and moved its legal home to Ireland. Not much else changed. Medtronic kept its corporate headquarters in Minneapolis. But Medtronic benefits from the move in two primary ways. First, while the tax rate on profits of U.S. corporations is 35 percent, the tax rate on Ireland-based corporate profits is only 12.5 percent. Additionally, the United States is one of only six developed economies that tax the global profits of corporations. If a multinational corporation makes profits in a foreign country, the firm pays taxes on those profits to the foreign government at the rate the foreign country charges. For corporations based in most countries, that is the end of their tax obligations. However, if a U.S.-based firm wants to bring those profits back to its home country either to invest in new facilities or to distribute dividends to its stockholders, it has to pay income tax on the profits earned in foreign markets. The rate the firm pays is the difference in the tax rate in the foreign country and the U.S. rate. For example, if Medtronic earned income in Ireland and then repatriated the profits to the United States, it would face a 22.5 percent additional tax rate, the difference between the U.S. and Irish corporate tax rates. Since Medtronic has accumulated $13 billion in earned profits abroad, it could face $3.5 billion to $4 billion in taxes if it brought those profits home. Thus, corporations, such as Medtronic, undertake tax inversions to save on taxes and, by extension, benefit their shareholders by being able to invest more in the firm to help it grow and/or return higher levels of dividends to shareholders.

Critics, however, point out that these firms are choosing not to pay taxes at the U.S. rates even though they have benefited and will continue to benefit from being American corporations. While inverters change their legal residence, they typically keep their corporate headquarters in the United States and stay listed on a U.S. stock exchange. As a result, they benefit from America’s deep financial markets, military might, intellectual property rights and other legal protections, intellectual and physical infrastructure, substantial human capital base, and national research programs. For example, Medtronic won $484 million in contracts with the U.S. government in recent years and plans to complete these contracts even though it will no longer be an American company; it hires students from top-notch American universities; and it files patents for all of its new technologies in the United States. Critics see the decision to move to a lower-tax country as unethical and unpatriotic. Jack Lew, the former U.S. Treasury secretary, echoed this perspective when he stated, “We should prevent companies from effectively renouncing their citizenship to get out of paying taxes. What we need is a new sense of economic patriotism, where we all rise and fall together.”

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Discussion Questions 1. Was Medtronic justified in moving its legal home to Ireland? 2. How should firms balance the desire to limit taxes to maximize cash generation with the

need to be a good corporate citizen? 3. How should the U.S. government respond to the increasing frequency of tax inversions?

Sources: Vivanco, F. 2015. Medtronic completes acquisition of Covidien. www.newsroom.medtronic.com, January 25: np; Sloan, A. 2014. Positively un-American. fortune.com, July 7: np; McKinnon, J. 2014. Obama administration urges immediate action on “inversion.” wsj. com, July 15: np; Sahadi, J. 2014. When U.S. companies dodge taxes, is it unpatriotic? finance.yahoo.com, July 23: np; Anonymous. 2014. Medtronic’s tax inversion lesson. wsj.com, August 13: np; and Gleckman, H. 2014. The tax-shopping backstory of the Medtronic- Covidien inversion. forbes.com, June 17: np.

Reflecting on Career Implications . . . This chapter discusses the challenges and opportunities of international markets. The following questions ask students to consider how the globalization of business can create both opportunities and risks for their careers.

International Strategy: Be aware of your organization’s international strategy. What percentage of the total firm activity is international? What skills are needed to enhance your company’s international efforts? How can you get more involved in your organization’s international strategy? For your career, what conditions in your home country might cause you to seek a career abroad?

Outsourcing and Offshoring: More and more organizations have resorted to outsourcing and offshoring in recent years. To what extent has your firm engaged in either? What activities in your organization can/should be outsourced or offshored? Be aware that you are competing in the global marketplace for employment and professional advancement. What is the likelihood that your own job may be outsourced or

offshored? In what ways can you enhance your talents, skills, and competencies to reduce the odds that your job may be offshored or outsourced?

International Career Opportunities: Taking on overseas assignments in other countries can often provide a career boost. There are a number of ways in which you can improve your odds of being selected for an overseas assignment. Studying abroad for a semester or doing an overseas internship are two obvious strategies. Learning a foreign language can also greatly help. Anticipate how such opportunities will advance your short- and long-term career aspirations.

Management Risks: Explore ways in which you can develop cultural sensitivity. Interacting with people from other cultures, foreign travel, reading about foreign countries, watching foreign movies, and similar activities can increase your cultural sensitivity. Identify ways in which your perceptions and behaviors have changed as a result of increased cultural sensitivity.

We live in a highly interconnected global community where many of the best opportunities for growth and profit- ability lie beyond the boundaries of a company’s home country. Along with the opportunities, of course, there are many

risks associated with diversification into global markets. The first section of the chapter addressed the factors

that determine a nation’s competitiveness in a particular industry. The framework was developed by Professor Michael Porter of Harvard University and was based on a four-year study that explored the competitive success of 10 leading trading nations. The four factors, collectively termed the “diamond of national advantage,” were factor endowments, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry.

The discussion of Porter’s “diamond” helped, in essence, to set the broader context for exploring competitive advantage at the firm level. In the second section, we discussed the primary motivations and the potential risks associated with international expansion. The primary motivations included increasing the size of the potential market for the firm’s products and services, achieving economies of scale, extending the life cycle of the firm’s products, and optimizing the location for every activity in the value chain. On the other hand, the key risks included political and economic risks, currency risks, and management risks. Management risks are the challenges associated with responding to the inevitable differences that exist across countries such as customs, culture, language, customer preferences, and distribution systems. We also addressed some of the managerial challenges and opportunities associated with offshoring and outsourcing.

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EXPERIENTIAL EXERCISE The United States is considered a world leader in the motion picture industry. Using Porter’s diamond framework for national competitiveness, explain the success of this industry. (Fill in the chart on page 233.)

Next, we addressed how firms can go about attaining competitive advantage in global markets. We began by discussing the two opposing forces—cost reduction and adaptation to local markets—that managers must contend with when entering global markets. The relative importance of these two factors plays a major part in determining which of the four basic types of strategies to select: international, global, multidomestic, or transnational. The chapter covered the benefits and risks associated with each type of strategy.

The final section discussed the four types of entry strategies that managers may undertake when entering international markets. The key trade-off in each of these strategies is the level of investment or risk versus the level of control. In order of their progressively greater investment/ risk and control, the strategies range from exporting to licensing and franchising, to strategic alliances and joint ventures, to wholly owned subsidiaries. The relative benefits and risks associated with each of these strategies were addressed.

SUMMARY REVIEW QUESTIONS 1. What are some of the advantages and disadvantages

associated with a firm’s expansion into international markets?

2. What are the four factors described in Porter’s diamond of national advantage? How do the four factors explain why some industries in a given country are more successful than others?

3. Explain the two opposing forces—cost reduction and adaptation to local markets—that firms must deal with when they go global.

4. There are four basic strategies—international, global, multidomestic, and transnational. What are the advantages and disadvantages associated with each?

5. What is the basis of Alan Rugman’s argument that most multinationals are still more regional than global? What factors inhibit firms from becoming truly global?

6. Describe the basic entry strategies that firms have available when they enter international markets. What are the relative advantages and disadvantages of each?

globalization 204 diamond of national advantage 205

factor endowments (national advantage) 205 demand conditions (national advantage) 205 related and supporting industries (national advantage) 206

key terms

firm strategy, structure, and rivalry (national advantage) 206 multinational firms 208 arbitrage opportunities 208 reverse innovation 210 political risk 211 rule of law 211 economic risk 212 counterfeiting 212 currency risk 212 management risk 213

outsourcing 215 offshoring 215 international strategy 218 global strategy 219 multidomestic strategy 220 transnational strategy 222 regionalization 225 trading blocs 225 exporting 226 licensing 227 franchising 227 wholly owned subsidiary 229

APPLICATION QUESTIONS & EXERCISES 1. Data on the “competitiveness of nations” can be

found at www.imd.org/research/publications/wcy/ index.cfm. This website provides a ranking on 4 main factors and 20 subfactors for 61 countries. How might Porter’s diamond of national advantage help to explain the rankings for some of these countries for certain industries that interest you?

2. The Internet has lowered the entry barriers for smaller firms that wish to diversify into international markets. Why is this so? Provide an example.

3. Many firms fail when they enter into strategic alliances with firms that link up with companies based in other countries. What are some reasons for this failure? Provide an example.

4. Many large U.S.-based management consulting companies such as McKinsey and Company and the BCG Group have been very successful in the international marketplace. How can Porter’s diamond explain their success?

ETHICS QUESTIONS 1. Over the past few decades, many American firms

have relocated most or all of their operations from the United States to countries such as Mexico and China that pay lower wages. What are some of the ethical issues that such actions may raise?

2. Business practices and customs vary throughout the world. What are some of the ethical issues concerning payments that must be made in a foreign country to obtain business opportunities?

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Domestic rivalry 1.

2.

3.

Related and supporting industries

1.

2.

3.

Factor conditions 1.

2.

3.

Demand conditions 1.

2.

3.

1. For a discussion on globalization by one of international business’s most respected authors, read Ohmae, K. 2005. The next global stage: Challenges and opportunities in our borderless world. Philadelphia: Wharton School.

2. Our discussion of globalization draws upon Engardio, P. & Belton, C. 2000. Global capitalism: Can it be made to work better? BusinessWeek, November 6: 72–98.

3. Sellers, P. 2005. Blowing in the wind. Fortune, July 25: 63.

4. Rivera, J. 2014. Gartner says sales of smartphones grew 20 percent in third quarter of 2014. gartner.com, December 15: np.

5. Anonymous. 2016. Why giants thrive. The Economist. September 17: 5–7.

6. Some insights into how winners are evolving in emerging markets are addressed in Ghemawat, P. & Hout, T. 2008. Tomorrow’s global giants: Not the usual suspects. Harvard Business Review, 66(11): 80–88.

7. For another interesting discussion on a country perspective, refer to Makino, S. 1999. MITI Minister

Kaora Yosano on reviving Japan’s competitive advantages. Academy of Management Executive, 13(4): 8–28.

8. The following discussion draws heavily upon Porter, M. E. 1990. The competitive advantage of nations. Harvard Business Review, March–April: 73–93.

9. Landes, D. S. 1998. The wealth and poverty of nations. New York: W. W. Norton.

10. A study that investigates the relationship between international diversification and firm performance is Lu, J. W. & Beamish, P. W. 2004. International diversification and firm performance: The s-curve hypothesis. Academy of Management Journal, 47(4): 598–609.

11. Part of our discussion of the motivations and risks of international expansion draws upon Gregg, F. M. 1999. International strategy. In Helms, M. M. (Ed.), Encyclopedia of management: 434–438. Detroit: Gale Group.

12. Anthony, S. 2012. Singapore sessions. Harvard Business Review, 90(4): np.

13. Eyring, M. J., Johnson, M. W., & Nair, H. 2011. New business models in

emerging markets. Harvard Business Review, 89 (1/2): 88–98.

14. Cieply, M. & Barnes, B. 2010. After rants, skepticism over Gibson bankability grows in non-U.S. markets. International Herald Tribune, July 23: 1.

15. Glazer, E. 2012. P&G unit bids goodbye to Cincinnati, hello to Asia. wsj.com, May 10: np.

16. This discussion draws upon Gupta, A. K. & Govindarajan, V. 2001. Converting global presence into global competitive advantage. Academy of Management Executive, 15(2): 45–56.

17. Stross, R. E. 1997. Mr. Gates builds his brain trust. Fortune, December 8: 84–98.

18. Anonymous. 2016. Why giants thrive. The Economist. September 17: 5–7.

19. For a good summary of the benefits and risks of international expansion, refer to Bartlett, C. A. & Ghoshal, S. 1987. Managing across borders: New strategic responses. Sloan Management Review, 28(5): 45–53; and Brown, R. H. 1994. Competing to win in a global economy. Washington, DC: U.S. Department of Commerce.

REFERENCES

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20. Capron, L. & Bertrand, O. 2014. Going abroad in search of higher productivity at home. Harvard Business Review, 92(6): 26.

21. For an interesting insight into rivalry in global markets, refer to MacMillan, I. C., van Putten, A. B., & McGrath, R. G. 2003. Global gamesmanship. Harvard Business Review, 81(5): 62–73.

22. It is important for firms to spread their foreign operations and outsourcing relationships with a broad, well-balanced mix of regions and countries to reduce risk and increase potential reward. For example, refer to Vestring, T., Rouse, T., & Reinert, U. 2005. Hedge your offshoring bets. MIT Sloan Management Review, 46(3): 27–29.

23. An interesting discussion of risks faced by Lukoil, Russia’s largest oil firm, is in Gimbel, B. 2009. Russia’s king of crude. Fortune, February 2: 88–92.

24. For a discussion of some of the challenges associated with government corruption regarding entry strategies in foreign markets, read Rodriguez, P., Uhlenbruck, K., & Eden, L. 2005. Government corruption and entry strategies of multinationals. Academy of Management Review, 30(2): 383–396.

25. For a discussion of the political risks in China for United States companies, refer to Garten, J. E. 1998. Opening the doors for business in China. Harvard Business Review, 76(3): 167–175.

26. Insights on how forensic economics can be used to investigate crimes and wrongdoing are in Fisman, R. 2009. The rise of forensic economics. Harvard Business Review, 87(2): 26.

27. Iosebashvili, I. 2012. Renault-Nissan buy into Russia’s aged auto giant. wsj. com, May 3: np.

28. Ferguson, N. 2013. Is the business of America still business? Harvard Business Review, 91(6): 40.

29. For an interesting perspective on the relationship between diversification and the development of a nation’s institutional environment, read Chakrabarti, A., Singh, K., & Mahmood, I. 2007. Diversification and performance: Evidence from East Asian firms. Strategic Management Journal, 28(2): 101–120.

30. A study looking into corruption and foreign direct investment is Brouthers, L. E., Gao, Y., & McNicol, J. P. 2008. Strategic Management Journal, 29(6): 673–680.

31. Gikkas, N. S. 1996. International licensing of intellectual property:

The promise and the peril. Journal of Technology Law & Policy, 1(1): 1–26.

32. Hargreaves, S. 2012. Counterfeit goods becoming more dangerous. cnnmoney.com, September 27: np.

33. Sandler, N. 2008. Israel: Attack of the super-shekel. BusinessWeek, Februrary 25: 38.

34. For an excellent theoretical discussion of how cultural factors can affect knowledge transfer across national boundaries, refer to Bhagat, R. S., Kedia, B. L., Harveston, P. D., & Triandis, H. C. 2002. Cultural variations in the cross-border transfer of organizational knowledge: An integrative framework. Academy of Management Review, 27(2): 204–221.

35. An interesting discussion on how local companies compete effectively with large multinationals is in Bhatacharya, A. K. & Michael, D. C. 2008. Harvard Business Review, 66(3): 84–95.

36. To gain insights on the role of national and regional cultures on knowledge management models and frameworks, read Pauleen, D. J. & Murphy, P. 2005. In praise of cultural bias. MIT Sloan Management Review, 46(2): 21–22.

37. Berkowitz, E. N. 2000. Marketing (6th ed.). New York: McGraw-Hill.

38. World Trade Organization. Annual Report 1998. Geneva: World Trade Organization.

39. Lei, D. 2005. Outsourcing. In Hitt, M. A. & Ireland, R. D. (Eds.), The Blackwell encyclopedia of management, Entrepreneurship: 196–199. Malden, MA: Blackwell.

40. Future trends in offshoring are addressed in Manning, S., Massini, S., & Lewin, A. Y. 2008. A dynamic perspective on next-generation offshoring: The global sourcing of science and engineering talent. Academy of Management Perspectives, 22(3): 35–54.

41. An interesting perspective on the controversial issue regarding the offshoring of airplane maintenance is in Smith, G. & Bachman, J. 2008. Flying in for a tune-up overseas. BusinessWeek, April 21: 26–27.

42. The discussion draws from Colvin, J. 2004. Think your job can’t be sent to India? Just watch. Fortune, December 13: 80; Schwartz, N. D. 2004. Down and out in white collar America. Fortune, June 23: 321–325; and Hagel, J. 2004. Outsourcing is not just about cost cutting. The Wall Street Journal, March 18: A3.

43. Porter, M. & Rivkin, J. 2012 Choosing the United States. Harvard Business Review, 90(3): 80–93;

Bussey, J. 2012. U.S. manufacturing, defying naysayers. wsj.com, April 19: np; and Jean, S. & Alcott, K. 2013. Manufacturing jobs have slid steadily as work has moved offshore. Dallas Morning News, January 14: 1D.

44. Wong, C. 2014. As China’s economy slows, so too does growth in workers’ wages. blogs.wsj.com, December 17: np.

45. Levitt, T. 1983. The globalization of markets. Harvard Business Review, 61(3): 92–102.

46. Our discussion of these assumptions draws upon Douglas, S. P. & Wind, Y. 1987. The myth of globalization. Columbia Journal of World Business, Winter: 19–29.

47. Ghoshal, S. 1987. Global strategy: An organizing framework. Strategic Management Journal, 8: 425–440.

48. For insights on global branding, refer to Aaker, D. A. & Joachimsthaler, E. 1999. The lure of global branding. Harvard Business Review, 77(6): 137–146.

49. Dawar, N. & Frost, T. 1999. Competing with Giants: Survival Strategies for Local Companies in Emerging Markets. Harvard Business Review , 77(3): 119–129.

50. Hout, T., Porter, M. E., & Rudden, E. 1982. How global companies win out. Harvard Business Review, 60(5): 98–107.

51. Fryer, B. 2001. Tom Siebel of Siebel Systems: High tech the old-fashioned way. Harvard Business Review, 79(3): 118–130.

52. The risks that are discussed for the global, multidomestic, and transnational strategies draw upon Gupta & Govindarajan, op. cit.

53. A discussion on how McDonald’s adapts its products to overseas markets is in Gumbel, P. 2008. Big Mac’s local flavor. Fortune, May 5: 115–121.

54. Einhorn, B. & Winter, C. 2012. Want some milk with your green tea Oreos? Bloomberg Businessweek, May 7: 25–26; Khosla, S. & Sawhney, M. 2012. Blank checks: Unleashing the potential of people and business. Strategy-Business.com, Autumn: np; and In China, brands more than symbolic. 2012. Dallas Morning News, November 27: 3D.

55. Prahalad, C. K. & Doz, Y. L. 1987. The multinational mission: Balancing local demands and global vision. New York: Free Press.

56. For an insightful discussion on knowledge flows in multinational corporations, refer to Yang, Q., Mudambi, R., & Meyer, K. E. 2008.

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Conventional and reverse knowledge flows in multinational corporations. Journal of Management, 34(5): 882–902.

57. Kidd, J. B. & Teramoto, Y. 1995. The learning organization: The case of Japanese RHQs in Europe. Management International Review, 35 (Special Issue): 39–56.

58. Gupta, A. K. & Govindarajan, V. 2000. Knowledge flows within multinational corporations. Strategic Management Journal, 21(4): 473–496.

59. Wetlaufer, S. 2001. The business case against revolution: An interview with Nestle´’s Peter Brabeck. HarvardBusiness Review, 79(2): 112–121.

60. Nobel, R. & Birkinshaw, J. 1998. Innovation in multinational corporations: Control and communication patterns in international R&D operations. Strategic Management Journal, 19(5): 461–478.

61. Chan, C. M., Makino, S., & Isobe, T. 2010. Does subnational region matter? Foreign affiliate performance in the United States and China. Strategic Management Journal, 31(11): 1226–1243.

62. his section draws upon Ghemawat, P. 2005. Regional strategies for global leadership. Harvard Business Review, 84(12): 98–108; Ghemawat, P. 2006. Apocalypse now? Harvard Business Review, 84(12): 32; Ghemawat, P. 2001. Distance still matters: The hard reality of global expansion. Harvard Business Review, 79(8): 137–147; Peng, M. W. 2006. Global strategy: 387. Mason, OH: Thomson South-Western; and Rugman, A. M. & Verbeke, A. 2004. A perspective on regional and global strategies of multinational enterprises. Journal of International Business Studies, 35: 3–18.

63. For a rigorous analysis of performance implications of entry strategies, refer to Zahra, S. A., Ireland, R. D., & Hitt, M. A. 2000. International expansion by new venture firms: International diversity, modes of entry, technological learning, and performance. Academy

of Management Journal, 43(6): 925–950.

64. Li, J. T. 1995. Foreign entry and survival: The effects of strategic choices on performance in international markets. Strategic Management Journal, 16: 333–351.

65. For a discussion of how home- country environments can affect diversification strategies, refer to Wan, W. P. & Hoskisson, R. E. 2003. Home country environments, corporate diversification strategies, and firm performance. Academy of Management Journal, 46(1): 27–45.

66. Arnold, D. 2000. Seven rules of international distribution. Harvard Business Review, 78(6): 131–137.

67. Sharma, A. 1998. Mode of entry and ex-post performance. Strategic Management Journal, 19(9): 879–900.

68. This section draws upon Arnold, op. cit., pp. 131–137; and Berkowitz, op. cit.

69. Salomon, R. & Jin, B. 2010. Do leading or lagging firms learn more from exporting? Strategic Management Journal, 31(6): 1088–1113.

70. Kline, D. 2003. Strategic licensing. MIT Sloan Management Review, 44(3): 89–93.

71. Martin, J. 1999. Franchising in the Middle East. Management Review, June: 38–42.

72. Arnold, op. cit.; and Berkowitz, op. cit.

73. An in-depth case study of alliance dynamics is found in Faems, D., Janssens, M., Madhok, A., & Van Looy, B. 2008. Toward an integrative perspective on alliance governance: Connecting contract design, trust dynamics, and contract application. Academy of Management Journal, 51(6): 1053–1078.

74. Knowledge transfer in international joint ventures is addressed in Inkpen, A. 2008. Knowledge transfer and international joint ventures. Strategic Management Journal, 29(4): 447–453.

75. Wen, S. H. & Chuang, C.-M. 2010. To teach or to compete? A strategic dilemma of knowledge owners in

international alliances. Asia Pacific Journal of Management, 27(4): 697–726.

76. Manufacturer–supplier relationships can be very effective in global industries such as automobile manufacturing. Refer to Kotabe, M., Martin, X., & Domoto, H. 2003. Gaining from vertical partnerships: Knowledge transfer, relationship duration, and supplier performance improvement in the U.S. and Japanese automotive industries. Strategic Management Journal, 24(4): 293–316.

77. For a good discussion, refer to Merchant, H. & Schendel, D. 2000. How do international joint ventures create shareholder value? Strategic Management Journal, 21(7): 723–738.

78. This discussion draws upon Walters, B. A., Peters, S., & Dess, G. G. 1994. Strategic alliances and joint ventures: Making them work. Business Horizons, 37(4): 5–11.

79. Some insights on partnering in the global area are discussed in MacCormack, A. & Forbath, T. 2008. Harvard Business Review, 66(1): 24, 26.

80. For a rigorous discussion of the importance of information access in international joint ventures, refer to Reuer, J. J. & Koza, M. P. 2000. Asymmetric information and joint venture performance: Theory and evidence for domestic and international joint ventures. Strategic Management Journal, 21(1): 81–88.

81. Dyer, J. H., Kale, P., & Singh, H. 2001. How to make strategic alliances work. MIT Sloan Management Review, 42(4): 37–43.

82. For a discussion of some of the challenges in managing subsidiaries, refer to O’Donnell, S. W. 2000. Managing foreign subsidiaries: Agents of headquarters, or an independent network? Strategic Management Journal, 21(5): 525–548.

83. Ricks, D. 2006. Blunders in international business (4th ed.). Malden, MA: Blackwell.

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chapter

After reading this chapter, you should have a good understanding of the following learning objectives:

8 LO 8-1 The role of opportunities, resources, and entrepreneurs in successfully

pursuing new ventures.

LO 8-2 Three types of entry strategies—pioneering, imitative, and adaptive— commonly used to launch a new venture.

LO 8-3 How the generic strategies of overall cost leadership, differentiation, and focus are used by new ventures and small businesses.

LO 8-4 How competitive actions, such as the entry of new competitors into a marketplace, may launch a cycle of actions and reactions among close competitors.

LO 8-5 The components of competitive dynamics analysis—new competitive action, threat analysis, motivation and capability to respond, types of competitive actions, and likelihood of competitive reaction.

Entrepreneurial Strategy and Competitive Dynamics

©Anatoli Styf/Shutterstock

PART 2: STRATEGIC FORMULATION

The disappearing photo app, Snapchat, experienced a meteoric rise. Started by a set of Stanford undergraduate students in 2011, the app had a user base in excess of 150 million and had reached 10 billion daily video views by 2016. As the app grew in popularity, CEO Evan Spiegel and CTO Bobby Murphy found themselves in a long-term battle with Reggie Brown, a Kappa Sigma fraternity brother of theirs who claimed he was the original creator of Snapchat. According to Brown, he shared his idea for an app that would allow users to share photos that would quickly self-destruct with Spiegel. They then recruited Murphy to do computer programming for the app. That first app, Picaboo, evolved into the widely used Snapchat. While the app became a success, the collaboration did not. Spiegel apparently decided that Brown wasn’t adding much to the team. He and Murphy locked Brown out of the company’s system and disavowed any claims that Brown was one of the firm’s founders or had any ownership rights to the company. In 2013, Brown sued, leading to an eventual confidential settlement in 2014. By that time, the overall firm was valued at about $20 billion. While the financial details of the settlement were never made public, Spiegel publicly admitted that Brown was central to the creation of the app, saying, “We acknowledge Reggie’s contribution to the creation of Snapchat and appreciate his work in getting the application off the ground.”

The Snapchat experience is not at all uncommon. Facebook, Twitter, Tinder, Beats Electronics, and others faced internal drama about who was responsible for the firms’ start and who should reap the substantial financial rewards of their success. Why is this so common? Entrepreneurial teams are often composed of friends and family, leading the participants to expect that they can trust their partners and have no need for a written contract or statement of ownership. Luan Tran, the attorney for Brown, put it this way, “You don’t think not to trust people you know a lot, and you don’t think they are going to screw you. It’s good to trust, but it’s much better to memorialize your trust in a document.” Amir Hassanabadi, another attorney who regularly works with start-up firms, recommends the following for founders on day one of their venture, “Go out to dinner. Settle who’s who and what’s what. Then put it in writing.”1

Discussion Questions 1. Why do you think that so many start-up firms have these disputes? 2. Why do founders often fail to work up formal written contracts about ownership and credit? 3. Would you feel comfortable having that conversation early on with a partner in a new busi-

ness? How would you initiate that conversation?

LEARNING FROM MISTAKES

The Snapchat case illustrates how important it is for start-up firms to formalize the roles of founders and set up formal contracts that lay out responsibilities and ownership rights if they want to avoid later drama.

In this chapter we address entrepreneurial strategies. The previous three chapters have focused primarily on the business-level, corporate-level, and international strategies of incumbent firms. Here we ask: What about the strategies of those entering into a market or industry for the first time? In this chapter, we focus on strategic entrepreneurship—the actions firms take to create new ventures in markets. In Chapter 12, we focus on a related

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issue—how established firms can build or reinforce an entrepreneurial mindset as they strive to be innovative in markets in which the firm already competes.

Companies wishing to launch new ventures must also be aware that, consistent with the five-forces model in Chapter 2, new entrants are a threat to existing firms in an industry. Entry into a new market arena is intensely competitive from the perspective of incumbents in that arena. Therefore, new entrants can nearly always expect a competitive response from other companies in the industry they are entering. Knowledge of the competitive dynamics that are at work in the business environment is an aspect of entrepreneurial new entry that will be addressed later in this chapter.

Before moving on, it is important to highlight the role that entrepreneurial start-ups and small businesses play in entrepreneurial value creation. Small businesses, those defined as having 500 employees or fewer, create about 65 percent of all new jobs in the United States and also generate 13 times as many new patents per employee as larger firms.2

RECOGNIZING ENTREPRENEURIAL OPPORTUNITIES Defined broadly, entrepreneurship refers to new value creation. Even though entrepreneurial activity is usually associated with start-up companies, new value can be created in many dif- ferent contexts, including:

• Start-up ventures • Major corporations • Family-owned businesses • Nonprofit organizations • Established institutions

For an entrepreneurial venture to create new value, three factors must be present—an entrepreneurial opportunity, the resources to pursue the opportunity, and an entrepreneur or entrepreneurial team willing and able to undertake the opportunity.3 The entrepreneurial strategy that an organization uses will depend on these three factors. Thus, beyond merely identifying a venture concept, the opportunity recognition process also involves organizing the key people and resources that are needed to go forward. Exhibit 8.1 depicts the three fac- tors that are needed to successfully proceed—opportunity, resources, and entrepreneur(s). In the sections that follow, we address each of these factors.

LO 8-1 The role of opportunities, resources, and entrepreneurs in successfully pursuing new ventures.

entrepreneurship the creation of new value by an existing organization or new venture that involves the assumption of risk.

EXHIBIT 8.1 Opportunity Analysis Framework

Resources Entrepreneur(s)

Opportunity

Sources: Based on Timmons, J. A. & Spinelli, S. 2004. New Venture Creation (6th ed.). New York: McGraw-Hill/ Irwin; and Bygrave, W. D. 1997. The Entrepreneurial Process. In W. D. Bygrave (Ed.), The Portable MBA in Entrepreneurship (2nd ed.). New York: Wiley.

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CHAPTER 8 :: ENTREPRENEURIAL STRATEGY AND COMPETITIVE DYNAMICS 239

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Entrepreneurial Opportunities The starting point for any new venture is the presence of an entrepreneurial opportunity. Where do opportunities come from? For new business start-ups, opportunities come from many sources—current or past work experiences, hobbies that grow into businesses or lead to inventions, suggestions by friends or family, or a chance event that makes an entrepreneur aware of an unmet need. Terry Tietzen, founder and CEO of Edatanetworks, puts it this way, “You get ideas through watching the world and through relationships. You get ideas from looking down the road.”4 For established firms, new business opportunities come from the needs of existing customers, suggestions by suppliers, or technological developments that lead to new advances.5 For all firms, there is a major, overarching factor behind all viable opportunities that emerge in the business landscape: change. Change creates opportunities. Entrepreneurial firms make the most of changes brought about by new technology, sociocul- tural trends, and shifts in consumer demand.

How do changes in the external environment lead to new business creation? They spark creative new ideas and innovation. Businesspeople often have ideas for entrepreneurial ven- tures. However, not all such ideas are good ideas—that is, viable business opportunities. To determine which ideas are strong enough to become new ventures, entrepreneurs must go through a process of identifying, selecting, and developing potential opportunities. This is the process of opportunity recognition.6

Opportunity recognition refers to more than just the “Eureka!” feeling that people sometimes experience at the moment they identify a new idea. Although such insights are often very important, the opportunity recognition process involves two phases of activity— discovery and evaluation—that lead to viable new venture opportunities.7

The discovery phase refers to the process of becoming aware of a new business concept.8 Many entrepreneurs report that their idea for a new venture occurred to them in an instant, as a sort of “Aha!” experience—that is, they had some insight or epiphany, often based on their prior knowledge, that gave them an idea for a new business. The discovery of new opportunities is often spontaneous and unexpected. For example, Howard Schultz, CEO of Starbucks, was in Milan, Italy, when he suddenly realized that the coffee-and-conversation cafe model that was common in Europe would work in the United States as well. According to Schultz, he didn’t need to do research to find out if Americans would pay $3 for a cup of coffee—he just knew. Starbucks was just a small business at the time but Schultz began literally shaking with excitement about grow- ing it into a bigger business.9 Strategy Spotlight 8.1 tells how two brothers took the realization that many people wanted to wear their optimism and turned it into a growing business empire.

Opportunity discovery also may occur as the result of a deliberate search for new ven- ture opportunities or creative solutions to business problems. Viable opportunities often emerge only after a concerted effort. The search process is very similar to a creative process, which may be unstructured and “chaotic” at first but eventually leads to a practical solution or business innovation. To stimulate the discovery of new opportunities, companies often encourage creativity, out-of-the-box thinking, and brainstorming. While a deliberate search can aim to identify truly novel and creative entrepreneurial opportunities, it can also be more focused to look for “obvious” opportunities that others have failed to see. Experienced entrepreneurs discussing ways to look for new entrepreneurial opportunities identify several ways to undertake a structured search for entrepreneurial ideas:10

• Look at what’s bugging you. What are the frustrations you have with current products or processes? Search for ideas on how to address these annoyances to identify entrepreneurial opportunities. For example, Jeannine Fradelizio noticed that at parties she hosted, guests would set down their wine glasses and forget which one was their glass. This would lead them to either abandon that glass and get another or end up drinking from someone else’s glass which would sometimes lead to a minor dispute. In an effort to avoid these mix-ups Fradelizio tried having her friends write their names

opportunity recognition the process of discovering and evaluating changes in the business environment, such as a new technology, sociocultural trends, or shifts in consumer demand, that can be exploited.

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